Velocity Financial is a vertically integrated niche real estate finance company specializing in investor loans secured by 1-4 unit residential rental and small commercial properties. Despite a challenging market environment, Velocity Financial’s strong fundamentals and strategic positioning offer a compelling investment opportunity.
The company’s robust growth trajectory, coupled with its effective business model and competitive advantages, make it an attractive option for investors seeking exposure to the real estate finance sector.
Business Profile
Velocity Financial operates through a nationwide network of approximately 2,000 independent mortgage brokers, which serves as a cornerstone of its competitive advantage. This extensive network has been cultivated over the company’s 20-year history, allowing it to effectively originate and manage a diverse portfolio of loans.
The company’s primary revenue streams include net interest income (NIM), gains on loan sales, upfront loan origination fees, unrealized gains/losses on fair value loans, and other income from loan servicing fees and real estate-owned properties.
The company’s business model involves acquiring loans through its mortgage broker network and financing these new loan originations using warehouse facilities. Once a critical mass of loans is achieved, Velocity Financial securitizes them through a real estate mortgage investment conduit (REMIC) structure and issues bonds to third parties.
This process has been successfully executed 31 times, issuing $6.4 billion in principal amount of securities as of December 31, 2023.
Growth Drivers
Velocity Financial’s growth is driven by several factors, including deeper penetration of its existing mortgage broker network, expansion of this network, development of new products, and strategic acquisitions of loan portfolios and businesses.
In Q1, the company experienced nearly 75% growth in origination volumes, indicating robust demand and effective execution of its growth strategy.
Loan Production
The company’s loan production has shown significant growth, with a nearly 75% increase in Q1. This growth is partially attributed to the struggles of traditional banks, which have been hindered by losses in their bond and commercial real estate portfolios. Despite Q1 typically being a slower period, Velocity Financial achieved a sequential growth rate of 7.5%.
Funding Strategies
Velocity Financial employs three main funding strategies:
- Warehouse Facilities: A short-term solution with higher costs.
- Securitization: Packaging loans into securities at regular intervals, approximately four times a year.
- Corporate Debt: Regular issuance of debt to fund operations.
In Q1, the company placed $75 million in new corporate debt (a 5-year senior note at 9.875%) and executed two securitizations totaling $505 million.
Securitization Process
Securitization allows Velocity Financial to access term financing at fixed interest rates through the bond market. The company retains the credit risk from these securitizations on its balance sheet, aligning its interests with investors and ensuring the production of high-quality loans.
Net Interest Margin (NIM)
The NIM, which is the difference between interest income from the loan portfolio and interest expenses on securitizations and debt, has been expanding. This growth in NIM, combined with operational leverage, has driven a rise in earnings.
Non-Performing Loans (NPLs)
While the NPL rate is 10.1%, Velocity Financial has a strong track record of resolving these with gains over their carrying value. Over 95% of non-performing loans are resolved without reaching foreclosure, mitigating the perceived risk.
Financial Performance
Velocity Financial has demonstrated strong financial performance with consistent revenue growth exceeding 50% in the past five quarters. The company’s earnings have also shown a notable rise, supported by a healthy balance sheet and positive cash flow.
Outlook and Risks
Key business drivers for Velocity Financial include property values, interest rates, and the securitization market. The potential for declining interest rates could benefit the company by reducing funding costs and increasing demand for loans.
However, risks include potential declines in property values and changes in the securitization market.
Valuation
The shares trade around 10x earnings, slightly above 3x sales, and 1.3x book value, which are modest given the company’s significant earnings growth. The current valuation metrics suggest that Velocity Financial is an attractive buy at its current price of $18.
Conclusion
Velocity Financial’s strategic positioning, robust growth trajectory, and effective business model make it an attractive investment opportunity. The company’s ability to navigate a challenging market environment and capitalize on growth opportunities positions it well for future success.
Given the modest valuation metrics, Velocity Financial seems to be an attractive buy at the current price.
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