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2019-10-22 20:28:41

Quick Take

Velocity Financial (VEL) has filed to raise gross proceeds of $100 million from a U.S. IPO, according to an S-1 registration statement.

The firm provides commercial real estate financing solutions for investor-centric loan requirements.

VEL has been performing well but is subject to the real estate cycle as well as looming net interest margin compression as U.S. interest rates weaken.

I’ll provide a final opinion when we learn more IPO details from management.

Company & Technology

Westlake Village, California-based Velocity Financial, known as Velocity Capital Management, was founded in 2004 to originate and manage investor loans secured by ‘1-4 unit residential rental’ and small commercial properties, which management refers to as ‘investor real estate loans’.

Management is headed by co-founder, CEO and Director Christopher D. Farrar, who was previously COO at Worth Funding.

Velocity’s portfolio was valued at $1.7 billion, representing total unpaid balance of all loans, including loans held for sale and investment, as of the end of June, 2019.

Below is a brief overview video of the company’s marketing campaign:

Source: Velocity Mortgage Capital

The company’s mortgage plans include a long-term ‘FlexPerm Loan’ for investors with possible term of up to 30 years, the ‘ARV Pro Loan’ for those in need of a short-term 'fix-and-flip' solution, the ‘Credit QuickFix Loan’ that represents a loan with higher Loan-to-Value [LTV] ratio as compared to hard money lenders, the ‘Fast50 Loan’ which represents a low LTV rate loan with easy credit requirements, as well as the Foreign Investor Loan for foreign investors that seek to invest in US properties. Source: Company website

Below is an overview graphic of the company’s composition of loans held for investment as of June 30, 2019:

(*) Percentages may not sum to 100% due to rounding.

(1) Portfolio stratifications based on unpaid principal balance for loans held for investment as of June 30, 2019.

(2) Represents LTV at origination for population of loans held for investment as of June 30, 2019. In instances where LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at time of acquisition.

(3) The approximately 1% portion of our loans held for investment with an LTV greater than 75% consists primarily of acquired loans.

Source: Company registration statement

Management intends to capture additional, incremental loan volume from its existing finance broker network as well as expand the network with additional mortgage brokers.

The network currently stands at 2,900 strong. For the first six months of 2019, VEL sourced 1,301 loans via 690 mortgage brokers, which is still a small number compared to the more than 590,000 state-licensed universe of mortgage brokers in the U.S.

Management also says it will look to ‘opportunistically acquire’ loan portfolios that meet its criteria.

Market & Competition

According to a 2019 market research report by UrbanLand, debt funds and nonbank lenders accounted for about 11% of the US commercial and multifamily real estate loans industry in 2018, a year-over-year increase of 7%.

Banks held the largest share of the US real estate market, accounting for about 40% market share in 2018, followed by government-sponsored enterprises at 22%, commercial mortgage–backed securities at 16%, and life insurance companies at 10%, as can be seen in the graphic below:

Source: Real Capital Analytics

Mortgage originations reached a record level of $549 billion in 2018, an increase of 39% as compared to originations in 2008, as displayed in the graphic below:

Source: Real Capital Analytics

Velocity competes with specialty finance companies, regional and community banks and thrifts, public and private entities, institutional investors, mortgage bankers, insurance companies, investment banking firms, as well as other financial institutions.

Major competitors that provide alternative financing solutions include:

HFF

CBRE Capital Markets (CBRE)

KeyBank (KEY)

Eastdil Secured (WFC)

JPMorgan Chase (JPM)

Meridian Capital Group

BofA Securities (BAC)

Source: Sentieo

Financial Performance

VEL’s recent financial results can be summarized as follows:

Strong topline revenue growth

Growing net interest income after provision for losses, though at a decelerating rate

Fluctuating net interest margins

Reduced and very low charge-offs to average loans

Highly variable cash flow from operations

Below are relevant financial metrics derived from the firm’s registration statement:

Total Interest Income

Period

Total Interest Income

% Variance vs. Prior

Six Mos. Ended June 30, 2019

$ 73,028,000

23.9%

2018

$ 124,722,000

27.5%

2017

$ 97,830,000

Net Interest Income After Provision For Loan Losses

Period

Net Interest Income After Provision For Loan Losses

% Variance vs. Prior

Six Mos. Ended June 30, 2019

$ 26,375,000

9.1%

2018

$ 48,602,000

34.6%

2017

$ 36,117,000

Portfolio Related Net Interest Margin

Period

Portfolio Related Net Interest Margin

Six Mos. Ended June 30, 2019

4.05%

2018

4.34%

2017

4.30%

Charge-offs To Average Loans

Period

Charge-offs To Average Loans

Six Mos. Ended June 30, 2019

0.01%

2018

0.03%

2017

0.09%

Cash Flow From Operations

Period

Cash Flow From Operations

Six Mos. Ended June 30, 2019

$ 9,205,000

2018

$ (72,485,000)

2017

$ 38,644,000

Source: Company registration statement

As of June 30, 2019, the company had $15.6 million in cash and $127.1 million in total liabilities. (Unaudited, interim)

Free cash flow during the twelve months ended June 30, 2019, was a negative ($27.3 million).

IPO Details

VEL has filed to raise $100 million in gross proceeds from an IPO of its common stock, though this figure is used to estimate filing fees and may differ in the final transaction.

Per the firm’s latest filing, the firm plans to use the net proceeds from the IPO as follows:

to repay a portion of our outstanding corporate debt and the remainder for general corporate purposes, including originating or acquiring investor real estate loans.

Management’s presentation of the company roadshow is not available yet.

Listed underwriters of the IPO are Wells Fargo Securities, Citigroup, JMP Securities, and Raymond James.

Commentary

Velocity is attempting to go public at a challenging time for non-life science IPOs.

Overall stock market volatility combined with the postponement of several IPOs has contributed to a negative sentiment in the IPO market for the near-term.

The firm’s financials show strong total revenue growth but uneven net interest margin which may be feeling the effects of a lower-trending interest rate environment.

At least charge-offs are rock bottom, so management appears to be executing on a solid underwriting process even as the firm grows, a good sign.

The market opportunity for investor-centric real estate loans is currently excellent. However, should the economy enter a recession, this market will likely dry up, forcing lenders like VEL to scramble for other sources of loans or face a reduction in revenue and net results.

VEL is operating in a very cyclical industry and its results are highly influenced by macroeconomic factors beyond its control.

Should the U.S. interest rate environment continue to weaken, the resulting net interest margin compression may negatively impact its profits.

When we learn more IPO details from management, I’ll provide an update.

Expected IPO Pricing Date: To be announced.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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