# Velocity Financial, Inc. (VEL) FY 2022 MD&A Verbatim Item 7 Management's Discussion and Analysis from Velocity Financial, Inc.'s 10-K for fiscal year 2022. SEC filing source: https://www.sec.gov/Archives/edgar/data/1692376/000095017023007616/vel-20221231.htm Accession: 0000950170-23-007616 Filing date: 2023-03-13 Report date: 2022-12-31 Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary. Confidence: high Company profile: /company/VEL/ All MD&A years: /company/VEL/mda/ Previous year: /company/VEL/mda/fy2021/ (FY 2021) Next year: /company/VEL/mda/fy2023/ (FY 2023) Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read together with “Item 6. Selected Financial Data” and the consolidated financial statements and related notes and the other financial information included elsewhere in this Annual Report. This discussion contains forward-looking statements, as described above under the heading “Forward-Looking Statements” that involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report. Business We are a vertically integrated real estate finance company founded in 2004. We primarily originate and manage investor loans secured by 1-4 unit residential rental and commercial properties, which we refer to collectively as investor real estate loans. Our primary source of revenue is interest income earned on our loan portfolio. Our typical loan is secured by a first lien on the underlying property with a personal guarantee and, based on all loans in our portfolio as of December 31, 2022, has an average balance of approximately $395,000. As of December 31, 2022, our loan portfolio totaled $3.5 billion of UPB on properties in 45 states and the District of Columbia. The total portfolio had a weighted average loan-to-value ratio, or LTV at origination, of 68.2%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 52.7% of the UPB. During the year ended December 31, 2022, the yield on our total portfolio was 7.77%. We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed 25 securitizations, issuing $5.4 billion in principal amount of securities from May 2011 through December 2022. One of our core profitably measurements is our portfolio related net interest margin, which measures the difference between interest income earned on our loan portfolio and interest expense paid on our portfolio-related debt, relative to the amount of loans outstanding over the period. Our portfolio-related debt consists of our warehouse facilities and securitizations and excludes our corporate debt. For the year ended December 31, 2022, our portfolio related net interest margin was 3.64%. We generate profits to the extent that our portfolio related net interest income exceeds our interest expense on corporate debt, provision for loan losses and operating expenses. For the year ended December 31, 2022, including net income attributable to noncontrolling interest, we generated income before income taxes and net income of $44.6 million and $32.5 million, respectively, and earned a pre-tax return on equity and return on equity of 12.2% and 8.9%, respectively. Items Affecting Comparability of Results Due to a number of factors, our historical financial results may not be comparable, either from period to period, or to our financial results in future periods. We have summarized the key factors affecting the comparability of our financial results below. Income Taxes Our REMIC transactions can create significant U.S. GAAP versus tax differences. The U.S. GAAP treatment considers each REMIC as a variable interest entity that is required to be consolidated in our financial statements, accounting for the securitization as a secured borrowing. Under IRS rules, the REMICs require sale treatment and we are required to either recognize taxable income or loss to the extent the fair market value of the REMICs is greater than or less than our cost basis, the payment of which creates either a deferred tax asset or deferred tax liability. We will continue to recognize deferred tax assets and liabilities for future tax consequences attributable to differences between the financial statement carrying amounts of our existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using the tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statements of operations in the period that included the enactment date, as applicable. 12 Interest Expense on Corporate Debt The 2021 Term Loan was a five-year $175.0 million syndicated corporate debt agreement. We incurred $20.6 million of interest expense related to our corporate debt during the year ended December 31, 2021. In March 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement (“the 2022 Term Loan”). A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes. We incurred $29.5 million of interest expense related to our corporate debt during the year ended December 31, 2022. Fair Value Option Accounting We have made an election to apply the fair value option ("FVO") accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. The fair value option loans will be presented on a separate line item in the consolidated balance sheet. We will not record a CECL loan loss reserve on fair value option loans. We utilize a third-party model to estimate the fair value of the FVO loan portfolio in accordance with ASC 820. We use a discounted cash flow methodology, that forecasts contractual cash flows, adjusting for projected prepayments and defaults, followed by discounting these cash flows back to a present value, using a reasonable discount rate. Recent Developments Securitizations In January 2023, we completed the securitization of $240.3 million of investor real estate loans, measured by UPB. Continued Market Uncertainties Our operational and financial performance will depend on certain market developments, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, a global recession, heightened stress in the commercial real estate and corporate debt markets, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance. Critical Accounting Estimates and Significant Accounting Policies Our consolidated financial statements are prepared in accordance with generally accepted accounting principles (“GAAP”) in the United States and follow general practices within the financial services industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. The most significant accounting policies we follow are summarized in “Note 2 — Basis of Presentation and Summary of Significant Accounting Policies.” Management considers an accounting estimate to be critical to reported financial results if (1) the accounting estimates require management to make assumptions about matters that are highly uncertain, and (2) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on our consolidated financial statements, results of operations, or liquidity. Our critical accounting estimates are summarized below. 13 Allowance for Loan Losses For our loans held for investment where we have not elected fair value option ("FVO") accounting, we calculate an allowance for loan losses. Under the current expected credit loss ("CECL") methodology, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. We identified the following portfolio segments based on risk characteristics of the loans in its loan portfolio (pool): • Residential 1– 4 Unit – Purchase (loans to purchase 1– 4 unit residential rental properties); • Residential 1– 4 Unit – Refinance (refinance loans on 1– 4 unit residential rental properties); • Commercial – Purchase (loans to purchase traditional commercial properties); • Commercial – Refinance (refinance loans on traditional commercial properties); • Short Term 1– 4 Unit – Purchase (short-term loans to purchase 1– 4 unit residential rental properties); and • Short Term 1– 4 Unit – Refinance (short-term refinance loans on 1– 4 unit residential rental properties). We determined the collectability of our loans by evaluating certain risk characteristics. The segmentation of our loan portfolio was determined based on analyses of our loan portfolio performance over the past nine years. Based on analyses of the loan portfolio’s historical performance, we concluded that loan purpose and product types are the most significant risk factors in determining our expectation of future loan losses. Loan purpose considers whether a borrower is acquiring the property or refinancing an existing property. Our historical experience shows that refinance loans have higher loss rates than loans for property acquisitions. Product type includes residential 1-4 unit property and traditional commercial property. Our historical experience shows that traditional commercial property loans have higher loss rates than residential 1-4 unit property. Short Term loans have a maturity of one to two years from origination. Long term loans have a maturity of up to 30 years from origination. We estimate the allowance for loan losses using relevant available information, from internal and external sources, relating to historical performance, current conditions, and reasonable and supportable macroeconomic forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as differences in underwriting standards, portfolio mix, delinquency levels, or term, as well as for changes in environmental conditions, such as unemployment rates, property values and changes in the competitive or regulatory environment. 14 We use an open pool loss rate methodology to model expected credit losses. To determine the loss rates using the open pool method, we start with our historical database of losses, segmenting the loans by loan purpose, product type and repayment period. A third-party model applying the open pool method is used to estimate an annual average loss rate by dividing the respective pool's quarterly historical losses by the pool's respective prior quarters’ ending unamortized loan cost balance and deriving an annual average loss rate from the historical quarterly loss rates. The model then adjusts the annual average loss rates based upon macroeconomic forecasts over a reasonable and supportable period, followed by a straight-line reversion to the historical loss rates. The adjusted annual average loss rates are applied to the forecasted pool balance within each segment. The forecasted balances in the loan pool segments are calculated based on a principal amortization using contractual maturity, factoring in further principal reductions from estimated prepayments. Estimated prepayments, or Constant Prepayment Rates ("CPRs") are developed from multiple loan characteristic considerations, such as property types, FICO scores, loan purpose, and prepayment penalty terms, which is the most significant driver of prepayment activity. The prepayment penalty terms differ between the short-term and long-term loans, and we have developed a CPR curve for our short-term loans (2-year or less) and one for our long-term loans (30-year). Data from 2012-2022 is used to develop prepayment rates for our long-term loans. Because of the prepayment penalty structure in our long-term loans, prepayments during the active penalty term are historically low and begin to ramp up after the prepayment penalty term. The active prepayment penalty term is considered for existing and new loans over the reasonable and supportable forecast period in determining estimated prepayments. We back-test the CPR curves on a quarterly basis and adjust the CPR curves as appropriate. The reasonable and supportable period is meant to represent the period in which we believe the forecasted macroeconomic variables can be reasonably estimated. Significant variables or assumptions incorporated in the macroeconomic forecasts include U.S. unemployment, treasury yields, U.S. real gross domestic product (GDP), and U.S. real estate housing prices. We consider multiple scenarios from different macroeconomic forecasts and use different forecast and revision periods for estimating lifetime expected credit losses. We have determined that once a loan becomes nonperforming (90 or more days past due), it no longer shares the same risk characteristics of the other loans within its segment of homogeneous loans (pool). We pull these loans out of the segments and evaluate the loans individually using the practical expedient to determine the credit exposure. Nonperforming loans are considered collateral dependent. Using the practical expedient, the fair value of the underlying collateral, less estimated selling costs, is compared to the carrying value of the loan in the determination of a credit loss. The allowance for loan losses is a valuation account that is deducted from the loans’ amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when we believe the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. The allowance for loan losses is maintained at a level deemed adequate by management to provide for expected losses in the portfolio at the balance sheet date. While we use available information to estimate our required allowance for loan losses, future additions to the allowance for loan losses may be necessary based on changes in estimates resulting from economic and other conditions. We made the accounting policy election not to measure an allowance for loan losses for accrued interest receivables. When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction of interest income and accrued interest receivable. Accrued interest receivable is excluded from the amortized cost of loans and it is presented as accrued interest receivable in the Consolidated Balance Sheets. Fair Value Option Accounting We have made an election to apply the fair value option accounting to all our originated mortgage loans on a go-forward basis beginning October 1, 2022. We will consider applying FVO accounting to acquired loans on a case-by-case basis. The fair value option loans will be presented on a separate line item in the consolidated balance sheet. We will not record a CECL loan loss reserve on fair value option loans. We utilize a third-party model to estimate the fair value of the FVO loan portfolio in accordance with ASC 820. We use a discounted cash flow methodology, that forecasts contractual cash flows, adjusting for projected prepayments and defaults, followed by discounting these cash flows back to a present value, using a reasonable discount rate. 15 Deferred Tax Assets and Liabilities Our deferred tax assets and liabilities arise from differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We determine whether a deferred tax asset is realizable based on facts and circumstances, including our current and projected future tax position, the historical level of our taxable income, and estimates of our future taxable income. In most cases, the realization of deferred tax assets is based on our future profitability. If we were to experience either reduced profitability or operating losses in a future period, the realization of our deferred tax assets may no longer be considered more likely than not and, accordingly, we could be required to record a valuation allowance on our deferred tax assets by charging earnings. How We Assess Our Business Performance Net income is the primary metric by which we assess our business performance. Accordingly, we closely monitor the primary drivers of net income which consist of the following: Net Interest Income Net interest income is the largest contributor to our net income and is monitored on both an absolute basis and relative to provisions for loan losses and operating expenses. We generate net interest income to the extent that the rate at which we lend in our portfolio exceeds the cost of financing our portfolio, which we primarily achieve through long-term securitizations. Accordingly, we closely monitor the financing markets and maintain consistent dialogue with investors and financial institutions as we evaluate our financing sources and cost of funds. To evaluate net interest income, we measure and monitor: (1) the yields on our loans, (2) the costs of our funding sources, (3) our net interest spread and (4) our net interest margin. Net interest spread measures the difference between the rates earned on our loans and the rates paid on our funding sources. Net interest margin measures the difference between our annualized interest income and annualized interest expense, or net interest income, as a percentage of average loans outstanding over the specified time period. Periodic changes in net interest income are primarily driven by: (1) origination volume and changes in average outstanding loan balances and (2) interest rates and changes in interest earned on our portfolio or paid on our debt. Historically, origination volume and portfolio size have been the largest contributors to the growth in our net interest income. We measure net interest income before and after interest expense related to our corporate debt and before and after our provisions for loan losses. Credit Losses We strive to minimize actual credit losses through our rigorous screening and underwriting process and life of loan portfolio management and special servicing practices. We closely monitor the credit performance of our loan portfolio, including delinquency rates and expected and actual credit losses, as a key factor in assessing our overall business performance. Operating Expenses We incur operating expenses from compensation and benefits related to our employee base, rent and other occupancy costs associated with our leased facilities, our third-party primary loan servicing vendors, professional fees to the extent we utilize third-party legal, consulting and advisory firms, and costs associated with the resolution and disposition of real estate owned, among other items. We monitor and strive to prudently manage operating expenses and to balance current period profitability with investment in the continued development of our platform. Because volume and portfolio size determine the magnitude of the impact of each of the above factors on our earnings, we also closely monitor origination volume along with all key terms of new loan originations, such as interest rates, loan-to-value ratios, estimated credit losses and expected duration. Factors Affecting Our Results of Operations We believe there are a number of factors that impact our business, including those discussed below and elsewhere in this Annual Report. 16 Our results of operations depend on, among other things, the level of our net interest income, the credit performance of our loan portfolio and the efficiency of our operating platform. These measures are affected by a number of factors, including the demand for investor real estate loans, the competitiveness of the market for originating or acquiring investor real estate loans, the cost of financing our portfolio, operating costs, the availability of funding sources and the underlying performance of the collateral supporting our loans. While we have been successful at managing these elements in the past, there are certain circumstances beyond our control, including any lingering impact of the COVID-19 pandemic, the Russia/Ukraine war, an expected recession, and macroeconomic conditions and market fundamentals, which can all affect each of these factors and potentially impact our business performance. Origination Volume Portfolio related net interest income is the largest contributor to our net income. We grew our portfolio related net interest income by $16.0 million or 16.7% from $96.6 million for the year ended December 31, 2021 to $112.6 million for the year ended December 31, 2022. The growth in net interest income is largely attributable to new loan originations which we have achieved by executing our principal strategies of expanding our broker network and further penetrating our network of existing brokers. We anticipate that our future performance will continue to depend on growing our origination/acquisition volume and believe that the large and highly fragmented nature of our core market provides meaningful opportunity to achieve this. We intend to grow our portfolio by continuing to serve and build loyalty within our existing network of brokers while expanding our network with new brokers through targeted marketing and improved brand awareness. Our future performance could be impacted to the extent that our origination volumes decline as we rely on new loans to offset maturities and prepayments in our existing portfolio. To augment our core origination business, we continually assess opportunities to acquire portfolios of loans that meet our investment criteria. In our experience, portfolio acquisition opportunities have generally been more attractive and plentiful during market conditions when origination opportunities are less favorable. Accordingly, we believe our acquisition strategy not only expands our core business, but also provides a counter-cyclical benefit. Competition The investor real estate loan market is highly competitive which could affect our profitability and growth. We believe we compete favorably through diversified borrower access driven by our extensive network of mortgage brokers and by emphasizing a high level of real estate and financial expertise, customer service, and flexibility in structuring transactions, as well as by attracting and retaining experienced managerial and marketing personnel. However, some of our competitors may be better positioned to market their services and financing programs because of their ability to offer more favorable rates and terms and other services. Availability and Cost of Funding Our primary funding sources have historically included cash from operations, warehouse facilities, term securitizations, corporate debt and equity. We believe we have an established brand in the term securitization market and that this market will continue to support our portfolio growth with long-term financing. Changes in macroeconomic conditions can adversely impact our ability to issue securitizations and, thereby, limit our options for long-term financing. In consideration of this potential risk, we have entered into a credit facility for longer-term financing that will provide us with capital resources to fund loan growth in the event we are not able to issue securitizations. 17 Two of our seven warehouse repurchase and revolving loan facilities have interest payment obligations tied to the one-month USD London Interbank Offered Rate, or LIBOR. Five of our warehouse repurchase and revolving loan facilities have interest payment obligations tied to the Secured Overnight Offering Rate ("SOFR"). The authorized administrator of LIBOR confirmed during March 2021 that it intended to cease the publication or loss of representativeness of LIBOR. In particular, the last date of publication or representativeness of one-month USD LIBOR will be June 30, 2023. We expect that the index used in the calculation of the interest rate for our warehouse facilities and corporate debt will transition from LIBOR to a Secured Overnight Financing Rate (“SOFR”) or a suitable replacement index prior to June 30, 2023. As we renew our financing agreements with our warehouse facilities, we are working with our warehouse facilities to include language on the transition to SOFR. We do not expect the cessation of LIBOR nor the transition to a replacement index to have a material adverse effect on our cost of funding, results of operations or financial condition. Loan Performance We underwrite and structure our loans to minimize potential losses. We believe our fully amortizing loan structures and avoidance of large balloon payments, coupled with meaningful borrower equity in properties, limit the probability of losses and that our proven in-house asset management capability allows us to minimize potential losses in situations where there is insufficient equity in the property. Our income is highly dependent upon borrowers making their payments and resolving delinquent loans as favorably as possible. Macroeconomic conditions can, however, impact credit trends in our core market and have an adverse impact on financial results. Macroeconomic Conditions The investor real estate loan market may be impacted by a wide range of macroeconomic factors such as interest rates, residential and commercial real estate prices, home ownership and unemployment rates, and availability of credit, among others. We believe our prudent underwriting, conservative loan structures and interest rate protections, and proven in-house asset management capability leave us well positioned to manage changing macroeconomic conditions. Operating Efficiency We generate positive operating leverage to the extent that our revenue grows at a faster rate than our expenses. We believe our platform is highly scalable and that we can generate positive operating leverage in future periods, primarily due to the technology and other investments we have made in our platform to date and our focus on a scalable, cost-effective mortgage broker network to generate new loan originations. Portfolio and Asset Quality Key Portfolio Statistics [[GREPCENT_TABLE]] [["","","December 31,"],["","","2022","","","2021","","","2020"],["","","($ in thousands)"],["Total loans (UPB)","","$","3,512,486","","","$","2,587,221","","","$","1,944,804"],["Loan count","","","8,893","","","","6,964","","","","5,878"],["Average loan balance","","$","395","","","$","372","","","$","331"],["Weighted average loan-to-value","","","68.2","%","","","67.7","%","","","66.1","%"],["Weighted average coupon","","","7.95","%","","","7.76","%","","","8.51","%"],["Nonperforming loans (UPB) (A)","","$","292,789","","","$","273,100","","","$","332,813"],["Nonperforming loans (% of total) (A)","","","8.34","%","","","10.56","%","","","17.11","%"]] [[/GREPCENT_TABLE]] (A) Reflects the UPB of loans 90 days or more past due or placed on nonaccrual status. Includes $39.6 million and $53.8 million of COVID-19 forbearance-granted loans 90 days or more past due as of December 31, 2022 and 2021, respectively. Total Loans. Total loans reflects the aggregate UPB at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for loan losses. Loan Count. Loan count reflects the number of loans at the end of the period. It includes all loans with an outstanding principal balance. 18 Average Loan Balance. Average loan balance reflects the average UPB at the end of the period (i.e., total loans divided by loan count). Weighted Average Coupon. Weighted average coupon reflects the weighted average loan rate at the end of the period. Weighted Average Loan-to-Value. Loan-to-value, or LTV, reflects the ratio of the original loan amount to the appraised value of the underlying property at the time of origination. In instances where the LTV at origination is not available for an acquired loan, the LTV reflects our best estimate of value at the time of acquisition. Weighted average LTV is calculated for the population of loans outstanding at the end of each specified period using the original loan amounts and appraised LTVs at the time of origination of each loan. LTV is a key statistic because requiring the borrower to invest more equity in the collateral minimizes our exposure for future credit losses. Nonperforming Loans. Loans that are 90 or more days past due, except for certain loans in our COVID-19 forbearance program, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. The dollar amount of nonperforming loans presented in the table above reflects the UPB of all loans that meet this definition. Originations and Acquisitions The following table presents new loan originations and acquisitions and includes average loan size, weighted average coupon and weighted average loan-to-value for the periods indicated: [[GREPCENT_TABLE]] [["($ in thousands)","","Loan Count","","","Loan Balance","","","Average Loan Size","","","Weighted Average Coupon","","","Weighted Average LTV"],["Year Ended December 31, 2022:"],["Loan originations \u2014 held for investment","","","4,133","","","$","1,730,526","","","$","419","","","","7.9","%","","","69.2","%"],["Loan originations \u2014 held for sale","","","2","","","","31,327","","","","15,663","","","","5.0","%","","","64.7","%"],["Total loan originations","","","4,135","","","$","1,761,853","","","","426","","","","7.9","%","","","68.0","%"],["Loan acquisitions \u2014 held for investment","","","14","","","","14,455","","","","1,032","","","","8.8","%","","","62.0","%"],["Total loans originated and acquired","","","4,149","","","$","1,776,308"],["Year Ended December 31, 2021:"],["Loan originations \u2014 held for investment","","","3,105","","","$","1,326,275","","","$","427","","","","6.9","%","","","69.6","%"],["Loan originations \u2014 held for sale","","","\u2014","","","","\u2014","","","","\u2014","","","","(\u2014",")%","","","(\u2014",")%"],["Total loan originations","","","3,105","","","$","1,326,275","","","","427","","","","6.9","%","","","69.6","%"],["Loan acquisitions \u2014 held for investment","","","26","","","","11,300","","","","435","","","","7.0","%","","","61.4","%"],["Total loans originated and acquired","","","3,131","","","$","1,337,575"],["Year Ended December 31, 2020:"],["Loan originations \u2014 held for investment","","","955","","","$","338,815","","","$","355","","","","8.3","%","","","68.0","%"],["Loan originations \u2014 held for sale","","","316","","","","96,223","","","","305","","","","9.7","%","","","68.3","%"],["Total loan originations","","","1,271","","","$","435,038","","","","342","","","","8.6","%","","","68.1","%"],["Loan acquisitions \u2014 held for investment","","","3","","","","3,467","","","","1,156","","","","6.5","%","","","73.5","%"],["Total loans originated and acquired","","","1,274","","","$","438,505"]] [[/GREPCENT_TABLE]] For the year ended December 31, 2022, we originated $1.8 billion of loans, which was an increase of $435.6 million, or 32.8% from $1.3 billion for the year ended December 31, 2021. The 2021 origination was increased by $891.2 million, or 204.9% from $435.0 million for the year ended December 31, 2020, due to the COVID-19 pandemic that adversely impacted our loan originations in 2020. 19 Loans Held for Investment Our total portfolio of loans held for investment consists of both loans held for investment carried at amortized cost, which are presented in the Consolidated Balance Sheets as loans held for investment, net, and loans held for investment at fair value, which are presented in the Consolidated Balance Sheets as loans held for investment, at fair value. The following tables show the various components of loans held for investment as of the dates indicated: [[GREPCENT_TABLE]] [["","","December 31,"],["(in thousands)","","2022","","","2021","","","2020"],["Unpaid principal balance","","$","3,512,486","","","$","2,499,798","","","$","1,931,875"],["Valuation adjustments on FVO loans","","","7,463","","","","27","","","","(2",")"],["Deferred loan origination costs","","","33,429","","","","33,360","","","","23,600"],["Total loans held for investment, gross","","","3,553,378","","","","2,533,185","","","","1,955,473"],["Allowance for credit losses","","","(4,893",")","","","(4,262",")","","","(5,845",")"],["Loans held for investment, net","","$","3,548,485","","","$","2,528,923","","","$","1,949,628"]] [[/GREPCENT_TABLE]] The following table illustrates the contractual maturities for our loans held for investment in aggregate UPB and as a percentage of our total held for investment loan portfolio as of December 31, 2022: [[GREPCENT_TABLE]] [["","","December 31,"],["","","2022","","","2021","","","2020"],["($ in thousands)","","UPB","","","%","","","UPB","","","%","","","UPB","","","%"],["Loans due in less than one year","","$","146,916","","","","4.2","%","","$","96,502","","","","3.9","%","","$","100,025","","","","5.2","%"],["Loans due in one to five years","","","31,777","","","","0.9","","","","5,023","","","","0.2","","","","79,398","","","","4.1"],["Loans due in more than five years","","","3,333,793","","","","94.9","","","","2,398,273","","","","96.0","","","","1,752,452","","","","90.7"],["Total loans held for investment","","$","3,512,486","","","","100.0","%","","$","2,499,798","","","","100.0","%","","$","1,931,875","","","","100.0","%"]] [[/GREPCENT_TABLE]] Allowance for Loan Losses Our allowance for loan losses increased to $4.9 million as of December 31, 2022, from $4.3 million as of December 31, 2021. The increase in allowance is primarily due to the increase in our loans held for investment carried at amortized cost from $2.5 billion as of December 31, 2021 to $3.3 billion as of December 31, 2022. Our allowance decreased to $4.3 million as of December 31, 2021, from $5.8 million as of December 31, 2020. The decrease in allowance is primarily due to the broad improvement in the U.S economy in 2021 as the U.S. economy recovered from the adverse impacts caused by the COVID-19 pandemic. Our allowance for loan losses is based on an analysis of historical loan loss data from January 1, 2015 through December 31, 2022, adjusted for macroeconomic forecasts. We strive to minimize actual credit losses through our rigorous screening and underwriting process, life of loan portfolio management and special servicing practices. Additionally, we believe borrower equity of 25% to 40% provides significant protection against credit losses should a loan become impaired. The various scenarios, the weighting of scenarios, as well as the forecast period and reversion to historical loss, is subject to change as conditions in the market change and the Company’s ability to forecast economic events evolves. To estimate the allowance for loan losses in our non-FVO loans held for investment portfolio, we follow a detailed internal process, considering a number of different factors including, but not limited to, our ongoing analyses of loans, historical loss rates, relevant environmental factors, relevant market research, trends in delinquencies, effects and changes in credit concentrations, and ongoing evaluation of fair values. 20 The following table illustrates the activity in our allowance for loan losses over the periods indicated: [[GREPCENT_TABLE]] [["","","December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Allowance for credit losses:"],["Beginning balance","","$","4,262","","","$","5,845","","","$","2,240"],["Impact of adopting ASC 326","","","\u2014","","","","\u2014","","","","137"],["Provision for loan losses","","","1,152","","","","(292",")","","","5,068","","(1)"],["Charge-offs","","","(521",")","","","(1,291",")","","","(1,600",")"],["Ending balance","","$","4,893","","","$","4,262","","","$","5,845"],["Total loans held for investment (UPB), excluding FVO (2)","","$","3,243,854","","","$","2,498,466","","","$","1,930,334"],["Allowance for credit losses / loans held for investment, excluding FVO","","","0.15","%","","","0.17","%","","","0.30","%"]] [[/GREPCENT_TABLE]] (1) The provision for loans losses would have been approximately $3.9 million for the year ended December 31, 2020, excluding the $1.2 million impact from the loans held for sale transferred to loans held for investment. The additional $1.2 million provision was mainly offset by the reversal of the $1.3 million valuation allowance on the held for sale loans, which was recorded to “Other income” in the consolidated statements of income. (2) Reflects the UPB of loans held for investment excluding loans held for investment at fair value (FVO). Credit Quality – Total Portfolio of Loans Held for Investment The following table provides delinquency information, by unpaid principal balance, on our held for investment loan portfolio as of the dates indicated: [[GREPCENT_TABLE]] [["($ in thousands)","","December 31, 2022 (A)","","","COVID-19 Forbearance","","","December 31, 2021 (A)","","","COVID-19 Forbearance","","","December 31, 2020 (A)","","","COVID-19 Forbearance"],["Performing/Accruing:"],["Current","","$","2,969,989","","","","84.6","%","","$","120,884","","","$","2,068,023","","","","82.7","%","","$","188,466","","","$","1,445,131","","","","74.9","%","","$","259,147"],["30-59 days past due","","","186,051","","","","5.3","","","","33,668","","","","127,046","","","","5.1","","","","36,579","","","","89,284","","","","4.6","","","","32,115"],["60-89 days past due","","","63,657","","","","1.8","","","","6,902","","","","31,629","","","","1.3","","","","8,262","","","","62,694","","","","3.2","","","","34,493"],["90+ days past due","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014","","","","1,953","","","","0.1","","","","1,953"],["Total performing loans","","","3,219,697","","","","91.7","","","","161,454","","","","2,226,698","","","","89.1","","","","233,307","","","","1,599,062","","","","82.8","","","","327,708"],["Nonperforming/Nonaccrual:"],["90 days past due","","","17,852","","","","0.5","","","","1,116","","","","19,533","","","","0.8","","","","5,325","","","","20,778","","","","1.1","","","","727"],["90+ days past due","","","32,566","","","","0.9","","","","1,681","","","","35,787","","","","1.4","","","","8,510","","","","82,004","","","","4.2","","","","34,120"],["Bankruptcy","","","22,435","","","","0.6","","","","7,272","","","","20,038","","","","0.8","","","","6,242","","","","12,655","","","","0.7","","","","1,650"],["In foreclosure","","","219,936","","","","6.3","","","","29,482","","","","197,742","","","","7.9","","","","39,045","","","","217,376","","","","11.2","","","","27,868"],["Total nonperforming loans","","","292,789","","","","8.3","","","","39,551","","","","273,100","","","","10.9","","","","59,122","","","","332,813","","","","17.2","","","","64,365"],["Total loans held for investment","","$","3,512,486","","","","100.0","%","","$","201,005","","","$","2,499,798","","","","100.0","%","","$","292,429","","","$","1,931,875","","","","100.0","%","","$","392,073"]] [[/GREPCENT_TABLE]] (A) Balance includes $201.0 million UPB of loans held for investment as of December 31, 2022, $292.4 million as of December 31, 2021 and $392.1 million as of December 31, 2020 in our COVID-19 forbearance program. Other than loans while they were in the COVID-19 forbearance program, loans that are 90+ days past due, in bankruptcy, in foreclosure, or not accruing interest are considered nonperforming loans. Nonperforming loans were $292.8 million, or 8.3% of our held for investment loan portfolio as of December 31, 2022, compared to $273.1 million, or 10.9% as of December 31, 2021, and $332.8 million, or 17.2% of the loan portfolio as of December 31, 2020. The decrease in total nonperforming loans as of December 31, 2022 compared to December 31, 2021 and 2020 was primarily attributable to loan resolutions by our Special Servicing department, along with improvement in the U.S. economy as the U.S economy recovers from the COVID-19 pandemic. 21 Resolutions of non-performing loans Historically, most loans that become nonperforming resolve prior to converting to REO. This is due to low LTVs at origination and our active management of the portfolio. The following tables summarize the resolution activities of loans that were nonperforming or became nonperforming during the periods indicated. We resolved $142.2 million, $201.9 million, and $83.4 million of long-term and short-term nonperforming loans during the years ended December 31, 2022, 2021, and 2020, respectively. We also resolved $16.2 million, $10.7 million, and $4.4 million of nonperforming loans transferred to REO during the years ended December 31, 2022, 2021 and 2020, respectively. From these resolution activities, we realized net gains of $10.8 million, $7.5 million, and $2.7 million during the years ended December 31, 2022, 2021, and 2020, respectively. This is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected. The table below includes nonperforming loan resolutions for our long-term loans and REO's. [[GREPCENT_TABLE]] [["Long-Term Loans","","December 31, 2022","","","December 31, 2021","","","December 31, 2020"],["($ in thousands)","","UPB","","","Gain / (Loss)","","","UPB","","","Gain / (Loss)","","","UPB","","","Gain / (Loss)"],["Resolved \u2014 paid in full","","$","50,441","","","$","5,073","","","$","62,703","","","$","4,106","","","$","45,662","","","$","2,029"],["Resolved \u2014 paid current","","","46,062","","","","449","","","","45,654","","","","650","","","","37,705","","","","1,213"],["Resolved \u2014 REO sold","","","10,204","","","","1,602","","","","10,151","","","","226","","","","4,362","","","","(498",")"],["Total resolutions","","$","106,707","","","$","7,124","","","$","118,508","","","$","4,982","","","$","87,729","","","$","2,744"],["Recovery rate on resolved nonperforming UPB","","","","","","106.7","%","","","","","","104.2","%","","","","","","103.1","%"]] [[/GREPCENT_TABLE]] The table below includes resolutions for our short-term nonperforming loans and REO's, now being held for investment, and also includes loans that were granted a COVID-19 forbearance in 2020. Prior to January 1, 2020, nonperforming loan resolutions presented only consisted of long-term nonperforming loans held for investment since the short-term loans, or loans with a maturity of two-year or less, were being held for sale until later in 2020. The short-term loans do not require prepayment fees and usually result in a lower gain when paid in full, as compared to long term loans. [[GREPCENT_TABLE]] [["Short-Term Loans","","December 31, 2022","","","December 31, 2021","","","December 31, 2020"],["($ in thousands)","","UPB","","","Gain / (Loss)","","","UPB","","","Gain / (Loss)","","","UPB","","","Gain / (Loss)"],["Resolved \u2014 paid in full","","$","36,516","","","$","2,100","","","$","43,613","","","$","2,312","","","$","\u2014","","","$","\u2014"],["Resolved \u2014 paid current","","","9,192","","","","61","","","","49,942","","","","195","","","","\u2014","","","","\u2014"],["Resolved \u2014 REO sold","","","5,966","","","","1,474","","","","534","","","","22","","","","\u2014","","","","\u2014"],["Total resolutions","","$","51,674","","","$","3,635","","","$","94,089","","","$","2,529","","","$","\u2014","","","$","\u2014"],["Recovery rate on resolved nonperforming UPB","","","","","","107.0","%","","","","","","102.7","%","","","","","N/A"]] [[/GREPCENT_TABLE]] Charge-offs Our actual losses incurred have been small as a percentage of nonperforming loans held for investment. The table below shows our actual loan losses for the periods indicated. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Average nonperforming loans for the period (1)","","$","266,129","","","$","307,562","","","$","246,972"],["Charge-offs","","","521","","","","1,291","","","","1,600"],["Charge-offs / Average nonperforming loans for the period (1)","","","0.20","%","","","0.42","%","","","0.65","%"]] [[/GREPCENT_TABLE]] (1) Reflects the monthly average of nonperforming loans held for investment during the period. 22 Concentrations – Loans Held for Investment As of December 31, 2022, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 52.7% of the UPB and mixed use properties represented 12.6% of the UPB. No other property type represented more than 10.0% of our held for investment loan portfolio. By geography, the principal balance of our loans held for investment were concentrated 22.8% in California, 19.9% in New York, 13.3% in Florida, and 7.5% in New Jersey. [[GREPCENT_TABLE]] [["Property Type","","December 31, 2022"],["($ in thousands)","","Loan Count","","","UPB","","","% of Total UPB"],["Investor 1-4","","","5,317","","","$","1,851,538","","","","52.7","%"],["Mixed use","","","1,056","","","","443,330","","","","12.6"],["Retail","","","637","","","","305,361","","","","8.7"],["Multifamily","","","546","","","","301,342","","","","8.6"],["Warehouse","","","344","","","","223,271","","","","6.4"],["Office","","","453","","","","199,034","","","","5.7"],["Other (1)","","","540","","","","188,610","","","","5.3"],["Total loans held for investment","","","8,893","","","$","3,512,486","","","","100.0","%"]] [[/GREPCENT_TABLE]] (1) All other properties individually comprise less than 5.0% of the total unpaid principal balance. [[GREPCENT_TABLE]] [["Geography (State)","","December 31, 2022"],["($ in thousands)","","Loan Count","","","UPB","","","% of Total UPB"],["California","","","1,251","","","$","802,005","","","","22.8","%"],["New York","","","1,259","","","","698,945","","","","19.9"],["Florida","","","1,218","","","","466,690","","","","13.3"],["New Jersey","","835","","","","261,656","","","","7.5"],["Other (1)","","","4,330","","","","1,283,190","","","","36.5"],["Total loans held for investment","","","8,893","","","$","3,512,486","","","","100.0","%"]] [[/GREPCENT_TABLE]] (1) All other states individually comprise less than 5.0% of the total unpaid principal balance. Real Estate Owned (REO) REO includes real estate we acquire through foreclosure or by deed-in-lieu of foreclosure. REO assets are initially recorded at fair value, less estimated costs to sell, on the date of foreclosure. Adjustments that reduce the carrying value of the loan to the fair value of the real estate at the time of foreclosure are recognized as charge-offs in the allowance for loan losses. Positive adjustments at the time of foreclosure are recognized in other operating income. After foreclosure, we periodically obtain new valuations and any subsequent changes to fair value, less estimated costs to sell, are reflected as valuation adjustments. As of December 31, 2022, our REO included 27 properties with a carrying value of $13.3 million compared to 34 properties with a carrying value of $17.6 million as of December 31, 2021. Key Performance Metrics [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Average loans","","$","3,092,198","","","$","2,125,847","","","$","2,043,665"],["Portfolio yield","","","7.77","%","","","8.56","%","","","8.19","%"],["Average debt \u2014 portfolio related","","","2,750,822","","","","1,814,048","","","","1,803,188"],["Average debt \u2014 total company","","","2,956,801","","","","1,968,938","","","","1,885,306"],["Cost of funds \u2014 portfolio related","","","4.64","%","","","4.71","%","","","4.87","%"],["Cost of funds \u2014 total company","","","5.32","%","","","5.38","%","","","5.30","%"],["Net interest margin \u2014 portfolio related","","","3.64","%","","","4.54","%","","","3.89","%"],["Net interest margin \u2014 total company","","","2.69","%","","","3.57","%","","","3.30","%"],["Charge-offs","","","0.02","%","","","0.06","%","","","0.08","%"],["Pre-tax return on equity","","","12.23","%","","","15.58","%","","","10.69","%"],["Return on equity","","","8.93","%","","","11.45","%","","","8.22","%"]] [[/GREPCENT_TABLE]] 23 Average Loans Average loans reflects the daily average of total outstanding loans, including both loans held for investment and loans held for sale, as measured by UPB, over the specified time period. Portfolio Yield Portfolio yield is an annualized measure of the total interest income earned on our loan portfolio as a percentage of average loans over the given period. Interest income includes interest earned on performing loans, cash interest received on nonperforming loans, default interest and prepayment fees. Portfolio yield is lower in 2022 primarily from a delay in the recovery of delinquent interest as compared to 2021. Average Debt — Portfolio Related and Total Company Portfolio-related debt consists of borrowings related directly to financing our loan portfolio, which includes our warehouse repurchase facilities and securitizations. Total company debt consists of portfolio- related debt and corporate debt. The measures presented here reflects the monthly average of all portfolio- related and total company debt, as measured by outstanding principal balance, over the specified time period. Cost of Funds — Portfolio Related and Total Company Portfolio related cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt as a percentage of average portfolio-related debt outstanding over the given period. Total company cost of funds is an annualized measure of the interest expense incurred on our portfolio-related debt and corporate debt outstanding over the given period. Interest expense includes the amortization of expenses incurred in connection with our portfolio related financing activities and corporate debt. Through the issuance of long-term securitizations, we have been able to fix a significant portion of our borrowing costs over time. The strong credit performance on our securitizations has allowed us to issue debt at attractive rates. Our portfolio related cost of funds decreased to 4.64% for the year ended December 31, 2022 from 4.71% and 4.87% for the years ended December 31, 2021 and 2020, respectively. Net Interest Margin — Portfolio Related and Total Company Portfolio related net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt as a percentage of average loans over the specified time period. Total company net interest margin measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our portfolio-related debt and corporate debt as a percentage of average loans over the specified time period. 24 The following tables show the average outstanding balance of our loan portfolio and portfolio-related debt, together with interest income and the corresponding yield earned on our portfolio, and interest expense and the corresponding rate paid on our portfolio-related debt for the periods indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["","","2022","","","2021","","","2020"],["","","","","","Interest","","","Average","","","","","","Interest","","","Average","","","","","","Interest","","","Average"],["","","Average","","","Income /","","","Yield /","","","Average","","","Income /","","","Yield /","","","Average","","","Income /","","","Yield /"],["($ in thousands)","","Balance","","","Expense","","","Rate","","","Balance","","","Expense","","","Rate","","","Balance","","","Expense","","","Rate"],["Loan portfolio:"],["Loans held for sale","","$","49,194","","","","","","","","","$","15,794","","","","","","","","","$","110,810"],["Loans held for investment","","","3,043,003","","","","","","","","","","2,110,053","","","","","","","","","","1,932,855"],["Total loans","","$","3,092,198","","","$","240,343","","","","7.77","%","","$","2,125,847","","","$","181,968","","","","8.56","%","","$","2,043,665","","","$","167,322","","","","8.19","%"],["Debt:"],["Warehouse and repurchase facilities","","$","292,490","","","","17,454","","","","5.97","%","","$","183,663","","","","9,706","","","","5.28","%","","$","168,099","","","","8,352","","","","4.97","%"],["Securitizations","","","2,458,332","","","","110,269","","","","4.49","%","","","1,630,385","","","","75,680","","","","4.64","%","","","1,635,089","","","","79,474","","","","4.86","%"],["Total debt - portfolio related","","","2,750,822","","","","127,723","","","","4.64","%","","","1,814,048","","","","85,386","","","","4.71","%","","","1,803,188","","","","87,826","","","","4.87","%"],["Corporate debt","","","205,979","","","","29,472","","","","14.31","%","(5)","","154,890","","","","20,609","","","","13.31","%","(4)","","82,117","","","","12,049","","","","14.67","%","(3)"],["Total debt","","$","2,956,801","","","$","157,195","","","","5.32","%","","$","1,968,938","","","$","105,995","","","","5.38","%","","$","1,885,305","","","$","99,875","","","","5.30","%"],["Net interest spread - portfolio related (1)","","","","","","","","","3.13","%","","","","","","","","","3.85","%","","","","","","","","","3.32","%"],["Net interest margin - portfolio related","","","","","","","","","3.64","%","","","","","","","","","4.54","%","","","","","","","","","3.89","%"],["Net interest spread - total company (2)","","","","","","","","","2.46","%","(5)","","","","","","","","3.18","%","(4)","","","","","","","","2.89","%","(3)"],["Net interest margin - total company","","","","","","","","","2.69","%","(5)","","","","","","","","3.57","%","(4)","","","","","","","","3.30","%","(3)"]] [[/GREPCENT_TABLE]] (1) Net interest spread — portfolio related is the difference between the rate earned on our loan portfolio and the interest rates paid on our portfolio-related debt. (2) Net interest spread — total company is the difference between the rate earned on our loan portfolio and the interest rates paid on our total debt. (3) Excluding the one-time debt issuance costs write-off of $3.5 million and prepayment penalties of $0.3 million associated with the $75.0 million repayment of our corporate debt in January 2020, the Corporate debt average rate would have been 10.08%; Net interest spread — total company would have been 3.09%; and Net interest margin — total company would have been 3.48% for the year ended December 31, 2020. (4) Excluding the one-time debt issuance costs write-off of $2.9 million related to our corporate debt refinancing in February 2021, the Corporate debt average yield would have been 11.40%; Net interest spread — total company would have been 3.33%; and Net interest margin — total company would have been 3.71% for the year ended December 31, 2021. (5) Excluding the one-time debt issuance cost write-off of $7.7 million and prepayment penalties of $5.3 million associated with the $170.8 million payoff of our corporate debt in March 2022, the Corporate debt average yield would have been 8.10%; Net interest spread — total company would have been 2.89%; and Net interest margin — total company would have been 3.10% for the year ended December 31, 2022. Charge-Offs The charge-offs ratio reflects charge-offs as a percentage of average loans held for investment carried at amortized cost over the specific time period. We do not record charge-offs on FVO loans which are carried at estimated fair value. We also do not record charge-offs on our loans held for sale which are carried either at fair value, or carried at the lower of cost or estimated fair value. 25 Pre-Tax Return on Equity and Return on Equity Pre-tax return on equity and return on equity reflect income before income taxes, and net income including net income attributable to noncontrolling interest, respectively, as a percentage of the monthly average total stockholders’ equity including noncontrolling interest over the specified period. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Income before income taxes (A)","","$","44,552","","","$","39,793","","","$","23,129"],["Net income (B)","","","32,519","","","","29,224","","","","17,777"],["Monthly average balance:"],["Stockholders' / Members' equity (C)","","","364,282","","","","255,331","","","","216,289"],["Pre-tax return on equity (A)/(C)","","","12.2","%","","","15.6","%","","","10.7","%"],["Return on equity (B)/(C)","","","8.9","%","","","11.4","%","","","8.2","%"]] [[/GREPCENT_TABLE]] Components of Results of Operations Interest Income We accrue interest on the UPB of our loans in accordance with the individual terms and conditions of each loan, discontinuing interest and reversing previously accrued interest once a loan becomes 90 days or more past due (nonaccrual status). When a loan is placed on nonaccrual status, the accrued and unpaid interest is reversed as a reduction to interest income and accrued interest receivable. Interest income is subsequently recognized only to the extent that cash payments are received or when the loan has returned to accrual status. Payments received on nonaccrual loans are first applied to interest due, then principal. Interest accrual resumes once a borrower has made all principal and interest payments due, bringing the loan back to current status. Interest income on loans held for investment is comprised of interest income on loans and prepayment fees less the amortization of deferred net costs related to the origination of loans. Interest income on loans held for sale is comprised of interest income earned on loans prior to their sale. The net fees and costs associated with loans held for sale are deferred as part of the carrying value of the loan and recognized as a gain or loss on the sale of the loan. Interest Expense — Portfolio Related Portfolio related interest expense is incurred on the debt we incur to fund our loan origination and portfolio activities and consists of our warehouse repurchase facilities and securitizations. Portfolio related interest expense also includes the amortization of expenses incurred as a result of issuing the debt, which are amortized using the level yield method. Key drivers of interest expense include the debt amounts outstanding, interest rates, and the mix of our securitizations and warehouse liabilities. Net Interest Income — Portfolio Related Portfolio related net interest income represents the difference between interest income and portfolio related interest expense. Interest Expense — Corporate Debt Interest expense on corporate debt primarily consists of interest expense paid with respect to the 2021 Term Loan and the 2022 Term Loan, as reflected on our consolidated balance sheets, and the related amortization of deferred debt issuance costs. 26 Net Interest Income Net interest income represents the difference between portfolio related net interest income and interest expense on corporate debt. Provision for Loan Losses Effective January 1, 2020, we adopted ASU 2016-13 Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments replacing the incurred loss accounting approach with the current expected credit loss (CECL) approach. Under the CECL methodology, the allowance for credit losses is calculated using a third-party model with our historical loss rates by segment, loans position as of the balance sheet date, and assumptions from us. Other Operating Income Gain on Disposition of Loans. When we sell a loan held for sale, we record a gain or loss that reflects the difference between the proceeds received for the sale of the loans and their respective carrying values. The gain or loss that we ultimately realize on the sale of our loans held for sale is primarily determined by the terms of the originated loans, current market interest rates and the sales price of the loans. In addition, when we transfer a loan to REO, we record the REO at its fair value at the time of the transfer. The difference between the fair value of the real estate and the carrying value of the loan is recorded as a gain or loss. Lastly, when our acquired loans, which were purchased at a discount, pay off, we record a gain related to the recognition of the remaining purchase discount. Unrealized Gain/(Loss) on Fair Value Loans. We have elected to apply the fair value option accounting to all of our originated mortgage loans on a go-forward basis beginning October 1, 2022. We also elected to account for certain purchased distressed loans at fair value using FASB ASC Topic 825, Financial Instruments (ASC 825). We regularly estimate the fair value of these loans as discussed more fully in the notes to our consolidated financial statements included elsewhere in this Annual Report. Changes in fair value are reported as a component of other operating income within our consolidated statements of income. Other Income. Other income includes the following: Unrealized Gains/(Losses) on Retained Interest Only Securities. As part of the proceeds received for the sale of our held for sale loans, we may receive an interest only security that we mark to fair value at the end of each period. Fee Income. In certain situations, we collect fee income by originating loans and realizing miscellaneous fees such as late fees. Operating Expenses Compensation and Employee Benefits. Costs related to employee compensation, commissions and related employee benefits, such as health, retirement, and payroll taxes. Rent and Occupancy. Costs related to occupying our locations, including rent, maintenance and property taxes. Loan Servicing. Costs related to our third-party servicers. Professional Fees. Costs related to professional services, such as external audits, legal fees, tax, compliance and outside consultants. Real Estate Owned, Net. Costs related to our real estate owned, net, including gains/(losses) on disposition of REO, maintenance of REO properties, and taxes and insurance. Other Operating Expenses. Other operating expenses consist of general and administrative costs such as, travel and entertainment, marketing, data processing, insurance and office equipment. 27 Provision for Income Taxes The provision for income taxes consists of the current and deferred U.S. federal and state income taxes we expect to pay, currently and in future years, with respect to the net income for the year. The amount of the provision is derived by adjusting our reported pretax income with various permanent differences. The tax-adjusted income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes. Consolidated Results of Operations The following table summarizes our consolidated results of operations for the periods indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Interest income","","$","240,343","","","$","181,968","","","$","167,322"],["Interest expense - portfolio related","","","127,723","","","","85,386","","","","87,826"],["Net interest income - portfolio related","","","112,620","","","","96,582","","","","79,496"],["Interest expense - corporate debt","","","29,472","","","","20,609","","","","12,049"],["Net interest income","","","83,148","","","","75,973","","","","67,447"],["Provision for (reversal of) loan losses","","","1,152","","","","(292",")","","","5,068"],["Net interest income after provision for loan losses","","","81,996","","","","76,265","","","","62,379"],["Other operating income","","","22,225","","","","8,188","","","","6,320"],["Total operating expenses","","","59,669","","","","44,660","","","","45,570"],["Income before income taxes","","","44,552","","","","39,793","","","","23,129"],["Income tax expense","","","12,033","","","","10,569","","","","5,352"],["Net income","","","32,519","","","","29,224","","","","17,777"],["Net income attributable to noncontrolling interest","","","308","","","","\u2014","","","","\u2014"],["Net income attributable to Velocity Financial, Inc.","","","32,211","","","","29,224","","","","17,777"],["Less undistributed earnings attributable to participating securities","","","491","","","","8,589","","","","\u2014"],["Less deemed dividends on preferred stock","","","\u2014","","","","\u2014","","","","48,955"],["Net income (loss) allocated to common shareholders","","$","31,720","","","$","20,635","","","$","(31,178",")"],["Earnings (loss) per common share"],["Basic","","$","0.99","","","$","0.90","","","$","(1.55",")"],["Diluted","","$","0.94","","","$","0.86","","","$","(1.55",")"],["Weighted average common shares outstanding"],["Basic","","","31,913","","","","22,813","","","","20,087"],["Diluted","","","34,131","","","","33,982","","","","20,087"]] [[/GREPCENT_TABLE]] Year Ended December 31, 2022 Compared to Year Ended December 31, 2021 Net Interest Income — Portfolio Related [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","$ Change","","","% Change"],["Interest income","","$","240,343","","","$","181,968","","","$","58,375","","","","32.1","%"],["Interest expense - portfolio related","","","127,723","","","","85,386","","","","42,337","","","","49.6","%"],["Net interest income - portfolio related","","$","112,620","","","$","96,582","","","$","16,038","","","","16.6","%"]] [[/GREPCENT_TABLE]] Interest Income. Interest income increased by $58.4 million, or 32.1%, to $240.3 million during the year ended December 31, 2022, compared to $182.0 million during the year ended December 31, 2021. The increase was primarily attributable to higher portfolio balances offset by a decrease in the average yield. The average yield decreased to 7.77% from 8.56%. Average loans increased $966.4 million, or 45.4%, from $2.1 billion for the year ended December 31, 2021 to $3.1 billion for the year ended December 31, 2022. The decrease in average yield is attributable to higher collection of delinquent and default interest in 2021. The following table distinguishes between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate. The effect of changes in volume is determined by 28 multiplying the change in average loan balance ($966.4 million) by the previous period’s average yield (8.56%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (0.79%) by the current period’s average loan balance ($3.1 billion). [[GREPCENT_TABLE]] [["","","Year Ended December 31, 2022 and 2021"],["($ in thousands)","","Average Loans","","","Interest Income","","","Average Yield"],["Year Ended December 31, 2022","","$","3,092,198","","","$","240,343","","","","7.77","%"],["Year Ended December 31, 2021","","","2,125,847","","","","181,968","","","","8.56","%"],["Volume variance","","","966,351","","","","82,718"],["Rate variance","","","","","","(24,343",")","","","(0.79",")%"],["Total interest income variance","","","","","$","58,375"]] [[/GREPCENT_TABLE]] Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which increased by $42.3 million, or 49.4%, to $127.7 million for the year ended December 31, 2022, from $85.4 million for the year ended December 31, 2021. The increase in portfolio related interest expense in 2022 was primarily attributable to an increase in loan portfolio. The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2022 and 2021. [[GREPCENT_TABLE]] [["","","Year Ended December 31, 2022 and 2021"],["($ in thousands)","","Average Debt (1)","","","Interest Expense","","","Cost of Funds"],["Year Ended December 31, 2022","","$","2,750,822","","","$","127,723","","","","4.64","%"],["Year Ended December 31, 2021","","","1,814,048","","","","85,386","","","","4.71","%"],["Volume variance","","","936,774","","","","44,093"],["Rate variance","","","","","","(1,756",")","","","(0.06",")%"],["Total interest expense variance","","","","","$","42,337"]] [[/GREPCENT_TABLE]] (1) Includes securitizations and warehouse repurchase agreements. Net Interest Income After Provision for Loan Losses Net interest income after provision for loan losses increased 7.5% over the prior year driven by higher net interest income. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","$ Change","","","% Change"],["Net interest income - portfolio related","","$","112,620","","","$","96,582","","","$","16,038","","","","16.6","","%"],["Interest expense - corporate debt","","","29,472","","","","20,609","","","","8,863","","","","43.0","","%"],["Net interest income","","","83,148","","","","75,973","","","","7,175","","","","9.4","","%"],["Provision for (reversal of) loan losses","","","1,152","","","","(292",")","","","1,444","","","","(494.5",")","%"],["Net interest income after provision for loan losses","","$","81,996","","","$","76,265","","","$","5,731","","","","7.5","","%"]] [[/GREPCENT_TABLE]] Interest Expense — Corporate Debt. Corporate debt interest expense increased by $8.9 million from $20.6 million for the year ended December 31, 2021 to $29.5 million for the year ended December 31, 2022 primarily due to the fees associated with paying off our 2021 term loan early. The corporate debt balance was $215.0 million as of December 31, 2022 compared to $170.8 million as of December 31, 2021, as a result of the 2022 Term Loan agreement we entered into in March 2022. Provision for (reversal of) Loan Losses. Our provision for loan losses increased by approximately $1.4 million from the reversal of $0.3 million for the year ended December 31, 2021 to a provision of $1.2 million for the year ended December 31, 2022. The increase in provision for loan losses is primarily attributable to an increase in general reserve resulting from the increased non-FVO loan portfolio. 29 Other Operating Income The table below presents the various components of other operating income for the year ended December 31, 2022 compared to the year ended December 31, 2021. The $14.0 million net increase is primarily due to the unrealized gains related to loans originated after September 30, 2022 and the 2022 election of fair value option for our Century mortgage servicing rights. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","$ Change","","","% Change"],["Gain on disposition of loans","","$","7,107","","","$","7,892","","","$","(785",")","","","(9.9","%)"],["Unrealized gain on fair value loans","","","8,265","","","","29","","","","8,236","","","","28400.0","%"],["Other income","","","6,853","","","","267","","","","6,586","","","","2466.7","%"],["Total other operating income","","$","22,225","","","$","8,188","","","$","14,037","","","","171.4","%"]] [[/GREPCENT_TABLE]] Operating Expenses Total operating expenses increased by 33.6%, or $15.0 million to $59.7 million during the year ended December 31, 2022 from $44.7 million during the year ended December 31, 2021. The increase was driven by higher origination activity as well as the fair value election for loans originated in the fourth quarter. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","$ Change","","","% Change"],["Compensation and employee benefits","","$","30,458","","","$","19,190","","","$","11,268","","","","58.7","%"],["Rent and occupancy","","","1,748","","","","1,769","","","","(21",")","","","(1.2",")%"],["Loan servicing","","","12,298","","","","8,282","","","","4,016","","","","48.5","%"],["Professional fees","","","4,179","","","","3,781","","","","398","","","","10.5","%"],["Real estate owned, net","","","(70",")","","","3,150","","","","(3,220",")","","","(102.2",")%"],["Other operating expenses","","","11,056","","","","8,488","","","","2,568","","","","30.3","%"],["Total operating expenses","","$","59,669","","","$","44,660","","","$","15,009","","","","33.6","%"]] [[/GREPCENT_TABLE]] Compensation and Employee Benefits. Compensation and employee benefits increased from $19.2 million during the year ended December 31, 2021 to $30.5 million during year ended December 31, 2022. The increase was attributable to higher commission expense driven by the increase in loan originations and not deferring compensations costs attributable to loan origination activities on FVO loans starting on October 1, 2022. Rent and Occupancy. Rent and occupancy expenses remained relatively consistent between $1.7 million to $1.8 million during the years ended December 31, 2022 and 2021. Loan Servicing. Loan servicing expenses increased from $8.3 million during the year ended December 31, 2021 to $12.3 million during the year ended December 31, 2022. The $4.0 million increase during the year ended December 31, 2022 is mainly due to the increase in our loan portfolio. Professional Fees. Professional fees remained relatively consistent from $3.8 million for the year ended December 31, 2021 to $4.2 million for the year ended December 31, 2022. Net Expenses of Real Estate Owned. Net expenses of real estate owned decreased from $3.2 million during the year ended December 31, 2021 to income of $70 thousand during the year ended December 31, 2022. The $3.2 million decrease is mainly due to a higher gain on sale of REOs resolved by our special servicing team. 30 Other Operating Expenses. Other operating expenses increased from $8.5 million for the year ended December 31, 2021 to $11.1 million for the year ended December 31, 2022, mainly due to an increase in appraisal costs on higher origination volume and resumed marketing activity via trade shows after a pandemic-impacted 2021. Income Tax Expense. Income tax expense was $12.0 million for the year ended December 31, 2022, compared to $10.6 million for the year ended December 31, 2021. Our consolidated effective tax rate as a percentage of pre-tax income for 2022 was 27.2%, compared to 26.6% for 2021. The 2021 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes. Year Ended December 31, 2021 Compared to Year Ended December 31, 2020 Net Interest Income — Portfolio Related [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2021","","","2020","","","$ Change","","","% Change"],["Interest income","","$","181,968","","","$","167,322","","","$","14,646","","","","8.8","%"],["Interest expense - portfolio related","","","85,386","","","","87,826","","","","(2,440",")","","","(2.8","%)"],["Net interest income - portfolio related","","$","96,582","","","$","79,496","","","$","17,086","","","","21.5","%"]] [[/GREPCENT_TABLE]] Interest Income. Interest income increased by $14.6 million, or 8.8%, to $182.0 million during the year ended December 31, 2021, compared to $167.3 million during the year ended December 31, 2020. The increase is primarily attributable to the increase in average yield and an increase in average loans (volume). The average yield increased to 8.56% from 8.19%. Average loans increased $82.2 million, or 4.0%, from $2.0 billion for the year ended December 31, 2020 to $2.1 billion for the year ended December 31, 2021. The increase in average yield is primarily attributable to the recognition of default interest and prepayment fees for resolutions of nonperforming loans. The following table distinguishes between the change in interest income attributable to change in volume and the change in interest income attributable to change in rate. The effect of changes in volume is determined by multiplying the change in average loan balance (i.e., $82.2 million) by the previous period’s average yield (i.e., 8.19%). Similarly, the effect of rate changes is calculated by multiplying the change in average yield (i.e., 0.37%) by the current period’s average loan balance (i.e., $2.1 billion). [[GREPCENT_TABLE]] [["","","Year Ended December 31, 2021 and 2020"],["($ in thousands)","","Average Loans","","","Interest Income","","","Average Yield"],["Year Ended December 31, 2021","","$","2,125,847","","","$","181,968","","","","8.56","%"],["Year Ended December 31, 2020","","","2,043,665","","","","167,322","","","","8.19","%"],["Volume variance","","","82,182","","","","6,729"],["Rate variance","","","","","","7,917","","","","0.37","%"],["Total interest income variance","","","","","$","14,646"]] [[/GREPCENT_TABLE]] Interest Expense — Portfolio Related. Portfolio related interest expense consists of interest incurred on our warehouse facilities and securitizations, which decreased by $2.4 million, or 2.8%, to $85.4 million for the year ended December 31, 2021, from $87.8 million for the year ended December 31, 2020. The decrease in portfolio related interest expense in 2021 was primarily attributable to the lower cost of funds, which decreased to 4.71% for the year ended December 31, 2021 from 4.87% for the year ended December 31, 2020. The decrease in cost of funds was partially offset by the increase in average debt balance. The lower cost of funds was mainly attributable to improved securitization spreads. 31 The following table presents information regarding the increase in portfolio related interest expense and distinguishes between the dollar amount of change in interest expense attributable to changes in the average outstanding debt balance (volume) versus changes in cost of funds (rate) for the years ended December 31, 2021 and 2020. [[GREPCENT_TABLE]] [["","","Year Ended December 31, 2021 and 2020"],["($ in thousands)","","Average Debt (1)","","","Interest Expense","","","Cost of Funds"],["Year Ended December 31, 2021","","$","1,814,048","","","$","85,386","","","","4.71","%"],["Year Ended December 31, 2020","","","1,803,188","","","","87,826","","","","4.87","%"],["Volume variance","","","10,860","","","","529"],["Rate variance","","","","","","(2,969",")","","","(0.16",")%"],["Total interest expense variance","","","","","$","(2,440",")"]] [[/GREPCENT_TABLE]] (1) Includes securitizations and warehouse repurchase agreements. Net Interest Income After Provision for Loan Losses [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2021","","","2020","","","$ Change","","","% Change"],["Net interest income - portfolio related","","$","96,582","","","$","79,496","","","$","17,086","","","","21.5","","%"],["Interest expense - corporate debt","","","20,609","","","","12,049","","","","8,560","","","","71.0","","%"],["Net interest income","","","75,973","","","","67,447","","","","8,526","","","","12.6","","%"],["Provision for loan losses","","","(292",")","","","5,068","","","","(5,360",")","","","(105.8",")","%"],["Net interest income after provision for loan losses","","$","76,265","","","$","62,379","","","$","13,886","","","","22.3","","%"]] [[/GREPCENT_TABLE]] Interest Expense — Corporate Debt. Corporate debt interest expense increased by $8.6 million from $12.0 million for the year ended December 31, 2020 to $20.6 million for the year ended December 31, 2021 primarily due to the increase in corporate debt balance. The corporate debt balance was $170.8 million as of December 31, 2021 compared to $78.0 million as of December 31, 2020, as a result of 2021 Term Loan agreement we entered into in February 2021. Provision for Loan Losses. Our provision for loan losses decreased by approximately $5.4 million from the provision of $5.1 million for the year ended December 31, 2020 to a reversal of $0.3 million for the year ended December 31, 2021. The decrease in provision for loan losses is primarily attributable to the improvement in the U.S economy as the U.S economy continues to recover from the negative impacts caused by the COVID-19 pandemic in 2020. Other Operating Income The table below presents the various components of other operating income for the year ended December 31, 2021 compared to the year ended December 31, 2020. The $1.9 million net increase is primarily due to the unrealized loss in 2020 related to interest-only securities that matured in 2020. The unrealized loss on interest-only securities is included in other income (expense). [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2021","","","2020","","","$ Change","","","% Change"],["Gain on disposition of loans","","$","7,892","","","$","7,576","","","$","316","","","","4.2","%"],["Unrealized gain on fair value loans","","","29","","","","442","","","","(413",")","","","(93.4",")%"],["Other income (expense)","","","267","","","","(1,698",")","","","1,965","","","","(115.7",")%"],["Total other operating income","","$","8,188","","","$","6,320","","","$","1,868","","","","29.6","%"]] [[/GREPCENT_TABLE]] 32 Operating Expenses Total operating expenses decreased by 2.0%, or $0.9 million to $44.7 million during the year ended December 31, 2021 from $45.6 million during the year ended December 31, 2020. This decrease is primarily attributable to a higher percentage of direct loan origination costs included in the compensation and employee benefits and other operating expenses in 2020 due to the suspension of loan production from mid-March through August. [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2021","","","2020","","","$ Change","","","% Change"],["Compensation and employee benefits","","$","19,190","","","$","20,731","","","$","(1,541",")","","","-7.4","%"],["Rent and occupancy","","","1,769","","","","1,743","","","","26","","","","1.5","%"],["Loan servicing","","","8,282","","","","7,802","","","","480","","","","6.2","%"],["Professional fees","","","3,781","","","","4,238","","","","(457",")","","","(10.8",")%"],["Real estate owned, net","","","3,150","","","","2,656","","","","494","","","","18.6","%"],["Other operating expenses","","","8,488","","","","8,400","","","","88","","","","1.0","%"],["Total operating expenses","","$","44,660","","","$","45,570","","","$","(910",")","","","-2.0","%"]] [[/GREPCENT_TABLE]] Compensation and Employee Benefits. Compensation and employee benefits decreased from $20.7 million during the year ended December 31, 2020 to $19.2 million during the year ended December 31, 2021. During April through August of 2020, when loan originations were suspended and staff was working on offering existing borrowers the COVID-19 forbearance program, compensation costs for the employees were expensed when, under normal operating conditions, the same compensation costs would be deferred over new loan production. Rent and Occupancy. Rent and occupancy expenses remained relatively consistent at approximately $1.8 million during the years ended December 31, 2020 and 2021 due to no change in office space. Loan Servicing. Loan servicing expenses increased from $7.8 million during the year ended December 31, 2020 to $8.3 million during the year ended December 31, 2021. The $0.5 million increase during the year ended 2021 is mainly due to the increase in our loan portfolio. Professional Fees. Professional fees decreased from $4.2 million for the year ended December 31, 2020 to $3.8 million for the year ended December 31, 2021 mainly due to the decrease in legal fees related to the IPO class action lawsuit which was dismissed in January 2021. Net Expenses of Real Estate Owned. Net expenses of real estate owned increased from $2.7 million during the year ended December 31, 2020 to $3.2 million during the year ended December 31, 2021. The $0.5 million increase is mainly due to a smaller gain on disposition and the increase in taxes and insurance for the properties. Other Operating Expenses. Other operating expenses slightly increased from $8.4 million for the year ended December 31, 2020 to $8.5 million for the year ended December 31, 2021 mainly due to the increase in appraisal fee expenses. Income Tax Expense. Income tax expense was $10.6 million for the year ended December 31, 2021, compared to $5.4 million for the year ended December 31, 2020. Our consolidated effective tax rate as a percentage of pre-tax income for 2021 was 26.6%, compared to 23.1% for 2020. The 2021 effective tax rate differed from the federal statutory rate of 21% principally because of state taxes. 33 Quarterly Results of Operations The following table sets forth certain financial information for each completed fiscal quarter since the quarter ended March 31, 2021. The quarterly information has been prepared on the same basis as the consolidated financial statements and includes all adjustments (consisting of normal recurring adjustments) that, in the opinion of management, are necessary for a fair presentation of the information presented. This information should be read in conjunction with the consolidated financial statements and related notes thereto included elsewhere in this Annual Report. Operating results for interim periods are not necessarily indicative of the results that may be expected for a full fiscal year. The following tables set for our unaudited quarterly results for the periods indicated: [[GREPCENT_TABLE]] [["","","Three Months Ended"],["","","December 31, 2022","","","September 30, 2022","","","June 30, 2022","","","March 31, 2022","","","December 31, 2021","","","September 30, 2021","","","June 30, 2021","","","March 31, 2021"],["","","(in thousands)"],["","","(unaudited)"],["Interest income","","$","65,632","","","$","63,419","","","$","59,243","","","$","52,049","","","$","49,360","","","$","46,923","","","$","44,978","","","$","40,707"],["Interest expense - portfolio related","","","40,854","","","","34,561","","","","28,752","","","","23,556","","","","23,666","","","","20,321","","","","20,566","","","","20,832"],["Net interest income - portfolio related","","","24,778","","","","28,858","","","","30,491","","","","28,493","","","","25,694","","","","26,602","","","","24,412","","","","19,875"],["Net interest margin - portfolio related","","","2.84","%","","","3.59","%","","","4.10","%","","","4.25","%","","","4.27","%","","","4.97","%","","","4.83","%","","","4.10","%"],["Interest expense - corporate debt","","","4,139","","","","4,011","","","","4,182","","","","17,140","","","","4,462","","","","4,488","","","","4,309","","","","7,350"],["Net interest income","","","20,639","","","","24,847","","","","26,309","","","","11,353","","","","21,232","","","","22,114","","","","20,103","","","","12,525"],["Net interest margin - total company","","","2.36","%","","","3.09","%","","","3.54","%","","","1.69","%","","","3.53","%","","","4.13","%","","","3.98","%","","","2.59","%"],["Provision for (reversal of) loan losses","","","(437",")","","","580","","","","279","","","","730","","","","377","","","","228","","","","(1,000",")","","","105"],["Net interest income after provision for loan losses","","","21,076","","","","24,267","","","","26,030","","","","10,623","","","","20,855","","","","21,886","","","","21,103","","","","12,420"],["Other operating income (expense)","","","11,029","","","","2,509","","","","3,039","","","","5,648","","","","2,617","","","","339","","","","2,432","","","","2,801"],["Operating expenses","","","20,413","","","","12,727","","","","14,279","","","","12,250","","","","12,095","","","","11,298","","","","10,650","","","","10,617"],["Income before income taxes","","","11,692","","","","14,049","","","","14,790","","","","4,021","","","","11,377","","","","10,927","","","","12,885","","","","4,604"],["Less income (loss) attributable to noncontrolling interest","","","(235",")","","","307","","","","126","","","","110","","","","\u2014","","","","\u2014","","","","\u2014","","","","\u2014"],["Income tax expense","","","3,465","","","","3,759","","","","4,019","","","","790","","","","3,024","","","","2,905","","","","3,432","","","","1,208"],["Net income","","$","8,462","","","$","9,983","","","$","10,645","","","$","3,121","","","$","8,353","","","$","8,022","","","$","9,453","","","$","3,396"]] [[/GREPCENT_TABLE]] Liquidity and Capital Resources Sources and Uses of Liquidity We fund our lending activities primarily through borrowings under our warehouse repurchase facilities, securitizations, other corporate-level debt, equity and debt securities, and net cash provided by operating activities to manage our business. We use cash to originate and acquire investor real estate loans, repay principal and interest on our borrowings, fund our operations and meet other general business needs. Cash and Cash Equivalents Our total liquidity plus available warehouse capacity was $559.3 million as of December 31, 2022 comprised of $45.2 million in cash, $14.0 million of available borrowings for unencumbered loans and $500.1 million of available warehouse capacity. As of December 31, 2021, we had liquidity of approximately $47.0 million in cash and cash equivalents comprised of approximately $36.0 million of unrestricted cash and $11.0 million of available liquidity on unfinanced loans. As of December 31, 2021, we had $349.9 million of available capacity under our warehouse and repurchase facilities. During the year ended December 31, 2022, we generated approximately $14.5 million of net cash and cash equivalents from operations, investing and financing activities. During the year ended December 31, 2021, we used approximately $27.3 million of net cash and cash equivalents from operations, investing and financing activities. 34 Warehouse Facilities As of December 31, 2022, we had five non-mark-to-market warehouse facilities and one modified mark-to-market warehouse facility to support our loan origination and acquisition facilities. One agreement is a two-year warehouse repurchase facility, three agreements are one-year warehouse repurchase facilities and two agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, two of the warehouse facilities bear interest at one-month LIBOR and four warehouse facility at SOFR, all at margins that range from 2.75% to 4.50%. We also had a short term repurchase agreement with a maximum borrowing capacity of $18.8 million. Borrowing under these facilities was $331.7 million with $500.1 million of available capacity under our warehouse and repurchase facilities as of December 31, 2022. As of December 31, 2021, we had four non-mark-to-market warehouse facilities and one modified mark-to-market warehouse facility to support our loan origination and acquisition facilities. One agreement is a two-year warehouse repurchase facility, two agreements are one-year warehouse repurchase facilities and two agreements are three-year warehouse facilities. The borrowings are collateralized by primarily performing loans, bearing interest at one-month LIBOR with a 0.75% floor plus a margin that ranges from 2.75% to 4.50%. Borrowing under these facilities was $300.1 million with $349.9 million of available capacity under our warehouse and repurchase facilities as of December 31, 2021. All warehouse facilities fund less than 100% of the principal balance of the mortgage loans we own requiring us to use working capital to fund the remaining portion. We may need to use additional working capital if loans become delinquent, because the amount permitted to be financed by the facilities may change based on the delinquency performance of the pledged collateral. All borrower payments on loans financed under the warehouse facilities are segregated into pledged accounts with the loan servicer. All principal amounts in excess of the interest due are applied to reduce the outstanding borrowings under the warehouse facilities, which then allows us to draw additional funds on a revolving basis under the facilities. The revolving warehouse facilities also contain customary covenants, including but not limited to financial covenants that require us to maintain a minimum net worth, a maximum debt-to-net worth ratio and a ratio of a minimum earnings before interest, taxes, depreciation and amortization to interest expense. If we fail to meet any of the covenants or otherwise default under the facilities, the lenders have the right to terminate their facility and require immediate repayment, which may require us to sell our loans at less than optimal terms. As of December 31, 2022, we were in compliance with these covenants. Securitizations From May 2011 through December 2022, we have completed 25 securitizations, issuing $5.4 billion in principal amount of securities to third parties. All borrower payments are segregated into remittance accounts at the primary servicer and remitted to the trustee of each trust monthly. We are the sole beneficial interest holder of the applicable trusts, which are variable interest entities included in our consolidated financial statements. The transactions are accounted for as a secured borrowings under U.S. GAAP. Tables summarizing the investor real estate loans securitized, securities issued, securities retained by the Company at the time of the securitization, and as of December 31, 2022 and 2021, the stated maturity for each securitization, the outstanding bond balances, and the weighted average rate on the securities for the Trusts as of December 31, 2022 and 2021, are included in Item 15. Exhibits, Financial Statement Schedules. The securities are callable by us when the stated principal balance is less than a certain percentage, ranging from 10%—30%, of the original stated principal balance of loans at issuance. As a result, the actual maturity date of the securities issued will likely be earlier than their respective stated maturity date. Our intent is to use the proceeds from the issuance of new securities primarily to repay our warehouse borrowings and originate new investor real estate loans in accordance with our underwriting guidelines, as well as for general corporate purposes. Our financing sources may include borrowings in the form of additional bank credit facilities (including term loans and revolving credit facilities), repurchase agreements, warehouse repurchase facilities and other sources of private financing. We also plan to continue using securitization as long-term financing for our portfolio, and we do not plan to structure any securitizations as sales or utilize off-balance-sheet vehicles. We believe any financing of assets and/or securitizations we may undertake will be sufficient to fund our working capital requirements. 35 Cash Flows The following table summarizes the net cash provided by (used in) operating activities, investing activities and financing activities as of the periods indicated: [[GREPCENT_TABLE]] [["","","Year Ended December 31,"],["($ in thousands)","","2022","","","2021","","","2020"],["Cash provided by (used in):"],["Operating activities","","$","48,674","","","$","57,622","","","$","54,892"],["Investing activities","","","(908,238",")","","","(656,483",")","","","87,739"],["Financing activities","","","874,016","","","","626,172","","","","(149,890",")"],["Net change in cash, cash equivalents, and restricted cash","","$","14,452","","","$","27,311","","","$","(7,259",")"]] [[/GREPCENT_TABLE]] Operating Activities Cash flows from operating activities primarily includes net income adjusted for (1) non-cash items including depreciation, provision for loan loss, discount accretion, and valuation changes, (2) changes in the balances of operating assets and liabilities, (3) gain on disposition of loans. For the year ended December 31, 2022, our net cash provided by operating activities of $48.7 million consisted mainly of $32.5 million in net income, and $32.2 million proceeds from sales of loans held for sale. For the year ended December 31, 2021, our net cash provided by operating activities of $57.6 million consisted mainly of $29.2 million in net income, and $20.2 million add-back of noncash debt issuance discounts and costs amortization. For the year ended December 31, 2020, our net cash provided by operating activities of $54.9 million consisted mainly of $96.1 million cash used to originate held for sale loans, offset by $79.6 million proceeds, net of repurchases, from sale of loans held for sale, $19.4 million in repayments on loans held for sale, and net income of $17.8 million. Investing Activities For the year ended December 31, 2022, our net cash used in investing activities of $908.2 million consisted mainly of $1.7 billion in cash used to originate held for investment loans, offset by $541.7 million in cash received in payments on held for investment loans and loans at fair value and by $292.5 million of proceeds from sales of loans originally classified as held for investment. For the year ended December 31, 2021, our net cash used in investing activities of $656.5 million consisted mainly of $1.3 billion in cash used to originate held for investment loans, offset by $568.8 million in cash received in payments on held for investment loans and by $135.8 million of proceeds from sales of loans originally classified as held for investment. For the year ended December 31, 2020, our net cash provided by investing activities of $87.7 million consisted mainly of $343.6 million in cash used to originate held for investment loans, offset by $342.0 million in cash received in payments on held for investment loans and by $99.6 million of proceeds from sales of loans originally classified as held for investment. We used $8.7 million in cash for escrow and corporate advances on loans held in the portfolio. We also received cash of $7.5 million from the sale of REO. Financing Activities For the year ended December 31, 2022, our net cash provided by financing activities of $874.0 million consisted mainly of $1.7 billion in borrowings from our warehouse and repurchase facilities and $1.4 billion in securitizations issued, respectively. The cash generated was offset by payments we made of $1.7 billion and $543.6 million on our warehouse and repurchase facilities and securitizations issued, respectively. 36 For the year ended December 31, 2021, our net cash provided by financing activities of $626.2 million consisted mainly of $1.2 billion in borrowings from our warehouse and repurchase facilities and $977.7 million in securitizations issued, respectively. The cash generated was offset by payments we made of $989.4 million and $643.5 million on our warehouse and repurchase facilities and securitizations issued, respectively. For the year ended December 31, 2020, our net cash used in financing activities of $149.9 million consisted mainly of $420.2 million and $536.7 million in cash from borrowings from our warehouse repurchase facilities and securitizations issued, respectively. This cash generated was offset by payments we made of $766.7 million and $398.3 million on our warehouse and repurchase facilities and securitizations issued, respectively. We received cash proceeds from the sale of our common stock in the IPO of $100.8 million, a portion of which we used to repay $75.0 million of principal on our corporate debt. We also received cash of $41.0 million in net proceeds from the issuance of preferred stock. We used cash of $8.9 million for debt issuance costs. April 2020 Preferred Stocks and Warrants On April 5, 2020, we sold 45,000 shares of Series A Convertible Preferred Stock and Warrants to purchase 3,013,125 shares of our common stock in a private placement to two of our largest stockholders. On October 8, 2021, we exercised our option to convert all of the 45,000 outstanding shares of Series A Convertible Preferred Stock into 11,688,310 shares of our common stock. The Warrants are exercisable at any time and from time to time, in whole or in part, by the holders until April 5, 2025 at an exercise price of $2.96 per share of common stock with respect to 2,008,750 of the Warrants, and at an exercise price of $4.94 per share of common stock with respect to 1,004,374 of the Warrants. Contractual Obligations and Commitments On February 5, 2021, we entered into a five-year $175.0 million syndicated corporate debt agreement (“2021 Term Loan”). The 2021 Term Loan had an interest rate equal to one-month LIBOR plus 8.00% with a 1.00% LIBOR floor and was paid off in March 2022. As of December 31, 2021, the balance of the 2021 Term Loan was $170.8 million. On March 15, 2022, we entered into a five-year $215.0 million syndicated corporate debt agreement ("the 2022 Term Loan"). The 2022 Term Loan bears interest at a fixed rate of 7.125% and matures on March 15, 2027. Interest on the 2022 Term Loan is paid every six months. A portion of the net proceeds from the 2022 Term Loan was used to redeem all the amounts owed pursuant to the 2021 Term Loan. The remaining portion of the net proceeds from the 2022 Term Loan is used for loan originations and general corporate purposes. As of December 31, 2022, the balance of the 2022 Term Loan was $215.0 million. Velocity Commercial Capital, LLC is the borrower of the 2022 Term Loan, which is secured by substantially all of the borrower’s non-warehoused assets, with a guarantee from Velocity Financial, Inc., formerly Velocity Financial LLC, that is secured by the equity interests of the borrower. The syndicated corporate debt agreement contains customary affirmative and negative covenants, including financial maintenance covenants and limitations on dividends by the borrower. As of December 31, 2022, we maintained warehouse facilities to finance our investor real estate loans and had approximately $331.7 million in outstanding borrowings with $500.1 million of available capacity under our warehouse and repurchase facilities. 37 The following table illustrates our contractual obligations existing as of December 31, 2022: [[GREPCENT_TABLE]] [["","","January 1, 2023 -","","","January 1, 2024 -"],["($ in thousands)","","December 31, 2023","","","December 31, 2025","","","Thereafter","","","Total"],["Warehouse and repurchase facilities","","$","331,740","","","$","\u2014","","","$","\u2014","","","$","331,740","","(1)"],["Notes payable (corporate debt)","","","\u2014","","","","\u2014","","","","215,000","","","","215,000"],["Leases payments under noncancelable operating leases","","","1,514","","","","1,379","","","","448","","","","3,341"],["Total","","$","333,254","","","$","1,379","","","$","215,448","","","$","550,081"]] [[/GREPCENT_TABLE]] (1) Amount represents gross warehouse borrowing. Balance of $330.8 million in the consolidated balance sheets as of December 31, 2022 is net of $926 thousand debt issuance costs. 38 Off-Balance-Sheet Arrangements At no time have we maintained any relationships with unconsolidated entities or financial partnerships, such as entities referred to as structured finance, or special-purpose or variable interest entities, established for the purpose of facilitating off-balance-sheet arrangements or other contractually narrow or limited purposes. Further, we have never guaranteed any obligations of unconsolidated entities or entered into any commitment or intent to provide funding to any such entities. New Accounting Standards ASU 2022-02, "Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures." The amendments in this ASU eliminate the recognition and measurement guidance for troubled debt restructuring by Creditors and require enhanced disclosures for certain loan refinancings and restructurings by creditors when a borrower is experiencing financial difficulty. ASU 2022-02 requires that an entity disclose current-period gross write-offs by year of origination for financing receivables. This ASU is effective January 1, 2023 for the Company. The adoption of this standard is not expected to have a significant impact on the Company’s consolidated financial statements.