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As filed with the Securities and Exchange Commission on October 18, 2019

Registration No. 333-            

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Velocity Financial, LLC

(to be converted as described herein into Velocity Financial, Inc.)

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   6199   46-0659719
(State or other jurisdiction of
Incorporation or organization)
 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

 

 

30699 Russell Ranch Road, Suite 295

Westlake Village, California 91362

(818) 532-3700

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

Christopher D. Farrar

Chief Executive Officer

30699 Russell Ranch Road, Suite 295

Westlake Village, California 91362

(818) 532-3700

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

With copies to:

 

William B. Brentani   Andrew S. Epstein
Daniel N. Webb   Jason D. Myers
Simpson Thacher & Bartlett LLP   Clifford Chance US LLP
2475 Hanover Street   31 W. 52nd Street

Palo Alto, California 94304

(650) 251-5000

 

New York, New York 10019

(212) 878-8000

 

 

Approximate date of commencement of proposed sale to the public: As soon as practicable after this registration statement becomes effective.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ☐

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering.  ☐

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐

CALCULATION OF REGISTRATION FEE

 

 

Title of each Class of

Securities to be Registered

 

Proposed
Maximum
Aggregate

Offering Price(1)(2)

 

Amount of

Registration Fee(3)

Common stock, par value $0.01 per share

  $100,000,000.00   $12,980.00

 

 

 

(1)

Estimated solely for the purpose of calculating the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.

 

(2)

Includes shares of common stock subject to the underwriters’ over-allotment option to purchase additional shares of common stock.

 

(3)

Calculated pursuant to Rule 457(o) under the Securities Act.

The registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933 or until the Registration Statement shall become effective on such date as the Commission, acting pursuant to said Section 8(a), may determine.

 

 


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EXPLANATORY NOTE

Velocity Financial, LLC, or the LLC entity, the registrant whose name appears on the cover of this registration statement, is a Delaware limited liability company. Prior to the completion of this offering, the LLC entity will convert into a Delaware corporation and change its name from Velocity Financial, LLC to Velocity Financial, Inc. We refer to this conversion throughout the prospectus included in this registration statement as the “Conversion.” As a result of the Conversion, the members of the LLC entity will become holders of shares of common stock of Velocity Financial, Inc. Except as otherwise noted in the prospectus, the consolidated financial statements and related notes thereto and selected historical consolidated financial data and other financial information included in this registration statement are those of the LLC entity and its subsidiaries and do not give effect to the Conversion. Shares of the common stock of Velocity Financial, Inc. are being offered by the prospectus included in this registration statement.


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The information in this preliminary prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and we are not soliciting offers to buy these securities in any jurisdiction where the offer or sale is not permitted.

 

PRELIMINARY PROSPECTUS    SUBJECT TO COMPLETION, DATED OCTOBER 18, 2019

            Shares

 

 

LOGO

Velocity Financial, Inc.

Common Stock

 

 

This is our initial public offering of shares of common stock of Velocity Financial, Inc. We are offering                  shares of our common stock to be sold in this offering.

Prior to this offering, there has been no public market for our common stock. The initial public offering price of the common stock is expected to be between $            and $            per share. We have applied to list our common stock on The New York Stock Exchange, or the NYSE, under the symbol “VEL.”

 

 

Investing in our common stock involves risks. See “Risk Factors” on page 19.

 

       Per Share      Total

Initial public offering price

     $                  $            

Underwriting discounts and commissions(1)

     $                  $            

Proceeds, before expenses, to us

     $                  $            

 

(1)

Please see the section entitled “Underwriting” for a complete description of the compensation payable to the underwriters.

The underwriters have the option to purchase up to             an additional shares of our common stock from us at the public offering price, less underwriting discounts and commissions, within 30 days after the date of this prospectus to cover over-allotments, if any.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

Delivery of the shares of common stock is expected to be made in New York, New York on or about                 , 2019.

 

 

Wells Fargo Securities              Citigroup    JMP Securities

Raymond James

The date of this prospectus is                 , 2019


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LOGO

Investor 1-4 Mixed-Use Commercial Multi-Family 2004 Year Founded $1.7 Billion Total Portfolio (1) $413 Million YTD Originations (2) +30% Y/Y Origination Growth (3) 8.80% Portfolio Yield (4) 65.0% Weighted Average LTV (5) $2.4 Billion Securitizations (6) 16.1% Pre-Tax Return on Equity (7) 46 Loans in 46 States & Washington, D.C. (8) (1) Reflects unpaid principal balance of all loans, including loans held for sale and loans held for investment, as of June 30, 2019. (2) Reflects total loan originations, as measured by original loan amount, for the six months ended June 30, 2019. Excludes 34 acquired loans with an aggregate principal balance of $8.9 million. (3) Reflects increase in total originations (97.6% to new borrowers), as measured by original loan amount, for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. For the six months ended June 30, 2019, excludes 34 acquired loans with an aggregate principal balance of $8.9 million. (4) For the six months ended June 30, 2019. Portfolio yield reflects total interest income earned on our loan portfolio as a percentage of average loan amount over the specific time period, annualized. Portfolio yield does not take into account general company expenses, such as cost of funds. (5) Weighted average loan-to-value calculated for the population of total loans outstanding as of June 30, 2019 using the original loan amounts and appraised loan-to-value at the time of origination of each loan. (6) Includes ten securitizations through June 30, 2019 and one securitization completed in July 2019. (7) Reflects income before income taxes as a percentage of the monthly average of members equity for the six months ended June 30, 2019, annualized our return on equity, which reflects annualized net income as a percentage of the monthly average of members' equity, was 11.4% for the six months ended June 30, 2019. See Managements Discussion and Analysis of Financial Condition and Results of Operations-Key Performance Metrics-Pre-Tax Return on Equity and Return on Equity. (8) Based on total portfolio of loans outstanding at June 30, 2019.


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TABLE OF CONTENTS

 

     Page  

Summary

     1  

Risk Factors

     19  

Special Note Regarding Forward-Looking Statements

     45  

Use of Proceeds

     47  

Dividend Policy

     47  

Capitalization

     48  

Dilution

     50  

Selected Consolidated Financial Information

     52  

Management’s Discussion and  Analysis of Financial Condition and Results of Operations

     54  

Business

     92  

Industry Overview

     110  

Management

     128  

Executive Compensation

     133  

Principal Stockholders

     149  

Certain Relationships and Related Party Transactions

     151  

Description of Capital Stock

     153  

Shares Eligible For Future Sale

     160  

Certain United States Federal Income and Estate Tax Consequences to Non-U.S. Holders

     162  

Underwriting

     165  

Legal Matters

     169  

Experts

     169  

Where You Can Find Additional Information

     169  

Index to Financial Statements

     F-1  

 

 

Through and including                 , 2019 (the 25th day after the date of this prospectus), all dealers effecting transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to a dealer’s obligation to deliver a prospectus when acting as an underwriter and with respect to an unsold allotment or subscription.

Neither we nor the underwriters have authorized anyone to provide you with information other than the information contained in this prospectus or in any free writing prospectus we may authorize to be delivered to you. We and the underwriters are offering to sell, and seeking offers to buy, our common stock only in jurisdictions where offers and sales thereof are permitted. The information in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of our common stock.

For investors outside the United States: We and the underwriters have not done anything that would permit a public offering of the shares of our common stock or possession or distribution of this prospectus in any jurisdiction where action for that purpose is required, other than in the United States. Persons outside the United States who come into possession of this prospectus must inform themselves about, and observe any restrictions relating to, the offering of the shares of common stock and the distribution of this prospectus outside of the United States.

 

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MARKET AND OTHER INDUSTRY DATA

We use statistical and economic market data and industry forecasts and projections throughout this prospectus, and in particular in the sections entitled “Summary—Our Market Opportunity” and “Industry Overview.” We have obtained substantially all of this information in the sections entitled “Summary—Our Market Opportunity—1-4 Unit Residential Rental Properties” and “Industry Overview—National Housing Market Overview” from a market study prepared for us in connection with this offering by John Burns Real Estate Consulting, LLC (which we refer to as “JBREC”), an independent research provider and consulting firm, based on the most recent data available as of September 2019, and we have obtained substantially all of this information in the section entitled “Summary—Our Market Opportunity—Small Commercial Properties” and “Industry Overview—Trends in Small Balance Lending” from a market study prepared for us in connection with this offering by Boxwood Means, LLC (“Boxwood”), an independent research provider and consulting firm, based on the most recent data available as of September 2019. Such information obtained from the JBREC market study is included in this prospectus based on JBREC’s authority as an expert on such matters, and such information obtained from the Boxwood market study is included in this prospectus based on Boxwood’s authority as an expert on such matters. Any forecasts prepared by JBREC or Boxwood are based on data (including third party data), models and the experience of various professionals, and are based on various assumptions (including the completeness and accuracy of third-party data), all of which are subject to change without notice. See “Summary—Our Market Opportunity,” “Industry Overview” and “Experts.”

In addition, this prospectus includes market and other industry data and estimates that are based on our management’s knowledge and experience in the markets in which we operate. The sources of such data generally state that the information they provide has been obtained from sources they believe to be reliable, but we have not investigated or verified the accuracy and completeness of such information. Our own estimates are based on information obtained from our and our affiliates’ experience in the markets in which we operate and from other contacts in these markets. We are responsible for all of the disclosure in this prospectus, and we believe our estimates to be accurate as of the date of this prospectus or such other date stated in this prospectus. However, this information may prove to be inaccurate because of the method by which we obtained some of the data for the estimates or because this information cannot always be verified with complete certainty due to the limits on the availability and reliability of raw data, the voluntary nature of the data gathering process and other limitations and uncertainties. As a result, you should be aware that market and other industry data included in this prospectus, and estimates and beliefs based on that data, may not be reliable.

 

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SUMMARY

This summary highlights the key aspects of this offering. It is not complete and may not contain all of the information that you may want to consider before investing in our common stock. You should read carefully the more detailed information set forth elsewhere in this prospectus, including under “Risk Factors” and in our consolidated financial statements and related notes before making an investment decision.

As used in this prospectus, unless the context otherwise requires, references to the “Company,” “we,” “us” and “our” refer to (1) following the date of the Conversion discussed under the heading “—Corporate Conversion,” Velocity Financial, Inc. and its consolidated subsidiaries, or any one or more of them as the context may require, and (2) prior to the date of the Conversion, Velocity Financial, LLC and its consolidated subsidiaries, or any one or more of them as the context may require. Additionally, references to our “board of directors” refer to (1) following the date of the Conversion, the board of directors of Velocity Financial, Inc., and (2) prior to the date of the Conversion, the board of managers of Velocity Financial, LLC. Except as otherwise indicated or the context otherwise requires, all information is presented giving effect to the Conversion. Except where otherwise noted, the consolidated financial statements and selected historical consolidated financial data and other financial information included in this prospectus are those of Velocity Financial, LLC and its subsidiaries and do not give effect to the Conversion.

Our Company

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 small commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 15 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers.

We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model capable of generating attractive risk-adjusted returns for our stockholders throughout various business cycles. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front-end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments.

Our growth strategy is predicated on continuing to serve and build loyalty within our network of mortgage brokers, while also expanding our network with new mortgage brokers through targeted marketing and improved brand awareness. We believe our reputation and 15-year history within our core market position us well to capture future growth opportunities.

Our Competitive Advantages

We believe that the following competitive advantages enhance our ability to execute our business strategy and position us well for continued growth:

Established Franchise with Strong Brand Recognition

We believe our reputation and deep history within the real estate lending community position us as a preferred lender for mortgage brokers. We have been originating and acquiring loans in our core market



 

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since our inception in 2004, making us a recognizable brand with a proven ability to execute. Additionally, we have successfully executed eleven securitizations of our investor real estate loans, raising over $2.4 billion in gross debt proceeds from May 2011 through July 2019. We have a keen understanding of this securitization market, including complicated structural issues, investor expectations and rating agency requirements. We believe we have a strong reputation with investors in the securitization market, which enables us to maintain efficient access to debt capital that ultimately improves our ability to offer competitive pricing to our borrowers.

Customized Technology and Proprietary Data Analytics

We have invested in and customized automated systems to support our use of data analytics which drives our lending process. We believe the investor real estate lending market requires a highly-specialized skill set and infrastructure. To effectively compete and execute on a sustainable long-term business strategy, lenders must control the cost to originate and manage loans without sacrificing credit quality. We believe our investment in technology and use of data analytics helps us achieve these critical objectives and positions our business for sustainable, long-term growth.

We apply the same asset-driven underwriting process to all of the loans in our portfolio, regardless of whether we originate or acquire these loans. Our credit and underwriting philosophy encompasses individual borrower and property due diligence, taking into consideration several factors. Our access to 15 years of proprietary data allows us to perform analytics that inform our lending decisions efficiently and effectively, which we believe is a strong competitive advantage.

Large In-Place Portfolio with Attractive, Long-Term Financing

We believe our in-place portfolio provides a significant and stable income stream for us to invest in future earnings growth. The majority of our loans are structured to provide for interest rate protection, by floating after an initial fixed-rate period, subject to a floor equal to the starting fixed rate. The loans are mainly financed with long-term fixed-rate debt, resulting in a spread that could increase over time, but not decrease. As a result, our in-place portfolio generally benefits from rising interest rates. Excluding the interest expense paid on our corporate debt, which we expect to partially repay with a portion of the net proceeds from this offering, we generated $33.7 million in portfolio related net interest income, representing a 4.05% portfolio related net interest margin, during the six months ended June 30, 2019. Including the interest expense paid on our corporate debt, we generated $26.9 million in total net interest income, representing a 3.25% net interest margin, during the six months ended June 30, 2019.

Our In-House Asset Management Results in Successful Loss Mitigation

Direct management of individual loans is critical to avoiding or minimizing credit losses and we work with our third-party primary servicers with whom we have developed strong relationships to emphasize disciplined loan monitoring and early contact with delinquent borrowers to resolve delinquencies. We have a dedicated asset management team that, augmented with primary servicing from our loan servicers, focuses exclusively on resolving delinquent loans. Our hands-on approach enables us to generally preserve the value of our assets and helps us to minimize losses. We believe this expertise, combined with our outsourced servicing relationships, gives us a distinct competitive advantage.

Our Experienced Management Team

Led by co-founder and Chief Executive Officer Christopher Farrar, our management team averages more than 25 years of experience in the financial services and real estate lending industries, including extensive experience in commercial and residential lending, structured finance and capital markets. We have successfully navigated both positive and negative economic cycles and retained our core team of



 

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experienced professionals in appraisal, underwriting, processing and production, while bolstering our finance and asset management team with professionals possessing extensive experience in financial reporting and real estate management. We believe our in-depth knowledge of our core market provides a distinct competitive advantage.

Our Growth Strategy

The market for investor real estate loans is large and highly fragmented. We have built a dedicated and scalable national lending platform focused specifically on serving this market and believe our capabilities position us well to maintain our reputation as a preferred lender in this market. Our growth strategy is predicated on further penetrating our existing network of mortgage brokers and expanding our network with new mortgage brokers. A key element of our implementation of this strategy is the growth and development of our team of account executives, as well as targeted marketing initiatives. We will continue to supplement the extension of our broker network with the development of new products to support the evolving needs of borrowers in our core market. In addition to our core origination business, we plan to continue to evaluate and opportunistically acquire portfolios of loans that meet our investment criteria.

Further Penetrate Our Existing Mortgage Broker Network

We strive to be the preferred lender within our network of approved mortgage brokers. We have developed a strong reputation in the market for high quality execution and timely closing, which we believe are the most important qualities our mortgage brokers value in selecting a lender. There is significant opportunity for us to further penetrate the more than 2,900 mortgage brokers with whom we have done business over the last five years. Approximately 95% of loan originators originated five or fewer loans with us during the six months ended June 30, 2019. We believe this presents a compelling opportunity for us to capture incremental volume from our existing broker network.

Expand Our Network with New Mortgage Brokers

We believe that our targeted sales effort, combined with consistent high quality execution, positions us well to continue adding to the network of mortgage brokers that rely on us to serve their borrower clients. During the six months ended June 30, 2019, we funded 1,301 loans sourced by approximately 690 different mortgage brokers, which we believe represents a small portion of the over 590,000 state-licensed mortgage originators in the United States as of December 31, 2018, according to the Nationwide Multistate Licensing System. The size of the mortgage broker market presents an attractive opportunity for us to capture significant growth with very small increases in the share of mortgage brokers that recognize our platform capabilities and utilize us as a preferred lender in our core market.

Develop New Products

Our primary product is a 30-year amortizing term loan with a three-year fixed-rate period which floats at a spread to the prime rate thereafter subject to a floor equal to the starting fixed rate. This product is used by borrowers to finance stabilized long-term real estate investments. We believe this product has strong receptivity in our market, as evidenced by our success in growing loan originations over time. Since our inception, we have continued to expand our product offering in response to developing market opportunities and the evolving financing needs of our broker network. For example, in 2013, in response to the increased demand for rental properties, we moved aggressively into the market for 1-4 unit residential rental loans, which comprised 46.3% of our held for investment loan portfolio as of June 30, 2019.

In March 2017, we began originating short-term, interest-only loans to be used for acquiring, repositioning or improving the quality of 1-4 unit residential investment properties. This product typically serves as an interim solution for borrowers and/or properties that do not meet the investment criteria of our



 

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primary 30-year product. The short-term, interest-only loan allows borrowers to address any qualifying issues with their credit and/or the underlying property before bridging into a longer-term loan. In June 2018, we added a second short-term, interest-only loan product which allows borrower draws for rehabbing residential rental property. Historically, we have aggregated and sold these short-term, interest-only loans at a premium to par to institutional investors, which has generated attractive income for us with limited capital while also allowing us to establish an underwriting track record and monitor the performance of these loans. Given our increased experience providing these loans, we are currently evaluating long-term financing alternatives for these loans and may elect to retain them in the future to be more consistent with our broader investment strategy of holding loans in our portfolio and earning a spread.

In June 2019, we began originating a 30-year fixed-rate amortizing term loan to complement our primary product as we believe there is meaningful demand for fixed-rate loans within our core market. More importantly, these loans provide our brokers with an alternative to the primary product enabling them to meet the specific needs of their customers.

Opportunistically Acquire Portfolios

We continually assess opportunities to acquire portfolios of loans that meet our investment criteria. Over the past 15 years, our management team has developed relationships with many financial institutions and intermediaries that have been active investor real estate loan originators or investors. We believe that our experience, reputation, and ability to effectively manage these loans makes us an attractive buyer for this asset class, and we are regularly asked to review pools of loans available for purchase. 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 augments our core origination business, but also provides a counter-cyclical benefit to our overall business.

Since 2008, we have reviewed over $10.3 billion of investor real estate loans, bid on approximately $523.8 million of loans that fell within our underwriting guidelines, and, through this process, selectively acquired 294 loans with total unpaid principal balance, or UPB, of $166.8 million.

Our Market Opportunity

We believe that there is a substantial and durable market opportunity for investor real estate loans across 1-4 unit residential rental and small commercial properties, and that our institutionalized approach to serving these fragmented market segments underpins our long-term business strategy. Our growth to date has validated the need for scaled lenders with dedication to individual investors who own ten or fewer properties, a base which we believe represents the vast majority of activity across our core market.

1-4 Unit Residential Rental Properties

Unless otherwise indicated, all statistical and economic market data and industry forecasts and projections included in this section “Summary—Our Market Opportunity—1-4 Unit Residential Rental Properties” is derived from a market study prepared for us in connection with this offering by John Burns Real Estate Consulting, LLC (which we refer to as “JBREC”), an independent research provider and consulting firm, based on the most recent data available as of September 2019. The following information contains forward-looking statements, which are subject to uncertainty, and you should review “Special Note Regarding Forward-Looking Statements.”

Residential housing is the largest real estate asset class in the United States with a total value of more than $27.2 trillion, according to the Federal Reserve Flow of Funds report for the first quarter of 2019. Since 1965, according to the U.S. Census Bureau, approximately one-third of this asset class has been rented. JBREC estimates that there were 45.7 million occupied rental units (including detached and attached units)



 

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in the United States as of June 2019, of which 15.7 million, or 34%, were one unit, or single-family, properties and an additional eight million units, or nearly 18%, were two to four unit properties.

 

 

LOGO

 

(1)

Source: JBREC, Federal Reserve, U.S. Census Bureau. Housing stock mix estimated using 2010 Census figures and trending data from the American Community Survey and Housing Vacancies and Homeownership.

JBREC believes a substantial portion of forecasted net household formation growth is expected to be renter households, which should strengthen demand for one to four unit residential rental properties. As the economy continues to drive job growth and the population ages, the U.S. Census Bureau reported a 1.2 million household increase year-over-year in the second quarter of 2019. This pace is similar to that experienced in other post-recessionary periods.

Demographic trends also will contribute to this future growth in renter households. Demographic shifts are forecast to increase the 35-44-year-old cohort (a primary driver of household formation) by 5.9 million people from 2018-2025, according to the U.S. Census Bureau. This cohort’s rentership rate grew from 32% in 2007 to 41% in 2019, consistent with an increasing propensity to rent across every age group driven by delaying of major life events, increasing student loan burdens, rising interest rates, and increasing underwriting criteria to obtain a mortgage.



 

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In addition, historically, JBREC believes many households merely preferred to rent due to the flexibility it provides. Consequently, the national rentership rate, which is the inverse of the homeownership rate as reported by the U.S. Census Bureau, has a long-term average of approximately 35% dating back to 1965. The national rentership rate is currently at 35.9%, after reaching a high of 37.1% in the second quarter of 2016, the highest rate since 1973.

 

 

LOGO

 

(1)

Source: U.S. Census Bureau. Rentership rate defined as the inverse of the homeownership rate as reported by the U.S. Census Bureau. Data for Q1 1965 through Q2 2019.

Historically, much of the ownership of one to four unit residential rental properties in the United States has been concentrated among smaller, non-institutional investors who own one to two properties. Since 2012, the single-family rental segment has been the most active, with larger institutional investors and operators acquiring these homes at scale, helping to grow the overall housing market share of single-family rental properties. Despite this growth, large institutional owners still own a very small percentage of these properties. The four largest publicly-traded, single-family rental REITs owned approximately 164,800 properties as of June 30, 2019, which constituted approximately 1.0% of the total 15.7 million single-family occupied rental housing stock. Although the precise number of properties owned by investors with 10 or more properties is unknown, JBREC believes that these institutional investors own approximately 7.0% of total single-family rental properties.

We believe the individual investors who own the vast remaining balance of these properties lack access to reliable financing given a number of factors, including government-sponsored enterprise (GSE) and bank exposure limitations and underwriting philosophies that deemphasize the meaningful personal equity typically invested, as well as a shortage of alternative lenders with the scale and desire to provide institutional financing in this market. As a result, we believe investors are forced to turn to local private money lenders or in many cases elect to purchase and hold their rental investment properties in cash. JBREC estimates that, at the time of purchase, mortgages were recorded on only 48%, or approximately 461,470, of the 963,400 non-owner occupied single-family properties purchased between October 2017 and September 2018.

Small Commercial Properties

Unless otherwise indicated, all statistical and economic market data and industry forecasts and projections included in this section “Summary—Our Market Opportunity—Small Commercial Properties” is



 

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derived from a market study prepared for us in connection with this offering by Boxwood Means, LLC (“Boxwood”), an independent research provider and consulting firm, based on the most recent data available as of September 2019. The following information contains forward-looking statements, which are subject to uncertainty, and you should review “Special Note Regarding Forward-Looking Statements.”

The U.S. commercial mortgage market had a record $574 billion in loan originations across various investor groups in 2018, according to an annual survey conducted by the Mortgage Bankers Association. Small-balance loans, or SBLs, account for a sizable subset of this lending market with an estimated $225 billion in loan originations in 2018, according to data from Boxwood. SBLs are typically defined as commercial mortgage loans secured by multifamily, mixed-use, and other commercial properties with an original amount of $5 million or less.

 

 

LOGO

 

(1)

Source: Boxwood. SBLs defined as commercial mortgage loans with an original amount of $5 million or less.

Given the size and diversity of collateral in the SBL market, there is substantial borrower demand for a wide range of loan sizes, which Boxwood broadly categorizes into two groupings: (i) loans of $1 million or less and (ii) loans of $1 million to $5 million. The majority of SBL originations, or nearly 70%, derive from the larger loan bucket, averaging an estimated annual volume of approximately $150 billion over the six-year period from 2013 to 2018. For loans of $1 million or less, originations averaged an estimated $70 billion per year for the same period.

Boxwood believes, however, that an enduring and distinguishing characteristic of the SBL market is the outsized quantity of smaller commercial mortgages that are backed by small income-producing and owner-user properties in communities across the country. The number of loans of $1 million or less far exceeds the amount originated in the larger bucket, averaging approximately 197 thousand per annum and representing over 70% of the total closed loans in the SBL market from 2013 to 2018. Boxwood believes this feature highlights the importance that such loans potentially play in wealth creation for private investors as well as in driving growth for small business owners, and also speaks to the significant fragmentation of the SBL market and extensive opportunities that have attracted lenders to the space.

Boxwood believes that, traditionally, commercial banks have been the leading source of debt financing in the SBL market but are increasingly vulnerable to the lending efforts of a wide variety of alternative or nonbank entities, including specialty finance companies, private lenders, debt funds, and online



 

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marketplace lenders. Over the six years ended in 2018, Boxwood’s research indicates that the top 15 lenders were still dominated by large national and regional banks, with only two nonbanks, CBRE Capital Markets and Arbor Commercial Mortgage, amongst the group. However, whereas these top 15 lenders commanded nearly 22% of the market in 2013, their aggregate market share narrowed to less than 18% in 2017 followed by a slight increase to 19% in 2018. Generally speaking, Boxwood believes that the market share of the top 15 lenders has been under pressure since 2012 when, following the financial crisis, the group’s share peaked at nearly 28%.

 

 

LOGO

 

(1)

Source: Boxwood. Based on top 15 lenders by origination volume from 2013 to 2018.

Boxwood believes that legacy systems, operational inefficiencies, and regulatory constraints have driven banks to pull back from SBL lending or move “up market” to larger loan sizes. Boxwood’s research indicates that the median loan size for the top 15 lenders increased steadily to over $1 million from 2013 to 2018, which Boxwood believes reflects a sharp decline in the number of loans originated by the group when combined with their declining share of annual origination volume over the same period. These factors create an opportunity for scaled nonbank lenders to both fill voids left by banks and better compete with banks through a more dedicated market focus and more nimble, technology-enabled platforms that can deliver greater speed and certainty of execution.

Our Portfolio

Loans Held for Investment

Our typical investor real estate loan is secured by a first lien on the underlying property with the added protection of a personal guarantee and, based on the loans in our portfolio as of June 30, 2019, has an average balance of approximately $321,000. As of June 30, 2019, our portfolio of loans held for investment totaled $1.7 billion of UPB on properties in 45 states and the District of Columbia. Of the 5,197 loans held for investment as of June 30, 2019, 97.5% of the portfolio, as measured by UPB, was attributable to our loan origination business, while the remaining 2.5% of the portfolio, or 95 loans, totaling $42.2 million in UPB,



 

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were related to acquisitions. During the year ended December 31, 2018 and the six months ended June 30, 2019, we originated 1,708 and 848 loans to be held for investment totaling $587.2 million and $291.8 million, respectively.

Our investor real estate loans held for investment have longer-term maturities compared to other commercial real estate loans. As of June 30, 2019, 99.9% of our loans held for investment, as measured by UPB, were fully-amortizing. The principal amount of a fully-amortizing loan is repaid ratably over the term of the loan, as compared to a balloon loan where all, or a substantial portion of, the original loan amount is due in a single payment at the maturity date. We believe that fully-amortizing loans face a lower risk of default than balloon loans, as the final payment due under the balloon loan may require the borrower to refinance or sell the property.

We target investor real estate loans with loan-to-value ratios, or LTVs, between 60% and 75% at origination as we believe that borrower equity of 25% to 40% provides significant protection against credit losses. As of June 30, 2019, our loans held for investment had a weighted average LTV at origination of 65.0%. Additionally, as of June 30, 2019, borrowers personally guaranteed 99.9% of the loans in our held for investment portfolio and had a weighted average credit score at origination of 707, excluding the 1.1% of loans for which a credit score is not available.

The following charts illustrate the composition of our loans held for investment as of June 30, 2019:

 

 

LOGO



 

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(*)

Percentages may not sum to 100% due to rounding.

(1)

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

(2)

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

(3)

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

Loans Held for Sale

Although our primary focus is long-term maturity real estate loans, we are continually assessing market developments for attractive opportunities in which we can leverage our experience, network and personnel. In March 2017, we began originating short-term, interest-only loans to be used for acquiring, repositioning or improving the quality of 1-4 unit residential investment properties. This product typically serves as an interim solution for borrowers and/or properties that do not meet the investment criteria of our primary 30-year product. The short-term, interest-only loan allows borrowers to address any qualifying issues with their credit and/or the underlying property before bridging into a longer-term loan. In June 2018, we added a second short-term, interest-only loan product which allows borrower draws for rehabbing residential rental property. Historically, we have aggregated and sold these short-term, interest-only loans at a premium to par to institutional investors, which has generated attractive income for us with limited capital while also allowing us to establish an underwriting track record and monitor the performance of these loans. Given our increased experience providing these loans, we are currently evaluating long-term financing alternatives for these loans and may elect to retain them in the future to be more consistent with our broader investment strategy of holding loans in our portfolio and earning a spread.

As of June 30, 2019, our portfolio of loans held for sale consisted of 306 loans with an aggregate UPB of $82.9 million, and carried a weighted average original loan term of 12 months and a weighted average coupon of 10.2%. As of June 30, 2019, 100% of our held for sale portfolio, as measured by UPB, was attributable to our loan origination business.

In line with our overall investment strategy, we target loans held for sale with LTVs between 60% and 75% at origination as we believe that borrower equity of 25% to 40% provides significant protection against credit losses. As of June 30, 2019, our loans held for sale had a weighted average LTV at origination of 67.0%. Additionally, as of June 30, 2019, borrowers personally guaranteed 100% of the loans in our held for sale portfolio and had a weighted average credit score at origination of 657.



 

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The following charts illustrate the composition of our loans held for sale as of June 30, 2019:

 

 

LOGO

 

(*)

Percentages may not sum to 100% due to rounding.

(1)

Portfolio stratifications based on unpaid principal balance for loans held for sale as of June 30, 2019.

(2)

Represents LTV at origination for population of loans held for sale as of June 30, 2019.

(3)

There are no loans held for sale with an LTV greater than 75%.

Recent Developments

July 2019 Securitization

In July 2019, we completed the securitization of $217.9 million of investor real estate loans, measured by UPB as of the July 1, 2019 cut-off date, issuing $207.0 million of non-recourse notes payable through the Velocity Commercial Capital Loan Trust 2019-2, or 2019-2. We are the sole beneficial interest holder of 2019-2, a variable interest entity that will be included in our consolidated financial statements. We refer to this transaction as the “July 2019 Securitization.”

August 2019 Refinancing

In August 2019, we entered into a new five-year $153.0 million corporate debt agreement with Owl Rock Capital Corporation, as lender. We used the proceeds of the term loans under this agreement,



 

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together with cash on hand, to redeem our outstanding senior secured notes and repurchase our outstanding Class C preferred units, which transaction we refer to as the “August 2019 Refinancing.”

Summary Risk Factors

An investment in shares of our common stock involves various risks. You should carefully consider the risks discussed below and under “Risk Factors” beginning on page 19 before purchasing shares of our common stock:

 

   

we are dependent upon the success of the investor real estate market and conditions that negatively impact this market may reduce demand for our loans and may adversely impact our business, results of operations and financial condition;

 

   

difficult conditions in the real estate markets, the financial markets and the economy generally may adversely impact our business, results of operations and financial condition;

 

   

we operate in a competitive market for loan origination and acquisition opportunities and competition may limit our ability to originate and acquire loans, which could adversely affect our ability to execute our business strategy;

 

   

loans to small businesses involve a high degree of business and financial risk, which can result in substantial losses that would adversely affect our business, results of operation and financial condition;

 

   

we have no operating history as a publicly traded company, and our inexperience could materially and adversely affect us;

 

   

we may change our strategy or underwriting guidelines without notice or stockholder consent, which may result in changes to our risk profile and net income;

 

   

a significant portion of our loan portfolio is in the form of investor real estate loans which are subject to increased risks;

 

   

funds affiliated with Snow Phipps Group LLC, or Snow Phipps, and an affiliate of a fund managed by Pacific Investment Management Company LLC, or TOBI, will own a substantial amount of our outstanding common stock following the closing of this offering and will have the ability to influence us;

 

   

we may not be able to successfully complete additional securitization transactions on attractive terms or at all, which could limit potential future sources of financing and could inhibit the growth of our business; and

 

   

if one or more of our warehouse repurchase facilities, on which we are dependent, are terminated, we may be unable to find replacement financing on favorable terms, or at all, which could have a material adverse effect on our business, results of operations and financial condition.

Corporate Conversion

We currently operate as a limited liability company formed in 2012, organized under the law of the State of Delaware and named Velocity Financial, LLC. Prior to the closing this offering, we will engage in the following transactions, which we refer to collectively as the “Conversion”:

 

   

we will convert from a Delaware limited liability company to a Delaware corporation by filing a certificate of conversion with the Secretary of State of the State of Delaware; and

 

   

we will change our name to Velocity Financial, Inc.



 

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The number of shares of common stock that holders of Velocity Financial, LLC units will receive in the Conversion is based on the initial public offering price in connection with this offering. Assuming an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, as part of the Conversion, holders of units of Velocity Financial, LLC will receive an aggregate of                  shares of common stock of Velocity Financial, Inc.

A $1.00 increase or decrease in the assumed initial public offering price would, as applicable, increase by                                          or decrease by                                          the number of shares of common stock received by holders of Velocity Financial, LLC units in the Conversion.

Our Corporate Information

Our offices are located at 30699 Russell Ranch Road, Suite 295, Westlake Village, California 91362, and the telephone number of our offices is (818) 532-3700. Our internet address is www.velocitymortgage.com. Our internet website and the information contained therein or connected to or linked from our internet web site are not incorporated information and do not constitute a part of this prospectus or any amendment or supplement thereto.



 

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The Offering

 

Common stock offered by us

             shares(1)

 

Common stock to be outstanding upon completion of this offering

             shares(1)(2)

 

Use of proceeds

We estimate that the net proceeds we will receive from this offering will be approximately $        million (or approximately $        million if the underwriters fully exercise their over-allotment option to purchase additional shares of our common stock), after deducting the underwriting discounts and commissions of approximately $        million (or approximately $        million if the underwriters fully exercise their over-allotment option to purchase additional shares of our common stock) and estimated offering expenses of approximately $        million payable by us.

 

  We intend to use approximately $        million of the net proceeds from this offering to repay a portion of our outstanding corporate debt, and the remainder for general corporate purposes, including originating or acquiring investor real estate loans.

 

Proposed New York Stock Exchange symbol

“VEL”

 

Risk factors

Investing in our common stock involves a high degree of risk. See “Risk Factors” beginning on page 19.

 

(1)

Assumes no exercise of the underwriters’ over-allotment option to purchase up to an additional                  shares of our common stock.

 

(2)

Assumes we offer the number of shares as set forth on the front cover of this prospectus and an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus. A $1.00 increase or decrease in the assumed initial public offering price would, as applicable, increase by                                          or decrease by                                         the number of shares outstanding upon completion of this offering, by                  shares, assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same.

Unless we indicate otherwise or the context requires, all information in this prospectus:

 

   

assumes that the Conversion has occurred based on an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus;

 

   

excludes                  shares of our common stock that may be issued in the future under our 2019 Omnibus Incentive Plan;

 

   

assumes no exercise by the underwriters of their over-allotment option to purchase up to              additional shares of common stock from us;

 

   

gives effect to the adoption and filing of our certificate of incorporation with the Secretary of State of Delaware and the adoption of our bylaws in connection with the Conversion; and

 

   

gives effect to our repurchase of our outstanding Class C preferred units on August 29, 2019 in connection with the August 2019 Refinancing.



 

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Summary Consolidated Financial and Other Information

The following tables summarize our consolidated financial and other data. We have derived the summary condensed results of operations data for the fiscal years ended December 31, 2018, 2017 and 2016 from our audited consolidated financial statements included elsewhere in this prospectus. We have derived the summary condensed results of operations data for the six months ended June 30, 2019 and 2018 and the summary consolidated statements of financial condition data as of June 30, 2019 from our unaudited consolidated interim financial statements included elsewhere in this prospectus. Our unaudited consolidated interim financial statements were prepared in accordance with U.S. generally accepted accounting principles, or U.S. GAAP, on the same basis as our audited consolidated financial statements and include, in the opinion of management, all adjustments, consisting of normal recurring adjustments, that are necessary for the fair statement of the financial information set forth in those financial statements. These interim results are not necessarily indicative of our results for the full fiscal year. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods. You should read this data in conjunction with “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes included elsewhere in this prospectus.

 

Summary Condensed Results of Operations
Data

  Six Months Ended
June 30,
    Year Ended December 31,  
    2019     2018         2018             2017             2016      
                (in thousands)  
    (unaudited)        

Interest income

  $  73,028     $ 58,956     $ 124,722     $ 97,830     $ 78,418  

Interest expense — portfolio related

    39,387       28,363       62,597       47,638       37,406  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income — portfolio related

    33,641       30,593       62,125       50,192       41,012  

Interest expense — corporate debt

    6,706       6,657       13,322       13,654       13,419  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    26,935       23,936       48,803       36,538       27,593  

Provision for (reversal of) loan losses

    560       (234     201       421       1,455  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    26,375       24,170       48,602       36,117       26,138  

Other operating income

    2,028       1,542       2,807       2,008       710  

Total operating expenses

    16,823       14,722       32,160       24,136       20,051  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    11,580       10,990       19,249       13,989       6,797  

Income tax expense

    3,350       5,714       8,700              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 8,230     $ 5,276     $ 10,549     $ 13,989     $ 6,797  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pro forma net income per share of common stock(1):

         

Basic

  $         $        
 

 

 

     

 

 

     

Diluted

  $         $        
 

 

 

     

 

 

     

Pro forma weighted average shares of common stock outstanding(1):

         

Basic

         

Diluted

         

 

(1)

Assumes conversion of Velocity Financial, LLC units into shares of our common stock in the Conversion.



 

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Consolidated Statements of Financial Condition
Data

   June 30,     December 31,  
   2019     2018     2017     2016  
           (in thousands)  
Assets         

Cash and cash equivalents

   $ 14,105     $ 15,008     $ 15,422     $ 49,978  

Restricted cash

     1,542       1,669       305       1,766  

Loans held for sale, net

     82,308       78,446       5,651        

Loans held for investment, net

     1,683,733       1,567,408       1,299,041       1,039,401  

Loans held for investment, at fair value

     2,974       3,463       4,632       7,278  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans, net

     1,769,015       1,649,317       1,309,324       1,046,679  

Accrued interest receivables

     11,326       10,096       7,678       5,954  

Receivables due from servicers

     33,618       40,473       25,306       22,234  

Other receivables

     3,321       974       1,287       439  

Real estate owned, net

     14,221       7,167       5,322       1,454  

Property and equipment, net

     5,045       5,535       5,766       3,875  

Net deferred tax asset

     5,698       2,986              

Other assets

     15,663       4,760       1,435       750  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total assets

   $ 1,873,554     $ 1,737,985     $ 1,371,845     $ 1,133,129  
  

 

 

   

 

 

   

 

 

   

 

 

 
Liabilities and Members’ Equity         

Accounts payable and accrued expenses

   $ 30,664     $ 26,629     $ 22,029     $ 12,264  

Secured financing, net

     127,062       127,040       126,486       119,286  

Securitizations, net

     1,261,455       1,202,202       982,393       742,890  

Warehouse repurchase facilities, net

     279,960       215,931       85,303       110,308  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities

     1,699,141       1,571,802       1,216,211       984,748  

Commitments and contingencies

        

Class C preferred units(1)

     27,400       26,465       24,691       23,036  

Members’ equity

     147,013       139,718       130,943       125,345  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total liabilities and members’ equity

   $ 1,873,554     $ 1,737,985     $ 1,371,845     $ 1,133,129  
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)   The Class C preferred units were repurchased in connection with the August 2019 Refinancing.

    

     June 30,     December 31,  

Portfolio Statistics(1)

   2019     2018     2017     2016  
           ($ in thousands)  

Total loans(2)

   $ 1,748,782     $ 1,631,326     $ 1,295,567     $ 1,038,033  

Loan count

     5,503       5,171       4,136       3,243  

Average loan balance(3)

   $ 318     $ 315     $ 313     $ 320  

Weighted average loan-to-value(4)

     65.0     63.8     64.4     64.5

Weighted average coupon(5)

     8.66     8.56     8.33     8.23

Nonperforming loans (UPB)(6)

   $ 104,180     $ 95,385     $ 74,943     $ 42,498  

Nonperforming loans (% of total)

     5.96     5.85     5.78     4.09

 

 

(1)

Reflects total portfolio of loans, including loans held for sale and loans held for investment, but does not reflect the July 2019 Securitization.

 

(2)

Reflects the aggregate unpaid principal balance of all loans, including loans held for sale and loans held for investment, at the end of the period. It excludes deferred origination costs, acquisition discounts, fair value adjustments and allowance for loan losses.

 

(3)

Reflects the average unpaid principal balance of all loans at the end of the period (i.e., total loans dividend by loan count).



 

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(4)

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.

 

(5)

Reflects the average coupon, or stated interest rate, on all loans at the end of the period weighted by unpaid principal balance.

 

(6)

Reflects unpaid principal balance of all loans that are 90 or more days past due, in bankruptcy or in foreclosure.

 

Key Performance Metrics

   Six Months Ended
June 30,
    Year Ended December 31,  
     2019     2018     2018     2017     2016  
     ($ in thousands)  

Average loans(1)

   $ 1,659,957     $ 1,345,135     $ 1,429,877     $ 1,167,999     $ 944,437  

Portfolio yield(2)

     8.80     8.77     8.72     8.38     8.30

Average debt — portfolio related(3)

   $ 1,466,799     $ 1,145,706     $ 1,234,818     $ 965,987     $ 802,683  

Average debt — total company(4)

   $ 1,594,393     $ 1,273,300     $ 1,362,412     $ 1,090,532     $ 914,467  

Cost of funds — portfolio related(5)

     5.37     4.95     5.07     4.93     4.66

Cost of funds — total company(6)

     5.78     5.50     5.57     5.62     5.56

Net interest margin — portfolio related(7)

     4.05     4.55     4.34     4.30     4.34

Net interest margin — total company(8)

     3.25     3.56     3.41     3.13     2.92

Charge-offs(9)

     0.01     0.02     0.03     0.09     0.13

Pre-tax return on equity(10)

     16.1     16.7     14.3     10.8     9.9

Return on equity

     11.4     8.0     7.8     10.8     9.9

 

(1)

Reflects daily average of total outstanding loans, including loans held for sale and loans held for investment, as measured by unpaid principal balance, over the specified period.

 

(2)

Reflects interest income earned on our total loan portfolio as a percentage of average loans over the specified period.

 

(3)

Reflects monthly average of all portfolio-related debt, which includes our warehouse repurchase facilities and securitizations, as measured by outstanding principal balance, over the specified period. Excludes our corporate debt.

 

(4)

Reflects monthly average of all company debt, which includes our portfolio-related debt and our corporate debt, as measured by outstanding principal balance, over the specified period.

 

(5)

Reflects interest expense incurred on our portfolio-related debt as a percentage of average portfolio-related debt over the specified period. Excludes our corporate debt.

 

(6)

Reflects interest expense incurred on all company debt as a percentage of average total debt over the specified period.

 

(7)

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 period. Excludes our corporate debt.

 

(8)

Measures the difference between the interest income earned on our loan portfolio and the interest expense paid on our total debt as a percentage of average loans over the specified period.



 

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(9)

Reflects charge-offs as a percentage of average loans held for investment over the specified period. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value.

 

(10)

Reflects income before income taxes as a percentage of the monthly average of members’ equity over the specified period. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Key Performance Metrics—Pre-Tax Return on Equity and Return on Equity.”

The following table presents a summary of our consolidated statement of financial condition as of June 30, 2019:

 

   

on an actual basis, derived from our unaudited statement of financial condition as of June 30, 2019;

 

   

on a “pro forma” basis, giving effect to the July 2019 Securitization, the August 2019 Refinancing, the Conversion and the adoption and filing of our certificate of incorporation with the Delaware Secretary of State prior to the closing upon the completion of this offering; and

 

   

on a “pro forma as adjusted” basis, giving further effect to our issuance and sale of                  shares of our common stock in this offering at an assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us and the application of the net proceeds from this offering as described in “Use of Proceeds.”

 

     June 30, 2019  
     Actual      Pro
Forma(1)
     Pro Forma As
Adjusted
 
     (unaudited, in thousands)  

Cash and cash equivalents

   $ 14,105      $                    $                

Total assets

     1,873,554        

Secured financing, net

     127,062        

Securitizations, net

     1,261,455        

Warehouse repurchase facilities, net

     279,960        

Total liabilities

     1,669,141        

Class C preferred units

     27,400        

Members’ equity

     147,013        

Total stockholders’ equity

            

 

(1)

In August 2019, we entered into a new five-year $153.0 million corporate debt agreement and used the proceeds of the term loans under this agreement, together with cash on hand, to redeem our outstanding senior secured notes and repurchase our outstanding Class C preferred units, which is reflected in the pro forma column as though it occurred on June 30, 2019.



 

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RISK FACTORS

An investment in shares of our common stock involves a number of risks. Before making an investment decision, you should carefully consider the following risk factors, together with the other information contained in this prospectus. If any of the risks discussed in this prospectus occurs, our business, financial condition, liquidity and results of operations could be materially and adversely affected, the market price of our common stock could decline significantly, and you could lose all or a part of your investment.

Risks Related to Our Business

We are dependent upon the success of the investor real estate market and conditions that negatively impact this market may reduce demand for our loans and adversely impact our business, results of operations and financial condition.

Our borrowers are primarily owners of residential rental and small commercial properties. Accordingly, the success of our business is closely tied to the overall success of the investors and small business owners in that market. Various changes in real estate conditions may impact this market. Any negative trends in such real estate conditions may reduce demand for our products and services and, as a result, adversely affect our results of operations. These conditions include:

 

   

oversupply of, or a reduction in demand for, residential rental and small commercial properties;

 

   

a change in policy or circumstances that may result in a significant number of potential residents of multifamily properties deciding to purchase homes instead of renting;

 

   

zoning, rent control or stabilization laws, or other laws regulating multifamily housing, which could affect the profitability of residential rental developments;

 

   

the inability of residents and tenants to pay rent;

 

   

changes in the tax code related to investment real estate;

 

   

increased operating costs, including increased real property taxes, maintenance, insurance, and utilities costs; and

 

   

potential liability under environmental and other laws.

Any or all of these factors could negatively impact the investor real estate market and, as a result, reduce the demand for our loans or the terms on which we are able to make our loans and, as a result materially and adversely affect us.

Difficult conditions in the real estate markets, the financial markets and the economy generally may adversely impact our business, results of operations and financial condition.

Our results of operations may be materially affected by conditions in the real estate markets, the financial markets and the economy generally. These conditions include changes in short-term and long-term interest rates, inflation and deflation, fluctuations in the real estate and debt capital markets and developments in national and local economies, unemployment rates, commercial property vacancy rates, and rental rates. Any deterioration of real estate fundamentals generally, and in the United States in particular, and changes in general economic conditions could decrease the demand for our loans, negatively impact the value of the real estate collateral securing our loans, increase the default risk applicable to borrowers, and make it relatively more difficult for us to generate attractive risk-adjusted returns.

We also are significantly affected by the fiscal, monetary, and budgetary policies of the U.S. government and its agencies. We are particularly affected by the policies of the Board of Governors of the Federal Reserve System, which we refer to as the Federal Reserve, which regulates the supply of money and

 

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credit in the United States. The Federal Reserve’s policies affect interest rates, which can have a significant impact on the demand for investor real estate loans. Significant fluctuations in interest rates as well as protracted periods of increases or decreases in interest rates could adversely affect the operation and income of the investment properties securing our loans, as well as the demand from investors for investor real estate loans in the secondary market. In particular, higher interest rates often decrease the number of loans originated. An increase in interest rates could cause refinancing of existing loans to become less attractive and qualifying for a loan to become more difficult.

We cannot predict the degree to which economic conditions generally, and the conditions for real estate debt investing in particular, will improve or decline. Any stagnation in or deterioration of the real estate markets may limit our ability to originate or acquire loans on attractive terms or cause us to experience losses related to our assets. Declines in the market values of our investments may adversely affect our results of operations and credit availability.

We operate in a competitive market for loan origination and acquisition opportunities and competition may limit our ability to originate and acquire loans, which could adversely affect our ability to execute our business strategy.

We operate in a competitive market for investment and loan origination and acquisition opportunities. Our profitability depends, in large part, on our ability to acquire our target assets at attractive prices and originate loans that allow us to generate compelling net interest margins. In acquiring our target assets or originating loans, we will compete with a variety of institutional investors, including REITs, specialty finance companies, public and private funds, commercial and investment banks, commercial finance and insurance companies and other financial institutions. Many of these competitors may enjoy competitive advantages over us, including:

 

   

greater name recognition;

 

   

a larger, more established network of correspondents and loan originators;

 

   

established relationships with mortgage brokers or institutional investors;

 

   

access to lower cost and more stable funding sources;

 

   

an established market presence in markets where we do not yet have a presence or where we have a smaller presence;

 

   

ability to diversify and grow by providing a greater variety of commercial real estate loan products on more attractive terms, some of which require greater access to capital and the ability to retain loans on the balance sheet; and

 

   

greater financial resources and access to capital to develop branch offices and compensate key employees.

Some competitors may have a lower cost of funds and access to funding sources that may not be available to us. Commercial banks may have an advantage over us in originating loans if borrowers already have a line of credit or construction financing with the bank. Commercial real estate service providers may have an advantage over us to the extent they also offer a larger or more comprehensive investment sales platform. In addition, some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of originations or loan acquisitions, and establish more relationships than us. Furthermore, competition for loans on our target assets may lead to the price of such assets increasing, which may further limit our ability to generate desired returns, and competition in investor real estate loan origination may increase the availability of investor real estate loans which may result in a reduction of interest rates on investor real estate loans. We cannot assure you that the competitive pressures we face will not have a material and adverse effect on our business, results of operations and financial condition. In addition, future changes in laws, regulations, and consolidation in the commercial real estate finance market could lead to the entry of more competitors. We cannot

 

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guarantee that we will be able to compete effectively in the future, and our failure to do so would materially and adversely affect us.

Loans to small businesses involve a high degree of business and financial risk, which can result in substantial losses that would adversely affect our business, results of operation and financial condition.

Our operations and activities include, without limitation, loans to small, privately owned businesses. Often, there is little or no publicly available information about these businesses. Accordingly, we must rely on our own due diligence to obtain information in connection with our investment decisions. Our borrowers may not meet net income, cash flow and other coverage tests typically imposed by banks. A borrower’s ability to repay its loan may be adversely impacted by numerous factors, including a downturn in its industry or other negative local or more general economic conditions. Deterioration in a borrower’s financial condition and prospects may be accompanied by deterioration in the collateral for the loan. In addition, small businesses typically depend on the management talents and efforts of one person or a small group of people for their success. The loss of services of one or more of these persons could have a material and adverse impact on the operations of the small business. Small companies are typically more vulnerable to customer preferences, market conditions and economic downturns and often need additional capital to expand or compete. These factors may have an impact on loans involving such businesses. Loans to small businesses, therefore, involve a high degree of business and financial risk, which can result in substantial losses, and in turn could have a material and adverse effect on our business, results of operations and financial condition.

We have no operating history as a publicly traded company, and our inexperience could materially and adversely affect us.

We have no operating history as a publicly traded company. Our board of directors and management team will have overall responsibility for our management. As a publicly traded company, we will be required to develop and implement substantial control systems, policies and procedures in order to satisfy our periodic Securities and Exchange Commission, or SEC, reporting and NYSE listing requirements. We cannot assure you that management’s past experience will be sufficient to successfully develop and implement these systems, policies and procedures and to operate our company. Failure to do so could jeopardize our status as a public company, and the loss of such status or the perception or anticipation by investors of a possible loss of such status could materially and adversely affect us.

The failure of a third-party servicer or the failure of our own internal servicing system to effectively service our portfolio of mortgage loans may adversely impact our business, results of operations and financial condition.

Most mortgage loans and securitizations of mortgage loans require a servicer to manage collections for each of the underlying loans. Nationstar Mortgage Holdings Inc. currently provides loan servicing on most of our loan portfolio, and we work with several other servicers for a small portion of our portfolio. We refer to these providers as our third-party loan servicers. A third-party loan servicer’s responsibilities include providing loan administration, issuing monthly statements, managing borrower insurance and tax impounds, sending delinquency notices, collection activity, all cash management and reporting on the performance of the loans. A third-party loan servicer may retain sub-servicers in any jurisdictions where licensing is required and the third-party loan servicer has not obtained the necessary license or where it otherwise deems it advisable. Both default frequency and default severity of loans may depend upon the quality of the servicer. If a third-party loan servicer or any sub-servicers are not vigilant in encouraging borrowers to make their monthly payments, the borrowers may be far less likely to make these payments, which could result in a higher frequency of default. If a third-party loan servicer or any sub-servicers takes longer to liquidate non-performing assets, loss severities may be higher than originally anticipated. Higher loss severity may also be caused by less competent dispositions of real estate owned, or REO.

 

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We have implemented our own internal special servicing and asset management capabilities and, as of June 30, 2019, we special service 429 distinct assets. The ability to internally service and manage loans in our portfolio, rather than rely on third-party loan servicers, has its own set of risks, including more direct exposure to lawsuits by borrowers and maintaining the necessary infrastructure to provide such special servicing capabilities.

Servicer quality, whether performed by third-party loan servicers or internally by us, is of prime importance in the default performance of investor real estate loans and securitizations. If we are unable to maintain our relationships with our third-party loan servicers, or they become unwilling or unable to continue to perform servicing activities, we could incur additional costs to obtain replacement loan servicers and there can be no assurance that a replacement servicer could be retained in a timely manner or at similar rates. Should we have to transfer loan servicing to another servicer for any reason, the transfer of our loans to a new servicer could result in more loans becoming delinquent because of confusion or lack of attention. Servicing transfers involve notifying borrowers to remit payments to the new servicer, and these transfers could result in misdirected notices, misapplied payments, data input errors and other problems. Industry experience indicates that mortgage loan delinquencies and defaults are likely to temporarily increase during the transition to a new servicer and immediately following the servicing transfer. Further, when loan servicing is transferred, loan servicing fees may increase, which may have an adverse effect on the credit support of assets held by us.

Effectively servicing our portfolio of mortgage loans is critical to our success, particularly given our strategy of maximizing the value of our portfolio with our proprietary loan modification programs and special servicing techniques, and therefore, if one of our third-party loan servicers or our internal special servicing fails to effectively service our portfolio of mortgage loans, it could have a material and adverse effect on our business, results of operations and financial condition.

We are dependent on certain of our key personnel for our future success, and their continued service to us is not guaranteed.

Our future success depends on the continued service of key personnel, including Christopher D. Farrar, our Chief Executive Officer, Mark R. Szczepaniak, our Chief Financial Officer, and Jeffrey T. Taylor, our Executive Vice President for Capital Markets, and our ability to attract new skilled personnel. We do not have employment contracts that provide severance payments and/or change in control benefits with most of our executive officers, and there can be no assurance that we will be able to retain their services. The departure of key personnel, until suitable replacements could be identified and hired, if at all, could have a material and adverse effect on our business, results of operations and financial condition.

Our growth strategy relies upon our ability to hire and retain qualified account executives, and if we are unable to do so, our growth could be limited.

We depend on our qualified account executives to generate broker relationships which leads to repeat and referral business. Accordingly, we must be able to attract, motivate and retain qualified account executives. The market for qualified account executives is highly competitive and may lead to increased costs to hire and retain them. We cannot guarantee that we will be able to attract or retain qualified account executives. If we cannot attract, motivate or retain a sufficient number of qualified account executives, or if our hiring and retention costs increase our business, results of operations and financial condition could be materially and adversely affected.

Inaccurate or incomplete information received from potential borrowers, guarantors and sellers involved in the sale of pools of loans could have a negative impact on our results of operation.

In deciding whether to extend credit or enter into transactions with potential borrowers and their guarantors, we are forced to primarily rely on information furnished to us by or on behalf of these potential borrowers or guarantors, including financial statements. We also must rely on representations of potential

 

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borrowers and guarantors as to the accuracy and completeness of that information and we must rely on information and representations provided by sellers involved in the sale of pools of loans that we purchase when we make bulk acquisitions. Our results of operations could be negatively impacted to the extent we rely on financial statements or other information that is misleading, inaccurate or incomplete.

Deficiencies in appraisal quality in the mortgage loan origination process may result in increased principal loss severity.

During the mortgage loan underwriting process, appraisals are generally obtained on the collateral underlying each prospective mortgage. The quality of these appraisals may vary widely in accuracy and consistency. The appraiser may feel pressure from the broker or lender to provide an appraisal in the amount necessary to enable the originator to make the loan, whether or not the value of the property justifies such an appraised value. Inaccurate or inflated appraisals may result in an increase in the severity of losses on the mortgage loans, which could have a material and adverse effect on our business, results of operations and financial condition.

We use leverage in executing our business strategy, which may adversely affect the return on our assets, as well as increase losses when economic conditions are unfavorable.

We leverage certain of our assets through borrowings under warehouse repurchase facilities and securitization transactions, as well as any corporate borrowings we may incur from time to time. Our use of leverage may enhance our potential returns and increase the number of loans that can be made, but may also substantially increase the risk of loss. There are no limits on the amount of leverage we may incur in our certificate of incorporation or bylaws. Our percentage of leverage will vary depending on our ability to obtain financing. Our two warehouse repurchase facilities and our new corporate debt agreement include certain financial covenants that limit our ability to leverage our assets. Our two warehouse repurchase facilities include covenants to maintain a maximum debt-to-tangible net-worth ratio of 6:1, while our new corporate debt agreement includes covenants to maintain a consolidated tangible net worth of at least $100 million plus 25% of consolidated net income (as defined in our new corporate debt agreement), a maximum debt to equity ratio of 1.50:1 or 1.25:1 (depending on the applicable term period and excluding warehouse and securitization debt), and an interest coverage ratio of 1.50:1 or 1.75:1 (depending on the applicable period and excluding warehouse and securitization debt). Our return on equity may be reduced if market conditions cause the cost of our financing to increase relative to the income that can be derived from our loan portfolio, which could adversely affect the price of our common stock. In addition, our debt service payments will reduce cash flow available for distributions to stockholders. We may not be able to meet our debt service obligations. To the extent that we cannot meet our debt service obligations, we risk the loss of some or all of our assets to foreclosure or sale to satisfy our debt obligations.

Our underwriting guidelines in the mortgage loan origination process may result in increased delinquencies and defaults.

Mortgage originators, including us, generally underwrite mortgage loans in accordance with their pre-determined loan underwriting guidelines, and from time to time and in the ordinary course of business, originators will make exceptions to these guidelines. There can be no assurance that our underwriting guidelines will identify or appropriately assess the risk that the interest and principal payments due on a loan will be repaid when due, or at all, or whether the value of the mortgaged property will be sufficient to otherwise provide for recovery of such amounts. Our underwriting guidelines are more narrow than some other mortgage lenders because we give primary consideration to the adequacy of the property as collateral and source of repayment for the loan rather than focusing on the personal income of the borrower. For example, while we emphasize credit scores in our underwriting process, there is no minimum credit score that a potential borrower must have in order to obtain a loan from us. Although we believe that this asset-driven approach is one of our competitive advantages, it may result in higher delinquency and default rates than those experienced by mortgage lenders with broader underwriting guidelines and/or those who require minimum credit scores or verify the personal income of their borrowers.

 

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On a case by case basis, our underwriters may determine that a prospective borrower that does not strictly qualify under our underwriting guidelines warrants an underwriting exception, based upon compensating factors. Compensating factors may include, but are not limited to, a lower LTV ratio, a higher debt coverage ratio, experience as a real estate owner or investor, higher borrower net worth or liquidity, stable employment, longer length of time in business and length of time owning the property. Loans originated with exceptions may result in a higher number of delinquencies and defaults, which could have a material and adverse effect on our business, results of operations and financial condition.

We may change our strategy or underwriting guidelines without notice or stockholder consent, which may result in changes to our risk profile and net income.

Our board of directors may change our strategy or any of our underwriting guidelines at any time without notice or the consent of our stockholders. We may also change our target assets and financing strategy without notice or the consent of our stockholders. Any of these changes could result in us holding a loan portfolio with a different risk profile from the risk profile described in this prospectus. Additionally, a change in our strategy or underwriting guidelines may increase our exposure to interest rate risk, default risk, real estate market fluctuations and liquidity risk, all of which could have a material and adverse effect on our business, results of operations and financial condition.

Our inability to manage future growth effectively could have an adverse impact on our business, results of operations and financial condition.

Our ability to grow will depend on our management’s ability to originate and/or acquire investor real estate loans. In order to do this, we will need to identify, hire, train, supervise and manage new employees. Any failure to effectively manage our future growth, including a failure to successfully expand our loan origination activities could have a material and adverse effect on our business, results of operations and financial condition.

If we fail to develop, enhance and implement strategies to adapt to changing conditions in the real estate and capital markets, our business, results of operations and financial condition may be materially and adversely affected.

The manner in which we compete and the loans for which we compete are affected by changing conditions, which can take the form of trends or sudden changes in our industry, regulatory environment, changes in the role of government-sponsored entities, changes in the role of credit rating agencies or their rating criteria or process or the United States economy more generally. If we do not effectively respond to these changes, or if our strategies to respond to these changes are not successful, our business, results of operations and financial condition may be materially and adversely affected.

Operational risks, including the risk of cyberattacks, could disrupt our business and materially and adversely affect our business, results of operations and financial condition.

Our financial, accounting, communications and other data processing systems may fail to operate properly or become disabled as a result of tampering or a breach of the network security systems or otherwise. In addition, such systems may be from time to time subject to cyberattacks and other cybersecurity incidents, which may continue to increase in sophistication and frequency in the future.

Breaches of our network security systems could involve attacks that are intended to obtain unauthorized access to our proprietary information or personal identifying information of our stockholders, destroy data or disable, degrade or sabotage our systems, including through the introduction of computer viruses and other malicious code, network failures, computer and telecommunication failures, infiltration by unauthorized persons and security breaches, usage errors by their respective professionals or service providers. If unauthorized parties gain access to such information and technology systems, they may be able to steal, publish, delete or modify private and sensitive information. Although we take various

 

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measures to ensure the integrity of such systems, there can be no assurance that these measures will provide protection. Breaches such as those involving covertly introduced malware, impersonation of authorized users and industrial or other espionage may not be identified even with sophisticated prevention and detection systems, potentially resulting in further harm and preventing it from being addressed appropriately.

Moreover, we are highly dependent on information systems and technology. Our information systems and technology may not continue to be able to accommodate our growth, and the cost of maintaining such systems may increase from its current level. Such a failure to accommodate growth, or an increase in costs related to such information systems, could have a material adverse effect on us.

We are headquartered in Westlake Village, California, in an area known for seismic activity and prone to wildfires. An earthquake, wildfire or other disaster or a disruption in the infrastructure that supports our business, including a disruption involving electronic communications or other services used by us or third parties with whom we conduct business, or directly affecting our headquarters, could have a material adverse impact on our ability to continue to operate our business without interruption. Our disaster recovery programs may not be sufficient to mitigate the harm that may result from such a disaster or disruption. Insurance and other safeguards might only partially reimburse us for our losses, if at all.

In addition, we rely on third-party service providers for certain aspects of our business, including software vendors for portfolio management and accounting software, outside financial institutions for back office processing and custody of securities and third-party broker-dealers for the execution of trades. An interruption or deterioration in the performance of these third parties or failures of their information systems and technology could cause system interruptions, delays, loss, corruption or exposure of critical data or intellectual property and impair the quality of our operations, which could impact our reputation and hence adversely affect our business.

Any such interruption or deterioration in our operations could result in substantial recovery and remediation costs and liability. While we have implemented disaster recovery plans and backup systems to lessen the risk of any material adverse impact, its disaster recovery planning may not be sufficient to mitigate the harm and cannot account for all eventualities, and a catastrophic event that results in the destruction or disruption of any data or critical business or information technology systems could severely affect our ability to conduct our business operations, and as a result, our future operating results could be materially and adversely affected.

Any disruption in the availability or functionality of our technology infrastructure and systems could have a material adverse effect on our business.

Our ability to originate and acquire investor real estate loans, execute securitizations, and manage any related interest rate risks and credit risks is critical to our success and is highly dependent upon the efficient and uninterrupted operation of our computer and communications hardware and software systems. Some of these systems are located at our facility and some are maintained by third-party vendors. Any significant interruption in the availability and functionality of these systems could harm our business. In the event of a systems failure or interruption by our third-party vendors, we will have limited ability to affect the timing and success of systems restoration. If such interruptions continue for a prolonged period of time, it could, have a material and adverse impact on our business, results of operations and financial condition.

Our security measures may not effectively prohibit others from obtaining improper access to our information. If a person is able to circumvent our security measures, he or she could destroy or misappropriate valuable information or disrupt our operations. Any security breach could expose us to risks of data loss, litigation and liability and could seriously disrupt our operations and harm our reputation.

 

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Risks Related to Our Loan Portfolio

A significant portion of our loan portfolio is in the form of investor real estate loans which are subject to increased risks.

Investor real estate loans are directly exposed to losses resulting from default and foreclosure. Therefore, the value of the underlying property, the creditworthiness and financial position of the borrower and the priority and enforceability of the lien will significantly impact the value of such mortgages. Whether or not we have participated in the negotiation of the terms of any such mortgages, there can be no assurance as to the adequacy of the protection of the terms of the loan, including the validity or enforceability of the loan and the maintenance of the anticipated priority and perfection of the applicable security interests. Furthermore, claims may be asserted that might interfere with enforcement of our rights. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us. Any costs or delays involved in the completion of a foreclosure of the loan or a liquidation of the underlying property will further reduce the proceeds and thus increase the loss.

A portion of our loan portfolio currently is, and in the future may be, delinquent and subject to increased risks of credit loss for a variety of reasons, including, without limitation, because the underlying property is too highly-leveraged or the borrower falls upon financial distress. Whatever the reason, the borrower may be unable to meet its contractual debt service obligation to us. Delinquent loans may require a substantial amount of workout negotiations or restructuring, which may divert our attention from other activities and entail, among other things, a substantial reduction in the interest rate or capitalization of past due interest. However, even if restructurings are successfully accomplished, risks still exist that borrowers will not be able or willing to maintain the restructured payments or refinance the restructured mortgage upon maturity.

Investor real estate loans, including performing and delinquent, are also subject to “special hazard” risk (property damage caused by hazards, such as earthquakes or environmental hazards, not covered by standard property insurance policies) and to bankruptcy risk (reduction in a borrower’s mortgage debt by a bankruptcy court). In addition, claims may be assessed against us on account of our position as mortgage holder or property owner, including responsibility for tax payments, environmental hazards and other liabilities.

Loans on properties in transition will involve a greater risk of loss than traditional investment-grade mortgage loans with fully insured borrowers.

While our primary focus is long-term maturity investor real estate loans, in March 2017, we began originating short-term, interest-only loans to be used for acquiring, repositioning or improving the quality of 1-4 unit residential investment properties. This product typically serves as an interim solution for borrowers and/or properties that do not meet the investment criteria of our primary 30-year product. The typical borrower of these rehab and resell loans has usually identified an undervalued asset that has been under-managed or is located in a recovering market. If the market in which the asset is located fails to improve according to the borrower’s projections, or if the borrower fails to improve the quality of the asset’s management or the value of the asset, the borrower may not receive a sufficient return on the asset to satisfy the transitional loan, and we bear the risk that we may not recover some or all of our investment.

In addition, borrowers usually use the proceeds of a conventional mortgage to repay a rehab and resell loan. Rehab and resell loans therefore are subject to risks of a borrower’s inability to obtain permanent financing to repay the loan. Rehab and resell loans are also subject to risks of borrower defaults, bankruptcies, fraud, losses and special hazard losses that are not covered by standard hazard insurance. In the event of any default under rehab and resell loans that may be held by us, we bear the risk of loss of principal and non-payment of interest and fees to the extent of any deficiency between the value of the mortgage collateral and the principal amount and unpaid interest of the transitional loan. To the extent we suffer such losses with respect to these loans, our business, results of operations and financial condition may be materially adversely affected.

 

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Any costs or delays involved in the completion of a foreclosure or liquidation of the underlying property may further reduce proceeds from the property and may increase the loss.

In the future, it is possible that we may find it necessary or desirable to foreclose on some, if not many, of the loans we acquire, and the foreclosure process may be lengthy and expensive. Borrowers may resist mortgage foreclosure actions by asserting numerous claims, counterclaims and defenses against us including, without limitation, numerous lender liability claims and defenses, even when such assertions may have no basis in fact, in an effort to prolong the foreclosure action and force us into a modification of the loan or a favorable buy-out of the borrower’s position. In some states, foreclosure actions can sometimes take several years or more to litigate. At any time prior to or during the foreclosure proceedings, the borrower may file for bankruptcy, which would have the effect of staying the foreclosure actions and further delaying the foreclosure process. Foreclosure may create a negative public perception of the related mortgaged property, resulting in a decrease in its value. Even if we are successful in foreclosing on a loan, the liquidation proceeds upon sale of the underlying real estate may not be sufficient to recover our cost basis in the loan, resulting in a loss to us. Furthermore, any costs or delays involved in the completion of a foreclosure of the loan or a liquidation of the underlying property will further reduce the proceeds and thus increase the loss. Any such reductions could materially and adversely affect the value of the commercial loans in which we invest and, therefore, could have a material and adverse effect on our business, results of operations and financial condition. In addition, if the federal or a U.S. state government imposes freezes on the ability of lenders to foreclose on property or requires lenders to modify loans, we may be precluded from foreclosing on, or exercising other remedies with respect to, the property underlying loans, or may be required to accept modifications not favorable to us.

Insurance on collateral underlying mortgage loans and real estate securities may not cover all losses.

There are certain types of losses, generally of a catastrophic nature, such as earthquakes, floods, hurricanes, terrorism or acts of war, that may be uninsurable or not economically insurable. Inflation, changes in building codes and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under these circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. Uninsured losses may also reduce the value of the underlying property. Any uninsured or underinsured loss could result in the loss of cash flow from, and the asset value of, the affected property.

Some of the mortgage loans we originate or acquire are loans made to self-employed borrowers who may have a higher risk of delinquency and default, which could have a material and adverse effect on our business, results of operations and financial condition.

Many of our borrowers are self-employed. The unpaid principal balance, or UPB, of loans to self-employed borrowers represented 69.0% of our total loan portfolio, or $1.2 billion, as of June 30, 2019. Self-employed borrowers may be more likely to default on their mortgage loans than salaried borrowers and generally have less predictable income. In addition, many self-employed borrowers are small business owners who may be personally liable for their business debt. Consequently, a higher number of self-employed borrowers may result in increased defaults on the mortgage loans we originate or acquire and, therefore, could have a material and adverse effect on our business, results of operations and financial condition.

We may be subject to lender liability claims, and if we are held liable under such claims, we could be subject to losses.

A number of judicial decisions have upheld the right of borrowers to sue lending institutions on the basis of various evolving legal theories, collectively termed “lender liability.” Generally, lender liability is founded on the premise that a lender has either violated a duty, whether implied or contractual, of good faith and fair dealing owed to the borrower or has assumed a degree of control over the borrower resulting

 

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in the creation of a fiduciary duty owed to the borrower or its other creditors or stockholders. We cannot assure prospective investors that such claims will not arise or that we will not be subject to significant liability if a claim of this type did arise.

Our portfolio of assets may at times be concentrated in certain property types or secured by properties concentrated in a limited number of geographic areas, which increases our exposure to economic downturn and natural disasters with respect to those property types or geographic locations.

We are not required to observe specific diversification criteria, except as may be set forth in the underwriting guidelines adopted by our board of directors. Therefore, our portfolio of assets may, at times, be concentrated in certain property types that are subject to higher risk of foreclosure, or secured by properties concentrated in a limited number of geographic locations.

Our loan portfolio changes over time, however, as of June 30, 2019, our loans were primarily concentrated in New York, California, Florida and New Jersey. Deterioration of economic conditions or natural disasters in these or in any other state in which we have a significant concentration of borrowers could have a material and adverse effect on our business by reducing demand for new financings, limiting the ability of customers to repay existing loans and impairing the value of our real estate collateral and real estate owned properties.

To the extent that our portfolio is concentrated in any region, or by type of property, downturns relating generally to such region, type of borrower or security, or the occurrence of natural disasters in those regions, may result in defaults on a number of our assets within a short time period, which may reduce our net income and the value of our common stock and accordingly reduce our ability to pay dividends to our stockholders.

The investor real estate loans we originate or acquire are dependent on the ability of the property owner to generate net income from operating the property, which may result in the inability of such property owner to repay a loan, as well as the risk of foreclosure.

The ability of a borrower to repay a loan secured by an income-producing property typically is dependent primarily upon the successful operation of such property rather than upon the existence of independent income or assets of the borrower. If the net operating income of the property is reduced, the borrower’s ability to repay the loan may be impaired. Net operating income of an income-producing property can be adversely affected by, among other things:

 

   

tenant mix;

 

   

success of tenant businesses;

 

   

property management decisions;

 

   

property location, condition and design;

 

   

competition from comparable types of properties;

 

   

changes in national, regional or local economic conditions or specific industry segments;

 

   

declines in regional or local real estate values;

 

   

declines in regional or local rental or occupancy rates;

 

   

increases in interest rates, real estate tax rates and other operating expenses;

 

   

costs of remediation and liabilities associated with environmental conditions;

 

   

the potential for uninsured or underinsured property losses;

 

   

changes in governmental laws and regulations, including fiscal policies, zoning ordinances and environmental legislation and the related costs of compliance; and

 

   

acts of God, terrorism, social unrest and civil disturbances.

 

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In the event of any default under a mortgage loan held directly by us, we will bear a risk of loss of interest and principal to the extent of any deficiency between the value of the collateral and the principal and accrued interest of the mortgage loan, which could have a material adverse effect on our cash flow from operations and limit amounts available for distribution to our stockholders. In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law.

Foreclosure can be an expensive and lengthy process and foreclosing on certain properties where we directly hold the mortgage loan and the borrower’s default under the mortgage loan is continuing could result in actions that could be costly to our operations, in addition to having a substantial negative effect on our anticipated return on the foreclosed mortgage loan.

We may be exposed to environmental liabilities with respect to properties to which we take title, which may in turn decrease the value of the underlying properties.

In the course of our business, we may take title to real estate, and, if we do take title, we could be subject to environmental liabilities with respect to these properties. In such a circumstance, we may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination, or we may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial. If we ever become subject to significant environmental liabilities, our business, financial condition, liquidity, and results of operations could be materially and adversely affected. In addition, an owner or operator of real property may become liable under various federal, state and local laws, for the costs of removal of certain hazardous substances released on its property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release of such hazardous substances. The presence of hazardous substances may adversely affect an owner’s ability to sell real estate or borrow using real estate as collateral. To the extent that an owner of an underlying property becomes liable for removal costs, the ability of the owner to make debt payments may be reduced, which in turn may adversely affect the value of the relevant mortgage-related assets held by us.

We will utilize analytical models and data in connection with the projections for our loan portfolio, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks.

We rely on analytical models (both proprietary models developed by us and those supplied by third parties) and information and data (both generated by us and supplied by third parties). Models and data will be used to make projections for our loan portfolio. When models and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. Some of the analytical models we use, such as mortgage prepayment models or mortgage default models, are predictive in nature. The use of predictive models has inherent risks. For example, such models may incorrectly forecast future behavior, leading to volatility in results. In addition, the predictive models used by us may differ substantially from those models used by other market participants

We may be required to repurchase or substitute mortgage loans or indemnify investors if we breach representations and warranties, which could harm our business, cash flow, results of operations and financial condition.

We have sold and, on occasion, we may sell some of our loans in the secondary market or as a part of a securitization of a portfolio of our loans. When we sell loans, we are required to make customary representations and warranties about such loans to the loan purchaser. Our mortgage loan sale agreements may require us to repurchase or substitute loans or indemnify investors in the event we breach a

 

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representation or warranty given to the loan purchaser. In addition, we may be required to repurchase loans as a result of borrower fraud or in the event of early payment default on a mortgage loan. Likewise, we may be required to repurchase or substitute loans or indemnify investors if we breach a representation or warranty in connection with our securitizations, if any.

The remedies available to a purchaser of mortgage loans are generally broader than those available to us against the originating broker or correspondent. Further, if a purchaser enforces its remedies against us, we may not be able to enforce the remedies we have against the sellers. The repurchased loans typically can only be financed at a steep discount to their repurchase price, if at all. They are also typically sold at a significant discount to the UPB. Significant repurchase activity could harm our business, cash flow, results of operations and financial condition.

Some of our portfolio assets may be recorded at fair value as estimated by management and may not reflect the price we could realize upon disposal.

Most of our portfolio assets will be in the form of loans that are not publicly traded. The fair value of securities and other assets that are not publicly traded is not readily determinable. Depending on whether these securities and other investments are classified as available-for-sale or held-to-maturity, we will value certain of these investments at fair value, as determined in accordance with Accounting Standards Codification™, or ASC, 820 — Fair Value Measurements, which may include unobservable inputs. Because such valuations are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, our determinations of fair value may differ materially from the values that would have been used if a ready market for these securities existed. Our results of operations and the value of our common stock could be adversely affected if our determinations regarding the fair value of these assets are materially higher than the values that we ultimately realize.

Risks Related to Our Organization and Structure

Snow Phipps and TOBI will own a substantial amount of our outstanding common stock following the closing of this offering and will have the ability to substantially influence us.

Following the closing of this offering, Snow Phipps will beneficially own approximately     % of our outstanding common stock and TOBI will beneficially own approximately     % of our outstanding common stock (in each case, assuming we offer the number of shares as set forth on the front cover of this prospectus at an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, and no exercise of the underwriters’ over-allotment option). In addition, pursuant to a stockholders agreement we intend to enter into with Snow Phipps and TOBI in connection with this offering, each of Snow Phipps and TOBI will have the right to designate certain persons as nominees for election as directors. Specifically, Snow Phipps will be entitled to designate up to two persons as director nominees and TOBI will be entitled to designate one person as a director nominee. As a result, although Snow Phipps and TOBI are not affiliated with each other, they may each be in a position to exercise significant influence over us, our board of directors and our management, affairs and transactions in a manner that you may not agree with or that you may not consider is in the best interest of all of our stockholders. In addition, the degree of control on our board of directors held by Snow Phipps and TOBI may be greater than their proportionate ownership of our common stock.

By virtue of Snow Phipps’ and TOBI’s stock ownership and voting power, in addition to their board nomination rights. Snow Phipps and TOBI have the power to significantly influence our business and affairs and are able to influence the outcome of matters required to be submitted to stockholders for approval, including the election of our directors, amendments to our certificate of incorporation, mergers or sales of assets. The influence exerted by Snow Phipps and TOBI over our business and affairs might not be consistent with the interests of some or all of our other stockholders. In addition, the concentration of ownership in our directors or stockholders associated with them may have the effect of delaying or preventing a change in control of our company, including transactions that would be in the best interests of

 

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our stockholders and would result in receipt of a premium to the price of our shares of common stock, and might negatively affect the market price of our common stock.

Our certificate of incorporation will provide that our directors who are affiliates of Snow Phipps and TOBI may engage in similar activities and lines of business as us, which may result in competition between us and such stockholders or another portfolio company of such stockholders for certain corporate opportunities.

Our certificate of incorporation will provide that our directors who are also employees or affiliates of Snow Phipps and TOBI may engage in similar activities or lines of business as us. Our certificate of incorporation will provide that no employees or affiliates of such stockholders, including those persons who are also our directors, have any obligation to refrain from (1) engaging directly or indirectly in the same or similar business activities or lines of business as us or developing or marketing any products or services that compete, directly or indirectly, with us, (2) investing or owning any interest in, or developing a business relationship with, any person or entity engaged in the same or similar business activities or lines of business as, or otherwise in competition with, us or (3) doing business with any of our clients or customers. In addition, our certificate of incorporation will provide that we have waived any interest or expectancy in any business or other opportunity that becomes known to a director of ours who is also an employee or affiliate of such stockholders unless the opportunity becomes known to that individual solely in his or her capacity as our director. As a result, certain of our directors who are also employees or affiliates of Snow Phipps or TOBI may compete with us for business and other opportunities, which may not be in the interest of all of our stockholders.

Some provisions of Delaware law and our organizational documents may deter third parties from acquiring us and may diminish the value of our common stock.

Certain provisions of the certificate of incorporation and bylaws that we will adopt upon the Conversion may have the effect of delaying or preventing a merger, acquisition, tender offer, takeover attempt or other change of control transaction that a stockholder might consider to be in its best interest, including attempts that might result in a premium over the market price of our common stock.

These provisions provide for, among other things:

 

   

the ability of our board of directors to issue one or more series of preferred stock with voting or other rights or preferences that could have the effect of impeding the success of an attempt to acquire us or otherwise effect a change of control;

 

   

advance notice for nominations of directors by stockholders and for stockholders to include matters to be considered at stockholder meetings;

 

   

certain limitations on convening special stockholder meetings; and

 

   

certain limitations regarding business combinations with any “interested stockholder.”

These provisions could make it more difficult for a third party to acquire us, even if the third-party’s offer may be considered beneficial by many of our stockholders. As a result, our stockholders may be limited in their ability to obtain a premium for their shares. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging future takeover attempts. These provisions could also make it more difficult for our stockholders to nominate directors for election to our board of directors and take other corporate actions. See “Description of Capital Stock.”

Failure to comply with requirements to design, implement and maintain effective internal controls, as well as a failure to remediate any identified weaknesses in our internal controls, could have a material adverse effect on our reputation, business and stock price.

As a privately-held company, we were not required to evaluate our internal control over financial reporting in a manner that meets the standards of publicly traded companies required by Section 404(a) of

 

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the Sarbanes-Oxley Act, or Section 404. As a public company, we will have significant requirements for enhanced financial reporting and internal controls. The process of designing and implementing effective internal controls is a continuous effort that requires us to anticipate and react to changes in our business and the economic and regulatory environments and to expend significant resources to maintain a system of internal controls that is adequate to satisfy our reporting obligations as a public company. If we are unable to establish or maintain appropriate internal financial reporting controls and procedures, it could cause us to fail to meet our reporting obligations on a timely basis, result in material misstatements in our consolidated financial statements and harm our results of operations. In addition, we will be required, pursuant to Section 404, to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting in the second annual report following the completion of this offering. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. The rules governing the standards that must be met for our management to assess our internal control over financial reporting are complex and require significant documentation, testing and possible remediation. Testing and maintaining internal controls may divert management’s attention from other matters that are important to our business. We will be required to include an attestation report on the effectiveness of our internal controls over financial reporting issued by our independent registered public accounting firm in our second annual report following the completion of this offering.

In reviewing the accounting for a certain transaction we completed in January 2018, as part of our 2018 election to be treated as a corporation for U.S. federal and state income tax purposes, as described below under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operation—Components of Results of Operations—Provision for Income Taxes,” our management identified a deficiency in the effectiveness of a control intended to properly document and review relevant facts and apply the appropriate tax accounting under U.S. GAAP, which impacted the beginning of year deferred tax asset and income tax benefit accounts and related disclosures. Our personnel responsible for preparing the opening deferred tax assets and liabilities and year-end deferred tax assets and liabilities did not have sufficient expertise to properly calculate the deferred tax positions. We did not perform a risk assessment to identify their lack of expertise in order to implement a sufficient control structure to prevent or detect the material misstatements in their income taxes accounts. The beginning of year deferred tax assets and liabilities, and the income tax benefits accounts and related disclosures were corrected as of the end of 2018. Management has concluded that the deficiency constitutes a material weakness in our internal control over financial reporting and, as a result, our internal control over financial reporting was not effective as of December 31, 2018.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements will not be prevented or detected on a timely basis. We have implemented a plan to remediate this material weakness by contracting with a nationally recognized accounting firm to have experienced tax personnel supplement and train our current accounting team. Although we believe this plan will be adequate to address the material weakness, there can be no assurance that the material weakness will be remediated on a timely basis or at all, or that additional material weaknesses will not be identified in the future. If we are unable to remediate the material weakness, our ability to record, process and report financial information accurately, and to prepare financial statements within the time periods specified by the rules and forms of the SEC, could be adversely affected which, in turn, to may adversely affect our reputation and business and the market price of our common stock.

 

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Our certificate of incorporation will provide, subject to limited exceptions, that the Court of Chancery of the State of Delaware and the federal district courts of the United States of America will be the sole and exclusive forums for certain stockholder litigation matters, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or stockholders.

Our certificate of incorporation will provide, subject to limited exceptions, that unless we consent to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall, to the fullest extent permitted by law, be the sole and exclusive forum for any (1) derivative action or proceeding brought on behalf of our company, (2) action asserting a claim of breach of a fiduciary duty owed by any director, officer, or other employee or stockholder of our company to the Company or our stockholders, creditors or other constituents, (3) action asserting a claim against the Company or any director or officer of the Company arising pursuant to any provision of the Delaware General Corporation Law, or the DGCL, or our certificate of incorporation or our bylaws or as to which the DGCL confers jurisdiction on the Court of Chancery of the State of Delaware, or (4) action asserting a claim against the Company or any director or officer of the Company governed by the internal affairs doctrine. Our certificate of incorporation will further provide that, to the fullest extent permitted by law, the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the United States federal securities laws.

Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and consented to the forum provisions in our certificate of incorporation. These choice of forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or any of our directors, officers, other employees or stockholders which may discourage lawsuits with respect to such claims. Alternatively, if a court were to find the choice of forum provisions contained in our certificate of incorporation to be inapplicable or unenforceable with respect to one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such action in other jurisdictions, which could harm our business, operating results and financial condition.

Our board of directors will be authorized to issue and designate shares of our preferred stock in additional series without stockholder approval.

Our certificate of incorporation will authorize our board of directors, without the approval of our stockholders, to issue          shares of our preferred stock, subject to limitations prescribed by applicable law, rules and regulations and the provisions of our certificate of incorporation, as shares of preferred stock in series, to establish from time to time the number of shares to be included in each such series and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. The powers, preferences and rights of these additional series of preferred stock may be senior to or on parity with our common stock, which may reduce its value.

Risks Related to Sources of Financing

We may not be able to successfully complete additional securitization transactions on attractive terms or at all, which could limit potential future sources of financing and could inhibit the growth of our business.

We have financed a large portion of our loan portfolio as securitizations, and we plan to securitize newly originated loans to repay our warehouse repurchase facilities, provide for long-term financing and generate cash for funding new loans. We plan to continue to structure these securitizations so that they are treated as financing transactions, and not as sales, for U.S. GAAP purposes. This involves creating a special-purpose vehicle, contributing a pool of our assets to the entity and selling non-recourse debt securities to purchasers. We retain a portion of the “first loss” subordinated securities issued by our trusts and, as a result, we are the first tranche exposed to principal losses in the event the trust experiences a loss.

 

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We use short-term credit facilities to finance the origination or acquisition of investor real estate loans until a sufficient quantity of eligible assets has been accumulated, at which time we would refinance these short-term facilities through a securitization of the eligible assets, such as issuances of commercial mortgage-backed securities or collateralized loan obligations or the private placement of loan participations or other long-term financing. When we employ this strategy, we are subject to the risk that we would not be able to obtain, during the period that our short-term facilities are available, a sufficient amount of eligible assets to maximize the efficiency of a securitization. We are also subject to the risk that we are not able to obtain short-term credit facilities or are not able to renew any short-term credit facilities after they expire should we find it necessary to extend such short-term credit facilities to allow more time to obtain the necessary eligible assets for a long-term financing.

From time to time one or more credit rating agencies may rate our new or existing securitizations. A lower than expected rating by one or more of these agencies or a reduction or withdrawal of a credit rating may adversely impact our ability to complete new securitizations on attractive terms or at all.

The inability to consummate securitizations of our portfolio or secure other financing arrangements on satisfactory terms to finance our loans on a long-term basis could require us to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or price, which could have a material and adverse effect on our business, results of operations and financial condition.

If one or more of our warehouse repurchase facilities, on which we are dependent, are terminated, we may be unable to find replacement financing on favorable terms on a timely basis, or at all, which would have a material adverse effect on our business, results of operations and financial condition.

We require a significant amount of short-term funding capacity for loans we originate. Consistent with industry practice, two of our existing warehouse repurchase facilities are short-term, requiring annual renewal. If any of our committed facilities are terminated or are not renewed or our uncommitted facilities are not honored, we may be unable to find replacement financing on favorable terms on a timely basis, or at all, and we might not be able to originate loans, which would have a material adverse effect on us. Additionally, as our business continues to expand, we may need additional warehouse funding capacity for loans we originate. There can be no assurance that, in the future, we will be able to obtain additional warehouse funding capacity on favorable terms, on a timely basis, or at all.

We may be required to maintain certain levels of collateral or provide additional collateral under our warehouse repurchase facilities, which may restrict us from leveraging our assets as fully as desired or forcing us to sell assets under adverse market conditions, resulting in potentially lower returns.

We currently finance our originations and investments in investor real estate using three warehouse repurchase facilities, which are our short-term revolving full recourse master repurchase agreements secured by certain of our underlying mortgage loans. Under our revolving warehouse repurchase facilities, the amount of available financing on our investor real estate loan portfolio is reduced based on the delinquency performance of the individual loans pledged under these facilities, and if the delinquency in our loan portfolio increases beyond certain levels, we may be required to pledge additional collateral, pay down a portion of the outstanding balance of these warehouse repurchase facilities, or liquidate assets at a disadvantageous time to avoid violating certain financial covenants contained therein and triggering a foreclosure on our collateral, any of which could cause us to incur further losses and have a material and adverse effect on our business, results of operations and financial condition.

In the event we do not have sufficient liquidity to pay down the financing when loan performance deteriorates, lending institutions can accelerate our indebtedness, increase our borrowing rates, liquidate our collateral and terminate our ability to borrow.

Further, our revolving warehouse repurchase facility agreements contain various financial and other restrictive covenants, including covenants that require us to maintain a certain amount of cash that is not invested or to set aside non-levered assets sufficient to maintain a specified liquidity position, which would

 

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allow us to satisfy our collateral obligations. As a result, we may not be able to leverage our assets as fully as we would choose, which could reduce our return on equity. In the event that we are unable to meet these collateral obligations, as described above, our financial condition could deteriorate rapidly. In addition, if we fail to satisfy any of the financial or other restrictive covenants, or otherwise default under our revolving warehouse repurchase facilities, the lenders have the right to accelerate repayment and terminate the facilities. Accelerating repayment and terminating the facilities would require immediate repayment by us of the borrowed funds, which may require us to liquidate assets at a disadvantageous time, causing us to incur further losses and have a material and adverse effect on our business, our results of operations and financial condition.

If a counterparty to our repurchase transactions defaults on its obligation to resell the underlying asset back to us at the end of the transaction term, or if the value of the underlying asset has declined as of the end of that term, or if we default on our obligations under the repurchase agreement, we will lose money on our repurchase transactions.

When we engage in repurchase transactions, we generally sell assets to lenders and receive cash from these lenders. The lenders are obligated to resell the same assets back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the assets to the lender is less than the value of those assets (this difference is the haircut), if the lender defaults on its obligation to resell the same assets back to us we may incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the value of the assets). We would also lose money on a repurchase transaction if the value of the underlying assets has declined as of the end of the transaction term, as we would have to repurchase the assets for their initial value but would receive assets worth less than that amount. Further, if we default on one of our obligations under a repurchase transaction, the lender can terminate all of the outstanding repurchase transactions with us and can cease entering into any other repurchase transactions with us. Our repurchase agreements contain cross-default provisions, so that if a default occurs under any one agreement, the lenders under our other agreements could also declare a default. Any losses we incur on our repurchase transactions could have a material and adverse effect on our business, our results of operations and financial condition.

Interest rate fluctuations could negatively impact our net interest income, cash flows and the market value of our investments.

Our primary interest rate exposures will relate to the yield on our investments and the financing cost of our debt, as well as interest rate swaps we may utilize for hedging purposes. Changes in interest rates will affect our net interest income, which is the difference between the interest income we earn on our interest-earning investments and the interest expense we incur in financing these investments. Changes in the level of interest rates also may affect our ability to invest in assets, the value of our investments and our ability to realize gains from the disposition of assets. Changes in interest rates may also affect borrower default rates if a significant percentage of borrowers have mortgages that reset to a substantially higher interest rate and are unable to make their new monthly payments as obligated under the terms of the mortgage loan.

While the interest rates used to calculate interest expense on our financing lines are subject to floors to the extent that our financing costs will be determined by reference to floating rates (such as LIBOR or a Treasury index) plus a margin, the amount of such margin will depend on a variety of factors, including, without limitation, (1) for collateralized debt, the value and liquidity of the collateral, and for non-collateralized debt, our credit, (2) the level and movement of interest rates and (3) general market conditions and liquidity. In a period of rising interest rates, our interest expense on floating rate debt would increase, and it is possible that any additional interest income we earn on our floating rate investments may not compensate for such increase in interest expense. Furthermore, during a period of rising interest rates, the interest income we earn on our fixed rate investments would not change, the duration and weighted average life of our fixed rate investments would increase and the market value of our fixed rate investments would decrease. Similarly, in a period of declining interest rates, the interest income generated on floating

 

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rate investments would decrease, while any decrease in the interest we are charged on our floating rate debt may not compensate for such decrease in interest income and interest we are charged on our fixed rate debt would not change. Any such scenario could materially and adversely affect or business, results of operations and financial condition.

Interest rate mismatches between our loans and our borrowings used to fund our portfolio may reduce our income during periods of changing interest rates.

We fund some of our loan portfolio with borrowings that have interest rates based on indices and repricing terms similar to, but of shorter maturities than, the interest rate indices and repricing terms of our loans. Accordingly, if short-term interest rates increase, this may adversely affect our profitability.

The majority of our loan portfolio is comprised of adjustable rate mortgages, or ARMs. The interest rate indices and re-pricing terms of the loans and their funding sources will not be identical, thereby creating an interest rate mismatch between our assets and liabilities. There have been periods when the spread between these indices was volatile. During periods of changing interest rates, these mismatches could reduce our net income and the market price of our common stock.

Interest rate caps on our ARMs may reduce our income or cause us to suffer a loss during periods of rising interest rates.

Our ARMs are subject to periodic and lifetime interest rate caps. Periodic interest rate caps limit the amount an interest rate can increase during any given period. Lifetime interest rate caps limit the amount an interest rate can increase through maturity of a loan. Our borrowings, including our warehouse repurchase facilities and securitizations, are not subject to similar restrictions. Accordingly, in a period of rapidly increasing interest rates, the interest rates paid on our borrowings could increase without limitation while interest rate caps would limit the interest rates on our ARMs. This problem is magnified for our ARMs that are not fully indexed. As a result, we could receive less cash income on ARMs than we need to pay interest on our related borrowings. These factors could lower our net interest income or cause us to suffer a loss during periods of rising interest rates.

Our existing and future financing arrangements and any debt securities we may issue could restrict our operations and expose us to additional risk.

Our existing and future financing arrangements (including term loan facilities, revolving credit facilities, warehouse repurchase facilities and securitizations) and any debt securities we may issue in the future are or will be governed by a credit agreement, indenture or other instrument containing covenants restricting our operating flexibility. Additionally, any convertible or exchangeable securities that we issue in the future may have rights, preferences and privileges more favorable than those of our common stock. We will bear the cost of issuing and servicing such credit facilities, arrangements or securities.

Under our warehouse repurchase facilities, the lenders have specific rights, including but not limited to, the right to review assets for which we are seeking financing, the right to hold a perfected security interest in certain of our assets, the right to accelerate payments due under the warehouse repurchase facilities, the right to restrict dividend payments made to us by certain of our wholly owned subsidiaries and the right to approve the sale of assets. We are a holding company that conducts all of our operations through wholly owned subsidiaries. Although our warehouse repurchase facilities do not limit our rights to pay dividends directly to stockholders, restrictions on our subsidiaries paying dividends to us limits our ability to receive cash from such wholly owned subsidiaries. These restrictive covenants and operating restrictions could have a material adverse effect on our business and operating results, restrict our ability to finance or securitize new originations and acquisitions, force us to liquidate collateral.

We may use derivative instruments, which could subject us to increased risk of loss.

We may use derivative instruments to help manage interest rate exposure. The prices of derivative instruments, including futures and options, are highly volatile. Payments made pursuant to swap

 

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agreements may also be highly volatile. In addition, our derivative instruments are subject to the risk of the failure of the exchanges on which our positions trade or of our clearinghouses or counterparties. Our option transactions may be part of a hedging strategy (i.e., offsetting the risk involved in another securities position) or a form of leverage, in which we will have the right to benefit from price movements in a large number of securities with a small commitment of capital. These activities involve risks that can be substantial, depending on the circumstances.

Uncertainty about the future of LIBOR could negatively impact our cost of funds, net interest income, cash flows and financial performance.

Borrowings under our 2019 Term Loans, revolving credit facility and warehouse repurchase facilities bear interest at rates that are calculated based on LIBOR. On July 27, 2017, the Chief Executive of the United Kingdom Financial Conduct Authority, which regulates LIBOR, announced that it intends to stop persuading or compelling banks to submit rates for the calibration of LIBOR to the administrator of LIBOR after 2021. The announcement indicates that the continuation of LIBOR in its current form cannot be assured after 2021. It is impossible to predict whether and to what extent banks will continue to provide LIBOR submissions to the administrator of LIBOR, if the administrator will continue to quote LIBOR after 2021 or, if it does continue to quote LIBOR, whether it will be determined on a consistent basis with the existing definition and will behave in a consistent manner to existing LIBOR, or whether any additional reforms to LIBOR may be enacted in the United Kingdom or elsewhere. Although alternative reference rates have been proposed, it is unknown whether these alternative reference rates will attain market acceptance as replacements of LIBOR.

If LIBOR ceases to exist, the method and rate used to calculate our interest rates and/or payments on our 2019 Term Loans, revolving credit facility and warehouse repurchase facilities in the future may result in interest rates and/or payments that are higher than, lower than, or that do not otherwise correlate over time with the interest rates and/or payments that would have been made on our obligations if LIBOR was available in its current form. Furthermore, although the variable interest component of our existing loan portfolio is based on the prime rate rather than LIBOR, uncertainty in the lending markets related to the future of LIBOR could increase the prime rate, which may increase borrower defaults and increase our credit losses. In addition, while our existing securitizations are largely fixed-rate debt, uncertainty in the lending markets related to the future of LIBOR could increase the general level of interest rates and risk spreads on our future securitizations. There is currently no definitive information regarding the future utilization of LIBOR or of any particular replacement rate. As such, the potential effect of any such event on our cost of capital, financial results, cash flows and financial performance cannot yet be determined.

Risks Relating to Regulatory Matters

The increasing number of proposed United States federal, state and local laws may affect certain mortgage-related assets in which we intend to invest and could materially increase our cost of doing business.

Various legislation, including related to federal bankruptcy law and foreclosure actions under state law, has been proposed that, among other provisions, could allow judges to modify the terms of residential mortgages in bankruptcy proceedings, could hinder the ability of the servicer to foreclose promptly on defaulted mortgage loans or permit limited assignee liability for certain violations in the mortgage loan origination process, any or all of which could adversely affect our business or result in us being held responsible for violations in the mortgage loan origination process even where we were not the originator of the loan. We do not know what impact this type of legislation, which has been primarily, if not entirely, focused on residential mortgage originations, would have on the investor real estate loan market. We are unable to predict whether United States federal, state or local authorities, or other pertinent bodies, will enact legislation, laws, rules, regulations, handbooks, guidelines or similar provisions that will affect our business or require changes in our practices in the future, and any such changes could materially and adversely affect our cost of doing business and profitability. We may be subject to liability for potential

 

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violations of various lending laws, which could adversely impact our business, results of operations and financial condition.

Mortgage loan originators and servicers operate in a highly regulated industry and are required to comply with various federal, state and local laws and regulations. If any of our loans are found to have been originated, serviced or owned by us or a third-party in violation of applicable law, we could be subject to lawsuits or governmental actions, or we could be fined or incur losses. In respect of our mortgage loan originations and acquisitions, if any third-party mortgage brokers, originators or servicers fail to comply with applicable law, it could subject us, as lender, assignee or purchaser of the related mortgage loans, to monetary penalties or other losses. Any such outcome could have a material and adverse effect on our business, results of operations and financial condition.

The securitization process is subject to an evolving regulatory environment that may affect certain aspects of our current business.

As a result of the dislocation of the credit markets during the previous recession, and in anticipation of more extensive regulation, including regulations promulgated pursuant to the Dodd-Frank Act, the securitization industry has crafted and continues to craft changes to securitization practices, including changes to representations and warranties in securitization transaction documents, new underwriting guidelines and disclosure guidelines. Various U.S. federal agencies, including the SEC, as well as the European Union have promulgated regulations with respect to issues that affect securitizations.

On October 21, 2014, the final rules implementing the credit risk retention requirements of Section 941 of the Dodd–Frank Act, or the U.S. Risk Retention Rules, were issued and have since become effective with respect to all asset classes. The risk retention rules generally require the sponsor of a securitization to retain not less than 5% of the credit risk of the assets collateralizing the issuer’s mortgage- backed securities. When applicable, the risk retention rules generally require the “securitizer” of a “securitization transaction” to retain at least 5% of the “credit risk” of “securitized assets,” as such terms are defined for purposes of that statute, and generally prohibit a securitizer from directly or indirectly eliminating or reducing its credit exposure by hedging or otherwise transferring the credit risk that the securitizer is required to retain. Our securitizations are subject to the U.S. Risk Retention Rules and, as a result, we have retained at least 5% of the credit risk for all of our securitizations since the U.S. Risk Retention Rules went into effect. The European Union has also adopted certain risk retention and due diligence requirements in respect of various types of European Union-regulated investors that, among other things, restrict investors from taking positions in securitizations. To the extent our securitizations are marketed in Europe, we would become subject to these additional regulations, which may increase our risk retention requirements and increase the complexity and costs of new securitizations.

The current regulatory environment may be impacted by future legislative developments, such as amendments to key provisions of the Dodd-Frank Act, including provisions setting forth capital and risk retention requirements. On February 3, 2017, President Trump signed an executive order calling for the administration to review U.S. financial laws and regulations in order to determine their consistency with a set of core principles identified in the order. The full scope of President Trump’s short-term legislative agenda is not yet fully known, but it may include certain deregulatory measures for the U.S. financial services industry, including changes to the Financial Stability Oversight Board, the Volcker Rule and credit risk retention requirements, among other areas. These legislative developments or those in the European Union, and other proposed regulations affecting securitization, could alter the structure of securitizations in the future, pose additional risks to our participation in future securitizations or reduce or eliminate the economic incentives for participating in future securitizations, increase the costs associated with our origination, securitization or acquisition activities, or otherwise increase the risks or costs of our doing business.

 

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We are subject to state licensing and operational requirements in certain states that may result in substantial compliance costs.

Although we do not engage in the highly regulated residential mortgage lending practice, we may be subject to licensing and operational requirements in certain states in which we do business. There can be no assurance that will be able to obtain any or all of the approvals and licenses that we desire or that we will avoid experiencing significant delays in seeking such approvals and licenses. In addition, in those states in which we are licensed, we are subject to periodic examinations by state regulators, which can result in refunds to borrowers of certain fees earned by us, and we may be required to pay substantial penalties imposed by state regulators due to compliance errors. Future regulatory changes may increase our costs and obligations by expanding the types of lending to which such laws apply or through stricter licensing laws, disclosure laws or increased fees, or may impose conditions to licensing that we are unable to meet. Future state legislation and changes in existing regulation may significantly increase our compliance costs or reduce the amount of ancillary fees, including late fees, that we may charge to borrowers. This could make our business cost-prohibitive in the affected state or states and could materially and adversely affect our business, results of operations and financial condition.

Any failure to obtain or maintain required licenses will restrict our options and ability to engage in desired activities, and could subject us to fines, suspensions, terminations and various other adverse actions if it is determined that we have engaged without the requisite approvals or licenses in activities that required an approval or license, which could have a material and adverse effect on our business, results of operation and financial condition.

Maintenance of our Investment Company Act exclusion imposes limits on our operations, which may adversely affect our operations.

We currently conduct, and intend to continue to conduct, our operations so that neither we nor any of our subsidiaries are required to register as an investment company under the Investment Company Act of 1940, as amended, or the 1940 Act.

We believe we are not an investment company under Section 3(a)(1) of the 1940 Act because we will not engage primarily, or hold ourselves out as being engaged primarily, in the business of investing, reinvesting or trading in securities, nor will we own investment securities with a combined value in excess of 40% of the value of our total assets (exclusive of U.S. Government securities and cash items) on an unconsolidated basis. Rather, we, through our wholly owned subsidiaries, are primarily engaged in the business of originating and managing investor real estate loans.

We hold our assets primarily through direct or indirect wholly owned subsidiaries, certain of which are excluded from the definition of investment company pursuant to Section 3(c)(5)(C) and/or Section 3(c)(6) of the 1940 Act. To qualify for the exclusion pursuant to Section 3(c)(5)(C), based on positions set forth by the staff of the SEC, each such subsidiary generally is required to hold at least (i) 55% of its assets in “qualifying” real estate assets and (ii) at least 80% of its assets in “qualifying” real estate assets and “real estate-related” assets. “Qualifying” real estate assets for this purpose include mortgage loans that satisfy conditions set forth in SEC staff no-action letters and other guidance, and other assets that the SEC staff has determined are the functional equivalent of whole mortgage loans for the purposes of the 1940 Act. Section 3(c)(6) of the 1940 Act excludes, among other categories of issuers, issuers that are primarily engaged in a Section 3(c)(5)(C) business activity directly or through majority-owned subsidiaries. The SEC staff has stated in a no-action letter that an issuer that acquires whole mortgage loans that are eventually transferred into a securitization trust which it sponsors for the purpose of obtaining financing to acquire additional whole mortgage loans, may treat as qualifying real estate assets for purposes of Section 3(c)(5)(C) any securities issued by that trust that it retains because such securities are acquired as a direct result of the issuer being engaged in the business of purchasing or otherwise acquiring whole mortgage loans. As the factual basis of this no-action position aligns with our business model, we accordingly the treat mortgage backed securities issued by our securitization trusts that we have retained as qualifying real estate assets.

 

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As a consequence of our seeking to avoid the need to register under the 1940 Act on an ongoing basis, we and/or our subsidiaries may be restricted from holding certain securities or may structure securitizations in a manner that would be less advantageous to us than would be the case in the absence of such requirements. For example, the restrictions of Section 3(c)(5)(C) may limit our and our subsidiaries’ ability to retain certain mortgage-backed securities issued by our securitization trusts. Thus, avoiding registration under the 1940 Act may hinder our ability to finance our operations using securitizations and execute our growth strategy.

There can be no assurance that we and our subsidiaries will be able to successfully maintain the exceptions to the 1940 Act we currently rely on. If it were established that we or any of our subsidiaries were operating as an unregistered investment company, there would be a risk that we would be subject to monetary penalties and injunctive relief in an action or actions brought by the SEC, that we would be unable to enforce contracts with third parties, that third parties could seek to obtain rescission of transactions undertaken during the period it was established that we were an unregistered investment company, and that we would be subject to limitations on corporate leverage that would have an adverse impact on our investment returns.

If we fail to comply with laws, regulations and market standards regarding the privacy, use, and security of customer information, or if we are the target of a successful cyber-attack, we may be subject to legal and regulatory actions and our reputation would be harmed.

We receive, maintain, and store non-public personal information of our loan applicants. The technology and other controls and processes designed to secure our customer information and to prevent, detect, and remedy any unauthorized access to that information were designed to obtain reasonable, not absolute, assurance that such information is secure and that any unauthorized access is identified and addressed appropriately. We are not aware of any data breaches, successful hacker attacks, unauthorized access and misuse, or significant computer viruses affecting our networks that may have occurred in the past; however, our controls may not have detected, and may in the future fail to prevent or detect, unauthorized access to our borrower information. In addition, we are exposed to the risks of denial-of-service, or DOS, attacks and damage to or destruction of our network or other information systems. A successful DOS attack or damage to our systems could result in a delay in the processing of our business, or even lost business. Additionally, we could incur significant costs associated with the recovery from a DOS attack or damage to our systems.

If borrower information is inappropriately accessed and used by a third-party or an employee for illegal purposes, such as identity theft, we may be responsible to the affected applicant or borrower for any losses he or she may have incurred as a result of misappropriation. In such an instance, we may also be liable to a governmental authority for fines or penalties associated with a lapse in the integrity and security of our customers’ information. Additionally, if we are the target of a successful cyber-attack, we may experience reputational harm that could impact our standing with our borrowers and adversely impact our financial results.

We may be subject to liability for potential violations of predatory lending laws, which could adversely impact our business, results of operations and financial condition.

Although we have certain controls and procedures in place in order to confirm that all loans we make or acquire are undertaken for business purposes, from time to time we may inadvertently originate or acquire a loan subject to the various U.S. federal, state and local laws that have been enacted to discourage predatory lending practices. The Federal Home Ownership and Equity Protection Act of 1994, or the HOEPA, prohibits inclusion of certain provisions in residential mortgage loans that have mortgage rates or origination costs in excess of prescribed levels and requires that borrowers be given certain disclosures prior to origination. Some states have enacted, or may enact, similar laws or regulations, which in some cases impose restrictions and requirements greater than those in the HOEPA.

 

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There can be no assurance that we will not inadvertently originate or acquire a consumer loan. If we were to originate or acquire such a loan, we would be required to comply with these laws and any breach of such laws could subject us to monetary penalties or give the borrowers a rescission right. Lawsuits have been brought in various states making claims against assignees or purchasers of high cost loans for violations of state law. If any of our loans are found to have been originated in violation of predatory or abusive lending laws, we could incur losses, which could materially and adversely impact our business, results of operations and financial condition.

Risks Related to this Offering

There is currently no public market for our common stock and an active trading market for our common stock may never develop following this offering, which could cause our common stock to trade at a discount and make it difficult for holders of our common stock to sell their shares.

Prior to this offering, there has not been a public market for our common stock. An active trading market for our common stock may never develop or be sustained, which may affect your ability to sell your common stock and could depress the market price of your common stock. We have applied to list our common stock on the NYSE. Listing on the NYSE would not ensure that an actual market will develop for our common stock. As a result, no assurances can be given that you will be able to readily sell your common stock at a price equal to or above the price you paid.

You will incur immediate dilution in the net tangible book value of the shares you purchase in this offering.

The initial public offering price of our common stock will be higher than the net tangible book value per share of outstanding common stock prior to completion of this offering after giving effect to the Conversion. Based on our net tangible book value as of June 30, 2019 after giving effect to the Conversion and upon the issuance and sale of                  shares of common stock by us at an assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, if you purchase our common stock in this offering, you will suffer immediate dilution of approximately $        per share in net tangible book value. Dilution is the amount by which the offering price paid by purchasers of our common stock in this offering will exceed the pro forma net tangible book value per share of our common stock upon completion of this offering. A total of                  shares of common stock have been reserved for future issuance under our 2019 Omnibus Incentive Plan. You may experience additional dilution upon future equity issuances or the exercise of stock options to purchase common stock that may be granted from time to time to our directors, officers and employees under our current and future stock incentive plans, including our 2019 Omnibus Incentive Plan. See “Dilution.”

The trading and price of our common stock may be volatile and could decline substantially following this offering.

The initial public offering price will be determined through negotiations between us and the representative of the underwriters and may bear no relationship to the price at which the common stock will trade upon completion of this offering. Further, the stock markets, including the NYSE, have experienced significant price and volume fluctuations. As a result, the market price of our common stock is likely to be similarly volatile, and investors in our common stock may experience a decrease in the value of their shares, including decreases unrelated to our operating performance or prospects. The price of our common stock could be subject to wide fluctuations in response to a number of factors, including those listed in this “Risk Factors” section of this prospectus, and others such as:

 

   

our operating performance and the performance of other similar companies;

 

   

actual or anticipated changes in our business strategy prospects;

 

   

actual or anticipated valuations in our quarterly operating results or dividends;

 

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our failure to meet, or the lowering of, our earnings estimates or those of any securities analysts;

 

   

publication of research reports about the real estate industry;

 

   

speculation in the press or investment community;

 

   

equity issuances by us, or stock resales by our stockholders, or the perception that such issuances or resales could occur;

 

   

the passage of legislation or other regulatory developments that adversely affect us or the assets in which we seek to invest;

 

   

the use of significant leverage to finance our assets;

 

   

loss of a major funding source;

 

   

changes in market valuations of similar companies;

 

   

actions by our stockholders;

 

   

general market and economic conditions and trends including inflationary concerns, and the current state of the credit and capital markets;

 

   

actual or anticipated accounting problems;

 

   

price and volume fluctuations in the overall stock market from time to time;

 

   

additions or departures of our executive officers or key personnel;

 

   

changes in the value of our portfolio;

 

   

any shortfall in revenue or net income or any increase in losses from levels expected by investors or securities analysts; and

 

   

the realization of any other risk factor in this prospectus.

If the market price of our common stock declines significantly, you may be unable to resell your shares at or above the initial public offering price. We cannot assure you that the market price of our common stock will not fluctuate or decline significantly.

We will incur increased costs as a result of being a public company.

As a privately held company, we have not been subject to the corporate governance and financial reporting practices and policies required of a publicly traded company. Following the completion of this offering, as a public company with listed equity securities, we will need to comply with new laws, regulations and requirements, certain corporate governance provisions of the Sarbanes Oxley Act, related regulations of the SEC and the requirements of the NYSE. Complying with these statutes, regulations and requirements will occupy a significant amount of time of our board of directors and management and will significantly increase our costs and expenses. We will need to:

 

   

institute a more comprehensive compliance function;

 

   

design, establish, evaluate and maintain a system of internal controls over financial reporting in compliance with the requirements of Section 404 of the Sarbanes Oxley Act and the related rules and regulations of the SEC and the PCAOB;

 

   

comply with rules promulgated by the NYSE;

 

   

prepare and distribute periodic public reports in compliance with our obligations under the federal securities laws;

 

   

establish new internal policies, such as those relating to disclosure controls and procedures and insider trading;

 

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involve and retain to a greater degree outside counsel and accountants in the above activities;

 

   

increased costs associated with employee equity compensation; and

 

   

establish an investor relations function.

Future offerings of debt securities, which would rank senior to our common stock upon our liquidation, and future offerings of equity securities, which would dilute our existing stockholders and may be senior to our common stock for the purposes of dividend and liquidating distributions, may adversely affect the market price of our common stock.

In the future, we may attempt to increase our capital resources by making offerings of debt or additional offerings or distributions of equity securities, including commercial paper, medium-term notes, senior or subordinated notes and classes of preferred stock or common stock. Upon liquidation, holders of our debt securities and shares of preferred stock, if issued, and lenders with respect to other borrowings will receive a distribution of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing stockholders or reduce the market price of our common stock, or both. Our preferred stock, if issued, would likely have a preference on liquidating distributions or a preference on dividend payments that could limit our ability to make a dividend distribution to the holders of our common stock. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, holders of our common stock bear the risk of any future offerings reducing the market price of our common stock and diluting their stock holdings in us.

Future sales of shares of our common stock, including by our existing stockholders, could depress the market price of our shares.

We cannot predict the effect, if any, of future sales of our common stock, or the availability of shares for future sales, on the value of our common stock. Sales of these shares by our existing stockholders, or the perception that such sales could occur, may cause the trading price of our common stock to decrease or be lower than it might be in the absence of those sales or perceptions.

Upon completion of this offering and after giving effect to the Conversion, Snow Phipps and TOBI and certain members of our management and our other existing stockholders collectively will own approximately     % of our outstanding shares of common stock (or approximately                  % of our outstanding shares of common stock if the underwriters fully exercise their over-allotment option), assuming we offer the number of shares as set forth on the front cover of this prospectus at an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus. These shares and the shares of common stock sold in this offering will be freely tradable without restriction or further registration under the Securities Act unless such shares are held by any of our “affiliates,” as that term is defined in Rule 144 under the Securities Act. In addition, in connection with this offering we intend to enter into a registration rights agreement with Snow Phipps, TOBI, certain other stockholders, and certain members of our management and directors which, among other things, will give Snow Phipps and TOBI and their respective affiliates the right to cause us to file registration statements under the Securities Act covering their shares of our common stock, or to include the shares of common stock held by such stockholders in registration statements that we may file. If we were to include common stock held by such stockholders in a registration statement initiated by us, those additional shares could impair our ability to raise needed capital by depressing the price at which we could sell common stock.

You should not rely on lock-up agreements in connection with this offering to limit the amount of common stock sold into the market.

Snow Phipps, TOBI, certain other stockholders, and certain members of our management and directors have generally agreed, for a period of 180 days after the date of this prospectus, that they will (1) not issue (in the case of us), offer, pledge, sell, contract to sell, sell any option or contract to purchase,

 

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purchase any option or contract to sell, grant any option, right or warrant to purchase, lend or otherwise transfer or dispose of, directly or indirectly, any shares of our common stock or preferred stock or other capital stock, or any securities convertible into or exchangeable or exercisable for shares of our common stock or other capital stock, (2) in the case of us, file or cause the filing of any registration statement under the Securities Act with the SEC with respect to any common stock or other capital stock or any securities convertible into or exercisable or exchangeable for any common stock or other capital stock (other than any registration statement filed pursuant to Rule 462(b) under the Securities Act to register securities to be sold to the underwriters pursuant to the underwriting agreement), nor publicly disclose the intention to make any filings relating to any registration statement, or (3) enter into any swap or other agreement, arrangement or transaction that transfers to another, in whole or in part, directly or indirectly, any shares of our common stock or preferred stock or other capital stock, or any securities convertible into or exchangeable or exercisable for shares of our common stock or other capital stock, subject to specified exceptions, without the prior consent of Wells Fargo Securities, LLC, Citigroup Global Markets Inc. and JMP Securities LLC. However, Wells Fargo Securities, LLC, Citigroup Global Markets Inc. and JMP Securities LLC may, at any time, release all or a portion of the securities subject to these lock-up agreements. See “Underwriting.” If the restrictions under the lock-up agreements with the persons or entities subject to the lock-up agreements are waived or terminated, or upon expiration of the lock-up periods, approximately                  shares (assuming we offer the number of shares as set forth on the front cover of this prospectus, an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, and no exercise of the underwriters’ over-allotment option) will be available for sale into the market, subject only to applicable securities rules and regulations. These sales or a perception that these sales may occur could reduce the market price for our common stock.

We have not historically paid dividends on our common stock and, as a result, your only opportunity to achieve a return on your investment may be if the price of our common stock appreciates.

We have not declared or paid cash dividends to date on our common stock and do not intend to pay dividends for the foreseeable future. Instead, we anticipate that all of our earnings in the foreseeable future will be used to provide working capital, to support our operations and to finance the growth and development of our business. Any determination to declare or pay dividends in the future will be at the discretion of our board of directors, subject to applicable laws and dependent upon a number of factors, including our earnings, capital requirements, overall financial conditions and limitations in our debt instruments. In addition, our ability to pay dividends on our common stock is currently limited by the covenants of our warehouse repurchase facilities and other credit facilities and may be further restricted by the terms of any future debt or preferred securities. Accordingly, your only opportunity to achieve a return on your investment in our company may be if the market price of our common stock appreciates and you sell your shares at a profit. The market price for our common stock may never exceed, and may fall below, the price that you pay for such common stock.

If securities analysts do not publish research or reports about our business or if they downgrade our stock or our core market, our stock price and trading volume could decline.

The trading market for our common stock will rely in part on the research and reports that industry or financial analysts publish about us or our business or industry. We do not control these analysts. Furthermore, if one or more of the analysts who do cover us downgrade our stock or our industry, or the stock of any of our competitors, or publish inaccurate or unfavorable research about our business or industry, the price of our stock could decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, we could lose visibility in the market, which in turn could cause our stock price or trading volume to decline.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

All statements (other than statements of historical facts) in this prospectus regarding the prospects of the industry and our prospects, plans, financial position and business strategy may constitute forward-looking statements. In addition, forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “should,” “expect,” “intend,” “will,” “estimate,” “anticipate,” “plan,” “believe,” “predict,” “potential” or “continue” or the negatives of these terms or variations of them or similar terminology. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we cannot provide any assurance that these expectations will prove to be correct. Such statements reflect the current views of our management with respect to our operations, results of operations and future financial performance. The following factors are among those that may cause actual results to differ materially from the forward-looking statements:

 

   

conditions in the real estate markets, the financial markets and the economy generally;

 

   

failure of a third-party servicer or the failure of our own internal servicing system to effectively service our portfolio of mortgage loans;

 

   

the high degree of risk involved in loans to small businesses, self-employed borrowers, properties in transition, certain portions of our investment real estate portfolio;

 

   

possibility of receiving inaccurate and/or incomplete information from potential borrowers, guarantors and loan sellers;

 

   

deficiencies in appraisal quality in the mortgage loan origination process;

 

   

competition in the market for loan origination and acquisition opportunities;

 

   

risks associated with our underwriting guidelines and our ability to change our underwriting guidelines;

 

   

loss of our key personnel or our inability to hire and retain qualified account executives;

 

   

any inability to manage future growth effectively or failure to develop, enhance and implement strategies to adapt to changing conditions in the real estate and capital markets;

 

   

operational risks, including the risk of cyberattacks, or disruption in the availability and/or functionality of our technology infrastructure and systems;

 

   

any inability of our borrowers to generate net income from operating the property that secures our loans;

 

   

costs or delays involved in the completion of a foreclosure or liquidation of the underlying property;

 

   

lender liability claims, requirements that we repurchase mortgage loans or indemnify investors, or allegations of violations of predatory lending laws;

 

   

economic downturns or natural disasters in geographies where our assets are concentrated;

 

   

environmental liabilities with respect to properties to which we take title;

 

   

inadequate insurance on collateral underlying mortgage loans and real estate securities;

 

   

use of incorrect, misleading or incomplete information in our analytical models and data;

 

   

failure to realize a price upon disposal of portfolio assets that are recorded at fair value;

 

   

any inability to successfully complete additional securitization transactions on attractive terms or at all;

 

   

the termination of one or more of our warehouse repurchase facilities;

 

   

interest rate fluctuations or mismatches between our loans and our borrowings;

 

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legal or regulatory developments related to mortgage-related assets, securitizations or state licensing and operational requirements;

 

   

our ability to maintain our Investment Company Act exclusion;

 

   

fiscal policies or inaction at the U.S. federal government level, which may lead to federal government shutdowns or negative impacts on the U.S. economy;

 

   

cyber-attacks and our ability to comply with laws, regulations and market standards regarding the privacy, use, and security of customer information;

 

   

our ability to remediate the material weakness in our internal controls over financial reporting and to comply with requirements to maintain effective internal controls over financial reporting;

 

   

the influence of Snow Phipps and TOBI over us;

 

   

adverse legislative or regulatory changes; and

 

   

the other factors discussed in “Risk Factors.”

The preceding list is not intended to be an exhaustive list of all of our forward-looking statements. The forward-looking statements are based on our beliefs, assumptions and expectations of future performance, taking into account the information currently available to us. These statements are only predictions based upon our current expectations and projections about future events. There are important factors that could cause our actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements. Other sections of this prospectus may include additional factors that could adversely impact our business and financial performance. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time and it is not possible for our management to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. Before investing in our common stock, investors should be aware that the occurrence of the events described under the caption “Risk Factors” and elsewhere in this prospectus could have a material adverse effect on our business, results of operations and financial condition.

You should not rely upon forward-looking statements as predictions of future events. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee that the future results, levels of activity, performance and events and circumstances reflected in the forward-looking statements will be achieved or occur. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this prospectus to conform these statements to actual results or to changes in our expectations.

When considering forward-looking statements, you should keep in mind the risks and other cautionary statements set forth in this prospectus, including those contained in “Risk Factors.” The risks and other cautionary statements noted throughout this prospectus could cause our actual results to differ significantly from those contained in or implied by any forward-looking statement.

 

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USE OF PROCEEDS

We estimate that the net proceeds we will receive from the sale of our common stock in this offering will be approximately $         million (or approximately $         million if the underwriters fully exercise their over-allotment option to purchase up to an additional                  shares of our common stock), in each case after deducting underwriting discounts and commissions and estimated offering expenses payable by us. A $1.00 increase (decrease) in the assumed initial public offering price of $        per share would increase (decrease) the net proceeds we will receive from this offering by $         million, assuming the number of shares offered by us, as set forth on the front cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

We intend to use approximately $        million of the net proceeds from this offering to repay a portion of our outstanding corporate debt and the remainder for general corporate purposes, including originating or acquiring investor real estate loans. In August 2019, we redeemed and paid in full our outstanding senior secured notes, which would have matured in December 2019 and bore interest at either 10% per annum (to the extent paid in cash) or 11% per annum (to the extent paid-in-kind), with a portion of the proceeds from new term loans, the 2019 Term Loans, under a new five-year $153.0 million corporate debt agreement with a new lender. The 2019 Term Loans bear interest at a rate equal to one-month LIBOR plus 7.50% and mature in August 2024.

DIVIDEND POLICY

We have not declared or paid cash dividends to date on our common stock and we do not intend to pay dividends for the foreseeable future. Any future determination to declare dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions, limitations in our debt instruments and other factors that our board of directors may deem relevant.

 

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CAPITALIZATION

The following table sets forth our actual cash and cash equivalents and capitalization as of June 30, 2019:

 

   

on an actual basis;

 

   

on a pro forma basis to give effect to the July 2019 Securitization, the August 2019 Refinancing, the Conversion and the adopting and filing of our certificate of incorporation with the Delaware Secretary of State prior to the closing of this offering; and

 

   

on a pro forma as adjusted basis to give further effect to our issuance and sale of                  shares of our common stock in this offering at an assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the cover page of this prospectus, after deducting underwriting discounts and commissions and estimated offering expenses payable by us and the application of the net proceeds from this offering thereof as described in “Use of Proceeds.”

The pro forma as adjusted amounts as of June 30, 2019 assume that the underwriters do not exercise their over- allotment option to purchase up to an additional                  shares of our common stock. You should read this table together with “Use of Proceeds,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes included elsewhere in this prospectus.

 

     June 30, 2019  
     Actual      Pro Forma(1)      Pro Forma
As Adjusted
 
     (unaudited, in thousands)  

Cash and cash equivalents

   $ 14,105      $                        $                
  

 

 

    

 

 

    

 

 

 

Secured financing, net

   $ 127,062      $        $    

Securitizations, net

     1,261,455        

Warehouse repurchase facilities, net

     279,960        

Class C preferred units

     27,400        

Members’ equity

     147,013        

Stockholders’ equity:

        

Preferred stock, par value $0.01 per share,                     shares authorized; 0 shares outstanding, actual; 0 shares outstanding, pro forma and pro forma as adjusted

            

Common stock, par value $0.01 per share, shares authorized; 0 shares outstanding, actual;                     shares outstanding, pro forma;                     shares outstanding, pro forma as adjusted

            

Additional paid-in capital

            
  

 

 

    

 

 

    

 

 

 

Total stockholders’ equity

     147,013        
  

 

 

    

 

 

    

 

 

 

Total capitalization

   $ 1,842,890      $        $    
  

 

 

    

 

 

    

 

 

 

 

(1)

In August 2019, we entered into a new five-year $153.0 million corporate debt agreement and used the proceeds of the 2019 Term Loans under this agreement, together with cash on hand, to redeem our outstanding senior secured notes and repurchase our outstanding Class C preferred units, which is reflected in the pro forma column as though it occurred on June 30, 2019.

A $1.00 increase or decrease in the assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, would increase or decrease, as applicable, on a pro forma as adjusted basis, cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by $         million, assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same and after deducting assumed underwriting discounts and commissions and estimated offering expenses payable by us and the

 

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application of the net proceeds thereof as described in “Use of Proceeds.” An increase or decrease of 100,000 shares in the number of shares sold in this offering by us would increase or decrease, as applicable, on a pro forma as adjusted basis, cash and cash equivalents, additional paid-in capital, total stockholders’ equity and total capitalization by $         million, assuming an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, and after deducting underwriting discounts and commissions and estimated offering expenses payable by us and the application of the net proceeds thereof as described in “Use of Proceeds.”

The number of shares of our common stock to be outstanding upon the completion of this offering is based on                  shares of our common stock outstanding as of June 30, 2019 after giving effect to the Conversion assuming we offer the number of shares as set forth on the front cover of this prospectus and no exercise of the underwriters’ over-allotment option. Such number of outstanding shares excludes                  shares of our common stock that may be issued in the future under our 2019 Omnibus Incentive Plan. A $1.00 increase or decrease in an assumed initial public offering price would, as applicable, increase by                                          or decrease by                                     the number of shares outstanding upon completion of this offering, assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same.

 

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DILUTION

If you invest in our common stock, your interest will be diluted to the extent of the difference between the initial public offering price per share of our common stock and the net tangible book value per share of our common stock after this offering. Dilution results from the fact that the per share offering price of our common stock is substantially in excess of the net tangible book value per share attributable to our existing equity holders.

Our historical pro forma net tangible book value as of June 30, 2019 was approximately $147.0 million, or $        per share of our common stock after giving effect to (i) the redemption in full of the Class C preferred units in connection with the August 2019 Refinancing; and (ii) the Conversion, including the restricted shares of common stock issued upon the conversion of all outstanding vested and unvested Class B units. Our historical net tangible book value represents the amount of total tangible assets (total assets less capitalized software) less total liabilities after giving effect to the pro forma adjustments set out above. Historical pro forma net tangible book value per share represents historical pro forma net tangible book value divided by the                  shares of our common stock outstanding as of June 30, 2019 after giving effect to the Conversion (assuming an initial public offering price of $        , which is the mid-point of the price range set forth on the front cover of this prospectus).

The following table illustrates this dilution on a per share basis assuming the underwriters do not exercise their over-allotment option.

 

Assumed public offering price per share

   $                

Historical pro forma net tangible book value per share as of June 30, 2019 after giving effect to (i) the redemption in full of the Class C preferred units in connection with the August 2019 Refinancing; and (ii) the Conversion, including the restricted shares of common stock issued upon the conversion of all outstanding vested and unvested Class B units, but before giving effect to this offering

   $    
  

 

 

 

Increase in net tangible book value per share attributable to this offering

   $    
  

 

 

 

Pro forma as adjusted net tangible book value per share on June 30, 2019, after giving effect to this offering

   $    
  

 

 

 

Dilution in as adjusted net tangible book value per share to new investor

   $    
  

 

 

 

A $1.00 increase or decrease in the assumed initial public offering of $        per share would increase or decrease the net proceeds we will receive from this offering by $        million, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us.

 

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The following table summarizes, on a pro forma basis as of June 30, 2019, after giving effect to the Conversion and the adoption and filing of our certificate of incorporation upon the completion of this offering, the differences between the average price per share paid by our existing stockholders and by new investors purchasing shares of common stock in this offering at an assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the cover page of this prospectus, before deducting underwriting discounts and commissions and estimated offering expenses payable by us in this offering:

 

     Shares Purchased(1)     Total Consideration     Average
Price Per
Share
 
         Number              %             Amount              %      
     (in thousands)            (in thousands)               

Shares purchased by existing stockholders

               $                     $                

New investors

                                                                        
  

 

 

    

 

 

   

 

 

    

 

 

   

Total

        100   $          100  
  

 

 

      

 

 

      

 

(1)

Assumes no exercise of the underwriters’ over-allotment option to purchase an additional                  shares of our common stock from us.

 

If the underwriters fully exercise their over-allotment option to purchase up to an additional                  shares of our common stock from us, the number of shares of common stock held by existing holders will be reduced to             % of the aggregate number of shares of common stock outstanding after this offering, and the number of shares of common stock held by new investors will be increased to                 , or     % of the aggregate number of shares of common stock outstanding after this offering.

Assuming the number of shares offered by us, as set forth on the front cover of this prospectus, remains the same, after deducting estimated underwriting discounts and commissions and offering expenses payable by us, a $1.00 increase or decrease in the assumed initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus, would increase or decrease total consideration paid by new investors and total consideration paid by all stockholders by approximately $        million.

The number of shares purchased from us by existing stockholders is based on shares of our common stock outstanding as of June 30, 2019 after giving effect to the Conversion, assuming an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover of this prospectus. Such number of outstanding shares excludes shares of our common stock that may be issued in the future under our 2019 Omnibus Incentive Plan. A $1.00 increase or decrease in the assumed initial public offering price would, as applicable, increase by                                  or decrease by                                  the number of shares purchased from us by existing stockholders.

Holders of our Class B units, including officers, directors, promoters and affiliated persons, will receive shares of our common stock pursuant to the Conversion on a                  for                  basis, assuming an initial public offering price of $        per share, which is the mid-point of the price range set forth on the front cover page of this prospectus. A $1.00 increase or decrease in the assumed initial public offering price would, as applicable, increase by              or decrease by              the number of shares received by holders of our Class B units pursuant to the Conversion.

 

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SELECTED CONSOLIDATED FINANCIAL INFORMATION

The following table presents summary consolidated financial information as of June 30, 2019 and December 31, 2018, 2017, 2016, 2015 and 2014, and for the six months ended June 30, 2019 and 2018, and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014. The consolidated statements of income information for the years ended December 31, 2018, 2017 and 2016 and the consolidated statements of financial condition information presented below as of December 31, 2018 and 2017, have been derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statements of income information for the years ended December 31, 2015 and 2014 and the consolidated statements of financial condition information as of December 31, 2016, 2015 and 2014 have been derived from our audited consolidated financial statements not included in this prospectus. The consolidated statement of financial condition as of June 30, 2019 and the consolidated statements of income for the six months ended June 30, 2019 and 2018 have been derived from our unaudited consolidated financial statements included elsewhere in this prospectus. These unaudited consolidated financial statements have been prepared on substantially the same basis as our audited consolidated financial statements and reflect all adjustments which are, in the opinion of management, necessary to provide a fair presentation of our consolidated financial position as of June 30, 2019, and the results of our operations for the interim periods ended June 30, 2019 and 2018. All such adjustments are of a normal recurring nature. These interim results are not necessarily indicative of our results for the full fiscal year. The historical results presented below are not necessarily indicative of financial results to be achieved in future periods.

The information presented below is only a summary and does not provide all of the information contained in our historical consolidated financial statements, including the related notes. You should read it in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements, including the related notes, included elsewhere in this prospectus.

 

Consolidated Statements of Income
Information

   Six Months Ended
June 30,
    Year Ended December 31,  
       2019             2018             2018              2017              2016          2015              2014      
     (in thousands)  

Interest income

   $ 73,028     $ 58,956     $ 124,722      $ 97,830      $ 78,418      $ 55,544      $ 23,288  

Interest expense — portfolio related

     39,387       28,363       62,597        47,638        37,406        25,159        9,979  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income — portfolio related

     33,641       30,593       62,125        50,192        41,012        30,385        13,309  

Interest expense — corporate debt

     6,706       6,657       13,322        13,654        13,419        9,717        4,927  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     26,935       23,936       48,803        36,538        27,593        20,668        8,382  

Provision for (reversal of) loan losses

     560       (234     201        421        1,455        378        279  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     26,375       24,170       48,602        36,117        26,138        20,290        8,103  

Other operating income

                  

Gain on disposition of loans

     2,858       939       1,200        984        196        683        3,130  

Unrealized (loss) gain on fair value loans

     (33     210       241        39        152        1,209        (663

Other (expense) income

     (797     393       1,366        985        362        272        75  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total other operating income

     2,028       1,542       2,807        2,008        710        2,164        2,542  

Operating expenses

                  

Compensation and employee benefits

     7,806       7,526       15,105        11,904        10,085        6,617        4,307  

Rent and occupancy

     736       610       1,320        1,115        801        500        366  

Loan servicing

     3,500       2,445       6,009        4,907        3,657        3,139        1,793  

Professional fees

     1,190       1,033       3,040        1,661        2,637        2,284        334  

Real estate owned, net

     862       693       1,373        603        451        710        2,972  

Corporate debt prepayment expense

                                             5,676  

Other operating expenses

     2,729       2,415       5,313        3,946        2,420        2,050        1,500  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

     16,823       14,722       32,160        24,136        20,051        15,300        16,948  
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income (loss) before income taxes

     11,580       10,990       19,249        13,989        6,797        7,154        (6,303

Income tax expense

     3,350       5,714       8,700                              
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss)

   $ 8,230     $ 5,276     $ 10,549      $ 13,989      $ 6,797      $ 7,154      $ (6,303
  

 

 

   

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

 

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Consolidated Statements of Financial Condition
Information

   As of
June 30,

2019
     As of December 31,  
   2018      2017      2016      2015      2014  
     (in thousands)  
Assets                  

Cash and cash equivalents

   $ 14,105      $ 15,008      $ 15,422      $ 49,978      $ 4,726      $ 2,935  

Restricted cash

     1,542        1,669        305        1,766        7,561        2,701  

Loans held for sale, net

     82,308        78,446        5,651                       

Loans held for investment, net

     1,683,733        1,567,408        1,299,041        1,039,401        868,592        417,058  

Loans held for investment at fair value

     2,974        3,463        4,632        7,278        10,143        13,091  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans, net

     1,769,015        1,649,317        1,309,324        1,046,679        878,735        430,149  

Accrued interest receivables

     11,326        10,096        7,678        5,954        4,633        2,348  

Receivables due from servicers

     33,618        40,473        25,306        22,234        12,667        3,534  

Other receivables

     3,321        974        1,287        439        1,591        1,223  

Real estate owned, net

     14,221        7,167        5,322        1,454        751        4,434  

Property and equipment, net

     5,045        5,535        5,766        3,875        1,473        690  

Net deferred tax asset

     5,698        2,986                              

Other assets

     15,663        4,760        1,435        750        512        516  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 1,873,554      $ 1,737,985      $ 1,371,845      $ 1,133,129      $ 912,649      $ 448,530  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
Liabilities and Members’ Equity                  

Accounts payable and accrued expenses

   $ 30,664      $ 26,629      $ 22,029      $ 12,264      $ 8,562      $ 3,706  

Secured financing, net

     127,062        127,040        126,486        119,286        96,169        48,020  

Securitizations, net

     1,261,455        1,202,202        982,393        742,890        396,983        174,755  

Warehouse repurchase facilities, net

     279,960        215,931        85,303        110,308        324,502        142,770  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

     1,699,141        1,571,802        1,216,211        984,748        826,216        369,251  

Commitments and contingencies

                 

Class C preferred units(1)

     27,400        26,465        24,691        23,036                

Members’ equity

     147,013        139,718        130,943        125,345        86,433        79,279  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities and members’ equity

   $ 1,873,554      $ 1,737,985      $ 1,371,845      $ 1,133,129      $ 912,649      $ 448,530  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

The Class C preferred units were redeemed in full in connection with the August 2019 Refinancing.

 

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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 our consolidated financial statements and the related notes and the other financial information included elsewhere in this prospectus. This discussion contains 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 prospectus, particularly under “Risk Factors.”

Our Company

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 small commercial properties, which we refer to collectively as investor real estate loans. We originate loans nationwide across our extensive network of independent mortgage brokers which we have built and refined over the 15 years since our inception. Our objective is to be the preferred and one of the most recognized brands in our core market, particularly within our network of mortgage brokers.

We operate in a large and highly fragmented market with substantial demand for financing and limited supply of institutional financing alternatives. We have developed the highly-specialized skill set required to effectively compete in this market, which we believe has afforded us a durable business model capable of generating compelling risk-adjusted returns for our stockholders throughout various business cycles. We offer competitive pricing to our borrowers by pursuing low-cost financing strategies and by driving front-end process efficiencies through customized technology designed to control the cost of originating a loan. Furthermore, by originating loans through our efficient and scalable network of approved mortgage brokers, we are able to maintain a wide geographical presence and nimble operating infrastructure capable of reacting quickly to changing market environments.

Our growth strategy is predicated on continuing to serve and build loyalty within our network of mortgage brokers, while also expanding our network with new mortgage brokers through targeted marketing, improved brand awareness, and the growth and development of our team of account executives. We believe our reputation and 15-year history within our core market position us well to capture future growth opportunities.

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 the loans in our portfolio as of June 30, 2019, has an average balance of approximately $318,000. As of June 30, 2019, our loan portfolio, including both loans held for investment and loans held for sale, totaled $1.7 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 65.0%, and was concentrated in 1-4 unit residential rental loans, which we refer to as investor 1-4 loans, representing 48.9% of the UPB. During the six months ended June 30, 2019, the yield on our total portfolio was 8.80%.

We fund our portfolio primarily through a combination of committed and uncommitted secured warehouse repurchase facilities, securitizations, corporate debt and equity. The securitization market is our primary source of long-term financing. We have successfully executed eleven securitizations, resulting in a total of over $2.4 billion in gross debt proceeds from May 2011 through July 2019. We intend to repay a portion of our existing corporate debt with a portion of the net proceeds from this offering.

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 repurchase facilities and securitizations and excludes our corporate debt. For the six months ended June 30, 2019, our portfolio related net interest margin was 4.05%. We generate

 

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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 six months ended June 30, 2019, we generated income before income taxes and net income of $11.6 million and $8.2 million, respectively, and earned a pre-tax return on equity and return on equity of 16.1% and 11.4%, 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

Velocity Financial, LLC was formed as a Delaware Limited Liability Company, or LLC, in 2012. Until January 1, 2018, we had elected to be treated as a partnership for U.S. federal and state income tax purposes, and as such, had generally not been subject to federal and state income taxes prior to January 1, 2018. Accordingly, the results of operations presented in this prospectus for the years ended December 31, 2017 and 2016 do not include any provision for federal or state income taxes.

Effective January 1, 2018, we elected to be treated as a corporation for U.S. federal and state income tax purposes. Accordingly, the results of operations for the year ended December 31, 2018 include the impacts of income taxes. As a result, the historical net income reported for any period prior to January 1, 2018, is not comparable to the net income reported for the year ended December 31, 2018 or the net income anticipated in future periods.

Furthermore, in connection with the new tax treatment, we began recognizing, and 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.

We calculated our deferred tax as of January 1, 2018 and, per U.S. GAAP, recognized a deferred tax liability offsetting to income in January 2018, the period in which the change was made. The January 1, 2018 deferred tax liability was $2.6 million. The Company recorded approximately $5.6 million of deferred tax assets for the year ended December 31, 2018, resulting in a net deferred tax asset of approximately $3.0 million as of December 31, 2018. Our provision for deferred income taxes is primarily due to the difference between the tax and U.S. GAAP treatment on the issuance of our securitizations. For tax purposes, the issuances are considered taxable sales; whereas, for U.S. GAAP purposes, the securities issued in our securitizations are considered financings.

As part of our 2018 election to be treated as a corporation for U.S. federal and state income tax purposes, management identified a deficiency in the effectiveness of a control intended to properly document and review relevant facts and apply the appropriate tax accounting under U.S. GAAP, which impacted the beginning of year deferred tax asset and income tax benefit accounts and related disclosures. Our personnel responsible for preparing the beginning of year deferred tax assets and liabilities and year-end deferred tax assets and liabilities did not have sufficient expertise to properly calculate the deferred tax positions. We did not perform a risk assessment to identify their lack of expertise in order to implement a sufficient control structure to prevent or detect the material misstatements in their income taxes accounts. The beginning of year deferred tax assets and liabilities, and the income tax benefits accounts and related disclosures were corrected as of the end of 2018. Management has concluded that the deficiency constitutes a material weakness in our internal control over financial reporting and, as a result, our internal control over financial reporting was not effective as of December 31, 2018.

 

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A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of annual or interim consolidated financial statements will not be prevented or detected on a timely basis. We have implemented a plan to remediate this material weakness by contracting with a nationally recognized accounting firm to have experienced tax personnel supplement and train our current accounting team. Although we believe this plan will be adequate to address the material weakness, there can be no assurance that the material weakness will be remediated on a timely basis or at all, or that additional material weaknesses will not be identified in the future.

In addition, prior to the closing of this offering, we will convert into a Delaware corporation and change our name to Velocity Financial, Inc., a transaction that we refer to as the “Conversion” in this prospectus. For more information regarding the Conversion, see “Summary—Corporate Conversion.” The Conversion will be accounted for in accordance with ASC 805-50 –Business Combinations, as a transaction between entities under common control. The Conversion is not expected to impact our provision for income taxes or our deferred tax assets and liabilities.

Interest Expense on Corporate Debt

In 2014, we entered into a five-year, $100.0 million corporate debt agreement with the owners of our Class C preferred units, pursuant to which we issued at par senior secured notes, the 2014 Senior Secured Notes, that mature on December 16, 2019. The 2014 Senior Secured Notes bear interest, at our election, at either 10% annually paid in cash or 11% annually paid in kind. As of June 30, 2019 and December 31, 2018, including paid-in-kind interest, the 2014 Senior Secured Notes balance was $127.6 million, and is presented as secured financing, net of debt issuance costs, on the consolidated statement of financial condition. During the six months ended June 30, 2019, we incurred $6.4 million of interest expense on $127.6 million of corporate debt related to the 2014 Senior Secured Notes.

In August 2019, we entered into a five-year $153.0 million corporate debt agreement with Owl Rock Capital Corporation. The 2019 Term Loans under this agreement bear interest at a rate equal to one-month LIBOR plus 7.50% and mature in August 2024. A portion of the net proceeds from the 2019 Term Loans was used to redeem the 2014 Senior Secured Notes. Another portion of the net proceeds from the 2019 Term Loans, together with cash on hand, was used to repurchase our outstanding Class C preferred units.

We intend to use a portion of the net proceeds from this offering to lower our interest expense through the partial repayment of the outstanding balance on the 2019 Term Loans. See “Use of Proceeds.”

Public Company Costs

Following the completion of this offering, we expect to incur additional costs associated with operating as a public company. We expect that these costs will include additional personnel, legal, consulting, regulatory, insurance, audit, and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act, as well as rules adopted by the SEC and national securities exchanges, requires public companies to implement specified corporate governance practices that are currently not applicable to us as a private company.

New Accounting Standard for Measuring Credit Losses

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which changes how entities will be required to account for credit losses. Under the current standard, credit losses are measured in accordance with an incurred loss model, which delays recognition of credit losses until it is probable that a loss has occurred. ASC 2016-13 replaces the incurred loss model with an expected credit loss model, referred to as the Current Expected Credit Loss, or CECL, model. The new standard requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable

 

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forecasts and requires enhanced disclosures related to the significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. In addition, ASU 2016-13 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. ASU 2016-13 will become effective January 1, 2020. The Company has selected a CECL software program and is currently working with the vendor to implement the software. The Company expects model validation and parallel runs to begin in the fourth quarter of 2019. Additionally, the Company is assessing updates to accounting policies, and documenting new processes and controls. The Company expects to adopt this ASU on January 1, 2020.

Recent Developments

July 2019 Securitization

In July 2019, we completed the securitization of $217.9 million of investor real estate loans, measured by UPB as of the July 1, 2019 cut-off date, issuing $207.0 million of non-recourse notes payable through the Velocity Commercial Capital Loan Trust 2019-2, or 2019-2. We are the sole beneficial interest holder of 2019-2, a variable interest entity that will be included in our consolidated financial statements. We refer to this transaction as the “July 2019 Securitization.”

August 2019 Refinancing

In August 2019, we entered into a new five-year $153.0 million corporate debt agreement with Owl Rock Capital Corporation, as lender. We used the proceeds of the term loans under this agreement, together with cash on hand, to redeem our outstanding senior secured notes and repurchase our outstanding Class C preferred units, which transaction we refer to as the “August 2019 Refinancing.”

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

 

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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 in the section of this prospectus titled “Risk Factors.”

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, 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 macroeconomic conditions and market fundamentals, which can 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 have grown our portfolio related net interest income by $11.9 million or 23.8% from $50.2 million for the year ended December 31, 2017 to $62.1 million for the year ended December 31, 2018 and by $3.0 million or 10.0% from $30.6 million for the six months ended June 30, 2018 to $33.7 million for the six months ended June 30, 2019. The growth in net interest income is largely attributable to our growth in 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 volume and believe that the large and highly fragmented nature of our core market provides meaningful opportunity to achieve this. We intend to grow originations 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

 

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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 repurchase 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.

We intend to use a portion of the net proceeds from this offering to lower our interest expense through the partial repayment of the outstanding balance on the 2019 Term Loans.

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.

 

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Portfolio and Asset Quality

Key Portfolio Statistics

 

     June 30,     December 31,  
     2019     2018     2017     2016  
     ($ in thousands)  

Total loans

   $ 1,748,782     $ 1,631,326     $ 1,295,567     $ 1,038,033  

Loan count

     5,503       5,171       4,136       3,243  

Average loan balance

   $ 318     $ 315     $ 313     $ 320  

Weighted average loan-to-value

     65.0     63.8     64.4     64.5

Weighted average coupon

     8.66     8.56     8.33     8.23

Nonperforming loans (UPB)

   $ 104,180     $ 95,385     $ 74,943     $ 42,498  

Nonperforming loans (% of total)

     5.96     5.85     5.78     4.09

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.

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 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, in bankruptcy, or in foreclosure are not accruing interest and 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.

 

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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:

 

($ in thousands)    Loan
Count
     Loan
Balance
     Average
Loan Size
     Weighted
Average
Coupon
    Weighted
Average
LTV
 

Six Months Ended June 30, 2019:

             

Loan originations — held for investment

     848      $ 291,783      $ 344        8.6     65.9

Loan originations — held for sale

     453      $ 121,075      $ 267        10.0     67.6
  

 

 

    

 

 

         

Total loan originations

     1,301      $ 412,858      $ 317        9.0     66.4

Loan acquisitions — held for investment

     34      $ 8,931      $ 263        7.2     61.7
  

 

 

    

 

 

         

Total loans originated and acquired

     1,335      $ 421,789          
  

 

 

    

 

 

         

Six Months Ended June 30, 2018:

             

Loan originations — held for investment

     808      $ 268,614      $ 332        8.4     63.1

Loan originations — held for sale

     206      $ 49,677      $ 241        9.8     65.0
  

 

 

    

 

 

         

Total loan originations

     1,014      $ 318,291      $ 314        8.7     63.7

Loan acquisitions — held for investment

          $                      
  

 

 

    

 

 

         

Total loans originated and acquired

     1,014      $ 318,291          
  

 

 

    

 

 

         

Year Ended December 31, 2018:

             

Loan originations — held for investment

     1,708      $ 587,241      $ 344        8.4     63.4

Loan originations — held for sale

     619      $ 150,056      $ 242        9.9     65.1
  

 

 

    

 

 

         

Total loan originations

     2,327      $ 737,297      $ 317        8.7     63.8

Loan acquisitions — held for investment

     19      $ 16,243      $ 855        7.3     53.5
  

 

 

    

 

 

         

Total loans originated and acquired

     2,346      $ 753,540          
  

 

 

    

 

 

         

Year Ended December 31, 2017:

             

Loan originations — held for investment

     1,630      $ 511,284      $ 314        8.4     64.3

Loan originations — held for sale

     176      $ 43,426      $ 247        9.6     69.7
  

 

 

    

 

 

         

Total loan originations

     1,806      $ 554,710      $ 307        8.5     64.7

Loan acquisitions — held for investment

                     
  

 

 

    

 

 

         

Total loans originated and acquired

     1,806      $ 554,710          
  

 

 

    

 

 

         

Year Ended December 31, 2016:

             

Loan originations — held for investment

     1,104      $ 348,419      $ 316        8.4     63.8

Loan originations — held for sale

                     
  

 

 

    

 

 

         

Total loan originations

     1,104      $ 348,419      $ 316        8.4     63.8

Loan acquisitions — held for investment

     6        985      $ 164        6.9     63.0
  

 

 

    

 

 

         

Total loans originated and acquired

     1,110      $ 349,404          
  

 

 

    

 

 

         

Over the periods shown, we have increased our origination volume by executing our strategy of continuing to serve and build loyalty within our network of mortgage brokers, while also expanding our network with new mortgage brokers through improved brand recognition. For the six months ended June 30, 2019, we originated $412.9 million of loans, which was an increase of $94.6 million, or 29.7% from $318.3 million for the six months ended June 30, 2018. For the year ended December 31, 2018, we originated $737.3 million of loans, which was an increase of $182.6 million, or 32.9%, from $554.7 million for the year ended December 31, 2017. For the year ended December 31, 2017, we originated $554.7 million of loans, which was an increase of $206.3 million, or 59.2%, from $348.4 million for the year ended December 31, 2016.

 

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Loans Held for Investment

Our total portfolio of loans held for investment consists of both loans held for investment at cost, which are presented in the consolidated financial statements as loans held for investment, net, and loans held for investment at fair value, which are presented in the financial statements 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:

 

     June 30,
2019
    December 31,  
(in thousands)   2018     2017     2016  

Unpaid principal balance

   $ 1,665,927     $ 1,551,866     $ 1,289,739     $ 1,037,857  

Discount on acquired loans

           (541     (911     (1,300

Valuation adjustments on FVO loans

     (470     (586     (841     (917

Deferred loan origination costs

     23,346       21,812       17,572       13,568  
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment, gross

     1,688,803       1,572,551       1,305,559       1,049,208  

Allowance for loan losses

     (2,096     (1,680     (1,886     (2,529
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for investment, net

   $ 1,686,707     $ 1,570,871     $ 1,303,673     $ 1,046,679  
  

 

 

   

 

 

   

 

 

   

 

 

 

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 June 30, 2019:

 

     June 30, 2019  
($ in thousands)    UPB       

Loans due in less than one year

   $ 1,104        0.1

Loans due in one to five years

     4,704        0.3  

Loans due in more than five years

     1,660,119        99.6  
  

 

 

    

 

 

 

Total loans held for investment

   $ 1,665,927        100.0
  

 

 

    

 

 

 

Allowance for Loan Losses

Our allowance for loan losses increased to $2.1 million as of June 30, 2019, compared to $1.4 million as of June 30, 2018. The increase in allowance is primarily due to the increase in our loan portfolio from June 30, 2018 to June 30, 2019.

Our allowance decreased to $1.7 million as of December 31, 2018, compared to $1.9 million as of December 31, 2017, and $2.5 million as of December 31, 2016. The decrease in the allowance for loan losses is based on an analysis of historical loan loss data from January 1, 2012 through December 31, 2018. 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.

To estimate the allowance for loan losses in our 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.

In June 2016, the FASB issued ASU 2016-13, which significantly changes the way entities recognize credit losses and impairment of financial assets recorded at amortized cost. Currently, the credit loss and impairment model for loans and leases is based on incurred losses, and investments are recognized as impaired when there is no longer an assumption that future cash flows will be collected in full under the originally contracted terms. Under the new CECL model, the standard requires immediate recognition of

estimated credit losses expected to occur over the remaining life of the asset. This new standard will be

 

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significant to the policies, processes, and methodology used to determine credit losses; however, the Company has not yet determined the quantitative effect ASU 2016-13 will have on its consolidated financial statements.

The following table illustrates the activity in our allowance for loan losses over the periods indicated:

 

     Six Months Ended
June 30,
    Year Ended December 31,  
($ in thousands)    2019     2018     2018     2017     2016  

Beginning balance

   $ 1,680     $ 1,886     $ 1,886     $ 2,529     $ 2,343  

Provision for (reversal of) loan losses

     560       (234     201       421       1,455  

Charge-offs

     (144     (272     (407     (1,064     (1,269
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ending balance

   $ 2,096     $ 1,380     $ 1,680     $ 1,886     $ 2,529  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Credit Quality — Loans Held for Investment

The following table provides delinquency information on our held for investment loan portfolio as of the dates indicated:

 

    June 30, 2019      December 31, 2018      December 31, 2017      December 31, 2016  
($ in thousands)   UPB     %      UPB     %      UPB     %      UPB     %  

Current

  $ 1,438,213       86.3    $ 1,358,043       87.5    $ 1,138,749       88.3    $ 920,070       88.7

30-59 days past due

    103,619       6.2        78,848       5.1        59,207       4.6        53,102       5.1  

60-89 days past due

    31,071       1.9        23,881       1.5        18,467       1.4        22,364       2.2  

Nonperforming loans:

                  

90+ days past due

    12,533       0.8        16,181       1.0        22,114       1.7        25,111       2.4  

Bankruptcy

    8,259       0.5        5,901       0.4        5,631       0.4        2,916       0.3  

In foreclosure

    72,232       4.3        69,012       4.5        45,571       3.5        14,294       1.4  
 

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total nonperforming loans

    93,024       5.6        91,094       5.9        73,316       5.7        42,321       4.1  
 

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total loans held for investment

  $ 1,665,927       100.0    $ 1,551,866       100.0    $ 1,289,739       100.0    $ 1,037,857       100.0
 

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Loans that are 90+ days past due, in bankruptcy, or in foreclosure are not accruing interest and are considered nonperforming loans. Nonperforming loans were $93.0 million, or 5.6% of our held for investment loan portfolio as of June 30, 2019, compared to $91.1 million, or 5.9% as of December 31, 2018, $73.3 million, or 5.7% as of December 31, 2017, and $42.3 million, or 4.1% of the loan portfolio as of December 31, 2016. We believe the significant equity cushion at origination and the active management of loans will continue to minimize credit losses on the resolution of defaulted loans and disposition of REO properties.

 

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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 table summarizes the cumulative number and UPB of all loans originated since January 1, 2013 that became nonperforming at some point through June 30, 2019. We classify a loan as nonperforming when it becomes 90 days delinquent or when it enters bankruptcy or foreclosure. Of the 732 loans totaling $273.2 million in UPB that became nonperforming over the specified period, we have resolved 400 loans totaling $151.5 million in UPB, or 55.5% of the cumulative nonperforming loans. We realized a net gain of $4.2 million, or 2.8% of the resolved principal balance, on these resolutions, which is largely the result of collecting default interest and prepayment penalties in excess of the contractual interest due and collected.

 

($ in thousands)   Loan
Count
    UPB(1)     % of Total
Resolved UPB
    Gain /
(Loss) ($)
    Gain /
(Loss) (%)
 

Resolved — paid in full

    268     $ 105,438       69.6   $ 5,208       4.9

Resolved — paid current

    106       34,434       22.7       410       1.2  

Resolved — REO sold

    26       11,630       7.7       (1,434     (12.3
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total resolutions

    400       151,502       100.0     4,184       2.8

Not yet resolved

    332       121,685        
 

 

 

   

 

 

       

Cumulative nonperforming loans(2)

    732     $ 273,187        
 

 

 

   

 

 

       

 

(1)

Reflects the unpaid principal balance at time of delinquency.

 

(2)

Reflects all loans originated since 2013 that became nonperforming at some point on or prior to June 30, 2019.

Our actual losses incurred are very small as a percentage of all loans that have ever become nonperforming. The table below shows our actual loan losses from January 1, 2013 through June 30, 2019, and through the years ended December 31, 2018, 2017 and 2016. Our average annual charge-off percentage since January 1, 2013 is approximately 0.02%. The table includes all loans originated over those periods, the year-end UPB amounts, the amount of loans that were ever nonperforming during those periods, and the actual losses for all loans that were either liquidated or converted to REO (life of loan) during the periods.

 

($ in thousands)

  January 1, 2013 to
June 30, 2019
    January 1, 2013 to
December 31, 2018
    January 1, 2013 to
December 31, 2017
    January 1, 2013 to
December 31, 2016
 

Loan originations

  $ 2,664,817     $ 2,373,034     $ 1,786,023     $ 1,274,509  

End of period UPB

    1,612,756       1,502,526       1,248,087       982,191  

Nonperforming loans(1)

    274,317       227,469       152,209       76,449  

Cumulative charge-
offs(2)

    1,820       1,551       1,171       326  

Average annual charge-offs(3)

    280       258       234       81  

Cumulative charge-off percentage(4)

    0.11     0.10     0.09     0.03

Average annual charge-off percentage(5)

    0.02     0.02     0.02     0.01

 

(1)

Reflects UPB of all loans originated since January 1, 2013 that became nonperforming at some point during the period indicated.

 

(2)

Reflects the total charge-offs on loans that were nonperforming and have been liquidated or converted to REO from January 1, 2013 through the date indicated.

 

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(3)

Reflects the average annual charge-offs on loans that were nonperforming and have been liquidated or converted to REO from January 1, 2013 through the date indicated.

 

(4)

Reflects the cumulative charge-offs as a percent of the end of period UPB.

 

(5)

Reflects the average annual charge-offs as a percent of the end of period UPB.

Concentrations – Loans Held for Investment

As of June 30, 2019, our held for investment loan portfolio was concentrated in investor 1-4 loans, representing 46.3% of the UPB. Mixed used properties represented 13.7% of the UPB and multifamily properties represented 11.3% 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 23.9% in New York, 22.2% in California, 12.0% in Florida, and 8.4% in New Jersey.

 

Property Type

   June 30, 2019  
($ in thousands)    Loan Count      UPB      % of Total UPB  

Investor 1-4

     3,001      $ 771,862        46.3

Mixed use

     614        227,695        13.7  

Multifamily

     460        187,894        11.3  

Retail

     375        158,418        9.5  

Office

     247        99,367        6.0  

Warehouse

     172        91,442        5.5  

Other(1)

     328        129,249        7.7  
  

 

 

    

 

 

    

 

 

 

Total loans held for investment

     5,197      $ 1,665,927        100.0
  

 

 

    

 

 

    

 

 

 

 

(1)

All other properties individually comprise less than 5.0% of the total unpaid principal balance.

 

Geography (State)

   June 30, 2019  
($ in thousands)    Loan Count      UPB      % of Total UPB  

New York

     874      $ 398,434        23.9

California

     876        369,981        22.2  

Florida

     742        200,475        12.0  

New Jersey

     588        139,544        8.4  

Other(1)

     2,117        557,493        33.5  
  

 

 

    

 

 

    

 

 

 

Total loans held for investment

     5,197      $ 1,665,927        100.0
  

 

 

    

 

 

    

 

 

 

 

(1)

All other states individually comprise less than 5.0% of the total unpaid principal balance.

Loans Held for Sale

We started originating short-term, interest-only loans in March 2017, which we have historically aggregated and sold at a premium to par to institutional investors. During the six months ended June 30, 2019 and June 30, 2018, we originated $121.1 million and $49.7 million of loans held for sale and sold $115.1 million and $19.3 million of held for sale loans, respectively. Given our increased experience providing these loans, we are currently evaluating long-term financing alternatives for these short-term, interest-only loans, and may elect to retain these loans in the future to be more consistent with our investment strategy of holding loans in our portfolio and earning a longer-term spread. As of June 30, 2019, our portfolio of loans held for sale, which were carried at the lower of cost or estimated fair value consisted of 306 loans with an aggregate UPB of $82.9 million, and carried a weighted average original loan term of 12.0 months, a weighted average coupon of 10.2%, and a weighted average LTV at origination of 67.0%.

 

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The following tables show the various components of loans held for sale as of the dates indicated:

 

     June 30,
2019
    December 31,  
(in thousands)   2018     2017     2016  

UPB

   $ 82,855     $ 79,335     $ 5,701        

Valuation adjustments

     (103     (173            

Deferred loan origination fees, net

     (444     (716     (50      
  

 

 

   

 

 

   

 

 

   

 

 

 

Total loans held for sale, net

   $ 82,308     $ 78,446     $ 5,651        
  

 

 

   

 

 

   

 

 

   

 

 

 

Concentrations – Loans Held for Sale

As of June 30, 2019, our held for sale loan portfolio was entirely concentrated in investor 1-4 loans, representing 100.0% of the UPB. By geography, the principal balance of our loans held for sale were concentrated 20.1% in California, 16.8% in New York, 11.3% in New Jersey, 9.3% in Florida, and 5.3% in Texas.

 

Geography (State)

   June 30, 2019  
($ in thousands)    Loan Count      UPB      % of Total UPB  

California

     28      $ 16,687        20.1

New York

     26        13,922        16.8  

New Jersey

     45        9,389        11.3  

Florida

     33        7,707        9.3  

Texas

     19        4,378        5.3  

Other(1)

     155        30,772        37.2  
  

 

 

    

 

 

    

 

 

 

Total loans held for sale

     306      $ 82,855        100
  

 

 

    

 

 

    

 

 

 

 

(1)

All other states individually comprise less than 5.0% of the total UPB.

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 June 30, 2019, our REO included 19 properties with an estimated fair value of $14.2 million compared to 12 properties with an estimated fair value of $7.2 million as of December 31, 2018, 14 properties with an estimated fair value of $5.3 million as of December 31, 2017, and seven properties with an estimated fair value of $1.5 million as of December 31, 2016.

 

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Key Performance Metrics

 

     Six Months Ended
June 30,
    Year Ended December 31,  
($ in thousands)    2019     2018     2018     2017     2016  

Average loans

   $ 1,659,957     $ 1,345,135     $ 1,429,877     $ 1,167,999     $ 944,437  

Portfolio yield

     8.80     8.77     8.72     8.38     8.30

Average debt — portfolio related

   $ 1,466,799     $ 1,145,706     $ 1,234,818     $ 965,987     $ 802,683  

Average debt — total company

   $ 1,594,393     $ 1,273,300     $ 1,362,412     $ 1,090,532     $ 914,467  

Cost of funds — portfolio related

     5.37     4.95     5.07     4.93     4.66

Cost of funds — total company

     5.78     5.50     5.57     5.62     5.56

Net interest margin — portfolio related

     4.05     4.55     4.34     4.30     4.34

Net interest margin — total company

     3.25     3.56     3.41     3.13     2.92

Charge-offs

     0.01     0.02     0.03     0.09     0.13

Pre-tax return on equity

     16.1     16.7     14.3     10.8     9.9

Return on equity

     11.4     8.0     7.8     10.8     9.9

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. The increase in our portfolio yield over the periods shown was driven by higher collections of contractual and default interest on nonperforming loans due to the efficiency and expertise of our asset management area, and, to a lesser extent, an increase in the weighted average coupon on the loans in our portfolio.

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 increased to 5.37% for the six months

 

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ended June 30, 2019 from 4.95% for the six months ended June 30, 2018, and from 5.07%, 4.93%, and 4.66% for the years ended December 31, 2018, 2017 and 2016, respectively. The increase in portfolio related cost of funds was the result of the seasoning of older, more costly securitizations, and to a lesser extent, the increasing LIBOR index rates, partially offset by lower spreads paid to investors in our more recent securitizations.

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. Over the periods shown, our portfolio related net interest margin decreased as a result of the seasoning of older, more costly securitizations and, to a lesser extent, the increasing LIBOR index rates, partially offset by higher portfolio yields and lower spreads paid to investors in our more recent securitizations. In addition to achieving lower spreads in our more recent securitizations, we have also been able to utilize more favorable structures that will result in a lower and more stable cost of funds over the life of the securities.

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:

 

    Six Months Ended
June 30, 2019
    Six Months Ended
June 30, 2018
 
($ in thousands)   Average
Balance
    Interest
Income /
Expense
    Average
Yield /
Rate(1)
    Average
Balance
    Interest
Income /
Expense
     Average
Yield /
Rate(1)
 

Loan portfolio:

            

Loans held for sale

  $ 61,013         $ 14,966       

Loans held for investment

    1,598,944           1,330,169       
 

 

 

       

 

 

      

Total loans

  $ 1,659,957     $ 73,028       8.80   $ 1,345,135     $ 58,956        8.77
 

 

 

       

 

 

      

Debt:

            

Warehouse repurchase facilities

  $ 201,832     $ 5,834       5.78   $ 133,134     $ 3,526        5.30

Securitizations

    1,264,967       33,553       5.30     1,012,572       24,837        4.91
 

 

 

   

 

 

     

 

 

   

 

 

    

Total debt — portfolio related

    1,466,799       39,387       5.37     1,145,706       28,363        4.95

Corporate debt

    127,594       6,706       10.51     127,594       6,657        10.43
 

 

 

   

 

 

     

 

 

   

 

 

    

Total debt

  $ 1,594,393     $ 46,093       5.78     1,273,300     $ 35,020        5.50
 

 

 

   

 

 

     

 

 

   

 

 

    

Net interest spread — portfolio related(2)

        3.43          3.81

Net interest margin — portfolio related

        4.05          4.55

Net interest spread — total company(3)

        3.02          3.27

Net interest margin — total company

        3.25          3.56

 

(1)

Annualized.

(2)

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.

(3)

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.

 

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    Year Ended
December 31, 2018
    Year Ended
December 31, 2017
 
($ in thousands)   Average
Balance
    Interest
Income /
Expense
    Average
Yield /
Rate
    Average
Balance
    Interest
Income /
Expense
    Average
Yield /
Rate
 

Loan portfolio:

           

Loans held for sale

  $ 26,306         $ 3,657      

Loans held for investment

    1,403,571           1,164,342      
 

 

 

       

 

 

     

Total loans

  $ 1,429,877     $ 124,722       8.72   $ 1,167,999     $ 97,830       8.38
 

 

 

       

 

 

     

Debt:

           

Warehouse repurchase facilities

  $ 171,637     $ 9,213       5.37   $ 145,878     $ 7,185       4.93

Securitizations

    1,063,181       53,384       5.02     820,109       40,453       4.93
 

 

 

   

 

 

     

 

 

   

 

 

   

Total debt — portfolio related

    1,234,818       62,597       5.07     965,987       47,638       4.93

Corporate debt

    127,594       13,322       10.44     124,545       13,654       10.96
 

 

 

   

 

 

     

 

 

   

 

 

   

Total debt

  $ 1,362,412     $ 75,919       5.57     1,090,532     $ 61,292       5.62
 

 

 

   

 

 

     

 

 

   

 

 

   

Net interest spread — portfolio related(1)

        3.65         3.45

Net interest margin — portfolio related

        4.34         4.30

Net interest spread — total company(2)

        3.15         2.76

Net interest margin — total company

        3.41         3.13

 

(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.

 

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     Year Ended
December 31, 2017
    Year Ended
December 31, 2016
 
($ in thousands)    Average
Balance
     Interest
Income /
Expense
     Average
Yield /
Rate
    Average
Balance
     Interest
Income /
Expense
     Average
Yield /
Rate
 

Loan portfolio:

                

Loans held for sale

   $ 3,657           $        

Loans held for investment

     1,164,342             944,437        
  

 

 

         

 

 

       

Total loans

   $ 1,167,999      $ 97,830        8.38   $ 944,437      $ 78,418        8.30
  

 

 

         

 

 

       

Debt:

                

Warehouse repurchase facilities

   $ 145,878      $ 7,185        4.93   $ 206,162      $ 9,064        4.40

Securitizations

     820,109        40,453        4.93     596,521        28,342        4.75
  

 

 

    

 

 

      

 

 

    

 

 

    

Total debt — portfolio related

     965,987        47,638        4.93     802,683        37,406        4.66

Corporate debt

     124,545        13,654        10.96     111,784        13,419        12.00
  

 

 

    

 

 

      

 

 

    

 

 

    

Total debt

   $ 1,090,532      $ 61,292        5.62   $ 914,467      $ 50,825        5.56
  

 

 

    

 

 

      

 

 

    

 

 

    

Net interest spread — portfolio related(1)

           3.45           3.64

Net interest margin — portfolio related

           4.30           4.34

Net interest spread — total company(2)

           2.76           2.75

Net interest margin — total company

           3.13           2.92

 

(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.

Charge-Offs

The charge-offs ratio reflects charge-offs as a percentage of average loans held for investment over the specified time period. We do not record charge-offs on our loans held for sale which are carried at the lower of cost or estimated fair value.

 

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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, respectively, as a percentage of the monthly average of members’ equity over the specified time period. The Company was not subject to income tax prior to January 1, 2018 because prior to that time it elected to be treated as a partnership for U.S. federal income tax purposes.

 

     Six Months Ended
June 30,
    Year Ended December 31,  
($ in thousands)    2019     2018     2018     2017     2016  

Income before income taxes (A)

   $ 11,580     $ 10,990     $ 19,249     $ 13,989     $ 6,797  

Net income (B)

   $ 8,230     $ 5,276     $ 10,549     $ 13,989     $ 6,797  

Monthly average balance:

          

Members’ equity (C)

     144,071       131,720       134,913       128,940       68,433  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Pre-tax return on equity (A / C)(1)

     16.1     16.7     14.3     10.8     9.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Return on equity (B / C)(1)

     11.4     8.0     7.8     10.8     9.9
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Annualized.

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

Through June 30, 2019, interest expense on corporate debt consists of interest expense paid with respect to the 2014 Senior Secured Notes, as reflected on our consolidated statement of financial condition, and the related amortization of deferred debt issuance costs.

 

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In August 2019, we redeemed the 2014 Senior Secured Notes and repurchased our outstanding Class C preferred units with the proceeds of the 2019 Term Loans, which bear interest at a rate equal to the one-month LIBOR plus 7.50% and mature in August 2024, together with cash on hand. We expect to repay a portion of the outstanding balance of the 2019 Term Loans with a portion of the net proceeds from this offering.

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

Provision for loan losses consists of amounts charged to income during the period to maintain an estimated allowance for loan and lease losses, or ALLL, to provide for probable credit losses inherent in our existing portfolio of loans held for investment (excluding those loans which we have elected to carry at fair value). The ALLL consists of a specific valuation allowance on those loans that are 90 days or more delinquent, in bankruptcy, or in foreclosure, and a general reserve allowance for all other loans in our existing portfolio.

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 the write-off of the remaining purchase discount.

Unrealized Gain/(Loss) on Fair Value Loans.    We have 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 prospectus. Changes in fair value are reported as a component of other operating income within our consolidated statements of operations.

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.

 

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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.

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 net income with various permanent differences. The tax-adjusted net income amount is then multiplied by the applicable federal and state income tax rates to arrive at the provision for income taxes. Prior to January 1, 2018, we had elected to be treated as a partnership for U.S. federal income tax purposes and were, therefore, not required to pay income taxes because of our treatment as a pass-through entity. Effective January 1, 2018, we changed our election to be taxed as a corporation for U.S. federal income tax purposes and are now recording provisions for income taxes.

Consolidated Results of Operations

The following table summarizes our consolidated results of operations for the periods indicated:

 

Summary Consolidated Results
of Operations

  Six Months Ended
June 30,
    Year Ended December 31,  
($ in thousands)   2019     2018         2018               2017                 2016        
    (unaudited)                    

Interest income

  $ 73,028     $ 58,956     $ 124,722     $ 97,830     $ 78,418  

Interest expense — portfolio related

    39,387       28,363       62,597       47,638       37,406  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income — portfolio related

    33,641       30,593       62,125       50,192       41,012  

Interest expense — corporate debt

    6,706       6,657       13,322       13,654       13,419  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    26,935       23,936       48,803       36,538       27,593  

Provision for (reversal of) loan losses

    560       (234     201       421       1,455  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    26,375       24,170       48,602       36,117       26,138  

Other operating income

    2,028       1,542       2,807       2,008       710  

Total operating expenses

    16,823       14,722       32,160       24,136       20,051  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    11,580       10,990       19,249       13,989       6,797  

Income tax expense

    3,350       5,714       8,700              
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 8,230     $ 5,276     $ 10,549     $ 13,989     $ 6,797  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Six Months Ended June 30, 2019 Compared to Six Months Ended June 30, 2018

Our earnings increase is mainly attributable to significant growth in our loan originations of 29.7% and the corresponding income earned from a higher balance of loans under management. Net interest income increased 12.5% partially offset by an increase in operating costs of 14.3%. Our net income increased 56.0% from $5.3 million for the six months ended June 30, 2018 to $8.2 million for the six months ended June 30, 2019.

 

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Net Interest Income — Portfolio Related

 

     Six Months Ended
June 30,
               
($ in thousands)    2019      2018      $ Change      % Change  

Interest income

   $ 73,028      $ 58,956      $ 14,072        23.9

Interest expense — portfolio related

     39,387        28,363        11,024        38.9  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income — portfolio related

   $ 33,641      $ 30,593      $ 3,048        10.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Income.    Interest income increased by $14.1 million, or 23.9%, to $73.0 million during the six months ended June 30, 2019, compared to $59.0 million during the six months ended June 30, 2018. The increase is almost entirely attributable to an increase in average loans (volume), which increased $314.8 million, or 23.4%, from $1.3 billion during the six months ended June 30, 2018 to $1.7 billion during the six months ended June 30, 2019. The average yield (rate) over those same periods increased from 8.77% to 8.80%.

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 volume (i.e., $314.8 million) by the previous period’s average rate (i.e., 8.77% annualized). Similarly, the effect of rate changes is calculated by multiplying the change in average rate (i.e., 0.03% annualized) by the current period’s volume (i.e., $1.7 billion).

 

($ in thousands)    Average
Loans
     Interest
Income
     Average
Yield(1)
 

Six months ended June 30, 2019

   $ 1,659,957      $ 73,028        8.80

Six months ended June 30, 2018

     1,345,135        58,956        8.77  

Volume variance

   $ 314,822      $ 13,798     

Rate variance

        274        0.03
     

 

 

    

Total interest income variance

      $ 14,072     
     

 

 

    

 

(1)

Annualized.

Interest Expense — Portfolio Related.    Interest expense related to our warehouse repurchase facilities increased $2.3 million to approximately $5.8 million during the six months ended June 30, 2019, compared to approximately $3.5 million during the six months ended June 30, 2018. Interest expense related to our securitizations increased by $8.7 million to approximately $33.5 million during the six months ended June 30, 2019, compared to approximately $24.8 million during the six months ended June 30, 2018. Our cost of funds increased to 5.37% during the six months ended June 30, 2019 from 4.95% during the six months ended June 30, 2018. The increase in interest expense — portfolio related was primarily due to the increase in borrowings for loan originations, as well as the impact of increased seasoning of older securitizations.

 

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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).

 

($ in thousands)    Average
Debt(1)
     Interest
Expense
     Cost of
Funds(2)
 

Six months ended June 30, 2019

   $ 1,466,799      $ 39,387        5.37

Six months ended June 30, 2018

     1,145,706        28,363        4.95  

Volume variance

   $ 321,093      $ 7,949     

Rate variance

        3,075        0.42
     

 

 

    

Total interest expense variance

      $ 11,024     
     

 

 

    

 

(1)

Includes securitizations and warehouse repurchase agreements.

(2)

Annualized.

Net Interest Income After Provision for Loan Losses

 

     Six Months Ended
June 30,
              
($ in thousands)        2019              2018          $ Change     % Change  

Net interest income — portfolio related

   $ 33,641      $ 30,593      $ 3,048       10.0

Interest expense — corporate debt

     6,706        6,657        49       0.7  
  

 

 

    

 

 

    

 

 

   

 

 

 

Net interest income

     26,935        23,935        2,999       12.5  

Provision for loan losses

     421        1,455        (1,034     (71.1
  

 

 

    

 

 

    

 

 

   

 

 

 

Net interest income after provision for loan losses

   $ 36,117      $ 26,138      $ 9,979       38.2
  

 

 

    

 

 

    

 

 

   

 

 

 

Interest Expense — Corporate Debt.     For the six months ended June 30, 2019 and 2018, the interest due was paid in cash. In August 2019, we refinanced the 2014 Senior Secured Notes with a portion of the net proceeds from the 2019 Term Loans — a five-year $153.0 million corporate debt agreement with a new lender. In connection with the use of proceeds from this offering, we intend to pay down a portion of the 2019 Term Loans to reduce our interest expense on corporate debt.

Provision for Loan Losses.    Our provision for loan losses increased $0.8 million from negative provision of ($0.2) million during the six months ended June 30, 2018 to $0.6 million during the six months ended June 30, 2019 primarily due to the increase in the loan portfolio.

Other Operating Income

The table below presents the various components of other operating income for the six months ended June 30, 2019 compared to the six months ended June 30, 2018. The $0.5 million net increase is primarily the result of increased volume in held for sale loans, partially offset by valuation adjustments.

 

     Six Months Ended
June 30,
              
($ in thousands)        2019             2018          $ Change     % Change  

Gain on disposition of loans

   $ 2,858     $ 939      $ 1,919       204.4

Unrealized gain (loss) on fair value loans

     (33     210        (243     (115.7

Other income (loss)

     (797     393        (1,190     302.8  
  

 

 

   

 

 

    

 

 

   

 

 

 

Total other operating income

   $ 2,028     $ 1,542      $ 486       31.5
  

 

 

   

 

 

    

 

 

   

 

 

 

 

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Operating Expenses

Total operating expenses increased $2.1 million, or 14.3%, to $16.8 million during the six months ended June 30, 2019 from $14.7 million during the six months ended June 30, 2018. This increase is primarily the result of additional personnel and loan servicing costs associated with higher loan origination volumes.

 

     Six Months Ended
June 30,
               
($ in thousands)        2019              2018          $ Change      % Change  

Compensation and employee benefits

   $ 7,806      $ 7,526      $ 280        3.7

Rent and occupancy

     736        610        126        20.7  

Loan servicing

     3,500        2,445        1,055        43.1  

Professional fees

     1,190        1,033        157        15.2  

Real estate owned, net

     862        693        169        24.4  

Other operating expenses

     2,729        2,415        314        13.0  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total operating expenses

   $ 16,823      $ 14,722      $ 2,101        14.3
  

 

 

    

 

 

    

 

 

    

 

 

 

Compensation and Employee Benefits.    Compensation and employee benefits increased from $7.5 million during the six months ended June 30, 2018 to $7.8 million during the six months ended June 30, 2019, mainly due to higher commission expenses and increased operations and sales staff to support our growth in loan origination volume.

Rent and Occupancy.    Rent and occupancy expenses increased from $0.6 million during the six months ended June 30, 2018 to $0.7 million during the six months ended June 30, 2019, due to the increase in office space.

Loan Servicing.    Loan servicing expenses increased from $2.4 million during the six months ended June 30, 2018 to $3.5 million during the six months ended June 30, 2019. The $1.1 million increase during the six months ended June 30, 2019 is mainly due to the increase in our loan portfolio.

Professional Fees.    Professional fees increased from $1.0 million for the six months ended June 30, 2018 to $1.2 million for the six months ended June 30, 2019, mainly due to increased legal and external audit fees related to our public offering initiative.

Net Expenses of Real Estate Owned.    Net expenses of real estate owned increased from $0.7 million during the six months ended June 30, 2018 to $0.9 million during the six months ended June 30, 2019, mainly due to a $0.2 million increase in REO operating expenses.

Other Operating Expenses.    Other operating expenses increased from $2.4 million for the six months ended June 30, 2018 to $2.7 million for the six months ended June 30, 2019, mainly due to increased data processing costs related to technology investments.

Year Ended December 31, 2018 Compared to Year Ended December 31, 2017

Our income before income taxes increased 37.6% from $14.0 million for the year ended December 31, 2017 to $19.2 million for the year ended December 31, 2018. Our strong earnings growth is mainly attributable to significant growth in our loan originations and a slight increase in our net interest margin. Net interest margin expansion was attributable to an increase in portfolio yield, partially offset by increasing portfolio related cost of funds.

 

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Net Interest Income — Portfolio Related

 

     Year Ended December 31,                
($ in thousands)    2018      2017      $ Change      % Change  

Interest income

   $ 124,722      $ 97,830      $ 26,892        27.5

Interest expense — portfolio related

     62,597        47,638        14,959        31.4  
  

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income — portfolio related

   $ 62,125      $ 50,192      $ 11,933        23.8
  

 

 

    

 

 

    

 

 

    

 

 

 

Interest Income.    Interest income increased by $26.9 million, or 27.5%, to $124.7 million during the year ended December 31, 2018, compared to $97.8 million during the year ended December 31, 2017. The increase is attributable to a combination of an increase in average loans (volume) and an increase in average yield (rate). Average loans increased $261.9 million, or 22.4%, from $1.2 billion during the year ended December 31, 2017 to $1.4 billion during the year ended December 31, 2018. The average yield over those same periods increased from 8.38% to 8.72%.

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 volume (i.e., $261.9 million) by the previous period’s average rate (i.e., 8.38%). Similarly, the effect of rate changes is calculated by multiplying the change in average rate (i.e., 0.34%) by the current period’s volume (i.e., $1.4 billion).

 

($ in thousands)    Average
Loans
     Interest
Income
     Average
Yield
 

Year ended December 31, 2018

   $ 1,429,877      $ 124,722        8.72

Year ended December 31, 2017

     1,167,999        97,830        8.38  

Volume variance

   $ 261,878      $ 21,929     

Rate variance

        4,963        0.34
     

 

 

    

Total interest income variance

      $ 26,892     
     

 

 

    

 

 

 

Interest Expense — Portfolio Related.    Interest expense related to our warehouse repurchase facilities increased $2.0 million, or 28.2%, to approximately $9.2 million during the year ended December 31, 2018, compared to approximately $7.2 million during the year ended December 31, 2017. Interest expense related to our securitizations increased by $12.9 million to approximately $53.4 million during the year ended December 31, 2018, compared to approximately $40.5 million during the year ended December 31, 2017. The increase in interest expense — portfolio related was primarily due to the increase in borrowings for loan originations. Our average cost of funds increased slightly to 5.07% during the year ended December 31, 2018 from 4.93% during the year ended December 31, 2017.

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).

 

($ in thousands)    Average
Debt(1)
     Interest 
Expense
     Cost of
Funds
 

Year ended December 31, 2018

   $ 1,234,818      $ 62,597        5.07

Year ended December 31, 2017

     965,987        47,638        4.93  

Volume variance

   $ 268,831      $ 13,257     

Rate variance

        1,702        0.14
     

 

 

    

Total interest expense variance

      $ 14,959     
     

 

 

    

 

(1)

Includes securitizations and warehouse repurchase agreements.

 

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Net Interest Income After Provision for Loan Losses

 

     Year Ended
December 31,
              
($ in thousands)        2018              2017          $ Change     % Change  

Net interest income — portfolio related

   $ 62,125      $ 50,192      $ 11,933       23.8

Interest expense — corporate debt

     13,322        13,654        (332     (2.4
  

 

 

    

 

 

    

 

 

   

 

 

 

Net interest income

     48,803        36,538        12,265       33.6  

Provision for loan losses

     421        1,455        (1,034     (71.1