Velocity Financial, specializing in bridge loans for rental and small commercial properties, is showing signs of being on the brink of a major breakthrough. While their Q1 2024 earnings call showcased strong performance, a closer look at the transcript reveals a potential game-changer: the company's shift towards fair value accounting and its implications for unlocking substantial hidden value.

CEO Chris Farrar subtly highlighted the addition of two new columns in their book value presentation. These columns represent the potential book value adjustment if all assets and liabilities were marked to fair value, aligning with a practice increasingly adopted by their peers. GAAP restrictions currently prevent reflecting this adjustment on their balance sheet, but the implications are noteworthy.

The company estimates that fully transitioning to fair value accounting could propel their adjusted book value to an impressive $16.81 per share, a significant increase from the current GAAP book value of $13.49. This discrepancy reveals a hidden reserve of roughly $3.32 per share in unrealized gains, concealed within their amortized cost portfolio.

This move is not merely an accounting technicality; it's a strategic decision capable of reshaping investor perception of Velocity Financial. As the company gradually shifts its entire portfolio to fair value over the coming years, this hidden value will steadily emerge, potentially prompting a substantial re-evaluation of the stock.

Imagine Velocity's stock price, currently hovering around $18, beginning to reflect its true intrinsic value as revealed by fair value accounting. The potential upside is significant, particularly when considering the company's solid fundamentals and favorable market conditions.

Velocity Financial Q1 2024 Performance Highlights

Velocity's Q1 performance speaks volumes: a 75% surge in origination volumes year-over-year, a record $2 billion in LOIs issued in April, and a robust pipeline strengthened by banks' continued retreat from lending in their niche. They are consistently originating loans with attractive 11% coupons and low LTVs, further enhancing their risk-adjusted returns.

The securitization market, a crucial funding source for Velocity, remains remarkably supportive. Their recent securitizations were met with overwhelming demand, achieving tighter spreads despite rising base rates. This strong investor appetite underscores the confidence in Velocity's disciplined credit practices and their ability to generate attractive returns.

What's even more impressive is Velocity's ability to navigate the challenging non-performing loans (NPLs) landscape. Despite a slight uptick in the NPL rate to 10.1%, their special servicing team consistently resolves these assets at favorable gains, averaging an impressive 2.5% gain over the past five quarters. This accomplishment not only mitigates potential losses but also significantly contributes to their bottom line.

Velocity's strategic focus on retaining earnings further reinforces their capital position, providing extra resources for growth and enhancing book value. Their recent issuance of $75 million in corporate debt underscores their dedication to expanding their portfolio and capitalizing on the plentiful opportunities within their niche.

The Market's Response: Will the Hidden Value Be Recognized?

The key question is: will the market acknowledge this hidden value and reward Velocity Financial with a higher valuation? If the company sustains its impressive performance, consistently unlocking these unrealized gains through its strategic transition to fair value accounting, the answer could be a resounding yes. Velocity Financial, the sleeping giant, might be poised to awaken, shaking up Wall Street with its explosive potential.

Hypothetical Scenario: Growth in Book Value Under Fair Value Accounting

The following chart illustrates a hypothetical projection of Velocity Financial's book value as they transition their portfolio to fair value accounting.

"Fun Fact: The term 'bridge loan' originates from its function as a temporary bridge between a short-term need and long-term financing, much like how Velocity Financial bridges the gap for borrowers seeking quick capital for real estate projects."