Executive Summary / Key Takeaways

• Broker Network Moat Drives Low-Cost Dominance: Velocity Financial's 21-year-old independent broker network creates a durable competitive advantage with 20-30% lower customer acquisition costs than multi-channel competitors, enabling market share gains as traditional banks retreat from non-QM investor lending.

• Retained Earnings Model Compounds Book Value at 20%+ Rates: Unlike mortgage lenders that sell loans for upfront gains, VEL retains 90% of originations on its balance sheet, reinvesting all earnings to generate 16.2% ROE and 20% annual book value growth, creating a self-funding expansion engine.

• Record Origination Momentum Meets Improving Credit: Q3 2025's $739 million in new loans (up 72% year-over-year) combines with declining nonperforming loan rates (9.8% vs 10.6% prior year) and consistent 3.3-3.8% resolution gains, demonstrating scalable underwriting discipline.

• Valuation at 1.2x Book Offers Asymmetric Risk/Reward: Trading at $19.61 with price-to-book of 1.20x, VEL trades at a discount to its 16.2% ROE and 24.1% pretax ROE, offering investors exposure to a compounding financial franchise at a modest premium to liquidation value.

• Critical Variables to Monitor: The investment thesis hinges on broker network retention as competitors digitize, and VEL's ability to scale to its $10 billion portfolio target while maintaining sub-10% NPL rates through the real estate cycle.

Setting the Scene: The Non-QM Investor Lending Niche

Velocity Financial, founded in 2004 and headquartered in California, spent two decades building what most mortgage lenders abandoned after 2008: a wholesale origination platform focused exclusively on real estate investors. The company operates as a vertically integrated non-qualified mortgage (non-QM) lender, originating loans secured by 1-4 unit residential rentals and small commercial properties through an extensive network of independent mortgage brokers. This isn't the conforming mortgage market dominated by Wells Fargo (WFC) and Rocket Mortgage (RKT); it's a specialized niche where borrowers prioritize certainty of execution over rate, and where banks have largely retreated due to regulatory complexity and balance sheet constraints.

The business model is elegantly simple yet structurally differentiated. Velocity originates loans, retains them on balance sheet at fair value, finances them through securitizations, and compounds earnings by reinvesting all profits into new originations. This creates a flywheel: retained earnings fund portfolio growth, which generates more net interest income, which funds more originations. The company supplements this with two strategic pillars acquired in December 2021: an 80% stake in Century Health Housing Capital, a Ginnie Mae issuer-servicer for multifamily and senior housing, and a technology platform that management is enhancing to improve productivity fivefold in key departments.

Industry structure favors specialists like VEL. Traditional banks, facing Basel III capital requirements and regulatory scrutiny, have reduced exposure to investor loans that don't fit conforming guidelines. This created a $10+ billion annual market served by non-bank lenders, where success depends on broker relationships, specialized underwriting, and efficient securitization execution. Velocity's 21-year track record positions it as a recognized brand within this broker ecosystem, a moat that digital-first competitors struggle to replicate.

Technology, Products, and Strategic Differentiation

The Broker Network: A 21-Year Accumulation of Trust

Velocity's core moat isn't software—it's relationships. The company has built and refined its network of independent mortgage brokers over 21 years, creating a low-cost distribution channel that competitors with retail branches or direct-to-consumer digital platforms cannot match. This matters because acquisition costs in mortgage lending typically consume 1-2% of loan balance; VEL's broker-driven model reduces this by an estimated 20-30%, directly expanding net interest margins.

The network's durability stems from specialization. Brokers serving real estate investors value VEL's ability to underwrite complex deals involving multiple properties, non-traditional income documentation, and quick closing timelines. Management emphasizes that borrowers "prioritize certainty of execution over just the interest rate," a dynamic that allows VEL to price loans at a premium while maintaining volume. In Q3 2025, new originations carried a weighted average coupon of 10.48% versus a portfolio average of 9.74%, demonstrating pricing power even as volume grew 72% year-over-year.

Retention and Servicing: The Compounding Engine

Unlike competitors that sell loans into agency pools for upfront gains, Velocity retains approximately 90% of originations on its balance sheet. This strategic choice transforms the business from a transaction-based originator into a compounding financial institution. Retained loans generate recurring net interest income (3.65% portfolio NIM in Q3) plus origination fees ($9.7 million in Q3, up 45% year-over-year). More importantly, retention creates long-term customer relationships that drive repeat business and cross-selling opportunities.

The Century acquisition enhances this moat by adding Ginnie Mae servicing capabilities for multifamily and senior housing loans. While small ($826.6 million in UPB serviced for others as of Q3), this provides fee income diversification and deepens relationships with institutional investors. Management's strategy of handling special servicing in-house while outsourcing primary servicing creates operational leverage—delinquent asset resolution generated $2.8 million in gains in Q3, representing 2.6% of the $108 million in UPB resolved, which was below the 3.3-3.8% average over the last five quarters. Q4 2024's $5.6 million gain on $79 million resolved (7%) shows upside in favorable markets.

Technology Investment: Scaling Without Proportional Headcount

Velocity is undertaking a 12-to-18-month technology program to improve process efficiency, citing a fivefold productivity gain in its post-closing department as proof of concept. This matters because the company's $10 billion portfolio target within five years would traditionally require proportional headcount growth. Management hopes to add "maybe a couple hundred people over five years" while implementing technology to minimize hiring, preserving operating leverage.

The initiative addresses a key vulnerability: scale disadvantage versus larger competitors. PennyMac and Rithm Capital operate with greater securitization volumes and lower funding costs due to size. VEL's technology push aims to offset this through superior unit economics—faster processing, lower cost per loan, and improved credit monitoring. If successful, it narrows the competitive gap while maintaining the specialized service that brokers value.

Financial Performance & Segment Dynamics

Portfolio Growth: The $10 Billion Trajectory

Velocity's loan portfolio reached $6.28 billion in UPB as of Q3 2025, a 32% year-over-year increase after netting out prepayments. This growth accelerates each quarter: Q1's $640 million in originations (up 69% YoY) led to Q2's $725 million (up 76% YoY) and Q3's record $739 million (up 72% YoY). Management describes this as "step function" growth—periods of rapid expansion followed by digestion—rather than linear progression, a pattern that suggests sustainable momentum rather than unsustainable acceleration.

The portfolio mix tilts increasingly toward commercial assets, which represented approximately $770 million of the $1.4 billion year-over-year increase. Small commercial loans (mixed-use, retail, office, multifamily) now comprise 49% of UPB, nearly even with 1-4 residential rentals at 49.3%. This diversification matters because commercial loans carry higher average balances (just under $450,000 in Q4 2024 versus $380,000-$400,000 for residential) and similar credit profiles, enhancing revenue per loan without incremental risk.

Credit Quality: The Resolution Machine

Nonperforming loans stood at 9.8% of the held-for-investment portfolio in Q3, down from 10.3% in Q2 and 10.6% a year prior. While this appears high versus traditional mortgages, it's consistent with VEL's historical range and reflects the non-QM nature of the portfolio. The critical metric is resolution performance: over 90% of NPLs resolve with borrowers either paying current (including default interest) or paying off the loan through refinancing or property sale.

This resolution efficiency generates consistent gains. Q3's $2.8 million in NPL resolution gains represented 2.6% of resolved UPB, which was below the 3.3-3.8% five-quarter average. Q4 2024's $5.6 million gain on $79 million resolved (7%) shows upside in favorable markets. These gains directly boost net interest margin and demonstrate underwriting discipline—VEL's collateral values and personal guarantees protect principal even when loans default.

The allowance for credit losses sits at 0.22% of amortized cost loans, down from 0.24% year-over-year, reflecting improved macroeconomic forecasts and the exclusion of COVID-era data from CECL models. Charge-off rates remain modest at 0.13% annualized in Q3, up from 0.05% a year prior but down from 0.31% in Q2, showing manageable credit volatility.

Margin Stability: The 3.5% NIM Target

Portfolio-related net interest margin was 3.65% in Q3, consistent with the five-quarter average of 3.62% and above management's 3.5% target. This stability is remarkable given the rate environment and reflects VEL's pricing power on new originations (10.48% WAC) and efficient securitization funding. The company's shift to fair value accounting for loans and securitized debt in 2022-2023 reduces accounting volatility, allowing investors to focus on cash economics.

Interest expense increased to $88.9 million in Q3 (from $63.9 million prior year) due to larger portfolio financing and higher rates, but this was offset by interest income growing to $144.1 million (from $105.1 million). The net result is a stable NIM that funds operating expenses and retained earnings growth.

Outlook, Guidance, and Execution Risk

Management's guidance is confidently optimistic yet grounded in observable trends. CEO Christopher Farrar states the "current pace [of production] is sustainable" and expects "a good run rate, if you want to project out for the rest of the year, and probably with a little bit of upward slope to that because we're seeing really good demand." This aligns with the $10 billion portfolio target within five years, which requires approximately 9.75% annual growth—well within recent performance.

The pipeline supports this outlook. Q3 new applications exceeded $1.4 billion, nearly double the $739 million in closed volume, indicating strong future production. Management notes that "banks are limiting their lending in our target niches," a tailwind that should persist as regulatory pressure keeps traditional lenders conservative. The "higher for longer" rate environment is viewed as beneficial, with management stating "our business is far less rate-sensitive than other mortgage segments" because borrowers prioritize execution certainty over rate.

Execution risks center on scaling the broker network and technology platform simultaneously. The company has 323 employees across five offices operating a hybrid model. Adding "a couple hundred people over five years" while implementing technology to minimize hiring requires precise execution—missteps could strain service quality and broker loyalty. Additionally, the single-counterparty securitization pilot launched in Q3, while reducing transaction costs, introduces concentration risk if the top-tier money manager relationship falters.

Risks and Asymmetries

Broker Dependency: The Channel Concentration Risk

Velocity's reliance on independent brokers creates vulnerability to channel disruption. If digital-first competitors like loanDepot or fintech disruptors offer brokers superior technology or pricing, VEL's acquisition cost advantage could erode. The risk is moderate but material—broker consolidation has reduced independent players by an estimated 10% year-over-year industry-wide, potentially increasing VEL's cost per origination.

Mitigation lies in relationship depth. VEL's 21-year track record and specialized product set create switching costs for brokers, who would need to rebuild investor relationships at a new lender. The company's in-house special servicing also differentiates it from competitors who outsource collections, giving brokers confidence that their clients will be treated fairly during distress.

Scale Disadvantage: The Funding Cost Gap

At $6.3 billion in portfolio UPB, VEL is a fraction of PennyMac's ($25.4 billion enterprise value) or Rithm Capital's ($37.5 billion EV) scale. This translates to higher securitization costs and less favorable warehouse terms. While VEL has completed 44 securitizations for $9.9 billion since 2011, larger competitors can issue more frequently and at tighter spreads.

The asymmetry is that VEL's specialized focus yields superior per-unit economics. Its 16.2% ROE and 39.6% profit margin are notably strong, exceeding that of Finance of America . This suggests that scale disadvantages are offset by operational efficiency. However, if securitization markets tighten significantly, VEL's smaller issuance size could become a material handicap, forcing it to accept wider spreads that compress NIM below the 3.5% target.

Credit Cycle Risk: The Real Estate Exposure

Nonperforming loan rates of 9.8% are manageable in a stable market but could spike in a real estate downturn. VEL's weighted average LTV of 65.5% (62.8% on new originations) provides a 35%+ equity cushion, and personal guarantees add recourse. Yet a severe commercial real estate correction could push defaults beyond historical resolution capabilities.

The company's resolution track record provides some comfort. Over 90% of NPLs cure or pay off, and REO properties (primarily 1-4 residential) are "very, very liquid and relatively easy to sell" due to deep investor markets. However, Q3's $7.9 million in REO net expenses (up from $2 million prior year) shows that liquidations can generate quarterly volatility. Management attributes this to "timing issues" rather than deteriorating collateral values, but investors should monitor REO valuation adjustments as a leading indicator.

Valuation Context

At $19.61 per share, Velocity Financial trades at 1.20x book value of $16.31 and 8.06x trailing earnings. This valuation is modest for a financial institution generating 16.2% ROE and 20% annual book value growth. The price-to-operating cash flow ratio of 13.63x and enterprise value-to-revenue of 24.25x reflect the market's recognition of VEL's compounding model, yet remain below typical multiples for high-ROE financials.

Peer comparison highlights VEL's quality. Finance of America (FOA) trades at 0.65x book but generates negative ROE (-2.86%) and operating margins (-28.75%). loanDepot (LDI) trades at 2.17x book but loses money with -27.73% ROE. PennyMac (PFSI) (1.61x book, 12.55% ROE) and Rithm Capital (RITM) (0.87x book, 11.04% ROE) are profitable but less efficient per dollar of equity. VEL's combination of positive earnings, high margins, and reasonable valuation multiple is unique in the non-QM space.

The $100 million ATM program, with $38.1 million raised year-to-date at an average price of $18.74, provides growth capital, resulting in approximately 5.4% dilution relative to outstanding shares (2.067 million shares versus approximately 38 million outstanding). Management's stated intent to raise capital through a "balanced mix of equity and debt" to maintain debt-to-equity ratio suggests disciplined capital management that preserves per-share value.

Conclusion

Velocity Financial has built an underappreciated compounding machine in a market segment that traditional banks have abandoned. Its 21-year broker network creates a durable moat that drives low-cost origination and market share gains, while its retained earnings model generates 20% annual book value growth at 16%+ ROE. Record origination momentum, improving credit metrics, and stable net interest margins demonstrate that this growth is not coming at the expense of underwriting discipline.

The valuation at 1.2x book value offers investors an attractive entry point for a high-quality financial franchise. While scale disadvantages and broker dependency present legitimate risks, VEL's superior per-unit economics and specialized focus provide defensive characteristics that larger, more diversified competitors lack. The key variables to monitor are broker network retention and the company's ability to scale to its $10 billion portfolio target while maintaining sub-10% NPL rates. If management executes, the combination of a durable moat, compounding capital, and reasonable valuation should generate attractive returns for long-term shareholders.