Altisource Portfolio Solutions (NASDAQ:ASPS) Q2 2020 Earnings Call

0:00 Good morning, and welcome to the Altistar Second Quarter 2020 Earnings Conference Call. My name is Brandon, and I'll be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, during which you can dial star 1 if you have a question. Please note this conference is being recorded, and I will now turn it over to Michelle Esterman, Chief Financial Officer. You may begin.

0:23 Thank you, Operator. We first want to remind you that the earnings release, Form 10-Q, and quarterly slides are available on our website at www.althysource.com. These provide additional information investors may find useful. Our remarks today include forward-looking statements which involve a number of risks and uncertainties that could cause actual results to differ. In addition to the usual uncertainty associated with forward-looking statements, The current COVID-19 pandemic makes it extremely difficult to predict the future state of the economy and its potential impact on Altisource. The inherent uncertainty of the impact of future events on Altisource is also impacted by Auckland's recent communication to us that it has been directed by an MSR investor to move field services and other service referrals from Altisource to another service provider. Please review the forward-looking statements section in the company's earnings release Quarterly Slides, and Form 10-Q, as well as the risk factors contained in our 2019 Form 10-K and First Quarter Form 10-Q, which describe factors that may lead to different results.

1:34 We undertake no obligation to update these statements as a result of new information or future events. During this call, we will present both GAAP and non-GAAP financial measures. In our earnings release and quarterly slides, you will find additional disclosures regarding the non-GAAP measures. A reconciliation of GAAP to non-GAAP measures is included in the appendix to the quarterly slides. Joining me for today's call is Bill Shepro, our Chairman and Chief Executive Officer. I would now like to turn the call over to Bill.

2:06 Thanks, Michelle. Good morning, and thank you for joining today's call. This morning, I will provide a brief summary of our second quarter financial performance and discuss the operational and financial impact on Altasource from COVID-19 and Aquin's communication to us that an MSR investor is directing it to move certain service referrals historically provided to Altasource to another vendor. I will also cover our objectives for the balance of the year, including our preparation to capture the countercyclical opportunity from higher delinquencies and our plans to reduce internal costs and grow earnings. As a result of the pandemic, AltaSource is facing an unprecedented and challenging business environment with industry-wide second quarter foreclosure initiations down by approximately 85% and lender-completed foreclosures down by 75% compared to the second quarter of 2019, despite the 306% increase in seriously delinquent loans over the same period.

3:07 Turning to slide five, As anticipated, our second quarter revenue of $91 million, adjusted pre-tax loss of $10 million, and adjusted EBITDA loss of $2 million reflect the full quarter impact from COVID-19, which was partially offset by our cost reduction efforts. Since the national emergency was declared in March, federal and various state governments have taken measures to provide financial support to residential mortgage borrowers, including mortgage forbearance programs, and foreclosure and eviction moratoriums. For varying lengths of time during the quarter, most states enacted stay-at-home orders and restricted services to only those deemed essential. These measures significantly reduced our default-related referrals and revenue for the quarter. Strong growth across our origination-related businesses from a historically low interest rate environment, success from our business development efforts and a rebound in June home sales partially offset these declines.

4:08 As you can see on slide six, second quarter revenue from customers other than Aquent, NRZ, and Resy in our core lines of business was 5% higher than the second quarter of 2019, driven by strong growth in our origination-related businesses, partially offset by a decline in some of our default-related businesses, primarily from governmental actions related to the pandemic. In this difficult environment, we acted quickly to reduce costs, worked to mitigate the impact to our customers and supported the safety of our employees. As a result, the vast majority of our staff are working from home, and we are able to preserve cash, ending the quarter with $68 million in cash and cash equivalents. Keep in mind that this excludes our marketable securities.

4:54 For a more detailed description of our second quarter financial performance compared to prior periods, please refer to today's press release and Form 10-Q. We anticipate this short- to medium-term pressure on our default-related businesses to continue. Governmental forbearance programs and moratoriums temporarily prevent servicers from pursuing foreclosure of delinquent loans. More recently, as set forth on slide seven, Aquinn advised us that an MSR investor instructed it to move certain referrals for field services to another service provider beginning in July, with a balance anticipated to be moved over the next couple of months. Aquin also advised us that this same investor intends to instruct Aquin to utilize a different provider for certain other services at unspecified future dates. We believe the MSR investor providing this direction is NRZ and that the referrals are being moved to service businesses that NRZ either owns or in which it has invested. We believe that these actions violate our agreements with Aquin and we are currently in discussions with Aquin to address this matter and have reserved all rights.

6:02 We estimate that revenue from the NRZ portfolios, excluding revenue we earned from our cooperative brokerage agreement with NRZ, represented approximately 39% or $79 million of our first half 2020 service revenue, the majority of which is in the lower margin field services business. We estimate that the field services portion of this service revenue was $58 million. Because it is difficult to predict the timing of the potential change of Altasource as the service provider, Our 2021 forecast conservatively assumes that we don't generate any revenue from these portfolios. The investor's decision to change service providers does not impact the cooperative brokerage agreement where we provide REO brokerage and auction services to NRZ.

6:49 To address lower than previously anticipated revenue from AQUIN and the extension of foreclosure and eviction moratoriums, we are developing a plan to implement additional cost reduction measures. As you can see on slide 8, based upon our current planning, we are forecasting Altasource to generate 2021 service revenue of $250 to $270 million, adjusted EBITDA of $35 to $43 million, and adjusted EBITDA margins of 14 to 16%. This forecast includes the anticipated impact from the pandemic, the loss of service referrals from the Aquan MSR investor that I just discussed, and our anticipated cost reduction measures. We believe there is a substantial opportunity for revenue growth and margin improvement from these amounts in 2022 and beyond.

7:39 Given the very volatile environment associated with the pandemic and the recent aqua news, there is greater uncertainty that could cause our actual results to differ materially from our forecast. We believe that despite these near-term headwinds, we have a strong set of mature and comprehensive real estate and mortgage businesses that are well positioned and ready to capture the opportunity from the higher delinquency environment once the temporary governmental programs are lifted. Keep in mind that the default business for AltaSource is not lost. Rather, it has been pushed off as a result of these programs. In a normal market, we estimate that for every 1% increase in delinquency rates, the addressable market for our default-related services increases by approximately $700 million.

8:25 Based on the increase in 30-plus day delinquencies since the beginning of the year, We estimate that the addressable market for our services has grown by over $2.7 billion. With our attractive and growing customer base, we should begin to benefit from the growing addressable market as the temporary governmental relief expires. Turning to slide nine and our business objectives. As we look to the balance of the year, we have three primary objectives. First, preserve cash. Second, position the default related businesses for tremendous medium to longer term upside. and third, continue to grow our origination services businesses. Beginning with our objective to preserve cash. Our top priority is to preserve liquidity given our current environment.

9:11 Altasource has a capital life business model with a highly variable cost structure. As I discussed earlier, we are developing a cost reduction program to achieve our 2021 financial objectives. This should leave Altasource in a good position when demand for our default related services returns and grows. This brings me to our second objective. Turning to slide 10 and our default related businesses.

9:34 We are optimistic about our long term potential for these businesses despite the short term challenges. As shown on slide 11, delinquency and unemployment rates are rising at a historically fast pace. According to Black Knight, the national 30 plus day mortgage delinquency rate in June was 7.6% compared to 3.2% in January and the number of seriously delinquent mortgages increased from 400,000 to 1.9 million, the highest level since early 2011. The unemployment rate remains high at 11%. As we look ahead, we believe the unprecedented level of foreclosure and eviction relief will subside and if unemployment rates are elevated, delinquency levels are likely to remain substantially higher than they were before the pandemic began.

10:23 This should drive a strong rebound in our default related businesses toward the middle to end of next year and is very much in line with the feedback we are receiving from our clients. In the meantime, we are enhancing our technology to improve the efficiency of our field services business and extend the reach of our HUBZoo marketplace. Turning to our third objective and growing our origination businesses. As you can see on slide 12, we have a robust suite of origination solutions that benefited from a low interest rate environment, and strong business development activity. In addition to market tailwinds, we have a large opportunity to grow our origination-related businesses by capturing greater wallet share from the LendersOne Mortgage Cooperative members and converting our sales pipeline. Slide 13 provides you with an update on select sales wins.

11:12 We are confident in Altasource's long-term potential. We believe that as the default-related market returns and as we continue to grow our originations-related businesses, will be a stronger, more diversified company that is better positioned to withstand varying economic cycles. We have an efficient and scalable business model that can adjust to the current environment and should benefit tremendously once delinquent loans begin to move through the normal default life cycle. I'll now open up the call for questions. Operator? Thank you. We'll now begin the question and answer session. If you have a question, please press star 1 on your telephone keypad. If you'd like to be removed from the queue, please press the pound sign or the hash key. If you're on a speakerphone, please pick up your handset first before dialing. Once again, if you have a question, please dial star 1 at this time.

12:08 We're standing by for questions. and from B. Riley, we have Raj Sharma. Please go ahead.

12:18 Hi, good morning. The loss in the MSR, which is NRZ related, you know, you had already alluded to that first quarter. Any sort of change, any more color in that on the timing of when this phase... Hi, good morning. Good morning. Any sort of color on the timing of when NRZ is entirely phased out? And also, is it the impact across? I know you mentioned that it's across default services and marketplace. So anything different from what you had alluded to in the first quarter?

13:04 Yeah, Raj, good morning. If you recall, earlier in the year, we mentioned that we estimated that the NRZ business Excluding the Cooperative Brokerage Agreement, which is not impacted by this, was about 40%, I think, for the first half of our revenue, service revenue. For the first half of the year, it represented about 39%, so slightly below what we said earlier in the year. From a timing perspective, in July, Aquin started to move some of the inspection work from Altasource to to Guardian, which is an NRZ-owned company. And we believe that activity, so inspections moved in July, and we believe the REO-related work we do in field services will move over the next couple of months.

13:59 And then as to the other services, we're not aware of timing. We're aware that there's AQUINS having conversations with NRZ about redirecting those services. We're not aware of the timing, but in the forecast, we We talked about in my prepared remarks, we just make the assumption, which we think is very conservative, that it's all moved before the beginning of next year. And again, none of this impacts the marketplace business.

14:25 Right. And then on the moratorium, when do you think the moratorium and any sort of color on that and the timeline of You know, the serious delinquencies are rising at an incredible pace. When do you, you know, once the moratoriums are lifted, when do you think they're lifted, and then when do you think they flow through? Your income statement.

14:54 So the forbearance program was put in place, the governmental forbearance program, I think it was in late March. and today you have close to 4 million borrowers under some form of forbearance and those plans can extend for up to a year where the borrowers don't necessarily have to be making any payments. On top of that, you have the moratoriums that were originally supposed to expire at the end of June that were extended to the end of August, both foreclosure and eviction. So that basically is put in absolute halt. So if you think about our, you know, about the, even in a historically low environment like last year, historically low delinquency environment, you probably had something like 120,000 foreclosure starts a quarter, and you probably had, and this is just an internal estimate, a rough estimate of 30,000 completions or so each quarter, and in the second quarter this year, there were 18,000 foreclosure starts, and I think under 10,000 might even been substantially less than that foreclosure completion.

16:01 And so the end is, you know, it's dropped like a rock. But what's the good news? That's the bad news for us. The good news is the revenue is not lost. You know, when you think about our business, you know, if you contrast it with the origination space, Raj, so in originations, you have interest rates at historically low levels, and you're pulling through to today all these future refinancing activities. You hear servicers talking about refinancing a certain percentage of their book that's refinanceable. In our case, we actually have a very large amount of business that's building, but not here today. The normal business that we would be working on, we're not receiving because of the moratoriums. Then on top of that, what's happening is you're seeing this massive three times increase in delinquency rates, and we're not yet benefiting from that. So we believe that's building a tremendous pipeline of future business for Altasource. And then to answer your question as to when, the moratoriums, at least as of right now, are extending to the end of August.

17:08 We're hearing it's possible they could be extended further, although nothing has been decided by the government. And then the forbearance plans, those will roll off Thank you.

17:50 Thanks, Rush. From Northland Securities, we have Mike Grondahl. Please go ahead.

17:57 Hey, Bill. Any estimate on the second quarter sort of missed revenue due to the forbearance situation?

18:09 Yeah. So, hi, Mike. So, in the second quarter, we actually performed a little bit better than our planning related to COVID-19 situation. The marketplace business got hit really hard in the second half of March, April, and May. And then because we still have a decent-sized inventory of REO, as the market came back, we're not getting a lot of new inflow, but we have an inventory. So as the home sale market really got strong starting in June, that came back. But, Mike, I would say we were probably off by at least 25%, if not more, in terms of total revenue in the second quarter. compared to what we would be in a more normal environment. Michelle, I don't know if you have anything to add to that.

18:54 Yeah, I think that's spot on, Bill.

18:58 Got it. And then on the expense side, is it possible to kind of, you know, a few of the areas you're targeting and sort of the total dollars, do you have sort of a range of dollars you think you can pull out?

19:15 Yeah, so if you remember, we initially had worked on a plan that was going to take our run rate down, Michelle, correct me if I'm wrong, from the end of last year. Was it $45 to $50 million?

19:26 Yeah, that's right.

19:28 And so, Mike, that was some planning that we had already started related to what's going on in our environment. And then when the moratoriums got extended and the news from Aquin sort of crystallized that risk that we've been talking about for some time, We've started developing additional plans. And I think Mike, without going into all the specifics, we're very, very actively working on plans that will get us to that 14 to 16% EBITDA margins for next year. But think about like in field services, Mike, which is one of our lower margin businesses, probably a 10 to 15% margin business. Most of the costs in that business are variable. If we don't receive a referral, We don't incur an expense.

20:15 And the same applies to a lot of our other services. So our outside goods and services automatically go down with a decline in referrals. And then beyond that, we're looking at basically everything at the company in terms of discretionary spending, unrelated to what we need to support the growth that we anticipate is coming, corporate costs, business unit costs. We're looking at all of it. and developing plans. Got it, got it.

20:46 It would be, so we sort of should expect 3Q and 4Q is when the forbearance stuff is really going to have the most effect because you were selling the inventory you had in 2Q, but you don't get much inflow. So that's where you're going to get hit the hardest. Is that fair?

21:05 Yeah, so we're working hard. So we think in the second half of the year, Mike, and again, there's a lot of uncertainty because we don't know if these moratoriums are going to get extended. We're not sure exactly what's going to happen when the moratorium is extended because some of those borrowers presumably that would have been impacted or benefited from the moratorium also have forbearance plans in place. So there's a lot of uncertainties right now that makes it very, very hard to predict the second half of this year. So with that caveat, based on our internal planning and and the cost savings we're working on, we're trying to basically keep the cash burn as low as possible for the second half of the year. And I don't know that we'll break even from an EBITDA perspective, but we think we're working hard to get close to break even.

21:55 And again, a lot of caveats around what's going on both with Aquin and the timing of the move to other vendors on NRZ's behalf, as well as what's happening with the moratoriums. Sure, sure.

22:09 And just last question, what are your legal rights? What are you kind of pursuing with Aquin? You said you were discussing talking with them. What are you hoping to gain?

22:22 Yeah, sure. So let me start by saying we have a very good working relationship with Aquin. And we're having a very constructive dialogue with Aquin right now regarding You know, this move by NRZ or this direction by NRZ to Aquin. I don't want to get into the details, Mike, but as there's more to report, we will. But we're having, we maintain a very strong relationship, working relationship with Aquin. We're having a very robust and constructive dialogue with Aquin around resolving these issues, and hopefully there'll be more to report soon.

23:01 Got it. Okay. Thank you.

23:04 Great. Thanks, Mike. And once again, if you do have a question, please dial star 1 on your telephone keypad. And we're standing by for any further questions. And we have a follow-up from Raj Sharma. Please go ahead.

23:26 Hi, Bill. Hi, Michelle. Just one follow-up on can you comment on your liquidity and how I know you just said you're trying your best to be breakeven. So there's no change in, can you comment on any debt obligations coming up and your ability, your cash levels and your ability to be able to withstand this decline in volume to the next year?

23:59 Yeah, so Raj, we feel, you know, based on the planning we've done and our current forecast, we feel good about our liquidity. And I think we ended the quarter with $68 million. I looked at our cash position a couple days ago. It was over $70 million. So cash continues to be strong. And as you know, we're a capital-like business. We spend very, very little on capital. If we spend another million, million and a half the rest of the year, I think that's probably a reasonable estimate. So we feel very good about our liquidity. And then when you look at our planning for next year and those EBITDA levels, we're talking about plenty of liquidity to cover our debt service. We believe we have plenty of liquidity to cover our debt service and generate some excess cash flow next year.

24:52 All right. And our last point, Raj, on the loan. It's a covenant-light loan. There's an excess cash clause, so if net debt to EBITDA gets above a certain level, a certain percentage of our 25% and then 50% of excess cash flow that we generate during that period is used to reduce the debt, but there's no financial covenants, and the loan doesn't mature until April 2024.

25:25 No amortizations.

25:28 There's a minor amount of amortization. I think contractual amortization is about $13 million between now and maturity. Great. Thank you.

25:39 Our next amortization event doesn't occur until March of 2023.

25:46 We feel very good about the Our liquidity and we've got a very good plan that we're developing that we think positions Altasource as a stronger, more diversified, fast-growing company that can take advantage of the growing delinquency rate, which we believe this revenue has not been lost but deferred.

26:08 And also, just one last question on the servicers. The new servicers, you added some new business. This quarter, any new wins?

26:39 We're very close to signing agreements with several banks and non-banks related to our marketplace business. So when volumes return, we'll have additional customers, so we should benefit from that. So we're very pleased with the pipeline, and it continues to grow and make progress. Thank you so much. Thanks, Brad. And once again, if you do have a question, please dial star 1 on your telephone keypad. And standing by for any further questions. Okay, showing no further questions at this point, we'll now turn it back to Bill Shepro for closing remarks.

27:31 Thanks, Operator. Thanks for joining today's call, and we look forward to Thank you, ladies and gentlemen. This concludes today's conference. Thank you for joining. You may now disconnect.