Real Matters Inc. (REAL) Earnings Call Transcript & Summary

Good afternoon, everyone. Thank you for joining us today on our virtual conference series, Enter the Metaverse, the world of virtual living. Crisis tends to pull trends forward that are all reforming. This conference series is an examination of these trends and how they're shaping our markets. This is the fourth session this week and the final one in the series. And today, we're hosting 3 fast-paced fireside chats with companies that are seeing new demand as a result of the recent pressures on our culture and economy. The first is with Real Matters who has been helping banks deal with the growing volume of refinancing in a low rate environment. The second is EXFO, who will help us understand the impact of all the teleconferencing, e-learning, streaming and video gaming we've been doing. And then finally, we'll hear from Dejero Labs, a private company at Waterloo, who'll help us understand the enterprise and broadcast side of the same network pressures. Now we are all facing challenges related to COVID-19. I want to take a second to extend Canaccord Genuity's best wishes for you and your family. We hope that you stay safe and enjoy good health as you navigate this new world. And so now for some introductions. I'm going to be the moderator. My name is Rob Young. I'm an Equities Analyst at Canaccord Genuity, covering the Canadian Technology Sector. I normally sit in Toronto, that's where I am today, and I've been doing this for the last decade or so. We are speaking today with Jason Smith, who's the CEO and Founder of Real Matters; and Brian Lang, he's the President and COO. Real Matters is a cloud software provider to the mortgage lending industry with about 90% of their business driven by the U.S. market. They've built a network where independent appraisal and noted professionals compete to provide their services to mortgage lenders. All of the largest regulated banks in U.S. are now using Real Matters, and they've been steadily moving a larger share of their work to them given improved customer experience, lower error rates and quicker turnaround times. We provide research coverage at Real Matters, ticker is REAL on the TSX. We rate the stock of buy with a $17 target and despite the market turmoil, the stock is up a little over 25% year-to-date and a little over 50% since the middle of March. Now we've got a number of prepared questions. But I hope you weigh in with your own by the conference portal. I'm going to be monitoring those submissions, and we'll bring those out at the end of the session. And so with that, get right into the questions here.

Real Matters has seen some very drastic changes in the demand for its services under a lower U.S. Fed rate. You've been very engaged with investors with updates. And you've talked about a market opportunity of 14.5 million refinance candidates. Can you give us some color about that estimate?

Sure. And it's Jason. Well, as you know, Rob, we're historically -- since we went public in May of '17, we've been experiencing strong growth. And that's by adding clients and growing share within those clients. And actually, in the first part of our IPO journey, the mortgage market was actually in decline as rates were rising. 2019 was largely a story. We did very well in the year, but it was a story of that market volume bottoming out. But we focused on high-teens growth and appraisal, and we've been experiencing higher growth in that in title. But yes, early March, what seemed to happen was a strong tailwind, really for the first time emerged on our business. And the spark for that was the drop in the 10-year rate down to levels of 1.0. And essentially, the 30-year mortgage rate is set off of the 10-year yield. And as that 10-year came down, mortgage rates dropped to about 3.25, and 70% of all U.S. mortgages were incented to refinance. And what that means is, if you can get 75 basis points drop in your rate, you just have to order another appraisal, which is what we do and title, which is what we do. And then the homeowner without cost in the U.S. can just switch their mortgage into a lower rate. So that just created an enormous amount of volume. In almost 2 weeks, the banks then had to raise rates again because they didn't have the underwriting capacity to handle that volume. It was stories of phone calls going unanswered into the branches and call centers, et cetera. So when we think about this, in my earlier comments, a year ago, we were really at multi-decade lows of refinance activity. So the banks just haven't been able to scale up their underwriting capacity to handle it. So they throttled the mortgage rate there to do that. So that's what we saw pre-COVID-19 and COVID-19, of course, hit. The banks all had to go into their BCP environments and working from home with their staff. So we saw a productivity drop, but we've been putting out updates on a weekly basis so that investors can get some sense of how this is going. And we continue to see stronger volumes than any week we did in 2019. So the lenders have really adapted well. The capacity, Rob, we think, is about 2 million to 2.5 million mortgages a quarter that the bank can do. And that's whether or not their purchases or refinances. So if there's at least 14.5 million refinances that are available, you got -- the banks prioritize the purchases. So we really think that this is a 2- to 3-year tailwind for us on top of the market share growth that we've been experiencing and are well-known for.

And you're expecting a certain amount of purchase. What's the impact of this demand for refi on appraisal and title? If we're moving into a weaker economy, and I bet -- we're going to see a lot of people put off plans to buy home. So purchase may go to 0, may go down significantly. Can you offset that with refinance model?

Now the quick answer is yes. Because there're so many of those refis, 14.5 million and the total capacity for the lenders is 2 million to 2.5 million a quarter, even if we saw unemployment rates go up, we saw forbearance rates go up, which we saw property values drop, then you still have a large pool relative to the constrained underwriting capacity of the lenders. So yes, I mean, this is usually, spring market is the busiest purchase market. So the banks would be pushing all the purchase volume through, and they've had some capacity to refi. And certainly, as we saw through industry stats in January and February and my comments early March is it was robust purchase activity. Surprisingly, the MBA came out this week, actually, purchases were up slightly week over week. But I would say that the market is predominantly refi right now. And we think for the next 2 quarters, there's sufficient of the pool, even with those potential negative factors to [Audio Gap] capacity. From a growth perspective for the industry to grow, really, the banks are going to have to hire more underwriters and do that in a work-from-home environment. So we're watching that really closely. That seems to be the hurdle for the industry to grow.

The other -- maybe just a little bit of an extension to that would just be the demands that the U.S. government is placing on banks to put through all sorts of other new types of loans for small and medium business and such, like is that going to distract them away from refi?

Yes. I mean I think the -- helping a homeowner get a lower rate is a -- is what the government would like to do because it's providing stimulus to the economy. So if that homeowner can save hundreds of dollars a month on their mortgage payment or access equity in their home, it's a great way for the Fed to be helping. So that 10-year rate that I said is at one point -- is actually sitting down at 0.65-ish right now. So we should be seeing sub-3.0 rates if there was capacity there in the marketplace to handle it. So we think this is a 2- to 3-year opportunity. It's going to take a long time. And that includes a return to full purchase in 2021 and the banks adding 20% to their underwriting capacity each year starting next year.

Okay. That's great. Now you don't keep any appraisers or notaries on staff like some of your competitors. Have you seen any change in the -- in your ability to bring appraisers and notaries onto the platform to satisfy this higher level of refi demand? Are you on mute?

Thank you, Rob. Thanks. This is a virtual conference 1.0. So I'll take that question. Thanks for the question. I think a really important foundation around our appraisal network is the fact that we've built up the network to compete for business. So the business that the appraisers do is very well-managed and very transparent for them on the platform. So things like turnaround time, quality, a lot of the nuances that are required in managing appraisals, we make sure it's very clear to our appraiser network, how they're performing. And we, therefore, manage volume to those appraisers based on those capabilities. So with that in mind, we have tens of thousands of appraisers, notaries, abstractors on our platform. And we end-up dishing out business to a subset of those folks on the platform based on performance. So we're very fortunate that we have quite a flex within our appraiser network to reach out to folks and bring them in. At the same time, the team is constantly bringing new appraisers and notaries onto our platform. So we have team set up, and that is their job is to bring on new appraisers and new notaries. And so we're bringing on hundreds a month onto the platform. And very fortunately, for us, nothing has changed. So the past month, the same amount of new appraisers has been brought on. And we're very fortunate also in that with the training we do with a lot of the new appraisers that come on, the quality of their work is actually better than sort of the rest of the network as a proportion. So we're getting good appraisers on, and we're not having a problem unnecessarily bringing them up.

That's interesting. And I mean, under these new work conditions, appraisers are going into people's homes, maybe you talk about what you've done, I think you have new policies and guidelines to help manage the process around that?

Well, I think, one of the small benefits in a very difficult situation that we're all going through is, I think we've aligned very clearly with our network on the fact that this is an essential service. The things they are doing are absolutely essential. So as Jason had talked about the idea of getting people access to either homes or equity in their homes is definitely an essential service. And so that's been very helpful, frankly, in keeping the engagement levels really high. So what we have had to do, though, Rob, is we have had to adapt a little bit along with our appraisers. And so one of the things we've done is something we've called safe space closings and safe space appraisals. So what that generally means is personal protection. So appraisers are wearing personal protection into the homes. It means asking the borrower to turn on the lights and open all the interior doors and make sure that the place is easy to access. It means potentially vacating the home for a lot of borrowers so that they're outside, either on the driveway, the backyard, they're finding a space to be in so that our appraisers can come in and look at the house. And the majority -- as you know, Rob, the majority of lenders are still ordering and requiring interior inspections, interior appraisals. So that's on the appraisal side. On the closing side, it's more about moving the closing from a kitchen table inside the house to porches, driveways, external foyers, that sort of thing, and making sure the document handling and verification is done well. And I think the -- for us, anyways, the way we know it's been reasonably successful is, we're getting very positive feedback from the network.

Okay. Like you said earlier, Jason, this is a very important transaction for the homeowners, so they're going to do what they need to do to get it done. There is pressure on the bank to do this and so they're going to make sure that it gets done. And then, I guess, the appraiser or the notary, they're independent professionals who are running their own business. And so this is probably a very busy time for them and an opportunity for them to make a bit of extra money. It's important to them as well, right?

They want to stay employed. Yes, for sure.

I mean just -- I mean taking that conversation, I mean, one of the questions I've been asking all of the companies in the series is just how do you see work culture? Are there any, like the first comments of this session, I said that crisis tends to pull trends forward. I mean what are you seeing in work culture? How do you see work culture changing in a post-COVID world?

So I'll take that one, Rob. So given the model that we have, which is, of course, network management, you've talked about, but the network management part of our business is incredibly tech-centric. So the way in which our people work every day is very much based off of the platform that we have and therefore, interacting with their PC, interacting with their appraisers, their notaries. And so there's a reasonable amount BAU of our employees that work remotely. So we sort of start with the fact that a lot of them can work remotely. And we are, again, quite fortunate when we've done business continuity plans, and so we've tested a lot. As you know, Rob, some of our businesses are in places like Buffalo and Toronto. So we've had some winter storms where we've actually had to test the BCP.

Sure.

And so good news is we were quite prepared for it. So in mid-March when we made the turn, we, in 24 hours, were able to take a workforce to 85% work from home. And today, we're running at 95%. So for us, anyways, it's fairly fortunate. I think it's built a little bit into our DNA, the idea of remote work. And so I think, frankly, it's going to become more a part of how we look at things. An example -- just a quick example for interest is we had our first big virtual town hall recently and best-attended event. So I'm not sure what that does, the best-attended town halls we've ever had. And so I think there's probably going to be a lot of lessons that we've learned through this move to more remote. And I think it will now become more of a mix, a little bit more of a hybrid as we move back towards looking at how work is going to look like in the future.

Yes. So part of this work from home is permanent, I guess, isn't it?

Some of it, I think. Some of the big benefits, I think we've seen will definitely become permanent.

Now one of the trends that the sell-side has talked about is our view of the Tier 1 banks getting more aggressive in residential mortgage. And now, like you said just a second ago, the U.S. government is leaning on them to -- for a number of underwriting programs right now, particularly the larger ones, I think. Maybe if you could talk about how the larger lenders and the smaller lenders are handling this pandemic differently?

Sure. Well, definitely, the deposit-taking institutions have lost share in the previous 3, 4 years relative to monoline nonbanks that sell to Freddie or Fannie. But as we saw in the last 3, 4 quarters in 2019, there seem to be a slow gain back of share from the larger deposit-taking institutions like Wells, or Chase or Citi. And when you think about it, they have millions of customers that they can draw from in terms of some credit cards and so on and so forth. And so I think they had a lot to clean up after the mortgage crisis, and there were a lot of new regs put on them. So they worked through that. And we saw some small quarter-over-quarter increases that seem to be quite consistent. I think it's too early to tell whether or not in this environment, the deposit-taking institution specifically will outgrow even large nonbanks. There's a lot going on. One lender took half of their home equity line of credit team, moved it all over to new mortgage origination for the kinds of things that we do. Those larger lenders have that capability where if you've got a mortgage-only monoline, they don't necessarily have the other departments to pull from. But there's forbearance going on, a lot of calls coming into the servicing department. So we're -- there's a lot going on. I think we haven't seen any significant changes between the mix of the business that we're getting from one client type to another client type. Though the larger lenders, be it nonbank or bank, do appear to have more flexibility in terms of how they do that.

Okay. And then to -- with all these changes happening real time, are you seeing any -- I mean despite the fact the banks are probably up to their eyeballs dealing with all this volume, is there any pull for any new services or functionality? What are your customers asking out of Real Matters in this environment?

Well, so as the banks looked to shore-up their capital for small business lending, being able to put out -- put reserves on for loan losses, et cetera, I think some of the nonstandard products that were offered, so think jumbo mortgages, so on and so forth, have been reduced. And the banks all have the ability to sell to Fannie and Freddie. And so that takes the capital off the balance sheet. And so really, what we've seen happen here is a standardization back again to what Fannie, Freddie or Ginnie, those are the government buyers of mortgages, what they are going to provide, notwithstanding some of the other regulatory requirements that still sit on institutions. And so earlier in this almost as, I think, proactive preventative -- potential preventative measure, they allowed in certain transactions of reduced slow appraisal, still needs to be completed by a licensed appraiser, but a drive by or a desktop in certain situations, different mortgage types and so on and so forth. What's incredible, I think, from what we're seeing is that the vast majority of our orders continue to be full interior appraisals. And I think for chief appraisers at banks, for appraisers themselves, they just know that the interior information can have such an impact on value. And if you're doing a cash-out refi or you want to get the value right, the homeowner doesn't have to be at home, as Brian said, leave the lights on, leave the doors open, the appraiser can go in and get it done in. So appraisers feel better about that as well. They don't like coming up with a value without knowing what's inside the 4 walls. So there's been a handful of cases where we've had a challenge. And so notwithstanding some of those options to ease up, the vast majority of orders continue to be for interiors. I think what I would add is, Rob, there's been many articles written out in the past about when we see automated valuation models, can we see that get in here? And is that a risk to the appraisal business? I think what's -- that's been my background, the data is really weak. You then also don't have the interior information that can weigh-in on the value. And so I think that this is a good window here where even the regulators sit up and said, "No, no, no, still no automated valuations, we still need a licensed appraiser." Markets are moving around right now in values as you could imagine, and this is where having that local market professional really can make a huge difference.

Yes. Especially now when -- I assume there's a lot of worry that housing prices will drop. And so if you don't have an appraiser, that's going to do a full appraisal, I mean there's more risk that you're going to miss price things, I assume. It is, I imagine, a bit of a worry that just given the banks are so busy and they have so much volume in front of them that they don't make the decision to lower the requirements of an appraisal. But especially since -- I mean they take that appraisal and they're not paying for it. That's passed on through to the homeowner. And then they strip the mortgage a lot of the time into 2 pieces, a servicing part and the actual mortgage and that's past the fingers. So there's some -- maybe if you could talk a little bit about some of those dynamics that help support the argument that the bank is going to continue to do a full appraisal even if they're like overwhelmed with volume?

Sure. So I mean, look, our turn times continue to be very quick on the network. We're getting appraisals done. The homeowner is in support wanting to get this transaction done. So they're not in the way -- they'd like to get it done tomorrow. And so we've stayed steady. I mean we've done a really good job, I think, with the model and with the professional appraisers in the network in getting appraisals done and not being the roadblock. A closing can be 45 days, and we're a fraction of that in terms of the appraisal and we tend to get ordered right upfront. So I would say from a time line perspective, that's not a challenge. For a homeowner who's about to refinance and get savings or buy $300,000, $400,000 mortgage, an appraisal that gives them the comfort that the value is right, the cost a few hundred dollars, is not an unreasonable issue. And so I think we're not the impact there for the bank. And then the bank has this licensed-regulated product that they know is the gold standard that they can then turn around and sell it, maybe Fannie and Freddie are going to change their rules at some point in time, they can keep it on the balance sheet if things change because they now have this full appraisal. They can securitize and sell it out to the secondary markets that were quite robust through this. So it really just allows the full gamut of options for what to do with that asset afterwards for an institution. So I continue to believe it will be the gold standard.

Yes. So if they do a full appraisal, the mortgage is more fungible. They can more easily move it in and out.

Correct, correct.

Okay. One other factor. I mean given that Fannie is allowing some drive-by and virtual appraisals, have appraisal fees changed at all since the beginning of the pandemic? Are you seeing any impact on your pricing? And for those familiar with the financial model, are you seeing any change in net revenue margins from any changes in pricing?

Well, I would say something I would say that, first of all, pricing for appraisal and closing services is a very local and regional piece. So they vary in counties all across the America. And we have enormous flexibility in being able to work with our customers to get that pricing reflected if we're seeing pricing change within the networks of appraisers or closers within a local market. And it's in everyone's best interest to be at market. So we're constantly moving fees and pricing around in order to make sure that we're priced right that the homeowner and the bank are going to get the right service levels relative to the rest of the market place. I would say that generically, that we're always working with them to have that flexibility. I think when we think about this 2- to 3-year very large opportunity, I do think we'll see fees going up in the marketplace to -- I mean 70% of all mortgages to be processed, I do think we'll see some inflation. I don't think it will be dramatic. And frankly, we get parts of the country that are dropping and other parts that are moving up based on those local supply/demand balances. That's what we do. I would say that the incentive for the bank if it's to get the drive-by or the desktop, if they do opt for that. And again, it's a very small minority of the orders we're receiving. They're really priced pretty closely to a full interior. It's really about working through those local laws. Such that, "Hey, if we -- can they just do a drive-by on the property?" So actually, our net revenue margin on an absolute dollar basis is the same for those other products as a full interior appraisal. So we actually don't expect to see a change on our margin profile or on our gross revenue profile from what we're seeing.

Okay. I get a question from the audience here around the shelter-in-place orders that we're seeing in some places prevent anybody from entering a home or like are there any parts of the mortgage process that are exposed to those shelter-in-place orders that prevent it from happening? Even if you can get the appraisal on the title complete, is there other parts that investors should worry about not being able to be completed?

I think that this was quite fluid when COVID-19 first hit, county, court, houses closing, so on and so forth. I think the industry adapted incredibly well. I mean the way I like to think about it is this is fundamentally an essential service in the U.S., and it's a big impact to the homeowner. And so Brink's is still running around with filling ATM machines with cash, but actually, in a modern society, it's having access to -- your line of credit, having access to those funds that you can auto bill pay and so on and so forth. So I think both the appraiser network, the local governors, the federal government, industry players like title insurers, have all come up with strategies to help continue to facilitate this access of capital that's so important for homeowners. So I would say that there, of course, been a handful of cases, but it is only a handful of cases. And we're not necessarily seeing a geographical significant shift in activity either. So strong support for helping homeowners access equity in their home or reduce or lower their payments and for the purchases that are still out there, helping getting those done.

Right. Great. So as we move into final stretch here, you closed December with about $80 million in cash, no debt. You've got access to about $40 million in credit line. Maybe you can talk about whether you think that is sufficient cash to run the business? Are any of your customers, do they look at your balance sheet as part of their share allocation decisions? And what cash outflows do you expect in the near term? How strong do you think that balance sheet will continue to be over the near term?

Well, I would say that maintaining a strong balance sheet, given the fact that we're highly regulated by all of our bank clients, they visit us quarterly in not only tech and security audits, et cetera, but also our financial wherewithal. They're responsible for paying the appraiser if we don't -- even if they paid us once. So it's maintaining a strong balance sheet does bode well and reflect well on our offering. So we'll always maintain a strong balance sheet. EBITDA is almost a proxy for cash for us in our business, and we've been building cash well. We've been active in our NCIB. I think that we're not seeing any change to our capital allocation strategy sitting here today, and that we have [Audio Gap] sufficient funds to operate our business.

All right. Well, that brings our session to an end. We're right at 1:30 now. Jason, Brian, thanks a lot for sharing all of this with your investors. And thanks for the great discussion. Thanks, everyone, who's watching or tuning in. Don't change the dial. We're going to run right into our second fireside with EXFO, starting in, I think, just seconds. So...

Thank you, Rob.

Thanks, Rob. Appreciate it.

Thank you.