MoneyThumb has a lot of customers who are private lenders and use our PDF financial file converters specifically designed for lenders to make quicker and more informed lending decisions. However, in these strange times that we are experiencing caused by the coronavirus pandemic, private lenders are being forced to take a step back before making each lending decision since many borrowers have been laid off or their business has been closed down. This could sorely affect their ability to repay a loan.
To help our readers understand how the coronavirus pandemic is affecting the private lending sector, the Rules of Thumb blog from MoneyThumb would like to refer you to a great article from the AAPL, (American Association of Private Lenders.) This article does a wonderful job of explaining in detail how the coronavirus is affecting the private lending sector. They make a comparison between our current pandemic and that of the 1918 Spanish flu paramedic. Quite an interesting read. We have included the text of the article below:
How the coronavirus is affecting the private lending sector
With the world reacting to the effects of the fast-spreading coronavirus, health officials and economists alike are looking to history to help predict both its advance and its lasting impacts. Nothing recent—like H1N1, SARS, Ebola, or the seasonal flu—have proven accurate or particularly helpful models.
Instead, scientists and the media are increasingly making comparisons to the 1918 Spanish flu pandemic. While we’re constantly hearing grim news about the immediate economic effects, what is the outlook for private lending in particular? Let’s explore, using the same 1918 model that’s proven the closest to our present-day reality thus far.
The Coronavirus Compared to the 1918 Pandemic
Governing bodies have taken similar steps to quell the spread of the coronavirus: isolation, quarantine, use of disinfectants, and limitations on public gatherings. These measures seem to be the fastest way to rid the general population of this kind of virus. During these times, the economic effects are dramatic.
A2007 article by Thomas Garrett, assistant vice president, and economist for the Federal Bank of St. Louis, examines the economic effects of the 1918 influenza pandemic. The article indicates an eerie parallel to today’s world. Merchants in Little Rock stated their business had declined by 40%. Others estimated a decrease of 70%. The only business in which there had been an increase in activity was the drugstore.
One difference between the two pandemics seems to be that the one in 1918 was reactive, whereas the current one appears to be proactive.
In 1918, businesses were hit hard because people were isolated and quarantined, thus few people enter an establishment to conduct business. Compounding that, the number of workers affected with the illness was tremendous; thus, the labor force and their income decreased substantially.
The current pandemic has, potentially, some advantages over the 1918 pandemic. Countries around the world have quarantined in the early stages of today’s pandemic. And, with the internet, which was not available in 1918, many workers can work at home. Companies such as Amazon still make home and office deliveries. The proactive measures that the world is taking will, hopefully, curtail the coronavirus so that it is short-lived and we all can get back to a relatively normal life. Still, the economic impact of this virus cannot be ignored.
Garrett points out: “Most of the evidence indicates that the economic effects of the 1918 influenza pandemic were short-term. Many businesses, especially those in the service and entertainment industries, suffered double-digit losses in revenue. Other businesses that specialized in health care products experienced an increase in revenues. Some academic research suggests that the 1918 influenza pandemic caused a shortage of labor that resulted in higher wages (at least temporarily) for workers.”
Impact on Private Lending
How does this affect the private lending sector?
In early February 2020, before the U.S. government implemented guidelines to help slow and eradicate the virus (e.g., no public gatherings of more than 250—since lowered to 100 and in some cases to 10), there was an ample supply of money flowing into private lending.
In addition, the capital markets were healthy and hungry, looking to place money in loans. The stock market was at an all-time high of over 29,500. By March 20, 2020, the stock market dipped below 19,000, a loss of more than 35%. Investors, as well as bankers, pulled back their appetite to place funds. Fear and concern pushed these would-be providers of capital to sit on the sidelines because most tumultuous markets make investors anemic.
In addition, although federal funds rates are near zero, many large banks have, for the most part, stopped accepting loan applications. Most banks will honor their commitments to fund loans that were already approved. But, until things settle down, they do not want to take, what they consider, undue risk.
The capital markets (those buying loans) have all but dried up. They did not slow down. They just stopped altogether—at least for now.
Private lenders are lowering loan to values (LTVs) and charging higher points and interest as the supply of money has shrunk. Private lending companies derive most of their capital from individual investors. Many of these investors are skittish during uncertain times. When the supply of money seemed to be endless, especially in California, rates and points charged were at historic lows (in the private lending community).
The demand for loans, however, has not been dramatically affected yet. The reason for this is that the supply of money provided by conventional lenders has diminished. Since conventional lending makes up the majority of capital available to lend, this factor has more than made up for the slower demand of loans needed. Although some borrowers have canceled their applications for loans due to uncertainty, there always seems to be a need to serve the borrowing community. People still move, loans come due, refinances as rates drop still occur—and these loan requests need a home.
Individual investors are demanding an increase in yield, even at historically low rates. This could be due to these investors attempting to take advantage of the low supply of money available for loans. It also could be that these investors remember when they were able to command a higher yield during uncertain times such as the Great Recession. The predominant reason, however, is most likely due to the unknown of how this virus will play out in the real estate market in an almost certain recession that will occur.
These investors will demand both a lower LTV on the loans they are making and a higher interest rate. Private lending companies that previously sold to the capital markets will also have to pay their investors a higher rate to attract money; thus, they will have to charge the borrower a higher rate. They will most likely also increase their spread at what they charge the borrowers as compared to what they pay their investors. Quality loans will be in demand for these companies. Loans that may have been marginal from a risk/reward standpoint just a few months ago will be turned down by many lenders.
If Garrett is right about a short-lived economic impact due to a pandemic, there is a window of opportunity for investors who are willing to lend. Due diligence will be very important. And, importantly, investors should not presume that a recession won’t be prolonged.
Conservative underwriting will be the law of the land, and lower LTV will be the benchmark. As one private lending company pointed out, there is always money to be made in real estate; one just needs to be prudent.
As of this writing, the number of illnesses and deaths worldwide have been relatively small compared to the 1918 pandemic. We can only hope that the world continues to take serious measures to limit the effects, from both a health and an economic perspective, so we can get back to “normal.”