Effect of Pandemic on Note Business (Medium and Long Term)

[Andy Mirza]

What are the medium and long term effects of the pandemic on the note business?

My thoughts:

Our business is not going away. There were lots of reasons this was a good business before and there will be for the future. During the times of fear and panic, it's easy to get nervous about the future. I have a friend who's in sales for solar panels. If we go into recession, he is right to worry about the future of solar in the next year or two.

For note investors, the same problems that existed before with non performing notes are still there. If anything, a recession will push more loans into default and make more product available. Some issues to think about:

1. Government interventions

    a. Temporary Bans on Foreclosures and Evictions: we are in unusual times that will result in unusual government interventions. We'll have to be flexible and evaluate coming decisions so that we can evaluate and make the best decisions for our businesses. For the next month or two or whatever time we as a society need to transition to a new normal, to overcome this initial fear, I'm in favor of keeping everyone in place.

Regardless of how borrowers have acted in the past, they are still human beings and we all need to stick together, practice social distancing to "flatten the curve" until things settle down. I'm ok with postponing lockouts. I'd prefer that foreclosures and eviction hearings move forward so that everything progresses but we can stop short of the lock outs for now.

However, how will the public and government respond? New York and San Francisco are already talking about banning evictions. How long will they ban them for? Are foreclosures next? Something we all have to think about.

b. Government bail outs, cash infusions, assistance: If the government provides assistance in various forms, this should help borrowers make payments on their loans. Good for the short term, most definitely. How long will it last? Good for the medium term?

2. Recession: Most people talk about recession for at least a couple of quarters. Without including government intervention, I would prepare for more loan defaults, the potential for real estate values to drop, and less capital that investors are willing to make into riskier investments. Do non performing notes count as "risky?" Depends on your viewpoint, I suppose....

It makes sense for investors to anticipate that we're going into a recession soon and to adjust your business model accordingly.

3. The Way People Do Business: one of the biggest implications we might face is the change in how others do business. As note investors, we're already used to working from an office. We typically communicate with vendors and colleagues primarily via phone and e-mail. Things aren't so different this week for me than it was last month.

I read an article last week that stated that the pandemic will accelerate the move of a significant part of the work force to working remotely from home. This transition was already happening before, is rapidly becoming the new normal for a large number of people, and will likely not change back once the crisis is over. It made a lot of sense to me.

Will it be easier for our vendors or harder? What things will be easier and what will be harder?

I'm sure I missed a lot of other things but these were the immediate ones that popped out at me. Very curious and interested to hear from others on this topic......

[Dion DePaoli]

It's interesting to see how the conversation in this thread will evolve over time.  So much has changed in the last two weeks and I am sure more happen as we roll forward.

In my opinion, and glimpsing back at the past recession, to which this is "similar" but not the same.  The hierarchy of impact seems to be a bit different with rippling waves eventually crossing everyone's path.

So far, I have seen Non-QM capital start to dry up.  There is already a pretty sizable discount pushing 15% from the market price 3 weeks ago.  Notable driving forces on that are ability to repay due to unemployment and other direct affects of the pandemic and extension risk.  Capitalization rates and return expectations will have to rise.  We will see interest rates increase in the near term which is going to be problematic for some of the recent paper that is looking for an investor.

Warehouse lines will get squeezed and shut down.  There has already been a series of redemption requests in many funds.  This is going to impact longer amortized loans and even the short term folks.  I have been seeing some private/hard money short term loans looking for investors so the originator can get the loan off their line.  As with anything, those folks who had a tighter set of underwriting may feel safer with their borrowers than others.  However, eventually, I think everyone will experience a credit crunch as we should expect values to start to decline in the near term.  How the haircut will be shared or allocated, if at all, will be told soon enough.

Nonperforming paper is in a pricing limbo, obviously the moratorium is affecting that market. We know HUD has came out with direction for forbearance for FHA (90 days) and Fannie/Freddie (12 months) it's not clear if that forbearance can be applied, by mandate or judicial argument, over loans in default prior to the last 2 weeks. With both of those situations lingering the larger servicers who have a large chunk of securitized loans will have some 'massive' and I emphasize "massive" cash problems. The bondholders get their payment and the servicer foots that advance bill while still having to capitalize collections. Couple that with now uncertain default remedy timelines due to the moratorium on foreclosure, eviction along with cash for keys - we can't be certain when and how we can displace the borrowers nor are we sure the forbearance is not just a longer drive to the same danger zone.

When this all happened in the previous recession pricing loans of all kinds was very tough.  Much of that pricing was dictated by the buyer as the seller's needed the cash.  However, at this stage, we have a bit of an issue where seller's should dump to get their 'potentially' highest price but buyers don't want to buy to much and end up with negative equity due to a decline in real estate values or get hit with extension risk buying in below prevail market rates and returns.

So I think we will see inventory circulating and may very well see the same inventory a couple of times before it finds an executable market price.  Deeper discounts will emerge and par and premium will be bad words once again.  That said, there are still some plans of attack that can be deployed to exploit what is going to be a complicated mess.