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

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

Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes

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......

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Dion DePaoliPro Member
Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
6y

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.

See this reply in the discussion

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  • Investor · Baltimore County, MD · Member since 2014 · 466 posts · 439 votes
    6y

    Micro: I would guess, as you alluded to, more NPNs will be available in 3-6 months and pricing for performers will increase. It seemed like pricing for NPNs and pricing for performing notes had kinda conflated some over the past 12 months.

    Macro: I do think we are headed for a recession, and this pandemic will only exacerbate things if not push the system to its breaking point. There is only so much the fed can do, and the federal government will be forced to raise taxes at some point.

    Sounds bleak, I know, but this is where opportunity lies.

  • Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    6y

    @Jamie Bateman headed for recession? My friend, we are already at the start, its already here. Hang on to your cash and be ready for "buying in the dip" which may take a year or so.

  • Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes
    6y

    At a macro level and In terms of increased inventory for NPN's, borrowers are going to have to burn through 3-6 months worth of reserves then another 4 months of delinquency for a bank to take action. I think it's going to be at least till the Spring/Summer of 2021 before we see meaningful increases in defaults.

    To @Bob Malecki point, the recession or at least a downturn has already begun. 

    When you start analyzing MSA’s, and sub markets of course these will be different across the nation, which is why focusing on certain markets will be key. 
     

  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    6y

    Since we still do not know how long this will last or what will or will not be done by the government I believe it is too early to tell. Few comments I would make are:

    1. Those thinking the markets will be flooded with NPL’s for main street investors, I would not bank on that right now (no pun intended). Let say this goes till June. Banks etc and debt would take 6+ months for it to change hands to a large fund (blackstone for an example). More than likely they would not immediately sell, or sell some smaller pools. That would still make it to a major player. Main Street investors are 4th on the food chain. I believe if we are to see an influx we will not see it until 2022 at the earliest.

    2. Remember why you are in this business. You in it to get borrowers back in payment plans or to foreclose and take a property. Most are in it to get borrowers reperforming. Also do you want a depreciating property of the economy is in recession? I would rather work with a borrower if they want to play ball (but if).

    3. Where I see the greatest opportunity is all the uneducated investors mortgaging their primary residences and taking personal loans to buy rental property and have zero reserves. There is a very large crowd of people who were wannabe investors who should not have bought property - especially in areas like Indy, Memphis and some of the other so called emerging markets. I believe you will see values their take the deepest dive - which Logan mentioned it will vary by MSA.

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  • Specialist · Fort Worth, TX · Member since 2014 · 528 posts · 226 votes
    6y

    That’s right @Chris Seveney, many of us are in the note business to keep a borrower in their home. I know that’s my primary goal and first option we present them with.

    If things continue like they are, then yes, going to be some time before small time note investors are there picking up inventory. I know for me, I’m already seeing a pickup in responses to my bank direct marketing.

    Looking at a small pool of scratch and dents and buy backs today. As the markets, both RE and stock, become more and more scrutinized, sellers will begin to move loans that they were once willing to sit on. 

  • Investor · Adkins, TX · Member since 2012 · 193 posts · 93 votes
    6y

    You all have valid points. We have to get the November election behind us.

    Look at Lumber Futures they have been dropping for the last 90 days.

    Since Feb 18 they have dropped over a $100 a contract.

    Futures Huh. Yes, I know very foreign. That is why they call them futures.

    If you are a DH Horton or a Home Depot and you have seen that kind of drop

    would that tell you something?

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    6y

    @Chris Seveney  good points.

    but your point on max leverage to buy rentals and BRRR pull out all your cash.. while sure popular to help people go from 2 rentals to 20 in a year and be a BP hero investor LOL.. I just cringe at some of those posts. and a lot of them are running their business's relying on heloc's and that is quite risky if those get frozen for a period of time. Seems to me the opportunity in the coming months/years is going to be more in the non owner occ commerical paper world.

    I think this go around govmit will do everything it can to keep homeowners in their homes.. 

  • Jay HinrichsBusiness Member
    Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
    6y
    Originally posted by @Boyd McClean:

    You all have valid points. We have to get the November election behind us.

    Look at Lumber Futures they have been dropping for the last 90 days.

    Since Feb 18 they have dropped over a $100 a contract.

    Futures Huh. Yes, I know very foreign. That is why they call them futures.

    If you are a DH Horton or a Home Depot and you have seen that kind of drop

    would that tell you something?

    lumber futures have a direct correlation to demand no question.. When i was in the Timber business ( log supplier in the northwest) this was a key indicator to log prices. The mills can just get stuffed and stop buying logs altogether.. Lumber futures are very thinly traded though.  U dont want to buy a future and then have to take delivery of 160,000 BD ft of dimensional lumber  :)

  • Investor · Orlando, FL · Member since 2014 · 110 posts · 90 votes
    6y

    This is a very concerning time and I agree with @Bob Malecki. I just saw that PaperSource was canceled for the time being and I am sure that will continue for other events. Keeping an eye on this post to hear from others on their opinions. 

  • Investor · Kerrville, TX · Member since 2015 · 53 posts · 72 votes
    6y

    PaperSource2020 is rescheduled to Sept. 3-5, Las Vegas, same hotel.

  • Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    6y

    Just from what I covered in my morning readings, 70% of the US economy is based on consumer spending. With most retail venues closed, that's a huge dent in the economy. The closures also stop workers from earning income so unemployment will start to spike. Once our borrowers carve thru their reserves (if they have any in the first place) then defaults will rise. 

    So, if you are holding performing debt right now, prepare for some of those loans to go sideways, and how that reduction in income will affect you/your investors until recovery. We've just rolled over the top of that roller coaster ride and heading down the steep slope may happen faster than we anticipate. 

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @Chris Seveney Lots of great points...

    My feeling, based on looking at past notes and tapes, is that there were a large amount of sub performing notes with borrowers that were just barely hanging on. 

    How many borrowers are out there that have spent the last ten years in one or two loan mods and/or one or two bankruptcies? These are the ones that I think will fail a lot sooner than we think. The other borrowers you mentioned that might have some reserves would come later.

    Yes, too early to tell how it will play out....

    As far as overleveraged investors, that is a scary thought 

  • Chris SeveneyBusiness Member
    Moderator
    Investor · VA · Member since 2015 · 21k+ posts · 19k+ votes
    6y

    @Andy Mirza - On FB tenant/landlord groups and even BP group, I see many wondering what they are going to do as they cannot pay the mortgage if the rent does not come in. Those as well as those who have short term rentals are going to get crushed. Unfortunately the short term rental market I do not see them getting any relief that will end up helping them. 

    If pricing does not crash, could see a lot of sub2 deals going, but unfortunately I think in markets with an abundance of STR and rentals they will see some decent price declines. This is just my opinion and we need to see the full outcome of all of this.

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  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    The Wall Street Journal is calling for state and federal officials to weigh the economic damage the lockdowns are doing if they last for another week or two. I think you need to sign in to read the whole op-ed piece so I'll quote the first paragraph here:

    "Financial markets paused their slide Thursday, but no one should think this rolling economic calamity is over. If this government-ordered shutdown continues for much more than another week or two, the human cost of job losses and bankruptcies will exceed what most Americans imagine. This won’t be popular to read in some quarters, but federal and state officials need to start adjusting their anti-virus strategy now to avoid an economic recession that will dwarf the harm from 2008-2009."

    The entire WSJ op-ed

  • Investor · Orlando, FL · Member since 2014 · 110 posts · 90 votes
    6y
    Originally posted by @William "W.J" Mencarow:

    PaperSource2020 is rescheduled to Sept. 3-5, Las Vegas, same hotel.

    I saw this come in a couple of days ago and very glad to see it is back on. Thanks for rescheduling it.

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    I wrote a BP blog post that goes into more detail on my thoughts on the immediate and medium term future:

    8 Coronavirus Pandemic Predictions (for Non Performing Notes)

    I've seen differing opinions from other note investors I respect so I know not everybody will agree with my predictions. That's ok, we're all doing the best we can to understand how this crisis will affect us. I welcome comments, especially from those who disagree, and hope the info is useful to folks :)

  • Investor · Fort Lauderdale, FL · Member since 2014 · 24 posts · 20 votes
    6y

    Thanks @Andy Mirza for starting this thread (and the other one re short-term impacts) and everyone's feedback thus far. Let me start by saying, I am not currently a note investor, so feel free to discount what I'm about to say, but I hope to join your elite club one day and I've been trying to learn as much as possible over the past few months as I formulate my plans. Thank you for letting me follow along - I've already seen this is a pretty tight group (unlike the rest of the BP forums), so I'll try not to taint the waters. 

    I agree with a lot of what has been said above - the massive job loss due to the virus will certainly have ripple effects through the entire RE industry (I'm already working with some of my tenants on rent adjustment plans). With respect to notes, an area I continue to read about in the WSJ and elsewhere but haven't seen mentioned yet (forgive me if I missed it) is the huge effect it will have on commercial mortgages. A lot of large PE firms and REITs that levered up over the years to purchase commercial notes seem to be getting crushed right now with bank margin calls due to the perceived downgrade in value for the underlying properties (due to a foreseen loss in paying tenants with companies going out of business and tenants not being able to make rent) and the banks' requirements to mark to market the loans they made to these firms/REITs to buy those mortgages. I've already heard of a few fire sales in order to free up cash for margin calls, and it seems like this is only the first inning. Based on what I'm seeing and hearing from some of my friends in PE, it seems like a lot of commercial NPNs are coming down the pipe in the coming months/years.  What do you all think? Thanks again for letting me join the convo.      

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @Zach Griffin Great comment and question! Most of us on here focus on residential paper, myself included. One exception that stands out is @don konipol. He'll have a well formed opinion and some insights. (For some reason, his name is coming up with the "@")

  • Member since 2019 · 7 posts · 5 votes
    6y

    Thank you for all of your comments. I rarely chime in but I appreciate learning from all of your points of view. I'd like to get your input on the headlines I've curated from your thoughts as well as the OPPORTUNITIES that lie ahead (I'm a smiley optimist at heart):

    The biggest headline I see is DO NOT BUY (right now): 

    I hate making blanket generalizations, however it seems foolish to think otherwise. Performing notes will likely become NPN, which is supported by the fact that RE experts are stating 25-50% of borrowers will likely default in the coming months. Therefore, if you purchase a performing note because of solid payment histories, that could all be thrown out the window relatively quickly. In the end, you'll be overpaying. Also, NPN are a riskier bet than just three months (or weeks) ago. Combine this with the fact that state and local governments are putting moratoriums on evictions/foreclosures and you can easily fall into a position of hemorrhaging money.

    I'm an action person-I hate waiting. I've waited so long to get into this and finally when I got my ducks in a row...BOOM. Coronavirus.

    So I ask you-what can I do right now to be in the best position to pounce when an opportunity arises in the next 6-12 months? So far, I could think of :

    1. Focus on networking

    2. Follow the markets and transfer more money to my solo 401k at the appropriate times

    ...what else? 

    Thanks for your thoughts. 

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @Michelle Burdo I don't think it's a bad time to buy NPNs, if you can find someone that is willing to sell right now. Yes, some of my late stage NPNs have been delayed by 1-2 months but I see that changing once we weather the worst of this in the next month or two. So far, it seems that foreclosures pre-dating the pandemic won't be treated the same as pandemic induced foreclosures.

    For performing loans, I agree that you should wait at least a couple of months before diving in. With the government stimulus, I don't think anybody will really be able to tell for certain what percentage are going to fail. Personally, on a couple of our re-performers where the borrowers were steadily paying for years, I'd be willing to do a forebearance until they got caught up and that's outside of any stimulus.

    Keep your eyes out for any panic selling or motivated sellers. The ones that don't have to sell or buy, have pulled out and are waiting to for things to settle down. One of our potential buyers was interested in buying one of our re-performers a month ago. Now, they're awash in so much good paper that people want to sell, that they're no longer interested in ours....  

  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    6y

    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.

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @Dion DePaoli It will be interesting to see how things play out. As always, we have an advantage over government and big banks in that we make quicker, better decisions and move much faster than them. Hopefully, we note investors can survive and thrive instead of getting destroyed!

    Current Observations:

    1. Those that don't need to sell their loans are waiting until things stabilize.

    We fit into that category. The shutdowns and moratoriums have pushed out the timelines on some of our assets. See the updates for Funds III and IV below.

    One of our main trading partners has indicated that they're not doing any buying or selling right now and are waiting to see how everything plays out.

    2. Normal buyers of performing and re-performing notes have stopped buying.

    A few weeks ago, we accepted bids from a large fund on two of our re-performing loans. When the lockdowns started a week later, the fund backed out of the trade. The note broker indicated that the fund didn't want to put their capital at risk right now and were backing out of all of their trades including a $20M one.

    This one makes a lot of sense, especially, for more conservative holders of paper. With so many people losing employment at the same time for an unknown period of time, it's difficult to know one's exact exposure to future defaulting borrowers even with the promise of government help.

    We don't need to sell our re-performers now so we'll just wait and see. There should be a lot more clarity in the next few months.

    3. The more aggressive note buyers are getting really good deals or better quality loans from motivated sellers.

    It's logical to assume that those that need to sell are ones that have liquidity issues or want to go to cash for safety.

    Our other main trading partner is buying aggressively right now. They indicated that they're buying performing and non performing notes for 10% less than they offered a few weeks ago. (We'd love to be in a position to buy from them in a month or two!)

  • Dion DePaoliPro Member
    Real Estate Broker · Northwest Indiana, IN · Member since 2011 · 2k+ posts · 2k+ votes
    6y

    @Andy Mirza

    Certainly the market, in it's entirety, has yet to respond.

    That said, yesterday's price is gone and what we are pondering, and will continue to for a minute, is tomorrow's price.

    It's good to see old names in BP threads. It's been a few years since I navigated the BP boards.

    I am circling back and seeing what the action is here. For the old and new. I would be interested in setting up a mastermind call once every 2 or 3 weeks if anyone is interested.

    An opportunity to exploit this is. Unfortunately, going to present itself. Might as well not ignore it.

    If anybody is game let me know.

    There are new tools. New players. New circumstances. The game isn't all that new though.

    DD

  • Investor · Kingston, WA · Member since 2008 · 1k+ posts · 1k+ votes
    6y

    Hi @Dion DePaoli good to see you here again-- I'm in for a mastermind, just let me know.

    Bob

  • Lender · Ladera Ranch, CA · Member since 2014 · 1k+ posts · 1k+ votes
    6y

    @Dion DePaoli Welcome back! I always enjoyed your posts, very well thought out and informative.

    Every now and then I see your compadre @Steve Hodgdon in real life....

    I'd be interested in the mastermind call. Maybe we can keep up with the times and make it a Zoom call :)

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