Before COVID-19 made its impact on private lending, there was a new trend developing in correspondent lending. In essence, lenders sitting on too much capital and not enough deal flow were lending to other lenders. It was the fastest-growing space in private lending.
All of a sudden, mortgage refinancing surged while demand for personal lending dropped. Small business lending is soaring. Is there a new normal in lending, or will we go back to the old normal once the current crisis is over?
Business Cycles, Black Swans, and Private Lending
Businesses cycles come and go. There are boom and bust cycles in every sector. We’ve seen various cycles in mortgage lending, real estate, banking, retail, e-commerce, financial services, and more. The savvy investor learns to anticipate the business cycles and develops an investment strategy for each type of cycle. Some investors don’t change their strategies from cycle to cycle but may focus instead on priorities, the value of their investments, or their asset class mix. Private lenders would do well to pay attention to the cycles, as well. That said, there are times when an unexpected black swan event throws a wrench in the business cycle. COVID-19 is such an event.
Heading into 2020, almost every economy around the world was expanding. Many of those economies, the U.S. included, were maturing in that expansion. Since the coronavirus outbreak, however, there have been disruptions on several levels.
For instance, here are a few ways COVID-19 has disrupted the global economy:
- U.S. import and export activity has declined significantly
- Labor market concerns have risen
- Federal Reserve interest rates have been cut sharply
- U.S. Treasury yields have hit historic lows
- Volatility is the order of the day
The list of black swan events that have suddenly made big economic impacts is diverse. War, famine, terrorist attacks, nuclear reactor meltdowns, stock market crashes, and technological failures, just to name a few. The curious nature of black swan events is that they are unpredictable. These are events that no one could foresee but that pack huge financial implications across one or more economies.
What’s interesting about black swan events is that they often create opportunities as they are shutting the door on others. Famed Wall Street trader Jesse Lauriston Livermore turned short positions into $100 million during the stock market crash of 1929, while others were losing their fortunes. While COVID-19 has led to massive unemployment and short-term small business closures, many private lenders are seeing a surge in loan applications. In short, business cycles can be relied upon to an extent, but unexpected events can cause disruptions to those cycles that can benefit those keeping their eyes open for new opportunities.
How to Protect Your Investments in An Age of Volatility
Emotional selling is often the worst thing an investor can do in times of uncertainty. That doesn’t mean investors should hold onto all positions indefinitely. But if you have your investment strategy thought out before a crisis hits, you’ll fare better during the storm.
What can private investors do right now to ensure assets are protected during this turbulent time? Here are a few ideas:
- First, don’t panic.
- Look for where the market is moving right now. Private lending has picked up in some areas. Due to a rise in unemployment and the inability of many renters to pay their rent and homeowners to make their mortgage payments, federal and state governments are issuing relief packages for small businesses. Those businesses that survive through the pandemic crisis may be in the market for a private loan on the other side.
- Try to identify short-term opportunities whenever possible. Until investment markets return to normal and regain some stability, volatility will be the norm. That doesn’t mean “sitting out” is the best strategy.
- Look at previous crises and see if you can find any patterns. Commercial real estate has often done well when residential struggled, and vice-versa.
- Continue to diversify your portfolio. Now might be a good time to look at your asset class mix. Is it heavily weighted toward an asset class that is struggling amid the current crisis, or heavily weighted toward high-risk investments? You might shift some of your assets to an asset class that will serve as a hedge against potential losses in those sectors. But keep in mind that short-term volatility may not affect the long-term position of individual assets within that asset class.
- Realize that, more often than not, real estate typically fares better long-term even if it struggles during short-term crisis moments.
- Don’t be afraid to adopt a wait-and-see attitude. Every investment portfolio is different. You only lose if you sell at the wrong time. Just because an asset’s value has been affected by the current crisis, that doesn’t mean that an asset’s value will remain at its current position after the crisis has passed. There is some talk of re-opening the economy in a couple of weeks. Whether that happens or not, and, if it does, how it happens could mean another shift in market forces that could send a ripple through the economy that counteracts recent market moves.
None of this should be construed as investment advice. You should talk to your financial advisor before making decisions regarding your portfolio, but panic selling is almost always a sure losing strategy, so don’t be overrun with emotion.
How Private Lending is Poised to Change in 2020
It is likely that private lending practices, including underwriting, will change in the short term. No one can be certain how COVID-19 will impact private lending long term. A lot depends on whether or not the economy can get back to normal soon, and how quickly it gets back to normal. That, of course, depends on how soon health and infectious disease professionals can develop a vaccine for the coronavirus and how soon cases of COVID-19 decline over the next few weeks. These are unknowns.
Sharestates is continuing to monitor the private lending industry and the economy overall. Meanwhile, investors should consider that loan underwriting practices are likely to change for the foreseeable future. Lenders are already tightening credit standards. In cases where lenders have been sitting on a lot of capital, those lenders run the risk of too rapidly approving loans and placing that capital at risk. That will require additional control measures to ensure that lending too often and too quickly does not place lenders and investors at risk. That may include a cap on loan originations, loan amounts, and some restrictions on the types of borrowers allowed for such loans.
While uncertainty increases investment risk for lenders and investors, sitting out could be a greater risk. Investors may have to look harder for good deals in this environment, but they do exist.