The 1918 influenza pandemic has frequently been compared to the Coronavirus outbreak we are currently experiencing in the world today.
Varying government agencies have taken similar steps to those during 1918’s pandemic to quell the spread of the Coronavirus; isolation, quarantine, use of disinfectants, and limitations of 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.
An article by Thomas Garrett, written in 2007 by Assistant Vice President and Economist for the Federal Bank of St. Louis that examines the economic effects of the 1918 influenza pandemic, indicated an eerie parallel to today’s world. Merchants in Little Rock stated their business had declined 40%. Others estimated a decrease of 70%. The only business in which there had been an increase in activity was the drug store.
One difference in the two pandemics seems to be that the one in 1918 was reactive, whereas the current one appears to be proactive. In 1918, not only were businesses hit hard by the isolation/quarantines of people – few people could enter an establishment to conduct business – but the number of workers affected by the illness were tremendous; thus, the labor force and the income derived by them had decreased substantially. The current pandemic has, potentially, some advantages over the 1918 pandemic; countries around the world have taken the above-mentioned steps in the early stages of today’s pandemic. With the advent of the internet, many workers can perform their jobs 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. However, the economic impact of this virus cannot be ignored.
Garrett points out that “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 healthcare 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”.
How does this affect the private lending sector? In early February 2020, prior to the US Government implementing guidelines to help eradicate the virus such as no public gatherings of more than 250 [since lowered to 100 and in some cases, 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, as fear and concern pushed these would-be providers of capital to sit on the sidelines, as most tumultuous markets make investors anemic.
In addition, although Federal Funds Rates are at 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 to be 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 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 cancelled 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 starting just 12 years earlier; however, the predominant reason 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 a lower loan-to-value on the loans they are making in addition to 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 those investors willing to lend. Due diligence will be very important, and investors should not presume that a recession is not prolonged. Conservative underwriting will be the law of the land and lower loan-to-values 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. So far, the number of illnesses and deaths worldwide have been relatively small compared to the 1918 pandemic. We can only hope that the world continue to take serious measures to limit the effects, both health and economics-wise, so that we can get back to “normal.”
