Every year about this time, our Geraci Leadership team takes a moment to reflect on the past year and discuss their thoughts about the next one. While the overall sentiment is generally a continuation of the market conditions from this year, each department has a slightly different take on what that could mean for you. Read on to learn more.
Let’s take a look at the big picture – what does 2024 bring?
Steven Ernest (Litigation): I’m sanguine about next year (that is a fun word, isn’t it?). This will be (is?) the fourth recession I’ve experienced as an attorney. First was the Bill Clinton / ‘Dot Com’ bubble bursting one during the late 1990s. Next came the September 2001 downturn. Third was the housing / financial services crisis of 2008. Now this one. Some of the indicators are the same, others are a bit different. Values are decreasing, and interest rates are rising. Those are common factors. Each has been a great time to be a litigator. I’d like to help you through this one, too.
Kevin Kim (Corporate & Securities): My overall sentiment for 2024 is it will be a continuation of 2023. The goal is to survive until 2025 when things will likely improve. 2024 will be the year that Private Lenders and the market will be tested to its limits. The volatility and stress of 2023 will continue for most if not all of 2024. This means, lenders will have to get smart about their operations, policies, procedures, and efficiencies. It will also mean lenders should also be in risk management mode. 2022/2023 vintage loans have a higher rate of delinquency and default. In addition, fraud, bankruptcy, and predatory borrower activity is on the rise. Lenders will need to be ready for all of this.
Dennis Baranowski (Banking & Finance): The return of balance sheet lending, combined with the anticipated continuance of the current market conditions in 2024 and the risks attendant with them, will lead to the industry utilizing creative funding alternatives and loan structures with greater frequency. The anticipated environment for 2024 offers a lot of opportunities for lenders that are willing to lend outside of the box. However, in order to fully reap the benefits of these alternatives, private lenders need to ensure that they have their house in order and the agreements covering them provide the necessary protection.
Melissa Martorella (Banking & Finance): When interest rates started to rise, the winners were lenders who had their own capital sources. Even if rate increases slow down, stop, or even head in the other direction, rates are still very high right now. As Dennis mentioned, we will see unique and creative loan structures, and going hand-in-hand with that, creativity will be the ability to rely on your own funds to lend. I expect to see even more multi-beneficiary loans, or loans from mortgage funds where the loans stay on the lender’s books rather than be sold.
Nema Daghbandan (Lightning Docs): Even though the likely result of 2024 is Groundhog’s day and mostly repeat of 2023, there is no actual certainty. The Fed has walked a tightrope of keeping interest rates high enough to not cause a serious recession. However, the problem is that recessions are often fed by consumer confidence and sentiment which are ultimately unpredictable in nature. Should consumers quickly tighten their belts and significant layoffs increase, the Fed may be forced to do reduce interest rates early. Funny enough, this may be a better opportunity for private lenders as inventories may move faster even though the general economy is faring poorer.
Anthony Geraci (Litigation): There will be a constant watching of metrics to cool inflation and see where the interest rate environment leads in 2024. While that occurs, we are largely in the new normal – rates won’t shock and awe in an increase again like they did in 2023.
Jennifer Young (Corporate & Securities): I anticipate a significant focus on lending compliance, particularly in light of the continued expansion of private lenders into new states. Successfully scaling your business demands a nuanced approach, requiring a thorough understanding and adherence to the unique licensing and compliance requirements of each state.
A lot of you have described thoughts related to a downturn or recession – what do you expect this will look like?
Steven: I think this recession will be a bit like a python attempting to digest a pig. The economy is the snake; the bad loans, borrowers, and non-existent interest rates since March 2021 are the pig. Eventually, the snake will gain something from the pig and feel better. Ultimately, the remnants of the pig will come out the back of the snake and be forgotten. What to do during the digestive period though? Glad you asked.
Kevin: It is likely that a significant amount of capital will flow into the private lending sector because of increased rates and the rated securitizations that are coming. This will lead to a surge of institutional capital entering the sector from the fixed income market. But this capital will come with strings – ratings means the loan tapes will be subject to higher standards both from an operational standpoint and a credit quality standpoint. All in all, DOOM is not here for us all. But, if you want to be a private lender that survives this downturn and thrives in the upswing, it’s imperative you prepare now.
What are some of the things lenders can do now to start preparing?
Steven: There are two kinds of pain; the pain of discipline, and the pain of regret. Which do you want to experience? Stick to your principles but evaluate everything. Consider carefully how much you care about factors such as LTV.
Melissa: It always makes sense to underwrite carefully, but it may be prudent to really think about your loans with a recession in mind. High LTV loans plus high interest rates could become problematic if the market collapses or property values fall. Borrowers may not be able to continue to make high monthly payments, so if you haven’t underwritten your loans carefully, you may see a rise in loan defaults. Even in the best-case scenario, an increase in defaults may be likely, so be sure to look at loans up front with recovery costs top of mind so you know there is enough equity in the property to cover costs of collection and to carry you if the loan doesn’t perform.
Jennifer: Strengthening internal operations and compliance protocols, securing the right talent, and cultivating strategic partnerships with legal experts will be key in navigating the complexities of multistate lending compliance with diligence and foresight. This proactive approach ensures not only adherence to compliance regulations but also positions your company strategically for sustainable growth.
Kevin: Make sure your back office is well-equipped with strong policies & procedures. Take a look at your Underwriting / Closing Team, Servicing, and Compliance Departments for starters. Look at areas where you can streamline efficiencies. Many clients went into build mode in 2023 – but I would recommend lenders concentrate on the things that move the company’s needle and outsource what they can to reliable third-party vendors. This includes closings. Finally, assess and manage risk. Start evaluating the risk profiles of loans and consulting to mitigate risk. Identify borrower fraud risk and create a risk mitigation plan for the long term.
Nema: Warren Buffet is often quoted as saying “Be Fearful When Others Are Greedy and Greedy When Others Are Fearful.” In conversations with our clients over the phone and at conferences, the general honest sentiment is one of fear. However, with the consumer mortgage market in complete shambles for the foreseeable future, there is a significant opportunity to hire some of the most talented operators in mortgage who are cumulatively looking for employment in a pretty crummy mortgage labor market. Some of the most talented former employees of our clients are actively looking for employment. They will provide their future employers much more value than their salaries demand today and will be one of the best investments made by our clients who can use this time to acquire top talent.
Melissa: Sometimes, it makes sense to take a step back and only make loans if they truly make sense. That may mean less deal flow, but it can be a great opportunity to look in house and clean up policies and procedures. Make sure you have the right people in the right seats and reach out to counsel and other third-party service providers to make sure your compliance and management is in order. That way, when you are ready to reenter the lending game, you are set up for success.
What happens if you do end up with defaults on your books?
Steven: Be a Robber Baron. This is a great time to fill up the warehouse. Sue your defaulted customers. Don’t walk away from them with the defeatist notion they don’t have anything. The point is … they don’t have anything now. They don’t have any money to fight with you, so it is cheaper to get the judgment. They won’t wiggle much. But it is too costly! Every nickel you spend perfecting judgments right now will come back dressed like a dime in a short while. There will never be a more cost-effective moment in time for you to rid your portfolio of bad debt. Sue them now, reduce the defaulted loans to judgments, get your hands on what collateral and assets exist, let the remainder gain interest at the State rate (10%), and collect them when the economy turns around. Waiting works against you (statute of limitation runs, you lose your evidence, customers accumulate money to fight you with, they’ll transfer their valuable assets). Every sensible indicator points you toward suing now.
Values will increase, rates will come down. Then you can collect on your (interest bearing) judgments. Imagine how upset your borrower’s next wife will be in three years when she finds out they can’t buy another house for their growing family because he has to pay your judgment first. Now is your chance to look like a genius in a few years.
What are some more deal related ways lenders can prepare?
Dennis: Look to non-real estate collateral and creative loan structures for starters. Start looking to ownership pledges, blanket liens on business assets, and securing borrower accounts of all kinds, including deposit and retirement accounts. We have also seen an uptick in different loan structures when your capital isn’t restricted, including shared appreciation loans, lockboxes with cash management controls in place, convertible debt structures, and combination debt/equity stacks.
Kevin: Get your capital right! If you’re an originator relying on the secondary market still – start diversifying capital sources. I strongly recommend a balance sheet if you want to be a direct lender. If you’re an existing balance sheet lender – evaluate your capital structures for longevity and scale to attract larger investors that are flocking to the space thanks to the higher returns.
Anthony: With banks constricting their lines of business, the capital market will still be in business, but be more selective on the deal flow. As a result, the better deals typically reserved to bank lines and exits will trickle back to the balance sheet lender, who will be able to pick deals more easily than they did before.
Dennis: And on that note, I suspect we will start seeing more multi-beneficiary loans, hypothecations, and participations rather than whole note loans or loan sales.
The uncertainty related to interest rates seems to be a theme going into 2024 as well – any thoughts there?
Anthony: We are at 15-year highs in credit card balances and layoffs are starting to show across several areas. People are running out of cash at an accelerated rate and borrowing to support their lives. This negative cash flow will create continued strains on people and we will start to see defaults creep up in Q2. We’re seeing the effects of the current interest rate environment take hold. As of the writing of this article, the CPI index was unchanged and job additions are slowing while unemployment slowly creeps up over time (but still near historic lows of 3.9%). Banks will change paths away from worrying about interest rates to worrying about the correction of the market. Likely we will see a pullback from banks financing deals as a result of their concerns of a turndown as soon as enough signs point to one. When that occurs, the sudden lack of liquidity will be similar (but to a lesser extent) to COVID-era lending.
And with that, can we round up our thoughts on next year?
Nema: When I speak to clients, most remain in a feeling of discomfort. Volumes for most are slightly down from 2022 but not as much as anticipated. Most are waiting for interest rates to come down, but few serious predictions have mortgage interest rates at a level which creates significant opportunity. So, what does that mean? Well, it’s Groundhog’s Day. Each day we wake up wondering whether something will change but when you look at the months and quarters we simply wake up and repeat. Maybe a little higher, maybe a little lower. The funny thing is that Groundhog’s day feels worse than it is. Most private lenders are growth junkies (so are we at Geraci) and so it can feel very uncomfortable to watch your margins get squeezed and continue, but the reality is that we are faring far better than most of us expected.
Anthony: I think we can be a bit more positive than we let on. We will start seeing a correction toward the end of 2024. Keep the powder dry and be ready to go.
*Please note that while our leadership team discussed the future, no assurances can be given, and their thoughts are based on a variety of assumptions that may or may not be realized.
The team at Geraci is ready to help with all of your private lending questions. Contact us today for a consultation.
