Spring 2020 Economic Update – COVID-19

We hope you’re staying healthy and safe. In light of the recent impact of the Coronavirus, we’ve been getting a lot of questions from investors. Our Co-Founder and CFO, Robert Fraser, put together a quick 24-minute video covering the following topics: 

  • COVID-19 Analysis (starting at 0:35)
  • Impact on the economy (5:24)
  • Hardest hit sectors (6:48)
  • Effect of the stimulus packages (9:49)
  • Impact on the housing market (13:15)
  • Potential impact on Aspen’s funds (19:08)

Video transcript:

Hi, everyone. Bob Fraser here, principal of Aspen Funds. We’ve been having a lot of questions about the economy and about Aspen in particular, and what does the current extraordinary circumstances, how is it going to play out in the economy? And so, I wanted to take a few minutes and answer some of those questions and give my perspective on what is happening and how things are going to play out.

So, let’s take a look real quick. I want to first just take a look at the virus and how it’s playing out. I think it’s important to know that while it’s a very serious disease, COVID-19, the Coronavirus has a 4%-ish mortality rate. It’s far below other historical mortality rates, including Ebola, 40%, MERS 34%. It is more prevalent, so there’s a lot more cases going on, so I’m not underplaying it, but I do want to point out that it’s not as deadly as some other diseases have been.

It is primarily focused on the younger ages. This is from the Centers for Disease Control. You can see the mortality rate compared to the flu. It’s definitely quite a bit higher. This is the flu over here, but you can see what’s happening is, for the below 50, right here, you see a mortality rate of 0.3% of people who contract the disease die. So, again, that’s a very low number, but it ends up being a disease that’s very much focused on the elderly. An 80 year old who contracts the disease has a 14% chance of dying. So, it’s very much focused on the older generations. I want to point out just in historical context that this Coronavirus is not a world ending disease. There’s a lot of talk out there about how this is going to change the world.

And I am a student of history and this is from my book, Kingdom Horizon. And I want to point out here the Black Death in the 1300s literally killed one third of the world population. The Spanish Flu, the 1918 flu, it was somewhere around 3%. I mean, we’re going to be way down here with hundreds of thousands, potentially died from the disease. Again, I don’t want to minimize that and if you’ve lost someone, my heart goes out to you. But from a global historical context, this is not as severe as things in the past. Now, we’re seeing US cases still rising exponentially. Basically the number of cases is doubling every two and a half days in the United States. I expect that to continue for the next few days because the US has been far behind other nations in terms of testing.

And so, as they test, you’re going to see the cases come forth. But as people are isolating themselves and practicing social distancing, as the retail is being shut down, you’re going to see this thing start to flat line, I believe. And so, right now it’s doubling, but I want to show you what’s happening in China. So, China basically after 30 days right here, they started flat-lining their cases. So, they were successfully isolated the cases and was able to keep this disease from spreading. I’m hopeful that the United States will flatline as well. So, we’re at day 20, China’s at day 30, again, we may be a little behind China’s prevention, but our government is on it. Trump just enacted the National Production Act and is getting medical supplies produced, is also fast tracking cures and there’s at least four immediate answers.

One includes the Chloroquine, which is the drug they use for malaria. There’s also two general purpose antivirals that have proven effective. And there’s also plasma transfusions. Of course, the real thing everybody’s working for is the vaccine, which they say is 12 to 18 months out. But my guess is we’ll see because so much resources and brain power is being focused on this, we’ll see these answers coming soon. Now, some people have argued that the data out of China is suspect, but I would also point out that South Korea as well has flatlined. So, as people are taking this seriously, they’re actually able to prevent the rapid spread of the disease. So, we’re hoping to see that.

The biggest impact is not just the healthcare system, really the bigger impact is on the economy. So, the response that the nations are doing and America is doing is having a massive effect on the economy. So, this is from Goldman Sachs who are some very smart guys who’ve done an economic analysis and they’re calling for a 25% drop in GDP Q2. So, that’s a very big number. That means that economic activity will drop by 25% in the quarter from April 1st to June 1st. That seems fairly realistic to me. They’re also calling for a 11% gain, positive gain in Q3 and continuing. So, it’s more of a V shaped recovery, right? Boom. And again, that’s what seems right to me. So, no one knows the future, but so 25% is extremely serious and it’s affecting a large part of the economy because 70% of the economy is consumer spending and so that’s being severely impacted and curtailed.

The retail apocalypse has been accelerated. This is, retail ETF has dropped huge. It’s interesting, it’s a three PE ratio for those trust track stock prices. But while the P has gone down, the E is about to go down. So, I’m not saying we should buy this, but retail has already been a sector that has been massively under pressure because of the online giants and retail is in huge transition. So, this is an event that’s pushing a sick man over the cliff and commercial real estate, as well, is being particularly hard hit. This is a CMB and you’ll see pretty significant discounting happening. These are retail landlords and office space landlords. And this may change, people want office space, but will the fact that everybody’s working virtually now, will people get used to that?

And will office space actually be in lower demand in the days ahead? No one can answer that. But right now you’re seeing pretty big disruptions in retail and in office space happening and they’re early, but commercial real estate, some sectors of it, some parts of it are in turmoil right now. My best guess is that while retail will continue to suffer that other parts of the commercial real estate space will do well. And the reason is, they’re going to drive bonds and interest rates to the floor and doing that will put pressure on cap rates, which mean prices will go up. So, other hard hit sectors besides retail is oil. I’ve been bearish on oil for probably five years now. Gasoline, interestingly enough, just hit 60 cents a gallon in the wholesale market, which translates to about a dollar 30 at the pump.

But I’ve been bearish on oil for several years. You’re going to see probably a lot of oil bankruptcies, unless there’s bailouts and you’re going to see … Again, they’re highly leveraged. A lot of these oil producers are extremely highly leveraged and so you’re going to see bankruptcies. You’re going to see bankruptcies in retail and probably in travel as well, but bankruptcies are not all negative. So, a bankruptcy, a business bankruptcy. What happens is the equity shareholders are wiped out, typically, and but the debt is restructured and the assets remain. So, planes don’t disappear. Commercial real estate doesn’t disappear. Oil wells don’t disappear. They just get restructured and the debt gets restructured and they continue operating. So, these other sectors are obviously very hard hit. Again, oil is another sick man that I think got pushed. In my opinion, I think we’ll see recoveries in these, good time to start booking your travel for later in the year, in my opinion.

So, the big reason why I’m more optimistic than I would otherwise be is the bailouts, they have learned their lesson. They learned from 2008 crisis that moving fast matters. That moving fast makes a big difference because there’s lasting impact. The economy will damage itself and injure itself to the point where it cannot be recovered at some point. And so, it’s super important to give it life support to keep it from getting injured at this point, so they’re acting fast. There’s bipartisan support, who can say hallelujah with me? It’s just awesome to see people actually working together in DC. I’m very excited that Trump is at the helm because Trump understands the economy. There’s a lot of wonder if we’ll see a V-shape recovery. I do think we have a very good shot at that, especially if Trump is at the helm because he understands business. He understands the economy.

We saw a very, very slow recovery in the 2008 crisis, and it was primarily because Obama does not understand business. He didn’t understand that jobs were created by businesses. And that you have to support business in order to create jobs, that you can’t create jobs by making a great speech. And so, we had this very, very slow, very, very lackluster recovery, which I believe we will see different. And depending on how the elections go in 2020, later this year, we’ll see. But I remain bullish at this point. So, the bailout includes 700 billion in bond purchases. Again, it’s extraordinary expanded unemployment benefits, tax day extended 90 days. They’re working right now on a $2.5 trillion additional bailout package, which includes direct payments to individuals, forgivable loans to businesses, help for student loans, payments, et cetera.

And we’ll see what all this is, but it’s going to be big. Europe also just passed about a $1 trillion stimulus. So, this is global and money is global today. So, when Europe stimulates, it stimulates America too. Bottom line is it will work, it will work. We will see a post COVID economic recovery. We need to get through this, the dark part of this virus, which again, as I pointed out, I’m hopeful that that’ll happen. I do believe we’ll see some sectors permanently altered like retail, potentially travel, potentially commercial real estate and some others. But bottom line is we’re not going to see lasting damage to the economy.

On the bailout, the Fed injected in one day, three days ago, $107 billion in purchases. Here’s the Fed’s balance sheet. You see it just skyrocketed here to the tune of, like I said, $107 billion in purchases just in one day. So, this is huge. They’re buying bonds, which is depressing, which is driving down interest rates across the economy. Regarding the housing market, the residential housing market. I agree with Kyle Bass who said, “We’re going to see 0% interest rates. We’re going to see enormous amounts of liquidity. I think inflation is going to run hot.” I don’t agree with him there, but he says, “I think it’s going to be really interesting housing market. I don’t expect housing prices to drop much in the United States.” I agree with him on that. In fact, prior to this crisis, we just saw existing home sales soar to a 13 year high in February.

So, we’re seeing huge demand for housing, as I have been saying for many, many years, that we see massive fundamentals and bullish fundamentals in the housing market. Single family housing. The Federal Reserve has driven mortgage rates to the ground. Look at this. Mortgage rates actually hit what? 3.3% on average, for a 30 year fixed mortgage. Their purchasing of bonds is going to continue to drive this down. Kyle Bass says, “0% interest rates.” I don’t know if we’ll get that far down. Can you imagine having a 0% mortgage on your house? What would that do to housing prices? And refinances, so you’re going to see a ton of refinancing. Just anecdotally talking to mortgage brokers, they’re saying, they’re 90 days out from closing right now. They’re so busy. So, housing prices have had a strong recovery.

So, we’re near the peaks, the previous peaks. But as I pointed out in my previous economic forecast, real housing prices, meaning adjusted for inflation, are well below the previous peaks, well below it, about 15% below the peak. How can this be? Well, so back in 2005 you could buy a piece of land, you could build a house on that land and you could sell that house and you could make a profit. Today, if you bought land and built a house on that land and sold it, you would actually lose money. Why is that? Well, because the building prices have continued to go up, including building materials and labor have continued to go up because of inflation. So, what’s happened for the last 15 years, inflation has made the steady track up. It has not stopped, but housing prices took this massive dip down and are now going back up.

So, they have to catch up. So, in order for housing … New housing is not going to be built until it can be built profitably. And that is not going to happen until prices rise further. So, we’re going to see prices rise further in the housing market. I’m just going over the fundamentals here. Price to rent ratios, which was one of my favorite housing fundamental analysis is very, very strong. You’ve seen basically for the last 15 years, rents have continued to rise, but housing prices, again, haven’t. And so you’re seeing the price to rent ratios are extremely low. So, it’s actually right now, in my region, it’s cheaper to buy a home and pay a principal and interest payment on a mortgage, than it is to rent a home. And as long as that’s happening, well guess what’s going to happen? People are going to buy instead of rent if they’re able.

So, you’re going to see lots of demand into single family homes. The housing prices had been buoyed by a massive supply squeeze. And saying this again, we’ve seen the month’s supply of houses in the United States is just extremely low and housing has been under-built for the last 14 years. Here’s the big crash in 2008. You see single family housing starts has crashed and it has not really recovered. It’s still way below its normal. This is multifamily, the green is multifamily, it too crashed, but it rapidly recovered. So, the cranes are out there building multifamily apartment complexes, but no new homes, single family homes that are being built are very, very few. So, it’s well below any time in the last 20 years. Again, there’s a huge shortage and supply squeeze for single family homes.

And I just, I did this, this is the same chart of single family homes divided by population. And you can see it’s lower, the population has continued to grow while single family homes have not. So, you’re seeing it well below anytime in the last 50 years. The bottom line is, is fundamentals of single family homes is still very, very strong and debt service as well. So, we enter this recession with consumers really having very low debt service payments. Meaning the cost of their debt relative to their income is at a low. So, specifically, again, I think our economy, I’m hopeful that we’ll see a V-shape recovery, and the bailout is huge and it’s going to have a massive impact. Now, let’s talk about Aspen in particular. I want to talk about our Aspen I, our income fund and I’m just super pleased with this fund.

It is just now coming in its eighth year and it’s just been a stellar performer, throughout that time we’ve made just minor tweaks here and there to the business model and it just continues to perform. I don’t see our ability to generate preferred returns impaired, at this time. People are protecting their homes, they’re wanting to stay in their homes and they’re making their payments. It’s interesting having people that do have their jobs are spending less money on extras. So far, out of some nearly 400 loans in our portfolio, we’ve had one request for a virus related payment holiday. Now, I do expect we will have more, but it’s just not material at this point. Our models are proving out. So, we’ve thought a lot about our business models. We’ve built this to be recession proof and so far it’s looking like it is.

First of all, as I said before, residential real estate is a bright spot, I believe it’s going to continue to be a bright spot with mortgage rates being driven to the floor and with demand, fundamental demand still being off the chart, I think it’s going to continue to be a bright spot. Very, very conservative underwriting. We’ve been telling you in our newsletters for the last several years we’ve been aggressively getting more conservative on our portfolio just to be defensive. So, this is our ITV, this is our investment to value. This is how much money we’ve invested in a loan, relative to the price of the loan. And you can see, basically two thirds of our portfolio is below 65%, or below 70%, sorry, below 70% of the value of the house.

So, that’s very, very conservative. Very, very conservative and not only that, not only do we have our monthly borrower payment streams, so that we get monthly payments from our borrowers, but we have had very strong deployment ratios. We’re running about 125% deployment ratio right now because we have a credit line with about 25% leverage. So, it means we’ve got a lot of loans that are actively paying. And then the final thing is, is that people are refinancing. So, what happens is, is you remember from our models, we buy loans at a steep discount. So, if we pay 50 cents on the dollar for a loan and that loan gets refinanced out, we get paid 100 cents on the dollar, so it’s a huge profit. We’ve already seen several refinance takeouts this quarter, which is not yet ended, as I record this, but we’re going to continue to see more.

So, bottom line is Aspen I is in fantastic shape. I’m not making guarantees or promises, but it looks amazing right now. So, our non-performing side, again, we’re very happy. We are seeing a few things happening here. One is court holidays, delaying court cases. So, this is where we buy nonperforming loans and we work them out. Well, a lot of that depends on court activity for us. And so we’re seeing courts actually saying, “We’re not accepting new cases or we’re pushing our calendars out 90 days.” So, we’re seeing a lot of that happening. We’re also seeing moves toward temporary moratoriums on foreclosure activity and these are the states wanting to just support and offer help to borrowers, homeowners and renters. We’re seeing a lot of that. And we’ve been seeing some slowdown in our portfolio.

However, I want to say again, we’re in the right sector. Residential real estate. Our asset queue is very, very deep, so if a loan gets stalled, we simply move to the next one. We have a massive queue of loans that we’re working on right now, so we’re just moving to the next one. We are aggressively staffing up our workout department and I want to point out that our partners are not paying for that, we’re paying for that as a management company. But we’re aggressively staffing and growing because there’s so much opportunity in this space. And we’re also rapidly improving our internal systems to work efficiently and to better work our assets. We’re doing lots and lots of deployments, which I’m super excited about, in new tools, new modeling, new systems that we’re building that are going to massively increase our productivity, is our hope.

Bottom line, we will see some impact, primarily the slowing of some of our workout processes for 90 days or so, on some of our assets. So, it remains to be seen the degree at which how we’ll be affected, but it doesn’t look like it’s going to be much. It’s just maybe marginally reduced returns for the second quarter is what it looks like now. Again, no promises, no guarantees, but that is my best estimate at this time. So, to all, that’s my economic update. That is my assessment of Aspen for this spring and the Q2 and Q1. And just to wish you all a happy and healthy home life as you sequester yourself in your house and trust you to make the best of this season. And thank you for being our partners and we’ll talk to you soon. All right. Bye-bye.

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