Reflections on the Pandemic So Far

We are currently somewhere around day 60 of our family’s quarantine, and the country is inching closer to reopening. Over those 60(ish) days I worked remotely from home, and held a TON of meetings with clients, colleagues, and others over Zoom. As you can imagine, everyone has handled the last two months a little differently. Some investors are more comfortable with volatility than others.

I had a chance this week to think back on the sentiment in general. How people are doing and feeling. How they’ve handled the last few months. What their financial situation is like right now. And while everyone has handled quarantine and the Coronavirus pandemic differently, there are some trends I’ve noticed across many of my conversations. I thought these trends might make an interesting blog post, so here are a few things that have been on my mind recently.

Will These Structural Changes Really Happen?

There’s a lot of talk out there about how the COVID-19 experience will change the way we work, play, and live forever. Speculation abounds that large corporations will ditch expensive office locations in droves, and the demise commercial real estate is a foregone conclusion. Why pay lofty rents when your team can work proficiently from home?

Professional services like healthcare, accounting, and financial planning are often included in this conversation too. Now that we’re all using videoconferencing technology like Zoom, why drive to see your CPA when you can conduct the meeting from your living room?

Perhaps some of this will take hold. But other than being a little more comfortable in a video conference, my guess is that in 24 months not much will have changed structurally. We’ll just have a few more options available.

I take this stance because we’ve been working with clients over Zoom at Three Oaks for several years now. Is it convenient? Absolutely! But it’s not a replacement for face to face relationships or a handshake. Zoom rooms don’t replace the camaraderie your team gets from a casual chat in the break room. And it makes group happy hours a lot less interesting.

Humans crave acceptance and naturally prefer herds. It’s why so many of us prefer to live in jam packed cities like New York and San Francisco. Its comfortable being close to other creatures like ourselves. So yes, more fortune 500 companies will downgrade their office space and offer more work from home options. But I don’t see the many of them swapping the energy that’s created from face to face interaction with an isolated home office & laptop. At least not entirely.

Thinking Long Term is REALLY Hard

Right now my wife is pregnant with our third kid. One thing she likes to tell our friends and family is that the only reason we’re having a third is because she blacked out during the delivery of the first two.

Our brains are wired to forget painful memories. It’s a coping mechanism.

When we take on new clients at Three Oaks, we spend quite a bit of time working through monthly cash flow. It’s really fundamental to our financial situations, and it helps frame the discussion of how much to set aside for a cash safety net.

Typically we recommend keeping anywhere between 6 and 24 months’ worth of cash on hand as a safety net, just for a rainy day. Over the last several years, I can’t tell you how many clients scoffed at the idea of keeping so much cash in the bank uninvested. With yields so low, it seemed foolish to keep so much money out of the market.

Looking back now, the same clients are thrilled that they funded their safety net first. Not because they avoided the market collapse in March, but because they can sleep at night if they end up taking a 15% or 30% pay cut. While they might attempt to collect unemployment if they’re furloughed or laid off, they’re not begging the bank for forbearance on next mortgage payment.

Is this the first recession we’ve experienced? Not by a long shot. So we should know that it’s important to keep some cash around for a rainy day. But we don’t. It’s easy to forget the emotions involved in tough economic periods. Remember, our brains are wired to forget the pain.

The Boring Stuff Is The Important Stuff

Like the cash safety net example above, a lot of solid financial planning is relatively boring. Getting more life insurance. Setting up powers of attorney and maintaining a list of contacts if anything should happen to you.

But when things get crazy, whether it be from pandemic, financial crisis, or war, it’s the boring items that often become the most important.

On top of that, they’re often the most neglected because they’re boring. A lot of people we work with get really excited about the concept of positioning their portfolio for long term growth. Getting them to sign a beneficiary designation form? Pulling teeth.

I didn’t intend for this to be a shameless pitch for working with a financial planner, but the accountability that a professional can provide can truly be priceless. It’s hard to think long term. For many of us, it’s also hard to take care of the boring stuff.

How to Get Your PPP Loan Forgiven

We’re now about six weeks into the CARES Act and in round two of the Paycheck Protection Program. The $310 billion allotted to the program in round two is beginning to dwindle, but has lasted longer than most bankers expected.

There could be another round of stimulus that replenishes the program over the next few months, of course. There seems to be widespread effort in Washington to ensure that businesses that need PPP funds are able to get them. Who knows whether that will eventually happen.

For many of the businesses the most pressing question is no longer how they can access the program & obtain funds to keep their operations going. It’s what must I do to have this loan forgiven? This post will cover what we know so far.

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Market Update: Q1 2020

Well here we are….one quarter into 2020, and the risk event we’ve all been waiting for has finally arrived. Volatility as measured by the VIX Index touched all time highs over the first quarter as the Coronavirus spread from China to Italy and the rest of the world.

The stock slide here in the United States was fierce, but a late quarter bounce regained a substantial portion of the lost ground. More ground, in my opinion, than the numbers really support.

From here, small cap and emerging markets are starting to look like wonderful bargains. But without knowing the extent of the economic damage & how long the world will be sheltering in place, it’s difficult to make that argument with too much confidence.

Here’s this quarter’s market update.

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The CARES Act: Implications for Individuals

As I’ve written about on the blog and covered on the podcast recently, the CARES Act is a big piece of legislation. (Remember….the total package is $2.2 trillion!). We’ve covered several sections of the bill and how it might impact you on the blog recently, including a deep dive into the paycheck protection program.

There are also many provisions in the bill we haven’t covered. Specifically, sections relating to stimulus checks, expanded unemployment insurance, mandatory distribution holidays, penalty free retirement account withdrawals, and student loan relief. Coincidentally, all have been commanding a large number of questions from clients of Three Oaks recently.

Like all legislation there is a great deal of gray area in this piece of legislation, especially given the urgency with which it was passed. The IRS, SBA, Department of Labor, and other government entities are scrambling to provide relevant guidance as soon as possible. So while there may appear to be some planning opportunities with regard to the law, it’s entirely possible they’re just a temporary mirage. Nevertheless, here’s what we know now about the CARES Act and how it might impact you as a taxpayer.

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The CARES Act Revisited: Updates to the Paycheck Protection Provision

A lot has happened in the past week. And now that we’ve had an opportunity to read through more details of the Paycheck Protection Provision, it’s become clear that the program’s rollout will be messy. In fact, it already is.

Last week I wrote a post outlining a few of the provisions in the CARES Act meant to provide economic relief to small businesses. What we’ve come to realize in the last few days is that the Treasury Department has a great deal of latitude in how these programs will actually be offered.

For example, the permits the Treasury Department to issue up to $349 billion of loans to small businesses through the Paycheck Protection Program. Businesses with fewer than 500 employees can apply through an SBA approved lender for loans up to either 2.5x their average monthly payroll over the previous year, or $10 million (whichever is less). The bill stipulates that the pay back period for the loans may be stretched out to up to 10 years, with an interest rate no higher than 4%.

Then, early last week, the Treasury Department stepped in and communicated that all loans will have a two year amortization period and 0.5% interest rate. And on Thursday, Secretary Mnuchin announced another interest rate revision to 1%.

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Unpacking the Coronavirus Stimulus Bill

As you may have heard, the Coronavirus stimulus bill was signed into law by president Trump last week. The package is called the CARES Act, and provides over $2 trillion of economic stimulus across a variety of channels.

My first thought here is sheer size of the package. $2 trillion is a TON of money. While at some point I’ll look into how the package will be paid for, I’ve spent more of my energy recently learning what’s in it. The bill includes a mix of forgivable loans to small businesses, bailouts to corporations in certain industries, and checks mailed directly to taxpayers falling under a certain amount of adjusted gross income.

For many of our clients at Three Oaks Capital, there is urgency surrounding the relief opportunities for small businesses. This post will cover the four sections I think are most relevant. I’ll circle back and try to cover implications and opportunities for individuals in a subsequent post.

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Where Do We Go From Here? Market Thoughts & The Risk of Financial De-Leveraging

Well that escalated quickly. We are now officially in the second fastest bear market on record. Bear markets become official when stocks fall 20% or more from their peaks. Ordinarily this takes months to play out. Bad news comes out, stocks sell off a bit. Everyone goes home, thinks about it, and comes back the next morning. More bad news comes out, stocks fall a bit further, and so on. Here’s some data from Marketwatch on how long it typically takes to enter a bear market:

With the Coronavirus driving the U.S. and much of the world to shelter in place, our economy has come to a screeching halt. Some forecasters are guessing that we’ll see a 5% drop in GDP this quarter, others are predicting as much as a 30% drop.

Whatever camp you reside in, the picture is not pretty. Markets did not take long to notice. Whereas it takes on average 136-137 trading days to enter a bear market based on the data above, it only took us 19 to get there this time – the second fastest on record:

So where do we go from here? A stimulus package is just about to be passed (finally). Markets rebounded as much as 12% yesterday and another 4.5% today. Even though the public health picture still looks bleak, we are starting to wrap our heads around how long the pandemic may continue.

Here are a few things I’m reading and my thoughts on what happens next.

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Coronavirus is Spreading…..Markets are Plunging…..Is it Time to Panic?

**Update: I wrote this draft on Saturday, and since then oil has dropped 30%, circuit breakers for the U.S. stock market fired this morning, and the 10-year U.S. bond yield has fallen below 0.5%. The charts and numbers you see here are as of Friday. My stance has not changed.

What do the following have in common?

U.S. marginal tax rates are too low
Central banks printing money will lead to asset bubbles
Washington partisanship
Political turmoil with Russia, the Middle East, or North Korea
Trade war with China

These are the risks that could derail the decade long bull market and business cycle we’ve enjoyed since 2009, according to market pundits. Viral contagion? Nowhere to be found.

At this point there are over 100,000 cases of Coronavirus across the world, with 400 being here in the U.S. While the media has certainly fanned the flames of panic, COVID-19 will have a substantial negative impact on the global economy. The best epidemiologists in the world are forecasting that 40%-70% of the world’s population will contract the virus. People are beginning to cancel flights & vacations. Small businesses are scrambling to put together “work from home” contingency plans. All of which will be a drag on the economy.

The markets have…taken notice. After a tumultuous few weeks, the S&P 500 is now down 8% on the year and investors around the world have flocked to safe havens like long term U.S. treasury bonds.

Here’s the return of TLT, a 20+ year U.S. government bond ETF over the last week and YTD.

TLT: 20+ Year US Bond ETF YTD Weekly Returns

The Coronavirus is Spreading....Is it Time to Panic?

Source: Kwanti

TLT: 20+ Year US Bond ETF YTD Returns

Source: Kwanti

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How to Obtain a Mortgage as a Business Owner

If you’ve bought a house in the past, you are probably familiar with the underwriting process involved when obtaining a mortgage. You might even have nightmares about the reams of paperwork you had to provide to your mortgage lender to get approved.

Being approved for a mortgage is not an easy process. For business owners it’s even more complex. Typically mortgage lenders provide pre-approvals based on some combination of your W-2 income history, pay stubs, or an offer letter from an employer. Unfortunately for business owners, these sources may not show consistent income a lender could use in a standard approval.

So what do you do? Recently I had Maggie Hopkins, a local Sacramento mortgage lender, on the podcast. Since she shared so much valuable information on the episode (and because I love re-purposing content), I thought I’d summarize the important points on the blog this week. If you own a business, here’s what you need to know about obtaining a mortgage.

The Typical Mortgage Underwriting Process

Like any bank, mortgage lenders want some assurances that they’re going to get their money back, plus interest, before giving any to you. So, when you walk into your mortgage lender and ask for financing, they’re going to ask for your tax returns, pay stubs, credit reports, and any other documents that might be relevant.

If you’re an employee collecting a w-2 salary, lenders may be willing to assume that income will continue indefinitely. They’ll also take your other debt into consideration, and use some type of debt to income ratio to determine how much they’re comfortable doling out.

If you don’t have a w-2 salary that doesn’t mean you can’t get a mortgage. But it does likely mean that you can’t get a conventional mortgage, that meets the down payment and income requirements established by Fannie Mae and Freddie Mac.

It also means lenders will look at your other sources of income. And for self-employment income, lenders historically use the average of your last two years. Doing so helps them confirm that your business profits are not a short term “flash in the pan” that might disappear next month.

This can be less than convenient, since net profit is usually the only metric that matters. Any type of fluctuation in bottom line profits in the last two years could impact your pre-approval amount or your eligibility entirely. Funding a big expansion or other expenses that might crimp profits over a short period of time tend to work against you. So do gray area personal expenses you might be running through your business: home office deductions, cell phone bills, etc. Anything that depresses your income, while ordinarily “good” for tax reasons, may mean you’re not able to obtain as much financing as you’d like.

Other Mortgage Options for Business Owners

So what are your options if the last two years haven’t been stellar? An obvious answer would be to wait it out. Take a two year period where you cut expenses as much as possible in order to prove adequate self employment earnings. Or simply grow revenues. (Although I should add, from a business management standpoint, growing revenues is not always the answer, and can lead to more pain than gain).

Another option is to pursue what’s called a “bank statement loan”. Whereas banks have been exceptionally rigid with their underwriting policies and standards since the mortgage crisis in 2009 (for good reason), they are starting to loosen more recently. Some lenders are beginning offer mortgages based on the deposits to your business bank account – not your tax returns or pay stubs.

As Maggie shared with me, these are typically 5, 7, and 10 year adjustable rate mortgages (ARMs). Which isn’t quite as appealing as a borrower in this low interest rate environment as a longer term fixed rate mortgage would be. Nonetheless, it can be very helpful. And you can always refinance later if your business income becomes more consistent over the few years after obtaining one.

Down Payments

Conventional mortgages require 20% down payments. Coming in with less than amount isn’t a deal breaker, but it means one of two things:

You need to obtain an FHA loan and private mortgage insurance
You need another type of unconventional (non-conventional?) loan on less favorable terms

FHA loans can be extremely helpful. You can put down as little as 3% since the FHA is guaranteeing the mortgage. The downside is that you have to pay private mortgage insurance (PMI), which can be anywhere between 0.55% and 2.25% per year. That’s added to the interest you’d pay on the loan anyway.

The alternative is to work outside the bounds of conventional loans. Realistically this means letting your mortgage broker go to work for you. Mortgage brokers can work with any number of different lenders, and should have a good understanding of which banks tend to offer the best terms for your situation. While you don’t necessarily need to pay private mortgage insurance if you have less than 20% down, do expect to pay a higher interest rate. Maggie also shared with me that while it’s possible to obtain a bank statement loan with less than 20% down, you’re probably not going to like the rate & other terms.

What to Make of Points, Rates, Closing Costs, and other Terms

Then there’s the question of points, rates, closing costs, and terms. One of the biggest takeaways I got from Maggie was that mortgages are one big package deal. Lenders try to ascertain your capacity and willingness to pay off the mortgage, and then extend an offer accordingly. Better credit scores mean that you’ll get more favorable terms. Negative marks on your credit history mean you’ll end up paying more.

From there it’s all negotiable. You can squeeze your annual interest rate down by buying points & paying more up front. Which could be a good idea if you’re certain you’ll stay in the house for the entirety of the loan. But that may not be your best option. At the end of the day the rate, closing costs, and term should all be aligned with your objectives for the property. If it’s a flip, pick the loan with the lowest possible down payment and closing costs. If it’s your forever house, scrutinize the rate.

At the end of the day, your mortgage broker’s job is find a lender to offer you a loan on the most favorable terms and the right structure. There are a ton of moving parts in the mortgage world. Just because you don’t have 20% down or two years of schedule C income doesn’t mean you can’t get into a house. Even if you own a business that doesn’t produce consistently high self-employment income.

2020 Reader Survey

For anyone who’s followed the blog for a while, you’ve probably noticed that we’ve made a few tweaks over the years. Frequency of posts, topics covered, and types of content (blog posts vs. webinars vs. podcasts) have all evolved quite a bit.

This past year we’ve gotten into the habit of offering monthly webinars, launched a podcast, and have continued to grow the financial planning firm at a pretty rapid pace.

All this has required a sizable investment of time and dollars. I’ve been very happy about all the positive feedback we’ve gotten, and continue to be humbled by your interest and readership.

To make sure we stay focused on producing the right “stuff”, I’d like to ask you for your feedback on what we’re putting out. If there’s anything you think we can be doing better, I’d love to know about it.

Thanks in advance for your time and feedback!

**Editor’s note: I’m trying a new widget for this survey. It should work on any desktop/tablet/mobile phone, but if you have any issues please let us know.