Overreaction is the only reaction for Fintechs
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RAJAT AGARWAL
MANAGING DIRECTOR

Born to a family of entrepreneurs and having worked across several different sectors, Rajat understands the nuances of building a successful company tempered by the unique realities of the Indian business ecosystem.

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VIKRAM VAIDYANATHAN
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26th Mar, 2020

In this episode of Matrix Moments, Vikram Vaidyanathan (Managing Director, Matrix India) and Rajat Agarwal (Director, Matrix India) share guidelines for Fintech firms on how to navigate their way through the perfect storm that is Covid-19 and why overreaction is the only reaction at this point. 

Rajat

Hello everyone. Welcome to Matrix Moments. This is Rajat here. I'm a Director at Matrix and today I have with me Vikram, Managing Director at Matrix. Both of us spend the majority of our time investing in and working with financial services companies. And today as we are all dealing with the coronavirus situation, clearly a Black Swan event, Vikram and  I have spent the majority of the last two weeks talking to lot of other financial services founders trying to ascertain what the impact could be and how we should think about it. These are tough times, we don't have all the answers, but we thought that as we do this exercise, it might be helpful for the rest of the ecosystem to know how we are thinking about it and how companies could potentially think about it. So Vikram, given that you work with so many NBFCs and fintech’s, how should founders, deal with this one of a kind situation? 

Vikram

Yeah. So, by now with the prime minister putting us on lockdown last night, It’s clear that this is an unprecedented situation. We are in unchartered waters. Anybody who says that they know what’s coming and have been through this before is wrong. We've been speaking with a lot of the founders in our portfolio and outside of our portfolio and we're trying to put together all of these learnings and hope you take these as learnings - some of it might work for a particular situation and not necessarily for all situations and with that caveat, let me share why I think FinTech and financial services is different from all other sectors that we're investing in and why for me overreacting is the only reaction acceptable for all fintechs. So what makes financial services and FinTech unique? You have four stakeholders. You have your borrowers, you have lenders, you have regulators and political constituents and then you have investors. Now all four are going through a once in a lifetime event. And usually, financial services is affected by a risk of fear of losing money. All of these four constituents have a fear of losing money and therefore they will react in a certain way.

This is fear of losing money plus a fear of losing their lives and the health of their loved ones. So it's a deep-rooted fear, a psyche that's taking over. Now all of these four constituents are interrelated. So for example, if some borrowers who've refused to pay some lenders, those lenders will not lend to the other fintech’s, which means an investor who was affected in one part of the portfolio will not invest in another part of their portfolio. A regulator might say, you know, hey, I want to save one constituent that is badly affected, therefore they don't have to repay, which might trigger off all these events and you end up in a vicious cycle. And that vicious cycle is immediately a falling knife,  where things can just happen overnight. And that's the fear that you're seeing playing out in public markets. And that is going to hit private markets. That's the reason that FinTech and financial services are different from other sectors where everything goes wrong together and immediately. Therefore, overreacting is the only reaction and you have to plan to say that I'm going to plan for the scenario where everything's going to go wrong at the same time. And when everything goes wrong at the same time, if you have not carefully planned that scenario on how you're going to react because you also have multiple parts of your business your assets, your liability, collections, you have risk, so many different facets of your business and unless you've done a scenario planning so that you are prepared to act at that point in time, I think it's very hard to turn it on with a switch. So plan for the worst, overreact as a team when you're planning for the worst and then execute daily and weekly. And as you hit certain triggers, then you know, if you do get to that worst-case situation, then you know how to act.

Rajat

So Vikram, how should companies think about these scenarios? Because you know, there are all sorts of these lingos going around with V-shaped plans. U-shaped plans L-shaped or W-shape, right? With the, you know, Covid coming back. What's your suggestion given what we've seen in China or in other places, re the microfinance crisis back in the day? Because I remember we were affected by it back then in 2010 as well.

Vikram

Yeah. Unfortunately, we have seen a bunch of them. We were affected by the global financial crisis and the microfinance crisis. There was a liquidity crisis and then there was the de-monetization crisis followed by another liquidity crisis. So, we have had a bunch of those, we have seen investors who have invested through this. In this particular case, let me just simplify the scenario planning. There are some people who predict a V- shape scenario, which is our best-case right now. And by the way, Harvard is saying that a V-shape scenario could be possible because all pandemics have gone through a V-shape. That’s the most optimistic version. Honestly, for me it looks hard to imagine that V-shape, especially from an India perspective.

Rajat

Especially for financial services.

Vikram

Yeah. Especially financial services. So I would be planning for a U shaped scenario essentially what that means is that there's a big falling knife, it’s deep and broad to be honest. It will take a long period of time to come back and it'll come back to the same level. So that's one scenario. And then the second is a scenario which is essentially an L where you never come back to that same level, at least in the 12 to 18-month runway that we are all planning with. That, of course, assumes that the global pandemic will take long. It will take long to subside. It will make a resurgence in the U.S and resurgence in Italy and might make a resurgence in India and all of these are interlinked, which essentially accounts for an L-shape scenario.

Now again, let’s just take a few constituents: the investors, the equity investors will react first because they are taking the highest risk, my sense is that if you're assuming an equity infusion coming or you're in the middle of the infusion, I would just be very careful – if possible, close it if you can, but if you are assuming that you're going to raise money over the next six months, that's an assumption that I would just take off the table.

Then it's a question of lenders and borrowers. The lenders, while being fearful will likely react to triggers because they have gone through all these cycles. They will not want to just shock the market because they know one particular shock in the market will essentially shock everyone else, but they will be forced to react to triggers. And react to triggers in the public markets, react to triggers that happened in their own portfolio when they are lending, not just to you but somebody else. And to also regulate which they have to follow their word to the T.

Rajat                                           

And I guess that means them increasing or encashing FLDG’s for marketplace lenders and stopping new disbursals - likely the unsecured guys will be hit the first, then overtime the secured ones.

Vikram

The second constituency is the borrowers, now with the borrowers, you'll have to be careful to figure it out your pockets of risk and I'm going to give you three dimensions, and we have a wide portfolio, across all of there.

So secured versus unsecured, SME versus consumer and whether you have the end-use control or if you don't have end use control, and I am taking a broad cut across these three and obviously the most, or at least in our view where we are seeing the best portfolio, hold up is secured with full end-use control and with mostly SME, less Consumer though I might be wrong. We don’t have consumer housing assets but consumer housing could be one of those – it’s secured, you have end-use control and you have consumer. Similar segments in SME is probably the best and the most likely to get affected is probably unsecured consumer low ticket size with no end-use control. So that's the spectrum of risk. Figure out where you land on that spectrum of risk and then take action on borrowers

Once you have all of this, I would say figure out your scenario plans in the U-shape as well as L-shape scenario, involve the team and output of the scenario should be 7 to 10 action items where you have big projects and start organizing your company by those projects and figure out these triggers. As soon as those triggers happen, you should be: project one executed, project two executed, project three executed and should be executed by teams, not necessarily by the functional leaders, but by cross-functional teams because you'll have to take action across, within functions. And in a time of crisis, you want to organize yourself by what my colleague Avnish calls it “tiger teams” which are just going off specific crisis action items. Rajat maybe you want to give examples of how companies reacted. What are the initiatives people have come up with so that people understand what some of the companies are implementing?

Rajat

Absolutely. I can give examples across companies of different product types and different customer segments that Vikram you alluded to across SME, consumer, secured and unsecured products. Companies are trying to think about this across 3 different dimensions – disbursals, AUM & collections, and Opex.

So, depending on, how much cash people should have on their balance sheets, from a runway perspective or from a leverage perspective, people are taking anywhere from a 70 to even a 100 percent cut in disbursements and budgeting for again, depending on how secure your product line is, anywhere from 15 to 30% of borrowers in the coming first quarter at least, to not be able to repay the loans. And in that context, how do you think about collections? How do you think about soft collection versus hard collections? And how do you think about being humane and empathetic to the borrowers? So that you can get at least some money out as collections, but not let the loan go NPA or go bad. And the last one on opex again, going back to how much capital people really have the cuts on fixed costs are going to vary anywhere from 10, 20% to even probably 60%. That’s because as Vikram was saying, all of this is going to come at the same time from lenders (liquidity tightening is going to happen), borrowers may not pay on time and so on. So in this perfect storm conditions, you need to take drastic actions if required and don't be shy from taking it.

Vikram

Last thing that I will add on the cost side is that obviously you have variable costs, which you can act on very quickly. There are fixed cost which can be made into variable costs, and think very carefully on how you can make some fixed costs and fix payments, especially into, variable cost. And then there are fixed costs, which, you know, involve decisions like teams and so on. Now some of the decisions are really brutal and we’re even having some of these conversations with folks, and I don't want to underestimate the human impact of some of these actions. Do it carefully, especially in a time like this where people are worried about their health and their children’s health and so on. So I would say involve the team. I think when you involve the team in some of these decisions, you'll see that they've even come up with very creative ways of committing to the company yet hitting the target cost.

Rajat

Yeah, we've heard examples where especially on insurance, people are offering to cover people’s insurance that were not otherwise covered, as well as on salaries, for example, trying to compensate with ESOP as much as possible. 

So, Vikram, any other learnings, from the portfolio and especially people who've been doing it for a while and have seen cycles?

Vikram

I was talking to a few of the experienced financial services guys and what they have seen help ride out these storms and I’ve jotted down a few, the first is having an acute understanding of your risk pockets. And a very granular understanding of your risk pockets.

So sometimes for some companies, it'll be geography. Some companies it could be branches, some companies, products. If you're a multi-product company, sometimes it'll just be segments of consumers and SME and almost all of them shut down all high-risk products. Last week or the week before, as soon as it started, everybody just said, no high-risk products and all my high-risk segments, I'm just going to stop. The second is to organize the company and collections by all those high-risk segments. And you know, I was talking to someone yesterday, they had the best collections week last week because they did this and they essentially said that I will collect everybody who's high-risk, and they actually had a better collection from the high-risk portfolio than they've ever had just because they had this granular understanding.

The second one, given I’m on collections, this is going to be especially tough because you can't visit your borrowers in most of the situations that you could go visit your borrowers and find how the situation is, So some of these practices, everybody's going to invent a new one. If I had one statement to make on your collections and on your borrowers is I would say keep the relationship alive, even if you're not able to fully collect during this time, you're able to re-trigger and renew the relationship when this is all over and be able to get back with them. What are the ways we could keep the relationship alive? One by, collecting much smaller installments than there are willing to pay,  therefore acting in a more human way. Second is trying to figure out how a relationship is continuing to be active while becoming an NPA while not making an installment, but a very high degree of frequent and transparent communication happening with the borrower. The last one is really tweak your incentives across your organization, towards collection, but one of the companies had a very interesting take, which is to cut the incentive threshold between that.

Which means, let’s say you have to achieve a hundred collections in order to get that incentive take that hundred down to 75 or 80. So that people know but they can actually hit that 75 to 80 sometimes it could be 50 or 60 depending on your organization but that actually promotes a higher degree of collection within the organization.

Rajat

Also, I guess people are repurposing some salespeople, right? 

Vikram

The entire organization has to only focus on risk pockets, collections.

Third from a strategic level is to stop thinking of your business if you’re in lending, as a balance sheet business, even if you're in the payments business, stop thinking of your business as a balance sheet and think of your business as a cash flow business and sometimes it takes a bit to adjust to think of your entire business as a monthly cash flow, which is money in and money out and matching inflows with outflows. If you're able to just match inflow and outflow and ride out this phase, you'll be fine at the end of the phase, so it's not a PNL situation. It's actually matching your inflow and outflow; inflows are your debt / equity and what your borrows are paying you and outflows are disbursements and payment that you have to make to your lenders and so on.

If you match them on a hundred a hundred, you will actually be okay at the end of it. I covered collections, disbursals I think Rajat has already touched upon that one. One tip I could give you is sustain enough disbursements in order to be able to collect, everything has to be collections driven and in certain segments, if you stop disbursing, and if you are not active then the borrower can think that the company is going down and this is not a lender worth paying and therefore you will need to manage different pockets, different segments in such a way that you sustain this person enough to collect. The last one I would see is communicate and over-communicate in this phase. It has to be clear, unambiguous and also has to be frequent where you can't be shut down and you can’t be looking inward. You have to just be communicating outward, your organization first, your lenders, second, we have borrowers and lenders and third, investors. One other tip is ban all hearsay and fear-mongering within your own ecosystem. Have centralized communication that is frequent and ensure that you're communicating clearly the risk and addressing the risk in an honest and open door manner. If there is fear-mongering that is happening around your company and once it takes on a vicious cycle, it’s hard to actually whiten that cycle. And last, just make all the don'ts very clear, in a crisis it’s very hard to figure out what to do but it’s easy to say these are all actions that you're going to stop. It gives a velar indication to the org of what you actually want to focus on and do.

Rajat

Well, I guess to conclude, I think, it's not all gloomy. Best companies in financial services have actually emerged out of these troubling times. I remember back in the day, Bajaj it was, I think the stock prices, was down to low single digits after the 2008 crisis, but they really started taking off from there on because they survived that crisis, I guess the best of the microfinance guys - Ujjivan, Bandhan, all of these guys came out, strongly on the other side of the microfinance crisis. In our portfolio, Five Star came out very well out of the demonetisation crisis. So there are great companies that can be built and hopefully, we'll get some out of this as well.

Vikram

Yeah. I would say we are long term FinTech and financial services and we will continue to be, and continue to do that. The ecosystem is very resilient and comes out of each crisis stronger. So this is just one of those things that we will have to navigate carefully and we will come out somewhere at the end of it. Just to echo what Rajat said the best companies will be able to navigate this crisis and come out stronger. And I will tell you that the survivors will really thrive because, given the lack of financial services, penetration, FinTech is really going to guide the innovation. And as soon as this thing is over, we will actually get that supply back in the market. Good luck, stay safe. Again just plan every scenario and act carefully as we hit different triggers. Feel free to shoot us an email. I would love for people to be adding to this thread,  all learning from each other.

Rajat

Yup. Thank you everyone and stay safe.