Letter to Investors
Chairman of the Board of NEO Finance
2020 March 18
We all see the threats facing Lithuania, the European Union and the world. We must respond quickly and boldly to protect employees, colleagues and family members from the threat of coronavirus. We also need to respond adequately and swiftly to the economic situation and make our own investment decisions.
In order to remain consistent and to be as transparent and open as ever, we are reporting the actions of our management and the team. Yesterday was the second extraordinary board meeting in the last week (remotely, of course). In response to the situation, we have made the following detailed decisions, which I try to prioritize:
1. In accordance with the Consumer Credit Act Amendment of 03/03/2020, we are immediately arranging for borrowers to take a “credit leave” by providing credit deferral part payment up to 3 months (in exceptional cases up to 6 months) as required by law. It is currently possible to postpone your credit deposit date by up to 1 month, so we'll be programming this functionality.
I believe that this Government proposal and decision is correct and this amendment to the law provides clarity on what to do with deferred payment when the borrower has been hit by the coronavirus economic crisis. This solution will allow the borrower to temporarily pay lower premiums until the circumstances leading to a temporary loss of income or additional costs change, and will allow investors to avoid terminating most contracts, even if revenues are temporarily reduced, but the investor will recover all interest due for that period;
2. Temporarily, until further notice, we suspend loan applications for refinancing loans where the borrower's DTI is greater than 40 percent. With this decision we are trying to foreclose on the riskiest group of borrowers. The decision has already been implemented on 18 March 2020.
3. We are changing the risk rating of C-rated loans and from now on we will not let through a portion of C-risk loans, leaving only the less risky portion of the loans at an approximate ratio of 80/20, i.e. rejecting about 20% of riskier C-rated loan applications. This decision has already been implemented on 18 March 2020.
4. Reduction of the maximum loan amount according to the ratings: for A rating the maximum amount is EUR 13,000, B - EUR 10,000, C - EUR 7,000. The total amount of available loans per borrower may not exceed: EUR 17,500 for A, EUR 14,000 for B, EUR 10,000 for C. We believe that this solution will help to reduce the credit risk borne by investors, as borrowers, while having a higher DTI ratio, may inadequately weigh their options and exclude possible future loss of income. This decision has already been implemented on 18 March 2020.
5. Significantly reduce advertising costs until the economic situation becomes clear. The goal is to save on operating costs. We see that we are already getting more borrower applications than usual, so we don't see the need to invest in additional advertising. As the situation changes and the need to put more loan applications on the market increases, we will be ready to increase the cost of advertising promptly.
6. Increase investment in selling and further developing a payment initiation service as demand for online billing grows rapidly.
7. Review and reduce operational costs as far as possible and, in the event of a reduction in labor resource needs, seek mutually acceptable solutions to reduce the payroll line without reducing staff's fixed salary.
As a reminder, one management decision was only made after the quarantine was announced, in the morning of March 16, 2020, which raised the interest rate on the bottom cap on all new-rated loans depending on the loan term. The minimum interest rate was increased by 1% for A, 2% for B and 3% for C. This was done in view of the increased risk of loan default due to the current economic situation and we believe that this was a necessary step to protect the interests of investors.
The Company plans to update the business continuity plan, as well as submit it to the Bank of Lithuania in accordance with the law, and to the Investors for information in the near future, same as every year (in March).
NEO Finance, AB is engaged in two types of activities: it provides a payment initiation service for electronic businesses, which allows these businesses to save significant amounts on purchases or services in the Baltic e-shops and is a P2P lending operator.
The Board believes that the current situation may have a positive impact on the financial results of the payment initiation service, as we are clearly witnessing the growing need for e-businesses to sign up for Neopay and accept payments from consumer payment accounts, thereby saving on billing costs. In order to meet the growing demand, the Company is increasing its human resources and allocating additional investments to these activities.
In the context of P2P lending activities, the Board, in response to the situation, adopted the above decisions to adapt to the changed situation in the Lithuanian economy. It is important to note that the economic situation in other countries does not affect the Company's activities (apart from the volume of investments by foreign investors) as the Company's investors and the Company itself lend directly only to citizens of the Republic of Lithuania working in Lithuania. However, as the demand for export goods and services diminishes, the economic downturn in other countries may have an indirect impact on the Company as a result of a decline in income or loss of income to its borrowers. The current economic situation in Lithuania has a greater impact on the income of borrowers as Lithuanian companies reduce their employment or terminate their employment. It is a very positive and important aspect that the Lithuanian Government have adopted an economic stimulus package in which subsidies or compensation for the salaries and employment of employees play the most important role. Employers, with the help of state aid, retaining employees and allowing them to take "credit leave," are likely to be able to gradually return to full-time employment and continue to meet their financial obligations in a few months' time as the threat of the virus and its negative impact on the economy diminishes. However, the decisions we make dictate that the number of non-performing loans may increase to a greater extent than before the quarantine due to the inability of subsequent borrowers to meet their financial obligations. We believe that the decisions made will fully or partially offset the possibly higher and currently more uncertain risk borne by investors when investing in new loans with higher interest rates and reduced risk. There is a strong likelihood that returns from past investment in consumer loans will not produce the returns that were expected in the past, and returns may decline significantly. However, in the most realistic scenario, provided that the number of non-performing loans does not increase by more than 2-2.5 times, investors who have invested in loans before the quarantine was announced will also earn positive returns from these earlier investments.
Company’s Cash flow
As has been mentioned several times, the Company's revenue collection business model is completely non-standard and in the current situation it can be called "anti-crisis" or "anti-cyclical". The Company receives all brokerage income related to the granted consumer credit from the borrower for the duration of the loan and does not withdraw any euro in advance, i.e. in the event of a full financing transaction on the NEO Finance platform, the brokerage income of the platform is not paid at the time of the transaction. Actual receipts are distributed throughout the duration of the loan and are collected at the monthly repayment of the borrower. Most of the costs incurred to earn this income (marketing, administration, etc.) are incurred in the month of the transaction. This method of revenue collection, even with a decrease in monthly installment revenue, allows the Company to obtain a significant revenue stream from previously concluded loan transactions, even with a significant reduction in new lending.
However, it is currently very difficult to say how much the monthly fee receipts from the borrowers and, consequently, the Company's brokerage fee, will decrease, as this will largely depend on the borrowers' need for a "credit leave". In any case, the Company has sufficient funds and future revenues to provide its services for a very long period after the reduction of operating expenses, therefore the current economic situation does not completely threaten the continuity of the Company's operations. As mentioned above, the Company will provide an updated stress-test simulation in the near future. It is also worth noting that the positive cash flow is likely to increase due to the growth of the Company's payment initiation services.
The Company is currently not in a position to calculate with sufficient certainty the impact of the coronavirus situation on the Company's financial results for 2020 due to too much uncertainty.
In my opinion, as Chairman of the Board, the situation can change very quickly, both for the more negative and for the positive. For example, the announcement of newly discovered drugs or the development of a COVID-19 vaccine could have a huge and swift response to the financial markets because they, like all of us, only have the belief that "everything will be fine soon."
It is very difficult to recommend how to deal with loans to investors, so everyone is deciding what to do with their investments on the platform for themselves. But as I said before, I fundamentally believe that investing in people's small loans (in our case the average loan is just 2,760 EUR) is one of the safest investments. Looking at the economic pyramid, the person is at the bottom of it. As the crisis unfolds, the pyramid will naturally fall from the top, and each part below it will be stricken less. In addition to this, even after falling on people, i.e. the base of the economy, they will not be completely destroyed by the crisis. A person may lose their job or otherwise stumble, but it is much easier for someone with loans of this size to bounce back than it is for businesses. More importantly, the State always strives to help its people.
I would like to take this opportunity to remind you of the Company's investments in the Company's sustainable business model and the safeguarding of Investor Funds that we have made since inception:
Licensed and supervised activities:
The Lithuanian market is actively regulated
• Supervision of the Bank of Lithuania
• Included in the Public List of Consumer Lenders
• The first company in Lithuania to be included in the Public List of Peer Lending Platform Operators
Electronic money institution holding a full operating license (EMI) in Lithuania
• Investor (lenders) money is held separately from the platform money
• > 98% of customer funds are kept in separate accounts with the Bank of Lithuania
• Internal and external audits
• Reports to the Bank of Lithuania
• Supervision of the Bank of Lithuania
• The capital must be at least 350 thousand Euro
• Statistics - LIVE online
• Reports - online
o Sales report - published quarterly
o Company report - published twice a year
o Audited financial statements are published annually
The shares are traded on the Nasdaq First North Baltic stock market.
Voluntary Stress-tests (insolvency management scenario in case of economic downturn)
• Performed annually
• Economic downturn modeling
Latest test done: Q1 2019, new to be announced soon
Future commissions = 5 million EUR
NEO Finance - Loan Originator
• Investors invest directly in the initial loan (not through the marketplace).
• Investors have more control over their investments.
• Social responsibility (lower borrowing costs).
Artificial intelligence algorithm-based credit risk assessment