The lack of industry reporting standards, suboptimal reporting and monitoring systems, and an aggressive focus on portfolio growth can quite easily create a heavily indebted and risky company. The possible vicious circle of compensating a future debt service gap via a new equity raise has been a common feature in the sector over the last decade. It is quite understandable for companies to focus on market penetration and footprint first and worry about portfolio management and cashflows later, especially with the social and sustainability impacts these companies have. However, given the current role of PayGo companies as microfinance institutions, ignoring those variables can lead to problems further down the road, and may jeopardize the goals of reaching universal access to electricity.
This article is aimed at PAYGo companies that are in the position to pro-actively focus on some of the key risk and value characteristics of their portfolios. Doing so will not only allow the company to obtain favorable funding conditions in the short term but will also provide more flexibility for future capital raises. This is crucial to reaching the level of private sector financing needed to achieve SDG7.
Transparency and standard setting
The key to unlocking financing for the PAYGo sector lies in transparency. It starts with creating a universal language on KPI’s between operators, lenders and other capital providers, initiated recently through GOGLA’s publication of the PAYGo Perform KPIs. This language will allow for a better mutual understanding of risk and therefore on risk distribution between all parties. One way to increase transparency on risk is to separate a Paygo portfolio into “buckets” of asset classes and track the behavior of these buckets and the cash flows stemming from these buckets. Asset buckets can be categorized on one hand according to their economic strength and risk and on the other hand based on impact criteria such as gender, economic activity or demographics.
- Economic strength: Payment behavior, VaR 30-60, churn rate, late days as % of total contract length, % down payment from total contract value, % down payment of SHS costs, fixed salary
- Demographics: economical/trading hotspots, gender, education, age groups, migrants
- Economic activity: entrepreneurs, farming type, occupation, SME’s
- Other: A combination of the above
Besides singling out individual criteria, consolidation of several KPIs into customer classes (e.g. class A, B and C), as shown below, is also possible. This will be of particular importance for portfolio management as well as sourcing of funding.
The performance of these grouped asset buckets can subsequently be monitored to support pro-active portfolio management. The increased visibility of the portfolio and cash flows generated by that portfolio allows for dynamic repossession management. Companies can set internal targets in terms of portfolio composition (e.g. such as having at least 75% Class A customers). The repossession policy can then minimize class C customers and ensure a healthy receivables portfolio which in turn enables better financing conditions.
With regard to financing mechanisms, to unlock the full benefit of cash flow-tracking, buckets of assets should ideally be ring fenced. This will enable debt financing based on the performance of an asset bucket which can be specifically pledged to a lender. Debt finance providers can therefore finance a specific pool of receivables based on their (i) risk appetite (ii) preferred ticket size or (iii) qualitative criteria such as support of specific demographics; asset buckets can be tailored to lenders and their specific lending criteria.
Funding would be linked to the receivables cash flows from the specific receivables portfolio funded, and the cash flows from that portfolio would be used for debt service and interest repayments. Therefore, the debt funder will be the only party to have recourse on that specific receivables' portfolio as it will be pledged to the lender. This in turn will allow for better financing terms which can be offered by lenders as the risks connected to certain asset classes can be more accurately determined and connected to the terms. On the other hand, by pledging a ring-fenced bucket of assets to specific lenders automatically ensures
tracking of cash flows and hence the implementation of a transparent cash flow waterfall.
By introducing transparency and a level of categorization into an asset portfolio the possible debt trap we spoke about in the beginning of our article can be avoided, and a PAYGo company’s assets and liabilities can be monitored and reported on an additional benefit of this practice will be better funding conditions through enhanced risk management and more clarity with respect to portfolio management.
The question that remains is how to practically implement this system without dedicating a significant amount on man hours to manually track the performance of a portfolio. In the mortgage, car loan and credit card industry fully automated systems already exist that will assist in defining portfolio criteria, set eligibility criteria, ringfence assets and their cash flows and generate automated cash waterfalls reports to capital providers. This level of automation, optimization and standardization has made these industries more transparent and efficient which in turn lead to significant decreases in transaction costs and thinner spreads on interest rates. The PAYGo industry should get ready to introduce these systems as well. We will elaborate on this in our next article.