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Questions on Demand Trends & Recovery

While the potential threat of the COVID-19 pandemic was brewing for a couple of
months, the use of widespread travel restrictions and local/regional shutdowns has
become the preferred approach to tackling the issue starting around mid-March.
This approach has led to a material decline in commercial activity and the way out
has not necessarily been thought through yet.

A set of questions is emerging that are all interconnected:

 How long could the decline in demand last?

 Will there be permanent demand destruction?

 To what extent will the myriad of economic recession responses help?

The level of permanent demand destruction is likely directly linked to the time it
takes to build momentum back towards a more normal level of economic activity.
The obvious risk from shutting down large chunks of the economy for a minimum of
several weeks is that a lot of businesses — and in particular small & medium-sized
businesses (SMB) — can face a cash crunch because they still have to pay their
fixed costs. This is where a myriad of economic responses come in — and we note
that governments and central banks around the world have mobilized quickly to help
mitigate the impact of mass layoffs and expected bankruptcies. The positive offset
of these actions must be considered, even if we acknowledge that the long tail of
these businesses is unlikely to survive.

Recovery Path & Duration of Demand Weakness

A reasonable recovery will likely last well into summer, and if the combination of
public health trends, research and economic stimulus does not work, we could be
looking at a 2021 recovery, with an outside chance of a stop-and-start two-year
process (in effect, an upward-sloping “W” rather than a “V-shaped” or a “U-shaped”
curve). Our current assumption is for material progress in the next six to nine
months, but we would look to 2021 trends for relative normalcy. To be clear,
normalcy in 2021 would still not be at what were prior assumed ‘normal’ levels, but
that is mostly because we are starting from a lower point in overall demand.

At a minimum, we are starting from a materially lower point assuming a bottom later
this year. We would point out that 15-20% of small businesses cease to exist in a
good year and so extreme churn is actually normal in the SMB space. Regardless
of the good intentions of the CARES Act in the U.S., the quantum of initial demand
destruction will most likely be greater in the near future. Outside the U.S. we do
know that certain other countries are considering providing rent and employee
compensation relief to small businesses.

Rapidly rising unemployment is another factor to consider. In addition to the direct

impact unexpected unemployment would have on a large section of the population,
there is the flow-through impact on rents / loans / childcare / health and other
expenses they may be unable to pay. One factor to monitor is the divergence we
are likely to see among consumer groups. In all probability, affluent consumers are
seeing their balance sheets improve because they are in better position to work
from home in a safe manner, and other than buying staples, there is very little to do
with their income presently.

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Meanwhile, poorer consumers / gig-economy workers are in tough shape since they
have much lower savings to begin with (according to the Federal Reserve’s 2019
survey on the well-being of the U.S. consumer, ~39% of Americans would be unable
to pay for an unexpected $400 expense out-of-pocket) and are likely to be laid off or
furloughed faster.

If a business is not allowed to stay open or if it can only operate in a curtailed

manner, the resulting ‘cash burn’ will likely lead to a rise in bankruptcies. Womply,
which sits within the value chain of the payments transactions of ~465k small
businesses, recently indicated that small businesses have ~27 days of cash on
hand (median), with restaurants at the lower end and professional firms (e.g.,
accountants, doctors, real estate agents) at the longer end of the spectrum. This
implies that any solution to protect SMB must begin executing in an efficient manner
right away – while the CARES Act was passed quickly, it still took a couple of
weeks, and we have already spent valuable time since it was passed to start the
process. Unfortunately this may have been too slow for many small businesses.

Further, we note that while small business bankruptcies have been a focus, large
businesses in several industries are also likely at risk. There are industry pairs to
consider as well — for example, travel (airlines, trains) and transit are linked to taxis
and ride-sharing; fitness (gyms, etc.) is linked to apparel; sports and entertainment
are related to the presence of restaurants and bars. If a lot of small businesses
have to file for bankruptcy because the stimulus did not get to them in time, it has
an impact on the payments business — then we have to worry about whether (and
how soon) these get replaced with new businesses and this replacement process
can take multiple years.

Is the Global Financial Crisis a Good Proxy for Today? The

Short Answer Is NO
For all its severity, the global financial crisis was a traditional downturn in many
ways.

The demand deceleration patterns associated with the pandemic response and the
global financial crisis are quite different. During the global financial crisis, the
deceleration in the demand for goods and services followed a decline in consumer
confidence. On the worst day of that downturn, a consumer with a little bit of cash
(or access to credit) could go to a restaurant and have dinner with friends / family or
go watch a movie or a game or concert. Consumers and corporations spent less
because they were financially stressed. In this particular case, we might eventually
arrive at a similar point if the downturn stretches out, but right now the issue is that
the number of active merchant acceptance points has gone down because of
government mandates that have forcibly shut down businesses. In effect, the ability
to spend no longer depends on just the consumer’s ability and willingness to buy, it
actually also depends on the merchant’s ability to sell.

The second big difference is the speed of deceleration. It has taken less than three
weeks to go from one of the stronger economic environments in recent memory to
the precipice of a dangerous downturn. Last time, there was a multi-quarter lead-in
to a downturn.

A third potential difference is likely to be the recovery time. Last time we saw a
multi-year, up-and-down recovery. It was a difficult path, but one could draw a line
between monetary and fiscal actions and the recovery. The current situation seems
more complicated.

© 2020 Citigroup
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– This problem is the combination of a public health issue and an economic

corollary which has become a deep problem on its own. The public health
issue can only be solved via adequate testing, prevention (vaccines – not just
hygiene and separation) and a cure. So far only the testing is being rolled out
and neither a vaccine nor a cure exists. Since separations and quarantines are
currently the only prescribed solutions, we have an unprecedented cessation
of commerce. Governments are responding the only way they know how —
using monetary/fiscal policies and/or massive stimulus packages. The trouble
is that without a vaccine or a cure, calls for a return to normalcy might need to
continue to be pushed out, and ultimately reduce the efficacy of currently
instituted government measures.

– We are essentially in uncharted territory as far as the time it will take to

potentially restart a swath of businesses. In this particular instance, a lot of
attention is being given to what happens to local businesses. We would
caution that the already-global nature of this problem necessitates the
restarting of global supply chains as well. This is not an easy task especially
when different countries and even U.S. states have different rules and
mandates about whether/how long their borders might stay closed (with
differing rules for people and cargo).

The rise of social media is a final crucial difference. We believe the fear of public
scrutiny and criticism could take away some flexibility in terms of responding to
lower revenues. For example, some companies may not want to do layoffs during
an especially tough time and others may limit pricing increases and rule changes
that hurt merchant relationships.

Permanent Demand Destruction

The answer to whether there will be permanent demand destruction is that it
depends on the sub-sector (and not all sub-sectors would reflect into card-based
payments) — clearly some sub-sectors will take longer to recover than others. For
example, will you rush to take your family on vacation or will you take a wait-and-
see approach? By the same token, going out to dinner might be an easier transition
to normalcy. And that trip to the accountant or financial planner or barber is unlikely
to be postponed.

In some cases, there will be a ‘spending shift’ rather than a ‘spending decline’ — for
example, accelerated use of eCommerce in retail or a reduction in corporate T&E if
more meetings start happening via video-conferencing, which more of the corporate
world will get used to. Finally, any analysis of this topic is likely to be complicated by
a probable cyclical downturn which can obviously hurt demand and it can seem like
a structural shift even though it is not.

© 2020 Citigroup
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Figure 1. Permanent Structural Demand Destruction is Possible (and Complicated by Economic Turmoil) with Offsetting Gains Possible
Permanent
Category of Business Demand
(Not a Comprehensive List) Destruction Comments
Construction Likely but 1. Related to 'Real Estate Services' point below…heightened bankruptcies would tend to create supply from
conditional existing inventory
2. Economic downturn would likely destroy demand for discretionary / large home projects (beyond the smaller
projects that working-from-home is currently enabling)
Entertainment / Sports Likely At a minimum, look for a slow return to prior levels of demand
Financial Services Unlikely
(e.g., Banks, Planners, Insurance)
Fitness Centers Likely but 1. Would separate out large facilities from those that offer personal attention. Likely positive demand shift to
conditional personal trainers and video sessions (already picking up)
Health Care Unlikely
Lodging / Tourism / Travel Likely 1. Slow consumer recovery to regain the confidence to travel for pleasure
2. Will we finally shift to fewer face-to-face meetings as the health crisis changes behavior, attitudes, and
capabilities regarding corporate travel?
Manufacturing Unlikely If anything, one might expect the opposite reaction with increased 'back up' reliance on independent (not
intrinsic to just-in-time supply chains) manufacturing
Personal Services Unlikely
e.g., Barbers, Laundry)
Professional Services Unlikely
(e.g., Architects, Accountants)
Real Estate Services Likely in 1. Would not expect direct impact on consumer real estate (homes, rentals)
targeted areas 2. Will an accelerated trend towards eCommerce and telecommuting hurt parts of commercial real estate?
Repair / Maintenance Unlikely These tend to be 'pull' services on an 'as needed' basis

Restaurants Likely but 1. Corporate T&E and related negative impact may persist
conditional 2. Look for slow recovery as consumer confidence about eating out in close proximity with others eventually
rebuilds
3. Restaurants tend to churn faster even in normal times and tend to have lower cash reserves than other small
businesses
4. Is it unreasonable to think that some of the demand shift towards grocery / delivery / takeout will persist?
Retail Likely 1. eCommerce-related 'hurt' has been part of the landscape for some time but we look for this to accelerate
2. Economic downturn would complicate the issue and introduce a cyclical add-on to the structural shift
Wholesalers Unlikely
Source: Citi Research

What Does ‘Not All eCommerce Is Equal” Mean?

This might seem like an odd question at first glance, but we raise it specifically
because of the consensus view that ‘eCommerce = good’, typically without
qualifying. One point is to consider what that eCommerce is being used for. A good
starting point is web traffic data, which supports the following commonsense views:

1. eCommerce dedicated to travel (airlines, hotels) and transportation (transit,

parking, ridesharing services), restaurant bookings, out-of-home entertainment
etc., shows expected sharp declines.

2. Shopping for staples is doing well (this includes in-home entertainment).

3. Shopping for discretionary items might depend on the price point and the
specifics of the item — for example, certain kinds of home furnishings might do
well temporarily as people figure out work-from-home, but in general
consumers are focused on survival and set-up.

4. Some mall stores have already furloughed the vast majority of their employees
from physical stores but are retaining their eCommerce employees — an
indication of relative spending shift. This applies to many smaller stores as well.

© 2020 Citigroup
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How Do We Translate the Divergent Performance of eCommerce into

Payments Performance?

 Broadly the exposure to eCommerce is favorable both because of the currently

seen volume acceleration and the better price point. But the merchant category
clearly matters as shown in the category description above.

 Online exposure is great, but remember that most merchants operate in an omni-
channel mode, which means that they are still likely hurting. Illustratively, if we
consider a merchant with 75% of their sales from physical store location(s) and
the rest online, and suppose the physical side is down 80% while the online
piece is up 40%, it means the entire business is down 50%. That is clearly better
than the down 80% (which was the case for brick-and-mortar), but it is obviously
not a good outcome. In our view, the merchant with some online presence has a
higher chance of survival, especially if the near-term objective is to supplement
income with whatever the stimulus might kick in and survive.

 In addition, merchant size is also a factor to be considered. In general, we would

say that smaller merchants tend to have a higher rate of attrition, all else being
equal.

 Consider the impact of value-added services — for example, pay-as-you-go or

other financing — and clearly this remark applies both from a demand
perspective and to protect the balance sheet.

 In the longer run, what we are experiencing should accelerate user behavior
(both consumer and corporate) towards eCommerce usage.

Do Payments / FinTech Companies Have Undiversified

Pockets of ‘Risk’?
In the initial days of the health crisis, geography was a differentiating factor as it
related to impact but given this is a global pandemic and differences in impact and
response can perhaps be regarded as a matter of timing, we do not regard
exposure to a specific geography as inherently riskier. Another point on risk is to
consider exposure to consumer versus corporate spending. In general, corporate
T&E spending should follow consumer spending almost simultaneously. Corporate
budgets tend to adapt at a slower pace.

Against the backdrop of widespread and sudden demand weakness, certain

exposures have been called out as being particularly risky. These include any
notable exposure to the following:

 Travel & Entertainment: The reason for this risk is obvious — between travel
bans, quarantines, and shutdowns, travel has nearly shut down. We would
include airlines, hotels, tolls and local transportation, and events in the T&E
category.

 SMB Exposure: The significant issue here is that small businesses tend to not
be cash-rich and generally use ongoing operations to fund working capital. This
means that when revenues go down suddenly, they have only a short period of
time before the cash runs out. Further, companies in the payments sector help
fund consumer purchases and/or enable merchant growth via merchant credit
offerings, and the overall credit card ecosystem also provides short-term liquidity
solutions to merchants.

© 2020 Citigroup
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We note that the type of exposure and the type of merchant are important to
consider — specifically, is the SMB paying on a per-transaction basis? Is it
eCommerce exposure? Is it a software purchase? Is it a loan? Is it a restaurant
(riskier) or an accountant (presumably less risky)?

 Mall Traffic: Most malls are shut, and a lot of retailers are laying off or
furloughing employees. So this risk is obvious.

 Sub-prime Consumer: While the initial hits during this downturn are from the
merchant side (due to merchants not being allowed to sell or due to the
heightened perception of risk associated with activities like travel), we believe the
rapidly rising unemployment level presents the next level of risk, i.e. the sub-
prime consumer.

© 2020 Citigroup
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