Last week, the Reserve Bank of India published its Financial Stability Report which said the NPAs in Indian banks are likely to hit c.15%. On the same day, Marcellus launched ‘Kings of Capital’ – our financials sector focused strategy, triggering a whole host of queries hinting that we may have lost our marbles. In our launch webinars and blog we have tried to address how it is not so much about the NPAs rising that we are concerned about, it is more about how the banks and NBFCs we invest in are prepared to fight this crisis. Incidentally, in this week’s blog, Morgan Housel covers this aspect beautifully using the analogy of how a cat is likely to get less hurt falling from a greater height than less as it allows the cat to prepare for the fall better. He then uses the example of an industry worst affected by Covid – airlines, where United and Southwest are reacting differently (the latter barely making any furloughs or paycuts) simply because of Southwest’s superior capital position from even prior to the crisis. Similarly, we don’t claim to know if the crisis will end in the next week or month or quarter. But we do believe the banks and NBFCs with a better capital position and a liability franchise have the best chance to survive this crisis and as a result at the end of the crisis, gain disproportionately as credit growth recovers sharply just when the competition is scrambling for capital. Nicholas Nassim Taleb referred to this as ‘Anti-Fragile’ in his remarkable book by the same name. Already, the difference shows with loans under moratorium showing significant variance amongst different banks and NBFCs.
“…Risk depends on how hasty your response must be. A small problem you have to scramble to protect yourself from with a snap judgement can be more dangerous than a larger problem you have time to deal with.
Every business will be impacted by Covid-19. Some worse than others. But one of the biggest differences in how much permanent damage 2020 will cause is whether a business has to scramble to protect itself or calmly deal with the new world.
United Airlines wasn’t in good shape before Covid. Then the bottom fell out. It may be about to lay off half its staff, which is the kind of thing that’s hard to recover from even if demand returns. Workers will go find something else to do.
Southwest Airlines is in a different spot. Long one of the most efficiently run airlines, its CEO told employees this month: ‘I want you all to know we will not furlough or layoff any Southwest employees on October 1 [when bailout funds expire], unlike our major competitors. Further, we have no intentions of seeking furloughs, layoffs, pay rate cuts, or benefits cuts through at least the end of this year….In January of this year, we had the lowest amount of debt to total capital in our history and a surplus of cash from 2019’s strong profits. We were prepared for the unexpected.’
Both airlines faced the same risk, the same virus, the same industry collapse. But United had to scramble towards a brutal fix while Southwest can breathe and think through a solution. It will likely make all the difference in the world.
Risk is weird like that. There is no topic in business and investing that gets more attention than risk. But it’s almost always viewed through a universal lens: “What risks are we going to face in the future?” Or just simply, “What’s the economy going to do next?”
But risk has little to do with what’s going to happen next and a lot to do with how much you can endure, and how calmly you can react to, whatever happens next.
To the leveraged investor a small setback is a huge risk because of how they’re forced to deal with decline: by selling to cover their debts, right now, this moment, whatever the price is. Don’t think, just scramble to do you gotta do in the face of panic. They’re like the cat locking its limbs into place, doing whatever they can to survive even if it breaks them to pieces.
Daniel Kahneman’s book Thinking, Fast and Slow is a play on his idea that you have two types of thinking: System 1, which is fast and instinctual (cat locking its limbs out) and System 2, which is slow and deliberate (cat relaxing and pushing its limbs horizontally).
He writes: ‘System 2 is the only one that can follow rules, compare objects on several attributes, and make deliberate choices between options. The automatic System 1 does not have these capabilities. System 1 detects simple relations and excels at integrating information about one thing, but it does not deal with multiple distinct topics at once, nor is it adept at using purely statistical information.’”

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Note: the above material is neither investment research, nor financial advice. Marcellus does not seek payment for or business from this publication in any shape or form. Marcellus Investment Managers is regulated by the Securities and Exchange Board of India as a provider of Portfolio Management Services. Marcellus Investment Managers is also regulated in the United States as an Investment Advisor.

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