Nu. Serving the Underserved! Equity Research! Part 2/3
Competition and Risks
Welcome to the Part 2 of Nu Deep Dive!
In Part 1 we explored how Nu came to be and how this fast-growing Brazilian fintech makes money! (Read Below)
Nu. Serving the Underserved! Equity Research Part! 1/3
We are living in the golden age of banking. It has never been faster and cheaper, to receive and spend money. Bank accounts are affordable and easy to use. Rather than taking 3 days, most transactions take mere hours. Credit cards and debit cards are accepted basically everywhere.
Today we are exploring Nu’s competition and taking a look at what risks the company must juggle operating a bank in volatile emerging markets!
Let’s take a look!
1. Competition
2. Risks
3. Part 3
1. Competition
Latin America has favorable competitive dynamics for Nu, as there are fewer legacy banks and fintechs than in Europe or the US.
However, financial services is one of the world’s most profitable industries, thus it’s not a surprise that many players are willing to take a swing.
Legacy Banks
Nu competes with all legacy banks. However, many of these banks have different business models. Whilst Nu focuses on low-income and middle-class customers, legacy banks derive the majority of their income from wealthy customers and corporations. They have deep and structural relationships with the largest companies in the region. These relationships mean that legacy banks hold billions more in assets and have much higher revenues and profits.
In the table above, I have placed a few select KPIs of Nu and some regional legacy banks. In terms of total assets, Nu is by far the smallest bank, holding around $50B in assets, 9 times less than Itau Unibanco’s $461B. However, if we look at the revenue, we notice that the difference is not as stark anymore.
Nu’s revenues of $5.5B are on par with Banco Colombia, despite half the assets. Additionally, despite having 7 times fewer assets, Nu’s revenues were half of Bradesco’s.
This shows that Nu can generate a higher return from its assets than its legacy competitors!
This is because corporations and wealthy individuals require higher interest rates on deposits than Nu’s client base.
If we look at the profitability, we see that Nu’s returns on assets and equity are systematically higher than those of legacy banks. Nu’s lower cost structure enables them to service customers without incurring high overhead costs.
Overall, Nu is well-positioned to take retail customer market share from legacy banks for years to come!
However, the corporate relationships of legacy banks are extremely strong and sticky. Huge companies are snails, especially any government-affiliated ones. Thus, it is highly unlikely that Nu can steal this business in the foreseeable future.
Mercado Libre
Mercado Libre is the Argentinian e-commerce giant, often nicknamed the “Amazon of Latin America”. However, it is more than just that. Increasingly, Mercado Libre is becoming an extremely popular financial services company, something Amazon has never tried to do.
Many beneficial trends are driving the growth of this company, such as rising e-commerce penetrations, growing internet access, logistics development, and others.
For those interested in learning more, a few months ago, I wrote a full Deep Dive on the company!
There are a few areas where Nu and Mercado Libre compete:
Digital Wallet – Mercado’s digital wallet allows people to deposit funds on it for use in everyday purchases on and outside Mercado’s platform. Widely accepted, it competes with Nu’s online banking product.
Payment Processing – Mercado has a comprehensive payment processing solution that offers POS systems and online payment processing. Competes with NuPay.
Loans – Nu originates loans from its e-commerce platform, offering BNPL loans to customers and business loans to its merchants. Competes with Nu’s credit products, such as credit card, and other loans.
Insurance – In the same way as Nu, Mercado Libre partners with insurance companies to sell insurance and collect a commission fee.
It will be interesting to see how the relationship between Nu and Mercado Libre develops. It could be one of those “friend-enemy” situations that is common with US big tech.
Netflix competes with Amazon Prime Video but uses AWS. Apple uses AWS and Google Cloud but competes with them in many areas.
Well, Mercado Libre is the region’s largest e-commerce platform, Nu certainly wants its members to use NuPay on it. At the same time, I am sure Mercado Libre wants Nu’s 114M customers to shop with them. Do they integrate NuPay to make that easy, or do they protect their financial business?
If they integrate NuPay, certainly millions of Nu’s customers will use it, taking away some of the payment volumes. But as an e-commerce company, Mercado wants to make purchasing stuff on its platform as easy as possible.
Mercado Libre is very focused on growing its financial services business, and it is likely that competition with Nu will intensify in the future.
Other
Inter is a Brazilian financial services company and a neo-bank. Inter offers bank accounts, personal loans, credit cards, and investment accounts. The company has 36M customers, from which it generated $744M in revenue.
Inter has operations only in Brazil and is not a serious competitor to Nu. Nu is much larger, and strong network effects are likely to lead the gap to increase. Additionally, its brand is much more well-known, enabling lower customer acquisition costs.
Apart from Inter, Nu competes with many other smaller neo-banks in Brazil. In the last few years, the Brazilian fintech industry has exploded, fueled by high demand and regulatory support. Furthermore, Nu has shown that innovative technology and low-cost operations can deliver strong profits even from lower-income customers.
Compared to Brazil, the fintech in Mexico, Colombia, and other parts of Latin America, is not as developed. This presents Nu with an opportunity to benefit from the first mover advantage again.
2. Risks
Operating in emerging markets is not a walk in the park as there are numerous large and serious problems that must be managed to be successful. Doubly so for a sophisticated bank.
Political and Regulatory Uncertainty
As an emerging market, Latin America has experienced both sides of extremes, fascist military dictatorships and leftist socialist uprisings.
This has left a lot of historical political and regulatory baggage. Nu’s ability to navigate this dynamic but volatile region is crucial for its long-term survival.
In 2023, Nu’s home country of Brazil survived a violent attempt by its outgoing president, Jair Bolsonaro, to overthrow the newly democratically elected government. Since then, the political situation has stabilized but there is no guarantee that there won’t be another coup attempt and that it will again fail.
At the same time, Bolsonaro was replaced by Lula. A leftist socialist president widely believed to be corrupt. Since coming to power, he has enacted programs aimed at reducing poverty, but they have come at a cost of fiscal discipline and have weakened the currency and the economy.
There is uncertainty about how any regulatory changes could affect Nu!
Higher taxes, fee caps, capital controls, and erratic interest rate policies could negatively affect Nu’s growth and profitability.
In Mexico, the situation is similar.
Mexico recently elected a socialist president, Claudia Sheinbaum, from the same party as the previous president. While her goals might be noble, there are fears that she will decrease investor confidence in Mexico, ultimately reducing economic growth.
Mexico is a beautiful but extremely corrupt and unsafe country that is run by violent criminal gangs. In 2023, there were over 30 thousand murders, up 1% from the previous year and 100% from a decade ago. How she chooses to tackle the security and political issues will determine the future of the country.
Obviously, a deteriorating political and security situation would negatively affect Nu!
Revenue growth could slow down, and loan volumes might decrease.
Moreover, political issues in Argentina, Peru, Chile, and other potential regions might slow down geographic expansion, putting pressure on growth. Nu has already said that they haven’t yet expanded to Argentina due to these issues.
Weak Economies
Despite being some of the most natural resource-rich areas on the globe, Latin American countries have relatively weak economies.
Unfortunately, that is unlikely to change as the World Bank estimates that the region will continue being the slowest-growing part of the globe!
GDP growth declined in 2024 from an already low 2.1% in 2023 to a measly 1.9%. Although growth is forecast to accelerate to 2.6% in 2025, in the graph above, we clearly see that the region is growing much slower than other emerging economies.
Latin America’s largest economy and Nu’s home country, Brazil, is dragging down the average, as it is projected to grow 2.2% in 2025 and 2.3% in 2026.
Additionally, Argentina’s new president is trying to fix decades of economic mismanagement by its socialist leaders. Meanwhile, despite an ongoing trend of nearshoring, Mexico is forecast to only grow by around 1.5% per year!
And these estimates might turn out to be optimistic if Trump goes ahead with his trade war!
As some of the main causes for the region’s economic underperformance, the World Bank mentions, low investment, weak productivity, fiscal constraints, a large informal economy, political instability, and high crime.
Latin American countries are trying to run a European-style socialist welfare model without the economic strength of Europe. If even Europe is starting to face an inability to pay for this system, Latin America has no chance.
Overall, investment in Nu is not a bet on the bank benefiting from improving economies. Rather, it is a bet on the company reducing the unbanked population and taking market share from incumbents.
However, weaker-than-expected economies could increase defaults, pressuring Nu’s margins. Additionally, growth could slow down, and hopes of geographic expansion might not materialize.
Loan Defaults
Before a bank gives out a loan, it asses the creditworthiness of a customer. Unfortunately, sometimes their assessment turns out to be incorrect, as the financial situation of a borrower changes, and they are unable to repay the loan. It wouldn’t make much sense to keep this bad loan on the balance sheet as the probability that the bank will recover all of the loan amount is low.
For this reason, there are various regulations and industry practices that set out the way in which banks account for such loans.
IFRS 9 is an international accounting standard under which financial institutions must estimate and record expected credit losses rather than just actual incurred losses, thus Nu’s $3.169B provision for 2024.
To calculate this provision Nu follows a strict process. First calculates the likelihood of a receivable defaulting within a defined time frame. Then it estimates the outstanding balance expected at default, after which it estimates the percentage of that balance that is not recoverable.
The company constantly reviews its estimates and provisions and adjusts them as new information comes in. If the probability of default increases Nu must adjust the provision up, however, if the economic conditions improve Nu must reduce the provision.
By having banks estimate expected losses and recognize them early instead of just booking actual loan losses, regulators want to encourage prudent risk management. Having to monitor their loan portfolio and adjust provisions depending on market conditions makes banks more resilient and safe.
If Nu’s methodology is overly lenient it might lead to actual loan losses being significantly higher than the provisions!
This could cause additional write-downs in the loan portfolio, leading to huge losses.
In 2024 the macroeconomic situation in Brazil has deteriorated, leading to increased defaults.
In the chart above we see Nu’s delinquency ratios for Brazil as of Q4 2024.
4.1% of all loans are 15 to 90 days overdue, whilst 7% of loans are over 90 days overdue.
This means that 11.1% of all loans are overdue, an increase from 10.2% a year ago!
This doesn’t mean that none of these payments will be collected, most probably will. However, it does mean that the quality of Nu’s loan portfolio in Brazil has deteriorated slightly.
Foreign Exchange Risk
USD is the reporting currency for Nu. However, as a regional bank in Latin America, Nu does not primarily deal in USD. Reais is the official currency of Brazil (BRL), the Mexican Peso of Mexico(MXN), and the Colombian Peso (COP) of Colombia. Logically, the citizens of these countries use the official currency of the country in all their day-to-day activities.
Nu’s deposits and loans are made in the local currencies of the country it operates in, with each local entity keeping an accounting ledger in the operating currency of the entity.
When it comes time to report results, all of Nu’s entities are consolidated, and their operating results are converted from local currencies to USD.
This means that Nu is exposed to the fluctuations of the foreign exchange (FX) market!
Simply put, if the Mexican Peso falls 10% against the USD, then the value of Nu’s revenues and earnings in Mexico falls 10%. (barring any hedging)
In the above graph, we see that since 2011, BRL has fallen 73% against the USD, a very steep decline. This was largely driven by lower commodity prices for Brazilian exports, reducing the demand for BRL and causing a recession. Since then, the Brazilian economy has remained weak and hasn’t really recovered. During the same period, MXN fell around 44%, whilst COP 66%.
Nu could deliver stellar growth, but an FX rate crisis could completely wipe out all the gains for investors!
However, it is not that simple.
I have seen some people suggesting that a 50% decline in BRL should be modeled when forecasting future earnings, but I disagree. Just because the last decade was weak for Latin American currencies doesn’t mean that the next decade will be the same.
It is entirely possible for currencies not only to be flat but to rise 10%, 20% or even 50%.
We simply don’t know how the FX market will behave in the next decade, so I find the idea that it is a certainty that USD will continue to rise against Latin American currencies foolish.
3. Part 3
This Deep Dive will conclude next week with the release of Part 3.
In Part 3 we will take a look at Nu’s finances, explore their opportunities for growth and finish with a valuation model!
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Thank you for this too. How did you get their $5.5B revenue? In Part 1, you mentioned NII of more than $8B.
https://api.mziq.com/mzfilemanager/v2/d/59a081d2-0d63-4bb5-b786-4c07ae26bc74/abb5b993-fc6b-c86d-4a75-fc2cb6236dfc?origin=1
Here on Page 5, they mention $11.5B revenue.