Part 1 – Intro to LatAm & Nu Holdings

Teeing Up the Conversation:

Nu Holdings was founded in Brazil 11 years ago. It’s a financial technology (fintech) firm with a broad range of credit, savings and other services for its clients. It aims to drive financial inclusion via easier access and seamless use cases as Latin America modernizes its monetary systems. The company calls 54% of Brazil’s population its clients (vs. 36% in mid-2022) and has more recently made steady progress in Mexico and Colombia. It has capitalized on a strong LatAm demographic featuring:

• A 40%-50% underbanked population rate (depending on the source).

• 80%+ credit card-less rates in Mexico and Colombia.

• Brisk middle-class growth with 40%+ of the aggregate population under the age of 30.

• A tech wave that is ahead of many developing nations, yet behind North America.

• A 90%+ smartphone penetration rate (consumers are familiar with app-based products).

• Increasingly business-friendly regulation.

• A $270 billion total addressable market (TAM) as of Q4 2021.

Its total market opportunity between the three nations is 14% of the USA’s total GDP and 60% of the total LatAm GDP. The competitive dynamics outside of the U.S. are far easier, the economic growth is faster (and more volatile) and the markets are less efficient. As we’ll see later, that same inefficiency breeds opportunity.

Here, we will explore how Nu has won with these products to date, its prospects, its risks and the investment case overall. I read everything there is to read on Nu; I dug through filings; I watched every company video; I interviewed the Chief IRO who took the company public; I scraped together insight from every single buy & sell-side contact I have in the space. This piece is the culmination of borderline-obsessive research organized and summarized in a way that shrinks months of learning down to 60 minutes. Let's begin.

Product Basics:

Nu’s core products are its credit cards, zero hidden fee and commission bank accounts, and personal loans. Aside from that, Nu provides investment accounts with the broadest asset-class access, lowest fees and lowest minimums on the market. With NuInvest, investors can enjoy the cheapest access to equity markets, treasury bonds, agriculture bonds, real estate and the very first Brazilian ETF with a dividend. Nu handles renewal of all expired bonds for its fixed income products, which is unique in LatAm. It also offers insurance products in a creative, asset-light fashion (discussed later), a shopping marketplace with exclusive discounts and so much more. Every product is tied neatly into a slick, easy-to-use app with 24/7 liquidity and customer service. And as you can see below, traction is excellent.

Everything is growing nicely as of its most recent quarter while active customers rose 27% Y/Y to 82.6 million:

• Active credit card customers rose 19% Y/Y to 41.2 million.

• Active NuAccounts (bank accounts) rose 31% Y/Y to 73.0 million.

• Active invest customers rose 85% Y/Y to 17 million.

• Active personal unsecured loan customers rose 30% Y/Y to 7.9 million.

• Active small and medium merchant accounts rose 50% Y/Y to 2.4 million. More on this later.

• Active insurance policies rose 60% Y/Y to 1.6 million.

Nu also offers something called “Caixinhas” (or “Money Boxes”) in its app for savers. This is a complementary tool to allocate money into buckets to meet specific financial goals (similar to SoFi vaults). It can be used for financial planning, tax preparation and even as collateral to raise credit limits. For Nu’s merchant accounts (discussed in detail later), these money boxes can be used for corporate budgeting and investing into highly liquid, low risk federal bonds. These are available for Brazilian and Mexican customers, and soon to be Colombian too.

The growth engine for Nu is wonderfully simple. It generates revenue via interest income, interchange fees and some commissions on products offered through partners. Its North Star is to rapidly compound customers and revenue per customer while maintaining one of the lowest cost banking platforms in the world.

Part 2 – The Formula

Nu’s edge vs. the competition and its momentum come from a few pieces. Here, we’ll dissect each of the pieces and how they connect to form the beginnings of a strong competitive moat.

Cost to Acquire & Serve:

Lending and credit are commodities. When something is deeply commoditized, competing on input cost intensity is one of the only ways to stand out. Nu excels at minimizing input costs. Nu’s customer acquisition cost (CAC) is $7 and “one of the lowest among global banks and fintechs.” Specifically, leadership thinks its CAC is 85% lower than competing incumbents. The digital nature of its tech stack yields more targeted and profitable marketing and lower fixed costs. It pairs this reality with a referral network that provides the vast majority of its new customer growth, cutting CAC further. That’s the beauty of offering great products: your members are magically inspired to spread the good word for free. Nu is very Duolingo-like in this regard.

Once it gets customers in the virtual door, its active cost to serve is $0.90 per month and near global industry lows. Its goal is to keep that under $1.00 or about 85% better than the competition. That means its growth spend is immediately delivering a solid contribution profit considering its $11.40 monthly revenue per retained user. In its first quarter with a customer, it makes $11.40 & spends $9.70 between servicing and acquiring. By quarter two, that $9.70 cost falls to $2.70 as CAC doesn’t recur for retained users. Its cost to serve has not grown, which is expected to continue… but the $11.40 average financial benefit merely builds as its most mature cohort has a $27 ARPAC (and briskly rising). That paves the way for explosive operating leverage that we’ll observe later on.

Cost of Funding:

Nu’s rapid deposit growth removed a key advantage that legacy incumbents had enjoyed. Now that it can use deposits, rather than warehouse credit or other expensive debt, its cost of funding the credit business is plummeting. Specifically, its cost of funding is 84% of the blended interbank Brazilian and Mexican rate while it yields significantly more profit from using these deposits to fund the rest of its business. Cost of funding actually bottomed at 80% of blended rates two quarters ago, but a mix shift to Mexican credit this past quarter led to the small rise.

Direct deposit proliferation also drives very easy credit card and other financial service cross-selling and virtually $0 in added CAC. This is true across all fintechs and is how firms like Robinhood can justify paying their entire interchange cut in rewards – they are counting on this deposit halo effect coming. Nu enjoys the exact same halo effect, but with far less competition in LatAm, enabling it to win with fewer rewards. Good recipe. The cross-selling that this process nurtures amplifies the cost to acquire and cost of service edges already discussed.

Cost of Risk or Credit/Underwriting Quality – Qualitative Setup

The other way to stand out in credit and banking is via stronger underwriting and risk pricing efficacy vs. the field. The digital, cloud-native make-up of its organization puts it in a better position to aggregate and leverage customer data profiles than a bank still running on paper and pencil. It has systems in place to utilize any and all structured AND unstructured data, which puts it in a pole position to capitalize on GenAI-based efficiency and constant underwriting upgrades. GenAI models need large swaths of relevant data to actually be useful. Nu has both massive data scale and an ability to readily use it better than the competition.

Their risk scoring improves with scale more directly than an incumbent from Brazil can claim. And as clients utilize more products, this data usage strength is bolstered even further. And as you can see, trends here are quite strong:

This unique recipe means a more granular customer data profile for serving each borrower. Still, we have to be careful here. Many, many lenders will pound their chests about a better algorithm or model that means they can price borrowers more accurately. In reality, these underwriting algorithms are black boxes. As public investors, we will never have the level of technological access needed to determine if they actually are uniquely valuable. No outsider actually knows how they work, we can only monitor the results. So? Claims of underwriting superiority are fine, but backing those claims up with concrete data is vital. Nu does just that.

Cost of Risk or Credit/Underwriting Quality – Liquidity, Expanding Credit Bands & Credit Health

Liquidity:

Nu’s capital ratios are in great shape. Specifically, NuBank’s (owned by Nu Holdings umbrella company) Capital Adequacy Ratio (CAR) is roughly double the 6.75% regulatory minimum. That does not even consider the $2.4 billion in excess cash that Nu Holdings (the umbrella company) has to allocate to NuBank if needed. Notably, Nu doesn’t sell any receivables like many others in the U.S. (SoFi, Lending Club, Upstart etc.), so this robust cash pile is not a temporary byproduct of liquidating loans.

This effectively makes its CAR triple the regulatory minimum while its profitability continues to rapidly improve and feed the balance sheet. How does this relate to risk and underwriting? Nu’s excellent liquidity position means that it can comfortably utilize the massive deposit liability growth to fund its credit book. Deposits give it the low cost vehicle to do this; fantastic liquidity gives it the keys to drive this vehicle. The result? Its cost of risk is 10% lower than Brazilian incumbents. That was a 15% lead before expanding more aggressively into Mexico. Its 40% loan-to-deposit ratio vs. 100%+ for a typical Brazilian bank leaves a massive runway to keep enjoying this lucrative formula.

Its managed credit risk (credit cards and personal loans) also continues to “outperform apples to apples competition for delinquency in the face of a more challenging backdrop” according to CEO David Vélez in the firm’s most recent quarter. That’s helping to facilitate things like sky-high ROE expectations of 120%+ for its long term personal lending business.

Legacy banks have access to the same low cost funding that Nu does. Fintechs boast a similar branchless configuration and digitally-native architecture compared to Nu. The real magic here is in its ability to combine the cost advantages enjoyed by incumbents and disruptors. It pairs these together to create the kind of cost model that nobody else in its market enjoys. It has the needed licensing to behave like a bank and the needed foundation to do so more efficiently and effectively.

Credit Band Expansion:

Great news, but it will be interesting to see how this develops as it continues to expand further down the credit spectrum in Brazil for 2024. As of its most recent public appearance, the team told us this expansion was going “as well or slightly better than expected.” So far, so great as it outperforms competition across nearly every income bracket:

Nu pulled back on personal lending in Q2 2022 as credit metrics showed fragility and it needed to reset and sharpen its underwriting parameters. It also reduced interest rate discounts vs. incumbents and moderated growth of the portfolio while these things played out. The aim was to “strengthen the credit resilience” amid somewhat uncertain times, but not terrible times. This proactive decision has facilitated the rapid personal loan growth we’ve seen since it accelerated originations from the Q2 2022 trough. In Q1 2024, personal loan volumes rose 88% Y/Y for more context.

It showed us the maturity to reel things in and maintain its balance sheet health for the long haul, rather than chasing risky originations to prop up revenue growth for a quarter or two. And again, even as it expands to riskier credit cohorts, it’s still full speed ahead here as it properly prices volatile risk. Nu has an 8% share of overall lending in Brazil (including secured, which we’ll cover shortly). It doesn’t see this as a ceiling, considering its current customer base represents much more than 8% of Brazilian lending. It already has the users in its ecosystem. It doesn’t need to go find them; it merely needs to continue successful cross-selling.

As briefly mentioned, going forward, Nu leadership told us that it will “expand the risk profile to newer cohorts” as it grows more confident in its underwriting. Tracking how this shapes up as its book of credit exponentially grows will be perhaps the most important thing for investors to do.

Its overall credit portfolio grew by 52% Y/Y FXN,  reaching $19.6 billion this past quarter and continuing Nu’s aggressive expansion. Delinquency rates did tick sequentially higher (chart is three paragraphs lower) with the risky cohort expansion in Q1, which was expected. While that’s true, this was offset by more lending-based revenue, which enabled net interest margin to keep expanding. This Y/Y expansion was also despite another credit mix-shift away from credit cards and towards personal loans (which has higher loss rates in general). Personal loans are now 23% of its total credit portfolio vs. 15% Y/Y as of last quarter. Finally, delinquencies in Brazil always tick seasonally higher from Q4 to Q1 due to holiday and Carnival timing. 

And again… delinquencies on an apples-to-apples basis are 10% better than average while it outperforms across basically every income bracket besides the ultra-wealthy.

Credit Health with Macro Context:

Below are key credit trends over the last three years. This section focuses mainly on Brazil, as that’s where the vast majority of its originations have taken place to date. NPL refers to non-performing loans that are late on payments; the numbers refer to days. 15-90 day is a leading indicator with 90+ day the lagging counterpart. Additionally, 90+ day NPL doesn’t have a time limit like 15-90 day does as borrowers move out of that bucket beyond 90 days. This means 90+ day has a “stock-piling” effect as the portfolio explosively grows in size. Furthermore, all of the stimulus artificially held NPL rates down throughout 2021 and into 2022. This leaves us with the upward movement in 90+ day NPL rates.

• The same related delinquency rate seasonality applies to these metrics too.

Nu was founded right at the end of a 13 year period in which Brazil grew at a robust, 3.3% average annual clip. Through that period, poverty and unemployment levels tanked, regulation got a bit easier and things were good. During its first five years of existence, Brazil’s GDP growth averaged slightly under 0.0%, with 2 years worse than -3% and 0 years better than 1.8%. In my view, that reality makes strong NPL rates during 2019 a decently good sign of underwriting strength. And this doesn’t even give Nu credit for the rapid underwriting model training that has played out over the last 5 years. 

• Important aside: Mexican economic trends roughly mirrored Brazil from 2014 to today. It avoided the multi-year contraction from 2015-2016 that Brazil suffered through as it relied less heavily on commodity exports and favorable pricing to power its growth. Its more established manufacturing presence helped to weather the commodity blow. That’s the main difference here.

Specifically, 15-90 day NPL in 2019 ranged from 2.2%-3.0%. It fared well in 2020 too, but weird pandemic-era aid makes those figures irrelevant as a longer term gauge. 2019 NPL metrics and its 179% Y/Y revenue growth point to Nu’s ability to execute amid a tougher backdrop. The evidence would be even more compelling if it entailed a material recession, but Brazil likely won’t have to deal with that in the near future. Even pessimistic macro economists see 1.3% GDP growth for 2024. Brazil’s Government sees 2.2% growth while its President sees 3% growth. Furthermore, the Central Bank continues to drive easier policy with its Finance Minister (Fernando Haddad) explicitly telling the press in April that there is “more room for rate cuts and growth.” Brazil is unique with its 10.5% interest rate and low inflation combination (Mexico & Colombia are ideal in that sense too). 

There is a LOT of room to cut to accommodate growth and help lenders like Nu perform even better. And while cuts could be a NIM headwind if asset yields decline faster than deposit interest rates, Nu fully expects NIM and risk-adjusted NIM to expand throughout 2024. The rising LDR is a big reason why. Nu has enjoyed three years of robust economic activity in Brazil, and that will likely remain the case. Brazil will certainly have another recession at some point, which will hurt its results to a degree. At the same time, a recession should favor (on a relative basis) stronger players like Nu to help them extend competitive leads vs. smaller, less profitable alternatives.

As you can see, NPL rates are now above 2019 levels and have been for nearly 2 years. That likely won’t change, considering its continued push into broader credit bands. While NPL rates are important metrics, as we’ve discussed, risk-adjusted NIM is the most important indicator for gauging whether Nu is properly pricing risk. Net interest margin is simply interest income minus interest paid for funding its loans. Risk-adjusted NIM accounts for riskiness of the loans and default probability by netting out CLAE from interest income. 

Something else to note here is Brazil’s state-sponsored debt-repayment called Desenrola. Desenrola offers certain discounts on outstanding principal to some borrowers. This raised collections activity on delinquent loans, diminished revenue realized from current existing loans and helped CLAE fall to 3.3% in Q4 2023. The impacts to revenue and profit are roughly neutral as the increased collections offset the discounts and costs associated with the collections. The discounts specifically impact NIM and is why that metric fell Q/Q. Risk-adjusted NIM was unimpacted due to the falling credit loss allowance expense. The impact of the program is now largely behind Nu, while the majority of renegotiations from it were with non-delinquent loans. That shows this program hasn’t been materially and unfairly helping their NPL rates.

Also note that overall CLAE and credit provisions continue to grow sharply. That is related almost entirely to Nu’s rapidly growing credit book, as well as some impact from extending into riskier credit buckets.The important thing is that Nu continues to expect upward NIM and risk-adjusted NIM momentum as it optimizes the balance sheet, shifts to interest earnings assets and sharpens its underwriting skills. And again, it thinks this will be the case regardless of more rate cuts likely coming in Brazil and Mexico. Brazil has already taken its rate from 13.75% to 10.5% since August 2023, with plenty more to do.

We’ll see how they do as their underwriting standards become bolder amid stronger Brazilian growth. So far, so good.

Approach to Credit:

Nu has an interesting approach to balance sheet risk. It’s one that I personally find compelling. It will assume balance sheet risk for shorter-duration credit like unsecured personal lending or PIX-financed credit cards (PIX covered later). The near-term maturities diminish rate, currency and geopolitical risk to a point of it wanting to assume that added exposure. Conversely, for longer-dated items like mortgages, auto lending and insurance policies, it uses 3rd party funding. For example, a company called Creditas partners with Nu for auto lending origination. The loans originate through Nu’s beloved interface, with its elite customer service and without its own dollars being issued. That structure has allowed it to vastly accelerate its secured lending and match competitors without putting liquidity in jeopardy.

The image below depicts what it does all on its own vs. when it uses partners. The customer counts are now outdated, and the product suite includes many more items that we’ve already discussed. Still, the overarching idea has not changed. The purple circle is what it uses partners for with the gray circle inside of it being what it does alone:

Tying Nu’s Approach Together:

Combining better cost to acquire and serve, lower cost of funding and stronger underwriting yields some wonderfully valuable consumer outcomes. Doing so while also offering a superior interface and 10 click, pre-approved applications vs. the days-long processes for others is icing on the cake. The setup breeds a truly special lender in LatAm; it paves the way for a 30x lifetime value to customer acquisition cost (LTV/CAC) when 3x is considered excellent; it facilitates a 90+ net promoter score (NPS), which is miles ahead of the pack.

Better efficiency, lower relative cost and better fraud algorithms also mean it can pass on savings to its clients. The result? Loan interest rates that are routinely 20%-30% lower than the competition. Again, cost edges are how you stand out in any competitive market; and banking is competitive. Whether it’s this interest rate item, more savings yield, cheaper travel accommodations, lower cost equity investing etc. Nu delivers cost edges in many ways that they leverage to offer better products while expanding NIM. It’s admirably taking advantage of the vast inefficiency in Brazil’s and Mexico’s credit systems. Removing just a bit of this inefficiency fosters the kind of results that make customer jaws drop. 

This asset-light configuration also makes it economically rational to service younger customers with just a few dollars in deposits. Nu can say yes to everyone, while incumbents must demand higher deposit minimums to cover higher fixed costs. A customer with $50 in deposits would be cash incinerators for legacy competition, but not for Nu. This allows it access to a consumer’s financial life earlier on. Not only does this give it a better chance to win more business later, but it also means a richer customer data profile to sharpen underwriting, offer targeted promotions, provide better, more personalized products and raise approval rates with confidence. 

Nu’s architecture positions it perfectly to take advantage of this incremental data and to capitalize on the GenAI boom. It already has a chat bot/co-pilot powered by GPT 4. It’s already using these models to power underwriting, detect fraud, automate software engineering and optimize payment orchestration too. Incumbents can stitch together siloed databases and 3rd party vendors all they want to, which can be a decent bandaid. But? To emulate Nu’s rapidly-improving, always training architecture, they’d have to blow up their existing operations and start from scratch. That’s the only way to perfectly match this disruptor… and that’s why it’s having so much success in disrupting. Nu’s foundation, interface, product velocity and customer delight have proven to be quite difficult to match for anyone in Latin America to date.

Customer Obsessed – a quick note on Nu’s Philosophy

Nu aims to shock and delight customers with service that they’re not used to. This positive shock fosters fierce loyalty and a desire to use Nu for all financial services. The impact on Nu’s markets is profound as well. Aside from sky-high NPS (which is inherently subjective), Nu surveys reveal that its products are improving lives in surprisingly broad ways. 37% of its customers think Nu has directly improved their living conditions, with 27% saying Nu has boosted their emotional and mental well-being. LoveBrands ranks it as the 5th most beloved brand in Brazil, which is not normal for a bank. Fast Company calls it the most innovative firm in all of Latin America. Marketing leverage, excellent customer retention and fabulous overall results discussed later are the byproducts. 

The Team, The Team, The Team:

There’s one more piece of Nu’s edge, which is more subjective and qualitative, but prevalent none-the-less. The leadership team resumes are very impressive. David Vélez Osorno is the Founder, Board Chairman and CEO. Before starting Nu, he worked in investment banking at Morgan Stanley and Goldman Sachs and got his MBA from Stanford. Most notably, he was a Sequoia Partner for two years where he ran the firm’s LatAm investment group. He has a pristine reputation.

Youssef Lahrech is the President and COO. He was hired in 2020 after working at Capital One for two decades. At Capital One, he held increasingly high-profile roles, with his final position being the SVP of U.S. Cards. He’s an MIT graduate.

Guilherme Lago is the firm’s CFO. He was first hired by Nu as its VP of Finance in 2019 and promoted to CFO in 2021. Before Nu, Lago worked at Credit Suisse for 15 years where he wrapped up his tenure as Managing Director of Investment Banking. He got his MBA from Harvard.

Henrique Fragelli is Nu’s Chief Risk Officer (CRO). He’s been in the role for 6 years, with a lack of leadership turnover here a small positive. He led HSBC’s global portfolio analytics for 3 years and worked as WestLB’s (U.K.) risk director for 2 years as well.

Jagpreet Duggal is Nu’s Chief Product Officer and has been for 4 years. He was the Director Product Management at Facebook for two years. He also worked as Google’s Head of Strategy for Google Display and as its brand advertising product lead. He graduated from Yale with a degree in Mechanical Engineering.

• Livia Martinex Chanes is the Nu Brazil CEO. She worked at Banco Itaú (key competitor) for 5 years in their tech division.

• Cristina Junqueiro is the firm’s Chief Growth Officer and a co-founder too. She also came from Banco Itaú where she helped lead their consumer credit, card and marketing divisions.

Executive compensation and incentives are reasonably well-aligned with shareholder interests. Because the company is incorporated in the Cayman Islands, it doesn’t need to disclose specific individual pay for executives. Still, it does provide some detail. The vast majority of executive compensation is paid out in restricted stock units (RSUs). Chief officers get a small fixed salary that makes up less than 5% of total compensation. In aggregate, Nu paid $123 million to executives in 2022 and $34 million in 2021 (compensation was impacted by its IPO). For context on comp intensity without that noise, it paid out $9 million in 2020.

Furthermore, of that $123 million in 2022 compensation, $78 million was from a 2021 contingent share award for David Vélez. These shares would have only been fully awarded if Nu reached $35.30 per share, but he still voluntarily canceled that $78 million in November 2022. Nu was dealing with increasingly fragile macro at the time, wanted to slow down dilution (which is now below 2%) and was looking to drive better efficiency as an organization. Vélez led by example. He saved the firm about 2% in overall dilution and $50 million in GAAP operating expenses over the next seven years as a result. Excluding this $78 million in forgone compensation, Vélez made $350,000 in 2022, with the average executive making $2.5 million. That’s not at all egregious.

In terms of how RSUs are doled out, Nu uses time-based vesting, with awards being granted in three year terms. I prefer profit and revenue-based targets to serve as the bogeys for receiving compensation. It has broad authority to issue shares to employees based on business performance and “long-term goal” progress. Finally, it has another share option plan (SOP) for executives but there are no plans to utilize that program in the future.

As of the most recent filing, here’s what Nu ownership looks like. Note that class B shares get 20 votes while class A shares get 1 vote.

• Vélez owns 76.1% of the total voting power mainly through an 89% class B share ownership.

• Cristina Junqueira owns 9.6% of the total voting power through an 11% class B share ownership.

• Sequoia owns 2.3% of voting power.

• Tencent owns 1.1% of voting power.

• Baillie Gifford, Berkshire Hathaway, JP Morgan and Blackrock are among the bellwether institutions owning 70.7% of class A shares.

Part 3 – Growing like a Weed

Brazil:

Winning in Brazil:

The importance of having 54% of Brazilians as customers cannot be overstated. That is quite impressive – especially for an 11-year-old company. During its short history, it has grown into the 4th largest financial institution in Brazil and the 5th largest in Latin America overall. And it continues to climb quickly up these rankings as it added more Brazilian customers in 2023 than the top five legacy banks combined. Nu is also not spending irrationally on marketing to drive this growth, as the aforementioned referral program considerably drives down average CAC.

Nu’s customer growth in Brazil remained a robust 22% last quarter despite having such an established presence. This has been high quality customer growth as well. As already covered, ARPAC continues to briskly rise with plenty of room to run; Engagement rates (monthly active customers) reached 83.2% of total vs. 82.1% Y/Y.

Perhaps most interestingly, active NuAccounts (bank accounts rose 31% Y/Y to reach 69 million. That’s an important metric for this business. As more customers embrace Nu as their primary banking account (PBA), the firm enjoys more consistent deposits, increased customer activity, higher ARPAC and better overall results. Securing a client’s PBA helps everywhere. 59% of its customers today use it as their PBA vs. roughly 50% 2 years ago. As you can see below, recent cohort trends are highly encouraging:

What’s Next in Brazil – Expanding to Affluent Customers & Secured Lending:

Looking ahead, Nu wants to expand to higher net worth cohorts through its Ultravioleta card bundle. The card resembles an AmEx or even Amazon Prime subscription more than solely a spending vehicle. It offers complementary access to Rappi Prime for free deliveries, NuTag for parking perks, airport VIP lounge access, 10 GB of complementary internet when traveling (early access), dedicated customer service lanes at some merchants, free toll road access and more. It also offers members a 1% cash back credit card (the black card), which has been popular. That speaks to the easier competition levels in Latin America vs. the U.S. – where Robinhood feels compelled to offer 3% cash back to compete. These perks helped increase Nu’s high net worth customers by 40% Y/Y in 2023. In 2024, Nu will continue to add new perks to cater to these affluent individuals within areas like secured lending, investing and insurance.

Secured lending is a key product focus for catering to these higher-end customers. It’s a $118 billion market in Brazil and is where Nu is finding the most success beyond the core to date. Importantly, the secured lending product introductions were also the main pieces missing from its affluent customer product suite vs. incumbents. Those pieces are now in place with two important secured product debuts in 2023.

The first is within a division of Nu called NuConsignado (or Nu consigned). Consigned loans are secured by payments automatically deducted from a Brazilian’s salary or pension. In April 2023, NuConsignado launched a cosigned loan product for Federal and Public Servants (SIAPE). Then, in October 2023, it launched another consigned lending product using Brazil’s Institute of Social Security (INSS). The INSS payroll product allows pensioners and retirees to repay loans using expected benefits under this program. It comes with the lowest interest rates in the public payroll loan category and, as with any Nu lending product, no hidden fees or commissions. 

Nu’s interest rate edge here stems from incumbents routinely offering their competing product through capital market middle-men. This added piece of the credit supply chain simply drives costs and siphons profit from the finite loan pie. Take rates for intermediaries are generally 10%-15%. That creates a large Nu edge vs. competition as it connects directly to Brazil’s version of Social Security (called CPF). 10%-15% pocketed gives it immense flexibility to undercut competition while maintaining strong NIM.

Nu’s Consignado product also comes with very low NPL rates and is more resilient than unsecured personal loans in the wake of macro cyclicality. Consignado proliferation means better credit diversification, more interest-earning assets and stronger credit durability.

Next, Nu launched another secured lending product using what’s called Fundo de Garantia do Tempo de Serviço (FGTS). FGTS is a federally mandated savings account where benefits can be used amid layoffs, unemployment, retirement or other adverse conditions. Under the FGTS secured lending product, payments are guaranteed by the savings balance. Overall, these three debuts (which together boast an industry-leading 80 NPS) helped secured originations double Y/Y last quarter and rise to 13.8% of originations vs. 10% Q/Q and 0% Y/Y. 

• Note that secured proliferation will not mean an end to NIM expansion. While secured NIM is often lower than unsecured pools, Nu still collects far more interest income than the alternative federal bonds that it would invest that cash in.

There’s no credit risk bottleneck for Nu secured lending like there is on the unsecured side. Instead, the main growth obstacle here has been building out the needed channel partner network to create product awareness. Now? This partner foundation has been laid over the last several months; the team fully expects secured’s 13.8% mix to rise through these products and new iterations to cater to a larger portion of the population. It plans to have secured lending products for 75% of Brazilians by the end of 2024 vs. 50% as of now.

To date, all of this secured lending growth has come from existing Nu customers. It has not used secured lending as a lead generator. It also hasn’t mastered diminishing friction in migrating loans from competitors to Nu. As a reminder, its digitally native operations and asset-light model allow it to routinely undercut lenders on existing unsecured loans. The same should be true for secured. Expanding this suite to brand new customers and legacy bank clients should be two incremental and powerful growth levers to keep momentum humming. It already has 60%+ of the highest earners in Brazil as its clients. Now, it’s about giving them more tools to juice engagement and revenue per user. It’s done so admirably thus far. Still work to be done on secured loans.

Nu wants to provide a compelling product suite for these customers to use Nu for every financial service; traction is already strong. Ultravioleta purchase volume doubled heading into 2024, as overall purchase volumes continued rapid growth. Card approvals are accelerating with more underwriting confidence, limits are rising alongside that same building confidence (along with upgraded customer segmentation) and aging cohorts are continuing to spend more. The flywheel just keeps spinning.

Mexico:

The formula for success in Mexico & Colombia is identical to Brazil, and it’s working just as well. Mexico (130 million people) is a highly compelling growth market for Nu Bank. It’s perhaps even more compelling of an opportunity than Brazil. GDP per capita is higher in Mexico, and all financial service products are more nascent in their development cycles. For example, only about 12% Mexican consumers have a credit card, providing significantly more greenspace vs. Brazil. It’s been effectively capturing this greenspace, as it took over as the leading new card issuer in Mexico in mid-2021. It’s also now outpacing the issuance of all three top incumbent banks. 

This may be because 50% of its Mexican clients have been previously rejected by other financial institutions. This reality fosters the same (responsible) “yes to everyone” edge Nu enjoys in Brazil. It can lead with ubiquitously accessible savings accounts and go from there. Again, that means more complete, dense customer data profiles through the lifecycle of a specific relationship. It means happier customers as well.

Most legacy incumbents offer savings account yields near 0% with some even charging their consumers to park their money in Mexico. After securing a full banking license in Mexico in October 2023, Nu was able to offer a 15% savings yield just a month later in November 2023. The license also allowed it to boost deposit limits, debut investment products, and offer payroll financing. Nu doesn’t see a 15% savings yield as permanent, but what a great incentive to get new customers in the door. As Mexican yields fall and it adds more tools to its suite, it thinks it can cut this rate. It has already begun to do so with a recent 25 basis point cut in Mexico from 11.25% to 11.0%, it also cut its rate from 15.0% to 14.75%.

So far, the debut of its high-yield savings product facilitated the deposit growth explosion that we’re now seeing. Specifically, deposits have increased 10x in under a year, from $200 million in Q3 2023 to $2.3 billion as of Q1 2024. Impressively, the high-yield offering “paid for itself” via coinciding boosts in interchange and lending-based revenue. And? The same cost of funding edge enjoyed in Brazil is now being matched in Mexico. It can shift to deposit-funded loans there and use more of its liquidity to originate credit.

Nu offered a wonderful graphic comparing its first 5 years in Mexico and its first 5 years in Brazil. While it did enjoy some built-in brand awareness in Mexico thanks to Brazilian ubiquity, all engagement and market share trends are favorable compared to its historic Brazilian success so far:

It took Nu just 4 quarters to reach the deposit levels its Brazil business got to in 5 years. Mexican customer growth is accelerating (106% Y/Y last quarter) with momentum continuing into Q2. Churn has been very low, word-of-mouth growth is the main source of customer adds (again, super low CAC) and Mexico is clearly looking like another Brazil for Nu. Impressive, to say the least.

Mexican growth is a core priority for 2024. It will keep its foot on the gas to nurture deposits, will look to add several new money-in and money-out products to bolster transaction volume, and will expand into more credit offerings. Encouragingly, there are reasons to believe credit demand will now follow deposit traction between a 2023 unsecured lending debut, planned secured products and the strong credit card momentum thus far – without entrenched incumbents to supplant.

Nu went very slowly in Mexico, just like it did in Brazil. It’s always conservative in new markets as it takes time for underwriting to improve enough to become a quality, profitable creditor. It has held back on Mexican credit growth as these models seasoned, which it actually treats as an R&D expense. With its lower-cost deposit funding now in place, its customer and database scaling and its delinquencies briskly falling, Nu has started to rev the Mexican growth engine starting this year.

Traction here not only means more revenue and net income, but more model durability too. Why? Mexico and Brazil might both be considered “Latin America'' but that title is immensely broad. The economies of individual Latin American nations do not closely mirror as do two U.S. states. Mexico’s economy is its own world compared to Brazil and the same can be said of Colombia. Relying less exclusively on only Brazil for growth will diversify its revenue base and protect against country-specific recession risk.

Colombia:

Colombia (50 million people) is where Nu’s presence is most nascent today. It didn’t have proper licensing from the Financial Superintendence of Colombia (SFC) until very recently, which prevented it from offering many of its desired products – including the all-important high yield savings account. With licensing now in place, a waitlist to sign up went live in January 2024 and customers there will be onboarded throughout the year. The account, like in Brazil and Mexico, comes with no hidden fees or commissions and open transfers to other accounts. It offers a 13% yield, which is in line with many peers. However, its lack of egregious fees and commissions make the 13% yield net out materially higher ex-other costs vs. others. This will surely help momentum like it did in Mexico, considering Nu will now be able to offer its omnipotent, “always yes” savings product for optimal top-of-funnel customer and data growth.

And even without this powerful addition to the product suite, it was already enjoying success there with its credit card (called La Moradita) business. It became the leading new issuer in Colombia as of 2022 and already has a 5% share of that market with 800,000 total card customers (900,000+ overall customers). 78% of Colombians still use cash for everything, and Nu is leading the cash displacement charge, with a massive runway.

To turbocharge its Colombian product expansion without depleting the balance sheet, Nu secured $150 million in financing from the Development Finance Corporation (DFC) in the USA and $265 million from the International Finance Corporation (IFC). The IFC loan was supposed to be $150 million, but exceedingly strong interest led to the additional outlay. This was also the IFC’s very first investment in a LatAm fintech, which offers confidence in Nu’s team and approach from a world-renowned organization.

In terms of the regulatory climate in Colombia, it’s less favorable than its other two markets (described in the regulatory section in the next part of this piece). Colombia is a “new frontier for financial reform” per the team. Political leadership there isn’t opposed to driving needed reform and digitization, it’s presently just not as much of a priority.

Mexico and Colombia will be 2024 margin drags as investments occur ahead of the opportunity. It took Nu 8 years in Brazil to turn profitable, but it should be faster here, with systems and infrastructure already in place. Importantly, continued efficiency gains in Brazil will perfectly offset the margin headwinds that these added investments will feature. So? Nu expects gross margin to be flat Y/Y in 2024 before resuming expansion towards its 50% goal.

Where to Next for Geographies?

Nu’s goal to rapidly expand ex-Brazil will foster aggressive investments in Mexico and Colombia in 2024. But? Those will not be its only three markets.

The company always invests ahead of opportunities and with a long-term mindset. For example, despite 6% of its 2023 revenue coming outside of Brazil in 2023, it enters 2024 with 21% of its headcount outside of Brazil. It is confident in winning these two newer markets and more markets thereafter. 42% of Nu’s operational talent is “allocated to growth and moonshot projects not yet at scale or operating.” That likely means there’s much more growth ahead (in Brazil too) and also means margins could be much higher than they are now.

The beautiful part of Nu’s business is that the runway in all three markets remains massive. Furthermore, the vast majority of the Latin America opportunity is within its existing footprint. Even in Brazil, where it has dominant customer share, Nu does not yet have dominant product share for anything it offers. For example, 40% of Brazilian CPF numbers are Nu members, yet it has single digit market share of most products there simply because it is still such a new player.  . The architecture of its business was designed to make both product and geographic expansion as seamless as possible. Still, the architecture of its business will make any potential further global expansion seamless. It frees Nu to effectively copy and paste the tech stack in new markets, following subtle tweaks to meet unique regulatory compliance. 

Beyond Mexico & Colombia, I think Argentina is the most intuitive next choice. Nu has had an engineering center there for quite some time and tried to jumpstart operations there pre-Covid in 2019. It ended up deciding to focus on Brazil, Mexico and Colombia, but may be looking to try again. The timing just wasn’t good in 2019. Argentinian corruption, an authoritarian government, uncontrolled spending and a sharp acceleration in inflation made the opportunity a larger headache than anything. Things now seem to be economically evolving for the better. The new regime is slashing regulation, driving private sector independence, cutting big government and has begun to address inflation. GDP per capita in that nation is between Brazil and Mexico, underbanked rate is near 50%, credit card adoption is lower and there’s plenty of opportunity for Nu to access.

Broadening the Product Suite:

Nu is a financial services company that “makes its customer base happier with an easier, more convenient day-to-day”. It is about making processes and legacy offerings much more convenient for Latin American customers. It is about emulating the slickest interfaces and applications across the planet to delight its end customer. The beauty (for Nu) of Latin America is that most consumer-facing experiences are still clunky, antiquated processes that treat the end customer poorly. Nu upended that reality in financial services, but it’s going to do so in more categories too. The two main examples to highlight are telecom and travel.

For Telecom, Nu recently secured Mobile Virtual Network Operator (MVNO) approval through a partnership with a company called Claro. Together, Nu will roll-out a product here in the third quarter. The partnership structure is ideal. MVNO’s in LatAm have been squeezed on margin by bigger boys like Claro for quite some time; telecom is a low-margin business that requires hefty volume to make fixed costs rational. Instead of buying data from major telcos and up-charging like other MVNOs do, Nu is creating a revenue sharing agreement with Claro. This is yet another example of leveraging Nu’s massive customer base.. It attracts entrenched, deep-moated partners wanting access to 54% of Brazilians on a single, easy-to-use platform. Claro will manage the network and Nu will simply enjoy another commission-based product to cross-sell to its massive customer base.

Travel is the other exciting product adjacency recently announced. Through a partnership with Hopper Technology solutions, Nu is creating “NuViagens.” This deepens the travel services from its previous “Global Account,” which helps with currency exchange through a partnership with Wise. In essence, NuViagens is an online travel hub and bookings service for its Ultravioleta high net worth members. Customers can use it to plan trips and pay for accommodations with a “guaranteed best price.” They are able to refund purchases if they can find a better deal, with 24/7 customer service.

I fully expect travel and telecom to be two of many product category expansions in the coming years. Nu is rounding out a super-app to juice LTV/CAC, motivate retention and improve the top-of-funnel. It’s well-positioned to tie all of this utility together into high value subscriptions down the road.

For both telecom and travel, Nu’s approach mirrors what it does for other non-core products, such as insurance. It’s not embracing the legacy, asset-heavy nature of these products by building out expensive systems to support them. It’s partnering, using Claro’s network and Hopper’s ecosystem to easily extend its light-weight software backbone to more categories. Less risk, but still more opportunity. 

Step one for Nu was getting Latin Americans to embrace Nu’s core products. With 54% Brazil on the platform and explosive Mexican member growth, step two is now giving them everything they want to ensure they never leave and generate more lifetime value.

Part 4 – Prospects & Risks

Regulation & Macro Risks:

A recession in Brazil would be a large headwind for this company. There was some economic weakness in 2020, which Nu weathered, but that weakness did not last long enough to be considered an actual recession. 

Lending is cyclical and sometimes unpredictable. That’s even more true outside of the U.S. So? A big risk here is seeing how Nu’s credit metrics play out through an economic downturn. Will they find compelling origination growth at healthy risk-adjusted NIM? We need to contemplate that for ourselves when deciding whether to invest. This is a presently tranquil time in Brazilian economics. The underwriting models have not been fully battle-tested since Nu’s inception. This is why non-U.S. investing is inherently more complex. You not only need to be right about the micro and macro… you need to be right about the geopolitics & currency translation. We’ve covered economic cycles since 2014 already, but we should cover currency and regulation here too. In Brazil, the currency has been fluctuating between 1 BRL = $0.17 - $0.21 for more than three years. This marks a promising bottoming pattern after the currency lost about 60% of its value from 2012 to 2020. Brazil’s aforementioned promise of more rate cuts could pressure the BRL further, but expected cuts in the U.S. should buffer that blow. 

Over the last two years, currency tailwinds have boosted Nu’s growth a bit. I don’t expect that to continue and wouldn’t be surprised if FX reverted to a small headwind in 2024 or 2025. The Mexican Peso has followed a similar trend, with more volatility since 2020 vs. the Brazilian Real.

From a regulatory point of view, things are actually favorable. Brazil embraced reform over the last few years to facilitate better competition and a more modern monetary system. Nu leadership constantly praises these efforts and tells us that Mexico is following behind… slowly but surely. The “trend is positive” as it spends a lot of time educating regulators. 

In Brazil, its Pix system has been instrumental in driving cash displacement, economic digitalization, accelerated card acceptance and the establishment of Brazilian modernization. It’s a real-time payment system managed by Brazil’s central bank, with similar levels of convenience enjoyed by Venmo or Cash App users in North America. Payments are all encrypted for enhanced security. 

Pix does impact some debit interchange revenue for Nu, but the numerous benefits from Pix far outweigh that modest headwind… especially considering Nu wasn’t charging for wire transfers before this like others were. This directly fosters faster velocity of money and nurtures pretty much every other product offered. Nu is using PIX exactly how PayPal is using Venmo peer-to-peer: as a lead generator and top of funnel secret weapon to drive more lucrative cross-selling. So far, so good, as Pix and Boleto Financing customers rose 94% Y/Y last quarter reaching 15.3 million. Boleto financing is a financing program that uses a credit card to pay bills in installments.

While Venmo-like convenience seems like table stakes for USA-based readers, this has not been the case in Brazil until more recently. Now it is, and the coinciding explosion in traction has been understandably strong. That is perfect for Nu’s digitally native suite, as it already calls 35% of its active card users PIX customers and accounted for 25% of all Pix volume as of the middle of 2022 (& rising). And there’s more reason for excitement here. 

Closely tied to PIX is a program called “Open Finance” in Brazil. If competition wants to offer their customers the ultra-convenient PIX product, which will increasingly become table stakes over time, they must share data with the program (i.e., with Nu). That not only erodes Nu’s data scale gap, but gives Nu more access to loans originated by competition; it can directly use this data to go after this business and offer cheaper refinancing. It also allows Nu to display balances from competing banks from right within the Nu app, saving customers $4 million in overdraft fees. Taking better care of the customer fosters trust, loyalty and more growth. This open data-sharing environment essentially gives Nu access to a larger portion of the population to pitch their best-in-class yields, interest rates and interfaces… and this is a population quite used to something more antiquated. In essence, Brazil wants open banking and open competition. That reality favors best-in-class products and models… which is Nu. It’s encouraging to see regulators there implement this kind of requirement. 

Mexico has two notable digital payment systems to discuss. First is Cobro Digital (CoDi). It launched in 2019 for peer-to-peer and in-store purchases with near-field communication (NFC) and tap-to-pay. Per Nu’s team, CoDi was designed in a way that dampened adoption via things like complex merchant taxing. Dinero Móvil (DiMo) launched in 2023 with a fixation on ease of use. It utilizes phone numbers and Mexico’s Sistema de Pagos Electrónicos Interbancarios (its Central Bank of Mexico’s electronic payment rail). The streamlined data entry needs and upgraded interface should make this more successful than CoDi has been to date. Both DiMo and CoDi can be seamlessly utilized from Nu’s app in Mexico.

Despite the regulatory environment being relatively easy at the moment, things could always change. Brazil has done things like implement interchange fee caps, which obviously limits Nu interchange revenue. Brazil and Mexico are less predictable than U.S. politics and so tracking regulatory climates in both countries is important here.

Build the Two-Sided Network Opportunity:

Nu is trying to build a two-sided, cohesive consumer and merchant network similar to PayPal’s. Today, the vast majority of Nu’s focus is on consumer banking. Still, it does have 2.2 million small and medium merchant enterprise (SME) accounts on its platform, which is the byproduct of its customers loving its offering and begging it to offer that too. It’s being pulled into this opportunity, like companies with superior products often are. This opportunity should be material, considering more than half of SME owners already have a Nu consumer account in Brazil. The value proposition for businesses is called “basic” by leadership, and it’s determined to improve here.

Its Nubank PJ product (for the smallest businesses and entrepreneurs) also has 4 million accounts as of the end of 2023, with 50% Y/Y growth. It just launched its first working capital product specifically for PJ customers to get fee-free access to credit lines. It collects interest on the credit issued. It already has a PJ card, invoice templates, smartphone tap-to-pay, tax help and custom permissions too for this group. That batch of services is what has driven the bulk of the traction to date, with the new working capital product set to augment momentum here.

It also has Nu Shopping, which offers promotions to customers from 150 partner stores like Shein, PlayStation, Uber, Nike or Booking.com from Nubank’s app. Nu registered 255 million visits in 2023. For Shein specifically, it ran a 3% cashback campaign to drive purchase volume.  Nu also already offers “NuCoin” which is essentially a loyalty program paid via currency that can only be used through the platform. I’m confident these points (or “coins”) will be redeemable in the form of purchases through the marketplace to create stickier, more active users. That seems inevitable. Nu Pay is the firm’s checkout accelerator to automate manual data entry and shrink clicks to purchase completion. It ties to Nu Shopping like chips and guac. It’s easy to see this being opened up to external merchants outside of Nu’s app in the future – just like PayPal and Shopify have so successfully done.

Successfully building this two-sided network would create some exciting possibilities. Like Amazon, Uber and others, Nu could easily charge for sponsored listings if the Marketplace got big enough. It can also provide merchants with a massive, targeted list of buyers to pursue at stronger marketing returns. This is where Nu’s tech architecture comes in handy. Its ability to utilize, surface and leverage needed granular data on propensity to repay or purchase history will greatly bolster merchant marketing returns just like it does for others. And? Its massive customer base can enjoy these unique promotions that Nu’s scale fetches. That will spin a compelling flywheel of strengthening word-of-mouth growth and pushing more merchants to its platform.

Balance Sheet Optimization – A Prospect & a Risk:

While not pressing, balance sheet optimization is a concern. A material chunk of Nu’s growth over the last two or so years has been driven by its shift to interest-earning assets while rising Brazilian benchmark rates have helped too. Specifically, its IEP rose 87% Y/Y (86% FXN) to reach $9.7 billion vs. the 69% overall revenue growth (64% FXN) that it posted for Q1 2024. Net interest income growth of roughly 100% Y/Y also greatly led overall revenue growth for this reason. That has been a consistent recent trend. 

It’s de-emphasizing revolving credit products, and shifting to installment style credit (for both cards and loans) as it puts more of those products in place. This shift includes a large push into PIX financing (using a card limit to make Pix-based payments that can be repaid in installments or all at once). Other secured lending products, like financed bank slips, traditional BNPL and unsecured personal lending have helped the transition too. Nu doesn’t rely heavily on revolving credit fees like incumbents do to power their results. It’s very comfortable with minimizing these fees whenever possible. It prefers net interest income (NII).

It’s quite confident in appropriately pricing risk to a point of making installment credit a higher-return endeavor for Nu than others. It even allows customers to calculate forward-looking fees so that when they consider a new product, they get a better sense of all-in cost. That’s partially thanks to real-time settlements to diminish default risk, lower transaction fees paid to third parties and compelling interest. Incumbents cling to revolving credit as they inundate consumers with fees.

The balance sheet optimization risk isn’t growth halting as this endeavor wraps up in the coming years. The risk is simply that results could slow as it loses one of many promising drivers of its growth. Revenue growth will likely more closely mirror product and member growth when optimization has finally been fully realized. That will happen, but with LDR, delinquencies and capital ratios all in good shape, it won’t happen soon.

Part 5 – Financials 

Customer Engagement:

There’s nothing really to note or pick on within these two charts. Nu’s customer growth remains rapid, yet slowing. That will always happen as the law of large numbers sets in and its opportunity matures. Growth still remains impressive while activity rates are up and to the right. Notably, you can see exactly where Nu raised savings account yields in Mexico and enjoyed the coinciding user growth acceleration in Q3 2023.

Demand & User Monetization:

The charts below depict the effectiveness of Nu’s growth engine. Its rapid user growth is being met with more product usage and more monetization as it also shifts the credit portfolio to interest-earning assets. Just like for the charts above, growth will always slow as numbers exponentially get bigger and bigger. The same will be true here, and 68% Y/Y growth for 2023 as a whole is very impressive at this scale.

In terms of how rate cycles will impact its FXN demand (so ignoring currency volatility here), there are competing factors at play. First, rate cuts will mean lower interest rates on new originations, which will hurt its NII from that point of view. That will pressure NIM, which is the primary concern from rate cuts. Encouragingly, as briefly mentioned, Nu expects the shift to deposit-funded loans to more than offset this headwind as it sees NIM expanding through the teeth of 2024 rate cuts. Furthermore, it will be able to buffer that blow with lower deposit yields like it has hinted at doing in Mexico. Finally, Nu will likely be able to accelerate origination growth amid easier policy and better liquidity. Interchange revenue from more purchase volume will all be boosted by the easier policy. For this reason, I see cuts as a net benefit to this business.

Finally, note that deposits generally fall from Q1 to Q4 along with purchase volume (and also gross profit margin (GPM)). This is due to the same aforementioned holiday timing in Brazil that leads to rising delinquencies into Q1. Deposits still rose Q/Q in Q1 due to the Mexico launch.

• The pandemic held back results materially in 2020.

• The re-opening helped Nu’s results in 2021 and 2022.

Margins and Returns:

Nu’s gross margin is revenue minus funding costs minus transaction expenses minus credit allowance expenses. Funding costs are tightly tied to benchmark rates, with the rising LDR serving as a strong off-set like it does for NIM. Transaction expenses stem from compensating other payment providers in the ecosystem; credit loss allowance expense (CLAE) is via inevitable losses from running a lending business. CLAE in gross dollar terms and in percentage terms is rising due to explosive portfolio growth, post-pandemic loss rate normalization and the expansion to riskier credit buckets.

Gross margin is connected at the hip to the firm’s NIM metrics. As you can see, gross margin dipped slightly in 2021 and sharply in 2022. Why? As a private company, Nu didn’t have to frontload credit loss provisions upon origination. It did not need to practice accounting methodology similar to the current expected credit loss (CECL) framework. Well? When it went public in the U.S. that changed. It was forced to frontload provisions like a legacy bank would. That threw off Y/Y credit allowance expenses, which means a hit to gross margin. That effect began in Q4 2021 and lasted through Q3 2022 as comps normalized and consistent gross margin expansion resumed. You also may notice that risk-adjusted NIM fell Q/Q in Q1 2024 for the first time in years. That’s related to rapid Mexican deposit growth, where interest spreads are less favorable than in Brazil. Furthermore, the Brazilian federal collections program (Desenrola) propped up net interest income by more than $60 million in Q4. Provisions normalized higher this quarter. Without this impact, risk-adjusted NIM would have been flat Q/Q. As a review, provisions are part of CLAE. As those provisions move higher, risk-adjusted NIM (which deducts CLAE) is impacted.

Per the team, risk-adjusted NIM will expand throughout 2024. One final GPM and NIM note. CLAE will keep growing, which will pressure these metrics. At the same time, loss rate comps are now normalized and it expects revenue gains to offset rising CLAE stemming from explosive credit growth and cohort expansion. That’s how it’s so confident in these data points improving over time – despite obstacles.

Finally for GPM, front-loaded growth investments in Mexico and Colombia will lead to a 2024 pause in gross margin expansion. Brazil’s GPM for Nu is expanding, but these two newer geographies are becoming a larger part of the business. GPM expansion is expected to resume in 2025 as Nu marches to its 50% GPM target.

Nu’s return on equity (ROE) rose to 27% in Q1 2024 27% and is already great… yet needs more encouraging context. The massive cushion of excess cash held on its balance sheet is a large ROE headwind. That cash could be earning more income bolstering returns, and that’s the plan as Nu leans back into originations. Its ROE is already over 40% in Brazil, and there’s no reason to think that can’t be emulated eventually in Mexico.

• Note that higher stock compensation from its higher share price eroded some (not all) of the GAAP operating leverage seen from Q1-23 to Q1-24.

The key operating expense buckets include customer support and operations, general and administrative (G&A), marketing and other expenses. These are the ingredients, aside from gross margin, powering the rapid operating leverage it has committed to delivering. Customer support (includes cloud infrastructure & data processing which rise with scale), collections, credit analysis and operations costs will need to keep growing a bit as Nu scales across Latin America. Given the branch-free nature of its operations, those costs will grow more slowly than revenue and leverage will continue.

Nu’s preferred KPI for operating efficiency is intuitively named the “Efficiency Ratio.” This is OpEx + transaction expenses divided by net interest, fee and commission income. It shows you how hard Nu is having to work, or how much it’s needing to spend, to support growth. Encouragingly, that spend requirement continues to diminish, with its efficiency ratio sitting at 36%. The trend here has (shockingly) been very positive. It did incur some added costs last quarter due to front-loaded Mexico and Colombia investments and more cloud consumption. Still, the ratio improved from 17% to 36% Y/Y to show you how rapidly their profit structure is maturing (without the growth engine slowing all that much).

Balance Sheet:

We’ve already covered this. As a quick review, Nu’s CAR is double the minimum, it has another $2.3 billion under the holding company to boost CAR by another 100% and it has significant room to keep raising LDR. Specifically, this rose to 35% from 25% last year (vs. 100%+ for incumbents), and it should continue to rise. As that happens, its cost of funding gap vs. legacy banks will continue to shrink and its funding edge vs. disruptors will grow. There is zero capital ratio bottleneck here. It is flushed with cash and is managing the balance sheet in a surgeon-like manner.

Valuation & Simplistic Modeling:

The scenarios provided below are based on all of the research we’ve covered thus far, sell-side estimates, macro context, market opportunity size and some conversations with buy-side contacts and Nu leadership. I realize the CAGRs are elevated, but the assumptions are not overly rosy. My revenue and net income margin expectations are below consensus. A 13x - 26x net income multiple implies a likely PEG ratio range of 0.3x-0.8x, with the midpoint being very similar to the multiples that its incumbent competition (like Banco Bradesco and Itau Unibanco) trades at. The worst case scenario is one that I view as the least likely with the base case being the most likely.

As always, my modeling is overly simplistic… and intentionally so. Just like Buffett and Lynch, I find spending more than an hour on this to be a waste of time. The future is inherently unknowable and tweaking one variable three years down the road would change the entire picture materially. I find it best to pull from all of the research and data I’ve collected to offer loose ranges of potential outcomes. I don’t provide price targets. I don’t tell you to buy or sell anything. I arm you with the information you need to make your own decision, and I provide my own opinions stemming from that information. This is why I provide several different scenarios. Please note that the market cap is now closer to $60 billion, which means return CAGRs are a tad lower than what is listed.

Nu made its way into my portfolio a few months ago and my handling of the position is covered in portfolio management posts sent to Max-tier subs. Thank you so much for reading and have a wonderful day.