Nu Deep Dive

A Complete and Condensed View of the Latin American Banking Disruptor

Table of Contents

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:

“Personal loan cohorts continue to exhibit expected behavior, enabling us to increase originations for yet another quarter.”

CFO Guilherme Marques do Lago

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.

“Our personal loan cohorts continue to exhibit expected behavior. This is enabling us to continue to increase originations… we see an opportunity to expand credit with attractive returns and robust resilience. This may lead to higher delinquency rates, which we expect to be more than offset by additional revenue.”

CFO Guilherme Lago 

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.

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