Nubank: A Brazilian FinTech Worth $10 Billion

August 5, 2019

MONTHLY ANALYSIS

SECTION 1: Nubank: A Brazilian FinTech Worth $10 Billion

If we gather a group of FinTech enthusiasts and ask them about neobanks, the discussion is likely to be focused on case studies mostly from Europe. However, the phenomenon of the increasing number of challenger/neobanks is not limited to Europe. There are over 80 challenger banks spread across the world, including Europe, South America, and Asia. Brazil’s Nubank and Banco Original, Germany’s solarisBank and N26, China’s MyBank (by Ant Financial) and WeBank, and Starling and Revolut from the UK are some wonderful neobank success stories.

Among these neobanks, we consider Nubank as one of the true disruptors for its value addition to the Brazilian banking customers who have been squeezed too hard by the oligopolistic banking industry in Brazil. In July 2019, Nubank was estimated to be valued at $10 billion, making it the most valued private technology company in the Latin American region. To put this in perspective, Nubank’s valuation is now almost three times of Europe’s most valued neobank N26. The July edition of Monthly Analysis for MEDICI Inner Circle members zooms into Nubank to find out what is so special about this six-year-old decacorn FinTech.

Nubank’s Growth Story

Founded in 2013, Nubank is a Brazilian FinTech startup that has emerged as one of the largest challenger banks in the region. It took just six years for Nubank to hit $10 billion in valuation, raising $820 million in six funding rounds and acquire approximately 12 million customers in Brazil. Nubank’s product and service offerings include credit cards, digital savings accounts, and the recently launched consumer loan service. Nubank has also planned digital account offerings for small-business owners.

Nubank was founded by David Velez, Cristina Junqueira, and Edward Wible. The face of the startup, David Velez, is a former partner of Sequoia Capital, and he was focused on the firm’s Latin American investments. Prior to that, David worked in investment banking and growth equity at Goldman Sachs, Morgan Stanley, and General Atlantic.

Nubank has achieved exponential growth in the number of customers – from 1.3 million in 2016 to reported 12 million as of July 2019. While initial growth can be attributed to it its credit card offering, the recent growth spurt can be witnessed in its customer-focused digital accounts.

Timeline of Product Portfolio Expansion

Credit Cards

The bank started its operations by offering a zero-fee, low-interest Mastercard Platinum credit card which customers can manage using their mobile phones. The mobile app provides real-time spending notifications, personalized categories for tracking payments, and the ability to lock and unlock the credit card directly from the app. It currently has over 5 million customers for its no-fee credit card. Now Nubank is recognized among the top five credit card issuers in Brazil. As of May 2019, Nubank had received 30 million applications for its credit cards.

It can be shocking to learn about the interest rates being charged by the Brazilian banking industry on credit cards. In Brazil, traditional banks’ credit card APRs stand between 200% to 500%, with some being even higher.

Looking at Nubank’s 140% APR, one could say that it is still very high, but relatively, it makes a lot more sense for a customer to get a Nubank card in Brazil.

Personal Bank Accounts

Earlier in 2018, Nubank received a finance license from the Brazilian Central Bank. In October 2017, it launched a free mobile bank called NuConta (NewAccount). At the time of its launch, the service was a no-fee digital account with automatic investments in public bonds, but it did not allow payments of bills or cash withdrawals. It was aimed to optimize yields and offer returns higher than traditional savings accounts. After receiving approval from the central bank, NuConta started to provide access to bill payments, account-to-account transfers, and the ability to earn interest. The result is a mix of current, savings, and payments account, which is selling itself like hotcakes.

As of July 2019, NuConta digital accounts was being used by over 7 million customers. The numbers make more sense when you notice that Brazil’s largest private bank Itaú has around 30 million account holders with Nubank’s service offering being less than two years old.

Loans

In January 2018, Nubank got clearance from Brazilian Central Bank to offer loans to customers, and in February 2019, it started offering personal loans through the Nubank app.

Business Accounts

In July 2019, Nubank indicated that it is planning to launch digital accounts for small-business owners.

Nubank’s rewards program enables its users to earn points with each purchase, which can be used instantly in the same purchase. In addition to flights and hotels, customers can use their points to erase frequent expenses, like Uber fares or online monthly service subscriptions. Customers can also use these points to erase their invoice expenses.

Nubank’s Strategic Direction

Credit Card Business

Initially, Nubank only targeted young, wealthy individuals, and applicants had to be referred by existing users. This premium-customer-only offering worked for Nubank and helped the company to be one of the largest FinTech companies in Brazil with no significant spend on the marketing, based on a member-get-member scheme where users refer the app to friends.

Nubank's credit card mobile application, which enables expense reporting, GPS, convenient daily limits setups, and real-time transaction monitoring, was a hit with young consumers. Demographics has served as an enabling factor for Nubank's fast growth. Nearly half of Brazil's population is under 30 years of age who are willing to pay for not having to visit banks. According to Nubank, 72% of its users are under 36 years old.

Nubank is working to increase the acceptance ratio of applications. In 2017, Nubank’s acceptance ratio of all card applications was at only 19%. It planned to relax some of its credit check models to improve its acceptance ratio. To build its scoring models, Nubank established a process to collect data from public platforms containing consumption patterns, delinquency history, and credit profiles. Furthermore, in 2018, the company implemented facial biometrics tools to improve the security of its digital onboarding process.

Nubank used to quickly approve credit card requests, decline it, or a large number of its customers were put into its ‘maybe’ category – the so-called waiting list. Recently, Nubank announced that it is going to automate the entire process and end the waiting list for credit cards. We can expect a sizeable increase in the number of its credit card customers this year.

In July 2019, Nubank announced that it had 12 million customers, including credit card and digital account users, becoming the largest digital bank in the world outside of Asia.

Digital Accounts

To expand the client base to accelerate growth, the company is expanding its offerings, including digital checking accounts and business accounts. For digital accounts, the strategy was to target young individuals who do not have much money and lacked sound financial literacy in terms of savings methods to earn interest income. The prevailing high fixed fees charged by Brazilian banks and the inconvenience of getting things done from a bank branch served as the essential ingredients for young consumers being attracted to Nubank. Its NuConta account offers zero annual or maintenance fees, interest on deposits, unlimited free transfers to any bank, and a debit card for payments & withdrawal. However, it charges a fee of R$6.50 for using its debit cards for withdrawal, which is currently available on two external networks.

Lending

In 2019, it started to offer loans through its mobile application. The approved loan amount is immediately transferred to the clients’ NuConta account. As per the initial media mentions about the plan, loans were first to be offered to 600,000 credit card customers and NuConta account holders in the first few months of the product launch.

Corporate Accounts

Nubank’s next move is to launch digital accounts for small-business owners with the aim to expand its product portfolio beyond individuals. To make its offering attractive, it is inviting entrepreneurs to test out its new small-business bank account solution for free.

Here is an observation: If we look at the high-level view, it is interesting to note that Nubank’s product portfolio expansions (from cards to personal digital accounts, then loans and upcoming business accounts) are in line with the market attractiveness of various customer segments in terms of profitability.

Nubank’s Revenue Streams

Nubank is not walking on the path of Revolut or Starling, which focus on multiple FinTech partnerships to build a marketplace like the banking business. Nubank is building its own product portfolio from scratch, one at a time.

Nubank generates revenues through interchange fees whenever its card is swiped. It gets foreign exchange fees for international transactions and interest on unpaid balances. Its digital accounts are set to generate interest income from investments, and it charges fixed fees every time its debit card is used to withdraw money.

In 2019, Nubank has started lending to businesses that will enable the bank to circulate deposits and earn more interest income from lending.

Financial Performance of Nubank

 

Nubank’s revenues have continued to grow since its inception. In FY17, it generated R$218 million, registering 183% in YoY growth. In FY18, its revenue more than doubled to R$471 million.

Nubank is in an expansion phase and incurs high costs & expenses. Its net income has continued to decline – it registered R$117 million in losses in FY17. In FY18, despite the push for accelerated growth, the company managed its losses better and reduced its losses from R$117 million in FY17 to R$100 million. Its efficiency ratio improved from 127% in FY16 to 65% in FY17, indicating improved expense management while scaling up.

Profitability Prospects

Recent regulatory changes and banking license approval should allow Nubank to transform into a full-service digital bank seamlessly. Given its strong brand recognition and attractive platform, Nubank would be able to capture a significant amount of cheap deposits, significantly reducing its funding costs. Earlier, Nubank was not allowed to capture client deposits; thus, it funded its entire operation through securitization of receivables and debt. Going forward, Nubank is likely to remain in the expansion mode, which would keep it from profitability, and its recent funding will provide the necessary fuel for this growth.

What Makes Nubank so Relevant in Brazil?

Nubank’s rapid growth is driven by favorable demographics and the banking landscape in Brazil. In a few words, banking is broken in Brazil, and Nubank has enchased this as an opportunity. Brazil has a large online user base, deep financial markets, an oligopolistic banking sector with generous spreads, innovative FinTech companies, and a scalable market with a population of over 200 million.

 

As per a report by BIS, in Brazil, credit card penetration is around 30%, which is better than other Latin American Countries (LAC). Nearly 85% of the population has mobile phones, and around 70% have bank accounts.

The Financial Development Index – which covers depth, access, and efficiency of financial institutions and markets – places Brazil way ahead of its LAC peers.

All the data indicates a reasonably mature customer base that is well-equipped with financial know-how and can easily decide what is best for themselves. The only challenge has been the lack of options in the market – this is the perfect recipe for disruption, and Nubank was well-positioned to encase this opportunity.

Nubank has benefited from the prevailing high-fee environment created by traditional banks by offering a zero-fee, low-interest rate credit card. Brazil has the world's highest credit card interest rate. The annual consumer rate for credit cards hovers at around 352% per annum. If you ask banks, they would say it’s due to high default rates, but we believe the primary reason for this high rate has been the lack of competition.

The oligopoly of banks with fatty returns have had a side effect on the overall banking service offerings for the consumers in Brazil, making banks complacent towards changing needs of the consumers. Banking in Brazil is not as competitive and efficient as in most places around the world, hence the opportunity and the pool of profits up for grabs for FinTech disruptors are outsized. The opportunity in the consumer lending business can be sensed if we look at the spreads of various countries. Among these, the Brazilian market beats its peers by miles.

This favorable setup for the incumbent banks has meant that they have been able to relax, charge high, and make attractive returns on capital without necessarily having to be leaders in efficiency, innovation, customer service, or digital transformation.

Brazilian banks also enjoy lucrative return-on-equity (ROE) ratios despite the country going through political and economic turmoil in recent years. The banking industry in Brazil is one of the world’s most lucrative. Itaú clocks nearly 19% in ROE and Bradesco clocks around 14%, even after almost three years of recession. According to a report by the International Monetary Fund, the ROE in Brazil’s overall banking system ranged between 11 to ~14% from 2012 to 2017. If we look at only public banks, this ROE cushion becomes fluffier with returns averaging around 16% (as of 2017).

Technology and regulation are challenging the three key pillars of banking in Brazil: lack of proper credit bureaus, physical presence, and lock-in on payrolls. These elements have contributed to the banking oligopoly, and banks would like to keep the status quo. However, FinTech companies are effectively managing the lack of a credit bureau in Brazil and offering attractive risk-based pricing to consumers through account scraping and better data mining. Similarly, bank branches are no longer the necessity to onboard clients, gather assets, or originate loans. The government eliminated the longstanding lock-in on payrolls last year, which provided a guaranteed flow of clients for banks. It will allow millions of workers to choose their financial providers freely.

Complacency Can Be a Killer

Brazil’s top five banks control ~80% of loans and deposits, along with dominant shares in other products, such as asset management, insurance, and brokerage. The recipe for FinTechs to disrupt such a highly concentrated market is to focus on prices rather than market shares. Grabbing significant market shares will remain a challenge for disruptors given incumbents have deep pockets and can respond by duplicating successful parts of the FinTech offering in the market or by acquiring them. However, acquisition of Nubank is unlikely, and incumbent banks can't replicate the FinTech's nimble cost base. This will continue to provide an opportunity where the FinTech firm can price its products much lower while targeting healthy margins. We are likely to witness banks starting to adopt lower prices. If incumbents remain complacent believing that high switching cost will prevent the customers like before and they can continue with business as usual, they are poised to witness some unpleasant market trends. Another challenger bank in Brazil, Banco Original, has interesting service offerings, but it has a significantly lower customer base than Nubank and seems to lack the aggressive growth agenda.

Competitive Landscape for Nubank in Brazil

Two years ago, Brazilian banks realized that a disruptive wave is coming their way. These banks started to invest in new apps, process simplification, and pricing aspects of their business. Apart from half-hearted attempts from banks, there is hardly any immediate competitive maneuver visible in the market. However, the market attractiveness is likely to draw the attention of some of the large and fast-expanding neobanks to venture in Brazil. For example, N26 announced that it would expand its business to Brazil and is likely to pose some competition for the well-established Nubank.

Recent Regulatory Developments

Brazil’s central bank is taking a pro-modernization stance and has become supportive of the agenda of a competitive market that offers improved services to the customers. In April 2019, the central bank published a directive on the governance of the open banking initiative. In its fruition, this will make the country’s 12 largest banks to open their customers’ transactional information available to external parties. We can expect increased FinTech traction in Brazil as open banking unfolds in the next three to four years. Nubank is well-placed with penetration of its mobile banking apps in the market and can leverage this opportunity as well. It also means that next banking disruptor will find it easier than Nubank to reach a significant customer base.

Earlier in April 2018, the National Monetary Council issued a new resolution that provides FinTech firms the opportunity to enter Brazil’s financial market. The new regulation is aimed to enhance competition, reduce market interest rates, and increase access to capital markets for startups. The resolution allows two types of FinTech firms to operate banking services without arranging partnerships with a bank: 1. Direct credit companies that provide loans & financing and acquire collection rights, always with own capital. 2. Peer-to-peer loan companies that broker loans and financing between peers. These guidelines do not have a direct implication for the already-established Nubank, but it can result in drawing more FinTech players towards opportunities in Brazil, resulting in increased FinTech competition.

Geographic Expansion: Opportunities in Latin America

Mexico: Nubank announced that it would be expanding to Mexico, where it plans to launch credit cards later this year. The office is planned to start with 20 employees, with the goal of expanding the staff size to ~80 by the end of 2019. Mexico presents similar dynamics and market opportunities for Nubank. Nubank’s Founder Velez explained the rationale, saying, "We've been studying the Mexican financial system for a few years, and we heard from a lot of customers about the challenges and headaches they face with existing services. These services have forgotten to put the consumer at the center of their strategy and their products. On top of that, more than 36 million Mexicans currently don't have any access to the bank system – and we want to contribute to this situation to change."

Argentina: Nubank has also announced its plans to start its business in Argentina. It aims to have 300 employees in Argentina by the end of 2020. According to Moody’s, Nubank’s entry in the market will increase the competition. Notably, 50% of the population in Argentina is unbanked (according to World Bank data). Also, the credit penetration in Argentina has been on pause for the last half a decade. Nubank is likely to create a ripple in the banking landscape of Argentina as well. However, Argentina can present some challenges from credit card issuers such as Tarjeta Naranja, Banco de Galicia, and Banco Santander, which hold major credit card market shares in Argentina.

Since 2017, Nubank has had a technology hub in Berlin, Germany, focused on infrastructure and data engineering. This lab is mainly used to hire engineering talent, which is a shortage in Brazil.

Conclusion

Nubank’s growth from zero to a $10-billion-valuation business with 12 million customers within six years since inception is an impressive success story.

If we think from the banks’ perspective, incumbents need to get their digital strategy right or risk losing a significant number of customers to disruptors like Nubank. Generic products, which are the bulk of banks’ portfolios, need to evolve into very specific, client-tailored, and risk-based prices. Graduating from the current "clicks-and-bricks" model is also something that banks should consider not just survival but efficiencies. Another challenge for established banks – and maybe the hardest of all – is to develop a unique digital identity. If we understood the signals right, Brazilians are not very happy with the way banks have operated and served them historically.

All said, analysts suspect that the rate at which lending spreads and overall banking fees fall in Brazil over the next couple of years will surprise many market participants. Nubank is already a revolution in Brazil, where it has 12 million customers that enjoy much better services and rates today. An environment of complacency towards customer service and sky-high rates by traditional banks will continue to help the challenger Nubank in Brazil in the near-term. Beyond Brazil, Nubank’s venture into Mexico and Argentina would open new channels for growth for the company.

SECTION 2: Current Affairs (June 20 – July 31)

All-Seeing Regulatory Eye

In July 2019, China’s central bank released the first draft of rules to regulate the country’s vast and often complex financial holding companies. The central bank is focused on the “blind business expansion” of FinTech giants such as Ant Financial.

Recently, Lyndon Nelson, a senior Bank of England official indicated that banks might need to hold more cash on hand to manage increasing vulnerability due to faster spread of negative news such as system outages, or cyberattacks. He said, “Operational resilience or the ability of banks to recover from cyberattacks or IT glitches, like the one faced recently by Sabadell subsidiary TSB bank, has risen up the regulatory agenda.” In the case of big banks, glitches are often due to their legacy systems that are not efficient to tackle outages. He adds, “Competitive pressure from agile FinTech companies that can update apps several times a week means that big banks will have to upgrade systems.”

In the last week of June 2019, Singapore’s MAS announced that it would issue five new digital bank licenses to non-bank firms soon. This would include two digital full bank licenses and up to three digital wholesale bank licenses. We have already covered this story at length here.

Taiwan has issued its first three digital banking license. These licenses have been given to Japan’s LINE Group, another Japanese e-commerce firm Rakuten Inc., and Taiwan's Chunghwa Telecom.

Since we mentioned Rakuten, the Japanese player has reached out to US regulators to open a bank in the US. The US banks have raised concerns over a foreign player’s entry to the market.

Saudi Arabia’s capital market regulator CMA has approved two companies for testing robo-advisory services for customers. The move is in line with the regulator’s aim to attract innovators and encourage the use of FinTech in the country.

New Fountain of Money

The Japanese telecom giant Softbank has announced its second big fund named Vision Fund II by amassing $108 billion in firepower. This time, Softbank will invest $38 billion of its own money and will entertain participation from a diverse set of investors including Apple, Foxconn, Microsoft, Standard Chartered, and Kazakhstan's sovereign wealth fund. Notably, Softbank is interested in the Latin American FinTech landscape. Earlier this year, Softbank was speculated to fund Nubank’s next funding round, but the deal couldn’t crystallize. Just two days after the Nubank’s recent funding round led by TCV, Softbank announced that it would be investing in Brazil’s publicly listed digital banking solutions provider Banco Inter SA.

Money Magnets

In July 2019, FinTech startup MoneyLion, which provides financial advice and access to loans and other services to US-based consumers, announced that it had raised $100 million in its Series C round. The funding round was led by Edison Partners and Greenspring Associates. Capital One also went for strategic investment in the startup.

SumUp Inc, a London-based electronic payments startup, announced that it had secured a $371-million loan from Bain Capital Credit, Goldman Sachs Private Capital, and others. The money will be used for the expansion of its customer base and product portfolio.

In the last week of July 2019, Australian challenger bank Judo announced that it had raised AUD $400 million from Bain Capital Credit, Tikehau Capital, OPTrust, the Abu Dhabi Capital Group, Ironbridge, and SPF Investment Management – this is touted as one of the largest single funding rounds in the Australian FinTech landscape.

London-based Soldo, a business banking account provider, raised $61 million in its Series B funding round, which was led by Battery Ventures Dawn Capital, and existing investors Accel and Connect Ventures. Soldo operates primarily in the UK, Ireland, and Italy, where it has over 60,000 customers. Soldo will use the funding to scale up in European markets.

Not So Liberal on Libra

In July 2019, Facebook’s quarterly filing to SEC highlighted the barriers around regulating a new technology with unclear rules in the US and other nations – this means that “there can be no assurance that Libra or our associated products and services will be made available in a timely manner, or at all.” Facebook’s planned cryptocurrency ‘Libra’ has been in controversy since its announcement in June 2019. Earlier this month, the US Congress had asked Facebook to stop any development on Libra to assess the possible risk it poses to the global financial system.

Open to Partnerships

FinTech startup Open, which offers a business banking service for SMEs and startups in partnership with banks, has announced a strategic partnership with Visa to enhance its business banking proposition for SMEs. The partnership will enable Open to launch a suite of innovative products that include business credit cards for SMEs, payment gateways, and real-time payments.

Brewing Latte and FinTech

In July 2019, Starbucks announced to license some parts of its mobile and loyalty technology for the broader restaurant industry. The platform will use some elements of Starbucks' intellectual property for ordering, loyalty, personalization, and payments technology used in its app. This move is seen as Starbucks’ change in focus from B2C to B2B. We have covered this B2B trend in our article here.

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