Nubank Q3 2022 Earnings Review: when tailwinds are gone
During the last year, Nubank (NYSE: NU 0.00) went through a period of explosive growth: the company’s interest-earning loan portfolio more than doubled and gross revenue more than tripled on a trailing twelve months basis. The company used a period of low delinquency rates to continue scaling its lending business and has masterfully navigated the rising rates environment greatly improving its net interest margins. In Q3 2022 Nubank even reported a net income of $7.8 million on a non-adjusted basis.
However, the tailwinds are gone, as delinquencies are rising, Nubank is tightening its underwriting standards, and the Central Bank of Brazil might be done raising rates. I would expect the next twelve months to be more challenging, as the company will need to find new levers of growth. At the same time, Nubank continues to grow its customer base in Brazil, Mexico, and Colombia, and has ample resources to weather a short-term downturn. Let’s keep our eyes on the long term, which, in my humble opinion, should be bright for Nubank.
“In our 9-year history as a company we have already seen a lot: we saw a GDP contraction of 7% during the years of 2015-2016, the largest recession in Brazilian history; we saw a presidential impeachment; we saw right-leaning governments and left-leaning governments coming and going across the three countries we operate. And today we see a slightly more volatile environment than we saw in 2021, which brings a bit more caution, but that also creates opportunities”
David Vélez, CEO and co-founder of Nubank
If you are new to Nubank, I suggest reading my earlier reviews:
👉🏻 Nubank, the world's largest neobank, goes public
👉🏻 Nubank Q4 2021 Earnings: why is Warren Buffett so bullish about this neobank?
👉🏻 Nubank Q1 2022 Earnings: rising interest rates are a trouble
👉🏻 Nubank Q2 2022 Earnings: what will drive the growth past 2022?
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Nubank added 5.1 million customers during Q3 2022, which represents a 46% growth compared to Q3 2021. The total number of customers reached 70.4 million, of which 66.9 million customers are based in Brazil, 3.0 million are based in Mexico, and 0.5 million are based in Colombia. In Brazil, Nubank’s customer base grew 41% YoY and now accounts for 39% of the country’s adult population. In Mexico Nubank’s customer base grew over 300% YoY, and 11% sequentially.
During the earnings call, David Vélez, the company’s CEO, stated that “Mexico and Colombia can be bigger than Brazil for us and we are growing in those markets faster than we grew in Brazil.” Brazil has a bigger population and GDP than Mexico and Colombia combined, so I’d assume the company’s chief expects the company to take a bigger market share in its new markets than it did in Brazil. In any case, I will continue arguing that Nubank’s success in Mexico and Colombia is critical for the further growth of the company.
The activity rate, or the number of monthly active customers as a percentage of the total number of customers, continued to improve, reaching 82% at the end of the quarter, and the company claims to be the primary banking partner for over 55% of its monthly active customers. Out of 57.4 million monthly active users, 50 million used digital banking accounts, 32 million used credit cards, and 6 million used NuInvest. The company’s press release claims that Nubank “became the fifth largest financial institution in Brazil in terms of the numbers of active customers, according to the Brazilian Central Bank.”
Nubank also shared some insights into the income profile of its customers (see the chart below). The point that the company’s management was trying to make is that Nubank is not focusing solely on the “underbanked” clients anymore, and has a customer base that is similar to the incumbents. This is how great Fintech companies are built (IMHO): they start by pursuing a customer segment that the incumbents don’t care about (not profitable, hard to reach, costly to serve), but once they build the muscles, they pursue the same customers that the incumbents serve (think of Square, which started by serving micro-merchants).
Loan Portfolio and Deposits
Nubank reported $14.0 billion in deposits at the end of the quarter, which represents a 72.8% growth compared to Q3 2021, and a 5.3% growth compared to Q2 2022. 82% of these deposits or $11.5 billion are classified as “Bank Receipts of Deposit” (Recibos de Depósito Bancário), and, unlike electronic money, can be used by Nubank for lending purposes. Nubank finances its lending origination solely from customer deposits and does not depend on the availability and conditions of external funding.
At the end of Q3 2022, the company’s loan portfolio, net of provisions, was $8.18 billion, which represents a 68.6% increase compared to Q3 2021, and a more modest 0.3% increase compared to the previous quarter. Excluding provisions, the loan portfolio was $9.7 billion, which represents an 84% increase compared to Q3 2021, and a 6.4% increase compared to the previous quarter. The interest-bearing part of the portfolio reached $3.5 billion, which represents a 147% growth compared to Q3 2021, and a 9.4% growth compared to Q2 2022.
The deceleration in personal loan origination, which resulted in a sequential drop in loan originations, and almost flat loan portfolio growth compared to the previous quarter, was the outcome of the company taking a more conservative approach to lending given rising delinquencies. Thus, the share of the non-performing loans with payment delays of 15-90 days, or NPL 15-90, increased from 3.7% in Q2 2022 to 4.2% in Q3 2022, and the share of non-performing loans with payment delays of over 90 days, or NPL 90+, increased from 4.1% in Q2 2022 to 4.7% in Q3 2022.
As mentioned earlier, Nubank does not lack funding (deposits greatly exceed the size of the loan portfolio), and, per the management’s comments, customer demand is also not a limiting factor. The company’s CFO was clearly excited about the upcoming launch of secured and payroll loan products, but gave cautious guidance regarding accelerating personal loan originations. The company’s management wants to see how delinquencies evolve, which is a meaningful course of action. However, this also means that loan portfolio growth will likely be muted in the coming few quarters.
Nubank reported $1.31 billion in gross revenue in Q3 2022, which represents 171.8% growth compared to Q3 2021, and 12.9% growth compared to Q2 2022. Interest income and gains on financial instruments grew 234.7% compared to Q3 2021 and 15.7% sequentially, while fee and commission income grew 71.9% compared to Q3 2021 and 4.9% sequentially. Interest income represented 75.5% of total gross revenue, up from 61.3% a year ago.
Nubank’s revenue over the twelve trailing months grew 214% YoY (Q4 2021 - Q3 2022 compared to Q4 2020 - Q3 2021). This outstanding growth was the result of a) Nubank easing its lending standards after the peak of the pandemic, and b) the company masterfully navigating the rising rate environment. As a reminder, at the onset of the pandemic, Nubank tightened its credit policies (as delinquencies skyrocketed), and the Central Bank of Brazil cut its interest rates. However, in 2021, Nubank returned to lending and the Central Bank of Brazil started rising rates. The company’s Q3 2022 results perfectly illustrate these forces.
Thus, as you can see from the interest income breakdown (see table below), interest income from both credit card products and personal loans almost tripled from $178.7 million in Q3 2021 to $471.9 million in Q3 2022, which was driven by an increase in the loan portfolio and Nubank passing rate increases toward consumers. In addition, Nubank’s income from purchases of credit card receivables from other lenders (reflected under the “interest income - other credit operations”) increased more than tenfold, from $4.5 million in Q3 2021 vs. $50.2 million in Q3 2022.
Nubank was also a major beneficiary of the rising interest rates, as its income from the deposits that the company holds at the central banks (reflected under “interest income - other assets at amortized cost”) increased almost sevenfold, from $19.5 million in Q3 2021 to $129.6 million in Q3 2022, and the interest income from the company’s securities portfolio (primarily government bonds, reflected under “interest income and gains (losses) on financial instruments”) more than tripled, from $92.3 million in Q3 2021 to Q3 2022.
Interchange fees remain the key driver of the fee and commission income. Thus, interchange fees contributed 76.4% of the total fee and commission income in Q3 2022 (up from 70.2% in Q3 2021). In September 2022, the Central Bank of Brazil issued a resolution, capping the interchange fee on all prepaid card transactions to 0.70% (the resolution will come into force on April 1, 2023). Nubank earned 1.08% and 1.15% in interchange fees in Q3 2021 and Q3 2022 respectively (interchange fees are calculated as a percentage of purchase volume), which means that the new resolution will hurt the company’s fee and commission income in 2023 (Nu’s prepaid cards generate 35.6% of the total purchase volume).
However, what could have an even bigger impact on the company’s fee and commission income is the deceleration of the purchase volume (spending by the cardholders). Thus, the purchase volume in Q3 2022 was $21.2 billion, which represents a 75.2% increase compared to Q3 2021, and 6.0% compared to Q2 2022. If the growth of the economy starts deteriorating, this will eventually hurt the consumers; and thus, Nubank’s revenue prospects.
Let’s briefly touch on the topic of the gross profit (I think a better way to look at the company’s income is through the lens of Net Interest Income and Net Commission Income, not gross profit). Nubank reported $427.0 million in gross profit for the quarter, which represents 90.7% growth compared to Q3 2021, and 17.5% growth compared to Q2 2022. Nubank calculates gross profit by deducting interest and transactional expenses, as well as credit loss allowance expenses from gross revenue. Nubank’s gross profit margin finally started improving in Q3 2022 after declining for three consecutive quarters.
Two factors allowed Nubank to improve its gross margin. First, the increase in the company’s interest expense started moderating, as the Central Bank stopped raising the rates, and, second, the deceleration in personal loan origination slowed down the increase in credit loss allowance expenses. During the earning call, the company’s CFO mentioned that a period of stable interest rates and moderate personal loan origination should allow the company to reach 35-40% gross profit margins. However, as the company starts scaling originations again (driving higher provisions), the gross margins are expected to compress.
Net Interest and Net Commission Income
I previously argued that it is worth “reorganizing” Nubank’s income statement into the structure used by banks. Thus, deducting “Interest and other financial expenses” from “Interest income and gains (losses) on financial instruments” gives us Net Interest Income, while deducting “Transactional expenses” from “Fee and commission income” gives us Net Commission Income (sometimes referred to as “Non-Interest Income”). See the table below for the “reorganized” income statement.
This perspective allows us to use standard performance measures applied to banking institutions, such as the Net Interest Margin. Thus, Net Interest Margin (NIM), which is Net Interest Income divided by interest-earning assets (interest-earning loan portfolio, corporate cash, etc.), increased from 7.6% in Q3 2021 to 11.1% in Q3 2022, which essentially, means that Nubank is now generating higher income from its assets. Please note that NIM increased in both Q2 and Q3 2022 despite lower origination volumes in the highest-yielding component of interest-earning assets, personal loans. However, we are yet to see how it evolves from here.
Interest-earning assets include i) Cash and cash equivalents ii) Financial assets at fair value through profit or loss iii) Financial assets at fair value through OCI iv) Compulsory deposits at central banks v) Credit Card Interest-earning portfolio vi) Loans to customers (gross) vii) Interbank transactions viii) Other credit operations ix) Other financial assets at amortized cost.
As discussed above, the key driver of the commission income is the interchange fees that Nubank earns on purchases by its cardholders. Therefore, it is worth looking at Net Take Rate, which can be calculated by dividing Net Commission Income by Purchase Volume. As the chart below illustrates, the Net Take Rate grew during Q4 2020 - Q3 2021 period, but stabilized at around 1.3% in Q3 2022. The cap in the prepaid card interchange should lead to a compression of the Take Rate, so further growth in the Net Commission Income can only come from higher purchase volumes.
Finally, I would like to highlight that Net Interest Income contributed 65.7% of the total net revenue (NII + NCI) in Q3 2022, up from 55.2% in Q3 2021. Drawing parallels to other financial institutions, I would expect this ratio to continue increasing over time (to 70-75%), which means that Nubank’s growth will become even more dependent on its ability to grow its loan portfolio and generate higher Net Interest Income.
Let's try to summarize. The acceleration that Nubank experienced in the last four quarters was a combination of returning to loan origination growth and increasing interest rates. None of that is going to continue into the coming quarters. Delinquencies increased, forcing Nubank to scale down originations, and the Central Bank of Brazil might be done with raising rates. On top of that, Net Commission Income is expected to experience a headwind due to the cap in the interchange.
Credit Loss Allowance and Operating Expenses
Nubank reported $375.5 million in credit loss allowance expenses and $421.9 million in total operating expenses, which, given the total revenue of $802.5 million (NII + NCI), lead to a $5.1 million income before taxes (a year ago, Nubank reported a $21.8 million loss before taxes). Please note that I show the “reorganized” income statement below (whereas “Net revenue” + “Credit loss allowance expenses” equals “Gross profit” in the original reporting).
Credit loss allowance expenses increased 195.6% compared to Q3 2021, and 10.9% compared to Q2 2022, reflecting an increase in the size of the portfolio, a higher volume of new loan originations, as well as a higher expected loss for the new originations. Credit loss allowance expense relative to the size of the portfolio (gross of ECL provisions) has been consistently increasing reaching 3.87% in Q3 2022 (from 2.41% in Q3 2021). Increasing delinquencies will eventually drive credit loss allowance higher, so the only way for Nubank to control the increase in credit loss allowance expenses will be to limit new originations.
Operating expenses increased 71.7% compared to Q3 2021, and 8.7% compared to Q2 2022. A large component (43%) of Nubank’s operating expenses are personnel-related expenses: out of $421.9 million in total operating expenses, $89.8 million came from “Salaries and associated benefits”, $78.9 million came from “Share-based compensation”, and $15.2 million came from “Other personnel costs”. This implies that Nubank can moderate further increases by slowing down hiring; however, decreasing the costs, in case such a necessity arises, would require staff reductions.
Nubank continues to excel at low “cost-to-serve”, which remained pretty much flat over the last two years (“cost-to-serve” is defined as average monthly transactional and customer support and operations expenses divided by the average number of monthly active customers). Customer acquisition cost has been continuously rising from $4.00 in Q3 2021 to $7.47 per new customer in Q3 2022; however, this trend has been compensated by an increase in the average monthly revenue per customer from $4.90 in Q3 2021 to $7.80 in Q3 2022.
The efficiency ratio, or the total operating costs divided by the net revenue (NII + NCI), improved from 70.0% in Q3 2021 to 52.6% in Q3 2022 (a lower number means an improvement). In terms of the efficiency ratio, Nubank's performance is similar to Itaú Unibanco and Bradesco; however, its lower customer acquisition cost and cost-to-serve should eventually (at a bigger scale) lead to superior results. At least this is the promise of a fully-digital bank, so let’s see if this materializes.
Please note that Nubank uses a different methodology for calculating the efficiency ratio in its reporting. Thus, the company divides the sum of operating and transactional expenses by the sum of NII and fees and commission income. Per Nubank’s methodology, the efficiency ratio was 55.1% in Q3 2022, which was an improvement from 72.3% in Q3 2021.
In summary, Nubank continues to excel at customer acquisition and cost-to-serve, a bigger scale allows the company to continue improving its overall efficiency ratio, and a slowdown in hiring could provide it with an additional lever in controlling operating expenses, in case such a need arises. However, rising delinquencies will eventually translate into higher credit loss allowance expenses, and the only way for Nubank to get a grip on this expense is to limit new originations.
Net Income and Adjusted Net Income
Nubank reported a Net Income of $7.8 million for the quarter, an improvement from a Net Loss of $34.2 million a year ago. I believe it was important for the company to show that it is capable to turn to profitability if it slows down growth (in this case by slowing down the origination volumes). Interestingly, but I doubt that coincidentally, the last time Nubank reported a Net Income for the quarter was in Q2 2020, when the company tightened its credit policies and slowed down originations following the outbreak of the pandemic.
The company also reported an Adjusted Net Income of $63.1 million for the quarter, an improvement from an Adjusted Net Loss of $1.2 a year ago. The company calculates Adjusted Net Income by adjusting Net Income for share-based compensation and respective taxes. Total share-based compensation expenses for the quarter were $78.9, which represented 6.0% of gross revenue, and 9.8% of net revenue (NII + NCI).
Things to Watch Ahead
NPL ratios / Loan originations. Non-performing loans are rising, and, as a response, Nubank is tightening its credit policies and lowering its origination volumes. The company is planning to launch secured loans (loans secured against the investment portfolio) and payroll loans (loans with automatic deduction of repayments from payroll); however, we will most likely see a period of muted loan portfolio growth, and, consequently, a period of muted interest income growth (at least until there is no improvement in NPL ratios).
Net Interest Margin. Nubank has been consistently improving its Net Interest Margin, which was partially driven by the rising rates (increasing income from the company’s cash balances and the portfolio of marketable securities) and partially by the company’s actions (passing along rate increases to borrowers). The Central Bank of Brazil might be done with raising interest rates, so it is interesting to see how the Net Interest Margin will evolve going further.
Take Rate / Purchase Volume. The new resolution capping the interchange for prepaid cards will be a headwind for the company’s commission income in 2023. However, a bigger driver of the commission income is the purchase volume, which has been rapidly decelerating (purchase volume increased by 75% compared to Q3 2021, and only 6% compared to Q2 2022). The growth of the economy is slowing down, and this should impact the consumers.
Growth outside of Brazil. Finally, I will continue stressing the importance that growth outside of Brazil has for the company’s prospects. Nubank reached the milestone of 3 million customers in Mexico, and the company’s CEO, David Vélez, mentioned on the earnings call that Nubank is growing in both Mexico and Colombia faster than it grew in Brazil. Nubank has a market cap of over $20 million, which, I believe, rests on the thesis that Nubank will become a dominant financial institution in Latin America. It’s exciting to see the company make progress toward this ambition!
This was a strong quarter for Nubank, but the rising delinquencies and deceleration of the sequential growth suggest that the next twelve months might be more challenging. Nevertheless, Nubank has sufficient resources to weather a downturn, so we should probably keep our focus on the long-term prospects rather than short-term challenges.
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Disclosure & Disclaimer: despite rocky performance in 2021 and 2022, I own shares in most of the companies that I write about in this newsletter, as I am extremely bullish on the transformation in the financial services industry. However, none of the above is financial advice, and you should do your own research.