SPECIAL REPORT: Finance in the AGe of covid
The addition to the global lexicon of contactless delivery and social distancing plays directly to the strength of the digital transformation underway in Latin America’s financial sector. The COVID-19 pandemic is speeding that process to a greater scale than ever before.
by Vinod Sreeharsha
As Peru was becoming a new global coronavirus hotspot in early June and economic uncertainty grew, the mobile banking company YellowPepper added Banco Interamericano de Finanzas, known as Banbif, to its real-time payment platform called PLIN. It was the fourth bank in the Andean nation to join this year following BBVA, Interbank, and Scotiabank. PLIN allows individuals to transfer money across accounts via smartphone apps.
One month earlier, as Brazil was closing in on the United States in number of COVID-19 cases, the Sao Paulo-based fin-tech Creditas resumed hiring new employees after having paused in March and April.
Meanwhile in neighboring Argentina, Buenos Aires-based Uala, whose investors include SoftBank and Tencent, has issued over 350,000 new debit cards since the pandemic began, more than a 20% jump according to company founder Pierpaolo Barbieri. “It’s the largest increase in absolute numbers of issued cards that we have had since we launched,” in 2017, he observed.
“What we expected over years is now happening over weeks.”
Pierpaolo Barbieri, Founder, Uala
Prior to COVID-19, Latin America was enjoying a fintech boom over the past six years due to a highly concentrated traditional banking sector and a maturing entrepreneurial ecosystem. Brazil and Mexico, combined, have over 1,000 start-ups in that sector, and many have drawn marquee foreign technology investors from Shenzhen to Sand Hill Road. Tech start-ups finally started having successful exits - acquisitions or initial public offerings - providing young local venture capital firms with returns on investment.
Yet the current grave moment and enormous uncertainty throughout the region pose the industry’s biggest test to date even as entrepreneurs in the region are accustomed to crisis. Some fintechs will emerge stronger and in a shorter time than they ever imagined. For others, their mere survival is in question.
Based on early assessments, the companies most likely to benefit offer services which are now in much greater demand and include online bank accounts or digital payments, as many people wish to avoid visiting bank branches. At the same time, with delinquencies on the rise, finance sector experts worry about segments like credit and lending. The booming wealth and asset management sectors, particularly in Brazil, also face their biggest tests.
“Everything around digital payments and e-commerce payments is doing well right now,” said Isaias Sznifer, a managing director with the advisory firm Greenhill & Co. based in Sao Paulo. When corporate earnings from the second quarter come out, “I expect to see a pick-up in the number of accounts being opened,” he predicted.
At the same time, “there’s going to be a shakeout of the fin-techs in the lending sector, both to SMEs and to consumers,” said Nathan Lustig, managing partner of Magma Partners, based in Santiago, Chile.
POCKETS OF CAUTION
Those providing consumer credit, especially unsecured loans, face particularly challenging times. “A lot of them I think might struggle with higher default rates and bigger write-offs,” noted Lustig.
There is good reason for the concern. In late June, the International Monetary Fund said it estimates Brazil’s economy will contract by 9.1% this year, what would be its biggest drop on record. Mexico is forecasted to contract by 10.5%. The multilateral forecasts Latin America’s economy overall will shrink by 9.4%. By comparison, Sub-Saharan Africa’s economy is only expected to fall by 3.2%.
In this year’s first quarter, the number of unemployed Brazilians rose to 12.8 million from 11.6 million in the fourth quarter of 2019.
“The magnitude of this is substantially larger than anything we’ve seen before on a regional level,” said Nicolas Szekasy, a founding partner of Kaszek Ventures in Buenos Aires. The Argentine has endured more crises than most - he was chief financial officer of Mercado Libre from 2000 to 2009 and Kaszek has raised four of its five funds amid a dismal economy in Brazil.
Funding in fintech companies has already fallen. According to Distrito Dataminer, $46.4 million was invested in 16 deals this year thru May, down significantly from $123.4 million invested in 28 deals during the same period in 2019.
Yet there are reasons to be hopeful. The fundamentals that drove the region’s fintech boom remain, and several of those trends have accelerated since the pandemic began.
Online deposits and transfers in Brazil grew by 25% from February to May. They reached a 5.7 million daily average number of transactions, according to a June 16 report by consulting firm BCG. It considered that a “drastic shift in consumer behavior online.” It also found a growing opportunity to tap into the lowest socioeconomic groups.
Peru is seeing similar changes. Serge Elkiner, co-founder and chief executive officer at YellowPepper, said he’s noticing greater adoption of online financial services and the banks his company is partnering with are moving faster. “They’re definitely accelerating their integration,” he noted.
YellowPepper plans to add three more banks there in the next 12 months. Peru is an important market for Visa, who in 2018 took a minority stake in the start-up.
In Argentina, Uala’s newest service is a money market fund for people to invest in to protect their money. Started about five months ago, around 470,000 individuals have used it to date, the company’s founder said. “What we expected over years is now happening over weeks,” noted Barbieri.
In Chile, CrediTu is providing home mortgage lending online, is growing, and raised debt financing during the pandemic. Traditional banks in the country aren’t used to working remotely.
And in Mexico, which last year exceeded Brazil by number of fintechs, payment companies like Conekta are growing.
HEEDFUL/HELPFUL
Large international players are paying attention and could alter the scene.
In June, Facebook-owned WhatsApp launched its payments tool for users in Brazil, allowing them to make payments to individuals or small businesses using the instant messaging device through Facebook Pay. It was the first market where the tech giant made this fully available. The deal drew the attention of Brazil’s central bank and anti-trust regulator, which suspended the operation on June 23 because the service was rolled out without proper analysis by the monetary authority.
Also last month, Brazil’s Central Bank granted a license to London-based TransferWise to operate as a foreign exchange broker in the country. It now plans to expand its offerings.
Local giants are expanding too. On June 8, MercadoLibre’s MercadoPago announced an expansion of its credit offerings for clients.
Latin American entrepreneurs after all are used to crisis. That’s another asset.
For example, Creditas, which offers payroll loans, home equity loans, and auto loans, was founded in 2012, and during Brazil’s massive 2014-2016 recession continued growing. The company started 2019 with 900 employees and now has 1500, according to Sergio Furio, founder and chief executive officer of the company. That is before it recently resumed hiring.
Furio thinks that one thing his company has done to prepare for the current moment is that it has always required collateral from consumers. That is so “they have skin in the game and so therefore the portfolio remains stable in moments of stress or a recession.”
Recognizing what lies ahead, many companies already slashed expenses, cut down on marketing, and adjusted expansion plans. The grow at all costs is no longer the mantra among venture backed fintechs.
“Many companies have had to totally abandon their plan of high growth for one of survival,” said Camilla Junqueira, managing director of Endeavor Brasil, a global non-profit seeking to promote entrepreneurship in developing countries. “They have completely changed their strategy.”
Nubank is another Brazilian fintech that has weathered past storms. It launched its first product, a digital credit card, in 2014. Brazil’s economy shrank by over three percent that year and next and contracted by 3.6% in 2016.
“The only thing our credit models have ever seen is Brazil in a recession,” said David Velez, co-founder and chief executive officer.
That means preparing for turbulence and volatility.
“The magnitude of this is substantially larger than anything we’ve seen before on a regional level.”
Nicolas Szekasy, a founding partner, Kaszek Ventures, Buenos Aires
“It’s what we know, and our models know, and our culture knows, which means we’ve been conservative,” said Velez. “Every time we made credit decisions, we had cushion.”
A report by Bain & Co. dated June 16 said that Nubank has seen a 34 % increase in user adoption during the pandemic. Others have too – MercadoPago has logged a 28 % jump and PicPay a 28 % spike.
“WAM” FACTOR
One sector that many thought would face difficulties from current conditions is Brazil’s booming wealth and asset management sector. Would retail investors get scared by major drops in Brazil’s main stock exchange?
Apparently not. In every month since February, the number of individual investors trading on the B3 exchange has increased. At the end of May, according to the bourse, it had 2.5 million persons, an 11 % jump from the end of March, when Brazil had already entered lockdown.
XP Inc, Brazil’s leading brokerage firm, has certainly kept busy. In June the firm said it poached Jose Berenguer from J.P.Morgan to run Banco XP, its new investment bank arm. Berengeur had been president of the American firm’s Brazil unit the past seven years.
The other main player, BTG Pactual’s digital platform, which has been pivotal in bringing the bank new clients in recent years, is also doing well. Even during the most critical moments in March, the investment platform did not have negative net money or loss of individual customers for a single day, said Marcelo Flora, head of BTG Pactual Digital.
Individuals put money into equity funds rather than withdrawing it, he noted. “We are very positively surprised with the behavior of the investors.”
Flora said his group is currently interviewing 40 people for new positions.
Payments is the other area in financial technology where the region and particularly Brazil is most advanced. PagSeguro’s share price on the NYSE plummeted to $14.95 on March 23 but has since mostly recovered. It was at $35.35 at market close on June 30, near its six-month high.
Stone Pagamentos also took a big hit, falling to $17.82 on April 3 but was already back to $38.76 by June 30, also near its six-month high. In April, total payment volume grew by 9% year on year, and in May it grew 23%.
Another advantage the region has are central banks that continue to view fintech favorably. They have sought to reduce banking concentration in the region.
Brazil’s Central Bank is prioritizing pushing an Open Banking initiative and a nationwide instant payments platform.
“Authorities have been doing a good job to increase competition,” said Augusto Lins, president of Stone Pagamentos. “I see a strong commitment from the Central Bank,” he observed. “Despite COVID, they’re pushing ahead.”
Still, numerous challenges remain, and much is still unknown about the new COVID-19 reality.
In Mexico, even before the pandemic, many thought its numerous challenger banks would eventually face a reckoning.
Lustig for example thought that would take another 18 to 24 months to occur. Now, “coronavirus is probably going to make that shakeout happen more quickly, over the next 6 to 12 months,” he calculates.
“THEY HAVE SKIN IN THE GAME AND SO THEREFORE THE PORTFOLIO REMAINS STABLE IN MOMENTS OF STRESS OR A RECESSION.”
Sergio Furio, Founder and CEO, Creditas
Delinquencies are up. In a survey within the Bain & Co. report, about 25 % of Brazilian consumers with loans said they won’t be able to meet the original terms of the financing, an alarmingly high figure. That is expected to increase in the coming months.
“Every credit provider is and should be concerned,” said Sznifer of Greenhill & Co.
Fintechs in insurance are in for hard times. And companies that sell financial software or enterprise financial management face difficulties. “Anyone selling to large, traditional companies is going to have a tough time right now,” said Jackie Hyland, a long-time observer of Latin America’s technology scene.
She said that is because large companies are more likely to cut costs by reducing employees or operations rather than implement new systems.
Yet, some segments within lending may do well. For example, a55 which provides credit to SMEs in Brazil and Mexico raised capital from Santander InnoVentures in May in part because there’s now a growing demand for credit from small businesses.
Hyland, an advisor to a55, said the company got more requests in the months of May and April than it did the year before.
“The need for capital is higher than ever,” said Hyland, who formerly led investments in Latin America for Accion Venture Lab and then worked at Silicon Valley Bank.
Which companies emerge successful will also depend on factors out of their control. For example, survival may depend on whether companies raised large rounds of financing last year.
Some startups through no fault of their own will get in trouble because they were in the wrong part of their capital raising cycle when the pandemic hit, said Lustig.
“I think that it’s going to be really hard to get those $25 million and higher deals done in Latam in companies that have not raised from U.S. or Asian money yet,” he said.
Still, the ecosystem is much more developed than it was during past crises.
“Founders in Latin America and in Brazil are better prepared for these types of scenarios,” said Szekasy, the partner with Kaszek.
Nor should one underestimate Latin American entrepreneurs and their unique ability to thrive amid chaos and uncertainty, compared to their counterparts in Silicon Valley, he and other experts say.
“They are already accustomed to working in very extreme conditions and facing huge obstacles,” noted Endeavor’s Junqueira. “They are resilient,” she said.