Digital lending spreads in Latin America are among the highest globally

December 30, 2019
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New takes on old lending categories. Similar to the evolution of the US fintech landscape, lending was one of the first financial services categories to be digitized in Latin America.

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Entrepreneurs targeting the sector did so with good reason: lending spreads in Latin America are among the highest globally, and traditional financial institutions tend to have manual underwriting processes as well as abysmal customer service.

In the unsecured consumer lending space, first movers such as Geru in Brazil, Kueski in Mexico, and Zinobe in Colombia were able to reach significant scale, but have faced increasing competition from local upstarts (e.g., Noverde and Rebel in Brazil) as well as international entrants (e.g., Branch and Tala from the US). Meanwhile, traditional banks (e.g., Santander) and asset managers (e.g., XP Investimentos) are entering the space with new digital offerings.

This market crowding is in part due to to the proliferation of debt capital from boutique credit funds (e.g., Victory Park Capital, Arc Labs), which has enabled alternative lenders to secure credit facilities in the early days of scaling their origination volumes. Likewise, with interest rates at record lows in countries like Brazil, asset managers and family offices are piling into fintech loan portfolios in search of higher yields. It is easier than ever to structure securitization funds in Latin America, with many fintechs turning to vehicles like a Fundo de Investimento em Direitos Creditórios, more popularly known as a FIDC in Brazil. Last but not least, with clear regulation in Brazil (e.g., SCD / SED licenses) and Mexico (SOFOM / SOFIPO licenses), setting up shop in the lending space is relatively straightforward.

Unfortunately, the unsecured consumer lending model has suffered from a lack of differentiation: over time, high interest rates and digital distribution have not proven to be particularly deep competitive moats, and price-sensitive users are just as likely to turn to a competitor for their next loan. Increased competition has resulted in what will likely be a race to the bottom in terms of pricing, and the players left standing in several years will either be those that can raise significant equity capital (to fund loans and acquire customers) or that can secure the lowest cost of capital for lending.

Taking the above into account, I prefer new takes on old lending categories that ideally exhibit some combination of the following attributes:

  1. Distribution advantage
  2. Modest capital intensity
  3. Unique underwriting capability

Unfortunately, few models possess one, let alone all three of these attributes, making it somewhat tricky to pick winners at the early stage. While no business model is perfect, I am most excited about the following new approaches in the lending sector in Latin America:

Advanced access to earned wages is a budding category that entails an attractive distribution element (B2B2C model lowers customer acquistion costs) and is capital-light (due to short tenor of loans). However, it remains to be seen whether the model will tropicalize well in Latin America, given similar products such as crédito consignado are quite entrenched in Brazil, for example.

  • Latin America: Xerpa, Fácio, Minu, ePesos
  • International: Payactiv, Earnin, DailyPay, Wagestream, Hastee

Point of sale lending appears quite compelling given the potential distribution advantage, however, offline merchant networks in Latin America have proven difficult to crack, with players typically focusing on online channels instead.

  • Latin America: Addi, Koin
  • International: Affirm, Klarna

Secured lending is particularly attractive given the asset-backed model entails an inherent underwriting advantage, resulting in higher portfolio quality and more affordable interest rates than the norm. That said, secured lending requires high levels of process optimization and automation to reach scale, as well as an abundance of debt capital. Collections can also prove quite onerous in Latin America in the event of defaults.

  • Latin America: Creditas, Credijusto, Agilis, R5
  • International: Figure

Small business lending represents a massive opportunity given Latin American small businesses face the largest credit gap of any region globally. Notably, electronic invoicing is mandated across most major Latin American economies (established in Chile before proliferating regionally), equipping lenders with a unique data advantage for underwriting if utilized properly. Automation plays a key role here as well: some startups still rely on traditional credit committees, which will likely inhibit scale. I prefer working capital loans over factoring solutions, given the latter proves highly complex and extremely capital-intensive.

  • Latin America: Konfio, Nexoos, BizCapital, Sempli, Weel, Omnibnk
  • International: OnDeck, Kabbage, Funding Circle, BlueVine, C2FO, Greensill

Lastly, credit-as-a-service models are becoming increasingly common in the region, which leverage both distribution (B2B2C model lowers customer acquistion costs) and underwriting advantages (model leverages unique data from partner institution). That said, this approach is plagued by long B2B sales cycles and low margins (depending on partner agreement), so scalability is still somewhat unproven.

  • Latin America: PayJoy, Migo (formerly Mines), Zen Finance
  • International: Zest AI, Blend, Upstart

So what does the future hold in store for our plucky band of digital lenders?

Path to exit for standalone lenders in Latin America will likely be via acquisition by a traditional financial institution looking to enhance its digital capabilities, a merger with a non-fintech startup looking to add lending to its product set (given saturation in the tech-enabled lending space, consolidation is inevitable), or potentially via IPO for those players that are able to reach escape velocity. In the event of a public offering, however, it remains to be seen how Latin American lenders will fare. Notably, former fintech darlings Lending Club and OnDeck in the US, as well as Funding Circle in the UK, have all been trading in the doldrums for some time.

Taking this into account, the future winners in the credit space in Latin America may actually not look much like lenders at all. If data is indeed the new oil, platforms with rich transactional data sets and sticky user bases (e.g., enterprise SaaS players, challenger banks, payments platforms, and even e-commerce) may be better positioned to offer sustainable digital lending products. Take the case of the meteoric rise of Square in the US, for example, which was able to leverage the transactional data on its payments platform to more intelligently underwrite loans for small merchants under its Square Capital division.

Regardless, given the massive credit gap in Latin America, the emergence of significant fintech lending businesses in the region is inevitable, and I can’t wait to see how the landscape shakes out in the coming years.

Las opiniones compartidas y expresadas por los analistas son libres e independientes, y de ellas son responsables sus autores. No reflejan ni comprometen el pensamiento u opinión de Latam Fintech Hub, por lo cual no pueden ser interpretadas como recomendaciones emitidas por la platafomra. Esta plataforma es un espacio abierto para promover la diversidad de puntos de vista sobre el ecosistema Fintech.

Entrepreneurs targeting the sector did so with good reason: lending spreads in Latin America are among the highest globally, and traditional financial institutions tend to have manual underwriting processes as well as abysmal customer service.

In the unsecured consumer lending space, first movers such as Geru in Brazil, Kueski in Mexico, and Zinobe in Colombia were able to reach significant scale, but have faced increasing competition from local upstarts (e.g., Noverde and Rebel in Brazil) as well as international entrants (e.g., Branch and Tala from the US). Meanwhile, traditional banks (e.g., Santander) and asset managers (e.g., XP Investimentos) are entering the space with new digital offerings.

This market crowding is in part due to to the proliferation of debt capital from boutique credit funds (e.g., Victory Park Capital, Arc Labs), which has enabled alternative lenders to secure credit facilities in the early days of scaling their origination volumes. Likewise, with interest rates at record lows in countries like Brazil, asset managers and family offices are piling into fintech loan portfolios in search of higher yields. It is easier than ever to structure securitization funds in Latin America, with many fintechs turning to vehicles like a Fundo de Investimento em Direitos Creditórios, more popularly known as a FIDC in Brazil. Last but not least, with clear regulation in Brazil (e.g., SCD / SED licenses) and Mexico (SOFOM / SOFIPO licenses), setting up shop in the lending space is relatively straightforward.

Unfortunately, the unsecured consumer lending model has suffered from a lack of differentiation: over time, high interest rates and digital distribution have not proven to be particularly deep competitive moats, and price-sensitive users are just as likely to turn to a competitor for their next loan. Increased competition has resulted in what will likely be a race to the bottom in terms of pricing, and the players left standing in several years will either be those that can raise significant equity capital (to fund loans and acquire customers) or that can secure the lowest cost of capital for lending.

Taking the above into account, I prefer new takes on old lending categories that ideally exhibit some combination of the following attributes:

  1. Distribution advantage
  2. Modest capital intensity
  3. Unique underwriting capability

Unfortunately, few models possess one, let alone all three of these attributes, making it somewhat tricky to pick winners at the early stage. While no business model is perfect, I am most excited about the following new approaches in the lending sector in Latin America:

Advanced access to earned wages is a budding category that entails an attractive distribution element (B2B2C model lowers customer acquistion costs) and is capital-light (due to short tenor of loans). However, it remains to be seen whether the model will tropicalize well in Latin America, given similar products such as crédito consignado are quite entrenched in Brazil, for example.

  • Latin America: Xerpa, Fácio, Minu, ePesos
  • International: Payactiv, Earnin, DailyPay, Wagestream, Hastee

Point of sale lending appears quite compelling given the potential distribution advantage, however, offline merchant networks in Latin America have proven difficult to crack, with players typically focusing on online channels instead.

  • Latin America: Addi, Koin
  • International: Affirm, Klarna

Secured lending is particularly attractive given the asset-backed model entails an inherent underwriting advantage, resulting in higher portfolio quality and more affordable interest rates than the norm. That said, secured lending requires high levels of process optimization and automation to reach scale, as well as an abundance of debt capital. Collections can also prove quite onerous in Latin America in the event of defaults.

  • Latin America: Creditas, Credijusto, Agilis, R5
  • International: Figure

Small business lending represents a massive opportunity given Latin American small businesses face the largest credit gap of any region globally. Notably, electronic invoicing is mandated across most major Latin American economies (established in Chile before proliferating regionally), equipping lenders with a unique data advantage for underwriting if utilized properly. Automation plays a key role here as well: some startups still rely on traditional credit committees, which will likely inhibit scale. I prefer working capital loans over factoring solutions, given the latter proves highly complex and extremely capital-intensive.

  • Latin America: Konfio, Nexoos, BizCapital, Sempli, Weel, Omnibnk
  • International: OnDeck, Kabbage, Funding Circle, BlueVine, C2FO, Greensill

Lastly, credit-as-a-service models are becoming increasingly common in the region, which leverage both distribution (B2B2C model lowers customer acquistion costs) and underwriting advantages (model leverages unique data from partner institution). That said, this approach is plagued by long B2B sales cycles and low margins (depending on partner agreement), so scalability is still somewhat unproven.

  • Latin America: PayJoy, Migo (formerly Mines), Zen Finance
  • International: Zest AI, Blend, Upstart

So what does the future hold in store for our plucky band of digital lenders?

Path to exit for standalone lenders in Latin America will likely be via acquisition by a traditional financial institution looking to enhance its digital capabilities, a merger with a non-fintech startup looking to add lending to its product set (given saturation in the tech-enabled lending space, consolidation is inevitable), or potentially via IPO for those players that are able to reach escape velocity. In the event of a public offering, however, it remains to be seen how Latin American lenders will fare. Notably, former fintech darlings Lending Club and OnDeck in the US, as well as Funding Circle in the UK, have all been trading in the doldrums for some time.

Taking this into account, the future winners in the credit space in Latin America may actually not look much like lenders at all. If data is indeed the new oil, platforms with rich transactional data sets and sticky user bases (e.g., enterprise SaaS players, challenger banks, payments platforms, and even e-commerce) may be better positioned to offer sustainable digital lending products. Take the case of the meteoric rise of Square in the US, for example, which was able to leverage the transactional data on its payments platform to more intelligently underwrite loans for small merchants under its Square Capital division.

Regardless, given the massive credit gap in Latin America, the emergence of significant fintech lending businesses in the region is inevitable, and I can’t wait to see how the landscape shakes out in the coming years.

Las opiniones compartidas y expresadas por los analistas son libres e independientes, y solamente sus autores son responsables de ellas. No reflejan ni comprometen el pensamiento o la opinión del equipo de Latam Fintech Hub y, por lo tanto, no pueden interpretarse como recomendaciones emitidas por la plataforma. Esta plataforma es un espacio abierto para promover la diversidad de puntos de vista en el ecosistema Fintech.
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