The coronavirus pandemic has brought the first critical test to digital lenders in Latin America, as the crisis strains funding resources and raises serious concerns over asset quality deterioration.
Some weaker players, experts say, won't survive.
"It feels like a wartime effort rather than an economic crisis," Rafael Pereira, founder of Brazilian fintech Rebel, said in an interview. "Fintech lending is a very capital intensive business. I'd make sure I have enough cash."
Unlike most traditional banks in Latin America, which rely primarily on deposits for funding, many fintech lenders depend upon the wholesale funding that has now all but dried up during the pandemic.
In Brazil, for instance, investment in start-ups sank 85% year over year in March compared to a year ago to just $18.6 million, according to a Distrito Dataminer report. Venture capital investment flows overall also dropped markedly during the month, reversing stronger than average flows in both January and February.
Capital markets, another significant funding source for digital lenders, are also effectively closed, as they are now being forced to pay "ridiculous prices" to securitize their loans, Pereira said.
The pullback on funding adds pressure to fintech lenders, which are also facing the prospect of rapidly deteriorating asset quality. Some fintech lenders warn that nonperforming loans could quintuple from prior levels.
With large informal economies and low banking penetration, fintech lenders exploded in the region within the past 5 years targeting under-served markets, such as low-income households and SMEs. According to a recent survey by the Brazilian Association of Digital Credit, or ABCD, 39% of digital lenders in Brazil serve individuals with monthly incomes between $516 and $2,227, while 40% serve customers earning less than $516 a month.
Those lending segments are now widely thought to be among the most at-risk, with isolation measures potentially undermining borrowers' capacity to repay.
"They are the first to lose their income," said Pereira, who also serves as president of ABCD.
Meanwhile, the micro and small enterprise segment — the "first wave of the (delinquency) cycle" according to Pereira — is already showing signs of deterioration. With isolation measures ongoing, more are expected to follow, as the average small business only has a cash flow buffer of between 20 and 30 days.
"Natural selection" to create a new fintech landscape
To combat the crisis, fintech companies have moved into survival mode. Non-essential expenditures have been slashed, while operating costs, in general, are being cut by anywhere from 30% to 50%. Fintechs are working heavily on their balance sheets to keep loans performing. With funding rounds on standby, companies are relying on internal financing to secure as much runway as possible.
Industry experts agreed that many players will not survive; however, they said those that do could wind up in a stronger position in a market with fewer competitors.
"It will certainly accelerate the natural selection process that was going to take place no matter what," said Gabriela Estrada, co-founder and CFO at Mexican credit card lender Vexi. "Those companies that have been cautious, with good scoring and underwriting procedures so that their book remains somewhat healthy, will have a super boom in the recovery phase."
That weeding out and clarity could pave the way for venture capital to return to the market with greater vigor.
"There is a pre-COVID valuation and a post-COVID valuation," Fabrice Serfati, a partner with Mexican VC firm Ignia, said. "Whoever remains cash abundant may try to buy-in their competitors, either to enhance technology or gain market [share]."
Other venture capital financiers acknowledged the opportunity that could emerge post crisis, but some remain cautious and stress that their most immediate concern is managing the impact on their existing portfolios.
"It is unclear as of how this (crisis) is going to unfold," James Sagan, managing partner with California-based venture capital firm Arc Lab, said. "Once it does, there will be lots of interesting ways to either buy distressed assets or inject fresh capital in fragile parts of the market."
As of April 24, US$ 1 was equivalent to 5.69 Brazilian reais.