Fintech--novel technology attempting to advance and automate the application of financial services--is rapidly expanding in Latin America in terms of origination volumes, geographical presence, and capital raised. In S&P Global Ratings' view, fintech will play a key role in local securitization markets within the region in the future. The major factors that explain this boom are shown in chart 2.
Amid fintech's expansion scenario, financing becomes a relevant factor to allow the acceleration of processes. To explain the different alternatives, we have divided the financing stages into three categories based on what we typically observe in the market: the initial phase, the consolidation phase, and the growth phase.
A sequential funding path towards securitization
During a fintech company's initial phase, funding sources are typically limited. Financial support mainly comes from individuals, such as family and friends and shareholders. In some locations, crowdfunding platforms are becoming a more frequent financing alternative. As an example, the fintech Klar, a Mexican start-up focused on the payment sector, raised $7.5 million U.S. Dollars (USD) from seed capital in 2019.
In the next stage, as the project begins to consolidate and the company needs another round of funding to scale even further, we often see private or angel investors enter the scene. They can contribute not only from an economic point of view, but from their experience and knowledge. One such example is Ebanx in Brazil, which raised roughly $30 million in October 2019 from a private equity round.
In the third stage, when these entities need a stronger capital injection to continue expanding, consolidating, and developing new products or gaining market share, funding sources usually take the form of debt or equity. Fintechs that issue debt prioritize maintaining ownership rights, while those that opt for equity financing are usually looking to obtain a higher amount of cash.
As a result, financial support generally comes from private equity, venture capital, bank credit lines, or the capital markets. According to its public announcements, the Brazilian digital bank Nubank raised over $1 billion from different U.S. venture capital firms over the past three years. Credijusto, a Mexican lending platform, announced that it raised USD100 million in debt financing from Goldman Sachs and another USD100 million from Credit Suisse in the past two years. In 2019, the Colombian lending platform Sempli obtained USD6.5 million in a series A investor round. Also, during the same year in Argentina, the payment platform Ualá has raised USD150 million in a series C offering, led by Tencent and SoftBank's Innovation Fund.
Brazil is taking the lead in terms of fintech capital market financing. We can highlight the case of Gerú, a Brazilian lending platform that issued up to $3 million of convertible notes in 2018 and another 238 million Brazilian reais (BRL) through several private securitizations that same year. After its merger with Rebel (creating OpenCo, the largest personal financing platform in Brazil) this year, it raised another BRL150 million through a series C equity issuance.
Securitization is ramping up as a financing tool for fintechs
Fintechs are increasingly considering securitization as the entrance door to financing through the capital markets. An example is Brazilian fintech Nubank, which already obtained BRL500 million throughout the issuance of an FIDC (Credit receivables-backed fund) backed by credit card vouchers. In the same line, the lending platform Creditas issued five deals up to BRL900 million, backed by auto loans, personal loans, and mortgage loans over the past 12 months.
Other examples in the region include Mercado Libre in Argentina, which accumulated funding equivalent to $175 million through notes issuance backed by consumer loans. Also, the lending platform Moni obtained funding for the equivalent of $6.9 million by issuing three series backed by personal loans. Finally, we observed some activity in Mexico with private placements, where Goldman Sachs granted loan facilities to Konfio ($160 million) and Mercado Libre ($125 million) over the past few years.
When issuers are getting ready to securitize, several originators take an interim step in the form of warehousing private facilities, which allows them to season their portfolios, get familiar with the securitization process, and, in some cases, to build a reasonable track record in terms of portfolio performance before entering the capital markets. These warehousing facilities are typically granted by development banks, such as International Finance Corporation (IFC) and Inter-American Development Bank (IADB), and private banks.
Fintech is building bridges for new types of asset classes
Historically, structured finance markets have focused on residential mortgages and equipment leases in Mexico, on consumer loans in Argentina, and on a variety of assets in Brazil, mainly concerning consumer and commercial lending.
In terms of fintech securitization, the markets that have been most active are Brazil, with a strong presence in digital banks, such as Nubank; Argentina; and, to a lesser extent, Mexico. The typical assets that have been securitized were credit cards, personal loans, small and midsize enterprise (SME) loans, and auto loans.
In our view, as long as the fintech industry develops, it could pave the way for market growth by widening the spectrum of securitized assets in each country and matching investors' need to diversify their asset allocations and generate higher returns with the originators' need for finding financing sources for the products these entities offer.
Speedbumps On The Track
Transactions involving secured and unsecured consumer loans, credit cards, trade receivables, SMEs and residential loans have already reached the market across the region, and we believe securitizations from fintechs could boom in the coming years. A deep dive into the originators themselves and a comparison to traditional peers evidences key aspects that must be taken into account when analyzing a fintech-originated transaction. In this regard, we distinguish between credit risk and operational risk factors.
We've observed that the corporate development stage can vary significantly, even between fintechs with a similar length of operational track record. Within our portfolio of rated transactions, Brazilian originators, such as Nubank and Creditas, have successfully tapped the global equity markets and have become frequent securitization issuers. Other companies have recently placed independent issuances, such as CashMe and TradeMaster, and some have gone through major corporate developments, such as OpenCo (the merger between Gerú and Rebel). In other instances, the regulatory and structural framework of operations has led to a less service intensive role of the originator, as is the case with payment solution companies. (See chart 3.)
Credit risks are setting the speed limit
In our experience, credit risk factors have resulted in higher base-case losses for fintechs relative to those applied in securitizations originated by more traditional ones. Therefore, notes issued are showing higher credit enhancement levels to absorb these losses and, consequently, the financial cost could, in some cases, be slightly higher than for other more mature or traditional issuers.
Because fintechs are a new trend in the market, and most have been operating for less than five years, track record has become one of the major challenges when analyzing asset performance. Within this time frame, they typically test the market and their products while honing their models and processes. A short credit history makes it difficult to get a sense of performance about a pool of credits.
As with any company in its initial phase, fintechs also go through the process of developing and improving policies, procedures, and models. Frequent model and policy updates therefore represent a key challenge. The focus on automation and system self-sufficiency for a large part of the origination tasks implies that systems and models must be constantly monitored and updated to accommodate changing variables and evolving operating conditions. As such, the majority of the labor force for fintechs typically comprises software developers. In our view, constant changes in models and processes can result in performance volatility, to the extent that a model revision that encompasses a significant portion of the variables analyzed or the model's output can materially affect future performance, and track record may be less relevant.
Finally, we do view several aspects of the pace of expansion as a risk factor that affects overall pool performance. The fast pace can lead to some appetite for riskier credit quality clients, as well as exposure to certain industries, products, or even client demographics that can result greater portfolio delinquencies.
Operational risks could make the road more slippery for investors
Operational risk constitutes one of the building blocks in our analysis and it could, in some cases, impose rating caps. We typically focus on traditional corporate measures, in addition to company-specific management and governance-related factors. In particular, we look to understand the company's capacity to access funding sources other than through securitization, its working capital and capital expenditures requirements, and its capital structure. The lack of adequate funding options, combined with the expectation of fast growth, can put pressure on the company's liquidity at a very early stage.
The composition of a fintech's shareholders is also relevant, as a high dependency on a single investor with small investment portfolio and no track record in the industry could lead to an underestimation of risks associated with a particularly aggressive market strategy. Similarly, we check the fintech founder's and managers' background to evaluate knowledge in the industry.
Other operational risk topics we emphasize are as follows:
Cyber risks and data protection: We review the mechanisms established to validate the identity of a person and if there are controls to avoid identity theft or any other crime in the origination of credits. How does the company operate in the event of a cyber-attack and what are the contingency plans so that the platform can operate as quickly as possible?
Although securitizations have lower exposure than other entities, such as corporates and financial institutions, the potential negative credit impact following a cyberattack could be more pronounced given the limited resources available to securitizations (see "Credit FAQ: How Could Cyber Risks Affect Structured Finance Transactions?," Sept. 8, 2021).
Maturity of corporate governance and internal controls: The fast-growth pace of fintechs is usually associated with significant expansion of its labor force, but the sophistication of internal controls and overall corporate governance may not follow closely. Overall, it is important to understand if the young corporate entity has developed its compliance and internal controls adequately to accommodate for its current and future portfolio size.
Collection process: It is important to understand how well documented the collection process is, what the flow of money is, and if there is operational dependence on third parties. What happens if the loan administrator is removed? How fast and simple is it to find a replacement, and how long does it take to start operating? Is there a back-up servicer in place?
Financial position: Poor financial management, a lack of profitability, and limited funding sources could result in weaker underwriting standards, misapplication of securitized cash flows, or an adverse impact on portfolio servicing. Any of these events could negatively affect pool performance.
The pace of portfolio growth: The rate of portfolio growth often has a significant impact on overall performance. Fintechs typically seek to gain market share at very fast pace, while adjusting their infrastructure and labor capacity along the way. Sizing future demand and anticipating operational needs is crucial to prevent potential failures in portfolio management and monitoring. Also, delivering on a fast-growth strategy can be challenging during adverse market conditions, which can lead to some flexibilization to origination standards and result in overall lower credit quality portfolio.
The potentially fast evolving profile of a fintech's portfolio of receivables, along with a typically aggressive growth appetite, can lead to a volatile performance not only for an eventual transaction pool, but also in the company's profit and loss and cash flow. Fintech securitizations remain somewhat of a novelty in the Latin American market, with a still small number of rated transactions, but our view of heightened disruption risk is present for the majority of those.
A recent example of impacts associated with operational and market-related risks was the fast deterioration in credit quality of the portfolio of loans to SMEs originated by Stone Pagamentos (FIDC SOMA III and FIDC SOMA IV). Over the second quarter of 2021, Stone recognized that 35% of the obligors in its credit portfolio were delinquent in principal payments for over 60 days, and 18.7% were delinquent for principal and interest. As a consequence, the company increased its provisioning for losses to BRL780 million, which affected the company's profitability levels for that quarter.
The spike in provisioning related to higher-than-expected delinquencies partially stemmed from operational issues following the recent implementation of registration companies (third parties responsible for the registration of ownership of every credit card receivable in Brazil). In addition, the company itself accelerated origination amid an evolving and untested revised operational structure, which contributed to the exposure of the transactions to pools of receivables subject to greater performance volatility. This highlights the importance of an operational track record in estimating future performance, as well as the servicing capacity and quality of the originator/servicer under a distressed situation to prevent uncontrolled run-off of delinquencies.
Unicorns Could Appear in The Way Taking Advantage Of Securitization Benefits
According to a report published by The Association for Private Capital Investment in Latina America (LAVCA), in 2020 close to $1.6 billion was raised for Latin America fintech startups, which remains as the most invested sector. We have recently seen a significant increase in the number of companies reaching valuations of $1 billion or higher (also known as unicorns), for example, Ualá, KAVAK, Clip, and Creditas, among others.
In our view, as fintechs evolve toward becoming unicorns, some of them could leverage the benefits of securitization as a recurrent funding source in order to follow their expansion plans. Gaining access to cheaper financing sources, diversifying their funding sources, and gaining presence in the capital markets are among the main reasons why we could see unicorns securitizing.
On the other hand, some companies could use securitization as their business model, such as those that follow an originate-to-distribute strategy. As companies evolve through the cycle, they will often pose lower risk by means of acquiring a track record, obtaining a relatively higher equity base, and gaining access to more experienced management, along with being subject to stricter internal controls, audit processes, and financing conditions.
As these companies' corporate structures and portfolios of products continue to evolve in complexity, it is possible to see alignments of interest and opportunities for partnerships. This was the case for the recently announced partnership between Nubank and Creditas, which will allow for the latter to distribute its credit products for part of Nubank's client base, and also can eventually lead to Nubank owning 7.7% of Creditas.
Fintech Securitization Seems Poised To Expand Beyond Brazil And Across The Region
With technological advances rapidly evolving, fintechs will continue to expand their operations and the range of products offered by them, aiding the borrowers on which they focus. We believe that this could eventually support the use of securitization in their respective markets. However, as previously noted, credit and operational risks will be key challenges that fintechs will face on the road.
Over the past years, we've seen a considerable number of fintechs consolidate within their respective local markets and in other countries. For example, we've seen Mercado Libre expanding throughout the region, and some others that have already started their expansion plans, such as Nubank, which recently started operations in Mexico and will soon expand to Argentina, and Creditas, which recently started operating in Mexico. In our view, these expansions could act as a natural trigger on the local securitization markets, as these entities could replicate the experience they had in securitizing their pools in their respective markets.
Lending-related fintechs may find securitization to be an attractive alternative, providing them access to more competitive financing terms and liquidity to support future growth. In addition, securitization emerges as an alternative for a better risk management perspective, as well as greater diversification of their funding sources without comprising ownership.
Finally, from an investor point of view, securitization could widen the asset classes to which fintechs are typically exposed, while offering attractive yields relative to other asset classes. Plus, securitized pools from fintechs have proven to show some resiliency to the pandemic thus far.
- Latin America Structured Finance: Surveillance Chart Book, Sept. 16, 2021
- Credit FAQ: How Could Cyber Risks Affect Structured Finance Transactions?, Sept. 8, 2021
- Credit Conditions Emerging Markets Q3 2021: Slow Vaccination Prevents A Robust Recovery, June 29, 2021
- Economic Outlook Latin America Q3 2021: Despite A Stronger 2021, Long-Term Growth Obstacles Abound, June 24, 2021
This report does not constitute a rating action.
|Primary Credit Analysts:||Facundo Chiarello, Buenos Aires + 54 11 4891 2134;|
|Marcus Fernandes, Sao Paulo + 55 11 3039 9743;|
|Daniela Ragatuso, Mexico City + 52 55 5081 4437;|
|Antonio Zellek, CFA, Mexico City + 52 55 5081 4484;|
|Analytical Manager:||Leandro C Albuquerque, Sao Paulo + 55 11 3039 9729;|
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