Earnings Call Transcript
Nu Holdings Ltd. (NU)
Earnings Call Transcript - NU Q2 2023
Operator, Operator
Good afternoon, ladies and gentlemen. Welcome to Nu Holdings Conference Call to discuss the results for the Second Quarter of 2023. A slide presentation is accompanying today’s webcast, which is available on Nu’s Investors Relations website, www.investors.nu in English and www.investidores.nu in Portuguese. This conference is being recorded and the replay can also be accessed on the Company’s IR website. This call is also available in Portuguese. To access, you can press the globe icon on the lower right side of your Zoom screen and then choose to enter the Portuguese room. After that, select mute original audio. Please be advised that all participants will be in listen-only mode. You may submit online questions at any time today using the Q&A box on the webcast. I would now like to turn the call over to Mr. Jorg Friedemann, Investor Relations Officer at Nu Holdings. Mr. Friedemann, you may proceed.
Jorg Friedemann, Investor Relations Officer
Thank you very much, operator, and thank you all for joining our earnings call today. If you have not seen our earnings release, a copy is posted in the results intersection of our Investor Relations website. With me on today’s call are David Vélez, our Founder, Chief Executive Officer and Chairman; Youssef Lahrech, our President and Chief Operating Officer; and Guilherme Lago, our Chief Financial Officer. Throughout this conference call, we will be presenting non-IFRS financial information, including adjusted net income. These are important financial measures for the Company but are not financial measures as defined by IFRS. Reconciliations of the Company’s non-IFRS financial information to the IFRS financial information are available in our earnings press release. Unless noted otherwise, all growth rates are on a year-over-year FX neutral basis. I would also like to remind everyone that today’s discussion might include forward-looking statements, which are not guarantees of future performance and therefore you should not put undue reliance on them. These statements are subject to numerous risks and uncertainties and could cause actual results to differ materially from the Company’s expectations. Please refer to the forward-looking statements disclosure in the Company’s earnings press release. Today, our Founder, Chairman and CEO, David Vélez, will discuss the main highlights of our second quarter 2023 results and provide an overview of our operations. Subsequently, Guilherme Lago, our CFO, and Youssef Lahrech, our President and COO, will take you through our financial and operating performance for the quarter, after which time we’ll be happy to take your questions. Now, I would like to turn the call over to David. David, please go ahead.
David Vélez, CEO
Thank you, Jorg. Good evening, everyone, and thank you for being with us today. Though the financial sector in Latin America has continued to face challenging conditions over the past quarter, Nu has managed to maintain its positive trajectory with operating trends showing resilience and further decoupling from the broader markets. In Q2 '23, once again, we achieved strong growth and increased profitability while maintaining healthy asset quality. We continue to be extremely focused and committed to strong execution on our core priorities while also maintaining significant investment in future growth opportunities. Turning to the main highlights of the quarter, we continued to grow customers at a strong pace, ending the quarter with 83.7 million clients. Once again, net-adds were very robust in Brazil at approximately 1.5 million customers per month. We also resumed growth in Mexico and expect an acceleration in the coming quarters as Cuenta Nu continues to be rolled out. Most of the Cuenta Nu customers added this quarter still came via cross-selling from credit cards. Our business model continues to compound growth and profitability. Revenues reached $1.9 billion in the second quarter, expanding 60% year-over-year. Our gross profit amounted to $782 million, a 113% year-over-year increase while our gross margin expanded again to 42% this quarter, consolidating the recovery initiated last year. Sequential gross margin expansion alongside ongoing efficiency improvements drove a substantial increase in net income, which reached $224.9 million or a 53% quarter-over-quarter growth rate. Adjusted net income reached $262.7 million, reflecting a 39% quarter-over-quarter increase. These slides provide a high-level review of our recent financial performance trends over the past two years, demonstrating our capacity to consistently expand both our customer base and revenues while compounding profits. During this brief period, Nu accomplished a significant milestone by doubling the number of customers from 42 million in mid-2021 to 84 million at the end of the second quarter of 2023. In addition, we surpassed 80 million customers in Brazil in July, establishing ourselves as the fourth biggest financial institution in the country by number of customers. The strong growth for our customer base linked to the increasing cross-sell and upsell opportunities, suggested by the high engagement of our platform, resulted in our quarterly revenues multiplying by more than 5x in only two years on an FX-neutral basis, a triple-digit revenue CAGR over this period. The next chart of this slide illustrates our resilient underwriting capabilities, quarterly gross profit, defined by total revenues deducted by funding costs, transactional expenses, and credit loss allowances, increased by almost 5x in the period, with gross profit margins expanding accordingly, even though credit delinquency has increased over the past 12 months and despite our conservative expected credit loss provisioning. Lastly, all of the aforementioned drivers combined with the strong operating leverage of our platform and the initial maturation of our early products in Brazil has led to a substantial acceleration in net income growth, particularly evident in this chart on the right over the past three quarters. We expect this compounded effect to continue in the coming periods, offering a valuable combination of growth with enhanced profitability in our platform. As we have previously noted, Nu’s inception in 2013 revolved around the concept of unbundling financial services. However, today, our most significant business opportunities lie in the rebundling of financial services by building a diversified multi-product, multi-segment, and multi-country portfolio of businesses. As shown in this slide, even our adjacent businesses have successfully garnered 1 million customers, demonstrating our remarkable cross-sell capacity. As we will discuss ahead in this presentation, we believe all our critical launches taking place this year will continue to help us earn the right to become primary banking providers for more and more customers, supporting our growth and profitability flywheel. Now, turning to our profitability, I would like to highlight the evolution of the key financial metrics we presented over the past quarters. From this quarter on, we will focus only on the numbers of our holding company, as we understand that our Brazilian operations are already well understood. The momentum continued into the second quarter, as you can see by the numbers on this slide. As our three geos continued to scale and benefit from the interim operating leverage of our model, the holding company is now translating its potential into profits. Nu Holdings recorded an impressive adjusted net income of $263 million in the second quarter, representing an adjusted annualized ROE of 19%. These current levels of profitability already position us on par with many traditional incumbent banks in the Latin American region, even though Mexico and Colombia are still in the early investing stages. Even more remarkable, we achieved these results while maintaining regulatory capital ratios of 20.2% in Brazil and 42.2% in Mexico, significantly above the minimum required of 10.5% in both countries. In addition to the capital in our subsidiaries, it’s important to note that our excess cash at the holding level of $2.4 billion means that we are extremely well capitalized to deliver on our expected growth ahead. Finally, it is important to emphasize that we are delivering sound levels of profitability, despite significant investments in future products and geographies, as well as a robust 60% year-on-year revenue growth rate, which few financial institutions at scale are able to show. As seen, once more, we are very excited with the momentum of the business. And now, I would like to pass it over to our CFO, Guilherme Lago, who will walk you through our numbers in detail. Go ahead, Lago. Thank you.
Guilherme Lago, CFO
Thank you, David, and good evening, everyone. As David noted, we delivered another set of strong operating and financial KPIs driven by our simple, powerful value-generating formula. First, consistently growing our customer base across our three geos and rapidly converting them into active ones. Second, increasing average revenue per active customer, or ARPAC, by leveraging our cross-selling and upselling capabilities. And third, delivering sustainable growth while maintaining one of the lowest operating costs in the industry. Now, let’s look at the second-quarter results to see once more how well these three elements keep generating value. Starting with our customer base, which expanded by 28% year-on-year, as we added 4.6 million new customers, reaching a total of 83.7 million customers at quarter-end. In Brazil, monthly net-adds continue at a level of about 1.5 million customers, achieved mainly through organic channels with very low customer acquisition costs. We are now the fourth-largest financial institution in the country in terms of the number of customers, according to the Brazilian Central Bank. As noted in our prior call, we have been achieving faster and sustained growth rates in Mexico since the launch of our digital savings account, Cuenta Nu. We have reached more than 1 million customers less than one month after its launch in May of this year. In Colombia, we already have 700,000 customers, and we expect to grow even more after the launch of our savings account in the country planned for the end of this year. Active customers increased 32% year-over-year, with the monthly activity rate posting another consecutive quarterly increase, reaching 82.2%, up from 80.2% a year ago. We believe this positive outcome speaks to Nu’s ability to continue growing our ecosystem while driving higher customer engagement. Moving to our second pillar, which is revenue expansion. As shown on the left chart, nearly 60% of our active customers are already primary banking relationship customers, which represents the percentage of our active customers who transfer out over 50% of their post-tax income monthly. In general, the more customers use Nu as their primary bank, the greater the number of products they use, driving successive increases in the monthly ARPAC they generate. The second chart is our product cross-sell chart, which shows how we have accelerated the pace at which our customers use our products. As we launch new products, we are successfully cross-selling them to our customer base and earning the right to become their primary bank. Lastly, the third chart is our ARPAC chart. The more we engage our customers and the faster we increase our cross-sell and upsell capabilities, the more sustainable the monetization of our expanding customer base becomes. This effect can be observed again this quarter, as our monthly ARPAC reached a new high of $9.3. The monthly ARPAC of our more mature cohorts are already at $24. Higher ARPAC led to another quarter of solid revenue growth, as shown in the next slide. Monthly ARPAC continued its steady sequential growth trend, expanding 18% year-over-year on an FX neutral basis. We are confident that there is still untapped potential for further ARPAC growth, bringing us closer to realizing our full ARPAC potential. ARPAC growth, along with sustained expansion of our customer base, resulted in a 60% year-over-year increase in revenue on an FX neutral basis, reaching a new record high of $1.9 billion. Moving to our cards business, purchase volumes increased to $26.3 billion, up 30% year-over-year on an FX neutral basis. Growth was mainly driven by successful product upsell and cross-sell strategies along with higher customer engagement. The right-hand chart displays how purchase volumes increase as cohorts age. Older cohorts consistently purchase higher volumes. It’s worth highlighting the newer cohorts appear to grow more slowly than older cohorts due to two factors. Number one, a disparity in scale as these newer cohorts account for almost 20 times more customers than older cohorts. Number two, newer cohorts have at least initially lower credit card penetration using debit only, which usually implies lower ticket sizes. Our market share in terms of purchase volume is approximately 13.9% of the industry’s total, with debit cards at 14.5% and credit cards at 13.6%. We are confident that we can further increase our shares in the future, given our steady new customer acquisition and the maturation of their relationships with us. Our consumer finance portfolio, composed of credit cards and personal loans, reached $14.8 billion, up 48% year-over-year. Total credit card loans maintained their growth trend, increasing 54% year-over-year to $12 billion as we continue to add new customers to our ecosystem while keeping our low and managed credit expansion approach. However, the highlight this quarter is the lending portfolio, which increased 33% year-over-year to $2.8 billion. Lending cohorts continued to perform better than expected, giving us the conviction necessary to increase loan originations once again. Let’s now move on to the breakdown of interest-earning loans in our credit card portfolio. As we have previously discussed in our earnings calls, our focus remains on increasing the share of interest-earning credit card loans. Our interest-earning installment balance continued to expand and now makes up a record high of 19% of our total credit card loan book. Conversely, revolving receivables were kept at 7% of total credit card receivables for the fourth consecutive quarter. We believe interest-earning installments have attractive risk-adjusted rates of return that allow us to further monetize our credit card business. As our lending portfolio continues to show strong resilience and a better-than-expected performance, we have once again increased our risk appetite and origination levels. This quarter, loan origination was up 53% year-over-year to BRL 7.3 billion. The performance of our personal loans cohort improved over the last several months, giving us the conviction necessary to increase loan originations. As our portfolio continues to show strong credit resilience, we progressively grow within our risk appetite, seeking to deploy capital profitably and consistently. The launch of public payroll lending complements this strategy and reinforces the opportunities for growth we have ahead. We are confident in our ability to continue to drive attractive growth in lending. This belief is supported by our large customer portfolio, our best-in-class underwriting platform, our strong capital base, and our ample liquidity position. Moving on to funding. Total deposits expanded 23% year-over-year to $18 billion this quarter, as we advance on our goal of building a robust local currency retail deposit franchise to fund the majority of our consumer finance operations. Our loan-to-deposit ratio increased to 35%, up from 33% last quarter, as we continue to optimize our balance sheet. In line with our expectations, our cost of funding in Brazil was at 80% of the interbank deposit rate in the country, demonstrating our progress in leveraging the value of our robust liability franchise. Just one month after the public launch of Cuenta Nu in Mexico, it hit an impressive milestone, crossing 1 million customers. At the close of the second quarter of 2023, Cuenta Nu accounted for 1.3 million customers and received total deposits of more than 1.5 billion Mexican pesos, equivalent to $90 million with a cost of funding lower than 80% of TIIE, the local interbank rate, and significantly below our current cost of funding in Mexico. We believe our value proposition has been well received, leading to a steady increase in new customers each month. This has contributed to further strengthen our deposit franchise in Latin America. We believe the combination of the continued growth of our credit card and lending portfolios together with the improvement of our funding costs have contributed to the expansion of our net interest income or NII, and our net interest margins or NIM to new record high levels. Our NII gained another digit this quarter, reaching $1 billion, which represents yet another strong growth of 133% year-over-year, resulting in an increase of 260 basis points in our net interest margin quarter-over-quarter. Now focusing on the last pillar of our strategy, maintaining a low cost to serve. We strongly believe that one of our platform’s most relevant competitive advantages is low cost to serve. In the second quarter of 2023, our cost to serve per active customer remained unchanged year-over-year at $0.80, while ARPAC increased by 18%, underscoring the strong operating leverage of our business model. As we stated in prior quarters, our aim is to keep our cost to serve at or below the $1 level, as we believe our scale provides us with significant operating leverage and bargaining power with our suppliers. Moving down the P&L, gross profit reached a quarterly record high of $782 million, up 113% year-over-year. Our gross profit margin reached 41.8%, more than 10 percentage points higher year-over-year. Consolidating the acceleration in the pace of expansion started in the third quarter of 2022. We were able to achieve this result, despite the fact that we had a higher level of provisions in this quarter, resulting from the expansion of the originations of our lending portfolio as we upfront credit loss provisions. Operating leverage is a key element of our strategy. By further increasing revenues and maintaining a low cost operating platform, we have boosted profitability. As shown on this chart, we have improved our efficiency ratio over time. In the second quarter, it reached another all-time low of 35.4% or 29.2%, excluding share-based compensation, improving for the sixth consecutive quarter. This level of efficiency already ranks Nu Holdings as one of the most efficient companies in Latin America. We expect to capture additional operating leverage as our scale increases through the continued expansion of our customer base, the upsell and cross-sell of our products and the launch of new features together with improved results in our new geos of Mexico and Colombia, which still operate with losses. Lastly, we continue to drive increased profitability, delivering adjusted net income of $263 million and net income of $225 million. These positive results confirm the effectiveness of our strategy and business model. While we are very pleased with the results we have achieved so far, let me emphasize that we manage our business with a view towards long-term value creation. This can require additional investments in the short term aimed at unlocking long-term value-creation opportunities. To conclude the review of our performance this quarter, let me recap the sustainable advantages across our four cost pillars. Number one, on cost to acquire, we added almost 5 million customers in the quarter while maintaining one of the lowest customer acquisition costs among consumer fintechs and banks globally. Number two, on cost to serve: our cost to serve remained below the $1 level, which we estimate to be 85% lower than those of incumbents. Number three, on cost of risk: we successfully manage the risk of our consumer finance portfolio amid a very challenging backdrop and continue to outperform competitors when comparing apples-to-apples. Youssef will provide more details on this topic shortly. And number four, on cost of funding: we maintain our cost of funding at the level of 80% of CDI as we began to unlock the potential of our retail deposits franchise, closing the negative gap we had against incumbent banks and widening the positive gap against consumer fintechs. We are very excited about what we achieved this quarter, and we are confident in our ability to develop and scale best-in-class products, expand internationally, and continue to operate at a low cost. Now, I’d like to turn the call over to Youssef, our President and Chief Operating Officer, who will walk you through some of the highlights of our asset quality.
Youssef Lahrech, President and COO
Thank you, Lago, and good evening to you all. Once again, let me take you through some of the key indicators of asset quality and credit portfolio health for the second quarter of 2023. Let’s start with the NPL trends. Overall, our leading indicator NPL 15-90 improved slightly over the last quarter, decreasing by 10 basis points to 4.3%, in line with our expectations. Part of that drop was driven by the improvement in the performance of our personal loan cohorts, as mentioned earlier. The 90 plus NPL ratio increased as expected from 5.5% to 5.9%. As in past quarters, this continues to be driven by the stacking behavior of loans moving through the delinquency buckets as 90 plus is more of a stock rather than a flow metric. And like in past quarters, we did not sell any credit receivables, which would have otherwise artificially decreased NPL rates by virtue of the purging effect of asset sales. Renegotiations for their part remained at around 9% of the book this quarter, and nearly half of those renegotiations came from loans that were current and not past due at the time of renegotiation. Turning to the performance of our credit card portfolio against the industry, this slide shows the time series of NPLs by income band, with the purple lines representing Nu and the gray lines representing the industry. We continue to see our NPLs outperforming the industry on a like-for-like basis and for lower income bands, our competitive advantage remains even more pronounced. Similar to prior quarters, our provisions increased, primarily driven by the growth in our portfolio. Remember that we front-load provisions when we originate loans based on the expected losses for the life of the credit, and in accordance with IFRS 9’s expected loss methodology. The increase in provisions, therefore, is directly linked to the higher loan origination volumes recorded in the quarter. Our risk-adjusted net interest margin reached another record high of 8%, expanding by 140 basis points quarter-over-quarter, and 570 basis points higher than a year ago. Having shared these data and perspectives on credit and asset quality, let me now turn the call back to our Founder and CEO, David Vélez, for his concluding remarks. David, back to you.
David Vélez, CEO
Thanks, Youssef. As we wrap up, I would like to talk about two relevant product launches that took place during recent months, Secured Loans in Brazil and Cuenta Nu in Mexico. We consider these two products as essential additions to a roadmap for both countries, given the relevance for us to grow our business and earn the right to become the primary banking relationships of more and more customers. Regarding Secured Loans, we officially launched Payroll Loans for federal employees in April and started the testing phase of FGTS-backed loans a few weeks ago. Including Payroll Loans in our roadmap is going to be essential for several reasons. First and foremost, we believe it gives us access to a large asset class for consumer lending in Brazil amounting to over BRL 600 billion. Currently, more than 35% of this market is already taken by Nu Mex clients, but through our banks. Second, we believe that offering Payroll Loans and now also FGTS-backed loans is crucial for us to establish primary banking relationships with an increasing number of customers that tend to be high income. It serves as the ideal product for those that are eligible, enhancing our engagement with them. Importantly, in this new line of products, we have decided to price aggressively given the advantages of our business model efficiency and the fact that we are not going through intermediaries. Lastly, incorporating Secured Loans into our portfolio is valuable due to the remarkably low level of effective losses associated with this product. We believe these initiatives will help us complement, balance and fortify our unsecured credit portfolio with lower-risk offers. We’re already dealing with all of these secured credit products, but still in testing mode with relatively small sample sizes. While we are still in the early days, we are on track with our expectations. The conversion rate is progressing nicely, which can be attributed to our differentiated user experience and attractive pricing. By eliminating loan brokers from the process, we have passed on some of the associated benefits to our final borrowers. In addition, the current level of losses for Payroll Loans has been better than initial expectations. With a well-established positioning for Payroll Loans in Brazil, we seek to underwrite to become primary banking providers for more and more customers in the future. Regarding Cuenta Nu, we officially launched it in May and within a month crossed the 1 million customer milestone in this product in Mexico. By the end of June, we reached 1.3 million accounts and collected more than 1.5 billion Mexican pesos in deposits. Just for the sake of comparison, the average deposit per customer in Mexico is more than 10x the average of Brazilian customers’ deposits when our checking account was launched in the country in 2017. Cuenta Nu plays a pivotal role in our roadmap for Mexico based on three key factors: diversifying funding sources and reducing costs. The LATAM markets are highly concentrated, making it challenging to rely solely on wholesale funding, as competitors may not be willing to fund our growth. Additionally, securitization products are usually shallow in Latin American markets and they often become inaccessible when needed the most. We believe that, to grow our consumer finance business in LATAM, we need to develop local currency retail deposits to provide a stable and sustainable funding source, today with an effective yield lower than 80% of the risk-free rate. And as mentioned before, significantly below our current cost of funding in Mexico of funding rates plus 100 bps, which means more than 12% per year. Accelerating customer growth. Cuenta Nu has the potential to unlock our referral flywheel, resulting in accelerated customer growth. Until the end of Q1 ‘23, we could only onboard customers who met our credit card threshold, leading to a high decline ratio of approximately 70% of applications. Now with Cuenta Nu in place, we have the opportunity to onboard 100% of applicants without necessarily incurring additional credit risk. And finally, data-driven credit underwriting. Since our credit underwriting engine is built on AI machine learning, making it crucial to have sufficient data scalability, the faster we grow our customer base, the more refined and accurate our credit assessment becomes, strengthening our risk management practices and supporting responsible lending. Notwithstanding the fact that the maturation curve of new products usually takes a year, we could not be more optimistic about the future given not only our early progress in these new launches, but also the upcoming additions planned for the second half, which include, to name only a few: payroll loan portability and refinancing, INSS payroll loans, FGTS lending, and Cuenta Nu, Colombia. As we have repeatedly stated, together with our customer attraction and cost differentiation, superior products, and services foster our cross-sell and upsell capabilities, which are essential for our business model, supporting retention, loyalty, growth, and profitability. With that, we would like to take your questions now. Thank you very much.
Operator, Operator
We will now start the Q&A session for investors and analysts. I would like to turn the call over to Mr. Jorg Friedemann, Investor Relations Officer.
Jorg Friedemann, Investor Relations Officer
Thanks, operator. And our first question comes from the line of Tito Labarta, Goldman Sachs.
Tito Labarta, Analyst
Hi. Good evening, everyone. Thank you for the call and for taking my question. Congratulations on another strong quarter. My question is about the level of provisioning related to loan growth, which I know significantly influences provisioning. I’ve noticed that early non-performing loans have shown a slight improvement, which seems to be a trend across the industry. I’m curious about when provisioning might start to become a positive factor. Your gross margin improved this quarter despite the circumstances, and you’ve previously indicated that gross margins could eventually reach around 60% when you’re more mature. If the credit outlook is getting better, could that potentially act as a positive factor in the near future?
Youssef Lahrech, President and COO
Hi, Tito. This is Youssef. Thanks for the question. So look, we don’t provide guidance on credit quality or delinquencies or consequently provisioning from a forward-looking perspective. But I mean, you can take a look at how the coverage ratios have trended in the appendix of our earnings presentation, page 33, I believe. And from a coverage of 90 plus, it’s been fairly stable around 213%, 214%. And the coverage of balance generally mirrors NPL 90 plus. And it has been largely performing per expectations. So, to your point, should delinquencies improve, obviously provisions can become a tailwind, but we’ll see actual performance as it comes in.
Tito Labarta, Analyst
Thank you, Youssef. I’d like to follow up on the loan growth. David, you mentioned that payroll loans have been launched. Can you provide any initial insights on how they are performing and whether they could become significant in the second half of the year, or will it take longer? This could also potentially lower the cost of risk since the risks associated with payroll loans are considerably lower.
David Vélez, CEO
Yes. No, absolutely. So, we had to integrate a number of different contracts to launch Payroll Loans. We did that already. We’re up and running in Q2. We’ve been integrating the product, making sure it is a great product for consumers, easy to understand. We’re getting comfortable more and more with the type of feedback we are receiving. And I think you’ll start seeing us increasing the pace of originations over the next few quarters, if everything goes according to plan. But yes, I mean, I think over the next few quarters, you should start seeing meaningful demand. And again, this is the largest profit pool in financial services in Brazil. So very large market. And as we’ve said in the past, our customer base accounts for something like 35% of that entire profit pool. And we have a great product going directly to consumers and we’re pricing very effectively. Interest rates are 30% to 40% below market. So, we think we have a very good value proposition that should allow us to take significant share in this market. But again, we’ll have to take step-by-step and see how those go as we start rolling it out to the entire customer base.
Guilherme Lago, CFO
And Tito, if I may, if I may complement here, a few thoughts on Payroll Loans. We have launched now CRP as a pilot test. In the second half of the year, we’re going to launch INSS and portability. And I highlight portability because in a declining interest rate environment, the ability to actually port loans from other banks may be a relevant source of growth for us, and it’s something that we intend to lean in heavily over the coming quarters. Having said that, I do not expect that payroll loans will actually move the needle that much in terms of P&L and loan balance in 2023. I think it is more something for 2024 and beyond.
Tito Labarta, Analyst
That’s great. Thanks, David, Lago, Youssef, and Jorg. And congrats again on the great quarter.
Jorg Friedemann, Investor Relations Officer
And our next question comes from the line of Pedro Leduc, Itaú.
Pedro Leduc, Analyst
Thank you, everyone, and congratulations. Good evening, everyone. I want to ask about service revenues, which did well. It seems like interchange has remained relatively stable despite the caps. How do you foresee that developing in the future? You also mentioned a gradual increase in credit appetite. Regarding funding costs, it’s encouraging to see the increase in deposits while costs remain stable. On the ground, it appears you are seeking longer-term instruments that may exceed 80% of the CDI. While there are ways to manage costs effectively, could you provide some insight into your outlook on the changing mix of funding liabilities and their associated costs? Thank you.
Guilherme Lago, CFO
Hi Pedro, this is Lago. Thanks so much for your question. I do believe that we will progressively increase the duration of our liabilities as we increase the duration of our assets. So, we will continue to actually match very well to our asset-liability book. However, we believe that we could do so still with a very healthy balance of short-term deposits at relatively low cost of funding at around 80% of CDI. And we can entertain other pockets of liquidity in the Brazilian and international markets that would allow us to increase the duration of reliability. So, we have recently started to issue longer-dated time deposits on our platforms, and we have been very pleased with the results. So, I would basically separate we have the short-term deposits that we believe will continue to grow at 80% of CDI average cost. And then, we have other pockets of liquidity that will be more than sufficient to provide us with adequate asset-liability management as we scale progressively, primarily the book of our secured lending consignado business.
Pedro Leduc, Analyst
Great. Thank you. May I do a follow-up as well?
Guilherme Lago, CFO
Yes, absolutely.
Pedro Leduc, Analyst
Yes. All right. When I look at your credit balance, a very nice portion of the interest-bearing growing. And then when I look within the credit card composition, the revolver are basically flat Q-on-Q in reais, while the others now, especially interest rate installments, grow. It’s a very nice achievement, especially given all the discussions surrounding this line about the revolver. You can elaborate with us and shed some light on how you’ve been able to grow the others, keep that one sort of flat despite the growing TPVs, that would be great. Thank you.
David Vélez, CEO
Certainly, Pedro. This is David. From the outset, we established a strategy for our credit cards that prioritizes transactors. We have always been wary of the revolving credit segment due to its inherent complexities, which often compel issuers to impose excessively high interest rates. Consequently, we opted to develop a model focused on transactors. Ideally, we would prefer a model with 100% transactors and no revolvers, allowing us to generate revenue solely from interchange. However, this is not feasible, and as a result, we accept a small percentage of revolvers, which we aim to keep to a minimum. We avoid accepting customers who are likely to revolve on their credit cards, which is why our revolver percentage is significantly lower at 7% compared to the market average of 16%. We recognize additional opportunities to provide financing that benefits customers, where we can implement pricing with genuine elasticity at much lower interest rates. For instance, our fixed financing option over recent quarters has proven effective, enabling customers to spread their payments over several installments at much lower rates. This creates a healthier portfolio characterized by longer durations and lower delinquency rates, benefitting both us and our customers. This growth can be observed in slide 14, where we have increased our interest-bearing balances from 8% to 19%, while maintaining the number of revolvers at a minimum.
Jorg Friedemann, Investor Relations Officer
And our next question comes from the line of Eduardo Rosman, BTG Pactual.
Eduardo Rosman, Analyst
Congrats on the numbers. I have a question related to the revolving credit card theme and these potential changes in the market. What’s your take on that? Should we expect something relevant to happen? If there’s a cap, shouldn’t this be an opportunity for Nu given its much lower cost to serve? You also just mentioned that you have less revolving than peers. So, any color here would be great.
Guilherme Lago, CFO
Rosman, this is Lago. Thanks for your question. The discussions around the economics of the credit card in Brazil have been going on for years, and they have certainly intensified over the past few months, involving both the government and many credit card issuers. But those discussions are not simple because the topic is really highly complex. As you know, credit card represents a very big industry in Brazil. It accounts for about 40% of the personal consumption expenditure or PCE of the country and over 20% of the GDP of Brazil. In 2022, the purchase volume of credit cards accounted for over BRL 2 trillion. So, it’s a very important, very large industry, and any drastic or material changes to its dynamics may have fairly relevant and material consequences for the economic output. I think all of the industry participants, the government, and the regulators are fully aware of this. And we are very confident that the industry will provide an adequate solution that will even evolve and further balance the product in a better equilibrium. I think it is very hard for us, Rosman, at this point in time to draw any high conviction outlook as to what is going to happen over the next few weeks or months. But we do not expect any drastic changes in the unit economics, nor do we actually believe that an interest rate cap will be welcomed by many of the industry participants or the regulators given the material negative impact that it may have on credit availability.
Jorg Friedemann, Investor Relations Officer
And our next question comes from the line of Yuri Fernandes, JP Morgan.
Yuri Fernandes, Analyst
Congrats on another very good quarter. I have one question regarding Brazil on the profitability. I understood that the focus would be the holding. But when we look to the earnings from Brazil, Brazil was maybe $190 million. It’s a good increase from the previous quarter of $20 million. But now we see an increase in maybe other markets or maybe the whole number. I just want to check this, what is the difference between the $225 million you printed in the holding in Brazil that in the previous quarters was over the profitability of the Company. Just checking if it’s the cash at the holding at a higher rate, something like that. Thank you.
Guilherme Lago, CFO
Yuri, thanks for the question. I think two comments here. One, I would be very cautious of drawing conclusions on the profitability of our Brazilian operations by looking only at the figures that we provide to the Brazilian Central Bank because these figures, they account only for our legal entities that are fully regulated in Brazil. They do not account for 100% of our operations in the country. Your second question, though, intuitively, yes. I think the way that we operate: we have profitable operations in Brazil. We have profitable operations at the holding company, largely as a result of the investment of the $2.4 billion of cash that we have there. And we have operations in Mexico and Colombia that are still posting losses as they are in high-growth investment situations.
Yuri Fernandes, Analyst
Thank you, Lago. I was referencing your presentation. You mentioned Brazil, and while I understand it aligns closely with the report from the Central Bank, I believe it's important to acknowledge the Brazilian consolidated earnings. Additionally, Lago, I have a follow-up question. How significant are higher-income clients to your strategy at Nubank? You have established a strong presence among lower and middle-income clients, which is a frequent topic of discussion with investors. We would appreciate your insights on higher-income clients. Thank you.
Guilherme Lago, CFO
No, absolutely. So look, moving into the high-income sector is one of the Company’s priorities for the 2023-2024 period. And we have invested a good amount of time and resources trying to understand globally how companies have succeeded breaking into the high-income segments in many parts of the globe. And we have basically crafted a strategy that is composed of two steps. One step is customer acquisition. The second step is customer monetization. I think in the first step, which is customer acquisition, when we look at the past 18 months, we are fairly pleased with how many high-income customers we have acquired in the country if you define a high-income customer as a customer who earns more than BRL 12,000. We already have over 60% of the high-income customers of Brazil being customers of Nubank. So I think the first step of this two-step strategy has been very successful so far. We are now entering into the second step, which is to deepen the relationship with those customers and to be able to increase our share of wallet with them. So if you compare the demographics of the customer base of Nubank with the customer base of incumbent banks, you see that, in terms of the number of customers, we have a relatively similar breakdown between low income, middle income, and high income. However, our share of wallet in the low income and middle income is still much higher than our share of wallet in the high income, and there lies the huge opportunity that we have to grow customer monetization in Brazil over the coming one or two years. However, Yuri, the growth into any new kind of demographic or segments, it’s not a sprint, it’s a marathon. By which I mean it’s not something that you’re going to be able to show results in one quarter, two quarters. I think it is a matter of a few years in which we will strengthen our value proposition and progressively grow into this new segment.
Yuri Fernandes, Analyst
Perfect. Thank you. And congrats again on the quarter.
Jorg Friedemann, Investor Relations Officer
And our next question comes from the line of Thiago Batista, UBS.
Thiago Batista, Analyst
Hi Guys. Congratulations for the results, very strong results. My question is about the good surprise of the ROE of 17% that you guys posted this quarter. Even with excess capital and also with losses in Mexico and Colombia, this level is already higher than most of the incumbents in Brazil in line with Itaú retail business, and since Nubank has structured a better efficiency ratio than peers. So my question is, how do you believe Nu will play the superior efficiency in the long term? So the bank should deliver or the fintechs deliver a much higher ROE than peers? Or part of this will be shared with clients, and consequently, Nu tends to have a much lower price than peers. So, how are you guys likely to play with the superior efficiency versus peers?
David Vélez, CEO
Yes. No, great question. I think it talks to the heart of the digital banking strategy we’ve been pursuing since the very beginning, which is similarly to what you’ve seen when you have technology companies, fully digital technology companies competing with traditional companies that are more offline operations. We have the opportunity to use the efficiency of our business model that now you can start really seeing especially around the operating efficiency. When we have our customers, so that we provide a product that has higher quality and lower cost, allowing us to win more share. And so, you start creating a bit of a flywheel where you gain share, you gain scale that scale gives you lower cost to serve. You then go back and pass that efficiency, again to the customer via better products and even lower pricing, and you have these reinforcing flywheel. We expect to do that in banking. So, part of our initial value proposition was charged zero fees. So even since the beginning, we started already charging no fees on that side and that meant an opportunity to compete on price. But as we grow and we get more data and our models mature and our cost to serve decrease even lower, we can then start doing both, lower fees and lower prices in credit products. So, specifically to your question, we think we’re going to be doing both. We will use the advantage of the business model to both gain share as well as ultimately see a higher return on equity than traditional incumbents, given ultimately, this cost structure advantage is very strategic and it’s going to be hard for competitors to match that cost structure advantage in a short period of time.
Thiago Batista, Analyst
No, very clear. If I can do a follow-up, my follow-up would be regarding artificial intelligence. If you guys are already using these? And where this should improve the bank’s operations? So, it will be more on costs, more on the asset quality. So how should this improve the operations of the bank?
David Vélez, CEO
Yes, we have been actively using artificial intelligence for a while now and have made significant investments in understanding how large language models can be applied in various ways. We see applications in many areas, from improving customer service at lower costs to enhancing fraud detection, anti-money laundering efforts, and defense. We are particularly excited about the potential applications for consumers, as we aim to reinvent the user experience. When we started the company, we viewed the smartphone as a means to put our bank in every consumer's back pocket. We believe AI will enable us to have a bank and banker available to every consumer, democratizing access to quality financial services for the 95% of the population that still lacks access to the best products. We firmly believe in the numerous opportunities this technology presents, both offensively and as a means to increase the efficiency of our operational model.
Eugene Simuni, Analyst
Great results here. I just wanted to ask about card issuance volume trends in Brazil and for you guys. Obviously, a very strong number with kind of 30% year-over-year growth in your purchase volume, FX neutral, I believe, much better consistently than what Brazil market is doing. But it is decelerating at a relatively rapid pace. And when we look at the Brazil overall numbers kind of with ABX reports, there seems to be significant deceleration this year as well. So just curious to hear your thoughts on kind of what’s going on in the market overall in terms of card issuance in Brazil, maybe some impact from PIX that you are seeing and then how that then gets reflected in your growth and kind of what we can expect in the second half of the year and going forward?
Guilherme Lago, CFO
Eugene, I think it’s very hard to address this question without making reference to the normalization post-COVID. What we have seen over the past two years, I would say 2021 and 2022 in Brazil, it was a very strong recovery from COVID loss and a fairly aggressive extension of additional credits in the country, additional credit cards in the country. And over the past, I want to say, 6 to 12 months, you’ve seen a deceleration in credit expansion in consumer finance in Brazil, including but not limited to credit cards. We continue to outpace the industry by a fairly large amount. We have been gaining market share at a clip of about 40 to 50 basis points per quarter throughout the past quarters. And we expect that this pace is to continue in the coming quarters even though we do not necessarily target kind of market share goals. But the pace at which we have been able to onboard new customers, the pace at which we have been able to mature existing cohorts and cross-sell credit cards suggest that we will continue to gain market share at a good pace in the foreseeable future.
Eugene Simuni, Analyst
Got it. And just maybe a very quick follow-up. Are you seeing any sort of negative impact from PIX success on card volumes?
Guilherme Lago, CFO
No, absolutely not. What we have observed is that PIX is an exceptional payment mechanism in Brazil. Primarily, we believe that PIX has been taking market share from cash. That's the main point. We have noticed some initial indications that PIX may also be impacting debit and prepaid cards, but there is no evidence to suggest that it is affecting credit cards. In fact, we have observed a strong correlation between the adoption of PIX and financial inclusion in Brazil, which sometimes goes hand in hand with an increase in credit card usage. This trend is somewhat similar to what has been seen in India with UPI, but it’s still too early to draw definitive comparisons between the two regions.
Youssef Lahrech, President and COO
This is Youssef. I would like to emphasize something David mentioned previously, which is that the initial impact on our PIX portfolio has been the rapid adoption of PIX financing using credit card limits. This has significantly contributed to the increase in our interest-bearing balances, providing a notable advantage for us.
Jorg Friedemann, Investor Relations Officer
And our last question comes from the line of Jamie Friedman, SIG.
Jamie Friedman, Analyst
Lago, in your prepared remarks, you noted the strength in the debit and prepaid component of the newer cohorts. I am curious, as that representation grows in your portfolio, are there specific products for financial inclusion that you believe would be better suited for that population? I am interested in the debit prepaid mix. Thank you.
Guilherme Lago, CFO
I would like to draw your attention to slide number 12, where you can see the evolution of credit cards and prepaid cards. As I previously mentioned, among younger and earlier cohorts, there is a higher usage of prepaid cards. We believe this is a beneficial way to initiate a consumer credit strategy at Nubank, allowing us to start a relationship with a customer using a prepaid card only. As we gather more information on the customer's income, spending, and saving behaviors, we can gradually become more comfortable and offer them a credit line on a credit card. Typically, we begin, as Youssef indicated, with a relatively low credit line through a “low and grow” approach. As the customer develops their credit history with us, we gradually increase this over time. You can observe that purchase volume tends to triple within the first 24 months. This approach has proven to be very effective in terms of customer engagement and asset quality, and we plan to continue following this strategy in the years ahead.
Jorg Friedemann, Investor Relations Officer
And in the name of Nu Holdings and its management team, I’d like to thank you all for the participation in this conference call. Over the coming days, our team will be responding to the questions sent through our webcast and email. We also take the opportunity to make our whole IR team available to any further questions you might have. And this concludes our earnings call. Have everyone a good night.
Operator, Operator
The Nu Holdings conference call has now concluded. Thank you for attending today’s presentation. You may now disconnect.