Creditas financial results Q4-2022
São Paulo, 21st March 2023
Context of the business
In 2022 we posted revenues of R$1.8bn, 118% increase compared to 2021 despite a much more conservative approach to growth during the second half of the year. Positive trend in gross profit is accelerating in Q4-22, increasing 60% vs. Q1-22, as we continue with our loan portfolio repricing and decreasing cost of credit.
The macroeconomic environment continues challenging, both locally and internationally. Prices remain under control in Brazil, with 5.6% inflation over the last 12 months (Feb-23 data) and market expecting to remain below 6.0% in 2023 and 4.0% in 2024. Brazil was the first country to start monetary tightening, with SELIC rate jumping from 2.0% in Mar-2021 to 13.75% in Aug-2022, a fast move by Brazilian Central Bank aiming to rapidly control prices. In normal circumstances Brazil would start lowering SELIC rates over the next couple of quarters as risks of inflation spiral have been significantly reduced and credit tightening of the banking industry has already hit consumers. However, the likelihood of interest rate cuts in Brazil fell over the last few months as increases in interest rates in USA and Europe creates a more complex framework due to potential currency impacts. The recent international banking crisis may change this situation as credit restrictions may limit the need for raising of interest rates, which has recently reflected in long-term rates.
At Creditas, we continue executing on our plan-to-profitability designed a year ago. We are successfully increasing efficiency, operational leverage, and portfolio repricing. We are now originating loans with the highest projected margins that we have ever seen to bring our gross profit back to normal levels. Improvement in gross profit of Q3-22 accelerated in Q4-22, and we expect a much more robust trend to continue through 2023. Our credit quality remains strong thanks to our focus on collateralized credit and high-quality customers. And with a more modest portfolio growth, we continue focusing our efforts on reducing customer acquisition cost and optimizing cash flows and return on capital. Finally, we have recently announced a migration of Creditas Auto towards a more asset-light business model to reduce capex and cash consumption while maintaining the channel as a unique source for auto loans.
Updating on the action plan we designed:
1. Keep portfolio growth high and sustainable: portfolio grew 59% in 2022 despite our more conservative approach to underwriting and slowing down commercial efforts in the second half of the year. We continue balancing growth and profitability so that portfolio growth provides future gross profit while keeping an eye on the negative short-term impact related to growth (IFRS provision frontloading and customer acquisition cost).
2. Accelerate repricing of loan portfolio: as anticipated, pre-fixed loans pricing has continued moving up from 32% in Sep-21 to 56% in Dec-22. Due to the long-term nature of our loans (4-year average maturity for pre-fixed loans and 15-year for floating loans) our average portfolio pricing continues increasing, from 32% in Sep-21 to 41% in Dec-22. This trend will continue through 2023 as the decay of our pre-fixed portfolio will be replaced by newer loans at new rates, accelerating gross profit expansion.
3. Increase gross profit: after gross profit compression during second half of 2021 and early 2022 due to high growth (IFRS provisions impact) and raising interest rates (funding cost impact) we are now experiencing the reverse effect with gross profit margin expanding from 10.1% in Q2-22 to 14.8% in Q4-22. We expect this trend to continue through 2023 to regain 40%+ gross profit margins. The combination of loan repricing, growing portfolio, stabilized cost of funding and lower IFRS provision impact create significant tailwinds for our profitability. As we will discuss later in our financial performance, despite record-high inflation and interest rates, we have not seen a significant deterioration of credit quality and our portfolios remain highly resilient. We expect the impact of the cycle to remain minor in our gross profit due to the presence of collaterals in all our financial products, something that we are already seeing as we saw reduction in the cost of credit of our portfolio in both Q3 and Q4-22.
4. Acquisition of Andbank’s Brazilian banking operations: after signing the acquisition agreement in July, Andbank completed the capital increase following the authorization from both Brazilian and European authorities, strengthening the balance sheet and accelerating deposits growth. The acquisition is in the process of approval by the Brazilian Central Bank.
5. Reduction of customer acquisition cost: we have managed to bring our customer acquisition cost to the minimum level ever thanks to (i) the impact of our automation efforts in lowering acquisition cost and increasing conversion and (ii) returning users and repeating customers now representing the majority of our new loan origination. In addition, as portfolio grows and loan repricing is materialized, CAC represents a significantly lower portion of our revenues.
6. Rationalizing our overhead: with significantly reduced hiring after March 2022, we continue increasing productivity per employee and expect to continue gaining operational leverage during 2023.
7. Migration of Creditas Auto business model: Creditas Auto was born with the objective of strengthening the relationship with our customers, providing consumers with a solution to buy, sell and trade a car. There are clear synergies with our lending and insurance operation, with Creditas Auto becoming our best auto finance loan originator. However, during the business expansion, we realized that we could be more efficient with a more agile business model that help us leverage the relationship with our partners and focus on intermediating the purchase of a car. During the next months we will migrate the business model of Creditas Auto to focus our efforts on C2C transactions (purchase of cars between individuals) and the optimization of the process to support the sale of our customers of Auto Equity and Auto Fin. This change has the objective of strengthening our business of lending and insurance and will be possible thanks to the expertise achieved in our ibuyer model through Creditas Auto. The result will be significant reduction in G&A and cash consumption due to the elimination of car inventory and facilities required.
Quarterly results for the period Q4-2021 through Q4-2022
Revenues of Q4-2022 posted at record R$500.2mn compared to R$358.8mn in Q4-2021, a 39% increase despite the reduction in portfolio growth rates (57% YoY growth in Q4 vs. 90% growth in Q3), impact of deflation in the home equity portfolio revenues (deflation of Aug-22 and Sep-22 impacts Q4-22 revenues due to the 2-months lag in loan pricing) and reduction in our car sales business in a new strategy to become more asset light (-31% car sales reduction YoY in our ibuyer model as we rapidly reduce our car inventory). Portfolio under management reached R$5,848mn compared to R$3,717mn in Q4-2021.
We delivered 118% growth in FY-22, slightly higher than the 100% target. We remained highly restrictive in our credit underwriting policies, especially in our Auto Finance business where we have seen more volatility both in the market and our specific portfolio. On the other side, while we continue with a credit conservative approach at this point of the cycle, we are seeing strong high-quality demand for our collateralized liquidity products, including Car Equity, Home Equity and Private Payroll loans, which constitute a strong platform for growth in 2023. Given the low LTVs of these products, we believe our product category is ideal to keep resilience in the current environment.
After seeing operational margins bottoming in Q2-2022 due to the impact of the sharp SELIC increase and the impact of IFRS provisioning frontloading related to our high growth strategy, we are experiencing an acceleration in operational margins, which have increased 43% since Q2-2022 from 10.1% to 14.5%. Operational margins benefited both from continuous loan portfolio repricing and lower cost of credit as our portfolio continues remaining resilient in current market conditions.
As a reminder, our operational margin is neutral to the level of interest rates in the economy but has compression and expansion depending on the speed of change in interest rates (impacting cost of funding while loan repricing lags behind due to the duration of our loan portfolio) and speed of growth (impacting IFRS provisioning frontloading). The upward trend in operational margins started in Q2-2022, coinciding with SELIC rate reaching 13.75% after bottoming in Q1-2020 at 2.00%, will continue during 2023 and 2024, to bring us back to our 40%+ steady-state operational margins. Potential decreases in SELIC rate would accelerate this return to historical average margins. Q1-2023 data is clearly pointing to record operational margin despite all the market turmoil.
The chart below shows the bridge between our steady-state operational margin (43.3%) and our Q4-2022 margin (14.5%):
22.8% of contribution margin (79% of the difference) is linked to the evolution of interest rates (mismatch between pre-fixed loans and floating funding sources) and the deflationary months impacting Q4-2022
1.0% of contribution margin (3% of the difference) is linked to our portfolio growth, as IFRS frontloads future credit provisions without any consideration of the credit behavior
5.1% of contribution margin (18% of difference) is related to aging of our portfolio cohorts above our expected credit losses
Inflation is still expected to finish the year below 6% as Brazilian Central Bank did a good job in raising rates before any other Central Bank in the world. Local uncertainty after the election has diminished and 2024 swap rates are now below 13%, but the likelihood of interest cuts in 2023 remain low. The Mar-17th Focus report pointed to an expectation of SELIC falling from current 13.75% to 12.75% by end of 2023 and 10.00% by end of 2024 (vs. 8.50% 3 months ago). At these SELIC levels, we would expect recovering ~40% gross profit margins in the next 12 months.
Looking at a historical perspective, in the chart below we overlap interest rates (SELIC) and inflation rates (IPCA). In the previous monetary cycle, when inflation reached 11.89% in 2016, SELIC stayed at 14.25% for 14 months; it took the BCB 9 months since inflation peaked to start the interest rate reduction cycle. It has now been 9 months since inflation peaked in the present cycle (11.73% in May-2022) and since then inflation has fallen to 5.6%.
Below operational margin we recognize 2 types of costs: (i) Customer Acquisition Costs that, despite generating gross profit over many years due to the long-term nature of the loans we originate, we recognize upfront and (ii) overhead costs, mostly related to product technology, a cost that unlike some incumbents, we don’t currently activate. As we continue building our portfolio, the impact of both CAC and overhead comes down on a relative basis as we get operational leverage thanks to scale. We expect both costs to come down significantly over the next quarters as we continue growing our revenues and operational margins well above the evolution of CAC and overhead. All in, our path to profitability is related to (i) expanding gross profit related to stabilization of SELIC, portfolio repricing and lower impact of frontloading IFRS provisions, (ii) lower impact of customer acquisition cost as portfolio builds and we get higher efficiency in acquiring customers through our own user base and (iii) operational leverage as we continue growing our revenue base to absorb existing overhead that will grow at a significantly lower pace.
Despite the gross profit compression experienced with the raise of interest rates, we have been able to reduce our net losses from R$363mn in Q4-2021 to R$209mn in Q4-2022. As we accelerate the expansion of gross profit and continue gaining operational leverage, we are confident on reaching profitability by the end of 2023 and continue with profitable growth in 2024.
We present all our financials under IFRS (International Financial Reporting Standards). The key definitions of our financial and operational metrics are below:
Portfolio under management – Includes (i) Outstanding balance of all our lending products net of write-offs and (ii) outstanding premiums of our insurance business. Our credit portfolio is mostly securitized in ring-fenced vehicles and funded by both institutional and retail investors. Our insurance portfolio is underwritten by 14 insurance carriers.
New Origination – Includes (i) volume of new loans granted and (ii) net insurance premiums issued in the period. If new loans refinance outstanding loans at Creditas, new loan origination includes only the net increase in the customer loan.
Revenues - Income received from our operating activities including (i) recurrent interest from the credit portfolio, (ii) recurrent servicing fees paid by the customers from the credit portfolio related to our collection activities, (iii) up-front fees charged to our customers at the time of origination, (iv) take rate of the insurance premiums issued, (v) total price of cars sold and (vi) other revenues from both lending and non-lending products.
Operational Margin - Margin calculation deducts from our revenues (i) funding costs of our portfolio comprising interests paid to investors, (ii) credit provisions related to our credit portfolio which, under IFRS, are significantly frontloaded to account for future losses and (iii) acquiring and preparation costs of vehicles sold.
Net Income - Net income deducts from our Operational Margin (i) costs of servicing our portfolio, including headcount, (ii) funds operational costs (e.g. auditors, rating, administration fees, etc), (iii) general and administrative expenses, including overhead, (iv) customer acquisition costs, (v) taxes and (vi) other income and expenses. We currently don’t activate any of our technology investments which include third party providers, third party platforms and salaries of our product technology team.
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