Nubank, the darling of the Latin American fintech world, continues to defy expectations. With nearly 100 million customers across Brazil, Mexico, and Colombia, the company seems unstoppable. Their recent Q1 2024 earnings call painted a picture of robust growth, accelerating revenues, and the tantalizing promise of replicating their Brazilian success story across the continent. But beneath the surface of this financial fiesta, particularly in Mexico, lies a potential risk that may have slipped past the keen eyes of most analysts.

Nubank's Mexican expansion, fueled by the aggressive "Cuenta Nu" deposit strategy, has yielded astonishing results. Deposit volumes have more than doubled in a single quarter, crossing the $2 billion mark. This feat was achieved in a fraction of the time it took them to reach similar milestones in Brazil, demonstrating the alluring power of their high-yield offering in a market starved for competitive returns.

However, this breakneck deposit growth creates a peculiar imbalance. While the company celebrates a deposit bonanza, their loan book in Mexico, last reported at $800 million in November 2023, lags considerably behind. This creates a scenario where Nubank is paying out high interest on deposits (15% net of taxes, potentially even higher gross) while their lending operations, primarily limited to credit cards, struggle to keep pace.

The Potential Consequences

The potential consequences are twofold. Firstly, this imbalance creates a negative spread, effectively eroding profitability as the cost of funding outpaces the yield on loans. Nubank is essentially paying more for the money it holds than it's earning from lending it out. While the company argues that the high returns on their Mexican credit card portfolio offset this discrepancy, the long-term sustainability of this strategy is questionable, especially as deposit volumes continue to balloon.

Secondly, the aggressive pursuit of deposits, even at the expense of short-term profitability, may be inadvertently shaping a riskier customer profile. Attracted by the high yields, individuals with a greater appetite for risk are flocking to Nubank. This concentration of risk-seeking individuals within their deposit base could potentially translate into a higher propensity for credit card defaults down the line.

This is not to suggest that Nubank is blind to these risks. During the earnings call, they acknowledged the need to "recalibrate" their deposit strategy in Mexico, hinting at a potential reduction in yields as they introduce additional product features to enhance the overall value proposition.

However, the question remains: will this recalibration occur quickly enough to mitigate the potential fallout? Or will the explosive deposit growth they've engineered transform from a triumph into a liability, jeopardizing their long-term profitability and undermining their aspirations for Mexican dominance?

The Numbers Tell a Story

Here's where the numbers raise further eyebrows. Let's assume Nubank's Mexican loan book grew at a conservative 10% monthly since November, reaching approximately $1 billion by the end of Q1 2024. Even with this optimistic loan growth, they still face a $1 billion deposit surplus. If this surplus is invested in government securities yielding around 11.25%, the negative spread widens further.

Now, let's add some context. Nubank's Brazilian operations are currently thriving with a loan-to-deposit ratio of 40%. Even with ambitions to increase this ratio significantly, it's unlikely to reach levels comparable to traditional banks (100% - 110%). This suggests that maintaining a balanced loan-to-deposit ratio in Mexico, crucial for long-term profitability, will require either a substantial deceleration of deposit growth or a dramatic acceleration of lending activities.

The Importance of Lending Product Expansion

The crux of the issue lies in the speed and effectiveness of Nubank's expansion into other lending products in Mexico. While they remain tight-lipped about specific plans, they have indicated an intention to launch "new products beyond credit card."

The success of these ventures is paramount. If they can replicate their Brazilian playbook, rapidly introducing and scaling products like personal loans, secured loans, and potentially even venturing into the underserved SME market, they may be able to balance the scales. However, replicating their Brazilian success in a market as unique and complex as Mexico is far from guaranteed.

Challenges in the Mexican Market

The Mexican market presents distinct challenges. Regulatory hurdles, consumer preferences, and the entrenched power of traditional banks create a formidable landscape to navigate. While Nubank's digital prowess and innovative approach offer a competitive edge, overcoming these obstacles will require a nuanced strategy and flawless execution.

Key Performance Indicators - Mexico

Reference: Nubank Investor Relations

The coming quarters will be crucial for Nubank in Mexico. Will they be able to transform their deposit windfall into sustainable, profitable growth? Or will this period of explosive deposit expansion be remembered as the prelude to a financial hangover, a cautionary tale of growth at all costs? The answer lies in their ability to navigate the tightrope between ambition and prudence, ensuring their Mexican fiesta doesn't turn into a financial siesta.

Deposit and Loan Growth in Mexico

The following chart illustrates the growth disparity between deposits and loans in Nubank's Mexican operations.

Reference: Nubank Investor Relations, Seeking Alpha Transcripts

"Fun Fact: Nubank's purple credit card is more than just a bold design choice. It's a deliberate strategy to stand out in a sea of traditional bank cards, reflecting the company's disruptive and unconventional approach to financial services."