Business Breakdowns
· Matt Reustle, Daniel Wu
[00:00:00] S0: And is this something that could expand outside of what's happening within the Meli ecosystem? [00:00:00] S1: Yeah, they've already taken that outside the Meli ecosystem. So in 2009 I believe is when Mercado Pago launched as a merchant acquiring service for digital merchants that were not on the marketplace. And then I'm not sure exactly when, but sometime later they also expanded into physical point-of-sale for off-marketplace merchants as well. So as I mentioned previously, $88 billion of GMV last year came from merchants that weren't directly on the marketplace. And that has been the main driver of growth for the payment processing business. It's just that expansion off-marketplace because then you've got a massive TAM there versus just the GMV of the marketplace. And we'll see that when we talk about the credit business as well, that there will be even further expansion off-marketplace just through products like the credit card, which can be used anywhere. [00:00:00] S0: On the processing side, who are they competing against in that region?
· Matt Reustle, Daniel Wu
[00:00:00] S0: On the processing side, who are they competing against in that region? [00:00:00] S1: The main payment processors are going to be the large banks. And then there are the fintech processors, of which Mercado Libre is one of them. And then a few other ones might be PagSeguro or StoneCo. But generally speaking, the competition looks pretty similar to what you have in the US. You'll have large banks that do a lot of the payment processing for very large merchants. So these are going to be very low fee, or it might be cents per transaction fee instead of a percentage take rate. And then in the area where Mercado Libre plays, which is the smaller merchants, it'll be more for the fintechs to compete in. [00:00:00] S0: You've referenced credit. I find the credit business here quite interesting because it's very different in regions outside of the US, which I can appreciate. Can you talk a little bit about not only how they've grown that business, but how they manage the risk of the credit business?
· Daniel Wu
[00:00:00] S1: Mercado Crédito is Meli's consumer and merchant credit business. And they basically just write short-term loans to marketplace buyers and merchants and then Pago Wallet users as well. Meli launched short-term loans in Argentina in 2016 before expanding it to Brazil and Mexico a year later. And then in 2021 it began issuing credit cards in Brazil, expanded that to Mexico in '23, and is preparing to launch credit cards in Argentina later this year. Credito has historically served underbanked users and micro and small merchants with limited or no access to credit. By facilitating this access to credit to these underserved cohorts, Meli can basically strengthen the engagement and stickiness of users and drive consumption across its entire ecosystem. Credit card adoption in particular brings significant ecosystem benefits to Meli beyond just the card spend itself. And that's one of the key pillars to Mercado Pago, achieving what management likes to call greater principality in its users' financial lives. So essentially trying to bring Mercado Pago up to the top of wallet. The credit business is arguably the most important growth driver for fintech, if not the entire company. Credit revenue was 33% of fintech revenue in 2021 and that grew to 42% in 2024. And this was entirely driven by the pretty phenomenal growth of the credit portfolio, up from $480 million at the end of 2020 to $9.3 billion today. And within that, credit cards have gone from $0 to $4 billion. Now partly offsetting that growth of the credit portfolio has been this steady decline in the yield of the portfolio. Gross interest margin after loan losses was annualizing at 50% at the end of 2020 and that's fallen to 28% today. These days Meli just reports a net interest margin after losses or NIM, but the funding costs haven't really changed that much. So there's other structural factors that are at play. And the main one is that credit cards are just a structurally lower NIM product. And I'm going to give some background to the credit card business in Brazil because this is not entirely intuitive that credit cards would be lower margin. But if you look at Brazil, where the majority of the credit card portfolio sits, the average rate on credit card revolving balances is 15% a month. And Matt, I'll let you take a guess as to what that APY is.
· Matt Reustle
[00:00:00] S0: 30 to 40%?
· Daniel Wu
[00:00:00] S1: Yeah, it actually annualizes to 450% a year. Wow. Which is absolutely insane. There's a lower rate for credit card installments with interest and that's around 180%. So then the question is, how can that be a low margin product? Well, if we take a step back and look at the credit card data. So nearly 80% of credit card receivables in Brazil are interest-free installments. And this means the 20% of credit card receivables that do pay interest need to earn enough interest income to cover the credit losses for the entire card pool plus the funding costs for the entire card pool plus the operational overhead plus earn an acceptable margin for the card issuer. If you look at the US I think 2/3 of credit card balances are interest earning and then even in Mexico that number is over 60%. So once you blend that rate out and just adjust for the fact that there's effectively a 45-day interest-free period on any card balances, the gross yield ends up being something like 40%. And compare that to the gross yield on personal loans that have been north of 80% over the past few years, especially in Argentina, and we can see why the credit card business is a lower margin product. As a matter of fact, Meli's entire Brazilian 2023 credit card cohort only became NIM positive this year and only 51% of the Brazilian credit card portfolio is currently NIM positive. The Mexico portfolio is still NIM negative and Argentina is also expected to be NIM negative for the first few years after the product launches. And then just the other reason as to why this is a structurally declining NIM is the fact that the credit business continues to push up market into higher credit quality cohorts. And that's obviously going to come with lower interest income. But we do think it is necessary for the healthy long-term growth of the credit portfolio. And you mentioned credit risk as well. Given the rapid growth of the credit business and the relatively high credit risk profile of the borrower base, I think it is fair to be concerned about blow-up risk, especially in an emerging market where economic conditions tend to be more unstable. If we look at the reported credit metrics, non-performing loans have been broadly stable since the launch of the credit card business except for a few quarters in 2022. And the portfolio has been adequately provisioned in all periods.
· Daniel Wu, Matt Reustle
For us beyond the reported metrics, we think management has been very prudent when it comes to managing the growth of the credit portfolio. So even though originations have grown an extremely fast clip, the priority is on building a sustainable credit business over the long term. So for example, when credit conditions started deteriorating in Brazil and Argentina in mid-2022, the company immediately scaled back origination volume and significantly tightened its underwriting standards. So while there was some temporary degradation of the credit metrics, it wasn't anything concerning to us and the provisions were more than adequate. [00:00:00] S0: What does the NPL percentage typically revolve around? You mentioned it was pretty stable. [00:00:00] S1: Yeah, I believe the NPL percentage is quite high relative to what we might think of in a developed market, but I think it bounced around mid-30s to low-20s and for the past several quarters now it's been around 28%. So if you think about it, a quarter of the credit book is essentially past due at any given point in time. And that again also contributes to why the net income margin after losses can be relatively low for the credit business.