The prospect of a sharp rise in global interest rates this year will prove a headache for many businesses but won’t hurt the growth trajectory of the fintech sector given its solid fundamentals, according to SoftBank Latin America Fund (SBLA).
As the Federal Reserve starts hiking interest rates in the months ahead, the region’s fintech businesses shouldn’t face difficulties accessing money to fund their expansion, said Felipe Fujiwara, investment leader for the sector at the Miami-based venture capital firm. Fintechs are operating in a market for financial services where there’s plenty of room for new players with innovative ideas to disrupt the status quo, he told iupana.
“The fact that we are far from a ceiling to the market potential provides enough room for companies to continue growing at accelerated rates even with a challenging macro scenario,” said Fujiwara.
Venture capital is pouring into the sector in response to growing demand from startups testing new business models and the more established firms, in a region that’s making big strides in financial innovation. Fintech investment in Latin America outpaced the rest of the world last year, soaring 269% to US$13 billion, according to data from CB Insights.
SBLA, which is part of Tokyo-based Softbank Group Corp., is among the region’s heavyweight investors, having allocated $5 billion to its first, dedicated Latin American tech investment fund in 2019. That was followed by a second, $3-billion fund in September 2021.
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Rising costs for credit fintechs
While capital is expected to keep flowing into the sector in 2022, investors will be keeping an eye on how quickly the Federal Reserve increases rates and removes excessive money market liquidity in response to an inflation surge over the past year.
Navigating portfolio allocation changes as the Fed lifts its key rate by as much as 1.25% percentage points this year will be fraught with difficulties, Blackrock executive Rick Rieder said in a note on the asset management giant’s website earlier this month.
The complex macroeconomic backdrop—with many Latin American central banks already raising borrowing costs to fight inflation despite weak economic growth—will impact fintechs on various fronts but those offering credit will be the most affected by higher rates. It will be hard for the increased cost of funding to be passed on fully to customers, Fujiwara said.
At the same time, some smaller fintechs may struggle to expand if they lack access to funds as surplus liquidity is sucked out of the capital markets. Selling the business to a bigger rival will be one option.
Merger and acquisition activity was already heating up in 2021, with firms such as Nubank and Creditas buying smaller competitors to expand and diversify their markets.
“Fintechs attracted a lot of capital from investors over the last year, but not all of them have potential to become really big businesses. Going forward there will be opportunities for large, well-capitalized fintechs to consolidate the market, taking advantage of an environment with lower liquidity,” Fujiwara said.
Apart from the challenging macro scenario, investors will also have to contend with political instability amid presidential elections in Brazil, the region’s largest economy.
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Businesses catching SoftBank’s eye
Fujiwara, who is also co-head of the company’s Brazil office, knows the sector from the inside, having previously co-founded Monet, a Sao Paulo-based credit fintech. That was before he entered the world of private equity, working at 30 Knots Capital, and finally moving into venture capital with SoftBank, according to SBLA’s website.
The firm’s portfolio includes many of the biggest tech names in the region, including Bitso, Clip, Creditas, Kavak, Konfio, Rappi and Ualá.
Fujiwara said SBLA looks favorably on businesses providing infrastructure for financial services, such as payment platforms Pismo of Brazil and Kushki of Ecuador, which have an important technological edge. SBLA invested in the firms’ series B rounds last year.
“They tend to be sticky with high switching costs and very defensible, have high margins and recurring revenues,” he said.
SBLA also likes business models with robust channels, such as Argentine digital wallet Uala and cloud-based SaaS business management platform Omie, which offer advantages in terms of customer acquisition costs, Fujiwara said. “These companies can monetize their clients via multiple products over a long period of time” providing a “high lifetime value,” he added.
As the region’s biggest fintech markets, Brazil and Mexico receive the lion’s share of SBLA’s capital allocation. Aside from solid political and financial foundations, the countries’ regulatory environment is also an important consideration, Fujiwara said.
“Especially for fintech, a very regulated industry, it is important to keep discipline and invest in countries with a good regulatory outlook and stability.
In Brazil and Mexico, we believe we have a degree of proper controls in place that ensure that the instability is contained between certain bands and the probability of radical or extreme changes is decreasing over time,” he said.