XP: the leading Brazilian retail broker

A 20-page primer on one of the companies best positioned to capture a Brazilian equities recovery.

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IMPORTANT EDIT ON HINDENBURG REPORT RUMORS REGARDING XP.

After publishing this report, I came across rumors suggesting that Hindenburg Research might be preparing a report on XP. I have no way to verify or refute these claims. It is unclear whether such a report even exists, whether Hindenburg is indeed behind it, or if it will ever be published. Nevertheless, I believe it is crucial to bring this information to the attention of anyone who has read my analysis, as these rumors introduce significant additional risks to the investment thesis.

Regardless of the accuracy of any potential claims against XP, two major risks stand out:

- If a short report of this magnitude is released, XP’s stock could move down violently, as has happened in previous occasions.

- Trust is paramount for a financial institution. If such a report is published and gains traction in Brazil’s mainstream media, it could trigger a crisis of confidence. I suspect this risk factor may be one reason why the rumored report was not published.

While I cannot predict how this situation will unfold, my commitment is to total trust, transparency, and honesty with readers. My report highlighted several critical points, including risks related to its banking activities and advisor network issues, but overall, my assessment was positive.

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Initially a growth darling with a nosebleed valuation, XP Investimentos led digital innovation in Brazilian brokerage and retail securities markets when it IPOed in 2020.

Five years after its IPO at $40, the name now trades at $13. Beyond the obvious overvaluation at the IPO, several factors contributed to this drop: Brazil’s macroeconomic environment has been unfavorable, the country’s investment landscape is challenging for brokers, and competition—particularly from BTG—is now stronger and better prepared.

Still, I think XP is, in many respects, a better company today at $13 than it was at $40 in early 2020. It has consolidated itself as one of the leaders in managed retail investment and has shown that it can adapt to a high inflation-adjusted interest rates environment. It is also very well positioned for a recovery in Brazilian equities —perhaps the best positioned among Brazil’s financials.

XP trades at a P/E below 10x while still growing at 10/20% per year. The company is returning capital to shareholders via buybacks and dividends, making its earnings yield more than just a theoretical game. This gives it strong potential as a leveraged play on a Brazilian equity rebound.

This article aims to break down XP’s key business metrics, how the company has evolved since Brazil’s current high-rate cycle began, its balance sheet, the risks it faces, the competitive landscape, and its strategy. Calling it a deep dive would be excessive, but I hope it offers more than the usual regurgitation of an investor’s presentation that has become all too common in the independent financial community.

If you are just skimming, read the Executive Summary. From there, you’ll find a structured breakdown of the thesis under the main headings, followed by appendixes with deeper insights into the company’s operations, plus some charts, and sources.

Other articles on Brazil Financials

Brazilian Banks Primer

Brazil Capital Markets Primer

Executive Summary

• Leading retail broker: XP has established itself as Brazil’s leading retail broker, holding a significant market share in sophisticated products such as equities, funds, and corporate credit distribution.

• Sophistication business thesis: XP’s core business thesis relies on the expectation that the Brazilian public will gradually shift from simple banking CDs to equities, funds, and credit as the country’s inflation-adjusted interest rates decrease. XP aims to capture that flow from the large banks.

• Headwind cycle: The 2022/24 cycle has been particularly negative to this thesis, with Brazilian inflation-adjusted rates remaining in high-single digits. This environment has weighed on the equities market and left little incentive for customers to look for products beyond CDs. Because its balance sheet is much smaller than that of the banks, XP cannot (and does not want to) compete too much in this business.

• Best positioned to capture the equities rebound: When and if inflation-adjusted interest rates decline, XP is well positioned to capture part of the flow, moving to more sophisticated strategies, like equities or corporate credit. This remains the main bullish opportunity for XP. In this regard, XP is arguably the most leveraged vehicle to a Brazilian equities recovery—and the only one that is both accessible and deep from the US.

• A larger balance sheet presents new risks: To sustain growth and retain clients, the company has had to adapt and offer more traditional banking products. While CDs are the primary offering, XP has also introduced retirement plans, credit cards, and collateralized credit. This has required a balance sheet expansion, which presents risks (mainly duration). That said, these risks seem controlled from a Basel perspective, and the company could have expanded faster but decided not to.

• Competition strategy based on advisors seems incorrect: On the competition front, the company is suffering. BTG had upped its retail brokerage game, leveraging its strong position in HNWI and private banking. Not only is BTG well regarded among sophisticated retailers, but XP appears to be allocating resources to the wrong competitive assets. XP is putting a lot of effort into its advisory network, yet, because of a flawed incentive structure , the network becomes almost a liability. The advisors are encouraged to push high-fee products, some of which may not align with investors' best interests—or, in certain cases, directly contradict them. Even if not widespread, specific cases like the promotion of structured operations (COEs), are damaging XP’s reputation gravely.

• The price is quite low: Despite the negatives in competition and the uncertainty about whether the macro context will help, XP seems over-discounted. After a week of fast appreciation, the name still trades at a P/E of 10x and traded close to 8x in early January 2025. The name is well positioned on the upside and has shown that it can at least keep its ground during an adverse context.

Basic context

What is XP

XP is the leading individual and retail brokerage in Brazil; it holds a market share of 40/50% in individual equities and a 20% market share in all equity securities.

The company was one of the pioneers in introducing important brokerage transformations in the country, such as open platforms (selling other people’s products), low or zero commissions, a mobile interface, and a simplified UI/UX.

XP’s main business thesis is that Brazilians will move to more complex financial behavior. The main force against it is the historically high inflation-adjusted interest rate in country

The Brazilian individuals market: unsophisticated, fixed income based, low equity penetration

Brazilian individuals hold about R$7.2 trillion in financial investments (XP is about R$1 trillion). The enormous majority of Brazilians invest in simple fixed-income products offered by the banks.

The main financial investment is in CDBs (Certificado de Deposito Bancario, R$1 trillion), the equivalent of a CD or term deposit. They yield very close to the interbank rate. Another big percentage is in even lower-yielding savings accounts called poupanca, and then pension plans and investment funds that also invest mainly in fixed income (R$1 trillion each).

There’s a good reason for this behavior. As I explained in the Brazilian primer, Brazil has historically had very positive inflation-adjusted interest rates. You could make good money just by holding government bonds or CDBs.

Equities are super underpenetrated. Equities held separately make up 4/5% of all assets and 6% of investment funds.

Current macro: the high-rates cycle

XP IPOed (2019) during a long interest rate cut cycle (from 14% in 2016 to 2% in 2021). This removed capital from fixed-income instruments into more sophisticated strategies. The company doubled client assets every year between 2018 and 2021.

The trend reverted with the return of inflation in 2021/22. The Brazilian Central Bank was probably the first large bank to hike and the most violent. Rates went from 2% in 1Q21 to 13.8% in 3Q22.

XP’s growth naturally stalled. First, equity prices were decimated with higher rates, so client assets decreased even without outflows. Second, people were less willing to move money from banks CDBs to risky instruments.

After the hike, XP has been growing at 15% to 20% rates, which are more related to the natural growth of financial assets than to the growth in clients or business (even if you keep clients steady, they can earn 13% to 14% on deposits, so the assets will grow at that rate). The company’s clients' equity holdings, for example, are in the same spot in 3Q24 as they were in 1Q21.

XP’s adaptation to the cycle: bankification

When you have these banking funding instruments being favored because of the macro conditions, it becomes much more a balance sheet business than an investment business by itself - Bruno Santos, XP’s CFO, 3Q23 earnings call

Equity income naturally got a hit after the rate cycle. Equity revenue in BRL is down 15/20% from its peak in 3Q21. This was driven by lower trading activity, stagnant balances, and decreased take rates.

The company has adapted by growing in fixed income, credit, and float. It has, in some sense, become more of a bank, to the detriment of the more traditional broker business. This has required the growth of its balance sheet.

New business lines

I do not particularly feel that the revenue breakdown above does service what XP has been doing, but it is the way the company breaks up its own data. Here is my understanding of which drivers have been added, in decreasing order of importance:

• Traditional bank intermediary, offering CDBs and regular fixed-income products. The company simply earns a fee or spread between the interbank or government rate it earns and what it pays its customers. This goes into fixed income above and is probably a big driver of earnings.

• Float: any broker or bank has float (liabilities for which it does not pay much interest or its own equity). With higher rates, this has become a larger part of income. It is reported above under Other Retail.

• Fixed-income distribution: a more investment banking and brokerage retail business. XP is the leader of secondary fixed-income trading (given its weight in brokerage) and is one of the largest players in primary distribution. It is dominant in some areas like securitized fixed income (CRIs and CRAs, which make up 10% of the retail investment market). This goes to fixed-income but also to Institutional and Corporate above (issuer services).

• Traditional credit: offering collateralized credit at very low rates but also extremely low NPLs (given the loan is fully collateralized by client assets). This includes credit cards, which also generate acquisition revenues. This is reported separately above.

If we consider the fixed-income related business lines (retail fixed income, other retail, credit, and cards), they have gone from 17% of revenues in 1Q21 to 42% in 3Q24. This does not include the probably also high weight of fixed income and ‘banking-type’ activities in the corporate segment.

Balance sheet growth and composition

A broker doesn’t necessarily require a big balance sheet, particularly if it deals with securities that are not included on its balance sheet (like simple equities and bonds). On the other hand, a bank is a balance sheet business. XP naturally moved to a bigger balance sheet and added leverage to offset the natural loss of ROA (maintaining ROE stable at about 20%).

The categories on the liability side that have grown the most (from negligible in 2020/21 to 50% of the balance sheet today) are financing instruments (CDBs, term deposits, etc.) and retirement plan liabilities. The rest of the business (repos, derivatives, intermediation) is pretty similar to the early hike cycle. Financing instruments, in particular, are a bank-type of liability.

The company has not changed much where it invests those assets, with the enormous majority going to FPVL and FVOCI securities (mainly government securities but also some corporate warehousing required for the fixed-income distribution business). Loan assets also grow with credit cards and collateralized credit, but they are very small in the grand scheme of things.

Moderation and limits to growth in banking

Despite this tremendous growth in its balance sheet, the company could also be considered conservative in growth. It has returned almost $1.5 billion to shareholders in the past two years, or almost half of its equity. The company could have maintained that equity in the balance sheet and expanded its assets more, with lower leverage ratios. Money is a commodity in banking and can always be put to some use. On several occasions, XP’s management has commented that they do not want to expand the balance sheet (and therefore banking activities) more than necessary.

Balance sheet risk: RWA and risk sources.

A 14/15x leverage bank would be a highly risky proposition because of credit, interest, and duration risk. However, brokers and investment banks can have more leverage because they are taking lower risks with their assets. Other brokers are also relatively levered. Interactive Brokers assets are 12x equity, whereas Charles Schwab assets are 14x equity.

In the case of XP, the lower risk of the assets is reflected in the Basel risk-weighted-asset calculation. Whereas XP sports R$ 270 billion in financial assets, its risk-weighted assets are much lower at R$95 billion. Under RWA, its leverage goes from 15x to 5x, and its capital ratios (20%) seem conservative.

Let’s understand why by looking at market and credit risk (operational, the other category in Basel, is not really important for our purposes):

• Credit: by buying government securities and lending collateralized (in loans and credit cards), the bank reduces its credit risk significantly. It still carries credit risk on repos and, in part, on its warehoused securities (corporate debt and equities). The derivatives also carry credit risk via counterparty if OTC, although Brazil has a developed clearing system in B3. This makes up 50% of the company’s RWA.

• Market: Here, the warehousing of securities and the holding of government bonds play a much bigger role because of the risk in interest rate changes, credit spreads, and equity prices. 25% of RWA.

• Pension plans: The assets (FPVL securities mainly) and liabilities carried in the balance sheet from pension plans do not expose the company contractually. The company does not promise a return to its pension plan owners, and therefore it the asset falls, the liability does too.

When we look at FPVL securities ex pension fund assets, 56% are government bonds onshore, with minimal credit risk. The rest are warehousing securities (debentures, equities, foreign fixed-income). In FVOCI, 95% are government bonds.

In terms of maturity, the company provides very scant information. My calculations show that most government securities are not short-term bills but rather have non-current maturities. This creates duration risk (rates moving up in the long-term and, therefore, bond prices moving down, or long-term rates moving down while short-term rates remain up). The company may get such a small RWA on market risk because it has derivative overlays over its fixed-income holdings.

The main balance sheet risk comes from duration, with long rates getting dislocated from short-term rates. If the LT moves up (bear steepening), the company faces capital losses. If the LT moves down (bull flattening or inversion), it may need to pay more on its financing instruments than what it receives on its securities, albeit offset by capital gains. However, it is possible that part of this risk is offset and protected by derivative overlays.

As an example of potential risks, the company recorded a R$1.1 billion loss on its FVOCI securities between 2Q24 and 3Q24, when Brazilian long-dated bonds were selling off.

For a worst-case scenario of this risk, see the Appendix under ‘Inflation, deficit, and Central Bank.’

Depreciation risk: low on the balance sheet, high on the income statement

The risk of BRL depreciation is unrelated to the balance sheet, given that the company’s dollar-denominated liabilities are negligible.

However, because XP’s business is done in BRL, a depreciation would decrease the translation of income into foreign currency for foreign investors. XP trades only in the US, and therefore its dollar-translated (not denominated) earnings are an important factor in its stock price, probably.

The converse is also true, though. If Brazil goes through a process of asset appreciation and capital inflows, the BRL could appreciate, providing a second engine of dollar-translated earnings growth.

Competition, market share, and strategy

Segments, competitors, and position

The Brazilian retail market is segmented into three areas by wealth: regular retail (varejo, up to R$50 thousand); high-income retail (alta renda, up to R$1 million), and HNWI (private, upwards of R$1 million). Because of Pareto and log-normal wealth distribution, most of the assets are in the top two segments.

We could also segment based on level of sophistication, like based on the instruments used for savings. This would be somewhat (but not exactly at all) related to the wealth distribution: more wealth, more sophistication.

There are no available public market shares for detailed segments, but below follows an approximate positioning:

• XP dominates in more sophisticated retail and high-income retail segments.

• BTG and Itau are strong in HNWI. BTG is also strong in corporate and investment banking.

• The remaining large banks (Banco do Brasil, Itaú, Bradesco, mainly) dominate low-sophistication retail and high-income retail, the biggest segments of the market.
  They also dominate in corporate banking, mainly via investment funds.
  They also have special brokers for sophisticated retail (Bradesco has Agora, Itau has Ion, and Santander has Toro), but they are not so big.

• The neo and digital banks have a good but still small position in low-sophistication retail and have products for higher-sophistication. They are small in higher sophistication.

XP, therefore, competes head-to-head with BTG and Itau, particularly in the upper market but increasingly in the lower market. More indirectly, XP competes with banks to convert unsophisticated customers into sophisticated ones.

XP does not really compete in corporate investments or unsophisticated retail investments because it does not have the balance sheet to do that.

The picture below shows the market shares for some important categories: equities (the largest of the sophisticated categories, but as commented, still very small), fixed income (which includes the large and unsophisticated CDBs), and TVMs (or securities, the mix of fixed income and equities). The two categories not included are investment funds (where XP’s market share in retail could be as much as 17% of AuC, but it’s difficult to determine with certainty) and pension plans (6% market share). The retail total (including all of the above) is close to 14/15%.

The BTG challenge

The consensus in the market is that BTG is the main challenger to XP’s dominance of the sophisticated retail investor.

Although I have found no such detailed figures, it is believed that BTG is very strong in private wealth management and is using that strength to expand to lower market areas. The investment bank has upped its game in the self-directed app-based model with BTG Pactual Digital and offers some of XP’s benefits, like collateralized loans and credit cards. BTG’s platform was listed as number 1 for retail investments by the FGV (the most important business school in Brazil), with XP ranking second.

In a specialized forum like r/investimentos, arguably a sophisticated retail forum, BTG is a clear winner in recommendations against XP. In fact, as we will explore more below, among this sophisticated crew, XP has become somewhat of a mockery.

BTG’s effort started from a lower base. The bank was more concentrated on the higher echelons of investment and corporate banking before. Still, the growth of its wealth management segment (which I believe is the most comparable to XP’s operations) is tremendous. Since 4Q20, XP has grown retail client assets by 80% (R$600 billion to R$1.1 trillion). In the same period, BTG grew wealth management from R$250 billion to R$850 billion, or almost 250%. BTG’s wealth management is now the same size as XP’s operations. The bank has also consistently surpassed XP in net inflows since late 2022 (see below).

Unfortunately, BTG does not provide figures that are so detailed that we can compare exactly where it is winning. Could it be just adding low-value CDBs? Potentially, yes, but unlikely, given that its core customers are HNWI, the most sophisticated segment of the market.

XP’s competitive asset may be a liability: the advisor network.

It seems to me that XP is betting on the advisory network, enhanced digitally, as the main competitive asset against BTG and the other banks. From the company’s 3Q24 call: ‘Transitioning from a product distribution firm to a service provider is key to differentiate ourselves from other players for the next decade. While competitors render financial planning to ultra-high private bank clients, we are offering to clients with 300K and above, which is only possible because of our tech-enabled platform. No other player in Brazil can do it on the same scale we are doing.’ The company has bought some advisories, it has minority stakes in others, prides itself in having one of the largest networks (on a non-exclusive basis), and has invested in technology that allows advisors to manage more clients and, therefore, leverage the personalized service to lower levels of the market. XP’s founder has referred to advisors as the ‘doctors of investment health’ and the company started as an advisory in 2001.

However, the majority of the information I have been able to collect points to the advisor network as a liability, not an asset. The reason? The compensation mechanism for advisors (commissions on trading and selling of products) leads to a natural conflict of interest with clients, which ends up alienating the best customers. This is one of my main concerns about the company’s competitive position.

In forums like r/investimentos above, the main criticism (almost the only one) of XP is that its advisors are incredibly pushy and that they offer terrible investments. For clients with some sophistication, being offered a bad product is a terrible blemish in their trust in XP. Many decided to move their accounts (in many many cases to BTG) simply to avoid the advisors.

The company has also come under heavy criticism from non-investment and investment influencers because its advisor network offers a terrible credit plus derivative structure product called COE. The product is not particularly ruinous to the investor, as it consists of buying a fixed-income product, like a very long-term bond or CDB, and adding a derivative overlay on top. The problem is that the derivative generally dies from theta costs, the company eats a big spread on the fixed-income product, and the advisor eats a good commission. The result is that the investor receives half or less of the interbank rate despite locking his/her money for up to 5 years. In some particularly terrible cases, advisors have convinced clients to take on collateralized loans to fund the operation, adding even more costs for the client.

The market for COEs is small, only R$78 billion, but XP potentially had as many as R$21 billion of these on its balance sheet (structured notes under financing instruments payable). Given the size of the operation, not many clients are affected by this, but the reputational cost, particularly with the sophisticated or early sophisticated clients (the most important for XP), is tremendous.

The advisor network even represents an actual liability for XP. According to Brazilian law, XP could be liable if an advisor working with XP (even if independent) is found guilty of wrongdoing against its clients. There has been news of lawsuits against advisors for COE operations.

In my opinion, the commission-on-sales model for independent advisors makes little sense. It introduces a huge conflict of interest and can easily become predatory to clients if left unchecked. A better model would be a commission on assets under advisory, as it would remove many conflicts and align interests.

The Investment Case

Even though parts of the write-up above may come up as negative, I don’t have a negative view of XP. It is only that it is better to deal with the negatives first.

On the positive side, I have two points: the leverage to an equities recovery in Brazil and the price.

Leverage to an equities recovery and a ‘normalization’ of rates

Starting with equities, no US-listed name is more leveraged to an equities recovery. The large and neo banks have value, and I’ve written about them, but their equities business is minuscule compared to credit. I’ve also written about B3 (with an ADR, BOLSY, without much volume), which is another interesting candidate. Finally, BTG, as a mix of investment bank, asset management, and wealth manager, would probably be the best choice, but the name is not traded in the US, not even as an unsponsored ADR.

To start with, XP is levered to the equities market because it’s a Brazilian equity and because a bull market in Brazil would probably come hand in hand with an appreciation of the BRL and, therefore, of the company’s earnings. These conditions apply to all of the companies in Brazil Financials.

However, it is much more levered because at least 20/30% of its business is equities and because a better equity market would attract capital, particularly from retail, to the equities market, where XP is very dominant, from the assets where the other players are dominant.

In particular, the scenario of a bull equities market and decreasing inflation-adjusted interest rates would lead many to ‘reach for yield’ in more complex products like equities, corporate credit (instead of government credit), and funds. During the Brazilian ‘bull’ of 2021 (if you can consider a bull market not surpassing pre-COVID levels), equities represented 15% of retail’s assets (higher on HNWI than on traditional retail) versus less than 10% today. For pure retail (not including HNWI), the figures are 7% and 4% respectively. That is, equities have a lot of space to grow in the Brazilian retail balance sheet.

XP as an acquisition target

The brokerage business is particularly suitable for M&A activity (XP itself has bought about 10 brokerages in its history) because client assets and advisors can be combined without much loss, and overhead can be reduced. The acquisition of XP would not represent much in terms of balance sheet risk either. For any bank, XP’s balance sheet is a small cake. This makes XP a potential target for gaining a leading position in retail brokerage from many candidates: any of the large banks, NuBank, and even BTG. Eventually, this could help realize some of XP’s value.

Price is undemanding

After the share appreciation of the last week, XP traded at a TTM P/E of 10x, but it started trading at a P/E of 8x and even lower this year.

This is for a company that has a strong position in its core markets, has adapted well enough to a very different market cycle, and is growing faster than the monetization of the economy.

The multiple seems like a potential margin of safety (not much growth is expected), and the actual growth, above the growth of M3 and the interbank interest rate (the basic growth for a financial institution), is a margin of safety against the potential depreciation of the BRL.

This leaves the equity opportunity a little underpriced, in my opinion.

Appendixes

The following appendixes cover key aspects relevant to XP’s competitiveness, which, while not central to the main thesis of the article, provide valuable insights for a deeper analysis. Below is an index of the topics included:

• Sources of information

• Competition: understanding the advisor network

• Competition: market shares

• Competition: client type deterioration

• Competition: take rates are unimportant

• Balance sheet: duration risk and warehousing

• Balance sheet: inflation, deficit, and Central Bank, the (moderate to low) risk of Turkification

• Balance sheet: credit card and loan are collateralized but not risk-free

• Management quality: XP early history, founders, owners, and managers

• Management quality: cost management

• Management quality: returns on equity and leverage

• Miscelaneous: Why does XP pay so little taxes? The presumed profit method, potential risks

Sources of information

Most of the information above was obtained from just a few sources:

• XP’s filings with the SEC, in particular its 20-F.

• XP’s spreadsheet is available on its investor relations website. Like most Brazilian companies, XP makes available a historical spreadsheet going back to before its IPO, per quarter, with important operational and balance sheet data. This should be copied by companies worldwide as it costs nothing and greatly helps the research process, leveling the field between large and small investors.

• ANBIMA, the Brazilian Association of Financial and Capital Market Entities, publishes the most comprehensive market aggregates data, including fund inflows, fixed income distribution, and retail and private banking financial asset aggregates. I have made heavy use of the figures for distribution and retail aggregates to calculate the market shares of XP, by comparing the aggregates with XP’s own figures. Unfortunately, ANBIMA does not make historical figures readily available. You can only find the latest figures on its website, with no archive (at least to my knowledge). However, I was able to retrieve past (but not comprehensive) data using the Web Archive. The process is a little complex, so contact me if you want to replicate it.

• r/investimentos in Reddit is an important Brazilian investors forum oriented to retail, but some people at least claim to have moderately large portfolios and invest professionally. It was a great source of competitive comments on XP versus BTG.

• I also got competitive comments from YouTube finfluencers comparing brokerage accounts (you can search for ‘Qual e a melhor corretora’ and search for videos) and also for understanding the COE structure.

• In the appendixes below you can find specific links and sources to the topics reviewed there.

Competition: market shares

As explained in the Sources section, I have derived most of XP’s market share information from ANMIBA. The data is not complete, segmented, and does not reveal most of the competitor’s market shares. I was able to reveal XP’s market shares because the company gives some details on client assets, but banks like Itau or BTG do not provide so much data (because wealth and brokerage are only a part of their businesses, instead of the totality). Still, I was able to find some interesting things.

First, we can repeat the original retail asset market shares. It reveals that while XP is a medium player in total retail assets (the large banks dominate investment funds, retirement funds, and CDs), it maintains a very strong position in equities, which is probably the most sophisticated asset class for retail investors.

The above chart also shows that despite not being a leader in CDs, XP has a 15% share in fixed-income securities (which includes CDs but also debentures, corporate bonds, and other securitizations). The company claims to be a leader in secondary offerings of fixed income in retail (3Q24 call). This can be confirmed with ANMIBA data on the distribution of fixed-income securities (which includes corporate and institutional clients as well). XP has a 12% share among all fixed-income securities (this time, not including CDs nor government, but only corporate debt securities). It is also very large in securitized fixed income (CRIs and CRAs are notes backed by receivables in real estate and agriculture) and dominant in hybrid fixed income (mostly closed-end credit funds).

Finally, I did not create charts, but the company has a 17% market share in investment funds for retail (R$260 billion in client assets in this category versus R$1.5 trillion for the whole category). Outside of retail, where most of this industry lives, it is extremely small (2% of the market and 3/4% when removing the five largest banks). XP also has a 6% market share in retirement funds (previdencia), a category for which data has only been compiled recently. Although small, this is a category that XP launched in 2019 only.

Competition: understanding the advisor network

XP’s management puts a lot of emphasis on its advisor network. It is one of the main KPIs that the company shares in every earnings release. XP is proud to have a network of almost 18 thousand advisors over the approximately 26 thousand in Brazil as of late 2024.

There are two types of advisors: internal and independent. The internal advisor has a more direct employment relationship with XP, probably a salary component, and uses XP’s offices. This figure is about 2.7 thousand (3Q24 call). The rest are part of a network of independent financial advisors who work with XP under different contracts that can be exclusive or not. They receive commissions and other benefits to bring their clients’ assets and trading to XP.

I have not found a complete explanation of the compensation mechanism for advisors. The line commissions and incentives under operating costs represent about 20% to 25% of the company’s revenues. I learned from YouTube videos (like this, this, and this) that the main compensation mechanism comes from commissions on trading activity, more than assets under advisory. Both internal and partner advisors derive their income from this. This is the basis of the conflict of interest that is harming the company.

The conflict of interest has prompted regulators to act. The CVM (Brazil’s SEC) released resolutions 178/2023 and 179/2023 with a more modern regulatory approach. Most important for this discussion, resolution 179/2023 requires advisors to inform their clients quarterly of how much they have received in the form of compensation from them.

Because XP releases the number of external partner advisors in quarterly KPIs, many could have noticed that the number of advisors has grown way faster than client assets and client revenues, particularly as the Brazilian cycle turned in 2021/22.

However, this is not necessarily a sign of business deterioration, as the commissions are paid on trades, and therefore related as a variable component to revenues. Besides some technology and service expenses related to managing the network, XP is not adding much in terms of overhead.

Competition: client type deterioration

One potential indication that competition is getting tougher for XP is that the company shows some signs of attracting lower-segment customers with fewer assets per customer.

For example, the company posts the chart below on its 20-F, showing net inflow (with appreciation removed) for each cohort of clients. All cohorts add money after their first year, but each adds less and matures faster. For example, the 2017 cohort added 200% more assets, but the 2021 cohort stagnated around 100%. The trend is evident in all cohorts. It is unlikely that people are not saving money to add to their accounts, so why are the numbers stalling earlier? (Note: the first at the side of each year in the chart below represents all assets of the cohort, in R$ billions).

Another sign is the stagnation in client assets over active clients. It is natural that client assets will grow over time, even with stable clients, simply because the assets appreciate (especially so after the allocation moves to fixed income). The only explanation I can find for assets/clients to remain fixed is that the company’s newer clients contribute fewer assets.

Competition: take rates are unimportant

In some bear articles about XP, I have seen people citing take rates (revenue over assets) at the aggregate level to show that the company is getting squeezed in the market.

This is an incorrect argument because it ignores the huge change in client asset allocation over time and that take rates are naturally different for different products. Equities generate more revenue than fixed-income securities (particularly CDs). Take rates fall a little by asset class (for example, in equities from 0.4% to 0.35%), but more so because there is a huge shift from equities to fixed income.

Balance sheet: duration risk and warehousing

As shown in the main article, most of XP’s assets are securities, either carried in FVPL or in FVOCI. Unfortunately, the company does not reveal a hot lot about them, and crucially not very important aspects like whether they are fixed or variable rate, and the actual duration (not even average duration). Still, I have been able to take up a few things from what they share.

We know that most of the investment funds correspond to retirement plans, and are therefore not a risk from credit or duration (the company has no liability more than managing the plans). Therefore, the majority of the assets in both FVPL and FVOCI are ‘Brazilian onshore sovereign bonds’ for a total of R$90 billion. The totality of these securities is probably tied to the R$84 billion under ‘Financing Instruments Payable’ in Liabilities (R$47 billion in time deposits, R$14 billion in financial bills and R$20 billion in structured notes).

Further, we know that of the R$93 billion classified as current by maturity, R$70 billion have no stated maturity, which corresponds very probably to investment funds (R$63B) and stocks (R$7B). This means of the remaining R$110 billion in assets, R$90 billion are non-current. How non current is non current? We don’t know, and that’s something that XP could improve.

We can also observe here that the size of the warehousing is close to R$13 billion (debentures, real estate receivables, agricultural receivables, etc.). Not a very big risk from the credit aspect.

Balance sheet: inflation, deficit, and Central Bank, the (moderate to low) risk of Turkification

Brazil has generally had high inflation-adjusted interest rates, and at least since the stabilization at the end of the 1990s, the country’s inflation rates have been moderate by modern emerging market standards (6.1% average since 1998 versus 2.5% during the same period for the US).

The country has very little foreign-denominated debt, and its government finances itself in its own currency. This eliminates much of the risk that emerging market currencies generally face from sudden capital flow reversals.

However, the country faces a government financing problem that is not massive but should not be disregarded. The Brazilian government owes 80% of its GDP, which at a 10%+ rate generates a secondary deficit of 8% of GDP and crowds out a lot of investment. Both sides of the political spectrum are worried about this, and I think there’s consensus around the need to return to primary fiscal surplus. Brazil’s primary fiscal deficit was only 0.4% of GDP in 2024 and will probably turn into a surplus in 2025. All of this is under a ‘leftist’ government.

The risk, however, is that Brazil’s situation spiralizes out of the control of the Central Bank in the same way that Turkiye and Argentina did. The deficits require higher rates to attract bond financing, which drives the monetization of the economy, which generates inflation, which in turn leads to higher rates and higher total deficits. At some point, inflation and rates become correlated and separate from the primary deficit. Ray Dalio says that when this happens the Central Bank went broke.

I don’t think Brazil is at or close to this stage. The country’s political spectrum is aligned around the need to reduce the deficits (even if they don’t agree on whether it should be done via expenses or taxes). However, it is also true that 15%+ Central Bank rates are already in the frontier region of the financial monetization problem, taking a life of its own. I have heard more than one Brazilian fund manager warning against this scenario. In my opinion, they were driven by a hard political bias against the current Brazilian government, but the risk is real nonetheless.

Balance sheet: credit card and loan are collateralized but not risk-free

XP has added loans and collateralized credit more as services to their customer than as big sources of income. As of 3Q24, the company had R$28 billion in loans, 8.5% of its assets. Not small but not a big part of the business either. Of these R$28 billion, about R$8 billion are in credit cards, R$12 billion in retail credit, and the rest to companies.

Because of their collateralization with customer assets, the loans should be very secure, but they do generate credit losses. In 2023 the company wrote-off R$90 million, and the same happened in 9M24. XP has R$360 million (1.5% of loans) in Stage 3, from R$180 million in Dec 2023 (even though the loan book has not grown).

Management quality: XP early history, founders, owners, and managers

XP was founded in 2001 as an advisory (maybe from this stems the reliance on the advisor model). As an advisor, they discovered that education and financial democratization were a good way to grow. The company bought a broker in 2007.

In 2012, they received growth capital and bought more brokers in 2014 and 2016, moving more directly into the digital model. These brokers are Clear (focused on retail traders) and Rico (focused on low-cost, the first to introduce zero fees in Brazil). From Clear XP, it starts to take off in AuC. In 2017, Itau, the largest private bank in the country, bought a 49% stake in the company, and in 2019 the company IPOs.

Here is a conversation with the company’s founder telling the early story.

Today, the company is still controlled by the founder group via a double-class structure, but the founders control only 19% of the shares. Itau has sold most of its stake to the market and now holds only 7% of the shares.

The Board has nine members, five of whom are insiders (the founder, Guilherme Benchimol, is Chairman, along with the CEO, CFO, and General Counsel). The insiders are all pretty young; none are above 50 yet. The majority joined the company between 2006 and 2012.

The company’s CEO, Thiago Maffra, is also young, at 40. He joined in 2015, after the acquisition of the first digital broker, and worked as a tech lead and CTO until 2021, when he took the CEO role. Still, his background is financial rather than technical, which leads me to believe his choice as CTO and then CEO has to do with his capacity for execution.

Management quality: cost management

The main benchmark of management quality is the results over time. So far, XP’s managers have shown a great capacity for growth while maintaining profitability. However, it remains to be seen if they can overcome the challenges posed by competition now.

Evaluating figures like efficiency or expense ratio outside of the company’s balance sheet leveraging makes no sense because any ‘bank’ (and in this respect, XP operates like a bank) can post better efficiency ratios by taking on more risk in the interest income side of the income statement.

Still, other figures unrelated to the balance sheet show good cost control. Below, we have operating costs as % of client assets (going down) and operating costs per client (flat since 2019 despite significant inflation in Brazil over that period). Another example is the cost cut measures leading to Administrative expenses (most of the costs except for commissions and clearing) falling in 2023 and 2024 in absolute terms.

Management quality: returns on equity and leverage

XP has maintained a very stable return on equity, even though its return on assets has consistently decreased. The only way to do this has been through returning equity to shareholders and, therefore, leveraging the balance sheet. This has been a stated objective of management since at least FY23, reverting the decreasing ROE trend seen since the cycle shift in late 2021.

Will this strategy prove too risky? We have discussed it in other areas. It does show respect for shareholder equity to maintain a sufficient return. This is not uncommon in Brazilian companies, where the cost of equity is a real thing, given that high real interest rates are prevalent.

Miscellaneous: Why does XP pay so little taxes? The presumed profit method, potential risks

According to regulations, XP’s tax rate should be close to 40% or 45% (IRPJ of 15% plus a surcharge of 10%, and CSLL of 9% plus a surcharge of 6% or 11%, depending on the activity). The company lists 34% as the combined tax rate on its 20-F.

However, as seen below, not only has the company ever paid those figures, but not even half of that sometimes. The reason is that XP has structured its operations to make use of a tax system known as Presumed Profit Method (or PPM, metodo da renda presumida). With this method an activity is taxed based on a fixed profit margin by activity. It follows that if the company is more profitable, it pays less taxes. The PPM method supposedly has a very low cap of revenues (R$80 million) but there seems to be ways for XP to structure its operations to structure its operations in such a way to save on taxes based on the methodology. XP is not the only Brazilian company that has used this method. Another one that comes to mind (also in teh financial sector and with very high margins) is Vinci Partners.

One important risk to take into account is Brazil’s super high tax litigation. XP is not the case, but many large Brazilian companies end up in tax lawsuits for billions of reais over whether or not they have calculated their taxes correctly. This is particularly true for goods, though, especially because of taxes on consumption and sales that belong in part to states and not the federal government. However, it is a risk to consider over the long-term for XP.

Finally, the recent changes to tax regulations (fore example, the fiscal reform of 2024, leading to the consolidation of different sales and consumption taxes) do not seem to have a big effect on income taxes, on which the above discussion is based.

Disclaimer: The opinions expressed in the Blog are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security or investment product.