Fitch Ratings has affirmed XP Inc.'s Long-Term Local and Foreign Currency Issuer Default Ratings (IDRs) at 'BB-' with a Negative Rating Outlook.
At the same time, Fitch has affirmed XP lnvestimentos SA (XPI) and Banco XP SA's (Banco XP) National Ratings at 'AA(bra)' with a Stable Outlook.
Key Rating Drivers
The ratings are highly influenced by XP Inc.'s strong business profile and leading retail brokerage franchise in Brazil, including a well-developed open architecture distribution business. The company's critical mass and sound pricing power continues to translate into strong financial metrics. These factors are weighted alongside its organizational structure, comprising several layers of intermediate holding companies. Fitch views the less straightforward structure as somewhat negative since, under Fitch's criteria, it increases the complexity of the company's overall business profile assessment.
The ratings also consider the high influence of the company's sound profitability through the cycles. Fitch believes that the operating environment exerts a high influence on XP Inc.'s ratings and prospects, particularly in relation to the company's domestic clients and operations.
XP Inc.'s Operating Environment Score (OE) is the same as the Brazilian banking system's, given the market in which it operates and the characteristics of Grupo XP's business profile. Fitch revised the OE score to 'bb-' from 'b+' to reflect the banking system's resilient performance despite recent challenges to the Brazilian economy. The Negative Outlook for XP Inc.'s ratings is driven by the OE, which mirrors Brazil's sovereign rating of 'BB-' with a Negative Outlook.
XP Inc.'s solid business model has evolved into a full service financial firm catering to the needs of mass market retail investors. The company's robust technological platform and strong brand reputation are key competitive advantages over domestic banks. XP Inc.'s competitive edge easily connects bank and asset managers financial and investment products to a large pool of retail clients. The one-stop solution gives XP Inc. a tool to escalate its business at a low marginal cost and should continue to support stability of earnings.
XP Inc.'s ratings also consider with moderate influence the 'Management and Strategy' factor. The administration has considerable depth, experience and credibility, as evidenced by the successful execution of its rapid customer driven growth combined with an increasing share of wallet of existing clients. The company also managed to diversify its geographical footprint through offices in New York, Miami and Europe supporting its distribution capabilities. Fitch believes XP Inc.'s culture of innovation and its relationship with the customer has reinforced its reputation and brand in the market.
The risk profile incorporates the likelihood of operational, cyber and reputational risk, although this has to date been well-backed by XP Inc.'s highly sophisticated risk management framework. XP processes are highly automated controls are sound and well supervised by the domestic regulator. The strong risk control framework supports the minimal operational losses to date. The risk profile assessment also comprises XP Group's aggressive growth appetite and levels, including inorganic expansion, which has been key to a sustainable increase in its franchise in the context of high liquidity and low leverage.
The financial profile is strong and continues to develop given the company's good execution. Profitability is sound as evidenced by company's pre-tax return on equity of 23.6% in 1Q22, 30.2% 2021 and 26.8% in 2020 (3YE average at 30.1%). Financial Intermediation, management fees and commissions represent XP Inc.'s primary sources of income. While this income stream is sensitive to client volumes and to a lesser extent changes in asset prices, it has proved resilient under most market conditions.
Fitch views the credit risk in XP Inc.'s loan portfolio as modest but increasing due to the portfolio's rapid growth. The loan portfolio is small relative to its equity. The company created its bank in 2019 and is already offering credit cards and collateralized credit, so Fitch will continue monitoring the evolution of the entity's asset quality.
Fitch views liquidity and funding diversity as solid when compared to other NBFIs. Liquid assets cover a large part of the company's short-term debt. Liquid assets/short-term funding (excluding deposits) represent 278% in 1Q22 (3YE Average at 230%). The bank has helped the group increase its stable retail deposit base. The deposit base was BRL14.1 billion on March, 2022, BRL9.9 billion in 2021 and BRL3.0 billion in 2020. The core metric for the bank's criteria is loan/customer deposits, which was 125% in 2021 and 98% in 2020.
Following the opening of the banking subsidiary, the company was able to grow its funding sources for the retail segment. XP Inc.'s leverage was adequate, tangible assets - repos-securities borrowed/ tangible equity was 4.9x in 1Q22. The CET1 of the prudential conglomerate of the financial institutions on the XP Group was 16% in December 2021.
Rating Sensitivities
Factors that could, individually or collectively, lead to negative rating action/downgrade:
XP Inc. - IDRs
Further changes in Brazil's ratings or Outlooks or in Fitch's assessment of the OE;
Relevant losses, which bring some damage to the company's image and/or worsen operating results, in addition to greater leverage, with greater risk on-the-balance sheet can negatively affect the ratings;
If the company starts to show volatility in earnings and profitability metrics.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
XP Inc - IDRs
Further changes in Brazil's ratings or Outlooks or in Fitch's assessment of the OE;
In the medium to long term, a relevant evolution of XP Inc.'s business profile, a substantial improvement in business model diversification, and a relevant strengthening of the franchise with better visibility of the organization's structure that could enable the entity to service its obligations in an event of a sovereign default.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
XP Inc.'s unsecured senior notes rating is equalized with the Long-Term IDR, as the probability of default is the same as that of the entity. The notes will also rank pari passu with other senior unsecured obligations.
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
XP Inc.'s senior unsecured debt ratings are sensitive to a change in its IDR.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
XP Inc.'s senior unsecured debt ratings are sensitive to a change in its IDR.
SUBSIDIARY AND AFFILIATE RATINGS: KEY RATING DRIVERS
XPI and Banco XP
The national ratings for XPI and Banco XP are based on XP Inc.'s support. Fitch mainly considers as core the role in the group the subsidiaries play for the strategy of XP Inc. It also considers with moderate importance the high degree of operational integration and joint management of related entities with XP Inc, among other factors. Fitch also considers the central role played by the bank in the group's business diversification and funding strategy to be highly important.
XPI is an operating holding company that consolidates the group's investments in Brazil. Fitch considers the high correlation between the default probability of XPI and XP Inc.
Banco XP is highly integrated with XP Inc. and, despite its still moderate representation, in the total assets (around 19%), it is very important in the business model and group development strategy. Its business model, fully integrated into the group, is aimed at offering banking products, especially credit cards and collateralized loans with investment guarantees from the XP Inc.'s customers, in addition to being the group's funding arm in the market.
SUBSIDIARY AND AFFILIATE RATINGS: RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
XPI and Banco XP - NATIONAL RATINGS
Any change in XP Inc.'s capacity or propensity to provide support could affect XPI and Banco XP's ratings.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
XPI and Banco XP - NATIONAL RATINGS
Any change in XP Inc.'s capacity or propensity to provide support could affect XPI and Banco XP's ratings.
Best/Worst Case Rating Scenario
International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
XP INC. 
