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On Aug 8, 2013, we reiterated our long-term recommendation on Itau Unibanco Holding S.A. (ITUB - Analyst Report) at ‘Neutral’ based on the company’s diversified product mix and expanded credit portfolio. Moreover, the improving economy in Brazil would act as a catalyst. However, increasing competition and undisciplined expense management pose risks.

Why Neutral?

On Jul 31, 2013, Itau Unibanco reported second-quarter 2013 recurring earnings of R$3.6 billion ($1.74 billion), up 2.9% sequentially. Including non-recurring items, Itau Unibanco’s second-quarter 2013 net income came in at R$3.58 billion ($1.73 billion), marginally higher than the prior-quarter earnings of R$3.47 billion ($1.73 billion).

The sequential increase was primarily attributed to stable expenses for allowance of loan and lease losses and increased managerial financial margin with clients along with higher banking service fees and income from banking charges. However, decreased financial margin with market and elevated non-interest expenses were the headwinds for Itau Unibanco.

The economy in Brazil, the domestic market of Itau Unibanco, is recovering at a sluggish pace. Based on the economy improvement in the first half of 2013, the Brazilian GDP is expected to be 2–2.5% in 2013, higher than 2012. Such progress will aid in improving the company’s business prospects.

Though provision for loan and lease losses decreased in the first two quarters of 2013 for Itau Unibanco, it has been increasing since the last 4 years with an elevated level of net charge-offs. Notably, for the year 2013, the company expects expenses for provision for loan and lease losses to range between R$19 billion ($9.5 billion) and R$22 billion ($11.0 billion).

Following the earnings announcement, the Zacks Consensus Estimate for 2013 has gone up 0.7% to $1.38 per share, over the last 7 days. For 2014, the Zacks Consensus Estimate has moved up 0.6% to $1.61 per share, over the same time frame. Hence, the company carries a Zacks Rank #3 (Hold).

Major Foreign Banks to Consider

Some better performing foreign banks include BBVA Banco Franc (BFR - Snapshot Report) with a Zacks Rank #1 (Strong Buy), while Barclays PLC (BCS - Snapshot Report) and Mitsubishi UFJ Financial Group, Inc. (MTU - Analyst Report) carry a Zacks Rank #2 (Buy).

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