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Brazil’s Itau Unibanco Holding S.A. (ITUB - Analyst Report) reported third-quarter 2013 recurring earnings of R$4.0 billion ($1.75 billion), up 11.1% sequentially. Including non-recurring items, Itau Unibanco’s third-quarter 2013 net income came in at R$3.99 billion ($1.74 billion), up 11.5% sequentially.

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

Operating revenues of R$19.6 billion ($8.6 billion) at Itau Unibanco in the reported quarter surged 2.1% sequentially. Managerial financial margin jumped 1.7% sequentially to R$11.8 billion ($5.1 billion). Annualized net interest margin with clients decreased 30 basis points sequentially to 9.1% in the reported quarter.

Banking Service Fees and Income from Banking Charges moved up 3.7% sequentially to R$5.6 billion ($2.4 billion). Revenues from insurance, pension plans and capitalization operations remained almost in line with the prior quarter at R$1.4 billion ($0.6 billion).

Itau Unibanco’s non-interest expenses came in at R$8.7 billion ($3.8 billion), up 1.2% sequentially. Notably, the company experienced a 2.7% rise in personnel expenses while administrative expenses decreased slightly from the prior quarter.

In the quarter under review, the efficiency ratio reached 48.2%, reflecting a decrease of 90 basis points from the prior quarter. A decrease in the efficiency ratio reflects an upswing in profitability. However, expenses for provisions for loan and lease losses at Itau Unibanco decreased 8.2% on a sequential basis to R$4.5 billion ($2.0 billion).

The nonperforming loan ratio (loan transactions more than 90 days overdue) was 3.9% in the reported quarter, decreasing 30 basis points sequentially. Moreover, nonperforming loans declined 5.6% sequentially to R$15.1 billion ($6.6 billion).

Itau Unibanco’s credit portfolio, including endorsements and sureties, reached R$481.0 billion ($213.0 billion) as of Sep 30, 2013, up 2.9% from the prior quarter.

As of Sep 30, 2013, Itau Unibanco’s total assets amounted to R$1.08 trillion ($0.5 trillion), up 1.9% from the end of the prior quarter. Assets under administration stood at R$622.4 billion ($275.6 billion), up 2.3% sequentially.

Moreover, annualized recurring return on average equity increased to 20.9% in the reported quarter from 19.3% in the prior quarter. The Bank for International Settlements (BIS) capital ratio was 17.5%, in line with the prior quarter.

Outlook

For the year 2013, the company expects expenses for provision for loan losses to range from R$19 billion ($9.0 billion) – R$22 billion ($10.4 billion). Moreover, non-interest expenses are expected to increase in the range of 4% – 6%, with total credit portfolio in the range of 8% – 11%.

Further, banking service fees and revenue of insurance, pension plan and capitalization are expected to elevate in the range of 15% – 18%. Risk-adjusted efficiency ratio is expected to improve 200 to 400 basis points.

In Conclusion

Itau Unibanco’s diversified product mix, increasing operating revenues and expanded credit portfolio are encouraging. Additionally, we believe that improving asset quality remains a positive catalyst for Itau Unibanco. However, increasing competition, elevated expenses and the stressed conditions in the Brazilian economy pose risks.

Itau Unibanco currently carries a Zacks Rank #3 (Hold). Some foreign banks that are worth considering include Deutsche Bank AG (DB - Analyst Report), Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Snapshot Report) and Credit Suisse Group AG (CS - Snapshot Report), all carrying a Zacks Rank #1 (Strong Buy).

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