In an effort to boost its payroll debit loans business, Brazil’s Itau Unibanco Holding SA ( ITUB - Analyst Report ) , through its subsidiary, Itau Unibanco S.A. has entered into a joint venture (JV) agreement with Banco BMG S.A. The JV will be called Banco Itau BMG Consignado S.A. and will offer payroll deductible loans across the country.

Itau Unibanco will have a 70% controlling stake in this JV while BMG will hold the remaining 30%. A majority of the members of the Board of the JV would be appointed by Itau. The JV will commence its business with an initial capital stock of R$ 1 billion ($492 million).

Moreover, the agreement terms entails Itau Unibanco to offer up to R$300 million per month as funding for BMG's Payroll Debit Loan operation for a term of five years.

Itau Unibanco aspires to be a leader in the payroll loans industry and expects its JV to originate a total payroll loan portfolio of R$12 billion in the next two years. The deal would also help the company in offering its banking products to approximately 3 million new customers.

In Conclusion

We believe that for Itau Unibanco, which is experiencing a rise in default rates on its loans, the move to boost the low risk payroll deductible loans business is a strategic fit. Notably, payroll deductible loans refer to loans which are being offered to clients who have a payroll account, where their salaries are deposited in the bank offering the loan.

The bank has the authoritative power to deduct the monthly instalments directly from the payroll account. Hence, the risk is low with such loans and chances of default reduce meaningfully.

Itau Unibanco’s solid business model, this strategic JV, a diversified product mix, growing service fees, cost controls and expanded credit portfolio are encouraging. But we believe that besides asset quality concerns, increasing competition and the stressed conditions in the Brazilian economy pose risks.

Itau Unibanco’s shares retain a Zacks #5 Rank, which translates into a short-term Strong Sell recommendation. However, its closest peer Banco De Chile ( BCH - Snapshot Report ) retains a Zacks #3 Rank, implying a short-term Hold recommendation.