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Provisions Pull Down Itau Profit

ITUB BCH

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Brazil’s Itau Unibanco Holding S.A.’s (ITUB - Analyst Report) reported third-quarter 2012 recurring earnings of R$3.4 billion ($1.7 billion), down 4.8% sequentially and 13.4% year over year. The company continued to experience elevated levels of provisions for loan losses.

Including non-recurring items, Itau Unibanco’s third-quarter 2012 net income came in at R$3.37 billion ($1.7 billion), slightly above the prior-quarter earnings of R$3.3 billion ($1.7 billion) but below the year-ago earnings of R$3.8 billion ($2.3 billion).

Operating revenues of R$19.5 billion ($9.6 billion) at Itau Unibanco were down 3.7% sequentially but moved up 0.9% year over year. The sequential decline primarily reflected a fall in the financial margin, impacted by the drop in the SELIC rate.

Moreover, the company experienced reduced growth of higher risks and spread portfolios. Yet, the declines were partly mitigated by a sequential dip in non-interest expenses as well as a slight decline in provisions for loan losses.

Managerial financial margin slipped 4.8% sequentially and 0.9% year over year to R$12.8 billion ($6.3 billion). Net interest margin with clients waned 30 basis points sequentially and 110 bps year over year to 10.6% in the reported quarter, mainly due to the decrease in the SELIC rate and higher growth in the loan portfolio of lower risk and spread.

Banking Service Fees and Income from Banking Charges moved down 0.9% sequentially to R$5.0 billion ($2.5 billion). However, it advanced 4.4% year over year. Revenue from insurance, pension plans and capitalization operations grew 2.1% sequentially and 13.4% year over year to R$1.5 billion ($0.7 billion).

Itau Unibanco’s non-interest expenses were R$8.1 billion ($4.0 billion) in the reported quarter, down 3.1% sequentially and 3.0% year over year. Notably, the company experienced a 5.4% decrease in administrative expenses though personnel expenses augmented only 0.5% from the prior quarter.

In the quarter under review, the efficiency ratio reached 45.5%, reflecting an increase of 50 basis points from the prior quarter.

The expenses for provisions for loan losses at Itau Unibanco decreased 0.8% sequentially but moved up 19.5% year over year to R$5.9 billion ($2.9 billion). Elevated default levels of the vehicle and enhancement in the personal loan portfolio (primarily installment payment plans and overdraft accounts) mainly contributed to this high level of provisions.

For the next two quarters, the company expects expenses for provision for loan and lease losses to range between R$ 5.5 billion and R$ 6.0 billion.

The nonperforming loan ratio (loan transactions more than 90 days overdue) was 5.1% in the reported quarter, decreasing 10 bps sequentially but advancing 40 bps year over year.

Itau Unibanco’s credit portfolio, including endorsements and sureties, reached R$417.6 billion ($205.8 billion) on September 30, 2012, inching up 1.0% from the prior quarter and 9.3% from the year-ago period.

As of September 30, 2012, Itau Unibanco’s total assets amounted to R$960.2 billion ($473.3 billion), up 8.0% from the end of the prior quarter and 14.7% from the comparable prior-year period.

However, recurring return on average equity decreased to 17.7% in the reported quarter from 19.4% in the prior quarter and 23.5% in the year-ago quarter. The Bank for International Settlements (BIS) capital ratio was 17.5%, up 60 basic points (bps) sequentially and 200 bps year over year.

Recent Development

On October 23, Itau Unibanco announced the sale of its remaining stake of 601,403 shares of Serasa to Experian. The company expects to experience an income before taxes of R$ 1.5 billion in the fourth quarter of 2012.

On September 24, Itau Unibanco acquired 44.4% of Redecard through a Tender Offer for a purchase price of R$ 35.00, amounting to 94.4% of the share capital (R$ 10.5 billion). Following the auction, additional shares were acquired, which lifted the company’s interest in the capital of Redecard to 98.0%, reflecting a total investment of R$ 11.3 billion. The company expects to complete the purchase of 100% shares by the end of 2012.
 
Moreover, through the association with Banco BMG S.A., established on July 9, 2012, Itau Unibanco targets to achieve a leading position in the offer, distribution and sale of payroll loans in Brazil. The company expects more significant results from this deal from the first quarter of 2013.  

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 installments directly from the payroll account. Hence, the risk is low with such loans and chances of default are substantially less.

In Conclusion

Though Itau Unibanco’s diversified product mix, growing service fees, cost control and expanded credit portfolio are encouraging, we believe that weak asset quality remains a major concern for Itau Unibanco. Given the company's rapid loan growth over the last five years and expansion into lower-income markets we expect asset quality metrics to remain stretched in the upcoming quarters.

Especially, Itau Unibanco’s vehicle loan category is experiencing significant rise in default levels and this remains a concern as this constitutes a significant portion of the company’s total credit portfolio. In addition to 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. Its closest peer, Banco De Chile (BCH - Snapshot Report) also retains a Zacks #3 Rank, implying a short-term Hold recommendation.

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