EUR 850.00 For Business Accounts Only

Morningstar | Itau Investors Hopeful for Pension Reform and Political Stability Should Remain Cautious

Despite Brazil’s volatile political environment during the third quarter, no-moat Itau Unibanco saw recurring net income growth of BRL 6.45 billion, a sequential increase of 1.1% and year-over-year increase of 3.2%. The biggest variance during the period was Itau’s improvement in credit quality driving a lower cost of credit. Itau’s cost of credit fell 9.4% on a sequential basis and 18.2% from last year’s third quarter. This is some of the best credit quality the bank has seen since 2015. For the quarter, Itau’s cost of credit fell to 2.1%, a 60-basis-point improvement from the previous year and a 160-basis-point improvement from two years ago. We’ll adjust our model to reflect the weakening Brazilian real, but we will maintain our fair value estimate at $8 per share. Though pension reform has been proposed by newly elected president Jair Bolsonaro, we’re not as confident as the market that pension reform will actually happen. Given the state of Brazil’s finances, we find it puzzling that Itau Unibanco trades at more than 2.5 times book value. For now, we’d avoid the shares, which still seem exceedingly expensive.

For the quarter, Itau’s total loans grew 13.4% from the previous year and 2.3% from the previous quarter. Loans to individuals were the biggest driver of loan growth with credit cards and consumer loans growing 3.6% from a year ago and 2.2% from the previous quarter. Within company loans, Itau saw an increase in loans to oil and gas companies of more than 21%. Again, it’s hard for us to imagine how Itau is managing to expand its loan book this quickly without seeing an accompanying rise in credit provisions. During the call, management said credit losses could continue to decline because the company is now employing artificial intelligence to improve its underwriting. While we’re happy to see the bank investing in technology, we’re skeptical that artificial intelligence will lead to significant improvements in credit quality, since it’s likely this technology could be copied.

Despite this quarter’s growth in loans, the company saw only a 3.3% year-over-year improvement in fee income. Total fee income fell 1.1% from the previous quarter. The decline in fees was the result of lower fees in asset management and credit guarantees. Credit card fees, which account for a little more than a third of total fee income, have seen a significant deceleration in recent quarters. While credit card fees rebounded 3.9% from the previous quarter, they declined in the first two quarters of 2018. Credit card fees have grown despite the recessions experienced in recent years. We find it puzzling that credit card fees remain sluggish despite a recovering economy.