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Morningstar | Itau Unibanco Starts 2019 on the Right Foot; Muted Loan Growth Offset by Higher Profitability

Itau Unibanco reported a 7.1% increase in year-over-year recurring net income, with lower operating income mitigated by a seasonal decrease in non-interest expense. Credit provisions as a percentage of total loans ticked up to 3.1% from 2.9% the prior quarter, though provisions remained below historical levels. Cost of credit, which represents the sum of net loan provisions and impairments, also increased up to 2.4% from 2.1%. We think that the bank’s cost of credit could continue to increase into the year, given that the wholesale banking segment was positively affected by one-time provision adjustments. Other upbeat items from the quarter included better financial margin spread, higher fund management fees, and improved return on equity, which increased 180 basis points to 23.6%. Loan growth of 1.5% for the quarter aligned with our expectations, as compared with our full-year forecast of 5.7%. We continue to believe management’s full-year guidance of 8%-11% growth in the credit portfolio is perhaps somewhat aggressive, especially considering results through the first three months. Lower fee and commission income was for the most part balanced out by higher margins and cost reductions, and we're maintaining our fair value estimate at $5.40 per share.

Looking at the loan portfolio, it appears that higher economic uncertainty and a waning economy might be limiting credit growth. Both credit card lending and corporate loans experienced declines for the quarter, at negative 1.3% and negative 0.4%, respectively. In addition to a quarterly decline, corporate lending was also down 5.8% year over year. We believe corporate lending is a decent gauge for business investment and declines in the corporate lending portfolio correlated to lower business confidence, which fell to half-year lows in April. On the positive side, personal, payroll, and vehicle lending were all up over 16% annualized in the quarter, with personal loans leading the pack at 6.5% sequential growth.

In late April, Itau announced that its card processor unit would accelerate advance payment options to small- and medium-sized merchants and reduce interest rates down to zero, effective May 2. This decision will most likely hamper profits of the business in the short-term, which by our estimate accounts for just 1.3% of total revenue. Unlike pure-play payment processors like Cielo, PagSeguro, and StoneCo, the vast majority of Itau’s profits are unrelated to payment processing. We like this move, since the overall impact on the bottom line should be negligible and Itau could potentially attract new clients for its banking and lending businesses. We note, however, that Brazil's antitrust regulator has requested additional information from Itau, and there’s a chance, however small, that the move could be deemed anticompetitive.

Annualized GDP growth in Brazil in the fourth quarter was just 0.4%, down from 2% in the third quarter. The IMF is forecasting 2019 real GDP growth in Brazil to reach 2.1%, lower than the overall emerging market average forecast of 4.4%. Growth forecasts for Brazil have trended downward since the start of 2019 as pension reform efforts stretch into the year with increasing uncertainty. The Central Bank of Brazil kept interest rates at 6.50% following its March meeting, which also marked one year since the benchmark rate was cut by 25 basis points to its current level. In its policy statement, the bank advised that current economic conditions continue to justify a stimulative monetary policy and that recent economic data came in below expected levels. If pension reform efforts fail and the Central Bank cuts interest rates in response to continued sluggish economic growth of the Brazilian economy, Itau Unibanco could experience substantive revenue declines and curtailed earnings growth.