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Morningstar | Itau's Strong 2018 Outweighed by Political Tumult and Pension Reform Uncertainty

The challenge for Itau Unibanco will be to navigate an increasingly volatile Brazilian economy and political environment while adjusting to lower interest rates unscathed. We believe net interest margin compression will continue as a result of lower rates and regulators that want to limit what banks can charge borrowers. While we forecast inflation to keep falling in the near term, we believe inflation could eventually rear its head farther out, pressuring Itau’s cost of deposits. Due to an overly generous pension system, Brazil's budget deficit is 6.9% of GDP, one of the larger budget deficits in the world. Given a weakening political situation, we believe it’s possible that elected officials could resort to printing money in order to meet these liabilities, detracting from Itau's returns. We believe the deceleration in loan growth at state-owned banks will provide some benefit to Itau Unibanco. From 2010 to 2015, the three largest state-owned banks expanded loans at a rate of nearly 20% annually. In comparison, Itau expanded its loan portfolio at a compound rate of only 10.2% during that time. In 2016, Brazil’s largest state-owned bank, Banco do Brasil, decreased its loan portfolio by more than 10%--a sharp reversal from the heady growth experienced a few years prior--and continued to shrink its loan book through 2018. It appears now Itau is starting to capitalize on dislocation among state-owned banks and has been able to accelerate loan growth. In the short run, we expect this to continue. Initially, we questioned the logic of Itau’s expansion into the Chilean market through the merger of Itau’s Chilean operations with Corpbanca. Banco de Chile and Santander Chile dominate Chile’s banking sector. However, given decreasing prospects in Itau’s home market, we think it makes some sense to look beyond Brazil as a defensive strategy, albeit a highly expensive one. The goal for Itau Unibanco is to become the regional money center for Latin America and someday resemble what HSBC is to Asia. We are encouraged that Itau has said additional acquisitions are too expensive.