By Guillermo Parra-Bernal and Natalia Gómez
SAO PAULO, Oct 29 (Reuters) - Itaú Unibanco Holding SA reported much higher-than-expected third-quarter earnings on Tuesday as efforts to focus on the least risky loan segments helped drive down defaults, cut provisions and boost interest and fee income.
São Paulo-based Itaú Unibanco, Brazil's largest non-government lender, said recurring profit, which excludes one-time items, was 4.022 billion reais ($1.84 billion), above the average estimate of 3.782 billion reais in a Thomson Reuters poll of eight analysts.
Compared with the prior quarter, recurring profit was up 11 percent, the fastest pace of earnings growth in five quarters. Itaú shares rose as much as 3.7 percent to a more than two-year high of 34.64 reais, their biggest jump in more than two months, on optimism that Brazil's No. 1 bank by market value is regaining luster after performing poorly for several quarters.
The results underscore Itaú's ability to outperform rivals as years of subpar economic growth and feeble demand for credit among indebted consumers are hurting the banking sector. The higher-than-expected earnings also suggest that the bank is benefiting from a yearlong policy implemented by Chief Executive Officer Roberto Setúbal to avoid riskier loans and streamline costs, rather than just the effects of a recent uptick in economic activity.
"As we've highlighted in numerous times in past research, Itau has dramatically altered its credit risk profile in recent years," said Saul Martínez, senior financial industry analyst with JPMorgan Securities in New York. "This is contributing to very good asset quality evolution."
Management plans to discuss third-quarter earnings in a conference call later on Tuesday.
As of Monday, Itaú stock was up 16.4 percent this year, compared with a 9.3 percent decline in Brazil's benchmark Bovespa stock index.
Overall results turned out robust. Controls in sales, general and administrative expenses more than compensated for a jump in payroll costs, and lower charges on bad loans partly offset the impact of a higher tax rate.
A gain on return on equity surprised analysts, since this measure of how well a bank uses shareholders' money has fallen at rival banks.
Itaú's ROE rose for the fourth consecutive quarter, to 20.9 percent, well above the 19.6 percent estimated in the poll. This was the highest level for the ratio since the last quarter of 2011.
"Profitability is impressive in a difficult macro backdrop," Martínez said.
Net interest margin, or the average interest rate charged on loans, taking into account risk-weighted assets, rose for the second consecutive quarter, to 6.5 percent, the highest level in a year. The increase helped boost net interest income despite Itaú's cautious approach to loan disbursements.
Net interest income also rose for the second straight quarter, reaching 11.84 billion reais, after lending-related revenue and income from trading financial securities recovered. The indicator rose 2.3 percent on a sequential basis, but fell 7.7 percent from a year earlier.
The bank's loan book rose 2.6 percent in a quarter-on-quarter basis to 456.56 billion reais, above the 450 billion reais expected in the poll. On an annual basis, loan disbursements grew 9.3 percent, within the bank's target of 8 percent to 11 percent credit expansion for this year.
While analysts said the bank was well positioned to meet that forecast, loan book growth is not coming at the expense of asset quality.
Loans in arrears for more than 90 days, a benchmark for delinquencies, fell to 3.9 percent of Itaú Unibanco's loan book. Analysts looked for the default ratio to reach 4.1 percent.
"Itau is delivering good earnings momentum," wrote Philip Finch, a strategist with UBS Securities in London. "The faster-than-expected asset quality improvement provides scope for provisions to come in below guidance, with further earnings-per-share upside potential."
Boosting profit, provisions for bad loans slumped 7.6 percent to 4.53 billion reais, still above expectations of 4.25 billion reais.
Fee income rose 3.6 percent from the prior quarter to 5.59 billion reais, below expectations of 5.69 billion reais. Despite a jump in employees' wages, operating expenses rose less than 1 percent to 8.70 billion reais, slightly above estimates in the poll.