Itau Unibanco Down to Underperform


We are downgrading our recommendation on Itau Unibanco Holding S.A. (ITUB) based on concerns related to its limited top-line growth as well as weak asset quality.

Itau Unibanco’s recurring earnings in third quarter 2012 of R$3.4 billion ($1.7 billion) were down 4.8% sequentially and 13.4% year over year. The company experienced revenue headwinds and elevated level of provisions for loan losses.

Operating revenues at Itau Unibanco in the reported quarter 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.

Though Itau Unibanco’s diversified product mix and cost control efforts are encouraging, we believe that the low interest rate environment, tepid economic recovery and weak asset quality remains an impediment to the enhancement of its profitability.

The economy in Brazil, the domestic market of Itau Unibanco, is recovering at a sluggish pace.  While the government is making efforts to send stimuli though economic policy in order to revive activity throughout the year, the intensity of such a revival is usually less than anticipated.

Moreover, with elevated concerns about the foreign scenario and its possible impact on the domestic activity, the Central Bank of Brazil continued to reduce the SELIC rate in the first nine months of 2012. However, this decrease in the SELIC rate adversely impacted Itau Unibanco’s net interest margin, which fell both sequentially and year over year in the reported quarter of 2012.

With increased growth in the loan portfolio of lower risk and spread, the pressure on margins is anticipated to continue. Hence, with such a backdrop, our concern remains for the overall growth prospects of Itau Unibanco.

Also, 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 (such as individuals and micro, small, and mid-sized companies) we expect asset quality metrics to remain stretched in the upcoming quarters.

Especially, the vehicle loan category is experiencing significant increase in default levels and it poses a risk as this constitutes a significant portion of the company’s total credit portfolio. We believe the higher level of provisions would affect its overall profitability going forward.

Itau Unibanco’s shares retain a Zacks #5 Rank, which translates into a short-term Strong Sell recommendation. However, its closest peer, Banco Bradesco S.A. (BBD), retains a Zacks #3 Rank, implying a short term Hold recommendation.

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