We are downgrading our recommendation on Itau Unibanco Holding S.A. (ITUB) to Underperform from Neutral based on the deterioration in its credit quality.
First Quarter Results
Itau Unibanco’s first-quarter 2012 net income came in at R$3.4 billion ($1.9 billion), below the prior-quarter earnings of R$ 3.7 billion ($2.0 billion) and year-ago earnings of R$ 3.5 billion ($2.1 billion). Excluding non-recurring items, Itaú Unibanco reported first-quarter earnings of R$ 3.5 billion ($2.0 billion), down 5.4% sequentially and 2.6% year over year.
Results of Itau Unibanco reflect the impact of rising default levels in the Brazilian economy. The company has increased its provision expenses that resulted in a fall in its profitability. However, on the positive side, it grew its operating revenues modestly and continued to lower its non-interest expenses.
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.
Notably, in the first quarter of 2012, Itau Unibanco has experienced a rise in default levels on its loans and its nonperforming loan ratio continues to show an increasing trend. Especially, the vehicle loan category is experiencing a significant increase in default levels and this remains a concern as this constitutes a significant portion of the company’s total credit portfolio.
As a result, Itau Unibanco’s management expects an increase in provisions in the upcoming quarters (in the first quarter it was R$6 billion, in the second quarter it is expected in the range of R$6 billion to R$6.4 billion, and in the third quarter between R$6.5 billion and R$7.1 billion.) We believe this increase in provisions would temper its overall profitability going forward.
While Itau Unibanco’s solid business model, diversified product mix, growing service fees, cost controls and expanded credit portfolio are encouraging, we believe that besides asset quality concerns, increasing competition and the stressed conditions in the Brazilian economy pose risks.
Itau Unibanco’s shares are maintaining a Zacks #5 Rank, which translates into a short-term Strong Sell recommendation. However, its closest peer Banco De Chile (BCH) retains a Zacks #3 Rank, implying a short-term Hold recommendation.
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