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Edited Transcript of ITUB4.SA earnings conference call or presentation 31-Jul-18 1:00pm GMT

Q2 2018 Itau Unibanco Holding SA Earnings Call

Sao Paulo Aug 7, 2018 (Thomson StreetEvents) -- Edited Transcript of Itau Unibanco Holding SA earnings conference call or presentation Tuesday, July 31, 2018 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alexsandro Broedel Lopes

Itaú Unibanco Holding S.A. - Group Executive Finance Director, Head of IR & Member of Executive Board

* Caio Ibrahim David

Itaú Unibanco Holding S.A. - Vice-President, CFO & CRO

* Candido Botelho Bracher

Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board

* Marcos Antônio Vaz de Magalhães

Banco Itaucard S.A. - Director

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Conference Call Participants

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* Carlos Gomez-Lopez

HSBC, Research Division - Senior Analyst, Latin America Financials

* Carlos Grein Macedo

Goldman Sachs Group Inc., Research Division - VP

* Eduardo Nishio

Brasil Plural Corretora de Cambio, Titulose Valores Mobiliários S.A., Research Division - Financial Sector Analyst

* Jason Barrett Mollin

Scotiabank Global Banking and Markets, Research Division - MD of LatAm Financial Services

* Jorge Kuri

Morgan Stanley, Research Division - MD

* Mario Lucio Pierry

BofA Merrill Lynch, Research Division - MD

* Philip Finch

UBS Investment Bank, Research Division - MD, Global Banks Strategist, and Latam Banks Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Itaú Unibanco First Quarter Conference Call to discuss 2018 Second Quarter results. (Operator Instructions)

As a reminder, this conference is being recorded and will (inaudible) live on the Investor Relations website at www.itau.com.br/investor-relations.

The audio webcast works with Internet Explorer 9 or above, and Chrome, Firefox and mobile devices, iOS 8 or above and Android 3.0 or above.

A slide presentation is also available on this site.

Before proceeding, let me mention that forward-looking statements are being made under the Safe Harbor of the Securities Litigation Reform Act of 1996. Actual performance could differ materially from that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risks and other factors.

With us today in this conference call in São Paulo are Mr. Candido Bracher, President and CEO; Mr. Caio Ibrahim David, Executive the Vice President, CFO and CRO; Mr. Alexsandro Broedel, Group Executive Finance Director and head of Investor Relations; Marcos Magalhães, Merchant Acquirer Executive Director.

First, Mr. Candido Bracher will comment on 2018 second quarter results. Afterwards, management will be available for a question-and-answer session.

It is now my pleasure to turn the call over to Mr. Candido Bracher.

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [2]

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Good morning, and welcome to our second quarter 2018 earnings conference call. Before I talk about our figures, I would like to briefly speak about the macroeconomic scenario. Since the beginning of the year, we have revised down our expectations of GDP growth in 2018 from 3% to 1.3%. This revision is mainly related to pretax. The impact comes from the trucker strike, an event which directly affected the economy and also the entrepreneurs' and investors' level of confidence. Second, the greater uncertainty regarding the approval of additional fiscal reforms, especially the pension reform. And finally, the relative disappointment with the pace of job creation in the formal labor market.

Although, it's important to say, we are seeking positive formal job creation. Despite these negative revisions in GDP growth, inflation remains under control and will continue to enable interest rates to be at low levels, reducing pressure on disposable income.

And although the economy is not growing at the pace we expected in the beginning of the year, we still see some improvement in the macro economic (inaudible).

In fact, talking about the economy I also want to share with you 2 commercial initiatives that we have just announced. The first one is related to our insurance operations, where we have replicated the open platform solution we have already adopted in the investment business.

This means that we started to offer products from other insurers in our platform, focused on meeting our customers' needs.

The second commercial initiative is related to our acquiring business. We announced the credit card trends, but [merchant] segment, it appeared on our machine family that can be purchased through its website.

The first machines launched are the Fox credit cards and the Mega Fox credit cards. Besides selling POS machines, the strategy is to have a simple commercial -- sorry, simple commercial proposal, based on shorter payment term to repay this and competitive rates for debit and credit card transactions.

With this operation, we aim at reaching self-employed people, micro entrepreneurs and small companies. This initiative complements our product offerings in the in the acquiring market. Today I have invited Marcos Magalhães, the head of our acquiring business, to address in the Q&A session any questions you may have about the new product.

With these initiatives, we reinforce our intention to better serve our customers, and our confidence in the Brazilian market.

So moving now to Slide 3, there highlight our financial performance in the quarter, you see this positive.

You see that our return on net income remains almost stable in the quarter in the level of BRL 6.4 billion. This result was supported by higher financial margins of clients, higher commission and fees and lower cost of credit.

These positive effects were compensated by a decrease in our financial market, with a market financial margin, with the market and higher non-interest expense.

Concerning non-interest expenses, it's important to stress that excluding the exchange rate variation in our Latin American operation, the growth was 4.4% in the quarter. We also continued to see improvement in the quality of our spread portfolio, with our nonperforming loans 90 days reaching 2.8%.

Lastly, our trends for order increased 3.7% this quarter, led by individuals and SME loans, and also by our Latin America portfolio.

On Slide 4, we present our income statement. I would like to highlight our first (inaudible) 2018 results, in which the income before tax and minority interest grew 10.5%. This performance is a result of lower cost of credit and higher fees and commissions. This performance was partially compensated by a temporarily higher effective tax rate, as a result of accounting of deferred tax assets at a 40% tax rate, while still paying a 45% tax rate.

On Slide 5, we present the evolution of the profitability and cost of equity of our operations.

Our recurring ROE reached 21.6% in the second quarter, in line with the average return of the previous 6 quarters.

On Slide 6, I present our business model chart, in which we break down the consolidated income statement of the first half of this year.

As you can see, the received insurance and services business lines continued to be the main driver behind our profitability. And represents almost 60% of our net income.

Although, the insurance and services business continues to be responsible for almost all of value creation, I would like to point out that since the fourth quarter of 2017, our credit business creates value as we see on the second column, we see a value creation of BRL 0.5 billion for credit, with retaining ROE in credit of 14.5%.

This compares to a cost of credit during the first semester of 13.5%. After the first semester, we have lifted our cost of credit to the level of 14.5% also.

Now on Page 7, we see that our credit portfolio was up 3.7% in the quarter. All portfolios and individuals have positive evolution in the quarter as we continue to see healthy demand from our (inaudible).

I want to highlight the increase of 3.5% in personal loans, and of 2.4% in car finance.

In the SME portfolio, we had another positive quarter with a 4.1% growth, led by the stronger demand in the period.

Looking at the past 12 months, the total portfolio grew 6.1%, even excluding the impact of deposition of (inaudible) in Brazil, the individual and the SMEs delivered a good performance.

In large corporates, we continue to see a subdued demand for loans. The reasons for that are related to a still active capital market (inaudible) as I mentioned in the first quarter earnings call.

Excluding the effect of foreign exchange valuation, the corporate portfolio would have decreased 3.1% in the quarter, and 10.5% in the year. The Latin American portfolio would have increased 2% in the quarter, and 3.1% in the year.

And finally, our total portfolio would have increased, a result of the foreign exchange rate variation, 0.4% in the quarter and 0.9% in the year.

On Slide 8, we see that our credit origination continues to show positive evolution. The origination of our consolidated credit portfolio grew 14% when compared to the same period last year. This increase was led by the stronger demand from our clients, both individuals and SMEs.

It's important to mention that the credit originations to individuals is already higher than in 2014.

I'd like to stress that this growth was exclusively driven by a better demand from our clients as we have not changed the risk appetite for the bank. As I mentioned in the previous slide, when it comes to our corporate, the demand is still moderate. But we continue to advise and help these companies to fund themselves in the capital markets as shown on the securities chart on the bottom right. Where we see that Private Security Issuance is 60% above what was the level in 2014.

Now on Slide 9, we show our net interest margin and the changes in the financial margin with clients. This quarter, you see we delivered a 4.5% growth in the financial margin with clients. This result, as you see in the bottom of the page, was mainly due to the change in credit mix towards higher yielding products and due to higher number of calendar days.

We also saw a positive evolution in the Latin American financial margin, driven by foreign exchange rate variation. So what we can see here is as the individuals and SMEs portfolio grow while the large corporate portfolio doesn't grow. This is positive for the credit mix and generates an increase in the financial margin with clients.

In the same period, our consolidated NIM remains stable, widening from our Brazilian operations increased 20 basis points.

For the net interest margin is increasing 20 basis points in the local market. More importantly, we saw an increase of 20 basis points in the consolidated, and 50 basis points in the Brazilian risk adjusted net interest margin due to lower cost of credit.

On Slide 10, I present the evolution of the financial margin with the market. The decline of services this quarter is mainly a result of lower gains in the trading book. And was in line with the guidance we have supplied in the beginning of the year, in line with our expectations.

Moving now to Slide 11, credit quality. We see that our delinquency ratios continue to show healthy trends. The 90-day NPL ratio improved 30 basis points compared to the previous quarter and reached 2.8%.

I highlight the important decrease of 60 basis points in SME, and of 10 basis points in the individual portfolio in Brazil.

We also had a decrease in the nonperforming loan ratio for corporate related to a renegotiation of the [50K], which I mentioned in the previous quarter.

This exposure was later sold to third-party.

In the 15 to 90 days nonperforming loan ratio, we saw an increase of 90 basis points in the corporate segment. I highlight that this deterioration was not concentrated in many clients or specific sector and is composed of companies that already have adequate level provisioning for their respective risks. This increase was compensated by an improvement of 60 basis points in the Latin American portfolio, leading to the stability in our early delinquency ratios.

On Slide 12, we present the evolution of our NPL creation. Our total NPL creation reached BRL 3.8 billion, significant decrease compared to the previous quarter, mainly due to a specific exposure from the wholesale portfolio that negatively impacted this indicator in the first quarter.

As I mentioned in the previous slide, this specific exposure was renegotiated and later sold in the second quarter. The increase in NPL creation of retail segment is a result of the credit origination growth.

Even though, we are still seeing some improvement in the credit quality of (inaudible) portfolios, it's important to highlight that our loan book has resumed growing, the NPL creation for this portfolio will continue to present nominal increase.

Slide 13 represent evolution of provisions for loan losses and cost of credit. Increase in our provision for loan losses this quarter is related to the growth in the [pay] portfolio. With a revision of preapproved limits, mainly of credit cards and also due to the impact of foreign exchange rate variation.

These products are increased in provision expenses, our cost of credit decreased in the quarter due to lower impairment charges and better results.

Now turning to Slide 14, we present our coverage ratio that reached 248% this quarter. And as I have mentioned in previous conference calls, we may experience some volatility in our coverage ratio, mainly because of the wholesale portfolio.

In this quarter, the increase of our coverage ratio was a result of a specific exposure of the wholesale portfolio that was renegotiated and sold afterwards. In the long term, we expect the coverage ratio to go down due to improvements in credit ratings of coverage but until then, we may see some volatility.

Page 15, in commissions fees and result from insurance operations presented, we had an increase of 2.4% in the quarter. This performance was mainly driven by the 9.1% growth in asset management fees associated with higher asset-management and performance fees, and 2 more working days in the period. We also had an increase of almost 30% in advisory and brokerage fees related to our investment bank.

Now turning to our noninterest expenses on Slide 16, we had an increase of 5% in the quarter. This growth was mainly due to the advertising expenses related to the Soccer World Cup and to foreign exchange variation in our Latin American operation.

I want to highlight that compared to the first half of 2017, expenses from Brazil excluding the impact of CitiBank, increased 10%, much below the inflation for the last 12 months.

In the quarter, we saw a reduction of 56 brick-and-mortar branches in Brazil, associated with synergies coming from the acquisition of Citi's retail operation.

On Slide 17, I comment on our capital ratios. Our Tier 1 capital ratio reached 14.2% to 70 basis points increase in 2018, was mainly (inaudible) to earnings accumulation in the period. And also by the approval of Brazilian Central Bank of our additional Tier 1 issued on March 2018.

I also want to mention that we are going to pay a BRL 4.7 billion as complementary dividend and interest in capital on August 30, 2018.

Now I'll -- to Slide 18. I want to share with you some figures related to our digital transformation journey.

In the first half of 2018, as we see in the top left of the chart, we reached a milestone with more than 10 million clients using our Internet, mobile or SMS channels. It's important to say that mobile is already our most accessed digital channel with more than 8 million users.

Also for the first time, we break down our financial transactions in the digital channel. In this context, in the Itaú bank, 18% of all credit origination, 38% of all the investments and almost 80% of the payments were made using digital channels.

(inaudible), we opened more than 120,000 new current accounts in the second quarter, which is close to 12% of the total accounts opened in the year. And as you see the chart, you can see that it's increasing rapidly and we expect it to continue to increase.

Now in the middle bottom about our digital branches. You see that they already represent 30% of the operating revenues in the retail business. With an efficiency ratio that is more than 4,000 basis points than a brick-and-mortar branch. You see we cannot in branches have an efficiency mix of 69.8%, and digital branches of 26.2%.

Although, we have seen a positive evolution in our digital assets, we still have a long road ahead of us to better educate our clients in the benefits of using our digital channels.

On Slide 19, I present the distribution of added value in the second quarter. We're the only bank, who have added BRL 18.3 billion to society that helped to boost the economy and to stimulate the transformational power of thousands of people.

Of that value, 18% was designated to our more than 130,000 direct shareholders. And approximately 1 million indirect shareholders in Brazil for investment and pension plans.

33% to taxes, fees and contributions, 29% to our employees and 18% to reinvestment in our operations.

Now on Slide 20, I would like to reiterate the forecast of 2018, as we originally disclosed in the beginning of the year.

We are comfortable that the ranges you are hearing represent our best estimates for the year, even taking into account the revisions in GDP growth for the year.

Last, on Slide 21, I want to invite you for the Annual APIMEC meeting on September 12. The event will be hosted in São Paulo. But it will also be webcasted with simultaneous English translation.

With that, I finish this presentation. And now, I would like to open for the questions you may have. Thank you.

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Operator [3]

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(Operator Instructions) Our first question comes from Philip Finch, UBS.

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Philip Finch, UBS Investment Bank, Research Division - MD, Global Banks Strategist, and Latam Banks Analyst [4]

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Thank you for your presentation. 2 questions for me, please. My first one is regarding your effective tax rate, which was at 34.4% in the second quarter, a bit higher than what we were expecting. Now can you discuss with us what you think could be a recurring level of taxes, bear in mind, potential changes in the level of social contributions? And my second question is regarding the FX impact of your second quarter results. Obviously the real weakened not insignificantly in the second quarter. So how did that impact your numbers, not just loan growth but NII as well as cost or even taxes?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [5]

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Thanks for your question, Philip. I will hand the phone here to Caio Ibrahim to answer your questions.

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Caio Ibrahim David, Itaú Unibanco Holding S.A. - Vice-President, CFO & CRO [6]

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Hi, Philip, thanks for your questions. Considering that the social contribution for next year would be around 15%, which pretty much what we expect. Effective tax rate would be around 30%, that's the forecast we are using for next year.

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Philip Finch, UBS Investment Bank, Research Division - MD, Global Banks Strategist, and Latam Banks Analyst [7]

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And the scenario that the social contribution doesn't come down? What should we see there?

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Caio Ibrahim David, Itaú Unibanco Holding S.A. - Vice-President, CFO & CRO [8]

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That, of course, would be a little bit higher than this, around 32% more or less. Regarding your FX (inaudible). Yes, go ahead.

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Philip Finch, UBS Investment Bank, Research Division - MD, Global Banks Strategist, and Latam Banks Analyst [9]

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I was just going to ask about the FX question as well. Please go ahead.

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Caio Ibrahim David, Itaú Unibanco Holding S.A. - Vice-President, CFO & CRO [10]

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In terms of FX, in our balance sheet as you know, we have our investment abroad fully hedged. So that contributes to -- do not have that major impact in our P&L. Of course, when you have the devaluation of the real, you have some impacts in the deferred tax assets, which is pretty much related to an impact in the shareholders equity. But well, we manage that quite well in that financial part of the risk management of the bank regarding market risk.

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Philip Finch, UBS Investment Bank, Research Division - MD, Global Banks Strategist, and Latam Banks Analyst [11]

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And were your costs in any way inflated because of FX?

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Caio Ibrahim David, Itaú Unibanco Holding S.A. - Vice-President, CFO & CRO [12]

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Inflated?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [13]

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Yes, Philip, our costs were inflated because of FX because of the costs in our Latin American operations. So the cost -- the real devaluated in real terms against the currencies of the countries where we have operations. So this provokes us -- and expressed in real terms, and I think we adjust the level of FX then. Although, relating to the level of expenses, it's important to stress that we have seen this second quarter increase in expenses every year for the past 3 or 4 years. And then despite the fact -- on top of the FX effect, you have the effect of the first quarter, it has seasonably a lower cost. So in the second quarter, we see increases. This year, besides this seasonal effects, we also have the FX rate and also other minor effects of the Soccer World Cup. All that taken into account, we're comfortable with the guidance we have supplied for expenses for the year.

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Operator [14]

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The next question comes from Carlos Macedo, Goldman Sachs.

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Carlos Grein Macedo, Goldman Sachs Group Inc., Research Division - VP [15]

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A couple of questions on loan growth here. First question, you kept your guidance for loan growth, you're already growing ahead of it, of course, the FX helped this quarter. But when we look at origination rebounding, and you look at the levels of where you're already growing, and in Brazil and in your consumer book and SMEs, shouldn't we think that it's possible -- you're, at least, you're going to get to the top of the guidance if not surpass it. Second question, you mentioned that you're not -- you haven't increased the risk appetite yet. The bank is still running at the same risk appetite, so it's more of a demand function for that acceleration and growth. What would it take for the bank's risk appetite to increase? What are you looking at? Is it unemployment? Is it GDP growth? Is it the result of the elections in Brazil? I mean, the operations outside of Brazil are doing really well. CorpBanca as a peer stepped-turned a corner. You know Paraguay, Uruguay for as small as they are doing really well. What would it take for you to really say, okay, now we can do it, now we're going to lower the ratings on the corporate book, we're going to grow a little bit more now there? Take a look and increase our limits. What would it take?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [16]

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Thanks for the questions. Excellent questions. So on your first question, you're right and we are seeing good momentum in asset growth, we are also seeing good momentum in services, fees and income growth. This is what makes us comfortable with the guidance we have, we have supplied. In which part of the guidance we're going to stay in we have chosen now not to indicate anymore -- within the guidance in which part we are staying. And the only thing that we are comfortable with the interval we have supplied. But I agree with you that there is positive momentum in this asset part of the book. As to risk appetite, let me make one comment first. There are across the both segments of the market that we are not catering, that we have decided not to enter and this is a structural decision taken quite some time ago when we have because of our perception that the higher risk segments of the market bring more volatility to results. And we have made an option to have growing results with low volatility. So when I refer to the change in risk appetite, what it would take for us to change the risk appetite is basically, I mean, to have the impression that another level of clients of higher risk has become less riskier because of GDP growth, because of sustainable economic growth perspectives ahead. And we don't have it yet. So we don't see yet that sustainability and economic growth, which can give us the comfort that companies will emerge from a more risky part of the spectrum to become safer credit.

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Carlos Grein Macedo, Goldman Sachs Group Inc., Research Division - VP [17]

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So this -- just to follow up. The strategy, therefore, is to remain relatively conservative, though. Attacking the parts of the market where you see less volatility. So that the consumer book or the parts of the consumer book that you have recently accelerated origination fall into that category, like some parts of auto, payroll loans, mortgages, that will be accurate to say, right?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [18]

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Yes. I mean that's accurate to say and that doesn't mean that we're not intensifying our commercial efforts. So the risk appetite is not the only driver of asset growth. Assets also can grow because you made better efforts and the segments where would you have already decided to serve and this is what we're doing. That's right.

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Operator [19]

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The next question comes from Mario Pierry, Bank of America Merrill Lynch.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [20]

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Let me ask you 2 questions as well. The first one is related to your net interest margin with clients in Brazil. You showed that your margin expanded 20 basis points quarter-on-quarter. Is it fair to say that you think that we have seen the bottom on margins in Brazil if you can also give us a little bit more details on this improvement this quarter, clearly a part of this improvement is related to the mix effect. But I wanted to understand from your perspective if you can give us some color on spreads, credit spreads. If you can talk on a product by product basis? If you're still seeing spreads coming down, or do you think they have normalized? Second question is related to your asset quality, you showed very clearly the NPLs and provision charges are near historical lows. But at the same time, when we look at your coverage ratios, they are historical highs, 250% coverage of NPLs when I look at your corporate book, or your wholesale book, your coverage ratios are around 950%. So what I'm trying to understand here looking forward, is there room for provision charges to still continue to come down?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [21]

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Thank you, Pierry, very good questions. First, concerning our net interest margin on our financial margin with clients. We are happy to see how resilient this margin is proving to be and that we are able to grow. If you remember just one year ago or so there were significant doubts in the market on how that margin would react to drop in the fixed- rate. And what we are showing is that this margin is quite resilient to the drop in the fixed-rate. And as we show at the bottom, the reason is not because spreads are not falling, this is why we break down in the bottom of the page the different effect we see that when we lose BRL 12 million in this margin because of asset spreads. And I still see a trend for spreads to reduce in the local market. I think that partially they will reduce because we will have better credit conditions. We will have the capacity to achieve -- positive information about the company, I mean the government is also working and the tax effects of (inaudible). I think the general trend is that credit is going to become cheaper. But we expect to grow this margin because frankly, I expect to see more vivid growth in assets, especially depending on the results of the elections and because I think that this move in the mix power lines of higher spread, this is a trend that will still continue for quite some time. I mean, I think the possibility of increased lines of higher spread (inaudible) I think is a tendency that will stay for quite some time. Now on asset quality and corporate ratios. I must confess that I'm also a bit puzzled that is coverage margin doesn't drop effect, I mean almost one year ago I said that it stands at the long-term trend will be to drop, although we could have some short-term volatility. And this is still the scenario. The dynamics here is very simple. We have today about BRL 36 billion, BRL 36.5 billion of provisions, a significant part of it, almost BRL 10 billion is provincial provisions. Provisions which we have made for credits, for companies that we see are still not out of the woods after the recession. Some of them are improving. Some of them are being renegotiated and some of them will default, are defaulting and will default. So, if these companies default, of course, the NPL 90-days will increase, the coverage ratio will decrease. If these companies improve, we will be able to revert the provisions and also in the space the coverage ratio will improve.

Meanwhile, we may see this -- and some effects are already happened when I refer to credit that we sold in this quarter. We sold this credit for a higher price than the amount we had less provisions. So this provoked a positive effect, but when we -- so the positive effect in fact decreased the coverage ratio. But at the same time, the NPL 90 drops and then the coverage ratio increases again. So we will see some volatility in this coverage ratio but yes, I think the answer to your question is yes, there is a potential in the medium run for this coverage ratio to decrease significantly and for us to have lower positions, especially in the corporate book.

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Operator [22]

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The next question comes from Jorge Kuri, Morgan Stanley.

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Jorge Kuri, Morgan Stanley, Research Division - MD [23]

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Could you please give us some details on your credit card pop initiative? Can you describe what the offering is going to be? Is it going to be a payment solution only, is it going to be a full ecosystem of products and services aimed at helping micro merchants run their businesses better, are you going to have prepaid cards just as the competitors that are in that micro merchant space do, is it required to have a bank account with credit card pop, I believe your competitors don't require one? How are you going to distribute the product? Are you going to have salespeople? Are you going to leverage the branches? Are you going to advertise? What do you think the cost of acquisition is going to be? And what targets do you have of active merchants or PPV by the end of this year and next year?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [24]

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Thank you very much for your question, Jorge. I will pass the phone to Marcos Magalhães, the Executive Director of Acquiring business.

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Marcos Antônio Vaz de Magalhães, Banco Itaucard S.A. - Director [25]

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Jorge, Marcos here, thanks for the questions. First let me comment on the -- on why we decided to launch these products. And the main reason is that because for our traditional acquiring operation this segment is pretty much new. We don't -- our current offering traditionally didn't tap into that sort of segment, self-employed and micro merchants segment. So in the commercializing that we planned for our business, we advised this opportunity a while ago, and we finally launched this introducing the initial pop as we announced as of last week. The idea is to have a very simple product offering. We believe that this market is yet sub penetrated currently we estimate that the penetration is around 20%, 20-ish-percent. So to -- there's a lot of room to grow. When we started the market, we also understood that there is upright elasticity in terms of the other remaining 80% that didn't enter the payment industry, if you will. And so we decided to also to simplify the pricing, to create only one offering with a very aggressive price, if you will. And we did that, again, by simplifying the product and transferring all the operational efficiencies that we gained through the consumer benefit or the micro merchant benefit. We launched initially with the (inaudible) being offered through a bank account or a savings account, not only current-account also saving account as well. And so it's very flexible in that respect. Going forward, it is also the plan to allow the settlement to be done into the prepared card, as you mentioned, but again always at the discretion of the client. If the clients want to have our prepaid card settled, he will have it, otherwise he can use whatever credit account or savings account that he might wish to. And as for the point regarding this evolving to an ecosystem, yes, of course, depends on the traction that we expect from the project but naturally, other products might be distributed through these into our cross sell agenda.

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Jorge Kuri, Morgan Stanley, Research Division - MD [26]

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Thanks for that. That was very useful. Just let me -- in the last 2 parts of my question on how do you plan to distribute the product? Is it through online? Is it through branches? Is it through salespeople? What do you think cost of acquisition is? And what are the targets that you've set for the business, either active merchants by year end 2019, or '18 or TPV as well?

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Marcos Antônio Vaz de Magalhães, Banco Itaucard S.A. - Director [27]

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Okay, the main channel that we believe are self-serving so it's digital channel. We don't expect to distribute these in a lot of channels. And the main thing for that is that we believe that this kind of targets that we are aiming can be found at a very low cost of acquisition through these domains. As of the branches, we -- in our case, we don't see much overlap in our branches with the start-up group. So it is not a priority to introduce in our branch at this point. As for volume, what we disclose is the initial goal of having around 100,000 to 150,000 credit customers by this year-end, and that's what we have disclosed so far.

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Operator [28]

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(Operator Instructions) The next question comes from Jason Mollin, Scotiabank.

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Jason Barrett Mollin, Scotiabank Global Banking and Markets, Research Division - MD of LatAm Financial Services [29]

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My question is about the sensitivity of your guidance to economic growth and FX volatility. I understand that -- the comments that you're not changing the guidance despite the lower economic growth. Itaú Unibanco has lost earnings drivers in lots of businesses, and I also recognize how resilient they have been, but how should we think about the sensitivity of your business to these times of -- I mean, the real moved 17% in the quarter. Interest rates, on the long side moved up and have come back a little bit. We're seeing economic growth expectations slow. I mean, how should we think about it. It seems like the origination has not -- you haven't seen a negative impact of this volatility as of yet in the second quarter. Should we expect that -- and if you could just provide some color?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [30]

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So I would not say that we did not see a negative impact in the origination from this worse sentiment in the market. I think origination would have been better, had the -- if it were not for the trucker strike, if the perspectives for the elections were clear, if you have a more -- especially in the corporate sector. When we look at the corporate sector, you see that in the last coverage, there's no growth at all. But also, in the confidence sentiment in general the project sentiment in general, I think we can expect a more dense growth in demand for credit specifically but also for services if we have better economics. Having said that, and we try to be -- to have no volatility in our results by design. So because we concentrate ourselves in the less risky parts of the markets, this is why we are not so much affected by -- in the short term -- by the economic growth. As to FX volatility, we try to operate hedged in FX and in interest rates as much as we can. So when we see this movement, we had moments this quarter, significant movements this quarter. Our hedging instruments, I mean protect our balance sheet. But expenses will be impacted by more developed currency because of all the expenses, which are made in the offshore banks. And these are not hedged. They are hedged by their own results. But so, if results won't be affected, necessarily, and the results in Chile, the results in Argentina and in Uruguay and Paraguay will not be affected by the level of FX rate in Brazil. But the costs and the line of expenses in our balance sheet will be affected by this. Another important effect of the exchange rate is not on results, it's on capital. And you will notice if you go through our MD&A that we have actively managed our foreign investments in order to avoid the capital consumption, which is normally created by ForEx devaluation.

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Jason Barrett Mollin, Scotiabank Global Banking and Markets, Research Division - MD of LatAm Financial Services [31]

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That's very helpful. Maybe just a follow-up question on your slide on digital transformation as well. You're showing, it's an interesting move from 22% digital operations representing 22% of your operating revenues, moving up to 30% in the second quarter of '18. Can you talk about what -- like how you're measuring that? Is that -- how should we think about your measuring these kind of retail operating revenues? Is there a deposit spread in there? Is there -- I think clearly it's fee income loan spreads et cetera, any color would be helpful.

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [32]

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I will ask Alexsandro Broedel to (inaudible)

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Alexsandro Broedel Lopes, Itaú Unibanco Holding S.A. - Group Executive Finance Director, Head of IR & Member of Executive Board [33]

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Hi Jason, Alexander here. Yes, you basically use the same criteria that you use to measure on the other part of our financial spreads. For example, take about mean for example, we take into account the mean of the transactions originated on the digital branches. So you can see that the spread, the cost is allocated the full cost allocated system and with caps allocated and everything else. So it's pretty natural occasion of our normal criteria to the digital banks and the brick-and-mortar bank. Not sure if I answered it completely.

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Operator [34]

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(Operator Instructions) The next question comes from Eduardo Nishio, Banco Plural.

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Eduardo Nishio, Brasil Plural Corretora de Cambio, Titulose Valores Mobiliários S.A., Research Division - Financial Sector Analyst [35]

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I have two questions as well. First one is on Revelation. If you can share your thoughts on recent CPE Parliament or commission inquiry, recommendation to central bank. I know that Mr. (inaudible) was very supportive with the end of the cross used in the sector. If you can give any color on what might happen will be very helpful? And my second question, if you could give us an update on the shift in XP deal, I will also appreciate it.

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [36]

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Thank you for your questions, Nishio. So relatively to the CPE in the Congress and its conclusions, I believe that the conclusions of the CPE were positive to the market. That dealt with real problems in the economy. One of those real problems is the very high nominal level of interest rates in credit cards, and as you know, one of the main reasons for this very high-level number of levels as interest rates and credit cards is the cross subsidies. In our case, for instance of Itaú, our total credit card credit portfolio is BRL 60 billion, out of which BRL 5 billion bear interest, and BRL 55 billion don't bear interest. So and out of this spread of this BRL 5 billion, we must pay all the delinquency of over BRL 60 billion portfolio. So this is what causes rates to be so high. One idea that came out of the CPE is to incentivate a new market, an additional alternative to the installments without interest, which will be the financing in the credit card and in this case, it would probably reduce the payment to the merchants from 30 days to 15 days or even to a few days. So I think we may imagine that this is a more logical evolution. It's a gradual process so the product has to be created, has to be adopted by many banks and will later gain some market share over the installment result of just creating a better balance in the economy. So we will have a higher portion of our credit card portfolio, banks will have a higher portion of the credit card portfolio bearing interest.

On the XP transition, I think there's no comment to be made. We still await a decision by the central bank as to the approval of the transaction.

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Eduardo Nishio, Brasil Plural Corretora de Cambio, Titulose Valores Mobiliários S.A., Research Division - Financial Sector Analyst [37]

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Just a follow-up question. So there'll be probably a shift on economics of the industry, right? So we have -- probably you bear the float from 32 days, let's say. And then on the other hand, you have the interest on the payment with bearing interest credit cards, right. Is that correct?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [38]

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So when you go to a merchant to buy a shoe, the merchant will offer you 2 alternatives or 3. One alternative is to pay at site. One alternative is we have today, installment result interest. So you can -- your shoe will cost 100 and you can pay it in 5 installments without interest, of BRL 20. And another alternative, a new alternative will be well, you can buy your shoe financed in the credit card with the interest of the credit card. But in this case, the shoe won't cost a BRL 100, but it will cost BRL 92. And the merchant, if he sells 100 in installments, he will receive the money also in installments 30 days after each installment. And if he sells it into the new majority, he will receive the funds 2 days after the sale.

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Operator [39]

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The next question comes from Mario Pierry, Bank of America Merrill Lynch.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [40]

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Let me ask one more question. We were looking on Page 15 of your presentation, and you show that your headcount, especially in Brazil continues to roll up, right. I think your headcount is up 6% year-on-year. You did have the integration of Citibank. But also, you show on Page 17 the significant investments in technology, the digital transformation that you're making. So was just wondering, given the benefits or the potential synergies with Citibank, all the investments in technology, why should your headcount continue to go up? Or do you think that the trend in the future is to see much lower expenses going forward?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [41]

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We're still growing our headcount, mainly because the investment in people we are making in our new insurance platform and in the acquiring business. They outnumber the economies of people we are having due to technology improvements. I think we're very much in an investing phase of the bank and it's fair to say on the medium run that I expect the efficiency in the (inaudible) bank to improve significantly.

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Mario Lucio Pierry, BofA Merrill Lynch, Research Division - MD [42]

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Is it fair to assume that expenses for you are unlikely that they should be growing in line with inflation going forward?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [43]

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I think they should be growing below inflation going forward.

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Operator [44]

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(Operator Instructions) The next question comes from Carlos Gomez, HSBC.

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Carlos Gomez-Lopez, HSBC, Research Division - Senior Analyst, Latin America Financials [45]

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My question is on the cost of credit and you have credit (inaudible) reduction. How much lower do you think it can get? And what do you expect the bottom in terms of cost of credit? Meaning the maximum amount of your recoveries, the grade-point in this (inaudible) going forward?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [46]

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I'm not sure I understand your question, Carlos. It was concerning the provisions of how much lower it can get? How much lower the delinquency rates can get?

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Carlos Gomez-Lopez, HSBC, Research Division - Senior Analyst, Latin America Financials [47]

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Correct. How much lower can they get? How much lower can the cost of credit get? And when do you think we will reach that point?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [48]

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I think, they can go lower. You still see I mean this improving trend. Of course, the provisions, they will increase as the portfolio increases, proportionate to it. But the cost of credit can still go lower because we are seeing still an improvement in the quality of credit. I think I estimate that we can see until the end of the year an improvement in this industry. And we're going to see the new entities coming with the better figures, or better delinquency rates than the older.

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Carlos Gomez-Lopez, HSBC, Research Division - Senior Analyst, Latin America Financials [49]

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So you think the delinquency can improve, let's say, the next or the year after? I am sure we are (inaudible) on it?

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [50]

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Well, I can't see that far forward. We still have the elections in the middle of the (inaudible) one. So I think it's prudent to say that we can see them still improving until the end of this year.

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Operator [51]

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This concludes today's question-and-answer session. Mr. Candido Bracher, at this time, you may proceed with your closing statement.

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Candido Botelho Bracher, Itaú Unibanco Holding S.A. - CEO, Executive President & Member of Executive Board [52]

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Thank you all. So I'd like to thank you all for your attention and for your questions. I think our results this quarter, they came with a top line, which was not to our liking because it was below the previous quarter. But when we look inside people will see very healthy trends. We see a growing credit portfolio, we see growing fees and incomes. We see growing financial margin with clients and the effects to the other side were costs, which were normally higher in the second quarter because of trends which we verify every year, and because of our lower financial margin with the market which is perfectly in accordance with the guidance we have provided and with our forecast. So in looking forward we see a continuation of this positive trend in the balance sheet of growing. Thank you very much.

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Operator [53]

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That does conclude our Itaú Unibanco Holding earnings conference for today. Thank you very much for your participation. You may now disconnect.