Itaú Unibanco Earnings: Good Results but High Interest Rates Are a Headwind to Loan Growth

No-moat-rated Itaú Unibanco ITUB reported good second-quarter earnings despite a challenging economic climate in Brazil, though, as we had anticipated, loan growth has slowed. Itaú reported operating revenue of BRL 38.8 billion, 3.7% higher than last quarter and 10.1% higher than last year. Net income increased 13.9% from last year to BRL 8.7 billion, which translates to a return on equity of 20.9%.

As we incorporate these results, we are increasing our fair value estimate for Itaú to $5.40 from $4.90 per ADR share. Around $0.30 of the increase comes from earnings and foreign exchange movements since our last update. Another $0.10 of the increase comes from higher non-interest income, as the bank’s card processing income continues to outperform expectations. The remainder of the increase comes from higher net interest income expectations as Itaú's loan growth deceleration this year has occurred slower than we had initially anticipated, partially offset by higher credit cost projections.

While still more resilient than we had expected at the start of the year, Itaú's loan growth decelerated meaningfully. Total loans were up 6.2% from last year to BRL 1.15 trillion but were effectively flat sequentially. That said, Itaú's higher-margin Brazilian loans outperformed, growing 1.2% sequentially versus a 5.4% decrease for the bank’s Latin American loans.

Itaú's credit quality did deteriorate further in the second quarter, but the bank’s credit performance remains noticeably stronger than its peer, Banco Bradesco. Over-90-day nonperforming loans were 3% of total loans, 0.3% higher than last year and 0.1% higher than last quarter. Total credit costs increased to BRL 9.4 billion from BRL 7.5 last year. We still expect credit quality in Brazil to deteriorate further, but with a coverage ratio of 212% and a common equity Tier 1 ratio of 12.2%, Itaú is in a strong position to withstand higher credit costs.