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The optimal way to drive through a sharp turn in the road is to slow down before you reach it, before accelerating out from the mid-point of the curve.
In much the same way, Itaú Unibanco has steered its way through the recent sharp recession in Brazil.
In 2012, the bank shifted into a defensive posture in terms of credit risk, shifting its retail portfolio more into secured lending (mortgages, payroll loans and car loans) and hitting the brakes on extending unsecured credit to riskier individuals.
The bank also pursued a strategy of increasing revenues from fees and commissions. That down-change of strategy before the economic downturn ensured the bank is well positioned to accelerate credit growth if and when the economic rebound occurs.
As well as increasing risk-adjusted lending behaviour before the crisis, Itaú also increased its provisions early and sharply in the early years of the slowdown. This means the bank is already lowering provisions and seeing a benefit in profitability that may be enhanced further if the loans against which the provisions have been made do not turn bad.
Provisions peaked in the first quarter of 2016; in the third quarter of 2017, and under new chief executive Candido Bracher, the provisions-to-loan portfolio ratio dropped to 3.6%, a rate not seen by the bank since 2009.
Meanwhile, the focus on fees has paid off. While the return on equity of the bank’s credit operations is 14.1% (almost the same as its cost of equity at 14%), its insurance and services operations generate a 47.7% return on equity and now account for 53% of the bank’s total profits – as well as adding a large stabilizer to revenues. Overall, return on equity increased by 230 basis points to 21.7% in the first nine months of 2017.
The bank’s ability to generate capital from retained earnings has been remarkable; Itaú generated about 80bp of tier-1 capital from retained earnings in the last quarter alone. This has enabled it to pursue acquisitions that boost its size and profitability – but they have to be accretive in terms of profitability.
In October 2017, Itaú formally completed its acquisition of Citibank’s retail bank in Brazil, which added R$ 8.6 billion ($ 2.6 billion) in assets, R$ 6.2 billion to its credit portfolio, R$ 4.8 billion in deposits and around 300,000 customers, whom the bank is already targeting to boost its commission and fee revenues.
Also in 2017, the bank bought a 49% holding in online brokerage XP Investimentos just days before the company had planned an IPO. The deal was seen as a mix of defensive play (it was also slightly dilutive) due to XP’s strong growth rates in the retail brokerage business, but the acquisition fits neatly into two of the bank’s strong themes: the higher income retail segment and the drive towards digitization.
The acquisitions barely dented its capital position. In fact, the bank has been so bizarrely profitable despite the macroeconomic backdrop that it has had to twice change its capital management strategy. Early in 2017, the bank changed its by-laws to increase the possible payout ratio to 45%, only to abolish any upper limits months later.
It is clear why, with lower provisions and no acquisitions in sight, the bank needs to increase dividend payouts to optimize its capital position – it expects to pay out about 60% of profits as dividends this year.
All this has led some analysts to start to describe Itaú as a dividend stock. Does Itaú’s chief financial officer Caio David agree?
“I’m not sure I would call us a dividend stock,” he says. “But we have defined our comfortable level of capital at around 13.5%, so if we are above that level – and currently we have 14.6% – we will increase the pay-out to our shareholders based on that difference.”
This has been a steady trend: since 2012, dividends and interest on own capital have increased by 484%, from R$ 2 billion in the first nine months of 2012 to R$ 11.4 billion in same period of 2017.
David also notes that this should continue in the years to come as the bank’s investment in technology continues to improve its efficiency, profitability and capital generation.
Nothing is perfect, however. The bank’s merger with Corpbanca in Colombia and Chile is proving problematic and the poor performance of its payment system, Rede, are the biggest negatives, but management says it is focused on both.
There is also a question about Itaú’s relative ability to take advantage of a surge in retail credit demand down the credit spectrum if the economy takes off again. How quickly would it be able or willing to shift to a more aggressive portfolio strategy?
But given how the bank has emerged from arguably the worst recession in Brazil’s history, it is unlikely these challenges will slow Itaú down.