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Itaú Unibanco had a good crisis. The bank weathered Brazil’s deepest ever recession in spectacular fashion, adopting a defensive posture as credit dynamics deteriorated to minimize defaults.
Although it suffered some large corporate defaults that pushed up provisioning, Itaú Unibanco’s conservative stance to higher-risk individual and small and medium-sized enterprise segments has worked well.
Now, however, the bank may require a strategic repositioning. That is not to say it isn’t still performing well. It is so profitable that it is returning money to shareholders at an unprecedented rate through special dividends and its return on equity was flat on the quarter at a more-than-healthy 20.9%. It is just that the momentum seems to be stalling. For every improvement there is a deterioration that is frustrating the even-higher profitability that might be expected as the economy recovers.
For example, in the third quarter of 2018, the bank grew its loan portfolio by 13.4% year on year, and it even skewed that growth to higher-risk/higher-return segments, but the net interest margin was flat in the lower interest rate environment.
The bank also enjoyed a lower cost of risk in the quarter, but this operational advantage was offset by an increase in non-performing loans (driven again by corporates), weak fee growth and higher expenses. From a return on assets perspective Itaú recorded its weakest performance since the third quarter of 2016.
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| Candido Bracher |
The bank is also feeling the pressure of new competition. It has long acknowledged that its payment system Redecard is a weakness and that new startups – such as Stone and PagSeguro – have radically altered the competitive landscape, as have innovative and cheaper solutions from other banks (most notably Santander Brasil’s Getnet). It is not the lost Redecard revenues that hurt Itaú most, it is the loss of wider corporate business as competitors use payment solutions as a bridgehead into other corporate and SME products and services.
On a recent analyst conference call, chief executive Candido Bracher highlighted the tough fight Itaú is facing in this important segment.
“I think we have still quite a way to go in our acquiring business. I think we can improve much more there,” he said. “It’s no secret to everybody how competitive this business has become in the past two years, and it’s becoming more competitive. In this scenario we have first lost some market share due to the competition, but we have restructured our activity in many ways with investment and we have been able now to stop this loss in market share.
“We don’t make the prices; the competition makes the prices, the market makes the prices.”
Despite the falling profitability of the corporate segment, Itaú has confirmed its strategic importance by hiring about 300 people to the business in the third quarter. The bank also added about 400 to its insurance sales team.
Overall the bank added 1,000 employees, although Bracher says the bank is looking to offset these headcount gains with efficiencies elsewhere. However, these hires negatively impacted the bank’s operating expenses and, combined with lower than expected treasury gains, led the bank to miss third-quarter consensus expectations and report relatively soft results.
Bracher says competition from fintechs has been much stronger on the services side of the bank’s operations rather than in the provision of credit: “Incumbents must find innovation before innovators find distribution,” he says. “This is more or less the race. As incumbents, we must find innovation to compete with the products offered by this new competition. And this is what we are doing and which is why I have shown here our investments in technology.”
Bracher not only points to investment in the digital banking platforms but also investments in big-data projects and in recruiting data scientists.
All this is of interest for the future, but the market has a shorter-term focus and the key question for investors is whether or not Itaú is prepared to react to a growing Brazilian economy in 2019 by freeing up its very strict credit controls.
Bracher was clear that recent increases in the bank’s loan portfolio came from an improvement in the risk scores and appetite of individuals and companies in Brazil, rather than from any changes to the bank’s risk controls.
But, for the first time in a long time, he says the bank is reviewing its approach to enable it to more fully benefit from the country’s recovery.
“We think that the steadiness we have seen in the improvement of companies and the perspectives we have ahead that may encourage us to review these levels of probability of default below which we do not lend,” he said, picking his words carefully. “We are studying this as we speak and we may submit to our board some measure in this direction over the course of this next quarter.”
The bank’s desire – and ability – to increase its exposure to the next economic cycle will be a fascinating struggle with both its external competition and its own internal risk philosophy.
