Earnings Call Transcript - ITUB Q2 2020

Operator, Operator

Good morning ladies and gentlemen, welcome to Itaú Unibanco Holding’s Conference Call to discuss the second quarter results of 2020. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. As a reminder, this conference is being recorded and broadcast live on the Investor Relations website at www.itau.com.br/investor-relations. A slide presentation is also available on this site. Before proceeding, I would like to 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 what is anticipated in any forward-looking comments due to macroeconomic conditions, market risks, and other factors. Joining us today on the conference call from São Paulo are Mr. Candido Bracher, President and CEO; Mr. Milton Maluhy Filho, Executive Vice President, CFO, and CRO; Mr. Alexsandro Broedel, Executive Director, Group Head of Finance and Investor Relations; and Renato Lulia Jacob, Head of Investor Relations and Market Intelligence. First, Mr. Candido Bracher will comment on the second quarter results of 2020. 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.

Candido Bracher, CEO

Thank you for taking the time to attend our 2020 second quarter earnings call. I hope you are all well and safe. Now, let us please move to Slide 2. I'd like to start by briefly discussing the macroeconomic backdrop which influenced our performance and the management strategy during this trying period. We have just been through what can arguably be considered the worst quarter in Brazilian history from a macroeconomic point of view. This becomes evident in our expectation of a GDP contraction of just over 10% as well as in the extinction of around 1.3 million formal jobs in this period. To face the scenario, the government reacted and cut interest rates to new historical lows, 3.35%. Additionally, to this date, it has injected approximately BRL 370 billion into the economy, roughly 5% of GDP. This very complex dynamic can be seen in the chart at the bottom of the slide, where we brought the daily variation of the Itaú Economic Activity Index. This index was built upon the high-frequency data that we get from our credit transactions and enabled us to monitor the economy's reactions closely and granularly. The economic activity bottomed out at the end of March with a 45% contraction when compared to pre-pandemic levels. However, we have already seen encouraging signs of recovery over the following months. Last week's data show that we are already at 90% of pre-COVID-19 activity levels. Moving to the next slide now. We were pretty clearly identifying this crisis as being different from any other challenge we have faced in our 96-year history, not just in its nature but in scale. We soon realized that credit would be the major risk factor for the financial sector, and that was exactly where we intensely focused our attention. Therefore, we acted fast and decided the right course of action must be extra careful and go the extra mile to support our customers. We believe that in the medium term, our initiatives will contribute to reduce potential credit losses and reinforce the perception of customers that we were present when they most needed us. We are convinced that this will more than compensate for any short-term loss of profitability. Since the beginning of the crisis, we have originated over 96 thousand loans, and we have also worked side by side with the government and actively participated in the programs they launched to support the most at-risk segments. We were the first private bank to commit to participating in the program to finance small retailers, disbursing all the facilities allocated to us in just a few hours and 100% digitally. In addition, we extended BRL 1.6 billion in the emergency payroll financing program for micro and small companies, and we underwrote BRL 2.9 billion to support energy generators, distributors, and retailers. So on Slide 4 now, we go into more details about the BRL 52 billion loan portfolio deposit profile with new repayment conditions, out of which 72% were individuals and 28% were micro and small companies. Firstly, it's important to highlight that 100% of those clients were performing, meaning no past dues by the end of February. 58% of this portfolio was already collateralized from their inception. Additionally, 90% of the portfolio is currently rated as AA to C. Finally, we show that the number of grace period requests has decreased significantly over the past 45 days. Moving now to Slide 5. Here, we describe how we have already allocated more than BRL 1 billion, and this resource was spread out in four different pillars of action to help fight the COVID-19 pandemic. It's important to emphasize that this is a nationwide program. For example, I'd like to highlight the donation of 105,000 oximeters, which were distributed to municipalities all over Brazil, as well as a BRL 100 contribution to produce two of the most advanced vaccines in partnership with leading organizations. Now on Slide 6, we present the integration of ESG teams into the bank's business and operations. Itaú Unibanco has a long ESG story that began more than two decades ago. At the top of this slide, we present a timeline showing the main milestones of this evolution, such as our participation in the Sustainability Index and adherence to commitments for good sustainability practices. Two weeks ago, we set a new milestone when in partnership with Santander, we launched a joint plan to promote sustainable development in the Amazon. This plan consists of 10 concrete measures divided into three priority fronts, which are shown here. These actions were personally presented to the Vice President of the country and to all the government representatives. Moving now to the results of the quarter. The bank ended the second quarter of 2020 with a BRL 4.2 billion recurring net income, translating into an ROE of 13.5%. This 7.5% net income growth was led by a 23% reduction in the cost of credit and higher trading gains. However, these effects were partially offset by the negative impact of the economic crisis on our fees and NII. We also have a higher effective income tax rate due to the full impact of the 5 percentage point increase in social contributions effective in this quarter. Finally, the loan portfolio grew by 2.9%, ending the period with a balance of BRL 811 billion. There are three things I'd like to highlight here. First, the loan portfolio was practically stable if we adjusted for the Forex valuation in the period. Second, there was a substantial change in the mix between segments, with large corporates growing a strong 3.6% quarter-on-quarter while individuals contracted by 3.9%. Lastly, as we rebuilt the portfolio, there was a very important change in the mix of products. There was a substantial contraction in credit cards and secured loans. This movement reflects not only a change in customer behavior and a drop in consumption levels but also our active risk management approach as we discourage the use of those products. What we believe is a good trade-off: temporarily give up part of our margin in order to protect our principles. On Slide 10, we show that the change in the credit mix, as explained in the previous slide, generated two effects. The migration of products from the retail portfolio posted a negative effect of BRL 600 million on our NII. The higher participation of the wholesale segment led to a further reduction of BRL 700 million in the financial market. Finally, the lower Selic rate had a negative impact of BRL 300 million on the remuneration of our working capital. Now, we present the evolution of the expected loss provision model and cost of credit. Our provisions for overdue operations strictly follow the rules defined by the regulator, where a minimum level of provisioning is required when the loan is available. The next dark blue layer is what we call aggravated risks. These are the amounts we have provisioned for overdue or renegotiated credits above the minimum defined by the regulator. Finally, we have potential losses, which contain the provisions made for clients that are neither delinquent nor renegotiated. The increase is not related to active delinquencies; it's mainly related to our future loss expectations. We show that due to the intensity of credit negotiations and proactive offering of more flexible payment terms, non-performing loans went down considerably. However, we believe these numbers do not fully reflect the extent of the crisis yet. Moving on to Slide 13, we see an important recovery in our financial margins with the market in the quarter, aligning more with historical levels. This performance was mainly due to higher gains in the trading desk and in our operations in Latin America. On Slide 14, we see a 10.5% drop in service revenues during the quarter, mainly reflecting lower economic activity triggered by the COVID-19 crisis. Despite this effect, we observed that our revenues are stable in the semester compared to the same period last year, mainly due to the good performance of the Asset Management division as well as advisory and brokerage services. I'd like to point out that our acquiring operation volumes are already at the same level as the previous year, and our credit card operations are close behind. Finally, our open investment platform, which started a couple of years ago, reached BRL 175 billion in assets under custody, representing a 7.2% growth over just one quarter. On Slide 15, we show our non-interest expenses, which are another important element of our performance. When we compare this quarter with the same period last year, we see a decrease of 4.4% in consolidated expenses with a 6.8% decrease in Brazil. If we adjust for inflation, expenses in Brazil fell in real terms by an impressive 9% during the period. One reason we have become more efficient is due to our consistent investment in technology. Now on Slide 16, we show how the usage of our digital channels has evolved over this crisis. Our digital customer base increased by 17.1% over the last year and we opened almost 1 million new bank accounts entirely through our app just this semester, representing a 131% increase year-over-year. Notably, we saw a particular increase in the adoption of digital channels by clients aged 50 and above. Currently, 47% of clients in that segment are using our apps and website. Despite the higher demand and volume of transactions in the digital channels, the availability of services remains at the highest levels in our history. Finally, I'd like to share with you a success case of how technology can help clients, especially during this crisis. In record time, we deployed new functionalities in our digital channels, enabling the fast and seamless deployment of over BRL 5.2 billion in government-sponsored facilities. Now on Slide 17, our Tier 1 regulatory capital has shown a slight recovery despite the still volatile scenario and ended the quarter with a capital ratio of 12.1%. Finally, on Slide 18, we decided to keep our guidance suspended due to the unprecedented nature of this crisis and because the health crisis has not yet been quelled. Unfortunately, there is no prospect for that. Despite the still low visibility ahead of us, it is important to give a sense of direction as to what we are currently expecting. Capital and liquidity should remain at appropriate levels, considering our internal stress test scenarios. In the short term, we should continue to see the large corporate portfolio expanding at a higher pace than retail. This trend may reverse if there is an increase in demand for credit from individuals and more activity from capital markets. Due to this and the potentially lower CD rate, it is possible we will see a further marginal reduction in the average rate of financial margins with clients in the short term. Commission, fees, and results from insurance should perform in line with the recovery trend of economic activity and the reopening of capital markets. We expect a further reduction in cost of credit in the short term. Our provisions will remain anchored in the expected loss model that will respond promptly to changes in the country's macroeconomic scenario and the financial conditions of our clients. We feel confident we will be able to deliver additional efficiency gains in the next quarters as a result of the continuous investment in technology, new ways of working, optimization of distribution channels, and structural efficiency projects. With this, I conclude this presentation and we may now start the Q&A session.

Operator, Operator

Our first question comes from Jorg Friedman of Citibank. Please go ahead.

Jorg Friedman, Analyst

Thank you very much for the opportunity to ask questions. I have two questions. Starting on provisions, your coverage of renegotiated loans decreased versus total NPLs. You also reduced the cost of credit quarter-over-quarter. So clearly, the expected loss model is making you a bit more optimistic ahead. I'd like to hear what you have seen from loans that already left your revised program this year. How are they performing versus the normal renegotiated portfolio? And how relevant do you believe this sample might be to predict future behavior during risk analysis? My second question relates to...

Candido Bracher, CEO

I'm sorry, I have a problem understanding you. I really can't grasp your first question. There's a problem with the reception here.

Jorg Friedman, Analyst

Can you hear me better now? Or should I try to repeat? Can you hear me now?

Candido Bracher, CEO

If you could dial in again, or if you speak very slowly and clearly because I really can't understand.

Jorg Friedman, Analyst

Okay, I'll try to speak very slowly. My question is, for the loans that already left your release program this year, how are they performing versus the normal renegotiated portfolio? How relevant do you believe this sample might be to predict the future behavior of operations under grace periods now? Okay. This is my first question. Could you understand it?

Candido Bracher, CEO

Yes, I could. Without going too much into the details, I can say that we had a first wave of renegotiations when we offered a 60-day grace period for basically everybody at the onset of the crisis. Many of these have matured now. Some of them went into the extended lines we offered. That means prolonging the grace period. But many have paid. The level of payments in this first prolongation of 60 days has surprised us and has been above what we expected, given that the crisis worsened during those first 60 days. When we follow up this renegotiated portfolio, the feedback is positive. What we observe in terms of liquidation and the financial health of the companies is rather encouraging.

Jorg Friedman, Analyst

Perfect. My second question relates to fees. You soft-guided that this should improve quarter over quarter ahead. I’d like to understand if you are incorporating the Central Bank's instant payment platform in this scenario and if it could jeopardize the growth of some line items such as checking accounts, debit cards, and collections. Thank you.

Candido Bracher, CEO

Okay. Thank you, Jorg. Yes, we expect – we expect peaks to be implemented during the second semester, but it will start slowly. It will certainly affect some of our income and transfer income. However, we still see it as a powerful tool for accelerating financial activity in Brazil, which is positive for us. Milton, do you want to add anything?

Milton Maluhy Filho, CFO

I agree with you, Candido. We believe this is still a project. We're going to work toward making it important in the financial system. We are not forecasting a significant impact this year yet. There is a ramp-up of this project, and we don't believe this will bring a major impact this year. But yes, you are right, in the midterm, we should see some impacts, mostly in terms of competition and a better experience for our clients. We will work closely with the Central Bank to make it happen. In terms of fees, we expect that some reasons for the better performance in the second semester will be due to investment banking activity and wealth management, as those lines are performing very well. We think credit card volumes will experience important recovery in the coming months.

Jorg Friedman, Analyst

That’s perfect. Thank you very much. Very clear.

Milton Maluhy Filho, CFO

You're welcome. Thank you, Jorg.

Operator, Operator

Our next question is from Henrique Navarro of Santander. Please go ahead.

Henrique Navarro, Analyst

Hi. Good morning, everyone. My first question is on provisions. Based on your presentation, we shall see provisions going down in the second semester compared to the first semester. But can we see the cost of risk go back to normalized levels in the third quarter if the current improvement in the macroeconomic scenario continues?

Candido Bracher, CEO

Thank you for your question. We have adopted a prudent stance throughout this crisis, as I explained. Since we think the most fragile quarter is behind us, it may be too soon in the third quarter to see the cost of credit return to normalized levels. We may begin to see an increase in delinquencies in the next year. For now, we will continue to provision based on our expected loss model. The two companies you asked about, Itaú CorpBanca and IRB, we see normal development in Itaú CorpBanca; there's no active changes there at all. Its management is performing well, and the crisis is being handled adequately. I think recovery in the Chilean economy will be normal.

Henrique Navarro, Analyst

Very good. Thank you.

Operator, Operator

Our next question comes from Jorge Kuri of Morgan Stanley. Please go ahead.

Jorge Kuri, Analyst

Hi. Good day, everyone. I have two questions, if I may. The first concern is on your credit card business. Card issuance was down 22% sequentially, and card acquiring 16%. I wanted to understand how July and the early days of August are trending. How rapidly is that coming back? Are you at 80%, 90%, or still below that? Any insight would be useful. My second question is about competition. How is competition shaping up in the banking system? The market was very varied in previous years regarding competition, mainly from new fintech-driven providers across different verticals. How is that evolution going? Are you seeing more aggressive competition or is it softening? Are the client acquisition costs increasing?

Candido Bracher, CEO

Thank you for your questions, Jorge. So regarding credit card usage, it dropped over 40% immediately after the lockdowns. Now it is between 10% and 15% below normal activity levels. Of course, it varies significantly by sector – for instance, it remains lower in the tourism and restaurant sectors. However, professionally, on average, we are seeing decreased card activity between 10% and 15% currently compared to pre-COVID levels. Moving on to competition, we continue to see strong competition in specific areas of the bank. The acquiring business and investment sectors are particularly competitive. Aside from the incumbents, new entrants are also becoming more established, impacting our market share. We see that as we adapt to new pressures, we are learning from our competitors, and I’m optimistic about the prospects moving forward.

Jorge Kuri, Analyst

Thanks, Candido. If I may follow up, regarding the fintech lenders, how are they trending? Do they have the balance sheet strength to withstand rising NPLs? How are their operational costs evolving during this pandemic?

Candido Bracher, CEO

We don’t see many of them yet, Jorge. Some credit card banks, which also have loans, are growing. But in terms of general loans, they still represent a very little market share. I'm not seeing them performing distinctly well as lenders right now.

Jorge Kuri, Analyst

All right. Thank you, Candido. Thank you for your answers.

Operator, Operator

Our next question comes from Carlos Gomez of HSBC. Please go ahead.

Carlos Gomez, Analyst

Thank you. Good morning. I have two questions. The first focuses on how you see your position in XP going in the future. The second: if you can explain, we believe you wrote off much of the goodwill of CorpBanca this quarter, but it didn't affect your financial statements. Can you tell us exactly what you did and whether you would consider increasing your participation in the bank in the future? Thank you.

Candido Bracher, CEO

Our investment in XP, made a little over three years ago, continues to provide us with an important position in a very dynamic market. We are happy with that investment. However, the Central Bank has barred us from acquiring control or taking a more active role within the company, so we keep an eye on it as an investment. Regarding CorpBanca, the reason behind its small impact on our loan figures in Brazil is due to a difference in how overpricing is treated by Chilean and Brazilian legislation. Here in Brazil, we amortize the goodwill, while in Chile, it must be deducted immediately. So the impact we had in Brazil with goodwill impairment is significantly lower.

Milton Maluhy Filho, CFO

In terms of Itau CorpBanca, we had an impairment of almost BRL 1 billion in Chile. When we look at Brazil, you must consider two main effects: first, we've been amortizing goodwill since 2016, and the second factor is our 38% holding in the bank, which directly influences the impairment amount in Brazil. So we faced a minor impact of BRL 19 million on our balance sheet.

Carlos Gomez, Analyst

Essentially, your tax loss crystallized at the moment there is a loss in Chile, allowing you to impair it in Brazil? The effective tax rate on impairment is high, almost 50%, right?

Milton Maluhy Filho, CFO

Yes. We have around BRL 700 million in tax credit due to this impairment, as noted earlier.

Operator, Operator

Our next question comes from Geoffrey Elliott of Autonomous Research. Please go ahead.

Geoffrey Elliott, Analyst

Hi, thanks very much for taking the question. On the re-profiled loans, you noted that the payments that have started up again have been better than expected. Can you provide some numbers around that? What proportion of clients who stopped paying are now paying again? And are those clients included within the re-profiled loan numbers that you’re providing? Thank you.

Candido Bracher, CEO

Thanks for the question, Geoffrey. We are not disclosing specific numbers on that. However, the clients who have resumed payments are not in any other program now, and this has surpassed our expectations. Another part of the clients transitioned to extended plans, and we have been positively surprised with the financial health metrics we’ve observed, reflected in our provisioning, based on expected losses.

Geoffrey Elliott, Analyst

Got it. Regarding BRL 38 billion of loans to individuals that were re-profiled and the BRL 15 billion of loans to small businesses, does that include the clients that have resumed paying?

Candido Bracher, CEO

Yes, it does.

Operator, Operator

Our next question comes from Jason Mollin of Scotiabank. Please go ahead.

Jason Mollin, Analyst

Hi, my question is also related to asset quality, kind of a follow-up. Itaú Unibanco reported a decrease on the NPL ratio in the second quarter sequentially. As you mentioned in your press release, this is the lowest level since the Itaú Unibanco merger. Can you help us understand the risk levels you see in the portfolio? It shows stability in segments D through H quarter-on-quarter. Is this signal of declining risk in the portfolio?

Candido Bracher, CEO

Both points are true. We were prudent in the first quarter, provisioning as we saw indicators, while expectations have since improved. The delinquency levels indicate that our provisions may decline as delinquencies increase next year, allowing us to assess how companies and individuals are recovering from the impact of the crisis. There is still some uncertainty about how Brazil will fare post-crisis, and while we are experiencing better performance than anticipated, we're cautious about sustaining this.

Jason Mollin, Analyst

Thank you, very helpful.

Operator, Operator

Our next question comes from Daer Labarta of Goldman Sachs. Please go ahead.

Daer Labarta, Analyst

Hi Candido and everyone, thank you for the call. A couple of questions also. First, on your margins. Margins seem to have fallen a bit. You probably made lower interest rates, but we did see margins increase at your peers. We also benefitted from higher trading gains. Can you help us understand this? Do you believe margins have bottomed? Do you think the mix shift continues to impact margins? Have you fully realized the impact of lower interest rates? If you can provide some more clarity on the margins. My second question is on your capital. It seems your core Tier 1 ratio increased by only 10 basis points, remaining below the 11% to 12% levels historically where you've been. Is this due to your offshore investments?

Candido Bracher, CEO

On margins, I think they've largely bottomed, but I can’t claim they have fully stabilized yet. The costs associated with clients in both individuals and large corporates are a priority for us as we navigate this crisis. While we were prudent, I think there could still be some compression in the next quarter, but I expect a recovery through better margins as economic activity resumes. Regarding our Tier 1 capital, our risk appetite is aligned with a target of a 13.5% capital loan ratio. While we remain comfortable at current levels, our focus is on recovery and taking measured steps to return to optimal levels.

Daer Labarta, Analyst

Thank you, Candido. If I can just follow-up on the margins, do you believe you are perhaps being more aggressive than your peers in terms of offering better credit lines to companies? And could these lead to healthier asset quality in the future?

Candido Bracher, CEO

To illustrate, an offered plan with six months grace and then thirteen months of payment gives us overnight maintenance plus 125. It's a very good line for clients, which we disbursed faster than our competitors. This reflects our focus on delivering the best possible solutions to clients, which aids them in dealing with challenges. Although we maintain a vigilant eye on competition, I feel optimistic about our position.

Daer Labarta, Analyst

Ok, very clear. Thank you, Candido.

Operator, Operator

Our next question comes from Pieta Alessandri of Credicorp Capital. Please go ahead.

Unidentified Analyst, Analyst

Hi, thank you. I wanted to ask regarding Itaú CorpBanca. We know about Itaú CorpBanca's capitalization strategy to sell approximately $350 million in Colombia. How do you plan to finance this strategy? Do you expect to accelerate the sale? Can you provide further details?

Candido Bracher, CEO

I'll let Milton address that since he’s more familiar with the details.

Milton Maluhy Filho, CFO

Yes, we have executed the forward sale for January of 2022 for $330 million plus interest. We are not planning to anticipate this acquisition as we are waiting for regulatory approval in both Chile and Colombia. We expect this acquisition will proceed as planned. On the other hand, when conducting our long-term capital planning, we take this acquisition into account, affecting our capital structure.

Unidentified Analyst, Analyst

Thank you very much. Regarding Itaú's grace period, we know that you have 120 and 180 days of grace periods for the renegotiated loans. When do you expect most of the renegotiated loans to be free? When do you expect them to begin paying again?

Candido Bracher, CEO

They have already started; we initially offered clients a 60-day grace period at the crisis onset. Many clients opted for this plan. We later offered extended grace periods, but many chose not to extend and opted to pay back at a higher rate than originally anticipated. To answer your question, we implemented this back in April, so clients will start to resume payments around the end of August to October.

Unidentified Analyst, Analyst

Thank you very much.

Operator, Operator

Our next question comes from Nicolas Riva of Bank of America. Please go ahead.

Nicolas Riva, Analyst

Thank you for taking my question. It appears that you are differentiating between the re-profiled loans owing to COVID-19, totaling BRL 52 billion in consumer loans and small business loans, compared to the stock of renegotiated loans. Can you clarify the reasoning behind this distinction? Is there a difference in risk profile between these categories?

Candido Bracher, CEO

Yes, Nicolas, you are correct. The stock of BRL 52 billion pertains to loans renegotiated in the crisis, which generally had issues prior, whereas the BRL 35 billion stock encompasses clients appearing to have long-standing financial difficulties. That’s where we apply different scrutiny measures. The BRL 52 billion includes new data, showcasing that many companies have experienced difficulties entirely due to the economic shutdown caused by the pandemic.

Nicolas Riva, Analyst

Thank you very much. Would it be fair to say that the recovery value should be higher and that there's a lower need for loan loss provisions in the re-profiled loans compared to the stock of renegotiated loans?

Candido Bracher, CEO

Yes, that's a safe assumption. The performance of the BRL 52 billion should indeed be significantly better than that of the stock.

Operator, Operator

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

Candido Bracher, CEO

I want to express my appreciation to all for listening, for the interest, and for your questions. I want to reaffirm that our strategy in dealing with this unprecedented crisis has focused on supporting our clients because it is what we believe is right and because it aligns with our objective to maintain a strong credit quality portfolio going forward.

Operator, Operator

That does conclude Itaú Unibanco Holding’s earnings conference for today. Thank you very much for your participation, and you may now disconnect.