Itau Unibanco Holding S.A. annual report, Q4 FY2017

Itaú Unibanco Holding S.A. — Form 20-F Summary

Business context and reporting period

Itaú Unibanco Holding S.A. is a Brazil-based universal bank with operations primarily in Brazil and additional businesses across Latin America, Europe, the United States and other jurisdictions. Its reportable segments are Retail Banking, Wholesale Banking, and Activities with the Market and Corporation.

The filing was submitted on April 20, 2018, and covers the fiscal year ended December 31, 2017. The financial statements are audited and prepared under IFRS as issued by the IASB. The filing does not provide a complete standalone fourth-quarter income statement; fourth-quarter information is presented selectively within annual disclosures.

Brazilian GDP grew 1.0% in 2017 after two years of recession. Inflation and interest rates declined materially, with year-end Selic at approximately 7.0%, supporting lower credit losses but pressuring interest income and margins.

Key financial metrics

Metric	2017	2016	Change
Total assets	R$1,434.97 billion	R$1,353.24 billion	+6.0%
Gross loan and lease portfolio	R$493.37 billion	R$490.37 billion	+0.6%
Net loan and lease portfolio	R$465.47 billion	R$463.39 billion	+0.4%
Banking product	R$111.05 billion	R$118.66 billion	-6.4%
Banking product net of loan losses	R$92.81 billion	R$96.54 billion	-3.9%
Net income	R$24.27 billion	R$23.58 billion	+2.9%
Net income attributable to parent	R$23.90 billion	R$23.26 billion	+2.8%
Basic earnings per share	R$3.68	R$3.57	+3.1%
Net interest margin	5.4%	5.8%	-40 bps
Return on average equity	19.7%	20.1%	-40 bps
90-day NPL ratio	3.1%	3.4%	-30 bps
Efficiency ratio	46.3%	45.1%	+120 bps

Management also reported recurring net income of R$23.9 billion under Brazilian GAAP, up 2.6%, and recurring ROE of 20.1%. These measures are not identical to IFRS net income and ROE.

Interest and similar income declined 10.4% to R$144.69 billion, reflecting lower rates and reduced yields on securities and loans.
Interest and similar expense declined 17.7% to R$78.33 billion, principally because of lower funding costs and reduced repurchase-agreement expense.
Banking service fees increased 7.9% to R$34.45 billion. Non-interest income increased 5.8% to R$41.46 billion.
Losses on loans and claims declined 17.5% to R$18.24 billion. Loan-loss expense declined 14.9% to R$20.75 billion.
The allowance for loan and lease losses was R$27.90 billion, equal to 5.7% of gross loans and 146.0% of non-accrual loans.
General and administrative expenses increased 6.3% to R$54.12 billion, partly due to personnel growth and Citibank integration costs.
Net cash provided by operating activities was R$8.64 billion. Investing activities used R$3.84 billion and financing activities used R$16.92 billion, producing a net decrease in cash and cash equivalents of R$12.12 billion. Cash and cash equivalents ended at R$83.31 billion.

Capital, debt and liquidity

Total stockholders’ equity was R$148.01 billion, including R$134.84 billion attributable to the parent company.
The BIS ratio was 18.8%, compared with 19.1% in 2016; Tier 1 capital was 16.2% and Common Equity Tier 1 was 16.2%.
Regulatory capital was R$142.25 billion, versus a minimum required referential equity of R$69.995 billion, leaving reported surplus capital of R$72.26 billion.
Average fourth-quarter Liquidity Coverage Ratio was 190.2%, compared with a 2017 regulatory minimum of 80%.
Deposits increased 22.3% to R$402.94 billion. Securities sold under repurchase agreements declined 10.5% to R$312.63 billion.
Interbank market debt was R$129.62 billion and institutional market debt was R$98.48 billion. Subordinated debt included in funding was R$52.70 billion.
The contractual-obligations table showed total obligations of R$613.18 billion, including deposits, market debt, guarantees, leases and other commitments.
Management stated that no debt default or financial-covenant event had occurred through December 31, 2017 and that it had no reason to expect such events in 2018.

Material changes versus the prior comparable period

Loan growth was modest overall, but the mix shifted toward individuals and lower-risk products. Individual loans increased 3.8% to R$190.15 billion, while corporate loans declined 11.6% to R$107.62 billion. Small and medium-business loans increased 0.9% to R$59.45 billion.
Latin American loans increased 7.6% to R$136.14 billion, partly reflecting exchange-rate movements and organic growth.
Asset quality improved: the 90-day NPL ratio fell to 3.1%, impaired loans declined 1.0% to R$30.02 billion, and net charge-offs declined to R$16.13 billion. However, early-stage delinquency increased, with the 15-to-90-day NPL ratio rising to 2.8% from 2.5%.
Citibank’s Brazilian retail operations were acquired and operational control transferred on October 31, 2017. The transaction added retail clients, branches, cards, deposits and loans, and generated R$631 million of goodwill. A R$504 million provision for Citibank integration expenditures was recorded.
The company acquired 84.2 million treasury shares during 2017 for approximately R$3.1 billion and cancelled 31.8 million common shares, subject to regulatory processing.
Itaú issued US$1.25 billion of perpetual subordinated notes in December 2017 at a fixed coupon of 6.125%, subject to Central Bank approval for inclusion as Additional Tier 1 capital.
The group sold its group-life insurance business effective April 1, 2017 and continued emphasizing mass-market insurance, pension and fee-based products.
The company agreed to acquire a minority interest in XP Investimentos for R$600 million of capital contribution and approximately R$5.7 billion of share purchases. The transaction remained subject to Central Bank approval as of the filing date, and management estimated an initial 0.8 percentage-point impact on the Basel index.

Outlook, management commentary, risks and unusual items

Management characterized 2017 as the beginning of Brazil’s economic recovery and expects continued benefits from lower defaults, disciplined expenses, digital transformation and selective loan growth. The strategic agenda emphasizes customer centricity, digital transformation, people management, risk management, sustainable profitability and internationalization. No specific numerical earnings or revenue guidance was provided.

Management expects additional productivity benefits from digital investments, including mobile banking, online account opening, automation, artificial intelligence and cloud infrastructure.
The new capital distribution policy targets a Tier 1 capital ratio of 13.5% and permits distribution of excess capital, subject to profitability, risk-weighted-asset growth, regulatory requirements, acquisitions, buybacks and other capital needs. The 2017 payout was 83% of recurring net income, including buybacks; dividends and interest on capital totaled R$17.6 billion.
Material risks include Brazilian economic and political conditions, fiscal reform uncertainty, interest-rate and foreign-exchange volatility, sovereign exposure, competition, funding costs, regulatory changes, cyberattacks, operational failures, reputational damage, model risk, insurance-reserve risk and integration risk.
Brazilian government securities represented approximately 20.6% of total assets and 72.3% of the securities portfolio, creating significant sovereign and market-risk exposure.
Provisions totaled R$19.74 billion, including R$7.28 billion for labor claims, R$7.00 billion for tax and social-security matters and R$5.30 billion for civil litigation. Possible-loss tax and social-security contingencies totaled approximately R$19.60 billion and were not provisioned.
The company faces litigation related to historical Brazilian economic stabilization plans and savings-account inflation adjustments. A settlement agreement was ratified by Brazil’s Supreme Federal Court in 2018, with a 24-month adherence period for eligible claimants.
A tax assessment related to the Itaú-Unibanco merger was cancelled by CARF’s ordinary instance in April 2017; management continued to assess the remaining related proceedings as remote or more likely than not to be successfully defended, depending on the proceeding.
IFRS 9 became effective January 1, 2018. Management estimated that adoption could reduce stockholders’ equity by no more than 3.0%, net of tax, based on estimates available at the reporting date.
Management and PwC concluded that internal control over financial reporting was effective as of December 31, 2017. PwC issued an unqualified audit opinion.

Important facts for investors to verify

Reconcile recurring Brazilian-GAAP results with IFRS net income, ROE and payout measures.
Assess whether improving 90-day NPLs offset the increase in early-stage delinquency, renegotiated loans and Latin American credit-loss expense.
Review the sustainability of net interest margin after the sharp decline in Brazilian interest rates and the impact of the credit-card revolving-credit regulation.
Verify the final accounting, regulatory approvals, capital impact and integration costs for Citibank and the proposed XP investment.
Confirm the eligibility and capital treatment of the December 2017 perpetual notes and any subsequent issuances.
Evaluate exposure to Brazilian sovereign securities, foreign-exchange positions, derivatives and stress-test losses.
Review the R$19.74 billion provision balance, possible tax contingencies, economic-plan litigation and settlement-related cash requirements.
Confirm the final number of outstanding common and preferred shares after buybacks and cancellations, as the filing presents different share counts for different reporting dates and post-filing events.
Assess the effect of IFRS 9 adoption and later regulatory changes on equity, provisions, capital ratios and dividend capacity.