Itaú Unibanco S.A is a company that passes the Buffett-Munger screener.
I.Understanding the Business and History
Itaú Unibanco S.A is the largest Latin American bank and one of the largest banks on the planet, with approximately 100,000 employees and operations in 20 countries throughout the Americas, Asia and Europe. Itaú is a universal bank with a range of services and products serving the most varied client profile – both individuals and companies of all sizes, from major transnational groups to local micro-entrepreneurs. In Brazil, Itaú has nearly 5,000 full-service branches and 28,000 ATMs.
Itaú is recognized for its governance practices and its management, which is focused on the generation of economic, social and environmental value. Its shares trade on the São Paulo (BM&FBovespa), Buenos Aires and New York stock exchanges.
History of Itaú
- The origian of Itaú dates from 1924, when Unibanco was founded by the MOreira Salles family.
- 1945 - Banco Itaú S.A was founded, as the Banco Central de Credito.
- 1960s - After a 20-year period of organic growth, as a result of the federal government's modernization of the Brazilian financial system, Itaú began a period between 1964 and 1969 mergers.
- 1970s - Itaú took its first steps towards an international presence with the opening of branches in New York and Buenos Aires.
- 1980s - Itaú became one of the first to transform itself into a multiple bank, thus legally formalizing an internal organization that had already been evolving since the '70s. Itaú started adopting state-of-the-art technology.
- 1994 - Banco Itaú Europa, Itaú Argentina and Itaú Bank (Cayman) were founded, expanding the vision and international operations.
- 1995-2001 - A spree of acquisitions including Bamerindus Luxembourg, Banco Del Buen Ayre.
- 2008 - Itaú Holding and Unibanco Holdings S.A announced the combination.
- The commercial banking business segment offers a wide range of banking services to a diversified base of individuals and companies. Services offered by the commercial banking segment include insurance,pension plan and capitalization products, credit cards, asset management, credit products and customized products and solutions specifically developed to meet customers’ demands.
- Itaú BBA is responsible for our corporate and investment banking activities. Itaú BBA’s management model is based on building close relationships with its customers by obtaining an in-depth understanding of their needs and offering them customized solutions. Corporate activities include providing banking services to large corporations and investment banking activities include offering funding resources to the corporate segment, including through fixed and variable income instruments.
- Through the consumer credit business segment, Itaú implements its strategy of expanding its offering of financial products and services beyond its current accountholders.
- The activities with the market and corporation segment manages interest income associated with Itaú Unibanco Holding capital surplus, subordinated debt surplus and the net balance of tax credits and debits, as well as net interest income from the trading of financial assets through proprietary positions (desks), management of currency interest rate gaps and other risk factors,arbitrage opportunities in the foreign and domestic markets, and mark-to-market of financial assets. This segment also includes the effect of nonrecurring items that are not considered in the managerial statement of income.
II.How Does the Business Operate?
Although Itaú has four segments, Itaú's main segment is commercial banking. A commercial bank's main operating model is to take in deposit and disburse loans. As the interest rates that a commercial bank was charged for deposits are lower than the interest rates it charges for loans, an interest rate spread is created. A commercial bank can also derive earnings from other sources such as income generated from investment securities.
Usually a commercial bank’s earning assets consist of real estate loans secured by customers' properties, commercial and industrial loans, consumer loans (installment and credit cards, etc.) and investment securities. Of the earning assets, usually securities portfolios are mainly invested in fixed income securities, which have lower yields than loans held to maturity due to the latter's higher risk. In good times, most banks shore up the balance of loans and reduce securities investments. In bad times, banks load up on the safest fixed income investments and only disburse loans to the most credible customers.
A commercial bank's principle liabilities include deposits and short-term and long-term debts. Different types of deposits have different interest rates (for instance, CD has a higher rates than on-demand deposits).
Banks face asset-liability mismatching risks because assets and liabilities often have different maturity dates both individually and on aggregate. To control asset-liability mismatching, banks closely monitor the grouping of assets and liabilities such that for each time tranche (say 90 days, 12 months, three years, five years), the notional amounts of assets and liabilities do not deviate too much. If a bank has more liabilities than assets that are exposed to maturity and repricing risk, the bank is considered to be liability-sensitive. If more assets than liabilities are exposed to maturity and repricing risk, the bank is considered to be asset-sensitive.
In a falling interest rates environment. a liability-sensitive bank will benefit from a wider net interest margin. Conversely, in a rising interest rate environment, an asset-sensitive bank will benefit from a wider net interest rate margin.
As an example, let's assume Bank A has disbursed a variable rate loan for $10 million to a customer that will mature in three years while taking on a variable rate deposit with a balance of $9 million that will mature in three years. Bank A is obviously asset-sensitive. If interest rates rise by 1% (for simplicity purposes, let's assume the rates for both the loan and deposits will rise simultaneously at the same rate, which in reality rarely happens), Bank A will earn $100,000 more on the loan it disbursed and pay only $90,000 more for the deposits as a result of the interest rates spike. The net effect is a $10,000 incremental income, which will widen the net interest margin (interest income/earning assets).
III. Competitive Advantages:
1. Premier banking brand in Brazil.
Itaú Unibanco S.A. is the largest Latin American bank. It is a very strong brand and is very well recognized in Brazil. It has a low customer turnover rate, especially among customers in the high income segment.
2. Large branch network in geographic areas with high economic activities.
Itaú Unibanco S.A. has an extensive network with 4,121 branches, 906 CSBs and 27,960 ATMs in Brazil and abroad, as of Dec. 31, 2012. Its branch network is strategically concentrated in Southeast Brazil, the country’s wealthiest region. Its branch network in other countries of the Southern Cone (Argentina, Chile, Paraguay and Uruguay) is also positioned in regions with high levels of economic activity.
3. Diversified products and service portfolio.
Itaú Unibanco S.A. offers a diverse line of products and services that cater to the needs of various types of clients. Its client base includes government, corporate, small and medium sized enterprises, retail customers and high-income individuals.
4. Experienced and quality management team.
Itaú Unibanco S.A.'s management team consists of both controlling family members and highly experienced banking veterans. The quality of management is demonstrated by the high ROA and ROE ratios and adequate capital levels.
The last several years have been characterized by increased competition and consolidation in the financial services industry in Brazil.
Per the most recent 20-F filing, as of Dec. 31, 2012, there were 136 multiple-service banks, 22 commercial banks and numerous savings and loan, brokerage, leasing and other financial institutions in Brazil.Itaú Unibanco S.A., together with Banco Bradesco S.A. (“Bradesco”), Banco Santander (Brasil) S.A. (“Banco Santander”) and HSBC Bank Brasil S.A. (“HSBC”), are the leaders in the non-state-owned multiple-services banking sector.
As of Sept. 30, 2012, these banks accounted for 40.7% of the Brazilian banking sector’s total assets.
Itaú Unibanco S.A. also faces competition from state-owned banks, which has increased recently. As of Sept. 30, 2012, Banco do Brasil S.A. (“Banco do Brasil”), Caixa Econômica Federal (“CEF”), and BNDES, ranked first, fourth and fifth in the banking sector, respectively, accounting for 42.9% of the banking system’s total assets.
The following table from S&P Capital IQ compares Itaú Unibanco S.A.'s ROA, ROE and net margin to its competitors. Itaú Unibanco S.A.'s numbers are above average.
|Company Name||LTM Return on Assets %||LTM Return on Equity %||LTM Net Income Margin %|
|Banco Bradesco S.A. (BOVESPA:BBDC4)||1.3%||17.7%||22.41%|
|Banco do Brasil S.A. (BOVESPA:BBAS3)||1.5%||26.9%||27.63%|
|Banco Santander (Brasil) S.A. (BOVESPA:SANB4)||1.2%||7.2%||23.37%|
|Banco Santander, S.A. (CATS:SAN)||0.3%||4.5%||9.85%|
|Bco Estado do Rio Grande do Sul SA (BOVESPA:BRSR6)||1.7%||17.2%||21.72%|
|Grupo Financiero Banorte, S.A.B. de C.V. (BMV:GFNORTE O)||1.4%||15.6%||28.73%|
|Royal Bank of Canada (TSX:RY)||1.0%||17.5%||27.87%|
|The Toronto-Dominion Bank (TSX:TD)||0.8%||13.4%||29.75%|
|Itaú Unibanco Holding S.A. (BOVESPA:ITUB4)||1.5%||17.3%||22.41%|
V.Profitability and Financial Strength (data from ITUB's latest 20F and S&P Capital IQ):
|Dec-31-2010||Dec-31-2011||Dec-31-2012||JP Morgan 2012||Wells Fargo 2012|
|Return on Assets %||1.90%||1.90%||1.50%||0.9%||1.4%|
|Return on Equity %||20.50%||20.40%||17.40%||11.0%||12.9%|
|Net Income Margin%||20.70%||23.80%||21.10%||23.2%||23.8%|
|Nonperforming Loans / Total Loans %||4.70%||5.10%||5.10%||1.5%||2.5%|
|Nonperforming Loans / Total Assets %||2.00%||2.30%||2.10%||0.5%||1.4%|
|Nonperforming Assets / Loans and OREO %||4.70%||5.10%||5.10%||1.6%||3.0%|
|Capital And Funding|
|Tier 1 Capital Ratio %||11.90%||12.60%||11.00%||12.6%||11.8%|
|Total Capital Ratio %||15.40%||16.40%||16.70%||15.3%||14.6%|
|Tier 2 Capital Ratio %||3.60%||3.80%||5.80%||2.7%||#N/A|
|Compound Annual Growth Rate Over Five Years|
|Net Interest Income||26.80%||19.80%||17.90%||-5.8%||1.1%|
|Non Interest Income||17.30%||16.00%||12.40%||1.2%||12.0%|
|Provision for Loan Losses||33.90%||23.10%||28.40%||-55.3%||-8.6%|
|Earnings from Cont. Ops.||17.80%||19.40%||11.60%||12.2%||19.5%|
|Normalized Net Income||20.50%||16.50%||10.10%||0.9%||19.9%|
|Diluted EPS before Extra||8.00%||9.70%||3.90%||16.1%||19.1%|
|Dividend per Share||7.50%||9.60%||8.30%||20.0%||90.2%|
|Tangible Book Value||33.80%||27.80%||20.20%||16.3%||17.9%|
Interpretation of the above data:
ITUB has admirable ROA and ROE ratios compared to JP Morgan and Wells Fargo, arguably the most well-managed U.S banks. However, the higher ROA and ROE come at the cost of riskier assets as indicated by the ratio of non-performing loans to total loans (or total assets). ITUB has been growing its loan portfolio at more than 27% per year for the past five years. However, the growth in net interest income has been lagging the growth in loan portfolio and provisions for loan losses shows sign of accelerating.
On the capital and funding side, both ITUB’s tier 1 ratio and total capital ratio meets the more stringent Basel III requirements by a decent margin.
The management team is led by a controlling family member and an outsider who spent years climbing up the corporate ladder.
President of the Board - Pedro Moreira Salles.
Pedro Moreira Salles is the son of Walter Moreira Salles, head of Unibanco for decades. He joined Unibanco in 1989 and became chairman of the board of directors in 1997, after serving as Vice Chairman for almost six years. The Moreira Salles family is the largest shareholder of. The family owns 100% of Companhia E. Johnston de Participacoes, which owns 50% common share of IUPAR Itaú Participacoes S.A., which owns 51% of common shares of Itaú Unibanco Holdings S.A.
CEO - Roberto Egydio Setubal
Roberto Setubal has been with Itaú since 1990. His long and extensive experiences with the company and its different subsidiaries is very valuable. The following is a list of positions Mr. Setubal has held at Itaú:
Itaúsa – Investimentos Itaú S.A.: Executive Vice-president since May 1994; Chairman of the Accounting Policy from August 2008 to April 2011.
Itaú Unibanco Holding S.A.: Vice-chairman of the Board of Directors and CEO since March 2003, Member of the Capital and Risks Management Committee since May 2008, Member of the Strategy Committee and Personnel Committee since June 2009, Chairman of the International Advisory Board from March 2003 to April 2009, Member of the Appointments and Compensation Committee from May 2005 to April 2009.
Itaú Unibanco S.A.: CEO and general director since April 1994. Member of the board of directors from April 1995 to March 2003; General Director from August 1990 to March 1994.
Banco Itaú BBA S.A.: Chairman of the board of directors since February 2003.
Below is the organization chart:
VII. Executive Compensation
According to the most recent 20-F filing, for the year ended on Dec. 31, 2012, the aggregate compensation accrued by Itaú for all members of the board of directors and the board of officers of the Itaú Unibanco Group for services rendered during that year in all capacities was approximately R$575 million. This figure includes salaries in the amount of approximately R$244 million, a profit-sharing plan in the amount of approximately R$160 million and contributions to employer-sponsored pension plans in the amount of approximately R$8 million.
The bank earned R$13 billion in net profit during 2012. Total executive compensation represents about 4.24% of net profits.
The board has also established compensation policies with the guidelines established by CMN Resolution No. 3,921. This measure established new rules related to compensation of management of financial institutions, establishing that variable compensation should be consistent with the institution’s risk management policies, of which at least 50.0% of the compensation must be paid in shares or share-based instruments and at least 40.0% must be deferred as payment for at least three years, and that the deferred payment is subject to clawbacks, based on the results of the institution or the business unit during the period of deferral.
The compensation structure is set up in a way that rewards long-term value creation as a sizable portion of the compensation is linked to long-term performance.
VIII. Recent Operation
Brazil's weak economic environment in the last two years has contributed to Itaú's contracting net interest margins, increasing non-performing loans and stagnant earnings growth. In reaction to the weak economic conditions, Itaú's management has sharply shifted the loan portfolio towards lower risk and lower margin ones. The percentage of consumer loans, small business and very small business loans, which are riskier than mortgage loans and payroll loans, has declined to just a little over 50% from more than 60% back in 2010. These steps by management serves to reduce credit risk and improving efficiency. I think this is the prudent thing to do in order to protect the bank from a more difficult macroeconomic environment. The following is the credit portfolio mix from the most recent annual report:
Management expects that Brazil's economy should return to growth, which should occur in tandem with new investments in infrastructure, increased government tax incentives, lower and more stable interest rates, and a reduced debt load.If Brazil's economy starts to take off again in the coming years, Itaú has positioned itself well to benefit from the recovery because of the above initiatives management has taken.
My primary valuation work and price targets are based on book value analysis. Itaú's book value per share has been compounding at 20% per year for the last 10 years. Taking the macroeconomic environment into consideration, Itaú's book value is unlikely to grow 20% per year in the next 10 years. For conservative purposes, let's assume Itaú's book value will increase at 10% per year. At the end of 10 years, Itaú's book value in USD terms will be approximately $36 per share. Applying a P/BV of 2.0x, we get a terminal value of $72. Discounting $72 at 10% for 10 years, I get roughly $28 per share, which offers a margin of safety of almost 50% at the current price.
Using GuruFocus' DCF model, Itaú also looks very undervalued.
- Economic instability in Latin America.
- More competition from public sector banks.
- Risk of lower lending rates and spreads due to ongoing government intervention in the industry.
- As of Dec. 31, 2012, approximately 16.6% of Itaú's total assets, and 63.4% of Itaú's securities portfolio, was comprised of debt securities issued by the Brazilian government. Any failure by the Brazilian government to make timely payments under the terms of these securities, or a significant decrease in their market value, will have a material adverse effect.
The following definitions are taken from S&P Capital IQ's Industry Survey - Banking
Leverage ratio:Tier 1 capital (mainly comprised of common stock, retained earnings and perpetual preferred stock) divided by average total consolidated assets.
Tier 1 capital ratio: Tier 1 capital divided by risk-weighted assets. Each asset is assigned a different risk level. For example, cash and short term investments are considered to be almost risk-less whereas non-secured loans are of higher risk.
Total capital ratio: This ratio is calculated by dividing total capital (Tier 1 plus Tier 2 capital, which includes loan loss allowances and subordinated debt) by risk-weighted assets.
Net interest margin (NIM): The NIM is calculated by dividing net interest income by average earning
assets. The NIM can vary with the particular business mix and risk taken.
Provision for loan losses: The provision, which appears on the income statement, is a quarterly charge taken against earnings; the charge then goes into an allowance to cover possible loan losses.
Noninterest expenses and the efficiency ratio: Noninterest expenses represent all expenses incurred in operations, including such items as personnel and occupancy costs. To calculate the efficiency ratio, add back foreclosure and repossession expenses, amortization of intangibles, and impairment of goodwill to noninterest expenses; then divide that figure by total revenues (calculated by adding tax equivalent net interest income and noninterest income).
Net charge-offs: Net charge-offs consist of gross charge-offs netted against recoveries. Gross charge-offs represent impairments in the value of loans and leases deemed uncollectible by management. Recoveries represent the value of amounts collected in excess of the carrying value on previously impaired loans and leases. Net charge-offs are usually measured as a percentage of average loans outstanding during a given period. For banks, annualized net charge-offs typically range between 0.1% and 2.0% of total loans. A higher percentage of net charge-offs implies that a bank has a risky loan portfolio.
Nonperforming loans: Loans on which income is no longer being accrued and repayment has been rescheduled are considered nonperforming.