Itau Unibanco Holding SA (NYSE:ITUB) Q2 2016 Earnings Conference Call August 3, 2016 10:00 AM ET
Marcelo Kopel - IR Officer
Eduardo Vassimon - EVP, CFO & CRO
Mario Pierry - Bank of America/Merrill Lynch
Tito Labarta - Deutsche Bank
Carlos Macedo - Goldman Sachs
Jason Mollin - Scotiabank
Jorge Kuri - Morgan Stanley
Nicolas Riva - Citigroup
Philip Finch - UBS
Carlos Gomez - HSBC
Victor Galliano - Barclays Capital
Pedro Fonseca - Haitong Securities
Good morning, ladies and gentlemen. Welcome to Itau Unibanco Holding Conference Call to discuss 2016 Second Quarter Results. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]
As a reminder, this conference is being recorded and broadcasted live on Investor Relations Web site at www.itau.com.br/investor-relations. The audio webcast works with Internet Explorer 9 or above and Chrome, Firefox and Mobile device iOS 8 or above and Android 3.0 or above. A slide presentation is also available on this site. The replay of this conference call will be available until August 9th by phone on 55-11-3193-1012 or 28204012, access code 3452156#.
Before proceeding, let me 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 that anticipated in any forward-looking comments as a result of macroeconomic conditions, market risks and other factors.
With us today in this conference call in Sao Paulo are Mr. Eduardo Vassimon, Executive Vice President, CFO, Chief Financial Officer and CRO, Chief Risk Officer; and Mr. Marcelo Kopel, IRO, Investor Relations Officer. First, Mr. Eduardo Vassimon will comment on 2016 second quarter results. Afterwards, management will be available for a question-and-answer session.
It is now my pleasure to turn the call over to Mr. Eduardo Vassimon.
Good morning, good afternoon. Welcome again. We'll be started at Page 2 with the relevant information. We're in this quarter consolidating in our financial statement. The operational CorpBanca given fact that the merger between Itaú Chile and CorpBanca was concluded on April 1st as controlling shareholders, although with 33%, 34% ownership only we're then consolidating our figures. We're presenting historical pro forma to allow a better comparison with previous periods and with this type of information. So we are including income statement over the line, all the lines 100% of Itau Unibanco results and the minority shareholder is shown in the minority shareholder line with that from the bottom line.
Going to Page 3, I'd like to call your attention to some particular points. In general, we believe that we had good quarter particularly considering still challenging environment. We start to see some more positive elements that allow us to be more constructive on the development of the Brazilian economy. We had in this quarter BRL5.6 billion recurring net income in the consolidated figure and BRL5.2 billion in the Brazilian operation. Given the CorpBanca operation and the importance that Latin America operations became after CorpBanca deal, we are going to present several indicators segregating the total and Brazil. In terms of ROE, both in the consolidated and Brazil, we run in this quarter around 21%. In terms of credit quality, measured by NPL 90 days, we had a small increase of 10 basis points both in Brazil and in the consolidated. We are going to talk a lot more about credits in the next slide.
Going to Page 4. So here, we are now back again to the 20% level return on equity in the consolidated, keeping this level in the Brazilian operation, both shown an increase compared to the previous quarter.
Going to Page 5, we have the main lines of our P&L. I'd like to call your attention to some points. First is a reduction of 5% on the managerial financial margin in this quarter compared to the previous quarter. This is partially due to the reduction of financial margin with the market from BRL1.7 billion in the first quarter, that was a particularly strong quarter, to BRL1.5 billion in the second quarter. Commissions and fees showed a strong growth of 6.6% in this quarter. We have some seasonality elements here in the first quarter, tends to be weaker. In 12 months, we have 7.1% increase, so a little bit below inflation. Another relevant point is the relevant stronger reduction in the result from loan losses, 23% below the level we had in the previous quarter.
Non-interest expenses, we had 4.6% increase this quarter, there are -- here again relevant seasonality. So it's, now if you're more prepared to look at 12-month period or comparing the first half of this year with the first half of 2015, we have a 6.3% increase, well below the inflation in Brazil. Income before tax and minority interest showed 19% contraction when we compare the first half of this year with last year, when you go to the bottom line, recurring net income, this reduction is 10%, so well below the 19%. And this is basically related to a lower implicit tax rates. Looking forward, we believe that in the whole year of 2016, the implicit tax rate should be something between 27% and 28%.
Going to Page 6, we have the breakdown here between Brazil and LatAm ex-Brazil on the P&L. I'd like to call your attention to the evolution of financial margin with clients in Brazil, we showed a reduction of around 3% here, but we had specific events of impairments of around BRL540 million. If we do exclude this element, we have had a growth of around 1% in this year in Brazil. Commissions and fees, again, a strong increase. So the bottom line both for Brazil and Latin America shows a good improvement compared to the previous quarter.
Going to Page 7, we have this breakdown between credit and trading on one side and insurance and services on the other side. The insurance and services business, that's more stable and less related to the economic cycle, so the relevant increase from BRL3 billion to BRL3.4 billion from the first quarter to the second one. While credit and trading showed a reduction from BRL2 billion to BRL1.8 billion, this is, as I already mentioned, partially related to the lower performance of margin with the markets. If we look at the recurring return on equity for insurance and services, we show a strong 36%, while for credit and trading, we are around 13%, so below cost of equity.
Going to Page 8, we have here the credit portfolio. As a result of the economic situation and a weak economic performance of the country, we had a nominal reduction of 4.5% in our credit portfolio expanded the credit portfolio. So including private securities, endorsements and sureties, and we exclude FX variations, this reduction would be smaller 1.6%. Credit card loans basically flat in this quarter compared with the previous one and 3.2% reduction in 12 months.
Two lines of business show here a nominal increase in 12 months; payroll loans and mortgage loans, mortgage loans is particularly stronger and this is aligned with our strategy of moving our credit portfolio to lower risk lines of products. Corporate loans suffered from both the economic environment and depreciation of the real in this quarter, that was around 10%. The same is true for Latin America with 8% nominal reduction. In the lower part of this page, we see the breakdown of our Latin America credit portfolio. Here it becomes clear that CorpBanca operations that comprise both Chile and Colombia represents 85% of our Latin America credit portfolios.
Moving to Page 9, we have here the evolution of the Brazilian loan portfolio in percentage. Here again we see strong increases in mortgage and payroll loans, strong reduction in vehicles and some stability in corporate personal loans and credit cards and a very small [indiscernible] some reductions over the previous years. On the upper part of this page, we include the Latin America portfolio that giving the incorporation of CorpBanca operations, now shows a strong number here in terms of percentage, 26% of the portfolio is now related to Latin America. Because we have only 33%, 34% in terms of economic interest, this would lead to 12.3%, if we calculate this, considering one-third of Chile and Colombia operations, a 100% of Argentina, Paraguay, and Uruguay.
Moving to Page 10, talking about financial margin, taking here this spread sensitive operations, we see reduction from 11.1% to 10.9% in this quarter. And this 10.9% was impacted again by the impairment that I mentioned previously. Without this element, this financial margin would have been 11.4%. In the risk-adjusted curve, we see a strong recovery from previous quarter, from 6.1% to 6.8% or 7.2% without the impairment. And here again is related effect that the previous quarter was we had a particular high number in terms of provision for loan losses.
Moving to Page 11, we show the financial margin with the market. Again, quite a good number of BRL1.5 billion, although lower than BRL1.7 billion we saw last quarter. In this line, looking at given the good performance of the first semester and incorporation of CorpBanca, we believe that we should reach something around BRL6 billion in terms of the final number for the year, so from the BRL5 billion that we had indicated before the CorpBanca operation.
Moving to Page 12, and starting to talk about credit quality, and a part of this is to have the 90-day NPL ratio on the consolidated basis. We see on the green line, the stability in Latin America NPLs. This of course is related to the less risk environment that we have in all the Latin American countries other than Brazil. In Brazil, we have a small increase of 10 basis points from 4.4 to 4.5 leaving the total also to 10 bps increase, 3.5 to 3.6. In the lower part of this page, we see Brazil-only 90-day, so the breakdown by segment for individuals we see a small reduction from 6% to 5.9%, showing our view that we are probably approaching the end of the cycle of increasing NPLs. We believe that we'll reach through the curve probably in the end of this year, in the first half of next year. For SMEs, we see a relevant increase here from 5.6% to 6%. This is a segment that is suffering a little bit more than other segments, but you have also an effect related to the reduction of the portfolio itself. So the denominator here has decreased. In a stable portfolio would have had 10 bps increase only. For corporate, we see a small increase from 1.5% to 1.6%.
Moving to Page 13, the 15 to 90-day NPL ratio and here it's Brazil only, we have here some technical limitations to have the CorpBanca operation. So we are focusing here on Brazil only. We see stability for individuals, and small increase for SMEs and a very relevant increase on the corporate NPLs. This is totally due to our particularities that - we saw 100% provision, but became overdue in this quarter and this has no effect on the bottom line, but this has to do -- we will roll out to the 90-day NPL next quarter, so we should expect a relevant increase on the 90-day NPL for corporate next quarter, but again without any impact on the bottom line, impact on the provisions, [indiscernible]. In Brazil as you may know, we are only allowed to write-off a transaction 180 days after its registered as it's 100% provisioned. So, by the way, in the last quarter of this year, this particular transaction will be in the write-off portfolio. So, this increase will come back -- NPLs will come back in the last quarter.
Going to Page 14, we have here the NPL lines with the excluding fully provisional credits, we see stability and this is Brazil only, we see stability in the vehicles portfolio around 2.3% and some increase for companies from 0.9% to 1.1%. On the lower part of this page, we see the NPL creation where we can observe nominal reduction for retail, for wholesale and for the total portfolio. So this is a positive information. The ratio between NPL creation loan portfolio for the wholesale showed a reduction from 0.9% to 0.7%, and this NPL creation giving what we explain about the specific transaction, will go up substantially in the next quarter again without any impact on the P&L.
On Page 15, talking about renegotiated loan operations, here it's important to mention that the figures previously or so before this quarter do not include CorpBanca. So this increase of BRL1.4 billion in the renegotiated loan portfolio. Out of this BRL1.4 billion, BRL1 billion is related simply to the fact that we are incorporating CorpBanca in those figures. So Brazil as we highlight here shows BRL400 million increase. On the lower part of this page, we see the 90-day NPL coverage for renegotiated loan operations. So quite high at 210%, and this figure will go down on the next quarter. Again for the same reason, this particular transaction that will go to the 90-day overdue range.
Next Page is 16, provision for loan losses by segment. We saw some increase in the retail portfolio, relevant decrease in wholesale and also on the total substantial reduction. Looking forward, we expect to see some increase both in the retail and the wholesale provisions. [indiscernible] in this quarter, but in any case, below what we saw in the first quarter that we believe to be the peak in terms of total provisions, and the peak for wholesale.
Going to next page, coverage ratio, 90-days NPL. We see what we believe to be a very sound figures. So reaching 215%, so increase in the total coverage ratio, not only in consolidated, but also in Brazil. This shall go down in the next quarters because related to this particular transaction that I mentioned several times.
Going to Page 18, [Technical Difficulty] in this new way of presenting the breakdown of allowance for loan losses by type of risk. So, we saw some migration from the potential to the aggravated, because we had anticipated some provisions, particularly in the wholesale segment. I'd also call your attention to the green part on the bottom in the overdue part of this chart, substantial amount is fully provisioned. Next page is the same chart, now on the consolidated figures. In here, just to mention that CorpBanca are fully included in the wholesale, here we have some limitations for the time being including everything in wholesale.
Moving to Page 20, provision for loan losses and NPL creation by segment. We see on the top the retail line consistently above 100%, reasonably stable. The nominal NPL creation here again showing a reduction from previous quarter. Wholesale is more volatile by nature, a very high 146% figure. And we can see here clearly that we have anticipated provisions both in the first quarter and in this quarter. So we shall see this coverage going down probably below 100% in the next quarter. Again, here related to the specific relevant case that I mentioned several times and again that's already fully provisioned. In the total on the bottom, a sound 119% ratio.
Going to Page 21, commissions and fees and insurance, I believe that we had a particularly stronger quarter in this respect. Again, there is some seasonality, the first quarter tends to be weaker, but even so was a strong quarter. When we look at 12-month evolution, we see 7.1% is still below inflation, but you can see that one particular line show the negative -- the only one that show the negative behavior is credit operations and guarantees, and this of course is directly related to the reduction of credit operations.
Moving to Page 22, we showed here 4.6% increase on our non-interest expenses or 6.7% if we exclude operations abroad. It's a high figure but here it will have a strong seasonality element. So I believe that is more appropriate to look at the 12-month growth figure, that's 4.6%, so well below Brazilian inflation. And this is, as you're going to see, we are very confident that we will be able to grow expenses well below inflation as we are going to talk more on the guidance. On the bottom part of this page in the right side, quickly mention that we continue to -- the process of migrating physical branches to digital branches, basically responding to our clients' needs.
On Page 23, the efficiency-ratio basically stable both at consolidated and Brazilian levels. Moving to Page 24, I'd like to call your attention to the very strong figure in terms of capital measured as CET1 fully loaded, so anticipating the schedule of Basel 13.2%, so, this after CorpBanca. This is related to the good profit generation that we had in this quarter, is related also to increased use of tax credit that is partially due to the FX behavior had 10% appreciation in this quarter, and finally to the low or no growth of our credit portfolio.
Moving to Page 25, we had some changes in our 2016 forecast. I'd like to highlight here that on a consolidated basis, the previous and the reviewed forecasts are not directly comparable, because the reviewed incorporates CorpBanca. So for instance, when we see in the provision for loan losses, I mean nominal increase in the range from BRL22 billion to BRL25 billion to BRL23 billion to BRL26 billion, this reflects simply the fact that we're incorporating CorpBanca provisions.
We had a substantial change in the total credit portfolio growth, and this is to a large extent due to the fact that the previous forecast was related to very different expectation for FX. So we had BRL4.5 at the end of this year. We changed to 3.25%, and the same is true to -- in relation to the Brazilian GDP expectation. So, this now tend to be worse than when we viewed our previous expectations for the combination of FX and GDP explains substantial part of this change.
In terms of financial margins, we had also a reduction here, and here again, there is an impact of FX. We are keeping our provision for loan losses forecast, we are very comfortable with this range BRL21 billion to BRL24 billion. Same is true for commissions and fee and insurance, keeping the 4.5% to 7.5% range. And we are improving here the non-interest expenses range. So, the new one from 2.5% to 5.5%. We believe the combination of those changes are positive in the total result.
Going to Page 26, just to mention that we announced this week bonus in shares of 10% following a process that we had increased over the years, this we will have to be still approved by Bank shareholders in our general meeting that will be called. And also to mention that we have kept the monthly dividends value at BRL0.015, so representing a 10% increase in the monthly remuneration.
So with that, I conclude my presentation. And of course, Marcelo Kopel and myself are ready to answer your questions. Thank you.
Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Mario Pierry, Bank of America/Merrill Lynch.
Let me ask you two questions, please. The first one has to do with your effective tax rate. You're paying an effective tax rate in the first half of this year of 25%, last year you were paying close to 30%. So what I wanted to understand is, your ability to pay an effective tax rate so much lower than the corporate tax rate, when the corporate tax rate was essentially increased to 45% recently. So in the Portuguese call, you mentioned that you do expect the tax rate of 27% to 28% this year. So if you could help us understand how you are able to maintain such a low tax rate and if you have any guidance for next year? And then I'll ask you my second question later.
The reason to have an effective tax rate below the corporate loan basically two, the reasons, the most relevant one is interest on capital that represent a substantial part of this reduction. You may know that we had an increase in the [indiscernible] rate, that's the rate that's applied to the that towards calculated reduction. And the second factor is the results coming from non-financial companies. So those are the two main elements. And yes, as I think I briefly mentioned, for the whole year of 2016, we are forecasting something between 27% and 28%, for next year is too early to say.
Okay, that's clear and then second question is related to your excess reserves rate and you used about BRL700 million this quarter. But your excess reserves to total around BRL10 billion historically or recently in just few years you were running an excess reserves of about BRL5 billion to BRL6 billion. So the question is, how should we think about your excess reserves, your ability to continue to draw this down as the economy starts to improve, I think there's a lot of evidence that the economy is starting to bottom here in Brazil? So, would this be a source of potential earnings tailwind for you going forward?
What you call excess reserves, we see this potential, provisions for potential losses and we have a dynamic process of setting the level of potential, provisions for potential losses. Yes, we had a net reduction of around BRL700 million as you mentioned, and this is the result of transfer from what you called excess provisions, complementary allowance to regulatory one because we had anticipated increase those quarters provisions that somehow materialized this quarter. So looking forward again, this is a dynamic process, we have all models, we have all judgment but even if we do not change the level of excess reserves as you call them, we are very comfortable with the level of provisions that we are indicating in the range and see from today our best estimate is the mid-point for that. In terms of the whole economy, I agree that we might be approaching the bottom. Of course in this assessment, we are considering that we are going to see a further stabilization in the political scenario and some relevant improvement in the fiscal situation. Until the end of the year, this should be discussed in the Congress. So in this scenario, we expect the economy to grow around 1% next year. We know that some analysts have higher figures 1.5%, 2%. So, in this more constructive scenario, I think we should -- it wouldn't be a surprise if we do not increase our provisions next year.
Just to be clear, what we've said at the end, so you think the provisions next year, they should stay stable or you said they shouldn't increase next year, correct?
Yes. In this scenario, I believe they should not increase. It means that could be either flat or other way.
The next question comes from Tito Labarta, Deutsche Bank.
Couple of questions also, one I guess following up on the question on excess reserves. Just to clarify, that did not go through the income statement. Just want to make sure, so the forecast or the guidance you're giving for provision expenses this year does not include the use of excess reserves. So, I want to clarify that from an accounting perspective. And then I have a second question on insurance which I can ask afterwards.
Hello, Tito. It's Marcelo. On the use of our excess reserves, the way we see it is, we have in the potential allowance sectors led with the potential names that could be comprising in those [Technical Difficulty] potential risks. As they materialize, there could be a transfer from potential into aggravated risk. And that's how it took place in this quarter. Nevertheless, to the extent we feel that we have more potential risks, the net of these could be zero because you are basically keeping the provision flat by having all the names added to that or the sectors added to that. So that's how we see it. So to the extent we feel comfortable with the provision level. It's a transfer, otherwise it's a transfer with the replenishment of the provisions, and that is incorporated in our guidance.
So you would offset any additional, any provisions with the potential use of excess reserves, and that is in the guidance you're saying, correct?
If they are in the base case we have, yes, if they are not contemplated, we would see additional buildups, and this is included in our guidance.
And then, my second question is on insurance, there's also a non-recurring charge here from the liability test of around BRL140 million. So, just want to understand that, is that something, it's non-recurring here, but could that be something that happens again particularly, I think with rates movement in interest rates, just want to get a little bit more color on the liability adequacy test?
So Tito, we do that test twice a year. The last test we did, if I'm not mistaken, was at the end of last year, and it was a positive amount, also shown under the non-recurring. And the way we see this, every time we run the test, in the scenario provided that rates are going down, that could be the case depending on the dynamics of the portfolio, that this could be a negative amount or not. But the fact is that, we will flag that and present that as a non-recurring item.
Okay. So the next test would be in the fourth quarter, is it?
Okay. And that would also be, any movements would also continue to be non-recurring in that?
Yes. And you would be able to see it.
The next question comes from Carlos Macedo of Goldman Sachs.
Two questions. First is a little bit broader question on capital. I mean, you're at 14.1%, fully loaded, and this is assuming now, until you get to 2019, you're going accumulate more capital at least because of the growth in the short-term. So, three things come out of this, either you expect loan growth to accelerate very quickly or two, you think that asset quality will take a precipitous nosedive and put some pressure on your capital despite all the excess provisions you have, or three you're gearing to make some acquisition that will dilute capital. I mean, is there a strategy for capital here, 14.1%, is this well above anybody else in the industry, and it's probably well above, I mean, I remember asking Roberto, at the end of the year, and then he said that you wanted to run the Bank at 12%, what's the plan for this excess capital? Dividends, capital reduction, saving up for a rainy day, I mean, what's the plan here? Second question, I'll ask once written here, it's about the guidance for and how to understand CorpBanca in that?
We see 12% as the minimum level to run the Bank considering that we are on -- operating basically on a non-investment grade country. So, we believe that it's important to have a higher level of capital. Yes, we are now at well above that. It has some volatility that, as you may know, it's related partially to the level of FX, because of the impact on tax credits. So we'd like to see more stability on this level. We do expect some growth in the credit portfolio but that is not a substantial one. We expect to grow a little bit our portfolio in real terms next year. We are basically forecasting inflation around 5%, 1% -- plus 1% GDP growth. So we expect to have on the base scenario goals that goes a little bit above 6%. Of course, we always look at opportunity of acquisitions. In Latin America, we are presently very focused on the integration of CorpBanca. And if there are no opportunities in terms of investment, if the credit growth is not relevant, we are going to most probably to keep our [indiscernible] distribution between 30% and 35% and we could consider in this scenario being more aggressive in buyback.
Just following up here, Vassimon, I mean you're going to add probably another 50 basis points to the end of the year and capital, even if the real were to go to 4%, you basically net at 14.1%. Is our buybacks really going to make a dent? I mean, how can you deploy all that capital in the near term? Even if you grow in real terms next year you're talking maybe 1% or 2%, it's still not sufficient with your -- in doing 16%, 17% ROE.
As you may recall, last year, we had around 2% of the free float we bought back of the shares. So we are prepared if we feel comfortable, if there are no other use of capital, to have a more aggressive behavior in this respect. We are not considering at this point changing our dividend policy. And we might see opportunities in terms of acquisition, we are going to follow this to see a more stable environment in terms of capital and then we act to avoid keeping excess capital for a long period.
Thank you. So just going back to the guidance, I mean, you're preparing the guidance including CorpBanca for prior periods. Should we look at Brazil guidance in the standalone basis to understand what the trends, if there are any changes to trends that we expect for the year, I mean particularly for expenses and fees?
Yes, you should look at Brazil on a stand-alone basis, because I'll give you a few examples here. Increasing loan loss reserve went up from 22 to 25 to 23, 26 is primarily due to CorpBanca. The fees line for example, Brazil was kept flat and the change you have is primarily related to FX movement that makes our revenues from abroad [indiscernible]. Same thing applies to expenses. Brazil, we're screening its expenses and the overall number is also been [Technical Difficulty] by the effect of Brazil and the effects on the operations abroad.
I was just going to ask on the provision for loan losses, the 23 to 26 that's reviewed guidance and includes the first quarter for CorpBanca as well, right?
Yes, it's in the proxy. If the numbers turned out to be comparable, they are made to be comparable, the 23 to 26.
The next question comes from Jason Mollin, Scotiabank.
My first question is about the Bank's disclosure on the impact of the impairment of securities on financial margin. Can you give us a little more color on the impairments taken this quarter and the expectation for more impairments in the future? And my second question is on non-performing loans and the impact of loan portfolio sales in the quarter. If you can talk about if that impact was significant, and the decision the Bank makes to sell portfolios or what's going on in that marketplace today?
As for impairments, we had some cases corporate names with a concentration on one particular name. So it's a company where we had a security held to maturity, and in our judgment, it does represent definitive loss, so that why we had this impairment. Looking for this, might happen again, it's part of the business. This particular quarter was larger than historical level, but in any case is incorporated in our margin guidance. Yesterday, the sale or transfer of financial assets, we have a detailed explanation, our MD&A on Page 19, and there was absolutely no relevant effect on the bottom line. Most of the sale profit was completely written down portfolios. So zero effect on bottom line. And we have a small effect on the other portfolio of only BRL26 million, so completely irrelevant on the bottom line. Looking further, we're going to continue to sell portfolios, when we believe that the sale of the portfolio would produce better opportunities for recover them would have making the collection internally. And I'd like to highlight the fact that we bought, in the end of last year, a company called Recovery here in Brazil that specialize in recovering assets. So, it's controlled by the Bank, and we have showed in this particular second quarter, BRL5 billion of completely provisional portfolio already written down -- written off. And we intend to increase this activity because historically the quarter has [Technical Difficulty] than our -- let's say, internal collection area.
The next question comes from Jorge Kuri, Morgan Stanley.
I have two questions. The first one is, can you give us an assessment of the leverage level and health and the outlook for recovery of the corporate and the consumer sector. How long do you think it's going to take for it to repair and what does this mean for credit recovery? Vassimon mentioned 2017 is probably not going to be a year with strong growth in real terms, I think you said 1% or 2% real credit growth next year. So where are we in that repair process of consumers and corporates and when would you think we could potentially see recovery is it 2018, is it 2019? And I'll ask my second question later.
Of course, given the still challenging environment, it's difficult to look much ahead of next year. But I think the base scenario, we see as I mentioned on -- you record a small but real growth of the portfolio next year, and we could have more relevant growth from 2018. We are seeing better behavior in terms of NPLs and possibility of reducing provisions in the individual's portfolio that has been more predictable, more stable and probably would pick a little bit earlier than the corporate or the Company portfolio. I think that more relevant recoveries probably we'll have to wait until 2018 and not in the next year.
But is it a matter basically of NPLs, you getting comfortable with that and then opening the pipes, or is it a matter of seeing better leverage levels of the consumer, is it a level of debt service ratio where you think the consumer has to be in order for it to continue to take credit again, same thing for the corporates, net debt to EBITDA remains very high. Is there a number or is it GDP growth, how do you think about that and how can you help us understand what are the triggers for you to see stronger credit growth? That's what I was looking for.
I think the basic indicators here and indicators related to GDP. Of course as we get more comfortable in the market environment and here I think it's important to mention that this fiscal stabilization is relevant I think by approving a fiscal measure in the second half of this year, regarding to the -- give a strong signal after a potential stabilization of debt to GDP ratio, it's something that we are following closely. And the growth of the portfolio is related to both the increasing demand and our own comfort with the whole environment. We are starting to see a better sign in terms of confidence industry for instance seems to have bottomed in terms of activity inventories are going down. So it's a lot of indicators that we are forming.
In terms of leverage of individuals, we are seeing a reasonable level, no relevant increase, particularly in declines in our own clients that we have more information. So there are several indication but all related to some extent to the GDP. So the combination of higher credit demand that will come in our view from increasing confidence. And not so tight credit criteria will allow us to have this growth in terms of credit portfolio. But again, not being particularly substantial next year, but it could have a much better environment in 2018. In terms of NPLs, just to emphasize that we are going to see a relevant increase in NPLs, offer corporates next year because of this specific case that we will roll out next quarter that we will roll out to the 90-day overdue range.
My second question is on car lending. That's an area where -- if I look at the last five years, almost 60% of the market share you lost of lending in Brazil was explained by moving out of the car loan business. What is the appetite for returning to that business? Is it just a structurally broken business that we're not going to see Itau move into for the foreseeable future or if it's more of a cyclical issue and we could potentially see you coming back to it, say 2018? Again, I think that's where probably the biggest market share opportunity is on the rebound, but wondering if that's something that is broken or not.
Of course market share is important but we are basically driven by the expectation of the bottom line and looking to reach the ideal balance between top line and provisions. Yes, we have lots and lot of market share, particularly in this car loan business, we don't believe by all means that's a broken business but it's important to remember that the business as a whole shrunk dramatically. I mean we had at some point a couple of years ago, production of around 3.5 million cars per year, we are down to below 2 million cars. So, the market as a whole shrunk. And the combination of top line and the provision and the economics of this line of business was not particularly interest in our view. So we have reduced dramatically. We are ready to grow when we feel comfortable again. But I don't see, frankly speaking any relevant growth in this particular line of business, this year or next year. In other lines, I think we could be a little bit more optimistic and again I believe that we are in a very privileged position in the Brazilian market to grow portfolio and there is demand and we feel comfortable giving our pool of capital.
The next question comes from Nicolas Riva, Citi.
The first one is on the net interest margin. So if I look at your guidance for loan growth, the midpoint of the guidance for loan growth implies 1% quarter-on-quarter loan growth in the third and fourth quarter. However, if I look at your guidance for net interest income with clients, the midpoint implies about 4% quarter-on-quarter growth in the next two quarters. Now I know that you probably want to have again the impairment the 540 million, and that should help. Besides that, what should drive that expansion in the interest margin with clients in the second half and if you expect spreads maybe to continue going up or less competition from the government banks? And the second question on NPLs, but specifically on consumer NPLs because your NPL ratio for the consumer loan book went down, improved for the first time since the first quarter 2015. And you already said that in the case of the corporate loan book, we will see the increase in the NPLs in the third quarter because of this specific corporate. However, in the case of consumer, do you think that we could be -- that probably we are past already the peak in NPLs for the consumer loan book?
Yes, let's start with the NPLs and then we'll go back to the NII question. On NPLs, it's a fact that we did see a reduction of 10 basis points here. But as we see unemployment still going up, we will still see NPLs for consumers growing up in a controlled way. As Vassimon mentioned before, the peak for that probably will be somewhere in the first half of 2017. Therefore, we expect it to go up in a controlled way. When NII -- when you adjust for impairment and back out the impairment, the implicit increase is somewhere around 2% per quarter we think it's doable, it will probably come through the pricing that reflects the risk in the market and that's basically how we've built the view for the second half of the year.
Just to add here that we are seeing repricing opportunities in a level slightly better than we anticipated. So this I think will help us to reach the level that Kopel mentioned.
Our next question comes from [indiscernible], Banco Safra.
Actually my question is related to provision charges. We saw along 2015 that credit recoveries were coming at a level and then dropped at the beginning of 2016 and when many problems have worsened and now with the expected signs of improvement in the coming scenario for 2017, and what is the moral level of credit recovery the Bank expecting for the next year, which you helped to this provision expenses and the another variable through the earnings growth?
At this stage we haven't really done any exercise for 2017. But what we can anticipate is, it's a cycle that we go through and 2017 shouldn't be a year that we could see a material difference in the recovery levels. And as I mentioned, the unemployment is still going in this year, our focus for this year is to end the year at 12.5% and next year at 13%. Therefore the recovery should probably accelerate more not in '17 but beyond that.
The next question comes from Philip Finch, UBS.
I have two questions, please. First, can you remind us how you're positioned for falling interest rates, and remind us the sensitivity to margins for every 100 basis for in the Selic, whether there are ways to offset this, and the time line typically for the impact to filter through? And my second question is regarding your digital banking strategy. So, on Slide 22 you show how you're switching away from traditional brick and mortar branches to alternative digital distribution channels. Can you share with us how much more scope there is for branch closure, and what sort of cost savings can you generate from this, and more generally from the move towards digitalization?
In terms of sensitivity to interest rates, I think it's important to segregate the margin with clients and margin with markets. Margin with clients is basically related to credit spreads. And these tend to be visible it's stable, not directly related to the nominal level of interest rates. Of course, in an environment of lower interest rates, meaning that the whole environment is more positive, you would have a lower spread, but as a result of the lower risk. So the risk adjustment margin, the risk adjustment spread should be reasonably stable over time. Then comes to the margin with the market, then we could have some effect of the reduction in interest rates, in our banking book. This is negative management that we do in our one capital, in our liquidity, but this is, would be felt over time. Just to mention that given the recent communication of Brazilian Central Bank, we now believe that interest rates should drop by 75 basis points this year, in the last quarter and in the base economic scenario, additional 250 basis during 2017. So, we would have some impact on the margin with the market, but the whole environment would, in this case be more favorable. In this environment, we should have some credit growth and reduction in risk.
Coming to the second question of digital bank strategy, the digital branches have basically two advantages. I mean it's more intelligent and more friendly way of interacting with our customers. Customers are going less and less to physical branches. And so, it's not only more convenient to the client, but is more efficient to the bank in terms of cost. This is in our view of some process I mean the reason of migration would follow our clients' demand. And of course our own ability to implement this change in terms of IT, we have closed about 150 branches in the last year. We expect to have the same reach in this year. So this is something that will be felt over time. But we are very confident that this is a reversible process. And typically what we do is, we observe a reduction in the flow of clients to physical branches and then we merge to physical branches.
So that and we migrate clients to digital branch. And we are going in the near future and this quarter is still, we are going to start opening digital accounts on a digital way, let's say, on a remote way, because the what you call digital accounts or digital bank is basically the migration from bank that originated in the physical branches and now migrates to digital ones. And we will, of course, we would keep this process but we will also start to originate, let's say, pure digital client. So, client will be able to open account without going to the bank. This is a new legislation that was released by Brazilian Central Bank a couple of months ago and it shall be ready soon to run this type of account or so.
The next question comes from Victor Galliano, Barclays.
Yes, couple of questions from me. Just on the credit quality continuing there, you've given us your indication or your thoughts as to where and when potentially we could see it peaking in the consumer cycle. What are your feelings with regards to SME and corporate? I understand that may be a bit harder to call, but I would imagine that we're thinking in those terms that it might lag the individual peak, but I would love to hear your thoughts on that and in particular with SME, which looks more troubled. And my other question is on Rede. If you could just talk to us a little bit about the lost market share there, what's driving that, is it more aggressive competition from Santander acquiring from CLO. And in terms of your strategy there, are you willing to give up market share in order to retain profitability, is that the game that's been played there?
As to credit quality, yes we are probably going to see the peak of NPLs for individuals earlier than for SMEs and corporates. It's hard to say how it would be but SME is a segment that is suffering a little bit more. We have tightened our credit particularly in this segment. We have reduced our portfolio, but the peak should be a little bit later than for individuals. For corporate, it is even harder to say because corporate depends, of course on some specific case. We have the impression that we have methods, I'd say the potential cases and we are positioned, provisioned for those potential cases. But of course by the nature of the business, there is always the risk of some surprise. But we haven't seen any new relevant case I would say, in the past quarters. So I think the potential problems are basically known, but corporate should recover also a little bit slower return than individuals. As to Rede, I will pass on to Marcelo.
The strategy on Rede is really to work differentiating ourselves with products and service that not go up their price. For us, share is important but most important is profitable market share, not simply going after very large clients that obviously can dilute your fixed cost base -- our fixed cost base, but not necessarily aggregate to the profitability of our Company. So yes, we are focused on keeping share, but in profitable segments. Therefore, we just believe there are specific product that caters for one specific segment of the market or a group of clients that want to have their -- they want to know up front how much they're going to pay for the usage of their terminals, including rent and the MVRs and all anything that could be charge them. So, that is, because demand from clients that we are basically offering them the solution for it. So, this is how we intend to grow our client base, not through pricing.
So, it's offering a more broader solution really and trying to cross-sell as much as you can really, and not enter into direct price competition with the others.
Price competition, we know where it ends.
The next question comes from Carlos Gomez, HSBC.
Two questions. The first one on provisions, so typically given guidance in absolute numbers, BRL21 billion to BRL24 billion in Brazil for this year, you have repeatedly said in the conference call that you don't expect provisions to be higher next year than this year. Are you referring to that in terms of absolutes, I mean, BRL21 billion to BRL24 billion, or in terms of relative as percentage of the portfolio, since the portfolio is going to be smaller? The second question refers also to your growth rate, you have said, you expect a small but positive real growth rate next year, the stable 6%. Right now, if your numbers are correct, and your real portfolio is declining at a rate of 7% year-on-year; so that would be a pretty quick swing. Have you seen any evidence so far that demand is turning around, and will it start to stabilize before it grows to 6%?
Let's start with the growth rate. What we are seeing is, if you strip out the FX components, and put the things in context there, there are -- there is demand, that is basically sitting on the sidelines, waiting for the scenario to be more clear and have more visibility in the scenario. So, one could argue that in the fourth quarter, after we see certain things approved, in the economy and even on the bigger picture scenario, we will see demand coming back, and this would be basically through investments and things like that. Consumption will not accelerate and the leverage is still here with the consumers, it has not increased as most had, but people are very -- they are still postponing their consumption decisions. Therefore, the resuming credit growth will come more from investments than from consumption. So, this is one thing.
On your comment regarding provisions in absolute terms, they are coming from a very severe year in terms of provisions when you put 2015, 2016 altogether, the accumulated growth in loan loss reserves net of recoveries more than 80%. So saying that we don't see room to grow in 2017, starts to the accumulation in last two years where we've been consistently increasing provision and you could see specifically on the corporate portfolio, we are running probably at 3 times the level we've run historically on this portfolio. So I think it comes together with the context not only on 2016, but also what we have been doing before that. So I don't know if that -- so, that's why we're giving, we are giving the guidance, forecasting NPLs on the corporate portfolio is harder especially because of the write-offs that will start to show up in the portfolio as we are fully provisioned in a very large number of stage. So I don't know if that answers or you want to follow up on that.
As you say NPLs will continue to rise and it's totally understandable and you have explained it very clearly. It's actually on the other side you have already provisioned a lot last year and this year. So actually I would expect your provisions to decline next year not just to be stable at elevated levels that we have seen in 2015 and 2016. I see that you are not saying that the you have been conservative about it. So I wanted to see if there is any specific reason for you to expect still this elevated level or given that you expect also a recovery in demand and activity?
I think, Carlos, we say that when we -- Vassimon said provisions will not go up, doesn't mean that they cannot go down. And the second thing is, as we start going up the portfolio, just the fact that you don't grow provisions implicitly you are diluting your provisions, because as a percentage of the portfolio, if the math works, you're going to be diluting your percentage over the cost of credit over your portfolio.
But again, at this point you are not, and you could, but you are not saying that you will reduce your provisions next year?
Yes. It's too early, we're probably going to have better visibility. The whole scenario for next year is heavily dependent on certain approvals in the Congress, and as we go through that threshold, visibility will be much better. So, we would probably, hopefully we're going be talking about that with more visibility during the course of the third quarter.
Our next question comes from Pedro Fonseca of Haitong.
I have one question left. It looks to me, it's my understanding that the Central Bank is now taking a closer look at provision requirements for bank guarantees. Do you envisage any sort of impact, in terms of requirements you may have to do in terms of bank guarantees or off balance sheet items?
You're right. Last week, Central Bank announced a new rule for provisioning for guarantees. In our case, we had already provision, this in our complementary allowance. So, there will be no impact for us given the fact that we had or had been provisioning for this type of risk. Of course, it's a lower type of risk, because in our case it is mainly related to fiscal guarantees that have a very low level of losses. But in any case, we have our radical vision, so there will be no impact in our balance sheet.
This concludes today's question and answer session. Mr. Eduardo Vassimon at this time you may proceed with your closing statements.
Thank you for your attention. Just like to emphasize that we believe this was good quarter with solid results. We are starting to see better concrete signs in terms of improvement of the economic environment. So, we believe that we should be approaching the end of this credit cycle to see better dynamics, reduction of the recent potential losses. We continue to emphasize the generation of fees that represent a very relevant part of our bottom line. We continue to be very focused on cost control and we are very well capitalized, and I believe in a privileged position mostly in terms of capital and liquidity to take advantage of a change in the cycle when the conditions are there. So again, thank you for your attention.
That does conclude our Itau Unibanco Holding earnings conference for today. Thank you very much for your participation. You may now disconnect.
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