Itaú Unibanco Holding S.A.

Transcription

1 Itaú Unibanco Holding S.A. a sociedade anônima incorporated in the Federative Republic of Brazil Quarterly Management s Discussion and Analysis of Financial Condition and Results of Operations as of and for the three-month period ended March 31, 2011 The date of this Management s Discussion and Analysis is May 19, v6

2 TABLE OF CONTENTS CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS...2 PRESENTATION OF FINANCIAL AND CERTAIN OTHER INFORMATION...3 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS...5 INDEX TO FINANCIAL STATEMENTS AS OF AND FOR THE THREE-MONTH PERIODS ENDED MARCH 31, 2011 AND In this quarterly update, except where otherwise specified or the context otherwise requires, all references to we, us, our or ourselves are references to Itaú Unibanco Holding S.A. ( Itaú Unibanco Holding ) and its subsidiaries, except where otherwise specified or the context otherwise requires. The business of Itaú Unibanco Holding is described in this quarterly update on a consolidated basis, except where otherwise specified or where the context otherwise requires. The term Brazil refers to the Federative Republic of Brazil. The phrase Brazilian government refers to the federal government of Brazil. Itaú Unibanco Holding is the parent of two main operating subsidiaries: Itaú Unibanco S.A. ( Itaú Unibanco ) and Banco Itaú BBA S.A. ( Itaú BBA ). Together with its subsidiaries and affiliates, Itaú Unibanco Holding is referred to in this quarterly update as the Itaú Unibanco Group. Itaú Unibanco carries on our commercial banking, consumer credit and other financial activities. Itaú BBA carries on our corporate and investment banking activities. On February 18, 2009, the Central Bank of Brazil (the Central Bank ) approved a series of transactions whereby the operations of Banco Itaú Holding Financeira S.A. (now Itaú Unibanco Holding) and its subsidiaries ( Banco Itaú Holding ) and Unibanco Holdings S.A., including its subsidiary Unibanco União de Banco Brasileiros S.A. ( Unibanco ) and Unibanco s subsidiaries ( Unibanco Holdings ), were merged v6 i

3 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS This Management s Discussion and Analysis of Financial Condition and Results of Operations as of and for the three-month period ended March 31, 2011 ( quarterly update ) contains statements that are or may constitute forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the United States Securities Exchange Act of 1934, as amended (the Exchange Act ). We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting our business. These forward-looking statements are subject to risks, uncertainties and assumptions including, among other risks: General economic, political and business conditions in Brazil and changes in inflation, interest rates, exchange rates and the performance of financial markets; Disruptions and volatility in the global financial markets; Difficulties in integrating acquired or merged businesses; Government regulations and tax laws and changes therein; Competition and industry consolidation; Increases in reserve and compulsory deposit requirements; Changes in our loan, securities and derivatives portfolios; Our exposure to Brazilian federal government debt; Incorrect pricing expectations and inadequate reserves; Effectiveness of our risk management policies; Losses associated with counterparty exposures; The ability of our controlling shareholder to direct our business; and Regulation of our business on a consolidated basis; The words believe, may, will, estimate, continue, anticipate, intend, expect and similar words are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. We undertake no obligation to update publicly or revise any forward-looking statements because of new information, future events or otherwise. In light of these risks and uncertainties, the forward-looking information, events and circumstances discussed in this quarterly update might not occur. Our actual results and performance could differ substantially from those anticipated in such forward-looking statements v6 2

4 PRESENTATION OF FINANCIAL AND CERTAIN OTHER INFORMATION The financial data set out in this quarterly update is derived from and should be read in conjunction with the unaudited interim consolidated financial statements of Itaú Unibanco Holding as of and for the three-month periods ended March 31, 2011 and 2010, which are included elsewhere in this quarterly update. Our unaudited consolidated financial statements as of and for the three-month periods ended March 31, 2011 and 2010 are referred to as our interim consolidated financial statements. We maintain our books and records in reais, the official currency of Brazil, and prepare our consolidated financial statements and our financial statements for statutory and regulatory purposes in accordance with accounting practices adopted in Brazil and applicable to institutions authorised to operate by the Central Bank ( Brazilian GAAP ). Accounting principles and standards generally applicable under Brazilian GAAP include those established by Law No. 6,404, as amended, including by Law No. 11,638 ( Brazilian Corporate Law ), by the accounting pronouncements committee (Comitê de Pronunciamentos Contábeis or CPC ), which began issuing standards in 2007, and by the federal accounting council (Conselho Federal de Contabilidade or CFC ), while interpretative guidance was issued before the CPC became active by the Brazilian professional body of independent accountants (Instituto dos Auditores Independentes do Brasil or IBRACON ). In the case of companies subject to regulation by the Central Bank, such as Itaú Unibanco Holding, the effectiveness of accounting pronouncements issued by accounting standard setters, such as the CPC, depends on approval of the pronouncement by the National Monetary Council (Conselho Monetário Nacional or CMN ) and the Central Bank which also establishes the effective date of the pronouncements. In addition, the Comissão de Valores Mobiliários ( CVM ) and other regulatory entities, such as the Superintendency of Private Insurance (Superintendência de Seguros Privados) and the Central Bank, provide additional industry-specific guidelines. Unless expressly stated otherwise, all financial data included in this quarterly update has been prepared in accordance with Brazilian GAAP. Brazilian GAAP differs in certain respects from generally accepted accounting principles in the United States ( U.S. GAAP ). No reconciliation to U.S. GAAP of the financial data presented in this quarterly update has been prepared for the purposes of this quarterly update or for any other purposes. There can be no assurance that a reconciliation would not identify material quantitative differences between our financial statements prepared in accordance with Brazilian GAAP and such financial statements as prepared on the basis of U.S. GAAP. On November 28, 2008, the shareholders of each of Itaúsa Investimentos Itaú S.A. ( Itaúsa ) and Unibanco Holdings approved the merger of the operations of Banco Itaú Holding (currently Itaú Unibanco Holding) and Unibanco Holding, resulting in the creation of Itaú Unibanco Holding. Subsequently, the financial operations of Itaú Unibanco and Unibanco were integrated through a series of reorganisation transactions completed on February 28, On December 28, 2007, Law No. 11,638 was enacted, primarily to enable the convergence of Brazilian GAAP with International Financial Reporting Standards ( IFRS ) and increase the transparency of financial statements in general. CMN Resolution No. 3,786, as amended, establishes that financial institutions meeting certain criteria, such as Itaú Unibanco Holding, are required to present consolidated financial statements in accordance with IFRS (as translated into Portuguese by IBRACON) for the year ended December 31, However, unlike IFRS, the Central Bank does not require presentation of comparative data for prior years. Under Central Bank Circular No. 3,516, publication of financial statements as of and for the year ended December 31, 2010 based on IFRS is required within 120 days of the end of such period. Accordingly, Itaú Unibanco Holding is required to present its consolidated financial statements based on IFRS to comply with CMN Resolution No. 3,786 and has published such financial statements prior to the date hereof. As a result of the issuance of Law No. 11,638, in a parallel process, CPC has issued approximately 40 standards with the objective of making Brazilian GAAP similar to IFRS as described above. In the case of Itaú Unibanco Holding, effectiveness of the standards issued by CPC depends on approval of the standards by the Central Bank. The CPC issued several standards for application beginning with the year ended December 31, 2008 and during 2009 and 2010 issued several additional standards. As of the date of this quarterly update, the Central Bank has approved four of those standards, which address impairment of assets, statements of cash flows, related parties v6 3

5 disclosures and provisions, and contingent liabilities and contingent assets. Itaú Unibanco Holding has applied those standards to its financial statements as described below: Impairment of Assets (CPC 01) and Statements of Cash Flows (CPC 03), beginning with the year ended December 31, 2008, prospectively (see Note 22(o) to our consolidated financial statements as of and for the year ended December 31, 2009); Related Parties Disclosures (CPC 05), beginning with the year ended December 31, 2009, prospectively (see Note 22(o) to our consolidated financial statements as of and for the year ended December 31, 2009); and Provisions, Contingent liabilities and Contingent Assets (CPC 25), beginning with the year ended December 31, 2010, prospectively (see Note 4(o) to our consolidated financial statements as of and for the year ended December 31, 2010). Standards issued by the CPC but not approved by the Central Bank are not required to be applied by Itaú Unibanco Holding. As presented in more detail in Note 22(l) to our interim consolidated financial statements as of and for the three-month period ended March 31, 2011, Itaú Unibanco Holding reclassified the following items as of and for the three-month period ended March 31, 2010: In the balance sheet, o the reclassification of liabilities related to our credit card rewards programs from Other Liabilities Credit Card Operations to Deferred Income; and In the statement of income, o o the reclassification of employee profit sharing plan costs from Profit Sharing to Other Operating Revenues (Expenses) Personnel Expenses and Income Tax and Social Contribution; and the reclassification of expenses related to our credit card rewards programs from Other Operating Expenses to Banking Service Fees Credit Cards. In addition, in our interim consolidated financial statements as of and for the three-month period ended March 31, 2011, there was a change in the basis for consolidating Financeira Itaú CBD S.A. from full to partial consolidation and Porto Seguro S.A. from consolidation to recognition under the equity method, which was also reflected as of and for the three-month period ended March 31, 2010 for comparative purposes. See Notes 2(b) and 22(l) to our interim consolidated financial statements. The financial statements included in this quarterly update are prepared in accordance with Brazilian GAAP effective as of the date reported. As a result, the financial information presented in this quarterly update may differ significantly from financial statements that could be prepared or actually prepared in accordance with IFRS and financial statements prepared in the future under IFRS or Brazilian GAAP (including financial information as of and for the three-month period ended March 31, 2011) v6 4

6 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion of our financial condition and results of operations should be read in conjunction with our interim consolidated financial statements and the notes thereto, included elsewhere in this quarterly update, as well Presentation of Financial and Certain Information. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed in forward-looking statements as a result of various factors, including those set forth in Cautionary Statement Regarding Forward-Looking Statements. Overview According to Bloomberg, Itaú Unibanco Holding ranked among the ten largest banks in the world in 2010 and was the largest bank in Brazil, each ranking based on market capitalisation. Our principal operations are: (i) commercial banking (including insurance, pension plan and capitalisation products, credit cards, asset management and a variety of credit products and services for individuals, small and middle-market companies); (ii) Itaú BBA (corporate and investment banking); and (iii) consumer credit (financial products and services to our nonaccountholders). Our results of operations are significantly affected by the following key factors, among others. Trends We expect that several factors will affect our future results of operations, liquidity and capital resources, including: the Brazilian economic environment, legal and regulatory developments, the effects of any continued international financial turmoil, including on our required liquidity and capital, the effects of fluctuations in the value of the real and interest rates on our net interest income, and the acquisition of any financial institutions we may make in the future. As part of our strategy, we continue to focus on Brazil and to review opportunities to grow. Effects of the Global Financial Markets on our Financial Condition and Results of Operations The global financial markets crisis has significantly affected the world economy since the last quarter of The crisis led to recessions and increasing unemployment in the world s leading economies, to a reduction in investments on a global scale, a decrease in commodities prices and a sharp decline in credit availability and liquidity, as well as a general reduction in the levels of transactions in the capital markets worldwide. As of the date of this quarterly update, the credit markets are recovering and the capital markets have been active around the world. The world economy has been recovering throughout 2010 and beginning of 2011, but several consequences of the crisis remain. Important risks have been identified in the aftermath of the financial crisis in Europe, such as the high debt levels that impair growth and increase the risk of sovereign default. Particularly, the markets have increased the risk premiums on debt of some countries in Europe. These countries debt is held by international financial institutions, and their economic situation may impact the results of banks and investment funds. Although the European Union is prepared to face these difficulties, a financial deterioration of any of these countries may impair the recovery of economies worldwide and, indirectly, Brazil s recovery. In the U.S., unemployment continues to be high, although there are signs of recent improvements in the labour market. This weakness in employment has important effects on consumer confidence and, therefore, on consumer spending. Finally, emerging markets, including Brazil and China, and a few developed economies are experiencing accelerating inflation prompting central banks to begin to tighten monetary policy v6 5

7 During the first quarter of 2011, a very strong earthquake, followed by a tsunami and a serious nuclear accident affected the Japanese economy. The effects are still to be fully accounted for, but the negative impact on the growth and fiscal accounts of Japan will be intense, with possible negative, although mild, impact on global growth. Several popular uprisings in countries in the Middle East and North Africa, prompting the fall of the Egyptian government, among others, are keeping pressure on oil prices, which could have a negative impact on global growth. Our results of operations since the last quarter of 2008 have been partially negatively affected by the global financial markets crisis. The prospects for 2011 have improved, but fiscal problems in advanced economies, sluggishness in the U.S. economy and inflation and other issues in developing economies may have an impact on future growth in Brazil and, therefore, on our results of operations. Brazilian Economic, Political and Social Conditions As a Brazilian bank with most of our operations in Brazil, we are significantly affected by economic, political and social conditions in Brazil. In recent years, we have benefited from Brazil s generally stable economic environment, with average annual gross domestic product ( GDP ) growth of approximately 4.2% from 2004 to 2010, which led to increased bank lending and deposits. The downward trend in inflation until recently had allowed the Central Bank to ease the benchmark interest rate payable to holders of securities issued by the Brazilian government and traded through the Special Clearing and Settlement System (Sistema Especial de Liquidação e Custódia or the SELIC ) from a high of 17.75% in December 2004 to a low of 8.75% in July Since July 2009, inflation has increased and, accordingly, the SELIC benchmark overnight interest rate has risen and was at 11.75% as of March 31, As a proportion of GDP, bank lending expanded to 46.4% in March 2011 from 26.2% in September In 2010, Brazil experienced strong growth and GDP expanded 7.5%. This was primarily due to the Brazilian economy rebounding from negative growth in 2009, and also the result of rapid expansion of domestic demand, driven mainly by the recovery of consumption and investment expenditures as well as stimulative fiscal expenditures in There are concerns about the acceleration of inflation. Consumer price inflation reached 5.9% in 2010, well above the median of the Brazilian government s target range of 4.5% and close to the stipulated maximum rate of 6.5%. In the first quarter of 2011, inflation continued to trend upward, reflecting not only the recent rise in commodity prices but also high inflation expectations based on opinion survey data from the Central Bank, an overheated labor market and inflationary inertia. The Consumer Price Index (Índice de Preços ao Consumidor Amplo or IPCA ) reached 2.44% in the first quarter of To combat inflationary pressures, the Central Bank increased the SELIC interest rate to 11.75% during the first quarter, 100 basis points above the December 31, 2010 SELIC interest rate. If inflation continues to rise, income of families may decrease in real terms leading eventually to higher delinquency rates in the Brazilian banking system. In addition, we have experienced some deterioration in non-performing loans in the very small and small companies market principally due to the increase in interest rates and other macroprudential measures taken by the Central Bank. Although Brazilian GDP for the first quarter of 2011 may still show high growth, economic fundamentals indicate a slight deceleration. The actual growth rate may reach 1.2% in the first quarter of the year, up from 0.7% in the last quarter of Growth should be moderate for the rest of 2011 as a result of the macroprudential measures as well as fiscal and monetary tightening. Based on opinion survey data from the Brazilian Institute of Economy (Instituto Brasileiro de Economia) at Fundação Getulio Vargas showing declines in consumer confidence levels and business confidence levels, we believe both consumers and entrepreneurs are less optimistic with respect to growth of the Brazilian economy. The Brazilian credit market is already impacted by the effects of the macroprudential measures and the tightening of monetary policy, as credit has grown at a more moderate pace in the first quarter of 2011 as a result of tighter credit conditions. New loans to consumers in March 2011 were 7.3% lower in seasonally adjusted real terms than in November 2010, the month that preceded the first round of macroprudential measures related to credit. The behavior of new consumers loans in the first quarter of 2011 reflected higher rates, spreads and also default rates. Business lending is also facing tighter conditions. The current account deficit (net balance from trade of goods and services and international transfers) reached 2.6% of GDP as of March 31, 2011, from 2.3 % as of December 31, v6 6

8 2010. Brazil s external solvency improved considerably, with US$317 billion in international reserves and US$279 billion in external debt as of March 31, Nevertheless, Brazil s external liabilities excluding foreign direct investments (mainly foreign portfolio investments) reached US$847 billion as of March 31, 2011, an increase from US$821 billion as of December 31, In addition, the Central Bank bought US$23.9 billion on the foreign exchange spot market in the first quarter of The recent balance of payments results could increase exchangerate volatility, potentially affecting our results. See Certain Effects of Foreign Exchange Rates on Our Net Interest Income. The international scenario remains a source of potential risk for the Brazilian economy. The following are among such international risks: high oil prices, due to geopolitical tensions in the Middle East and North Africa, could threaten the global recovery; highly indebted countries in Europe could spur another financial crisis in the international markets and the acceleration of inflation in emerging countries may affect the level of activity and increase volatility in the Brazilian currency, the real, with respect to the U.S. dollar, the euro, the yen, the yuan and other currencies. The Brazilian government could choose to adopt further macroprudential measures to prevent excessive asset growth. In December 2010, the CMN adopted certain macroprudential measures, including: (i) increased additional required reserves ratios from 8.0% to 12.0% for demand and time deposits; (ii) increased regular reserve requirements for time deposits from 15.0% to 20.0%; and (iii) increased capital allocation from 11.0% to 16.0% for loans to individuals with maturities of 24 months or longer. The Central Bank expected these measures to increase required reserve deposits by R$61 billion, but in fact, it increased them by R$82 billion as of December 31, We are also exposed to tax-policy and regulatory changes, which are sometimes adopted on short notice. For instance, in October 2010, the government increased the tax on financial transactions (Imposto Sobre Operações Financeiras or IOF ) to 6.0% applicable to foreign exchange transactions made by foreign residents for purposes of investing in the Brazilian financial and capital markets (the IOF/FX ). There are certain exceptions to this general rule, including for certain foreign investments in equity securities, variable income securities, private equity funds, venture capital funds and funds that invest in such funds, which are currently taxed at 2.0%. The IOF/FX rate was also raised to 6.0% for remittances made by foreign investors to comply with margin requirements imposed by stock or commodities and futures exchanges. The IOF/FX tax was also imposed on the assignment of shares traded in the Brazilian stock market in order to permit the issuance of depositary receipts ( IOF Bonds ) at a rate of 1.5%. The Central Bank also increased the IOF/FX tax on offshore short-term issuances (i.e., that have a stated maturity of 720 days or less) to 6.0%. Long term issuances (i.e., that have a stated maturity of more than 720 days) are still taxed at 0%. The IOF is also levied on credit transactions granted by Brazilian banks and companies ( IOF/Credit ) and pursuant to Decree No. 7,458, effective as of April 8, 2011, the IOF/Credit on credit transactions granted to individuals was increased from a rate of % a day (or 1.5% a year) to % a day (or 3.0% a year). In addition, in 2008, a tax on withdrawals from checking accounts, or the CPMF, was abolished; there is a risk, however, that this may be imposed again. Furthermore, a number of regulatory changes for the domestic banking sector are under consideration, such as limits to compensation packages of financial institutions, additional disclosure of derivative transactions and further modifications to capital requirement models. These changes have the potential to adversely affect our operations and profitability. On April 30, 2008, Standard & Poor s Rating Services upgraded the long-term rating of Brazil s sovereign foreign currency debt to BBB- from BB+, lifting it to investment grade. On May 29, 2008, Fitch Ratings followed suit and upgraded Brazil to investment grade, raising its rating to BBB- from BB+, and on April 4, 2011, to BBB. On September 22, 2009, Moody s Investors Service Inc. raised Brazil s sovereign rating to Baa3 from Ba1. These upgrades have contributed to further increase the inflow of foreign capital, which in turn has strengthened the real. Yet, the rating agencies have highlighted weaknesses in Brazil s fiscal policy, including Brazil s high debt-to-gdp ratio in comparison to countries with similar credit ratings, along with structural impediments to growth and investment vis-à-vis similarly situated countries. The table below shows the real GDP growth, the inflation rate, exchange rate variation and the interest rates in Brazil as of and for the twelve-month period ended March 31, 2011 and the years ended December 31, 2010, 2009, 2008, 2007, and 2006: v6 7

9 As of and for the Twelve- Month Period Ended March 31, As of and for the Year Ended December 31, Real GDP growth % (1)... n.a. 7.5 (0.6) Inflation rate% (2) (1.4) Inflation rate % (3) Exchange rate variation % (R$/US$) (4) TR (a reference interest rate) % (5) CDI (interbank interest rate) % (6) SELIC (overnight interest rate) % (5) (1) Source: Instituto Brasileiro de Geografia e Estatística ( IBGE ). (2) Source: General Price Index Internal Availability (Índice Geral de Preços Disponibilidade Interna or IGP-DI ), as published by the Fundação Getulio Vargas. (3) Source: IPCA, as published by IBGE. (4) Source: Central Bank (accumulated rates for the period, negative numbers mean appreciation of the Brazilian real). (5) Source: Central Bank (period end) data are presented in percent per annum. (6) Source: Central Bank (period end) data are presented in percent per annum. Certain Effects of Foreign Exchange Rates on Our Net Interest Income The variation of the real may affect our net interest income. A certain amount of our financial assets and liabilities are denominated in or indexed to foreign currencies, primarily the U.S. dollar. When the real depreciates, we incur losses on our liabilities denominated in or indexed to foreign currencies, such as our U.S. dollardenominated long-term debt and short-term borrowings, because the cost in reais of the related interest expense increases. At the same time, we realise gains on monetary assets denominated in or indexed to foreign currencies, such as our dollar-indexed trading securities and loans, due to increased interest income from such assets measured in reais. When the real appreciates, the effects are the opposite of those described above. Consequently, the management of the gap in foreign currencies can have material effects on our net income. Our foreign currency gap management also takes into account the tax effects of such positions. As the profits from exchange rate variation on investments abroad are not taxable, we aim to maintain sufficient hedges (a liability position in foreign exchange derivatives) to reduce the potential effects from our total foreign-exchange exposure, net of tax effects. Unless otherwise indicated, the discussion in Management s Discussion and Analysis of Financial Condition and Results of Operations relates to our average interest rates and yields. Interest rates cited are measured in reais and include the effect of the variation of the real against foreign currencies. Seasonality Generally our retail banking and our credit card businesses experience some seasonality, with increased levels of retail and credit card transactions during the Christmas season and a subsequent decrease of these levels at the beginning of the year. We are also affected by seasonality in our banking service fees related to collection services at the beginning of the year, which is when taxes and other fiscal contributions are generally paid. Finally, we experience a seasonal decrease in personnel expenses in the first quarter of the year because of the summer vacation season during this period v6 8

10 Discussion of Critical Accounting Policies General Our main accounting policies are described in Note 4 to our interim consolidated financial statements. The preparation of the financial statements involves certain assumptions that are derived from historical experience and various other factors that we deem reasonable and relevant. While we review these estimates and assumptions in the ordinary course of business, the portrayal of our financial condition and results of operations often requires our management to make judgements on matters that are inherently uncertain. The following discussion describes the areas that require the most judgement or involve a higher degree of complexity in the application of the accounting policies that currently affect our financial condition and results of operations. Use of Estimates and Assumptions The preparation of financial statements in accordance with Brazilian GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates and assumptions are used for, but not limited to, the calculation of the allowance for loan and lease losses, the selection of useful lives for certain assets, the determination of whether a specific asset or group of assets has been impaired, the expected realisable amount of deferred tax assets, the market value of certain financial instruments, the classification and computation of contingent liabilities and the amount of technical provisions for insurance, pension plans and capitalisation. The accounting estimates made in these contexts require management to make assumptions about matters that are highly uncertain. In each case, if management had made other estimates, or if changes in these estimates occur from period to period, it could have a material impact on our financial condition and results of operations. Therefore, actual results may differ from our estimates. Allowance for Loan and Lease Losses The allowance for loan and lease losses represents our estimate of the probable losses on our loan and lease portfolio at the end of each reporting period. The allowance for loan losses is calculated taking into consideration the classification of loan losses in one of nine different risk levels (from AA through H). The classification of the risk levels is a judgement that takes into consideration the economic and political situation, credit quality trends, past experience and the portfolio s specific and global risks, as well as Central Bank and CMN guidelines. CMN rules specify a minimum allowance for loan losses and other extensions of credit in each rating category ranging from zero per cent (in the case of a credit that is not in arrears) to 100.0% (in the case of any credit that is more than 180 days in arrears). In addition to recognising allowances for loan and lease losses in accordance with the CMN minimum requirements, we also recognise an allowance that we identify as generic, which represents our estimate of the allowance as of any given date based on our historic loss experience, which beginning in December 31, 2010, is measured using models employed in credit risk management based on Basel II. Beginning in December 31, 2008, we also recognised an additional allowance, which represents an adjustment to our generic allowance considering the economic scenario. As of December 31, 2009 and in the first three quarters of 2010, we included as part of the additional allowance countercyclical provisions which, beginning on December 31, 2010, we no longer record as such; under the third Basel Accord ( Basel III ), countercyclical provisions will be addressed as part of a required capital buffer. The methodologies to compute the generic allowance depend on several criteria including the criteria used to segment our loan portfolio, the period used to measure our historical losses, the specific method used to measure such historical losses, the impact of our loan granting criteria on losses over time and other factors. Additionally, the methodologies used to measure the additional allowance also depend on significant judgements, including the relationship between the level of loan losses observed and economic factors as of any given date. If our estimates differ from the amounts actually collected, additional provisions may be required. Market Value of Financial Instruments In accordance with Brazilian GAAP and specific rules of the Central Bank, we record some of our financial instruments at market value. Financial instruments recorded at market value on our balance sheet include mainly securities classified as trading, available-for-sale, and other trading assets, including derivatives. Securities classified v6 9

11 as held-to-maturity are recorded at their amortised cost on our balance sheet, and their corresponding market values are disclosed in the notes to our interim consolidated financial statements. Market value is defined as the value at which a position could be closed out or sold in a transaction with a willing and knowledgeable party. We estimate market value using quoted market prices when available. When quoted market prices are not available, we use a variety of sources, which include dealer quotes, pricing models and quoted prices of instruments with similar characteristics or discounted cash flows. The determination of market value when quoted market prices are not available involves judgement by our management. Similarly, judgement must be applied in estimating prices when no external parameters exist. Other factors that can affect the estimates include incorrect model assumptions and unexpected correlations. While we believe our valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies and assumptions to determine the market value of certain instruments could result in a different estimate of market value at the reporting date, which may affect the amount of revenue or loss recorded for a specific asset or liability. Judgements are also required to determine whether a decline in market value below amortised costs is permanent in available-for-sale or held-to-maturity securities, therefore requiring cost basis to be written down and recognition of related effects on our results of operations. Factors that are used by our management in determining whether a decline is permanent include mainly the observed period of the loss, the degree of the loss and the expectation, as of the date of analysis, as to the potential for realisation of the security. Contingent Liabilities We are currently party to civil, labour, tax and social security proceedings arising from the normal course of our business. We normally make provisions for these contingencies based on the following: (i) for lawsuits individually reviewed, on the opinion of internal and external legal counsel and the probability that financial resources will be required to settle the claim, where settlement amounts may be estimated with sufficient certainty and (ii) for lawsuits collectively evaluated, by use of statistical references by group of lawsuits, type of legal body (small claims court or regular court) and claimant. We classify as probable, possible or remote the risk that such contingencies arising from these proceedings will materialise into actual losses for us. We generally recognise provisions for these contingencies when we classify the loss related to these claims as probable. While we do not recognise provisions for contingencies whose risk we consider possible or remote, we disclose contingencies whose risk we consider possible. We measure contingency amounts by using models and criteria that, in spite of the uncertainty of these contingencies terms and amounts, we feel accurately estimate their values. Although we believe that these contingencies are adequately reflected in our interim consolidated financial statements, their outcomes may result in obligations to pay amounts higher than the aggregate values of our contingency provisions, given the inherent difficulties in estimating the exact amounts involved in the claims made against us. Recent Developments Acquisition of Banco Carrefour On April 14, 2011 Itaú Unibanco, one of our main operating subsidiaries, entered into a share purchase and sale agreement governing the acquisition by Itaú Unibanco of 49% of Banco CSF S.A. ( Banco Carrefour ) for the amount of R$725 million. Banco Carrefour is the entity responsible for the offering and distribution, on an exclusive basis, of financial, insurance and pension products and services through the distribution channels of Carrefour Comércio e Indústria Ltda., which operates under the Carrefour brand in Brazil and includes 163 hypermarkets and supermarkets and related e-commerce channels, and had 7.7 million accounts and a credit portfolio (gross value) of R$2,254 million as of December 31, This transaction is subject to approval of the Central Bank. Principal Shareholders On March 30, 2011, BlackRock, Inc. informed us, according to Article 12 of CVM Instruction No. 358, that it owned preferred shares representing approximately 7% of the issued preferred shares of Itaú Unibanco Holding. In addition, BlackRock, Inc. informed us that it holds our shares for investment purposes only. Reverse Stock Split and Simultaneous Stock Split On April 25, 2011, our shareholders approved a reverse split of our common and preferred shares in the proportion of 100 shares to one share of the same type in order to adjust our shareholder base to reduce v6 10

12 administrative costs and improve the efficiency of our book-entry system. Our shareholders also approved a simultaneous stock split of one share to 100 shares, which will maintain the market price of our shares at an appropriate level to ensure liquidity. This transaction is subject to ratification by the Central Bank. Once this is approved and we provide additional details through an announcement to the market, we will establish a period of at least 60 days for holders of our common and preferred shares holding shares in a number not a multiple of 100 share lots to adjust their share lots at their discretion through the Brazilian stock exchange ( BM&FBOVESPA ). Once the 60-day period for adjustment of shareholdings has expired, fractional shares arising from the reverse split will be regrouped into integral numbers and sold at an auction through BM&FBOVESPA. Stock Option Plan On April 25, 2011, our shareholders approved modifications to the Stock Option Plan in order to (i) adjust the rule for termination of the beneficiary holding options; (ii) adjust the term for defining the price of simple options; and (iii) expressly provide that the beneficiaries, upon investing their bonuses in the stock option program and thereby receiving bonus options, may acquire stock directly from our treasury. Compensation On April 25, 2011, our shareholders also approved (i) compensation for members of our board of directors in an annual aggregate amount of R$11 million, (ii) compensation for members of our board of officers in an annual aggregate amount of R$115 million, and (iii) monthly individual compensation of R$12,000 and R$5,000 for members and alternate members of our fiscal council, respectively. Management The members of our board of directors and board of officers were reelected on April 25, 2011 at our annual shareholders meeting and at a meeting of our board of directors held on April 28, 2011, respectively. The election of the members of our board of directors and the election of the members of our board of officers on April 25, 2011 and April 28, 2011, respectively, are pending approval by the Central Bank. All of the members of our board of directors and board of officers were reelected for a term of one year. In addition, Mr. Eduardo Hiroyuk Miyak and Mr. Rogério Paulo Calderón Peres were elected as officers for a term of one year. Mr. Eduardo Hiroyuki Miyaki (born 06/11/1972) was elected as a member of our board of officers on April 28, 2011 (with his election and investiture subject to approval by the Central Bank). He has been an officer of Itaú Unibanco since June He was the manager and compliance officer of the Money Laundering Prevention program of the Itaú Unibanco Group from 1996 to 2003 and, from 2003 until 2004, he was a manager responsible for its internal audit department for our treasury and asset management units. Mr. Miyaki was also the manager of our internal audit of treasury, capital markets, insurance and securities units from 2005 to 2010, when he became a managing director of Itaú Unibanco. He holds a degree in Civil Engineering from Universidade de São Paulo, a postgraduate degree in sanitation from Federal University of Gunma Province in Japan and an a post-graduate degree in Business Administration from Fundação Getulio Vargas. Mr. Miyak also holds an MBA in International Finance and Business from the Leonard Stern School of Business of New York University. Mr. Rogério Paulo Calderón Peres (born 02/02/1962) was elected as a member of our board of officers on April 28, 2011 (with his election and investiture subject to approval by the Central Bank). He has been an officer of Itaú Unibanco since April 2009 and member of the Disclosure and Trading Committee of Itaú Unibanco Holding since June Mr. Calderón was an executive officer of Unibanco União de Bancos Brasileiros S.A. from 2007 to April 2009 and of Grupo Bunge from 2003 to Mr. Calderón was a member of the board of directors of Fertilizantes Fosfatados S.A. Fosfertil ( Fosfertil ), Ultrafertil S.A. and Fertifos S.A., an officer of Bunge Brasil S.A. and Fertifos S.A. and member of the Audit Committee of Fundação Bunge, Bungeprev - Fundo Múltiplo de Previdência Privada and Fosfertil from 2003 to From 1981 to 2003 he was a partner at PricewaterhouseCoopers s audit, tax and consulting divisions. Mr. Calderón holds a degree in Business Administration from Fundação Getulio Vargas, a degree in Accounting from Fundação Paulo Eiró and has completed a postgraduate course from the E-Business Education Series from Darden Graduate School of Business Administration of University of Virginia. He also attended courses at the Summer Executive Business School at the University of Western Ontario Canada, the Center for Executive Development Faculty of Princeton University, v6 11

13 Management of Continuing Education and Training Professionals in Arundel, England and Executive Business Development at Fundação Getulio Vargas. In addition, the members of our fiscal council were also reelected on April 25, 2011 at the annual shareholders meeting to serve for a term of one year. Mr. Ernesto Rubens Gelbcke and José Caruso Cruz Henriques were elected as alternates to our fiscal council. Finally, Mr. Alcides Lopes Tapias is no longer a member of our audit committee. Since 2009, the personnel committee has been in charge of establishing compensation principles and practices, as well as stock options and overseeing recruiting, training and retaining talented employees. However, in view of the creation of the compensation committee by our board of directors at a meeting held on February 17, 2011, in response to CMN Resolution No. 3,921, some of the responsibilities of the personnel committee regarding the establishment of the main compensation polices and principles of the Itaú Unibanco Group were transferred to the compensation committee. As a result of these changes, the main functions of the compensation committee currently include: (i) discussion and analysis of the existing compensation models of Itaú Unibanco Holding, Itaú Unibanco and Itaú BBA (including the treasury unit); (ii) proposal of a compensation package for the CEO of Itaú Unibanco Holding for approval by the board of directors; and (iii) evaluation and approval of the compensation packages proposed by the CEO for the executive vice presidents and executive officers of Itaú Unibanco Holding, Itaú Unibanco and Itaú BBA, including fixed and variable compensation components, benefits and long-term incentive compensation. The impact of CMN Resolution No. 3,921, as well as other legislation relating to existing compensation practices in countries in which our subsidiaries operate, is being studied by the compensation committee. Recent U.S. Legislation The Foreign Account Tax Compliance Act generally provides that, beginning on January 1, 2013, a 30% withholding tax will be imposed on certain U.S.-source payments made to foreign financial institutions that do not enter into an agreement with the U.S. Internal Revenue Service to provide information on financial accounts held by certain U.S. persons and U.S.-owned foreign entities. Results of Operations for Three-Month Period Ended March 31, 2011 Compared to Three-Month Period Ended March 31, 2010 Highlights Net income for the three-month period ended March 31, 2011 amounted to R$3,530 million, with an annualised return on average equity of 22.7%, compared to 25.0% for the same period of As of March 31, 2011, consolidated assets totaled R$778,472 million and total stockholders equity was R$63,731 million. As of the same date, our solvency ratio on a fully consolidated basis was 16.1%. The balance of credit transactions, including endorsements and guarantees, was R$344,855 million as of March 31, 2011, a 21.9% increase compared to March 31, As of March 31, 2011, credit to individuals increased by 18.4%, while credit to companies increased by 24.3%, compared to March 31, With respect to credit to individuals, the highlights were mortgage loans, credit cards and personal loans, with increases of 61.8%, 21.0% and 24.1%, respectively. With respect to credit to companies, the very small, small and middle sized companies portfolio increased 29.1% from March 31, 2010 to March 31, 2011, while the corporate portfolio increased 20.9% during the same period. Our results of operations for the three-month period ended March 31, 2011, when compared to the three-month period ended March 31, 2010, reflected a significant impact from exchange rate variations. The exchange rate between the U.S. dollar and the real changed significantly. During the three-month period ended March 31, 2011, the real appreciated 2.3% against the U.S. dollar, while in the same period in 2010 the real depreciated 2.3% against the U.S. dollar. In 2011, there was a change in the basis for consolidating Financeira Itaú CBD S.A. from full to partial consolidation and Porto Seguro S.A. from consolidation to recognition under the equity method, including for comparative purposes. See Note 2(b) to our interim consolidated financial statements v6 12

14 Net Income The table below shows the major components of our net income for the three-month periods ended March 31, 2011 and Three-Month Period Ended March 31, Variation (%) (In millions of R$) Income from financial operations... 22,361 18, % Expenses of financial operations... (10,481) (8,252) 27.0% Income from financial operations before loan losses... 11,880 9, % Result of loan losses... (3,173) (2,976) 6.6% Gross income from financial operations... 8,707 6, % Other operating revenues (expenses)... (3,537) (2,441) 44.9% Operating income... 5,170 4, % Non-operating income % Income before taxes on income and profit sharing... 5,213 4, % Income tax and social contribution expense... (1,470) (1,023) 43.7% Profit sharing... (35) (62) (43.5)% Minority interest in subsidiaries... (178) (222) (19.8)% Net income... 3,530 3, % For the three-month period ended March 31, 2011, our net income was influenced by provisions for contingencies related to civil litigation in connection with economic plans (an after-tax expense of R$108 million). See Note 22(k) to our interim consolidated financial statements. Income from Financial Operations The table below shows the major components of our income from financial operations for the three-month periods ended March 31, 2011 and Three-Month Period Ended March 31, Variation (%) (In millions of R$) Loan, lease and other credit operations... 13,680 12, % Securities and derivative financial instruments... 5,208 4, % Insurance, pension plan and capitalisation... 1, % Foreign exchange operations (98.0)% Compulsory deposits... 2, n.m. Total income from financial operations... 22,361 18, % Our income from financial operations increased by 22.9% from R$18,190 million for the three-month period ended March 31, 2010 to R$22,361 million for the same period in 2011, an increase of R$4,171 million. This increase is primarily due to increases in income from compulsory deposits, income from loan, lease and other credit operations and to a lesser extent income from securities and derivative financial instruments and insurance, pension plans and capitalisation products. The increase in income from compulsory deposits reflects the impact of new requirements implemented by the Central Bank during 2010, increasing significantly the required volume of deposits. This increase was partially offset by a decrease in income from foreign exchange operations. Income from Loan, Lease and Other Credit Operations Our income from loan, lease and other credit operations increased by 13.7% from R$12,032 million for the three-month period ended March 31, 2010 to R$13,680 million for the same period in 2011, an increase of R$1, v6 13