UPDATE 3-Itau Unibanco profit drops less than expected

* Q2 recurring profit down 14 pct as default rate surges

* Assets rise 15 pct from year earlier to 596.4 bln reais

* Loan portfolio grows year-on-year but down from 1st qtr (Adds CEO, CFO comments, analyst views, byline)

By Elzio Barreto

SAO PAULO, Aug 11 (Reuters) - Itau Unibanco, Latin America's largest bank by assets, said second-quarter recurring profit fell 14 percent as provisions for bad debt grew, but the drop was less steep than analysts had expected.

Bad debt provisions more than doubled as the bank, like smaller rival Bradesco (BBDC4.SA)(BBD.N), had to set aside more cash because of loan delinquencies.

Defaults will likely edge higher until September but should fall in 2010 to near 2008 levels as Brazil's economy expands, Chief Executive Roberto Setubal said in a speech to business leaders on Tuesday.

"We have data showing that at the margin, it's improving," Setubal said. "The economy is bouncing back, growing at a much faster rate."

Itau Unibanco shares (ITUB4.SA) dropped 4.1 percent in afternoon trading, compared with a 1.9 percent decline in the benchmark Bovespa index .BVSP, on concern about profitability in the coming months because of the surge in defaults and bad debt.

"The results were a bit disappointing because of the drop in profitability and weak margins," said Laura Schuch, a banking analyst at the Ativa brokerage in Rio de Janeiro.

Recurring net income, which excludes the sale of stakes in credit card processing companies Visa Inc (V.N) and VisaNet VNET3.SA, fell to 2.43 billion reais ($1.31 billion) from 2.84 billion reais a year earlier. Including one-off items, profit fell 8.1 percent to 2.57 billion reais.

The bank, formed when Itau took over smaller rival Unibanco in an all-stock deal last November, was expected to post recurring profit of 2.37 billion reais, according to the average estimate of seven analysts in a Reuters survey.

Return on equity, a key gauge of profitability, averaged 22.3 percent in the second quarter, down sharply from 26.5 percent a year earlier but higher than the 18.2 percent in the first quarter.

Itau Unibanco's total loans rose 15.1 percent year-on-year to 265.97 billion reais but were down 2.5 percent from the first quarter as a surge in Brazil's real BRBY cut the value of lending in foreign currencies.

Lending is expected to expand 10 percent to 15 percent in 2009 and should grow as much as 25 percent next year as Brazil emerges from recession, Chief Financial Officer Silvio de Carvalho said in a conference call with journalists.

"We have clear signs that credit has become an important factor in the economic recovery now underway," Carvalho said. "Everything leads us to believe that the crisis is behind us."

Second-quarter consumer loans rose 13.2 percent year-on-year to 96.54 billion reais and were up 2.2 percent from the first quarter. Corporate credit grew 17.1 percent from a year earlier to 145.98 billion reais but dropped 4.5 percent from the first quarter because of the effect of foreign exchange variations on loans to large businesses.

Default rates, measured by loans that have remained unpaid for 90 days as a percentage of total debt, jumped to 5.4 percent from 4 percent a year earlier. The so-called nonperforming loans index also rose from 4.4 percent in the first quarter.

The bank's provisions for bad debt jumped to 22.92 billion reais in June from 11.66 billion reais a year earlier because of the rise in defaults.

The bank presented the year-earlier results on a pro forma basis because Itau and Unibanco did not operate as a joint financial company at the time.

Itau Unibanco finished the quarter with 596.4 billion reais in total assets, down from 632.7 billion reais in the first quarter, but up from 518.79 billion reais a year earlier. ($1=1.849 reais) (Reporting by Elzio Barreto; additional reporting by Aluisio Alves; editing by John Wallace)