UPDATE 4-Brazil's Itaú keeps discipline, expects further drop in defaults
* Recurring profit 3.502 bln reais, below poll forecast
* Net interest margin plummets, casts shadow on results
* Loan delinquencies decline more than expected in poll
* Expense controls, rising fee income bolstered profits
By Guillermo Parra-Bernal and Aluísio Alves
SAO PAULO, Feb 5 (Reuters) - Itaú Unibanco Holding SA will sustain a tighter grip on loans and expenses this year after efforts by Brazil's largest private-sector bank to put a lid on bad credit bore fruit in the fourth quarter.
Itaú's loan book is expected to expand 11 percent to 14 percent this year, while sales, general and administrative expenses could rise between 4 percent and 6 percent, the bank said on Tuesday. Credit growth was 7.5 percent last year, below management's 9 percent to 10 percent guidance.
The new forecasts underpin growing caution among private-sector lenders as Brazil enters what could be the third straight year of sub-par economic growth. Itaú is scaling back lending in risky segments such as auto loans and focusing instead on mortgage and paycheck-deductible credit - areas where interest rates tend to be lower but defaults are less likely.
While fourth-quarter profit at Itaú fell short of analysts' estimates, results were encouraging for a bank that struggled in the past two years. Defaults fell more than expected, provisions and expense growth came in below guidance and fee income posted a healthy expansion.
The bank earned recurring profit, or net income excluding one-time items, of 3.502 billion reais ($1.75 billion), compared with the average 3.523 billion forecast in a Thomson Reuters poll of five analysts. Profit rose 2.6 percent from the third quarter.
"Results showed encouraging trends in terms of asset quality, cost control and fee income generation," said Mario Pierry, a senior banking analyst with Deutsche Bank Securities.
Preferred shares of Itaú, the company's most widely traded class of stock, jumped 3.3 percent to 34.45 reais following the results.
Loans in arrears for 90 days or more, an industry benchmark for defaults, fell to the equivalent of 4.8 percent of outstanding loans, from 5.1 percent in the prior quarter. Analysts had expected a so-called default ratio of 5 percent.
The bank also saw fewer short-term defaults in an indication that asset quality should improve in coming quarters. Loans in arrears between 15 and 90 days fell to 3.6 percent of total loans, the lowest level in at least five years and third consecutive quarter of improvements.
Defaults will keep falling this year, and probably at a faster pace than rivals, Chief Executive Officer Roberto Egydio Setúbal told reporters in São Paulo. "We are very confident that this downward trend will continue throughout the year," he said.
FARING BETTER THAN RIVALS
Bad-loan provisions fell 6.5 percent to 4.995 billion reais, below the poll's 5.21 billion reais estimate. The bank sees provisions totaling between 19 billion reais and 22 billion reais this year, below analysts' consensus of 24 billion reais.
Yet, loan disbursements rose 7.4 percent last year, falling short of the 9 percent to 10 percent guidance provided to investors in July. Setúbal expects loans for investment projects and mortgage credit rising at a robust pace in 2013.
Net interest margin at Itaú, or interest earned from loans excluding funding costs, fell to 5.8 percent from 6.3 percent in the third quarter. Analysts have said that margins, which they expected to remain stable, might continue to compress as the government presses lenders to lower borrowing costs.
Fee income rose 9.4 percent on a sequential basis, while operating expenses rose 0.4 percent. Itaú expects fee income, or revenue from financial services, investment-banking and non-interest activities, to grow between 11 percent and 14 percent, following a below-guidance rise of 8.5 percent last year.
It said operating expenses would rise by 4 to 6 percent this year, in a sign the bank might put additional emphasis on efficiency. Expenses rose 1.8 percent in 2012.
The bank's return on equity rose to 18.4 percent, the first increase in three quarters, beating the 17.7 percent estimate predicted in the poll. ROE, as the widely used gauge of profitability is known, rose after Itaú booked its buyout of Redecard SA as a capital transaction -- allowing it to reduce equity without affecting key capital indicators.