UPDATE 1-Margin compression is Itau's 'biggest challenge'-CEO
* CEO sees no clear trend for interest margin this year
* Itaú's interest margin has steep quarterly drop
* Redecard buyout unlikely to impact future profit
By Guillermo Parra-Bernal
SAO PAULO, Feb 6 (Reuters) - Slowing a decline in margins is the biggest challenge at Itaú Unibanco Holding SA, its chief executive said on Wednesday, signaling Brazil's No. 1 private-sector lender is struggling to keep profitability on pace.
The trend for net interest margin (NIM), or the interest earned from loans excluding funding costs, in the coming quarters is "not clear" at the moment, CEO Roberto Egydio Setúbal told investors on a conference call to discuss fourth-quarter earnings, which were reported on Tuesday.
NIM was the weakest link in an otherwise robust quarter as the lender fared better than analysts expected.
Asked whether he believed margins would keep falling this year, Setúbal said it was natural that they continued to compress as interest rates remain at record lows in Latin America's largest economy. But he said a modest hike in the benchmark Selic overnight lending rate could take place around the end of this year.
"Ensuring that margins grow or stay where they are pose the biggest challenge for us at the moment," Setúbal said on the call, adding that "it would be desirable to see them posting low single-digit growth, but we will see."
While NIM is falling for all banks as Brazilian President Dilma Rousseff presses lenders to cut interest rates, margin compression at Itaú has been steeper than at rivals. That is partly because Itaú scaled back lending in risky segments such as auto loans to focus on mortgage and paycheck-deductible credit - areas where lending rates tend to be lower but defaults are less likely.
Risk-weighted NIM, or interest earned taking into account the credit risk embedded, fell to a multiyear low of 5.8 percent in the fourth quarter from 6.3 percent in the prior three months, and 7.4 percent a year earlier. Some analysts expect NIM to reach 5 percent by year-end.
Itaú is sticking to loan and budget discipline in hopes of protecting profits as Brazil enters what could be the third straight year of sub-par economic growth. Setúbal said the only way to effectively fight a decline in margins is through stringent cost efficiency.
Preferred shares of Itaú, its most widely traded class of stock, fell nearly 1 percent on Wednesday, partially erasing Tuesday's 2.5 percent gain. The stock is flat so far this year.
While fourth-quarter profit at Itaú fell short of analysts' estimates, results were seen as encouraging for a bank that has struggled with issues ranging from a spike in defaults to failed bets in some credit segments over the past two years.
Defaults fell more than expected, provisions and expense growth came in below its forecast and fee income posted healthy expansion.
The bank said on Tuesday that recurring profit, or net income excluding one-time items, totaled 3.502 billion reais ($1.75 billion), below the average 3.523 billion target in a Thomson Reuters poll of five analysts. Profit rose 2.6 percent from the third quarter.
The decision by Itaú to book the buyout of Redecard SA as a capital transaction will have no impact on future earnings, Setúbal said.
The transaction, which allows Itaú to reduce equity without affecting key capital indicators, will also permit the company to forgo booking goodwill expenses in coming results, he said on the call.
Return on equity, excluding the impact of the Redecard transaction on capital, amounted to 17.7 percent, below the 18.4 percent ROE reported in Tuesday's earnings report, Setúbal added.