(Adds comments from CEO Setubal, updates share performance)
By Guillermo Parra-Bernal
SAO PAULO, Feb 7 (Reuters) - Itaú Unibanco Holding SA expects to cut loan-loss provisions by at least one-quarter this year, underscoring the ability of Brazil's No. 1 bank by market value to keep defaults and costs in check despite a challenging economic outlook.
On Tuesday, the São Paulo-based bank projected loan book growth of up to 4 percent this year, despite shrinking interest income. Provisions are seen between 14.5 billion reais and 17 billion reais ($4.65 billion and $5.46 billion), compared with a record 22.1 billion reais last year.
Based on line-by-line guidance, Itaú could earn a profit of 24.5 billion reais this year, above the 23.9 billion-real consensus estimate compiled by Thomson Reuters. Profit at Itaú gained steam last quarter as falling defaults and robust fee income led to a bigger-than-projected cut in provisions.
Recurring net income, or profit excluding one-time items, came in at 5.817 billion reais last quarter, up 4 percent from the third quarter and above Thomson Reuters' average consensus estimate of 5.762 billion.
Return on equity, a gauge of profitability, also beat forecasts, hitting 20.7 percent last quarter. Based on the new guidance, which sees declining provisions and expense growth below annual inflation, ROE could stay around 20 percent this year.
"Our provision guidance is in line with our projections for the behavior of loan delinquencies, which is the most favorable in recent times," Chief Executive Officer Roberto Egydio Setubal told reporters at an event to discuss quarterly results.
Itaú shares posted their biggest intraday jump in more than two weeks on Tuesday, rising up to 4 percent to 39.55 reais, a 52-week high. Banking and financial shares took a ride on Itaú's rally, a sign of confidence over the industry's ability to weather Brazil's nearly three-year-old recession.
"We view Itaú's results, guidance and increase in payout as positive for the shares," said Marcelo Telles, a New York-based senior banking analyst with Credit Suisse Securities. "The bank continues to outperform peers on the asset quality front."
Banks in Brazil are struggling with the country's harshest recession since 1901 and fallout from "Operation Car Wash," a sweeping corruption probe into state firms and large corporate borrowers. Both have contributed to a three-fold jump in Brazilian bankruptcy filings over the past couple of years.
Setubal's focus on cost and default controls paid off, allowing Itaú to offset declining loan origination volumes and decreasing loan repricing power as the central bank began to cut borrowing costs aggressively late last year.
By setting conservative guidance goals for this year, Setubal is pointing to some of the challenges facing Itaú: more companies refinancing looming obligations, and unemployment preventing households from remaining current on their debt, analysts said.
Provisions earmarked for clients involved in the Operation Car Wash probe are "adequate at current levels," Setubal said.
Many of companies targeted by the probe have had to refinance their loans, file for bankruptcy protection or restructure other obligations.
Setubal retires in April after more than two decades at the helm of Itaú and will be replaced by Cândido Bracher, for over a decade his lieutenant at Itaú's corporate and investment banking arm Itaú BBA SA.
Bracher will have to contend with a sharp decline in Brazilian interest rates, a slow Latin American economic recovery and uncertainty stemming from U.S. President Donald Trump's protectionist policies, analysts said.
Interest income fell 2.2 percent last quarter, although they came in above expectations. The default ratio fell to 3.4 percent, well below consensus estimates, after Itaú wrote off a loan from an unidentified large borrower.
Provisions came in at net 4.819 billion reais, well below an estimate of 5.380 billion reais for the quarter. Non-performing loan formation, a gauge of future defaults that may result in additional provisioning, slumped to the lowest level in six quarters, the bank said.
The coverage ratio, or how much capital has a bank available to cover bad loans, rose to 222 percent last quarter, the highest in at least two years.
$1 = 3.1150 reais Additional reporting by Aluísio Alves in São Paulo; Editing by Louise Heavens, Chizu Nomiyama and W Simon