1 Annual Report 2005
2 Highlights Risk rating agencies Moody s upgraded its Financial Strength rating for Itaú, while Fitch Ratings followed suit for its Individual rating, reflecting the strong performance associated with our consistent profitability and gains in operational efficiency. Under these classifications, Itaú is rated as Brazil s best bank. Itaú was also selected as Brazil s best bank by Euromoney and Global Finance magazines, and as the most ethical and best managed of Latin America s largest banks by Latin Finance magazine. For the fourth consecutive time, the Itaú brand was selected as the most valuable brand name in Brazil, valued at US$1.342 billion by English consulting firm Interbrand. For the sixth consecutive time, Itaú was chosen to be part of the select group of companies which make up the Dow Jones Sustainability World Index (DJSWI). It is the only Latin American bank on the index, which features 312 companies from 24 countries, chosen from the 2,500 largest companies by market value on the Dow Jones Global Index, which itself represents 60 industrial sectors. Our inclusion in the DJSWI takes into account financial performance and, principally, the quality of company management transparency, corporate governance and socio-environmental responsibility. Itaú also joined the São Paulo Stock Exchange (Bovespa) Corporate Sustainability Index (ISE), which began in 2005 and is made up of 28 Bovespa-listed companies which demonstrate best practices in keeping with sustainable development. Itaú created an Executive Committee for Socio-Environmental Responsibility and a Socio- Environmental Responsibility Commission, both of which are responsible for establishing and implementing the Bank s Socio-Environmental Responsibility Policy. Through a public bidding process, Banco Itaú won the payroll contract for the City of São Paulo s 210,000 employees, and the management of its financial assets. In November, Itaú BBA opened a representative office in China, broadening its capacity to serve Brazilian companies seeking access to the Chinese market. On December 29, we signed a Termination Agreement ending Itaú s strategic alliance with America Online Latin America, releasing the two parties from the obligations contained in the June 12, 2000 Strategic Interactive Services and Marketing Agreement, and from any respective amendments and other contracts (see details in Explanatory Note 20 in the Financial Statements which accompany this Annual Report).
3 Introduction The Itaú Annual Report has been published since 1966, and represents an important reference source for the Bank s growth over the past four decades. Countless changes have been systematically introduced to improve transparency and inform readers on our corporate social responsibility and business sustainability. In 1999, we published our first Social Report, which followed guidelines set up by the Ethos Institute, and included a Social Statement recommended by the Brazilian Institute of Social and Economic Analyses (Ibase). Previously, our Reports had contained a specific section on our social and cultural activities. In keeping with the latest international standards for presenting accounts, in 2004 Itaú began publishing a cross-referenced index based on Global Reporting Initiative (GRI) guidelines, which shows the location of economic, environmental and social information in the Annual Report, Financial Statements and Social Report. Only a little over 700 companies worldwide follow the GRI guidelines, which seek to standardize and promote comparisons with companies everywhere. The information in this Report refers to all the operations and results in 2005 for Banco Itaú Holding Financeira S.A., which is generally referred to as Itaú or the Bank. However, the Report also includes discussions of Banco Itaú S.A. and Banco Itaú BBA S.A. activities in Brazil and abroad. Our Annual and Quarterly Reports, in addition to providing the most updated information about the Bank, are also available on the Itaú website at the Report, readers can access the internet using the Learn More feature to get additional information about the many topics we cover. If you have any questions, comments or suggestions, or would like more copies of the Report, please our Investor Relations area at Happy reading!
4 Primary Indicators and Highlights Change (%) Earnings in R$ millions (1) 2001 (04/05) Gross Income from Financial Operations 11,157 10,200 9,224 7,250 5, Income from Services, Insurance, Pensions and Annuities 14,417 12,398 10,129 7,777 6, Non-Interest Expenses (2) 10,428 9,015 8,770 8,425 7, Operating Income 8,183 7,342 5,714 4,255 3, Consolidated Recurring Net Income 5,443 4,870 3,717 3,080 2, Consolidated Net Income 5,251 3,776 3,152 2,377 2, Earnings per Share in 2004 and 2005 (in R$) (other years: per 1,000 shares) Consolidated Net Income Book Value Interest on Own Capital Preferred Share (PN) Price (3) Market Capitalization (in R$ millions) (4) 62,980 44,092 30,453 17,743 19, Balance Sheet (in R$ millions) Total Assets 151, , , ,141 81, Total Loans (including endorsements and sureties) 67,756 53,275 44,581 45,414 34, Non-earmarked, Raised and Managed Own Resources 248, , , , , Subordinated Debt 4,584 4,765 4,814 5,707 1,433 (3.8) Consolidated Stockholders Equity 15,560 13,971 11,879 9,036 7, Reference Equity (5) 20,644 19,806 17,185 16,573 10, Financial Ratios (%) Average Return on Equity Recurring Average Return on Equity Average Return on Assets Efficiency Ratio (6) Solvency (Basel) Ratio (7) Fixed Assets Ratio (7) Selected Measures Assets under Administration (in R$ millions) 120,287 99,753 81,102 59,167 55, Number of Employees 51,036 45,316 42,450 43,215 45, Number of Branches 2,391 2,282 2,321 2,314 2, Number of PABs (banking services outlets) (1.0) Number of ATMs 22,023 21,150 20,021 17,926 13, (1) The consolidation of Banco Itaú BBA appears only on the Balance Sheet, and does not affect results.(2) Includes staff expenses, other administrative expenses, CPMF and other tax expenses, and other operating expenses. (3) Based on the average price for December. (4) Calculated based on the average price of Itaú preferred shares in December. (5) Capital base, calculated in compliance with Central Bank of Brazil Resolution 2.837, dated May 30, 2001, based on consolidated economic-financial data. (6) Since 2004, calculated in compliance with international criteria as described in the Management Analysis of Operations. (7) As of December 31.
5 Annual Report 2005 Principal Indicators and Highlights (inside front cover) Chairman s Message 2 The Economy in Review and 2005 Results Banco Itaú 60 Profile 62 Banking 63 Banco Itaú BBA 78 Profile 80 Investment Banking 80 International Presence 84 Banco Itaú Europa 86 Banco Itaú Buen Ayre 88 Message from the President 6 Outlook for 2006 Banco Itaú Holding Financeira Profile 10 Financial Sector Analysis 12 Results 14 Management s Discussion and Analysis of Financial Condition and Results of Operations 14 Share Price and ADR Performance 36 Ratings and Recognition 38 Credit Portfolio 40 Consumer Clients 63 Retail Itaú Personnalité Itaú Private Bank Commercial Clients 65 Micro Companies Small Companies Middle Market Companies Institutional Clients Public Sector 66 Home Loans 67 Credit Cards Account Holders 68 Insurance, Pensions and Annuities 70 Corporate Banking 81 Selected Highlights for Senior Management and Directors 90 Corporate Information 94 Financial Statements 97 Glossary 182 Management 44 Corporate Governance 46 Risk Management 52 Cost Management 54 Brand Management 56 Business Performance 58 Fund and Portfolio Management 71 Itaú Corretora de Valores 72 Capital Markets Services 73 Itaucred Operations 74 Automobiles 74 Credit Cards Non-account holders 75 Taií Consumer Finance 76 1
6 Chairman s Message Itaú has built up its sustainability over 60 years through a corporate culture founded on ethics and quality service. Today, these same attributes are shared by our 51,000 employees, who serve over 16 million clients. The Economy in Review After 60 years in the industry, Itaú is fully prepared to continue its uninterrupted, sustained growth. Steady results throughout the institution s history, seen yet again in 2005, reflect its unceasing efforts to ensure our practices maintain their capacity to create value for everyone with whom we do business, independent of macroeconomic conditions. In 2005, for example, growth of the Brazilian economy was less robust than in 2004, with GDP finishing lower.this slowdown was most evident in the third quarter of the year, with a contraction of 1.2% against the previous quarter. As a result, this economic situation impacted investments and the demand for durable consumer goods, which also posted lower growth rates. On the other hand, inflation remained close to the 5.1% ceiling established by the Central Bank: the IPCA broad-based consumer price index hit a high of 5.7% for the year, which represented a better control over prices in comparison to 7.6% in 2004.These results augur well for consolidating the economic stability process and attaining the 4.5% goal set for Banco Itaú Holding Financeira S.A. Annual Report 2005
7 Despite higher interest rates in 2005, total credit with non-earmarked resources rose 18.8% over 2004, due primarily to the 29.7% rise in consumer client credit, while commercial loans grew 11.1%. The Brazilian real also continued to strengthen against the US dollar in In spite of this, domestic exports grew 22% year-on-year, thanks to higher prices of exported goods and a stronger global economy. Another reason for optimism comes from Brazil s reduction of its foreign debt from US$220 billion in 2004 to approximately US$186 billion at year-end. Contributions came from the private sector and the public sector, in addition to an early repayment of part of its debt with the International Monetary Fund. 3
8 Chairman s Message Responsible management and operational excellence have placed Itaú in the Dow Jones and São Paulo Stock Exchange sustainability indices.we earned Moody s highest rating for financial strength in Brazil, and the highest individual rating in Brazil from Fitch Ratings. Apprehensive economic growth led to maintaining the Public Debt-GDP ratio at 51%, halting the declining rates of previous years. In 2006, there will be room for economic expansion, supported by fiscal adjustment and inflationary target policies.this should bring about a positive impact on the performance of the financial sector, which has long displayed a robust character and high level of competitiveness, as Brazil remains the only country in Latin America whose leading financial institutions are locally controlled Results Unrivaled Performance An invaluable gauge to ensure sustainability, Itaú s consolidated earnings continued their growth of previous years, rising to R$5,251 million in 2005 and generating an average return of 35.3%. Total assets reached R$151,241 million, up 16.0% from This performance was driven by growth in consumer loans and the acquisition of goods, specifically in credit cards and automobile financing. As a result, the credit portfolio climbed 27.2% to reach R$67,756 million at year-end. Itaú s preferred shares ended the period up 46.5%, while common shares finished 47.0% higher. These increases extended to one of the Bank s principal intangible assets: the Itaú brand, which once again was considered the most valuable in Brazil. Clear evidence of the value of our brand comes from the shared values and strength of Itaú s performance culture as demonstrated by our almost 51,000 employees, who constantly seek a better relationship with the Bank s 16 million-plus clients. 4 Banco Itaú Holding Financeira S.A. Annual Report 2005
9 These results, which are due to our recognized operational excellence and responsible conduct, have allowed the Bank to be part of the Dow Jones and São Paulo Stock Exchange corporate sustainability indices, while our consistent performance over many years allowed Moody's and Fitch Ratings to upgrade Itaú s ratings. Based on these evaluations, we are now known as Brazil s best financial institution. The segmentation strategy we adopted some years ago years has been accompanied by a series of acquisitions and partnerships, and sticking with this business model has led to growth in markets such as Consumer Credit, Insurance and Pensions. Our international presence also expanded with the 2005 opening of a Banco Itaú BBA representative office in China, which is designed to handle Brazilian corporations with commercial interests in this increasingly important market. Economic stability and increased investment capacity allow the Bank to create new avenues for growth, but any actions we take will always be in keeping with the ethical values that underline the 60 years of Itaú s history. These are the foundations that ensure the creation of value for our shareholders, help us overcome social challenges, let us respect our natural resources, and give us the incentive for economic development. Thank you to everyone who shares Itaú s vision. Cordially, Olavo Egydio Setubal Chairman of the Board of Directors 46.5% was how much Itaú preferred shares rose in value in
10 Message from the President In 2005, Itaú strengthened its position in the Consumer Credit segment through strategic focus and an eye to the future, which are fundamental characteristics of every Itaú operation in Brazil and overseas. Valuing a legacy and culture developed over 60 years. Staying connected with the present and being alert to future trends, while always seeking superior results. This is how Itaú has built on its performance each year and consolidated its leadership among private sector banks in Latin America. In 2005, it was no different. Our credit portfolio grew 27%, particularly in consumer finance, which led to greater overall earnings and a larger client base. The consumer finance segment has consolidated itself after the first wave of expansion, begun in 2004, making Itaú a leading competitor in this market. Our Taií financing arm increased its loans to lower income clients, adding 1.5 million new non-account holder customers to the Bank s portfolio, through strategically located points of sale in the states of São Paulo and Rio de Janeiro. Part of this presence was via the Companhia Brasileira de Distribuição (CBD Paõ de Açucar) supermarket chain, which maintained Financeira Itaú-CBD s (FIC) expansion policy. In the same area, our partnership with Lojas Americanas S.A. (LASA), through Financeira Americanas Itaú S.A. (FAI), allowed products and financial services to be offered exclusively to LASA outlet customers in Brazil. Among the larger growth segments was automobile financing, which rose 80.1% from 2004 and ended the year with a total portfolio of R$11.2 billion, thanks to the efficient exploitation of expansion opportunities. 6 Banco Itaú Holding Financeira S.A. Annual Report 2005
11 This same strategy was successfully adopted for credit cards, whereby Itaú became the sector leader with a 21.7% market share in 2005, due to a new management agreement with Credicard which helped segregate the 7.6 million cards managed between Itaú and its partner, Citibank. This measure benefited all new clients through the Bank s technology, quality and wide range of products and services, in addition to leveraging the client base to 12.2 million card holders. Itaú also won the right to manage the financial assets and employee payroll of the City of São Paulo. This brings us a further 200,000 accounts, which should generate an additional 3% to 4% in earnings from retail operations. All our business activities arise from the ongoing effort to anticipate changing conditions, plus having a clear strategic focus and solid ethical base, all of which guide Itaú s initiatives. This direction led to the reworking of our Vision in 2005, as well as the creation of the new Code of Ethics, which relied on the participation of representatives from various areas and levels of the Organization. Amongst the primary actions designed to ensure Sustainability was the creation of our Executive Committee for Socio-environmental Responsibility and the Socio-environmental Responsibility Commission, which will ensure that all our businesses comply with the policies these two bodies establish and implement. One example is Itaú s analysis of socio-environmental impacts when granting credit, a result of our adoption of the Equator Principles, which establish criteria for project financing in excess of US$50 million. Using the same criteria, Itaú has developed a methodology to evaluate investments of lesser value for middle market companies. 7
12 Message from the President Other areas of attention in 2006 will be the investment banking and credit cards segments, in addition to insurance, pensions and annuities, which have considerable growth potential for the coming years. Increasing the number of areas and ways where we interact with the public is also an Itaú hallmark. In 2005, we launched the Itaú Ombudsman's Office (Ouvidoria Corporativa Itaú) which is an additional forum for dialogue within the Itaú customer support system, which has been in operation since We also introduced the Itaú Wants to Hear You campaign to encourage and publicize the use of our customer communication channels. Such initiatives strengthen our commitment to ongoing improvement, and employ the knowledge gained through customer opinions and suggestions to create valuable ways to improve our products and services. Outlook for 2006 The expansion of the credit portfolio and merging of the synergies arising from our strategic alliances and partnerships will be an important challenge in The consolidation of the market, combined with reduced chances of growth through acquisitions, outline the conditions where by Itaú will employ the best methods to attain suitable gains in scale in its operations. Among the strategies to be implemented is increasing Itaú s geographic coverage in segments where the demand for credit tends to be greater, due to Brazil s prevailing economic conditions. We therefore expect an increased number of business units geared to servicing small companies, and expanded automobile financing activities. In the area of consumer finance, the Taií financing arm hopes to have 300 outlets open by year-end through a nationwide expansion, particularly in Brazil s northeast and south. We will also seek to offer our clients an even wider variety of financial products through efforts based on high sales productivity and a focus on earnings, the result of our cost and risk 8 Banco Itaú Holding Financeira S.A. Annual Report 2005
13 management strategies. We also plan to introduce co-branded and private label credit cards through Lojas Americanas S.A. and grow our client base through an increased presence of Financeira Itaú CBD in the Companhia Brasileira de Distribuição supermarket chains. In the credit cards market, the integration of Itaucard s operations with those of Credicard should bring about synergies in several areas, including the ability to generate credit card sales among non-account holder customers, the management of partnerships, more focused activities in the Corporate Business segment, and the diversity of Itaú s distribution channels. On the other hand, the acquisition of Orbitall Brazil s leader in the credit card processing market added significant benefits and should provide increased efficiency thanks to the possible synergies with Itaú s existing infrastructure. These efforts are all designed to maintain the Bank s market leadership by optimizing its results. Banco Itaú will also be dedicated to increasing its market share in Insurance, Pensions and Annuities, which are sectors offering considerable growth potential in Brazil in the coming years. Another key area of activity will be increasing our market share in the fast-growing Investment Banking segment through Banco Itaú BBA. Earnings resulting from these activities have been taking up a steadily growing portion of our corporate client financial margin, and we expect that in three to five years Itaú BBA will be Brazil s leading investment bank. In light of the expected economic conditions for 2006, with continued stability, inflation control, lower interest rates, a slight recovery in income and GDP growth of 3% to 4%, Itaú is well placed to maintain the same efficient performance that has characterized the Organization for so many years. Our ability to finance growth also allows us to adequately project our earnings and the creation of value for all our shareholders, employees, clients and the general public. By being active in all segments of the economy, Itaú expects to contribute even more to the sustainable development of the country and consequently, be present in the lives of all Brazilians. Sincerely, Roberto Egydio Setubal Chief Executive Officer With a 22% market share in credit card sales, Itaucard is Brazil s leader in this segment 9
14 Banco Itaú Holding Financeira Profile The new vision guides Banco Itaú Holding Financeira (Itaú), one of Brazil s largest financial institutions. With over 16 million clients, Itaú has developed the structure, products and services to satisfy the needs of a wide variety of markets in Brazil and overseas. Through Banco Itaú and Banco Itaú BBA, it is active in all areas of domestic economic activities. At year-end, Itaú s net shareholders equity was R$15.6 billion, it had R$151.2 billion in assets and a market capitalization of R$63.0 billion. Its shares are traded on the São Paulo (Brazil), Buenos Aires (Argentina) and New York stock exchanges. A commitment to excellence has made Itaú part of sustainability indices such as the Dow Jones Sustainability World Index (DJSWI) and the Bovespa Corporate Sustainability Index (ISE). As Brazil s largest wholesale bank, Itaú BBA serves the country s 1,000 largest organizations,and is also highly active in investment banking, where it combines specialized service for large corporations with the high volume operations and service quality of Banco Itaú. Banco Itaú operates in a wide variety of market segments: micro, small and middle market companies, the public sector, institutional investors and consumer clients, plus high income (Personnalité) and high net worth (Itaú Private) individuals, who receive specialized products and service designed to meet their needs. It also handles underwriting, custodian services, securities brokerage, credit cards, consórcios, insurance, bonus-enhanced annuities and private pension plans, automobile financing as well as sub-prime lending for non-account holders. Its extensive service network offers 4,558 facilities, including branches, banking services outlets, electronic service units in companies and at Taií offices, and more than 22,000 Itaú ATMs. Consistent investments in technology allow 2.6 billion operations to be conducted annually through self-service, ATMs, telephone, fax and internet, plus direct debit card purchases. Itaú is also internationally recognized as a leader among Brazilian private sector financial institutions operating abroad. It serves consumer and commercial clients through its branches in Japan, the United States, the Cayman Islands, Portugal, England, Argentina and China, while Banco Itaú BBA has branch offices in Uruguay and the Bahamas, plus representative offices in Shanghai, Buenos Aires and New York. Itaú s consolidated overseas investments totaled R$6.5 billion (US$2.8 billion) at year-end, including non-financial activities. 10 Banco Itaú Holding Financeira S.A. Annual Report 2005
15 Itaú s Vision To be the industry's best performing bank, long lasting, renowned for being sound and ethical, and distinguished by highly motivated teams committed to customer satisfaction, to the community and to generating competitive advantages. 11
16 Financial Sector Analysis Higher savings rates, easier access to capital markets and increased banking services, available at 24,000 service points, helped drive the banking sector in The Economy Economic growth in 2005 lagged that of 2004.The slowdown in GDP, which began at the end of 2004, bottomed out in the third quarter, dropping 1.2% from the previous quarter.this contraction was due in part to a considerable stockpiling of goods in the industrial sector. With restrictive monetary policies and slow growth in average real wages, investments backed off along with demand for durable consumer goods. Only the exceptional performance of exports prevented the Brazilian economy from slowing further. On the other hand, inflation only marginally exceeded the 5.1% ceiling established by the Central Bank: the IPCA price index measured inflation at 5.7% in 2005 against 7.6% in 2004, pointing to a goal of 4.5% in billion in 2004 to US$118.3 billion in 2005, benefiting from higher prices of exported goods and a stronger global economy.these positive conditions allowed the Central Bank to embark on a purchasing policy which added US$21.5 billion to foreign reserves during the year. Public sector debt as a percentage of GDP was relatively stable in 2005, finishing at about 51.7%, halting the slide in the Debt-GDP ratio which highlighted 2004.The policy to improve the debt profile, however, continued through larger issues of pre-set securities, which reached 27.2% of the federal securities debt, helping foreign currencydenominated debt drop from 23% to 9% of net sector public debt.these actions also helped reduce the impact of exchange rate fluctuations on the fiscal accounts. In 2005, the real strengthened about 16% in nominal terms and over 20% in real terms in against the US dollar. At the same time, Brazil reduced its total foreign debt from US$220 billion in December of 2004 to about US$188 billion at year-end.the private sector and public sector both greatly reduced their debts in foreign currency, highlighted by the Brazilian government s early repayment of US$15.8 billion to the International Monetary Fund (IMF). Brazil s exports rose from US$ Banco Itaú Holding Financeira S.A. Annual Report 2005
17 The Banking Sector The trend to grow assets continued in 2005, through higher savings and substantial growth in sourcing funds from capital markets, while the availability of banking services grew to over 24,000 facilities (branches and service outlets). Property loans to commercial clients grew 35.2% in 2005, while working capital grew 21.2%. Demand deposits posted real growth of 7.7% from December 2004.Term deposits had real growth of 27%, while savings remained unchanged from the previous year. Despite high interest rates, total credit with nonearmarked resources rose 18.8% from 2004.This increase was driven primarily by consumer credit, which rose 29.7%, while commercial client credit climbed 11.1%. Increased consumer loans led to a slight increase in delinquencies, with the proportion of the portfolio over 90 days in arrears going from 6.2% in November 2004 to 6.8% by November In tandem with substantial growth in the automobile sector, whose domestic sales rose 6.3% against GDP growth of 2%, consumer financing for automobile purchasing rose 26.3%. Credit cards were another product which performed well in the consumer client segment.the number of cards issued grew 27.4%, with transactions increasing 25.1%. Sales per card fell steadily during the period, going from R$229 to R$207, or a 9.6% drop.this was due to competition between the leading operators, who have now begun marketing cards to increasingly lower income groups. Capital markets were much more buoyant in 2005 than in previous years. Debenture issues rose fivefold from R$10.5 billion to R$51.5 billion, while the value of shares issued climbed 17% from R$3.9 billion in 2004 to R$4.6 billion by year-end. The average yearly rate for pre-set certificates of deposit rose from 16.2% in November 2004 to 16.7% by November 2005, following an increase in the Selic inflation rate, which was directly affected by the demand of public sector funds. Finally, the share of non-earmarked credit in bank assets (1) grew from 21% in September 2004 to 24% by September 2005.The share of government securities in the portfolio also increased, though somewhat less, moving from 20% in September 2004 to 21% in September Central Bank of Brazil sample of 104 financial institutions, including the following types:commercial Banks, Universal Banks having a Commercial Portfolio or Savings Banks that are not part of a banking conglomerate; and Banking Conglomerates containing at least one institution which is a Commercial Bank or Universal Bank having a commercial portfolio. 18.8% growth in total credit with non-earmarked resources in
18 Results Management s Discussion and Analysis of Financial Condition and Results of Operations Positive macroeconomic conditions, combined with our strategic decision to focus more on commercial activities in segments where we have traditionally kept a low profile, such as consumer credit and loans to micro, small and middle market companies, resulted in steady growth of the credit portfolio and altered the dynamic of our revenue sources throughout the year. We have modified the calculation for Return on Net Equity (ROE) and introduced the metric of Annualized Return on Average Net Equity, where the closing balance of net equity has been replaced by its average balance. The average balance accumulated for the year is obtained by the arithmetic average of the balances on the last day of the past five quarters (Dec. + Mar. + Jun. + Sept. + Dec. / 5). Figures in the tables in this Annual Report are expressed in millions,unless otherwise indicated.calculations of yearly changes and totals are expressed as percentages. Future expectations arising from the reading of the Management Discussion and Analysis of Financial Condition and Results of Operations should take into consideration the risks and uncertainties that involve any activities which are beyond the control of the companies of the Itaú conglomerate,including political and economic changes,volatility in interest and foreign exchange rates, technological changes, inflation, financial disintermediation, competitive pressures on products and prices, and changes in tax legislation. 14 Banco Itaú Holding Financeira S.A. Annual Report 2005
19 Managerial Income Statement Our strategy for managing the foreign exchange risk on capital invested abroad is designed to prevent exchange rate fluctuations from affecting results.to achieve this objective, we use derivatives to neutralize foreign exchange risk and remunerate investments in reais (R$). Our hedging strategy also takes into account all the related tax effects associated with the non-taxability/deductibility of exchange rate fluctuations when the real is strengthening/weakening against foreign currencies, as well as those arising from the types of derivatives used. When there is considerable variation in parity between the real and other foreign currencies, a significant impact is reflected in various line-item entries in the financial statements, with particular emphasis on financial revenues and expenses. As a result, in Q205 the Management Discussion & Analysis began including the Managerial Income Statement, which highlights the impact of exchange rate fluctuations on capital investments abroad and the effects arising from hedging these positions.the Managerial Income Statement is derived from a series of reclassifications made to the general Income Statement, while the managerial financial margin includes two adjustments in relation to the overall financial margin: (i) all the effects of exchange rate fluctuations on investments abroad, which are distributed over several line-item entries in the general income statement; and (ii) the tax effects of hedging these investments, which are reflected in the general income statement in the tax expenses (PIS and COFINS) and income tax and social contribution line entries. Additionally, the managerial financial margin has been broken down by Banking operations associated with customer business activities;treasury in which an opportunity cost is attributed to each transaction; and Management of the foreign exchange risk on investments abroad, which is essentially the remuneration of capital used for these investments, expressed at the CDI (certificate of deposit) rate.the following table shows how the managerial financial margin is determined for managing the foreign exchange risk of investments abroad. The real strengthened 11.8% against the US dollar during 2005, finishing the year at reais to the dollar, down from R$ the previous December. In 2004 the trend was similar, as the real rose 8.1% against the dollar over the year, closing with an exchange rate of reais to the dollar, while in 2003 the final figure was R$ in R$ Millions Initial Balance Gross Value Tax Effects Net Value 2005 Capital Investments Abroad (A) 5,637 Exchange Variation on Investments Abroad (B) (752) (752) Effect of exchange risk management of investments abroad (C) = (D) + (E) 2,237 (829) 1,408 Assets Position in DI (D) 5,637 1,042 (386) 656 Liabilities Position in Foreign Currency (E) (8,957) 1,195 (443) 752 Managerial Financial Margin of Exchange Risk of Investments Abroad (F) = (B) - (C) 1,485 (829) 656 Initial Balance Gross Value Tax Effects Net Value 2004 Capital Investments Abroad (A) 5,687 Exchange Variation on Investments Abroad (B) (395) (395) Effect of exchange risk management of investments abroad (C) = (D) + (E) 1,517 (562) 955 Assets Position in DI (D) 5, (329) 559 Liabilities Position in Foreign Currency (E) (9,036) 628 (233) 395 Managerial Financial Margin of Exchange Risk of Investments Abroad (F) = (B) - (C) 1,122 (562)
20 Consolidated Statement of Income in R$ Millions Banco Itaú Holding Managerial Adjusts 2005 Accounting Exchange Tax Effects Managerial from Variation from Hedge of on Investments Investments Abroad Abroad Managerial Financial Margin 13, (829) 13,272 Banking Operations 12, ,017 Treasury Management of Foreign Exchange Risk from Investments Abroad net of tax effects 1, (829) 656 Result from Loan Losses (2,827) (12) - (2,840) Provision for Loan and Lease Losses (3,716) (12) - (3,729) Credits Recoveries and Renegotiated Net Income from Financial Operations 11, (829) 10,432 Other Operating Income / (Expenses) (2,974) (2,776) Banking Service Fees 7, ,738 Result from Operations of Insurance, Capitalization and Pension Plans Non-Interest Expenses (10,428) (31) - (10,459) Tax Expenses for ISS, PIS and COFINS (1,613) (1,509) Equity in the Earnings of Associated Companies Other Operating Income 518 (31) Operating Income 8, (725) 7,656 Non-Operating Income Income before Tax 8, (725) 7,676 Income Tax and Social Contribution (2,321) (17) 725 (1,613) Extraordinary Results (192) - - (192) Profit Sharing (481) - - (481) Minority Interests 45 (183) - (138) Net Income 5, ,251 Reconciliation of the Managerial Financial Margin of Management of Foreign Exchange Risk on Investments Abroad (see table on previous page): R$1,368 million plus R$117 million = R$1,485 million. in R$ Millions Banco Itaú Holding Managerial Adjusts 2005 Accounting Exchange Tax Effects Managerial from Variation from Hedge of on Investments Investments Abroad Abroad Managerial Financial Margin 11, (562) 10,634 Banking Operations 9, ,231 Treasury Management of Foreign Exchange Risk from Investments Abroad net of tax effects 1, (562) 559 Result from Loan Losses (927) (8) - (935) Provision for Loan and Lease Losses (1,582) (8) - (1,589) Credits Recoveries and Renegotiated Net Income from Financial Operations 10, (562) 9,699 Other Operating Income / (Expenses) (2,858) (48) 71 (2,836) Banking Service Fees 6, ,166 Result from Operations of Insurance, Capitalization and Pension Plans Non-Interest Expenses (9,015) (19) - (9,034) Tax Expenses for ISS, PIS and COFINS (1,183) - 71 (1,114) Equity in the Earnings of Associated Companies Other Operating Income 315 (35) Operating Income 7, (492) 6,863 Non-Operating Income 29 (0) - 29 Income before Tax 7, (492) 6,892 Income Tax and Social Contribution (2,092) (1,600) Extraordinary Results (1,094) - - (1,094) Profit Sharing (358) - - (358) Minority Interests (52) (13) - (64) Net Income 3, ,776 Reconciliation of the Managerial Financial Margin of Management of Foreign Exchange Risk on Investments Abroad (see table on previous page): R$1,053 million plus R$69 million = R$1,122 million. 16 Banco Itaú Holding Financeira S.A. Annual Report 2005