Brazil's GDP shrunk by 1.78% y-o-y in 1Q 09 (compared to +6.13% in 1Q 08), and the central bank (BCB) forecasts a slight contraction of 0.57% in GDP for 2009, followed by growth of 3.5% in 2010. Brazil's annualized CPI inflation eased further in May 2009 to 5.20% from 5.61% in March 2009, with inflation expected to fall to an annualized rate of 4.39% in December 2009 and 4.3% in FY 2010 Source: BCB survey 12 June 2009. Lower inflationary pressure and contraction in GDP prompted the BCB to further reduce its short term interest rate (SELIC) rate by 100 bps to 9.25% on 10 June 2009, with an expectation of 9% for FY 2009 and 9.14% for FY 2010 Source: BCB survey 12 June 2009. Although we are concerned that the decline in GDP will affect credit off-take, we have marginally raised our total loan estimates based on improved expectations for the impact of recent rate cuts on credit demand coupled with improvement in consumer and business confidence indices in May and June 2009. The merged Itau-Unibanco has a strong capital adequacy ratio of 16.5%, well above the BCB's minimum requirement of 11%, and is therefore well-placed to withstand the current financial crisis. We also expect cost efficiency to improve, as synergy benefits begin accruing. However, we remain concerned about the ongoing deterioration in asset quality, with delinquency ratio rising to 5.6% in 1Q 09 and expected to rise to 6.9% in 3Q 09. Consequently, we expect provision expenses to stand at around 6.1% of total loans in FY 2009, remaining at a high level in FY 2010.

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