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UPDATE 2-Credit at Ita+¦ could soon be profitable again -CEO

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SAO PAULO, Aug 1 (Reuters) - Itaú Unibanco Holding SA's lending segment could turn profitable again in coming months, Chief Executive Officer Cândido Bracher said on Tuesday, a sign Brazil's No. 1 lender has detached itself from the nation's harshest credit market downturn in two decades.

Recurring return on equity for the segment hit 14.5 percent in the second quarter, equaling fundraising costs, Bracher told a Tuesday conference call to discuss quarterly results. Lending ROE "could possibly" top Itaú's cost of capital in the quarters ahead, he said.

The highest lending ROE in three years reflected the success of Bracher's predecessor Roberto Egydio Setubal's focus on loan segments offering less risk of default. The indicator, a gauge of segment profitability, came in at 13.2 percent last quarter and 12.9 percent a year earlier.

"This somewhat shows the de-risking of our lending portfolio and how disciplined we are in earmarking credit," Bracher said.

Preferred shares, Itaú's most widely traded class of stock, rose the highest in three months on optimism that a profitable credit segment could lift earnings projections. The stock rose 3.8 percent to 38.72 reais in afternoon trading.

Whether lending turns profitable again hinges on the pace of a domestic economic recovery and if creditworthiness issues afflicting many large Brazilian borrowers ease, Bracher said. Individual borrowers seem more prepared now to take on new loans more quickly than their corporate counterparts, he added.

Loan book growth could gain steam through year-end, investor relations head Marcelo Kopel said in another call, noting that conditions for corporate lending are slowly turning healthier.

"We think management is being conservative," said Eduardo Rosman, a senior banking analyst with Banco BTG Pactual.

PROFIT BEAT

Itaú kept piling up excess capital last quarter. If risk-weighted assets keep growing at a slower pace than excess capital, the bank will analyze whether to increase payouts, disburse more loans or step up acquisitions, Kopel said.

The bank had 118.4 billion reais of regulatory capital as of June, of which 56.6 billion reais were allocated to lending activities, and 29.2 billion reais classified as extra capital.

Itaú's rivals have pointed to signs of recovery in domestic credit markets over the past week. Still, banks are fretting over how to deploy extra capital amid lingering economic and political turmoil.

Profit beat expectations, with interest income and recurring ROE staying near all-time highs. Itaú may book slightly higher loan-loss provisions this year after broadening the way it classifies impairments.

Loan book quality for Itaú's largest corporate borrowers also showed slight signs of improvement. But as the recovery lost steam last quarter, Itaú raised coverage ratios to 243 percent, cushioning balance sheet risks.

The indicator, a gauge of a bank's ability to absorb potential loan losses, could rise further, Bracher warned.

Itaú projected combined provisions, loan discounts and impairments between 15.5 billion reais and 18 billion reais ($4.97 billion and $5.8 billion) this year. The indicator previously accounted just for provisions.

Itaú also lowered a target for interest income growth, while keeping goals for fee income, expense growth and loan book expansion unchanged.

Bracher sees combined provisions ending this year near the highest point of guidance. Interest income should stay around the target's mid-and lowest points, he added. (Reporting by Guillermo Parra-Bernal; Editing by Frances Kerry, Jonathan Oatis and Bernard Orr)