(Updates share performance in paragraphs 3-5)
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 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 at least three years reflected the success of a focus by Bracher's predecessor Roberto Setubal 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 the process of disbursing credit," Bracher said.
Preferred shares - Itaú's most widely traded class of stock - rose the most in three months on optimism about a profitable credit segment. The stock closed 3.2 percent higher at 38.50 reais on Tuesday.
Whether lending turns profitable again hinges on the pace of a domestic economic recovery and easing of creditworthiness issues afflicting many large Brazilian borrowers, Bracher said. Individual borrowers seem more prepared to take on new loans more quickly than their corporate counterparts, he added.
Loan book growth could gain steam, 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.
Itaú kept piling up excess capital last quarter. If risk-weighted assets keep growing more slowly 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 that, 56.6 billion reais were allocated to lending and 29.2 billion reais were 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 lowered a target for interest income growth, while maintaining goals for fee income, expense growth and loan book expansion.
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 Bernard Orr and David Gregorio)