Bank Hapoalim B.M. (POLI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim Third Quarter 2022 Results Conference Call. For your convenience, this call will be accompanied by a PowerPoint presentation. May we suggest, if you have not yet done so, that you access the presentation on the bank's website, www.bankhapoalim.com, by clicking on Financial Information on the homepage and then click on the Third Quarter 2022 Report Presentation. [Operator Instructions] As a reminder, this conference is being recorded November 23, 2022. With us on the line today are Mr. Ram Gev, Chief Financial Officer; Mr. Victor Bahar, Chief Economist; and Ms. Tamar Koblenz, Head of Investor Relations. I would like to remind everyone that forward-looking statements for the respected company's business financial condition and results of its operations are subject to risks and uncertainties that could cause actual results to differ materially from those contemplated. Such forward-looking statements include, but are not limited to, product demand, pricing, market acceptance, changing economic conditions, risks in product and technology development and the effect of the company's accounting policies as well as certain other risk factors, which are detailed from time to time in the company's filings with the various securities authorities. Mr. Gev, would you like to begin?

Good afternoon, and thank you for joining us today to discuss Bank Hapoalim's third quarter results. The bank is reporting a very strong set of results, net income of NIS 1.78 billion, return on equity of 15.9% as you can see in Slide 3. 9 months results are no less impressive, NIS 4.8 billion in net income and 14.6% in return on equity. These results demonstrate the strength and resilience of our business, delivering strong financial performance and a robust balance sheet quarter-by-quarter, all achieved by our consistent execution of our strategy. Let me turn now to the main factors that drove our profitability in Slide 4. On financing income, we continue to benefit from continuous healthy and responsible credit growth, which in this quarter was also boosted by the Bank of Israel and Fed rate increase and the higher CPI. As a result of these factors, our income from regular financing activity was up 17.2% versus last quarter and almost 55% versus the third quarter of 2021. Another important element demonstrating our strong performance is fees. Fees continue to grow at a double-digit pace and reflect the impact of the Isracard new agreement. This quarter, we recorded NIS 95 million in credit card fees in respect of the second and third quarters, roughly NIS 50 million per quarter. On costs, our cost-to-income ratio dropped to 41.5% in the quarter, demonstrating significant positive jaws. We view our credit quality as a strong asset of the bank, especially in the current environment of rising interest rates and high inflation. Whatever scenario may evolve, we have the right reserves and our very low credit loss expenses and NPLs are good positioned for any negative macroeconomic development. Lastly, on capital, we ended the quarter with a CET1 ratio of 11.10%, and the Board of Directors declared a dividend of NIS 536 million, constituting 30% of our quarterly net profit. Our strong capital generation gives us the ability to grow our book at what we believe is the right space for the current environment, maintain the required buffers and execute our dividend policy. Capital distributions declared or paid out in the 9-month period amount to almost NIS 1 billion. I'm moving to Slide 5 and 6, where I would like to point out some important points regarding our interest and noninterest income. On Slide 5, we show the development and drivers of interest income. On the top left side, we see the continued growth in income from regular financing activity and the jump in the last quarter due to the rate hikes. We grew our credit book by 2.6% in the quarter and 8.2% year-to-date. As you know, and as we mentioned in previous calls, the pace of growth was adjusted earlier this year to reflect the current environment and allow us to focus on risk-adjusted pricing. Growth was boosted by the macroeconomic development. The average Bank of Israel interest rate in the third quarter was 1.52% versus 0.47% in the second quarter. The fed rate jumped from 0.96% in the second quarter on average to 2.39% in the third quarter, both bringing our financial margin up 34 basis points to 2.58%. Looking ahead, rates are expected to continue rising. The average Bank of Israel interest rate for the fourth quarter is 2.92%, and the current market expectation for the fed rate is 3.9%. Our unique balance sheet position, which is characterized by the largest retail deposit base in the industry, will allow us to benefit from the new interest rate environment. Our unique balance sheet position also stems from the exposure we created to CPI over the last couple of years, currently standing at 53% of our equity. Moving to Slide 6, where we highlight the noninterest drivers of our activity. As mentioned earlier in the context of fees, the Isracard agreement contributed NIS 95 million, which were recorded this quarter in respect of the second and third quarters. Of this amount, NIS 54 million are in respect of the third quarter. In addition, we see growth in credit handling and account management fees. Poalim equity, our investment platforms, contributed NIS 94 million from the beginning of the year despite the negative trend of capital markets in that period. And this is due to the fact that Poalim Equity managed to develop a layer of activity that is less capital market sensitive, such as equity based indemnities, investment in private equity funds and advisory commission. Another parameter affecting our income is our real estate assets. We continue to downsize our branch network to increase efficiency, now standing at 169 branches. At the same time, we continue to examine and promote alternative to the betterment of properties currently used by head office units. These buildings are expected to be vacated in the course of the relocation to the Poalim Center, our future headquarters building. Continuing with cost and efficiency on Slide 7, the cost income ratio is improving, and proves that while income is growing, costs stayed disciplined, and we're actually almost flat in the last 9 months. I'm moving to Slide 8, where we discuss asset quality. On the left-hand side, we present our loan loss expenses, which remained very low. This was driven by the ongoing low individual provision, coupled with a recovery from individual borrower as may occur from time-to-time. On the right-hand side, you see our NPLs continuing to decline, constituting only 0.78% of the loan book. Nevertheless, we increased the collective provision, partially attributed to the construction and real estate sector. The bank estimates that the quality of the credit portfolio in this segment is good as reflected in all credit quality indicators. However, the changes in the economic environment indicate an increase in the probability of worsening in this sector, and consequently, of an increase in the level of borrower's credit risk. As a conservative measure, the bank continued to increase its collective allowance in respect of this portfolio. In the current environment, a strong balance sheet, disciplined risk management and the right buffers are important differentiators. Moving to Slide 9, where we show another differentiator of Bank Hapoalim, our deposit base of which 58% are retail deposits. Following a long period of growth, we now see that customers are shifting to securities, mainly money market funds, resulting in a slight decline in deposits. In terms of liquidity, we are well above both LCR and its [rhetorical] targets. And lastly, on capital, on Slide 10, we maintained our robust capital position due to high organic capital generation and our continued focus on mitigating risk-weighted assets. The CET1 capital ratio stood at 11.10%, up 14 basis points since January. This quarter, the Board declared a dividend of NIS 536 million, 30% of net profit. Before we conclude our discussion, a few words on the macroeconomic environment. We are seeing some signs that point to slower growth rates. Third quarter growth declined to 2.1%, far below the potential of the economy. The decrease in consumers' purchasing power together with rate hikes and a decrease in financial wealth, all have adverse effects on growth and on private consumption in particular. Sales, the consensus forecast is that carrying slowdown will not evolve into a recession in Israel, with the economy actually expected to outperform other advanced countries. This projection is mainly based on the favorable fundamentals of the Israel economy, such as budget surplus, stable energy prices and more. The labor market is still strong, though we recently have seen a slight increase in unemployment rate to a level of 4.1%. Inflation is up to 5.1% in the last 12 months. Price increases have been broadening into many types of services, including rentals. We do believe that higher interest rates and government policy aiming to reduce inflation in Asia have the ability to curb inflation significantly next year. The Bank of Israel increased its key rate to 3.25% this week. We believe that future rate hikes are going to be lower as inflation expectation are already anchored in the target and the economy is getting softer. Finally, on Slide 12, I would like to summarize the key takeaways. Very strong profitability in the quarter and 9-month period with a double-digit return on equity. Rates had significant impact on our results due to a favorable balance sheet structure. Credit growth was healthy and strong, aligned with the macroeconomic uncertainties. The cost/income ratio dropped materially, and we continue to show positive jaws. Our loan book continued to improve, but as we mentioned before, the current very low level of provisions will normalize at some point. Our capital grew organically, allowing us to grow our book at the right pace and pay dividends. And with that, I thank you for joining us today. And let's open the call for your questions.

[Operator Instructions] The first question is from Chris Reimer of Barclays.

Congratulations on the strong quarter. Just touching on the macroeconomic environment following the Bank of Israel comments and your own comments seeing signs of slowing growth. At your level, are you seeing any impact at this stage.

I'll start answering, and maybe Victor will elaborate more. Obviously, we see the environment and uncertainties and the level of interest rates are reasonably affecting demand. We, as you know, adjusted earlier this year, our growth rate reflecting uncertainties, our risk appetite and our aim to execute our strategy being risk-sensitive, price-sensitive and selective. When we look actually where we see a change in demand, the main area where we see is mortgages, which the level of demand is lower than we saw at the beginning of the year in 2021. But we have to remember that the level of demand is still relatively high and at a level very similar to what we saw at 2019 before COVID-19. As for consumer lending, so far, demand wasn't so high, relatively flat, taking into account our risk appetite. So we don't see much change. And as for commercial and corporate, it depends when -- it depends on the segment, and Victor will elaborate on that. But infrastructure demand is still high and growing. We assume that the impairments and uncertainties may have some impact on demand, but it will vary between 1 sector to other. Victor?

Well, Chris, as you said, we do see some significant slowdown in the rest of growth, but it's not balanced. On the one hand, we do see also stagnation, for example, in private consumption. And at the same time, we also can see an increase in investment, which means that, for example, the result is that there is a decline in the demand for credit in the retail division. At the same time, we do see increase in the demand for credit in the corporate division. So the total picture, I would say, is mixed.

And just following on that, assuming that the level of activity does slow down, what segment would you say of the portfolio was most at risk of facing higher provisions?

Well, based on the macro situation and the risk of a sustained global inflation and higher interest rates, and based on other countries' experience, I would say that the real estate market is now more risky. We actually never experienced the real estate crisis in Israel. That's why I emphasize other countries' experience. And in any case, I think in Israel, we have some idiosyncratic characteristic of this economy, for example, demographic trends and the fact that the level of unsold department is still low. So overall, the real estate market is, right now, more riskier than in the past. But we think that in Israel, we still believe in our clients. We continue to follow them in their activity. But at the same time, we monitor this sector more carefully.

Yes. Chris, if I can add to what Victor said, I appreciate between the external situation of what we see in the global economy, in Israel and what we see inside with our loan portfolio. No doubt that markets and economic conditions have more and more negative signs. And if you combine it with the higher interest rate environment, it can be a potential challenge for households, for individuals and corporates. And if the situation will get worse, it will affect everyone. So the question is not whether it will have the effect. The important question is, what will be the effect on different corporates. And let's say, if we take Bank Hapoalim, our loan book or credit portfolio book, it's a very quality one. We actually don't see, we don't see any negative signs. And on the contrary, we see improvement in situation of borrowers and repayments, et cetera, due to our very positive portfolio. NPLs are lower than the last quarters. Problematic debt significantly decreased in this quarter. Write-offs are in very low levels. So I think that the quality of our loan book and our underwriting standards, our sound underwriting standards, and our policy and risk appetite proves itself today and in the future, in any negative cycle. Nevertheless, like I mentioned earlier, we still increased collective allowance due to conservative approach. We have cautions. We built them in the last quarter to cope with any change in the market or the deterioration in the economy.

The next question is from Konstantin Rozantsev of JPMorgan.

I think you provided great color already in the first responses. And I'll just build on a few areas discussed in this first question. So could you give us some high-level perspective how you see higher rates and high inflation effect in the bank's loan quality? You mentioned that you have a very high quality book, and on a sequential basis, you only see improvements as of now. But going into next year, do you expect any tangible impact from higher rates and high inflation? And if you could put some numbers behind this as well, what sort of credit loss ratio are you seeing, are you expecting in the final quarter of this year and in 2023?

Well, the asset depends on the level of interest rates and how long we'll be in a situation of high interest rates. Generally speaking, obviously, high interest rate, a potential negative effect on borrowers depends on the particular situation. That's the reason why I mentioned before that as for the moment, we don't see any, let's say, negative effect or people saw increasing write-offs, et cetera, et cetera. On the contrary, the NPLs and other figures in parameters are in a very good position. But 2 elements that we have to remember, that looking forward, I can't tell whether it's a few quarters or even more, we assume that the level of credit losses will be normalized at some point. This is visible to assume. And in that situation, what is important is the quality of the loan book. And the numbers of Bank Hapoalim are very good consumer, corporate and other elements. We also run stress scenarios to check the question that you were right, running stress scenarios. And according to them, we should not see a major effect our portfolio. And you can see it if you look at, let's say, at some notes that we have in our financial statements, you can see that our absorption rate is very good. The absorption rate of our customers is very good. Financing level of some segments is relatively low to the industry. So in short, obviously, higher interest rates will have an effect. We think that our relative position is very good, and we are well-prepared for any change in the situation.

That's extremely useful color. And you mentioned that you're seeing credit loss ratio normalizing right in the coming quarters. Should it be normalized into some pre-COVID levels or pre-2020 levels? Is it fair to assume?

Like I mentioned, you can't predict when it will happen. But I think it's reasonable to assume that it will happen gradually. If you look at the past, let's say, credit loss ratio for Bank Hapoalim was about 20, 25 basis points overall. So it's reasonable to assume that it will be normalized to that level. Basically, based on the assumption you take, we think, in any case, we will benefit from the quality of our loan book and our conservative approach, especially from the beginning of this year.

The next question is from Mika Goldberg of Segal.

First of all, congratulations on a very strong quarter. A couple of questions. First of all, you mentioned that you see fee growth being very strong. And I'm just wondering if you exclude the extra quarter you included for the Isracard's agreement, does that still leave growth coming through?

You mentioned correctly that our fees increased double digit, and the main effect is the new agreement with Isracard that roughly affect NIS 50 million per quarter. We still see, while excluding this element, we still see a positive effect on fees quarter-by-quarter. The first element is account management fees that we see rise from the second quarter. And if we compare it to the [indiscernible] quarter in 2021, so in account management fees, we see increase in refinancing fees guarantees. And absolutely, if you look at trading fees, it depends on the level of trading of stocks, et cetera. So it will depend whether it will continue or change a little bit. It depends on the condition of the market. ForEx transaction, we see increase. It depends, the last one depends on, let's say, what quarter you are. Usually, the third quarter, ForEx transactions are higher than the first and second one. But in short, excluding the credit cards, we see overall an increase in fees.

You mentioned that the hike in interest rate is contributing strongly to your top line revenues, your interest income. You also mentioned that a marginally declining kind of impact. And I'm just wondering, is there any time or any scenario in which the rising interest rate and a pass-through and people taking their money away from current accounts, et cetera, and you're raising the interest rates on deposits, can you turn this into a negative, not into an incremental smaller positive?

Well, that's a very good question. As we now we can see our model for -- at the beginning of the quarter and the end of the quarter, we're looking forward, the effect is positive for increasing rate hike, and our unique balance position enables us to benefit from that. But the basic assumption at the model, and you're right at that, one of the basic assumptions is the behavior of consumers or customers, their preferences. And we assume that when interest rate is high, getting higher and you are more and more time in that environment, more and more customers will shift to money market funds and will shift from current account deposits to timed deposits. Whether it will be at some point have a negative effect or low, let's say, positive effect, we can't tell whether it will be. But every quarter, we're examining our assumptions. But it's reasonable to assume that as long as we are in a higher interest rate, the effect will be lower for every 1% increase. By the way, if I can add, Mika, you can see that our -- the assumptions in our models are relatively conservative. If you look at the table at the second quarter statement, the effect was NIS 1.2 billion for 1% interest, parallel interest rate hike. Actually, if you look at this quarter, the effect was higher than that because customer behavior and preferences didn't change as the assumption was in the model. But it can be changed from time-to-time, and we examine every quarter.

So based on that, your current projections around, I think, NIS 700 million, NIS 800 million are likely to be also lower than will come through?

Our current assumption, and you were correct is that the number that you mentioned, roughly NIS 800 million. But it depends on the, like I mentioned, the behavior preferences of the customers. So basically, what we have now is the assumption we use for the table. Like we saw last quarter, the final results were higher than that. But I can't assure you that it will be the same for the future. Let's say, a new environment for customers and they are getting used to it, and their preferences may change in a different way than we assumed.

Okay. So maybe to ask this in a different way. In Q2 are any some of your current account deposits went down. Can you tell us what happened in Q3? I assume they went down much more than that. Just talking about the checking account, the -- what's the rate of the withdrawal on that side?

If I understand, you asked about the current account deposits on nonbearing interest deposits. The portion were down from 44% in the second quarter to 41% in the third quarter. The first quarter, just to add, it was, I think, 47%. So you see that the customers' behavior and preferences changes. The main assumption is what will be the speed or the pace of that change.

I understand. Okay. I have another question about the cost of credit and the quality of credit. You mentioned about -- and I'm wondering on 2 things. You mentioned that it's strong, and that you actually see an improvement. You don't see any deterioration whatsoever. And I'm just wondering, how does that coincide? How does that work together? What we recently saw financial published by some of the credit card companies and the nonbank finances who significantly increased their provisions for the consumer loans. I think you mentioned that the real estate loans are the ones that are more risky. And I'm just wondering, on your side, you also have significant exposure to car rent loans. Some of these companies published had that same kind. Are you seeing a deterioration there? Is it different in the bank than at these companies? What's the reason they are providing a net, or I mean, more importantly, you don't see that because you're a better quality, different kind of balance sheet, not that kind of credit?

Okay. Thank you, Mika. First, we saw that, let's say, nonbank companies or credit card companies published statement. I don't know what we're their consideration in, let's say, deciding what is the level of their credit clauses or what was write-offs and what was collective allowances. But I can say that, generally speaking, there are differences between companies, especially banks in risk appetite, cautions maybe, in some cases, the underwriting policies, et cetera. And you can see that for banking industry, but I can speak for Bank Hapoalim, the writing standards are very strict. The risk appetite is very, let's say, defined, invasively conservative. So we built a credit portfolio that is very, very good and well ready for any change. We see, like I mentioned, situation of our customers that's even improving. So there is difference between what we see in the economy and our portfolio book. Obviously, like I mentioned at the beginning, there can be a possibility of a change. And in that situation, what is important is the, let's say, the cautions on one hand, and the second hand, the portfolio quality.

Very clear. Can you tell me how much the implementation of SAAR for current common equity Tier 1 in this quarter and how much the implementation of the Bank of Israel regarding the financing impact?

So the SAAR effect was approximately NIS 2.6 billion in credit risk assets, NIS 2.6 billion. And it's approximately 7 basis points in common equity Tier 1 capital ratio and 10 basis points in total capital ratio. That's for the SAAR, okay? And as for Bank of Israel directive, regarding the LTV, as for September, it was 3 basis points in common Tier 1, the effect of the directive.

It's still under discussion.

Okay. Guy, the Chief Accounting adding there are Q&A session with Bank of Israel or the industry of some issues of implementing, and obviously, the last one, the LTV, what I mentioned, can change if Bank of Israel would issue a different implementation guidance.

I understand very clear. So despite all that, you've succeeded to reduce your risk-weighted assets and in spite of growth hasn't grown as fast. Is there more potential left for you to mitigate risk weighted assets in future quarter or all done?

Yes, that's correct. And thank you, Mika, you noted it's a very important element in our report. And if you look from the beginning of the year, we grew in balancing credit about NIS 28 billion, while risk-weighted assets grew almost by half. And this is not by accident. It's a result of an effort that we're investing in the beginning of the year, and we sold changing in global economies and uncertainty is very high. And we've decided to invest efforts in more -- being more efficient in risk-weighted assets. And this is -- for us, this is not onetime efforts. So we continue to take it to 2023. And we have internal targets on that element. We want to be in a situation that, let's say, risk-weighted assets reflecting credit will grow lower than the growth in credit. So in short, yes, this is element that we issued, that we invested in efforts, and we see it as ongoing mission for us.

[Operator Instructions] There are no further questions at this time. This concludes the Bank Hapoalim Third Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.