Bank Leumi le-Israel B.M. (LUMI) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to Leumi's Annual 2019 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded February 26, 2020. With us online today are Mr. Hanan Friedman, President and CEO; Mr. Omer Ziv, First EVP and CFO. I would like to remind everyone that forward-looking statements with respect to 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 demands, 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 risk factors, which are detailed from time to time in the company's filings with the various securities authorities. A PowerPoint presentation, which is available on the bank's website, www.bankleumi.com, will be used during the conference call. I would now like to turn over the call to Ms. Daphna Golden, VP, Investor Relations. Ms. Golden, please go ahead.

Thank you, operator. Ladies and gentlemen, we thank you for taking the time to join us on this results call of Bank Leumi's financial statements for the year ended December 31, 2019. Hanan Friedman, President and CEO; and Omer Ziv, First EVP and CFO, will be presenting the development, strategy and major takeaways from the financial statements. We are joined today by our colleagues, Dr. Gil Bufman, Chief Economist; and Mr. Shlomo Goldfarb, Chief Accounting. The presentation can be found on the IR section of our website and on the TASE website as well. I'd now like to turn the call over to Hanan.

Thank you, Daphna. I'm proud to present Bank Leumi's results for 2019 and our strategy moving forward for the first time as President and CEO of Leumi. Today, we once again presented strong results achieved by Leumi during the past year. As the new President and CEO, I would like to take this opportunity of thanking Rakefet Russak-Aminoach, my predecessor; and David Brodet, the former Chairman of the Board, for the great contribution to Bank Leumi over the years. I would also like to thank the Board of Directors of Leumi, headed by Dr. Samer Haj-Yehia for their trust in appointing me as the CEO of Bank Leumi. I'm very fortunate to have received an organization with a strong business and risk management culture, which I intend to preserve and to focus on further strengthening. This will give us added leverage for healthy growth. During 2019, Leumi did not only continue improving returns from core banking activities but also maintain robust capital adequacy as well as our cautious risk management. In addition, as the market leader, last month, we completed the first international issuance of Tier 2 bonds by an Israeli financial institution to foreign investors. The demand was remarkable, more than $4 billion in favorable spreads. This once again proved our capability of implementing innovative and out-of-the-box strategic moves. In parallel, we continued our journey of preparing the bank for future opportunities and challenges. I will now turn the call over to our CFO, Omer Ziv, for a review of our financial results. Then I will come back and elaborate on the bank's strategy and the overall readiness to face the challenges from the over -- the ever-changing banking system. Over to you, Omer.

Thank you, Hanan, and good day all. In 2019, we continued, as in previous years, to increase our income significantly, to improve the cost income ratio, to decrease headcount and maintain our LLP and NPL at low levels. I will start with Slide #3. The improvement in the result is in most parameter. The income reached nearly ILS 14 billion. The cost-to-income ratio continued to improve, dropping from 60.6% to 56.8%. The ROE rose from 9.5% to 9.8%, and the EPS grew by 10% from 2.5 -- ILS 2.15 to ILS 2.37. These results were also affected by Leumi Card. Going forward, unless otherwise stated, I will analyze the performance, net of the effect of Leumi Card, and the profits from its sales in 2019. Moving on to the next slide. Looking at this figure, we can see that the total income, excluding the effect of Leumi Card, rose in 2019 by 7.7% driven primarily by finance income. The cost income ratio dropped to 58.1%, and ROE increased to 9.2%. Continuing on to Slide 5. On this slide, we will take a deeper look at the 2019 results. Finance income increased sharply by 10.2%. Net interest income increased by nearly ILS 260 million, driven mainly by the growth in the credit portfolio. This increase was achieved even though the CPI for 2019 was much lower than in 2018, 0.3% compared to 1.2% last year. The difference in the CPI also added adverse effects on the NIM in 2019, making it similar to the NIM in 2018. The noninterest finance income, excluding the impact of the sales of Leumi Card, reached ILS 1.4 billion in 2019 compared to ILS 0.7 billion last year. This increase is mainly attributed to derivatives and foreign exchange and to the performance in the capital markets. Fees, commissions and other income were up slightly year-over-year by 0.7%. Within that, fees and commissions dropped by 2.4% compared to last year due to the increase in account management fees and financial product distribution fees. The 2019 loan loss expense ratio was up to 22 basis points compared to 15 basis points last year. The increase in the loan loss expense ratio to a level slightly above 20 basis points is mainly attributed to the fact that the substantial collection of debt, which has been written off in the past, came to an end. Having said that, the LLP remains at the low level and so is the NPL, which was only 75 basis points in 2019. Operating and other expenses increased by 3.5% compared to last year. The increase in salary expenses is mainly due to an increase in bonus provisions, including the bonus granted on the signing of the new 2019 collective wage agreement. The increase in other expenses is mainly the result of an accounting loss due to exchange of bond series, which, in essence, reflect still their interest payments on future periods and also due to an increase in pension expenses and advertising costs. Moving on to Slide 6. The finance income in Q4 2019 increased by 11.6% compared to last year. The net interest income was slightly less than last year due to a negative CPI of 0.2% in Q4 2019 compared to a positive CPI of 0.1% in the corresponding period last year. The noninterest income increased mainly the result of the REIT capital market in Q4 2018. The cost income ratio in Q4 2019 improved compared to the corresponding period last year. In most quarters, ratio is relatively high because the expenses are not spread out linearly throughout the year. And as last year, the expenses were higher in the fourth quarter compared to the first 3 quarters. The Q4 2019 loan loss expense ratio was 23 basis points, very similar to the ratio for the total year of 2019. As for the net income, it rose by 11.4% and reached ILS 742 million. Continuing on to Slide 7. The downward trend in our employee positions has continued. At the end of 2019, we carried out another successful efficiency plan in which 400 employees left Leumi. The impact of that on our salary expenses will be reflected in 2020. As a result of the drop in the number of employee positions, the income per employee continued to rise. Looking now at Slide 8. Our loan book was up to ILS 282.5 billion at the end of 2019 [Audio Gap] higher than last year, utilizing the effect of the depreciation in the foreign exchange our loan book increased by 4.8% compared to last year. As in previous quarters, we continue to focus on growth in the middle market, mortgages and so forth. Let's continue to Slide 9. Our public deposits increased by 2.4% from the end of 2018, reaching ILS 373.6 billion. The loan-to-deposit ratio remained conservatively low at 76%. And turning now to Slide 10. This slide illustrates our robust capital ratio, our leverage ratio and liquidity ratio. In all of which, we are much above the minimum requirements. CET1 remained high up to -- at 11.88%, and our equity at the end of the year reached ILS 35.4 billion. Having said that, the reduction in the interest rate during 2019 is not yet fully reflected in our CET1 ratio since any change in our pension liability due to the interest rates affected our regulatory capital gradually over 8 quarters. This lead me to Slide 11. Considering the strong yields and the high capital adequacy ratio, the Board of Directors approved a dividend of 40% for the fourth quarter, reflecting a 4.2% annual dividend yield. In addition, the Board of Directors has approved another ILS 700 million buyback plan for 2020, which we'll start implementing at the beginning of next week. The accumulated return to shareholders for 2019 amounted to ILS 2.1 billion. ILS 1.4 billion are dividend and ILS 700 million are the buyback plan. All in all, this represents a 60% effective profit distribution. To sum up my part, I am moving on to the next slide. Bank Leumi's outcomes and trends for 2019 are similar to those of previous year. Strong results, a significant increase in finance income, an improvement in the cost income ratio and a high-quality credit portfolio are reflected in a low level of credit loss expense ratio and NPL. We continue to present strong equity ratio, alongside a high percentage of profit distribution. These strong ratios enabled the Board of Directors to approve this morning another buyback plan for 2020, which is the third buyback plan in the last 3 years. 2020 presents several challenges, which Hanan will elaborate on, including a very low level of interest rates and growing competition. Our winning strategies, strong balance sheet, strong financial ratios and, of course, the additional efficiency plan that we implemented at the end of 2019, all of these provide Leumi with a strong head start going forward. I will now turn the call over to Hanan. Hanan?

Thank you, Omer. While there is much to be proud of in 2019, we at Bank Leumi are fully aware of the macroeconomic environment and the material changes in the banking system. We are well aware of the fact that we must be doing much more, much faster, much larger and much more markedly in order to make further significant steps in our improvement in the successful path we are on. To recap some of the last year's highlights, 2019 was, by all means, an eventful year at Bank Leumi. We provided yet another efficiency plan, following which 400 employees left the bank at the end of 2019. We also signed a new collective wage agreement tailored to the bank's evolving needs physically, much more flexibility with regard to our technology employees, data analysts and other professional while utilizing a flexible employment model. We also launched a new operations division in order to centralize, simplify and derisk operational activities while making it easier to identify and realize efficiencies. We have many more digitalization and robotics initiatives underway. This is a win, win, win situation, better and faster customer experience, reduction of costs and de-risking of our personal risks. At the beginning of 2019, we completed the sale of Leumi Card, thus, fully implementing the requirements under the [indiscernible] relations. We were the first bank to achieve these targets and at a good price. We also completed the sale of Leumi Romania, thus reducing our global footprint as we maintain our focus on our key markets, Israel, the U.S. and the U.K. During 2019, we started our relocation to Lod. The operations division of Leumi have already relocated as part of the bank's total relocation project from Tel Aviv to Lod. And we expect to sell our real estate in Tel Aviv in the coming years. Centralizing the bank's various units in one campus creates significantly more efficiency and productivity opportunities. And finally, as I mentioned earlier, we are the first in the financial industry in Israel to issue Tier 2 bonds to foreign investors in a very successful issuance that took place last month. Before going into 2020, I would like to touch on our customers. At Bank Leumi, we don't take our customers for granted. We know that there are other choices in the market, particularly in this age of fintech and heightened competitive landscape. And so in 2019, we implemented several initiatives to strengthen our customer experience. These initiatives have already begun to bear fruit, including, for example, the ability to get service at any branch of the bank not just at the customers' branch, the ability to make an appointment with a banker and not have to wait in line, the functionality and convenience to check with a service representative via our digital app, our reduced vendor [ MPs ] and others. We launched several customer journeys based on state-of-the-art models and AI capability. These leverage our advanced marketing and sales capabilities. All these initiatives are customer-focused aimed at improving user experience with the bank. Much has been accomplished, but there is still much more to implement. We have many more initiatives in the pipeline. We, the management team, are focused on it, and it will be a priority going forward in 2020. We will implement many data-driven customer journeys, which will target the customers on a real-time basis with tailor-made value propositions. This brings me to elaborate on 2020. The year 2020 presents us with significant challenges that we in Leumi are ready to face and to mitigate them. On the macroeconomic front, while we enjoy strong and growing economy, Israel is not immune to the global interest rate environment and the challenges it creates for revenue and earnings growth. At the same time, the presence of new entrants, fintechs and bigtechs into the market is already being felt and will continue to intensify. Bank Leumi identified those range some time ago. And as such, have implemented and will continue to implement value proposition that position us well to meet these challenges. One example is PEPPER, our mobile-only bank. We are the only incumbent bank in Israel with such an offering. Our strategy was for continued focus on making significant leaps in both customer service, industry and responsible growth. This, together with accelerated streamlining technology, robotics and digital offerings. Bank Leumi's strategy was and will continue to be maintaining the high-quality credit portfolio. Even while preserving our conservative risk appetite, we can still achieve higher growth in low-risk segments. We'll achieve this by greatly improving our customer service, especially by shortening the time of response and by implementation of service level agreements. We will do it by embedding a large number of innovative customer journeys. We'll also do this by extending digital service offerings, leveraging data capability to create smart, customized value position. All of the above are part of our world plan. Alongside the great lift in business and service, Bank Leumi will accelerate its streamlining processes. This, by leveraging the synergy realized through the new operations division, incorporating advanced technologies, robotics and improved processes. The benefits of all of these results in a material improvement in excellence and operational efficiency. Bank Leumi's digital strategy enables service experience tailored to growing customer expectations. Bank Leumi is the leader of banking innovation. Launching PEPPER is just one of many examples. This puts Leumi in a good position to cope with the changes in the banking business model. We'll continue to intensify our efforts in implementing this strategy. We'll continue to be ready to swiftly make the adjustments required to meet market competition and resolving customer expectations. Finally, a word on technology transformation. During the last 2 years, we have been in the process of scoping a significant core system upgrade to meet future banking challenges. The goals of the project include a significant reduction in the duration and cost of launching new products, heightened ability to unveil innovation, significant improvement and streamlining of work processes, real-time work capabilities and the ability to leverage opportunities brought by the world of open banking. In light of the complexity of legacy systems, the preferred option was the replacement of the core system. However, given the accumulated experience of banks worldwide as well as the innovative technologies that exist today to mitigate risks and to face costs, we decided to make a detailed analysis of transformation program of our technologies on an incremental basis through so-called modernization approach. Performing the upgrade in this detailed manner, we significantly reduced project risks and costs and even allow the banks to immediately benefit from capabilities achieved during the project's rollout. The management team will do whatever it takes to ensure success, minimize the time frame and the cost, avoid disruption and not lose sight of the objective. I'm moving on to my final remarks. Leumi of today is a bank with great fundamentals, returns, capital adequacy, risk management, credit portfolio, advanced digital capabilities and centralized operational center. We will continue to prepare ourselves in all aspects for the opportunities and challenges that the future holds. We'll continue to provide our customers innovative solutions to streamline our activities and to keep our high-quality credit portfolio while expanding and growing our business. With that, we will now open the line to Q&A. Operator?

[Operator Instructions] The first question is from Tavy Rosner of Barclays.

This is Chris Reimer on for Tavy. In the press release, you mentioned the responsible growth using smart models. And in your opening comments, you also touched on the different types of changes being made to customer experience and customer support. Can you give us some color just on the idea of the smart model? And generally speaking, what kind of growth rate do you think you can achieve using this?

Sure. Thank you for the question, Chris, and I will elaborate a little bit. As I mentioned in the past years, our strategy was very successful, including several growth engines. We aim to continue with the growth engines that we focus on it in the past few years and others. Regarding the leverage of the data capabilities and AI capabilities, I refer mainly to customer journeys that will give us 2 benefits. First of all, to target the customers on a real-time basis much before our competitors will target them. The second one is streamlining of the cost of doing business because when we do the transaction using the digital app that we have or other digital measures that we could use based on smart customer journey, we give our customers a much better experience, much faster experience, and the cost of doing the business is much lower. So it's a win-win situation, both for the customer and for us.

Maybe I will just add for your question about the pace of growth in 2020. So as I mentioned through the presentation, the pace of growth in 2019, if you neutralize the effect of the appreciation in the shekel, was 12.8%. Looking forward, after putting the milestone as Hanan mentioned in his review, we are expecting that the pace of growth in 2020 will be at least 12.8% but maybe even a little bit higher.

Okay. Looking at expenses in 2019, slight growth in both salaries and in maintenance and other expenses. Just regarding the salaries though, when do you think you might be able to stabilize the expense there and reach a point where the absolute level of expenses stay flat?

Chris, thank you. I would say like that. If you look on 2018 and 2019, also a year before, the expenses were more or less flat at the same level. This year, there is a slight increase of 3.5%. Part of it is on the accounting expense, which we brought forward, expenses that should have been written in the future since of the exchange of the bond series. Looking forward, because we implemented an additional buyback plan at the end of 2019, in which one, employees at Leumi at the end of 2019, we expect that the salary expenses in 2020 will be lower than the salary expenses in 2019. With regard to the other expenses, it will be more or less at the same level. Maybe it will be a little bit lower, maybe a little bit higher, but it will be more or less at the same level. So if I look at all the expenses because we expect that the salary expenses will be lower and we expect that the other expenses will be more or less at the same level, so we expect that, overall, there will be a slight decrease in the expenses looking forward to 2020.

Okay. That's helpful. And just one, if I could, about the progress at PEPPER. Are there any KPIs, number of active users you can share with us?

Thank you for this question. First of all, I want to clarify that I believe that PEPPER is a very successful challenger bank. It is a great success and it is a strategic asset of Bank Leumi. During the past year, PEPPER has been the highest recruiter of new accounts in the market. We will continue to leverage this platform and enable it to grow the terrific growth rate it's been growing up to now. As always, we are reviewing a competitive landscape that it is operating in. And with the platform's strong capabilities in this facility, we are ready to adopt changes and deal with any challenges from that arena. Regarding specific KPIs. So we have our internal KPIs for PEPPER. And even though we are not publishing their figures, I could assure you that the main KPIs were achieved during 2019.

Next question is from Micha Goldberg of Excellence.

First of all, congratulations. It looks like a stellar year. A couple of questions, please. First of all, looking into 2020, do you see any pressure on interest margins either from U.S. rates or a change in loan mix?

Micha, Gil here. Well, first of all, at the moment, we're looking at very unclear environment when it comes to interest rates because this all has to do with what's going on in the world with the virus and changes in expectations. Expectations currently are for a drop -- market expectations are for a drop in U.S. Fed funds rate. And it could be quite possible that the Bank of Israel, despite the previous statements that they're trying to avoid rate cuts, if things really do soften from a macro point of view and there is a substantial slowdown in growth, let's say, in a scenario where this virus thing does not go away quickly, that could push the Bank of Israel towards a small interest rate cut. There's not much to cut there at 25 basis points. I mean, the most that I can think about would be a drop to 10 basis points. And that once again is within a scenario where there is a substantial downturn in the macroeconomic environment, which, at the moment, we do not see as a central scenario. The Bank of Israel has stated on this. They IMF is talking about this and both of those institutions do see the global economic picture starting to turn around sometime in the second quarter of 2020. And that, I think, could create a situation where simple bank rates do not have to be changed.

And just to understand, does that mean that we're going to have some pressure on margins for the bank in 2020?

I do not believe so. No.

Okay. And secondly, there's a huge -- this year you had a huge income, from managers income, a lot of capital gains and derivatives and all that. Do you see that likely to repeat itself in 2020?

With regard to the capital market, Micha, we cannot expect what will happen there. So we'll have to wait and see. I would just mention that in parallel to the good results in the capital markets this year, the CPI was only 30 basis points while the expectation in the market that the CPI for 2020 will be around 80 basis points. So at this stage, it's very early to estimate what will be the result in the customer market.

Okay. And that includes the large gains from Leumi Card and Super Plan? Are these things that can be repeated in 2020?

We had only one Leumi Card. So we aren't expected -- not to believe such kind of capital gain in 2020, but we have Leumi partners that each year have a -- and new investments and still other ones. What I can mention also that, as Hanan pointed out, in his review, is we are in the process in which we are transferring our activity Lod. So it might be that even in 2020, or the latest at 2021, we start selling real estate in here in Tel Aviv. So by that -- by this aspect, it might be that we will record profit from selling one of the buildings or more in 2020 or maybe at the beginning of 2021.

That will be interesting. A lot could happen so fast. I mean, you could turn that around. Usually, the last time you guys sold large buildings it took, I think, more than 9 months or a year for that to be completed. Is that something that can actually be sold and recognized in 2020?

Well, the demand is huge because the real estate is located in a central place in Tel Aviv, so there is a huge demand for this building. It can happen in 2020. But as I mentioned, it might be also -- it might happen at the end of 2020. It might happen at the beginning of 2021. We are not rushed, but our intent -- our -- we intend to start the process of realize our real estate during this year. It might be extended to next year. I cannot assure that will happen in 2020. If not, it will happen in 2021.

Okay. Very exciting. Another question. Capital ratios are exceptionally high, 11 -- almost 11.9%. And yet, you're coming out with a new buyback program of ILS 700 million, and you're not upping your dividend policy. I'm just wondering, do you need all the excess capital? Or is there something else you might be able to do within capital? Seems to me that it's relatively high.

A good point that you're right. I would say that, first, as I mentioned in the presentation, the effective -- the effect of the decrease in the interest rate is not yet fully reflected in the CET1 ratio since any change in interest rate with regard to the pension liability is recorded to the CET1 by 8 quarters. So I would say that, effectively, what will happen in the future depends on what will happen with the interest rate, that is it will remains constant just for the clarification, I would say that the effective interest rate is not 11.9%. It's lower. That's fair. Secondly, we have CECL in the way. In Israel, we have to implement CECL in 2022, which is only 2 years ahead. So we believe that with these 2 policies, as I mentioned, the 60% dividend payout ratio, which is the highest in the industry currently, currently it's not at this stage.

Okay. That's clear. Could you quantify what the full impact of the lower yields are on your CET1 right now being constant?

I would say roughly because it depends, as I mentioned, at rate level, which is a mix of the risk-free rate and the spread of doubling the U.S. industry. I would say that roughly, it's around maybe 40 basis points, maybe 50 basis points, something like that.

Great. And what would be potential impact with CECL?

It's still early to estimate because on the one hand, what happened with the calculation with CECL is that on the one hand, it increased the provision in unsecured reserves. But on the other hand, it decreased the provision with regards to mortgages. So it depends what will be the final instructions of the Bank of Israel, which haven't published yet. So it's very hard to predict what will be the final number. But we want to be prepared to any scenario.