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

Ladies and gentlemen, thank you for standing by. Welcome to Leumi's First Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 27, 2020. With us on the line today is Mr. Omer Ziv, First EVP and CFO. . 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. A PowerPoint presentation, which is available on the bank's website, www.bankleumi.co.il 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 First Quarter Ended March 31, 2020. 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 Shlomo Goldfarb, Chief Accountant. 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 Omer.

Thank you, Daphna, and good day all. I would like to thank you for joining us to review Leumi's Q1 2020 results. It has been a unique and challenging quarter. The current losses due to COVID-19 are mainly reflected in a significant increase in the loan loss expenses and substantial losses in the capital market. Having said that, it's important to keep in mind the following 3 points. Firstly, all of the entire increase in the loan losses is due to an increase in the collective provision. The increase in the specific provision is relatively low. Moreover, while some of the other banks in Israel published their financials in March and also recorded a material increase in loan loss provision due to the coronavirus in the fourth quarter of last year, in Leumi, the entire increase was recorded in this quarter. Secondly, until now, the vast majority of losses from the capital markets that were written in the first quarter were offset in the second quarter. Having said that, I would like to mention that the capital markets have been volatile lately, and this volatility might continue. Thirdly, the vast majority of these losses were offset by a material decrease in the pension liability due to the increase in their discount rate. We look at this liability as a natural hedge to our interest risk exposure. The point is that the profit from this significant decrease in the pension liability is recorded directly to the comprehensive income and from there to the P&L over a period of about 10 years. This is the reason that even though the losses amounted to ILS 232 million, the total comprehensive income amounted to a significant positive number, ILS 1.4 billion. Now before moving further to the financial analysis, with your permission, I would like to touch upon the coronavirus pandemic in Israel, the stabilizers introduced by the government and the Bank of Israel and some measures that we have taken in order to cope with the spread of COVID-19. I will start with Slide #3. The severity of COVID-19 in Israel has been modest compared to other countries. Israel, with a population of about 9.2 million, has at to date, less than 17,000 COVID-19 cases with approximately 2,000 active cases and less than 300 deaths. The vast majority of infected people were not in critical condition, and the death rate is comparatively low. Israel population is relatively young. The median age is less than 30, an advantage in dealing with the virus. In addition, the government acted swiftly to reduce international air travel and to impose a nationwide lockdown that lasted for about 6 weeks. The lockdown has been loosened substantially since late April, and most of the economic sectors have now started to be active again. The Israeli government's initial aid program introduced in March 2020 included a declared fiscal impulse of ILS 80 billion, followed by declared expansion to ILS 100 billion in May. The Bank of Israel steps included, among other things, a reduction of the interest rate from 25 basis points to 10 basis points, QE in the form of government bond purchases of up to ILS 50 billion, repo lines created in shekels for nonbank financial companies receiving both government bonds and corporate bonds, and FX swap lines for Israeli banks. Continuing to Slide 4. COVID-19 has led to a leap in digital adoption by customers across business lines. This refers both to customers who were considered non-digital and to new digital solutions offered by the bank. In order to cope with the pandemic, we've deployed a company-wide effort to continue to assist our customers, while ensuring employee safety and maintaining security. In a very short period of time, we have migrated to working remotely on all fronts, the frontline, back office and headquarter functions. As part of our efforts to aid our customers, we have offered tailored solutions for corporate customers, we have granted secured loans with government guarantees and have enabled most of our customers to receive a deferral in payment in all of the business sectors. All of the above were achieved in conjunction with ongoing and heightened monitoring of risk factors and cutting of costs in order to mitigate the effects of reduced income. Moving on to the next slide. Based on the effects of COVID-19 on Israel's economy, the Bank of Israel's forecast as of late May 2020 for the main macroeconomic parameters are as follows: GDP, minus 4.5% in 2020 and positive GDP growth of 6.8% in 2021; unemployment rate, 6.3% in 2020 and 6.7% in 2021; inflation rate, minus 0.5% in 2020 and positive 0.7% in 2021. Interest rates, according to the Bank of Israel's forecast, in mid-2021, the interest rate is expected to be 0 to 0.1%. Now with your permission, I will turn back to the financial results. Moving on to Slide 6. The net loss for Q1 2020 was ILS 232 million. As I mentioned in my opening remarks, this loss was driven by: First, a substantial increase in loan loss expenses, which totaled ILS 860 million, of which nearly 90% was in collective provision; second, significant losses in the capital markets, the net interest income for Q1 2020 presented losses of ILS 660 million. As I pointed out, the vast majority of these losses have been offset since the end of the quarter, yet the markets continue to be volatile. As I mentioned earlier, there is a huge gap between the P&L results and the comprehensive income due to a decrease in the pension liability of nearly ILS 3 billion as a result of the increase in the discount rate. This reduction is recorded directly to the comprehensive income. Parallel to the recovery in the capital markets after the balance sheet date, there has been an increase in the pension liability after the balance sheet date. As a result of the losses in the P&L, the financial ratios for Q1 2020 are not at all indicative: loan loss provision, 1.2%; cost income ratio, 74%; and the ROE, minus 2.6%. Continuing on to Slide 7, which shows the breakdown of income and expenses in greater detail. Net interest income increased by 2.3%, driven mainly by growth in the credit portfolio. In Q1 2020, the credit portfolio increased materially, mainly due to the use of credit lines and the liquidity needs of our customers. I will elaborate later in the presentation. The NIM reached 2.07%, similar to that of last year. The NIM was adversely affected by a negative CPI of 0.5% in the first quarter of 2020 and by the sharp decrease in the Fed interest rate in March. This decrease as well as the decrease in the Bank of Israel interest rates in April are expected to have a negative impact on the NIM in the coming quarters. With regard to the net interest income, some of this negative impact is expected to be offset by the substantial increase in loan and deposits and by increase of some of the spreads during the crisis. The decrease in the noninterest finance line item is mainly related to the losses in the capital markets. And as I mentioned earlier, most of the losses were offset after the balance sheet date. I will elaborate in the coming slides on loan loss expenses, the increase in commissions and the reduction in expenses. Moving on to the next slide. The loan loss expenses, which totaled ILS 860 million are highly exceptional compared to previous quarter. While the increase in the specific loan loss expenses, which amounted to ILS 104 million, is relatively low compared to previous quarter, the major increase is in the collective provision. The NPL is still at a low level of 74 basis points. The increase in the collective provision of ILS 756 million is due to the expected effects of the coronavirus on our credit portfolio. It is based, among other things, on the assumption of the Bank of Israel regarding the unemployment rate, GDP pace of growth, specific internal analysis of the risks involved in our different credit sectors and other factors. We have increased the collective provision in order to cope with a potential increase in the classification of debt in the future from non-problematic debt to problematic debt. Classification within problematic debt categories and the possible adverse development in the number of days in arrears. I'm moving forward to Slide 9. Q1 is also exceptional in terms of fees and commissions. In Q1, we recorded an increase of more than 10% in fees and commissions. The main increase was due to a security transaction and due to exchange differential as a result of extensive [force] activity, mainly by institutional customers. I would like also to draw your attention to the slight increase in credit card commissions, even though the activity in March was lower than usual. This is the result of the improvement in our percentage of the interchange commission. Moving on to the next slide. Operating and other expenses in Q1 2020 decreased by 7.3% compared to last year to ILS 1.8 billion. The decrease is attributed to salaries and related expenses, which were down by ILS 400 million, mainly due to provisions for bonuses. I'm continuing to Slide 11. Net loans to public at the end of March 2020 totaled nearly ILS 295 billion, an increase of 6.1% since last year, and 4.3% since the beginning of the year. This high increase was affected by the coronavirus crisis, which led to a huge amount of credit line usage and to a substantial increase in demand for loans by our customers in order to cope with their liquidity needs. The increase was mainly in corporate business, where the analysis of risk is on an individual basis. As in previous quarters, the increase in credit was also in middle market and mortgages. In parallel, we have continued to be very cautious in the unsecured retail and with small businesses, which are considered to be riskier segment. Following the lift of the lockdown and the gradual reopening of the economy, some of the loans that were taken during the first quarter were deemed after the balance sheet date. Continuing on to the next slide. As of March 2020, deposits by the public amounted to nearly ILS 419 billion, a 12% increase since the end of 2019. This significant increase was across the board and reflects, among other things, a transfer of funds from the capital markets to deposits due to the volatility in the capital markets. As a result, the loan-to-deposit ratio continues to be relatively conservative and reached a level of 70%. I'm proceeding now to Slide 13. Due to the coronavirus crisis, the Bank of Israel decided at the end of March 2020 to reduce the minimum regulatory capital adequacy requirements until September 2022. In accordance with this instruction, the minimum capital requirements from the bank are 9.25% for CET1 and 12.75% for the total capital ratio. The Bank of Israel also declared that given the economic situation resulting from the coronavirus crisis, it is expected that the banks will reconsider the dividend distribution and the continued implementation of buyback plans at least until the end of September 2020. As a result, the bank's Board of Directors decide in mid-April at this stage to discontinue the dividend distribution and the implementation of the buyback plan. I'm turning now to Slide 14. This slide illustrates our solid capital ratio, CET1 and TCR, our leverage and liquidity ratios, in all of which we are much above the minimum requirements. The decrease in CET1 and the TCR is mainly due to the sharp increase in credit since the beginning of the year and due to the dividend distribution of nearly ILS 300 million and the implementation of the first phase of the buyback plan in a period of losses. The compensation through the drop in the pension liability of nearly ILS 3 billion is not reflected yet in this ratio since it will be recorded to the regulatory ratios over same quarters. I'm moving on to my final remarks. There is still a lot of uncertainty regarding the effects of the first wave of the coronavirus on the economy. A lot of uncertainty, whether there will be a second wave and many other questions. Throughout the presentation, I elaborated on the effects of the first wave on the financials. But there are additional aspects such as the increase in the use of digital channels and solutions across the board and the possibility of working remotely in different areas. It will be interesting to see the development of this aspect in the future. I would like to thank you again for joining us today, and to open the line for questions, Operator?

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

So this is Chris Reimer on for Tavy. Just going back to your comments on the provisions and the 90% to the collective segment. Can you give us any color about what's included there? Are there any specific industries reflected there? Or is it just a general conservatism?

Thank you for your question. It is composed -- it's a composition of 2 elements or a few elements. First, as I mentioned in the presentation, the expectation for the unemployment rate, the GDP and other macroeconomic parameters are there for all the sectors and they impact the calculation. Secondly, we've made an internal analysis, sector by sector, in order to see the increasing risk of each sector due to the -- due to COVID-19. Just to give you a sense, we take each sector -- we've taken each sector in ranking, between 1 and 5 in order to see the specific increase in risk. And as you can imagine, the first-line sectors are the airline sector, the hospitality sector, the energy sector. And in the second line, you can find the retail sector, et cetera. So it's a combination of macroeconomic parameters, which affect all of the sector and a specific analysis of -- there are tens of sectors in our calculation. And above that, in order to cope with potential increase in problematic debt or within the categories of problematic debt and potential increase in delinquent payments, we put another buffer based on different estimations from different aspects. We took into account different scenarios that we are making here in the bank. And all of this, at the end, reflects in this 90% increase, in this [normal than this] ILS 756 million increase in the collective provision. Now looking forward, it depends whether our estimation were too conservative or maybe there will be -- maybe the situation will be worse than our expectation. And also it -- and it's not taking into account currently a second wave. If there will be a second wave, it's a completely different scenario. It's mainly based on the first wave effect. And if there will be a significant second wave, so it will be a different story.

Okay. Got it. Just relating to the increase of digital channels that you also mentioned earlier and about how many of the employees are being able to work from home. Given the success of this, can you perhaps accelerate branch closures?

No, the branch closure is not the question because what we -- it mainly affects the users in the branches, and I will explain. It doesn't matter whether we have 200 branches or 190 branches. And what is more important is the office space of these branches. And since there is a leap in the use of digital channels, it may increase the phase of decreasing the office space in the future because the leap in the digital is not only in non-digital customers, it's only with -- is also with the solution that we implement with regard to corporate, for example, with regard to guarantees and et cetera. And according to our experience, after those customers discover the digital, they don't want anymore to go back to the traditional channels.

The next question is from Borja Ramirez of Citi.

I have 2 quick questions. Firstly, regarding loan losses, assuming there is no second outbreak of COVID-19, is it a sensible assumption to assume that cost of risk could decline in coming quarters? And my second question is, there has been a strong growth in loans in the quarter and also in deposits, could you provide more details on the potential evolution of net interest income for 2020?

First, with regard to the first question, if there will not be a second wave, we believe that our current provisions are well enough. We don't need any more provision, and we calculate our provision on conservative assumptions. So we are satisfied with total provision. And if there will not be a significant second wave, we believe that in the next quarter -- we expect that in the next quarter, the credit loss expenses will be significantly lower, that's first. But this expectation is based on what we see currently in Israel. As I described in the presentation, there was almost completely lift of the lockdown, most of the industries reopened again, even the restaurant and hotels and swimming pools were open today in Israel. So our assumption is based on what we see. If things will get worser, so we will be, as I mentioned, in a different scenario, that's first. With regard to the loan and deposits, I would say that the major increase was driven by the corporate segment, in which we feel very comfortable because the analysis there is customer by customer. The increase is exceptional with regard to Leumi pace of growth in loans. It was ILS 12 billion in 1 quarter. As I mentioned, some of these loans were redeemed after the balance sheet date. Since there is -- since corporate feel much more comfortable in these days than the panic that was during March, we -- but looking forward, if our pace of growth was around 3% a year, 4% a year, I believe that since we kick down the year with a very high percentage of growth. So looking forward for the total year, we expect at this stage that the total growth will be higher than in the usual year. With regard to the deposit, I will say that in opposite to the credit in which I mentioned that some of it was within after the balance sheet date, the deposit, the level is more or less as it was at the end of March. So in terms of the amount, those numbers will attract positively the net interest income during the next quarter. The net interest income are affected also by other things for example, the CPI. The CPI in the first quarter was minus 0.5% and according to -- the forecast of the Bank of Israel from now till the end of the year is expected to be 0 because for the total year, the expectation is 0.5%. So this is -- also will affect positively the net interest income. On the negative side, I will mention again that there was a drop in the Fed interest rate. There was also a decrease in the Bank of Israel interest rate in April. So what we've done is that because of the crisis, we increased in some areas, the margins, but still the total effect I expect to be negative effect on the income. So I cannot give you numbers, but this is the major parameter which will affect the net interest income in future quarters.

The next question is from [indiscernible] Yun of Lazard Asset Management.

Can you hear me, Omer?

Yes. I hear you well.

I had just 1 quick follow-up. Did you just say that the overall net-net, so loan growth will be positive, NIM will come down, but net-net income will be slightly negative. Is that what you just alluded to?

No. I didn't say that. I said that there are different parameters, which affect the net interest income. I mentioned that in terms of amount, so there is an increase in the loans, as I pointed out, there is increase in deposits. So by -- so in terms of amount, it will have a positive impact on the net interest income. Another parameter, which will be -- which will have a positive impact is the CPI, which was 0.5% -- minus 0.5% in the first quarter. And for the total year, this is the expectation. So it means that now the expectation is that the CPI will be 0. So it's higher than the minus 0.5% in the first quarter. And thirdly, the third positive aspect was with regard to the increase in margin due to the increase in risk. There is an increase in risk in credit. So we update, in some areas, the interest level. So this is the parameter, which will affect positively the net interest income. The negative impact will come from the Fed interest rate decline and from the Bank of Israel interest rate decline. What will be the total effect is based on your -- I can't give you a number, it will be irresponsible for me to give a number because there is lots of unknown at this stage. So I just explained the parameter, which will affect the net interest income. I didn't say that the total effect will be negative. It can go different directions.

Sounds good. And one -- just 2 questions. One is, in your costs, how much of the benefit were there from the bonus provision? And second question is, I think your deposit cost went down like 16 basis points year-on-year. Can you -- so were there any -- is there any further deposit repricing left remaining?

Is there any what, I didn't hear?

Further deposit repricing remaining?

Well, I would say like that. With regard to the bonus provision, based on the results, you can imagine that there is no bonus when you -- there's no bonus provision when you recorded losses of ILS 130 million. With regard to the deposit cost, they were affected by the reduction in the -- by the changes in the Fed interest rate. Last year, the Fed interest rate was around 2.4% as far as I remember, on average, now it was much, much lower. And it's also a mix of cash and other deposits, which affected the price of deposits. So you have to analyze all these aspects in order to get to any conclusion.

Okay. And just last follow-up on the bonus provision. Can you quantify the amount or not?

I pointed out that...

How much was the benefit compared to last year. I mean, this year certainly is going a bit...

No, I cannot give you the decline with regard to last year, because it's not public data, so I cannot share it in this conference call. But I can say that due to the result, there is no loan loss provision in this quarter.

The next question is from Vishal Iyer of BlueBay Asset Management.

Just a quick one, I guess, on the real estate and construction sector. If you could give some color as to what the health of that sector is? And then just secondly, to clarify, I think if I heard you right, you mentioned that the pension liability decline has not been registered in capital. Is that correct?

I didn't hear you well. Can you repeat on the first question? The second question I hear, but not the first.

Sorry, sorry about that. The first question was, could you give some color on the health of the real estate and construction sector?

I will answer to the question about the pension liability and Mr. Gil Bufman, our Chief Economist, will refer to the construction sector. With regard to the pension liability, there was a decrease of -- the pension liability in Bank Leumi is a natural hedge to our interest risk exposure. So what's happened in this quarter is that the spreads opened significantly -- were opened significantly. So on the one hand, it decreased significantly our securities. On the other hand, it reduced significantly the pension liabilities, but due to mismatch in the accounting treatment, with regard to the pension liability and with regard to the securities, the -- all the decrease in the pension liability was recorded directly to the comprehensive income, while with regard to the securities, some of the losses were recorded to the P&L. That's first. With regard to the regulatory capital requirements, while the reduction in the securities due to the increased spread was recorded to the regulatory -- to CET1. Immediately, the positive effect of the reduction of the pension liability we recorded to the regulatory capital over the next 8 quarters. So there is a mismatch. You'll see the negative impact of the offering of the spread on the capital ratio. And you don't see the positive impact, which is due to the reduction in the pension liability, you will see in the following 8 quarters. And also, I would like to mention that, as I pointed out in the presentation, there was a recovery after the balance sheet date in the capital market. So also it impacts the pension liability at the same way. I mean that in the second quarter, you will see a positive impact of the recovery of the capital market till now because I don't want to make any expectations with regards to what -- with regard to the -- what will happen in the capital market in June. But till now, there is a recovery in the capital market. So there is a positive impact. You will see in the second quarter, the positive impact of the security on the capital ratio. And with regard to the pension liability, they will -- it will increase in the second quarter. In order, it's like -- and the total effect will be that you will see the positive impact of the security but you won't see the negative impact of the pension liability in the second quarter. So I hope I was clear enough.

Yes, that's perfectly clear...

Does it answer your second question?

Yes, that's perfectly clear.

Okay. So now Gil will answer you to the first question.

Gil Bufman here. I'll talk briefly about the real estate sector here in Israel. The first part of the sector, obviously, is the residential sector, which is probably the most important and many times gets most of the attention. And the main characteristic of the residential real estate sector is one of excess demand or, in other words, a lack of adequate supply, and that has to do mainly with the fact that Israel demography -- demographic characteristics are very strong, and we have a population growth rate of about 2% per year, which generates about 60,000 new households per year, and that's at the same time, while we have housing starts running at about 50,000 or so. So there's this basic demand, and it's a very, very tight market. Moreover, we might see a return of investors, the buy-to-let people coming back into the market and increasing demand even further. So that part of the market is quite strong. The macro story of Israel this year despite the substantial shock to the economy, the macro story, is still okay, especially compared to other countries. So all in all, the residential real estate part of Israel looks quite good. When it comes to office space, do remember that Israel has a fast-growing high-tech services sector. It's a sector that doubles itself every 5 years or so. And this sector requires a lot of office space. And with that being the case and while seeing ongoing growth even throughout the first quarter of the year for which we have data for high-tech services, this means that this demand element has remained very strong and is going to continue to be very strong. So that is going to support this part of the real estate market, the office space market. And that is despite the fact that we have a lot of supply about to come in over the next 2 years. So we might see a temporary and passing decline in occupancy rates, but it's something that the market will deal with quite well, mainly because of the ongoing increase in demand by a segment of the economy that would not get in an adverse way by the virus, if anything, demand for high-tech services, cybersecurity, fintech, software has increased during this period. The last segment is obviously retail space, and that's going to be a challenging story there because we don't know exactly how the consumer is going to change his preferences. And if there is going to be a big move away from shopping malls or things like that, that still has to be seen. So if there are some risks there, I think they pertain mainly to large shopping malls, not so much to specific small shopping centers that might be located in new neighborhoods being built up. So that's where there is a little bit of a risk, mainly uncertainty going ahead, seeing how the virus will affect consumption patterns and how that will affect the demand for retail space. So in a nutshell, that's what we see for the real estate sector here in Israel.

[Operator Instructions] There are no further questions at this time. This concludes Leumi's First Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.