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

Ladies and gentlemen, thank you for standing by. Welcome to Leumi's Third Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, November 17, 2020. With us online today is Mr. Omer Ziv, First EVP and CFO. I would like to remind everyone that forward-looking statements for the respective 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 this 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 9 months of 2020 and the third quarter ended September 30, 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, Shlomo Goldfarb, First EVP and Chief Accountant; and Dr. Gil Bufman, Chief Economist. 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 results. Looking back on the third quarter mainly feel as if we were on a roller coaster. We started the quarter with slightly optimistic development after the lifting of the first lockdown. But after a while, the pandemic spread again, and we ended the quarter with a second lockdown, which deepened the negative economic effect of the pandemic. The new publication about a vaccine early next year indicates that there is light at the end of the tunnel. But at this stage, there are still lots of unknowns along the way. The uncertainties is still with us, and this has had a major impact on our results, mainly through another substantial increase in our pre-provision in the third quarter. Having said that, this increase was much lower than it was in the previous quarter. The increase in the credit provision was focused again on the collective provision so that we will be prepared to cope with possible negative development in delinquency of payments when the different stimulus plans come to an end. But even with this significant increase in the credit provision, we have been able to record an ROE of 8.4% in Q3 2020 with a CET1 capital ratio of 11.7%, which is not insignificant. I will go into the analysis of the results shortly. But before doing that, I would like to provide an update on the coronavirus pandemic in Israel and select macro-related data. I will start with Slide #3. Following the reopening of the market in late April, the number of new COVID-19 cases started to increase as the second wave began, peaked in early October and has declined substantially since. Currently, the number of active cases is down to approximately 8,000 from a peak of over 72,000 in early October. In October, the broad unemployment rate reached 20.3%. This includes employees temporarily absent from work due to the coronavirus crisis, and those dismissed since March who are not currently part of the workforce. According to the Bank of Israel, this number is expected to improve by the end of the year with a further substantial decline anticipated by the end of 2021. An international comparison for GDPs in the third quarter of 2020 compared to the final quarter of 2019 shows that Israel's GDP fell by 2.6%, less than that of Germany and the U.S., which were 4.1% and 4.2%, respectively, and similar to the modest decline of the South Korea GDP. The rate of decline in Spain and the U.K. of more than 9% was more severe than that of Israel. The latest data includes a 37.5% annualized increase in Q3 GDP in Israel. The surge of the GDP was the result of an across-the-board rebound in demand and especially that of net external sales. Bank Leumi's forecast for the change in GDP in 2020 is minus 3.4%, which is a much more moderate decline than as expected for the U.K. and EU countries. Now with your permission, I will turn back to the financial results by moving on to the next slide. Before going into the results, I would like to give you a review of the deferrals in payments, the NPL and the problematic debt. On the right, you can see that deferrals in payment due to COVID-19 as of September 30, 2020. The total payment deferred at the end of September 2020 were ILS 1.2 billion. 30% of the outstanding payment deferrals are related to housing loans to private individuals in which the LTV average ratio based on the date of approval is only 45%. You can also see that approximately 54% of the total debt deferral has expired and are being paid as required as of September 30. The total debt, of which ILS 1.2 billion were deferred, amounted to ILS 19.3 billion, of which 48% is composed of housing loans to private individuals. Looking at the left, the NPL ratio has increased only modestly and is still at a low level. It means that at this stage we don't yet see a significant effect of COVID-19 on the NPL. Having said that, we have seen an increase in the troubled debt during the last quarter. The majority of the increase is in special mention debt, the least severe level of troubled debt. Due to the second lockdown and its effect and due to the fact that numerous measures and stimulus plans are still being put in place by the government and the Bank of Israel, we decided to take a conservative approach and classified the group of debt and specific debt as special mention debt, despite the fact that currently they are meeting their payment terms. The reason is that once the deferrals end and stimulus plans introduced by the government expire, we expect that some of the customers may not be able to pay the debt according to the original terms. Moving on to Slide 5. Despite the increase in the special mention debt in the third quarter, the loan loss expenses in Q3 was substantially lower than the first 2 quarters of the year, 0.76% compared to approximately 1.2% in each of the first 2 quarters of 2020. As in previous quarters, the increase was in collective provision. The increase was caused by classification of debt from non-troubled debt to special mention debt, as I mentioned earlier, and also by increasing the severity of the indicators which the calculation of the collective provision is based on. This indicator relates mainly to the probability of credit failure, which is based on risk levels and economic sectors these customers sold into. [ We worsened ] the indicators as a result of the second lockdown during September and October and its possible effect on the economy. Since the beginning of the year, we increased the credit provision by ILS 2.3 billion. 88% of the increase was in the collective provision, mostly in order to deal with the negative developments that we might see in the following quarters. The loan loss provision ratio, as a percentage of total debt, increased from 1.16% on December 2019 to 1.75% on September 30, 2020. I'm continuing on to Slide 6. The ROE in the first 9 months of the year was 4.5% compared to 9.6% last year after excluding the effect of the sale of Leumi Card. The reduction in the ROE was materially affected by the increase of ILS 2.3 billion in the credit loss expenses, mainly in the collective provision as discussed earlier, and by the decrease in the noninterest finance income due to the losses in the first quarter. The net interest income decreased by 2.6% compared to last year. The decrease is mainly attributed to the difference in the CPI between the periods. The CPI for the first 9 months of 2020 was minus 0.6%, while the CPI for the corresponding period was a positive 0.5%. If you mutualize the effect of the difference in the CPI between the periods, the net interest income is very similar to last year. The NIM reached 1.2 -- 1.92%, a decrease of 23 basis points compared to the first 9 months of 2019 as a result of the difference in the CPI between the periods and as a result of the decrease in the Fed and the Bank of Israel's interest rates. The decrease in the interest rate was offset by the increase in the average credit portfolio. The decrease in the noninterest finance line item is mainly related to the losses in the capital markets in the first quarter of the year and to derivative and foreign exchange, mainly as a result of the decrease in the nonrisk interest rate in the first quarter. I would also like to mention that noninterest finance income for the first 9 months in 2020 includes income before tax of ILS 92 million from the revaluation of Visa U.S. shares, while last year's figures include income before tax of ILS 123 million from the sale of Super-Pharm and SHVA. I will elaborate on fees, commissions and expenses later in the presentation. I'm moving on to Slide 7. The ROE in the third quarter was 8.4%, only 30 basis points lower than last year. This yield was achieved in spite of the increase in the credit loss expenses by ILS 300 million compared to the third quarter last year. The negative impact of the credit loss expenses was offset by an increase in income and a decrease in expenses. The net interest income increased by 5.9% compared to last year. As for the first 9 months of the year, this increase is mainly attributed to the difference in the CPI between the periods. The CPI in Q3 2020 was plus 0.1% while the CPI in Q3 2019 was a negative 0.7%. The NIM reached 1.29% for the first 9 months of 2020, a decrease of 11 basis points compared to Q3 2019. This drop is a result of the decrease in the Fed and the Bank of Israel interest rates, net of the difference in the CPI between the periods. The decrease in the interest rate was offset by the increase in the average credit portfolio. The noninterest finance income was higher than last year and reached ILS 457 million, mainly due to the revaluation of Visa U.S. shares, as I mentioned earlier. Last year, the profit from the sale of Super-Pharm and SHVA was recorded in the first half of the year. I will elaborate on fees, commission and expenses shortly. Turning to Slide 8. Fees and commissions increased in the first 9 months of the year by 1.3% compared to last year and reached ILS 2.5 billion. This increase was driven by an increase in securities transactions and exchange differentials. This was the result of extensive activity mainly in the first quarter of the year. The increase was offset by a decrease in account management fees and financing transactions due to, among other things, a decrease in activity as a result of COVID-19. Fees and commission in Q3 2020 were 1.5% lower compared to Q3 last year due to the outbreak of the virus in the third quarter, which reduced activity in different areas. Moving now to Slide 9. In the first 9 months of 2020, as well as in Q3 2020, we succeeded in reducing the operating expenses and other expenses by approximately 10% compared to last year. The decrease is in salary expenses and in other expenses. The reduction in salary expenses was mainly due to lower provisions for bonuses and the decrease in the number of employees at the end of last year. The reduction in other expenses are in different areas as a result of measures that we took in order to cope with the negative effects of COVID. Also, we should keep in mind that the crisis led to a significant acceleration in digital activity in all segments. The cost-income ratio for the first 9 months of the year has continued to improve and reached 55%. The cost-income ratio for Q3 2020 reached a very low level of 50.4%. This ratio is not indicative and doesn't yet reflect our position since it's affected by the income from the revaluation of Visa U.S. shares and the lower provision for bonuses. I'm turning now to the next slide. As in previous quarters, we have continued to focus our growth in middle market, mortgages and corporate. In middle market, we increased our credit portfolio by 5.2% compared to last September, in mortgages by 5.8% and in corporate by 6.4%. At the same time, we have continued to be very cautious in the unsecured retail and with small businesses, which are considered to be riskier segments. I would also like to add that state-backed loans granted in the first 9 months of the year, ILS 4.5 billion, 64% of it to small businesses and the remainder to corporate and commercial customers. The total state-backed loans granted by Leumi year-to-date was approximately ILS 5.7 billion. Continuing on to the next slide. As of September 30, 2020, deposits by the public reached ILS 427 billion, mainly as a result of the increase in deposits in the first quarter of 2020 due to the transfer of funds from the capital market to deposits. As such, the loan-to-deposit ratio continues to be relatively conservative and reached a level of 67%. I'm proceeding now to Slide 12. As a reminder, due to the coronavirus, the Bank of Israel decided to reduce the minimum regulatory capital adequacy requirements and the leverage ratio. The instruction will be effective until March 31, 2021, with transition instructions for the 24 months following this date. In accordance with these instructions, the minimum capital requirement for the bank are 9.24% for CET1 and 12.74% for the total capital ratio. The leverage ratio requirement is 5.5%. The Bank of Israel also stated that given the situation, they are expecting banks to reconsider the dividend distribution and the continued implementation of the buyback plan. At this stage, the dividend distribution and implementation of the plan are on hold. I'm turning now to Slide 13. This slide illustrates our full capital ratio, CET1 and TCR, and our leverage and liquidity ratios. In all of this, we present ratios much above the minimum requirements. In a year with a severe pandemic and a significant increase in the credit provision of ILS 2.3 billion, it's not a minor achievement. I'm moving on to my final remarks. The results of the third quarter show that we are on the right path. We have been able to increase the income and decrease the expenses related to last year. We presented an ROE of 8.4% despite credit loss expenses in the quarter of ILS 0.5 billion and despite a strong Tier 1 equity ratio of 11.7%. Of course, we should keep in mind that, in parallel to the significant credit loss experienced in Q3, the results were affected positively by Visa income and the provision for bonuses. But in the fundamentals, we ended the quarter with significant credit provision of 1.75% of the total credit in order to cope with possible negative development. We have been able to offset the negative effect of the reduction in the interest rates by the increase in the credit portfolio. We have managed to implement our strategy and increase our credit portfolio significantly in mortgages, middle market and real estate in a year with a negative GDP. And we succeeded in reducing our expenses substantially. All of this, together with yesterday's news about another success in developing a vaccine for the pandemic, give us hope that the light at the end of the tunnel might be even closer than we saw during the last several months. 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.

First, I just wanted to follow up on Omer's comments on the concluding remarks. You mentioned the light at the end of the tunnel and also the fact that the bank ended the quarter quite well with most of the KPIs positive. So just looking at your provisions, can you give us some color on how you see the approach to collective provision? How do you calculate? How do you get to that amount? And coming back to the opening remarks with the light at the end of the tunnel, would you say that perhaps the level of provision is being overly conservative at the moment?

Tavy, first, good to hear from you. A very good question. First, after a long period, yes, there is a light at the end of the tunnel because we heard about the news about the succession of the new vaccine, but it will take time. It's not something that's going to happen tomorrow. During that time, anything can happen. Because now the collective -- the economic situation is mainly led by the health situation. It's not something that I can foresee, because we just came back from a second lockdown here in Israel a month ago. And in the last few days, the number of new cases start to rise again. And nobody knows whether we are in front of a third lockdown in a month from now or maybe later. So it's very hard to really forecast and see what will happen in the future because it's mainly based on health parameters and not on economic parameters. Now with regard to the collective provision, as you mentioned, we increased this provision by ILS 2.3 billion in the first 9 months of 2020. Almost 90% of it is in the collective provision. Now this increase is based on very a complicated model with terms of parameters in which we split all the segments to different sectors. In each sector, there is a rank between, let's say, 1 to 5 based on the risk of these sectors. Now we take every customer and also ranking between, let's say, 1 to 12 in order to put them in the right level of risk. We take the macroeconomic parameter, the GDP, pace of growth, which, at this stage, the forecast is much better than it was a month ago. A month ago, the Bank of Israel published 2 scenarios of GDP to 2020 between minus 5% to minus 6.5%, something like that. And now Leumi's forecast GDP to 2020 is only minus 3.4%. Because for the last -- from the end of -- from the last quarter of 2019 until now, the GDP is only, only in saying, but it's only minus 2.6%. So there is also macroeconomic parameter. There is unemployment parameter. So it's very complicated model in which we try to forecast the development in the future. Now what we did, we -- the vast majority of this increase in the collective provision was made in order to cope with negative developments that didn't happen yet. I mentioned through the presentation that in this quarter, based on the second lockdown, we decided to classify more group of customers to a group that's called special mention debt, which we -- group of customers that, in usual business, we have not classified them special mention debt. Because we expect that after all these stimulus plans come to an end, there will be a group of the customer, we don't know exactly which because we're just making a forecast, but part of our customers will not be able to pay as usual. So I think you will see a lot of number when the other banks will publish their financials. And I can share with you that the number -- that there is a wide range of best-estimate forecast. We try to guess what will happen in the future. It's not easy. And we will have to be patient and wait a few quarters, and then we will know whether we've been too conservative. Or it might be the other way, maybe we need more credit loss expenses. But we will have to be patient. And as in previous years, you know Leumi for a long period, we took the conservative approach in our calculation.

Great. That's very helpful. And the last one for me on cost. So your 9-month figure on salaries basically show a 15% decrease year-over-year. So obviously, some of it is due to the fact that you haven't paid high bonuses this year. I guess, if you were to normalize that, perhaps looking into 2021 when you factor in the -- some of the earlier retirements and natural retirement, when you factor all of that in, what kind of expense decrease shall we see for the salary line?

Well, as you mentioned, the major part of the decrease is related to the lower provision for bonuses due to the pandemic, but part of it, and not a minor part, is related to the streamlining process that we are doing every year. And as you remember, last December, 450 employees left Leumi. So the effect of that is also in these numbers. So if you want to make this calculation, those are the numbers in front of me. But in the yearly financial, there is -- there are data about the average cost of an employee in Leumi. And you can do the calculation and see what part of it came from the decrease -- the drop in our employee numbers. And the other part is, as you mentioned, the provision for loss. So looking forward to 2021, part of it is permanent because of the decrease in our employees, and part of it is related to the bonus provision. I can share with you that, in this year, as in previous years, you can also -- you should also expect for another decrease in our employee numbers until the end of the year.

Great. And congrats on the strong results.

Your next question is from Micha Goldberg of Excellence.

Great results. First of, congratulations. A couple of questions to follow up. First of all, I was just wondering, regarding your provision levels and reserves. It looks like your current reserves are around 1.7% of your loan book. That compares slightly lower than U.S. and U.K. European peers, which are closer to 2%. Do you think that the 1.7% is lower than that and you should see higher numbers? Or Israeli banks, or Leumi specifically, is pretty much comfortable at these reserve levels?

I will say like that -- first, I would like to speak about Leumi with your permission. And I think when I look at the 1.75% that you mentioned, provision for loan book, and when I compare it to other banks, it really first depends on the mix of the portfolio. In Bank Leumi, as you know, about, I would say, 30% or even more of our loan book is related to mortgages, in which the risk is much, much lower than in other segments. Also, we have a relative high portfolio in real estate with very strong securities. So it really depends on the mix of the portfolio and also for the appetite for risk that you have taken. In Bank Leumi, for example, in the last 2 years, we are at the same level or even decreased a little bit our unsecured retail portfolio and the small business portfolio. So I would say that roughly 1.75% is a high level. And as I mentioned through the presentation, it can vary because we're just trying to guess what will happen in the future based on the very, very complicated model, but I feel that we, as usual, took the conservative approach.

Okay. Another question regarding what you mentioned, you said almost 90% of all your provisions year-to-date have been statistical group provisions. And I'm just wondering, you're saying you're not seeing any major deterioration in NPLs and it's only up slightly. So I was wondering, when do you expect to see any [ NPL formation ] coming through? Is that only likely to happen later this year? Or you think only in 2021 or even later than that?