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

Ladies and gentlemen, thank you for standing by. Welcome to Leumi's Second Quarter 2021 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, August 12, 2021. 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 effort of the company's account -- 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. Adi Molcho Weinstein, VP, Investor Relations. Ms. Molcho Weinstein, please go ahead.

Thank you, operator. Ladies and gentlemen, we thank you for taking the time to join us on this results call for Bank Leumi's financial statements for the second quarter of 2021 ended June 30. 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, Ms. Hadar Zamir, Head of Accounting; and Mr. [indiscernible] standing in for our Chief Economist. The presentation can be found on the IR section of our website and on the Tel Aviv Stock Exchange website. I'd now like to turn the call over to Omer.

Thank you, Adi, and good day all. I would like to thank you for joining us to review Leumi's results. Let's start with Slide 3. As you can see on this slide, the figures speak for themselves. We are continuing to demonstrate very strong results, both in the second quarter and the first half of 2021. This quarter, we recorded a 17.9% ROE on the back of a 15% ROE in the previous quarter, resulting in a 16% return for the first half of 2021. These yields were achieved even though we have around 12% CET1 ratio due to the limitations on distributing dividends. Our cost-to-income ratio has declined to 43.1% this quarter and 46.1% for the first half of 2021, well below 50%. We see a negative credit loss expense ratio of 0.2% this quarter and 0.24% for the first half of 2021. 2/3 of this reduction is from the specific provisions, mainly due to collection, and the third is from the collective provision. A new ratio we are introducing is the preprovision net revenue to average asset ratio. We recorded a yield of 1.5% for the first 6 months of the year and 1.7% for the second quarter. The ROA is also strong, above 1% in the first half of the year and in the second quarter. Moving on to Slide 4. If we look at the broader picture of the last 2 years at our income growth and our expenses, the results are impressive. Despite COVID, we were able to increase our income by 22% and decrease our expenses by 8% in the same period. This is not a minor achievement. We do see a slight increase in expenses in the first half of 2021, but this is mainly due to higher bonus provisions given the positive results obtained. This [indiscernible] like movement which we've been experiencing for a long period has resulted in a significant improvement in our cost-to-income ratio from about 60% to 43% this quarter. This is a direct result of the improved efficiencies in our operations. Having said that, it is important to mention that an efficiency ratio of 43% for the first half -- or for the second quarter or 46% for the first half doesn't reflect our position as yet. We should keep in mind that the income for the first half of 2021 was impacted significantly from a CPI level and by 2 transactions of Leumi Partners, a wholly owned subsidiary, which mainly manages our nontraded investment portfolio. Nevertheless, the improvement was also due to a great degree from our back-office automation as well as our transition to digital and was achieved despite COVID and despite a decrease in the interest rate. Let's continue to Slide 5. The net interest income in the first half of 2021 increased by more than ILS 800 million compared to last year. As I pointed out, this increase was achieved despite the decrease in the Fed interest rate and those of the Bank of Israel. The difference in the CPI level affected this increase significantly, but it was also affected by the substantial increase in our credit portfolio. In Q2, the net interest income increased by ILS 650 million, for the reason I mentioned earlier. As a result, the NIM reached 2.03% and 2.15% for the second quarter of 2021. The noninterest finance income for the first half of 2021 reached over ILS 1 billion. The noninterest finance income was positively affected by the high profit recorded this quarter in 2 Leumi Partners transactions. The ironSource and Retailors IPOs resulted in a gain profit of ILS 382 million pretax, both coming to fruition during Q2. It is important to mention that Leumi Partners is the PE investment of Leumi, as part of our [indiscernible] management. In the second quarter, the noninterest finance income is similar to Q2 last year despite the gains from Leumi Partners. This is mainly because the Q2 figures of last year were positively affected by the rebound in the capital markets after the plunge in the market in Q1 of 2020 with the outbreak of COVID. Expenses were up by 6.5% in the first half of 2021 compared to last year. This increase was in salary expense as a result of provision for bonuses due to the strong results. The increase was offset partially by the decrease in other expenses. Quarter-to-quarter expenses were up by 11.3%, again, mainly due to bonus provision. I would also like to mention that Q2 expenses last year were at a relatively low level due to the outbreak of the pandemic and the lockdown during this period. Moving on to Slide 6. Fees and commissions increased by 3.1% for the first half of 2021. This increase was mainly driven by both securities and financing transactions and was offset partially by a decrease in account management fees and exchange differentials commissions. The change in exchange commissions is mostly due to the relatively high volume of activity and foreign currency weakness in Q1 of last year with the outbreak of COVID. Looking at the second quarter, we see a nearly 10% increase in fees and commissions, mostly due to the low activity recorded in the second quarter of last year due to the outbreak of COVID. Continuing to Slide 7. Before moving on to review the credit loss expenses, I would like to present a brief overview of the COVID situation and other macroeconomic factors affecting the Israeli economy. At this stage, the Delta variant has led to a significant increase in active cases, still currently lower than in previous wave. The current number of active cases is about 40,000 cases lower than the peak of 85,000 in early February of this year. Over 80% of the population, 16 years or older have been fully vaccinated. Israel is also the first country to apply a third dose of the vaccination with over 50% of the eligible population, mostly elderly or members of high-risk groups. They've already received a third dose and this number is growing daily. Regarding the GDP, the Bank of Israel's forecast on July call for a 5.5% increase in GDP in 2021, followed by a 6% increase in 2022 based on the assumption that COVID-19 will be contained. These figures put Israel among the highest in the peer group of small open economies and international comparison or GDP forecast by the OECD. Broad unemployment rates were down to 9.1% in June 2021 from a peak of 37.1% in April 2020. As a reminder, this includes employees temporarily absent from work due to the coronavirus crisis and those dismissed in the beginning of the pandemic in March of 2020. According to the Bank of Israel, unemployment is also expected to improve by the fourth quarter of the year to 8% with a further substantial decline to a level of 5.5% by Q4 2020. As for the CPI, the Bank of Israel expect the CPI to reach 1.7% in 2021, following a negative 0.7% rate of 2020. As we saw in previous slides, the higher the CPI, the more positive the impact on our results. Moving on to Slide 8. As in the first quarter, we continued in the second quarter to record a negative loan loss expenses. The total income from credit loss expenses for the first half of the year amounted to ILS 370 million, reflecting a level of minus 24 basis points of credit loss expenses. 2/3 of it relate to reduction in specific provisions due to collections, while only 1/3 of the reduction relates to the collective provision. The coverage ratio, I mean, the ratio between the total provision and the total debt, decreased to a level of 1.58% at the end of June 2021, still well above the pre-COVID ratio of 1.16% at the end of 2019. We have decided at this stage to remain cautious given the uncertainty on the back of the widening spread of the Delta variant. The improved -- the improvement in the quality of our credit portfolio is also reflected in the 9% decrease in our travel [indiscernible] in the second quarter. The decrease is across the board, mainly due to collections. The NPL also declined slightly to less than 1%. Let's move to Slide 9. The credit portfolio increased by about 10% in the last 12 months. This impressive growth was focused again in line with our strategy in middle-market, mortgages and corporates with real estate playing a significant role in the corporate portfolio. Continuing to Slide 10. The loan-to-deposit ratio remained highly conservative, reaching 65% in Q2 2021, giving us a strong buffer for further growth. During the first half of 2021, deposits continued to grow by approximately ILS 40 billion on the back of the significant growth in 2020. Let's move to Slide 11. This slide illustrates our solid capital ratio, CET1 and TCR, and our leverage and liquidity ratio. In all of these, we present ratio much above the minimum requirement. They're also much above the minimum requirement when we take into account the return to pre-COVID level requirements as expected at this stage at the end of September 2021. Moving on to Slide 12. The Board of Directors announced this morning a dividend distribution of ILS 630 million. This amount reflects 30% of 2020 profit, the maximum that can be distributed at this stage according to the instruction of the Bank of Israel. The ILS 630 million dividend reflects a 3.3% semiannual yield. Currently, till the end of September 2021, according to the restrictions of the Bank of Israel, we are not allowed to distribute more dividend. But when it allows, our strong equity ratios clearly demonstrate our capability to distribute additional significant dividends and/or to adopt another buyback plan. I'm moving on to the next slide to my final remarks. The consistent improvement in our results is remarkable. Even though we are aware that this level of ROE in the last 2 quarters don't reflect our position as yet, the improvement in our fundamentals are clear. We were able to offset the negative impact of the decrease in the interest rates. We are consistently increasing our credit portfolio to align with our strategy in middle market, mortgages and corporates, with high focus on real estate. And we succeeded again in reducing our expenses with putting aside the bonus provision. I would like to mention that we have also started our journey toward hybrid working, based on a model in which our employees can work remotely 1 day a week. As for the credit provision, we are well above our pre-COVID provision level, which means that we are well prepared for any negative developments that may occur with the outbreak of the Delta variant. All of this, along with our high equity ratio and our low credit-to-deposit ratio, put us in a strong position looking forward. 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.

This is Chris Reimer on for Tavy. You talked about the strong loan growth for the mortgage segment. It seems to be a strategic segment for most of the banks in Israel. So I was wondering if you're seeing any pricing pressure?

Chris, thank you for the question. First, the -- as you mentioned, the mortgage credit is a hot market currently in Israel based on the high demand for investing in real estate. Now there is a big competition. And at the end, there is some impact on the prices in this competition. But since the demand is so high, so there is an impact, but not a significant impact. And also when you mention what is the impact, you have to take into account the mix of the price because if there is a reduction in the fixed interest rate is 1 point, and if the mix is that is more toward a variable interest rate, so it means maybe that there is a small reduction in the near term, but in the long term, we might even benefit from it. So to put it short, I would say that the competition is high. There is some impact on prices. But it's more driving from the mix of the credit and not a reduction in the price itself.

The next question is from Borja Ramirez of Citi.

I have 2 quick questions. My first question is regarding the loan demand. Now it seems quite strong in terms of mortgage, the financial corporate. I would like to ask if you could please provide some color regarding the expected demand for the rest of the year, if it could remain as strong as it currently is? And then my second question is on the deposit evolution. It seems that the increase in deposits in Israel has had some correlation with the asset purchases of the Bank of Israel. I would like to ask you if it is possible that once we start to see the Bank of Israel slowing down the asset purchases, if we could see the stock of deposits at system level to maybe show a smaller growth or even decline?

Borja, thank you for your question. First, regarding the demand for loans. So if I touch a minute ago the mortgages, so the demand to mortgages will continue to be high, even though the Bank of Israel take a few measures in order to calm down the market. But it seems that in the near future, the demand for mortgage will continue to be high. Regarding the other sector, I would say that -- I mentioned in the presentation that the GDP in Israel for 2021 and also for 2022 is expected to be between 5.5% to 6%. So it's higher than it used to be in the past. Pre-COVID, our GDP was 3% to 4% due to the rebound of the economy based on the measures that we take in Israel. So I do expect the demand to continue to be high. But if the question is whether we will continue to maintain double-digit numbered pace of growth, it seems to me that the answer is no. It seems to me that we'll be above the GDP pace of growth, but I don't -- but if I want to be more realistic, so I'm not expecting every year that we increase our credit portfolio by 10%. It was impacted by the rebound in the economy after the COVID outbreak. Now regarding the deposits, I think that according to our data, the increase in deposits is mainly related to the COVID -- again to the COVID implications because most of our private customers and also in the business sector still prefer to be cautious, improve their money in deposits and wait a little bit less in order to be able to cope with any negative deterioration that might happen in the future because the situation is still -- there are periods that we feel more comfortable and periods that we feel less comfortable. And I do believe that when the health situation will be more stable, so -- and I saw it in the second quarter before the outbreak of the Delta variant. So I assume that this large increase in the deposit amount will decrease. Some of the money will go to investments, some of the money will go to the capital market and -- for other users that at this stage are relatively conservative when I compare it to periods pre-COVID. Did it answer your question, Borja?

Yes. That's was very clear.

Thank you.

The next question is from Micha Goldberg of Excellence.

First of all, congratulations on a stellar quarter and a very strong first half. First question, if it's possible, if you could explain slightly what do you see as the underlying profitability? I mean, obviously, this quarter was exceptionally strong, trading gains and CPI, both added significantly. So I was just wondering, when you do your underlying calculus, what is it that you see as Leumi's current sustainable underlying return on equity?

Micha, thank you for your question. It's very hard to put a specific number because it depends what are your assumptions about the future. I mean what is the assumption about the CPI level which affected, as you mentioned, significantly the second quarter results, what is your assumption about the profit that we will derive from Leumi Partners. Leumi Partners is our PE arm investor. And if you look backwards, pre-COVID so 2019, 2018, every year, not every quarter, but every year, there is significant profit for Leumi Partners. It depends what are your assumptions about the health situation because currently, we announced minus 24% -- 24 basis point credit loss expenses, while -- what will be in the third quarter, in the fourth quarter depends on the health situation and the economy situation that will be driven by the health situation. So there are a lot of parameters that affect this number. So what I can say, and I pointed it out in the presentation that the fundamentals are very good. And when I mean fundamentals, I mean, first, the increase in the credit portfolio. Second, the automation of the back office operation, the movement to digital, the very tight management of the expenses that cost to our expenses -- the cost that are expenses -- the other expenses, not the expenses due to the bonus, decrease in the first half compared to last year. We were able to maintain -- if we neutralize the CPI, we were able to maintain the more or less at the same level with the decrease in the interest rates. So the commissions were up by 3%. And even if I take out the high volume of activity in securities and other stuff, there are still -- you can assume that they can -- that we are able to increase them by 1% to 2%. So the fundamentals are very good. When we look at the deferral, the delinquent payment, the deferrals are not significant. So all the fundamentals are very good. What is the exact number? I cannot say because it depends on the assumption. But we feel and we see it through the number that the efficiency ratio improved significantly and consistently. So we are not at 46%. Maybe we are something around 50%. But this is the main thing that I can say at this stage. And also take into account one last comment, that even though the ROE is very high and not reflected our position as yet, but it was based on 12% CET1 ratio because of the restrictions to distribute dividends. So when you look on the future and try to figure out what is the ROE, we should also take assumptions about the dividend that the Bank of Israel will allow us to distribute because we don't need this 12% CET1. So when the equity -- when the CET1 will decrease, it will impact positively the ROE. So there are a lot of parameters that affect this number that you try to figure out.

Right. No, that's clear. I just wonder -- if I can put a question differently. I mean it seems to me that it's obvious that with interest rates being as low as they are right now and equity being as relatively high as they are right now, what fundamentally has changed that would allow you to make a double-digit return on equity over time?

I think that the major parameter are the trade portfolio. The bigger the trade portfolio, the biggest result based on the fact that we do it in the right way. And for example, in retail, the major -- the vast majority of our loans are through automatic model in which there is no intervention of human being. So it means it's more accurate. So the bigger the credit portfolio, the accurate the interest rate that we stated when we sell our loan, the increase in commission that we were able to achieve in different areas and the tight management of expenses not only because of automation, not only because of moving on to digital. But because of the fact that there are still lots of areas that we can do better, all of these improve the results quarter after quarter, I mean the core results.