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 2021 Results Conference Call. [Operator Instructions] [Operator Instructions]. As a reminder, this conference is being recorded, November 16, 2021. With us 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 security 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. 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 of Bank Leumi's financial statements for the third quarter of 2021 ended September 30, 2021. 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, Hadar Zamir, Head of Accounting; and Dr. Gil Bufman, Chief Economist. The presentation can be found on our 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. Before moving on to review the Bank's results, I would like to present a brief overview of the COVID situation and major macroeconomic factors affecting the Israeli economy. The macroeconomic parameters are in favor of the Bank. The decline of Israel's GDP was only 2.2% in 2020 of the rate of decline that was posted in the OECD countries. Israel has dealt with the pandemic effectively and has been a world leader in several areas. These include the first round of vaccinations, the recent booster shot and the implementation of the Green Pass. On November 11, the active number of cases were slightly above 6,000. The percentage of positive tests was just 0.65% and the number of physically ill dropped to less than 150. The Bank of Israel's forecast holds for a 7% growth in the GDP in 2021 and a 5.5% growth in 2022. The current level of Israel's GDP is well above that of late 2019 prior to the pandemic. The IMF shows an expectation of 7.1% for 2021 and 4.1% for 2022. In the first half of October, the broad unemployment rate, by that I mean the rate that takes into account the employees temporarily absent from their places of work due to COVID, fared to a level of 7.1%. This is the lowest broad unemployment rate recorded since the start of the crisis, which at its peak was at 36.7% mainly due to furloughed employees. The drop in unemployment comes against the backdrop of the return of the economy to routine operation. Looking ahead, we expect the broad unemployment rate to gradually decline to 5.2% in the end of 2022 of the Bank of Israel's forecast. Israel enjoys price stability. Even with global surge of inflation, Israel inflation rate remained substantially lower than inflation in the U.S., a 2.3% year-over-year in Israel in October, compared to 5.4% in the U.S. and 4.1% in the Eurozone. The main reason for Israel's relatively modest increase in inflation are the strength of the shekel which has appreciated significantly since the end of 2019 and Israel's abundance of domestic resource natural gas, which is the main source of electricity generation in Israel. Bank of Israel expects a rate of inflation of 2.5% in 2021 and 1.6% in 2022. The market expectations are higher. The level of interest remained at a low level. However, in its focus from last month, the Bank of Israel included a small initial hike of 15 basis points to 25 basis points during 2022. Now let's turn to the Bank's result, by moving on to Slide 4. As you can see in this slide, the figures speak for themselves. We continue to demonstrate very strong results both in the third quarter and the first 9 months of 2021. We recorded 16% ROE in the third quarter and 15.7% return for the first 9 months of 2021. These yields were achieved on the back of the strong growth in a credit portfolio. In the last 12 months, the Bank's loan book grew by 13.7%, an impressive growth that will continue to affect future quarters. Our cost to income ratio reached 47.4% in the third quarter and 46.5% for the first 9 months of 2021. We recorded a negative loan loss expenses ratio of 0.44% in the third quarter and a negative 0.31% for the first 9 months of 2021, due to collections and due to the improvement in the macroeconomic factors in Israel, as mentioned earlier. Let's continue to Slide 5. Net interest income in the first 9 months of 2021 increased by ILS 1.3 billion compared to the first 9 months of 2020. This increase was achieved despite the decrease in the Bank of Israel and the Fed's interest rate. The difference in the CPI level affected this increase significantly, but it was also affected by the substantial increase in our credit portfolio. The 2.2% CPI level for the period also led to an increase in the NIM to a level of 2% in the first 9 months of 2021. The non-interest finance income for the first 9 months of 2021 reached above ILS 1.3 billion. The non-interest finance income was positively affected by derivatives and foreign exchange and by the high profit recorded in the second quarter of the Leumi Partners transaction. The ironSource and Retailors IPO resulted in a profit of ILS 397 million pretax. It is important to mention that Leumi Partners is the pre-investment of Leumi as part of our nostro portfolio. Income from fees and commissions increased by 4.5% in the first 9 months of 2021, mainly as a result of the increase in activity, additional evidence of the economic rebound Israel is experiencing. Operating and other expenses increased by 6.3%, mainly as a result of bonus provisions due to the high returns achieved this year. The other expenses continued to decline, despite the increase in activity. All of these factors together with the negative credit loss expenses resulted in ROE of 15.7% for the first 9 months of 2021. Moving on to Slide 6. In the third quarter, the trends are similar to those for the first 9 months of 2021. In Q3, the net interest income increased by ILS 455 million for the reasons I mentioned earlier, continued growth in our credit portfolio and a higher CPI of 0.8% this quarter, both of which affected our finance income positively. In the third quarter, the non-interest finance income is below Q3 last year. This is mainly because the Q3 figures last year were positively affected by the revaluation of Visa shares as well as the rebound in the capital markets after decline in the capital markets in Q1 last year with the outbreak of COVID. Income from fees and commissions increased by 7.4% compared to Q3 last year as a result of the growth in activity. Operating and other expenses increased by 6.1%. Again, this is mainly the result of high bonus provision due to the high return achieved. Regarding the other expenses, they have been down compared to Q3 last year. All these together with the negative credit loss expenses brought us to a high double-digit ROE of 16% for the third quarter. Moving on to Slide 7. Fees and commissions increased by 7.4% for the third quarter and by 4.5% for the first 9 months of 2021. This increase was mainly driven by fees on securities, credit card and financing transactions due to increase in activity. It was offset partially by a decrease in account management fees and exchange differential commission. The decrease in exchange differential commission is mostly due to the relatively high volume of activity in foreign currency that occurred in Q1 last year with the outbreak of COVID. Continuing to Slide 9. As I mentioned earlier, the expenses increased in the first 9 months of 2021 and Q3 by slightly above 6% mainly due to the provision for bonuses on the back of the [indiscernible]. The other expenses were down both in the first 9 months and in Q3 compared to the corresponding periods. The tight expense management, the back office automation as well as our transition to digital along with the increase in income resulted in a significant reduction in the cost to income ratio compared to corresponding period. Continuing to Slide 8, in the first 9 months of 2021 and in Q3, the negative credit loss expenses had a substantial effects on our results. The total income from credit loss expenses for the first 9 months of 2021 amounted to ILS 729 million, of which ILS 359 million were recorded in the third quarter. For the first 9 months, more than half of the loan loss income relates to reduction in specific provision due to collections, while the main reduction relates to the collective provision. The majority of the reduction in the collective provision was in Q3 as a result of the significant improvement in the economic indicators as I elaborated earlier and the success in Israel in coping with the Delta variant outbreak in the third quarter. The government succeeded in keeping the economy open during the outbreak with a relatively minimal impact on economic activity. The coverage ratio, which is the loan loss provision to gross loan to the company were off to a level of 1.42% at the end of September 2021, still well above the pre-COVID ratio of 1.16%. The improvement in quality of our credit portfolio is also reflected in the negligible level of write-offs for both the third quarter and the first 9-months of 2021 and by the NPL which also continue to decline reaching the level of 0.84%. Continuing to Slide 10. The credit portfolio increased in the last 12 months by nearly 14%. This impressive growth was focused again in line with our strategy in middle market, mortgages and corporates, which really is playing a significant role in the corporate portfolio with a strong focus on residential real estate. Continuing to Slide 11. The loan to deposit ratio remains conservative, which is 65% in Q3 2021 giving us a strong buffer for further growth. The deposits also continue to grow in the third quarter and the total increase since the beginning of the year was 12.1%. I'm moving now to Slide 12. On the back of the excellent results and under the easement of restrictions by the Bank of Israel, the Bank announced this morning a dividend distribution of ILS 1.4 billion this quarter, reflecting the maximum allowed distribution by the Bank of Israel of 30% of 2021 net income. This follows the ILS 630 million distributed in the last quarter. Currently, till the end of December 2021, according to the restrictions of the Bank of Israel, we are allowed to distribute a maximum of 30% of 2021 profit, in addition to the dividend that was announced in the second quarter from the profit of 2020. Let's move to Slide 13. This slide illustrates our solid capital ratio, CET1 and TCR and our leverage and liquidity ratios. Across the board, we present ratios much above the minimum requirements. They are also much above the minimum requirements when we take into account the return to pre-COVID level requirements as expected at this stage at the end of 2021. Moving on to Slide 14. Before opening the line for questions, I would like to mention the merger agreement between Bank Leumi USA and Valley National Bancorp, which was announced in September of this year. As a result of the merger, we will no longer be considered a source of strength in our U.S. activity. That means the substantial reduction in our operational risk, while at the same time, we will continue to operate in the U.S. market through Valley. As a result of the merger, in the following quarters, we are expected to record a profit of ILS 650 million to ILS 750 million, net of tax from the sale and to improve our CET1 ratio by approximately 0.5%. At this stage, I would like to thank you again for joining us today, and to open the lines for questions. Operator?

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

This is Chris Reimer on for Tavy. Congratulations on the strong results. I was wondering if you could comment on the Bank of Israel draft published earlier this week, the directive aimed at increasing transparency and competition for mortgages? And how you think this might have an impact on the Bank?

Chris, thank you for your question. So as you pointed out, the Bank of Israel published a draft regarding instructions with regard to mortgages. As far as I understand, they are looking for a standard path of taking out mortgages that talking about 3 main standard paths, and which will be according to both the duration that the customer would like to take. And also additional path which will be fit to specific request of the customers which can be different between different banks. They are also talking about shortening the timeline of dealing with proposal for mortgages in banks. It's still hard to predict what will be the impact of this draft on the activity. And since first, it's only a draft and it can be changed in the next half of the year. Secondly, there are already lots of mortgage advisors that help our customers in their consideration which mortgage to take. So, I don't think it will have a material impact on our business. It might have some slight negative impact on the new mortgages that we take out in the future if there will be limitation. Now the path of mortgages are very wide. If we narrow only to 3 or 4 paths, so it might have a slight pressure on price, but we don't predict it to be significant.

Okay. Also regarding loan growth, loans continue to grow at a really high pace. Do you see this level of sustainable heading into 2022?

Well, the pace of growth this year was impacted I believe also from the rebound from the COVID in Israel, and from the high demand, very high demand in the mortgage sector that we just mentioned. As I pointed out in the presentation, the GDP pace of growth next year is expected to be, I don't know, somewhere between 4% to 5.5%. And we do expect Leumi to have a significant growth above the GDP pace of growth. I don't expect it to be 14% that it was in this year, but expected to be significant above the GDP pace of growth.

The next question is from Borja Ramirez of Citi.

I have 2 quick questions. The first one is regarding costs. It seems you are showing better cost control than peers that supported so far with lower growth year-over-year in operating expenses versus peers. Could you provide more details on the underlying trends? And also any actions for efficiency? And then my second question would be on excess capital. So do you currently have the largest capital buffer among the peers that reported equity, and this will be likely greater after the U.S. transaction is closed potentially next year. Could you provide any details on what could be the potential usage of excess capital maybe organic growth or distribution or any other actions?

Thank you, Borja, for your questions. First regarding to the cost/income ratio, yes, so we improved significantly in managing our expenses. And as I pointed out in the presentation, this improvement is due to tight expense management at the back -- I mean the back office automation as well as our transition to digital which lowered our cost. And it also affected as you mentioned by the significant increase in our income. So this is the main reason. I think that the more digital we are, the more automate we are, the activity increase because it's more convenient for our customers. It's more cheaper to our customers. And the benefits are from all the player in this playground. So that's first. Now regarding our equity ratio, so as you mentioned, we have the highest equity ratio in the industry. And on top of the 11.8% that we currently have, there is 0.5% that you mentioned that was derived from the merger of our U.S. subsidiary with Valley National Bank. We will use it, I think, for 4 main issues. First, to continue to increase our credit portfolio. And if you take backward, not only in 2021, but also in 2020, our pace of growth was much above the GDP pace of growth. Secondly, we will continue to invest a significant amount in IT in improving our data analysis, in improving our core system, because when we look forward, we expect those issues to be the main driver for keeping a leadership in the Israeli market. Thirdly, we will use it in order to cope with the regulations that are along the way. I mean, the CECL regulation that is expected to be implemented in the first quarter of 2022. And there is another regulation regarding derivatives, which is expected to be in 2 steps. The first step is in the second half of 2022 and the second is in the first half of 2023. And the fourth element is of course dividend and buyback plan. We have the full ability to continue to keep or to share with our shareholders 5% of dividend each year and I hope it will be as it was in the past, a mix of dividend and buyback plan. As a matter of fact, this year, we will distribute even higher amount than we distribute pre-COVID because till now we announced on ILS 2 billion dividend and in last quarter ILS 600 million, this quarter ILS 1.4 billion, together ILS 2 billion only for the first 9-month. And pre-COVID, it was ILS 2.1 billion for the total year. So I expect that the total year dividend this year will be even higher than it was pre-COVID. And because we have a very strong equity ratio, if it be allowed by the Bank of Israel and I expect the Bank of Israel to release the limitation on distribution of dividend at the end of the year. So we have the full capabilities to keep this high dividend distribution also in the following year.

[Operator Instructions] There are no further questions at this time. This concludes Leumi's third quarter 2021 results conference call. Thank you for your participation. You may go ahead and disconnect.