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 2022 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded August 16, 2022. With us online 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 this conference call. I would now like to turn the call over to Ms. Adi Molcho Weinstein, VP, Investor Relations. Ms. Molcho Weinstein, please go ahead.

Thank you, operator. Ladies and gentlemen, thank you for taking the time to join us on this results call for Bank Leumi's financial statements for the second quarter of 2022. 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 Dr. Gil Bufman, Chief Economist. The presentation presented here 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 thank you all for joining us for the presentation of our Bank Leumi results for the first half of 2022 and for the second quarter. As usual, I would like to start with a short review about the main macroeconomic parameters in the Israel economy. Israel has several unique growth drivers that are helping to offset some of the negative impact of a sourcing slowdown in the global growth. These include rapid population growth, a surge of much-needed residential construction starts, ongoing high-tech growth, sales and exports despite the global trend and a rapidly growing natural gas sector with exports to neighboring countries. When we look at the GDP pace of growth, after a very strong pace of growth in 2021 of 8.2%, the focus of the Bank of Israel is for 5% pace of growth in 2022 and 3.5% in 2023. As a matter of fact, today, the CBS in Israel presented the data for the second quarter of 2022. Based on that, the expectation and the forecast is even better. Based on that, and our Chief Economist, Gil Bufman can elaborate on it later, our expectation is that in 2022, the GDP pace of growth in Israel will be 6%, much higher than the expectation on the Bank of Israel. When we look at the unemployment rate, we can see that it dropped to the level of 3.3%, much lower than the unemployment rate pre-COVID. As for the CPI, we believe that this year, the CPI will be around 5%, but next year, we expect the CPI to drop again to a more reasonable level, between 2% to 3%. Regarding the Bank of Israel interest rate, which is currently 1.25%, we expect that by the beginning of 2023, it will rise to a level of 2.5% to 2.75%. I mentioned all of that because 99% of our activity is in Israel or -- not 99%, but above 95% is in Israel, and the better the Israel economy, the better Leumi results. With that, I would like to continue to the next slide and start analyzing Leumi results for the second quarter and for the first half of the year. Again, the ROE is impressive, 18.5% for the second quarter and 17.1% for the first half of the year. This strong ROE was led by a few parameters. First, very strong pace of credit growth. In the first 6 months of 2022, we were able to increase our credit portfolio by 12.3%. As a result, our net interest income increased significantly. And on the other hand, we were able, in the same period, to decrease our expenses. As a result, our cost-to-income ratio reached to a level of 40% for the first half of the year and 35% in the second quarter. The credit loss expenses remain at a very low level of 5 basis points for the first half and 14 basis points for the second quarter. The results for the first half and for the second quarter, of course, were impacted positively by the profit from the merger of Bank Leumi USA with Valley Bank, in which we recorded a net profit of ILS 645 million in the first half of the year. And in the first quarter, we recorded ILS 194 million in the second quarter, ILS 450 million net of tax. In the next slide, we present a broad picture of the cost-to-income ratio and the credit loss expenses for the last 3.5 years, and we can see the significant improvement in the cost income, ratio and the very low credit loss expenses in most of the period apart from 2020 with the outbreak of COVID. As a result, the ROE rose to a level of 17.1% in the first half of 2022. Now moving on to Slide #6. From now on, we neutralized the result of BLUSA in the previous period in order to concur [indiscernible], we reported that on the pro forma financials in our financials. So when we look at the finance income, we can see a significant increase of 12% in the first half of the year compared to the first half last year, and an increase of 19% in the second quarter compared to the second quarter last year. This increase was led by substantial increase in the net interest income of 23% in the first half of the year and 21% in the second quarter. The increase in the net interest income was led, as I pointed out earlier, with a significant increase in our credit portfolio and of course, by the increase in the interest rate and in the CPI, which reached to a level of 3.1% in the first half of the year and 1.9% in the second quarter. As for the noninterest finance income, we can see a decrease compared to last year. This decrease was, of course, impacted by the capital market, which in the first half of last year was much better than in the first half of this year, and from onetime income this year related to the merger of Bank Leumi USA with Valley, and in the previous years, significant profit from the investments with [ Retailors ] in ironSource, which impacted significantly the result last year. When we look at the expenses, we can see that, again, Bank Leumi succeeded in reducing its expenses, even though we increased our activity significantly. In the first half of the year, we reduced our expenses by 3.4% compared to last year, and in the second quarter, we decreased our expenses by 3.8% compared to last year. On Slide #7, we can see the improvement in our NPL. The NPL dropped to a level of 70 basis points, a level which is lower than the level pre-COVID. As a result, the total provision to NPL rose to a level of slightly less than 190%. In the next slide, we can see that as a result -- we can see that the coverage ratio, I mean the ratio between the provision to the total debt, rose from a level of 1.16% pre-COVID to a level of 1.36% in June 2022. This reflects an increase of 50% in our credit provisions. And as I pointed out earlier, the credit loss expenses remained at a very low level, 4 basis points for the first half of the year and 14 basis points for the second quarter. In the next slide, we can see that we were able to increase our commissions in the last 2 years by 4.3% on average. When we compared the first half of the year compared to the first half of the year last year, we can see that the increase in commission reached to a level of almost 5%. This increase was mainly driven by exchange differentials commissions due to high activity in the first half of the year in foreign exchange and due to an increase in the final transaction of commissions due to the increase in our credit portfolio. There is a strong linkage between the increase in our credit portfolio and the commissions from financial transactions. In the next slide, we present the efficiency ratio for the second quarter and for the first half of the year. For the first half of the year, the efficiency ratio, when we neutralize those results, reached to a level of slightly less than 40%, and in the second quarter, to 35%. On the right, we neutralized not only those results, but also the profit from the merger of Bank Leumi USA with BLUSA, and we can see that even when we neutralize this effect, in the second quarter, we were able to achieve a cost-to-income ratio which is slightly less than 42%. It's impressive cost-to-income ratio. In the next slide, we present the increase in the credit portfolio. In the first 6 months of the year, we increased our credit portfolio by 12.3%. As a matter of fact, in the last 12 months, we increased our credit portfolio by 23%. The increase, again, was focused according to our strategy in middle market, mortgages and corporate. In middle market, we increased our credit portfolio by slightly less than 16%; in mortgages, 9%; and in corporate, by 22%. In the next slide, we can see that we were able to increase our deposits in the last 12 months by 15%, and we can see that the loan-to-deposit ratio remained conservative at a level of 68%. The last slide of the presentation presents our equity ratio, leverage ratio and liquidity ratio in all of which we are much above the minimum regulatory requirement. I would like also to mention that the Board of Directors approved a dividend of ILS 400 million for the second quarter, which reflects 20% of the profit of the second quarter. I would like to end my presentation by saying that, again, Bank Leumi presents very strong results, very strong ROE, consistent improvement in the cost income ratio, very low level of credit loss expenses. And when we [indiscernible] to that, the expectation for continuing increase in the interest rate, it puts us in a very strong position looking forward. With that, I would like to open the line for Q&A. Operator?

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

I just wanted to discuss the outlook a little bit. We're seeing some signs of macro headwinds. We saw recently a decrease in new home sales. You mentioned the increase in inflation. When you look ahead, I'm talking about next 6 months, next 12 months, how do you see, I guess, loan growth stabilizing? And at the same time, do you expect to pick up in the level of loan growth provisions?

So when I look forward, I still see a potential and good demand for loan in Israel because, as I pointed out at the beginning, the CBS data for the second quarter of 2022 are quite positive. They are even better than we expect before, and they expect that the GDP pace of growth in Israel -- and based on that, we expect that the GDP pace of growth in Israel in 2022 will reach a level of 6%. Having said that, I don't expect that the pace of growth will continue to be as strong as it was in the last 12 months. The last 12 months is very unique because the demand was very high due to different parameters, low level of interest rates and all the turnout of the COVID period, which because in 2020 the demand for loan was so low, so for 2021 and 2022 are like something that we should take it together with 2020. So I believe that there will be a good demand for loan, but the pace of growth will not be as strong as it was in the last 12 months. What exactly will be the number? It's hard to predict at this stage, but I assume that it will be lower. And when I look forward for 2023 and from there also, I will say that the GDP next year is expected to go back to a level of around 3.5%, maybe a little bit more, which is the usual level of the pace of growth of the Israel economy. So when we come back to normal, I would expect that Bank Leumi will be able to grow around 10% a year, maybe a little bit more, but this will be more or less the pace of growth that I can predict at this stage. Now regarding the credit loss expenses. As I mentioned, we built, in the last 2.5 years, very strong credit provisions. We increased the credit provision by ILS 1.5 billion, which is around 50%. So I would say that we built quite a conservative credit provision, which enables the bank to handle any eventualities that might arise. Having said that, I don't think that it's reasonable that the banking industry in Israel will continue to operate in a very low credit loss expenses ratio. At the end, we will come back to a level which will be at the level pre-COVID and even higher because of the implementation of the season method. It will be gradually. But at the end, we will be there. We cannot preserve -- any of the bank in Israel, I believe, a credit loss expense ratio, which is around 0 or 10 basis points is not natural. So I expect that gradually, we start to come back to -- I think Bank Leumi, we start come back to the level as it was pre-COVID and even higher.

That's good color. And I guess last one for me with regards to expenses. When you look at them on a pro forma basis, I mean, they were still down compared to a year ago. As you mentioned in the past, your efficiency plans with a decrease in number of employees and the real estate optimization, again, I know you don't provide guidance, but I guess, thinking ahead next 12 months, how should we think of the upcoming further declines in the level of expenses?

Okay. I will say that, first, as we mentioned, we were able to decrease our expenses compared to last year by around 3.4%. The decrease was in the salary expenses as well as in the other expenses. Now since we are increasing our activity significantly, I will be happy if we will maintain our expenses more or less at the same level. I don't know if we will be able, again, to continue to increase our income and decrease our expenses, but I do believe that we will be able to maintain our expenses more less at the same level, and I will explain why. On the one hand, there are pressure of CPI issue, which increased the cost. All the side effect of the Ukraine and Russia war, which increasing expenses in different areas. For the technology costs, which increased expenses. So all of this pushed the expenses up. On the other hand, we are taking different measures to balance this increase. You mentioned the growth in our employee numbers. In the last few years, we were able to decrease our employee numbers by hundreds of employees every year. This trend is not going to change because the more technology we have, the more efficient we are. And also, we are in a process of moving to our headquarters from the center of Tel Aviv near the airport. It will also save cost. We move to a hybrid work model in which every day, 20% of the employees are working from remote. This also will contribute to reduce costs. So when I look at all the picture, I think that we have the ability to keep the expenses at more or less at the same level within significant -- continuing significant increase in our income.

The next question is from Micha Goldberg of Psagot.

First of all, congratulations on a stellar quarter and an amazing first half. A couple of questions. When I compare the pro forma Q1 and Q2 net interest income and I try to derive the impact of the rising interest rates, I guess, the number of that is somewhere between ILS 100 million and ILS 150 million. Does that seem to be correct for quarter 1?

First, I would say it's very hard to take out of the figure the impact of the increase in the interest rates because at the end, the net interest income is composed of many parameters. The vast majority of them is, first, the increase in the credit portfolio; secondly, the CPI; and thirdly, the net interest income; and fourth is the foreign exchange. So there are mix of parameters that affect the net interest income, and it's very hard to figure out the effect of the -- just the effect of the interest rate. I would also say that as long as the time will pass, this effect will be higher, not only because the interest rates will continue to increase, also because there will be more and more loans that will come to a point in which we will update the interest rate because the interest rates increase. So now we just start to see the impact of the interest rates. But going back to your original question, we don't disclose it, and I cannot refer to it. I'm just saying that it's very hard to separate it on the other components.

Okay. Another question. I mean, you mentioned in the presentation that your coverage, your loan loss coverage ratio is very high. You mentioned that you've boosted your provisions during the corona year. So I'm just wondering, I mean, compared to some of your local banks, do you have a lot more potential for provisions to be released in the coming quarters, years? Or is it something that has already been used for other purposes?

With your permission, I will relate to Leumi. I don't want to relate to other banks. Regarding Leumi, as I pointed out, we built the provision already. It is a conservative provision. It's conservative provision. This is also the instruction of the Bank of Israel to build the provision in a conservative way. So when we look at the different scenario in the way we built it, we believe that because it's conservative, so even though -- even though a different scenario may develop in the future, due to the fact and due to the conservative way that we built it, we have the ability to cope with any eventuality that might arise. And as a matter of fact, this is the basic idea behind the CECL method that we implemented at the beginning of the year. The CECL method tries to build the provision in a way that when bad things happen, so we have already the provision for them. This is the basic idea behind the CECL. This is one of the basic rationale behind this system. So in the bottom line, we feel that we are in a position in which we have a quite conservative provision also for a negative scenario that might arise in the future.

Okay. Another question regarding credit quality. I noticed that your total problematic debt went up by around 12% over the quarter. Is that indicative of any deterioration in asset quality? Or is it something technical? How should we read into that?

Micha, I missed it. What is exactly the 12% that you mentioned?

Problematic debt.

Okay. So let me just look at the figure. There is nothing special in the -- in this period, the problematic debt -- let me just see.

ILS 6,061 million in Q2 versus ILS 5 billion for...

I'm not aware of something significant. The only thing I can say that happened in the first half or in the second quarter, as I mentioned earlier, is that we are coming back to a more, let's say, reasonable world condition. And I mean, for example, in unsecured retail, the delinquency payment, which was very low, very low in the last few years, starts coming back gradually to the level that it was pre-COVID because people spend more and business spend more. In the COVID period, people took the money and didn't waste it. So we see a trend in which gradually the world coming back to be more reasonable world as it was pre-COVID. But this is the only issue that we see in the problematic debt and nothing further.

Very clear. Now when I compare the pro forma numbers on fees between Q1 and Q2, I see numbers went slightly down. Is there something happening there? Is it because of the sale of BLUSA that you also lose local fees or something else? Or is it just the seasonality?

You compare the fees for the second quarter to the first quarter. It's the same number. It's the same number. It's almost the same number. It's...

Small drop. By about...

It's ILS 882 million to ILS 872 million. It's the same number. I mean, it's ILS 10 million. It's nothing. It's the same number.