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 2023 Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded November 29, 2023. 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. I would now like to turn the call over to Ms. Hagit Argov, CFO. Ms. Argov. Please go ahead.

Thank you, and good afternoon to you all. Thank you for joining us today for a review of Leumi's third quarter of 2023. Today, I'm joined by Mr. Omer Ziv, Deputy CEO and Head of the Capital Markets Division; and our colleague Dr. Gil Bufman, Chief Economist. The presentation can be found on the IR section of our website and on the TASE website. As you know on 7 October Israel woke up to a horrible terrorist attack launched on Tel Aviv, our [indiscernible] prayers are with the families of many victims, the missing [indiscernible] women and children, [indiscernible] and with all the soldiers in the IDF and the security forces. Before we discuss the [ Bank's ] position in more detail. Firstly, a few words on the network situation and some key messages. Slide 3 shows some key economic indicators. While we expect the swords [indiscernible] the iron war to [indiscernible] on the level of economic activity in the fourth quarter and 2024. the Israeli economy started this period with strong and with good underlying growth, falling inflation, low unemployment and low government debt to GDP. We assume that the main part of the world remains [indiscernible] and debt intensity declines regularly. Bank Leumi estimates that GDP growth will slow to 1% in 2024, mainly reflecting the negative impact of the war in [indiscernible] 2024. We see a resumption of quarter-on-quarter growth in 2024 with an emphasize from government consumption, both civilian and defense and also investments in fixed assets, including construction. We also expect the private construction will rise [indiscernible] start to rebuild their purchases of durable goods. On Slide 4 are the key messages from the quarter. The start of Iron War began in Israel on 7th October resulted, among other things, in a decline in economic activity and an increase in economic uncertainty and risks. Q3 2023 results include an increased loan loss provision of ILS 1 billion or 0.95% of average loans reflects the lower economic activity caused by the war, and the increased uncertainty. Despite the fact that the war began in October, which was after the reporting period of Q3, the total volume of [indiscernible] Israel [indiscernible] provision debt for conservative assumptions of the impact of the war. In addition to the government's aid package and the various [indiscernible] measures to soften the economic impact on households and corporates. Several measures taken by Bank Leumi include extensions [indiscernible] on loan payments and [indiscernible] for affected customer customers. The bank has also established an [ A ] fund to support the rebuilding and rehabilitation of Kibbutz Be’eri on the Gaza border, assuming that 100% of the eligible customers take advantage of this benefit, the bank estimates that the cost would be around ILS 560 billion. Q3 net income was ILS 1.8 billion reflecting an ROE of 13.6%. Earnings were supported by 32.3% cost-income ratio and comes despite the higher quarterly loan loss provision. Let us turn to Slide 5 in the presentation, where we present the key metrics and indicators for the quarter and the first 9 months. Net income for the first 9 months of the year was ILS 5.2 billion and improved the higher third quarter provision and also the ILS 1.1 billion impairment of the bank's stake in Valley in the third quarter. The cost-income ratio stood at 32.3% in the third quarter from 39% in the third quarter of 2022. The cost-income ratio for the first 9 months of 2023 was 31.4%. Credit expenses were 0.95% in the quarter and 0.56% for the 9 months with almost all of the charge coming from collective provisions due to the geopolitical situation. Credit grew by 1.9% in the third quarter and 8.4% in the first 9 months 2023. Core deposits from private individuals, a key focus for the bank are up 6% year-to-date. The Bank of Israel supervisor of banks also [indiscernible] that as a result of the war, we reconsider the size of the dividend that we distributed. As a result, the bank has announced a 20% dividend payout from Q3. This is in addition to the ILS 1.4 billion of dividends announced in the previous quarter of 2023 and the buyback program of which ILS 600 million out of ILS 800 million was already completed. Together, this represents a 38% payout overall. The bank has for the [indiscernible]. Let us turn to Slide 6 in the presentation where we describe that strong starting point as we enter this period, we show 3 parameters. Firstly, in recent quarters, the bank has been building a large cushion for credit losses. At the end of the third quarter, this stood at almost 1.5% of gross loans and close to double the rate of NPL. Secondly, the bank's high profitability, averaging about 15% over the last 3 years, provides a large buffer with which to absorb a slowdown in activity and any potential credit losses. Lastly, the bank loan capital provision and the capital buffer of more than 1%, which allows us to absorb any potential losses and also to continue to [ fulfill ] customer needs. Slide 7 shows the breakdown of income and expenses. At the bottom right, the 45% year-on-year increase in pre-provision net revenues in the first 9 months of 2023 to ILS 11 billion. Financing income, top left, increased by 33% to ILS 13 billion, driven by higher net interest income. Fees and commission top right rose by 6.7%. Operating expenses, bottom left were up 1.7% year-on-year. Slide 8 shows a snapshot of income and expenses in Q3. Pre-provision net revenue grew 39% year-on-year, driven by financing income, up 30% year-on-year and fees up 10%. Turning to Slide 9. We can see the quarterly development of net interest income helped by higher volumes and high [indiscernible] and interest rate [indiscernible]. Net interest income was up 31.5% year-on-year in the first 9 months and 15% in the quarter. The decline in NIM in the third quarter was due to the lower CPI and the increase in interest [ paying ] deposits. Slide 10 shows the year-on-year increase and breakdown of fee and commission income. The main increase in financial transactions in the period came as a result of the increase in credit activity. Turning now to expenses on Slide 11. In the first 9 months, operating expenses on the debt increased by 1.7% when compared with the first 9 months of 2022. While quaterly expenses grew 3.1% year-on-year. The higher costs are due to higher pension, depreciation, marketing and IT expenses. On the right-hand side, we present the bank's positive cost income trends. Quarterly cost income ratio declined to 32.3% from 39% in the third quarter of 2022. 9-month cost income ratio declined to 31.4% from 39.5% in the parallel period last year. Slide 12 shows the development of loan loss expenses. As mentioned earlier, we have been increasing the collective provision in the recent quarter to reflect the higher interest rate and slower economic activity and increased the provision significantly in the third quarter in anticipation of the negative effects of the war [indiscernible]. You can see that in the third quarter and previous quarters, almost all of the expense comes from collective provisions, credit expenses in the first 9 months were 0.56%. Slide 13 shows our previous quality indicators. We see a small increase in NPL on the left, although this remains low on a historical basis. Provision for doubtful debt on the right increased to 1.47% while the ratio of allowance for doubtful debt to NPL remain at healthy 2x. And moving ahead now to Slide 14. The slide shows that our loan book increased to ILS 417 billion in the first 9 months and 8.4% decrease since the end of 2022. While we continue to grow in each of our target segments. We saw the strongest growth in the third quarter in mortgages which were up 3.1%. Slide 15 shows the deposit growth. Here, we highlight the growth in core deposits from private individuals, which increased 6% in the first 9 months and are up almost 7% year-on-year. It is important to note that our deposit base is well diversified and our liquidity ratios remain strong. Our LCR at the end of the quarter was 130%. Slide 16 shows the bank [indiscernible] capital ratio. The common tier 1 capital ratio was 11.3%, up from 11.23% at the end of the second quarter, given the bank's cushion of more than 1% above the regulatory requirements. The total capital ratio stood at 14.42%. Slide 17 shows the key investment highlights for Bank Leumi. As I mentioned before, the bank is entering this period of uncertainty with very good performance indicators. It's worth noting that the bank with will return around ILS 800 million of pretax profit in the first quarter of 2024 from selling 2 headquarter building. In conclusion, Bank Leumi continues to present consistent and strong financial performance supported by a best-in-class cost income ratio and robust credit quality indicators. The best strong profitability and healthy capital buffer enabled us to continue to grow our market share in our target segments and put Leumi in strong position for the future despite the effect of the war. With that, I will now open the call for questions.

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. [Operator Instructions] The first question is from Chris Reimer of Barclays.

Congratulations on the strong results. First off, I was wondering if you could talk about some of the trends you're seeing in the U.S., particularly how you see the performance of Valley Bank?

First of all, Valley is doing very well after the -- all the [indiscernible] with the National Bank in the U.S. at the beginning of the year, we see gradually recovery in Valley's activity. We do see improvement in the stock price. We do see improvement in the result as well as increasing the deposit base and continuing -- keeping very low credit or expense ratio. I would like to mention that apart from the equity cost visibility that we write due to our investment in Valley, Valley contribute to the bank profitability also by the different corporation that we have in Valley. I mean Valley supports our customers outside of Israel. And there are dozens of participation that we are making with Valley in our credit portfolio. So the profitability from Valley is not only in the equity line, but it as well in the credit lines, the result of the participation and the cooperation that we are making in Valley [indiscernible].

That's some good color there. And I wanted to touch on expenses also. If you could talk about some of the moving parts in the expense line, what's driving the decrease in salaries this quarter? And how should we be looking at the ramp-up to the move to the new headquarters?

So as Hagit mentioned, overall, if we look at the first 9 months of the year, the total expenses increased by 1.7%. And in the third quarter, we do see also a slight increase compared to the year-on-year and to the previous quarter. Now the decrease in the salary expenses is -- when you -- first of all, when you look at the expenses and you talk about the decrease in the salary expenses, you should bear in mind that part of the salary expenses according to the accounting rules are recorded in the other expenses, depends on the effect of the interest rate on the pension expenses according to the accounting rules, is classified with the other expenses. So you should look at both of these parts together. In the salary expenses, you'll see a slight decrease due to the [indiscernible] at the end of the year in Bank Leumi. And due to the fact that the ROE in this quarter was lower than the ROE in the previous quarter and the provision for loan loss is, of course, lower than the previous quarter because it's connected to the rate of the ROE. But as I mentioned, there is an increase in the pension -- in the pension expenses, which related to the interest rate due to the increase in the [indiscernible].

Got it. And just related to the building expenses and how you're ramping up to the move.

Can you repeat the question?

If you could give a little more color on building expenses and if there's anything left material in that as you complete the move early next year?

Okay. First of all, we expect that when we will move next year our headquarters from Tel Aviv [indiscernible]. Not only we will see the profit of pretax of ILS 800 million, but see another decrease in the maintaining expenses due to the fact that the in [indiscernible], the way we are organized is much more effective, much more cost effect than here in Tel Aviv [indiscernible] 2 buildings that we build, I don't know, 20 years ago. So by this respect, we should expect an additional decrease in maintaining costs regarding the headquarter at the beginning of 2024. On the other side, we expect that the IT cost will continue to increase because longer we're moving our customers from branches to digital channels, we decrease the building expenses. But on the other side, we increased the IT expenses as well.

The next question is from Laurent Bonnet of BNP Paribas.

Firstly, congratulations for your results. I mean business model these robust good capital buffer -- and liquidity is around. I have only 1 question, unique question. Looking at provision, they are -- not the range but we see from -- compared to Q2 2023, that was from [indiscernible] announced has tripled. My only question is, I mean, how do you foresee -- I know it's related to get by geopolitical situation? But do you see this trend continuing and Leumi keep on increasing those provisions? Or have we reached a peak?

First of all, I did mention that out of the 95 basis point credit loss expense ratio in the third quarter, 83 basis points are composed of the collective provision and only 12 basis points are related to the specific provision. Secondly, significant pulp of this increase is related to the geopolitical circumstances according to the instruction of the Bank of Israel. And as we did with the outbreak of COVID, we always prefer to be more cautious and to build our provision based on a conservative assumption. And of course, if you turn out that geopolitical situation will be less severe. This means that we'll be able to even release some of these provisions. Now when we look forward, the main parameter that we should bear in mind, the development in the geopolitical circumstances. As long as the war will be lifted in focus in this Southern border according to our forecast, we already built a cautious provision, which will enable us to deal with the effect of the war after the and you should expect a decrease in the credit loss expense ratio in the following quarters. But if the war will extend to the northern border or to other border, so we should look at it again and see what will be the effect of the war. Currently, it seems to us that we are in a very conservative assumption. We took into account the few months war with the fact that with the relatively low GDP ratio growth next year, year-over-year. So if the situation we'll be focused only on the Southern border as I mentioned, you should expect a decrease in the credit loss expense ratio in the following quarters. You mentioned another [ positive ], which is important. If you look at the NPL, the NPL is only 74 basis points. NPL is less effect by different conservative assumption. The rules are more tough, and the NPL is only 74 basis points. And if you compare it to average 2021, it was 75 basis points. So it's not something which is high. Also, when you compare to our [indiscernible], you will find that our NPL is significantly lower than most of our peers.

The next question is from Ali Dhaloomal of Bank of America.

I have question regarding the deferral programs. Can you elaborate on these and give us a bit more color? Are the length of this up to 6 months, who are the consumers who have opted in? Are they essentially retail or corporate customers? And also, will the bank bear all the cost of this deferred?

Okay. So first of all, there is a table in the financial, I try to find [indiscernible]. There is a table that I think it's on Page 64 on the [ Hebrew ] version. And there, you can see that the total deferrals until now are ILS 1.3 billion of which -- and you can see that [indiscernible] each the deferral that [indiscernible] interest is about 25% of the total deferral. So currently, we are not talking about a significant number. If you look at this page, you will find that the deferral mainly in the mortgage area and in SME. This is the main segment that used the deferral. The deferrals are up to 5 months. It depends if you are customers that live near the border or customers that live in the [indiscernible] war, or live more far away from the border, but the maximum period of deferral is out of 5 months. And based on this number currently the deferrals are not significant, but we should wait and see.

The next question is from [ Irri Barr of the Fenics. ]

I just have 2 questions, 1 related to your well, specific provisions compared to the rising NPL in the quarter. So I see that the specific provision is ILS 122 million and the rise in NPL was about ILS 600 million. I just wanted to ask if because, well, the low amount of specific provisions is mainly because you expect a high recovery on those loans. And I would like also to ask about what you see this period in this regard. So your real estate clients, do you see further deterioration material deterioration in this sector now in this period?

Okay. [indiscernible] obviously, the real estate market and then we go to another because the strategic provision is only part of the NPL. The specific -- the ILS 122 million is the expenses. It's not the total specific provision. So you cannot -- it cannot be equaled to the NPL. Now if you talk about the real estate business, so currently due to the war in Gaza, we do see a slowdown in selling, slowdown in the completion pace of projects and a slight decrease in apartment price. First of all, the slowdown in selling -- it's natural. Israel is now in a war. People are not [indiscernible] mood to go to buy apartments. And of course, this is something temporary that we start seeing part as long as the war continue. And it's also different in different parts of the country. For example, in Tel Aviv we do see a slowdown in the selling. But in Yehuda Halevi, the pace of selling is high. So it's something that is different between different parts of the country. And moreover, a significant part of our project -- project of affordable house, so in this kind of project because the government subsidize a significant portion of the price, the chance that the buyer will lose their opportunity to buy an apartment with the subsidized price is very, very low. Now regarding the pace of completion, it's, of course, related to the fact that there is lack of [indiscernible] employees currently due to the war but the government already approved additional 10,000 foreign employees to the [indiscernible] real estate sector. I can say that regarding our customers, the sites that are closed are negligible. And the vast majority of our projects are based on the foreign employees and moreover, the portion of the human resources in the total budget of projects is not significant. So even if we will see an increase in the cost of projects due to the fact that there will be more foreign employees that are more expensive than [indiscernible] employees because we already have unexpected cost in all of our budget of at least 10%. The effect of that will not be significant. Now regarding the decrease in the temporary -- slight decrease apartment prices in Israel. So of course, is due to the war, it's not significant. And we expect that because of the lack of supply in Israel even before the war started, so this lack of supply just being more severe. So we expect that after a few months, we will see an increase in apartment price. But in any way, currently, the current selling prices are higher than our underwriting prices [indiscernible] in the budget are very conservative. So with this slight decrease in apartment price, it's still higher than the prices in our budget. And at the end, you can always look at the absorption rate. The absorption rate for Bank Leumi was very conservative. We are not entering into a project with absorption rate, which is lower than 30%. The absorption rate is the rate that represent how much the price can go down or the costs can go up, and we are not even close to this area. This is the reason why despite the war the NPL in real estate, the problematic debt, if you will compare the problematic debt to real estate impact with our peers you will find that our ratio is very low compared to our peers. So in the bottom line, we feel that we have a lot of mitigation to the trend that I just mentioned. We have a very strong customer. We don't have nonrecourse loans. So the macro picture is less relevant to our portfolio.

The other question is related to the credit growth in 4Q. Can you please just give a color on that? Do you see a real decrease in demand for credit from the different segments or only few segments. Can you please just provide some insight on that?

We expect that the pace of the credit growth in the fourth quarter will be low due to the war. People are less -- the consumption is lower. The activity is lower. Now it starts to recover, but October was very, very weak as well as the first half of November. So we expect that the fourth quarter will be -- will not be significant in the credit pace of growth. But we are okay with that. As Hagit mentioned since the beginning of the year, our credit growth was 8.4%, much higher than our peers. And what is more important is that despite the fact that our pace of growth was higher than our peers. When you look at the parameters that we face, the quality of our credit portfolio, you will find that our parameters in most of the ratio are better than our peers.

The next question is from Micha Goldberg of Psagot.

Congratulations on the strong quarter. You mentioned that you wrote down the ILS 1.1 billion for your investment in Valley. And I was just wondering, under what scenario will you be able to recover some of that?

The simple answer would be that in most of the cases, we will be able to recover that when we sell the loan -- when we sell the -- sorry, the investment or part of the investment. But you should bear in mind that every quarter, we recall equity profit due to the fact that we present the Valley on an equity basis. So effectively, you'll see this coming back via the equity profit, which every quarter positive -- from an economic perspective, every quarter, it will [indiscernible] it back to the play that we were before. But the simple answer is that if we will not write the equity profit, which is the [indiscernible] we will write the profit when we sell part of the investment.

And do you have any limitations on you lock up for selling part or all of your stake in Valley National?

Currently, according to the agreement, we can sell at least 25% for investment without lock up so this is not -- we don't have effective barrier regarding that.

Understood. You also mentioned some sizable real estate gains that you're looking to gain in Q1. Are there more real estate gains likely to happen following your move to new headquarters? Or have you completed all the potential real estate gains?

First of all, 1 of the -- out of the 2 buildings that Hagit mentioned, we sold only half of it so we have the second part that we didn't sell. We are moving to [indiscernible], but half of the building the more expensive one, still below [indiscernible] We decided currently not to sell this half. Apart from that, we do have a few other buildings with potential profitability because we record the real estate in our financials based on the historical value, but not in the amount or in the size that these 2 headquarters.

Great. You also mentioned some potential cost savings following your move to the [indiscernible] headquarters. I'm just wondering, can your cost-to-income ratio go further down than it's currently at, like the 32%, 34%. Can it go lower? And if so, where would that potentially be going?

First of all, you are right. When we move to [indiscernible]. So it's a potential for further decrease in our maintaining cost because our new effort are much more effective than this building in Tel Aviv. But as I pointed out earlier, we do see an increase in the IT cost because of the movement of our customers to digital services [indiscernible] will balance 1 another. So I think in the bottom line, we will see decrease in maintenance costs. We will see increase in IT costs, but -- and regarding the cost-to-income ratio that we mentioned, our target is to remain the cost-to-income ratio between the range of 30% to 35%. We believe we can do that.

Great. You mentioned you lowered your payout by 20%. In the quest of the Bank of Israel and also hold of your buyback. And I'm just wondering when do you foresee that the Bank of Israel will allow you to reinstate your dividend policy? And once that is done, will you seek to go back to your original payout? I think it was up to 40% and maybe I'm wrong.

You are not wrong. Effectively, we were around 40%. If you add the buyback into the 30% dividend payout ratio in cash. So together, we were around 40%. I think the answer for that is related to the geopolitical development in Israel [indiscernible] the Bank of Israel, [indiscernible] the bank to be more cautious because of the war. I assume that by March 2024 when we -- when we publish the annual report, we will know much more about the geopolitical situation than we know now. So it seems to me that till then the Bank of Israel -- if the situation continues to be relatively calm [indiscernible] is in the last month, I expect that the Bank of Israel [indiscernible] bank to pay more. And if you look at other numbers, we have, of course, the capabilities to pay more. We have a tier 1 equity ratio of 11.3%. We have total equity ratio of 14.5%, very high profitability ratio, LCR is 130% so by all parameters, we have all the capabilities to increase our dividend payout ratio. But currently, we cannot do it due to the geopolitical situation.

I understand. Now I seem to remember that a while back, maybe in the heydays, you guys paid up to 60%. Once things get reinstated and the economy gets back on track, would that definitely be a similar kind of longer-term objective? Or is that something that seems above what you currently would like to pay out?

First of all, it's too early to say something about that because of the many unknown around us. I would say just that the 60% was in a period that our pace of growth was just slightly above the GDP pace of grow. Since then, we proved that we have the capability to increase our credit portfolio much more than the GDP pace of growth. And at the end, we should split our [indiscernible] between dividends and pace of growth. And the answer for that will be dependent on the opportunities [indiscernible] in the future, which currently too early to predict.

Okay. Clearly understood. My last question based on what you just said, I was just wondering, you've gained significant market share. Looks like you gained its market share on much faster loan growth, and I think you mentioned that you'll be growing faster, both compared to GP as well as compared to some of your larger peers. And I'm just wondering, does this imply over the longer term that the cost of risk should also be longer -- should be higher?

First of all, if you compare our cost of risk in the previous quarter before this quarter because this quarter doesn't reflect anything depends on the level of [indiscernible] that you are targeting. But previous to this quarter, our cost of risk were very similar to our peers. And if you look at numbers that are less related to let's say, judgment like NPA or if you look at the ratio of the problematic debt out of the total loan, you will find that despite the fact that our pace of growth is -- not only in this year, it was also in 2022. It was also in 2021. We are talking about a very long period. You will not find that our cost of credit goes higher. So I don't assume that according to the data here and according [indiscernible] review that they just gave about the real estate exposure, which is 1 of our biggest drivers in our pace of growth. I don't expect that our cost of risk will be different or higher than our peers.

There are no further questions at this time. This concludes the Bank Leumi Third quarter 2023 results conference call. Thank you for calling in. You can disconnect.