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

Ladies and gentlemen, thank you for standing by. Welcome to Leumi's Fourth Quarter and Full Year 2023 Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded March 19, 2024. I would like to remind everyone that forward-looking statements for the respected company's business, financial condition and results of this 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 and 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 over the call to Mr. Michael Klahr, Head of Investor Relations, Mr. Klahr please go ahead.

Thank you, operator. Ladies and gentlemen, we thank you for taking the time to join us for Bank Leumi's Fourth Quarter and Full Year 2023 Results Conference Call. Joining me today is Mr. Hanan Friedman, President and CEO; Mr. Omer Ziv, Deputy CEO and Head of the Capital Markets division; and Ms. Hagit Argov, CFO and Head of the Finance division. We are also joined by our colleague, Dr. Gil Bufman, Chief Economist. A presentation will be presented during the call for those joining by Link and will also be available on the IR section of the bank's website for those dialing in. I would now like to turn the call over to Hanan.

Thank you, Michael. Good afternoon. Earlier today, we published our 2023 financial results. Although 2023 has been a challenging year on both the local and global macroeconomic landscape, I am pleased to say that we have demonstrated strong results in accordance with our targeted growth strategy. Excluding the depreciation from the Valley stock in the bank's financial statements, our ROE reached 15.9%, a high rate considering the events of 2023. We have displayed significant growth in our net interest income, resulting an increase of 22.9%. The Income from fees and commissions increased by 7%, while our expenses were almost flat, a moderate growth of only 3%. Our cost-to-income ratio continued its positive trend, reaching an annual rate of 32.6% and remains the best in the Israel banking system. In line with our strategy, one of our goals this year was fast growth of our mortgage portfolio and the large-scale cooperation segments, including residential real estate. While these lines of business may offer lower margins, they present much lower risk levels, which definitely is an advantage in the current situation. Since the beginning of the war, we have been well prepared with high liquidity levels and substantial equity reserves, positioning us well for the anticipated growth in the post war period. Entering 2024, Leumi's holds clear strategy targeting specific areas that best serve our ROE objectives and are aligned with our risk appetite. The targeted growth potential is still far from being tapped. The leverage level in the Israel market, households and business segments are still low. This, together with the potential of additional income from existing bank customers leaves much room for growth and optimism for the post-war days. We proved this year that we have outstanding execution capabilities based on being focused and based on our technology capabilities, which together enable us to effectively and rapidly translate strategy into tangible results. An excellent example is our success in executing our growth strategy in the mortgage sector. It took us only 2 years to increase our market share significantly. And today, our market share in new mortgages is over 30%. At the beginning of the process, it was just 14. We did this without comparison on risk management while maintaining the lowest rate of high-risk mortgages in the market. For example, according to Bank of Israel report of December 2023, our high-risk mortgages are 34% lower than the average of the market. This can also be learned from our low NPL ratio in the housing segment compared with the rest of the Israel banking system. In 2023, the total of our mortgage loans increased by more than 9%, much higher than our competitors. And we did it while maintaining prices at the average of the market. I must say that it's even more impressive given that this landmark was achieved against an uncertain macroeconomic backdrop with high inflation, high interest rates and the slowdown of the activity in the real estate market. So how did we achieve this? We utilized our advanced digital platforms to offer flexible user-friendly mortgage services, which allowed us to complete a mortgage transaction remotely in a matter of hours like mortgage by Zoom, while leveraging the mortgages to acquire new customers. A success in the mortgage sector is evidence of our excellent execution capabilities. I am confident that we will attain similar success in other focus areas we are implementing now; all while keeping risk levels in light of our conservative risk appetite. Another enabler is utilization of our technological edge in order to evolve into efficient, lean and edge organization, integrating advanced technologies, including air tools and expanding the range of features available remotely have encouraged customers to shift towards our personalized digital services. This, combined with the automation of operational processes has increased our productivity and enabled us to achieve more with fewer resources and to reduce our workforce. A recent example of this is the state guaranteed loans fund launched at the beginning of the war, where we obtained a market share that exceeds our general market share by more than 25%. Apart from our technological achievements, enhancing our operational flexibility has also played an important role. We signed a 4-year collective agreement that grants us additional new way in managing our human capital moving forward. Moreover, this week, we completed the move of our headquarters to the new campus near load. This transition holds several upsides. First, it's great for cost streamlining. Second, we can now record a profit of over ILS 800 million from the sale of our previous headquarters that will be done in the first quarter. And third, the consolidation of units within the same campus will enable a further leap in synergies between lines of business. Based on current projections, Israel is expected to experience moderate growth in 2024. As commonly observed, markets often compensate for their underperformance by a rebound in the post-war scenarios. Therefore, we have the perfect storm to execute our growth strategy in focus areas. Entering 2024, Leumi is committed to maintaining the quality of our credit portfolio in accordance with our conservative DNA. With no substantial groups and our NPL ratio of 0.85% is significantly lower than our competitors. As a result of the war, we recorded an increase in collective provisions driven by external macroeconomic factors. However, our specific credit losses remain minimal, highlighting the quality of our risk management capabilities and the success of our strategy. Throughout 2023, Leumi distributed dividends and made buyback transactions amounting to ILS 2.35 billion with significant equity reserves. We are optimistic that soon the regulator will allow us to increase our dividend distribution. On a personal note, on October 7, Israel was truly attacked, leaving us all shocked. A chain of events since then has had significant impact on the Israeli society. I would like to share with you how proud I am of our employees and the organization for pushing through from the beginning of the war and right up to today. In spite of everything, we were determined to lend initiatives for the benefit of our customers and the Israeli society. We granted benefits and waivers to the affected population. In addition, we launched several philanthropic initiatives, including supporting the rebuilding process of Kibbutz Be'eri, supplying much-needed workers to the farmers in Gaza by funding grants to students who came to replace the foreign workers. Recently, we also launched a plan to help young students overcome the gaps in order to successfully pass the matriculation exams. I would like to take this opportunity of thanking our stakeholders, our employees, our customers and you, our investors, for your continued support. With that, I will hand over to Hagit, who will walk you through the financial results.

Thank you, Hanan. Hello, everybody. Good afternoon. Before we discuss the bank's provision in more detail currently [Technical Difficulty] on the macro situation in some key results. Slide 3 shows some key economic indicators. While we expect lower economic activity in 2024 due to the war in Gaza, the Israel economy started this period in strong health and we are already seeing some small signs of recovery, for example, in consumption and employment since the start of the year. Bank Leumi estimates that GDP will grow at 1.8% this year and 5% in 2025 with an emphasis on government consumption, both civilian and defense and also investments in fixed assets, including construction. We also expect the private consumption will rise as value displays, household start to rebuild their purchases of durable goods. Slide 4 shows that despite the challenge in the environment, Bank Leumi was again able to report a strong set of full year financials, continuing the positive performance of recent years. Over the last 3 years, we have grown our revenue by 42%, while keeping our costs almost flat. Adjusted ROE in 2023 increased to almost 16%. On Slide 5 are the key messages from the quarter. The IronSource war, which began in Israel on 7 October, resulted in, among other things, a decline in economic activity and an increase in economic uncertainty and risk. In addition to the government ad package and the various bank of sale to soften the economic impact on how sales incorporate further measures taken by Bank Leumi include exemptions and deferrals on loan payments and cuts to feed for affected customers. The bank has also established a head fund to support the rebuilding and rehabilitation of Kibbutz Be'eri on the Gaza boarder. Assuming that 100% of the eligible customers take advantage of these benefits, the bank estimates that the cost would be around ILS 575 million, which includes present and projected future claims for these benefits. In the first quarter of 2023, the bank reported net income of ILS 1.8 billion and ROE of almost 14% despite the weaker economic activity due to the war and the high quarterly provision, the bank will distribute 20% of fourth quarter profits as dividends, in line with Bank of Israel directives. This brings the total dividend distribution for 2023 to ILS 1.75 billion, which in addition to ILS 600 million buyback is equal to a 33% payout and a yield of more than 5%. Continuing with the result for the full year and Q4, let us turn to Slide 6. Net income for 2023 was ILS 7 billion, which includes the ILS 1.1 billion impairment of the bank's stake in value in the first quarter and the higher provisions in the second half of the year. ROE for 2022, excluding the value impairment, was 15.9% compared with 15.6% in 2022, which excludes profits from the sales of BLUSA that were recorded in the previous year. The cost income ratio declined to 32.6% in 2023 from 37.2% in 2022. Here, I wish to point out that the credit expenses were 0.63% in the quarter and 0.58% for the full year, mainly due to an increase in collective provisions as a result of the geopolitical situation. Credit grew by 9% in 2023, while core deposits to private individuals, a key focus for the bank grew by almost 7%. And Slide 7 shows the breakdown of income and expenses for the full year. Pre-provision net revenue, bottom right-hand side chart, increased 27% year-on-year to ILS 14.3 billion, supported by higher financing income and higher fees. Operating expenses were up 3.2% year-on-year. Slide 8 shows a snapshot of income and expenses in Q4, while net interest income increased year-on-year and fees were also up strongly, pre-provision net revenue was down year-on-year, mainly due to lower noninterest in financing income. Net interest income was negatively impacted by the weaker CPI in the fourth quarter versus Q4 2022. In Slide 9, we can see the quarterly development of net interest income and margin when excluding the impact of the CPI. Net interest income increased by more than 30% in 2023 to ILS 14.8 billion, while in the fourth quarter, it increased 8.7% to ILS 3.8 billion due to higher levels of activity and also helped by a strong NIM. I would like also to draw your attention to the fact that despite the macroeconomic environment, we were able to increase the NIM excluding the CPI in Q4, third with Q3. Slide 10 shows the year-on-year increase and breakdown of fee and commission income. These were up 7.2% in 2023 and 8.7% in the fourth quarter, mainly due to an increase in financing transactions supported by the increase in credit activity. As you can see in the chart at the top right of the page, this is ongoing trend. On Slide 11, you can see the continued improvement in the bank's cost income ratio, which improved further in 2023 to 32.6% from 37.2% in 2022. Slide 12 shows the development of loan loss expenses. Q4 credit expenses on the right, stood at 0.63%, down from 0.95% in the previous quarter, with most of the costs coming from the collective provision, which reflects the slower economic activity and increased level of uncertainty. Credit expenses for the full year were 0.58% from 0.13% in 2022, with almost all the increase coming from the collective provision. The specific credit loss expense ratio for the total year of 2023 was only 0.08% out of the 0.58%. Indeed, as can be seen on Slide 13, the bank prudently increased provision for doubtful debt by ILS 1.7 billion in 2023 to ILS 6.7 billion or 1.5% of gross loans. At the same time, let me highlight the NPS of 0.85% on the left and total troubled debt of 1.78% remain at historically low levels and are among the lowest in the Israeli banking sector. I'm moving ahead now to Slide 14. This slide shows that our loan book increased to ILS 419.5 billion in 2023, a 9% increase since the end of 2022. We continue to grow in all our target segment, which are mortgages, middle market and corporate sectors. Slide 15 shows deposit trends. Here, we highlight the growth in core deposits, top left from private individuals, a key focus area of the bank. This increased by 7% in 2023. It is also important to note that our deposit base on the right is well diversified and our liquidity ratios remain strong. Slide 16 shows the bank's solid capital ratios. The core Tier 1 capital ratio on the left was 11.66%, up from 11.3% at the end of the third quarter, giving the bank a significant buffer. The total capital ratio in the middle stood at 14.72%. The bank's leverage ratios have also been increasing as can be seen in the graph on the right. Finally, Slide 17 summarizes the key takeaways from the quarter. Bank Leumi was able to achieve a healthy letting ROE despite the challenging economic backdrop. Asset growth, together with strong margins, are driving higher net interest income and fees. We benefit from our best-in-class cost income ratio. NPLs remained low with strong coverage while our large capital buffer and strong liquidity provide us with lots of flexibility to grow or to increase capital return depending on the market conditions. It is worth noting that the bank will record more than ILS 800 million of pretax profits in the first quarter of 2024 from selling 2 headquarters building. In conclusion, Bank Leumi continues to present consistent and strong financial performance supported by best-in-class cost income ratio and robust credit quality indicators. The bank's strong profitability and healthy capital buffer enable us to continue to grow market share in our target segments and put Leumi in a strong position for the future despite the effect of the world. With that, I will now open the call for questions. Operator?

[Operator Instructions]. The first question is from Ulle Adamson.

This is Ulle Adamson from T. Rowe Price. I have a question regarding the asset quality. Are you starting to see any pressures at all in any segments you have specifically in construction, commercial real estate, whether some issues with workforce post the war started. So any comments on the quality of the outlook and especially if this war was superior for several months, where do you expect to start seeing pressures?

I will answer as follows. First of all, we did see a slowdown in October and November, but since the end of December, we start to see increase in pace of sales in almost all of our projects. And we start to see the economy in different sector start to recover. When we talk specifically about construction loans, our mitigation to the increase of the risk in the geopolitical circumstances is mainly based on increased equity requirement in each project, making different scenario in order to predict what can happen. And of course, tightening different parameters in our underwriting system. On average, I would say that the pace of sales in our project is around 17%. The pace of completion is around 60%. When you look at our absorption rate, you will find that the power form 1 project with absorption rate, which is around 25%, the vast [Technical Difficulty]. When we look at LTV, we'll find that the loans with LTV above 18% decreased significantly. In fact, for a couple of months due to regulation, we are not granting any more loans with LTV above 80%. And by the end of the year, these loans are expected to be a negligible number. So overall, we don't expect a significant increase in our provision in construction loans. As for office space, our appetite for office space loan for years was very moderate. The vast majority of our projects are preleased or presale. So also in this area, we don't expect a significant increase in provision. And as for commercial real estate, the vast majority of the loans are around logistics center or a small neighbor commercial center. And also there, we see a significant increase in internal of credit cards. So also there, we don't see a significant increase in risk. Just to give you more details from our total exposure in real estate, about 60% is related to construction, 15% related to office space and around 15% related to commercial real estate. The vast majority of our customers are very strong customers. Lots of loans are with a personal guarantee. It's very strong collateral. So the bottom line is that we don't expect significant increase in our credit loss expenses in the following quarters in real estate. I would like also to point out what Hanan and Hagit mentioned that if you look at the main parameters, which are objective and reflect the quality of our credit portfolio, so our NPL is 0.8%, one of the lowest in the industry. And if you look at the ratio of the trouble debt out of the total debt, it's only 1.8%, the lowest ratio among our peers.

The next question is from Chris Reimer of Barclays.

Congratulations on the solid results. I wanted to ask about building and other expenses, which have been up over the year. Given that you've completed the transition of the headquarters; can we expect an immediate reduction there? Or will it take a little longer?

Chris, I would say as following. First of all, as Hanan mentioned, this year, despite the fact that our finance income increased by around 20%. The overall cost increased by only 3%. Now when you look at other expenses, you should bear in mind that the other expenses include salary expenses because significant part of the pension costs, which are, in effect, salary expenses are recorded in other expenses. As Hagit presented in your presentation, when you put the pension expenses together with the salary expenses, we will not find a significant increase in other expenses. I would also like to mention that the fourth quarter include onetime expenses related to the pension liabilities of ILS 160 million, which is not expected to be repeated in the following quarter. And also, I would like to point it out that the more we use our technology, the more you will see a transfer from salary expenses to IT expenses, as you saw in this year, because the more technology we are, we need more places in the cloud, for example, but we can be more efficient in our salary expenses. So overall, this year, as in previous years, we were able to increase significantly the income. At the same time, the expenses increase was very moderate. And this is the major reason why in this year as in the previous years, we were able consistently to continue to decrease our cost income ratio, which is below 32% for the total year.

And you gave some great commentary about the real estate segment of the loan book. How would you characterize the other various segments, if there's any changing trends especially over the last 3 months versus the last 6 months?

So I would say like this, the most exposure sectors to the effect of the war with Hamas of course, the individual sectors, unsecured retail and the small business and in this sector, you will see in the financial that actually, we decreased our credit portfolio, most of this segment in the fourth quarter. I would also say that from our total credit portfolio, only 13% is composed of unsecured retail and SME. So overall, these segments have, of course, the highest margins in the loan, but also the highest risk, and we are at least in this period, as we were in previous years, but of course, in this year, in this period, it's more important, we were very cautious regarding our growth in this segment in the last few quarters. And looking forward, it really depends how the situation will developed. We strongly believe when and we see it in the last couple of months, gradually, the economy situation in Israel is improved gradually.

The next question is from Yuri [indiscernible].

Congratulations for your great results. I have a couple of questions. I would start by your NIM trend. Excluding CPI, I see that your NIM was increasing. So I would like to know what drove the increase. If I'm not mistaken, none of the other banks in the sector actually reported increase in NIM this quarter.

I would like to say that we were also surprised to see the increase in the NIM excluding CPI in the fourth quarter. I believe it's coming from fewer components. First of all, the movement of money from client account to time deposit almost top in the last couple of months. Secondly, with 2 different measures in order to improve our profitability, both in terms of credit and in terms of deposits. Thirdly, the capital market was much better in the fourth quarter compared to the third quarter. So it's a combination of things. Now looking forward, if you ask me whether we will be able to continue to increase our NIM in the following quarters, I will not say that. But I will say that we continue to invest a huge effort as we did in the last quarter in order to try to mitigate that. Expect that decrease in NIM as a result of the decrease in the interest rate, so we will be able to decrease this expected decrease to minimum.

So you mentioned the movement from the current account to bank deposit. Do you think that it really stopped or did you see some money passing from non interest current accounts to time deposits?

Looking back for the last few months, it's still relatively stable. And if we expect and we do expect that the interest rate is in downward trend. So it seems to me that the chance that we will see a significant additional movement on current account to time deposit is a low.

And let's talk about value a little bit. Can you please -- when I check today the market value, if I'm not mistaken, of your folding in Valley is the ILS 1.6 billion while the book value of value in your books at the end of the year was 2.63%? Do you consider any write-down again in the coming months? So is it possible to see later on a write-off if things are getting better in labor?

I would answer as following. First of all, you are right that since the beginning of the year, there was a significant decline in Valley stock price as another original bank due to what happened with NYCB. This bank has a problem with this provision. And as a result, there was a negative effect on all of the regional bank in the U.S., including Valley. When we look specifically on Valley data, we just mentioned a few data, the write-offs in Valley is only 14 basis points out of their total loans. The allowance out of the total loans is stable, around 93 basis points, even lower than 2022. So based on data and other data, the total exposure to office space is only $3.3 billion. It's around 5%, and there is project to [indiscernible] office loan is only $300 million. So based on this data and other data, we believe that the market reaction, what happened with NYCB is a bit overreacted. But of course, we have to be patient and see how it will develop in the following month. On top of that, I would like to say that, as you mentioned, that Valley is recorded in our financials by only ILS 2.6 billion out of ILS 731 billion total balance sheet. So in terms of Bank Leumi, Valley is important, but their effect on our result is not significant. And even if I will take into account a negative scenario in which their market value will not improve significantly in the following months, it means only a few hundred million shekel impairment according to your calculation, which its effect on our ROE is less than 0.1%, even if I take an extreme scenario. So the bottom line is that we do expect that value stock price will improve. We should, of course, wait a few months and see whether our expectation will come into effect on that. And the total effect of Valley on our results, as I mentioned, are not significant. Looking forward, the profit that we recalled from Valley are recorded in 2 lines, in the equity line as equity profit every quarter in line with the profit at the value reported every quarter. And in the net interest income due to participation that we are making this ad.

And the last question is regarding your dividend. I understand that the guidance from BOI was to control or maybe to reduce dividends made payments. But as I see Bank Leumi and all other banks now accumulate too much on a lot of equity, a lot of the liquidity. And so when do you expect to resume normal dividend distribution? Again, are you in talks with the BOI I don't know, to resolve the situation?

I would say that you are totally right. Our equity buffers are quite increased. We have a Tier 1 of 11.7% total equity ratio of almost 15%. And we have all the ability in terms of liquidity ratio as well as equity ratio to increase our dividend distribution ratio. As you mentioned, due to the geopolitical situation, the Bank of Israel, as in the past, prefer to be more cautious and strike the bank to be very cautious in their dividend return. It's obvious that this cannot be for a long period. I expect that -- first of all, in Israel, the situation has improved month after month we don’t see any extreme negative scenario, which the chance that we see is relatively low. We expect that during 2022, I cannot put any finger -- during 2024, the Bank of Israel the bank to pay dividend as they can do. I would like just to emphasize that in previous years, with this equity ratio, we mix the dividend not only by dividend but also by buyback plan. So they were used not long ago that we distributed about 60% payout ratio every year.

Yes, but you haven't completed the full program, yet.

This program is finished. But of course, we have the ability to approve another lens when it is possible.

We also mentioned that the current guideline of Bank of Israel was just for 2 guidelines. First was at the beginning of the world for the previous quarter. And recently, we got for this quarter. So I assume that soon we will push hard Bank of Israel not to issue additional guidelines like they did the last quarter.

[Operator Instructions]. The next question is from Valentina [indiscernible] of Barclays.

I was just wondering whether you can give us some color on the deferred loss portfolio. What trends do you see in the first month of this year? And also if you can share whether you have made some provisioning gains in deferrals and how much you expect extra provisioning to take this year for the deferrals? And my last question is on the bank levy, if you can share a bit more color on bank levy the impact on the bank.

I will say like this. First of all, in the financial report that the total grades in our loan is ILS 1.6 billion out of a portfolio of ILS 426 billion, so it's negligible. And as I mentioned earlier, we are not expected increase in our credit loss expense ratio in 2024, unless we will be in very negative extreme scenario, but currently it doesn't seem reasonable. That's fair. Now regarding the tax that you mentioned, the tax on banks that was put on hold last week. So according to this legislation in 2024 and in 2025, there is an additional tax on banks of 6% is like a tax. Actually, in 2024, it's only 5.5% due to the fact that the registration just passed a week ago. There is a ceiling of total payment of the total industry of ILS 1.2 billion in 2024 and ILS 1.3 billion in 2025. So based on this ceiling and based on the fact that Bank Leumi is unique by this respect because we have a relatively high pension liability with high deferred tax asset. So it means that because of this increase, we will record the benefit in our deferred tax that related mainly to this pension liability. The total effect on our results in 2024 as well as in 2025 is not expected to be significant. We assume that it might be around 0.5% of our ROE at most.

The next question is from Ulle Adamson.

This is Ulle Adamson from T. Rowe Price again. I just have a couple of follow-up questions. Bank Leumi has 2 Tier 2 instruments your bonds outstanding, which seems to be pricing in a potential extension risk, just as much as you can comment what would be the bank policy of calling its Tier 2 notes at the first call date. And especially as you talked about the dividends and the capital buffers, how comfortable you would be potentially doing that? And secondly, are you concerned about losing their BB ratings on the Tier 2s and A ratings on the bank itself?

Regarding the call of Tier 2, when you look backwards, we issued already fuel Tier 2 vehicle, and we paid them back at the call date. We prefer to pay them other call date. For 2 reasons, first of all, we understand that this is the expectation of our investors, and we expect that. It's very important to us to keep a long-term relationship with all of our investors. We did it in the past. There is no reason that we will not do it in the future. Secondly, if we don't call it, it means that even though we paid their higher interest rates, the benefit that we see in the equity from that reduced significantly. We have already a significant buffer in our equity ratio. So it's too early. Now we are just at the beginning of 2024, but we don't expect, at least at this stage, not to call them in the call date in 2 years from now. The second question, the rating of the bank in Israel is affected by the geopolitical situations. It's very hard to predict how the geopolitical situation with the be of. We do see improvement in the last couple of months, and we expect this improvement to continue, but we have to be more patient. Till now only one rating agency decreased the rating, so we are still rated A, I would say, across the board. The chance that we will see a significant decrease in rating according to our expectation is relatively low.

There are no further questions at this time. This concludes Leumi's Fourth Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.