Israel Discount Bank Limited (DSCT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank First Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, May 27, 2020. If you have not yet done so, please access the presentation on the bank's website, investors.discountbank.co.il. I would like to remind everyone that forward-looking statements with respect to the company's business, financial position 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. Ms. Koblenz, would you like to begin?

It's David Kaplan instead of Ms. Koblenz. Sorry about that. But anyway, thank you all for joining us. Good afternoon, and welcome to Discount Bank's First Quarter 2020 Financial Results Conference Call. Participating in today's call are our CFO, Barak Nardi; and Joseph Beressi, our Chief Accountant. We will start with a summary of the results by Barak, and then we will open it up for questions. Now handing over to Barak.

Thank you, David. Good afternoon. I hope you are all healthy and slowly returning to some form of normal. I'll start with Slide 3. Discount took a number of steps to help our customers and employees to get through this difficult time. With the breakout of COVID-19 in Israel, we established a management task force to structure and lead the way we operated during COVID-19. We applied a series of immediate measures and adjusted the way we operated. We kept our branch network as active as possible, given the restrictions, expanded call center hours and the functionality of our digital channels. We took special care to maintain business continuity and to ensure our employees' health as critical employees operated in capsules to ensure safe social-distancing practices, and many other employees work from home. When it comes to our customers, we provided a number of financial assistance packages, including mortgage and credit card forbearance, allowing to break term deposits at no cost and short-term loans to customers and SME through the government-backed small business fund. Discount Group lent out ILS 1.8 billion to roughly [ 4,800 ] customers as part of the program. Lastly, we also provided assistance to the wider community through volunteering, donations and accelerating payments to our suppliers. Turning to Slide 4. Our clear message today is that the Discount Group entered 2020 with a very strong balance sheet and solid cushions over regulatory requirements, putting it in a resilient position and ability to navigate this downturn successfully. This is substantially related to the bank's success over the past 6 years in changing the way we work and reshaping ourselves to be a different bank. Our total equity continues to grow, amounting to ILS 19.4 billion, a 7.2% increase in the last 12 months. Common equity tier 1 ratio stands at 9.99%, reflecting a 1.1% cushion over our Board target. In order to ensure the bank -- that banks will be able to support customers' credit needs, the Banking Supervision department temporarily reduced the minimum threshold required for common equity tier 1 and total capital ratio. Accordingly, our Board CET1 ratio target was lowered to 8.9% from 9.9%. Further to the supervision guidelines, we temporarily suspended our dividend distribution. LCR and leverage ratios continue to be well above the regulatory target, allowing us sufficient room for growth. Obviously, the economic crisis created by the disruption of COVID-19 is having a significant negative impact and will no doubt lead to higher LLP. At this relatively early stage, more of the losses can still be classified as expected losses and have not yet been realized. In light of these expectations, we have increased our allowance for credit losses, which is now equal to 1.63% of the credit book. On Slide 5, we provide some of the highlights of the quarter. Obviously, the financial results of Q1 2020 were also shadowed by COVID-19. Net income was down to ILS 279 million with ROE of 6%. However, in spite of all of the challenges, the bank continued to operate in all areas, generating profit from our superior asset liability management team, growing our loan book and maintaining strict cost discipline that resulted in costs remaining flat year-over-year and down 8% versus Q4 2019. Slide 6 shows how COVID is impacting the trends in our loan book. While we did see growth on both a quarterly and a year-on-year comparison, the growth -- comparison, the growth was mainly driven by mortgages and corporate lending. Consumer borrowing as well as debt of small and medium businesses slowed as we saw a drop-off in demand and activity due to COVID. These trends were similar across the banking sector. According to a Bank of Israel report on the Israeli banking system, March saw significant growth in credit, mainly in corporate, while in April, the total credit in the system franked. This finding highlights the slowdown of the economy and the impact of the shutdown. Our revenue growth and the diversified source of business are the focus on Slide 7. Our total income grew this quarter by 13% as compared with the first quarter of 2019. We see growth in all areas of our business, including lending, fees and trading. Our income from current operations advanced nicely on both a quarterly and annual basis, 2% during this quarter and 5.8% year-on-year. Fee income continued to grow year-over-year. The decline in fees during this quarter reflects the slowdown we saw in our credit card business due to the lockdown. Noninterest income was up significantly as a result of a gain from realization of some of our bond portfolio early in the quarter and income from derivatives and FX differences. Moving to the right side of the slide. NII as compared with a year ago was up 2.4% or ILS 34 million. That increase of ILS 34 million is broken down between volume of ILS 96 million as our loan book grew 7.6%, while pricing contribution was minus ILS 62 million, impacted by the macro environment as the fed rate, LIBOR, Israel CPI and the Bank of Israel rate were all down or flat and offset the gain from volumes. Accordingly, NIM was down from 2.66% to 2.47%. Moving now to Slide 8. Cost income ratio was down this quarter to 58.6%, the lowest level in many years and clearly impacted by COVID-19. High level of noninterest income and low level of expenses, mainly driven by a reduction of profit-based expenses like bonuses and payments to credit card partners and by lower yields impacting our pension liabilities, all contributed to the low cost-income ratio and significantly positive Jaws. Reserve build of provision for credit losses is the most impactful item on our P&L in the quarter, and we review it on Slide 9. While there was a small reserve build applied in Q4, the majority of our reserves came in Q1 and can clearly be seen in the significant increase in general provisions from ILS 153 million in Q4 to ILS 518 million in Q1. This reserve build resulted in a ILS 656 million credit loss expenses on the P&L, constituting 1.42% of total credit. As I mentioned earlier, we believe that our reserve reflects the inherent risk in our portfolio as uncertainty is high. The increase in the reserve includes significant updates to the statistical model we apply on group provisions. The breakdown of the ILS 656 million credit loss expenses is ILS 545 million on group provisions, including mortgages; and ILS 111 million on specific provisions. Slide 10 demonstrates the material improvement of our loan book in recent years due to the tightening of our underwriting standards, monitoring capabilities and overall improvement in processes. While we grow the loan book year-after-year, credit quality indicators improved and even closed the gap we historically had with peers up until the end of Q3 '19. Obviously, COVID-19 has changed that trend for now, again, similar to what we see with our peers. We estimate that post crisis like this one, that it is likely to take 6 to 9 months for the provision cycle to run its course. In the next few slides, we will review the results of our main subsidiaries, starting with IDB in New York, on Slide 12. IDB New York managed to deliver a strong quarter despite its reserve build that saw LLP increase from low single digits to $15 million. This was significantly mitigated by noninterest income, driven by gains on the sale of bonds, facilitating customer derivative contracts and by credit growth. Cost reduction was a major theme in New York, and its cost-income ratio decreased to 51.6%. On the next slide, we highlight the results of Mercantile. The same COVID-19 trends we have seen in Discount are relevant for Mercantile as well. Here also, the increase in general provisions in light of COVID-19 led to significantly lower net income and ROE. Results then have been the run rate in the recent past. Mercantile saw a small decrease in credit on the backdrop of a dip consumer -- a dip in consumer and small and micro businesses demand for new credit. Mortgages and medium enterprise -- mortgages to medium enterprises, on the other hand, continued to grow. Q1 was the first full quarter to include the full consolidation of Municipal Bank. The integration of Municipal's business is going well and opens new business opportunities for Mercantile. The final subsidiary, which we will highlight today is Cal, our consumer credit card company. Cal continues to demonstrate its ability to grow, having added over 200,000 new active cards in the past 12 months and a 10% increase in the transaction turnover. The transaction turnover grew at a slower pace than last year due to the impact of the global lockdown. We are starting to see signs of a recovery in the credit card business. The Bank of Israel published a report a week ago showing the total spending in credit card in Israel on May 18 was only 12% lower than the beginning of the year as compared with spending in credit cards on April 17 that was 42% lower than the beginning of the year. The COVID-19 had a significant impact on Cal's bottom line. Cal recorded a loss of ILS 7 million due to a ILS 105 million credit loss expenses offsetting the growth of 9.3% in total income. This sums up the financial review of Q1 '20. And before we open the call for your questions, I would like to briefly elaborate on where we stand in terms of our strategy on Slide 16. Through COVID-19, we recognized how the new circumstances accelerated trends that the banking industry has been facing in recent years. Clearly, the most notable one regards to the even stronger shift to digital, where quick adoption of digital was evident across different populations and ages. Another related trend is the acceleration of reduction in the usage of physical branches on account of virtual channels. We also see changes in the way companies work. The most evident one is the remote working or a mix of in-place and remote working. This new mode of working is a chance to improve and modernize processes and save some of the costs associated with physical presence. All these trends accelerate our existing strategic focus and provide even greater potential, mainly in the areas of cost-cutting and streamline processes. Moving to Slide 17. One of the impact of COVID on our business is the effect it has on our ability to accurately forecast our financial performance. As such, we have put our 2021 financial targets under review. On the other hand, COVID-19 does not prevent us from looking ahead and building our future. As we said in the previous quarter, we identified 5 areas that we plan to focus on in the coming years in order to further increase the group's value. These areas of potential are based on our current strategy, along with some adjustments made to reflect the changing banking industry and the macro environment. I will not go into each of them again but would only discuss the second area of potential as an example. Although it has improved dramatically in recent years, our underlying cost-income ratio is still higher than peers. Most of the gap comes from salary costs, and we believe that we have the potential to enhance cost-cutting measures there. Now with the insight from COVID-19, we understand that we can further push our internal cost-cutting targets based on a faster shift of our customers to digital savings related to a mix of remote and in-office working as well as other factors. To summarize. When I joined Discount Bank only 5 months ago and after closely following its transformation over the last years, I realized that even with all the great achievements the bank has marked in recent years, we still have a material potential across the group, and now even more. I'm confident that our identified potential, backed by our proven execution capabilities and our robust platform, will continue the positive track record achieved in recent years. Thank you, and we can now open it up for your questions.

[Operator Instructions] The first question is from Bruce Schoenfeld of BlueStar Global Investors.

Sorry, I was muted. Can you provide a little more detail on the cost-to-income improvement in this quarter? Specifically, how much is kind of one-off due to the pandemic and the closure of the economy? And how much of that improvement might be sustainable going forward?

So as I mentioned before, the cost-income was highly impacted by items that are related to COVID-19. The 2 main items we can say. One is the bonus payment that we didn't accrue for in Q1 because we are below our target. And the second item is lower yields impacting our pension liabilities. Both of them contributed -- had a significant impact. So I cannot give you the exact breakdown of what -- how much is coming from this and how much it's representing. But of course, the 58% that we are currently -- are showing is not representing the actual going forward cost-income ratio we have. At the same time -- just wait, one more thing. At the same time, we are focusing a lot on cost cutting. And of course, some of the improvement we can see in our results are as a result of the steps we are taking even before the corona and throughout the corona on cost-cutting measures that, of course, should remain with us also after the COVID is over.

The next question is from Tavy Rosner of Barclays.

I had a follow-up with regards to your comments on the provision side. The instructions from the Bank of Israel a couple of weeks ago gave all the CFOs kind of a lot of leeway to make their own assessment with regards to provisions. So I guess when you look at your reserve build, what does that cover? Does that cover specific industries that you have in mind or it reflects your analysis of your portfolio where you think that some of the borrowers won't be able to pay back within the next 6 months? Can you just run me through the thought process that led you to provision that number?

Yes. Sure. So it's not a specific related. And as I said before, most of it comes from a general provision. And we currently believe that our loan loss provision and the increase in allowance for credit losses reflect the potential that is embedded -- currently embedded in our current loan book. At this relatively early stage, most of the losses are classified as expected loss and yet to be realized. We do believe that after such a crisis, it takes between 6 to 9 months for the expected loss to materialize. So we need to wait and see whether this amount we've put in Q1 reflects accurately the actual loss that we are going to see in the future.

Right. I understand. And then you talked about the strategy with regards to some efficiency potential. And I guess in the context of COVID and with a lot of your customer moving to digital and a lot of employees kind of working from home, I would think that you have now a great opportunity to launch another wave of streamlining by reducing some of the real estate footage and so on. Do you have anything in the pipeline that you can comment on?

So I won't be very specific. But generally speaking, even before the corona, we identified the cost area. The efficiency is the biggest potential for us, a very significant potential. And as you said, the COVID trends we are seeing even drive it to even make the potential higher. And the potential comes from 2 areas: one, customers moving to digital and not coming to branches and using -- calling call centers. So this is one very positive trend as the reduced usage of branches on account of usage of virtual channels, again, can drive another efficiency measure. And also using less people. One of the things we find during this crisis that although many employees were on vacation, the bank runs almost as usual. So this gives some confidence that we can reduce our task force. So of course, we have already thinkings around what we need to do, and I'm quite confident that we will be able to deliver our very challenging targets around cost cutting.

The next question is from Borja Ramirez of Citi.

I have 2 quick questions. One is a follow-up on loan losses. Assuming there is no further outbreak of COVID-19, is it a safe assumption to assume that the cost of risk could be lower in coming quarters? And then my second question is on margin. Your deposits showed strong growth quarter-over-quarter. Could you provide details on the potential impact on the net interest margin? And also, could you provide your views on margin trends going forward?

So regarding your first question, as I said before, the current levels of losses and allowances reflect our best estimation of the inherent potential losses. And I can't give you any specific estimation about Q2 or further quarters. But you need to bear in mind that 1.42% loan loss provision that we presented in Q1 is reflecting COVID impact. It is too early to talk about return to normal or how LLP will progress even in theory because there is uncertainty around the length and depth of the crisis, both in terms of health and the economic aspects. There is also uncertainty regarding the pace of recovery. So we need to see. If theoretically, and only on a theoretical basis, if we -- the health epidemic in Israel is behind us and we estimated correctly the impact on our current portfolio, then in the next quarter, it should start to go down. But I think it's too early, and there is a lot of uncertainty, so we need to wait and see. Regarding the second question of NIM. So yes, you've opened with deposits. Yes, we did see a big deposit growth, mainly of our customers getting out of stocks and stock market and then move the money into deposit. So this is the main driver. The NIM was down a little bit, mainly because of 2 things. In Israel, it's the CPI. The CPI, we had a negative CPI of almost of 0.5%, and it had a negative impact on NIM. And the second reason is the LIBOR going down, and it had its impact on our U.S. business. So this was those 2 macro parameters, CPI and LIBOR, that impacted the decline in NIM in Q1 versus Q4 2019.

[Operator Instructions] There are no further questions at this time. Mr. Kaplan, would you like to make your concluding statement?

Thanks, everyone, for joining us, and we look forward to talking with you in a couple of months. Have a good day.

Thank you. This concludes the Israel Discount Bank's First Quarter 2020 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.