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

Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank Second Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded August 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 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. Ms. Koblenz, would you like to begin?

Thank you, Jani. Good afternoon and welcome to Discount Bank second quarter financial results conference call. I will now hand over to Barak Nardi, CFO.

Thank you, Tamar. Good afternoon and I hope you are all healthy and slowly returning to some form of normal. I'll start with Slide 3. The second quarter was heavily impacted by COVID-19 as the economy was shut down for around 5 weeks. In this slide, we present some of the factors that reflect the changes in the environment we are operating in. As a result of the slowdown in business activity and high uncertainty in the market, demand for credit decreased, especially in the household segment. On other end, mortgages grew and developing market is still strong. The commercial and corporate sectors were supported in part by the government-backed lending program. Credit card spending in the quarter saw a significant drop off during the shutdown that began to recover as the restrictions were lifted and is now almost back to where we were at the beginning of the year. In light of the economic situation, we are also seeing increased level of loan deferrals, which reached 15.7% of the total credit in the system according to Bank of Israel data. Another important data point is the grace period given to mortgage customers presented on the lower right-hand side of the slide. The mortgage market saw the number of loans in a grace period increase from 3.4% to a peak of 24.7% in May, which significantly decreased to 11.5% at the end of July. Turning to Slide 4. We highlight some of the key trends that we are seeing internally that are similar to the trends we see market-wide. First, deferral requests are down significantly, having dropped from 48,600 in March to only 2,000 in August. The peak of the requests came early on as customers took the opportunity to defer when uncertainty was highest prior to the government acting to support the economy and the individuals. When looking at the bank's deferral per sector, we are seeing very similar trends to the broader market, with the majority of deferrals in mortgage and SME in much smaller amounts in consumer, medium-sized businesses and corporate loans. An encouraging factor is that many of our customers that request the deferrals has gone back to servicing their loans once the 3-month deferral period ended. Specifically, we saw an increase in the amount of mortgages for which the deferral period has ended, from 9% at the end of June to 61.5% as of the 21st of August. One trend that we are happy to see stay and continue to grow is the digitization of the banking sector, which will have a long-term positive implication on our business. We have seen significant growth of transactions through digital channels, including 55% growth in the number of accounts that are opened online as well as 5x growth in the number of customers that are using our app to schedule meetings with bankers instead of coming to the branch to wait on line. These are important changes in how we interact with our customers. On Slide 5, we highlight the underlying strength of the bank and its balance sheet that constitutes the platform for our future growth. Discount Group entered 2020 in a strong position, with solid cautions of regulatory requirements, putting it in a resilient position with the ability to navigate this downturn successfully. This is 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 19.5 billion, a 4.6% increase in the last 12 months. Common equity Tier 1 ratio stands at 10%, reflecting a 1.2% cushion overall target. LCR and leverage ratio continues to be well above the regulatory targets, allowing us sufficient room for growth. Obviously, the economic crisis created by the disruption of COVID-19 is having a significant negative impact, yet most of the credit loss expenses are expected losses and have not yet been realized. In light of this expectation, we have increased our allowance for credit losses, which is now equal to 1.82% of the credit group. On Slide 6, we provide some of the financial highlights of the quarter. Obviously, the financial results of Q2 2020 were again overshadowed by COVID-19 and 2 nonrepresentative expenses that we will talk about later. Net income was down to ILS 174 million, with ROE of 3.7% in the second quarter. However, since the result are so heavily impacted by COVID and are not representative of business as usual in our underlying strength, we believe that these are the main takeaways. First, our loan book grow in our targeted segments where we continued to take market share. Second, we recorded over ILS 1 billion in credit loss expenses in the last 3 quarters. That reflects the potential for credit losses in the future and not the actual write-offs, which we are still not seeing. Third, we grow our NII despite unsupportive macro environment. Lastly, today, we announced that the Board of Directors approved an early retirement plan for 300 employees to retire by the end of 2020. This is the first step in materializing our cost-cutting potential, a substantial pillar of our strategy. Slide 7 highlights our strategy as we continue to grow faster than the market average, while focused on the segments where we see growth potential, which are mortgages and medium enterprises. We saw growth on both a quarterly and year-on-year comparison, which is coming in every segment, except in consumer credit where the shutdown in the economy created a drop-off in demand. That is a similar trend to what we see in the banking sector. Our total income declined versus both Q1 '20 and Q2 '19, as can be seen on Slide 8. The decline was driven mainly by lower fee income, reflecting the slowdown in economic activity due to the lockdown and lower noninterest financing income versus previous quarter due to a decline in derivative activity and bond realization. Our NII, on the other end, was slightly higher than in previous quarter despite lower NIM. The NII was positively impacted by our loan growth and was offset by the lower interest rate. Compared to a year ago, NII was lower due to lower CPI and lower interest rates, which were partly offset by the increases in volumes. Moving to Slide 9. Our cost-to-income ratio, which was 62.2% in the first half of 2020 compared with 65.2% for all of 2019, improved despite the 2 nonrepresentative expenses, provisions for legal proceedings and a change in the discount rate that impacted long-term employee rewards that brought total expenses to an increase of 3.4%. Salary expenses were 7.4% lower versus the second quarter of 2019 and 3.6% lower versus last quarter, mainly as a result of reduction in performance-based bonus payments. Behind the ongoing management, of course, today, we announced a significant early retirement program. The plan is expected to have a positive impact on our costs in the coming years and I will elaborate on it in a minute. The reserve build of provisions for credit losses continues to be the most impactful item on our P&L and we review it on Slide 10. We recorded a ILS 532 million loan loss provision, 1.14% of total credit during the quarter. Of that amount, $442 million was for general provisions. We continued to build reserves to reflect the inherent risk in our portfolio. Its uncertainty remains high. As a result, our allowance for credit losses as a percentage of total credit increased to 1.82% from 1.33% a year ago as can be seen in the graph on the right side of the slide. It is important to highlight that in practice, we are not yet seeing an increase in write-offs, as can be seen in our net write-offs as a percent of average balance of credit of 0.19%. In the next few slides, we will review the results of our main subsidiaries, starting with IDB New York on Slide 12. IDB New York managed to maintain similar levels of net income driven largely by lower credit loss expenses. The economic shutdown led to an increase in deposit and a drop in demand for credit. However, the lower interest rates reduced the cost of deposits and resulted in a slight increase in NII. On the next slide, we highlight the results of Mercantile, starting from December 2019, is benefiting from the merger with Municipal Bank. Mercantile's credit loss expenses were similar to Q1 '20. However, 2.3% growth in credit that coupled with growth in noninterest income led to a 2% increase in total income. Mercantile had a very strong quarter with growth across every parameter, and if not for the COVID, reserve build could have been even better. Moving to Slide #14. The credit card sector was significantly helped by the situation. Credit card companies saw lower turnover domestically and abroad and decreased demand for consumer credit. Despite that, Cal grew faster than its competitors in both transaction turnover and in the number of active cards, increasing its market share. As we presented in the opening of this deck, according to Bank of Israel data, the total spending in credit cards in Israel has almost gone back to normal in July. But as long as travel is restricted, that part of the business is still challenged. This sums up the financial review of the second quarter of 2020. On Slide 16, we again highlight the main themes and trends that we are seeing in the market. The quick adoption of digital, the reduction in traffic in our branches and changes to our operating and service model. All these trends accelerate our existing strategic focus and provide even greater potential, mainly in the areas of cost-cutting and streamlining processes. Moving to Slide 17. COVID does not prevent us from looking ahead and leveraging our solid infrastructure as we build toward the 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. I will not go into each of them again, but would only discuss now the second area of potential of increasing efficiency. In this pillar, we aim to close the gap with our peers in cost-to-income ratio, where the main driver comes from salary cost. In order to monetize this potential, we introduced an early retirement plan today, as detailed on Slide 18. The target is 300 employees aged 50 to 66. The plan, plus roughly 150 employees reaching natural retirement, totaled an approximate 450 people who are expected to retire by 2021. The plan offers an additional 200% on top of the mandatory severance pay, plus a bonus for a certain group of employees. The total estimated cost of the plan is ILS 550 million, of which a substantial amount is already charged in other comprehensive income. The bank estimated approximately ILS 210 million will be charged to profit and loss by the end of 2020. The impact on our CET1 ratio is very small. With that, I wish to conclude our call and emphasize that this plan is only one example of how we can achieve our potential and meet our strategic goals. Our proven execution capabilities, backed by our robust platform for future growth, will allow the future improvement of the group in the coming years. Thank you. And we can now open it for your questions.

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

Over the first few slides, you basically showed an improvement of the situation as of middle of August compared to the end of June. A lot of KPIs seems to be improving. And I guess looking ahead, since we're already close to the end of the third quarter, what worries you the most when you look at the economy in general? Are there any specific industries that you feel that, even at the end of August, there's still a concern going forward or you feel that the trend is definitely improving, and then looking ahead, we can potentially see recoveries down the road?

Okay. So overall, yes, you are right. We do see some positive trends from end of June until now. But we do -- we still believe there is a lot of uncertainty around -- uncertainty, both when it comes to economic aspects and health aspects. And we need to wait and to see whether there is a new wave. We are approaching the winter soon, so maybe there will be a bit of deviation. So I think we are mainly bothered with the uncertainty. And if the trends will continue to be positive, so we will have some room for -- to be optimistic.

That's helpful. And then you mentioned the pickup in digitization and many transactions now being digital. And I guess, looking into the long-term, do you think that can translate into branch closure on one hand, perhaps employees working from home on the other hand and that could also help out your cost reduction structurally?

Yes. So moving to digital is a very positive trend. Discount Bank, we have a very strong digital asset and our customers are moving into digital faster than we originally expected due to COVID. And yes, the impact of it could be less usage of branches and more employees working from home. And I think the end result of it could be another -- opportunities to continue the efficiency efforts and cost reduction. And first step, we announced today that we are -- came with an early retirement plan of 300 people. And part of it is moving to digital. We can allow ourselves to work and to operate with less -- with a lower number of employees.

Great. Thank you, and congrats on the strong result.

Thanks.

The next question is from Borja Ramirez of Citi.

I have a quick question, if I may, on the cost cutting plan. So I understand there's around 450 employees that will retire by 2021. And would it be possible to provide indications on the cost savings on a fully phased-in basis by 2021?

So yes, the 450 people that you are mentioning, they are composed of 2 groups. 150, it's the natural retirement that -- employees that expect to be retired naturally in the next 2 years. 300 is the early retirement. And both of them together is 450. Regarding the cost savings, so there are a number of moving parts, and we haven't disclosed the net impact. As far as the growth impact of the plan, the best I can guide you is to multiply the number of planned headcount reductions by the average wage as we reported at the end of 2019. So I think it will give you more or less the potential cost cuts.

[Operator Instructions] The next question is a follow-up question from Borja Ramirez of Citi.

Sorry, I have a follow-up question, if I may. So you have -- I would say your -- you had a -- given the environment, you have a solid trend in net interest income. Would it be possible to provide more details in the evolution of net interest income in the -- for example, the second half of the year, because there are several moving parts in the -- some additional clarity would be helpful.

So I think it's a bit difficult to assess because there are 2 different factors. One important factor is the loan growth. And we do see in -- overall, in our market, in our system, a reduction in the demand for credit. So this is one element that we don't have clearance around. The second is the macroeconomic parameters, especially around CPI. So I think those are the 2 main factors. One is CPI; second, the loan growth, the future loan growth. And therefore, we are not providing an estimation. But based on those elements, we will see what is the NII for the remainder of this year.

There are no further questions at this time. Ms. Koblenz, would you like to make your concluding statement?

Thank you for joining us today, and have a nice weekend.

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