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

Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank Third Quarter 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, November 24, 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, please?

Yes. Thank you. Good afternoon, and welcome to Discount Bank's third quarter results conference call. Participating in today's call are Barak Nardi, CFO; and Joseph Beressi, Chief Accountant. I will now hand over to Barak.

Thank you, Tamar. Good afternoon, and I hope you are all staying safe. Obviously, Q3 is still a COVID-19 quarter. I will open the call with a short market overview that presents what we're currently seeing. On Slide 3, we present some of the factors that reflect the changes in the environment we are operating in. We are still seeing low demand for credit in the consumer segment and an opposite trend in the mortgage sector. In the credit card market, we see a more stable trend in credit card activity as compared with Q2. According to the Bank of Israel data, the balance of deferred loans as of September was ILS 160 billion, constituting 7.2% of total loans in the banking system. With the reopening of the economy in the middle of Q2, 54% of the loans that requested deferrals so far have completed the deferral period as of September. Turning to Slide 4. We highlight some of the key trends that we are seeing internally that are similar and in some cases, even better than the trends we see market-wide. First, deferral requests are down significantly, having dropped from 48,600 in March to a level of 3,000 to 4,000 in recent months, reflecting that there is no significant peak in deferral requests due to the second lockdown. When looking at the deferrals in Discount Bank and Mercantile Bank, a total of ILS 18 billion were deferred. Of that amount, ILS 7 billion or 4.7% of our loan book is still in deferral. The remaining ILS 11 billion or 61.4% of the deferred loans are no longer in deferral. This is better than the 54% in the sector based on the Bank of Israel data. On Slide 5, we highlight the underlying strength of the bank and its balance sheet that support our future growth. Discount Group entered 2020 in a strong position with solid cushions of regulatory requirements, putting it in a resilient position with the ability to navigate this downturn successfully. Our total equity continues to grow, amounting to ILS 19.7 billion, a 3.8% increase in the last 12 months. Common equity tier 1 ratio stands at 10.1%, reflecting a 1.2 cushion over the Board targets. LCR and leverage ratio continues to be well above the regulatory targets, allowing us sufficient room for growth. While the environment was certainly slightly improved, we continue to build our reserves on account of COVID but at a slower rate than in previous quarters, with our coverage ratio reaching 1.91%, up from 1.82% at the end of June. On Slide 6, we provide some of the financial highlights of the quarter. We reported adjusted ROE of 7.7% in the quarter. There were a number of onetime events in this quarter. The most significant was a provision on account of the legal proceeding in Australia. This is an ongoing claim that first became known to the bank in 2016, and we are working toward an out-of-court settlement. The other 2, income from the sale of shares of VISA Inc. and expenses related to early retirement programs, offset each other. On our credit book, once again, we produced a market-leading increase of 8.2% year-on-year and 1.9% versus the previous quarter, which drove an increase in interest income. As mentioned earlier, our retail build continued but at a slower pace, resulting in a lower credit loss expenses ratio of 0.7% versus 1.28% in the first half of 2020. Lastly, our early retirement plan has been very successful with 540 employees across the group signing the offer so far. Slide 7 shows that the loan book continues to grow, and we continue to take share particularly in mortgages and corporate. The mortgage book grew 3.7% in the quarter and 14% year-over-year. That, plus our 4.2% quarterly and 18.7% annual growth in the corporate sector, highlights the effectiveness of our focused strategy. Consumer and small businesses began to slow earlier in the year, mainly on account of the impact from COVID that led to a decline in demand. Looking at the mix of our loan book. You can see the effectiveness of our focus on our strategy as mortgages are now 21.4% of our total book, up from 20.3% last year, and the medium enterprises segment is 6.9%, up from 6%. Total income increased versus both second quarter of 2020 and third quarter of 2019, as can be seen on Slide 8. The increase was across all areas of income, including net interest income, which was up 0.9% quarter-over-quarter and 5.6% year-over-year, benefiting from CPI and the increase in our loan book. Noninterest income went up mainly due to the income from the sale of shares of VISA Inc. Another contributor was fees, which were up 7.4% versus last quarter as market activity picked up during the summer when the economy was reopened. It's reflected in the increase in credit card turnover. Moving to Slide 9. Our cost-to-income ratio which -- was 61.4% on an adjusted basis in the first 9 months of 2020 compared with 65.2% for all of 2019 and continues to improve. On an adjusted basis, total expenses remained flat versus last year. The quarterly reported numbers included some onetime costs, including ILS 168 million provision related to legal expenses as we are in negotiation for a settlement in the civil case we are managing in Australia as well as early retirement plans, which I will elaborate on in a bit. I remind you that most of the cost of the early retirement plan in Discount Bank and Mercantile will be booked in the fourth quarter, where we expect an expense of ILS 344 million, which is expected to materially impact next quarter's results. On Slide 10, we show that loan loss provision this quarter declined to a level of 0.7%, reflecting the continued build of the reserve but at a slower pace. Although the loan loss provision ratio in the quarter appears to show a downturn trend, it's important to highlight that we continue to increase our reserve as uncertainty is still high. Therefore, our allowance for credit losses as percent of total credit increased to 1.91% from 1.81% in the previous quarter and 1.35% at Q3 2019. This increase means that we continue to account for the potential losses in our loan book due to the still high uncertainty in the economy, which is highly correlated to the lack of clarity in the health crisis. That being said, another important highlight is that we are still not seeing an increased rate of write-off by our customers. Even with the excitement around the announcement of the various vaccines, it is still too early to say that the tide has turned, and we will continue to act cautiously and assess the situation as it develops. Taking a deeper look at the credit quality on Slide 11, you can see the shift in the classification of problematic debt in this quarter. Total problematic debt is up in Q3 versus Q2 and versus last year as a result of an increase in debt classified as special mention on account of debt deferred during the COVID-19 pandemic. Substandard and impaired debt balances, however, are lower versus the previous quarter. This is further seen in our NPL ratio, which is down to 0.59% versus 0.77% last quarter and essentially unchanged compared to last year. In the next few slides, we will review that results of our main subsidiaries, starting with IDB New York on Slide 13. IDB New York saw some recovery during the quarter in the demand for credit. At the same time, both the lower NIM and the increased LLP led to lower net income in this quarter. On the next slide, we highlight the results of Mercantile. Mercantile's credit growth continued to expand 21% year-on-year. This was mainly driven by growth in the mortgage and corporate sectors. Some of it is attributed to the purchase of Municipal Bank. Credit loss expenses were slightly lower than the second quarter but still significantly higher than pre-COVID levels and similar to the trends we mentioned earlier. Moving to Slide #15. Cal continued to increase its market share during the quarter as the economy in Israel was reopened, and this led to more spending locally. Cal's results were impacted by significant events in the quarter, including a ILS 64 million income from the sale of shares of VISA Inc. and an expense of ILS 38 million for early retirement program, resulting in an ROE of 16.1%. This sums up the financial review of the third quarter. Moving to Slide 17. COVID does not prevent us from looking ahead and leveraging our solid infrastructure as we build towards 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 and the fourth one of driving disruptive innovation. On cost, the main driver comes from cutting salary costs. In order to monetize this potential and on the back of the success we had with the initial plan, we expanded our early retirement plan as detailed on Slide 18. Out of the total plan of up to 640 employees, 540 employees have already signed the retirement agreement and are expected to leave by the end of 2020. Overall, we expect that the employees who participate in the plan plus the employees reaching natural retirement will reach around 700 people who are expected to retire by 2021. The plan increased the liability on our books by ILS 545 million. And as I mentioned earlier, we are -- ILS 44 million before tax will be charged to the P&L in Q4. Moving to Slide 19. Another area of focus is bringing disruptive innovation for our clients. With 16% market share, we are big enough to make an impact and yet small enough to be flexible and not be concerned about cannibalization to our business and to come up with real disruptive innovation. Last year, we launched our API store, being the first Israeli bank to bring this innovation to the Israeli financial sector. We have developed the capacity to work and collaborate with fintechs and became their first choice of partners in the banking system. Recently, we signed an agreement with 2 new fintechs, riseup and Amir Cash Flow. These start-ups offer cash flow management tools for the retail and SME businesses. riseup provides retail customers with expected cash flow based on their current account and credit card activity. Amir Cash Flow is focused on small and medium businesses, offering cash flow software connected to bookkeeping software. With that, I wish to conclude our call and emphasize that COVID does not prevent us for moving ahead and executing on our plan to meet our strategic goals. Our proven execution capabilities backed by our robust platform for future growth will allow the further improvement of the group in the coming years. Thank you, and we can now open it up to your questions.

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

Apologies, I joined 5 minutes late, so if you already touched on it. First, if you could just comment a little bit about the legal proceeding in Australia. What is it exactly about? And what's the total bank exposure from here?

Sure. So as I mentioned, the case in Australia is an ongoing claim that first became known to the bank in 2016, and now we are working on an out-of-court settlement. We are in the midst of the negotiation, and that would bring an end to this situation. So I can't give more specifics right now, but ILS 245 million that were added to the provisions for legal proceeding during the first 9 months of 2020 and the amount that were provided for earlier reflect the exposure that we see to this case. So we don't expect that this case will have a material impact on our future results.

Okay. That's helpful. And then you mentioned the ongoing cost-cutting measures, streamlining the early retirement. I just wanted to ask with regards to corona and some of your workforce working from home. Do you expect that to further decrease your real estate footprint when you look at your office space, your branches and so on? Does that have a positive impact on your ongoing streamlining measures?

I think one of the good things that corona brought is the digital usage among our customers, and we see less customers coming to the branches and instead using the digital assets. And maybe a result of it in the future will be a reduction in number of branches. And another element is employees working from home and actually is working very good. And it might, in the future, if it will -- this trend will remain after COVID is over and some of it might remain, it could lead to a lower need for office spaces, and it could have a positive impact on overall costs.

The next question is from Joseph Dickerson of Jefferies.

Just 2 things, if I may. Can you talk about the longer-term aspirations around achieving a 10% type of ROE and when you think you might get there? Because there's quite -- obviously, Q4 is going to have some charges in it. But just you've had the highest number of early retirements you've had. Credit should normalize. On the other hand, you're keeping up a pretty good pace of growth. So if you could just walk through the moving parts on the timing there. And then what are the hurdles that have to be cleared with the Bank of Israel to clear a path for the industry to get back to repatriating capital to shareholders?

So regarding the 10% aspiration, first, of course, it's an aspiration of ours. But I think during -- since we are into this -- into COVID and still, it's too early to call when it is going to be over and when LLP is going to be back to normal levels. It's too early to call what is the timing we can reach the 10%. So I think we need to wait a little bit more and to see how things are being stabilized, and then we will be able to assess more accurately what is the timing we can reach those numbers because it's mainly being impacted by COVID, influencing the LLP because we are growing in terms of revenue, we are cutting costs. And I think that the main point is there's a lot of uncertainty around it, the level of LLP and how fast we are going to be back to normal levels. So this is regarding this question. Regarding your second question about the dividend payout. So as you know, at the beginning of this crisis, Bank of Israel has requested the different banks to hold all dividends because they want to make sure they have enough of capacity to providing loans. And I do believe that -- I don't expect to see any changes in terms of the instructions or the guidance before we have more clarity around the situation and when COVID is going to end. But in this time, I don't expect Discount Bank to behave differently than the other banks. So this rule or this instruction applies to all banks. And I think Bank of Israel will wait to see to get more clarity about the COVID situation before they change their approach regarding dividend payout.

[Operator Instructions] The next question is from Micha Goldberg of Excellence.

I understand the Bank of Israel did not postpone the implementation of CECL, and it should be starting in January 2021. I was just wondering what is your expectation of the impact on capital and provisions.

I think it's too early to call, Micha. But I think that what we can say for sure is the fact that we increased -- during this crisis, we increased the coverage ratio actually substantially from a level of 1.3% to almost 2%, will minimize the impact of CECL implementation. So I cannot say what would be the exact impact, but obviously, the impact would be -- we believe the impact would be relatively lower than otherwise.

I thought the Bank of Israel receives initial estimates from the bank. Is that incorrect?

Micha, can you say again?

Yes. What?

They requested that you repeat the question.

I'm sorry. I was just -- I just understand that the Bank of Israel has already received initial estimates from the banks. So there must be some kind of estimate. So is there an estimate you're not sharing or it's too early to make that estimate?

Micha, the estimations we have provided, first of all, it was in a wide range, but it was pre COVID. And we do believe that COVID and the fact that we substantially increased our LLP coverage ratio will -- probably will have a substantial impact on it. So I don't think we need to refer to relatively non-updated estimation that we have provided before.

Okay. And another question just on your risk-weighted assets. I mean you've been growing it pretty strongly recently. I'm just wondering, is there anything that you can and/or plan to do to try to mitigate the risk-weighted asset growth that you're growing relatively quick on the loan side?

You meant about ways to reduce risk-weighted assets?

Yes, to mitigate -- I mean you're growing your loans pretty quickly. And I was wondering -- since we're at 10.1% of your common equity Tier 1, which I think is pretty much your target, and you continue to grow, I was just wondering if there's any plans and options to make that work.

First of all, we feel comfortable with the CET ratio. And it's 10.1%, and it's still way above the regulatory targets and our growth targets. So we feel very comfortable that we have enough room for growth. We grew this quarter versus last year substantially in credit. We are planning to have substantial growth in the future. And according to our plans, we don't see -- we don't expect to have any issues or any limitations coming from equity level. And we are -- ongoing, we're always reviewing our ways to reduce, but we don't have anything substantial we are working on. But as I said, we don't see any major restriction around being able to go with our existing level of equity.

Okay. Just to confirm, your internal target of common equity Tier 1 is 10.1%, right? Or am I wrong?

10.1% is not the target. 10.1% is the current situation.

So what's the current target? I remember you guys upped it.

Our Board target is 8.9%, and we are 1.2% above the Board target.

I'm sorry, is the bank -- the Board -- the Discount Bank's target is what?

Currently, the regulatory target is 8.2%. The Board target is 8.9%, and we are currently at a CET ratio of 10.1%. It's 1.2% above the Board's targets.

Right. But I'm assuming that the current lowered targets by the Bank of Israel are not going to allow you to pay back the dividend, right? You're going to have to go back to original levels. So that -- I mean for a dividend payment, that's not so relevant.

Yes. But -- so we will need to wait and see. But we are even above -- we are currently above the previous target, so we don't see any issue over there. But we need to wait and see to get Bank of Israel's instructions.

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

Yes. Thank you, everyone, for joining us today, and have a nice evening.

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