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

Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank Fourth Quarter and Full Year 2020 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded March 16, 2021. If you have not yet done so, please access the presentation on the bank's website at investors.discountbank.co.il. I would like to remind everyone that forward-looking statements for the respected 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 security authorities. Ms. Koblenz, would you like to begin, please?

Good afternoon, and welcome to Discount Bank's Fourth Quarter and Full Year 2020 Financial Results Conference Call. Participating in today's call are Uri Levin, CEO; Barak Nardi, CFO; Joseph Beressi, Chief Accountant We will start with opening remarks by Uri, followed by a summary of the results in our new strategic plan by Barak, and we'll then open it up for questions. I now hand over to Uri.

Thank you, Tamar, and good afternoon, everyone. We're meeting today to summarize 2020, which was dramatic in every way possible. We had challenges and issues that were far from the norm just a year ago. And yet, despite all of that, in my first year as CEO, I can clearly state that 2020 was a very good year for Discount Group, enhancing our position as the rising power in the Israeli banking market. 2020 was a year in which a Discount Group navigated through the downturn while producing solid financial results, improving the robustness of our credit portfolio and of our business. We completed the year with ILS 1.3 billion in adjusted net income and 6.7% adjusted ROE. In the fourth quarter, we recorded ILS 421 million in adjusted net income and a 9.1% adjusted ROE. This was achieved while increasing the reserve ratio of significantly to 1.95%, reflecting our conservative approach to the impact of COVID-19. In 2020, we faced significant macro challenges driven by the global shutdown that impacted each and every person on the globe. Israel, similarly to the crisis in 2008, proved to be resilient. Despite the negative GDP, high unemployment rate and numerous shutdown, the vast majority of the Israel economy found ways to adopt. Israel is currently leading the world in vaccinating its population hopefully, leading to a better 2021. Our economy forecast 2021 GDP growth of 5% and 0.9% inflation has since begun to improve. At the same time, the crisis is far from being over. And its financial adverse implications will clearly have a significant impact on 2021. That is well indicated by the 11% unemployment forecast and continued low interest rate environment. Despite all of the challenges that we faced in 2020, we launched an ambitious 5-year strategic plan whose ultimate goal is to become the best financial institution for its customers while delivering superior value for our shareholders over time. We also immediately started executing on our strategy. The most significant achievement was the execution of the largest ever early retirement plan in which 739 employees, constituting 8% of the workforce retired from the group. This plan will have a significant impact on our results for years to come, and will also have a positive impact on organizational culture. Beyond that, we grew our credit book in targeted segments faster than our peers, improved the service provided to our customer and announced the first of its kind corporation with Shufersal to transform PayBox into a disruptive player offering unique customer centered, financial services from a variety of providers. When looking ahead, discount group is in a unique position to leap forward. Discount Group has been a significant competitive force for the last several years. But now the market is opening up, allowing the competitive forces to be significantly more successful. This has been driven mainly by pro competition regulation, technology, and maybe most importantly, clients who are gradually willing to act in order to get a better offering. Discount Group is big enough to make a difference and yet small enough not to fear cannibalization. With our digital capabilities pro client approach and openness to innovation, we are best placed to significantly grow within traditional banking while also becoming a leading disruptive player. Our strategy was built exactly around those trends and focuses around 3 axes: first, accelerating the evolution of traditional banking, gaining significant market share while focusing on delivering superior customer experience; second, leading revolution in banking through disruptive innovation, driving initiatives similar to PayBox; and third, maximizing group value, leveraging our subsidiary's potential and driving synergies across the organization. I have full confidence that our unique positioning, unparalleled improving potential and proven strategic execution capabilities will allow us to successfully execute our ambitious strategy and become the best financial institution for its customers while delivering superior value for our shareholders over time. As we start the year with cautious optimism regarding the recovery of the economy, we are extremely optimistic regarding the future of Discount Group. Thank you for your ongoing trust. I promise that we will continue to work extremely hard to be sure that we deserve this trust. I now hand it over to Barak.

Thank you, Uri. Good afternoon all, and I hope you all are well. I will open my presentation with an overview of the financial results, and then we'll elaborate on our 5-year strategy. Starting with the highlights of the fourth quarter and the full year on Slide #7. In 2020, we showed solid results despite the significant impact of COVID on the economy. We achieved adjusted ROE of 9.1% for the fourth quarter and 6.7% for all of 2020. The adjustments were mainly on the account of our early retirement plan. Our loan book grew by 5.2% in 2020, driven by mortgages and corporate lending, although loan loss provision in the quarter were lower than in previous quarters of 2020 as economic factors in Israel improved on the backdrop of the improving health situation. In 2020, we executed our largest ever early retirement plan in the group. This plan, coupled with natural retirement, led to 739 employees retiring across the group that's representing 8% of the total workforce. The contraction of the workforce occurred mainly at the end of 2020 and will have a positive impact on our cost base going forward. Even before we see the impact of early retirement on the cost structure, we can see that our [ free cost management ] led to a 2.4% positive Jaws ratio as our income grew by 1.6%, while the expenses declined 0.8% year-over-year. On Slide 8, you can see the impressive growth of our loan book, driven by mortgages and corporates, mortgages, which is a focus of our strategy, grew by 15% at the highest growth rate among all banks and now it's almost 22% of our total loan book. Our corporate lending was also very strong, up 16% in 2020. The reduction in consumer credit similar related to the trend of the sector was on account of reduced demand by customers. Our quarterly income increased during the year and outpaced our peers. As presented on Slide #9, we showed a few positive trends. Our NIM proved very resilient finishing the year at 2.35%, and our NII was up year-on-year, driven by loan growth. In addition, we had a strong year in noninterest financing income, which was up 54% driven both by our excellent ALM as well as by realization out of the investment portfolio at Discount Capital. Fee income was lower, in line with the trends seen sector-wide as customer activity was lower, and some of it moved to digital channels. As you can see on Slide 10, we continue to show improvement in our adjusted efficiency ratio, which was 62.5% in 2020, down from 66.1% in 2018. This, along with our income growth, produced a positive Jaws ratio of 2.4% and continued improvement in our productivity ratio. They included a number of significant cost related onetime events. The most significant of them was the largest ever retirement plan with 656 employees retiring from the group as part of this plan. In addition, 83 employees naturally retired by December 2020. All in all, 739 employees left the group, constituting 8% of the workforce. The total cost of the plan is ILS 555 million, of which almost ILS 450 million was booked to the P&L in 2020, and the rest will be booked in Q1 2021. Throughout the year, we increased our allowance for loan losses and the impact of that can be seen on Slide 11. Loan loss provision this quarter continued to decline to a level of 0.42%, reflecting the continued build of the reserve but at a slower pace. Write-offs remain at the same level as they were before the crisis. Looking ahead, we do see some positive signs, one is that the health crisis is coming more under control with the vaccination rate increasing. The second is that the rate of loans of which the deferral period ended stands at 68.8%, up from 61.4% at the end of Q3. However, the economic implications of the crisis is still unclear. And as long as the government support is in effect, 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. On Slide #12, we touched on the progress of our subsidiaries. Our banking subsidiaries, IDB New York and Mercantile, proved quite resilient with loan book growth in targeted segments. Both Cal and Mercantile implemented staff reduction as part of the group's early retirement program, as we mentioned earlier. Lastly, Discount Capital had a very strong year helped significantly by a number of exits from its investment portfolio and was also very active with $192 million in new investments in 2020. Now we would like to drill down and give more details on our strategic plan that we are very excited about. Let's turn to Slide 14. As Uri said, we aim to take leadership and to be the best financial institution for our customers and delivering superior value for our shareholders. Our strategy has 3 main pillars: first, to accelerate the evolution of traditional banking; second, to lead the revolution in banking through disruptive innovation; and third, to maximize group value. I will briefly elaborate on each of them in the next few slides. Slide 15 represents the first pillar of accelerating the evolution of traditional banking. Within this pillar, our goal is to increase the group's competitiveness, market share and profitability. This goal will be achieved by focusing on 5 main areas. The first is to continue to strive to provide superior customer experience that will create a distinct competitive advantage for us. It is our plan to take a step to be a fully customer-centric organization by making wide reaching and significant efforts across all divisions of the bank that will lead to a fundamental change in our work processes and principle of service. The second area of focus is around growth. We aim to grow above market in total revenues and credit to the public in targeted sectors, like mortgages. To do this, the bank will implement new operating models for retail and business banking activities, including changes to service, sales and operational [ positive loss ]. The third area is to be the forefront of innovation in traditional banking. We will expand the range of our digital services, leverage advanced data capabilities and tighten the cooperation with fintechs, to improve the value proposition for our customers. The fourth area of focus is to create an effective enterprise platform based on high operational efficiency and banking excellence. We will automate, digitize and improve processes to promote efficiency and shorten response time by implementing new working methods to improve central processes. We will also continue to reduce the workforce, optimize real estate space and save on procurement expenses. Lastly, we will strive to be the best employer for our employees. We will work to empower our managers and staff at all levels to shape an organizational culture that promotes performance, excellence and continuous improvement. On Slide 16, we presented the second pillar of our strategy, which is to lead the revolution in banking through disruptive innovation. Our main goal is to be a leading player in the world of future banking. Our unique positioning creates a competitive advantage as a player that is large enough to make an impact and yet small enough not to fear cannibalization. Within this pillar, we will establish new nonbanking ventures based on in-depth cooperation with third parties and fintech companies. One great example is the collaboration which -- with Shufersal to develop PayBox into Israel's leading digital wallet and in the second stage to become a marketplace for Voya Financial services. And lastly, on Slide 17, we present the third pillar of maximizing the group's value with the goal of empowering each of our subsidiaries and leveraging the synergies between them. Discount Bank as the parent company will identify and act on potential synergies between the group companies, whether it will be on the income side or the cost side, making great contribution to the group's economy value. One example where we have already made progress on this pillar is the planned new headquarters for the entire group in [indiscernible], which will facilitate our ability to work more closely together to achieve our goals. Moving to Slide 18. To summarize the strategic chapter of this deck, this is our 5-year strategy. And going forward, we will look to provide you with an update on the progress we are achieving in each of the year. A new plan for the years 2021 to 2025 include internal financial targets for maximizing ROE, improving efficiency and growing the group's market share. Wrapping up, on Slide 19, we are already acting on and seeing results from our strategy. In 2020, we reduced our workforce by 8%, lowered credit book in targeted segments, provided the highest level of customer service according to the latest Marketest survey and signed a first of its kind cooperation with Shufersal to develop PayBox into Israel's leading digital wallet and more. These are only a few of the first outcomes that we achieved and certain that going forward, the Discount Group will continue to rigorously execute on our strategy and create superior value for our shareholders. Thank you.

Before we open it up for your questions, I would like to take this opportunity and say that after 7.5 fascinating years as the Head of IR Discount Bank, this is my last earnings call, and I want to thank Uri, Barak and my former managers for their trust in me. Thank you. And with that, we will now start the Q&A session.

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

This is Chris Reimer on for Tavy. First off, with regards to dividends, it seems the Bank of Israel has indicated it won't allow resumption of dividends before the third quarter. If that's the case, and given your excess capital position, do you anticipate the potential distribution of a onetime special dividend towards the end of the year?

So as you mentioned, Bank of Israel currently is putting on all dividend until -- at least until September 30. At the time -- when the time is right and -- that we can pay a dividend, we will make the right balance between dividend payout and the ability to continue supporting our substantial credit goals.

Okay. Also just about Paybox and the digital wallet, you've mentioned it a lot over the last few weeks. Can you elaborate a little bit about the business model and the potential for revenue generation down the road?

Thank you for this question. We do believe PayBox is definitely something worth discussing mainly as it shows our approach to disruptive play in the market. We believe the market is changing. And while we put most of our attention into improving our position within traditional banking and gaining from what we believe becomes a more competitive market where we believe we will win significantly. We also believe that we need to keep effort in what's happening outside of traditional banking. And the way to do it is to do it outside of the bank by really allowing a play that will disrupt the banking and will compete with all the banks, including Discount Group. For this, we've joined with the most powerful retailer in Israel. We're going to set up an individual company and we're going to start by having a digital wallet. This will only start leveraging PayBox clients and Shufersal clients, building a very significant scale of clients on which we will build financial offering. It's a journey. It's a journey where we probably have made sure that the investment will be really reasonable as we're sharing that with Shufersal. There is a business model for digital wallet and it's really once it's based on credit cards, then there's revenues coming in for the business. And this will allow us for time to develop the real disruptive play offering financial offering. Clearly, we have significant business models. This is why we have started, but also, it is clear that the journey in the business model will change. We're not sharing it yet. But we will in due course.

The next question is from Micha Goldberg of Excellence.

First, congratulations. It did look like a successful, very tough year. A couple of questions, if I may. First of all, you've obviously been very aggressive on your early retirement scheme and other efficiency measurements. But yet, it doesn't seem like it's -- at least that stated number is coming through. I wonder when do you think we will be able to see the products of this -- the efficiency measurements.

So as we mentioned, almost all of the retirements took place at the last days of 2020. So the impact will be seen in 2021 going forward. In Q1 of 2021, we'll still have some negative impact of the retirement plan because some of the costs will be booked in Q1. But going forward, we start seeing the substantial savings in people cost based on this retirement plan.

Okay. Secondly, you mentioned your provisions for problematic debt, and they seem to be significantly higher than some of the other banks, and your NPLs and other credit quality parameters seem to be slightly better. I was just wondering when I compare this to previous downturns, are we going to see more recoveries in this uptick? Or is it going to be a similar kind of one way movement in which you provide more but don't provide -- get more recoveries?

So first of all, the increase in problematic debt is a normal development of the crisis as collective provisions made early on move now to the [ value of classification ] and review the specific. So it's not a surprise. We believe that the provision that reported earlier in 2020 properly reflects the invent risk of our portfolio. So I think it's more or less give the picture. So I don't -- we don't expect -- we expect the current number or current provision to cover those classifications.

Micha, I would add to this. We've started -- enter this crisis and expect the extreme scenario, the expectations for macro impact were very significant with significantly more reduction in GDP towards the 5%, 6%, 7% with significant unemployment with significant impact on the market and, hence, on our clients. And definitely, we can say that today, 4 quarters into this crisis, we're still expecting the impact to be embedded within our clients and within our credit portfolio, not as part of group provisioning, but the specific provisioning. So meaning that the impact of the crisis currently were significantly lower than we expected. Having said that, we still think that we need to wait and see to see what's happening with pandemic, what's happening with the macro economy, what's happening with our clients as we move on, what's happening with especially SMEs and consumers while the -- with the government -- as the government support stops and as we stop postponing the debt payment. Having said that, we still feel very comfortable with where we currently have been provisioned for. And potentially, we're overpessimistic or too -- or afraid that the impact will be more significant than it is. And if this is the case, then we expect that 2021 where GDP will be better than expected, unemployment will be low, but most importantly, the recovery will be faster. Definitely, we will be able to see the impact also on our provisioning. The pace of this provisioning going into the P&L is also a question mark because it depends on what will really happen. But if that is the case, then we should be seeing this within 2021 or maybe 2021 and 2022.

Very clear. Another question, you mentioned growth in your loan book, specifically in the mortgage segment. I was just wondering with the increased competition in that market segment, together with the Bank of Israel's clear indication of an interest of reducing, squeezing the margins. Is this something that is going to squeeze general margins for Discount in 2021 and further on?

So I think the mortgage space, although the strong competition is a clear -- it's a huge potential for us. Actually, we have currently more demand than what we are able to supply, and we are very optimistic. Currently, in mortgages, we are substantially below our potential market share and we have a huge room for growth. And as we define it even in our strategy, this is one of the key strategic pillars. And in 2020, you already can see the substantial growth. We have double-digit growth around 15%, and we are planning to continue and go over there in a very significant numbers. And although the competition, we are very optimistic that we can grow on our market share in mortgages in a substantial way in the coming few years.

And you don't think there was going to be a squeeze on your margins because of that?

I'm not sure. Currently, we are not seeing it. I think that there is a lot of demand and we are not expecting any squeeze or substantial squeeze in the margin.

Okay. Very clear. 2020, you guys recognized significant trading gains. How is that looking for you in 2021? I mean, are we going to be able to repeat that? Or should we assume that the number will be significantly lower than what you have recorded in 2020?

Although in 2020, we have superior numbers, but even if you go back to 2018 and 2019, Discount always had a very good performance around -- in this line item. So of course, 2020 was very unique because some of the revenue is a result of what happened in the market during the crisis. So no, probably, we won't see 2020 numbers, but we are still expecting high numbers in this line item in 2021 and forward.

Okay. Very clear. Another question, you mentioned the rollout of the digital wallet and PayBox. And I'm just wondering in light of the changes expected in the banking index. And obviously, the pickup expected in the usage of credit card following a relatively poor year. Would you consider IPO-ing your subsidiary Visa ICC in 2021?

Currently, there is no plan as such.

Okay. And last -- well, 2 last question. First of all, is there any color you can give us on expected impacts of CECL? I know it's still early but if you can give any guidelines that will be appreciated. And secondly, do you have any time frame on the rollout of your digital wallet and other potential financial products that you wanted to offer on that platform?

So regarding CECL, Q1 '22 is when we are required to report. But starting with the Q3 report, we will begin giving data on the expected implications. We are now in the process of reviewing the CECL impacts. It's still too early to estimate what would be the impact. In some segments, we might see an increase in provisions, in other, we might see a reduction. But overall, I don't expect to have a substantial impact.

As for PayBox rollout, we're still waiting for Bank of Israel approval after getting the competition committee approval and we expect to get it in the next few weeks. We're already working significantly to pushing forward. And it will -- you will see the outcome in the several few months, and we also have more clarification on the journey as time progress.

The next question is from Ethan Etzioni of Etzioni Portfolio Management.

Yes. Can you give a little more color, please, in the increase on the problematic loans? I see it went up in the fourth quarter. What is the source? From what industries is it coming?

So as I mentioned before, we don't give or provide specific information on specific customers. But overall, I can say that it's more or less natural development of the situation. One second. So it's a normal course of development of the crisis as the collective provisions now made early on move through the various classifications and I review the specifics. We -- as I mentioned before, we do believe that the provisions we already have and that we have recorded in 2020 are probably properly reflecting the damages, so it doesn't create us any additional impact. At the same time, we should review our NPL numbers which our NPL numbers remained relatively low, even when you compare it to the benchmark to the other banks.

But the increase in the problematic loans is larger than the increase in the provisions. Is it not or where am I wrong?

It's not larger. It's -- first of all, not for all the problematic, of course, you need to have a full allowance. And some of it's coming from the hotel industry and other. And we hope that some of them later on will be reversed. So it doesn't -- we don't need to approve for all the problematic debt. And as I mentioned before, we do feel comfortable with the level of provision we have, and we do believe that it correctly reflects the inherent risk that we have in our existing portfolio.

And I think maybe it's worth mentioning, because I think while maybe there were -- I would say differently. While it is very clear that in terms of essence, our credit portfolio has proven to be as good as in the rest of the industry, at least, if not better. I think we also demonstrate during this crisis that we take a more conservative approach, and we want to be on the safe side. And this is also reflected in the problematic debt as it is reflected in our models for group provisioning. Because if you look in the underlying, the underlying is not different. The NPL is an underlying important indicator. Our specific provisioning is an indicator. And all that is in line with the industry, if not better. And on the same side, we'd rather be more conservative in our approach to risk, and I have no doubt that, that will be beneficial for us in the future.

Okay. Going back to the early retirement plan. Can you give us some idea of what you think your salary run rate is going to be in '22?

It's -- we didn't disclose the net impact. Of course, the growth impact is going to be very significant with more than 700 employees leaving the group. So the growth impact will be very substantial. When we need to calculate -- when we are planning to calculate the net impact, we need to take into consideration some salary increase and hopefully, a bond payment. But overall, we do believe that the net impact is going to be positive, which will mean negative, negative impact decline in people costs. And while revenue is expected to grow it will have a very positive impact on our cost-to-income ratio and specifically on salary and cost -- people cost as a percentage of total revenue.

So you think it's going to -- the salary for '22, let's say, will be below ILS 3 billion?

I think we can say for sure that the salary is not going to grow, and we will be -- we will see some reduction. We are not stating the exact number, but I think that the trend should be a reduction in overall people cost.

Okay. Going to your real investments in the Discount Capital. You mentioned in the presentation that the investments at cost are ILS 1.4 billion. Can you give us some idea what the market value of these investments are?

It's not something we disclosed. But as we saw in the past, usually, Discount Capital investments were very successful, and we do believe that in '20 -- during this crisis, in the market, there were some good opportunities, and we are optimistic about the value of the investment capital has made.

Last question for me. Regarding exchange rate differentials, usually, you have several tens of millions of profit every quarter. This quarter was about breakeven, what happened there?

So it's something we check, and we can take offline.

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

So before Tamar is concluding, I would like to take this opportunity to thank Tamar for the great job she has done in the last 7.5 years and her great contribution to Discount and to wish her good luck in her next role.

Thank you. Thank you, everyone, and have a nice evening.

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