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 2021 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 25, 2021. If you have not 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 securities authorities. Mr. Nardi, would you like to begin, please?

Yes. Thank you. Good afternoon, everyone, and I hope you're all well. Today, we reported record results on both an adjusted and unadjusted basis, robust net income, ROE and credit growth was driven by executing on our strategy and further supported by an improving economy as seen by our negative LLP. We also reached 2 milestones passing ILS 300 billion in assets and ILS 20 billion in equity. On Slide 5, we show that health and macro trends continue to improve with positive COVID cases and 0 unemployment trends improving credit growth on the right and deferral related to the pandemic almost entirely behind us. At the same time, we remain cautious monitoring all indicators like the recent GDP numbers which may signal that we are not entirely in the clear yet. Slide 6 lays out the major highlights of the quarter, including adjusted ROE of 16.2%, quarterly net income of ILS 662 million, and negative LLP of 0.3%. The higher NII, up 3.4%, and the tight expense from, down 3.2% led to an adjusted cost-to-income ratio of 60.6% and a positive Jaws ratio of 8.3% in Q1 2021. This quarter also includes the final stage of the early retirement program that began in Q3 of 2020 and ended early in January of this year. Moving to Slide 7, you can see our strong credit growth, especially in targeted segments. Our overall credit grew by 5.7% year-over-year and 2.3% from the beginning of this year. Mortgages, which is one of the key pillars of our strategy, grew by 15.7% year-over-year and 4% from the beginning of this year, continuously increasing its market share. Another key pillar, corporate lending, grew 12.5% year-over-year and 1.8% quarter-over-quarter. We are also seeing some slight improvement in the medium-sized business portfolio. And as we move further out of the crisis, we expect to see the consumer lending pickup. On Slide 8, you can see that our credit growth and strong noninterest financing income drove the growth in total income versus the last quarter. This continues to be held back somewhat by the low interest and inflation environment. CPI, however, seems to be back on the rise with March and April CPI at plus 0.9%, which generally has a positive impact on NII. On Slide 9, you can see that the tight expense control and the efficiency program led to an improved adjusted gross income ratio. Salary and related costs are 4% down versus previous quarter, beginning to reflecting the impact of the 754 employees that participated in our early retirement plan and those that reached natural retirement. Clearly, the strong ROE results will result in higher bonuses as well. But overall, our expenses are under control. In the coming quarters, we'll give a better picture of the impact full of the retirement plan. The clearest example of the strong underlying macroeconomic situation is in Slide #10. The negative LLP was driven mostly by a release of provisions on the balance sheet that were made during the crisis. Even with this release, we still maintain a reserve ratio of 1.883, higher than pre COVID, continuing the trend we have seen throughout the crisis, customer deferral trend downward, write-offs are not increasing, and our customers continue to work to pay down the loan. Please notice in this slide that there is a small mistake in the graph color that got switched. Moving on to our subsidiaries, starting with Mercantile on Slide 11. Strong credit growth, the valuation gain on shares of Zim shipping and the negative LLP were significant drivers of Mercantile's record ILS 150 million net income and 20% ROE results. Mercantile continues to perform well and achieved strong results as it focuses on its growth strategy. Presented on Slide 12, we continue to see demand for credit growing, while the net income continues to be impacted by qualitative factors adjustments for COVID. On Slide 13, we present another record quarter, this time for Cal, with net income of ILS 60 million and 12.9% ROE, significant growth in transaction turnover and sustained growth in active cards as the underlying factors that drive the business for Cal. Cal continues to be negatively impacted by the reduction in air travel and tourism, which we hope will begin to change later in this year. Lastly, on Slides 14 and 15, just a few words on our strategy. As we laid out in detail in March on the call with you, we are fully focused on being the best financial institution for our customers and delivering superior value for our shareholders over time. Our strategy is 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. We are tenaciously executing on our strategic plan. On Slide 15, we highlight a number of achievements that we hit during the quarter, including completing our early retirement program; maintain high loan growth in targeted sectors; receiving recognition for innovation in retail banking; and lastly, preparation for launching the tokenization of credit cards in our leading digital wallet, PayBox, along with our partner, Supercell, the largest retailer in Israel. Q1 was a great start to 2021, and we look forward to more positive updates as the world economy continues to recover. With that, let's open it up for your questions.

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

I was wondering if you could comment a little bit about the NIM trajectory that we've seen over the past couple of quarters?

Can you repeat the question, Tavy?

Yes. Could you comment on the NIM trajectory, net interest margins? I think they've been declining for the past couple of quarters?

Sure. So I think the NIM going down is a combination of 2 things. First of all, we do see a change of the mixture. When mortgages are up, and consumer loans are down, as a result, you see the NIM as a percentage going lower. So this is one impact. The second element is we do see, in some segments, a stronger competition around price, especially in the areas where there is still low demand for credit like consumer and small businesses. We do expect that when the demand is going to increase, especially around consumers and small businesses, we will start seeing an opposite trend.

Okay. That's helpful. And then just talking about the growth in mortgages. Is that a result of your strategic plan to grow among your existing customer? Or are you competing on price? What's driving the growth?

So we -- as part of our strategy, we announced and we decided that mortgages is one of the top 3 pillars of our strategy. We identified huge potential over there. Currently, we are below our natural market share and mortgages, of course, is not limited to the natural market share because every customer that takes mortgages usually checks more than one bank. So we have a huge potential over there, and we see a substantial demand. We were able to increase our market share during the last 4 quarters, but the good news that there is huge potential for -- to continue growing. And the story is not around price. The demand is huge. And currently, our challenge is to answer -- is a capacity challenge and to answer all the demand. So we are working on to improve our platform. We just introduced a digital mortgage and we are optimistic that with the steps we are taking, we'll be able to answer all the demand and to continue growing our market share and the size of the business without the need to reduce prices.

The next question is from Micha Goldberg of Excellence.

First of all, congratulations on a very strong quarter. A couple of questions. It seems to me that your balance sheet is starting to balloon with deposits in cash and low-yielding securities, like almost 3%, 2%, I think, of your total balance sheet, which is like, I don't know, 7% or 8% more versus last year. Is there any way you can deploy those low-yielding assets in a different way to support your margins or increase yield?

First of all, we are not sure. It's something that will be stable like this. Some of it is temporarily. The increase of deposits, we do believe that with the market, the overall economic environment in Israel is changing. We will see more -- these line items will go down and people will invest more. So we don't think it's ongoing. Always, we are looking for smart ways to where we should invest the money and do with the money. So when there are opportunities, we are taking them. So this is a general answer.

But is 30% of your assets in no yielding or low-yielding, is that reasonable over time? Or is there like a target that you think that the number should be at?

It's -- we didn't declare on specific numbers. We are working to have a different -- to work on a better mix, but I can't share with you a specific target we are having.

Okay. Another question, which I think is related to the same trend. I mean, loans and deposits have come down again to 88% after, I think, a couple of years of hard work of getting it rightly up. I mean that, too, obviously will pressure something on margins. Is that something -- I mean, deposits went up significantly in this quarter. And I mean the crisis seems to be pretty much behind us. Is there any policy in place on trying to see that number doesn't grow too fast? Or I mean, what are you guys thinking about that?

First of all, the debt solution is to continue increasing the loan. So as you can see in Q1 results, we are growing -- we have substantial growth in terms of loan in this quarter according to the banks that published until now, we are growing faster than our peers. And regarding deposits, as I mentioned before, I don't -- we do expect deposits to start going down. So I do expect the ratio of loan-to-deposit ratio will get higher further this year.

So you realize that deposits are growing all of the triple rate that your credit is going, right?

Yes. This was happened in 2020 and in the first quarter, but we do expect to see this trend changing.

Okay. Another question about your nonperforming loans or nonaccruals, it's a little different than the other banks that reported so far. You have kind of seen a 20% increase in this quarter over last quarter, yet the other 2 banks that are published have seen either flat or a decline. Are you seeing something different? Or is the rapid loan growth that over the last couple of years just kind of have succeeded in managing, starting to hurt you on the NPL side? Where is that coming from? And how should we look at that?

So regarding NPL, when you look versus Q4, you're right, it's growing. When you're looking versus quarters before pre COVID, for example, Q1 '20, it's declining. And so we think, overall, our number is reasonable, even when you present -- you compare the percentage of NPLs out of total credit versus other banks. So it seems very, very reasonable. But overall, we do expect that as part of this crisis, which we accrued a lot and the LLP was very high in 2020, some of it will -- by the end of the day, will hit NPL, will hit write-off. So for us, it's something we are expecting, and it's not surprising us. And as you can see, we still have a very high coverage ratio, although we had a negative LLP. So we do feel very comfortable with the reserve ratio -- with the overall reserve we have at this stage.

Okay. And then a small question, on OCI, it looks like your fair value adjustment for fixed income and other relevant debentures is like over ILS 400 million negative. Where is that coming from?

Can you repeat the question, Micha, sorry?

Yes. On the OCI, the other comprehensive income there's a net loss of around ILS 407 million due to securities. I'm just wondering where is that coming from, market seems to have been pretty strong. So I was wondering, on the one side, you have recorded a significant amount of gain, and on the other one you seemed to have accumulated losses. I'm just wondering where it's coming from.

So we'll check and we'll get back to you.

Okay. And then 2 more small questions. I saw that risk-weighted assets grew quite nicely over the quarter. I think the loan part of the risk, whatever, over ILS 5 billion. I'm just wondering because loans didn't grow that quarter so much. So like what is that because the NPLs grew, and they're more than 100% of risk-weighted assets? Why are risk-weighted assets on the loan risk growing faster than your loan growth? I mean, assuming that, as you said, mortgages are the main part of that. And I think there's something like 35 to 45 risk weight on that. So in theory, the numbers should be lower. How come it's higher?

So overall, there is a very strong correlation between the credit growth and the risk-weighted asset growth. For most -- specifically why they grow a little bit more, we can provide you later on the details.

The next question is from Borja Ramirez of Citi.

I have a couple of quick questions. The firstly is regarding the volume growth. It was quite strong in the first quarter. I would like to check if you could provide some color for the rest of the year, if we could see this strong volume growth or if it could potentially slow down? And my second question is regarding the early retirement plan, if it could be possible to provide some details on the potential cost savings going forward?

So I'll start with the early assignment plan. As I mentioned, this was the last quarter of -- with the negative impact of the plan. Overall, in this plan, which we launched in Q3 '20 and just now finished more than 750 employees left the bank. Around 100 of them by natural retirement and the rest is part of the early retirement programs. Overall, I think we can start when you're looking at our salary cost, especially when we are deducting the bonus elements, you can see the decrease in salary cost versus 2020. And we do expect to continue seeing the positive impact later on in 2021. Of course, as I mentioned before, I think the key or 2 major elements of our strategic plan: one was around cost cutting, and it's mainly coming from people cost; and the second is coming from revenue growth, especially in mortgages. And we do see very good results in both aspects. Regarding the deposit growth you asked about. So we did see in Q1 a substantial increase in deposit growth. It mainly came from corporates and not from consumer. And we do expect that not continue seeing this trend at the rest of 2021.

Sorry my question when I also -- are more towards the loan side, if you could kindly provide details on loan volumes going forward?

Sure. So overall, we had a very strong Q1 growth in terms of loans. We do expect that around mortgages and corporate and midsized business will continue to see substantial growth, especially in mortgages. There is a very big demand in the overall market, and we're continuously taking -- gaining market share. So we expect this trend to continue. We do expect at areas where we had not only us, the entire market had negative growth. So not growth at all like consumers and small businesses, with the recovery of the economy, we do expect that those sectors will start growing, start back growing, unlike what we have seen in the last 12 months, and it's something we are expecting to have -- to see industry-wise, not only in Discount Bank in the next few quarters.

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

Just one more question, if I may. I mean you just pretty much wrapped up around the 600 earlier retirement plan FTEs. And is that showing up that much in your staff costs, what should we be expecting going forward?

So first of all, when you look at the staff cost, you need to eliminate the bonus amount because in 2020, the bonus were -- the bonus accrual was very minimal. And in 2021, it's based on the existing ROE or the ROE expectation is higher. But even -- and when you look at the numbers without salary cost, without the bonus component, you do see, when you look at Q1 versus a quarterly average of 2020, you can see the reduction, for example, versus Q1 2020, you will see 4% reduction. So overall, it is a very positive sign. And overall, in 2021, we do expect that salary cost will be -- will show a very good trend versus 2020. We, of course, we cannot share specific focus or specific numbers.

Okay. But in general, now that the early retirement scheme is completed in Q1, we should be -- or we should anticipate that staff costs should be going down? Is that a reasonable anticipation or assumption?

There are different elements. For example, there's the annual salary increase that you take into consideration, and it's something which should be seen later this year. On the other hand, in some cases, we are recruiting. So I think what we already see in Q1 is very, very positive trend. I cannot comment versus Q2 to Q4 numbers are going to be at the same level or a bit higher, a bit lower. But overall, I think the trend and the picture is very positive. And as I mentioned earlier, the people cost or the salary cost is the main cost pillar. And we do see in Q1, an adjusted cost income ratio of 60.6%. So overall, we are very optimistic and very happy with the cost situation. And of course, we will always continue to see how we can improve and continue to reduce costs.

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

I only -- I would like only to thank everyone for participating, and see you all in next quarter.

Thank you. This concludes the Israel Discount Bank First Quarter 2021 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.