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 2022 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 23, 2022. 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 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, risk and 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. Kaplan, would you like to begin?

Thank you very much, and welcome to our first quarter 2022 earnings call. I'll turn it over to Barak now, who will go through our presentation, which is available on our website, and then we will open up for Q&A.

Thank you, David. Good afternoon, everyone. I hope you are all well. Starting with Slide 4 in our presentation, we will begin the review of the financial results. Our strong first quarter results show the clear execution of our strategy with solid credit growth, especially in mortgages that help generate net income of ILS 983 million and an ROE of 18.3%. Adjusted for the sale of real estate assets, net income was ILS 668 million and the ROE was 12.4%. Lastly, our CET1 ratio of 7.55 following the equity raise puts us in an excellent position to continue to grow and to achieve our goals. Expectations for higher rates continue to be priced into the market and we talk about that on Slide 5. The yield curve in Israel and in the U.S. continue to imply higher rates at all duration. Looking at the 5-year duration, the expectation for where rates in Israel will be has moved from 0.42% in at the beginning of the year to 2.16% now. CPI expectations have also moved significantly with the 1-year forward expectation at 3.3% versus a 0.3% 1-year forward expectation at the beginning of 2021. The expected increases in rates and CPI will contribute to the bank's financial results. At the same time, we are monitoring the ongoing development of the macro situation and we'll react accordingly. On Slide 6, we present the financial highlights and the main factors that led to our strong results this quarter. First was the solid execution across each of our subsidiaries, and I will touch on that a bit later in the presentation. Second was the focus on our targeted strategy to grow in the areas that have the greatest impact and highest returns for the bank and its shareholders. Mortgages, our key strategic pillar, were up 5.2% year-to-date and 27.7% over the past year. Our focus on mortgages and our tight risk management continues to produce low level of LLP and write-offs. At the end of Q1, we completed a successful equity raise in which we increased our equity capital by ILS 1.4 billion, and this was a major part of the 10.55% CET1 we reported this morning. The capital raise enables the bank to continue its growth momentum and realize its significant potential with an emphasis on the areas and strategic focus of the bank, mortgages and medium-sized businesses, taking advantage of the opportunities that currently exist in the market. Lastly, we announced a dividend in respect of Q1 2022 totaling almost ILS 200 million and equal to 20% of Q1 net income. Moving to Slide 7, you can see that we delivered strong credit performance, especially in our targeted segments, mortgages and medium businesses. The growth of our mortgages, which is the main focus areas of our strategy, was 27.7% over the past year and 5.1% in Q1 alone. This growth would have been higher, if not for the sale of a portion of our mortgage portfolio during the quarter. This drove the mix of mortgages to 25.4% of our total credit book, up from just under 22% at the end of 2020 when we set out on our new strategy. We also delivered significant growth in medium enterprises, another one of the core areas of our strategy. During Q1, we deliberately held back corporate lending growth. Now post our successful equity raise, we are well positioned to grow in this sector as well. Looking ahead, we see many additional opportunities for growth, and we'll examine each of them to make sure that our credit growth is sustainable, profitable and responsible. Total income shown on Slide 8 highlights the strength of the underlying business with NII growth of almost 20% and fees up 14% versus Q1 '21, driving the growth. This was partly offset by a decrease in noninterest financing income as a result of our interest derivative position, much of which will likely reverse and generate income at the rest of the year. Total income increase of 21.6% includes the sale of real estate assets. On the expense side, the main impacts were increased activity at Cal that comes along with higher payments with partners and salary increases that are part of the wage agreement. Slide 9 highlights our high-quality loan book and conservative underwriting. LLP of negative ILS 60 million and low levels of write-offs continued to contribute a positive impact. The negative LLP is a result of collections and reclassification of strategic customers and of new models and methodologies implemented through CECL. Moving on to the performance of our subsidiaries, starting with Slide 11. Mercantile produced a set of very strong results with net income of ILS 121 million and an ROE of 12.9% this quarter. This was mainly generated by robust loan growth, particularly in mortgages that were up 7.5% in the quarter. In New York, as seen on Slide 12, we saw credit growth of 16.5% and deposits were up 13.3% in the past year. This growth, coupled with lower LLP helped to deliver ROE of 9.7%. Cal, shown on Slide 13, opened 2022 with a very strong Q1, delivering net income of ILS 80 million, an ROE of 14.3%. The results were driven by 22.9% year-over-year consumer credit growth, 20.5% year-over-year transaction turnover and low levels of LLP. In addition to the financial strength, Cal also completed a number of strategic agreements with major players in Israel who provide credit and payment as a service. To finish up, we continue to focus on execution of our strategy as we build towards achieving our 2025 financial target of more than ILS 3.5 billion in net income, more than 12.5% ROE and a cost-to-income ratio lower than 55%. As shown on Slide 5, the interest rate expectations today are almost 0.5 point higher than when we announced our target, and this gives us an additional tailwind towards achieving the target. Thank you all, and we can open now for your questions.

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

I have two, please. When you look at your growth rate combined with the fact that the expectations for rates growing, I mean, what do you see as a sustainable level of growth without compromising your underwriting policy? And I guess my second question is related. I mean when you also look at the LLP level, what do you think is a sustainable rate once you factor in the rates going up in the foreseeable future?

So regarding growth rates, as you can see, in this quarter, we grew a little bit more than 2%. And this is when the corporate segment went down and because of equity. Because of held equity, then we are going to raise it in the future. So we expect -- we think that the current rate of 2 -- above 2% is sustainable also for the future. And regarding LLP. LLP -- negative LLP is not something that's sustainable. CECL is new, and we need to wait a little bit and to see within a few quarters what is the new normal. The new normal, of course, is not negative. But I assume or we expect that the new normal should be lower than historical LLP level prior to corona.

The next question is from Micha Goldberg of Psagot.

First of all, congratulations on what looks like a stellar quarter -- another one stellar quarter, I'm sorry. A couple of questions, if I may. The first question is regarding your risk-weighted assets, they grew by 3.3%, while your credit grew by 2.2%. Could you explain what the difference is? And is this something we should consider to be a kind of looking forward as well. So every, I don't know, 2% growth on credit will be accompanied with an additional 50% growth on your risk weighted assets of 3% growth?

Micha, do you want to ask all the questions at once and then we'll go through them as we answer?

Sure. My second question has to do with your capital ratios. So you're currently after raising are at 10.55%. I understand that since the end of the quarter, the impact of capital markets and yields has reduced capital adequacy by another 11 bps. So you're really at this point having 70 bps above your internal target. So assuming a 1:1 ratio on risk-weighted asset growth and loan growth, that really supports something like a 6%, 7% loan growth. And if I take into account impacts of new accounting practices and the Bank of Israel's real estate capital requirements, I'm just wondering how much loan growth can you go based on the current levels of capital ratio? And are you in a concern that if capital markets continue to go south, you would need to be in additional need of more capital? That's my second question. My third question is, can you explain how the dollar impact on your P&L and your risk-weighted assets? And lastly, I was just wondering as to recovery. One of the other banks have reported they had huge recoveries. And it's one of the things that seems to be elusive to discount. I was wondering, are there significant recoveries potential at Discount Bank? It's just a very different credit book that's why that spend doesn't come through at discount. Just wondering how that compares to some of the other banks.

Sorry, could you just repeat the third question, it was a little hard to hear you.

I'm sorry, on recoveries, I was just wondering...

No, no, no. The one before recoveries.

I think one was on the actual capital ratios, is that the question? I was just wondering...

One on the dollar, I think. You asked in between one on the dollar.

I just want to know the dollar impact is on your P&L and your risk-weighted assets, nothing major.

Yes, I'll answer your question. I hope I won't miss anything. So regarding -- I'll start with the second question of loan growth. Yes, as you mentioned, we are well above our regulatory targets. The targets are 9.75%, we are 10.55%. Even with the additional impact -- negative impact of 0.11%, we are still well above. And when you're looking ahead, we don't think we have limitation for growth because if we produce and -- if we are able to produce double-digit ROE on ongoing basis, it can support our loan growth. So we don't see currently -- we don't see in the equity there's a limitation for future loan growth. So this is regarding the loan growth. Regarding the risk-weighted assets, I think the excess growth in risk-weighted assets versus the loan growth is coming from some off-balance sheet items. But overall, it's not something that is very significant. And overall, on a long-term basis, we expect the risk-weighted assets to grow at the same pace as the loan. So it's something that is temporarily. Regarding the impact of dollar, it's not very significant. As we published, there is a positive impact on equity I think of around ILS 80 million in equity and CET1 ratio. And in terms of P&L, it's not -- currently, it's not something very significant. In terms of recoveries, as we publish some, around half of the negative LLP is coming from specific customers with some recoveries. It's not very significant, but it exists and -- but it's not -- and it's a specific customer we should mention.

The next question is from Joseph Dickerson of Jefferies.

I just had a quick question on the cost-income ratio target of 55%, given the adjusted business is at 63.7% and you had a pretty strong quarter of both loan growth and NIM expansion. So I guess, what are the building blocks to get to the 55% target in 2025?

So first of all, if I start with the current number, the adjusted one of a little bit above 63%. We need to take into consideration that it's higher. One of the reasons it's higher than other banks is because we are consolidating the credit card company, Cal, its operational company. And with higher cost income ratio, excluding Cal we are around 60%. So it's still -- but it's a better number, but still we have a great room for potential. And the way we are going to reach the 55% is growing revenue much faster than cost. We expect in the following years, that the pace, the revenue growth pace coming from loan growth with the backwind of interest rate and inflation will grow much faster than expenses. So by that, we'll reach gradually the cost-income ratio of lower than 55% in 2025.

The next question is from Michael Klahr of Excellence.

Firstly, just again on the costs. So I see salaries was up 3% year-on-year, excluding bonuses. And I just wanted a bit of help whether we should be expecting that kind of growth through the remainder of the year at that kind of rate. And my second question was on credit growth, and whether you're seeing any signs of a slowdown in mortgages or corporate as interest rates start to rise? And also given more general market turmoil, et cetera, especially in the capital markets, whether you're starting to see an impact there.

So regarding salaries. So the 3% increase is more or less representing the wage agreement. So on an ongoing basis, this is more or less the salary growth. And as I mentioned earlier through answering Joe's question, assuming that this is more or less the run rate for salary growth, we expect the revenue to grow in a much faster pace. Regarding slowdown, I think if we look at the overall macro conditions, overall they are favorable to the banks. The expectation around interest rates and inflation are positive. As we indicated in our financial statements, every 1% in terms of interest rate increase generates additional ILS 1 billion in terms of revenue. On the other hand, we need to take into consideration that there might be a decrease in demand. Currently, we don't see it yet but it might evolve. And specifically around mortgages, we think that even if there will be some decrease -- some decline in the mortgage -- in demand to mortgages, we believe that we'll be able to keep our fast pace because we still at a low market share, we still are not working on the demand side, we're solving our capacity issue. So we believe that even with a lower demand in terms of overall market, we will be able to continue our strong growth momentum around mortgages.

Can you just remind us what the weighting, the risk weighting of your -- or the rough -- roughly is of your mortgage portfolio?

Mortgages is around 50%. But -- so the translation to risk-weighted assets is around 50%. You need to take into consideration that we are from quarter-to-quarter, we are increasing our mortgage mix. So currently, we are at 25% -- above 25% of total loan book and we will continue to increase this -- the mortgage mix.

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

Yes. Thank you all for joining us for Q2. We look forward to talking to you again in August.

Thank you. This concludes the Israel Discount Bank First Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.