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 2022 Results Conference Call. [Operator Instructions] With us on line today are Mr. Barak Nardi, Mr. Joseph Beressi and Ms. Lena Schwartz. As a reminder, this conference is being recorded August 11, 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 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. Schwartz, would you like to begin?

Yes. Thank you. Good afternoon, everyone, and thank you for joining our second quarter results conference call. I'd like to turn it over to Barak Nardi for the overview and highlights for the second quarter. Barak?

Thank you, Lena. Good afternoon all, and I hope you are well. Starting with Slide 4, we will begin the review of the financial results. Our strong second quarter results show the clear execution of our strategy that helped us generate net income of ILS 680 million and an ROE of 11.8%. We have grown in credit by 16.4% year-on-year, leveraging the equity raise at the end of the first quarter. At the same time, we continue to remain committed to improving the efficiency ratio, which stood at 59.2% for the second quarter. Now I would like to elaborate on the financial highlights of the second quarter and first half, as you can see on Slide 5. The ILS 680 million net income was largely driven by increase in revenues from core banking activity as we continue to execute our strategy of credit growth. We leveraged our successful ILS 1.4 billion equity raise at the end of the first quarter into almost ILS 15 billion or 16.7% credit growth over the second quarter. We focused on our targeted segments where we believe we have the greatest potential to outgrow the market and which can bring the highest contribution to the bank and our shareholders. As such, we grew by about 29% in mortgages and by 22% in medium enterprises year-over-year. We also took advantage of a unique market opportunity, which allows us to grow in high-quality corporate credit by 10.3% during this quarter. As a result and supported by growth in net interest margin, our net interest income grew by 23% year-on-year, and we view it as the clear strength of the bank. At the same time, we remain focused on the quality of our lending. After several quarters of credit loss expenses released, we have recorded ILS 131 million of credit losses expense, which is about 0.23% of the average credit balance, and it is related largely to credit growth and change in macro assumptions, which was partially offset by the improvement of the quality of the loan book according to our model. Other credit metrics continue to remain solid. Lastly, this is another quarter where, alongside the growth, we have announced on a 20% dividend distribution totaled about ILS 136 million. On Slide 6, I would like to briefly touch upon some key indicators of the Israeli economy and explain the mixed impact on the bank's results. The fundamentals of the Israeli economy are still strong with unemployment rate of 3.4%, back to pre-COVID level, and the expectation for 2022 GDP growth are still impressive, about 5% according to Bank of Israel, despite the expected slowdown of the global economy. Inflation has increased, yet it remains actually lower compared to many other developed economies. Bank of Israel has followed the Fed and started to increase interest rates during the second quarter. While the macro indicators of the Israel economy are still robust, we look cautiously on the development in the global economy and the volatility in the market, and on the potential impact on the local economy. At the same time, we do see a positive impact of increasing interest rates on our results with an increase in NII. However, the full impact of the rate increase is not yet reflected in our numbers, and I will elaborate more on this later. And finally, we are confident in our ability to carefully navigate in this condition. And all in all, we expect to benefit from the net positive impact of rising rates on our bottom line for increase in revenues, and this is despite the potential negative impact on the borrowers as reflected in increase in credit losses. On Slide 7, you can see our strong credit growth. As mentioned, leveraged by the equity raise, we grew by almost ILS 15 billion or 6.7% in second quarter and by almost 17% year-on-year. We focused on our targeted segments. First of all, mortgages, which grew by 7.1% during the quarter and by almost 29% year-on-year and are now comprising almost 26% of our loan book compared to about 22% when we set our strategy. Credit to medium enterprises grew by about 4% during the quarter and by 22% year-on-year. During the second quarter, we took the opportunity of market conditions and leveraged our capital raise to grow by 10% in corporate credit after we held back in the growth in Q1. We believe that this was a unique opportunity to grow responsibly in this segment by taking profitable high-quality loans, which is aligned with our risk appetite. Looking ahead, we see many additional opportunities for growth, and we'll examine each of them to make sure that our lending is sustainable, profitable and responsible. On Slide 8, you can see a very good demonstration of the strength of our core business. NII grew by 23% versus last year to above ILS 2 billion, and fee income grew by above 8%. This was partly offset by a decline in noninterest financing income as a result of our interest derivatives position, much of which will likely reverse and generate income in the course of the year. Total income grew by 13.2% in the second quarter compared to same quarter in 2021. As you can see from the chart on the right-hand side, we continue growing in what we define as income from regular financing activity. This is the income from our core banking activities, our bread and butter. These numbers exclude the impact of CPI, derivative, fair value adjustment, et cetera. The impact for regular financing activities grew this quarter by almost 24% versus last year, and NIM increased 2.63%. I would like to stress that we recorded this substantial increase in net interest income in the second quarter, while the base rate has only started to increase. It means that we have not yet seen the full impact of the rate hikes, and we expect to continue to benefit from it in the upcoming quarters. Moving to Slide 9. The expenses remained overall flat this quarter, and they grew slightly compared to last year, largely due to expenses related to increased activity at CAL. CAL's payment to partners have increased because of much higher issuing and credit activity. Our increase in income and the disciplined cost management led to improving cost-to-income ratio to 57.2% for the first half of 2022, continuing an improving trend over the past year. On Slide 10, you can see some of our key credit metrics. This quarter, after 5 consecutive quarters of credit loss releases, credit losses were 0.23% from the average credit, all of it generated by general group provisioning. The main driver for the LLP this quarter are the substantial credit growth we had and the change in macro assumptions, and particularly the increasing interest rates. It was partly offset by the improvement of the quality of the loan book according to the model implemented with CECL, which is why the individual provision remains negative. We remain focused on the good quality of our lending and maintain solid NPL and NPL coverage ratio. Moving on to the performance of our key subsidiaries, starting with Slide 11. Mercantile produced a set of very strong results with net income of ILS 144 million and an ROE of 15.5%. This was mainly generated by robust loan growth, particularly in mortgages that were up 7.6% in the quarter. Mercantile cost-to-income ratio improved to below 50% this quarter, supported by top line growth from core banking activity and strict cost management. In New York, as you've seen on Slide 12, we saw higher net interest margins, which led to a 26.7% increase in net interest income. Coupled with still negative credit loss expenses, the ROE stood at 10.8%. CAL shown on Slide 13 enjoyed a very positive momentum in 2022, following the post-COVID economic recovery and increase in private consumption and particularly material increase to overseas travel. Overall activity volume in credit cards and consumer lending has grown materially, leading CAL to produce ILS 81 million net income in the second quarter, with ROE of 14.6%. Moving on to Slide 14 and 15. We continue our path toward achieving our target with our 3-pillar strategic plan, and our determined execution enable us to do so. At the same time, rising interest rate expectations, which are almost 0.7% higher now compared to the time of the announcement of our financial target, allow us to accelerate the pace towards achieving those targets. To summarize, I would like to emphasize the key takeaway from this quarter results, as you can see on Slide 16. First, we delivered strong second quarter results, which reflect continued execution of our strategic initiatives, while at this stage, we only partially benefited from the rising interest rates. Second, we leveraged the equity rate to generate ILS 14.6 billion credit growth, focusing on our targeted sectors, mortgages and medium enterprises. We also took advantage this quarter of the market opportunity and grow substantially in corporate lending. Third, we remain focused on increasing revenues from core banking activity and on tight cost control, leading us to improve cost income ratio. And lastly, the interest rate increases allows us to accelerate the pace towards reaching our target of ILS 3.5 billion in net income, 12.5% ROE and below 55% cost-to-income ratio. With this, I will finish the overview and would like to open to your questions.

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

This is Chris Reimer on for Tavy. The loan growth, you already mentioned earlier, the strong loan growth and loan loss provisions having been rather low. Looking ahead, given the macro headwinds and raising rates, how should we think about loan growth and LLPs through the cycle?

So first of all, regarding loan growth, we still see a demand for loan growth in Israel. As I mentioned before, I don't think that the 6.7% we grew this quarter is representative, because we had some specific opportunities this quarter that I don't believe will be -- will stay in the next quarter. But still, I do expect to continue to see overall growth -- credit growth in the Israeli market. Regarding the LLP, and as I mentioned, our entire LLP is coming from group provisioning. And a big portion of it is due to the macroeconomic situation, especially the rising interest rates, so we put some provision to reflect this additional risk. So it's too early to call what is going to be in the next quarter. But currently, we believe that our current LLP and current provision reflecting accurately the current situation as we see it.

Okay. And just touching on costs. Costs and efficiencies have been a key priority for you guys. Are you comfortable with where you are -- where the expenses are today? Or should we expect further cost-cutting measures in the near future?

So first of all, as we mentioned, it's a key priority for us, and we are very happy and proud with the results. First of all, with the decline in cost-income ratio this half, and also the fact that revenue is growing much faster than expenses. We still believe we have additional potential to continue reducing our cost, and it's a clear uptake for us. One other comment I would like to add is when you analyze our expenses growth, you need to take into consideration that part of our portfolio in CAL, the credit card company. They have a different P&L structure and their expenses -- where the business is growing, there is also an impact on their expenses because part of the revenue is being paid to the partners and it's going to the other expenses line. So if you put -- and this is a good reason for the expense to grow. If you put CAL aside, so the Discount Group result is even better when you look at the expense growth. So it's another thing you need to take into consideration.

The next question is from Micha Goldberg of Psagot.

First of all, congratulations on a very strong quarter and a great first half. A couple of questions about -- you mentioned net interest margin expanding. And I'm just wondering if you exclude the impact of the CPI and the hike in interest rates, are the underlying core margins expanding? Or are they dropping?

So I think even if you put aside the positive impact of CPI, we still see a positive result. And it's coming from 2 areas, first of all, the increase interest rates; and second, a change of mix and bringing into our portfolio some very profitable deals. So actually, the increasing NIM is coming from 3 elements: the CPI, the interest rate that is being growing and the mix and the more profitable deals we brought into the table.

So even if you exclude the CPI and the Bank of Israel interest rate hike impact, you are saying there is still an expansion in your margins?

Yes, I think a very substantial impact in CPI and the interest rate. But even if you exclude them, the results are good. I don't think -- so we are not giving a specific disclosure what is the impact when you put that aside. But overall, we feel very comfortable with the margins even when you put aside those 2 external factors.

Okay. Because you provided those numbers in your report and when you exclude those, it actually looks like the margins are slightly on the way down. But maybe my numbers are wrong. Okay. Another question, I understand Visa ICC, your subsidiary, is supposed to implement CECL in January -- from January 1, 2023, is that correct?

Yes.

Does it have any impact on your capital ratios? Or is that insignificant?

So I heard your question regarding CAL, and they will start implementing CECL in '23. What was the other question, Micha?

I was just -- I was wondering if the change and the implementation of CECL on Visa ICC will have an impact on Discount Bank's equity ratios?

It's not -- it's insignificant.

Okay. Now I understand as of July 1, there are 2 new regulations that also have impact on your capital ratio, the SA-CCR on the dividend and the Bank of Israel requirement on risk-weighted assets for it, highly leveraged real estate lending. Could you tell me what the impact of those 2 will be on your capital ratio?

You are not sounding very well. So I'm not -- I didn't understand the question.

Can you hear me now?

Micha, you're asking about the impact of SA-CCR and the new rule on loans to the real estate?

Yes.

So the first one is less than 0.1%. It's about, I think, 5 basis points, 0.05%, the SA-CCR. And the new guideline on real estate loans will affect our capital adequacy ratio by around -- the maximum is 0.1%. This will be implemented along the next 4 quarters.

Okay. So just 0.025% per quarter, right?

Maximum, yes. 2.5 basis points per quarter.

Yes. Per quarter, yes. Okay. Great. So when you take that and look at your current capital buffer, is that enough to let you grow at even much lower rates than you're currently growing the loan book? Or is there anything else that needs to be done?

No, we feel very comfortable with it. We think that our growth, together with profits we are going to generate in future quarters, we believe we have sufficient room for sufficient growth, credit growth in the areas we are targeting. And as I mentioned before, we don't think the 6.7% quarterly growth is representative. But when we are looking at representative numbers, we feel very comfortable with the level of equity we have right now.

The next question is from Michael Klahr of Excellence.

Well done on a good quarter. I wanted to ask, firstly, on margins and what you're seeing in individual segments or categories. So for example, mortgages, are you seeing higher spreads, lower spreads or unchanged? And the same question also with middle market and with corporate. I just wanted to understand a bit more what's going on away from interest rates on the margin side in terms of...

So overall, and as I mentioned before, when it comes to the corporate segment, we just see some very interesting opportunities in the second quarter, which enabled us to take some deals in a higher spread than used to be in previous quarters. Overall, we do see, in some sectors, the spreads are getting higher. For example, also in mid-sized businesses, in housing a little bit. So it's not a dramatic changes, but the overall trends that we see in the second quarter versus previous quarters, it is a positive one.

Would that -- is that also true in mortgages? Where are spreads in mortgages versus, let's say, 6 months ago? Are they high or low or the same, would you say?

In mortgages?

Yes, mortgages.

In mortgages, they are a bit higher.

They're a bit higher. Okay. All right. And also, I just wanted to ask also on capital. So I got your answer to the last -- to the question from the last caller. But just by my calculations your -- even if you grow on a -- at a lower rate through the second half, your capital is going to decline, your CET1 will decline. So just wanted to understand where -- what the important levels are for you in terms of the 20% dividend payout. And is there perhaps a chance that you would need to raise more capital 6 months from now if growth rates don't moderate as much as you expect them to?

So first of all, it depends -- when you make this [ nice ] and it depends what you assume our profitability. So when we take into consideration our growth plan and the planned or the estimated profit, we feel very comfortable with the level of equity we have. We think we will be able to support our growth plan. We will take also into consideration that we reduced the level of volatility we had because we shifted some of our bonds to [ L2 ] maturity. So even if we are going to have some macroeconomic surprises and [ impeding ] yields, the impact of it on our CET ratio is -- was going to be much lower than it used to be. So we feel sufficient. We feel also sufficient with the level of 20% dividend. And we are planning -- the outlook is to continue paying this dividend going forward.

Okay. All right. So if anything -- if we take all those different factors, if anything is going to give way here, it's on the growth side rather than anything else, rather than the dividend or the -- or additional equity raising?

Yes. But the growth rate, as I mentioned, 6.7% we have grown in credit in the last quarter is not a representative. It's not going to be the rate going forward. But using a growing reasonable rate that we used to grow also in the past, we believe that we really can support it. And with the existing equity level, combining with the profit we are going to gain in the dividend, we feel very comfortable with the current situation.

[Operator Instructions] There is another question by Micha Goldberg from Psagot.

I hope you can hear me better now.

Yes.

Okay. Just one question I had and I think I missed. If I remember correctly, your original ruling about leaving Visa ICC and the ownership of Discount Bank is supposed to expire or be reexamined by the end of this year. I'm just wondering if you have any indication where that's going to go? And what will you do if you're required to sell that off?

To sell -- referring to CAL?

Yes, Visa CAL.

Okay. So currently, the point where the government can make a decision to split CAL from Discount Bank is until the end of January 2022. If they are not -- if they won't decide, so CAL is staying with Discount. We believe, first of all, we have a good reason why Discount should keep CAL. First of all, we think when you combine this with the current political situation and the fact that probably there is not going to be a new government until early 2023, there is a very good chance that the decision -- there is not going to be made any decision to CAL out of Discount. So we feel comfortable with the current situation. And you know if we will have to sell CAL, first of all, we will get -- we'll have time to do it, both POLI and LUMI got between 3 to 4 years to do this kind of transaction. CAL is a great company, a great asset, and we will get full value for it. But we feel very comfortable currently that we will be able to keep CAL and enjoy from their good performance.

There are no further questions at this time. Thank you. This concludes the Israel Discount Bank Second Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.