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 2022 Results Conference Call. [Operator Instructions] With us online today are Mr. Barak Nardi, Mr. Joseph Beressi and Ms. Lena Schwartz. As a reminder, this conference is being recorded November 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 respective company's business, financial condition and results of its operations are subject to risks and uncertainties that would 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?

Thank you. Good afternoon, everyone, and I hope you are well. Starting with Slide 4, we will begin the review of the financial results. Our exceptional third quarter results show the clear execution of our strategy that combined with higher interest rates helped us to generate net income of ILS 893 million and ROE of 15%. Our efficiency ratio improved materially and stood at 55.2% for the third quarter, bringing up very close to our long-term strategic target of 55%. Now I would like to elaborate on the financial highlights of the third quarter and first nine months of the year, as you can see on Slide 5. Our ILS 893 million net income in the third quarter did not include any special one-off items and was largely driven by increase in revenue from core banking activity supported with rising interest rates. Net -- NII in the third quarter increased by 37.6% from parallel quarter in 2021 and reached almost ILS 2.3 billion. This material growth in revenue drove an improvement in our cost/income ratio has improved to 55.2%. Credit growth slowed down a bit in the third quarter, aligned with lower demand we are observing. Nevertheless, we remain 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. At the same time, we remain focused on the quality of our lending. In the third quarter, we have recorded ILS 101 million of credit loss expense, which is about 18 basis points of the average credit balance and is related largely to increase improved basic provision, which reflects worsening macro assumptions, 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 we have announced on a 20% dividend distribution totaled about ILS 179 million. On Slide 6, I would like to briefly touch upon some key macroeconomic indicators of the Israel economy and explain the potential impact on the bank's results. The fundamentals of the Israel economy are still strong, and the expectation is for economic growth to continue in 2023, but at a much lower pace as the rising interest rate is pulling down the economic activity and the demand. Labor market is still strong and expected to remain relatively resilient, although we have seen slight increase in unemployment in recent data. Inflation is rising. Nevertheless, it remains structurally lower compared to many other developed economies. Now I would like to discuss the impact of the macro developments on the bank. We start to observe early signs of slowdown in economic activity and cooldown of the demand. As such, the credit growth slowed down in Q3, and we expect similar trends to continue in the next quarter. At the same time, the impact of increasing interest rates on the profitability is material and positive as we have seen in the substantial increase in net interest income in the third quarter, in line with our previous expectations. Another impact of interest rate increase is on the [ BOI ]. So far, we have not observed a deterioration in individual BOI capabilities to [ service business ]. Yet, we continue to increase the credit loss provision to reflect worsening macro expansion. Finally, we are looking at the development in the economy and expect operating conditions to remain volatile. Nevertheless, we are confident in our performance and expect the net outcome of the mix impact of the macroeconomic environment and particularity of the increasing interest rates to be positive to the bank. On Slide 7, you can see our credit growth. As mentioned in the third quarter, credit growth slowed down and we grew by about 2%, which was evident across all segments. Nevertheless, compared with the third quarter of 2021, we grew by 16%, focusing on our targeted segments. Mortgages, which grew by 26% year-on-year and are now comprising about 26% of our loan book compared to about 22% two years ago. And credit to medium enterprises that grew by about 18% year-on-year. Looking ahead, we continue focusing on sustainable, profitable and responsible lending opportunities. On Slide 8, you can see a very good demonstration of the strength of our core business and the impact of higher interest rates on the performance. The average interest rate in third quarter was 1.5% compared to almost 0.5% only in previous quarter and close to zero in Q3 2021. As a result and in line with our anticipation, NII grew by 37.6% versus last year to about ILS 2.3 billion. In addition, fee income grew by about 8%. Total income grew by 23.8% in third 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 is financing income from current operations. This is the income for our core banking activities, our bread and butter. These numbers exclude the impact of a few items of CPI, derivatives and fair value adjustments. The income from regular financing activity grew this quarter by 42% versus last year, and NIM increased to 2.74%. Going forward, we expect that the impact of additional increase in interest rates will remain positive, although its marginal impact will moderate. Moving to Slide 9. The expenses grew this quarter, mostly because of growth in other expenses, largely due to revenue-related expenses linked to increased activity at [ CAL ]. Nevertheless, due to the exceptional increase in revenue, which materially outpaced the broking expenses, as you can see on the right-hand chart and as evident by positive Jaws of 12.8%, cost/income ratio continued improving, reaching 56.5% for the first nine months of 2022, and 55.2% for third quarter, bringing up close to our strategic target of below 55%. On Slide 10, you can see the evolution of credit loss expenses. This quarter, we are still not observing a material deterioration in specific borrowers conditions as evidenced by a very low specific basis provision, we continue to increase group basis provisions to reflect worsening macro assumptions, in particularly increasing interest rates. Overall, credit loss expense stood at 0.18% from credit in third quarter and cumulative credit loss expense in nine months was 0.1%. On the next slide, you can see additional asset quality metrics. Allowance for loan loss provisions from total credit increased slightly to 1.31%. Nonperforming loans from total loans were 0.67% slight improvement from previous quarter, largely due to improved classification of problematic borrower. NPL coverage is also very strong at the loan provision cover nonperforming loans by almost twice. These indicators reflect the solid quality of our loan book and our conservative underwriting. Touching briefly on funding and liquidity on Slide 12. Our deposit base is granular and diversified with about 54% in retail base. Households and small enterprises. Deposit base continues to grow. Total deposits grew by 3.3% from the previous quarter by almost 20% from third quarter of 2021. We continue to maintain solid liquidity ratios above, far above the regulatory limit. Moving on the performance of our subsidiaries, starting with Slide 13. Mercantile produced very strong results this quarter with net income of ILS 185 million and ROE of 19.3%. This was mainly due to increase in net interest income [indiscernible]. Loan growth slowdowns Mercantile as well as overall credit grew by 17.4% year-on-year with even growth of 30% in mortgages. Mercantile cost-to-income ratio continues to improve and was below 50% this lockdown. In [indiscernible], still on Slide 14, we saw higher net interest margin, which led to 43.8% increase in net interest income. After five consecutive quarters of credit loss provision release, credit losses were positive this quarter at 0.23%, reflecting the shifting economic environment. CAL, shown on Slide 15, continues to enjoy a very positive momentum in 2022, following 24.1% increase in consumer credits and 16% increase in credit card transaction. turnover. CAL recorded net income of ILS 109 million in Q3, with ROE of 20.9%, which included also profit from sales of Visa Inc. shares of about ILS 30 million. To summarize, I would like to emphasize the key takeaways from this quarter results. First, we delivered record Q3 results with ROE of 15% and cost-to-income ratio of 55.2% as we remain focused on continued execution of our strategic initiatives. Second, we benefited from increase in interest rates, which became evident during the quarter and led to increase of 37.6% in net interest income to ILS 2.3 billion in Q3. Third, the credit growth in Q3 slowed down, aligned to market conditions, we remain focused on our targeted segments and grew by 26% year-on-year in mortgages and 18% year-on-year in medium enterprises. And lastly, loan book continued to display resilience with solid asset quality metrics that reflects worsening macro indicators in increasing group basis provisioning. With this, I will finish the overview and would like to open to Q&A.

[Operator Instructions] The first question is from Chris Reimer of Barclays.

First off, I wanted to touch on the macroeconomic slowdown. Also, what you mentioned in your opening statement that you are seeing a cooldown in demand. If you could just give some color on what segment you might be seeing impacted more than others?

Well, thanks. First of all, the closure is across the board. I think one of the things that Bank of Israel increased the interest rates in order to cool down inflation of the [indiscernible], they are expecting or the pushing to see slowdown in economic activity. So this is not a surprise. So the closure is across the board. I think the most dominant segment that we start seeing is one is around consumer credit. It's a first that we see a substantial slowdown. And second -- the second area is mortgages, where the higher interest rate pulled down the market a little bit and the growth rate this quarter is lower than what we have seen in the past. So I do believe that Q3 growth that we're currently experiencing is a more accurate reflection of what is expected to be a fall.

Okay. And assuming that the level of activity does slow down more, what segment of the portfolio do you see most at risk of facing higher provisions?

So overall, as I said before, at this point, we still don't see specific like any specific signs yet. So the level of write-offs is very low. So currently, we don't see that it's negative side. But we do expect that with higher interest rates, a higher level of LLP will come. So first of all, I think we will experience it across the board. And we start -- as I mentioned before, we already started putting group provisioning exactly for this scenario. If I try to be more specific, I think the two areas that we might see higher LLP, it might be around -- first around real estate, where in recent years, the leverage over there was quite high. And I think with higher interest rates, we might find some negative activity over there. And second is around consumer credit with higher interest rates aligned with households that have both mortgages and maybe other consumer credit, we -- I do believe that they will do everything they can to pay the mortgage, but in other consumer credit, we might see some more defaults than we used to see in the past.

Got it. That's a very helpful message for me.

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

First of all, congratulations on an excellent quarter. Just a short one on the numbers. Is there anything unique onetime in this quarter that [indiscernible] trying to exclude in order to get to some kind of return on equity.

No. As I mentioned before, in this quarter, we don't have any like onetime that we shouldn't expect to see in future quarters. So it's a very solid -- quarter. Of course, as I mentioned before, and I'm not so that we can expect that the low -- very low LLP. In this quarter, we continue to next quarter, but we don't have any special like onetime that you should exclude.

Okay. My second question then is, I mean, it looks like your last, I don't know, several quarters, if not the last couple of years, your profitability has been significantly above your long-term strategic guidelines of 12.5% by 2025. And I'm just wondering, will you be reconsidering that return on equity target? And if so, will you be publishing helping in that direction later on?

So I think as you mentioned and you are right, we actually wish this quarter, the long-term targets we have put for 2025. We need to take into consider -- that both in terms of ROE and cost/income ratio. We need to take into consideration that when we put the target, it was only a year ago, but it was a totally different economic environment with total different interest rate expectations. We are working internally on our future targets. And after we let it, we need to see whether we communicate updated targets or no, it's too early to call. And I think there are also in this period there is some uncertainty around the interest rate level, the implication. So I think it will be wise to wait a little bit before setting long-term goals and communicating them.

Okay. One more question. I mean you mentioned there could be a potential deterioration in asset quality in the future, although at this point in time, not seeing that. I'm just wondering on your provision policy, would have there been more prudence to provide more this quarter on that to have to put more aside in a case of future deterioration.

No, based on our model also this quarter, in the previous quarter, we put based on macro indicators and the rising interest rate we put aside. For country, we feel very comfortable with our current level of provisioning, and we think it will serve us in future development. So I don't think there was a need to put more upside at this stage.

I understand. And my last question is you mentioned that credit demand is slowing down, and you expect that might continue to slow down even more. If the current profitability is almost sustainable even with a slightly higher cost of risk. Then my question is why do you need to sort of 5% growth rate and, I don't know, let's say, 12% return on equity, why do you need to keep so much capital on. In other words, would you consider paying out more dividends?

Well, first of all, I think always we like to look at this on like to look at the equity of the scarce resources and to have the right balance between supporting growth and paying our dividends. We had a policy of up to 30%. And I do think at least the trend of very high ROE of double-digit and a fulfillment of the current expectation of slow growth rate, it might make sense in the future to continue to look at the dividend payout and to see what is the right timing to continue the increased trend towards the 30% policy revenue.

There are no further questions at this time. Thank you. This concludes the Israel Discount Bank's third quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.