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 2023 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded May 17, 2023. 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, 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. I would like to move first to Mr. Gad Barlev, Head of Investor Relations. Mr. Barlev, would you like to begin?

Thank you. Good afternoon, and welcome to Discount Bank's first quarter financial results conference call. Today, we have the opportunity to reflect on our accomplishments in the last quarter and provide you with an overview of our outstanding performance. Participating in today's call are: Barak Nardi, CFO; and Yossi Beressi, Chief Accountant. We will start with a review of the financial results by Mr. Barak Nardi, and will then open it up for questions. I will now hand over to Barak.

Thank you all for joining us today. I'm very proud to present our first quarter results. Starting with Slide 4, we'll begin the review of the financial results. Our exceptional first quarter results show the clear execution of our strategy, that combined with higher interest rates impact generate net income of almost ILS 1.3 billion, an ROE of 20.1%. Our efficiency ratio improved materially, reaching 46.1%. Given our strong results and our confidence in the robustness of our core business, we have decided to raise the dividend payout to 30% of net income. This reflects our long-term journey to increase value for our shareholders. Moving to Slide 5. Before moving to discuss the financial highlights, I would like to briefly touch upon some key macroeconomic indicators of the Israeli economy. The fundamentals of the Israeli economy are solid, and the expectation is for economic growth to continue in 2023, but at a much slower pace than '22. As a result of the rising interest rates, we see some slowdown in the economic activity and the demand for credit. Given the recently published April CPI rising by 0.8%, it is hard to assess at this stage what would be the inflation for 2023 and whether the next interest rate increase, which is expected to happen soon, will be the last one for the year. On Slide 6, I would like to elaborate a bit on the financial highlights of the first quarter. Over ILS 1.27 billion net income and 20.1% ROE was largely driven by revenue increase from core banking activity, supported with an additional 1% rising of the interest rate during Q1. As a result, NII increased by 7.9% quarter-over-quarter and by 52.1% year-on-year. This material revenue growth drove a substantial improvement in our cost-to-income ratio that has reached 46.1% compared with 55.3% in Q1 '22. Total credit grew by 3.5% this quarter and by 14.5% year-on-year. At the same time, we remain focused on the quality of our lending. In the first quarter, we have recorded credit loss expenses of ILS 204 million, which is about 33 bps of the average credit balance and is largely related to an increase in group basis provisions. Other credit metrics continue to remain solid. Lastly, as mentioned before, we increased our dividend payout to 30% of Q1 net income. On Slide 7, you can see our sales growth. As mentioned before, our total credit grew by 3.5% in the first quarter, led by 6.9% growth in corporate and by 5.6% growth in medium enterprises. At the same time, we're already seeing the slowdown of the economic activity and the cooldown of the demand, with mortgages growing only by 2.5% this quarter as the housing market slows down, and with consumer credit declining by 2% quarter-over-quarter. Looking ahead, we continue focusing on sustainable, profitable and responsible lending opportunities and on keeping a well-balanced loan book. On Slide 8, you can see a very good demonstration of the strength of our core business and the impact of higher interest rates. The average interest rate in the first quarter climbed to 3.89% compared with 2.92% in the previous quarter and close to 0 in the first quarter of the previous year. As a result and in line with our anticipation, our NII grew in the first quarter by 52.2% year-on-year and by 7.9% quarter-over-quarter. In addition, fee income grew by 7.5% year-on-year. As a result, total income grew by 16.5% quarter-over-quarter and by almost 38% year-on-year. As you can see from the chart on the right-hand side, we continue growing in what we define as financing income from current operations. This is the income from our core banking activities, our bread and butter. These numbers exclude the impact of a few items such as CPI derivatives and fair value adjustments. The income from regular financing activities grew this quarter by around 57% versus Q1 '22, and our NIM increased to 3.18%. The average Bank of Israel interest rate is expected to continue rising, supporting another incline in NII in the following quarters of '23. Moving to Slide 9, we discuss expenses and cost income ratio. Our expenses were retained at the same level as the previous quarter with reduction in salary expenses and incline of other expenses, largely due to revenue-related expenses and special items in CAL. Strong revenues, alongside with restrained expenses, led to a material improvement in cost-to-income ratio down to 46.1% compared with 55.3% a year ago. As you can see on the right-hand chart, we are constantly improving our cost-to-income ratio, showing positive JAWS of 10.1% CAGR between 2019 and 2023, generated by 16.5% revenue CAGR with only 6.4% expense at CAGR. Switching to Slide 10, you can see the evolution of credit loss expenses. This quarter, we are still not observing any material deterioration in specific borrower conditions. As evidenced by the low specific basis provision, we have kept the group basis provision high to reflect the potential that exists with the current interest rate environment. Overall credit loss expense stood at 33 basis points for the quarter. On the right-hand side, you can see additional asset quality metrics. Nonperforming loans remained relatively low with the NPL from total loans ratio at 63 basis points, compared with 67 basis points in previous programs. NPL coverage is also very strong as the loan loss provision covers nonperforming loans by more than twice. These indicators reflect the solid quality of our loan book and our conservative underwriting. Moving now to Slide 11. We announced today that dividend payout is going up from 20% to 30%. This, coupled with the high profitability we are showing, generated a dividend yield of above 6%, substantially higher than before. As you can see in this slide, we are continuously growing our net income and dividend payout, creating value for our shareholders. At the same time, capital ratios remained solid as well. Now I would like to move on and quickly review our main subsidiaries. On Slide 12, you can observe the record results of Mercantile Bank, with net income of ILS 237 million and ROE of 23%. This is largely achieved by NII growth of around 57% year-on-year and by 8% quarter-over-quarter. Cost-to-income ratio is substantially improved to 37.9%. Mercantile grew its loan book by 2.6% this quarter, driven by well-balanced growth across most segments. Moving to talk on IDB Bank on Slide 13. The bank presents solid performance with a net profit of around $30 million, in line with previous quarters and ROE of 10.5%. Loan book remained stable and asset quality continued to be strong with release of provisions for credit losses. On the deposit side, we were able to attract new customers. And as a result, the bank's deposit base grew by 2.8% during this quarter to a level of $10.8 billion. On another topic, IDB is expected to sign on consent orders with the U.S. regulators relating to issues that are required to be addressed in its AML/BSA compliance program following the findings of regular review held at IDB New York. These orders do not include restrictions on the ongoing activity of IDB New York or on the implementation of its strategic plan, and they also don't include any penalties. Moving now to Slide 14 to discuss CAL. CAL is presenting strong results in the first quarter with an adjusted net profit of ILS 85 million and ROE of 15.6%. Consumer credit grew by 19% year-on-year and by 6.5% quarter-over-quarter, and transaction turnover is growing as well. Nevertheless, in light of the strong results of Discount Group, CAL attributes only 5% to the group's net profit. The future separation of CAL is expected to have a very limited impact on Discount's ongoing profitability. To summarize on Slide 15, I would like to emphasize the key takeaways from this quarter results. First, we delivered yet again record results with net income of ILS 1.27 billion and with ROE of 20.1%. Second, we generated a substantial revenue increase from core banking activity, driven both by our credit growth and by the increase of interest rates. This creates a very strong basis for our future growth as well. Third, cost income ratio went down significantly from 55.3% in Q1 '22 to 46.1% this quarter. Fourth, once again, we present a responsible credit growth in line with the current macro conditions with asset quality metrics remaining strong. And lastly, given the very strong performance of Discount and the confidence we have in our ongoing profitability, we have raised the dividend payout to 30% of net income, and we continue our long-term journey to increase value for our shareholders. 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.

I wanted to ask about provisions going forward. How should we be looking at provisions considering the higher rate environment?

As I mentioned before, at this stage, we don't see a deterioration, and we are already around 1 year into a higher interest rate environment. But since we do expect that going forward, the higher interest rate will create some deterioration. This is the reason why for a few quarters in a row, we already put some group provisioning for it. So I can't tell you whether it will be next quarter or 2 or 3 quarters from now, but we do expect we will see some negative impact going forward. But nevertheless, we do believe that the positive impact of the higher interest rate on our NII will be significantly more significant than the negative future impacts from higher loan losses.

Got it. And just regarding the capital adequacy requirements. This quarter, you only had a buffer of 40 basis points. How comfortable are you with that buffer level?

You mean for Q1 or for total CET?

For total, total.

Yes. So it's around 40. We feel very comfortable because given the high -- on one end, the higher profitability, and we are at a high double-digit profitability on one end. And on the other end, we do expect to be a credit growth at a slower pace than what we have evident in the last quarter. We do think that we have sufficient capital to continue distributing dividend and, at the same time, keeping sufficient equity buffers.

The next question is from Micha Goldberg of Psagot.

Congratulations on an excellent quarter, a good start to the year. A couple of questions, if I may. First one, just a technicality. I think I noticed that the risk-weighted assets grew by 5% in this quarter, like almost double of credit growth. What is the reason for that? Or am I mistaken?

So first, you are not mistaken. Part of it is driven by credit risk -- our off-balance credit risk, so this is one portion. The second piece is some market risk and CPI risk that grew some of the derivatives activity and other. So it's not a very big gap. And for the new basis, we assume it will be more or less the same. It will grow more or less at the same pace of the overall credit.

Okay. Now another thing I noticed on the balance is that, I mean, among the banks that have reported today locally, you're the only one that has a quite a drop in deposits by 1%. I saw the other banks actually increased their deposits. I'm just wondering what the reason for that is? Are we seeing increased switching? Is it beta growing? And how is that impacting your margins?

So overall, when you look at the -- so you're right, in total deposits, we were down a little bit. But in consumer deposits, we went up. We went down mainly in corporate deposits and it was a pricing issue. We decided to -- not to take those deposits. We have sufficient liquidity. So we felt comfortable not to take those deposits in those price, but we are fine with it. And when you look at retail deposits, which did the most significant piece, we were able to grow this quarter as well.

Okay. Do you see continued switching and increasing beta? Or is that -- are we past that now? Are we seeing deposit move out of current account deposits?

Actually, it's in the same pace that we have seen in previous quarters. It's very moderate. It's not something very significant. So you can see actually in all banks, they published that noninterest-bearing deposits were down this quarter but not in a substantial amount.

And the core Q-over-Q was around 10%, is that correct?

For which field?

For current account deposits, if they are down.

10% Q-on-Q, no, it's substantially less. It's even near, it's around 10% year-on-year, not Q-on-Q.

Okay. Sorry, I saw a different number. Okay. Could you tell us a little bit about what the process is for the -- towards divestiture of Visa ICC? What's the time frame? What needs to be done? And how quick can you move that in current markets and et cetera?

So actually, the legislation -- so the decision was made at the end of January. So we have 3 years to do it. Actually, we have enough time. I'm not sure that we'll utilize the entire time, but we have 3 years to do it. And the good news is that just recently, the Ministry of Finance decided that we are allowed to also to sell CAL to institutional, which creates a good opportunity for us and will help us most probably to get a better deal. So it's a good news. We will start -- we'll start the process. I can't tell you now whether it will take 1 or 2 years. We'll make sure that we'll get the best value we can, and we have the sufficient time to do it.

Okay. And the recommendation by the Ministry of Finance, is that a final one? Or does it require additional legislation before you can actually go after that? Or can that be done in parallel?

No. So actually, it's the final recommendation. It's now to go to -- we'll have to go through legislation. But since everyone's supporting it, we don't expect any issue. It's only a matter of technicality. And of course, we are not -- we can start the process. But we assume that within the next few months, we'll finish the legislation process.

I understand. Okay. Very nice. Now I mean there's been some issues in the U.S. regional banks recently, and one of your competitors has significantly written off its stake in a sizable bank in the U.S. And I'm just wondering, how do you see your holding in IDB New York, the higher increased liquidity in the U.S. and what else is going on with regulatory requirements over there? Is that imposing more on your -- and is it going to reduce profitability over the mid to long term? And could there be a chance, a risk that you will have to write off some value on that as well?

First of all, we don't need to write value. You might need to write value when you have like an equity, equity investment. We are fully consolidating IDB New York, so we don't need to write off anything even in the future. IDB Bank is a very solid bank. They show a very strong result. I think the good news that while we saw in some of the competitors the deposit base was declining, IDB New York was able to grow their deposit base. They were able to recruit new customers as well. Some of them were moving from the bank that got hit. So overall, the bank is perceived for some as safe haven and people -- customers move their money over there. So we feel very comfortable at all with the bank and with the current performance, especially around the deposit base growth.

Okay. Any update on the process of finding a new CEO? Is that -- I mean, are we -- should we be expecting a final candidate in the next couple of weeks, a month? Can you give us any color on that?

The Chairman already announced that we've put together a committee to recruit a new CEO. He committed that it will take -- it will be a quick process. So I can't tell you if it will be 2 weeks, 3 weeks or 4 weeks, but it should be a relatively quick process. And I'm quite sure that no matter who will be CEO, the successful journey of this group will continue.

Yes, I agree. One final question, if you can. Once Visa has been sold, what is the impact on your Common Equity Tier 1? What the capital release we should expect, not including the capital gains, just the risk-weighted asset change?

So actually, we have not disclosed it, but it's quite significant. Maybe in future quarters, we will disclose this number. But what we have disclosed that if we'll distribute this excess capital, it will be created as dividends, the impact on ROE and net income is going to be insignificant. And actually, the -- being separated from CAL, cost income ratio is going to improve significantly by around 3 points, so it will be significant.

The next question is from [ Gelit Barr ] of Excellence.

I just wanted to ask about your credit portfolio in IDB New York and how comfortable you are with -- what -- any exposure you have on real estate, like [indiscernible] real estate. Can you please elaborate on that a little bit?

So I'm not sure we are providing disclosure to the mix. But only one I can tell you that IDB Bank is a very solid and conservative bank. They know in a more tough time, they're actually even not growing their credit portfolio because they don't want to take any asset risk. And you can see that in the last quarter, the credit book was not growing, it was more or less stable. Their loan loss are very low. And actually, they have a negative LLP this quarter. So overall, the book is conservative. The performance is good. It's actually very well diversified between real estate and other C&I element. So it's very well spread also in different geographies. They have activity on top of New York, also in Florida and California. So overall, it's a good and solid portfolio.

With no much concentration on any difficult sector for a moment?

They have their internal limitation, so they're not closing the limitation, and they are not overconcentrated in one specific sector or segment.

[Operator Instructions] There are no further questions at this time. Thank you. This concludes the Israel Discount Bank's First Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.