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 2023 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded August 14, 2023. If you have not yet done so, please access the presentation at 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 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. I would now like to pass the call over 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 Second Quarter Conference Call. Today, we have the opportunity to reflect 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 we'll 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 second quarter results. Starting with Slide 4, we will begin the review of the financial results. Our very strong second quarter results show the clear execution of our strategy, that combined with higher interest rate and thus generate net income of almost ILS 1.2 billion an ROE of 18%. Our efficiency ratio is maintained below 50% at 47.5%. Given our strong results and our confidence in the robustness of our core business, we have decided to raise the dividend policy to up to 40% of net income. This reflects our long-term journey to increase value for our shareholders. At this point, the actual dividend payout remained at 30%. 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. Despite the political unrest, the fundamentals of the Israeli economy are solid, and the expectation is for economic growth to slow down to 3% in the next 12 months. As a result of the higher interest rate, the current expectation is for inflation to converge into Bank of Israel range of below 3% with an estimation of 4.6% for the next 12 months. Labor market showed strength and expected to remain relatively resilient to bring unemployment level at around 4%. I would like to elaborate a bit on the financial highlights of the second quarter. Our ILS 1.2 billion net income and 18% ROE was largely driven by revenue increase from core baking activity supported with an additional 70 basis points rising of the average interest rates during Q2. As a result, NII increased by 7% quarter-over-quarter and by 41.5% versus the prior quarter in '22. Our cost-to-income ratio was maintained at a low level of 47.5% compared with 59.2% in Q2 '22. Given the macro condition, we see lower demand for credit. Therefore, the total credit grew by only 1.6% this quarter. At the same time, as expected, we see increase in credit loss expenses. In the second quarter, we have recorded ILS 312 million of credit loss expense, which is about 49 basis points of the average credit balance. Lastly, as mentioned before, we announced a change in our dividend policy, raising the payment to up to 40% of the net income. As mentioned, the actual dividend payout remained at 30% this quarter. On Slide 7, you can see our credit growth. As mentioned before, our total credit grew by 1.6% in the second quarter led by 3.8% growth in medium enterprises and by 2.6% growth in corporate. At the same time, we are seeing the slowdown of the economic activity and the cool down of the demand with mortgages growing only by 1.5% this quarter as the housing market slowed down and with consumer credit declining by 1.2% this quarter. Looking ahead, we continue focusing on sustainable, profitable and responsible lending opportunities and 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 second quarter climbed to 4.58% compared to about 3.89% in previous quarter and less than 50 basis points in the second quarter of the previous year. As a result and in line with our anticipation, our NII grew in the second quarter by 41.5% year-on-year and by 7.1% quarter-over-quarter. In addition, fee income grew by 2% year-on-year. Total adjusted revenue grew by 3% compared with the previous quarter and by 41% year-on-year. As you can see from the chart on the right-hand side, we continue growing in what we define financing income from current operations. This is the income from our core banking activity, 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 48% versus 2Q '22. And NIM increased to 3.33%. Moving to Slide 9, to discuss the expenses and cost income ratio. Our expenses were retained at the same level as the previous quarter with slight reduction in salary expenses.. Our strong revenue, alongside the restrained expenses, led to a material improvement in cost-to-income ratio down to 47.5% compared with 59.2% 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 12.5% CAGR between 2020 and 2017, generated by 19.5% revenue CAGR and by -- only by 7% expense at CAGR. Switching to Slide 10. You can see the overall credit loss expense climbed to 49 basis points in the second quarter in line with current macro conditions. This quarter, we are beginning to see an increase in specific provisions due to specific borrowers but still not observing any material regulation. We have kept the group basis provision high to reflect the potential risks that exist within the current interest rate environment. On the right-hand side, you can see additional asset quality metrics. Nonperforming loans rise with the NPL from total loan ratio at 0.89% compared with 63 basis points in previous quarter and 81 basis points in Q2 '22. Allowance for loan loss provisions went up to 1.39%, reflecting our conservative approach. Moving now to Slide 11. We can observe our ample liquidity and diversified deposit base. On the left, you can see that 47% of our deposits are from retail and private entrepreneurs and only 12% are from institutional funds. On the right-hand side, we present the stability of our deposit base, while customers are shifting from noninterest-bearing deposits to time deposits as interest rates declining. Our liquidity ratios are well above the regulatory demand presenting a solid LCR of 134.5%. Now I would like to move on and quickly review our main subsidiaries on Slide 12. Starting with Mercantile Bank represents a record net income of ILS 258 million, an ROE of 23.7%. Cost-to-income ratio has improved to 37%. Mercantile grew its loan book by 6.9% year-on-year with a well-balanced growth across most segments. Moving to talk on IDB Bank. The bank presented lower net income of $22 million and ROE of 7.5%, mainly due to higher salary expenses. The bank maintained total assets of $12.2 billion with asset quality remains strong. CAL is presenting strong results in the second quarter with a net income -- with an adjusted net income of ILS 89 million and ROE of 16.7%. Consumer Credit grew by 12.4% year-on-year, and transaction turnover is growing as well. Nevertheless, in light of the strong results of Discount Group, CAL attributes only 5.4% to the group's net focus. The future separation of CAL is expected to have a limited impact on Discount's ongoing profitability. Moving now to Slide 13. We announced today the dividend policy is raised up to 40%. At this stage, actual dividend payout remains at 30%. As you can see in this slide, we are constantly growing our net income and dividend sales, creating value for our shareholders. At the same time, capital ratio remain solid as well. On Slide 14, we are delighted to present our new campus, new [ phone ] for Discount and Mercantile Head Office units that gathers employees from 18 separate sites. This state of the art facility is designed to change the way we work [indiscernible], to improve collaboration through direct interest and communication. As we announced last week, as part of the expected divestiture from CAL Discount will acquire culture of the campus. On Slide 15, I would like to briefly update you regarding Greenlend, our new disruptive innovation initiative. As we already discussed before, in addition to the drivers from the traditional banking, Discount is also focused on creating value through disruptive innovation. Discounts unique position creates a competitive advantage if the player is large enough to make an impact and yet small enough not to take any [ validation ]. After introducing PayBox in 2021, we have announced earlier in '23 the establishment of Greenlend, a new fintech company to provide digital credit in partnership with the English Technology Company, Ezbob. The new company will offer a flexible, immediate and customized solutions in the field of consumer credit and credit for small businesses in a simple and fast digital process for customers of all banks. Less than 5 months after announcing Greenlend earlier this month, we received Bank of Israel approval to control an old Greenlend in partnership with Ezbob, and the company will start operating very soon. The launch of Greenlend is another set in the implementation of Discount Group's strategy to stimulate competition in the banking system through the promotion of disruptive innovation and the establishment of ventures that will operate as independent companies and compete with the entire banking system, including Discount Bank itself. To summarize my overview on Slide 16, I would like to emphasize the key takeaways from this quarter results. First, we delivered yet again very strong results with net income of ILS 1.19 billion, an ROE of 18%. Second, we generated a substantial revenue increase from core banking activity driven by the increase in interest rates and credit growth. Third, cost income ratio maintained below at 47.5%. Fourth, once again, we present a responsible credit growth in line with the current macro conditions with asset quality remaining strong and reflecting the challenging market conditions. And lastly, given our very strong performance and the confidence we have in our ongoing profitability, we have raised the dividend policy to up to 40% as we continue our long-term journey to increase value for our shareholders. Before finishing the overview, I would like to add on one more thing on a personal note. After almost 4 years, as Discount's CFO, I'm moving into a new role to be the Chairman of CAL and Mercantile, our two largest subsidiaries. It's been an enriching and fulfilling journey for me and I would like to thank you all for being an important part of this journey. With this, I will finish and would like to open to Q&A.

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

Thank you for the presentation. I wanted to talk on capital adequacy. If my math is right, the 13.2% total capital is 70 basis points over the Bank of Israel requirement. Feel free to correct me if I'm wrong. But if that's the case, are you comfortable with that kind of suffer? I'm especially asking in the context that you increased dividend payout standard.

You said the total? or the Q1?

Yes, the total.

Yes. So with 70 basis points above the requirement -- and we feel very comfortable given the fact that we create such a substantial -- and one substantial ROE, which is a strong double digit on one end. And on the other end, we see the credit demand, that is lower than it used to be and currently the annual growth rate is around -- between 6% to 8%. We feel very comfortable with the gap we have between the ROE we are creating and credit growth rate. And we feel very comfortable with the current quarter we are above the regulatory target. And it's been higher than [ it used to be ]. I think last quarter, it was a little below 13% and now we are at 13.15%. So overall we feel very comfortable with the [ 45 ] basis points above a year.

Okay. And then I want to talk about -- the kind of level of interest of clients, I think, renegotiate their loan. So necessarily problematic debt of more sectors that's starting to feel pressure? Is there a specific segment that just beyond the mortgage, is there anything segment that you're all looking at that you should be focusing on in the foreseeable future.

First of all, we don't see -- not the amount of customers looking to negotiate the terms. I think it was more than 6 months ago we offered a plan for the mortgage borrowers to be able to freeze the mortgage also and restructure, [indiscernible] and many retail customers can [indiscernible]. So there are requests, but it's not very significant, and we did it in case-by-case basis. Regarding the areas where we look to know more carefully around, of course, mainly around real estate, it's around the hi-tech sector, mainly -- maybe around nonbank credit providers. I think those are the main areas.

Okay. And just lastly, in the past, we talked about the bank potentially divesting CAL, I think they have 4 years to do, so can you elaborate on, obviously, the selling price will have an impact on what kind of contribution you get. But can you give a sense of what kind of uplift do you expect from -- it can be from a capital perspective or from capital adequacy with the impact of CAL been divested?

So first of all, it's not something that nor will happen to know. We have between 3 to 4 years to do it. We started counting only at the beginning of this year. So still, we still have time. As we show in Slide #12, we see that without CAL, there will be a slight negative impact on ROE and a very positive impact on efficiency ratio. And of course, it is expected to free some capital. We don't disclose the exact number because it's also dependent on the price or the value we are going to get for CAL, but of course, it will free some capital. And later on, we need to see what we do with this capital. Of course, we are not disclosing at this stage what would be the amount of capital that is going to be [indiscernible] by selling CAL.

The next question is from [indiscernible] of Phoenix.

Thank you very much for the presentation and congratulations for the results. I just have two questions, one about, NPLs. So nonperforming loans increased just in -- numbers. By segments, it's more linked to the real estate construction and to lesser extent to real estate other activities. Can you elaborate from that what -- is it linked only to one big client falling or group of clients? And what you expect to see in the coming months? The second question is...

Maybe I'll start with the first question. The NPLs. So yes, NPL went up to 89 basis points. Actually, it's maybe significantly higher than previous quarter. But if you compare it to second quarter of '22, it's more or less at the same level, and we really feel that we are in the benchmark. The reason it went up, it's due to specific customer. It's not many customers, a specific customer. We are, of course, not disclosing the main details. And this is coming from the corporate sector. Behind this, we cannot give specific details. But it starts with taking a conservative approach, and we are taking conservative approach, and we feel right approach, but we feel very comfortable. First of all, with the stability of our portfolio and quality of our portfolio. Second, with our overall NPL level within the benchmark. And as I mentioned before, we also increased the allowance for loan loss provision to reflect this conservative approach we are using.

Okay. The second question is linked to the [indiscernible] data credit data published lately by the BOI, we see construction in the credit growth globally in the system so that 0.25% -- do you think that this is a turning point in credit growth?

Main credit growth in the system for its entire credit or...

The whole system contracted by 0.25% in June?

Overall, we need to see until all banks in the next few days, all banks are publishing the financial statements. Today, we show that we are growing by 1.5%. I think while we are growing at the same pace in this quarter. I don't see -- assuming that the other banks will grow more than they think. So still, we are seeing growth. It's lower than we used to see, but we still see growth -- and as we have indicated before, we do expect with the higher interest rates we'll generate a lower growth. Currently, I don't see a decline in credit, but we do see a slower growth rate. And it's early -- it's too early to call and to say what is going to be in Q3, but I can only refer to Q2 numbers where we see a growth that is with lower -- slower pace than we used to see in previous quarter. I can't predict what it's going to be in Q3 and Q4.

This is mainly because of lower [indiscernible] from Israel Discount Bank or also because of lower credit demand?

I think it comes mainly from lower demand and mainly in the consumer credit because we do see growth both in the corporate and the mid-market. It's mainly around lower demand, both in consumer credits and in mortgages -- no mortgage, consumer credit.

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

First congratulation on another strong quarter. A question. You mentioned the new payout policy. But you're still paying 30%. When do you anticipate you'll be starting at 40%?

First of all, you know, we published 40%, so we have intention going. Regarding the pace, it depends on how we see the progress of the credit demand on one end on the LLP, on the other end profitability. So I can't tell you whether it's going to be next quarter or quarter after it, but we have the intention of getting there, but we don't disclose the specific quarter when it's going to be.

Okay. And when you look at your internal capital targets, what would be sufficient for you to say that you feel comfortable going at 40%. I mean you were 10.35% now. Where do you feel comfortable in the number, let's say, 40%?

No, we feel comfortable with the current numbers we are, as you can see, our current numbers, both when referring to Tier 1 and total capital ratio are higher than we used to -- to every previous quarter. In Q1, it's 7 basis points above previous quarter. In total -- total 24 basis points above, so we feel very comfortable with the buffer we have. We always manage to add the right balance between adding the right customer on one end and providing dividend on the other end. So I don't think the buffer is an issue. We're not looking for higher buffer.

Assuming that you pointed out during the presentation that profitability will remain within similar kind of double-digit number that you've been doing right now, loan growth will remain approximately in the same inventory network and we're going to continue building the common equity Tier 1 in the next couple of quarters?

By the end of say, that Q1 is a result on one end profitability, on the other hand -- profitability and growth on the other end dividend payout. We always take those consideration. I can tell you that the reason we put up to 40% is not just to put a number, is to show our intention to work together. I can't be more specific whether it would take a quarter or more, but this is our overall direction we are planning to get there.

Okay, clear. Question. A potential S&P downgrade of Israel's Credit Rating. What would be the impact on the common equity Tier 1?

According to what we heard, it's around 20 basis points.

Okay. That's clear. Okay. Another question. I mean, your margins have been widening very nicely recently. And I'm just wondering, do you see the current levels at peak levels? Or do you think there is more expansion in the next couple of quarters?

Yes, I think it could be, actually because the cumulative interest rates won't go up anymore. And I think that the average interest rate in Q3 is going to be a little bit higher than in Q2. So we will see -- we have some pressures on deposits and customers are looking for more. So I think we are -- maybe we are not at the peak, but we are around the peak. And this is what we currently see. If there will be future additional interest rate increase maybe it will continue growing. But at this point of time, it seems like we are near the peak.

Okay. Great. I saw you guys are moving out to your new campus, but I'm just wondering, are there any additional potential real estate gain to be had in the coming quarters? Or alternatively, any expenses that one should be thinking about as a result of move?

So we already recognized some substantial gains. We have some, still to go once the sale of Mercantile, which we should expect to be later this year. And then we haven't sold yet our -- the current [indiscernible]. So it will be later on. I'm not sure it will be in '23 or '24, but we are looking -- we'll see another gain, so this is on one hand. On the other hand, moving to the new real estate, of course, the depreciation is going to be higher currently in -- so we are going to have some positive effects, negative effects both sides.

Okay. Another question. I mean, you get in charge of the divestiture of Visa, and I then -- so in your report of the government or the Ministry of Finance is proposing to change Class 10, which will allow local institutional investors to bid for the controlling visa but has not yet been approved by the legislator, right? Is that still in the process? And so can you tell what the time frame on that potentially would be?

Yes. It's still in the process. We have heard the Ministry of Finance people saying they are supporting it, they are working on it. I thought it will be finalized later on in '23 -- already in '22. So it will be -- enable us to sell CAL also to local institutions.

Great. And then my last question on Mercantile sales doing remarkable profitability. And in the past, you got considered all kind of thoughts about what to do with your stake. Is there any current talk of consolidating this and IPO it off or selling it? What are the options for your stake in Mercantile?

First of all, Mercantile is a great subsidiary and showing great growth -- phenomenon growth. They have showed record ROE and profitability this quarter. They have huge potential, especially in the first highest growing sectors in the Israeli market [indiscernible] June. And I think the fact that we are being operated as a stand-alone brand and stand-alone company, we have lot of advantages and experience expertise over there. So currently, we don't have any reason to treat it any differently than it's being done today.

There are no further questions at this time. Thank you. This concludes the Israel Discount Bank Second Quarter 2023 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.