Israel Discount Bank Limited (DSCT) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank Fourth Quarter 2023 Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, March 11, 2024. 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 2023 Annual Financial Report Conference Call. Participating in today's call are Avi Levi, CEO; Assaf Pasternak, CFO; and Yossi Beressi, Chief Accountant. We will start with the opening remarks by the CEO, Mr. Avi Levi, who will provide variable insights into our bank's successful year and navigate the complexities of the financial and social landscape of 2023. We will continue with a review by Mr. Assaf Pasternak that will elaborate on key initiatives and our financial results for the fourth quarter and the year. Afterwards, we will open the call for questions. I will now hand over to Avi.

Thank you, Gad. Thank you all for joining us today. I'm honored to present my first investor call presentation amidst this challenging time. Our commitment to supporting our customers, employees and their families remain unwavering. Our bank's employees are actively engaged in various initiatives nationwide to aid those affected by recent events. We continue to hope for the safe return of the objective. Now moving to Slide 4. I'm thrilled to share with you the Discount Bank group's remarkable achievements. This year, our net -- our record net income soared to ILS 4.2 billion with a return on equity of 15.7%. Within the Israeli banking segment of the group, Discount and Mercantile alone attained an impressive ROE of 19.3%. These results reflect the determined execution of our strategic plan with the benefit of higher interest rates. Our net income growth was fueled by 26% increase in net interest income and a responsible 7.6% credit rate. Our efficiency ratio improved significantly to 49.6%, where Discount and Mercantile alone attained a ratio of 42.3%. Our total equity at the end of 2023 amounted to ILS 29.2 billion. Given Bank of Israel expectation, the bank has announced a dividend payout of 20% for the fourth quarter of 2023. Moving to Slide 5. You can see the journey we have made in the past 10 years. This is not a tale of a successful single year but the outcome of a resolute decade-long journey of continuous enhancement. This transformational journey has significantly improved the bank, leading to the current financial results. Our net income surged from ILS 500 million to ILS 4.1 billion, elevating the return on equity from approximately 4% to over 15% and reducing the cost-to-income ratio from 87% to less than 50%. We set ambitious targets for 2025: net income of ILS 3.5 billion, return on equity of 12.5% and efficiency ratio of 55%. We almost achieved the goal by 2022 but exceeded them in 2023. We are confident in our potential to disrupt the evolving banking sector given our position as a medium-sized bank large enough to make impact through stride yet nimble enough to capitalize on them. This necessitates our agility and commitment to innovation. To harness the potential, we are leveraging a robust change platform and dynamic managerial approach focused on delivering exceptional value. Moving to Slide 6. I would like to briefly address the macroeconomic challenges in 2024 to elucidate the potential impact on the bank results. The underlying fundamentals of the Israel economy remains robust, a resilience demonstrated during the past crisis. This strength is reflected in the recovery of the labor market and the distortion of GDP growth in the pre-war trajectory -- to the pre-war trajectory. It is crucial to underscore the importance of a well-balanced fiscal budget and prioritize government support, especially towards SMEs, construction and high-risk sectors. These segments play a pivotal role in fostering economic stability and growth. Supporting SMEs are essential as they form the backbone of the economy, driving job creation, innovation and local economy development. By offering targeted assistance, the government can bolster the resilience, preserve jobs and stimulate economic activity at the grassroot level. Similarly, back in the construction sector is vital due to the ripple effect on other industries. Investment in construction not only create jobs within the sector but also boost demand across the economy, fueling infrastructure development, supporting the housing market and strengthening the overall economic foundation. The banking sector is facing unique challenges this year, including lower interest rates, reduced credit demand, a weaker business cycle and uncertainties in the macroeconomic and geopolitical landscapes. Despite these challenges, recent macroeconomic indicators show an upward momentum in private consumption credit, credit card turnover and the Bank of Israel composite state of the economy index as of January 2024, where you can see at the bottom of the slide. With the end of the war hopefully not much longer, we foresee the start of the growth trajectory in the market. Discount Bank will capitalize and with ample equity and adequate cushion for absorbing credit losses is positioned to support economic growth in the later half of 2024 while remaining committed to the community and those impacted by war. Moving to Slide 7. The past year marked a significant transaction for Discount group, as we relocated the headquarters to a new campus outside of Tel Aviv. This move signifies not just a change in physical environment and sitting in open space seating for all of us, but a substantial shift in our work culture, fostering a more collaborative, innovative work setting. This is one-of-a-kind campus, and I invite you all to visit us when you are here. You were the bar our 2 leading innovation initiatives, PayBox, which you might know, our subsidiary PayBox is partnership -- in a partnership with SuperSold, the largest supermarket chain in Israel, has emerged as the leading e-world with 2.5 million engaged subscribers, continue to introduce new products. PayBox aim to maintain its leading position in the industry by offering cutting-edge services, and hopefully, to get to balance during 2025. The other one is Greenlend. Greenlend is an embedded finance solution delivered third-party collaboration obtained bank visible approval in August through strategic collaboration with ezbob. This milestone position us for a timely product launch in upcoming months. In my tenured CEO, I have appointed new Executive Board members and within the organization, emphasized internal growth and understanding of the bank's needs. Looking forward, we are committed to refining our strategy to align with evolving objectives in the dynamic banking sector landscape. Moving to Slide 8. I would like to wrap up by discussing our commitment to supporting the Israel economy during these challenging times. Over the past 5 months, Israel have faced unprecedented events that have impacted communities and individuals nationwide. Amid a plethora of support initiatives and dedicated volunteers, Discount Group has chosen to focus its efforts on 3 key areas where our impact can be truly meaningful. The first one is Keren-OR or life foundation in English. Discount Group has established a foundation to aid -- to help children and teenagers aged 10 to 18 who were affected by the conflict along the southern border of Israel during the recent war. With an initial allocation of ILS 50 million, the fund will collaborate with 3 cities and 4 regional councils in the West mega region to offer a comprehensive long-term support for these young individuals to aim to help restore their personal and community security, facilitating the return to normality and empowering them to become leaders of positive change in their community. Managed by the professional team at his net foundation, which has been supported by the bank since 2005, Keren-Or will operate for at least 3 years. The fund commenced operation in November '23, concluding over 2,000 workshops in the first 3 months involving thousands of children and teenagers. The second initiative is Discount Command Center. During conflict in response to emerging needs, we launched the Discount Command Center in collaboration with [indiscernible] or Giving Hope Foundation. This initiative is dedicated to addressing the immediate requirements of injured soldiers in the rehabilitation world at Chiba Hospital. Supported by a network of bank employees, volunteers and financed by Discount Group. We provide swift assistance to soldiers and their families, aiding them on their journey back to full functionality. Our third initiative centers around supporting 2 ideas combatant regimens, a long-standing effort that intensified during the recent conflict. Lastly, I'd like to touch upon Bank of Israel aid program. The bank has emerged this aid package, enhancing both its scope and duration. Initially estimated at ILS 278 million for 6-month to aid plan for affected customers in November '23. The total expenditure was reduced to ILS 182 million and not all -- as not all customers availed in terms of the benefit. Recently, the Bank of Israel announced extension of the aid program for an additional 3 months. We are well equipped to manage this extension. In closing, I would like to extend my gratitude to all of you for joining us today. And together, we hope for the safe return of the hostages and speedy resolution to the ongoing conflict. I would like to hand over the floor to Assaf Pasternak, our CFO, to share the financial strategic review. Thank you.

Thank you, Avi, and good afternoon, everyone. I will open my part of the presentation with an overview of the financial results and then will elaborate on the key performance indicators. Starting with Slide 10, I will begin the review looking ahead on some key macroeconomic indicators in the Israel economy. The Israel economy has entered the war with solid fundamentals, historically low unemployment, low public debt and inflation convergence into range. The GDP and economic activity have suffered a major setback during the fourth quarter with a decrease of 5.8% in GDP and 10% in the private sector in the first 3 months of the war, as hundreds of thousands of Israelis were recruited to an army service and the daily normal life of many Israelis was interrupted by the course of the war. Starting January, the economy regained momentum and unemployment sharply declined. Therefore, we have updated our GDP growth forecast for 2024 and assume a rise of 2% of GDP compared with the third quarter of 2023. This is led mainly by public expenditure. And yet, our updated forecast subtract 1.1% from our pre-war forecast and stand at 3.1% for 5 quarters. Looking at former crisis. We believe that the Israeli economy is resilient and fast to recover, bringing steep demand for credit and an increase in private consumption. It is yet too soon to determine, but once the war will be over, we expect to see recovery along the second half of '24. The bank's current expectation is for Bank of Israel rate to decrease to 4% by the end of '24, higher than the market expectation that stand at the range of 3.75. Inflation is expected to converge within Bank of Israel upper limit of 3% and decrease to 2.7% by the end of the year as a higher rate and below are suppressing demand across all segments. We believe that with the increased public sector demand and a conservative monetary approach of Bank of Israel, '24 will deliver a balance between inflation and growth. The shakel strengthening brings the exchange rate as a swap rate to the pre-war prices during the last 2 weeks. Moving to Slide 11. The bank entered the world with solid fundamentals. Our diversified loan portfolio in Israel and the U.S.A. has demonstrated robustness, and credit loss expenses are decreasing. Considering the financial aspect, the bank has sufficient capital cushion with Tier 1 capital ratio of 10.7% and after liquidity with LCR ratio of 130% based on diversified deposit base both in shekels and in dollars. In this quarter, the bank has declared, in accordance with Bank of Israel directive, a dividend of 20% of the net income. The local capital market demonstrates strength, the recent bond offerings were executed with no margins. the equity market easily absorbed the impact of Moody's sovereign downgrade, while Tel Aviv 35 index exhibit stability. With this strong basis, we continue to serve our customers and support the economy. Turning to Slide 12, we will begin to review financial results and elaborate a bit on the financial highlights of the fourth quarter, end of the year. Our ILS 4.2 billion in net income and 15.7% ROE for '23 was largely driven by revenue increase from core banking activity, supported with the steep pricing of the interest rate. Credit grew by 7.6% on a yearly basis, mainly attributed to medium enterprises and corporates. Credit growth slowed down in the fourth quarter to 0.2% as a result of the war, aligned with lower demand for consumer credit. At the same time, we remain focused on the quality of our lending. In the fourth quarter, we have recorded ILS 390 million of credit loss expenses, which is about 59 basis points of the average credit balance and is related largely to higher-than-normal collective allowances. This level reflects the risks from the war and security conditions. Other credit metrics continue to remain solid. NII increased by 26% for the year. The fourth quarter presented a decline of 5.6% quarter-over-quarter and is largely driven by low CPI and cost of benefits under Bank of Israel aid outline. With material revenue growth drove an improvement in our cost-to-income ratio and reached -- that reached 49.6% on a year basis and 53.4% in the fourth quarter itself. We are focused to keep expenses restraint and to bring efficiency ratio to lower levels. On Slide 13, you can see our credit growth. As mentioned, in the fourth quarter, credit growth slowed down to 0.2% as economy was set back due to the war. The medium enterprises and corporate segments continued to show strength during the fourth quarter and grew by 3.9% and 2.6%, respectively. Nevertheless, on a year basis, we grew by 77.6% focusing on our targeted segments. Corporates grew by 15.5% year-over-year, mortgages grew by 6.4% year-over-year and now comprising 26.4% of our loan portfolio compared to around 20% 4 years ago. The credit to medium enterprises grew by 16.4% year-over-year. Looking ahead, we anticipate that post war, there will be a higher demand for credit across all segments. On Slide 14, you can see a good demonstration of the strength of our core business and the impact of higher interest rates. The average interest rate in the second half of 2023 climbed to 4.75% compared to less than 3% in the fourth quarter of '22. As a result, in line with our anticipation, the NII in '23 grew by 25.8% versus last year to about ILS 11 billion. In addition, fee income grew by about 2.7%. Total income grew by 24% compared to last year. As you can see from the chart on the right-hand side, the income from regular financing activities, what we define as financing income for current operations, grew by -- in the fourth quarter by 8.6% year-over-year. The decrease in the second half of the year is an outcome of higher deposit beta, resulting in higher cost of funds and an increase in interest expenses. Nevertheless, comparing the third and fourth quarters, we have seen a hike in the increase in cost of funds, and interest expenses were retained at the same levels as previous quarter. A decrease of 1.6% quarter-over-quarter and a decline of 19 basis points in NIM from 3.02% to 2.83% is attributed mainly to CPI and the rest to the exemption from interest payments to affected customers under Bank of Israel aid outline. Examining the macroeconomic perspective, it is yet early to assess deposit beta behavior in the declining rate environment expected along 2024. I will move to Slide #15 to discuss expenses and cost-to-income ratio. Our cost was rose 10.4% this year primarily as a result of increased maintenance expenses, which increased by 13.4%, mainly led by increased depreciation expenses resulting from the reallocation of our new campus. We expect to reduce some of these costs by selling the former buildings. Other expenses grew by 12.5%, higher by ILS 300 million, which is mainly from expenses on IT and computer and other expenses in CAL and IDB New York. Salary expenses grew by 7.9% year-over-year as a result of a new 3-year collective wages agreement with the labor union and higher workforce targeted to improve the availability to our customers and target IDB New York's consent order. The increase in expenses was forecasted by the bank due to these planned steps. But as we enter '24, we are focused on reducing costs by improving procurement processes, digitalizing operational procedures, shifting activities from the branches with back office and optimizing IT resources. We understand that our efficiency is critical for our future growth and success. And therefore, we raise the value of cost and efficiency in our workers' comp for '24. In the fourth quarter, expenses were retained and the bank has written a decrease of 24 -- ILS 21 million in total expenses, around 1% compared to the third quarter. As you can see on the right-hand chart, we are constantly improving our cost-to-income ratio, showing positive JAWS of 11.5 CAGR between 2023 generated by 17.5% revenue CAGR and only 6% expense CAGR. Switching to Slide 16. You can see that overall credit loss expense sharply declined to 59 basis points in the fourth quarter as macro assumptions related to the effect of the war in Gaza are mitigated. In the fourth quarter, the provisions are still mainly driven by collective allowance provisions, those were beyond the normal due to the extension of the war. As you can see in this slide, in this quarter, we are still not observing any material deterioration in specific debt as reflected from the low provision for specific credit losses. On the right-hand side, you can see additional asset quality metrics. Nonperforming loans with NPL ratio slightly increased to 0.91% compared with 0.84% in the previous quarter and 0.62% in the fourth quarter of '22. Coverage ratio increased to 1.6% as a result from the high group basis provisions, reflecting our conservative approach. Moving now to Slide #17. You can observe our ample liquidity and diversified deposit base. On the left, you can see that 45% of our deposits are from our retail and private customers and only 11% are from institutional funds. On the right-hand side, we present the stability of our total liquidity base over time, while customers are keeping 58% of the funds in interest bearing time profits. Our liquidity ratios are well above the regulatory demand, presenting a solid LCR of 131% and NSFR of 124%. Slide 18, I would like to move on the strategic review started with this slide. As we laid out in the past, we are fully focused on being the best financial institution for our customers and delivering excess value to our shareholders over time. I am very happy to say that thanks to the successful execution of our strategy, combined with supportive macro environment, we've reached our 2025 strategic targets already in '23. The bank's strategy consists of 3 pillars -- sorry, the bank's strategy consists of 3 pillars. The first is winning in the traditional banking. We are define -- we define 3 drivers. The first driver is customer experience, where we are building customer-centric organization and focusing on delivering the best-in-class direct channel for direct banking and enhanced one-stop shop call center. The second driver is accelerated growth in main focus areas such as mortgages, commercial, corporate and small businesses. The third driver is achieving banking excellence through establishing a culture of continuous change, shifting back-office activities from front-end and cost reduction. Our second pillar is innovation. We continue to create disruptive innovation both externally, PayBox and Greenlend, and internally. This cost unique positioning creates a competitive advantage as a player that is large enough to make an impact and yet small enough not to feel cannibalization. The last pillar of our strategy is maximizing the group's value with the goal of empowering each of our subsidiaries and leveraging the synergies between them. Moving to Slide 19. As mentioned, we have reached our '25 strategic targets already in '23. In '24, we will unveil a new strategic plan and targets for 2030. The new plan will focus on efficiency and banking excellence alongside with disruptive business development. Now I would like to move on and review our main subsidiaries on Slide #20. Starting with Mercantile Bank that presents a net income of ILS 880 million and return on equity of 19.7%. The cost-to-income ratio reached 39%. Mercantile grew its loan book by 7.7% year-over-year by well-balanced growth across most segments. Moving to talk to on IDB New York Bank. In this year, the bank has presented lower net income of $64 million and return on equity of 5.5%. In the fourth quarter, the bank reported a net loss of $4.4 million attributed to a released loss of $30 million on the AFS debt-secured portfolio. The adjusted profit for the fourth quarter would be $16 million. Other factors were higher salary expenses due to the constant orders implication and rising cost of funds in the entire U.S. regional banking system. The bank maintained total assets of $12.2 billion with asset quality continued to be strong. CAL is maintaining strong results in the year with a net income of ILS 278 million and return on equity of 12%. Consumer credit grew by 10% year-over-year, and transaction turnover is growing as well. CAL results in the fourth quarter were affected by the war with a decrease of 6.3% in income from credit card transactions. The future separation of CAL is expected to have a limited impact on Discount Group ongoing profitability and ROE, while it will improve the efficiency ratio by more than 3%. Slide 21. As mentioned before, in addition to [indiscernible] for the traditional banking, we also continue to grow potential for the disruptive innovation. Less than 3 years after PayBox spinoff, PayBox is become Israel's leading wallet for managing money outside the bank. In its third year as a stand-alone entity, PayBox present a substantial growth in all the key business drivers, reaching ILS 750 million deposit balance, ILS 6.6 billion annual transaction volume with 2.4 million linked accounts and around 1.4 million active quarterly users. We have high expectation for PayBox in the coming years. Slide #22. Going back to the year -- to this year and to our current challenges, I'm telling to this slide. In light of the current situation, we would like to elaborate about the stability of our capital ratio in volatile capital markets. As you can see in this slide, we are continuously growing our capital ratio and our buffer. At the same time, our capital ratios remain solid and well hedged against various market scenarios, such as interest rates, exchange rates and CPI and credit downgrade of the state of Israel by S&P. The scenario of sovereign downgrade will deduct 20 basis points from our Tier 1 capital ratio and is being considered within the capital buffer. Slide 23 illustrates the progression of the net profit and dividend payout over the years from 15% in 2018 up to 30% in the first half of '23. Given the security uncertainties and the war in Gaza, the Board of Directors has decided in accordance with Bank of Israel directive to distribute 20% of our net income as dividends. This decision is in line both with the bank's strong capital position and confidence in generating consistent profit together with the aim to strengthen our capital in response to the projected post-war credit demand. We believe the suppressed demand for credit will exhibit higher growth in the quarters to come once the war will be over. To summarize my overview, on Slide 24, I would like to emphasize the key takeaways from this quarter results. First, we delivered solid results with net income of ILS 4.192 billion and return over equity of 15.7% after a substantial provision for expected credit loss in the second half. Second, we present a responsible credit growth with a well-diversified loan portfolio. Third, asset quality remains solid and coverage ratio amounting to 1.6%, reflecting the current risks. Our higher group provision under CECL reflects the prudent risk approach, and our moderate decline in NPL saw solid loan book and conservative credit approach. Fourth, we generated a substantial revenue increase from core banking activity driven both by our credit growth and with the backwind of Bank of Israel to state. The decrease in net interest income in the third quarter due to the higher cost funds was halted and interest expenses are kept at consistent levels. And lastly, at this point, dividend payout has increased to 20% in consideration with Bank of Israel directive and with our projection for a future increase in credit demand and outside our ability to generate stable long-term profitability. With this, I will finish and would like to open to Q&A.

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

I have 2 questions. The first one, the government talked about imposing special tax on Israeli banks. I wanted to know where does that stand. And if you have any idea of the scope and the amount that would you have to pay, any color would be helpful.

Yes. So the government has imposed the tax of ILS 2.5 billion. As far as -- we understand this is the final. And it will be divided between the banks. We didn't publish the exact amount that will affect the bank. But I've seen some estimations that are very close to what -- to our estimation.

Okay. As far as your question, it's going to be implemented in 2024-2025. I have seen iterations of either it will be a onetime payment or it will be spread across 2 years? Do you have any...

Payments will be done along the year.

Quarterly.

Quarterly probably. And the percentage is 6% on the profit for tax deficits. So probably, we'll pay every -- we pay to the tax authorities every month. So probably it will include the part of this burden monthly. At the end of the year, we'll see what is our tax -- for tax rate versus income. And we'll adjust the payment. Just remember that there is a fee of ILS 1.2 billion on all the banks. So if the banks will pay more than debt in 2024, the tax authorities will have to give the bank the excess amount over the ILS 1.2 billion. And in 2025, it will be ILS 1.3 billion. So that's the calculation that -- you can roughly calculate 6% on the income before taxes of the bank. But this is -- it will give any -- well, of course, you should look at the figures of the bank solo because it doesn't relate to ICC or IDB New York. So you have to divide the income from those sources, Mercantile and the Discount Group. So...

Okay. Got it. No, that's helpful. And I guess the second was around the outlook. So you gave good comments around the situation, the macro, the different moving parts. Assuming nothing changed, nothing worse and nothing improve, which just stays in the current status quo, how should we think of, I guess, loan growth and loan loss provisions? These are the 2 swing factors that have been interesting getting yourself out in 2024?

Yes. So I'll refer to that, Tavy. If nothing extreme will happen to either side, let's put it aside for because we are not in a position to estimate what happened. I believe as we both, Assaf and myself said, the Israel economy is robust, and we see even now the economy is growing slowly but steadily. And we see a recovery. So looking forward to 2024. I assume that given no -- nothing extreme happens, we will see slowly the economy recovers and going forward. Now talking about the expenses for credit losses, we provided a general allowance both in the third quarter and the fourth quarter, a bit less ILS 1.2 billion of the provisions for credit losses in '23 in general provisions from the ILS 1.5 billion we provided, we like for expenses losses. And this, to our opinion, should cover any deterioration in -- during 2024. Hopefully, nothing happens. We'll be able to call them back into our P&L after, let's say, a couple of quarters that we see things stabilizing. It can be either in '24 or '25, again, depends on the situation. But currently, we are -- we believe that we have a very good cushion or a reasonable cushion to cover all future credit losses given the current situation in our estimations.

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

Congratulations on a strong quarter and excellent year. You mentioned that IDB had a pretty poor year this year. I'm just wondering what is it that you can do in order to try to improve profitability in IDB New York? And is that -- on that currently on your strategic project?

Well, IDB New York is struggling with 2 things, as Assaf mentioned. The first one is the high cost of funds. Unfortunately, relevant and very similar to what happened in the regional banks, the wholesale banks as IDB New York. And we don't see it improve in the near future, maybe later in '24. But currently, there's a high competition on the source of funds and high pricing. So again, I don't think things will change in the near future. The second issue is the expenses mainly in the consent order of the recovery plan, remediation plan. And unfortunately, this is probably not going to change in '24 as well. So we keep on conducting the remediation, plan and we will do so in -- during the whole year of 2024. We are looking into it. We are -- we cut 50 positions in IDB New York in the past quarter. Some of them will return -- we will recruit during '24, but we'll probably keep 20% -- 50% of what we cut still outside of IDB New York. So we are trying to look for an expensive cut in IDB New York, but I don't think the situation is going to change dramatically. And there will be a major turnover during '24.

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