Mizrahi Tefahot Bank Ltd. (MZTF) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome to the Mizrahi Tefahot Bank Ltd. Fourth Quarter 2021 Business Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded March 1, 2022. With us on the line today are Mr. Adi Shachaf, CFO; and Mr. Menahem Aviv, Chief Accountant. We would like to draw your attention to Slide #1 of the financial statement for the fourth quarter 2021 presentation, which includes general comments regarding legal responsibility, including that, the information contained in the presentation constitutes information from the bank's 2021 quarterly reports and/or immediate reports as well as the periodic quarterly and annual reports and/or immediate reports published by the bank in previous years. Accordingly, the information contained in the presentation is only partial, is not exhausted and does not include the full details regarding the bank and its operations or regarding the risk factors involved in its activity and certainty, and certainly does not replace the information included in the periodic annual and/or quarterly or immediate reports published by the bank. In order to receive the full picture regarding the bank's 2021 quarterly reports, the aforesaid reports should be pursued fully as published to the public. The bank's results in practice may be significantly different from those included in the forecasting information as a result of a large number of factors, including inter alia, changes in the domestic and global equity markets, macroeconomic changes, geopolitical changes, legislation and regulation changes and other changes that are not under the bank's control, which may lead to estimations, not realizing and/or to changes in the business plan. The forecasting information may change subject to risks and uncertainty due to being based on the management's estimations regarding future events, which include inter alia, global and local economic development forecast, particularly regarding the economic situation in the market, including the effect of macroeconomic and geopolitical conditions, expectations for changes and developments in the currency and equity markets forecast related to other various factors affecting exposure to financial risks, forecasts with respect to changes to borrowers, financial strength, public preferences, changes in legislation and the provisions of regulators, competitors' behavior, the status of the bank's perception, technological developments and human resource developments. Mr. Shachaf, would you like to begin?

Yes, please. Thank you very much, and good afternoon, everybody. Welcome to Mizrahi Tefahot Fourth Quarter Analyst Call. As you saw, our results for the quarter and the year were quite robust, and I would like to use this call to highlight a couple of points. Before we start, maybe one word on the macroeconomic environment in Israel. We have seen a decline in unemployment with the forecast of further improvement for next year. After a negative GDP growth in 2020, forecast for 2021 is around 8% and 1-year inflation expectations from OTC markets as of yesterday are around 2.9%. We saw an increase in actual inflation in Israel and even more so in the U.S. We also saw an increase in residential property prices, which is not reflected directly in the CPI. As for the recent developments in Ukraine, it is hard to predict the way this conflict will develop, but we are closely monitor the market. As for Q4 results, we have seen an increase in all major balance sheet items. Negative provisioning has also contributed to Q4 results, but much less than Q2. I remind you that in 2020, the vast majority of the provisions were collective and not specific based on the macroeconomic environment and were mainly COVID-19 related. As the macro parameters are improving, we are gradually reducing the 2020 COVID collective provision. We can also say that from the peak in deferrals in May 2020 mortgage, full deferrals are now practically behind us. So given current health conditions, we could say that the mortgage portfolio has proved to be resilient or immune to COVID. As for CECL effect, I would expect no drama going forward with the high-quality mortgage portfolio benefiting from the new regime and balancing the effect on the commercial non-mortgage credit. I think that the credit portfolio in the Israeli banking sector as a whole and, of course, our own credit portfolio are high quality. And in that respect, the transition to CECL should be relatively smooth. The net profit and the return on equity reflects the strong balance sheet, the good efficiency ratio and the contribution of Union Bank to our results. Given the temporary integration cost in the high variable remuneration expenses, which are based on the high return on equity, we believe we are on the path set by our strategic plan. Our cost-income ratio target established in our strategic plan is to be below 50% by the end of the plan. And that means that by 2025, we should be with the [ 40 handle ] with regard to cost-to-income ratio according to the plan. The merger is advancing as planned. We already started the migration of branches. And of course, most of the cost synergies expected to materialize gradually along 2022 with full effect starting in 2023. We see a continued growth in mortgages with real demand coming from real people who wants to buy an apartment. The year 2022 started similar to the 2021 average. We saw high growth of corporate credit in Q4, which represent a continuous work throughout the year. Again, we expect future growth to be aligned with our strategic plan. Financing revenues from current operations continue to grow. You can see that from Q3 of 2020, financing revenues from current operations follows a positive and consistent trend quarter-by-quarter. Operating commissions also follow a healthy trend. And on the expense side, most of the increase can be attributed, as I was saying, to performance-based remuneration. Liquidity is very robust with core deposits around 67% of all deposits and total deposits continue to grow to more than ILS 300 billion. As for capital adequacy ratio, with CET1 ratio at 10.04 and total capital ratio of 13.66 and the total ratio includes the $600 million CoCo issuance that was recognized out in Q2. We have announced that ILS 271 million dividend, which represents 40% of 2021 Q4 profit in line with the bank's dividend policy. Last but not least, we are preparing for the Bank of Israel new transparency initiative for the mortgage market. We've raised the new initiative. We think that more transparency is always good for the market as a whole. And of course, as a major participant in the market, we support any initiatives that improve the transparency of the market. The availability of more data we think would increase demand for professional bankers advice, which is one of our core strategic pillars in the mortgage market. And we always favor an intelligent dialogue with our clients. We are still examining the exact details of the initiative. But from what we saw so far, we could say that it looks like a step in the right direction. All in all, I think we are following our strategic plan. And like always, the balance sheet growth of this quarter will contribute to the profitability of future quarters. Thank you very much for your attention. And with that, I leave you with the hands of Mr. Menahem Aviv, our Chief Accountant.

Let's go to the main figures that are as follows: net profit in 2021 reached ILS 3.188 billion compared with ILS 1.610 billion in 2020. Return on equity in 2021 reached 15.8%. Equity of the bank amounted ILS 20.8 billion. Total revenues reached ILS 10.320 billion. Financial revenues from current operations in 2021 reached ILS 6.1 billion compared with ILS 5.6 billion in 2020, increase of 9.6%. The ratio of provisions to loans in 2021 reached minus 0.10%. Operating and other expenses in 2021 totaled ILS 5.6 billion. The main balance sheet items are about the total assets grew by 8.9%, loans to the public 10.6% and the deposits from the public 8.3%, and that's all our figures. Thank you.

We will now go to Q&A.

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

This is Chris Reimer on for Tavy. I was wondering if you could revisit the time line and the characteristics of the synergies that you expect still to get from the acquisition of Union Bank?

Okay. So in September 2020, we have completed the acquisition, and we started the migration, which is supposed to be gradual. The time line for the full completion of the merger is by the end of 2022. And having said that, what is actually happening that gradually employees are leaving the group for joining the Mizrahi Group and branches are closing gradually according to the plan. So Union Bank had 35 branches, and we intend to keep 7 or 8 branches, and that means that roughly speaking, 80% of the branches are gradually closing. We already started to close some of them. And again, it would be gradually along 2022 with migration of clients. And at the end of the process by the end of 2022, we will reach the steady state. And this is why I would think that full synergy would be achieved in 2020 -- starting 2023. And in 2022, we see a partial synergies. Most of the synergies can be related to 3 pillars: employees, real estate and IT expenditure. While the employees and real estate are relatively gradual, the IT according to the agreement with Bank Leumi, who provides the IT for Union Bank, would be starting from 2023.

Got it. That was excellent color. I was also wondering if you could describe -- the loan book has seen such strong growth in the last few quarters. I was wondering if you could maybe expand on what's contributing to all of that growth? And how sustainable you think it is?

Okay. So if we look at the year as a whole, we saw not only in Mizrahi but within the entire system a major increase in the amount of mortgages. And since we are roughly 1/3 of the market, then it is reflected, of course, also in our balance sheet. So this is something we saw along the year of 2021. And as I was saying, at least for the start of 2022, it looks at the market as well, again, I think we are a good representation of the market. And this phenomena is with us. And as I was saying, it is mainly because there is a relatively shortage of new starting of building of apartments. So there are 2 aspects of it. One is the historical backlog shortage. And the other one is the flow in the last 2 years, we also saw that the flow of new starting of apartment is below the demand. So not only there is a historical backlog shortage of inventory, but also we are not building enough on the flow. And since Israel is relatively young economy, median age is roughly 30 years, then we see a strong demand for real people who need to buy an apartment. And it reflects in the amount you see in the entire system and within our balance sheet. On the non-mortgage credit, we saw a relatively high growth in business credit in Q4. And we expect again that the average future should be around our strategic plan.

The next question is from Micha Goldberg of Sogo (sic) [ Excellence Nessuah Brokerage Services ].

First of all, congratulations on what looks to me like a strong quarter and a strong year. And I was just wondering, you mentioned something along this line about the cost, which seems to be significantly higher in Q4. And I think you mentioned your remuneration as the main driver. And I was just wondering if you could elaborate slightly on that because Q4 was not as profitable as the other quarters in this year, which would have us anticipate that performance based remuneration will be lower than the last couple of quarters. So where does that stem from? And how much of that really is -- some of that has just to do with that? And if we exclude that, where are the real costs pretty much at this point in time?

Okay. So since the annual results was relatively and even not relatively high in terms of return on equity close to 16% or 15.8%. Then the variable compensation portion that was allocated to close the year in Q4 was what was decided by the Board of Directors and in line with a very good annual results. And you can see that even though -- also in Q3, we saw allocation for variable compensation. In Q2, of course, what was decided is to increase the variable compensation to be aligned with the good results. So I think this is the main explanatory variable for the increase in cost that you saw.

Okay. So excluding that variable costs would have been more or less the same as last quarter? Or how would we look at that?

Yes, quite similar.

Okay. And can you give us any formula of how to look forward to where is this compensation? I mean, assuming next year is not going to be as robust in return on equity as this year. Should we be anticipating a drop in that performance-based compensation?

No. Unfortunately, we do not -- this is the sole prerogative of the Board of Directors to decide and there is not a close -- disclosed formula, but relatively speaking, usually it is reasonable to expect that as ROE is higher then variable compensation is higher, but it's not a mathematical sense.

Okay. Another question. You mentioned the large mortgage demand that has been accelerating, I think, through much of 2021, and I just wondered a couple of things. First of all, based on the recent numbers that the market -- all the banks provided, it seems that margins have come down quite significantly. I assume it has to do with the -- this change the reform the Bank of Israel imposed in the beginning of 2021 regarding floating rate. I wondered, is that the case? And two, is it something that we should continue to expect in 2022 as well? Or should we expect some kind of a revival of the margins? And secondly, are you seeing similar kind of growth in 2022? Is there any risk that demand going forward? Was 2021 a unique kind of year against the background of low interest rates and high level of certainty. And should we now looking at a lower growth rate? That would be appreciated.

Okay. So I'll start with the second question. For the first -- for the start of 2022, we saw something similar to the average of 2021 in the mortgage. Of course, we cannot predict the future and know exactly what would be the rate of demand for mortgages. The current 2021 and beginning of '22 is higher than our strategic planned assumption, but we are following the market in this [indiscernible] represented. The macroeconomic variables, I think, are still there, but you can never know for sure. As for your first question regarding the margins, then for the first part of the question, yes, the Bank of Israel a reform contributed also to better prices for clients. It's relatively stable, and we do not give forward guidance for margin.

Okay. In the notes of your annual report, you have some explanation about the impact of CECL. And I'm just wondering you were quite elaborative. But I would just -- can you confirm that the net equity impact as recorded on January 1, 2022, would be approximately ILS 300-something million , but it will be smooth out as an impact on common equity Tier 1 for the next 4 years, 75% in this year, 50% next year, 25% year after and then 0 in 2025. Is that correct? Or am I mistaken by that understanding?

You are correct.

Okay. And my last question is towards the release of collective provisions that you mentioned, which seem to me that you have released only approximately 50-something percent of provisions made against corona in 2020. Banks across the globe have -- definitely in the U.S. and some other countries have released significantly more. I'm just wondering, is there a quantitive reason? Is there an economic reason why you haven't released more? Is that something that can still happen in the future? Or just something inherent in a local economy or at Mizrahi that will make it difficult for you to live up to the similar kind of releases that we've seen in some of your U.S. counterparts?

[ I want ] to say it was very little numbers, not minor numbers that still were at the end of 2021, and it will be released by the time I think probably in the next 1 or 2 years. So maybe at the end of 2022.

The next question is from David Gubbay of Excellence.

I'm actually standing into [ Michael Clare ]. Going back to the mortgage market. His question was whether to get a sense of the competition -- the current competition and whether you feel that you'll need to cut prices in order to maintain market share in new mortgages above 30%?

So of course, there is a very strong competition in the mortgage market. Even I remind you before the reform for the last, I don't know how many years, we always saw a big competition there, and we are able, I think, to adjust. As I was saying before another question, we do not give guidance for pricing but we are competing. We are happy with our market share and we are at the market -- we are a big player at the market. And I think so far at least, we've proved that we can compete fairly with a very strong competitor.

Okay. And the second question is understanding the sensitivity of inflation and rising rates on mortgage provision rates over the coming year. What are your models telling you for, say, 1% rise in rates?

We cannot predict. It's a new regulation CECL. We are just learning it, so we cannot predict now.

But maybe to complete the other side of the picture, generally speaking, I think all banks in Israel are benefiting from positive inflation in terms of profit. And maybe -- I don't know exactly what's the position in and the other banks that may be because our composition of balance sheet is more tilted towards mortgages than others than maybe on a relative basis, we can even profit for more.

There are no further questions at this time. This concludes the Mizrahi Tefahot Bank Ltd, Fourth Quarter 2021 Business Results Conference Call. Thank you for your participation. You may go ahead and disconnect.