Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank second quarter 2023 results conference call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question and answer session. For operator assistance during the conference, please press star zero. As a reminder, this conference is being recorded August 14th, 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 respective 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 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, welcome to Discount Bank's second quarter conference call. Today, we have the opportunity to assess our accomplishment in the last quarter and provide you with an overview of our outstanding performance. Participating in today's call are Barak Nardi, CFO, Yossi Beressi, Chief Accountant. We will start with a review of the financial results by Mr. Barak Nardi, 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 begin the review of the financial results. Our very strong second quarter results show the clear execution of our strategy, which combined with the higher interest rates, helped us generate net income of almost ILS 1.2 billion and ROE at 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 remains 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 high interest rates, the current expectation is for inflation to, inflation to converge into Bank of Israel range of below 3%, with an estimation of 2.6% for the next 12 months. Labor market shows strength and expected to remain relatively resilient, keeping unemployment level at around 4%. In slide six, 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 banking activity, supported with an additional 70 basis points rising of the average interest rate during Q2. As a result, NII increased by 7% quarter-over-quarter, and by 41.5% versus the parallel quarter in 2022. Our cost-income ratio was maintained at a low level of 47.5%, compared with 69.2% in Q2 2022. Given the macro conditions, 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 slows down and with consumer credit declining by 1.2% this quarter. Looking ahead, we continue focusing on sustainable, profitable, and responsible lending activities and a well-balanced loan book.
On slide eight, 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 4.68%, 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 as financing income from core 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 adjustment. The income from regular financing activities grew this quarter by around 48% versus to Q2 2022, 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 with the strong expenses, led to a material improvement in cost-income ratio, down to 47.5%, compared with 59.2% year ago.
As you can see on the right, on the right-hand chart, we are constantly improving our cost-income ratio, showing positive job of 12.5% CAGR between 2020 and 2022, generated by 19.5% revenue CAGR and by only by 7% expense 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 provision due to specific borrowers, but still not observing any material acceleration. We expect the group-based 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 measures.
Non-performing loans rises in the NPL from total loans ratio is 0.89%, compared with 63 basis points in previous quarter and 81 basis points in Q2 2022. Allowance for loan losses went up to 1.39%, reflecting our conservative approach. Moving now to slide 11, you can observe our, our ample liquidity and diversified deposit base. On the left, you can see that 47% of our deposits are from retail and private customers, and only 12% are from institutional funds. On the right-hand side, it presents the stability of our deposit base, while customers are shifting from non-interest bearing deposits to time deposits and interest rates is climbing. Our liquidity ratios are well, well above the regulatory demand, presenting a solid LCR of 134.5%.
I would like to move on and briefly review our main activities on slide 12. Starting with Mercantile Discount Bank, which presents a record net income of ILS 258 million, and ROE of 23.7%. Cost-to-income ratio is improved to 37%. Mercantile grew its loan book by 6.9% year-on-year, with a well-balanced growth across most segments. Moving to 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 remaining strong. CAL is presenting strong results in the second quarter, with a net income of, 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 going well. Nevertheless, in light of the strong results of Discount Group, CAL attributes only 5.4% to the group's net profit. The future separation of CAL is expected to have a limited impact on Discount 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 payout, creating value for our shareholders. At the same time, capital ratio remains solid as well. On slide 14, we are delighted to present our new campus, a new home 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, through these processes, and to improve collaboration through a direct, interesting communication. As we announced last week, as part of the expected divestiture from CAL, Discount will acquire CAL's share 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. Discount's unique positioning creates a competitive advantage as a player that is large enough to make an impact, and yet small enough not to take any regulation. After introducing PayBox in 2021, we announced earlier in 2022, the establishment of Greenlend, a new fintech company that provides digital credit in partnership with the English technology company, ezbob.
The new company will offer 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 five months after announcing Greenlend, earlier this month, we received Bank of Israel approval to control and own Greenlend in partnership with ezbob, the company will start operating very soon. The launch of Greenlend is another step 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 our 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 shekels, an ROE of 80%. Second, we generated a substantial revenue increase from core banking activities, driven by the increase in interest rates and credit growth. Third, cost-income ratio remained low at 47.5%. Fourth, once again, we present a responsible credit growth in line with the current market condition, with asset quality remaining strong and reflecting the challenging macro conditions. 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 my overview, I would like to add on one more thing on a personal note.
After almost four years as Discount CFO, I'm moving to a new role to be the chairman of CAL and Mercantile, our two largest activities. 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.
Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. If you have a question, please press star one. If you wish to cancel your request, please press star two. If you are using speaker equipment, kindly lift the handset before pressing the numbers. Your questions will be polled in the order they are received. Please stand by while we poll for your questions. The first question is from Tavy Rosner of Barclays. Please go ahead.
Hi, thank you for taking my questions, and thank you for the presentation. I wanted to talk on on capital adequacy. If, 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, with, with, with that kind of buffer? I, I'm, I'm especially asking in the context of the increased dividend payouts down the road.
You refer, Tavy, to the total or to the Q1?
Yeah, the total.
Yes. So, so it's, it's 70 basis points above the requirement. We feel very comfortable given the fact that we create such a, a substantial, and one substantial ROE, which is a strong double digit on one end. On the other end, we see the credit demand, and it's lower than it used to be, and currently, the annual, the annual growth rate is, you know, around, between 6%-8%. We feel very comfortable with the gap we have, between the the ROE we are creating and the credit growth rate. We feel very comfortable with the current buffer we have about the regulatory target. You know, it's, it's, it's been higher than it used to be.
I think, last quarter it was a little bit below 13%, and now we are 13.16%. Overall, we feel very comfortable with the 60, sorry, the basis points above the requirement.
Okay, thank you. Then I want to talk about the kind of level of, of, of interest from, from clients asking to renegotiate their, their loans. Not necessarily problematic debt, but more sectors that, that's starting to feel pressure. Is there a specific segment that just beyond the mortgage, is there anything segment that, that you are looking at, that you should be focusing on in the foreseeable future?
First of all, we don't see, you know, mass amount of customers looking to, to negotiate their terms. You know, I think it was more than 6 months ago, we offered a plan for the mortgage borrowers to be able to freeze the mortgage or to restructure, redeploy, and many, little customers came with this request. There are requests, but it's not very significant, and we do it in a case-by-case basis. Regarding the areas where we look, you know, more carefully around, of course, it's mainly around real estate, it's around the hi-tech sector, mainly, maybe around non-bank credit providers. I think those are the main, the main areas.
Okay, thanks for that. Just lastly, in the past, you talked about the bank potentially divesting CAL. I think they have four years to do so. Can you elaborate on, obviously, the selling price will, will have an impact on what kind of contribution you get. Can we have a sense of what kind of updates you expect from, it can be from a capital perspective or, or from capital advocacy? What's the impact of CAL being divested?
First of all, it's not something that's not going to happen tomorrow. We have between 3-4 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, number 12, we see that without CAL, there will be a slight negative impact on our ROE and a very, very positive impact on efficiency ratio. Of course, it is expected to free some capital. We won't disclose the exact number because it's also dependent on the price or the value we are going to get for CAL.
Of course, it will free some capital, and later on, we need to see what we will do with this, with this capital. Of course, we are not disclosing at this stage, what will be the amount of capital that is going to be freed by selling CAL.
Okay, thank you very much, and, and good luck with your future endeavors within the group.
Thank you, Tavy.
The next question is from Iris Barr of Phoenix. Please go ahead.
Hi, thank you very much for the presentation and congratulations for the results. I just have two questions, one about NPLs, so non-performing loans increased, just by, if I look at the numbers by segments, more linked to the real estate construction and to a lesser extent, to real estate, other activities. In the right from that, what's, 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, the second question will be after.
Maybe I'll start with the first one, the NPL.
Yeah.
Yeah, 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 2022, it's more or less at the same level, and we really feel that we are, you know, in the benchmark. The reason it went up, it's, it's, it's due to a specific customer. It's not many customers, it's specific customer. We are, of course, not disclosing their name or details. And it's coming from the from the corporate sector. Behind this, we cannot, we cannot give specific details. But it's part of taking, you know, a conservative approach, and we are taking conservative approach, and, and we think this was the right approach.
We feel very comfortable, first of all, with the stability of our portfolio and quality of our portfolio. Second, with our overall NPL level that is in the benchmark. As I mentioned before, we also increased the allowance for loss provision to reflect this extra to reflect this conservative approach we are using.
Yeah. Okay, thank you. The second question is linked to the raw data, credit data published lately by the Bank of Israel. We see construction in the credit growth globally in the system, so by 0.25%. Do you think that this is turning point in credit growth going forward?
You mean credit growth in the system for, for entire credit or what?
Yes, in the whole system, were constructed by 0.25% in June.
You know, overall, you know, we need to see until all banks in the next few days, all banks are publishing the financial statements. You know, today, we, we, we show that we are growing by 1.5%. I think Hapoalim are growing at the same pace in this quarter. I don't see... I assuming that the other banks will grow more or less the same, still we are seeing growth. It's lower than we used to see, we still see growth. As we indicated before, we do expect that the higher interest rates will generate a lower growth.
Currently, you know, I don't see a decline in credit, but we do see a slower growth pace, and it's too early to call, and to say what is going to be, you know, in Q3. But I can only tell the Q2 numbers, where we see a growth that is the lower, slower pace than we used to see in previous quarter. It's, you know, I can't predict what is going to be in, you know, Q3 and Q4.
Is it mainly because of, well, you always capitalize from side of the bank, or, or, or also, because of, lower credit demand?
I think it, it comes mainly from lower demand, mainly in the consumer credit, because we do see growth both in the corporate and in mid-market. It's mainly around lower demand, both in consumer credits and in mortgages and non-mortgage consumer credit.
Mm-hmm. Okay, thank you very much.
If there are any additional questions, please press star one. If you wish to cancel your request, please press star two. Please stand by while we poll for more questions... The next question is from Micha Goldberg of Psagot. Please go ahead.
Thank you. First of all, congratulations on another strong quarter. A question, you mentioned the new payout policy that you still pay at 30. When do you anticipate you'll be starting at the 40%?
First of all, you know, we published 40%, so we have the intention of going there. Regarding the pace, you know, it depends on how we see the progress of the, of the credit demand on one end, on the LCR on the other end, profitability. You know, I, I cannot, I can't tell you whether it's going to be next quarter or quarter after it, but we, we have the intention of, of getting there, but we, we don't disclose the specific quarter when it's going to be.
Okay, thank you. When you look at your internal capital targets, what would be sufficient for you to say that you feel comfortable going to 40%? I mean, you're at 10.35% now. Where, where, where do you feel comfortable at the number, let's say, 40%?
No, we feel comfortable with the current numbers we have. As you can see, our current numbers, both when referring to Q1 and total capital ratio, are higher than we used to, to have in previous quarter. In Q1, it's 30 basis points above previous quarter. In total, total is 24 basis points above. We feel very comfortable with the buffer we have. We always manage to have the right balance between adding the right buffer on one end and for providing dividend on the other end. I don't think that the buffer is, is, is an issue. We're not looking for higher buffer.
Assuming that you pointed out during the presentation that, you know, profitability will remain within similar kind of double-digit numbers that you've been doing right now, and loan growth will remain approximately the same numbers right now, we're gonna see continued building of your common equity in one in the next couple of quarters.
You know, by the end of the day, the Q1 is a result on one end, profitability. On the other end, profitability and growth, on the other end, dividend payouts. You know, we always take those considerations. I can tell you that the reason we put up to 40% is not just to put a number, it's to show our intention to go together. You know, I can't be more specific whether it will be next quarter or more, but this is our overall direction, and we are planning to get there.
Right. Okay, clear. Question, a potential S&P downgrade, of Israel's credit rating, what would be the impact on your common equity, Q1?
According to what we heard, it's around 20 basis points.
Okay. That's clear. Okay, another question. Your margins have been widening very nicely recently, and I'm just wondering, do you see the current levels as peak levels, or do you think there is more expansion in the next couple quarters?
Yeah, I think it could be a peak because assuming that 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. We will see. We, we have some, you know, pressures on deposits and customers are looking for more. I think we are, maybe we are not at the peak, but we are around the peak, and, and, and, and this is what we, I, I currently, currently see. You know, 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 a new campus, and I'm just wondering, are there any additional potential real estate gains to be had in the coming quarters, or alternatively, any expenses that one should be thinking about as a result of the move?
We already already recognized some substantial gains. We have some still to go. One, the sale of Mercantile building, which we should expect to see later this year. Then we haven't sold yet our, the current, HQ in Tel Aviv, so it will be later on. I'm not sure if it will be in 2023 or 2024, but we are looking, we'll see another gain. This is on one end. On the other end, moving to the new real estate, of course, the depreciation is going to be higher than it currently is. We are going to have some positive effects and negative effects, both, both sides.
Okay. Another question, I mean, you're in charge of the investor of Visa, and I, I, I read somewhere in your report that the government or the Ministry of Finance is proposing to change Clause 10, which will allow local institutional investors to bid for the control on Visa. That has not yet been approved by the legislator, right? Is that still in the process? Can you tell me what the timeframe on that potentially would be?
Yeah, it's still, it's still in the process. We heard the, the Ministry of Finance people saying they are supporting, it, they are working on it. I hope it will be finalized, later on in 2023, already in 2023. It will be enable us to sell CAL also to local, institutional.
Great. Then my last question, I mean, Mercantile showed really remarkable profitability and, and in the past, you have considered all kind of thoughts about what to do with your stake. Is there any kind of thought of consolidating it and IPO it off or selling it? Well, what are the options for your stake in Mercantile?
First of all, Mercantile is great subsidiary and showing great results, phenomenal results. They show record ROE and profitability this quarter. They have good potential, especially in the fast, highest, growing sector in the Israeli market, hi-tech sector, on total of June. I think the fact that they are being operated as a standalone unit and standalone company creates a lot of advantages and experience, expertise over there. Currently, we don't have any reason to go, to treat it any differently than it's being done today.
Okay, thank you very much, and congratulations, and good luck on your new endeavors.
Thank you. Thank you very much.
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.