Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank 1st quarter 2023 results conference call. All participants are at present in 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 May 17th, 2023. If you have not yet done so, please access the presentation on the bank's website investors.discountbank.co.il. I would like to remind everyone that forward-looking statements for the 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 like to move first to Mr. Gad Barlev, Head of Investor Relations. Mr. Barlev, would you like to begin?
Thank you. Good afternoon, welcome to Discount Bank first quarter financial report conference call. Today, we have the opportunity to reflect on our accomplishments in the last quarter and provide you with an overview of our outstanding performance. Participating in today's call are Barak Nardi, CFO, and Joseph Beressi, chief accountant. We will start with the 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 first quarter results. Starting with slide four, we begin the review of the financial results. Our exceptional first quarter results show the clear execution of our strategy that combined with higher interest rates, helped us generate net income of almost ILS 1.3 billion and ROE of 20.1%. Our efficiency ratio improved materially, reaching 46.1%. Given our strong results and our confidence in the robustness of our core business, we have decided to raise the dividend payout to 30% of net income. This reflects our long-term journey to increase value for our shareholders. Moving to slide five. Before moving to discuss the financial highlights, I would like to briefly touch upon some key macroeconomic indicators of the Israeli economy.
The fundamentals of the Israeli economy are solid, and the expectation is for economic growth to continue in 2023, but at a much slower pace than 2022. As a result of the rising interest rates, we see some slowdown in the economic activity and the demand for credit. Given the recently published April CPI rising by 0.8%, it is hard to assess at this stage what would be the inflation for 2023 and whether the next interest rate increase that is expected to happen soon will be the last one for the year. In slide six, I would like to elaborate a bit on the financial highlights of the first quarter. Our 1 point...
Our ILS 1.27 billion net income and 20.1% ROE was largely driven by revenue increase from core banking activity, supported with an additional 1% rising of the interest rate during Q1. As a result, NII increased by 7.9% quarter-over-quarter and by 52.1% year-on-year. This material revenue growth draw a substantial improvement in our cost-to-income ratio that has reached 46.1% compared with 55.3% in Q1 2022. Total credit grew by 3.5% this quarter and by 14.5% year-on-year. At the same time, we remain focused on the quality of our lending.
In the first quarter, we have recorded credit loss expenses of ILS 204 million, which is about 33 basis points of the average credit balance and is largely related to increase in group basis provisions. Other credit metrics continue to remain solid. Lastly, as mentioned before, we increased our dividend payout to 30% of Q1 net income. On slide seven, you can see our credit growth. As mentioned before, our total credit grew by 3.5% in the first quarter, led by 6.9% growth in corporate and by 5.6% growth in medium enterprises.
At the same time, we already seeing the slowdown of the economic activity and the cool down of the demand, with mortgages growing only by 2.5% this quarter as the housing market slows down and with consumer credit declining by 2% quarter-over-quarter. Looking ahead, we continue focusing on sustainable, profitable and responsible lending opportunities and on keeping a well-balanced loan book. On slide 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 fourth quarter climbed to 3.89% compared with 2.92% in the previous quarter and close to 0 in the first quarter of the previous year.
As a result, and in line with our anticipation, our NII grew in the first quarter by 52.2% year-on-year and by 7.9% quarter-over-quarter. In addition, fee income grew by 7.5% year-on-year. As a result, total income grew by 16.5% quarter-over-quarter and by almost 38% year-on-year. As you can see from the chart on the right-hand side, we continue growing in what we define as financing income from current operations. This is the income from our core banking activities, our bread and butter. These numbers ex-exclude the impact of few items, such CPI derivatives and fair value adjustments. The income from regular financing activities grew this quarter by around 57% versus Q1 2022, and our NIM increased to 3.18%.
The average Bank of Israel interest rate is expected to continue rising, supporting another incline in NII in the following quarters of 2023. Moving to slide nine, discuss expenses and cost-to-income ratio. Our expenses were retained at the same level as the previous quarter, with reduction in salary expenses and incline of other expenses, largely due to revenue-related expenses and special items in Cal. Strong revenues alongside with restrained expenses led to a material improvement in cost-to-income ratio down to 46.1% compared with 55.3% a year ago. As you can see on the right-hand chart, we are constantly improving our cost-to-income ratio, showing positive jolt of 10.1% CAGR between 2019 and 2023, generated by 16.5% revenue CAGR with only 6.4% expenses CAGR.
Switching to slide 10, you can see the evolution of credit loss expenses. This quarter, we are still not observing any material deterioration in specific borrower conditions, as evident by the low specific basis provision. We have kept the group-based provision high to reflect the potential risk that exists with the current interest rate environment. Overall credit loss expense stood at 33 basis points for the quarter. On the right-hand side, you can see additional asset quality metrics. Non-performing loans remain relatively low, with the NPL from total loans ratio at 63 basis points, compared with 67 basis points in previous quarter. NPL coverage is also very strong, as the loan loss provision covers non-performing loans by more than twice. These indicators reflect the solid quality of our loan book and our conservative underwriting. Moving now to slide 11.
We announced today that dividend payout is going up from 20% to 30%. This, coupled with the high profitability we are showing, generates a dividend yield of about 6%, substantially higher than before. As you can see in this slide, we are continuously growing our net income and dividend payout, creating value for our shareholders. At the same time, capital ratios remain solid as well. I would like to move on and quickly review our main subsidiaries. On slide 12, you can observe the record results of Mercantile Bank with net income of ILS 237 million and ROE of 23%. This is largely achieved by NII growth of around 57% year-on-year and by 8% quarter-over-quarter. cost-to-income ratio is substantially improved to 37.9%.
Mercantile grew its loan book by 2.6% this quarter, driven by well-balanced growth across most segments. Moving to talk on IDB Bank on slide 13. The bank presents solid performance with a net profit of around $30 million in line with previous quarters and ROE of 10.5%. Loan book remains stable and asset quality continue to be strong with release of provisions for credit losses. On the deposit side, we were able to attract new customers and as a result, the bank deposit base grew by 2.8% during this quarter to a level of $10.8 billion.
On another topic, IDB is expected to sign on consent orders with the U.S. regulators relating to issues that are required to be addressed in its AML/B SA compliance program following the findings of regular review held at IDB New York. They also don't include any penalties. Moving now to slide 14 to discuss Cal. Cal is presenting strong results in the first quarter with an adjusted net profit of ILS 85 million and ROE of 15.6%. Consumer credit grew by 19% year-on-year and by 6.5% quarter-over-quarter. Transaction turnover is growing as well. In light of the strong results of Discount Group, Cal attributes only 5% to the Group's net profit.
The future separation of Cal is expected to have a very limited impact on Discount's ongoing profitability. To summarize on slide 15, I would like to emphasize the key takeaways from this quarter results. First, we delivered yet again record results with net income of ILS 1.27 billion and with ROE of 20.1%. Second, we generated a substantial revenue increase from core banking activity, driven both by our credit growth and by the increase of interest rate. This creates a very strong basis for our future growth as well. Third, cost-to-income ratio went down significantly from 55.3% in Q1 2022 to 46.1% this quarter. Fourth, once again, we present a responsible credit growth in line with the current macro conditions with asset quality metrics remaining strong.
Lastly, given the very strong performance of Discount and the confidence we have in our ongoing profitability. We have raised the dividend payout to 30% of net income, and we continue our long-term journey to increase value for our shareholders. With this, I will finish the overview and would like to open to Q&A.
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 pulled in the order they are received. Please stand by while we pull for your questions. The first question is from Chris Reimer of Barclays. Please go ahead.
Yeah. Hi. Thanks for taking my questions. I wanted to ask about provisions going forward. How should we be looking at provisions considering the higher rate environment?
Thanks. As I mentioned before, at this stage, we don't see a deterioration, and we are already, you know, around one year into a higher interest rate environment. Since we do expect that going forward, the higher interest rate will create some deterioration, this is the reason why for a few quarters in a row, we already put some group provisioning for it. You know, I can't tell you whether it will be next quarter or two or three quarters from now, but we do expect we will see some negative impact going forward. Nevertheless, we do believe that the positive impact of the higher interest rate on our NII will be significantly more significant than the negative future impact from higher loan losses.
Got it. Thanks. Just regarding the capital adequacy requirements, this quarter, you only had a buffer of 40 basis points. How comfortable are you with that buffer level?
You mean for Q1 or for total city?
For total.
Yeah. It's around 40. We feel very comfortable because given the high on one end, the higher profitability, and we are at a high double-digit profitability on one end. On the other end, we do expect to be a credit growth at a slower pace than what we have evident in the last quarter. We do think that we have sufficient capital to continue distributing dividend and at the same time, keeping sufficient equity buffers.
Great. Okay, thanks. That's for me.
The next question is from Michael Goldberg of Psagot. Please go ahead.
Hi, congratulations on an excellent quarter. A good start to the year. A couple of questions if I may. First of all, just a technicality. I think I noticed that the risk-weighted assets grew by 5% in this quarter, like almost double of credit growth. What is the reason for that, or am I mistaken?
First, you are not mistaken. Part of it is driven by credit risks that are off off-balance credit risk. This is one portion. The second piece is some market risk and CVA risk that grew some of it because derivative activity and other. It's not a very big gap. For the year basis, we assume it will be more or less at the same. It will grow more or less at the same pace of the overall credit.
Okay, thank you very much for that clarification. Another thing I noticed on the balance sheet is that, I mean, among the banks that have reported today locally, you're the only one that has a quite a drop in deposit, by 1%. I saw the other banks actually increased their deposit. I'm just wondering what the reason for that is. Are we seeing increased switching? Is BETA growing, and how is that impacting your margins?
Overall, you're right, in total deposits, we were down a little bit, but in consumer deposits, we went up. We went down mainly in corporate deposits, and it was a pricing issue. We decided not to take those deposits. We have sufficient liquidity, so we felt comfortable not to take those deposits in those price, but we are fine with it. When you look at retail deposits, which these are the most, the most significant piece, we were able to grow this quarter as well.
Thank you. Do you see continued switching and increase in BETA, or is that... Are we, are we past that now?
Uh, we don't-
deposit move out of current account deposits.
It's actually in the same pace that we have seen in previous quarters. It's very moderate. It's not something very significant. You can see it actually in all banks that publish that the non-interest bearing deposits were down this quarter, but not in a substantial amount.
The Q- over- Q was around 10%. Is that correct?
For which, for which piece?
For current account deposits that are down.
10% Q- on- Q? No, it's substantially less. It's year-on-year it's around 10% year-on-year, not Q- on- Q.
Okay. I saw a different number. Okay, thank you for that. Could you tell us a little bit about what the process is for the forced divestiture of Cal, ICC? You know, what's the timeframe? What needs to be done, and how quick can you move that in current market and et cetera?
Actually, the legislation. The decision was made at the end of January. We have three years to do it, so actually we have enough time. I'm not sure that we'll utilize the entire time, but we have three years to do it. The good news is that just recently, the Ministry of Finance decided that we are allowed to also to sell CAL to institutionals, which is create good opportunity for us and will help us most probably to get a better deal. It's a good news. You know, we'll start the process. I can't tell you now whether it will take one year, two years.
We'll make sure that we'll get the best value we can, and we have the sufficient time to do it.
Okay. Thank you. The recommendation by the Ministry of Finance, is that a final one, or does it require additional legislation before you can actually go out with that, or can that be done in parallel?
No. Actually it's the final recommendation. It's now has to go through. We'll have to go through legislation. Since everyone supporting it, we don't expect any, you know, issues. It's only a measure of technicality. Of course, we can start the process. We assume that within the next few months, we will finish the legislation process.
I understand. Okay, very nice. Now, I mean, there's been some, you know, issues in the U.S. regional banks recently, and one of your competitors has significantly written off its stake in a sizable bank in the U.S. I'm just wondering, how do you see your holding in IDB New York, the, you know, high increased liquidity in the U.S. and what else is going on with regulatory requirements over there? Is that imposing more on your... Is it gonna reduce profitability over the mid to long term? Could there be a chance, a risk that you will have to write off some value of that as well?
First of all, we don't need to write value. You might need to write value when you have like an equity equity investment. We are fully consolidating IDB New York, we don't need to write off anything, you know, even in the future. IDB Bank is a very solid bank. They show a very strong result. I think the good news is that while we saw in some of their competitors, the deposit base was declining, IDB New York was able to grow their deposit base. They were able to recruit new customers as well. Some of them were moving from the banks that, you know, that got a hit.
Overall, the bank is perceived, you know, as for some as safe haven and people, customers, move their money over there. We feel very comfortable, first all with the bank and with their current performance, especially around the deposit base growth.
Okay. Thank you very much. Any update on the process of finding a new CEO? You know, should we be expecting, you know, final candidate in the next couple of weeks or months? Can you give us any color on that?
You know, the chairman already announced that he's put together a committee to recruit a new CEO. He committed that it will take, it will be a quick process. You know, I can't tell you if it will be, you know, two weeks, three weeks or four weeks, but it should be a relatively a quick process. I'm quite sure that no matter with the CEO, the successful journey of Discount Group will continue.
Yes. I agree. One final question, if you can. Once Cal has been sold, what is the impact on your common equity or one? What's the capital release we should expect? Not including the capital gains, just the risk-weighted assets change.
We actually, we have not disclosed it, but it's quite significant. You know, maybe in future quarters we will disclose this number. What we have disclosed that if we'll distribute this excess capital that will be created as dividend, the impact on ROE and net income is going to be insignificant. Actually, the being separated from Cal, cost-to-income ratio is going to improve significantly by around 3 points. It will be significant.
Thank you very much, and good luck.
Thanks, Michael.
The next question is from Hilit Bar of Excellence. Please go ahead.
Hi. Thank you for taking my question. I just wanted to ask about your credit portfolio in IDB New York, how comfortable you are with what, if any, exposure you have in real estate, commercial real estate. Can you please elaborate on that a little bit?
I'm not sure what we are providing disclosure to the mix, but overall, I can tell you that, IDB Bank is a very solid and conservative bank. They know in a more tough time, they actually even not growing their credit portfolio because they don't want to take any asset risk. You can see that in the last quarter, their credit book was not growing. It was more or less stable. Their loan loss over are very low, and actually they have a negative LLP this quarter. Overall, the book is conservative. The performance is good. It's actually very well diversified between real estate and other C&I elements.
It's very well spread, you know, also in different geographies. They have activity on top of New York, also in Florida and California. Overall, it's, it's a good and solid portfolio.
With no, much concentration on any, difficult sector for the moment?
It's, you know, they have their internal limitations. They're not crossing the limitation, and they are not over-concentrated in one specific sector or segment.
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 pull for more questions. There are no further questions at this time. Thank you. This concludes the Israel Discount Bank first quarter 2023 results conference call. Thank you for your participation. You may go ahead and disconnect.