Ladies and gentlemen, thank you for standing by. Welcome to the Israel Discount Bank Q2 2022 results conference call. All participants are 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. With us online today are Mr. Barak Nardi, Mr. Joseph Beressi, and Ms. Lena Schwartz. As a reminder, this conference is being recorded August 11, 2022. 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 position and results of its operation 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 effects 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. Ms. Schwartz, would you like to begin?
Yes, thank you. Good afternoon, everyone, and I thank you for joining our Q2 results conference call. I'd like to turn over to Barak Nardi for the overview and a few highlights of the Q2. Barak.
Thank you, Lena. Good afternoon, all, and I hope you are well. Starting with slide 4, we will begin the review of the financial results. Our strong Q2 results show the clear execution of our strategy that help us generate net income of ILS 680 million and an ROE of 11.8%. We have grown in credit by 16.4% year-on-year, leveraging the equity raise at the end of the Q1. At the same time, we continue to remain committed to improving the efficiency ratio, which stood at 69.2% for the Q2. Now I would like to elaborate a bit on the financial highlights of the Q2 and first half, as you can see on slide 5.
The ILS 680 million net income was largely driven by increase in revenues from core banking activity, as we continue to execute our strategy of credit growth. We leverage our successful ILS 1.4 billion equity raise at the end of the Q1 into almost ILS 15 billion or 6.7% credit growth over the Q2. We focused on our targeted segments where we believe we have the greatest potential to outgrow the market and which can bring the highest contribution to the bank and our shareholders. As such, we grew by about 29% in mortgages and by 22% in medium enterprises year over year. We also took advantage of a unique market opportunity, which allowed us to grow in high-quality corporate credit by 10.3% during this quarter.
As a result, and supported by growth in net interest margin, our net interest income grew by 23% year-on-year, and we view it as a clear strength of the bank. At the same time, we remain focused on the quality of our lending. After several quarters of credit loss expenses release, we have recorded ILS 131 million of credit loss expense, which is about 0.23% of the average credit balance, which is related largely to credit growth and change in macro assumptions, which was partly offset by the improvement of the quality of the loan book according to our models. Other credit metrics continue to remain solid. Lastly, this is another quarter where alongside the growth, we have announced on a 10% dividend distribution totaled about ILS 136 million.
On slide six, I would like to briefly touch upon some key indicators of the Israeli economy and explain the mixed impact on the bank's results. The fundamentals of the Israeli economy are still strong, with unemployment rate of 3.4% back to pre-COVID levels, and the expectation for its 2022 GDP growth are still impressive, about 5% according to Bank of Israel, despite an expected slowdown of the global economy. Inflation has increased, yet it remains structurally lower compared to many other developed economies. Bank of Israel has followed the Fed and started to increase interest rates during the Q2. While the macro indicators of the Israeli economy are still robust, we look cautiously on the development in the global economy, on the volatility in the market, and on the potential impact on the local economy.
At the same time, we do see a positive impact of increasing interest rates on our results by increasing NII. However, the full impact of the rate increase is not yet reflected in our numbers, and I will elaborate more on this later. Finally, we are confident in our ability to carefully navigate in these conditions. All in all, we expect to benefit from the net positive impact of rising rates on our bottom line through increasing revenues, and this is despite the potential negative impact on the borrowers is reflected in increasing credit losses. On slide 7, you can see our strong credit growth. As mentioned, leveraged by the equity raise, we grew by almost ILS 15 billion or 6.7% in Q2 and by almost 17% year-on-year.
We focused on our targeted segments, first of all, mortgages, which grew by 7.1% during the quarter and by almost 29% year-on-year and are now comprising almost 26% of our loan book, compared to about 22% when we set our net strategy. Added to medium enterprises grew by about 4% during the quarter and by 22% year-on-year. During the Q2, we took the opportunity of market conditions and leveraged our capital rates to grow by 10% in corporate credit after we held back in growth in Q1. We believe that this was unique opportunity to grow responsibly in this segment by taking profitable high-quality loans, which is aligned with our risk appetite. Looking ahead, we see many additional opportunities for growth, and we'll examine each of them to make sure that our lending is sustainable, profitable, and responsible.
On slide eight, you can see a very good demonstration of the strength of our core business. NII grew by 23% versus last year to above ILS 2 billion, and fee income grew by about 8%. This was partly offset by a decline in non-interest financing income as a result of our interest derivative position, much of which will likely reserve and generate income at the close of the year. Total income grew by 13.2% in the Q2 compared to same quarter in 2021. As you can see from the chart on the right-hand side, we continue growing in what we define as income from regular financing activity. This is the income from our core banking activities, our bread and butter. These numbers exclude the impact of CPI, derivative, fair value adjustment, etc.
The income for regular financing activities grew this quarter by almost 24% versus last year, and NIM increased to 0.63%. I would like to stress that we recorded this substantial increase in net interest income in the Q2, while the base rate has only started to increase. It means that we have not yet seen the full impact of the rate hikes, and we expect to continue to benefit from it in the upcoming quarter. Moving to slide 9. The expenses remained overall flat this quarter, and they grew slightly compared to last year, largely due to expenses related to increased activity at CAL. CAL's payment to partners have increased because of much higher issuing and credit activity.
Our increasing income and the disciplined cost management led to improving cost-income ratio to 57.2% for the first half of 2024, continuing an improving trend over the past years. On slide 10, you can see some of our key credit metrics. This quarter, after five consecutive quarters of credit loss releases, the credit losses were 0.23% of the average credit, all of it generated by general group provisioning. The main drivers for the LLP this quarter are the substantial credit growth we had and the change in macro assumptions, in particular the increasing interest rates. This was partly offset by the improvement of the quality of the loan book according to our models implemented through ECL, which is why the individual provision remains negative. We remain focused on the good quality of our lending and maintain solid NPL and NPL coverage ratio.
Moving on to the performance of our key subsidiaries, starting with slide 11. Mercantile produced a set of very strong results with net income of ILS 144 million and an ROE of 15.5%. This was mainly generated by robust loan growth, particularly in mortgages that were up 7.6% in the quarter. Mercantile cost to income ratio improved to below 50% this quarter, supported by top-line growth from core banking activity and strict cost management. In New York, as seen on slide 12, we saw higher net interest margin, which led to 26.7% increase in net interest income. Coupled with still negative credit loss expenses, the ROE stood at 10.8%. CAL, shown on slide 13, enjoyed a very positive momentum in 2022.
Following the post-COVID economic recovery, including private consumption and particularly material increase to overseas travel. Overall activity volume in credit cards and consumer lending has grown materially, leading Cal to produce ILS 81 million net income in the Q2, with ROE of 14.6%. Moving on to slides 14 and 15. We continue our path toward achieving our target as our three-pillar strategic plan and our determined execution enable us to do so. At the same time, rising interest rates and expectations, which are almost 0.7% higher now compared to the time of the announcement of our financial targets, allow us to accelerate the pace towards achieving those targets. To summarize, I would like to emphasize the key takeaways from this quarter results, as you can see on slide 16.
First, we delivered strong Q2 results, which reflect continuous execution of our strategic initiative, while at this stage, we only partially benefited from the rising interest rates. Second, we leveraged the equity rate to generate ILS 14.6 billion shekel credit growth, focusing on our targeted sectors, mortgages and medium enterprises. We also took advantage this quarter of the market opportunity and grew substantially in corporate lending. Third, we remain focused on increasing revenues from our banking activity and on tight cost control, leading us to improve cost-income ratio. Lastly, interest rate increases allows us to accelerate the pace towards reaching our target of ILS 3.5 billion in net income, 12%-15% ROE, and below 55% cost-income ratio. With this, I will finish the overview and would like to open to your questions.
We'll begin the question and answer session. Ladies and gentlemen, at this time, we'll 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, this is Chris Reimer on for Tavy. Thank you for taking my questions. The loan growth, you already mentioned earlier, strong loan growth and loan loss provisions having been rather low. Looking ahead, given the macro headwinds and raising rates, how should we think about loan growth and LLPs through the cycle?
First of all, regarding loan growth, we still see a demand for loans and growth in Israel. As I mentioned before, I don't think that the 6.7% we grew this quarter is representative because we had some specific opportunities this quarter that I don't believe we'll see in the next quarter. But still, I do expect to continue to see overall growth, credit growth in the Israeli market. Regarding the LLP, as I mentioned, our entire LLP is coming from group provisioning and a big portion of it is due to the macroeconomic situation, especially the rising interest rates. We put some provision to reflect this, additionally. You know, it's too early to call what is going to be in the next quarter.
Currently, we believe that our current LLP and current provision are reflecting accurately the current situation as we see it.
Okay. Just touching on costs, cost efficiencies have been a key priority for you guys. Are you comfortable with where you are, where your expenses are today? Or should we expect further cost-cutting measures in the near future?
Well, first of all, as you mentioned, it's key priority for us, and we are very happy and proud with the results, first of all, with the declining cost-income ratio this quarter. Also the fact that revenue is growing much faster than expenses. We still believe we have additional potential to continue reducing our costs, and it's clear upside for us. One other comment I would like to add, when you analyze our expenses growth, you need to take into consideration that part of our portfolio is CAL, the credit card company. They have a different P&L structure and their expenses, where their business is growing, there is also impact on their expenses because part of the revenue is being paid to the partners and it's going to the other expenses line.
If you put CAL aside, this is good news, this is a good reason for the expense to grow. If you put CAL aside, the Discount Group result is even better when you look at expense growth. It's another thing you need to take into consideration.
Okay. Yeah, thanks for the color. That's it for me.
The next question is from Micha Goldberg of Psagot. Micha, please go ahead.
Hi, good afternoon. First of all, congratulations on a very strong quarter and a great first half. A couple of questions about you mentioned net interest margins expanding, and I'm just wondering if you exclude the impact of the CPI and the hike in interest rates, are the underlying core margins expanding or are they dropping?
I think even if you put aside the positive impact of CPI, we still see a positive result. It's coming from 2 areas. First of all, increased interest rates, and second, a change of mix and bringing into our portfolio a very profitable deal. So actually, the increasing NIM is coming from 3 elements, the CPI, the interest rate that is being growing, mix, and the more profitable deals we brought into the table.
Even if you exclude the CPI and the Bank of Israel interest rate hike impact, you are saying there's still expansion in your margins?
I think there is substantial impact in CPI and the interest rate, but even if you exclude them, the results are good. I don't think. I'm not giving a specific disclosure what is the impact when you put it aside. Overall, we feel very comfortable with the margins even when you put aside those two external factors.
Okay. 'Cause you provide those numbers in your reports, and when you exclude those, it actually looks like the margins are slightly on the way down, but maybe my numbers are wrong. Okay. Another question, I understand. I understand Visa ICC, your subsidiary, is supposed to implement CISL on January first, 2023. Is that correct?
Yes. Mm-hmm.
Does it have any impact on your capital ratios, or is that insignificant?
I heard your question regarding CAL, and they will start implementing CISL in 2023. What was the other question, Micha?
I was wondering if the change and the implementation of CECL on CET1 will have an impact on Discount Bank's equity ratios.
It's insignificant.
Okay. Thank you very much. Now, I understand that as of July first, there were two new regulations that also have impact on your calculation of the FCCR on the dividend and the Bank of Israel requirement on risk assets for highly leveraged real estate lending. Could you tell me what the impact of those two will be on your capital ratios?
I didn't understand the question.
Anything in Hebrew, you know?
No.
Micha, you're asking about the impact of the FCCR and the new rule on loans to the real estate?
Yes.
The first one is less than 0.1%. It's about, I think, five basis points. 0.05 FCCR. The new guideline on real estate loans will affect our capital adequacy ratio by around the maximum 0.1%. This will be implemented over the next four quarters.
Okay. Just 0.025%, right?
Maximum, yeah.
Oh.
2.54 basis points?
Per quarter.
Yeah, per quarter, yeah.
Okay, great. Thank you very much. When you take that and look at your current capital buffer, is that enough to let you grow at even much lower rates than you're currently growing your quick loan book or is, I mean, is there anything else that needs to be done?
No, we feel very comfortable with this. We think that our growth, together with the profits we are going to generate in future quarters, we believe we have sufficient room for sufficient growth, credit growth in areas we are targeting. As I mentioned before, we don't think that the 6.7% quarterly growth is representative. When we are looking at representative numbers, we feel very comfortable with the level of equity we have right now.
The next question is from Michael Klahr of Excellence. Please go ahead.
Hi, good afternoon and, well done on a good quarter. I wanted to ask a bit on margins, and what you're seeing in individual segments, or categories. For example, mortgages, are you seeing higher spreads, lower spreads, or unchanged? And the same question also with middle market and with corporate. I just wanted to understand a bit more what's going on, away from interest rates, on the margin side in terms of the.
Overall, as I mentioned before, when it comes to the corporate segment, we did see some very interesting opportunities in the Q2, which enabled us to take some deals in higher spreads than used to be in previous quarters. Overall, we do see, in some sectors, the spreads are getting higher. For example, also in mid-size businesses, in housing a little bit. It's not dramatic changes, but the overall trend that we see in the Q2 versus previous quarters is a positive one.
Well, is that also true in mortgages? Where are spreads in mortgages versus, let's say, six months ago? Are they higher, lower, or the same, would you say?
In mortgages?
Yeah, mortgages.
In mortgages, they are a bit higher.
They're a bit higher. Okay. All right. Also, I just wanted to ask also on capital. You know, I got your answer to the last question from the last caller. Just, you know, by my calculations, your capital is gonna decline and your CET1 will decline even if you grow at a lower rate through the second half. Just wanted to understand where, you know, what the important levels are for you in terms of the 20% dividend payout.
You know, is there perhaps a chance that you would need to raise more capital, you know, six months from now, if growth rates don't moderate as much as you expect them to?
First of all, you know, it depends. When you make this analysis, it depends what you assume our profit will be. When we take into consideration our growth plan or estimated the profit, we feel very comfortable with the level of equity we have. We think we will be able to support our growth plan. We need to take also into consideration that we reduce the level of volatility we had because we shifted some of our bonds to held to maturity. If we are going to have some, you know, macroeconomic surprises in increasing yields, the impact of it on our equity ratio was going to be much lower than it used to be.
We feel sufficient. We feel also sufficient with the level of 20% dividends, and we are planning, you know, if the outlook is to continue paying this dividend going forward.
Okay. All right. If anything, you know, if we take all those different factors, if anything's gonna give way here, it's on the growth side rather than, you know, rather than anything else, rather than the dividends or the, you know, or additional equity raising.
Yeah. The growth rate, you know, as I mentioned, the 6.7% we have grown in Q1 in the last quarter is not representative. It's not going to be the rate going forward. Using a reasonable growth rate that we used to grow also in the past, we believe that we really can support it, and with the existing equity level aligning with the target we are going to gain in the dividend. We feel very comfortable with the current situation.
Okay. All right. Thank you.
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. There's another question by Micha Goldberg from Psagot. Please go ahead.
Hi. I hope you can hear me better now.
Yeah.
Okay. I apologize for that. Yeah, just one question I had, and I think I missed. If I remember correctly, your original ruling about leaving ICC and the ownership of Israel Discount Bank is supposed to expire or be reexamined by the end of this year. I'm just wondering if you have any indication where that's gonna go, and what will you do if you're required to sell that off?
We're trying to CAL?
Yes, Visa CAL.
Currently, the point where the government can make a decision to split CAL from Discount Bank is until the end of January 2022. If they won't decide, so CAL is staying with Discount. We believe, first of all, we have a good reason why Discount should keep CAL. First of all, we think when you combine this with the current political situation and the fact that probably there is not going to be a new government until early 2023, there is a very good chance that there is not going to be made any decision that, you know, to take CAL out of Discount. We feel quite comfortable with the current situation. You know, if we will have to sell CAL, first of all, we will get.
We'll have time to do it. Both Poalim and Leum got between 3-4 years to do this kind of transaction. CAL is a great company, great asset, and we will get, you know, full value for it. We feel very comfortable currently, we will be able to keep CAL and enjoy from their good performance.
Thank you very much. Again, congratulations on a strong quarter.
Thank you. Thank you, Micha.
There are no further questions at this time. Thank you. This concludes the Israel Discount Bank Q2 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.