Ladies and gentlemen, thank you for standing by. Welcome to Leumi's third quarter 2023 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. As a reminder, this conference is being recorded, November 29, 2023. I'd 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 turn the call over to Ms. Hagit Argov, CFO. Ms. Argov, please go ahead.
Thank you, and good afternoon to you all. Thank you for joining us today for a review of Leumi's third quarter of 2023. Today, I'm joined by Mr. Omer Ziv, Deputy CEO, and Head of the Capital Markets Division, and our colleague, Dr. Gil Bufman , Chief Economist. This presentation can be found on the IR section of our website and on the TASE website. As you know, on 7 October , Israel woke up to a horrible terrorist attack launched on its citizens. Our thoughts and prayers are with the families of many victims, the missing men, women, and children, taken hostage, the fallen soldiers, and with all the soldiers in the IDF and the security forces. Before we discuss the bank's position in more detail, firstly, a few words on the macro situation and some key messages. Slide three shows some key economic indicators.
While we expect the start of the Iron War to weigh on the level of economic activity in the fourth quarter and 2024, the Israeli economy started this period with strong health, with good underlying growth, falling inflation, low unemployment, and low government debt to GDP. We assume that the next part of the war remains limited to Gaza, and that its intensity declines gradually. Based on these estimates, the GDP growth will slow to 1% in 2024, mainly reflecting the negative impact of the war on early 2024. We see a resumption of quarter-on-quarter growth in 2024, with an emphasis on government consumption, both civilian and defense, and also investment in fixed assets, including construction. We also expect that private consumption will rise as any constraints out of start to reduce the purchases of durable goods.
On slide four are the key messages from the quarter. The start of Iron War began in Israel on 7th October, resulted, among other things, in a decline in economic activity and an increase in economic uncertainty and risk. Q3 2023 includes an increased loan loss provision of ILS 1 billion, or 0.95% of average loans, to reflect the lower economic activity caused by the war and the increased uncertainty. Despite the fact that the war began in October, which was after the reporting period of Q3, the Supervisor of Banks in Israel instructed us to include provisions based on conservative assumptions of the impact of the war.
In addition to the government's aid package and the various Bank of Israel measures to soften the economic impact on households and corporates, several measures taken by the Bank Leumi include extensions and discounts on loan payments and caps to fees for affected customers. The bank has also established an aid fund to support the rebuilding and rehabilitation of Kibbutz Be'eri on the Gaza border. Assuming that 100% of the eligible customers take advantage of this benefit, the bank estimates that the cost would be around ILS 560 billion. Q3 net income was ILS 1.8 billion, reflecting an ROE of 13.6%. Earnings were supported by equity income ratio and comes despite the higher quarterly loan loss provision.
Let us turn to slide five in the presentation, where we present the key metrics and indicators for the quarter and the first nine months. Net income for the first nine months of the year was ILS 5.2 billion, and includes the higher third quarter provision and also the ILS 1.1 billion impairment of the bank's stake in Valley in the third quarter. The cost-income ratio to the 32.3% in the third quarter, from 39% in the third quarter of 2022. The cost-income ratio for the first nine months of 2023 was 31.4%. Credit expenses were 0.95% in this quarter and 0.56% for the nine months, with almost all of the charge coming from collective provisions due to the geopolitical situation.
Credit grew by 1.9% in the third quarter and 8.4% in the first nine months of 2023. Core deposits to private individuals, a key focus for the bank, are up 6% year to date. The Bank of Israel, supervisor of banks, also requested that as a result of the war, we reconsider the size of the dividend that we proposed. As a result, the bank has announced a 26% dividend payout for this week. This is in addition to the ILS 1.4 billion of dividend announced in the previous quarter of 2023, and the buyback program of which ILS 600 million out of ILS 800 million was already completed. Together, this represents a 38% payout overall. The bank is for the program through the buyback program on hold.
Let's turn next to the presentation, where we display the bank's strong starting point. As we enter this period, we show three parameters. Firstly, in recent quarters, the bank has been reserving a large portion of credit losses. At the end of the third quarter, this stood at almost 1.5% of gross loans and close to double the rate of NPLs. Secondly, the bank's high profitability, averaging about 60% over the last three years, provides a large buffer with which to absorb a slowdown in activity and any potential credit losses. Lastly, the bank's strong capital position and the capital buffer of more than 1%, which allowed us to absorb any potential losses and also to continue to support customer needs. Slide seven shows the breakdown of income and expenses.
At the bottom right, the 45% year-on-year increase in pre-provision net revenue in the first nine months of 2023 to ILS 11 billion. Financing income, top left, increased by 33% to ILS 13 billion, driven by higher net interest income. Fees and commission, top right, rose by 6.7%. Operating expenses, bottom left, were up 1.7% year-on-year. Slide eight shows a snapshot of income and expenses in Q3. Pre-provision net revenue grew 39% year-on-year, driven by financing income, up 30% year-on-year, and fees up 10%. Turning to slide nine, you can see the quarterly development of net interest income, helped by higher volumes and higher needs and interest rate growth. Net interest income was up 31.5% year-on-year in the first nine months and 15% in the quarter.
The decline in needs in the first quarter was due to the lower CPI and the increase in interest paid before this. Slide 10 shows the year-on-year increase and breakdown of fee and commission income. The main increase in financing transaction in the period came as a result of the increase in credit activity. Turning now to expenses on slide 11. In the first nine months, operating expenses on the left increased by 1.7% when compared with the first nine months of 2022. While total expenses grew 3.1% year-on-year. The higher costs are due to higher pensions, depreciation, marketing and IT expenses. On the right-hand side, we present the bank's cost-income ratio trend. Quarterly cost income ratio declined to 32.3% or 39% in the nine months.
Cost-income ratio declined to 31.4% from 39.5% in the parallel period last year. Slide 12 shows the development of loan loss expenses. As mentioned earlier, we have been increasing the collective provision in recent quarters to reflect the higher exercise and slower economic activity, and increased the provision significantly in the third quarter in anticipation of the negative impact of the war and third Bank of Israel instructions. You can see that in the first quarter and previous quarters, almost all of the expense comes from collective provisions. Credit expenses in the first nine months were 0.56%. Slide 13 shows our credit quality indicators. We see a small increase in NPLs on the left, although this remains low on historical basis.
Provision for doubtful debt on the right increased to 1.47%, while the ratio of allowances for doubtful debt to NPLs remained at healthy 2 x. Moving ahead now to slide 14. The slide shows that our loan book increased to ILS 417 billion in the first nine months, and 8.4% increase since the end of 2022. While we continue to grow in each of our target segments, we saw the strongest growth in the first quarter in mortgages, which were up 3.1%. Slide 16 shows deposit trends. Here we highlight the growth in core deposits from private individuals, which increased 6% in the first nine months, and they are up almost 10% year-on-year. It is important to note that our deposit base is well diversified, and our liquidity ratios remain strong.
Our LCR at the end of the quarter was 130%. Slide 16 shows the bank's current capital, capital ratios. The current Tier 1 capital ratio was 11.3% up from 11.23% at the end of the second quarter, giving the bank a cushion of more than 1% above the regulatory requirement. The total capital ratio stood at 14.42%. Slide 17 shows the key investment highlights for Bank Leumi. As I mentioned before, the bank is entering this period of uncertainty with very good performance indicators. It's worth noting that the bank will record around ILS 800 million of pretax profit in the first quarter of 2024 from selling two headquarters buildings.
In conclusion, Bank Leumi continues to present consistent and strong financial performance, supported by a decent gap, stock interest ratio, and robust credit quality indicators. The bank's strong profitability and equity capital buffer enable us to continue to grow market share in our target segments and put Leumi in a strong position for the future, despite the effects of the war. With that, I will now open the floor for questions.
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're 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.
Hi, thank you for taking my questions, and congratulations on the strong results. First off, I was wondering if you could talk about some of the trends you're seeing in the U.S., particularly how you see the performance of Valley Bank.
Hi, Chris, thank you for your question. First of all, Valley is doing very well. Now, after all the mess that happened with the national bank in the US at the beginning of the year, we see a gradually recovering in Valley activity. We do see improvement in the stock price. We do see improvement in the result, as well as increasing the deposit base, and continuing keeping very low credit loss expense ratio. I would like to mention that apart from the equity cost stability that we write due to our investment in Valley, Valley contributes to the bank profitability also by the business that we having, that we have with Valley from.
I mean, Valley supports our customers outside of Israel, and there are dozens of participation that we are making with Valley in our credit portfolio. So the profitability for Valley is not only in the equity line, but it is really the credit line, as a result of the participation and the cooperation that we are making with Valley across the board.
Thanks. Thanks. That's some good color there. And I wanted to touch on expenses also. If you could talk about some of the moving parts in the expense line, what's driving the decrease in salaries this quarter, and how should we be looking at the ramp up to the move to the new headquarters?
So as Hagit mentioned, overall, if we look at the first nine months of the year, the total expenses increased by 1.7%, and in the third quarter, we do see also a slight decrease compared to the year-on-year and to the previous quarter. Now, the decrease in the salary expenses is. When you, first of all, when you look at the expenses and you talk about the decrease in the salary expense, expenses, you should bear in mind that part of the salary expenses, according to the accounting rules, are included in the other expenses. Depends the effect of the interest rate on the pension expenses, according to the accounting rules, is classified to the other expenses. So you should look at both of the, of these parts together.
In the salary expenses, you see a slight decrease due to the downturn of the employee number at the end of the year in Bank Leumi, and due to the fact that the ROE in this quarter was lower than the ROE in the previous quarter, and the provision for bonus is, of course, lower than the previous quarter because it's connected to the rate of the ROE. But as I mentioned, there is an increase in the pension expenses, which related to the interest rate due to the increase in the interest rate.
Got it. And just related to the building expenses and how you're ramping up to the move?
Can you repeat the question?
If you could give a little more color on building expenses, and if there's anything left material in that as you complete the move early next year?
Ah, okay. First of all, we expect that when we will move next year to our headquarters from Tel Aviv to Lod, not only we will see the pre-tax profit of ILS 800 million, but we will see another decrease in the maintenance expenses due to the fact that in Lod, the way we are organized is much more cost-effective than here in Tel Aviv, two buildings that were built, I don't know, 20 years ago. So in this respect, you should expect an additional decrease in maintenance costs regarding the headquarters at the beginning of 2024.
On the other side, we expect that the IT cost will continue to increase, because as long as we're moving our customers from branches to digital channels, we decrease the building expenses, but on the other side, we increase the IT expenses as well.
Thanks. Thanks for that. That's it for me.
Thank you, Chris.
The next question is from Laurent Bonnet of BNP Paribas. Please go ahead.
Good afternoon, good afternoon, all. Firstly, congratulations for your results, and your business model is robust. Good capital buffer and liquidity is around. I had only one question, unique question. Looking at provision, there are not the rates, but we see compared to Q2 2023, that those provisions in amounts have tripled. My only question is, I mean, how do you foresee, I know it's related to the geopolitical situation, but do you see this trend continuing and Leumi keep on increasing those provisions, or have we reached a peak?
Hi, Laurent. Thank you for your question. First of all, Hagit mentioned that out of the 95-basis point credit loss expense ratio in the third quarter, 83 basis points are composed of the collective provision, and only 12 basis points are related to the specific provision. Secondly, a significant part of this increase is related to the geopolitical circumstances. According to the instructions of the Bank of Israel, and as we did with the outbreak of COVID, we always prefer to be more cautious and to build our provision based on a conservative assumption. And of course, if it turns out that the geopolitical situation will be less severe, it means that we'll be able to even release some of these provisions.
Now, when we look forward, the main parameter that we should bear in mind is the development in the geopolitical circumstances. As long as the war will be limited and focused in the southern border, according to our focus, we already built a caution provision, which will enable us to deal with the effects of the war. After that, and you should expect a decrease in the credit loss expense ratio in the following quarter. But if the war will extend to the northern border or to other border, so we should look at it again and see what will be the effect of the war.
Currently, it seems to us that we are in a very conservative assumption, we took into account a few months more, with the fact that, with the, relatively low GDP base to go next year, year-over-year. So if this situation will be focused only on the southern border, as I mentioned, we should expect a decrease in the credit loss expense ratio in the following quarter.
Thank you.
Let me mention another parameter, which is important. If you look at the NPL, the NPL is only 74 basis points. NPL is less affected by different conservative assumption. In the rules are more tough, and the NPL is only 74 basis points. And if you compare it, for example, to 2021, it was 75 basis points, so it's not something which is high. Also, when you compare to our peers, you will find that our NPL is significantly lower than most of our peers.
Okay. Thank you, Omer.
The next question is from Ali Dhaloomal of Bank of America. Please go ahead.
Good afternoon, and thank you for the call. I have just a question regarding the deferred programs. Can you elaborate on these and give us a bit more color? Are the length of these up to six months? Who are the consumers who have upped them? Are they essentially retail or corporate customers? And also, will the bank bear all the cost of these deferrals? Thank you.
Okay. So, first of all, there is a table in the financial. I try to find it currently from this page. There is a table that, it, I think it's on page 64 on the English version, and there you can see that the total deferrals till now are ILS 1.3 billion, of which, and you can see that the, the, in which the deferrals that don't bear interest is about 25% of the total deferrals. So currently, we are not talking about a significant number. If you look at this page, you will find that the deferrals are mainly in the mortgage area and in SME. This is the main segment that use the deferrals.
The deferrals are up to five months. It depends if you are a customer that live near the border or a customer that live in the affected by the war and live more far away from the border. But the maximum period of deferral is up to five months. And based on this number, currently, the deferrals are not significant, but we should wait and see.
Understood. Thank you.
The next question is from Irit Bar of The Phoenix. Please go ahead.
Hi, thank you very much for taking my call. Good evening to everyone. I just have two questions, one related to your well, specific provisions compared to rising NPL in the quarter, in the Gaza. So, I see that the specific provision is ILS 122 million, and the rise in NPL was about ILS 600 million. I just wanted to ask if it's because well, the low amount of specific provisions is mainly because you expect high recovery on those loans. I would like also to ask about this period in this regard, so real estate client, do you see further issue and clear deterioration in the sector now, so in this period?
Okay. So maybe I will touch first of all about how we see the real estate market, and then we go to the number, because the specific provision is only part of the NPL, and the specific, the 122 is the expenses. It's not the total specific provision, so it cannot be equal to the NPL.
Now, if you talk about the real estate business, so currently, due to the war in Gaza, we do see a slowdown in selling, slowdown in the completion phase of project, and a slight increase in apartment price. First of all, the slowdown in selling, that is natural. Israel is now in a war. You know, people are not, the customers are not in the mood to go to buy an apartment.
And of course, this is something temporarily that we start to see as part as long as the war, you know, continues. And it's also a difference in different parts of the country. For example, in Tel Aviv, we do see a slowdown in the selling, but in Jerusalem, the pace of selling is high. So it's not something that is different between different parts of the country. And moreover, a significant part of our projects are projects of affordable housing. So in this kind of project, because the government subsidizes a significant portion of the price, the chance that the buyer will lose their opportunity to buy an apartment with a subsidized price is very, very low. Now,
Regarding the pace of completion, it's of course related to the fact that there is lack of Palestinian employees currently due to the war, but the government already approved additional 10,000 foreign employees to the different to the real estate sector. I can say that regarding our customers, the sites that are closed are negligible, and the vast majority of our projects are based on the foreign employees. Moreover, the portion of human resources in the total budget of projects is not significant.
So even if we will see an increase in the cost of project due to the fact that there will be more foreign employees that are more expensive than Palestinian employees, because we already have an unexpected cost in all of our budget, you know, of at least 10%, the effect of that will not be significant. Now, regarding the temporary slight decrease in apartment prices in Israel, so of course, is due to the war. It's not significant, and we expect that because of the lack of supply in Israel, and even before the war started, so this lack of supply just will be more severe. So we expect that after a few months, we will see an increase in apartment price.
But in any way, currently, the current selling price are higher than our underwriting prices. Our underwriting prices in the budget are very conservative, so with this slight decrease in apartment price, it's still higher than the prices in our budget. And at the end, you can always look at the absorption rate. The absorption rate will make to be very conservative. We are not entering into a project with absorption rate which is lower than 30%. The absorption rate is the rate that presents how much the price can go down or the cost can go up, and we are not even close to this area.
This is the reason why despite the war, the NPL in real estate, the problematic debt in real estate, if you will compare the problematic debt in real estate in Bank Leumi to our peers, you will find that our power actually is very low compared to our peers. So in the bottom line, we feel that we have a lot to mitigate to the strength that I just mentioned. We have a very strong customers. We don't take not only cold loans, so the macro picture is less relevant to our portfolio.
And the other question is related to the credit growth in Q4. Can you please just give a color on that? Do you see a real decrease in impact in demand for credit from the different segments or only few segments? Can you please just provide some insights on that?
We expect that the pace of the credit growth in the fourth quarter will be low due to the war.
People are less, the consumption is lower, the activity is lower. Now, it starts to recover, but October was very, very weak, well, the first half of November. We expect that the fourth quarter will not be significant in the credit pace of growth, but we are okay with that. It mentioned since the beginning of the year, our credit growth was 8.4%, much higher than our peers. The nice, and what is more important, is that besides the fact that our pace of growth was higher than our peers, if you look at that reflect, the quality of our, despite in most of the ratio, are better than our peers.
Yeah. Okay, thank you.
Thank you.
The next question is from Micha Goldb erg of Psagot. Please go ahead.
Hi, good afternoon, and congratulations on the strong quarter. You mentioned that you wrote down ILS 1.1 billion for your investment in Valley, and I was just wondering, under what scenario will you be able to recover some of that?
The simple answer would be that in most of the cases, we'll be able to recover that when we sell the loan. When we sell the. Sorry, the investment or part of the investment. But you should bear in mind that every quarter, we record equity profit due to the fact that we present the value on an equity basis. So effectively, you see this coming back via the equity profit, which every quarter is positive and from an economic perspective, every quarter, it will bring us back to the place that we were before. But the simple answer is that if we will not write equity profit, which is quarterly, we will write the profit when we sell part of the investment.
Thank you for that. Do you have any limitations on your lockup for selling part or all of your stake in Valley National?
Currently, according to the agreement, we can start, we can sell, at least 25% by investment, without lockup. So this is not really, we, we don't have effective barrier regarding that.
Understood. Thank you very much. And you also mentioned some sizable real estate gains that you're looking to gain in Q1. Are there more real estate gains likely to happen following the move to new headquarters, or have you completed all the potential real estate gains?
First of all, one of the, out of the two businesses that Hanan mentioned, that Hagit mentioned, we sold only half. So this second part that we didn't sell, we are moving to loan, but half of the building, the more expensive one, still belongs to Leumi, and we decided currently not to sell this half. Apart from that, we do have a few other building with the potential profitability, because we record the real estate in our financial based on the historical value, but not, you know, in the amount or in the size that this will echo.
Great. Thank you very much for that. You also mentioned some potential cost savings following your move to the new headquarters. I'm just wondering, can your cost income ratio go further down than it's currently at, like the 32%-34%? Can it go lower, and if so, where would that potentially be going?
First of all, you are right. When we move to Lod, so it's a potential for further decrease in our maintenance cost because our new headquarters are much more effective than this building. But as I pointed out earlier, we do see an increase in the IT cost because of the movement of our customers to these type of services. I assume it will balance one another. So I think in the bottom line, we will see increase in maintenance cost. We will see increase in IT costs, but the bottom... Regarding the cost income, as you mentioned, our target is to remain the cost income ratio between the range of 30%-35%. We believe we can do that.
Great. You mentioned you lowered your payout by up to 20% on the request of the Bank of Israel and also halted your buyback. And I'm just wondering, when do you foresee that the Bank of Israel will allow you to reinstate your dividend policy? And once that is done, will you seek to go back to your original payout? I think it was up to 40%, but maybe I'm wrong.
No, you're not wrong. Effectively, we were around 40%. If you add the buyback into the 30% dividend payout ratio in cash, together, we were on 40%. I think the answer to that is related to the geopolitical development in Israel. Currently, the Bank of Israel is likely going to be more cautious because of the war. I assume that you know, by March 2024, when we publish the annual report, we will know much more about the geopolitical situation than we know now.
So, I see, I think, it seems to me that till then, and the Bank of Israel, if the situation continues to be relatively calm, that is, like it is in the last month, I expect that the Bank of Israel will enable the bank to pay more. And if you look at our numbers, we have all the capabilities to pay more. We have a Tier 1 equity ratio of 11.3%, we have total equity ratio of 14.5%, very high profitability ratio, LCR 130%. So, by all parameters, we have all the capability to increase our dividend payout ratio, but currently we cannot do it due to the geopolitical situation.
I understand. Now, I seem to remember that a while back, maybe in the heyday, you guys, 60%. Once things get reinstated and the economy gets back on track, would that definitely be a similar kind of longer-term objective, or is that something that seems above what you currently would like to pay out?
It's first of all, it's too early to say something about that, because of the many unknown around us. I would say just that the 60% was in a period that our pace of growth was just slightly above the GDP pace of growth. Since then, we proved that we have the capability to increase our pace portfolio much more than the GDP pace of growth. And at the end, we should split our sources between dividend and pace of growth, and the answer for that will be dependent on the opportunity in the market, in the market, in the future, which currently is too early to predict.
Okay, clearly. So my last question, based on what you just said, I was just wondering, you've gained significant market share, or it looks like you gained market share, on much faster loan growth. And I think you, you mentioned that you'd be growing faster, both compared to GDP as well as compared to, some of your larger peers. And I'm just wondering, does this imply over the longer term that the cost of risk should also be longer, should be higher?
First of all, if you compare our cost of risk in the previous quarter, the fourth quarter, because this quarter doesn't reflect anything, depends on the level of conservativity that you are targeting. But, previous to this quarter, our cost of risk were very similar to our profile. And if you look at numbers that are less related to, let's say, judgment, like NPA, or if you look at the ratio of the problematic debt out of the total loan, you will find that despite the fact that our pace of growth is high, not only in this year, it was also in 2022, it was also in 2021. We are talking about a very long period, you will not find that our cost of risk was higher.
I don't assume that according to the data I have, for example, to the review that I just made about the real estate exposure, which is one of our biggest drivers in our pace of growth, I don't expect that our cost of risk will be different or higher than up here.
Thank you very much, Omer, Hagit.
Thank you.
There are no further questions at this time. This concludes the Bank Leumi third quarter 2023 results conference call. Thank you for calling in. You can disconnect.