Ladies and gentlemen, thank you for standing by. Welcome to Leumi's Second Quarter 2022 Results conference call. All participants are 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 16, 2022. With us online today is Mr. Omer Ziv, First EVP and CFO. 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. A PowerPoint presentation, which is available on the bank's website, www.leumi.co.il, will be used during this conference call. I would now like to turn the call over to Ms. Adi Molcho Weinstein, VP Investor Relations. Ms. Molcho Weinstein, please go ahead.
Thank you, operator. Ladies and gentlemen, thank you for taking the time to join us on this results call for Bank Leumi's financial statement for the second quarter of 2022. Omer Ziv, First EVP and CFO, will be presenting the development, strategy, and major takeaways from the financial statement. We are joined today by our colleagues, Ms. Hagit Argov, Head of Accounting, and Dr. Gil Bufman, Chief Economist. The presentation presented here can be found on the IR section of our website and on the Tel Aviv Stock Exchange website. I'd now like to turn the call over to Omer.
Thank you, Adi, and thank you all for joining us for the presentation of our new results for the first half of 2022 and for the second quarter. As usual, I would like to start with a short review about the main macroeconomic parameters in the Israeli economy. Israel has several unique growth drivers that are helping to offset some of the negative impact of a sourcing slowdown in the global growth. These include rapid population growth, a surge of much-needed residential construction starts, ongoing high-tech growth, sales and exports despite the global trends, and a rapidly growing natural gas sector with exports to neighboring countries.
When we look at the GDP pace of growth, after a very strong pace of growth in 2021 of 8.2%, the focus of the Bank of Israel is for 5% pace of growth in 2022 and 3.5% in 2023. As a matter of fact, today, the CBS in Israel presented the data for the second quarter of 2022. Based on that, the expectation and the forecast is even better. Based on that, and our Chief Economist, Gil Bufman, can elaborate on it later, our expectation is that in 2022, the GDP pace of growth in Israel will be 6%, much higher than the expectation of the Bank of Israel.
When you look at the unemployment rate, we can see that it dropped to a level of 3.3%, much lower than the unemployment rate pre-COVID. As for the CPI, we believe that this year the CPI will be around 5%, but next year we're expecting the CPI to drop again to a more reasonable level between 2%-3%. Regarding the Bank of Israel interest rate, which is currently 1.25%, we expect that by the beginning of 2023 it will rise to a level of 2.5%-2.75%. I mention all of that because 95% of our activity is in Israel. The better the Israel economy, the better the new results.
With that, I would like to continue to the next slide and start analyzing the new results for the second quarter and for the first half of the year. Again, the ROE is impressive. 18.5% for the second quarter and 17.51% for the first half of the year. This strong ROE was led by a few parameters. First, very strong pace of credit growth. In the first six months of 2022, we were able to increase our credit portfolio by 12.3%. As a result, our net interest income increased significantly, and on the other hand, we were able in the same period to decrease our expenses. As a result, our cost-income ratio reached to a level of 40% for the first half of the year and 35% in the second quarter.
The credit loss expenses remain at a very low level of five basis points for the first half and 14 basis points for the second quarter. The results for the first half and for the second quarter, of course, were impacted positively by the profit from the merger of Bank Leumi USA with Valley National Bank, in which we recorded a net profit of ILS 645 million in the first half of the year. In the first quarter, we recorded ILS 194 million, and in the second quarter, ILS 450 million net of tax. In the next slide, we present the broad picture of the cost-income ratio and the credit loss expenses for the last three and a half years.
We can see the significant improvement in the cost-income ratio and the very low credit loss expenses in most of the periods, apart from 2020 with the outbreak of COVID. As a result, the ROE rose to a level of 17.1% in the first half of 2022. I'm moving on to slide number six. From now on, we neutralize the results of Bank Leumi USA in the previous period in order to compare apples to apples. We reported that on the pro forma financials in our financials. When we look at the finance income, we can see a significant increase of 12% in the first half of the year compared to the first half last year, and an increase of 19% in the second quarter compared to the second quarter last year.
This increase was led by substantial increase in the net interest income of 23% in the first half of the year and 21% in the second quarter. The increase in the net interest income was led, as I pointed out earlier, with a significant increase in our credit portfolio, and of course, by the increase in the interest rate and in the CPI, which reached to a level of 3.1% in the first half of the year and 1.9% in the second quarter. As for the non-interest finance income, we can see a decrease compared to last year. This decrease was of course, impacted by the capital market, which in the first half of last year was much better than in the first half of this year.
For one time income this year related to the merger of Bank Leumi USA with Valley, and in the previous years, significant profits from the two investments, Riskified and ironSource, which impacted significantly the result last year. When we look at the expenses, we can see that again, Bank Leumi succeeded in reducing its expenses even though we increased our activity significantly. In the first half of the year, we reduced our expenses by 3.4% compared to last year, and in the second quarter, we decreased our expenses by 3.8% compared to last year. On slide number seven, we can see the improvement in our NPL. The NPL dropped to a level of 70 basis points, a level which is lower than the level pre-COVID.
As a result, the total provision to NPL rose to a level of slightly less than 190%. In the next slide, we can see that the coverage ratio, I mean the ratio between the provision to the total debt, rose from a level of 1.16% pre-COVID to a level of 1.36% in June 2022. This reflects an increase of 50% in our credit provision. As I pointed out earlier, the credit loss expenses remain at a very low level, four basis points for the first half of the year and 14 basis points for the second quarter.
In the next slide, we can see that we were able to increase our commissions in the last two years by 4.3% on average. When we compared the first half of the year compared to the first half of the year last year, we can see that the increase in commission reached to a level of almost 5%. This increase was mainly driven by exchange differentials commission, due to high activity in the first half of the year in foreign exchange, and due to an increase in the finance transactions commission, due to the increase in our credit portfolio. There is a strong linkage between the increase in our credit portfolio and the commissions from financial transactions. In the next slide, we present the efficiency ratio for the second quarter and for the first half of the year.
For the first half of the year, the efficiency ratio, when we neutralize Glusker results, reached a level of slightly less than 40%, in the second quarter to 35%. On the right, we neutralize not only Glusker results, but also the profit from the merger of Bank Leumi USA with Glusker. We can see that even when we neutralize this effect in the second quarter, we were able to achieve a cost-income ratio, which is slightly less than 42%. It's impressive cost-income ratio. In the next slide, we present the increase in the credit portfolio. In the first six months of the year, we increased our credit portfolio by 12.3%. As a matter of fact, in the last twelve months, we increased our credit portfolio by 23%.
The increase, again, was focused according to our strategy in middle market, mortgages, and corporate. In middle market, we increased our credit portfolio by slightly less than 16%, in mortgages, 9%, and in corporate, by 22%. In the next slide, we can see that we were able to increase our deposits in the last 12 months by 16%, and we can see that the loan to deposit ratio remained conservative at level of 68%. The last slide of the presentation present our equity ratio, leverage ratio, and liquidity ratio, in all of which we are much above the minimum regulatory requirement. I would like also to mention that the board of directors approved a dividend of ILS 400 million for the second quarter, which reflect 20% of the profit of the second quarter.
I would like to end my presentation by saying that, again, Bank Leumi presents very strong results, very strong ROE, consistent improvement in the cost-income ratio, very low levels of credit loss expenses. When we add to that the expectation for continued increases in the interest rates, it puts us in a very strong position looking forward. With that, I would like to open the line for Q&A. Operator?
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 a 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. Good afternoon. Thank you for the presentation, and thanks for taking my question. I just wanted to discuss the outlook a little bit. We're seeing some signs of macro headwinds, you know. Recently, a decrease in new home sales, you mentioned the increase in inflation. When you look ahead, I'm talking about next six months, next 12 months, how do you see loan growth stabilizing, and at the same time, do you expect to pick up in the level of loan loss provisions?
Hi, Tavy. Thank you for the question. When I look forward, I still see a potential and good demand for loan in Israel because as I pointed out at the beginning, the CBS data for the second quarter of 2022 are quite positive. They are even better than we expect before, and they expect that the GDP pace of growth in Israel. Based on that, we expect that the GDP pace of growth in Israel in 2022 will reach a level of 6%. Having said that, I don't expect that the pace of growth will continue to be as strong as it was in the last twelve months.
The last 12 months were unique because the demand was very high due to different parameters, low levels of interest rates, you know, the turn out of the COVID period. Because in 2020 the demand for loan was so low, so 2021 and 2022 are like something that we should take it together with 2020. I believe that there will be a good demand for loan, but the pace of growth will not be as strong as it was in the last 12 months. What exactly will be the number? It's hard to predict at this stage. I assume that it will be lower.
When I look forward for 2023 and from there, also, I will say that, the GDP next year is expected to go back to a level of around 3.5%, maybe a little bit more, which is, you know, the usual level of the pace of growth of the Israeli economy. When we come back to normal, I would expect that Bank Leumi will be able to grow around 10% a year, maybe a little bit more. This will be more or less the pace of growth that I can predict at this stage. Now, regarding the credit loss expenses, as I mentioned, we built in the last 2.5 years, very strong credit provision.
We increased the credit provision by ILS 1.5 billion, which is around 50%. I would say that we built quite a conservative credit provision, which enables the bank to handle any eventualities that might arise. Having said that, I don't think that it's reasonable that the banking industry in Israel will continue to operate in a very low credit loss expenses ratio. At the end, we will come back to a level which will be as the way pre-COVID and even higher because of the implementation of the CECL method. It will be gradually, but at the end we will be there. We cannot preserve any of the bank in Israel, I believe, a credit loss expense ratio, which is around zero or 10 basis points is not natural.
I expect that gradually we start come back to the level as it was pre-COVID and even higher.
Thanks, that's good color. I guess last one for me with regards to expenses. When you look at them on a pro forma basis, they were still down compared to a year ago. As you mentioned in the past, your efficiency plans with the decreasing number of employees and the real estate optimization. Again, I know you don't provide guidance, but I guess thinking ahead next 12 months, how should we think of the upcoming further declines in the level of expenses?
Okay. I will say like that. First, as you mentioned, we were able to decrease our expenses compared to last year by around 3.4%. The decrease was in salary expenses as well as in the other expenses. Now, since we are increasing our activity significantly, I will be happy if we will maintain our expenses more or less at the same level. I don't know if we will be able again to continue to increase our income and decrease our expenses. I do believe that we will be able to maintain our expenses more or less at the same level, and I will explain why.
On the one end, there are pressure of, you know, CPI issue which increase the cost, all the side effect of the Ukraine and Russian war, a war which increasing expenses in different areas. Technology costs, which increase expenses. All of these push the expenses up. On the other end, we are taking different measures to balance this increase. You mentioned the drop in our employee numbers. In the last few years, we were able to decrease our employee numbers by hundreds of employees every year. This trend is not going to change because the more technology we are, the more efficient we are. So also we are in a process of moving to our headquarters from the center of Tel Aviv near the airport, which will also save costs.
We move to a hybrid work model in which every day, 20% of the employees are working remotely. This will also contribute to reduce costs. When I look at the overall picture, I think that we have the ability to keep the expenses in the end more or less at the same level with a significant continuing increase in our income.
Great. Thank you. I'll get back to the queue.
Thank you.
The next question is from Michael Klahr of Sagot. Please go ahead.
Hi, good afternoon. First of all, congratulations on a stellar quarter and an amazing first half. A couple of questions. When I compare the pro forma Q1 and Q2 net interest income, and I try to derive the impact of the rising interest rate, I get to a number that is somewhere between ILS 100 million and ILS 150 million. Does that seem to be correct for quarter one?
Hi, Michael Klahr. Good afternoon. First, I would say it's very hard to take out of the picture the impact of the increase in interest rates because, in the end, the net interest income is composed of many parameters. The vast majority of them is, first, the interest in the credit portfolio, secondly, the CPI, and thirdly, is the net. Sorry, the net interest income, and four, the foreign exchange. There are a mix of parameters that affect the net interest income, and it's very hard to figure out just the effect of the interest rate.
I would also say that, as long as the time will pass, this effect will be higher, not only because the interest rate will continue to increase, but also because there will be more and more loans that will come to a point in which we will update the interest rate because the interest rates increase. Now we just start to see the impact of the interest rates. Going back to your original question, we don't disclose it and I cannot refer to it. I'm just saying that it's very hard to separate it from the other components.
Okay, thank you for that. Another question, I mean, you mentioned in presentation that your coverage, your loan loss coverage ratio was very high, and you mentioned that you boosted your provisions during the corona year. I'm just wondering, I mean, compared to some of your local banks, do you have a lot more potential for provisions to be released in the coming quarters, years, or is it something that has already been used for other purposes?
With your permission, I will relate to Leumi. I don't want to relate to other banks. Regarding Leumi, as I pointed out, we build the provision in a way that it is a conservative provision. It's a conservative provision, this is also the instruction of the Bank of Israel to build the provision in a conservative way. When we look at the different scenario and the way we build it, we believe that because it's conservative, so even though a different scenario may develop in the future, due to the fact and due to the conservative way that we built it, we have the ability to cope with any eventuality that might arise.
As a matter of fact, this is the basic idea behind the CECL method that we implemented at the beginning of the year. The CECL method tries to build the provision in a way that when bad things happen, so we have already the provision for them. This is the basic idea behind the system. This is one of the basic rationales behind this system. In the bottom line, we feel that we are in a position in which we have a quite conservative provision also for negative scenarios that might arise in the future.
Okay, thank you very much for that. Another question regarding credit quality. I noticed that your total problematic debt went up by around 12% over the quarter. Is that indicative of any deterioration in asset quality, or is it something technical? How should we read that?
Michael, I missed you. What is exactly the 12% that you mentioned?
The problematic debt.
Okay. Let me just look at the figure. There is nothing special in this period, the problematic debt. Let me just see.
6,061 in Q2 versus five-
Let me see. I'm not aware of something significant. The only thing I can say that happened in the first half and in the second quarter, as I mentioned earlier, is that we are coming back to a more, let's say reasonable, world and condition. I mean, for example, in our secured retail, the delinquency in payment, which was very low in the last two years, start coming back gradually to a level that it was pre-COVID because people spend more and business spend more. In the COVID period, you know, people put the money and didn't waste it. We see a trend in which gradually the world coming back to be more reasonable world as it was pre-COVID.
This is the only issue that we see in the problematic debts and nothing further.
Very clear. Thank you for that. Now, when I compare the performance numbers on fees between Q1 and Q2, I see numbers went slightly down. Is there something happening there? Is it because of the, you know, the sale of Bank Leumi USA that you also lose local fees or something else, or is it just the seasonality?
You compare the fees for the second quarter to the first quarter? It's the same number.
Yes.
It's the same number. It's almost the same number. It's
A small drop. Most other banks-
It's 882 to 872. It's the same number, Michael Klahr. The difference is ILS 10 million. It's nothing.
Okay.
It's the same number.
Okay. Thank you. The drop in other expenses in the quarter?
The drop in other expenses, You mean compared to the first quarter?
Yes. ILS 30 million, approximately.
Okay. The drop is mainly in other expenses as a result of reducing maintenance costs and depreciation costs. This was the main driver for decreasing in costs, yeah, in the second quarter compared to the first quarter.
Okay, great. That's sustainable over the next couple quarters as well.
I suppose it will be sustainable, yes.
Okay. Thank you for that. Now a little more general question. You know, you mentioned at the beginning of your presentation, the strong GDP numbers that came out, earlier today. You know, I was just wondering what your current outlook is for, you know, the growth in Israel and for the next couple of years and, rates and, inflation as those are relatively relevant for the bank, I think. Thank you very much.
Yeah.
Thank you. Hi, Omer. It's Gil Bufman here. Yes, the Central Bureau of Statistics came out earlier with updated revised figures. Before we get into the Q2 figures, it's worth noting that the growth numbers for 2020 and 2021 were revised upwards. The decline in 2020 was even smaller than it was to begin with, a decline of only 1.9%. That's the year of the outbreak of the pandemic. Then in 2021, the number that we had previously was 8.2% growth. It's now 8.6%.
All in all, if you look at the level of GDP in the second quarter of 2022, you compare that to the fourth quarter of 2019, the last quarter before the pandemic, you have more than 12% growth in real terms. That's about annualized, that's about 5% per year on average, with the pandemic period in that. It's great economic growth. I think it has a lot to show as far as the strong fundamentals of Israel, the resilience of the economy, and the ability to continue and grow even when faced with substantial difficulties. As Omer mentioned, we have 6.8% growth annualized in the second quarter. Looking at these numbers and their breakdown.
First of all, it's pretty widespread growth. It's not just one sector or one item that is pulling it all. It's widespread growth. Our updated forecast for 2022 is easily 6% growth, possibly more than that. The Bank of Israel in their forecast of July fourth was 5%. When they take into account the latest figures, my guess is that they'll be updating as well. Even when taking into account the slowdown in global economic activity, I believe that the numbers for next year's growth, 2023, are somewhere in the area of around 3.5% or so. Overall, the numbers are quite good in terms of growth. Inflation, we did have a surprise with yesterday's CPI figure, 1.1% surprised the market in general.
We are looking for inflation this year ending up at about 5%. We are looking for a decline in inflation back to within the inflation target range next year to about the pinpoint number is 2.4%. Given the strong growth and the ongoing price increases, it looks like the Bank of Israel is going to continue to tighten. The Bank of Israel was very clear that they want to take advantage of the strength of the economy, the ability of the economy to handle higher interest rates, so I think they're going to move ahead. In addition, the Bank of Israel has spoken many times recently about the need to front-load the interest rate increases.
I think that the increase of the interest rate to where what they had targeted previously, 2.75%, I think that's gonna happen quite quickly over the next few months. By late this year, early next year, I think that they're gonna be more or less in that area of 2.50%-2.75%. That's pretty much where things are going to be. It's a pretty good economic picture, much better than most other countries in the world. Rapid growth, resilience, broad base. Of course, that goes hand in hand with ongoing demand for credit, financial activity, banking services, things like that. It all goes hand in hand.
Thank you very much. Omer, great and a great quarter.
Thank you. Thank you, Micheal.
The next question is from Danit Gini of Excellence. Please go ahead.
Hi, good afternoon. Thanks. Thank you for the presentation. I have three questions about the quarter. What credit growth do you expecting for second half of the year? The second question is, what is happening to the non-mortgage spreads? Are you seeing any impact in the provision from weakened economy?
Can you repeat about the second question? I missed it.
The second?
Yeah.
What is happening to the non-mortgage spreads?
Please.
The non-mortgage spreads. Non-mortgage fees.
We don't.
The non-mortgage portfolio within real estate, is that what you were saying?
Mortgage margin.
Margin.
Margin.
Margin.
Yeah. Thank you.
As for your first question, I cannot go into specific number in this discussion, of course. I can say that I expect due to the increase in the interest rate, and due to, I would say, a little bit cool down in the demand for loans in different areas, that the pace of growth in the second half of the year will not be as strong as in the first half. There is still a good demand outside, but I don't expect that the pace of growth will be as strong as it was in the first quarter. Now, regarding the margin in the mortgage portfolio, of course, there is a strong competition there.
The margin is more or less at the same level. This is also mainly due to, of course, the increase in the interest rate and to the CPI. There is a significant portion of the mortgages which are linked to the CPI due to the significant increase in the CPI, so they push the margin up. Overall, I will say that on the one end, there is competition that push the margin down. On the other end, there is the interest rate increase, there is the CPI. Overall, there is nothing material there at this stage, at least.
Regarding the macroeconomic environment and its effect on the provision, it's one of the parameters that, based on that, we build our credit provision. Of course, the expectation in the second quarter, let's say, there were more clouds in the second quarter than there were in the previous quarter. As Gil pointed out, we believe that the macroeconomic situation in Israel is strong. We believe the Israeli economy is strong. Almost all the parameters present a very strong performance. It has effect on the provision, but Israel is.
I believe different in its position for most of the other countries in which the macroeconomic parameters are not as strong as in the Israeli economy. In the presentation, in the first slide, there is even a comparison of the GDP pace of growth to the other economy. You can see that in the last three years, the pace of growth in the Israeli economy is much higher than all of the countries that are presented there.
Okay, thanks a lot.
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 are no further questions at this time. This concludes Leumi's second quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.