Earnings Call: Q2 2022

Aug 15, 2022

Summary

Q2 net profit reached ILS 1.053B, supported by balance-sheet expansion and strong financing revenues. Credit growth is expected to moderate as rates rise, while management reported no unusual asset-quality deterioration.

Ladies and gentlemen, thank you for standing by. Welcome to the Mizrahi Tefahot Bank Ltd. Second Quarter 2022 Business Results Conference Call. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for the question-and-answer session. For operator assistance during the conference, please press star zero. As a reminder, this conference is being recorded August 15th, 2022. With us on the line today are Mr. Adi Shachaf, CFO, and Mr. Menahem Aviv, Chief Accountant. We would like to draw your attention to slide number 1 of the financial statement for the second quarter 2022 presentation, which includes general comments regarding legal responsibility, including that the information contained in the presentation constitutes information from the bank's 2022 quarterly reports and/or immediate reports, as well as the periodic quarterly and annual reports and/or immediate reports published by the bank in previous years. Accordingly, the information contained in the presentation is only partial, is non-exhaustive, and does not include the full details regarding the bank and its operations, or regarding the risk factors involved in its activity, and certainly does not replace the information included in the periodic annual and/or quarterly or immediate reports published by the bank. In order to receive the full picture regarding the bank's 2022 quarterly reports, the aforesaid reports should be pursued fully as published to the public. The bank's results in practice may be significantly different from those included in the forecasting information as a result of a large number of factors, including, inter alia, changes in the domestic and global equity markets, macroeconomic changes, geopolitical changes, legislation and regulation changes, and other changes that are not under the bank's control, which may lead to the estimations not realizing and/or to changes in the business plans. The forecasting information may change subject to risks and uncertainty due to being based on the management's estimations regarding future events, which include, inter alia, global and local economic development forecasts, particularly regarding the economic situation in the market, including the effect of macroeconomic and geopolitical conditions, expectations for changes and developments in the currency and equity markets, forecasts related to other various factors affecting exposure to financial risks, forecasts with respect to changes to borrowers' financial strength, public preferences, changes in legislation, and the provisions of regulators, competitors' behavior, the status of the bank's perception, technological developments, and human resource developments. Mr. Shachaf, would you like to begin? Thank you very much. Welcome to the Mizrahi Tefahot second quarter analyst call. As you saw, results for the quarter were robust, and I would like to use this call to highlight a couple of points. Maybe before we start, one word on the macroeconomic environment. We've seen a solid Israeli economy with low unemployment rates. Forecasts for the 2022 GDP growth are around 5%. We saw an increase in actual inflation in Israel, and even more so in the U.S. Nevertheless, one-year inflation expectation from OTC market went down since our last call from around 3.15% to around the 2.70%, and the Bank of Israel rate went up to 1.25%. As for our Q2 results, we have seen an increase in all major balance sheet items. We have seen strong financing revenues growth, which reflects the balance sheet growth in the previous quarter, and for the most part, does not include the accelerated credit growth of the last months. Provisions came back to a more normal territory, although still on the low side after the negative provision of 2021. We think that our credit metrics reflect a balanced credit portfolio with adequate risk management. To the most part, increasing provisions are coming from collective provisions due to the increase in the credit portfolio. We have continued to see in Q2 a very strong demand for mortgages. However, total mortgages in the market went down from approximately ILS 12 billion in June to approximately ILS 10 billion in July. The net profit and the return on equity reflects the strong balance sheet, the high CPI figures in the quarter, the good efficiency ratio, and the contribution of Union Bank to our results. As for the merger, it is advancing as planned and is expected to be completed by year-end. We already closed the majority of the branches, and of course, most of the cost synergies are still ahead of us with full effect starting 2023. Our cost-income ratio for the quarter is 45%, and I remind you that our cost-income ratio target, as published in our strategic plan, is to be below 50% by the end of the plan in 2025. Financing revenues from current operations continue to grow. You can see that from Q3 2020, financing revenues from current operations follow a positive and consistent trend quarter by quarter. On the expense side, increase in salaries is also affected from variable remuneration. Liquidity is very robust with core deposits around 67% of all deposits, and total deposits continue to grow. As for the credit growth, we can clearly see that besides the growth in mortgages, we have witnessed an accelerated growth also in our corporate credit portfolio. If in the years 2015 to 2020, we saw an average annual increase in the total credit portfolio, both mortgages and corporate, of approximately ILS 12 billion, we have seen a growth of approximately ILS 15 billion just in the second quarter, and ILS 27 billion for the full first half of the year. We think that the last couple of months presented a unique opportunity to gain market share with decent margins. We still see a demand for credit, although in a decreasing pace, and that is the main reason why we feel comfortable to distribute a dividend of 30% of our profit for this quarter. As you can see, our Q1 capital is 10%. All in all, I think we are following our strategic plan and accommodating to the new monetary environment. Thank you very much for your attention, and with that, I leave you with the hands of Mr. Meno Aviv, our Chief Accountant. Thank you, Mr. Shahaf. The main figures of our financial statement for Q2 2022 are as follows. Net profit in Q2 2022 reached ILS 1 billion and 53 million, and net profit in the first half 2022 reached ILS 2 billion 207 million. Return on equity in Q2 reached 19.4%. In H1, reached 20.6%. The equity amounted ILS 22.2 billion. Cost-income ratio reached in Q2 2022 to 45%. Financial revenues from current operations in Q2 reached ILS 2 billion 53 million. Total revenues in Q2 2022 reached ILS 3 billion 203 million. Operating and other expenses in Q2 reached total to ILS 1 billion 442 million. The ratio of provisions to loans in Q2 reached 0.14%, and ratio of Tier 1 reached 10%, and the total ratio reached 13.38%. Mr. Shachaf, I think we can go to Q&A now. 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 poll for your questions. The first question is from Tavy Rosner of Barclays. Please go ahead. Hi, good afternoon. Thanks for taking my questions, and thanks for the presentation. I wanted to discuss the operating assumptions going forward with the environment you described, rising rates alongside some macro headwinds. When we think about the second half of the year and even 2023, obviously, you do not provide guidance, but I am trying to understand how you see the kind of loan growth that is sustainable under both higher rates and macro headwinds, and perhaps at the same time, where do you see provisions kind of normalizing in this environment? As you were saying, we do not provide forward guidance, but I did mention, for example, that we saw in July a decrease in the entire market for the demand for mortgages, for example. It went down from ILS 12 billion in June to approximately ILS 10 billion in July. You can assume that this pace of credit growth is not perpetual and is not steady state. It is reasonable to assume that with higher rates, credit growth in the next quarter would probably not be as high as it was in the first six months, and especially in this quarter. Right. With regards to credit quality, as rates increase, they tend to put some pressure into some of your end markets. I'm just wondering how you see things through this cycle. So far, as I was saying, the increase in the provision was mainly for collective provisions due to the increase in the portfolio. I think the last year pre-COVID was 2019, because 2020 was maybe higher than usual, not maybe, and 2021 was lower than usual because of the negative provisioning. But so far, we don't see anything material specific is coming, but we are monitoring and underwriting as prudent as we can. Great. Thank you. I will go back to the queue. The next question is from Micha Goldberg of Psagot. Please go ahead. Hi, good afternoon. Congratulations on an excellent quarter. A couple questions. First of all, just a follow-up on Tavy's question. I mean, NPLs seem to have gone up this quarter. There were some other banks that reported similar kind of trends. I mean, are we now in an upward trend of NPLs? Is this something purely technical? I mean, cost of risk is going up slightly in the last couple of quarters. So, I mean, are we seeing deterioration in the asset quality, or is this just a technical thing? As I was saying, there are some technical things about it, of course. Again, 2021 should be looked at together with 2020 because it was not representative due to the post-COVID provisioning. I think we are getting to more normal territories. Again, the last, let's call it full normal year, which has nothing to do with COVID, was 2019. So we can look there to see maybe a base for something which is non-COVID related. Are you seeing some deterioration in asset quality or not really? We haven't seen so far any unusual deterioration. Okay, thank you. You mentioned the Union merger, which you said is going to be completed at a time somewhere at the end of the year, but most of the merger synergies are not yet incorporated. I was just wondering, could you try and specify what most of those items would be and how significant they are likely to be in 2023? I'll try. Basically, there are three main pillars of expenses for every bank. One is the salaries, the second one is the real estate, stemming mainly from the main building and the branches, or rent, depends. The third one, of course, is the IT expenditure. Union Bank does not have an independent IT system. It purchases the IT services from Bank Leumi. In that respect, we haven't seen any synergies because we will start to see them only in 2023. As for the headcount, some of the employees have already left, but still a lot of them are expected to leave gradually from now to the end of the year, and maybe small amounts a couple of months later. Then, all in all, again, the full cost saving from the headcount is expected also in 2023. As for the real estate, we closed most of the branches that are supposed to be closed, but still, it is gradual over the years. This is also will be with full materialization in 2023. I think we summarized the main three pockets of expenses for Union Bank. Thank you. Have you published any guidance or any expectations of what the actual saving would contribute to return on equity? No, but Union Bank's reports are, of course, public, so you can all see there roughly what are the expenditures, and if you get reasonable assumptions, you can get a clue to the area. Okay, thank you. I noticed in the quarter that the other expenses went up quite significantly. Is there anything one time in that in the quarter, or is this something that we should be ongoing? No. We had a one-off capital gain in Q1 from the real estate sale, but this quarter there was nothing very material. Inflation in the quarter was 2%. Again, I cannot project future inflation, but it was higher than the previous quarters. But on the cost side, there was nothing one time. The numbers that are currently are reflective and representative of future quarters as well? There was nothing specific to explain the hike in cost? Yeah, there was an increase in salaries. A lot of it came from variable remuneration because return on equity was high in the quarter. But other than that, nothing extra special. Okay. Another question. The new accounting principles and regulatory requirements for capital, the SA-CCR and the Bank of Israel regarding land financing, will that hurt your Tier 1 capital in Q3? The effect of these two regulations is taking care of planning. We try to take the necessary steps to accommodate it, to optimize what has to be optimized. And of course, we will allocate as the regulations say, but we considered it when we took all our decisions, also the dividend. Okay. Thank you very much. The next question is from Konstantin Rozantsev. Please go ahead. Yes. Congratulations on the results, and thanks a lot for taking my questions. The questions are kind of resembling a bit the ones asked earlier, but I just wanted to get a bit more color and details from you on these areas. In terms of the loan quality and loan quality outlook for the bank, I just wanted to get your view. How do you see higher rates and high inflation impacting the loan quality overall in the upcoming periods, in the second half of this year and into the next year? I guess the overall concern is that Israel as an economy has been operating at next to zero rates for an extended period of time, and they are increasing quite drastically right now. Are you concerned a lot about the loan quality developments in the next couple of years? If you could please provide maybe some outlook for some numerical estimates for the cost of risk, for the provisioning rates for the second half of this year and next year too. The second quick question, could you please comment briefly on the Do you expect any activity in the Eurobonds market space in the near term, in the seniors or subs? If you could please share some color there too. Thank you. Sure. I will start with the second question. Of course, we cannot know when and if we will tap or approach market. We always consider all funding possibilities. Our first endeavor there was the international CoCo that we issued in 2021, but we cannot tell. Of course, it also depends on the market conditions. As for the first question regarding loan quality, I think the biggest business in loans we have is, of course, the Israeli mortgage, which is very solid and robust as we see it. At the end of the day, these are real people that buy real apartments in Israel. As I was mentioning before, we did see in July, in this month, a decrease in the demand for mortgages. Probably some of it can be attributed to the higher rate environment, but this is probably not the only factor influencing the demand. So far, as I was saying, we did not see anything in particular, but of course, we are always monitoring and asking hopefully the right questions as part of our underwriting process. Got it. Thanks a lot. Do you have any estimates for the provisioning rates in the next, say, like half a year, like 2023 as well? Is there some estimate for the provisioning levels for the entire loan portfolio? Unfortunately, we do not give such forward estimates. Okay, understood. Thanks a lot for the comments. Thank you. Thank you. There are no further questions at this time. This concludes the Mizrahi Tefahot Bank Ltd. Second Quarter 2022 Business Results Conference Call. Thank you for your participation. You may go ahead and disconnect.