Earnings Call: Q1 2022

May 24, 2022

Summary

Q1 net profit reached ILS 1.154bn, or ILS 875m excluding the ILS 279m real estate gain; adjusted ROE was 16.6%. Strong credit growth and merger synergies support prospects, while capital-rule uncertainty and competitive pressure remain.

Ladies and gentlemen, thank you for standing by. Welcome to the Mizrahi Tefahot Bank Ltd. First Quarter 2022 Business 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 May 24, 2022. With us on the line today are Mr. Adi Shachaf, CFO, and Mr. Meno Aviv, Chief Accountant. We would like to draw your attention to slide number 1 of the financial statement for the first 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 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 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 provision of regulators, competitors' behavior, the status of the bank's perception, technological developments, and human resources developments. Mr. Shachaf, would you like to begin? Thank you very much. Good afternoon, everybody, and welcome to our Q1 analyst call. As you saw, results for the quarter were quite robust, and I would like to use this call to highlight a couple of points. Before we start, maybe one word on the macroeconomic environment. We've seen a decline in unemployment with a forecast of further improvement for the year. Forecast for 2022 GDP growth is around 5.5%, and one-year inflation expectations from OTC markets is around 3.15%. Bank of Israel rate went up by 0.4% to 0.75%. We saw an increase in actual inflation in Israel and even more so in the U.S., and we also saw an increase in residential property prices, which is not reflected in the CPI. As for the recent development in Ukraine, it is hard to predict the way this conflict will develop, but we are closely monitoring the market. As for our Q1 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 2021, 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 provisions of 2021. We think that our credit metrics reflect a balanced credit portfolio with adequate risk management. We have continued to see in Q1 a very strong demand for mortgages, with future rate hikes potentially down the road. Expected inflation environment should also be beneficial for the bank, as we are naturally long inflation. As for CECL effect, you can see that there is no drama in the figures, with the high-quality mortgage portfolio benefiting from the new regime and balancing to some extent the effects of the commercial non-mortgage credit. I think that the credit portfolio in the Israeli banking sector as a whole, and for sure our own credit portfolio, are of high quality, and in that respect, the transition to CECL should be relatively smooth. The net profit and the net return on equity reflect the strong balance sheet, the good efficiency ratio, and the contribution of Union Bank to our result. The merger is advancing as planned. We already started the migration of branches, and of course, most of the cost synergies are still ahead of us, with full effect starting 2023. We have booked a one-off ILS 279 million net profit from the sale of real estate assets, which brought our cost-income ratio to 43.2%. Excluding this item, our cost-income ratio is 48.8%, 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. We see a continuous growth in mortgages with real demand coming from real people who want to buy an apartment. The year 2022 started similar to the 2021 average. Financing revenues from current operations continue to grow. You can see that from Q3 2020, financing revenues from current operations follow a positive and relative very consistent trend quarter by quarter. On the expense side, after the increase in Q4 2021, which can be mainly attributed to variable remuneration, you can see that we are back to the path of our strategic plan. Liquidity is also 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, let's call it boring, usual growth in mortgages, we have witnessed an accelerated growth of 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've seen a similar growth of approximately ILS 12 billion just in the first quarter. We think that the last couple of months present a unique opportunity to gain market share with decent margin. That is the main reason why we've decided not to distribute dividend for this quarter. As you can see, our Tier 1 capital is 10.01%. Bearing in mind the draft regulation on excess capital allocation on 75% class LTV development loans that can potentially require for retroactive allocation of capital, we think it is in the best interest of our stakeholders that the bank will hold sufficient capital levels that enable us to continue the momentum of credit growth. This should help us to create extra profitability for the coming years. All in all, I think we are following our strategic plan, and like always, the balance sheet growth of this quarter will contribute to the profitability of future quarters. To conclude, we think that after excluding the one-time capital gains, we are today a bigger and more profitable bank than we were just a couple of years ago before COVID. The merger with Union Bank, the continuous mortgage growth, the business credit growth, the improved cost-income ratio, and the new monetary environment with higher level of rates and inflation all work to the same direction of potential improved profitability and ROE compared to the pre-COVID business and monetary environment. Thank you very much for your attention. With that, I leave you with the hands of Mr. Menahem Aviv, our Chief Accountant. Thank you, Mr. Shachaf. The main figures that included in the financial statements are as follows. Net profit in Q1 2022 reached ILS 1 billion 154 million compared with ILS 676 million in the same period last year. Excluding the effect of the capital gain from sales of assets, it reached ILS 875 million. Return on equity in Q1 2022 reached 21.9%, and excluding the effect of capital gains, it reached 16.6%. The equity amounted ILS 21.2 billion. Total revenues in Q1 2022 reached ILS 3 billion 213 million. Financial revenues from current operations in Q1 2022 reached ILS 1 billion 815 million. The ratio of provision to loans in Q1 2022 reached 0.011%. Operating and other expenses in Q1 totaled ILS 1 billion 388 million. The cost-income ratio reached 43.2%, and excluding the effect of capital gains, reached 48.8%. Ratio of Tier 1 capital to risk elements reached 10.01%, and the total ratio reached 13.40%. That's it. We can go now for a Q&A. Thank you. Ladies and gentlemen, at this time, we will begin the question and answer session. If you have a question, please press star 1. If you wish to cancel your request, please press star 2. 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 question. Just a quick one, maintenance one on my end. Can you remind us if your long-term ROE target factor in any rate hike, or they were actually assuming still the 10 basis points base rate that we had when you announced the plan originally? In our strategic plan, as you were mentioning, targets have assumed, for the sake of the strategic plan, a constant rate of 0.1%, and it did not include any assumption for rate hikes. So probably, it could be better. Right. Yeah, that was going to be my follow-on. Is it fair to assume that the rate hikes will benefit your bottom line substantially, so I guess, does it pay for you guys to kind of update the target, to kind of tell the market where you think you can be? Currently, we stick with our strategic plan. We assume a target for 14% return on equity steady state by 2025. It is true that we are higher now, but as for now, this is still the strategic plan. We are not giving a forward guidance. It is true that if inflationary environment and further rate hikes are usually beneficial for banks in Israel, and for us especially. Thanks for that. I guess just a broader question on the outlook. When you factor in some macro headwinds, the rising rates, do you see on one hand the risk that loan growth might decelerate in the foreseeable future? I guess, same questions for the provisions. Shall we expect them to pick up as a result of the macro and the higher rate? I think the right way to look at it is maybe to smooth or average out the pace of growth. As we are saying, we've seen an accelerated growth rate in the last couple of months due to opportunities in the market. in 2021, for example, the non-mortgage portfolio grew less. So if you average it out, even though it's not smooth, but on the average, it maybe reflects more. This is not a perpetual pace of growth. As for the margin, as I was saying, we came back. Not margin, sorry, provisions. We came back for more normal territory. I think the best benchmark should be, again, it's not precise, but looking at pre-COVID figures of 2019, because 2020, we saw over-provisions, and in 2021, we saw under-provisions because some of the over-provisions came back. Maybe the last time we saw, we used to, if there is such a thing as a normal environment, and in 2019 should be it. Great. Thank you for that. I will go back to the queue. The next question is from Micha Goldberg of Psagot. Please go ahead. Hi, good afternoon. First of all, congratulations on a very strong quarter. A couple of questions. I noticed that Mizrahi is really the only bank in Q1 that has positive provisions. I am just wondering what explanation is that. I mean, you used to have or claim that you have the highest quality of credit. It just stands out, and I was wondering, is that because you are more conservative, more provisions are likely to recover in the future quarters? Why is that? It is outstanding that you guys are significantly higher than all the other ones, which is not your natural position. It's Menno. If you go to the results of the other banks, you can see that most of the provisions or unprovision made come from a recovery that they made in the first quarter. It's not for the regular provision, so I don't think it will happen on regular basis, and we are not different from them. The reason why we usually, and we think we still are, more solid in that respect is because the composition of our portfolio, which is more tilted toward mortgages, have lower provisions. If you factor it with a higher weight, then on the average, it gives us usually a better result. This is for the long run, I think the right way to look at it. Okay, thank you. I was just wondering, I mean, you're right, it seems like there were a lot of recoveries at the other banks. I seem to remember that during the last couple of years, you guys also made significant provisions on the mortgage book, pretty much on the back of the COVID. Is that totally cleaned out and there's nothing there to be recovered, or future tell? We cannot predict what will be the next quarters. As I said, in the other banks, as I see it's one time that it happened in this quarter, and they had some major recoveries from big clients. Okay, thank you. Now, on that same point, I noticed that under the new CECL regulation, the non-performing loans seem to go up slightly in the quarter. They seem to be very fluctuating over the last couple quarters as you guys provide that data. I was just wondering, are you indeed seeing any kind of deterioration, or is it just technical that is up and down? It looks more technical if you are talking about the NPLs quarter figures that we have published. Yes. Yeah. You see the difference between quarter to quarter, if I remember right, it is 1.13 in one quarter, 1.07 in another, 1.06, 1.23, and the annual was 0.98, I think, if I remember right. Basically, it is more technical. We haven't seen any material change to these kind of figures. Okay. A question about margins. It seems to me that when you neutralize the CPI impact, that your margins are slightly contracting. I am just wondering, is that the case, or is that also something that is not really representative of what is currently going on? The profits of this quarter are basically more reflected or almost totally reflected from the balance sheet of the end of 2021. If you remember, there we saw some contraction, relatively minor, but still a contraction in the margins of mortgages. Do not know what will happen in the future, assuming rates are going up and will go up. Anyone can make his own inferences where should it be. Okay, thank you. The last question about the fact you stopped dividends for this quarter. I am just wondering, A, it looks like your risk-weighted asset density is slightly higher than some of the other banks. I am just wondering, is there something you could do to try to improve that? Two, are you more exposed than the other banks to what you mentioned, the Bank of Israel draft regarding capital requirements, or is it just a pure conservative issue that you are currently stopping your dividend payment? I do not know. Of course, I do not know exactly what happens in the other banks. I can assume that we would not be the one that impacted the most. But again, it is an assumption. I do not really know the figures of each bank. Yes, there is some conservatism there, and the main reason was to give us the ability to capture the opportunity that we think will not last much longer to increase our market share with decent margins that meet our ROE targets. Okay, thank you very much. My final question is, when do you expect merger savings from Igud to start filtering in? Thank you very much. True, very good point. In Q1, the results we have just published, the cost synergy side of Union Bank are not really material. They will be gradual towards the end of 2022, end of the year, and it will be actually fully materialized commencing 2023. Yes, you are right. The numbers are not yet including the cost synergies positive from the Union Bank merger. Thank you. Have you given guidance to what generally the impact could be on your bottom line, or is that something that needs to be calculated? It needs to be calculated, unfortunately. Alrighty, thank you very much. Thanks. The next question is from Michael Klahr of Excellence. Please go ahead. Hi, good afternoon. Most of my questions have been answered. I just want to ask about margins in the mortgage segment. Obviously, there's been a lot very strong growth ahead of the rate rises and also a lot of competition from some of your competitors. I just wanted to understand where are you in terms of pricing? I remember you used to be priced at a premium to your competitors. I think, if I remember rightly, it was about 20 basis points. Do you still have that premium? Have you been dropping price? What's going on there generally in terms of pricing with all the competition? Thank you. We're not allowed to discuss relative prices, and we don't have all the data, and for sure, we're not giving forward guidance on prices. Usually, as a strategy, probably the best way to look at it is the constant return on equity. We try to, in all areas, not just mortgages, to receive the appropriate margin that reflects in our ROE targets. But of course, we are part of the market. The market is very competitive, and we deal with this competition. Can you tell me generally about spreads, whether spreads are contracting or increasing, or if you give us any color around that? What's been going on over the last 3-6 months with all this additional growth? It's hard to say exactly. It varies, but we saw, as I was saying before, a slight reduction in margins in 2021. Further on, it depends mainly on the rate hikes pace. Okay. All right. Thank you. Willie, do you provide on the question of capital and the Bank of Israel draft, can you give us any kind of sensitivity or any indication on the potential? I know it's unclear whether it's going to be front-loaded or exactly what it's going to be, or how it's going to look, or whether you're going to have to do it historically as well. But can you give us a sense of the magnitude, or some sort of range in terms of the potential hit to capital that could come about from this measure? Unfortunately, since it's a draft, we cannot predict exactly, and we do not give exact figures because we don't always have the exact figure. But once this will materialize to be a final resolution, of course, we will publish what needs to be published. We would not violate in that respect the regulatory regime. Okay. Do you have any indication on timing? Do you have any idea about timing or? No, that's totally with the regulator hands. Whenever Bank of Israel will decide, it will be public. Great. Thank you. Thank you very much. Thank you. There are no further questions at this time. This concludes the Mizrahi Tefahot Bank Ltd. First Quarter 2022 Business Results Conference Call. Thank you for your participation. You may go ahead and disconnect.