Earnings Call: Q1 2024

May 20, 2024

Summary

Q1 ROE reached 14.6%, with CET1 of 12.11% supporting a 40% dividend payout. Credit quality remained strong, while war-related uncertainty, inflation pressures and sovereign downgrades cloud the outlook.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim first quarter of 2024 results conference call. For your convenience, this call will be accompanied by a PowerPoint presentation. May we suggest, if you have not yet done so, that you access the presentation on the bank's website, www.bankhapoalim.com, by clicking on Financial Information on the homepage, and then click on the First Quarter 2024 Report presentation. All participants are at 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 May 20th, 2024. With us on the line today are Mr. Ram Gev, CFO, Mr. Victor Bahar, Chief Economist, and Ms. Tamar Koblenz, Head of Investor Relations. I would like to remind everyone that forward-looking statements for the respected 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. Mr. Gev, would you like to begin? Thank you, and good afternoon to you all. I will briefly review the financial results. Bank Hapoalim delivered yet another strong quarter, in which we not only present high profitability, but also continue to demonstrate our high preparedness for different macroeconomic scenarios. Let's turn to slide 3 for the highlights of the quarter. The bank ended the quarter with 14.6% return on equity, marking nine quarters in a row in which we delivered impressive double-digit return on equity. The CET1 ratio stood at 12.11%. Due to the high capital buffer, we announced a 40% dividend payout ratio according to our policy. This is, of course, in line with Bank of Israel guidelines. What also continues to stand out in our results is the high quality of the book, with the NPL ratio staying below 1% and our strong buffer of 1.87% allowance to credit. These two factors, the quality of the book coupled with the reserve we have built at the right time in recent quarters, are the reason for our ability to decrease the collective provision this quarter. This, along with a very low level of individual provision, resulted in a near zero loss provision. The cost income ratio continued to be strong with the ratio below 40%. Finally, we grew our credit book by 1% this quarter. Taking into account that in the current period, there is tremendous importance to the changes in the macroeconomic environment, along with the strong fundamentals of the economy, we will now expand on the macroeconomy in greater detail. Moving to slide 4 to 7 for a discussion by our chief economist, Victor Bahar. Thanks, Ram. Although the war is still with us, its impact on the economy has decreased substantially in the first quarter as rocket attacks on the major cities ceased, and most of the reservists to the army were released. GDP grew by 14.1% annualized in the first quarter, after contracting by 21.7% in the previous quarter. However, the level of GDP is still lower than that of pre-war. The economy has suffered damages. Residents of the Gaza envelope and the northern border settlements have not yet returned to their home. The construction and tourism sectors are not working at 100% capacity. The recovery relies on a largest extent on government spending that has created a high deficit and therefore is not sustainable. On the positive side, the labor market is tight and the number of people absent from work declined to almost normal levels. Consequently, wages are rising at a pace that do not align with price stability. The increase in wages is across the board in terms of economic sectors, signaling that inflation environment is still elevated. The year-on-year inflation has declined in the first quarter, reflecting short-term impact of the war. However, we believe that the long-term effects of the war are actually inflationary. The Bank of Israel interest rate decreased at the beginning of the year to 4.5%. Just like in the U.S., expectations for further cuts has moderated, and now the markets imply not more than one cut for this year. The budget deficit increased to 7% of GDP in the last 12 months, mainly as a result of sharp increase in defense expenditures. Anyhow, as can be seen on slide 6, high fiscal deficits are quite common nowadays in many advanced economies. Assuming that the war will come to its end this year, next year's deficit is expected to decline to level which persists in many advanced economies. The level of debt is still lower than debt prevails in most advanced economies, and previous governments have usually managed to implement significant fiscal consolidation. Israel's credit rating was downgraded by Moody's and S&P. The rating actions were already priced in the market, and the risk premiums are still elevated at 150 basis points for 10 year. Lastly, the demand for credit declined, probably as a result of the war and the high interest rates. At the same time, the asset under management of institutional investors continued to increase, and local banks hold the high capital ratios. That led to a squeeze in credit spreads in the corporate bond market, as seen on slide 7. Back to you, Ron. Thank you, Victor. Please turn to slide 8. The message of this slide is the consistent high level of net income and return on equity we are presenting in recent years. It's important to mention that this quarter, return on equity was also impacted by the high capital surplus. A back-of-the-envelope calculation of a more representative level of capital will bring the return on equity to an even higher level. Another parameter affecting return on equity is the legislative amendment for the achievement of the state budget goals for 2024 in view of the war. According to this legislation, a special temporary tax will be imposed on Israeli banks, which in this quarter amounted to 4.5% add on over the regular tax payment. Moving to slide 9. This slide focuses on one of our main differentiators, which is our preparedness for various scenarios. On capital, we are reporting a CET1 ratio of 12.11%, roughly 180 basis points over the minimum regulatory requirement. This high buffer allowed for the resumption of our full dividend policy this quarter and will allow for future growth as opportunities arise, a potential for future increase of various capital distributions, and of course, keeping a buffer as long as the level of uncertainty is relatively high. On liquidity, we maintain strong LCR and NSFR well above regulatory targets, thanks to our stable over time retail deposit base. On slide 10, we continue to describe our level of preparedness. It is reflected in our decision to adjust the pace of our growth since 2022 to the economic environment and the level of demand in different segments, while not compromising the quality of our book. The NPL ratio remains at a relatively low level below 1%, while we built a substantial allowance buffer covering 175% of the NPL. It is this position that allowed us to decrease the collective allowance this quarter. We reached the current period with a solid allowance buffer, which was built over the last several quarters. In addition, some economic factors we took into account in the CECL model in previous quarters, such as the unemployment level, housing prices, and GDP growth, turned out better than anticipated. Lastly, individual provisions remain low. All of this led to an income of ILS 14 million from credit losses. Let's turn to slide 12 to discuss income. Although the interest rate decreased in January, total income was up 1.8% this quarter versus previous quarter. This was attributed to several factors. In financing income, inflation was higher, though relatively low. War related grants were lower than previous quarter, and the share of non-interest-bearing deposits has been stable at 28% for the last three quarters. In addition, fees grew nicely. Let's move to slide 13 and 14. We grew our credit book by 1% this quarter and by 4.3% in the last 12 months to ILS 411 billion. As we mentioned in our previous conference call and conversation with the market, we had already aligned our credit growth pace in 2022 and more so in 2023, when we identified the changes in the global and local economy. The pace of the growth also reflects the impact of macro dynamics on the demand for credit in each segment. Our deposit base, on slide 15, continued to grow with 60% of total deposits attributed to the retail segment. Retail deposits grew nicely by 1% this quarter and 4.7% in the last year. Our robust liquidity position demonstrated by the 137% LCR that allowed us to buy back ILS 1 billion in bonds. Following the successful transaction, the board approved a buyback framework of an additional ILS 2 billion to be potentially executed by the end of 2024. On costs in slide 16, total expenses increased versus the previous quarter, mainly as the fourth quarter salary and expenses were positively impacted by end of the year adjustments of performance-based bonuses. When comparing to the corresponding quarter, you need to take into account that the change in salary and related expenses is attributed to the wage agreement signed in 2023. The cost income ratio is below 40% due to the high level of income, while costs are under control. On slide 17, we present another important lever. As you know, we are in the process of building a new headquarters building, Poalim Center. The center is going to be best in class in terms of operational efficiency and employee experience and is well located on a primary transportation hub in Tel Aviv. For those of you who pass by the La Guardia interchange in Tel Aviv, you will notice that we are in the final stages of building the core, which is rising to 42 stories. In view of the exciting future move to Poalim Center, we will gradually sell our owned properties, some of which are currently undergoing a betterment plan and therefore incorporate future value. I continue with slide 18. Following the last few quarters in which we increased the collective allowance, we were able to slightly decrease it in the first quarter of 2024. As I mentioned before, macroeconomic assumptions used in the collective allowance model turned out better than expected as we view them today, which allowed the slight decrease in the collective allowance. In addition, the individual provision remained low, so that together with the automatic write-offs, we recorded ILS 14 million income from credit losses. In the next slide, we can see that although total problematic debt increased this quarter, the NPL layer stayed almost unchanged, as well as the NPL ratio. In the middle graph, we present a slight decrease in the collective allowance and therefore a slight decrease in total allowance, which still covers 175% of the NPL. On the right-hand side, you see that deferrals granted at the onset of the war are decreasing fast and a significant portion are back to payments as usual. Slide 20 shows another key strength of the bank, our high underwriting standards across the credit book. Here we focus on the real estate book and show that we are less exposed to the more risky layers. In land financing, only 7% of loans have LTV over 80%. In financing of completed properties, which are mainly commercial real estate and income-generating properties, only 3% have LTV over 80%. Lastly, real estate under construction is assessed by the stability of the project to absorb a price drop without incurring a loss. In this category, let's look at the up to 25% price drop segment. Only 1% of the projects in this category are at risk if prices drop by up to 25%. These figures reflect the advantage of Bank Hapoalim compared to its peers, especially when it comes to the level of risk of the credit portfolio. The next slide is on capital. The CET1 ratio increased to 12.11%, well above both internal and regulatory minimum targets. Our solid position derives from strong organic capital generation capabilities reflected in the 12.3% growth in shareholders' equity in the last 12 months. In addition to the solid CET1 ratio, both the total capital ratio and the leverage ratio are comfortably above minimum requirements. Bear in mind that in the second quarter of 2024, the common equity CET1 capital ratio will include the effect of Israel's sovereign rating downgrade by S&P, as disclosed in our report. On dividends, our robust position in capital allowed us to return to a full payout ratio according to our policy. So we declared a 40% dividend payout ratio in the amount of ILS 775 million. I will now summarize the key takeaways in slide 22. First quarter data reflect a rebound in economic activity after the initial shock. However, the level of uncertainty is still high. We are consistently delivering strong double-digit return on equity due to a high level of income coupled with cost control. We are presenting a best-in-class level of preparedness for various scenarios, thanks to capital liquidity and allowance buffer. The CET1 ratio is well above minimum targets and requirements, allowing us to resume a 40% dividend payout ratio according to policy. This quarter, we slightly reduced the collective provision as factors we took into account in the allowance model turned out better than anticipated. Lastly, as you probably know, our CEO, Dov Kotler, has informed the board of his intention to conclude his service. A search committee headed by the chairman of the board has already commenced its work, and the CEO will continue to serve in his position until a successor is named. With that said, let's open the call for your 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 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 polled in the order they are received. Please stand by while we poll for your questions. The first question is from Tavi Rosner of Barclays. Please go ahead. Tavi? Yeah, sorry. Can you guys hear me? Yeah. Now you are unmuted. Sorry. Thank you. Sorry for the background noise, and thanks for taking my question. I wanted to ask two questions, please. The first one is, how should we think of provisions for the remaining of the year, assuming there is no deterioration of the geopolitical situation? The second question would be around dividends. You talked about the increased payout to 40%, but that still leaves you with significant excess capital. Do you think the Bank of Israel would be willing to facilitate an increase of the payout or for you guys to reintroduce dividend buybacks or both of them in the future, or that would only happen once the war is over? Thank you. Hi, Tavi, and thank you for your questions. I will start with the first one. You asked about the provisioning and, let us say, next quarters, et cetera. I cannot relate to the next quarters. Obviously, it depends on the economic situation and the development of the war, the extent, the duration. But two elements can help you understand the position. First, we are now, and it is reflected in our provision and low credit losses for this quarter. Our position currently is very strong, with high buffers and adequate provision. We built the reserves on time and over the last quarters. So we are in a very good position, provision wise, looking forward, if the situation is not deteriorating. Obviously, if the situation is improving, we assume it will be reflected in the parameters within the CECL methodology, the input. It is reasonable to assume that if situation will be better than expected, that we will see recovery over the quarter in the future. We gave sensitivity data in our disclosure that can help you figure or calculate or assess the figures. We are using, under the CECL methodology, different scenarios and probability for each scenario. So we gave disclosure what will be, let us say, the outcome if we rely only on the most pessimistic scenario or if we rely or adopt only the optimistic scenario. So this can give you some figures that will help you look at the future. But obviously, in short, it depends on the situation of the economy and the war. But we are ready for both scenarios, deterioration and better situation as well. And like I mentioned, if the situation is better than expected, then we have potential for a recovery. That is for the first question. As for the second question, like you mentioned, we are back to 40% payout ratio. Obviously, we were in consistent dialogue and fruitful dialogue with the Bank of Israel and fully coordinated with them. While taking this decision, the board of directors took into account the Bank of Israel guideline and the substantial buffers above requirement, and the very good performance. If we are looking at the future and taking some assumptions that situation is going to improve, obviously, the buffers that we have and the trend of the economy will allow us potentially to increase payout ratio. Obviously, it depends on the situation of the economy, but basically we have buffers. We have a very high surplus of few billions above requirements. Obviously, the board of directors and the management will decide the future, what will be the exact way to increase payout ratio. But obviously, the uncertainty level is high at the moment, so it is too early to say. But there is a potential for maybe increased payout or other ways to distribute the surplus. Thank you, Ram. That is all for me. I will get back to the queue. 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. The next question is from Micha Goldberg of Psagot. Please go ahead. Hi. Thank you very much. Great quarter. Question, why did deposits go down significantly in this quarter? Hi, Micha. Thank you for your question. You are right that overall deposits are a little bit low, and the reason is very simple. We have very good position in LCR and NSFR, wide and broad-based, liquidity based, mainly relying on retail deposits. So we have very high flexibility in managing liquidity, and we were able to be more selective in deposit offering. Mainly the decrease in institutional deposits. That is the reason. I will mention as well, if you look at the data, that retail deposits increased. Like you know, we published an immediate report relating to buyback for debt that we did. That is another proof for our very high flexibility in liquidity. Great. Is this something that you would continue in the future? Yes, the board of directors adopted a second plan of $2 billion. We published this as well for the upcoming quarters. Great. You mentioned the search committee for the CEO, replace CEO. Is there a timeframe on that? Is there a timeframe when they are supposed to provide candidates, et cetera? The candidate is still June 4th. Great. Okay. I noticed in the last couple of weeks that the Bank of Israel has been discussing potentially allowing non-bank financial institutions insurance to allow to take deposits. Is this something you guys view as a potential risk? If so, what do you think is the timeframe and what could potentially be on your margins? Yeah. Thank you. We are monitoring that, and the issue is not new. I think it is from last year, but there were some developments in the last days. Overall, we view competition as very good element. We deal well with competition because it is improving services, it is improving products and engagement with the customers. As for today, we have very high competition within the sector and within institutions or companies outside the sectors. For example, credit card companies that can offer today credit and new banks that offer deposits, et cetera. As for this proposal, we think that when dealing with deposits, the two most important elements are trust that you gain over the years. In order to be a material effect, you need the trust and stability. So this institution will have to gain this trust over the periods ahead or the years. Bank Hapoalim, as a leading bank in Israel, already have the trust. The customer choose over the time to, again and again, to work with Bank Hapoalim because of this trust. I think, or I assume that the Bank of Israel or other regulators will impose on this institution a regulation and supervision that create more confidence and requires stability. Overall, it is not new, the competition. We are dealing with that. It is important for the sector, but I think the trust will matter. Great. Bottom line, it is not likely to be a significant threat. Is that what you are saying? Yes. I assume that for newcomers, it will take time to gain trust or to be a material effect. Great. Another question. I saw risk-weighted assets grew by over 2%, yet credit only grew by 1%. What was the other percentage that grew risk-weighted assets? Was it off-balance sheet? What changed the- Yeah. Thank you. It's a mix of reasons. First, the blend of credit growth, it depends what products. That's the first element. The second element is off-balance assets in the quarter. The third element is the operational risk and market risk due to a higher level of revenues and operations. It has an effect. Great. Last question from me. I understand that Bank of Israel is considering implementing some form of Basel IV. Can you give it any guidelines on what the timeframe would be? Looking at risk-weighted assets and CVAs and other issues, is this likely to be negative for Bank Hapoalim, or could it possibly be a flat to even positive? Thank you very much. Yes. Bank of Israel didn't publish yet the draft or implementation guidelines or implementation date regarding Basel IV or Basel III calibration, and didn't publish the QIS. It's too early to relate for that. Naturally, we are preparing ourselves and the bank for the implementation. I can say two elements. It's no doubt that in Israel, due to the high conservative approach already of Bank of Israel and banks in Israel, the effect will be less material in Israel than we see in other territories. That's the first element. The second element, no matter when it will be implemented, it will be gradual. We assume it will be gradual implementation. Taking this element with the high buffers that we have and the strong balance sheet position, we will know how to cope with that and deal with that in a good way. Thank you very much. Thank you. There are no further questions at this time. This concludes Bank Hapoalim first quarter 2024 results conference call. Thank you for your participation. You may go ahead and disconnect.