Earnings Call: Q3 2023

Nov 16, 2023

Summary

Q3 ROE was 13.4%, supported by disciplined credit growth and strong capital and reserve buffers, while income declined as interest-rate tailwinds faded. War-related relief costs could reach ILS 420 million, mainly in Q4, depending on customer uptake.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim Q3 2023 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 Q3 2023 Report Presentation. 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 0. As a reminder, this conference is being recorded November 16, 2023. With us on the line today are Mr. Ram Gev, Chief Financial Officer, 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 which 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 effects 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? Good afternoon. As you all know, on October 7, Israel woke to a monstrous terrorist attack launched by Hamas-ISIS, who controls Gaza, on Israeli civilians. I would like to dedicate my opening today to send our thoughts and prayers to the families of the victims, wounded, and missing men, women, and children taken hostage by Hamas-ISIS. My presentation today will begin with several slides in which we review the macroeconomic situation in Israel, the government and Bank of Israel measures to support individuals and businesses, and the bank's operations and support for its customers and civilians in Israel. Following this part, I will briefly review the financial results. In times like this, it's important to understand the environment we operate in, as well as the bank's position. Bank Hapoalim has entered the current situation with a very high level of preparedness in every aspect: business continuity, financial buffers, and a track record of strict underwriting. A clear proof of our strong position is the dividend distribution we declared this morning. Before we discuss the bank's position, a few words on the macroeconomic situation, starting with slide 3 and 4. Israel has a track record of recovering from external economic shocks like security events and COVID-19. Maybe this time it's a bit different in several ways, such as the length of time, consumers' mood, the economic toll, and more. The immediate effect of the war was a drop in economic activity. Consumption decreased, construction projects were shut down, and more than 300,000 civilians were recruited as reservists. But now, almost six weeks from the outbreak of the war, we have managed to create a sort of wartime routine. The economy is not running at 100% capacity, of course, but not very far. Traffic is almost back to normal, consumption is recovering, and the education system is almost fully functioning. Unlike the real economy, the reaction of financial markets was moderate. Israel's risk premium in the fixed income market increased to 130 basis points, while in the local market, the Bank of Israel launched a plan of selling up to 30 billion USD from its foreign currency reserves and actually managed to calm the markets. The level of exchange rates now is not much different than the pre-war levels. The government bond yields are similar to pre-war levels, even though the deficit is going to be high. The stability of the financial markets can be attributed to the exceptional favorable initial conditions of the economy. Full employment, low public debt, high forex reserves, all of these are working for the economy and the markets now, providing a good entry point based on strong fundamentals. In slide 5, government policy is, of course, an important pillar providing corporates and households a bridge over these challenging times. The government aid package is still evolving, but the framework is basically similar to what they used during COVID-19. It is important to bear in mind that economic crises in Israel are usually limited in time. One cannot expect a rebound in activity like after COVID, mainly because global circumstances are different now. But on the other hand, we do see the economy getting back on track as soon as the war is over. I am moving to slide 6. Bank Hapoalim is fully operational since the first day of the war. The bank has strong capabilities to deal with different situations and create high operational flexibility and business continuity in different scenarios. I am moving to slide 7. Several days after the outbreak of the war, the bank introduced a series of significant support measures and benefits we offered our customers, mainly for those who were directly affected by the war. The benefits include those in accordance with the outline published by the Bank of Israel, as well as additional benefits beyond that outline. These benefits include deferral and exemption of loan and mortgage payments, exemption from various fees, loans with preferred terms, and more. As we disclosed in our financial report, if all relevant clients redeem the maximum benefits, the overall cost will be approximately ILS 420 million, which will be booked mainly in the fourth quarter. The final amount is subject, of course, to customers' behavior and the extent they will redeem the benefits. In addition to introducing customer benefits, we have decided to donate ILS 100 million through the foundation of Poalim Rebuild, an aid fund we established focused on the restoration of the communities in south of Israel, villages were destroyed and part of their members were murdered. Moving to slide 8. As I mentioned before, our starting point for this period is significant, and let me mention four essential aspects. I will begin with credit growth. As we mentioned before in previous investor calls, we had already aligned the pace of growth since 2022, taking into account the global uncertainties we saw back then. So we reduced growth from 4%-5% in a quarter to 1%-2% each quarter in the last four quarters. This pace of growth is allowing us to be more selective and maintain the quality of the book. While doing so, we consistently build the allowance buffer, now standing at ILS 7.7 billion, constituting 1.86% of total credit. The combination of these two factors, responsible growth and solid allowance buffer, positions us at the best in sector preparedness to cope with future developments. Let's move on to discuss the other two elements, capital and liquidity, in slide 9. Another important decision we made in 2022 was to increase the capital buffer quarter by quarter while continuing to distribute dividends to our shareholders. We increased our capital buffer to 130 basis points over the minimum regulatory requirement, or 103 basis points over minimum internal target. We hold the highest CET1 ratio in the sector. Liquidity has always been a strength of Bank Hapoalim, and we continue to present robust liquidity metrics thanks to our stable retail deposit base. To summarize this part, our conservative approach and the high buffers we consequently built have proved to be the right decision taking at that time, as it puts us in a strong position today to cope with what potentially lies ahead. I will now discuss Bank Hapoalim's third quarter results. Slide 11 summarizes the highlights. 13.4% return on equity for the quarter, 15.4% for the 9-month period, with a 38.9% cost-income ratio. We continue to lead responsible and diversified credit growth, as the growth in our business was spread over several economic sectors. This growth was achieved while maintaining the high quality of the book. Lastly, we are continuing to fortify our balance sheet with buffers of loan loss reserves, capital, and liquidity, while also creating substantial shareholder value by continuing paying dividends. This quarter, the board of directors decided on paying 20% of net income to our shareholders. Moving to slide 12. Our profitability relies on a relatively high level of income, coupled with a low cost-income ratio. Following six quarters of growth, during which total income grew by 58%, total income decreased this quarter, mainly as a result of exhaustion of the rise in interest rate. As we can see in slide 13, income from regular financing activity is lower this quarter, mainly due to the lower CPI and the continued migration to interest-bearing deposits. Income from non-regular financing activity was negative this quarter as a result of relatively high realization of bonds. Fees, on the other hand, grew 8% this quarter versus the second quarter. However, some of this growth is driven by refunds of premiums paid in the past for portfolio insurance. Let's move to slide 14 and 15. We grew our credit book by 1.1% this quarter and by 4% from the beginning of 2023 to ILS 404 billion, well diversified between segments of activity. As I mentioned before, credit growth was aligned to the changing environment in 2022 and moreover in 2023, reflecting our responsible approach as well as the impact of macro dynamics on the demand for credit in each segment. Our deposit base, on slide 16, continued to show stability, with 59% of total deposits attributed to the retail segment. Migration to interest-bearing deposits continued, but at a slower pace than in previous quarters, 4% versus roughly 10%, bringing the share of non-interest-bearing deposits to 28%. On costs, on slide 17, total expenses increased this quarter mainly due to a decline in salary expenses, as well as in maintenance and depreciation. The lower salary and related expenses are attributed to the collective wage agreement signed in July. In maintenance and depreciation expenses, we also recorded higher figures last quarter due to some IT R&D asset impairment. Moving to slide 18. As I mentioned before, following the last four quarters in which we increased the collective allowance, we continued doing so in the third quarter as well, on the back of the increase in the probability of a slowdown due to the consequences of the war. The specific provision, however, remained very low, lower than long-term representative levels. This quarter, we also recorded high recoveries, which even turned it into a negative figure. So in total, credit losses amounted to ILS 662 million, or 0.66% of total credit in the quarter, and 0.47% in the nine-month period. The next slide shows our resilient asset quality as well as the fast recovery in problematic debt. Total problematic debt increased this quarter as a result of an increase in non-performing loans. This increase is not directly attributed to the potential effects of the war on our customers. However, it does reflect our tighter approach regarding classifications in this environment. The NPL ratio is now 0.97% of total credit. On the right-hand side, you can see the high reserve and its gradual build. The total reserve is ILS 7.7 billion, of which ILS 6.8 billion is the collective allowance. The balance sheet reserve covers 168% of the NPL. The next slide is on capital. The CET1 ratio increased to 11.52%, well above both internal and regulatory minimum targets. Considering the solid capital buffers and the importance we accord to continued dividend distributions, and taking into account the high uncertainty, the potential impacts of the war on the economy and the financial results of the bank, the board of directors decided to declare a dividend of ILS 334 million, which is 20% of net income. The dividends we declared in respect of the last four quarters amount to ILS 2.4 billion, reflecting a dividend yield of 5.8%. Before we open the call for your questions, I will summarize the key takeaways. Clearly, the economic position of Israel has changed significantly in the last six weeks, but the Israeli economy has strong fundamentals, and we see the economy getting back on track as soon as the war is over. Bank Hapoalim arrived at this period with best-in-sector preparedness, thanks to a good combination of responsible credit growth, capital buffers, ample liquidity, and a strong allowance buffer. The third-quarter results reflect continued good performance, with 13.4% return on equity and a 38.9% cost-income ratio. We gradually increased the collective provision in the last few quarters. This quarter's increase was also due to potential consequences of the war. Our capital is robust, and it was important for us to continue dividend distributions, taking into account the high uncertainty. As a leading financial organization, Bank Hapoalim is an integral part of the economy and society of Israel. We have always stood by our customers in times of need and will continue to do so in the current period. With that, let's open the call for your questions 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 decline, please press star two. 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. I have a couple of short ones. First one would be on the dividend. Given your strong buffers, I am wondering if the 20% is more of a conservative decision given the environment, or it is more of a Bank of Israel directive not to go over 20%? Hi, Tavy, and thank you for your question. You asked about dividends. So, obviously, the bank has high level of capital ratios, Tier 1 and overall capital ratios, and we have significant surplus comparing to the minimum and internal requirement. So, obviously, these levels allowed us to continue with our policy, and it was important to the board of directors to distribute this quarter as well. Obviously, we are aware and taking into account Bank of Israel guideline concerning capital planning and profit distribution policy, reflecting, let us say, the war and uncertainty about, let us say, the length of the war. The combination of these two, the position, the very strong position of the bank, and importance we see in dividend distribution. But taking into account the guideline, the board of directors decided distribution of 20%. Okay, thanks for that. Then I wanted to talk about the impact of the current war. So, you alluded to banking facilities to customers, and we have read headlines about banks offering clients to postpone mortgage repayments by a couple of quarters, and same thing with some retail loans and so on. So, I guess it makes sense that we would not see an increase in bad debt or debt under consideration. I guess, can you give us a sense of how many people reach out and ask to reschedule their payments, or anything that can help us in terms of percentages of retail base that are asking to delay payments? I just want to get a sense if there is really an impact or it is more headlines and overall, the economy is doing well and people are overall are doing okay. Yes, thank you. This is very important and interesting question about the effect of the war. Obviously, we are 40 days into the war, and the answer what is in the future depends on how, let's say, things will go from now, what will be the length of the war or military operation, et cetera. You are right, and the main aspect is the support and benefits we give to our customers. It is important to note that there are different benefits for different, let's say, circles of customers, depend on the level of damage or how the customers are affected. We are giving full disclosure about the maximum impact of this benefits and support. Obviously, it depends what will be the customer behavior. But the maximum is disclosed as, and it is about ILS 420 million if all the customers will use all the benefits and support that we are giving. Obviously, past experience in times that not all the customers use all the, let's say, measures and benefits. That is the first element. The second one is the behavior we see now is mainly, let's say, some psychological or behavioral elements due to the level of uncertainty that characterized the first weeks of the war. Obviously, in times of uncertainties, customers, let's say, in some circles use benefits in order to manage their cash flows. So part of what we see, the numbers as we see for now, is some psychological element and behavioral element. Very similar to the psychological element that we saw in COVID-19, but in lower numbers. But we have a table that we put in our financial report about the amount and the deferrals. So, I can direct you to that table 3-1, including details regarding debt modification. You can see it is very comprehensive table, but total amount of deferred payments is, let's say, a little bit less than ILS 1 billion. Okay, great. Thank you for the detailed answer, and I will get back to the queue. The next question is from Irit Bar of Hapoalim. Please go ahead. Hi, good afternoon. Thank you very much for this presentation. Just one question about credit ratings. We understand that Moody's put the ratings of Israel and Israeli banks on review for downgrade. What could be the cost for you, increasing cost of the- Did you model that downgrade, so the downgrade of the Israeli government or the downgrade of Bank Hapoalim debt? Can you just a little bit elaborate on that? What could be the impact of such downgrade? Hi, Irit, and thank you for the question. You mentioned the Moody's, but what is affecting Bank Hapoalim modeling is S&P rating for the State of Israel. We disclosed the impact of downgrade of the State of Israel rating, and the direct impact is 0.23% on Tier 1 capital ratio and 0.29% on total capital ratio. Obviously, downgrading the rating of the State of Israel can have some indirect effects, but we saw that in volatile times, the Bank of Israel put some measures and act very fast in order to calm markets and deal with different situations. The direct effect is like I mentioned, and again, it's for a situation of downgrade by S&P. Okay. Thank you very much. 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, Ram. Thank you for taking my question as well. I have a couple, if it is okay. First of all, I saw that the sensitivity table you guys put out on a potential impact of a decline of interest rate went down significantly versus the last quarter, like by ILS 400 million. What is your reason for that? Hi, Micha, and thank you for the question. You are right, there is a change in the table. Actually, from time to time, there are some changes, and the reason is very simple. The table is based on assumptions, and part of the assumptions are assumptions regarding the behavior of the customers, and the behavior of the customers, we are learning about it because we are in a different interest rate environment than before. We are learning about it from, let us say, the behavior in the last quarter. So it is reasonable to assume that we are changing or updating the models, and the change you see is a change, the result of the behavior we see by our customers. Is it safe to assume that this is something that will continue? Is this a behavior that is likely to reduce the impact of a lower interest rates also in coming quarters, or is that irrelevant? Yeah, it's hard to say whether it will continue the trend like you mentioned. It depends how customer will act or what will be the interest rate environment. It's hard to say whether next time it will be lower or higher, but what we saw is the behavior led us to, let's say, decrease the impact. Okay, thank you very much. You mentioned that non-performing loans increased in Q3, and it actually went up quite significantly. I'm just wondering, is that a certain amount of specific loans? Is it from across all your loan book? What does that number imply? It's quite a significant jump QoQ, and I assume it doesn't really include everything that happened during the last month and a half. Yes, thank you. If you look at the absolute numbers, they are still relatively low. In percentage, like you mentioned, there is a change, but the absolute numbers are relatively low. From time to time, it's something that we characterize every quarter. There is, let's say, one or two, let's say, borrowers that are classification, changing the classification. It's not related to the war, but it's affected from the war, and I explain. The situation of the customer is not related to the war, but we tightened and, let's say, we're more cautious in classification of those customers. Indirectly, the fact it's affected by the situation of the war, but the, let's say, the situation of the customers, like you mentioned, specific customers, one or two, is not related to the war. We are, like in other elements, more conservative and cautious. I understand. Okay, thank you. I also noticed that the arrears, 90-day arrears, went down significantly in the quarter. It seems like counterintuitive to what's currently going on. Can you explain that drop, or is that a technicality? Can you repeat, Micha? Yeah. In your credit risk table, and I think in note 6 or 5 or one of those, you also provide the 90-day arrears, and that went down quite significantly, by 34% QoQ. I was just wondering, it seems to be like counterintuitive when things are deteriorating and people have less cash flow to pay. So I was just wondering what the reason for that significant decline was, or is it just a technicality or something? Yes. It's not a significant change or something. It's technical, but we can check this one and be back to you. Okay, thank you very much. Another question I had is, I'm just wondering because I saw some of the other banks mentioned that they're not leaving their headquarters as planned. I remember you scheduled to move headquarters towards 2025, and I'm just wondering, based on what's currently going on, is it safe to assume that that probably will be delayed? No, the plans are still there. We are about to move by late 2025. The building is located in Tel Aviv, and it's in initial stages of building. By the way, everyone who is driving near Tel Aviv can see already, I think, 14th floor. But the plans are still, and we are on track. Obviously, the war situation affects some construction in the area of Tel Aviv for the short term, but we are continuing as usual, and obviously, it will enable us to realize some capital gains while selling our current location, let's say, in the next coming years. Thank you very much, Ram, and I'm joining you in prayers for a safe return of our hostages. Thank you very much. This concludes the question and answer session. This concludes the Bank Hapoalim third quarter 2023 results conference call. Thank you for your participation. You may go ahead and disconnect.