Earnings Call: Q1 2023

May 22, 2023

Summary

Q1 net profit exceeded ILS 2bn with 17% ROE and nearly 40% YoY income growth. Strong capital and liquidity supported a 40% payout, while slower credit demand and ongoing reserve builds temper the outlook.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim First Quarter 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 First Quarter 2023 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 22nd, 2023. With us on the line today are Mr. Rongev, 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 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. Mr. Gev, would you like to begin? Good afternoon, and thank you all for joining us today to review Bank Hapoalim's first quarter results. We are reporting very strong results today, more than 2 billion ILS in net profit and 17% return on equity. Let's focus on the main factors supporting this strong set of results. I will start with slide 4. Three important elements stand out when reviewing our results. First, profitability, which is mainly driven by the continuous increase in income from our core banking activity. In addition, due to strong capital generation and buffers, the board decided to raise the payout ratio to 40% of net profit in accordance with our dividend policy. In respect of the first quarter, we will distribute dividends of more than 800 million ILS to our shareholders. Second, our balance sheet is fortified with a CET1 ratio of 11.36% and LCR of 127%, both well above regulatory minimum targets. Third, our portfolio is characterized by high underwriting standards and reflects our prudent approach, as reflected, for example, by two important metrics. The average LTV of our mortgage book is 46%, and our real estate under construction loan book has very low sensitivity to price drops. On slide 5, we illustrate the leap in income and profitability driven by an almost 40% increase in total income year-on-year and a low cost-to-income ratio of 39%. Moving to slide 6, looking at our balance sheet, it's clear that we have built the right buffers. On capital, our CET1 ratio is more than 100 basis points over the minimum regulatory requirement, and the leverage ratio is 6.53% versus the current minimum requirement of 5.5%. Liquidity is another major strength of Bank Hapoalim. LCR and the NSFR are both at 127%, well above the 100% minimum requirement. Another two important figures to take into account in liquidity are LDR, which in our case is now at 75%, and our important well-developed base of retail deposits, which constitute 59% of total deposits. On credit quality, all metrics are strong. NPL declined slightly to 0.85%, and the NPL coverage ratio increased to 166%. Nevertheless, despite the still low credit loss expenses, we have continued to build our allowance for credit losses, now constituting 1.65% of total credit. Moving to slide 7, the third element we are highlighting this quarter is our risk management and underwriting approach. We were the first bank to identify that the risk environment had changed already at the beginning of 2022, and as a result, we adjusted the pace of credit growth in 2022 to make sure that risk and pricing were well balanced. This responsible approach is still leading our operations and reflected in the pace of growth. In the real estate sector, our approach is consistently prudent. As an example, we can take a look at the metrics we are showing in this slide. We are more focused on the housing construction segment, and we built reserve of 1.95% of real estate allowance for potential negative scenarios. Moreover, our sensitivity to price drops in the real estate under construction book is quite limited. In our mortgage book, the indicators are resilient as well. The average LTV of the entire book is 46%, and the average rate of credit losses is close to zero. I will now review in short the macroeconomic environment and further details from the balance sheet and P&L. As shown on slide 9, the economy is cooling down with first quarter growth of 2.5%, which is close to zero in per capita terms. Global circumstances are affecting exports, and the tight monetary conditions coupled with inflation have eroded consumers' purchasing power. Having said that, this is not a recession, not according to official data, and maybe more importantly, not in terms of the labor market, which is still tight and at full employment. In the housing market, we see a major decline in the number of new home sales and some increase in the stock of unsold apartments. Prices of new apartments have declined moderately. Inflation, which was previously lower than in other advanced economies, is now converging to the same levels as fluctuations in energy prices have less influence on the local economy. We still have some price increases in the pipeline, but overall, we believe inflation will slowly decline in the second half of the year. About interest rates, we project that we are close to the terminal rate. Monetary conditions are now tight, the real interest rate is high, and hopefully, it will curb inflation over time. Coming back to the bank's results, as we can see in slide 10, our core revenues were boosted by activity growth and spreads. On the left side, we see the continuous growth in income from regular financing activity and the jump in the financial margin, both affected by the rising rates, credit growth, and the CPI. Let's move to slide 11 and 12. We grew our book by 1.5% this quarter and 8.3% in the last 12 months, while maintaining diversification. Our credit growth demonstrates our responsible approach and the impact of different market dynamics in each segment. Moving to slide 13, where we show one of the most important differentiators of Bank Hapoalim, our deposit base, of which 59% are retail deposits, is the largest in the sector. Retail deposits continue to grow, albeit at a slower pace, and the share of non-interest-bearing deposits now stand at 32%. As mentioned before, LCR and NSFR are well above regulatory targets. On costs, in slide 14, total expenses increased this quarter, mainly due to an increase in salaries and bonuses. At the same time, the cost-to-income ratio stayed at a low level of 39.1%. In addition, we continue to report strong positive jaws. Moving to slide 15. We continued building reserves of collective provision in the first quarter in view of potential macroeconomic effects and uncertainties. Accordingly, credit losses amounted to ILS 185 million, or 0.2% of total credit. The next slide is on capital. Our equity grew by 11.3% year-on-year, and the CET1 ratio increased to 11.36%, well above both internal and regulatory minimum targets. Given the bank's resilient buffer and the strong profitability, the board decided to increase the payout ratio to 40%, as I mentioned earlier. The dividend declared in the last 12 months amounts to ILS 2.3 billion, representing a dividend yield of 5.2%. Before we open the call for your questions, I will summarize by saying, the first quarter continues a long period of strong delivery and responsible management of the bank. The first quarter, in particular, demonstrates the leap in income, as well as our fortified balance sheet. But not less importantly, we did not compromise on risk or transaction profitability in order to grow faster, and we have allocated the right buffers and allowances for future negative developments. Our income continues to benefit from a favorable balance sheet structure. Cost-to-income is below 40%, with substantial positive jaws. And lastly, the dividend payout ratio has increased to 40%, with more than ILS 800 million dividend. I am happy to answer your questions now. 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 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 Micha Goldberg of Psagot. Please go ahead. Hi, good afternoon, and congratulations on a very strong quarter. A couple of questions, if I may. First of all, can you give us any insight as to the progress you're making versus the wage agreement, the new labor union agreement? Okay. Hi, Micha. Thank you for your question. Like you know, we are in a negotiation with the union relating to a new agreement with them. I can say that the discussions, the negotiation is with respect for each party, and we hope it will be fruitful. It's hard to predict when it will be finalized, but we will hope it will be finalized in the next few weeks. Okay, thank you very much. Should we be anticipating additional cost once an agreement has been signed, or has everything already been provided for? Yes. It's hard to say today. Obviously, management want to create an agreement which is to benefit of the bank for the long term, balancing, let's say, salary terms and the needs for the bank for the future. So we want to achieve a balanced result. Okay, I understand. Thank you very much. Just a question on margin expansion. I mean, obviously margin has been growing nicely the last couple quarters. I'm just looking forward, and where do you see that balancing out when higher interest rates have no longer a positive impact on top line, and dropping CPI will hurt the top line? Is there a period in time that you could see margins contracting again this year? Is that too early to estimate? Thanks. Yes, thank you. Well, this is a very good question. There are several vectors that affect the margins. The first one, and the most important, is the interest rate. Obviously, higher interest rate basically means higher margins, but there are some vectors that offsetting partially this effect. For instance, the shift from current account deposits to time deposits. As long as we are in a high interest rate environment, and as long as it's getting higher, then it's reasonable to assume that we see shift. This is very logical behavior and preferences by customers. So that's the first element, the interest rate. The second one is the inflation CPI. We think that the second half of the year, inflation rate will be lower than the trend we see today. So that's second element. The third element is, let's say, the demand for credit and the relation between the demand and the supply. Our strategy, like we talked before in previous conference call, is to balance growth and profitability in transactions, so we don't usually put, let's say, bad transaction on our balance sheet. So these are the three vectors that affect the margin. In short, I can say that higher interest rate means higher net interest margins, but the effect is lower each time than before. Thank you very much. My last question is what you just mentioned about switching out of current account. I mean, it definitely seems in the last couple quarters, the switching has increased significantly. You're now down to 11% over the quarter, 30% year to date, and look to one year. Is that picking up in this coming quarter? Are we seeing that number coming down? Or people, like, how is that trending into the current account? Thank you very much. Yes, you are right. You mentioned 11%, and that is the number for the quarter, the shift between, let us say, current account deposits and time deposits. Like I said earlier, this is very reasonable to assume that this will continue. It is hard to say whether we are now at the peak or it will be higher, because it depends on, let us say, the interest rate environment, but as well as, let us say, the average amount of current deposits, how it spreads among customers, et cetera. I can share with you that if you look at our previous numbers, it is not acting the same or increasing from month to month. There are some months that you see different pace than others, but the level we saw for the last quarter was 11%. If we are talking liquidity-wise, it is important to note that this shift from current account to time deposits is not affecting the liquidity. In some circumstances, it is improving even liquidity. Okay, thank you very much, and congratulations on a strong quarter. If there are any additional questions, please press star 1. If you wish to cancel your request, please press star 2. Please stand by while we poll for more questions. The next question is from Serena Globe of Insight Investment. Please go ahead. Good afternoon. Thanks for the call. I was wondering if you could give us a bit more color on the cost of risk and NPLs going forward. Thank you. Okay. Thank you, Serena, for the question. Well, this is a hot topic in every call. I will say a couple of things. First, when we look at the write-offs and the specifics provision, we see very low numbers. We are still seeing very low numbers. The numbers for the quarter were almost zero for specific provision. That is a result of two elements. The first one is the quality of our loan book, but as we all know, the rebound effect of the COVID. So, the numbers are relatively low. What affect mainly in the last quarters, the credit losses, is the reserve build that we are doing. This is the fourth consecutive quarter that we are increasing our collective allowance and building the reserves. Obviously, we look at the future, there can be some scenarios of deterioration in the macroeconomic situation, et cetera. We think it is the right moment to build the reserves. So we provided more than ILS 700 million for the last three quarters as a collective allowance, just building the reserves. Like I mentioned, we do not see write-offs or material specific credit losses, but it is reasonable to assume, and I think that when looking in the future, even without any deterioration or uncertainties, that we will see these numbers getting normalized in the next few quarters. In past years, the credit losses were between 20 to 25 basis points. Since then, the bank loan portfolio has even improved. But I think for the future, it is reasonable to assume that we will see some normalization in that element. Nevertheless, we are building the provisions. So what you see most affecting the credit losses in the last few quarters is the reserve build. About NPL, the NPL is relatively low, standing at the quarter at 0.85%, and this reflects as well the quality of our loan book. That is for credit losses. Thank you. In terms of funding needs for 2023, do you actually expect to tap the European market? Yeah, thank you. Like you can see, our liquidity ratio and NSFR are very high, about 127%. Obviously, funding needs depends on demand for credit and GDP growth for 2023. There is some slowdown in the Israeli economy, and the demand is lower in all segments than what we saw in 2022 and 2021. So actually, our, let's say, funding today based on our well-developed deposit base, mainly retail deposit base, is sufficient for funding for the near-term and mid-term future. Obviously, if we'll see increase in, let's say, demand or back to normal demand for credit, we have sufficient liquidity and the option to address issuing bonds, et cetera. But as we see it now, we don't have a need for that in the near future. In terms of Tier 2 bonds? Tier 2, no as well. Our capital ratio is Tier 1, 100 basis points above minimum regulatory requirement. Total capital ratio is well-positioned, and the organic capital generation capability is very, very good. So we have, let's say, enough resources to maintain flexibility in executing our strategy, maintain buffers, and like we mentioned, even raising this payout ratio to 40%. Thank you. Just marginally speaking in terms of political/macro developments, I mean, do you expect any of the rating agencies to actually revise their rating for the sovereign, or what's your view there? Okay. I think both Moody's and S&P reflected in their announcements the situation in Israel. What is common to both of them is that they emphasize the strength of the Israeli economy, and we agree with that. The Israeli economy is a very strong economy with good metrics and good fundamentals. We see that today as well. Obviously, the judicial reform has some impact about uncertainties in the economy. Both of them mentioned that reaching a consensus or agreement about the reform is a key factor for the future. What we see now in Israel that there is a dialogue between coalition and opposition about that, and we hope that they will finally found the consensus toward passing the reform in a manner that there is a wide agreement. I think if it will happen, it will contribute and be additional to the good metrics of the economy. Thank you very much. The next question is from Irit Bar of Excellence. Please go ahead. Hi. Thank you very much for taking my call. Congratulations for the strong results. I just wanted to ask if you can just provide some color on your expectation on credit growth, and maybe by segment, and do you expect mortgage loans to recover? Hi, Irit, and thank you for your question. Well, demand for credit is very important for the whole sector and I think the economy nowadays. I will say generally, we see slowdown, and maybe Victor will elaborate on that. We see slowdown in the economy, and this reflected in demand for credit as well, overall segments. But the dynamics are different between segments, and I will elaborate. If I will start with consumer lending, well, what you see overall the sector, that the demand is lower than before. The growth is nearly zero in the sector, and there are a couple of reasons for that. First, the interest rate. Second, and not less important, consumers use their, let's say, deposits or liquidity to have an early redemption of credit that they were granted before. So that is for consumer credit. For mortgages, on mortgages, we see lower demand, material lower demand than in 2022. But while comparing to the numbers before COVID in 2019, 2018, which were not low numbers, the numbers today or the demand is relatively similar to those years. What we see, but I do not think we can call it a trend, but those are early signs, we see in the last couple of weeks some higher demand in the pipeline for mortgages. I cannot say whether it is a change in the trend or back to previous demand, but we see it. I think when we analyze what happening in the mortgage, a lot of customers are on the sidelines. Let's say it is like a spring, maybe they are waiting for interest rate to go down or getting used to the level of the interest rate, but this is as for mortgages. If we are talking on corporate and commercial middle market, we see lower demand. Still, the demand is higher than what we see in consumer. Still, the demand is higher, though in lower pace than in 2021 and 2022. I think what we see today is that part of the corporate, let's say, waiting with some transactions, or it is taking more time than before to finalize transaction and get the credit. They are more cautious in transactions, so this is affecting the demand as well as the GDP growth. But looking at the future, I think that residential, for instance, transaction, infrastructure, et cetera, it is in the focus of the government, and it is very important for the development of the country, so we still see demand in here. Victor, you want to add something? Maybe with regard to the mortgage market, I think that, for example, if you look at the number of new home sales, it has declined to a very low number of 2,500 units per month. It is very hard to assume that this level will prevail in the next, let us say, 12 months. It is much below the demographic trends of this economy, which means we need actually some 60,000 units per year. So 2,500 units per month is very low, and as the market will find a new equilibrium, I believe that we see some recovery also in the mortgage market. Thank you. Thank you very much. There are no further questions at this time. This concludes the Bank Hapoalim first quarter 2023 results conference call. Thank you for your participation. You may go ahead and disconnect.