Earnings Call: Q3 2022

Nov 23, 2022

Summary

Q3 net income reached ILS 1.78 billion with 15.9% ROE, supported by rate-sensitive financing income and disciplined costs. Credit quality remained strong, while management anticipated eventual normalization in credit losses and continued to monitor real estate and deposit behavior.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim Third Quarter 2022 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 Third Quarter 2022 Report Presentation. All participants are at present in a listen-only mode. Following management's formal presentation, instructions will be given for a question-and-answer session. For operator assistance during the conference, please press star zero. As a reminder, this conference is being recorded November 23, 2022. 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 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 filing with the various securities authorities. Mr. Gev, would you like to begin? Good afternoon, and thank you for joining us today to discuss Bank Hapoalim third quarter results. The bank is reporting a very strong set of results, net income of ILS 1.78 billion, return on equity of 15.9%, as you can see in slide 3. Nine-month results are no less impressive, ILS 4.8 billion in net income and 14.6% return on equity. These results demonstrate the strength and resilience of our business, delivering strong financial performance and a robust balance sheet quarter by quarter, all achieved by our consistent execution of our strategy. Let me turn now to the main factors that drove our profitability in slide 4. On financing income, we continue to benefit from continuous healthy and responsible credit growth, which in this quarter was also boosted by the Bank of Israel and Fed rate increase and the higher CPIs. As a result of these factors, our income from regular financing activity was up 17.2% versus last quarter and almost 55% versus the third quarter of 2021. Another important element demonstrating our strong performance is fees. Fees continue to grow at a double-digit pace and reflect the impact of the Isracard new agreement. This quarter, we recorded ILS 95 million in credit card fees in respect of the second and third quarters, or roughly ILS 50 million per quarter. On costs, our cost-to-income ratio dropped to 41.5% in the quarter, demonstrating significant positive jaws. We view our credit quality as a strong asset of the bank, especially in the current environment of rising interest rates and high inflation. Whatever scenario may evolve, we have the right reserves, and our very low credit loss expenses and NPLs are good position for any negative macroeconomic development. Lastly, on capital, we ended the quarter with a CET1 ratio of 11.10%. The board of directors declared a dividend of ILS 536 million, constituting 30% of our quarterly net profit. Our strong capital generation gives us the ability to grow our book at what we believe is the right pace for the current environment, maintain the required buffer, and execute our dividend policy. Capital distributions declared or paid out in the nine-month period amount to almost ILS 1 billion. I am moving to slide 5 and 6, where I would like to point out some important points regarding our interest and non-interest income. On slide 5, we show the development and drivers of interest income. On the top left side, we see the continuous growth in income from regular financing activity and the jump in the last quarter due to the rate hikes. We grew our credit book by 2.6% in the quarter and 8.2% year-to-date. As you know, as we mentioned in previous calls, the pace of growth was adjusted earlier this year to reflect the current environment and allow us to focus on risk-adjusted pricing. Growth was boosted by the macroeconomic development. The average Bank of Israel interest rate in the third quarter was 1.52% versus 0.47% in the second quarter. The Fed rate jumped from 0.96% in the second quarter on average to 2.39% in the third quarter, both bringing our financial margin up 34 basis points to 2.58%. Looking ahead, rates are expected to continue rising. The average Bank of Israel interest rate for the fourth quarter is 2.92%, and the current market expectation for the Fed rate is 3.9%. Our unique balance sheet position, which is characterized by the largest retail deposit base in the industry, will allow us to benefit from the new interest rate environment. Our unique balance sheet position also stems from the exposure we created to CPI over the last couple of years, currently standing at 53% of our equity. Moving to slide 6, where we highlight the non-interest drivers of our activity. As mentioned earlier in the context of fees, the Isracard agreement contributed ILS 95 million, which were recorded this quarter in respect of the second and third quarters. Of this amount, ILS 54 million are in respect of the third quarter. In addition, we see growth in credit handling and account management fees. Poalim Equity, our investment platforms, contributed ILS 94 million from the beginning of the year, despite the negative trend of capital markets in that period. This is due to the fact that Poalim Equity managed to develop a layer of activity that is less capital market sensitive, such as equity-basis investment in private equity funds, and advisory commission. Another parameter affecting our income is our real estate assets. We continue to downsize our branch network to increase efficiency, now standing at 169 branches. At the same time, we continue to examine and promote alternatives to the betterment of properties currently used by head office units. These buildings are expected to be vacated in the course of the relocation to the Poalim Center, our future headquarters building. Continuing with costs and efficiency, on slide 7, the cost-to-income ratio is improving and proves that while income is growing, costs stayed disciplined, and were actually almost flat in the last nine months. I am moving to slide 8, where we discuss asset quality. On the left-hand side, we present our loan loss expenses, which remained very low. This was driven by the ongoing low individual provision, coupled with a recovery from an individual borrower, as may occur from time to time. On the right-hand side, you see our NPLs continuing to decline, constituting only 0.78% of the loan book. Nevertheless, we increased the collective allowance, partially attributed to the construction and real estate sector. The bank estimates that the quality of the credit portfolio in this segment is good, as reflected in all credit quality indicators. However, the changes in the economic environment indicate an increase in the probability of worsening in this sector, and consequently, of an increase in the level of borrowers' credit risk. As a conservative measure, the bank continued to increase its collective allowance in respect of this portfolio. In the current environment, a strong balance sheet, disciplined risk management, and the right buffers are important differentiators. Moving to slide 9, where we show another differentiator of Bank Hapoalim, our deposit base, of which 58% are retail deposits. Following a long period of growth, we now see that customers are shifting to securities, mainly money market funds, resulting in a slight decline in deposits. In terms of liquidity, we are well above both LCR and NSFR regulatory targets. Lastly, on capital, in slide 10, we maintained our robust capital position due to high organic capital generation and our continued focus on mitigating risk-weighted assets. The CET1 capital ratio stood at 11.10%, up 14 basis points since January. This quarter, the board declared a dividend of ILS 536 million, 30% of net profit. Before we conclude our discussion, a few words on the macroeconomic environment. We are seeing some signs that point to slower growth rates. Third quarter growth declined to 2.1%, far below the potential of the economy. The decrease in consumers' purchasing power, together with rate hikes and a decrease in financial wealth, all have adverse effects on growth and on private consumption in particular. Still, the consensus forecast is that current slowdown will not evolve into a recession in Israel, with the economy actually expected to outperform other advanced countries. This projection is mainly based on the favorable fundamentals of the Israeli economy, such as budget support, stable energy prices, and more. The labor market is still strong, though we recently have seen a slight increase in the unemployment rate to a level of 4.1%. Inflation is up to 5.1% in the last 12 months. Price increases have been broadening into many types of services, including rentals. We do believe that higher interest rates and government policy aiming to reduce inflation inertia have the ability to curb inflation significantly next year. The Bank of Israel increased its key rate to 3.25% this week. We believe that future rate hikes are going to be lower, as inflation expectations are already anchored in the target and the economy is getting softer. Finally, on slide 12, I would like to summarize the key takeaways. Very strong profitability in the quarter and nine-month period, with a double-digit return on equity. Rates had significant impact on our results due to a favorable balance sheet structure. Credit growth was healthy and strong, aligned with the macroeconomic uncertainties. The cost-to-income ratio dropped materially, and we continued to show positive jaws. Our loan book continued to improve, but as we mentioned before, the current very low level of provisions will normalize at some point. Our capital grew organically, allowing us to grow our book at the right pace and pay dividends. With that, I thank you for joining us today, and 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 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 polled in the order they are received. Please stand by while we poll for your questions. The first question is from Chris Reimer of Barclays. Please go ahead. Hi. Thanks for taking my questions, and congratulations on a strong quarter. Just touching on the macroeconomic environment following the Bank of Israel comments and your own comments, seeing signs of slowing growth. At your level, are you seeing any impact at this stage? Okay. Thank you, Chris, for your question. I'll start answering, then maybe Victor will elaborate more. Obviously, we see the environment and uncertainties and the level of interest rates visibly affecting demand. We, you know, adjusted earlier this year our growth rates, reflecting uncertainties, our risk appetite, and our aim to execute our strategy, being risk-sensitive, price-sensitive, and selective. When we look actually where we see a change in demand, the main area where we see is mortgages, which the level of demand is lower than we saw at the beginning of the year in 2021. But we have to remember that the level of demand is still relatively high and at a level very similar to what we saw at 2019, before COVID-19. As for consumer lending, so far, demand wasn't so high, relatively flat, taking into account our risk appetite, so we don't see much change. As for commercial and corporate, it depends. It depends on the segment, and Victor will elaborate on that. But infrastructure demand is still high and growing. We assume that the environment and uncertainties may have some impacts on demand, but it will vary between one sector to other. Victor? Well, Chris, as you said, we do see some significant slowdown in the rate of growth, but it is not balanced. On the one hand, we do see also stagnation, for example, in private consumption. At the same time, we also can see an increase in investment, which means that if, for example, the result is that there is a decline in the demand for credit in the retail division, at the same time, we do see increase in the demand for credit in the corporate division. So, the total picture, I would say, it is mixed. Mm-hmm. Great. Thanks. Thanks, that is really helpful. Just following on that, assuming that the level of activity does slow down, what segment would you say of the portfolio was most at risk of facing higher provisions? Well, based on the macro situation and the risk of sustained global inflation and higher interest rates, and based on other countries' experience, I would say that the real estate market is now more risky. We actually never experienced a real estate crisis in Israel. That is why I emphasize other countries' experience. In any case, I think we in Israel, we have some idiosyncratic characteristics of this economy. For example, the demographic trends and the fact that the level of unsold apartments is still low. So overall, the real estate market is right now riskier than in the past, but we think that in Israel, we still believe in our clients. We continue to follow them in their activity, but at the same time, we monitor this sector more carefully. Yeah. If I, Chris, if I can add to what Victor said, I differentiate between the external situation of what we see in the global economy and in Israel, and what we see inside with our loan portfolio. No doubt that markets and economic conditions have more and more negative signs. If you combine it with a higher interest rate environment, it can be a potential challenge for households, for individuals, and corporates. If the situation will get worse, it will affect everyone. The question is not whether it will have effect. The important question is, what will be the effect on different corporates? Let's say if we take Bank Hapoalim, our loan book or credit portfolio book is a very quality one. We actually don't see any negative signs. On the contrary, we see improvement in situation of borrowers and repayments, et cetera, due to our very quality portfolio. NPLs are lower than the last quarter. Problematic debt significantly decreased in this quarter. Write-offs are in very low level. I think that the quality of our loan book and our underwriting standards, sound underwriting standards, and our policy and risk appetite proves itself today and in the future in any negative cycle. Nevertheless, like I mentioned earlier, we still increase collective allowance due to conservative approach. We have cautions. We did them in the last quarters to cope with any change in the market or the deterioration in the economy. Okay. Yeah, thanks a lot. That's great color. That's it for me. The next question is from Konstantin Rozantsev of JP Morgan. Please go ahead. Oh, yes. Thanks a lot for the presentation and for taking my questions. I think you provided great color already in the first responses, and I'll just build on a few areas discussed in the first question. Could you give us some high-level perspective how you see high rates and high inflation affecting the bank's loan quality? You mentioned that you have a very high-quality book, and on a sequential basis, you only see improvements as of now. But going into next year, do you expect any tangible impact from high rates and high inflation? If you could put some numbers behind this as well, what sort of credit loss ratio are you seeing, are you expecting in the final quarter of this year and in 2023? Thanks a lot. Okay. Thank you, Konstantin, for the question. The answer depends on the level of interest rates and how long we'll be in a situation of high interest rates. Generally speaking, obviously high interest rates have potential negative effect on borrowers. It depends on their particular situation. That's the reason why I mentioned before that as for the moment, we don't see any, let's say, negative effect or defaults or increase in write-offs, et cetera, et cetera. On the contrary, the NPLs and other figures and parameters are in a very good position. But two elements that we have to remember that looking forward, I can't tell whether it's a few quarters or even more, we assume that the level of credit losses will be normalized at some point. This is reasonable to assume. In that situation, what is important is the quality of the loan book. The numbers of Bank Hapoalim are very good consumer, corporate, and other elements. We also run stress scenarios to check the question that you raised. We're running stress scenarios, and according to them, we should not see a major effect on our portfolio. You can see it if you look at, let's say, some notes that we have in our financial statements. You can see that our absorption rate is very good. The absorption rate of our customers is very good. Financing level of some segments is relatively low to the industry. In short, obviously, higher interest rates will have an effect. We think that our relative position is very good, and we are well prepared for any change in the situation. Got it. Thanks a lot. That's extremely useful, Kobi. You mentioned that you're seeing credit loss ratio normalizing, right, in the coming quarters. Should it be normalizing to some pre-COVID levels or pre-2020 levels? Is it fair to assume? Like I mentioned, you can't predict when it will happen, but I think it's reasonable to assume that it will happen gradually. If you look at the past, let's say, credit loss ratio for Bank Hapoalim was about 20-25 basis points overall. So it's reasonable to assume that it will be normalized to that level. Basically, based on the assumption you take, we think in any case, we will benefit from the quality of our loan book and our conservative approach, especially from the beginning of this year. Got it. Thanks a lot. Thanks a lot. Extremely useful. The next question is from Micha Goldberg of Psagot. Please go ahead. Hi, good afternoon. First of all, congrats, guys, on a very strong quarter. A couple of questions. First of all, you mentioned that you see fee growth being very strong. I'm just wondering if you exclude the extra quarter you included for the Isracard agreement, does that still leave growth coming through? Thank you, Micha, for the feedback and for the question as well. You mentioned correctly that our fees increased double digits, and the main effect is the new agreement with Isracard that roughly affects ILS 50 million per quarter. We still see, while excluding this element, we still see positive effects on fees quarter by quarter. The first element is the account management fees that we see rise from the second quarter, and if we compare it to the prior quarter in 2021. So in account management fees, we see increase in financing fees, guarantees, and absolutely, if you look at trading fees, it depends on the level of trading of stocks, et cetera. So it will depend whether it will continue or change a little bit. It depends on the condition of the market. Forex transaction, we see increase. It depends. The last one depends on, let's say, what quarter you are. Usually, the third quarter, forex transactions are higher than the first and second one. But in short, excluding the credit cards, we see overall increase in fees. Okay, thank you for that. You mentioned that the hike in interest rate is contributing strongly to your top-line revenues, your interest income. You also mentioned that in the marginally declining kind of impact. I am just wondering, is there any time or any scenario in which the rising interest rate and the pass-through and people taking their money away from current accounts, et cetera, and you raising the interest rates on deposits, can turn this into a negative, not into an incremental smaller positive? Thank you, Micha. Well, that is a very good question. As we now, as we can see, our models for at the beginning of the quarter and the end of the quarter, we are looking forward, the effect is positive for increase in rate hike, and our unique balance position enables us to benefit from that. But the basic assumption at the model, and you are right at that, one of the basic assumptions is the behavior of consumer, of customers, their preferences. We assume that when interest rate is high, getting higher, and you are more and more time in that environment, more and more customers will shift to money market funds and will shift from current account deposits to timed deposits. Whether it will be at some point have a negative effect or low, let's say, positive effect. We can't tell whether it will be, but every quarter, we are examining our assumptions. It's reasonable to assume that as long as we are in a higher interest rate, the effect will be lower for every 1% increase. Okay, thank you. By the way, if I can add, Micha, you can see that the assumptions in our models are relatively conservative. If you look at the table at the second quarter statement, the effect was ILS 1.2 billion for 1% parallel interest rate hike. Actually, if you look at the third quarter, the effect was higher than that, because customer behavior and preferences didn't change as the assumption was in the model. It can be changed from time to time, and we examine it every quarter. Based on that, your current projections around, I think, ILS 700 million-ILS 800 million are likely to be also lower than will come through? Our current assumption, and you were correct, is the number that you mentioned, roughly ILS 800 million. But it depends on, like I mentioned, the behavior preferences of the customers. Basically, what we have now is the assumption we use for the table. Like we saw last quarter, the final results were higher than that. But I can't assure you that it will be the same for the future. It's, let's say, a new environment for customers, and they're getting used to it, and their preferences may change in a different way than we assume. Okay. Maybe to ask this in a different way, in Q2 already, some of your current account deposits went down. Can you tell us what happened in Q3? I assume they went down much more than that. Just on the term of the checking account, what's the rate of the withdrawal in that time? If I understand, you ask about the current account deposits or non-bearing interest deposits. The portion were down from 44% in the second quarter to 41% in the third quarter. Okay, thank you. In the first quarter, just to add, it was, I think, 47%. You see that the customer's behavior and preferences changes. The main assumption is what will be the speed or the pace of that change. I understand. Okay, thank you very much for that. I have another question about cost of credit and quality of credit you mentioned about, and I was wondering two things. You mentioned that it's strong, and you actually see an improvement. You don't see any deterioration whatsoever. I'm just wondering, how does that coincide, how does that work together with what we recently saw financial published by some of the credit card companies and the non-bank finances who significantly increased their provisions for the consumer loans? I think you mentioned that the real estate loans are the ones that are more risky, and I'm just wondering, on your side, you also have significant exposure to car loans. Some of these companies published at that same time. Are you seeing a deterioration there? Is it different in the bank than at these companies? What's the reason they are providing and you are not? I mean, more importantly, you don't see that. Is that because you're a better quality, different kind of balance sheet, not that kind of credit? Thank you. Okay, thank you, Micha. First, we saw that, non-bank companies or credit card companies published their statements. I don't know what were their consideration in, deciding what is the level of their credit losses or what was write-offs and what was the collective allowances. I can say that, generally speaking, there are differences between companies, especially banks, in risk appetite, cautions, maybe in some cases, underwriting policies, et cetera. You can see that for banking industry, but I can speak for Bank Hapoalim, the underwriting standards are very strict. The risk appetite is very, defined and relatively conservative. So, we built a credit portfolio that is very, very good and well ready for any change. We see, like I mentioned, situation of our customers that's even improving. So, there is difference between what we see in the economy and our portfolio book. Obviously, like I mentioned at the beginning, there can be a possibility of a change. In that situation, what is important is the, let's say, the cautions on one hand, and the second hand, the portfolio quality. Okay. Very clear. Thank you. Okay. Thank you. Can you tell me how much the implementation of SA-CCR hurt Common Equity Tier 1 in this quarter, and how much the implementation of the Bank of Israel rule regarding the financing impacted? Okay, thank you. The SA-CCR effect was approximately ILS 2.6 billion in credit risk assets, ILS 2.6 billion, and it's approximately 7 basis points in Common Equity Tier 1 capital ratio, and 10 basis points in total capital ratio. That's for the SA-CCR. As for Bank of Israel directive regarding the LTV, as for September, it was 3 basis points in common tier 1, the effect of the directive. Thank you. But it's still under discussion? Guy, the Chief Accountant, adding, there are Q&A session with Bank of Israel over the industry of some issues of implementing, and obviously the last one, the LTV, what I mentioned, can change if Bank of Israel would issue a different implementation guidance. I understand very clearly. Despite all that, you succeeded to reduce your risk-weighted assets, and despite the growth, having grown as fast. Is there more potential left for you to mitigate risk-weighted assets in future quarter, or are you all done? Yeah, that's correct. Thank you, Micha. You noticed very important element in our report. If you look from the beginning of the year, we grew in balance in credit about ILS 28 billion, while risk-weighted assets grew almost by half. This is not by accident. It's result of an effort that we investing since the beginning of the year when we saw the changing in global economies and uncertainty high, and we decided to invest efforts in being more efficient in risk-weighted assets. For us, this is not one-time effort, so we continue to take it to 2023, and we have internal target on that element. We want to be in a situation that, let's say, risk-weighted assets reflecting credit will grow lower than growth in credit. In short, yes, this is element that we issue, that we invested in efforts, and we see it as ongoing mission for us. Thank you very much, Ron. Very impressive. Thank you. 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. There are no further questions at this time. This concludes the Bank Hapoalim third quarter 2022 results conference call. Thank you for your participation. You may go ahead and disconnect.