Earnings Call: Q2 2022

Aug 15, 2022

Summary

Q2 net profit was ILS 1.34bn with 12.3% ROE, supported by financing income and fee growth, while lending growth was moderated amid uncertainty. Strong deposits and rate sensitivity support further income potential; CET1 was 11.14%.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim Second 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 Second Quarter 2022 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 zero. As a reminder, this conference is being recorded August 15th, 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 filings 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 second quarter results. This is yet another strong quarter for Bank Hapoalim. Actually, the fifth in the last year and a half in which we present a double-digit return on equity. This quarter, we present 12.3% return on equity with ILS 1.34 billion in net profit. As you will see during the presentation, our results remain strong. 17% growth in financing profit, 13% growth in fees, cost-income ratio below 50%, and CET1 ratio of 11.14%. In almost every parameter, we saw an improvement. Now, let me go over those key elements, starting with slide 3. First, our excellent results are an outcome of rigorous execution of our strategy of growing the core business with an emphasis on risk and prices, while controlling costs. Indeed, we posted a 15.7% increase in total income this quarter versus the corresponding quarter, while our cost-income ratio dropped to less than 49%. This continued trend created significant positive jaws and resulted in the aforementioned profitability for the quarter. The performance for the six-month period is also impressive, with ILS 3 billion in net profit, representing a 13.9% return on equity. Second, in light of the developments in the macroeconomic environment, we aligned our credit growth to better reflect the current uncertainties. In the current environment of high uncertainty, where the high inflation and increasing interest rates might have an impact on bank customers at some point, we think that it is more responsible and appropriate to adjust the pace of our growth to the new environment, rather than continue growing at the pace we saw in 2021, which was a rebound year. We are still witnessing very high demand for credit in the market. As we discussed early in this year, we took a responsible approach to growth and actively lowered the pace while focusing on risk-adjusted pricing. Once we identify that the level of uncertainty is reasonable, we have all the required resources to change the pace. We were also able to maintain the high quality of the book, as reflected in our NPL ratio, which continued to decline and now standing at 0.87%. On capital, we ended the quarter with a CET1 ratio of 11.14%. The board decided to resume dividend distribution and declared a dividend of ILS 403 million, constituting 30% of our quarterly net profit. Our sound management of capital and risk-weighted assets, the measures we took to reduce the sensitivity of the capital to market volatility, and our high organic generation of capital allowed us to maintain stable capital buffers and avoid addressing the capital market and rely on its support. All other regulatory limits and ratios, such as the LCR and leverage ratio, are well above the target, and the real estate exposure limit is well below the threshold. We have no effective constraints and can enhance the pace of growth in the future when we identify that the level of uncertainty has gone down. Finally, after over a decade of almost zero interest rates, this quarter reflects the initial impact of the rise in interest rates on our profitability. Thanks to our high sensitivity to rates due to our large retail deposit base and a large portion of non-interest-bearing deposits, the expected continued upside from the new interest rate environment is substantial. As disclosed in the rate sensitivity model in our report, as of June 30, a 1% parallel interest rate hike under the model assumptions will boost our financing income by ILS 1.2 billion on an annual basis. Before we move to discuss our numbers in greater detail, let me take a minute to describe the macro picture as we see it. I am referring to slide 4 and 5. While the world is on the verge of recession, in Israel, we are only seeing some early signs of lower growth. As you can see in the upper graph, the consumer confidence index decreased and private consumption has flattened. The picture is not totally clear yet, as exports of services, for example, are still performing well and hotel occupancy is high. We also look at new home sales, which declined compared to 2021, but to a level that in pre-COVID times was considered high. Overall, it will be fair to say that the level of economic activity is still high, and even if there is a slowdown, it is relatively to the last quarter of 2021, which was kind of an outlier. Inflation is up to 4.4%, and like in most advanced countries, the changes in prices are broadening. Stable natural gas prices are a major factor mitigating global inflationary pressures in Israel. We believe that inflation is now close to the peak and is expected to decline over time. The Bank of Israel interest rate was increased to 1.25%, and we expect further tightening in the coming months. Markets expect the Bank of Israel rate to peak in the middle of next year at 2.5% and then begin to decline. At the same time, Israel has low beta to the world economy. The unemployment rate returned to 3.4%, while job vacancies are high. Wage pressures intensified in some industries. The government balance turned from deficit to a surplus, mainly as a result of increased tax receipts, which gives the government more possibilities to tackle inflation by reducing taxes. Finally, even after several years of fast growth in mortgages, households' leverage is still low in global comparison. The private savings rate in Israel is high, and households tend not to refinance their debt. This, among other things, supports our confidence in our mortgage portfolio in times of higher rates. Now back to the results with slides 6 and 7, where we demonstrate the continued positive evolution of our profitability, which mostly derives from core banking, while improving efficiency. Income from regular financing activity, which reflects the core bank contribution, is up 35% compared to the same quarter last year and 18% versus last quarter. Fees are up almost 13% compared to the corresponding quarter and 1.6% versus last one. At the same time, costs stay disciplined, leading to a continuous improvement in cost-income ratio, which is down to less than 49%. First half figures are no less impressive. A 13% increase in income from regular financing activity versus the first half of 2021. Almost 11% growth in fees and a 49.8% cost-income ratio. Clearly, this positive trend will continue going forward with the interest rate expected to reach 2.5% in the 12-month horizon. On slide 8, we present our loan book, which grew by 2.1% this quarter, or almost 15% year on year. This growth mostly came from corporate credit and mortgages this quarter, as demonstrated in slide 9. Slide 10 shows one of our balance sheet's outstanding strengths. ILS 307 billion in retail deposits, the largest retail deposit base in the sector. Another parameter that we view as a relative advantage is the share of non-interest-bearing deposits, which account for 44% of total deposits. This figure, coupled with the theoretical sensitivity of financing profit to the change in rates, provides a good picture of the potential for further income growth going forward. In terms of liquidity, we are well above both LCR and NSFR regulatory targets. Slide 11 presents the continuous growth in financing profit as a result of credit growth, and in the second quarter, also supported by the increase in rates. I want to also draw your attention to the right-hand side of the slide, which shows the year-on-year 24% growth in income from regular financing activity, excluding CPI. Moving to slide 12, where we show the positive trend in fees, which grew by almost 13% year-on-year. Another factor that will impact our fees is the in-principle agreement with Isracard, which we announced a few weeks ago. Upon signing the detail agreement, the average contribution will be ILS 50 million on average every quarter in our income from fees. This is, of course, an estimate based on 2021 credit card turnovers and could be different subject to future turnovers, et cetera. On slide 13, the cost-income ratio is improving, although total expenses grew versus comparable periods to support our growth. I would like to focus on the right-hand side of the slide, where we show the significant positive jaws I mentioned in my opening. Total expenses in the first half of 2022 increased by only 1.4%, while total income rose by almost 12% in that period. This brings a very high positive jaws ratio and clearly indicates that we are on the right track to further improve productivity. On slide 14, we demonstrate our high-quality book. In this quarter, provisions remain relatively low, and the NPL ratio is down to 0.87%. Nevertheless, the allowance for credit losses remained relatively conservative and high at ILS 6 billion, constituting 1.62% of credit risk-weighted assets. This is not a coincidence. The high quality of our book is an outcome of our conservative underwriting standards, which characterize our way of doing business. On capital, in slide 15, we maintained our robust capital position due to high organic generation and reduced the impact of the markets on our OCI. As a reminder, in light of the volatility we witnessed during the first quarter, we transferred ILS 3.5 billion from our available-for-sale to the held-to-maturity portfolio, leading to a relatively low impact of the change in the yield curve on our capital. This quarter, we declared a dividend of ILS 403 million, or 30% of net profit, and plan to continue dividend distribution on an ongoing basis. In slide 16, we present our strategy, which you already know. Clearly, we see that our strategy bears fruit, as reflected in the continuous improvement of our performance. I can share that in order to leverage on this momentum, we're currently working on a new updated strategic plan for the medium to long term with a global firm. Lastly, on slide 17, I would like to summarize the key takeaways. Very strong profitability in the quarter with double-digit return on equity and high positive jaws. Robust income growth driven by the continuous growth in activity, supported by rates increase and higher CPI. We took a responsible approach to credit growth and aligned the pace to macroeconomic uncertainty. Once we identified that the level of uncertainty is reasonable, we have all required resources to change that pace. Our capital grew organically, allowing us to grow our book at the right pace and resume dividend payments. We maintained the high quality of the loan book. Lastly, our balance sheet is uniquely positioned to benefit from the expected rate increase. With that, thank you for joining us today. 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. Almost, Rabbi Shairos? 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 Konstantin Rozantsev from J.P. Morgan. Please go ahead. Yes. Thanks a lot for the presentation. Congratulations on the results, and thank you for taking my questions. The first question that I wanted to ask, could you please comment, how do you see the high rates and high inflation in the economy affecting the bank's loan quality in the coming periods? So in the second half of this year and in 2023, do you expect the impact to be tangible, and do you have any particular guidance for the credit loss ratio in these periods? Is it going to be substantially different from some normalized levels observed in 2018, 2019? Or is it going to be pretty much the same? Thank you. Thank you, Konstantin, for your question. You referred to loan portfolio quality. Well, like you see in our numbers, our loan portfolio book has very good figures that kept improving for the last years, and we see this trend as well in the last quarter. Obviously, the credit losses as for this quarter are low, and it reflects the quality of our loan book, and obviously, the long tail effect of COVID-19 rebound as well. When looking at the future, we are not giving guidance on that, but if you look at, let's say, the numbers of 2019, 2018, et cetera, before COVID, you will see that overall percentage of credit losses is about 0.2%-0.25%, and that is before pre-COVID numbers. Obviously, like I mentioned, we are keeping improving our loan book and the parameters of quality loan book. So that number can assist you. We are not sure that we will see a line to those numbers in the next few quarters, but overall, this is the trend for the long term, as obviously, the numbers all over the industry and banking industry globally for the quarters are not representative for the long term. But in short, we believe in the quality of our loan book, the good standards of underwriting, and believe we will benefit from that in the future as well. Understood. Thanks a lot. If I could also request, I could also ask for a few. My understanding is that Israel has been operating with next to zero rate for a protracted period of time in the past. I am just curious to understand if we are, as the rates increase and increase quite drastically from these 0% levels, if we are well prepared, kind of as a group across different types of the lending of the bank to these increase in rates. My understanding is that you are not too concerned, and so in the next year and a half, we should be looking at the cost of risk close to these pre-COVID levels. Is it a fair understanding, or is there a risk that the cost of risk could end up tangibly higher than that? Thank you, Konstantin. If I understand, you ask about the effect of increasing rate, and whether it affect the quality of the loan book or credit losses. We are doing all the time stress tests and sensitivity tests to our loan portfolio, mortgages portfolio, consumer credit portfolio, et cetera. We monitor it carefully. For instance, for mortgages, the parameters of the portfolio, the PTI, the LTV, are very good parameters. While running those sensitivity tests and stress tests, we see that the customers still able to serve the debt. When we are looking back, the last decades, for example, in situation of rate hikes, we see that it did not affect much the ability of the customers to serve the debt. Obviously, the final outcome is a combination of the level of interest rate and the quality of our loan book. We believe that we benefit from the quality of our loan book in this situation, the risk appetite that we have. We have to remember that we are still relatively in an environment of relatively low level of interest rate. Combining with, let's say, it's a good and sound underwriting standards, we believe that the quality of the loan book will also serve us in the future in future rate hikes. Understood. Thank you very much. The next question is from Tavi Rosner of Barclays. Please go ahead. Ram, in your prepared remarks, you mentioned adjusting the loan book growth rate to the current macro. Just to be clear, you're talking about making sure you stick to your underwriting policies and basically not being tempted to go alongside the growth and taking too much risk compared to what you're comfortable with. Is that what you mean when you're talking about adjusting the growth rate? Hi, Tavi, and thank you for the question. Like we said at the end of last year, 2021 was a unique rebound year. When looking at 2022, and looking at the global uncertainties and changes that may occur, we think that the current pace is more appropriate, taking into account the uncertainties, and growing the existing pace. Like you can see, we grew at 5.5% for the first half. Obviously, like I mentioned, if we will see that the uncertainty level is lower in the future, we have all the resources to make the adjustments and adjust the growth pace. It depends, obviously, as well with the demand for credit that will be in that period. But overall, we feel very comfortable with the growth pace today. It is lower than what was in 2021. We think it is more responsible to be in that growth rate and not changing the risk appetite and growing at the same pace like in 2021 to grow in 2022 when you see the uncertainty. Right. Got it. Thanks for that. 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 Second Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.