Earnings Call: Q1 2022

May 23, 2022

Summary

Q1 net income reached a record ILS 1.65bn, with 15.6% ROE and CET1 of 11.17%. Credit growth moderated, while rate sensitivity supports financing-income upside; dividends may resume from Q2, subject to conditions.

Ladies and gentlemen, thank you for standing by. Welcome to the Bank Hapoalim First 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 the financial information on the homepage, and then click on the First 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 0. As a reminder, this conference is being recorded May 23rd, 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 respective company's business, financial condition, and results of its operations are subject to risk 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, risk 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. Gabbay, would you like to begin? Good afternoon, and thank you for joining us today to discuss Bank Hapoalim's first quarter results. I am proud to present this quarter, which is a record quarter for Bank Hapoalim, with ILS 1.65 billion in net income and 15.6% return on equity. Cost-to-income ratio was 50.9%, and the CET1 ratio stands at 11.17%, actually increasing despite that first effect of the rise in yields. Our results reflect a number of key elements that I would like to focus on. First, the continued growth of our activity in line with our consistent execution of our strategy, coupled with the high contribution of the CPI, led to a strong increase in income while expenses were curbed. This continued trend creates significant positive jaws. In recent conference calls, I mentioned that we aim for positive jaws in our profitability, and we are proud to see that we are making it happen. A main driver of this profitability was credit growth. Over a year ago, we set substantial growth targets for the business and retail divisions of the bank, and indeed, credit growth was considerable quarter by quarter, riding on the economic rebound. As you can see, this quarter's growth was still relatively high, but not as high as the 2021 pace. We believe that this balanced pace of growth better suits the current and developing risk environment. I remind you that this is in line with what we discussed in our last call. We see the changes in the U.S. and global economy that could also trickle down to Israel, and we think that keeping the high pace of last year would not fulfill the proper balance expected at this time. My second point relates to inflation. In early 2021, we made another substantial decision that has an impact on our results. We recognized that it would be beneficial to increase the exposure of the bank's balance sheet to the CPI. Indeed, as our financial report shows, we have been harvesting the fruits of this decision for several quarters. It appears to have been a good call, both in terms of the near future, with the CPI for the second quarter of 2022 almost fully known, as well as for the more distant future, as the inflationary environment rises. The third factor affecting our results was income from credit losses due to significant recoveries of individual allowances. Although this high level of recoveries is not routine, it reflects the bank capabilities and responsible decision-making when it comes to risk. The same is true for our current provision for credit losses, which is clearly low. Obviously, it is still impacted by the post-COVID effect. Looking ahead, it is reasonable to assume that we will probably see convergence towards higher levels. Our quality of the loan book, our underwriting capabilities, and high portfolio diversification will continue to play a significant role over time. The fourth material decision we have made that I would like to mention relates to capital. Some of you questioned our decision to prioritize the execution of our strategy over distributing an additional dividend in respect of 2021 in the last quarter. It is now clear that everything that has happened since then, and I mean the intensified rising interest rate curve alongside with negative developments in the macro environment, has further justified that decision. Now, back to this quarter, the board continues to prioritize the implementation of our long-term growth strategy, and therefore resolved to refrain from dividend distribution this quarter. This is despite our very strong numbers in this quarter and growth of 21 basis points in the Q1 capital ratio to 11.17%. This cautious approach of the board is supported by the market volatility and rising uncertainty in the economic environment, including in connection with the possible slowdown in global activity. It is important for us to return to a trajectory of ongoing dividend distribution soon, and we consider our solid capital position and balanced growth as important elements that support a possible dividend resumption in respect of the second quarter of 2022 and onward. One last important element to highlight before we move to review the slides is the highly significant upside we see for the bank from the expected Fed and Bank of Israel interest rate hikes, as disclosed in our report. This upside is driven by our largest-in-sector retail deposit base. Now, let's quickly go over the presentation. I won't go into every slide in detail. The presentation is clear and detailed, so I will just stress our key takeaways from each main topic. Slide 3 presents the main messages for the quarter. I touched upon those messages in my opening. Slides 4 and 5 relate to the macro environment. We think that the global economy is approaching a more challenging period, which includes softer economic activity, elevated inflation, and tighter monetary conditions. The Israeli economy and financial system are well-positioned to cope with this volatile and riskier period. Obviously, it's fair to assume that the global changes will have some impact on Israel. We witnessed some decline in economic activity in the first quarter, but we have to keep in mind that last year's growth was quite exceptional, and if we smooth the data, the Israeli economy is still on a positive trend. Some of the effects that supported fast growth last year are now working in the opposite direction, and I can mention two of them. The flow of venture capital money to Israeli high-tech companies has decreased, and Israelis are now back to traveling abroad, which affects domestic demand. Inflation has increased to 4% in the last 12 months, still lower than in most advanced countries, but price increases are broadening against the backdrop of a tighter labor market. The central bank began to hike rates, and the market expects now a 2.75% rate a year from now. I'm moving to slide 5. As I said, we believe the Israeli economy is resilient, and we can see through almost any parameter. In the labor market, for example, we are returning to full employment with high demand for workers. The fiscal stance has improved, and the deficit declined to only 0.6% of GDP in the last 12 months. The housing market is vibrant, and we finally do see a reaction from the supply side. The number of housing starts increased substantially, which can help stabilize the market going forward. I'm moving ahead to slide 7, 8, and 9, where we show our impressive continuous credit growth across most segments, and more importantly, its impact on income, which is consistently growing quarter by quarter. Slide 10 shows one of our balance sheet's outstanding strengths. We have the largest retail deposit base in the sector, amounting to ILS 296 billion, bringing our retail deposit to loans ratio to 81%. As I mentioned earlier, our deposit base is one of our competitive advantages for the future. Slide 11 presents the continuous growth in financing profit. I want to draw your attention to the right-hand side of the slide, which shows the 12.2% year-on-year growth in income from regular financing activity, excluding CPI. Another note to point out in this slide is our sensitivity to interest rates. Just to give you some color on our sensitivity to interest rates, you can see in our report that a parallel increase of 1% in rates is estimated to increase financing income by ILS 1.5 billion. Obviously, it is subject to the model's assumptions. Moving to slide 12, where we show the positive trend in fees, which grew by almost 9% year-on-year. In slide 13, cost-to-income ratio is improving, although the first quarter's expenses were almost 3% higher versus last quarter. This increase is mainly due to a provision for performance-based bonuses and an increase in the provision for vacations. Slide 14 and 15 are highly important, especially as we might face a certain slowdown in the economy. On the right-hand side of slide 14, we present several indicators reflecting the high quality of the book. For example, 141% of our non-performing loans is covered by the allowance. Moreover, the NPL ratio continues to decline and is now 0.92% under the CECL accounting standard. To complete the picture, it's important to understand that the high quality of our book is an outcome of our conservative underwriting standards. In slide 15, we present a few facts and figures characterizing the quality of our underwriting. I will not go over all of them, just highlight a few. Only 1.1% of our real estate projects that are still under construction have an absorption rate lower than 25%. On mortgages, around 60% of loans have an LTV lower than 60%, and only 0.5% of our mortgage book is in arrears of 90 days or more. This healthy picture also applies to the consumer credit book, where our charge-offs are very low, an excellent starting point to the period when defaults will be back to normal, if and when it happens. On capital, in slide 16, it's important for me to share that in light of the macroeconomic volatility, as we can see in the rates curves and the dollar-shekel exchange rate, we have taken steps to optimize capital and mitigate risk-weighted assets. Those high capabilities allowed us to absorb the adverse effect, and thanks to our organic capital generation, we presented an increase in our CET1 ratio. As I mentioned earlier, we consider the level of capital ratios and the expected growth as important milestones on the path towards potentially renewing dividend distribution in respect of the second quarter of 2022 and onward. Obviously, it's subject to all the regular caveats. In slide 17, we present our strategy, centered around three pillars, the main of which is the growth in core banking. Our commitment and determination in the implementation of our strategy creates a growing and improving bank. Lastly, on slide 18, we summarize the key takeaways. Very strong profitability in the quarter. Credit growth still high, but adapted to the current environment in terms of risk. We see a continuous positive trend in our core bank business. We maintain a high-quality loan book, thanks to a prudent underwriting approach. Our capital is robust, and its level is important element in supporting a possible dividend resumption in respect of the second quarter of 2022 and onward. We see a significant upside potential as we are well-positioned to benefit from the expected interest rate hikes. With that, let's open the call for your questions. Thank you. Ladies and gentlemen, at this time, we'll 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 Tavy Rosner of Barclays. Please go ahead. Hi, good afternoon. Thanks for taking my questions. I wanted to touch a little bit about the sensitivity to interest rate hikes. You mentioned that in your prepared remarks, and obviously, it depends on the assumptions you're using. I just wanted to touch on one assumption, which is your retail deposit base. You mentioned that being one of your competitive advantage. Does your model assume that a portion of your retail base will kind of shift from non-interest-bearing deposits into the interest-bearing deposits? Is that factored into the figures that you mentioned, the assumptions of the rate hikes? Tavy? Thank you, Tavy, for the question. Well, this is very interesting and important question while taking into account the announcement by Bank of Israel. Generally speaking, the effect of 1% parallel increase in interest rate is ILS 1.5 billion annually. Obviously, this relates to Fed increase and local Bank of Israel interest rate increase as well. If you want to understand the portion of the effect of the local interest rate, then you should look at the portion of shekel assets and the portion of shekel liabilities in our balance sheet. Overall, if you look at the tables and the numbers, it's around, let's say, between 85% to 90% overall, the effect of the ILS 1.5 billion multiplied by zero, for example, the late announcement, 0.4%, you will get some figures. Obviously, like you mentioned, and correctly, this is based on a model and assumptions. There are assumptions in the model. By the way, I assume every bank uses its own models and has its own assumptions. So it's not fully comparable, but as an answer for your question, yes, we are taking into account some shift in deposits as a result of interest rate change. What's important of that while calculating the effect is understanding that the main vector that supports that this is a large portion of retail deposit base. So if you are having some comparable numbers or figures, that's a very important element while comparing numbers from different banks. As I mentioned, the models may vary from one bank to another. That's helpful. Then last one for me. This is relatively unknown territory. I mean, it's been a while since the Bank of Israel is increasing the rates that they face. When we factor in the rate hikes, the macro environment, how should we think of loan growth into the next foreseeable future? What do you see as a sustainable, reasonable kind of growth rate? Yeah. Thank you, Tavy. Victor will take that question. Well, thanks, Tavy. If you look at the financial markets right now, if you look at the IRS market right now, it implies some rate of 2.5% one year from now. With inflation of 4%, for us, it looks quite reasonable, though we think maybe it will be a bit below 2.5%, but right now, 2.5% a year from now looks very reasonable for us. Okay. Thanks, guys. I appreciate it. The next question is from Micha Goldberg of Excellence. Please go ahead. Hi. A small correction, currently from Fedot, but question on slide 15. Can you tell us what percentage of your construction and real estate credit risk has currently LTV of over 75? Micha, thank you for your question. You ask what portion of our real estate is above LTV of 75? Yes. I mean, I'm simply trying to understand what the potential impact would be of the Bank of Israel's guidance on the new 75% housing loan thing. You have in your slide here required amount of information, so I was wondering what you can show there. You're asking about housing and LTV in housing and mortgages? Yeah. Are you asking about the draft new instruction by Bank of Israel? I am asking regarding the draft, regarding construction real estate loans. Okay. You ask about the effect of that. Well, the numbers or the estimates for the effect are not public. Obviously, the effect also depends on the implementation, whether it will be a one-time implementation or gradual implementation. So the effect will depend on that. You can see in our quarterly report, we have some disclosure about the percentage, what is between 65% and 85%. And there you can see the numbers. It is in table 3-9. Can you tell me more or less what the size of what the corporate real estate loan that is- About 50%, between 65% to 85%. How much is 50% in billions of ILS? It depends if we look overall or only on land. If you look on land between 65% to 85%, it's about ILS 16 billion. Overall, between 65% to 85%, I think it's a little bit than ILS 23.6 billion. Okay. The relevant number would be somewhere near ILS 16 billion exposure. No, it depends how it spreads in this group. It is not necessarily, let's say, spread evenly in this group. So it is reasonable to assume that as long as you are in high portion or high level of financing, the portion is even lower. Okay, understanding. It is not a dramatic potential impact, but it is definitely a significant one. Yeah. It is a dynamic element as well. But like I mentioned, we did not disclose any public data about the effect of that. Obviously, it will have some effect. The effect will depend as well as on the implementation, whether it will be one time or gradually over time, et cetera. I understand. Thank you very much. Another question. I mean, I am just wondering, you said, I think, that you did a lot of effort to increase your capital adequacy ratio, and you come next year, 11.17%, which is something like 70 bips above your internal targets, correct? I am just wondering, I mean, you mentioned, I think, earlier on that you had slowed down the loan growth, and we are going to see that in the second quarter. Would it be prudent maybe to consider raising capital so you can start growing again? I remember in the past, you guys had a very strong strategy on growing loans. So, I am just wondering, in the current situation where demand seems to be still very strong, would you consider that as an option? Well, like you mentioned, we, and like the board of directors said, decided last time to allocate capital to growth and implementing and executing our strategy. That is the case for this quarter. We feel very comfortable with our capital position, with our capital ratio, and we see an increase of 21 basis points, despite the economic environment, in our first-tier capital ratio. Like we said, we feel comfortable with that level and with the growth pace we see. Obviously, this year, we are looking on moderate growth rate than in last year. It is aligned with our strategy, and it is also aligned with the possible change in the macro environment. Overall, we have sufficient capital to implement our strategy in the future. Obviously, everything is subject to, like we mentioned in our aspiration for dividend, it is subject to macroeconomic conditions and other elements of the- Okay. Thank you very much. The next question is from Michael Klahr of Excellence. Please go ahead. Hi. Good afternoon. Thanks for taking my questions. Firstly, did you disclose what the impact is to date in the second quarter from the declines in the bond market? Could you give a number of what the hit to capital is from the market volatility over the last, since the beginning of the quarter? Yeah. Thank you, Michael, for the question. We have disclosed the effect on page 25 of our report. Overall, the effect since the end of the first quarter till the publishing of the report, the gross effect is ILS 400 million, but net effect, net from offsetting by the effect of employee benefit and tax, it's around ILS 100 million. Okay. So quite small. Secondly, I just wanted to ask on dividends. Just to be clear, in the second quarter, you're going to come with a policy or a clearer outlook as to dividends going forward, or you're just going to come with a dividend for that particular quarter? Well, our policy, like you remember in the reports, is distributing up to 40%. Like we said, the growth rate and our current capital position, letting us say that we feel very comfortable when we see in those elements very important in potential resumption of dividend distribution based on the second quarter results. Obviously, it's subject to all the elements that we disclosed and all the tests, and I assume that the amount, if and when the amount and the percentage will be subject to those elements. I suppose what I am asking is, are you going to come with any At the moment, right, you had a dividend policy, 0% to 40% is very wide and leaves a huge amount open to interpretation. You even had it in the last quarter, right, when you did not pay a dividend or suspended the dividend. I suppose I am just trying to get an understanding as everyone is subject to the same macro conditions and the changes in the macro environment. But are we going to come to a position where we are going to be able to look forward and say, "This is the Hapoalim's dividend going forward, assuming a, I do not know, a quarter one ratio above their internal targets, et cetera"? Are we going to be kind of guessing every quarter as to what it may be based on the macro conditions and the growth rates at that particular time? Yeah. Michael, I think we were very clear in what we said and what we disclosed, that the bank estimates that current solid capital position and the balanced growth are very important elements that supports a possible, let us say, dividend resumption in respect of the second quarter and onwards. The policy is, like you mentioned, up to 40%. The board of directors will take into account, after the second quarter reports, all the elements and decide what will be the portion. But the intention is very clear, and the way we see our position and growth rate is very clear. Obviously, like you mentioned, it is subject to some elements, but we see our position now very important towards resuming based on the second quarter results. Okay, thanks. Then just lastly, I just wanted to ask on the rates of provisioning, and you said that you would expect that to kind of normalize or go higher further out. Should we think, obviously, I think those significant recoveries kind of surprise the market. If you look across your portfolio, what is your sense in terms of further recoveries? Also, how comfortable are you with your current rates of allowances, given the couple of We have had a negative GDP reading in the quarter. We are seeing other kind of flags in terms of the rate of growth in the economy. Just wanting to understand how you feel with your current credit quality. Thank you. Well, thank you, Michael. If you look at our last reports, you will see that every quarter we have recoveries as part of managing our portfolio. From quarter to quarter, there are some events that you see large recoveries, like we see in this quarter. When looking at the future, it is important to understand that this number that we see today in the last quarter obviously affected by the COVID effect. If we look in the future, it is reasonable to assume that we will be back to, let us say, the normal rate. It is hard to say what is the normal rate, because it depends on the terms in the future. But if you look at the past, Bank Hapoalim rates were about, before COVID, between 0.2% to 0.25%. So, looking at the future, it is reasonable to assume that we will be back to numbers. Whether it will take more time or whether it will be less than this number, depends on the macro environment terms. But obviously, our good quality of the book will be important element in the scheme of how we will return to numbers and what will be the exact numbers compared to those numbers. Okay. 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 First Quarter 2022 Results Conference Call. Thank you for your participation. You may go ahead and disconnect.