Israel Bank Valuations Lowest Outside Europe on Bad Debts

Israeli bank valuations are falling to levels that preceded a surge in loan losses three years ago, just as 20 billion shekels ($4.9 billion) of company debt comes due and economic growth slows to the weakest pace since 2009.

The Tel Aviv Banking Index trades for 0.58 times net assets at the 4:30 p.m. close in Israel, less than every financial-stock gauge outside Europe, after dropping 38 percent in the past 12 months, data compiled by Bloomberg show. The last time valuations sank to this level was in November 2008, four months before Bank Leumi Le-Israel Ltd. and Bank Hapoalim Ltd., the nation’s biggest lenders, posted loan losses that cut industry profits to record lows.

More than 30 Israeli companies sought debt forgiveness since 2011 as refinancing costs rose and growth slowed, the Israel Securities Authority said in a July 1 report. Nonperforming loans may increase to 5 percent of the total by mid-2013 from 3.8 percent in September, according to Moody’s Investors Service Inc., amid the biggest wave of restructurings in three years.

“Valuations of the banks haven’t reached the bottom yet,” Yossi Efrati, who oversees $1.5 billion as the head of investments at Hachshara Insurance Co. in Tel Aviv, said in a July 26 interview. “We may see more downside and in the long-run we don’t expect historical upside to return.”

‘Rising Risks’

Bank Leumi, whose Chief Executive Officer Rakefet Russak-Aminoach took over on May 1, is down 44 percent in the past year compared with a 9.9 percent drop in the nation’s benchmark TA-25 stock index. Bank Hapoalim, where Zion Kenan became CEO almost three years ago, has lost 33 percent, while Israel Discount Bank Ltd., led by Reuven Avraham Spiegel, dropped 45 percent in the same period. All three lenders are based in Tel Aviv. Ramat Gan, Israel-based Mizrahi Tefahot Bank Ltd., run by Eliezer Younes, slid 18 percent.

The Tel Aviv banking index has fallen 13 percent this year, compared with a 2.3 percent gain for the TA-25.

Bank Leumi and Bank Hapoalim both said on May 31 that first-quarter profit fell more than 20 percent as they posted a combined 528 million shekels of provisions.

Loan-loss provisions at Bank Leumi will probably jump 63 percent this year to 1.2 billion shekels while those at Bank Hapoalim may rise 17 percent to 1.4 billion shekels, a three-year high, according to Yaniv Pagot, the chief strategist at Ramat Gan-based Ayalon Group Ltd., an investment firm with 13 billion shekels under management. The combined 2012 estimate of 2.6 billion shekels compares with about 3.7 billion shekels to cover bad loans reported by the lenders in 2008.

Struggle Ahead

Israeli companies will struggle to issue new debt and roll over maturing liabilities to pay obligations coming due in 12 months, Moody’s said in a report on May 8, the same day it cut the outlook on the nation’s banks to negative from stable. Government efforts to increase competition and curb fees may drag on growth, reducing pretax profits by as much as 9 percent, according to a July 23 report from the ratings company.

Citigroup Inc. reduced the 12-month price estimates for Leumi and Israel Discount Bank by about 50 percent on July 24 to 9 shekels and 4 shekels, respectively, while lowering ratings on both to neutral from buy. Leumi shares closed at 8.95 shekels on July 26 and Discount last traded at 3.7 shekels in Tel Aviv.

The Tel Aviv Banking Index tumbled to 0.47 times net assets during the depths of the global financial crisis in March 2009, data compiled by Bloomberg show. Lenders in the index reported 2.5 billion shekels of provisions for loan losses that month, contributing to a drop in their combined annual net income to 205 million shekels, the lowest level since Bloomberg began tracking the data in 1996.

Accumulated Debt

While banks’ share prices and earnings rebounded from March 2009 through 2010 as the economy recovered from a recession, the expansion has weakened every quarter since then as exports to Europe waned. Gross domestic product growth fell to 2.7 percent in the first quarter from 7.6 percent at the end of 2010, according to government data.

Companies from Delek Real Estate Ltd. to Tao Tsuot Ltd. took on obligations when the economy was expanding twice as fast. The nation’s 10 biggest conglomerates now have about 140 billion shekels of accumulated debt, equivalent to 16 percent of GDP, according to Moody’s.

The Tel Aviv banking index’s price-to-book ratio dropped to 39 percent below that of the MSCI All-Country World Financials Index last week, the widest gap since December 2004, according to data compiled by Bloomberg. The gauge’s valuation is lower than 33 of 41 industry indexes in developed and emerging countries, the data show.

‘Not Buying’

While Israel banks are cheap, “we are not buying, as there is uncertainty regarding provisions and economic growth,” said Ronen Elgali, the head of research at Tel Aviv-based Sphera Funds Management Ltd., which oversees about $450 million.

Yields on bank bonds suggest that investors are confident that falling profits won’t erode lenders’ financial strength and the government will stand behind them, according to Ayalon’s Pagot.

The yield on Bank Hapoalim’s inflation-linked notes due March 2021 dropped 119 basis points, or 1.19 percentage points, during the past year to 2.17 percent, according to exchange data compiled by Bloomberg. Yields on Bank Leumi’s bonds maturing November 2017 fell 102 basis points to 1.75 percent. The Merrill Lynch Global Broad Market Financial Index dropped 57 basis points to 3.37 percent for the past 12 months through last week.

“The Bank of Israel’s banking supervision department will do everything in its power to maintain the stability of the banking system,” Governor Stanley Fischer said in a speech at an economic conference at the Dead Sea on June 28.

New Guidelines

The Supervisor of Banks said in a report last week that borrower concentration continues to be a focus of risk and is “liable to have a marked effect on the banking corporations’ capital.” Regulators issued draft guidelines for improving risk management in the financial system last month. Yoav Soffer, a Bank of Israel spokesman, declined to comment.

Ofra Preuss, a spokeswoman at Bank Hapoalim, declined to comment when contacted by phone on July 11. The office of the spokesman of Bank Leumi said in an e-mailed response on July 16, the lender doesn’t have a comment.

“We have shown improvement in our loan book over the past year and our exposure to large borrower groups is among the lowest compared to our peers,” Barry Simon, the head of investor relations at Israel Discount Bank, the country’s third-largest lender by assets, said in an e-mailed response to questions on July 12.

‘Quality Characteristics’

Investors recognize Mizrahi Bank’s “quality characteristics,” Benny Shoukron, a company spokesman, wrote in an e-mailed statement on July 11, citing its price-to-book ratio relative to peers. The 0.84 ratio is the highest in the Tel Aviv banking index, according to data compiled by Bloomberg.

At least 34 companies started debt settlement talks with bondholders last year, up from 20 in 2010, according to the latest data from the Israel Securities Authority on July 1.

Restructurings are under way for about 7 billion shekels of debt, Moody’s Midroog said in a report in June. Refinancing costs have increased, with 41 percent of corporate bonds trading at yields above 8 percent at the end of June, compared with 29 percent in April, according to a July 4 Standard & Poor’s Maalot report.

Debt Settlement

Delek Real Estate, the Ramat Gan-based property company controlled by Israeli tycoon Isaac Tshuva that owes 2.1 billion shekels in unsecured debt to bondholders, reached an initial agreement in July for a 1.5 billion-shekel settlement.

A court-appointed trustee is negotiating a debt settlement of more than 330 million shekels between Tao, the investment company controlled by Israeli entrepreneur Ilan Ben Dov, and bondholders, according to a Tel-Aviv Stock Exchange filing on June 28.

Bank Leumi took 4.9 million shekels from Tao’s account for immediate repayment of debt. The Petach Tikva-based company owes 79 million shekels to the lender, according to the stock exchange filing.

“I wouldn’t recommend investing in the banking sector in Israel,” Joseph Wolf, an analyst at Barclays Plc in Tel Aviv who rates Hapoalim a buy, said by phone on July 27. “The combination of a slowing economy and a more stringent regulatory environment means that banks will have a hard time growing and producing good returns in 2012.”

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