Foreign Banks Cast Dark Shadow Over Local Counterparts

The cloud of pessimism that has engulfed the market hit a new low yesterday in the banking industry.

The rising stock market at the beginning of 2008 seemed to give good reason for optimism, but the cloud of pessimism that has since engulfed the market hit a new low yesterday in the banking industry.

Local analysts as well as Moody's rating agency have reiterated recently that Israeli banks are infinitely more stable than foreign ones, mainly because unlike in many foreign economies, Israel has not yet developed a market for exotic - and poisonous - financial instruments that have exacerbated the crisis elsewhere. Nevertheless, foreign financial institutions have a significant affect on local banks. Risk exposure comes from two major channels - nostro, investments in securities of foreign banks by large local banks, and deposits in foreign banks.

The bankruptcy of a foreign bank can inflict losses on an Israeli bank though investment in corporate bonds or financial instruments, or through loss of deposits with the defaulting bank. With the exception of exposure to failed Icelandic banks, this hasn't happened in Israel yet. Nevertheless, even if a bank does not fail, the reverberating shockwaves in banks worldwide, together with falling share values, are causing losses to local banks.

According to financial reports for the third quarter 2008, the five largest banks in Israel were exposed to risk totaling NIS 110 billion. Bank Leumi carried the largest exposure, of some NIS 48 billion, followed by Bank Hapoalim, with an exposure of NIS 30.5 billion to the storms being weathered by foreign banks. This was true as of the end of the third quarter of 2008, and there may well have been dramatic changes since then, with some of the banks diverting deposits or part of their securities investments to safer havens like government bonds. Diverting of assets can also mean selling off securities at a loss, for instance.

Third-quarter financials also revealed a risk exposure of some NIS 7 billion through investments and deposits in relatively risky financial institutions with BBB rating or lower. Again, Bank Leumi carried the highest exposure, of NIS 2.6 billion. Nevertheless, it is clear today that higher ratings do not provide immunity to the risks.

The primary concern is over write-offs that the banks will be forced to report in coming quarters for their devalued securities portfolios. Although markets have somewhat rallied recently, Monday's losses on Wall Street are not indicative of optimism. Bank Leumi, for instance, reported that its equity account declined some NIS 900 million in the interim between the end of the third quarter and publication of its financial report. If the bank recognizes part of these declines as permanent, the write-offs will affect its financial results. This is also the case for other banks, which have reported declines of their portfolios after the third quarter.

In addition, recognition of the fact that the global crisis is deepening leads to the unavoidable conclusion that the slowdown in the Israeli economy is heading toward a recession - and banks are the first to be affected by the economy. The effect is manifested in increased provisions for doubtful debt, which are debts that the bank believes unlikely to be collected and are reported in their financial reports as costs - to the detriment of their results financial results. Provisions for questionable debts in the third quarter reached 1% of its credit portfolio, and there are fears that this could increase to 2002 levels - 1.7%, leaving financial results bruised in the coming quarters.