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Earlier this week Bank Hapoalim issued a profit warning over anticipated losses from regular operations for the second half of 2008. Hapoalim expects to record operating losses of 1%-3%, net losses of 0%-2% for all of 2008 and net profits of over NIS 1 billion for the second half of the year.

Considering the bank's net losses of NIS 973 million for the first half of 2008, profits for the entire year are expected to be minimal at best. In the first half of 2008 Hapoalim had operating losses of NIS 1.46 billion. The significance of the profit warning is that the operating profits the bank expects to record for the second half of the year will not exceed the losses incurred in the first half, resulting in a net loss from regular operations (excluding one-off profits of about NIS 50 million from the sale of Bank Yahav).

This was Hapoalim's second profit warning this year, following the publication in May of $1.3 billion in losses stemming from the sale of the bank's mortgage-backed securities portfolio. At that point Hapoalim forecast profits from regular operations, but now the picture appears gloomier, with anticipated third-quarter net return on equity of 7%-10%.

Sources at Hapoalim attribute the profit warning to the impact of the global financial crisis on banking systems worldwide, including in Israel. Hapoalim had previously reported $109 million in exposure to Lehman Brothers, which collapsed, and industry sources estimate Hapoalim's exposure to Washington Mutual, which also failed, at $25 million. Hapoalim figures it will have to write off a large share of its exposure to Lehman Brothers, but should be able to recoup about 60 cents on the dollar from its investment in Washington Mutual, and has therefore provisioned about $10 million for that eventuality.

Hapoalim's exposure to troubled foreign banks is apparently not the only reason for the profit warning. The global crisis has weakened the repayment capability of the local business sector too, prompting the bank to increase its provisions for doubtful debts in the coming quarters.

Recently, for example, Milomor, controlled by Fredy Robinson, applied to the Tel Aviv District Court for protection from creditors, the largest of which is Hapoalim, which had provided long- and short-term financing totaling NIS 490 million. The repayment of those loans is now doubtful and Hapoalim will have to provision accordingly, if it has not already done so.

Milomor is an example of a small company in trouble, but there are larger companies that the market fears will by unable to repay their debts. These include Lev Leviev's Africa Israel Investments and Yitzhak Tshuva's Delek, both of which owe the bulk of their loans to Hapoalim, and whose share prices have plummeted tens of percent since the beginning of the year. Leviev, for example, recently had to sign liens on his entire stake in Africa Israel to the banks in order to strengthen the securities he had provided against the loans he had received. Even if the bank's third-quarter reports show no provisions for its big borrowers, this is certainly a possibility in the coming quarters.

Hapoalim is not the only bank likely to suffer from the global financial crisis. Israel's other large banks are equally vulnerable, but unlike the others, Hapoalim has had a particularly difficult year, with poor overall results due to its losses from the sale of its mortgage portfolio. In addition, since Hapoalim is the only bank to publish targets for this year, it is also the only one that had to revise them downward.

Bank Leumi, for example, had greater exposure than Hapoalim to both Lehman Brothers and Washington Mutual - to the tune of about $180 million and $50 million respectively. Its corporate loans division has some more problematic borrowers, such as Tower Semiconductors and Eyal Ben-Dov's Tao Tsuot, and Leumi will likely be provisioning for doubtful debts from these clients. Leviev has also received loans from Leumi.

Yuval Ben-Zeev, head of research at Clal Finance, was not surprised by Hapoalim's profit warning.

"On the one hand," said Ben-Zeev, "NIS 1 billion in profits for the second half of the year is good news, as this reflects 11% return on equity. Still, there is no doubt that these figures are not as good as we thought. The difference between the 2%-4% return from the profits on regular operations (as forecast in April and August, after the publication of the second quarter reports) and a negative return of 1%-3%, based on the current announcement, is about NIS 900 million, as the [bank's] equity is about NIS 18 billion. This shows that even when the crisis is worsening, the bank remains optimistic. The more interesting figures are the bank's targets for 2009, which could be as much as 12%-13%." Hapoalim's share price has shrunk by 51% since the beginning of the year, reducing the bank's market capitalization to NIS 11 billion - about NIS 18 billion less than its record high in 2007.