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A year ago Bank Leumi CEO Galia Maor began a press conference marking the publication of the bank's financial results by cracking jokes at the expense of Bank Hapoalim, which at the time was embroiled in the debacle of its failed investment in American mortgage backed securities.

"I just happened to open our report to the important chapter on risk management at the bank," said Maor, hinting that the risks were not properly managed by the competition, whose name she did not mention. A year later it is unlikely that Maor will begin her upcoming press conference with such jokes.

On page 152 of Leumi's third-quarter financial statement, hidden under Note 12, "Events after the preparation of the balance sheet," is the following sentence: "If the capital markets continue to decline, this will have a negative effect on the fourth quarter's financial statement."

There was undoubtedly truth in that warning.

This week analysts cautioned against write-offs in Leumi's imminent fourth-quarter financial report. Darren Shaw, of UBS Israel, even lowered the investment bank's recommendation for Leumi's shares from Buy to Sell and predicted the bank would be issuing a profit warning.

Among other things, the analysts are concerned about Leumi's securities portfolio, which at NIS 41.6 billion is the largest of all the banks. Hapoalim currently has NIS 30 billion invested in securities.

One of the reasons for Leumi's giant portfolio is the bank's strategic non-banking assets policy, which extends to shares in The Israel Corporation, Paz Oil and Migdal Insurance.

At the end of the third quarter of 2008 Leumi's securities portfolio had declined by NIS 1.79 billion, and this sum was defined as a temporary decline.

The question now is how long such declines can remain temporary. Last October those declines were joined by an additional NIS 930 million that have yet to be applied to the bank's equity account.

Over half the losses that Leumi deducted from its equity account - NIS 940 million - had been provisioned for over a year. Over NIS 500 million were losses incurred over the previous 6-12 months, and about NIS 230 million were less than six months old.

A breakdown of the losses based on the sinking values of securities during that period shows that about NIS 1 billion of the losses stemmed from declines of up to 20% in the value of certain securities. The remaining NIS 750 million in losses stemmed from declines of over 20% in other securities.

The most frightening analysis in Leumi's financial report concerns the type of securities that shrank. NIS 1.33 billion of Leumi's NIS 1.8 billion in equity account write-offs at the end of the third quarter are defined as "other bonds." Industry sources suggest that this refers to bonds issued by foreign banks.

Although there is no telling exactly which foreign banks' bonds are in Leumi's portfolio, an indication of the performance of such bonds can be drawn from the Merrill Lynch index that tracks bank bonds. This index, which checks the yield to investors, has risen 4.4% since the end of October 2008. This means that Leumi's portfolio may have recovered a bit.

The increase in the Merrill Lynch index may be due to investor assessments that governments will have no option but to nationalize banks, because neither the United States nor European governments will allow their banks to collapse. Even so, that 4.4% increase includes a 3.4% backtrack since the beginning of the year.

Leumi's benefit from the improved foreign bank bond performance is also uncertain, as analysts estimate that since the end of the fourth quarter Leumi has been making every effort to reduce its corporate bond holdings, replacing them with government bonds.

Even that measure could cost Leumi dearly, as it will record the losses from the sale of the foreign bank bonds in its fourth-quarter statement. In addition, any securities that were not sold are likely to be worth even less than before.

That figure of NIS 2.7 billion in losses by the end of October 2008 really scares the market.

The uncertainty surrounding developments in Leumi's securities portfolio since then only added to investor anxieties, and were the main reason for the 20% slump in the bank's share price during the fourth quarter. That figure is much higher than the shrinkage in the share prices of the other banks, which receded by 4%-13% (apart from First International Bank of Israel, which shed 26% over the quarter).

Further uncertainty clouds Leumi's financial health due to potential problem borrowers. Some examples of the credit collection challenges facing Leumi surfaced in recent months as many Israeli companies confessed to cash flow difficulties.

Leumi has lent money to such companies as Vita-Pri Hagalil, Fredy Robinson's Milomor Trade and Prime Gan Oranim.

Leumi also has considerable exposure to Prisma Capital Markets, as the bank financed the investment management company's purchase of Hapoalim's provident funds.

Prisma is strapped for cash due to massive withdrawals by clients since that acquisition. These are some small examples from Leumi's loan portfolio, but are an indication of the problems facing the banks in general due to the financial difficulties of corporate borrowers throughout Israel.

Leumi has already made significant provisioning for doubtful debt in previous quarters. In the first nine months of 2008, for example, Leumi's provisions for doubtful debt were about NIS 400 million higher than Hapoalim's and accounted for 70% of the provisioning by all five big banks.

If that trend continues in the coming year, Leumi's profitability could be severely eroded.

Shaw estimates that Leumi will record losses of NIS 2 billion in the fourth quarter of 2008, due to even higher provisioning than that recorded by the bank in 2001-2002, and a decline of about NIS 1 billion in the value of the bank's securities portfolio.

The only question that remains is whether this estimate is also too optimistic.