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Shares of Israel Discount Bank and Bank Leumi had a very bad time last week - Discount fell about 12% and is now down 33% from the start of the year, the worst performance by any of the five large banks. Leumi dropped 10% and is now down 17% this year.

The pressure on the two stocks comes from overseas. The huge losses racked up by the semi-governmental U.S. mortgage lenders Freddie Mac and Fannie Mae have brought these U.S. firms near the verge of bankruptcy, said a number of senior U.S. government officials at the end of last week. Fannie Mae shares have plunged 74% since the start of the year, and 85% over the past 12 months. Freddie Mac shares performed even worse: down 77% since the start of the year, 87% over the past 12 months.

And what does that have to do with Leumi and Discount? Discount has a large investment in the two firms' mortgage-backed securities, and if as feared Fannie and Freddie have to raise a total of $75 billion in the near future - a near-impossible task - the value of the securities held by Discount will plummet. They were valued at NIS 9.3 billion at the end of the first quarter. This sum is even larger than the bank's entire equity value of only NIS 9.2 billion.

Leumi has invested NIS 4.1 billion in similar securities - no small sum - but this represents only about 20% of Leumi's equity.

Almost as worrying is the collapse of IndyMac Bank, which the U.S. Federal Deposit Insurance Corporation seized last Friday - the second largest U.S. bank failure in history.

IndyMac was one of the largest subprime mortgage lenders; the bank collapsed after customers withdrew $1.3 billion in deposits within 11 days in June. The bank had assets of $32 billion and revenues of $2.8 billion in 2007 - but a market value of only $28.3 million after its shares fell 95% over the past two years. The takeover is expected to cost the FDIC between $4 billion and $8 billion.

Until very recently, investments in Freddie Mac and Fannie Mae were considered rock solid, as they had an implied guarantee from the U.S. government, though not an official one. This made Leumi and Discount's investments safer than those of Bank Hapoalim, which invested in similar mortgage-backed securities issued by investment banks without any government back-up. Now it seems that Freddie Mac and Fannie Mae may not be immune after all.

The two U.S. firms have also seen a widening gap between the premium demanded on their bonds compared with U.S. government bonds. This premium has doubled in the past few weeks from about 0.4% to between 0.8% and 0.9%.

Israeli analysts forecast at the end of last week that large write-offs at Leumi and Discount are not likely, but they said there is a lack of certainty about these investments - so the shares have suffered.

For now both Leumi and Discount are valuing their MBS securities from the two semi-federal lenders at book value, 100 cents on the dollar. But analysts are worried that if the U.S firms are forced to re-evaluate their portfolios and bring much of the off-balance-sheet mortgages back on board, write-downs will be inevitable.

It is even possible that the U.S. government will be forced to nationalize the two enormous lenders in some form. In any case, the risk of default seems low, analysts say. But that does not mean they will keep their full value, and here lies the risk.

It seems Mizrahi-Tefahot is still the Israeli bank with the lowest exposure to the U.S. credit markets.

According to Yuval Ben Zeev from Clal Finance Batucha, even if the banks are forced to write down the value of their holdings, they will affect only the equity on the balance sheet and not the profit-and-loss statement. While the amounts could be significant due to the size of the investments, there are a number of mitigating factors: The banks have hedged some of the risk of the bonds and the investments have a short duration. But for now there is still a risk due to the uncertainty in markets, even for assets which are considered safe, Ben Zeev said. He added that Clal is not changing its recommendations for the two banks - for now. Ben Zeev said he thought the two were underpriced; Discount is selling at a market-to-book ratio of only 0.74. Leumi's price represents 1.14 times its equity value, but after neutralizing Leumi's holdings in The Israel Corporation, the price-to-equity ratio is only 0.93.

Supervisor of Banks Rony Hizkiyahu spoke of the matter last week. "There is no doubt the subprime crisis is still not over and there are still lessons to learn, but in the meantime the risks [related to] the federal agencies are still low," he said.

Hizkiyahu had forced Bank Hapoalim to set aside further capital toward the risks of its MBS portfolio, which in the end led Hapoalim to sell its entire portfolio. But for now Hizkiyahu does not seem to feel that similar action is needed for Leumi and Discount.

Sources close to Hizkiyahu told TheMarker yesterday that if the spreads for Freddie Mac and Fannie Mae's bonds increase significantly, in other words if there is a sharp drop in the value of the bonds - then the supervisor will reconsider his position on Discount and Leumi.

Nimrod Halperin contributed to this article.