Is Israel's Bond Market Cruising for a Fall?

Key bonds fell sharply on Sunday, but it is not yet clear that investors are repricing risk.

Moti Milrod

On Sunday, bond prices for many leading holding companies, among them IDB Development Corporation, Discount Investment Corporation, Africa Israel Investments and Alon Blue Square, fell steeply. Jerusalem Economic Corporation shares plunged 8%.

Still, it is still too early to see whether this signals a change in direction for the market. Sunday’s declines were limited to a few companies, mainly holding companies whose ability to repay debt over the long term is a little more in doubt that before. Each company has its own cause for concern.

The declines in IDB Development and Discount, for instance, came on the heels of the abortive initial public offering on Wall Street of the agrochemical concern Adama. The failure will not only inevitably reduce the value of Discount, which owns 40% of Adama, but also reawaken concerns about IDB’s two controlling shareholders, Edurado Elsztain and Moti Ben-Moshe.

The pair have put more than 1 billion shekels ($259 million) into IDB and have given bondholders another 300 million shekels. But apart from reports that the two are fighting over strategy and control, there has been little good news from the IDB group.

Close to a year after Elsztain and Ben-Moshe won control, the conglomerate remains financially unsteady: Its debts to bondholders and banks amount to 4 billion shekels while the value of its core holdings, including Super-Sol, Cellcom Israel and now Adama, have been falling.

It is more difficult to relate the drops in Africa Israel and JEC to a specific event. Market sources point to the cover story in the British weekly The Economist about Russia’s growing economic problems and the risk of recession there caused by Western sanctions.

Africa Israel has extensive real estate investments in Russia, while JEC has residential real estate interests in the St. Petersburg area, making them both exposed to Russia’s ups and downs.

In all events, the droop in holding company bond prices, together with the 5% decline in Adama bonds, prompted considerably volatility in the overall bond market. The Tel-Bond Yields index lost 2% while the Tel-Bond 20 dropped 1%, although the share market was considerably more placid: The TA-100 index lost just 0.6%.

Whatever gyrations the fixed-income market suffered on Sunday, the fact remains that investment money is still flowing into the market, and raising money there is easy. Africa Israel itself raised 700 million shekels just three months ago in a new bond series and JEC did the same a year ago.

However, Sunday’s movement may signal a growing awareness of the risks in the market. Even if those risks have yet to be priced into local bonds market-wide, warning signals have been sounding for some time.

“The biggest, fundamental threat is due to the fact that the yields that government bonds, Makamim [short-term notes] and other longest-term bonds unlinked to inflation are the lowest they have ever been in the Israeli capital market,” said Zvi Stepak, one of the principals of the Meitav Dash group.

“That means prices are very high. They aren’t sustainable over the long term, which invites trouble. Under such circumstances, any negative external trigger could easily bring down bond prices,” he said last March.

The Bank of Israel offered its two cents in May. “Concerns about underpricing of risk in the bond market have been growing. Spreads continue to narrow and in recent months have reached very low levels, similar to those seen in the second quarter of 2008.” That was on the eve of the big global market financial blowout.

The central bank repeated its warning in the minutes of its August interest rate meeting.

So far, the Israeli market has ignored the warnings. The flood of money going into the market has been stronger than any of the dams erected by those worriers.

However, Sunday’s gyrations were not the only hint that the warnings are beginning to be heard. Last week the bond sale by the American real estate company Spencer Equity Group met with very weak demand. Likewise, the bond sales by the Hamashbir Lazarchan retail group failed. The investing public is no longer ready to put up money for debt at any price.

Government bond prices are unlikely to escape any washout in the bond market. Last weekend Israel received a blow from the rating company Fitch, which revised its outlook on sovereign foreign debt to Stable from Positive. Fitch expressed concern about the deepening government deficit, Israel’s slowing economy and the growing defense budget.

The reaction in the market was very restrained. The longest-dated shekel bonds, due in 2042, fell 0.5% on Sunday.

But this could just mark the beginning. Between slowing economic growth and growing security problems, it is hard to understand why the risk premium on Israeli 10-year bonds is the same as that on their U.S. peers.