Last week saw the approval of one of the most important mergers in Israeli banking: Mizrahi Tefahot Bank, the country’s third-largest lender and its most profitable one, is closer than ever to buying control of Union Bank, ranked sixth with a market share of around 2%.
The go-ahead for the merger given by Judge Oded Shaham of the Jerusalem Competition Tribunal effectively reverses a May 2018 decision by the Competition Authority, which had ruled that the merger would hurt competition, especially in retail banking. The authority had been under immense pressure from Finance Minister Moshe Kahlon and Economy and industry Minister Eli Cohen to block the merger.
The court has not released a full version of its ruling but in a condensed statement it said that “given the characteristics of Union Bank, the difficulties it faces and the absence of any indication that the bank significantly influences the other players in the market, there is no basis for concluding that the bank’s absence is likely to significantly harm competition.”
The Competition Authority has not issued an official response to the ruling, but sources said officials were studying it and no decision had been made. In any case, however, the authority will have to decide about the future of the banks’ loans to the diamond industry.
Both banks are leading players in the segment, with Union alone having loans outstanding in the hundreds of millions of shekels. Sources say the authority will condition final approval of a merger on Union’s divesting the portfolio. It will be a challenging task for the banks because the sector is regarded as increasingly risky due to falling diamond prices. Most of the big banks in Israel have stopped lending to it altogether.
If the merger does go through, Mizrahi will buy the 75% stake in Union owned by its controlling shareholders and another 25% traded on the Tel Aviv Stock Exchange. Mizrahi will pay in shares the equivalent of 60% of Union’s shareholders’ equity. Adding in a 100-million-shekel ($28.8 million) dividend to be paid to shareholders before the deal is completed, the total payout will be about 1.5 billion shekels.
The terms of the merger ensure it does nothing to compromise Mizrahi’s capital adequacy while enabling it to increase its dividend payout, which today stands at 40% of net profit.
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News of the merger approval caused the price of Union stock to spike 15.5% higher Thursday, although it retreated 0.7% Sunday to close at 20.25 shekels on the TASE, or 0.57 of book value. Mizrahi shares rose 4.2%, shedding 2% on Sunday to end at 91, or 1.35 times book.
Union has been controlled for the past 26 years by a handful of Israel’s richest families. The biggest among them is Shlomo Eliahu, who controls a 27.1% stake. Since Eliahu acquired Migdal Insurance in 2012 he has been under orders from the Bank of Israel to divest his Union holding, although he succeeded in delaying the deadline. The Union sale will enable him to repay as much as 400 million shekels of personal loans.
The No. 2 shareholder is the Landau family, which owns the energy group Ratio, among its other interests, with 24.8% in Union. The Manor family and Yael Almog-Zakai, with 22.9%, have interests in the auto and real estate sectors, among others.
Despite their wealth and influence, the group never succeeding in improving Union’s performance or market share. There were several reasons for that, among them the controlling shareholders’ refusal to inject more capital into the bank.
In addition, Union was saddled with the high 200 million shekel annual cost of having Bank Leumi manage its computer systems. Labor costs were also a hefty 400 million a year because the bank’s collective bargaining agreement tied wage terms to those at Leumi. Regulatory barriers prevented it from expanding services.
The result was that Union’s return on equity over the last few years was 4%-5%, much lower than for the rest of the banking system.
Union tried to be more competitive, among other things by offering interest on checking accounts that enabled it to lure thousands of new clients. That was a big increase for a small bank, but it had no impact of the banking system as a whole.
Under the leadership of its previous CEO, Eli Younes, Mizrahi Tefahot undertook a successful series of mergers and acquisitions, among them the merger of its Tefahot mortgage unit into the parent company to create the bank that exists today.
Under the current CEO, Eldad Fresher, Mizrahi concluded that it had realized all the growth potential it could get out of the booming mortgage market where it enjoys a 35% share. Its current strategic plan calls for increasing lending to business.
Thus, when Union Bank was put up for sale at the end of 2017, Mizrahi saw it as a rare opportunity to boost profits and enhances its status in the banking sector. Union is the biggest of Israel’s three small banks, all of which were in one way or another on the block.
Completing the Union deal will turn Mizrahi from a mortgage-focused lender into a real bank better able to compete with the two dominant players, Bank Leumi and Bank Hapoalim. Union has shareholders’ equity of 2.36 billion shekels and 36 branches nationwide.
Even if some of them are shuttered after the merger, the addition of the Union branches fit nicely with Mizrahi’s branch-focused strategy, which stands on contrast to its competitors. All told, it will have about 200 branches across Israel when the merger is done.
It will also get a loan portfolio of 26.4 billion shekels, boosting the combined total of the merged bank to 229 billion. Its market share will grow to 21.3% from 18.8%. What interests Mizrahi in particular is Union’s loan book to small businesses and households, worth 11.7 billion and 5 billion, respectively.
In addition, Mizrahi can expect to enjoy a giant accounting profit of about 1 billion shekels. This is due to an accounting rules that states that when a bank is acquired for less than its shareholders equity, as it the case with Union, the buyer can book the difference as negative goodwill.
Given the size of the number, sources said it was likely that the Bank of Israel will demand Mizrahi book the profit over several years, instead of in one.
Against that, Mizrahi will likely laying off 500 to 600 Union employees out of a total payroll of about 1,200 (800 of them permanent staff). That will require charges of as much as 500 million shekels to cover the cost of enlarged severance terms, a figure that will also be taken over a period of years.