Where Only Giants Dare Tread: Israel's Bond Market

Biggest bond borrowers are also the biggest borrowers from banks, creating systemic risk, BoI warns.

Centralization in the capital market is worsening, the Bank of Israel warns in its annual report for 2012. How does it know? The bond market has become the fief of giants, the very giant business groups that also borrow the most from the banks.

Meanwhile, the amount of credit the bond market provides to medium-size companies (raising between NIS 100 to 500 million) is shrinking.

If 16 percent of the debt was issued to medium-size companies in 2007, in 2012 medium-size companies received only 7.1 percent, the central bank says.

“At the end of 2012, about 91 percent of outstanding debt in the bond market was issued by borrowers owing investors more than NIS 500 million,” the bank’s report says.

In 2007, for example, the large companies comprised 80 of the bond market; in 2004 that was 76 percent.

So, when big borrowers stumble into trouble, they impact not only the bond market but the banks, the Bank of Israel warns.

One reason for the situation is the development of sprawling business conglomerates: they own many companies, and accordingly they are also responsible for growing chunks of bank and non-bank credit, the central bank says.

Banks meanwhile have scaled back lending to business in general as risk rises (economic slowdown) and because they have been forced to increase their core capital adequacy ratios (Basel III).

However, as stated above, while the weight of business credit has decreased among the banks in recent years, there has been an opposite trend in the bonds market.

Since most of the institutional investors are themselves controlled by the large business groups, it is perhaps no coincidence that there is a direct connection between that fact and the increase in the share that these groups receive in the bonds market. For example, the IDB group, which is one of the big borrowers, controls Clal Insurance Enterprise Holdings.

Here's another example. Yitzhak Tshuva's Delek Group, which is also one of the largest borrowers in the country, controls Phoenix Insurance Company and Excellence Investments.

While Bank of Israel officials do not mention the name of any group explicitly, including that of IDB, it hints in that group's direction. “The years of intense activity in the corporate bonds market (2005–2007) were also the years when the large business groups’ expansion accelerated, and they increased their span of control in business pyramids that were leveraged by bond issues. The situation of some of these groups has deteriorated over the past two years, and some even have difficulty meeting their financial obligations. The reasons for this include decreased profits caused by an economic slowdown, the social-justice protest and certain reforms such as the one that was carried out in the cellular telephone market.

“As a result, and also as a result of the bonds-market crisis, their ability to roll over the enormous debts that they issued during the market’s peak times has been affected," the Bank of Israel reported.

The problem is when trouble spreads among the companies in a given business group, it can have system-wide impact,. This is because the public has learned to distinguish among the various companies in the business groups by their financial stability. Accordingly, unlike in 2008, the increases in yield in 2012 is not across the board; rather, it is concentrated mainly in financially-troubled companies within the business groups, without automatically influencing the rest of the members in the group. This is caused, among other things, by tighter corporate governance and supervision of the transfer of funds between companies within the business group.”

Reuters