Analysis

Israel's Bank Hapoalim Tax Probe Simmers Amid Mistrust

Winding up the U.S. investigation is top agenda item for the new CEO of Israel’s biggest bank

The logo of Bank Hapoalim is seen at their main branch in Tel Aviv, Israel on July 18, 2016.
Amir Cohen/ REUTERS

When Bank Hapoalim reported weak results last week for the third quarter, people close to its new CEO, Dov Kotler, were quick to broadcast the message that their boss wasn’t responsible and that the numbers were nothing more than leftovers from the era of his predecessor, Arik Pinto.

There is some justice to this version, but there is no escaping the fact that the next half year will be a critical time for Kotler. The head of Israel’s biggest bank, with 9,000 employees, must make decisions that will weigh heavily on its future.

The first item on his agenda is to quickly wind up the U.S. and New York State investigation into Hapoalim’s alleged role in helping American clients evade taxes. When he announced he was stepping down last April Pinto has said, “I plan to do everything I can to conclude the affair and reach an agreement before I end my terms.”

Pinto is no longer at the bank but the affair is not over. In Pinto’s defense, it should be said that he inherited the problem from his predecessor, Zion Kenan. And Kenan, with the banking of then chairman Yair Seroussi, had chosen to take a gradual approach to resolving the issue.

Most of the set-asides for the expected cost of a settlement were taken during Pinto’s term, but neither he nor the bank’s current chairman, Oded Eran, succeeded over the three years that Pinto was CEO in bringing the investigation to a close.

Senior executives in the banking and legal system have an explanation for the delay.

“Relations are tense between regulators at the American Justice Department and the New York State Financial Services Department and the Bank Hapoalim executives who are dealing with the matter and that’s due to the poor way in which the affair has been handled over the last years,” said one.

“Only when the American regulators change their stance and signal they’re ready to end the investigation will there be any movement. When this will happen and how many more hundreds of millions of dollar the bank will pay is hard to know at this stage,” the source said.

Those tense relations and lack of trust between the two sides was the product of a strategy developed by Hapoalim’s attorney in the case Pinhas (Pini) Rubin, of the Tel Aviv firm Gornitzky & Company and the bank’s U.S. attorneys.

In consequence, at one stage Hapoalim was forced at the behest of regulators to review the numbers involved in the probe anew and retain the services of the U.S. accounting firm Deloitte. Hapoalim was also required to retain at its own cost an independent, outsider observer that reports directly to regulators on the bank.

The result, according to the bank’s financial reports, is legal, accounting and consulting fees that have added up to 100 million shekels ($28.9 million) so far.

All told, the investigation has cost Hapoalim 3.35 billion shekels more than any other Israeli bank ensnared in similar investigations has set aside, namely Bank Leumi and Mizrahi Tefahot Bank. That amounts to close to $1 billion, a sum equal to what it lost on mortgage-backed securities in the U.S. during the financial crisis more than a decade ago.

Among other things, Hapoalim has as a result not been able to distribute dividends. Not paying dividends has left it with excess capital of more than 4 billion shekels and its return on equity is just 7.6%.

Kotler was not involved in the affair, but if he also fails to wind it up over the next six months it is reasonable to assume that he will also be tarnished by it. Next month the bank and regulators are expected to have another meeting, which was initiated by the bank’s chief legal counsel, Yael Almog, with the aim of moving things forward.

Meanwhile, Hapoalim is not succeeding to extricating itself from one of its biggest investment failures ever – buying control 13 years ago of Turkey’s Bank Pozitif.

Again in the third quarter, Hapoalim’s results were weighed down by a further write-down in the value of the Turkish lender, in this case 63 million shekels. Pozitif is engaged in business, retail and investment banking but doesn’t have a license to take deposits, which reduces its value.

At the end of 2008, Hapoalim valued it holding in Pozitif at 873 million shekels. Today, after the latest write-down, it’s valued at just 33 million. The drop is due a write-down in goodwill in Pozitif itself as its Kazakhstan unit (since sold) as well as to a weaker Turkish lira versus the shekel. Even if Pozitif was generating profits, its contributions to Hapoalim;’s shekel earnings was much less.

Nevertheless, Hapoalim’s exposure to Pozitif is bigger than its investment because part of its loan book is exposed to the Turkish unit via collateral or guarantees provided by Hapoalim.

In recent years, Kenan, Seroussi, Pinto and Eran failed in their attempts to sell Pozitif, whose activities had been greatly curtailed. Will Kotler succeed where they didn’t?

Another item on Kotler’s to-do list is negotiations over a new collective labor agreement with Hapoalim’s workers committee. In recent weeks rumors have circulated that management is seeking to cut more than 1,000 jobs. The bank denies this but, no matter, Kotler will have his hands tied on making progress on other issues the bank faces if he doesn’t agree on a new contract.

Via a vis credit cards, it’s not clear when Hapoalim when the bank plans to divest its 33% remaining stake in Isracard, which is worth some 900 million shekels.

In any case, Kotler will not be able to involve himself with the issue to avoid conflicts of interest after he served as an adviser to Warburg Pincus, the U.S private equity fund that bought Isracard rival Max. Nor will another key Hapoalim executive – Ram Gav, the incoming head of the financial division and chief financial officer of Isracard.

Since the initial public offer in Isracard, investors have gotten a zero return. They are now watching closely to see if Hapoalim decides to keep it as a publicly traded company with no controlling shareholder or to find a buyer as Leumi with Max that will move the company in new directions.

The bank’s operating agreement with Isracard is due to expire in the next few years. Kotler’s big choice then will be either to renew the agreement With Isracard and preserve their joint leading market share or opt for a strategy of weakening Isracard and strengthening its competitors, Max and Cal.