Israel's Mizrahi Bank Pays for Playing Tough With U.S. Regulators

Justice Department seeks $347 million in penalties in tax probe

Eldad Frisher speaks
Tomer Appelbaum

When Bank Leumi reached an agreement to pay a hefty $400 million penalty three-and-a-half years ago to end an investigation into allegations it helped Americans evade U.S. taxes, CEO Rakefet Russak-Aminoach was widely criticized for acting hastily. A tougher line, it was reasoned, could have limited the damage.

But as Mizrahi Tefahot Bank learned last week – and presumably Bank Hapoalim as well – playing tough with the U.S. Justice Department is by no means a sure bet: Mizrahi, Israel’s third-largest bank, reported last Tuesday that the U.S. was offering to settle for $347 million.

That is a huge sum relative to Mizrahi’s size, equal to 10% of its shareholders’ equity. Moreover, the number of American clients Mizrahi allegedly helped was only a fraction the number Leumi was accused of aiding. Based on relative numbers of clients, Mizrahi had expected to be hit by a fine of about $80 million.

The bank said its board of directors rejected the U.S. offer, but the hard line it took didn’t convince stock market investors, where the bank’s shares tumbled 9.3% since the announcement to 65.10 shekels ($17.51) by Sunday. Hapoalim, which is also being investigated by the U.S. and by New York State, saw its shares fall more than 5% to 25.25 shekels.

“When you get a major upset like this, the logical thing to do is to bring the [Bank of Israel] banks supervisor into the picture, delay your next financial report and get on the first flight to the U.S. to meet with the Justice Department and open fast-track negotiations. Mizrahi’s heads decided otherwise,” said a one banking-legal source, who asked not to be identified, over the weekend.

Analysts expressed doubt that the strategy of Mizrahi and Hapoalim of playing for time and hoping to end of with a relatively small penalty was not working. Hapoalim, which is led by CEO Arik Pinto, has made provisions totaling $365 million, close to the amount Leumi already paid, and the figure is likely to grow. Meanwhile, it has run up legal costs of 400 million shekels.

Other, bigger banks like Credit Suisse and Deutsche Bank that sought to appeal penalties imposed by the U.S. failed because the balance of power lies with the authorities, analysts said. The hope that the Trump administration would abandon the Obama era policy of large fines on erring financial institutions has proven to be unfounded.

Alon Glaser, a banking analyst at Leader Capital Markets, said he had expected Mizrahi to pay between $150 million and $200 million and termed the Justice Department figure an “unpleasant surprise.”

“We now assume that because of the immense of power of U.S. authorities and the bank’s desire to end the affair quickly and without additional penalties the final penalty will not be significantly different from the [Justice Department’s] current demand,” he said.

Significantly for Mizrahi and its CEO Eldad Fresher, the U.S. offer doesn’t include any admission of personal responsibility on the part of past or current Mizrahi executives. Fresher was chairman of Mizrahi’s Swiss unit and in charge of the bank’s international operations during some of the years the bank was aiding tax evaders (2000-2011).

On the other hand, Mizrahi has a branch in Los Angeles, which could bring California banking authorities to join the investigation and demand their own penalties. Failing to reach a settlement could lead to an even steeper fine in court. Mizrahi is also at risk of a separate probe and penalties from Israeli authorities.

Mizrahi didn’t say last week what its next step would be. It is due to release its second-quarter results on Thursday, although it may delay it for several days as legal and financial experts debate how to handle the latest news.

Until now Mizrahi has set aside just $46 million for expected penalties, just 13% of what the U.S. demanded last week. Over the weekend, legal and banking sources as well as analysts covering the bank said Mizrahi would have no choice but to boost that amount by $300 million.

For now, however, the consensus was that Mizrahi would set aside $100 million in its second-quarter report. That figure would wipe out its quarterly profit and maybe even leave it with a small loss.

However, that’s just the start of the problem, warned Glazer, because the bank’s capital adequacy ratio of 10.16% is just above the minimum 9.86% required by regulators. The gap is likely to narrow further in the second quarter because of the expected provision, assuming Mizrahi increased lending.

“What that means is that the bank is expected after the quarterly provision to be close to the regulatory minimum, which will harm its ability to grow and will lead to its either cancelling or reducing its dividend,” Glazer said.