Are Israel's Equity Analysts Biased in Favor of the Banks?

Last month UBS Investment Bank issued a grim forecast for the Israeli banking system. The Swiss bank suggested that Israel's banks would need a NIS 22.5 billion cash infusion over the next two years. Its report elicited stormy responses, including from local analysts who denounced their UBS peers, contending they were cut off from the local economy and had projected the world's troubles onto the Israeli banking system. "This isn't America," wrote Terrence Klingman, head of the research department at Excellence Investments.

Yet it's not certain Klingman and his colleagues are justified in their criticism of UBS. The worst economic crisis in 80 years has been raging for a year and a half, yet no Israeli analyst has urged investors to sell bank shares.

Quite the opposite. At best, some are issuing Neutral or Market Perform recommendations, while others say Buy. In the past few months almost all the senior analysts have called for buying bank shares. Yet the shares have a mind of their own and have their southward tumble.

Some analysts argue that a Sell is unwarranted because investors understand that Neutral means Sell.

That is arrant nonsense. There is a reason the rating system includes a Sell recommendation.

Meanwhile, if you've been reading the analysts' reports, you know that Alon Glazer of Leader Capital Markets cautioned against Hapoalim's mortgage security-backed bond portfolio. Yuval Ben-Ze'ev, head of research at Clal Finance, predicted the profit warning at First International Bank of Israel and surmised that the write-offs at Hapoalim were not over. Klingman included a warning in his July 2008 review about the effects of the global crisis on Israel's banks. Lior Rabinowitz, banks analyst at IBI, expressed concern last November regarding Bank Leumi's losses on securities.

Yet none counseled investors to sell the bank shares - and the target prices they set continued to be far above the market prices. This is worth remembering when reading Ben-Ze'ev's warm recommendations for Hapoalim and Leumi on Tuesday. Klingman issued a similar opinion last week.

Cut off from reality

In November 2007 Glazer upgraded his recommendation for Hapoalim to Market Perform and set a 12-month target price of NIS 22. He later lowered the target price, but retained the recommendation. In September 2008 Glazer reinstated an Outperform recommendation for the bank's share, with a target price of NIS 15.50.

What has happened since then? Hapoalim shares are trading at NIS 7, after losing about 12% since the beginning of 2009 and more than 50% in the past year.

Ben-Ze'ev's forecast for Hapoalim has not panned out, either. In October 2007 he issued an Outperform recommendation and a target price of NIS 25. That was downgraded to Market Perform in January 2008, alongside a target price of NIS 21. In May Ben-Ze'ev switched back to Outperform, with a target price of NIS 20.50, but retreated in August to a target price of NIS 17. In September he adjusted the target price downward, to NIS 16, and in November he repeated his Market Perform recommendation, but without a target price.

IBI's research chief Yuval Zehira was even more optimistic, as he and Rabinowitz stood by their September 2007 Buy recommendation for Hapoalim. Even so, as the months went by their target price gradually receded, from NIS 25.80-26.80 at the beginning of 2008 to NIS 21.3 toward the year's end, when they suddenly cut the target price by 8 shekels, to NIS 13.30.

Klingman recommended buying Hapoalim shares in May 2008, with a target price of NIS 19.07. This opinion was adjusted to Neutral in September, without a target price, and last week he reverted to his Buy recommendation, with a target price of NIS 8.50.

This incongruence with reality also typifies the analysts' recommendations for the other banks' shares. In September 2008 Ben-Ze'ev set a target price of NIS 16.50 for Bank Discount, with an Outperform recommendation. This was downgraded in November to Market Perform, with a target price of NIS 13, and in December the target price disappeared. Discount's shares are now trading at NIS 2.60.

Possible conflict of interest

Glazer has stuck by his Buy recommendation for Leumi shares since mid-2007, gradually lowering his target price from NIS 20 to NIS 17.5 by September 2008. The current share price is about NIS 7. Klingman had a similarly rosy assessment of Leumi's share until September 2008, but now his recommendation is Neutral, with no target price.

The analysts' apparent over-optimism may be due to bank pressure on the investment houses and their controlling shareholders in Israel's tiny, crowded capital market.

The truth is that the local analysts, not UBS, are the ones who are detached from reality, refusing to recognize the true impact of the global financial crisis on Israel's banks.

"We were downbeat on the banks throughout most of 2008," says Glazer, "but we felt that at equity multiples of up to 0.6, we were correct in upgrading the recommendations, even though the shares continued to decline. I think the banks were not expensive when we upgraded the recommendation and are still not expensive.

"Our job is to indicate when prices justify selling - when the markets are rising too much or when there is a risk. Perhaps our optimism was premature, but it is wrong to say we did not notice the crisis. I think the prices reflect catastrophe in the banking system, while in the end we're likely to find that things weren't that bad after all."

"I've been pessimistic since January 2008," says Ben-Ze'ev. "I said not to declare the stable-cleaning was over so fast, but wasn't pessimistic enough."

Rabinovitz and Zehira stated: "We understand the need to examine the analysts' recommendations by comparing the share's performance to recommendations at certain points in time. Still, this is a partial view of the picture. In a comprehensive survey we published in November 2008, we wrote that investing in Israeli bank shares at that time should take into account the risks (low equity ratios, combined with declining profits, higher doubtful debt and losses from securities portfolios). Our recommendation for the institutional investors' shares portfolios in 2009 included the banking sector, based on an assessment that it will respond well when the market changes direction. We still maintain that belief."

No response was available from Klingman.