Midroog to Lower Leumi's Ratings for Capital Notes

Downgrades for other banks expected to follow soon.

Ratings agency Midroog is expected to announce it is lowering Bank Leumi's rating for subordinated capital notes from Aaa,the equivalent of Maalot's AAA, to Aa1. However, the Leumi's other ratings, such as for bond issues, are not being changed.

Midroog is also expected to lower other banks' capital note ratings. The agency also provides ratings for Israel Discount Bank, First International Bank, Union Bank and Otsar HaHayal. It does not rate Bank Hapoalim.

These subordinate capital notes are similar to bonds, but allow the bank to raise capital counted toward its capital adequacy ratios that it is required to maintain. This capital, and ratio, is the safety cushion the supervisor of banks requires all banks to keep when granting credit. Such capital is considered Tier 2, or supplementary capital, to core Tier 1 capital, which is shareholder's equity.

In October, Midroog announced it was moving the banks' capital notes to its watch list in advance of a possible downgrade. The reason was a rise in financial uncertainty in capital markets and greater risk in the local financial sector.

The big fear is for the bank's financial strength if a number of big borrowers are unable to pay back their debts, which will also affect the banks' ability to provide further credit - and, of course, badly hurt their bottom lines.

Midroog also fears that a significant economic slowdown will hurt the banks' big customers.

In June, Maalot lowered the ratings for all the banks' capital notes across the board, though that rating agency said it was due to their adoption of the rating methodology of its parent firm, Standard and Poor's. S&P requires that subordinate notes be rated one notch lower than the regular rating for more senior debt.

Leumi, and Bank Hapoalim, are still rated AAA by Maalot, the highest rating, while the capital note rating was lowered to AA+.

In the first half of 2008, Israeli banks raised NIS 6 billion in such notes, in order to strengthen their capital ratios in advance of the implementation of the new international Basel 2 standards for bank stability and capital requirements. By the end of 2009, the banks will need to have a 12% capital adequacy ratio, compared to today's average for all the banks of 11.5%.

In the third quarter Leumi actually passed the required level and hit 12.08%, but Basel 2 requires a reevaluation of risk levels using new risk parameters, and the ratios may very likely have to be lowered based on the new calculations.