Taking Stock / The Borrowers and the Bill

Most of the marketplace remains mired in recession. Tens of thousands of small, medium-sized and large businesses are struggling to survive, yet the big banks are about to irritate their careworn customers by presenting a dramatic improvement in their quarterly results.

Last year, the banks could claim sympathy pains with their unhappy business clients, which were going broke at a terrifying rate. But this year, characterizing the relationship between the banks and their customers is a yawning gap.

Remember that much of the improvement in the banks' results are one-time developments, first and foremost huge gains in their proprietary investment portfolios from a few giddy weeks, though the surge on the market has ebbed already. Also, the index gap worked in the banks' favor.

Yet a few elements in the supervisor of banks' annual review, published last week, reminded us how the banks make hay even during droughts, and also, what monsters lurk behind their balance sheets.

l Credit granted by the banks for leveraged buy-outs (LBO), since the fad began to pick up momentum in 1997, totals some NIS 29 billion. Of that, 29 percent was extended to buy shares in banks, and 23 percent to acquire control of telecommunications and computer companies.

About 55 percent of that credit for LBOs was for highly leveraged deals in which the banks provided more than 80 percent of the money for the deal.

No less than 48 percent consisted of non-recourse loans, in which the borrowers are not personally liable, meaning, the banks are the ones assuming the risk.

The most impressive datum of the lot: As the value of the acquired companies collapsed, and interest bills began to balloon, 16 percent of the outstanding loans exceeded 100 percent of the value of the acquired asset - or in banking argot, the loans are underwater. Their equity is negative.

l LBOs are just a fraction of the total leverage granted in Israel, with the encouragement of the banks. From year-end 1997, the ratio between outstanding credit to GDP has shot up from 1.1 to 1.84. Meaning, the banks have granted credit totaling 84 percent more than Israel's GDP; while five years ago, credit exceeded GDP by only 10 percent.

Naturally, all the leveraged transactions were in real estate. But there too, the rate of borrowing skyrocketed. Bank credit to the real estate industry is now equivalent to five times that sector's turnover, compared with less than three times its turnover five years ago.

This is doomed to end in tears, with massive charges and write-offs, with debt refinancing and rescheduling, eventually lowering the ratio between debt to GDP in each of these industries.

We saw something similar in the previous decade. Then it was the kibbutzim and farmers who had borrowed far beyond their capacity to service their debts. And indeed, it is unsurprising that the only sector where leverage has dropped is agriculture. There, the ratio of debt to turnover dropped from 1.73 to 0.75.

l The leverage fever naturally triggered a steep climb in provision for doubtful debt by the banks, which bit deep into their profits these last two years. It also exposed the fact that even though the bank chiefs devoted most of their time to sewing up grandiose, well-publicized deals, these ultimately caused them nothing but grief.

Analysis of the results posted by the banks and their subsidiaries over the last nine years shows where their profits come from. The only two areas that generated yields of over 10 percent on equity, on average, were the mortgage banks (12.2 percent) and credit cards (13.1 percent). The credit card figures are biased downward because of the shocks caused by Visa Alpha's establishment, and the collapse and liquidation of the Discount-Leumi partnership Visa ICC.

Why are the banks making money on mortgage lending, but not on business lending? For two reasons. The mortgage business targets households, which unlike the big boys, tend to repay loans, simply because they have no choice. Secondly, most of the mortgage banks' profits don't even come from financial mediation, but from insurance fees. Each year they rake in some NIS 400 million from marketing life and housing insurance.

In the last two years, the banks' return on equity on their activities with businesses has been dwindling toward zero. In some cases, the figure has turned negative.

What has left their heads above water are households, which are their best and most obedient customers. They pay the fees; they repay loans; and, mainly, they keep silent.