Deutsche Bank analyst Dan Harverd warns that the Bank of Israel's recent forecast of negative 0.2% GDP growth in the economy in 2009 weighs on potential banking sector results. With banks set to report fourth quarter 2008 results in several weeks, Harverd is concerned that unrealized losses sitting on bank's books will begin to affect actual reported results, and problem debts are set to rise as the economy falls.
Harverd worries that the securities portfolio at Bank Leumi (TASE: LUMI) carries the most risk among big banks. "It has the highest risk weighting and highest amount of unrealized losses, making it the bank with the highest likelihood of large write-offs. Its NIS 42 billion securities portfolio is 40% larger than Bank Hapoalim's (LSE: BKHD; TASE: POLI) NIS 30 billion portfolio despite a similar sized balance sheet, representing 14% of assets versus 10% at Hapoalim."
As of September 30, Leumi's portfolio, which was only 39% invested in government bonds, incorporated NIS 1.8 billion in unrealized losses that have yet to pass through the income statement, and global stock markets fell further in the fourth quarter. This is a much larger scale of unrealized losses than the NIS 200 million for Hapoalim, which has 55% invested in government bonds.
Harverd forecasts that Leumi will be required to recognize a portion of these losses as permanent in its fourth quarter report, but it is difficult to assess the absolute amount, though he adds that that unrealized losses are already reflected in book value, since the adjustment to fair value is recorded on a quarterly basis in shareholders equity.
Harverd finds that while Israel Discount Bank (TASE: DSCT) has a relatively large investment portfolio, at 17% of assets, he sees it as less risky since it is three-quarters invested in government bonds or government-backed mortgage securities. Conservative Mizrahi Tefahot Bank (TASE:MZTF) has the smallest securities portfolio, at 7% of assets, and it has 73% invested in government bonds.
Leumi also continues to have the largest exposure in Israel's banking sector to asset backed securities, and has NIS 900 million in CLOs, which reported NIS 200 million in unrealized losses at the end of the third quarter.
The Deutsche Bank analyst also looks at problem debts, noting that in the current economic downturn, the sectors that have had the most difficulties have been construction and real estate, as well as the financial sector. Leumi, Hapoalim, and Discount each have about 22-25% of their loan portfolio in those sectors, while Mizrahi only has 16%.
Harverd expects Mizrahi to emerge as Israel's most profitable bank, with double digit return on equity in 2009. He estimates earnings per share (EPS) of NIS 2.59 in 2009. He also sees the recent acquisition of Bank Yahav will help margins. He also sees Mizrahi as the most likely bank to acquire other banks and integrate them successfully.
Harverd maintains a "Hold" rating on Hapoalim, saying that as it is the leader in the corporate segment, Hapoalim has the highest exposure to corporates that will need to refinance bond debts in 2009-11. Problematic debt increased 24% in the third quarter, compared to the previous quarter, and the analyst expects it will rise further given the deteriorating economy since then.
He maintains his "Hold" rating on Leumi, though a recovery in fertilizer and shipping industries, where Leumi has significant non-bank investment holdings, would help its results. He sees earnings per share of NIS 0.77 in 2009.
Published by Globes [online], Israel business news - www.globes-online.com - on February 3, 2009
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