2016 was a fairly good year for the banks. Despite the low interest rates and increased regulation, the five biggest banks finished 2016 with an aggregate NIS 8.11 billion profit, less than 2% below their 2015 profit. This year's profits were favorably influenced by the sale of Visa Europe shares, which generated over NIS 1 billion in revenue, while on the other hand, provisions for streamlining plans and investigations by the US authorities had a negative impact on some of the banks' results.
Despite these standard issue good results, however, beneath the surface, some disturbing findings are starting to emerge, headed by an increase in provisions for credit losses, mainly in the fourth quarter of the year, and mainly in credit to households.
Household credit: The economy's next affliction?
"There is an increase in expenses for credit losses in the retail sector, and that should serve as a warning," Bank Hapoalim (TASE: POLI) CEO Arik Pinto told "Globes." Like other bank managers who spoke about this subject in recent weeks, Pinto agrees that the reason is changes in bankruptcy legislation that benefit borrowers. "The changes in legislation are making the bankruptcy proceeding more accessible, and are having a deleterious effect on payment ethics, while increasing the banks' risk. This is liable to lead to the exclusion of groups from obtaining credit and an increase in the price," he says.
Bank Leumi (TASE: LUMI) CEO Rakefet Russak-Aminoach also cites this trend, saying, "Like the rest of the banking system, Bank Leumi is also seeing an increase in risk for credit to households. The target for growth in credit is modest growth on the same scale as economic growth," she told "Globes."
What do the numbers say? The banks' provisions in the household sector totaled NIS 1.54 billion in 2016, a rise of more than 70%, compared with the provisions for 2015. At the same time, it is important to stress that this increase is not due merely to debt collection difficulties; there are also accounting reasons, and the steep increase in this activity at most of the banks is another factor. Still, this figure is quite disturbing, especially in view of the fact that the Strum Law, aimed at increasing credit competition between the banks, is taking effect right now, bringing with it the entry of additional players into the market. The question is whether the combination of increased supply and rules making it easier for borrowers who get into trouble and making the bankruptcy process "more worthwhile" is liable to cause Israel's next economic crisis.
It appears that some of the banks are aware of the problem. Mizrahi Tefahot Bank (TASE:MZTF) announced that it would focus on increasing its business credit in the coming years, and less on retail banking. Bank Hapoalim's retail credit grew by only 2% last year, and Bank Leumi's by 1.5% (excluding mortgages). "The changes in collection are making us more meticulous in underwriting. For example, we decided to decrease credit for buying cars, because the pricing in this category does not reflect the risk," Pinto says.
What else can be learned from the banks' 2016 financial statements?
Mizrahi-Tefahot: Over 10% return on equity
The average return on equity for the five biggest banks in 2016 was 8.1%, down from 8.8% in 2015. Only one bank was over 10% - Mizrahi-Tefahot, with 10.3%. Bank Leumi was in second place with 9.3%, followed by Bank Hapoalim, whose poor fourth quarter pushed its return on equity down to 7.7%. The lowest of the five was Israel Discount Bank (TASE: DSCT) with 6.6%, despite the many changes instituted by the bank in recent years, including the expansion of its credit portfolio and aggressive streamlining plans. Discount Bank believes that its profit indicators will also improve, with return on equity exceeding 10% by 2022.
It is important to note that at the current interest rate, the return reported by the banks is definitely reasonable. If the Bank of Israel raises the interest rate in the coming years, the banks will be able to increase their financial spread, possibly boosting their return on equity over 10% again.
What can also help the banks improve their profit margins is cutting expenses. Last year, the banks continued their streamlining processes, announcing voluntary retirement plans at a cost of over NIS 3 billion (for which the Bank of Israel granted them accounting concessions). Meanwhile, despite the cost of financing the streamlining plans and expenses that mount automatically, salary expenses dipped NIS 100 million to NIS 17.3 billion in 2016.
Credit portfolio: Bank Hapoalim and Bank Leumi contracted, Discount Bank expanded
The aggregate credit portfolio of the five largest banks grew nearly 3% to NIS 932 billion in 2016. There was, however, no uniform trend among the banks. The two largest banks were occupied with meeting the capital adequacy ratio target (the ratio of equity to risk assets, headed by the credit portfolio). The targets for the larger banks are tougher than for the others. In order to meet those targets, the larger banks had to manage their credit portfolios well, and even cut back on credit to large businesses. Bank Leumi cut its business and real estate credit by NIS 3.5 billion to NIS 51.5 billion, while Bank Hapoalim's cutback was even steeper, with credit dropping NIS 11 billion to NIS 79.2 billion.
The beneficiaries of the bigger banks' credit contraction were the medium-sized banks, whose credit business rose substantially in 2016. The credit portfolios of Mizrahi-Tefahot Bank, Discount Bank, and First International Bank of Israel (TASE: FTIN) climbed by an average of 8%, and by over 10% in some categories. The steepest rise was at Discount Bank, with a credit portfolio increase of nearly 11%. It is doubtful, however, whether the medium-sized banks can repeat this handsome growth in the various categories. Now that Bank Hapoalim and Bank Leumi have met their equity targets, they can, and intend to, resume the expansion of their credit portfolios in all categories. "There are no more equity constraints on us; this year, we can resume growth in business credit, too. This will take time; it will be gradual," Pinto says. Credit competition, especially in business credit, is likely to intensify in 2017.
A flood of dividends: "Only" 13% of profits
The banks distributed NIS 1.065 billion in dividends in 2016, amounting to only 13% of their profits. The ratio of dividends to profits is projected to rise dramatically this year. First of all, only three banks received permission to distribute dividends in 2016: Bank Hapoalim, Mizrahi-Tefahot Bank, and First International Bank. Sources reported this week that both Bank Leumi and Discount Bank will resume distribution of dividends, after distributing no dividends for six years. Bank Leumi today announced that it would distribute a 20% dividend starting this year, while Discount Bank has not announced its policy, but did say it had received permission from the Bank of Israel to distribute a dividend. Mizrahi-Tefahot Bank, controlled by the Ofer-Wertheim group, received permission to increase the proportion its dividend to 30%. Bank Hapoalim, controlled by Shari Arison, has received the same green light, and plans to ask for permission to distribute 50% of its profits to its shareholders. In the bottom line, the banks are expected to double the amount of the dividend they distribute in 2017.
Published by Globes [online], Israel Business News - www.globes-online.com - on April 2, 2017
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