Israel's big five banks reported combined profits of nearly NIS 24 billion in 2022. These were record profits which in any normal year would have boosted the banks' share prices to new peaks. In 2021 the TASE Banking Index rose 58% but Israel in the spring of 2023 is a very different kind of place.
The planned judicial overhaul, the global economic crisis with high inflation and rising interest rates have changed the rules of the game over the past year. Consequently the share prices of Israeli banks have fallen by double and in some cases nearly triple the main indices on the TASE.
So while the Tel Aviv 35 Index (which includes the big five banks) has fallen by 2.5% since the start of 2023, and the Tel Aviv 125 Index has fallen 4%, the Banking Index was down 7% as of Sunday. Over the past three weeks the Banking Index fell 11.5%, while the Tel Aviv 35 Index fell just 2.5% over the same period. The banks have opened this trading week with good gains, partly due to stronger sentiment worldwide and perhaps even a correction for a sector suffering from the banking crisis in the US.
Leader Capital Markets VP Alon Glazer said there are two main reasons for the gap between the share performance of the banks and the general performance of TASE indices. "Investors are distancing themselves from Israel due to the political events and changes in the judicial system," he says. "Since the banks reflect the Israeli economy, they are likely to be harmed in the event of a deterioration in the Israeli economy."
A capital market source echoes these sentiments. "When banks' (share prices) are declining, you always have to look at the movements of foreign investors. When there is a recession or a slowdown, everyone takes a hit, but the foreign investors tend to realize their holdings in the bank shares first, while the local investors are not in a hurry to sell these shares," he explains.
Indeed, a look at Israeli bank share returns shows that in the days before Prime Minister Binyamin Netanyahu's statement on the pause in judicial reform legislation, there was optimism among investors and the stocks rose. However, immediately after Netanyahu's speech on March 27, when it became clear that it was only a delay with an option to restart the legislation from where it was stopped, the sharp declines returned, while the broad indices remained relatively stable.
The banks themselves addressed the issue explicitly in their 2022 financial reports. Israel Discount Bank, for example, stated that according to economists in Israel and around the world, these changes could have a negative impact on the financial markets and the stability of the economy in Israel. "The effects may also harm the bank and its customers," Discount explained. Bank Hapoalim stated, "The judicial process may have negative effects on the Israeli economy, the bank's customers and the bank itself." Bank Leumi said the legislative process and protests, "May have a negative effect on the Israeli economy and as a result on the bank's performance."
The importance of the banks to the Israeli economy is reflected in the fact that since the start of 2023, 40% of the trading on the TASE has been in the shares of the big five banks.
The banks are exposed to Israel's credit rating
Last Friday, international ratings agency Moody's cut Israel's credit outlook from positive to stable, but for the time being the agency has not cut the rating itself. Discount has said, "The credit rating of the State of Israel has a direct effect on capital requirements, given that capital requirements for exposures to the government and public sector entities (for example: local authorities) and banks, are derived from the credit rating of the state. In the bank's estimation, if and to the extent that it lowers Israel's credit rating, this will cause a decrease of 0.18% in the Tier 1 capital ratio (the ratio between the bank's risk assets - mainly credit, and its equity)." Bank Hapoalim will also price any downgrade if S&P cuts Israel's credit rating, as causing a 0.2% fall in its Tier 1 capital ratio.
Between rate hikes and appetite for risk
Glazer explains that the second reason for the fall in bank share prices is the rise in interest rates. "At a time like this, the fear of damage to the bank's credit portfolio and the repayment ability of borrowers increases significantly, while the political events are an additional weight," he says.
Israel in the past year is an economy that has become used to interest rate hikes (nine consecutive increases since April 2022) and is adjusting to the new global and local macroeconomic conditions. According to a capital market source, the fact that bank shares, especially of the big ones, are more liquid, explains the sharp declines in their share prices. "While the average order to buy or sell Mizrahi Tefahot, Discount or First International shares amounts tens of thousands of shekels, with Hapoalim and Leumi it can reach NIS 100,000 or more. Every transaction in their shares is more significant."
TASE data show that in recent years Leumi and Hapoalim have been the most heavily traded shares on the market. Since the start of 2023, Hapoalim's share price has fallen 8% and Leumi is down 7.3%. The smaller First International Bank has seen its share price fall 10% since the start of the year. A source said that the reason for First International's bigger decline was its higher p/e ratio so that this was a kind of market correction.
Just a few months ago, in December 2022, a similar trend was seen of disconnection between the leading indices in the stock market and the banks index against the background of interest rate hikes and concerns about recession and credit losses. In their recently published reports, the banks commented on the rise in credit risk. Leumi wrote, "As of the date of publication of the report (mid-March), economic activity in the local economy continues to grow, but at a slower pace. The slowdown is reflected, among other things, in a real fall in the rate of sale of new apartments, as well as the results of the rate increase on borrowers, especially on leveraged borrowers, private individuals and sectors of the economy with high credit activity. The bank also regularly examines the effect of the increase in rates in the economy on the credit risk in the portfolio, including in various sensitive scenarios."
Leumi, by the way, was the bank with the sharpest rise in its credit portfolio in 2022 (18%), despite slowdown concerns and its significance for borrowers. Investors may be underpricing the rapid growth in the credit portfolio looking towards the future.
The bank share price that has suffered least recently is that of Mizrahi-Tefahot Bank, which has fallen by less than 3% since the start of the year.
This is despite its large exposure to loans in the mortgage sector, an industry that has seen a slowdown in recent months due to rate hikes and inflation, which are making housing loans more expensive by about NIS 1,000 a month this year alone. "The level of risk in the mortgage portfolio increased from low to low-medium," Mizrahi-Tefahot wrote, "due to uncertainty on the possible future effects of the rate hikes and inflation on borrowers' ability to repay, and this due to the nature of the bank's mortgage portfolio, although as of this date, risk indicators do not show a material deterioration or a material change in risk level. The interest rate risk level rose from low-medium to medium, due to the increase in the interest rate environment, the high level of uncertainty and the possible effects on the behavior of borrowers and depositors, while the overall level of market and interest risk remained low-medium."
However, Mizrachi added that the bank examines risk indicators and risk levels constantly and that if the future risk potential decreases, the level of risk in the housing credit portfolio will drop back to low.
So how did it happen that the bank that is most exposed to the mortgage market recorded the most moderate decline in share price? The market had already priced in Mizrahi's exposure to the mortgage sector by the end of 2022, and the bank prepared accordingly with the largest provisions for credit losses (safety cushions in case borrowers do not repay loans). Mizrahi's credit portfolio grew at a moderate rate relative to its rivals, and despite large exposure to housing loans, and nine consecutive rate hikes - no large write-offs were recorded in the bank's credit repayments. Investors seem to have expected worse results.
The consequences: damage to pensions
The decline in bank share prices is directly linked to the savings of the Israeli public, since investment institutions hold them through members' funds. The effect of the declines on the public's savings is particularly evident in the three banks without a controlling interest - the institutional holdings in Bank Leumi amount to about 29%, the vast majority through provident funds and mutual funds, while in Bank Hapoalim it is 31.3% and in Discount 33%. In the two banks in which there is a controlling core, the influence is less. In Mizrachi-Tefahot the institutions hold 12%, while in First International their holding is only 6.3%.
Take Leumi for example. Last summer the bank's market cap was about NIS 50 billion, while before the increases at the beginning of the week its market cap had fallen below NIS 40 billion. This decrease of about 20% damages the returns of savers, which can be seen in the reports of the institutions that manage the public's savings.
Published by Globes, Israel business news - en.globes.co.il - on April 18, 2023.
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