CHAPTER XI: BANK PRIVATIZATION

Background

In the early 1980s, Israel's major commercial banks artificially supported the prices of their publicly traded shares. In October 1983, a number of factors including hyper-inflation and the desire of bank shareholders to dispose of their bank shares in favor of foreign currency, set the stage for a collapse in the bank share market and for a possible financial disaster. To prevent this, the Government of Israel bought from the public and assumed custody of the shares of Israel's major commercial banks, with the intention of selling them at a later date. The banks subject to this Arrangement were: Bank Leumi, Bank Hapoalim, Discount Bank, I.D.B. Holdings, Israel General Bank, Union Bank and United Mizrahi Bank.

Ten years later, in 1993, the Government of Israel, which under the Arrangement was due to assume control of the banks, formally decided not to become involved in the control and operation of the banks. The Law for the Arrangement Bank Shares (1993) stated that the Government's goal was to dispose of the shares, and to avoid Governmental involvement in the operation of the banks until the shares were sold. The law also provided for structural changes in the Israeli banking system in accordance with the Government's policies. The law also established a trustee committee for each bank to direct each bank's affairs.


The Brodet Committee Report

The Government of Israel set up a committee in order to investigate and evaluate the concentration of economic power in the hands of the banks. The main Israeli commercial banks, are investors, and have holdings in many Israeli companies. The committee, headed by David Brodet, the Director General of the Finance Ministry, submitted its findings in December 1995. The recommendations of the committee were accepted and a law was passed approving them.

The committee's findings and recommendations were as follows: The Israeli banks have real holdings in a large number of companies. This fact leads to a high degree of centralization and may lead to a conflict of interests between the banks as financial intermediaries, and companies that are both subsidiaries and clients. The committee defined a "held company" as a commercial company whose core business and activity does not arise from financial activities. The committee recommended that the banks be limited in their control of held companies. The recommendations were to limit the holdings in the above companies to 25% by the end of 1996 (later to be reduced to 20%). It was also recommended that the total holdings of a bank in the above companies should be no more that 15% of the shareholders' equity of that bank. Bank Hapoalim was required to sell all its holdings in either Koor or Clal before the end of the decade. The implementation of the findings is now underway and it is expected to accelerate in the near future.

The Brodet committee based many of its recommendations on a study prepared by Prof. A. Bebchuk, Prof. L. Kaplow and J. Fried (all from Harvard). The study describes the holdings of the banks (namely, Bank Leumi and Bank Hapoalim) in the non-financial sector. Leumi controls Africa-Israel (a large holding company) while Hapoalim controls Hapoalim Investments (which was partially sold recently) and has partial control of Koor, Clal and Delek, all of which in turn have holdings in many other non-financial companies. The study concludes that the degree of concentration in the non-financial sector of the Israeli economy is high, and the companies that now belong to the Hapoalim group make up a significant percentage of the value of this sector. The authors recommend separating the conglomerates from the banks, and in particular separating the blocks in Koor and Clal from Bank Hapoalim.


Policy

The current Government is seeking to accelerate the bank privatization process. The public market is preferred but if that is not a viable possibility, the banks will be sold to private investors. M.I. Holdings Ltd., a company fully owned by the Government, is responsible for coordinating the sale of Israel's major commercial banks. Meir Yacobson is currently the CEO of M.I. Holdings. The Government has two primary objectives: The first is to sell at a reasonable and fair price to the best buyer (but not necessarily to the highest bidder); the second is to transfer controlling interests only to buyers who will exercise control over the long-term.

Meir Yacobson, CEO of MI Holdings states "We are planning and checking into the possibility of offering some of the banks abroad. Based on the interest shown by foreign investors in the IPO of Israel Discount Bank in 1995, I feel there is sufficient reason to believe there will be interest in other banks as well." Bank Leumi is considered a good candidate for a foreign public offering.


Implementation

From December 1991 through August 1996, about $1.55 billion in immediate and future proceeds were raised through the sale of shares in the banks subject to the Arrangement. Nine transactions were carried out during this period covering seven banks. The following chart sets forth sales of the bank shares from 1991 through August 1996:

SALES OF BANK SHARES UNDER THE ARRANGEMENT (1991 - 9/96)
($ millions)

Chronologically, activities in connection with the bank shares since 1989 were as follows:

1989-1991: One Class of Bank Shares. In preparation for the eventual sale of the banks, varying classes of bank shares were converted into one common class, with former holders of higher classes compensated according to a pre-set scheme.

8-12/1991: Sale of controlling interest in IDB Holdings. As part of this sale to the Recanati Group, the Government received 53% of IDB's holdings in Discount Bank. As a result of the sale IDB held only 13% of Discount Bank, whereas before it had owned 66%. As a result of the transaction, the Recanati Group's control of IDB Holdings increased from 20% to 57%. The Recanati Group immediately sold 4.8% of IDB Holdings to William M. Davidson, a U.S. investor. The total consideration received by the Government was $230 million plus 53% of Discount Bank.

July 1992: Sale of General Bank ("Bank Clali"). A total of 24.5% of the bank was sold for $16 million to institutional investors, in packages of up to 5% each of the bank's equity.

August 1992: Tender for United Mizrahi Bank. A 26% controlling interest in the bank appeared to have been sold to a group led by Gad Zeevi for $100 million along with an option to purchase an additional 25% for $80 million. However, the pending transaction was terminated in January 1993 when the Bank of Israel refused to give its approval.

November 1992: Public offering of IDB Shares. This sale, which disposed of the Government's remaining 42.5% of the company, included both shares and options and resulted in immediate proceeds of $220 million and proceeds from the sale of options (all of which have since been exercised) of $185 million.

May 1993: Public offering of Bank Hapoalim. Shares and options totaling 18% of Bank Hapoalim were sold on the TASE for an immediate $150 million and $150 million in future options proceeds (the first of two series was exercised). Approximately 1.6% of the sale was to bank employees. (The second series of options was not fully exercised due to the decline in the bank's share price in 1994).

May 1993: Sale of controlling interest in Union Bank. The GOI and Bank Leumi together sold 60% of Union Bank ("Bank Igud") to the Shlomo Eliyahu Group (an insurance concern) based on a total bank valuation of $137.5 million. Of the total $82.5 million consideration paid, Bank Leumi received 42% and the GOI 58%. The Government and Bank Leumi together still own 40% of Union Bank.

August 1993: Public offering of Bank Leumi. Shares and options totaling 22.4% of Bank Leumi were sold on the TASE for an immediate $195 million and $233 million in options (exercisable in March and July 1994). Approximately 1.8% of the sale was to bank employees. (The options were not fully exercised due to the decline in the bank share price in 1994).

November 1993: Secondary offering in Bank Hapoalim. A total of 6.9% of Bank Hapoalim was sold for $120 million, of which $17 million was purchased by employees of the bank. The Government had attempted to sell 11% of Hapoalim but was successful in selling only 6.9%.

November 1993: Secondary offering in Bank Leumi. This offering was postponed.

November 1994: Sale of controlling interest in Bank Mizrahi. The GOI sold 26% of Bank Mizrahi to the Wertheim / Ofer Group for $110 million. The buyers received an option to purchase another 25% for $105.8 million.

March 1994: Tender for Bank Leumi. Only one investor group (Safra Group through Republic Bank) participated in the tender for a 20% controlling interest in the bank. In early 1995, the Safra Group decided to withdraw from the tender.

February 1995: Tender for 20% to 40% controlling interest in Bank Hapoalim.Two investor groups bid for the bank, one led by the Renaissance Fund, Claridge Israel, Charles Bronfman, Ted Arison, Goldman Sachs and others (Renaissance Group), and another led by Eliezer Fishman and Bear Stearns (Fishman Group). In August 1996, the Renaissance Group withdrew from the tender and the current situation remains unclear. Speculation is that the Renaissance Group withdrew from the tender mainly because carrying out the recommendations of the Brodet report would reduce the value of the bank. The withdrawal of the Renaissance Group is a major blow to the privatization process as it comes after the group invested 18 months and a few million dollars in due diligence expenses. This may send a negative signal to other potential buyers in the future.

March 1996: Public offering of Discount Bank. Shares and options totaling 15.7% of Discount Bank were sold on the TASE for an immediate $79.7 million and $80 million in future proceeds. The shares and options were offered to both the public and employees. The GOI now remains with 71% of the equity in the bank after full dilution.


Outlook

The Government would like to sell the remainder of its bank holdings within the next three to four years. 1994 and 1995 were a major disappointment as the decline in share prices on the TASE impacted the demand for the secondary offering of Bank Hapoalim and caused the cancellation of the planned secondary offering of Bank Leumi. In addition, not all of the outstanding options have been exercised as bank share prices declined below the exercise price during the year. The withdrawals of the Safra Group from the tender for Bank Leumi and of the Renaissance Group from the tender for Bank Hapoalim ware also major disappointment. For each bank, the Government plans to first sell a controlling interest before completely liquidating its position.


Major Issues

Major issues which could delay additional sales of the Government's interest in the banks include:

• Licensing problems. Purchasers of a controlling interest in an Israeli bank must be approved by the Bank of Israel. This can be a long and onerous bureaucratic procedure in which all members of the acquiring party must be approved. In addition, all members of the purchasing group must be approved by the appropriate authorities in countries in which the target bank operates (including in the US).

• Market size. While the Government would like to make large offerings on the Tel Aviv Stock Exchange, disposing of its interests as quickly as possible, such offerings can be burdensome on the market.

• Banking Structure. Banking in Israel is concentrated in a few large banks which provide universal banking services (i.e. commercial banking, investment banking, etc.). As a result of the banks' strong influence on the Israeli economy, the Government must be especially careful in identifying acceptable buyers. Moreover, many potential buyers (Clal, to name one) are themselves owned by banks and are therefore inappropriate purchasers. In addition, trust and provident funds managed by banks are prohibited from purchasing their own bank's shares, and may purchase a maximum of 10% of another bank's shares.

• Institutional owners. Political pressures and non-business considerations are sometimes brought to bear by quasi public institutions such as the Jewish Agency and the World Mizrahi Organization which are involved in the ownership of some of the banks.
  
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