"The banking sector has no few problems. Investors, however, should hold shares of the two major banks, Bank Hapoalim and Bank Leumi, in their investment portfolio, according to their market weight. These are anchor shares, if you wish, cash cows. They will not provide the portfolio bonanza, but they will yield a higher return than that of a risk-free asset, at relatively low risk. Also, the banks’ dividend policy creates an average return of 10% on the share". "Globes" heard this from Shai Yaron, banking and insurance sector analyst at the Ofek investment firm.
Yaron points to two trends that will affect the banking sector – mergers and Internet. "The banking world today is going through an interesting period of mergers. Competition and mounting demands make it difficult for small banks to survive, and the answer is 'to be big'. The obvious conclusion is that there will remain fewer small and medium size banks.
"This is today’s global fashion, although it still has not caught up with us because of existing regulation. Like everything else, though, it will get here eventually, and then things will look lively. No few small banks have listed shares: when the mergers start, they won’t be there. From the standpoint of the capital market, this could be an investment opportunity.
"Internet is one platform and it creates a situation in which it is banking that is important, and not the banks. Internet can pose a threat to banks, in that it facilitates the provision of banking services on a basis of low commissions and small margins. The large banks realise this. With all the innovative aspects of Internet and business opportunities, it’s hard to see a small bank threatening the large ones. There is, after all, such a thing as economy of scale. However, a situation could well come about in which a middling-size bank can resort to the assistance of this medium in order to achieve accelerated growth".
The manner in which banks function as an economic company comes in for a fair dose of criticism from Yaron. In his assessment, they are not adapting themselves to technological changes. "The bank branch with which I work has not changed in thirty years. Maybe they replaced the carpeting and armchairs, but the basic service, the nature of the activity, have hardly changed at all. The world, on the other hand, has vastly changed in that period.
"The banks’ principal cost is still manpower and physical infrastructure. They have made scarcely any perceptible progress in this field. Their problem is that they have to cope with powerful works committees and are therefore afraid to make changes that could cause systemic upheavals. Look at the voluntary retirement plans of Bank Hapoalim or Bank Leumi. They are prepared to pay a little more to get people to resign voluntarily and maintain industrial peace. This is not a system that can accommodate upheavals. Discount Bank is an example of a system that has undergone upheavals, and its image, in the capital market too, was tarnished thereby.
The creative role played by accountancy in the banks’ financial statements can be surmised from some of Yaron’s remarks, however carefully he chooses his words. "The big banks have the advantage of ammunition they have stockpiled over the years, and which they can let loose over the various statements, in such a way that profits are not always necessarily linked to actual performance. The banks enjoy historical holdings whose economic value is greater than the books show – for example, Koor in Bank Hapoalim or Leumi Insurance in Bank Leumi. These holdings handily enable the bank to ‘peg’ its statements in accordance with the timing best suited to its needs".
As regards the banks’ dividend policy, Yaron says "This is still not the ‘blue chip’ in the United States, but these are certainly shares of companies that expect dividends to be distributed. These are companies that are no longer chasing growth. They enjoy financial strength, and are definitely expected to be consistent about distributing dividends".
"Globes": And what about the 25% tax payment for investors looking to their net results?
"That is true. There is a certain distortion. A private investor looking at net results has to pay tax, whereas he is not taxed in the increase in share value. I, however, would rather get a little more, that I am sure of getting, than nothing. Dividends accruing to an investment portfolio are an important part of portfolio management".
Discount Bank, for example, is restricted as to dividend distribution. Would you not recommend buying its shares?
"Contrary to the market’s prevailing opinion, we have every confidence in Discount Bank. As an investor, I look for the underdog, and that is what Discount Bank is. I look for the ones nobody recommends, but which do have potential. Discount Bank went through some serious difficulties. But for quite some time now, the feeling is that Mintkevitz and Granot have taken hold of the reins and are trying to put the bank on the high road.
"This bank can only benefit from its forthcoming privatisation. True, processes in the banking system are slow, and Discount Bank is no exception. But in my opinion, the bank is past its low ebb, and now on the way up. An analysis of what happened in Discount Bank shows that it suffered two material problems: heavy real estate credit, reflected in the volume of doubtful accounts, and a low efficiency level. I don’t want to go into the matter of efficiency, but it is traditionally held that due to problems in labour relations and wage levels, the bank suffered low efficiency levels.
"The global trend is one of inter-bank mergers. At the moment, due to Israeli regulations, Discount Bank cannot merge with Mercantile Bank. I assume, though, that the merger fashion will reach our shores. As stated, the answer, in the banking world, is to be big. Where bank mergers are concerned, Discount Bank is very advantageously positioned in the middle. Not Bank Hapoalim or Bank Leumi, but Discount Bank. It has its own, homegrown Mercantile Bank, so that if restrictions are lifted, it can merge with Mercantile. On the other hand, Discount Bank also has holdings in First International, and will benefit from any merger involving that bank.
"Another possibility is via Union Bank. If the Eliyahu group, holder of Union Bank, acquires control in Discount Bank, then the way is open for a new merger vis-a-vis Union Bank.
"Discount Bank shares can provide a genuine bonanza on an investment portfolio. The bank is currently trading at 80% of equity. As a bank, it enjoys the deployment and infrastructure of a large bank. Of course, it has receded somewhat in recent years, but under the right management, it can regain its former standing".
And what about Mizrahi Bank?
"The Mizrahi share is conveniently priced. The share has taken off in recent months, starting to close the gap with the most outstanding shares in the sector. But even after racing forward, it is still trading at an attractive price. In my assessment, Mizrahi’s main potential lies in its possibly merging with another bank. This is a bank that is likely to merge when the merger season commences, whereupon the share will race ahead".
We haven’t mentioned First International Bank.
"The First International Bank is a fantastic bank in itself. It has excellent portfolio quality. It enjoys growth well in excess of average for the system. It has no non-financial investments, so that anyone investing in it has a focused banking investment. The bank’s recent investment in Visa Alpha is in the banking sector. As stated, anyone purchasing the International share is investing in a pure, net banking share".
But?
"But it is hard for the bank to compete with the big boys, and the attempt to come in with Visa Alpha took a toll on its health. Alpha was not sufficiently innovative. True, strategically speaking, the bank was supposed to gain access to the households sector, which is a highly profitable sector. But if you are about to compete with the big boys, you had better be innovative.
It’s no use trying to compete with the big boys through a price war, and the bank certainly took a drubbing.
"What happened was that everybody cut prices, stepped up competition, and that was that. Today, everyone is raising commissions again. Visa Alpha’s acid test will be by year-end, when Leumi and Discount spin off from Visa ICC. Then we will know more about the way the credit cards market is going to develop in future.
"To sum up, as a risk investor, I am also looking for a premium on risk. I am taking a risk by investing in International, in spite of the bank’s good qualities, but it’s by no means sure that I am getting sufficient premium on the risk. That is why there is a problem with giving a recommendation on International. I assess, however, that since the bank is a good candidate for merger, then in the long run investment in it does carry potential".
What about the small banks?
"There are lots of small banks in the market, and I assume that they will merge in future or run into real survival problems. Maybe banks specialising in a particular niche will be better able to survive.
"Bank Otzar Hashilton, for example, specialises in its niche and benefits from an exclusivity agreement for the transfer of State funds to the authorities. But even that agreement is valid only for another ten years, and beyond that, the bank will have to develop further activities, or merge.
"Maritime Bank is an interesting investment. Controlling shareholder Michael Steinhardt is obliged to dispose of control in the bank by the end of 1999. At present, Zeevi is the pertinent candidate; but he must wait for permission from the Supervisor of Banks. Zeevi has already acquired a portion of the shares and has reached 10%. What is interesting is that Zeevi reached agreement with Steinhardt to purchase Maritime bank at equity, whereas the bank is trading on the market in a range of 0.5-0.6 of equity.
"True, the bank’s profitability is not good. This makes investing in its shares less attractive, even though there is no stability risk. On the other hand, though, changes of control make shares more attractive".
You are talking about mergers, but nothing is happening.
"In practise, there is nothing to preclude small mergers, and everyone knows small banks have no future. Even so, no mergers are taking place. The banks may be waiting for the economy to emerge from the recession, or hoping for a better market".
What about Clali Bank?
"Clali is an example of a bank that has a specific field of expertise, in this case, the capital and currency market. The bank’s performances currently suffer from significant capital surpluses not being utilised for banking activity, and this is hampering it. These surpluses, however, do secure it high financial stability.
"The bank is also an example of a foreign international concern entering into Israel's banking market. The South African Investec group came into the bank, and is now trying to position it as part of the group. It is estimated that the group will continue to develop Internet banking activity. The big question is how successful this move will be. At present, Internet banking activity suffers from low margins, and in order to make a profit, what is needed is a large, stable mass of transactions.
"The bank’s capital surpluses make it a candidate for acquiring other small banks through a merger process, and this will jump it up a notch in banking activity and in customer base. There was talk of this in the past, and the debate could very well resume in future".
So – to invest or not to invest?
"In the long term, this can be an interesting investment, in light of the share price and the possibility of a merger. But in the short term, barring any significant event, it’s liable to be a waste of time".
Published by Israel's Business Arena October 7, 1999