Despite mounting regulation, greater competition, and a rise in consumer credit risk, 2018 was a good year for banks in Israel. Their biggest problem was the investigations in the US.
Bank Hapoalim and Mizrahi Tefahot Bank were investigated on suspicion of abetting tax evasion by their customers. The investigation cost the two banks over NIS 2 billion in 2018, including legal expenses. Mizrahi Tefahot Bank reached a settlement with the US authorities, putting an end to its affair there, while Bank Hapoalim is still in settlement talks and may very well make additional provisions for this investigation.
Despite these large-scale provisions, the banks finished 2018 with a NIS 9.3 billion aggregate profit in 2018, 2% more than in 2017. Without the provisions for the investigations, the banks' aggregate profit would have been a record NIS 11 billion.
The banks' 2018 results
Mizrahi Tefahot Bank has consistently had the highest return on equity of any Israeli bank, but Bank Leumi led in this category in 2018 with a 9.5% return on equity. The banks' aggregate return on capital in 2018 was 8.5%.
The consistent improvement in the banks' business results was also reflected in their share prices. The Tel Aviv Stock Exchange banking index rose 15% in 2018, more than double the 7% return on the Tel Aviv 35 index.
The banks' good results resulted from a combination of two main factors. The banks achieved their equity targets, enabling them to increase their credit and increase their revenue. At the same time, the deep streamlining processes implemented by the banks in recent years are reducing their expenses.
Credit granted to businesses by the banks rose 9.3% to NIS 211 billion in 2018, after a decade of declining business credit portfolios caused primarily by competition from the capital market, which offered cheaper credit. The banks also reduced their exposure to large borrowers, after a considerable number of such borrowers encountered difficulties. The banks' policy was to prefer consumer credit at the expense of business credit. Furthermore, the banks focused on improving their capital ratios in recent years. In order to reach the targets set by the Bank of Israel, the banks had to reduce their exposure to business credit (this was true mainly of Bank Hapoalim and Bank Leumi).
Credit provided by the banks
Now, however, it appears that business credit is becoming an important growth focus for the banks, particularly Bank Leumi; their aggregate business credit portfolio rose 10% in 2018. The shekel depreciation against the dollar also contributed to the growth in the banks' credit, which is reported in shekels.
Despite the growth in 2018, the banks' business credit portfolio today is different from what it was a decade ago. The banks are still reluctant to finance large borrowers and holding companies (actually, there are now almost no such companies). Instead, the banks are focusing on financing the real estate and infrastructures sector. They no longer compete so much with the capital market in standard credit, because the capital market usually offers lower prices. Instead, the banks are turning to complex and larger deals for which a higher price can be charged.
The growth in business credit was sparked by the achievement of the banks' equity targets, but this is not the sole reason. Another reason is the banks' increasing reluctance to grant consumer credit. The risk of this credit rose in recent years as a result of a rapid increase in its volume and changes in bankruptcy procedures that have made this option more attractive to borrowers at the banks' expense. The result was a sharp rise in provisions for losses on this credit and improvement of debt collection processes.
It appears that this process has affected the banks' appetite. Bank Hapoalim and Bank Leumi reduced their exposure to consumer credit, while the medium-sized banks, which grew strongly in this market, slowed their growth in it in 2018.
Credit for small businesses rose 5% in 2018, and 8-9% among the medium-sized banks. The increase among the large banks, however, was negligible, while the risk rose.
Revenue from financing grew 9.4% to NIS 30.7 billion in 2018, an increase that played an important role in improving the banks' results. The increase in financing revenue exceeded 10% at Bank Leumi, Mizrahi Tefahot Bank, and Israel Discount Bank. The increase in revenue outstripped the 6.5% rise in the aggregate banks' credit portfolio, showing that the banks improved their spreads, even though the interest rate remained negligible and unchanged in 2018 (the interest rate was raised only at the end of the year).
Wider spreads in the mortgage market also contributed to the increase in revenue. For example, Bank Hapoalim's revenue from mortgages jumped by over 20%. The Bank of Israel raised its interest rate slightly at the end of the year. This increase, and possibly also additional increases in 2019, will further boost the banks' financing revenue, their main sources of revenue.
The banks' revenue from fees was up 2.3% to NIS 13.1 billion in 2018. Revenue from fees fell in previous years, following various regulatory initiatives, but also went up 1.5% in 2017.
The slowdown in regulatory instructions helped reverse the negative trend in revenue from fees. The banks also benefited from increased use of credit cards, which boosted their revenue in the sector by 8.5% in 2018. Furthermore, the new revenue distribution agreements signed by the banks with the credit card companies will increase their share of the revenues, thereby raising their revenue from fees even further in the coming years. Revenue from current account fees and fees in securities, however, remained unchanged in 2018, or even fell.
The banks provided NIS 2.1 billion for credit losses in 2018, 70% more than in 2017, but the rate of provision for credit losses is still low at only 0.2% of the portfolio.
The increase in provisions resulted from a decline in recovery (repayment of problem debt for which provision was made) in the business sector. The reason was not a decline in the situation of the business sector; the banks provided billions of shekels over the years for large borrowers in difficulty, but the debt arrangements and sales of assets enabled them to recover part of these provisions and provided them with revenue from this item, as in the cases of Lev Leviev and former "Globes" controlling shareholder Eliezer Fishman. This source of revenue has now been mostly exhausted. The figures show that the banks had NIS 1 billion in revenue from provisions for losses in the business sector in 2017, compared with only NIS 200 million in 2018.
On the other hand, provisions for credit losses on loans to consumers and small businesses are still high, given regulatory changes having a negative impact on the payment ethic in Israel. The volume of provisions for credit losses in these two sectors exceeded NIS 2 billion, the same as in 2017.
Provisions for credit losses are on an upward trend. The figures are still low, but it is likely that when the interest rate in the economy begins to rise, more borrowers will have trouble meeting their debt payments, and provisions will increase.
The banks' salary expenses totaled NIS 16.1 billion in 2018, less than 2% more than in 2017. Their success in reining in their salary expenses is an impressive achievement, given the mechanism that automatically increases their salaries.
The banks are enjoying the results of their cost-cutting programs in recent years, when over 6,000 employees left the banks. The pace of streamlining dropped in 2018: 970 employees left the banks (excluding Mizrahi Tefahot Bank, which is still expanding and hiring employees). The steepest drop in staff was at Bank Hapoalim - 500.
The pace of reduction in stall will probably continue in 2019, since most of the banks are not planning voluntary retirement programs this year. Most reduction in staff this year will come from natural retirement of employees and possibly a cut in temporary staff. The slowing of streamlining was also reflected in the slower pace at which branches were closed in 2018; this will be further reduced to 3-5 branches per bank in 2019, compared with 10 branches in 2018.
A major task facing the two large banks, Bank Hapoalim and Bank Leumi, will be reaching a new wage agreement with their workers' committees. This will be difficult for management of the two banks; given the improvement in the efficiency ratio and profit, the workers' committees will increase their demands, in comparison with previous years.
Given the absence of a massive cost-cutting program and the challenge of reaching new wage agreements, it will be interesting to see whether the banks manage to continue containing their salary expenses in the coming years.
Published by Globes, Israel business news - en.globes.co.il - on March 31, 2019
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