In May 2020, Bank Hapoalim (TASE: POLI) announced that it would pay a $875 million fine as part of an agreement with US law enforcement agencies. The move brought an end to a serious affair in which it admitted to helping its US customers evade taxes. A year earlier, Mizrahi Tefahot Bank (TASE:MZTF) paid $195 million for its part in the affair. Even earlier, in 2014, the third Israeli bank involved, Bank Leumi (TASE:LUMI), managed to settle its part by paying a $270 million fine.
The investigation into tax evasion facilitation, opened in 2008, overwhelmed Israeli bank subsidiaries abroad in general and in the US in particular. The episode made a media comeback last week, when Leumi announced it had reached an agreement to merge Leumi USA with Valley National Bancorp, in a deal that would give Leumi USA a $1.2 billion market cap, and yield Bank Leumi hefty capital gains of between NIS 650 million and NIS 750 million.
In the Israeli banking community, there is a consensus that this is an excellent financial deal for Leumi. If implemented, Leumi USA’s market cap will be 140% above equity, i.e. a 1.4 multiplier on equity. By way of comparison, Leumi itself trades at a NIS 40 billion market cap, reflecting a multiplier of less than 1.
Leader Capital Markets VP Alon Glazer said, "This is a very positive step for Leumi and signifies a good price. Past events taught us all a lesson about getting into deep trouble with international activity, and that’s why it's preferrable for Leumi to move from full control in a US bank to a tradable, liquid holding.
"I hope Leumi will take another step and realize part of its holding in the merged bank (which will be 14.2% according to the agreement), because there’s no reason to hold so many shares over time."
"You can't grow as a boutique bank in the US"
Speaking to Globes a day after the deal was signed, Leumi CEO Hanan Friedman and Valley National CEO and chairman Ira Robbins explained why the merger was decided on. Friedman: "History teaches us that although Israeli banks operating in the US had a high volume of activity, growth was far slower than the US banking industry, which says a lot. We discovered that you can’t be a boutique bank in the US and grow."
Market insiders note that despite the value it brings to Leumi USA the deal will remain good only as long as the merged bank's share does not fall, because 90% of the deal is based on shares, with only a small part based on cash. A review of Valley National’s share, however, reveals it at 1.22 (as of last week), while competing banks have higher multipliers. So, although the bank specializes in mergers, and has acquired a number of financial entities, over time its share has not increased significantly in value - which may make it easier for Leumi to sell of a portion of its holding in the merged bank.
Another reason for Leumi's need to carry out the merger right now is the agreement it signed in 2018 to sell 15% of Leumi USA's shares to two investors - investment funds MSD Capital and Endicott Management, for $140 million. This deal reflected a $933 million market cap for Leumi USA, far less than the Valley deal, but also states that if within four to five years Leumi USA shares do not become tradable, the funds have the option to sell them back to Leumi.
Discount - The US activity leader
Of the five largest banks, four more are active in the US in one way or another, the largest being Israel Discount Bank (TASE: DSCT) with total deposits of almost $10 billion (as of the first half of 2021), followed by Leumi with about $7 billion in deposits, Hapoalim with about $4 billion, and Mizrahi Tefahot with little activity, relative to the others.
Discount is also the largest in terms of public credit with a portfolio of $7.6 billion, followed by Leumi USA (5.4) and Hapoalim (4.5). By comparison, Valley National's credit portfolio stands at $32 billion, as of the end of the second quarter of 2021.
"We’ll benefit from their growth because, from now on, we’re part of them. We can refer Israeli customers to receive service from Americans who know the local market well. Israeli companies that approach us will get service from a Leumi partner bank, so they’ll feel at home and enjoy a much broader value proposition", Friedman notes.
The connection to Israel is a consideration when choosing a bank
However, not everyone agrees with the Leumi CEO’s statement. Moreover, some banking market sources believe this merger will set off the battle of the Israeli banks for the hearts - and the wallets - of Jews and Israelis living in the US and of Israeli companies wishing to launch US activity.
These sources say that the merger may harm Leumi USA's Israeli affiliation in the eyes of existing and potential customers, although Leumi USA CEO Avner Mendelson is expected to serve as vice chairman of the merged bank, and senior members and senior executives at Leumi USA will serve in a variety of key positions.
Discount US and Hapoalim US are, therefore, already making preparations for a customer attrition trend. For these two Israeli banking subsidiaries, this may be an opportunity, as the connection to Israel is one of the main considerations for Jewish and Israeli customers when choosing an Israeli bank operating abroad.
Mendelson himself explains that this is exactly the reason for the merger. "Our competition is with the American and not the Israeli market; this a market that competes with different companies, different sectors and different sizes. In high-tech, competition is definitely not with Israeli banks but with Silicon Valley Bank, JPMorgan and the like," he says, speaking from the US.
"Our activity, like the other Israeli banks, is mostly not with Israeli customers. It’s impossible to build a bank with only Israeli customers, so the struggle for the tech world isn’t just with competitors from Israel. We serve hundreds of companies, between 600 and 700, and the connection with Valley National will allow us to grow with those companies. To date, working with some of them has been challenging, because of the glass ceiling blocking our ability to compete for unicorns [companies valued at over a billion dollars]," adds Mendelson.
Do you think that the other Israeli banks operating in the US will follow in your footsteps?
"This step is trivial, if you understand where the market is heading and read the writing on the wall. Everyone understands there are limits to organic growth, also because you’re a foreign bank bound by foreign regulation. The need to scale up just increases, and I won’t be surprised if we see other banks doing what we did, after years of consideration, examining and analyzing the market, and getting to know every relevant bank across the US.
"You have to understand that all of us - the US team, Hanan [Friedman, Leumi CEO], and the team in Israel - knew Valley National in depth. It wasn’t picked because of the price but because of my connections and dialogue with the Valley folks over four years. Hanan met and got to know Ira, Valley CEO Ira [Robbins]. We wouldn't have made the move without it being a good fit, along with Ira's innovative vision. He understands the need to focus on technological investments. He knows Israel well and its potential for aligning all sides, and is enthusiastic about the deal, especially about leveraging the connection to Israel, Leumi, and definitely with Israeli corporate and tech companies."
Discount and Hapoalim will expand via digital
Despite their desire to increase activity by taking in Leumi USA customers, should they decide to leave that bank after the merger, Discount and Hapoalim have no current plans to open new branches, due to the high cost of maintaining offices in the main US cities. Discount currently has seven branches in the US - in New York, New Jersey, Florida and California. Hapoalim has a central branch in New York, and branches in Miami, New Jersey and Los Angeles.
This year, for example, Discount moved its US headquarters to a new building in Manhattan with rental costs (excluding taxes, insurance and other related expenses) totaling about $8.4 million a year. Its policy, therefore, is to expand primarily through digital means.
The Leumi USA deal is also a golden opportunity for Discount and Hapoalim to learn where they stand in terms of market value for their US operations. The price paid by Leumi, $1.2 billion, places Discount US, which is ostensibly larger than Leumi US, in a good position for future sale or merger negotiations. Given the low profitability of these overseas subsidiaries, compared with the excellent results for the first half of 2021 reported by their Israeli parent companies, it’s possible that the Leumi USA merger won’t be the last one.
Published by Globes, Israel business news - en.globes.co.il - on October 10, 2021
Copyright of Globes Publisher Itonut (1983) Ltd. 2021