Banking Sector: Profitability Under Threat
BMI View: We expect profitability in the Israeli banking sector to moderate in 2013, as banks will have to deal with stricter regulations, while asset growth will continue to decline. That said, underlying threats to stability will remain minimal in 2013.
Data from the Bank of Israel (BoI) show that deposit growth in the commercial banking sector came in at 5.0% y-o-y in December 2012, and averaged 9.0% throughout the year. We expect deposit growth to remain below 2012 levels in 2013, as a result of base effects, coupled with our view that private consumption will increase only 2.5% this year from 3.0% in 2012 ( see our online service, March 3 , ' Lower Imports Underpin Faster Growth In 2013'). We forecast deposit growth averaging 6.5% and 7.0% in 2013 and 2014, respectively.
|Expanding Slowly in 2013|
|Israel - Banking Sector Deposits (ILSbn)|
Loan growth came in at 2.6% y-o-y in December 2012, averaging 4.6% during the year. We expect credit growth to accelerate slightly in 2013. With the inflation rate having increased only 1.5% y-o-y in February 2013, while the domestic economy will remain in a soft patch this year, we expect the central bank to cut interest rates by 25 basis points to 1.50% before end-2013, which will help support loan growth to a certain extent.
That said, the BoI published on March 19 new draft guidelines on credit for housing and real estate, in a bid to stem threats to the credit profile of banks from a potential housing bubble. The central bank increased the amount of capital that banks are required to hold against most types of home loans, and also told the lenders to set aside additional provisions for credits that may not be repaid. With mortgages accounting for approximately 30.0% of the commercial banking sector's credit portfolio, this will ensure that lending will grow at only modestly. We project total loans to increase 5.0% in 2013 and 5.2% in 2014.
Total assets in the commercial banking sector contracted 2.1% y-o-y in December 2012, compared to average growth of 6.2% in 2012. Given our view that loans will expand slowly this year, which will not be offset by a sharp expansion of the industry's bond portfolio, we forecast total assets of the industry increasing only 5.5% and 6.0% in 2013 and 2014, respectively.
|Israel - Banking Sector Loans (ILSbn)|
Profitability Remaining Constrained...
Profitability in the sector increased significantly in Q312. That said, although most top Israeli banks had not reported Q412 earnings at the time of writing, profitability has likely decreased significantly over the past few months, in line with the view expressed in our previous research note on the sector ( see our online service, 'Banking Sector: Profitability Set To Decrease', December 12 2012). Mizrahi-Tefahot, Israel's fourth-largest lender and the first top bank to report quarterly earnings, posted Q412 net profits of ILS270mn (US$73mn), a 9.7% decline compared to the same period in 2011, mainly due to lower financing income and higher operating expenses and taxes. Bank Leumi, Israel's largest lender by assets, stated on March 4 that it expects to report net losses of ILS100mn in Q412, compared to net income of ILS479mn in Q312, due to an ILS340mn provision to cover expenses from an investigation by US authorities into suspicions of tax evasion by bank customers. Indeed, equity valuations have performed modestly over the past few months, with the Tel Aviv Banking Index having traded sideways between 1,099-1,999 since November 23 2012.
|Sideways Trading To Continue|
|Israel - Tel Aviv Banking Index|
We expect profitability to increase only modestly in 2013. With interest rates likely to be cut further and lending growth still weak, net interest income will drop. The sector will also have to deal with a stricter regulatory framework over the coming years. The central bank recently required banks to raise their core Tier 1 capital ratio to 9.0% by the end of 2015 and to 10.0% by end-2016 for the two largest banks, Bank Leumi and Bank Hapoalim. In addition, the aforementioned new set of guidelines for housing credit will result in increasing costs for the industry.
... While Stability Looks Assured
We reiterate our view that underlying risks to stability remain low. The loan-to-deposit ratio has been falling steadily, coming in at multi-year lows of 0.79 in December, and, given our view that deposits will grow faster than loans in 2013, this trend is set to continue. Moreover, the securities portfolio of the industry is growing robustly - accounting for 12.3% of total assets in September, the highest level since November 2007 - reflecting the banks' conservative asset allocation strategy. Finally, the new guidelines on housing credit will improve the banking sector's stability vis-a-vis the potential threat from a housing bubble.