BMI View: Israel's commercial banking sector is facing a difficult period, with credit growth slowing and profitability contracting. Although we forecast loan growth accelerating, profitability will remain subdued due to increasing concerns associated with loan quality, which is resulting in an uptick in loan-loss provisioning. That said, the sector is still well placed to weather a storm over the coming quarters, given its conservative asset allocation strategy and rigorous regulatory standards.
Data from the Bank of Israel (BOI) show deposit growth in the commercial banking sector has accelerated in recent months, while credit growth has slowed considerably. However, we expect this trend will be partially reversed. Deposit growth came in at 10.1% year-on-year (y-o-y) in June, compared to average growth of 7.2% in 2011. However, the government will likely decrease its support for the economy over the coming months ( see our online service, September 3, 'Further Austerity Measures Unlikely') and with base effects kicking in, the pace of expansion will slow. We forecast deposit growth averaging 8.5% and 7.5% in 2012 and 2013 respectively.
|Set To Slow|
|Banking Sector Deposits (ILSbn)|
Conversely, though credit growth has been slowing in recent months, averaging 5.7% y-o-y in H112, compared to 8.1% in 2011, we forecast it rising at a faster pace. This is mainly a result of the issuance of new mortgages, which account for a quarter of the commercial banking sector's credit portfolio, as the value of new mortgages spiking by 17% month-on-month in August. This was a 71.0% jump from average growth over the previous 12 months. That said, credit growth will not outpace deposit growth. Israel's weak macroeconomic backdrop, with growth set to slow in the coming quarters ( see 'Growth To Slow Heading Into 2013', Sepetmber 12), will limit lending. Moreover, increasing concerns over loan quality will incentivise the sector to maintain a conservative asset allocation strategy. Finally, while there is a risk the government could adopt macro-prudential policies such as limitations on mortgages to cool demand in the housing sector (as consumer price inflation has mainly been triggered by elevated housing prices), we do not think these policies will be implemented in the short term. As a result, we forecast credit growth averaging 6.5% and 6.8% in 2012 and 2013 respectively, down from 8.1% in 2011.
|Growth To Accelerate|
|Banking Sector Loans (ILSbn)|
Well Placed To Weather A Storm
We reiterate our view that the sector is currently well placed to handle a period of instability ( see 'Banking Sector: Entering A Rough Patch', July 27). The loan-to-deposit ratio has been falling steadily, coming in at 0.81 in June. Although this trend could reverse, this is unlikely to result in significant risks as the ratio is already low by the standards of other OECD economies such as Germany and Italy. In addition, the sector's securities portfolio grew by 53.4% y-o-y in June, making up 11.5% of total assets, its highest level since January 2008. As a result, low-risk assets are increasing as a portion of total assets. The country's conservative regulatory standards will also hedge against the risk of instability in the sector.
However, concerns relating to loan quality are increasing. According to the Israel Securities Authority, more than 30 Israeli companies have sought debt forgiveness since 2011, as refinancing costs rose and growth slowed. Due to increasing concerns that Israeli companies will struggle to roll over maturing liabilities to pay obligations, Moody's cut the outlook for the nation's banks to negative from stable in May. As a result, Bank Leumi Le-Israel, Israel's largest commercial bank, set aside almost five-times as much cash in Q112 than in Q111 to cover bad loans. Concerns over ongoing poor loan quality could constrain asset growth as banks continue to increase their loan-loss provisioning.
|Bank Stocks Taking A Hit|
|Tel Aviv Banking Index & Tel Aviv 100 Index|
Profitability Will Remain Subdued
Profitability in the sector has fallen significantly in recent months, with profit at Bank Leumi falling by 50.0% y-o-y to ILS280mn in August and net income at Bank Hapoalim (the country's second-largest commercial bank) falling by 15.0% y-o-y to ILS610mn in the same month. Equity valuations have taken a hit as well, with the Tel Aviv Banking Index underperforming compared to the Tel Aviv 100 Index by over 11.0% since the beginning of Q212. As a result of increasing concerns over loan quality, the sector will continue to adopt a conservative asset allocation strategy, with portfolio assets set to grow further. As a result, profitability will remain constrained for the foreseeable future.