Domestic slowdown, global crisis hamper Israeli banking

The fundamental credit outlook for the Israeli banking industry is negative, reflecting the expected slowdown in the domestic economy, as well as the impact of the ongoing global financial and economic crisis, Moody's Investors Service said in its new Banking System Outlook on Israel.
"With some delay, Israel is now feeling the effects of the ongoing global financial and economic crisis. The banking system has been indirectly affected by (a) the increased risk aversion and the repricing of risk globally that has negatively affected the valuation of their securities portfolios, (b) the defaults by international financial institutions leading to counterparty exposure losses, and (c) the fall in global real estate prices that is impacting some of their larger corporate exposures," said Constantinos Pittalis, a Moody's senior analyst. That said, in Moody's view, the banking system as a whole has a manageable exposure to "toxic assets" and is not over-exposed to troubled financial institutions overseas.
Furthermore, the domestic corporate bond market has major refinancing needs over the next couple of years, suggesting that Israeli banks may have to participate in such refinancing given that such corporations are also bank customers. Finally, the banks' asset mix has gradually moved towards a higher proportion of loans compared to more liquid holdings and investments, thus increasing the likely adverse impact of a deteriorating credit portfolio on the banks' financial fundamentals.
Moody's cautions that profitability is under pressure due to exposure to some defaulted overseas financial institutions and losses on the banks' securities portfolios, while the ongoing capital markets reforms in Israel are curbing the ability of the banking sector as a whole togenerate fees and commissions.
"Problematic exposures will likely increase, leading to elevated provisioning expenses and pressuring bottom-line profitability. This suggests that some banks will have difficulty reaching the 12% minimum capital adequacy ratio by the end of 2009," added Christos Theofilou, a Moody's associate analyst.
On the positive side, dominant and stable franchise positioning within Israel supports the rated banks' financial strength ratings. With franchise value hard to develop further in Israel, increased competition from non-bank financial institutions and recent reforms limiting opportunities for earnings diversification domestically, Israeli banks have increased their cross-border activities by acquiring banks in emerging markets and have moved ahead with other investments abroad — moves that have raised their overall risk profile.
In the current market conditions, Moody's considers liquidity and retail funding to be key strengths of the Israeli banking system. Israeli banks benefit from a large, stable customer deposit base, that adequately funds their lending business. Deposits have been highly stable over the past few years and this has supported the banks' ratings. Furthermore, Israeli banks do not depend on foreign funding, and so the ongoing financial crisis has not hurt their funding position. Liquidity management is considered adequate.
"In 2009, the Israeli banks are expected to implement the new guidelines of the Basel II agreement. Moody's expects this to lead to more focused and better risk management, improved decision-making and increased transparency and disclosure," added Theofilou.