Merrill Lynch warns again on Israeli banks

The investment bank has cut 2009 earnings estimates by 40% since Lehman Brothers collapsed.

Worsening economic conditions in Israel, and the global credit crunch, lead investment house Merrill Lynch to lower its earnings estimates on Israel's banks still further.

Along with a previous earnings estimates cut, Merrill has reduced its earnings estimates for the industry by 40% since Lehman Brothers collapsed in September.

In the middle of October, Merrill cut its 2009 estimate by 14%, but said that the strong fundamentals of Israel's economy would prevent a further drop in economic activity. Since then, the economy has suffered what the bank calls a "marked deterioration", leading to concerns of recession rather than just a slowdown. News of bankruptcies and layoffs are becoming routine, and the spreads of corporate bonds over government yields have jumped, reflecting investor fears of more bankruptcies.

Merrill analysts Haim Israel and Micha Goldberg are now cutting their 2009 average earnings estimates for Israel's banks by 26%.

The Merrill analysts find that the deepening US and EU recession, lower corporate profitability, and serious risks to the corporate sector’s cash flow is likely to hurt the corporate loan book of the banks, which accounts for approximately 55% of the total NIS 600 billion loan book. Likewise, the increase in unemployment, lower real wages and a negative wealth impact from falling stock markets worldwide will all constrain consumer spending, further hurting banking sector asset quality.

Merrill warns of a possible credit crunch in Israel, as reports of corporations having cash flow difficulties and much tighter bank credit conditions mount. The banks loans are also overly exposed to several "overleveraged conglomerates" - Israel’s six largest borrowers accounted for some NIS 130 billion of bank debt at the end of 2007, a figure more than double the sector’s equity. Rising non-performing loans and loan loss provisions are now the sector biggest risk. If any of these large borrowers default, it would seriously deplete capital.

Merrill cuts its 2009 earnings estimate for Bank Hapoalim (LSE: BKHD; TASE: POLI) by 35%, for Bank Leumi (TASE: LUMI) by 20%, for Mizrahi Tefahot Bank (TASE:MZTF) by 11%, and Israel Discount Bank (TASE: DSCT) by 42%.

Merrill cut its price objectives for Israel's leading banks as well, lowering Bank Hapoalim to NIS 9.1 from NIS 11.20, Bank Leumi to NIS 12.1 from NIS 14, Discount Bank to NIS 3.30 from NIS 4.10, and Mizrahi to NIS 19.70 from NIS 23.50.

Bank Leumi remains the only major bank with a "Buy" recommendation by Merrill. Discount is rated "Underperform", and Hapoalim and Mizrahi are rated "Neutral".

Merrill finds Mizrahi a defensive play, but fairly valued. Mizrahi is "predominantly focused on high-quality local consumers, with practically no exposure to overseas markets, almost zero exposure to toxic assets, a strong likelihood of a significant capital release in 2010, a high quality loan portfolio and strong management with a proven track record."

Discount Bank, on the other hand, "has a high and rigid cost base, sizeable exposure to the US middle market and a strategy that has seen a recent rapid increase in credit growth. These factors could all seriously hamper short-term earnings growth in the current difficult economic environment. Furthermore, the bank’s structurally lower profitability, relatively low core-tier 1 ratio and yet unproven management could leave it highly sensitive to the worsening economic environment."

Published by Globes [online], Israel business news - - on November 24, 2008

© Copyright of Globes Publisher Itonut (1983) Ltd. 2008

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