Globes

Bank credit losses could be worrying sign for economy

Israel's banks saw an increase in provisions for credit losses, mainly in the fourth quarter of the year, and
mainly in credit to households.

2016 was a fairly good year for the banks. Despite the low interest rates and increased regulation, the
five biggest banks finished 2016 with an aggregate NIS 8.11 billion profit, less than 2% below their 2015
profit. This year's profits were favorably influenced by the sale of Visa Europe shares, which generated
over NIS 1 billion in revenue, while on the other hand, provisions for streamlining plans and
investigations by the US authorities had a negative impact on some of the banks' results.

Despite these standard issue good results, however, beneath the surface, some disturbing findings are
starting to emerge, headed by an increase in provisions for credit losses, mainly in the fourth quarter of
the year, and mainly in credit to households.

Household credit: The economy's next affliction?

"There is an increase in expenses for credit losses in the retail sector, and that should serve as a
warning," Bank Hapoalim (TASE: POLI) CEO Arik Pinto told "Globes." Like other bank managers who
spoke about this subject in recent weeks, Pinto agrees that the reason is changes in bankruptcy
legislation that benefit borrowers. "The changes in legislation are making the bankruptcy proceeding
more accessible, and are having a deleterious effect on payment ethics, while increasing the banks' risk.
This is liable to lead to the exclusion of groups from obtaining credit and an increase in the price," he
says.

Bank Leumi (TASE: LUMI) CEO Rakefet Russak-Aminoach also cites this trend, saying, "Like the rest of the
banking system, Bank Leumi is also seeing an increase in risk for credit to households. The target for
growth in credit is modest growth on the same scale as economic growth," she told "Globes."

What do the numbers say? The banks' provisions in the household sector totaled NIS 1.54 billion in 2016,
a rise of more than 70%, compared with the provisions for 2015. At the same time, it is important to
stress that this increase is not due merely to debt collection difficulties; there are also accounting
reasons, and the steep increase in this activity at most of the banks is another factor. Still, this figure is
quite disturbing, especially in view of the fact that the Strum Law, aimed at increasing credit competition
between the banks, is taking effect right now, bringing with it the entry of additional players into the
market. The question is whether the combination of increased supply and rules making it easier for
borrowers who get into trouble and making the bankruptcy process "more worthwhile" is liable to cause
Israel's next economic crisis.

It appears that some of the banks are aware of the problem. Mizrahi Tefahot Bank (TASE:MZTF)
announced that it would focus on increasing its business credit in the coming years, and less on retail
banking. Bank Hapoalim's retail credit grew by only 2% last year, and Bank Leumi's by 1.5% (excluding
mortgages). "The changes in collection are making us more meticulous in underwriting. For example, we
decided to decrease credit for buying cars, because the pricing in this category does not reflect the risk,"
Pinto says.

What else can be learned from the banks' 2016 financial statements?

Mizrahi-Tefahot: Over 10% return on equity

The average return on equity for the five biggest banks in 2016 was 8.1%, down from 8.8% in 2015. Only
one bank was over 10% - Mizrahi-Tefahot, with 10.3%. Bank Leumi was in second place with 9.3%,
followed by Bank Hapoalim, whose poor fourth quarter pushed its return on equity down to 7.7%. The
lowest of the five was Israel Discount Bank (TASE: DSCT) with 6.6%, despite the many changes instituted
by the bank in recent years, including the expansion of its credit portfolio and aggressive streamlining
plans. Discount Bank believes that its profit indicators will also improve, with return on equity exceeding
10% by 2022.

It is important to note that at the current interest rate, the return reported by the banks is definitely
reasonable. If the Bank of Israel raises the interest rate in the coming years, the banks will be able to
increase their financial spread, possibly boosting their return on equity over 10% again.