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Middle EastFebruary 6 2006

Horizons must widen

Following capital market reform, Israel’s banks are being forced to look overseas for expansion opportunities, says David Lipkin.
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In 2005, there was something of a revolution in Israeli banking and capital markets. The government sold two of the country’s biggest banks, Bank Leumi and Israel Discount Bank, which it had owned for 22 years, since the 1984 bank share crisis. A major reform was also implemented in the capital market at unprecedented speed. Within two months of the Knesset’s (Israeli parliament) approval of the Capital Market Reform Commission’s (CMRC) recommendations, most of the banks had sold their provident funds and their mutual funds, the bulk of which were bought by insurance companies and some by US investment funds.

In the wake of the big changes, Israel’s two biggest banks are planning to expand their operations overseas. Bank Hapoalim and Bank Leumi are considering buying banks and extending their private banking activity in the US, Europe and the Far East.

The last public event in which Israeli prime minister Ariel Sharon participated before he suffered a stroke last month was a ceremony marking the sale of an effective controlling stake of Bank Leumi to two US hedge funds. Cerberus Global Investment and Gabriel Capital agreed to pay NIS2.5bn ($544m) for a 9.9% stake of Leumi with an option for a further 10.1%.

Mr Sharon had previously objected to the plan of Binyamin Netanyahu, then minister of finance, to sell Bank Leumi by offering share options to the public. Mr Sharon maintained that this was a pre-election gift to the public and demanded that the bank be sold to investors, as was done with Bank Hapoalim, Israel’s largest bank.

Mr Sharon did, however, give his backing to Mr Netanyahu’s implementation of the largest reform to take place on Israel’s capital market. The banks were ordered to sell their mutual and provident funds within four-to-eight years and will gradually be allowed to market pension and life insurance plans to their customers to compensate them for their loss of income.

Surprise sales

The biggest surprise was that, within a matter of weeks, most of the funds – containing more than NIS80bn of the public’s money – were bought. The Israeli insurance companies and two foreign investment funds that bought them paid an aggregate sum of nearly NIS4bn. Even the members of the capital market reform commission, headed by director general of the Ministry of Finance Yossi Bachar, were taken aback by the speed of the sale, which far exceeded the commission’s assessment of the timescale needed.

The supposition was that private brokers and foreign investors would buy the funds. The insurance companies that bought most of the assets were willing to pay top prices because long-term and medium-term savings go hand in hand with the insurance and pension fund field. Israeli capital market analysts say that insurance companies’ willingness to pay such high prices is because the asset is worth more to them than it is to the seller.

The two foreign buyers of the funds are Markstone Capital Partners and York Fund. Markstone raised $800m from US institutional investors, including California and New York state workers pension funds.

Privatisation is slow

The sale of the banks was a very different matter to that of the fund sales, with bureaucracy delaying the deals.

In February last year, buyers from Israel and the US vied to buy Israel Discount Bank, the third largest bank in Israel. Mathew Bronfman, son of US billionaire Edgar Bronfman, won the tender for the acquisition of a controlling stake. He bid $282m, the highest price for a 24% stake of the bank’s government-owned shares.

However, the central banks in Israel and the US took eight months to approve the deal. The execution of the deal was delayed by a probe conducted by the New York Reserve Board into the involvement of the bank’s New York subsidiary in laundering $2.2bn from Brazil over a period of five years. According to an agreement with the New York State Prosecutor’s Office, Bank Discount of New York will pay a $25m fine.

Ironically, Bank Discount of New York was the jewel in Israel Discount Bank’s crown. It was the biggest and most successful Israeli bank overseas and the biggest moneymaker for its parent bank. That was one of the reasons why consortiums from Israel and the US competed for the acquisition of the bank, counting on the possibility of expanding its operations in the US.

Power shift

With the fund sales Zvi Ziv, Bank Hapoalim’s CEO, and Eitan Raff, chairman of Bank Leumi, told The Banker that they made it clear to the CMRC that they would not wait several years for it to happen. There was a window of opportunity when insurance companies and investment funds were offering high prices for the funds, they say.

Mr Raff warns, though, that the concentration of power in the capital market has shifted from the banks to the insurance companies. The insurance companies will now manage substantial sums of money, without the control and supervision that the regulator imposed on the banking system, he says.

The banking sector is changing its strategy after selling its mutual and provident fund activity. Discussions are already under way at Bank Hapoalim about the direction it will take, the aim being to improve yields. Its financial statements for the first nine months of 2005 indicate that its profits for the entire year will be the highest that it has recorded. The goal is to achieve a return of more than 15% on equity, says Mr Ziv. This calls for more flexibility in managing the bank’s funds and sometimes taking slightly higher risks.

Domestic straitjacket

Mr Ziv says that there is not much room for the bank to expand its activity domestically and reaching global markets is an important goal in the next few years. Last year, Hapoalim stepped up its overseas acquisitions, acquiring Inter-Maritime Banks, C Kredi Ve Kalkinma Bankasi (C-Bank) of Turkey and US brokerage company Investec, and opening a private banking centre in Miami, Florida. It recently sold its investment in Signature Bank of New York, generating a one-time profit of $110m.

Hapoalim’s Swiss arm is succeeding in the private banking sector, according to Mr Ziv. Inter-Maritime was successfully merged into Hapoalim Switzerland. It has a representative office in Hong-Kong and is considering opening a branch in Singapore. It is also exploring the possibility of entering the Chinese market.

Hapoalim intends to expand C-Bank’s activity in Turkey. The aim is to get involved in retail banking in the big cities, such as Istanbul, Izmir and Ankara.

In the wake of the capital market reform, Bank Hapoalim intends to upgrade and improve the quality of its consulting network. It will take several months before the bank enters the pension consulting field and, later, life insurance, says Mr Ziv. He believes that it will be a big mistake to prohibit the banks from selling insurance.

However, he says that Hapoalim does not plan to venture into holding companies to the extent that it has done in the past. “Our focus will be on the banking field,” he emphasises.

He believes there is too much involvement from banking regulators. Regulatory control is getting tighter, he says. The capital market reform has created a new situation in which a contract for the provision of provident fund services requires the approval of the Superintendent of the Banks, the Capital Market Commissioner and the Restrictive Trade Practices Controller.

Mr Raff warns that, in this new environment, Bank Leumi cannot grow domestically because the regulator will not allow it to buy one of the medium-sized banks. The regulator wants to create a third big bank to balance the power of the two leading banks, which is an improbable task given the profitability of the banking system.

The CMRC also pronounced that the bank cannot invest in holding companies, says Mr Raff. Leumi will have to sell two of its investments in Israel to comply with the new law. That means it will have to look for investment alternatives overseas, he says.

Bank Leumi intends to expand its operations in the US and set up branches in locations with potential. It already has 12 branches in the US, including one in Silicon Valley. It is also expanding into eastern Europe. It bought Eurom Bank in Romania late last year to take advantage of what it sees as good business potential in Romania and Bulgaria. Eurom Bank will serve nearly 300 Israeli companies operating in the area. Leumi also has an active representative office in Hungary and is considering buying other banks in eastern Europe.

The bank is exploring activity in south-east Asia, where it will be able to use its current activity in the private banking field, according to Mr Raff. This year it will examine a plan to open a branch or representative office in Singapore and follow up possibilities for venturing into the Chinese market.

Mr Raff believes that the government and the Knesset should allow the banks to sell life insurance in the near future rather than requiring them to wait five years. The banks want to market insurance policies and not engage in underwriting, he stresses.

Credit directive

Israeli banks are preparing to implement a new directive of the Superintendent of the Banks, which requires them to set credit lines for their customers that they cannot exceed. The directive will go into force in July 2006, after which the banks will have to bounce cheques of customers who exceed their credit limits, making them restricted customers.

The aim of the directive is to put a stop to the phenomenon of hundreds of thousands of bank customers exceeding their overdraft credit limits and paying high penalty interest. Many customers are so heavily overdrawn that there is a risk they will not be able to repay their debts to the banks.

Mr Ziv says that had the directive come into effect on January 1 this year, as originally planned, the Israeli marketplace would not have been ready. Hundreds of thousands of customers would have been left without credit lines and their cheques would not have been honoured.

The directive requires banks to ask millions of customers to sign agreements that set out their approved credit lines. This is a daunting task and it is not clear if it will be completed even by July’s implementation date.

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