February 14, 2017 / 5:13 PM / a year ago

Fitch Upgrades Bank Leumi's & Bank Hapoalim's VRs to 'a-'; Affirms IDRs

(The following statement was released by the rating agency) LONDON, February 14 (Fitch) Fitch Ratings has upgraded Bank Leumi Le Israel B.M.'s (Leumi) and Bank Hapoalim B.M.'s (Hapoalim) Viability Ratings (VRs) to 'a-' from 'bbb+'. Both banks' Long- and Short-term Issuer Default Ratings (IDRs) have been affirmed at 'A' with Stable Outlooks and 'F1', respectively. A full list of rating actions is provided at the end of the rating action commentary. The upgrades in the banks' VRs reflect the improvements the banks have made in risk management and risk appetite, particularly by reducing concentrations. The upgrades also factor in the increases in capitalisation, particularly in view of the banks' improving risk profiles. KEY RATING DRIVERS - IDRs, SUPPORT RATINGS AND SUPPORT RATING FLOORS (SRF) Hapoalim's and Leumi's Long-Term IDRs and SRF are driven by our expectation of an extremely high probability that support will be provided to these two banks by the Israeli state if needed. Fitch's expectation of support from the authorities is underpinned by Israel's strong ability to provide support to banks, as reflected in the sovereign's ratings ('A+/Stable'), combined with Fitch's belief of a strong willingness to do so. The key drivers of the strong probability of support are the deposit-driven liability structure, the interconnection of the banking system and the absence of a deposit insurance guarantee. Our view is reinforced by the banks' systemic importance, large domestic franchises (each accounting for about 30% of sector assets), their importance to the Israeli economy, and the lack of developed resolution legislation. KEY RATING DRIVERS - VRs The ratings of Leumi and Hapoalim reflect their strong franchises in their domestic market, the sound implementation of their medium-term strategy, strengthened risk frameworks and improved capitalisation. The ratings also factor in their large customer deposit bases and healthy asset quality. Both banks are predominately focused on Israel, and given the fairly small market, concentrations by economic sector, and in some instances by obligor, is difficult to avoid. However, Leumi and Hapoalim have reduced large exposures, supported by prudential regulations, and Fitch expects this to continue in the foreseeable future. The banks have also tightened underwriting criteria, which has led to improved risk appetite scores. Profitability has been under pressure from low interest rates and high cost bases, although due to limited competition and diversified income streams, the banks have been able to maintain strong revenues and adequate returns. Profitability has also been supported by very low loan impairment charges, which, in our view, are unlikely to be sustainable at current levels. Both banks have set down plans to improve efficiency, which we believe will allow profitability to remain sound over the medium-term. Asset quality has strengthened consistently over the past five years, helped by a growing economy, low unemployment and low interest rates. Reserve coverage of impaired loans has risen and appears adequate, given the levels of collateral backing the loan book and the high recoveries recorded each quarter. However, risks arising from the large individual exposures remain, in Fitch's view, as do the risks generated by legacy loans extended to holding companies, often on a leveraged basis. We believe these risks are diminishing however. The banks' capitalisation has improved since the Bank of Israel implemented a 10% minimum capital requirement at both banks to be achieved by 1 January 2017, supplemented by capital to be set aside against large exposures to single industries. Risk-weighted assets continue to be calculated using a mixture of the standardised approach (Basel III) and some domestic overrides, which are in our view conservative for some types of lending. Both banks achieved their minimum requirement by end-3Q16, largely through retained earnings, but also, partly by reducing loan growth and the sale/insurance of some exposures. Leverage ratios compare well internationally for both banks Both banks are liquid and well-funded, with large volumes of customer deposits funding amply funding their loan books. The banks also issue on the local market to meet domestic investor needs. Both banks' liquidity buffers consist of cash and high-quality sovereign bonds. RATING SENSITIVITIES IDRS, SUPPORT RATINGS AND SUPPORT RATING FLOORS The IDRs, SRs and SRFs are sensitive to a change in Fitch's assumptions around the Israeli authorities' propensity or ability to provide timely support to the banking sector. While the introduction of a resolution law is in discussion, Fitch does not expect this law to come into effect in the short-term. The country does not operate a deposit guarantee system and the practical implementation of resolution tools, such as bail-in of senior creditors, remains unlikely in Fitch's view. Given the high level of ratings of the banks we do not expect further upgrades of Israel's IDR to result in a further upgrade in the Long-Term IDR of either bank. VR Ratings would likely be downgraded if the banks' capital falls below current targets which could be the case if profitability falls significantly. This could, for example, result from the banks being forced to divest highly profitable businesses, such as is the current proposal for credit cards, without having the possibility of finding alternative sources of income. Ratings could also be under pressure from a material reduction in capitalisation, such as in the case of a larger- than- expected payment, such as for a fine, with no concrete plan to reinstate capital quickly. The VRs could also be downgraded if the banks increase risk appetite beyond current plans to cope with pressure on profitability. Given the already high ratings in the context of their operating environment, any further upgrade of the VRs is currently unlikely. The rating actions are as follows: Leumi Long-Term IDR: affirmed at 'A'; Stable Outlook Short-Term IDR: affirmed at 'F1' Viability Rating: upgraded to 'a-' from 'bbb+' Support Rating: affirmed at '1' Support Rating Floor: affirmed at 'A' Hapoalim Long-Term IDR: affirmed at 'A'; Stable Outlook Short-Term IDR: affirmed at 'F1' Viability Rating: upgraded to 'a-' from 'bbb+' Support Rating: affirmed at '1' Support Rating Floor: affirmed at 'A' Contact: Primary Analyst Claudia Nelson Senior Director +44 20 3530 1191 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Ellen Six Associate Director +44 20 3530 1596 Committee Chairperson Redmond Ramsdale Senior Director +971 4424 1202 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. 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