Moody's: Israel's banking system outlook changed to negative
Rating agency praises resilient economy but says operating environment, growing geopolitical tensions could further compromise business confidence and economic activity
The downgrade in the outlook of the banking systems, banks which have seemed nearly immune to the European debt crisis, could ignite a bank debenture yield increase trend as well as cause financing within the Israeli market to become more expensive.
Moody's noted that the operating environment in Israel will remain challenging, with GDP growth expected to decelerate significantly in 2012. Weakening export demand will be the primary driver of the slowdown in growth, stemming from the unresolved euro area crisis that will limit Israel's European exports.
Additionally, growing geopolitical tensions, related to Iran and the changing political landscape in neighboring countries, could further compromise business confidence and economic activity.
Nonetheless, Moody's acknowledges that Israel's economy has proven resilient to repeated shocks in the past.
The negative outlook captures the modest capital levels and the resulting limited shock-absorption capacity of the system. Although Moody's believes that the banks will gradually increase their capital levels, the system Tier 1 ratio will likely remain below those of international peers over the outlook period.
In terms of asset quality, Moody's expects a gradual increase in non-performing loans to 4.5%-5.0% by mid-2013, from 3.8% in September 2011, primarily driven by the slowdown in economic growth.
Over the outlook period, Moody's expects that credit risks will remain elevated because of the banks' concentrated loan exposures to highly-leveraged, Israeli conglomerates.
Rising corporate bond yields and reduced investor interest will challenge corporates' bond refinancing capabilities and potentially exacerbate asset-quality issues by constraining corporates' repayments on their bank loans.
The banks' funding profiles remain stable, with customer deposits accounting for 75% of total assets as of September 2011 and a sector-wide loans-to-deposits ratio of 91%.
Customer deposits have historically been sticky (stable) and the country's high savings rate supports the sector's funding profile. Israel's rated banks maintain solid liquidity buffers given their role as net interbank lenders, with liquid assets accounting for an estimated 26% of total assets.
Moody's believes that banks' funding profiles will not change significantly over the outlook period, although the current global operating and funding environment implies that local banks will have to contend with rising funding costs.
Bottom-line profitability will likely remain at similar levels to those seen in 2011. Increased provisioning requirements and subdued revenue growth will be offset by cost-cutting initiatives as banks aim to improve their relatively weak efficiency indicators.
Moody's expects that projected profitability will translate into modest pre-provision and bottom-line returns on risk-weighted assets of around 1.3% and 0.7%, respectively.
