After credit downgrade, Moody’s lowers deposit ratings of Israel’s five largest banks

Lower rating increases borrowing costs for banks, which in turn will likely be passed on to consumers and lead to higher lending rates

Sharon Wrobel is a tech reporter for The Times of Israel.

Offices of Discount and Hapoalim banks in the center of Tel Aviv (Miriam Alster/ FLASH90)
Offices of Discount and Hapoalim banks in the center of Tel Aviv (Miriam Alster/ FLASH90)

Moody’s Investors Service has downgraded the deposit ratings of Israel’s five largest banks, a move that could push up borrowing costs for consumers and businesses.

Late on Tuesday, the US credit ratings agency cut the long- and short-term deposit ratings of Bank Leumi Le-Israel, Bank Hapoalim, Mizrahi Tefahot Bank, Israel Discount Bank and First International Bank of Israel by one notch to A3 from A2.

The agency said its decision comes on the heels of “potential further weakening of the sovereign’s capacity to provide support” amid the ongoing war with the Hamas terror group. The action was “driven by a lower government support uplift” — referring to the state’s ability to support the banks — and came for the same reasons that led to the downgrade of Israeli government debt on Friday, the agency said.

That decision saw Moody’s cut Israel’s sovereign credit rating to A2 from A1, the first ever downgrade, and attached a negative outlook as the “ongoing military conflict with Hamas, its aftermath and wider consequences materially raise political risk for Israel, as well as weaken its executive and legislative institutions and its fiscal strength, for the foreseeable future.”

The ratings agency also lowered the debt outlook on the five Israeli banks to negative, citing the “potential for a significantly more negative impact on the economy in the event of an escalation in the ongoing conflict, which could lead to the banks’ standalone fundamentals being impacted more severely than is currently assumed.”

“The decision to lower the ratings of the banks is not much of a surprise as the downgrading of Israel’s government debt has an impact on the risk perception of the banks, as they rely on the economy,” Liran Lublin, head of trading at IBI investment house, told The Times of Israel. “A lower rating means that the financing sources of the banks become more costly which they would then pass along to consumers and that will likely make it more expensive for borrowers or customers to get loans.”

A Jerusalem branch of Bank Hapoalim (photo credit: Nati Shohat/Flash90)
A Jerusalem branch of Bank Hapoalim. (Nati Shohat/Flash90)

In general, commercial banks raise capital from two main sources: deposits from the public and issuing bonds on the capital market. The banks charge a lending or interest rate to consumers who take out mortgages and other household and corporate loans and they pay interest on deposits by the public depending on their size and duration.

A lower credit rating translates into higher borrowing costs for the banks when issuing or raising debt because investors view them as riskier bets, which means that their cost of money or capital becomes more expensive. As such, higher borrowing costs for downgraded banks can influence lending rates.

“The direct impact of the downgrade on the banks will be limited because it mainly reflects what the bond market already expected and has priced in,” said Lublin. “The increase in the level of risk is likely to lead to a slowdown in credit rates due to higher interest rates and reduced competition for new credit.”

Meanwhile, Moody’s expressed that it “continues to assume a very high probability of government support for the five large Israeli banking groups that it rates given their systemic importance and the Israeli government’s long-standing practice of supporting such systemically important banks, in case of need.”

However, the ratings agency said it expects the banks’ loan quality to suffer from the war impact because of their “relatively high, albeit varying, exposure to the construction and real estate sectors.” Many building sites have been shuttered and real estate projects are being delayed following Hamas’s devastating October 7 attack and the subsequent war.

Palestinian workers, upon which the construction industry relies, disappeared overnight, as Israel enacted an immediate ban on workers from Gaza and restricted access to most of those from the West Bank.

New construction in the southern town of Sderot, January 2, 2024. (Moshe Shai/FLASH90)

“The five banks… would be particularly affected in the event of a sustained disruption in real estate activity and demand,” Moody’s wrote in the report. “The construction industry, in particular, is facing a lack of workers.

“Underlying demand for residential units continues to be driven by a young and growing population and banks are mostly exposed to residential construction, but they also have exposure to income-generating properties and raw land,” the agency added.

Israel’s largest lenders have generated record profits over the past year, enjoying the fruits of high interest rates on loans and mortgages.

Moody’s commended the five banks for using “strong revenues in 2023 to proactively book collective provisions against downside macroeconomic scenarios and affected sectors, such as construction and real estate,” and for cutting dividend payouts in the third quarter of 2023.

“Profitability, which benefited from higher interest rates, will also decline from recent exceptionally high levels because of higher cost of risk, lower credit growth, the support measures to customers and a planned increase in bank taxes,” Moody’s said. “The banks had, however, achieved large cost efficiency gains in recent years that support profitability and enhance their ability to withstand and recover from shocks.”

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