Outlook on Bank Hapoalim and Bank Leumi Revised to Positive on Improved Economic Conditions in Israel

Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

Primary Credit Analyst: Stephanie Mery, Paris (33) 1-4420-7344; [email protected]

Secondary Contact: Terence Klingman, RAMAT-GAN +972-3-7539708; [email protected]

• We believe economic conditions for the Israeli banking sector have improved, and we now assess the trend for the economic risk score of our Banking Industry Country Risk Assessment (BICRA) as positive. • If we were to raise our economic risk score, this would result in a higher anchor of 'bbb+' for Israeli bank ratings. • We are consequently revising our outlook to positive from stable on Bank Hapoalim B.M. and Bank Leumi le-Israel B.M., and affirming our 'A-/A-2' ratings on the banks. We are also affirming our 'BBB+/A-2' ratings on Israel Discount Bank (IDB). • The positive outlooks on Bank Hapoalim and Bank Leumi reflect the possibility of an upgrade over the next 12-24 months if economic conditions for banks in the country continue to improve. • The stable outlook on IDB reflects that we don't see the same degree of rating upside for the bank within our two-year rating horizon, given its lower capitalization and faster-than-peer loan growth.

PARIS (S&P Global Ratings) Oct. 24, 2017--S&P Global Ratings today revised its outlook on Israel-based Bank Hapoalim B.M. (Hapoalim) and Bank Leumi le-Israel B.M. (Leumi) to positive from stable, and affirmed its 'A-/A-2' long- and short-term issuer credit ratings on the two banks. We also revised to positive from stable the outlook on Leumi's U.S.-based subsidiary, Bank Leumi USA, and affirmed our 'BBB+' long-term issuer credit rating on the bank.

Finally, we affirmed our 'BBB+/A-2' long- and short-term issuer credit ratings

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

on Israel Discount Bank (IDB). The outlook remains stable.

The rating actions follow our review of the Israeli banking sector and reflect our positive view of the economic environment and improved operating conditions for banks. Consequently, we now see the economic risk trend as positive rather than stable under our Banking Industry Country Risk Assessment (BICRA) for Israel. We may raise the ratings on Leumi and Hapoalim should economic conditions continue to improve over the next 12-24 months. Moreover, the outlook revision to positive takes into account our forecast of the banks' risk-adjusted capital (RAC) ratio rising sustainably above the 10% threshold for a strong capital and earnings assessment, due to lower risk weights that would accompany an improved economic risk score. Our outlook on IDB remains stable because we expect that its RAC ratio will stay below the 10% threshold and takes account of its accelerated loan growth and higher provisions.

Our bank criteria use our BICRA economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. The anchor for banks operating in Israel is 'bbb'. A potential improvement of our economic risk assessment would lead us to revise the anchor to 'bbb+'.

We now view the economic risk trend in Israel as positive. The positive trend reflects Israel's consistent economic growth, sustained low unemployment, and high and increasing GDP per capita, while also taking into account decreasing corporate leverage. In addition, a combination of macroprudential measures and government-driven supply-side initiatives in the housing market has led to a deceleration of both house price inflation and property-directed lending growth over the past year.

Over the past decade, Israel's sustained economic growth and strong currency have boosted GDP per capita to about $40,000. Israel's debt burden is relatively stable and evenly balanced between the various economic sectors, following years of corporate and government deleveraging coupled with a rise in household leverage from a low base. Israel's external fundamentals remain strong, in our view, with a positive current account balance and an improving net creditor position. However, as a small, open economy in the Middle East, Israel remains vulnerable to geopolitical shocks and a rise in global protectionist sentiment. In addition, large property-related exposures pose a key risk for banks. Lending for construction, commercial real estate, and mortgages now accounts for about 45% of total bank loans, up from 32% in 2006, as property prices boomed. Lower-risk mortgage loans account for 71% of the total property-related exposure, with construction and commercial real estate making up the rest. Israeli banks' historically high single-name corporate borrower concentration has declined markedly over the past five years. Holding company structures are gradually being dismantled and large corporates have deleveraged and increasingly tap non-bank sources of funding. The financial strength of the Israeli household, in aggregate, masks wide disparities in wealth, income, and skills.

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

The banking system is highly concentrated and barriers to entry are high. It is well regulated and conservatively funded by core domestic deposits. This has helped Israeli banks deliver consistent and stable profits since 2009, notwithstanding fierce ongoing competition from the bond market and institutional investors for market share in corporate lending.

Hapoalim and Leumi have leading positions in the Israeli market, with superior domestic market diversification, and robust franchises. With total assets of Israeli new shekel (ILS) 450 billion (about $129 billion) for Hapoalim and ILS437 billion (about $125 billion) for Leumi as of June 30, 2017, the banks' overall market shares each account for about 30% of the local banking system's loans and public deposits. This, together with their distribution network, makes the banks the two largest banking groups in Israel, serving over 2.5 million customers each.

OUTLOOKS BANK HAPOALIM The positive outlook on Hapoalim indicates the possibility of an upgrade over the next 12-24 months if Israel's economic and operating environment becomes more supportive, ultimately resulting in a higher anchor for Israeli banks. That aside, we expect that Hapoalim will continue moderately strengthening its capitalization, reaching a RAC ratio of about 10% in the next two years, which could result in a stronger capital and earnings assessment and improvement in its stand-alone creditworthiness. We anticipate that it will maintain conservative underwriting standards, while expanding its loan book at a measured pace and maintaining its disciplined approach to cost control.

We could revise the outlook to stable if the positive economic trend reverses, driven perhaps by renewed imbalances in the housing market. While our forecasts include additional provisions for an outstanding U.S. regulatory settlement, we could also revise the outlook to stable if the settlement is substantially in excess of our expectations, or if the bank adopts a more aggressive capital-management strategy, such as a combination of higher dividend payouts and faster book growth.

BANK LEUMI The positive outlook on Leumi indicates the possibility of an upgrade over the next 12-24 months if Israel's economic and operating environment becomes more supportive, ultimately resulting in a higher anchor for Israeli banks. That aside, we expect that Leumi will continue moderately strengthening its capital, reaching a RAC ratio of about 10% in the next two years, which could result in a stronger capital and earnings assessment and improvement in its stand-alone creditworthiness. We anticipate that it will maintain conservative underwriting standards while developing its loan book at a measured pace and continuing to improve its relatively modest efficiency ratios. We also expect the bank to maintain a more modest dividend payout than most peers.

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

We could revise the outlook to stable if the positive economic trend reverses, driven perhaps by renewed imbalances in the housing market. We could also revise the outlook to stable if we witness larger-than-expected pension-related costs deriving from the bank's defined-benefit pension that would hurt its capitalization.

BANK LEUMI USA The positive outlook on Bank Leumi USA matches our outlook on its parent. We assess the bank to be highly strategic to its parent, and therefore rate it one notch below Leumi's supported group credit profile. All things equal, if we upgrade its parent, we would upgrade Bank Leumi USA. If we revise the outlook on its parent to stable, this would trigger the same rating action on the bank.

ISRAEL DISCOUNT BANK The stable outlook on IDB reflects our view that the bank's business and financial profile are not likely to change materially over the next two years. Although we believe that the positive economic developments in the banking sector will support the bank's strategic plan and related improvements, we believe that it is not likely to be important enough for us to upgrade the bank within our outlook horizon. For instance, we anticipate that its RAC ratio will increase slightly, but remain below the 10% threshold needed for it to achieve a stronger capital and earnings assessment.

We could raise the ratings on IDB if its credit loss experience improves beyond our expectations, and if it succeeds in closing the efficiency gap with most of its peers at a faster pace than we currently project. In addition, we may raise the ratings over the next two years if we raise our sovereign rating on Israel coupled with Israel's economic and operating environment becoming more supportive, ultimately resulting in a higher anchor for Israeli banks.

We could lower the ratings if we see a material deterioration in IDB's asset quality or capitalization. In addition, if the bank's efficiency plan proves to be ineffective, we could reassess our view of the bank's earnings capacity and ability to cover tail risks, which could lead to a downgrade.

BICRA SCORE SNAPSHOT Israel To From

BICRA Group 4 4

Economic risk 4 4 Economic resilience Intermediate risk Intermediate risk Economic imbalances Intermediate risk Intermediate risk Credit risk in the economy Intermediate risk Intermediate risk Trend Positive Stable

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

Industry risk 4 4 Institutional framework Intermediate risk Intermediate risk Competitive dynamics High risk High risk Systemwide funding Low risk Low risk Trend Stable Stable

*Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores are on a scale from 1 (lowest risk) to 10 (highest risk). For more details on our BICRA scores on banking industries across the globe, please see "Banking Industry Country Risk Assessment Update," published monthly on RatingsDirect.

RATINGS SCORE SNAPSHOTS Bank Leumi To From Issuer Credit Rating A-/Positive/A-2 A-/Stable/A-2

SACP bbb+ bbb+ Anchor bbb bbb Business Position Strong (+1) Strong (+1) Capital and Earnings Adequate (0) Adequate (0) Risk Position Adequate (0) Adequate (0) Funding and Average (0) and Average (0) and Liquidity Adequate Adequate

Support (+1) (+1) GRE Support (0) (0) Group Support (0) (0) ALAC (0) (0) Sovereign Support (+1) (+1)

Additional Factors (0) (0)

Bank Hapoalim To From

Issuer Credit Rating A-/Positive/A-2 A-/Stable/A-2

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

Support (+1) (+1) GRE Support (0) (0) Group Support (0) (0) ALAC (0) (0) Sovereign Support (+1) (+1)

Additional Factors (0) (0)

Israel Discount Bank

Issuer Credit Rating BBB+/Stable/A-2

SACP bbb Anchor bbb Business Position Adequate (0) Capital and Earnings Adequate (0) Risk Position Adequate (0) Funding and Average (0) Liquidity Adequate

Support (+1) GRE Support (0) Group Support (0) ALAC (0) Sovereign Support (+1)

Additional Factors (0)

ALAC--Additional loss-absorbing capacity.

RELATED CRITERIA

• General Criteria: S&P Global Ratings' National And Regional Scale Mapping Tables, Aug. 14, 2017 • Criteria - Financial Institutions - General: Risk-Adjusted Capital Framework Methodology, July 20, 2017 • General Criteria: Methodology For Linking Long-Term And Short-Term Ratings , April 7, 2017 • Criteria - Financial Institutions - Banks: Bank Hybrid Capital And Nondeferrable Subordinated Debt Methodology And Assumptions, Jan. 29, 2015 • General Criteria: National And Regional Scale Credit Ratings, Sept. 22,

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

2014 • General Criteria: Group Rating Methodology, Nov. 19, 2013 • General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings, Oct. 24, 2013 • Criteria - Financial Institutions - Banks: Quantitative Metrics For Rating Banks Globally: Methodology And Assumptions, July 17, 2013 • Criteria - Financial Institutions - Banks: Banks: Rating Methodology And Assumptions, Nov. 9, 2011 • Criteria - Financial Institutions - Banks: Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 • General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 • General Criteria: Understanding Standard & Poor's Rating Definitions, June 3, 2009

RATINGS LIST

Outlook Action; Ratings Affirmed To From Bank Hapoalim B.M. Counterparty Credit Rating A-/Positive/A-2 A-/Stable/A-2

Bank Leumi le-Israel B.M. Counterparty Credit Rating A-/Positive/A-2 A-/Stable/A-2

Bank Leumi USA Counterparty Credit Rating BBB+/Positive/-- BBB+/Stable/--

Ratings Affirmed

Israel Discount Bank Ltd. Counterparty Credit Rating BBB+/Stable/A-2

Additional Contact: Financial Institutions Ratings Europe; [email protected]

Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action

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1935998 | 300000945 Outlook On Bank Hapoalim And Bank Leumi Revised To Positive On Improved Economic Conditions In Israel

can be found on the S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following S&P Global Ratings numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.

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