Bank Hapoalim B M : Fitch Affirms Bank Hapoalim Long-Term IDR at 'A' and Short-Term IDR at 'F1+'

Bank Hapoalim B.M.

Key Rating Drivers

Support Drives Ratings: Bank Hapoalim B.M.'s Issuer Default Ratings (IDRs) reflect Fitch Ratings' view of a very high probability that Israel (A+/Stable/F1+) would provide support to the bank, if needed. Fitch believes that Israel's ability and propensity to support Hapoalim is very high, particularly given the bank's systemic importance in the country, holding about 30% of banking system assets.

Universal Banking Franchise: Hapoalim's Viability Rating (VR) reflects a strong franchise in retail and corporate banking in Israel, asset quality that we expect to remain resilient considering the bank's material exposure to the property sector, and adequate capitalisation. The VR also reflects the bank's sound funding, given its large deposit base, and strengthening profitability, which in 2022 benefitted from significant demand for credit and from several interest rate increases during the year.

Close Regulatory Oversight: Hapoalim's underwriting standards are conservative, helped by tight regulatory limits and oversight. Like other Israeli banks, Hapoalim has material exposure to the construction and real estate sectors, which results in risk concentration and makes its asset quality vulnerable to a sharp decline in real estate prices. However, the majority of its exposure is to residential projects, which we expect to continue to perform adequately given high population growth and structural demand for housing in Israel.

Asset Quality Remains Sound: Hapoalim's impaired loans ratio decreased to 0.8% at end-September 2022, partly benefitting from high loan growth, particularly in mortgages. We expect higher loan impairment charges next year as the loans season. Asset quality will also be affected by higher interest rates and high inflation (albeit lower than many other countries), but due to sound underwriting and resilient operating environment we expect the impaired loans ratio to remain below 1.5% over the next two years.

Strong Earnings Recovery: Profitability benefitted from loan growth (+8% in 9M22), which boosted net interest income, as well as from wider net interest margins due to increasing interest rates. Cost efficiency continues to improve. We expect positive profitability trends to remain, with the bank's operating profit/risk-weighted assets (RWAs) ratio expected to remain above 2% in 2023, despite slowing loan demand. This is due to weakened credit demand on higher mortgage rates and a decrease in housing transactions in Israel, already observable in 4Q22.

Capital Buffers Adequate: Headroom in our capitalisation score is limited, but capitalisation remains adequate, with a common equity Tier 1 (CET1) ratio of 11.10% at end-September 2022. Hapoalim uses the standardised approach for credit risk, which results in high RWAs density (RWAs/total assets) of 62%. We expect the bank to maintain a moderate buffer above the regulatory requirement, which has reverted to 10.23% following a temporary reduction. Our assessment also considers the bank's improved internal capital generation.

Large, Stable Deposit Base: Hapoalim's solid and stable funding base consists mostly of customer deposits, which exceed the size of the loan book. It also has proven access to domestic and international debt markets. Liquidity is strong, with a 126% liquidity coverage ratio at end-September 2022.

Hapoalim's 'F1+' Short-Term IDR is the higher of two possible Short-Term IDRs that map to a 'A' Long-Term IDR because we view the sovereign's propensity to support as more certain in the near term.

Banks

Universal Commercial Banks

Israel

Ratings

Foreign Currency

Long-Term IDR	A
Short-Term IDR	F1+
Viability Rating	a-
Government Support Rating	a

Sovereign Risk (Israel)

Long-TermForeign-Currency IDRA+

Long-TermLocal-Currency IDR	A+
Country Ceiling	AA

Outlooks

Long-TermForeign-Currency IDRStable

Sovereign Long-Term Foreign-	Stable
Currency IDR
Sovereign Long-Term Local-	Stable
Currency IDR

Applicable Criteria

Bank Rating Criteria (September 2022)

Related Research

Fitch Affirms Bank Hapoalim at 'A'; Outlook Stable (December 2022)

Global Economic Outlook (December 2022) Fitch Affirms Israel at 'A+'; Outlook Stable (August 2022)

Analysts

Michael Bojko, CFA [phone] [e-mail]

Rory Rushton

[phone] [e-mail]

Rating Report │ 26 January 2023

fitchratings.com

1

Banks

Universal Commercial Banks

Israel

Rating Sensitivities

Factors that Could, Individuallyor Collectively, Lead to NegativeRatingAction/Downgrade

Hapoalim's IDRs are primarily sensitive to a weakening of Israel's ability or propensity to support the bank. A downgrade of Israel's Long-Term IDR would likely result in a downgrade of Hapoalim's Government Support Rating (GSR) and its IDRs. A reduced propensity of the Israeli authorities to support the country 's largest banks, which could be signalled by the introduction of a deposit guarantee scheme at first, and subsequently by effective bank resolution legislation, would also result in a downgrade of the bank's IDRs and GSR.

A sharp deterioration of asset quality that results in an impaired loan ratio of above 2% for an extended period combined with the CET1 ratio declining below current levels and weakening internal capital generation could result in a VR downgrade. Given the bank's significant exposure to the real estate sector, a sharp decline in real estate prices would put pressure on asset quality, and therefore on the VR.

Factors that Could, Individuallyor Collectively, Lead to Positive Rating Action/Upgrade

An upgrade of Israel's Long-Term IDR is unlikely to result in an upgrade of the bank's GSR and Long-Term IDR as we typically do not assign GSRs above 'a' for domestic systemically important banks in countries whose sovereigns are rated 'AA' or 'AA-' and where support propensity is high.

An upgrade of Hapoalim's VR is unlikely given the bank's geographical concentration. It would require a material and structural improvement in profitability that allows the bank to generate stronger and more stable operating profit/RWAs while also maintaining materially higher capital ratios, which we do not expect.

Other Debt and Issuer Ratings

Rating level	Rating
Subordinated Tier 2 debt: long-term	BBB
Source: Fitch Ratings

Subordinated debt is notched down from the bank's VR, in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss-severity risk profiles.

Hapoalim's USD1 billion Tier 2 notes are rated two notches below the bank's VR, reflecting poor recovery prospects in the event of a failure of the bank, in line with Fitch's base-case notching for Tier 2 debt.

Bank Hapoalim B.M.
Rating Report │ 26 January 2023	fitchratings.com	2

Banks

Universal Commercial Banks

Israel

Ratings Navigator

Bank Hapoalim B.M.	ESG Relevance:

Banks

Ratings Navigator

Operating Environment

Financial Profile

Business Profile

Risk Profile

Asset Quality

Earnings & Profitability

Capitalisation & Leverage

Funding & Liquidity

Implied Viability Rating

Viability Rating

Government Support

Issuer Default Rating

20%

10%

20%

15%

25%

10%

aaa

aaa

aaa

aaa

AAA

aa+

aa+

aa+

aa+

AA+

aa

aa

aa

aa

AA

aa-

aa-

aa-

aa-

AA-

a+

a+

a+

a+

A+

a

a

a

a

a

A A Sta

a-

a-

a-

a-

a-

a-

A-

bbb+

bbb+

bbb+

bbb+

BBB+

bbb

bbb

bbb

bbb

BBB

bbb-

bbb-

bbb-

bbb-

BBB-

bb+

bb+

bb+

bb+

BB+

bb

bb

bb

bb

BB

bb-

bb-

bb-

bb-

BB-

b+

b+

b+

b+

B+

b

b

b

b

B

b-

b-

b-

b-

B-

ccc+

ccc+

ccc+

ccc+

CCC+

ccc

ccc

ccc

ccc

CCC

ccc-

ccc-

ccc-

ccc-

CCC-

cc

cc

cc

cc

CC

c

c

c

c

C

f

f

f

ns

D or RD

The Key Rating Driver (KRD) weightings used to determine the implied VR are shown as percentages at the top. In cases where the implied VR is adjusted upwards or downwards to arrive at the VR, the KRD associated with the adjustment reason is highlighted in red. The shaded areas indicate the benchmark -implied scores for each KRD.

VR - Adjustments to Key Rating Drivers

The operating environment score of 'a' has been assigned below the implied 'aa' category implied score due to the following adjustment reasons: sovereign rating (negative), size and structure of economy (negative).

The business profile score of 'a-' has been assigned above the implied 'bbb' category implied score due to the following adjustment reason: market position (positive).

The capitalisation & leverage score of 'a-' has been assigned above the implied 'bbb' category implied score due to the following adjustment reason: leverage and risk-weight calculation (positive).

Bank Hapoalim B.M.
Rating Report │ 26 January 2023	fitchratings.com	3

Banks

Universal Commercial Banks

Israel

Company Summary and Key Qualitative Factors

Business Profile

Strong Domestic Franchise and DiverseBusiness Model

Hapoalim is Israel's second-largest bank by total assets and by net income. It is not materially smaller than the largest bank. As a universal retail and commercial bank it provides a wide range of retail, commercial, capital market and private banking services, with good domestic market shares across all major segments.

International activities, apart from the US, have decreased in importance in recent years, with only moderate exposures remaining (about 4% of net customer loans at end-9M22). These mostly centre on middle-market commercial clients within the group's US branch. Hapoalim has discontinued activities in its Swiss private bank, and the entity will be closed once procedures to return its banking licence are complete. In March 2022 Hapoalim purchased the minority's shareholder's shares in Bank Pozitif, a Turkish bank, for USD5 million in order to bring an end to legal proceedings. Hapoalim has been trying to sell the bank for several years, and the loan book (ILS137 million; <0.1% of group loans) is in run-off.

The bank's business model is diversified, but still reliant on net interest income. Non-interest income comes largely from fees and commissions, including account-management and loan-application fees, as well as from trading activities in Israeli government bonds and in other securities traded on behalf of clients. Trading activities are reported in the bank's financial management segment, which also includes earnings from derivative positions used to manage the bank's exposure to interest rate risk and to the consumer price index (CPI), given its exposure via CPI- linked mortgages and other assets, as well as gains and losses from its equity investments in non -financial corporations. Hapoalim's strategy is to grow its loan book across all lending segments while improving cost efficiency through digital innovation and other cost-efficiency measures.

Net Customer Loans

ILS381.6bn, end-3Q22

Other retail

10%

International & other

6%Mortgages

33%

Small

businesses

9%

Commercial

15%Corporate

27%

Source: Fitch Ratings, Hapoalim

Business Model Split 9M22/end-3Q22

			Households			Small business
			Commercial			Corporate
			International			Financial management
(%)			Adjustments
100
80
60
40
20
0
		Pre-tax profit	Credit		Deposits

Results and operations of segments based on management approach Source: Fitch Ratings, Hapoalim

Risk Profile

Credit underwriting standards are stringent by global standards and are influenced by very prudent banking regulation that seeks to limit the contingent liability that the banking sector presents to the sovereign. Residential mortgages are subject to regulations including maximum 75% loan-to-value (LTV) ratios and a maximum term of 30 years. Hapoalim also minimises the number of mortgages with a payment-to-income ratio greater than 40% - partly because loans above this limit have higher capital requirements.

SMEs and large corporations represent about half of total loans at end-9M22 and are diversified by sector, although geographically they are concentrated in Israel. The largest sector exposure is to the construction and real estate (CRE) sector, and most exposures are secured on residential property developments with a smaller exposure to commercial property. The CRE sector has been identified by the regulator as a potential risk, and so Hapoalim and its peers are subject to regulatory limits and increased scrutiny of exposures and collateral. Concentration limits for the sector were increased by 200bp during the pandemic but will be reduced to pre -pandemic limits from 2026.

Hapoalim has faced large conduct fines in recent years, particularly from its USD874 million settlement with the US Department of Justice in 2020 related to allegations of helping clients avoid US taxes. The bank was also engaged in a lawsuit brought by the minority shareholder of Bank Pozitif, although the acquisition of the minority shareholder's stake for USD5 million ended these proceedings. The full ownership of Bank Pozitif may help Hapoalim exit the Turkish market, either through a sale or a wind-down of the business, further reducing operational risk.

Bank Hapoalim B.M.
Rating Report │ 26 January 2023	fitchratings.com	4

Banks

Universal Commercial Banks

Israel

Domestically, the Bank of Israel continues to focus on customer redress and conduct, which we expect to result in further conduct expenses, albeit for lower amounts than the above cases. For example, in February 2022 the bank was required to refund customers an estimated ILS7 million for overcharging the cost of sending registered letters. Hapoalim is also involved in several class-action lawsuits, which was flagged in the 9M22 auditors' review as an 'emphasis of a matter' as some are at an early stage where the probable outcome cannot be assessed. These lawsuits often involve multiple banks and so, in our view, are typically more reflective of sector-wide operational risks.

The bank's exposure to market risk arises primarily from interest-rate and CPI risks in the banking book, which we view as moderate in light of the bank's framework of limits. The bank undertakes trading activities, which are predominantly client-driven, and appetite for traded market risk is modest. Market risk also arises from ILS3.2 billion of private equity and quasi-equity investments made through the bank's subsidiary Poalim Equity, which at end-9M22 amounted to 7% of the bank's CET1 capital.

Bank Hapoalim B.M.
Rating Report │ 26 January 2023	fitchratings.com	5