The Bank of Israel Banking Supervision Department is concerned about the bank's large exposure to real estate and mortgages. "The risk level of companies in the construction and real estate sector is higher than in other economic sectors. The high exposure of the banks to credit to the construction, real estate, and mortgage sector, and to consumer credit, and the prevailing correlations between these types of credit, constitute a hazard for the banking sector," the Bank of Israel wrote in its annual banking supervision report, published today.
In view of the prolonged bull market for real estate and mortgages, the Bank of Israel noted that it had conducted a stress test last year for the banking system to check its resilience to shocks in the mortgage market in the event of deterioration in Israel's geopolitical situation, accompanied by a global economic crisis. The stress test included a situation in which unemployment increases to 12.4% and housing prices plunge by 25%. "Such a scenario will significantly damage borrowers. The default rate will be 7.3%, amounting to 53,000 borrowers, and the banks' losses will reach NIS 10 billion."
This scenario, however, does not include an interest rate hike. The Bank of Israel stated that if the interest rate rises to 3% at the same time, the number of borrowers in difficulties would rise to 63,000 (8.6% of all borrowers). For the sake of comparison, only 1% of the loans in the mortgage market are currently more than 90 days in arrears.
The Bank of Israel also published the results of a stress test in the real estate sector last year, but that scenario would have caused failure to repay by only 23,000 borrowers, less than half of the result in the current stress test.
The differences in results reflect the Bank of Israel's anxiety about the growing risk in the real estate market. "The stress test that the Banking Supervision Department conducted this year focused on a domestic crisis combined with a global shock. The results of this scenario showed that credit to housing and the construction and real estate sector was sensitive to economic shocks, and indicated a significant effect on the banking system," Supervisor of Banks David Zaken wrote in his introduction to the report. The stress test also addressed the effect of such a crisis on the entire banking system. The scenario shows that in such an event, the banks would post an aggregate NIS 7 billion loss, with most of the loss resulting from provisions of over NIS 40 billion for credit losses. Nearly 40% of the credit loss would come from financing for real estate and mortgages. An additional NIS 3 billion loss would be suffered by the banks' securities portfolio; the Bank of Israel notes that this is not an especially high loss.
In the bottom line, the Bank of Israel says that such a stress test will have a significant effect on the banks, but that no risk to their stability is yet foreseen. The Bank of Israel adds that the banks' exposure to the construction and real estate sector grew by 3% to NIS 111 billion last year. "About 48% of the banks' credit portfolio is exposed to developments in the local real estate market, through both direct exposure to the sector and through exposure to credit secured with real estate, such as mortgages," the Bank of Israel writes," adding, "Credit to the real estate sector includes mainly financing for income-producing real estate, which features credit for long periods and sensitivity to interest rate changes. The low interest-rate environment increases anxiety about over-valuation of income-producing real estate and discounting of the proceeds from it."
Published by Globes [online], Israel business news - www.globes-online.com - on June 24, 2015
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