The crisis devastating Israel's tourism industry cannot be exaggerated. The relentless hostilities, exacerbated by the economic slowdown and the surge of global terrorism have left Israel's hotels floundering and foundering.

Data from the government statistician show a 60% drop in sleep-overs by tourists in the first nine months of 2001, compared with the parallel period of last year. The 12% increase in domestic tourism doesn't even begin to help.

As if all that weren't bad enough, it transpires that another factor is savaging the fortunes of Israel's tourism industry: the shekel's 3.7% devaluation against the dollar, which created tremendous financing costs for debt-laden companies that borrowed, mainly, in dollars.

The problem is not trivial. The third quarter is traditionally the year's strongest for hotels, starting as schools let out for summer and continuing with the Jewish holidays. Not this year: the fall break brought no succor. Third-quarter revenues plunged against the parallel.

The banks are sweating bullets
Tourism plunging ¿ mood grim - financing costs mounting - All in all, the banks are turning frantic. Why? Because they have financed most of the investment in Israel's hotels.

The Dan hotel chain, controlled by the Federmann family that also controls Elbit Systems (Nasdaq:ESLT), owes about NIS 750 million. Rival hotel chain Isrotel, controlled by British businessman David Lewis, isn't in enviable condition either: it owes NIS 837 million n short- and long-term obligations. Both chains are listed on the Tel Aviv Stock Exchange.

How will they meet their enormous financial obligations? No answer offers itself.

In the middle of the fourth quarter, the dollar plunged, which should generate first-quarter financing income for the hotels that borrowed in dollars. But that's icy cold comfort. Currency games won't solve their problem and the dollar picked up again after the wave of terrorism that rocked Israel this Saturday and Sunday.

For the third quarter, the Dan chain posted an operating loss of NIS 10.3 million, and that's before its financing costs and losses by affiliated companies. Its financing costs are nothing to sneeze at ¿ NIS 23 million for the third quarter, and NIS 32 million for the nine months.

Granted, in the parallel nine months the financing costs were even higher at NIS 56 million. But again, that isn't a warm and fuzzy thought.

Isrotel, which operates chiefly in Eilat, can't gloat. It posted an operating loss of NIS 5.2 million for the third quarter, bringing its nine-month operating loss to NIS 23 million.

In the past, the hotels' CFOs claimed that analysts should focus on cash-flow. They blamed the losses on heavy amortization charges, which create a bright red bottom line but allow them to service the companies' debts.

No more. A glance at Dan's and Isrotel's cash flow report raises serious questions about their ability to repay the banks. Dan's third-quarter operations resulted in a negative cash flow of NIS 167,000. Isrotel's operations consumed NIS 3 million in the third quarter ¿ and, remember, those three months were supposed to be the year's strongest.

For the nine months Dan soaked up NIS 12 million cash. Cash flow from investment consumed another NIS 8.8 million. Who foots the bill? The banks, of course. This year Dan borrowed NIS 170 million, replacing an old NIS 150 million loan.

Isrotel also found itself visiting its banks cap in hand, walking out with an NIS 105 million net loan.

Both chains have unusually high book value, NIS 490 million in Dan's case and NIS 400 million in Isrotel's. Nice, but it doesn't generate cash. It might also mislead, creating the impression of financially sound-as-a-rock companies, while in practice each has a mere few millions cash in the kitty. And they are losing money on their regular operations.

Note that it isn't their loan burdens per se that is worrisome. It's their ability, or lack thereof, to service their debts, which are growing deeper and deeper.