(NEW YORK) In recent years the heads of Bank Hapoalim felt that their potential for growth in the local market was about to end ¿ not only because Hapoalim¿s market share in Israel was growing steadily, but mainly because of the regulatory restrictions imposed by banks in Israel. This feeling prompted the bank's stewards to seek alternatives for growth in markets overseas, where their activities were limited and therefore had greater potential.

The greatest business opportunity for the bank came along toward the end of 1999, when HSBC, the third largest bank in New York, acquired the Republic Bank from the Safra family. Hapoalim sensed a trend that this merger only reinforced ¿ the large banks were merging or buying out the smaller banks and were thus giving up an important sector of the market.

"This is the sector composed of established clients with assets of several million dollars," explains Scott Shay, chairman of Signature Bank, which was founded in order to serve this population, neglected during the mergers. A client of HSBC with $5 million worth of assets can speak with an answering machine when he calls the bank ¿ he'll need closer to $50 million before he gets personal treatment.

"A client with $5 million is very important to us," says Shay, "and will receive the same treatment as a $50-million client at HSBC."

This is the market sector that Hapoalim targeted when it decided to take the plunge into American personal and small business banking. Despite a difference of opinion among the bank¿s senior management, Hapoalim opened six branches of Signature in New York in May 2001. Hapoalim initially invested $60 million in Signature and supplemented this with $55 million a few months ago. In the coming months Hapoalim will increase its investment by tens of millions of dollars more.

Existing banks are expensive

Unlike other Israeli banks that began operating in New York by buying an existing bank, Hapoalim started Signature from scratch. By building the bank from the ground up, Signature could operate it in keeping with its expressed goals. "If we had bought an existing bank it would have paid a high price," says Shay. Signature's unique path required a massive investment, and the clients¿ peace of mind demands even more investment by Hapoalim.

Many of Signature's clients transferred from other banks (including Republic) and feel safer if the bank has high equity. They see it as an indication of the bank¿s stability, but Hapoalim sees it as taking money out of its pocket. As a subsidiary of Hapoalim, Signature's balance sheet is combined with Hapoalim's but the need to funnel capital to Signature in order to provide security to the clients means that a lot of capital is sitting idle and is not generating money apart from the yield on its investment.

Hapoalim knew that Signature's foundation had to be strong, so the establishment of the bank was accompanied by a successful campaign to woo managers and clients from Republic. Five of the six senior managers at Signature today are former Republic employees and 70 of Signature's 200 employees transferred from Republic. Some of them say that Signature is an attempt to recreate Republic, which had very prestigious status before being sold. Signature paid handsomely for good workers, spending $13.3 million on salaries in its first eight months of operation.

Such generosity is not surprising, considering the clientele the transferring workers brought with them. "Most U.S. clients will follow their banker first and then their bank," explain Signature's managers, and they know what they're talking about. The bank has so far attracted $750 million in deposits and its clients' assets are worth $1 billion. Much of this money probably belongs to former Republic clients who decided to switch banks when Republic was sold, choosing the bank to which their personal banker or branch manager transferred.

Operating balance by the end of the year

A tour of Signature's branches, which now number eight, gives the impression of seriousness and reliability. Outwardly at least the system seems well oiled, as if it had been operating for years. The branches are sparkling, painted in a shade of mustard yellow and are stylishly decorated. Customer traffic is low due to the fact that this is not a retail bank but rather a bank designed to serve the business and private client market.

Will Hapoalim's adventure prove successful? The bank's top executives think so and expect to reach an operating balance by the end of the year even though at least two small obstacles stand in their path.

1 ¿ The target market ¿ Signature's managers claim that they are entering a market that has been neglected by the big banks. "We will fill the gap," they said when the opened their branches last May. "We will fill the vacuum that has been created," they claimed. It is a bit hard to believe, however, that the U.S. and New York in particular could have a market sector without competition, or with little competition from other banks.

An article published last weekend in U.S. financial newspaper Crain's exposed the stiff competition with which Signature will have to contend in the near future. According to Crain¿s over 100 bank branches are due to open in New York this year and the retail market is "exploding." The article claimed that giant banks like J.P. Morgan, Chase and Fleet Bank are planning an aggressive campaign to win a larger share of deposits.

True, Signature's target market was neglected in recent years, but Hapoalim did not "discover America" ¿ the giant local banks are doing that now, and the competition will be tough. For the sake of illustration, deposits by New York residents grew from $44 billion in 1996 to $234 billion in 2001 (an increase of 430%), while the number of bank branches shrank during that period by 17, to 889 branches. In recent years banks have been trying to keep customers away from the branches ¿ now they are trying to draw them back.

Low interest will hamper daily operations

2. Interest rates ¿ when Signature was founded interest in the U.S. stood at 5%. The difficult recession that hit the world's largest economy brought rates down drastically ¿ to below 2%. This translates to a drop in revenues. Sources at Hapoalim estimate that Signature has lost $8-10 million in revenues so far, which means that the bank could have reached an operating balance within half a year of opening its doors.

True, the American economy is already showing signs of recovery, but it has still not proven that the recession is behind us.

Even the governor of the Federal Reserve, Alan Greenspan, is not convinced and the fact remains that interest rates in the U.S. are still low. This means smaller profit margins for the bank and lower yields on capital invested in interest-bearing instruments. In the meantime the low interest rates are hampering Signature¿s day-to-day operations.

"The bank's central goal is the development of overseas markets," said Hapoalim board chair, Shlomo Nehama this week, and the bank really is hanging a lot of its hopes on Signature. So far the bank has met its goals and has even performed better that expected. Whereas the founders originally spoke of 2,500 accounts and customer assets of $2 billion within three years, after just one year Signature already has 3,500 accounts and about a billion dollars in customer assets.

The real test will be whether Signature can compete with the big banks that are sharpening their swords in preparation for the battle over client assets. Signature has a strong foundation of former Republic managers, employees and clients. The question remains as to whether its ambitious management, backed by Hapoalim, will be able to overcome the obstacles in its path and start to generate added value by 2003.