The Bronfmans' opportunity to clean up Discount Bank

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By NITZAN COHEN
Israeli banks will soon report third-quarter results. The most interesting one will be Discount Bank's. Discount, the country's third-largest bank, wants to challenge Leumi and Hapoalim. But it has been deteriorating for many years, losing ground to the big two, while Mizrahi-Tefahot keeps gaining ground. The real reason Discount's controlling shareholders, the Bronfman family, sacked Shlomo Zohar, the bank's chairman, remains vague. Rumors that the recent Visa-Cal scandal has something to do with it have been denied by the Bronfmans, and the Bank of Israel has continued its antidemocratic tradition of keeping vital information hidden from the public. Nevertheless, the appointment of former Finance Ministry director-general Yossi Bachar as the new chairman gives Discount an opportunity to improve. Discount is suffering from several serious diseases. Its credit portfolio is terrible, with billions of shekels of bad loans. It employs about 6,000 workers organized in a strong union. Mizrahi-Tefahot operates more branches with a similar amount of assets, but has only 4,000 workers. Discount also suffers from an aging technology infrastructure, especially compared to the competition. The Bronfmans bought their shares in the bank from the state in 2006, after 23 years of government ownership. The state still holds 25 percent of the bank. Under the Bronfmans, the bank hasn't taken any serious steps to clean up its balance sheet or address its personnel problem. Instead, under the management of Giora Ofer, Discount has focused on increasing its share of the household-banking market and improving customer service. Discount now has a good chance to deal with its problems. Under Bachar, it can take advantage of Leumi's internal control struggle and Hapoalim's managerial vacuum. The fund Discount runs to pay compensation to workers has performed well, and Bachar should use its high gains to encourage workers to take early retirement, despite any challenge from the union. However, Discount's biggest problem is its lack of capital. It recently sold its shares in Bezeq, Hot and the Harel insurance company, and that should help. But it's not enough. Next year the bank must comply with stricter capital regulations that require an increase in the capital-adequacy rate (the ratio between the bank's equity and the loans it makes) to 12%. Therein lies the problem: its substantial sour loans. Bachar and Ofer should aggressively write down those foul investments. The bank is supposed to present a higher provision against these bad loans in its third-quarter report. But beating the average of the local banking system won't be enough. Bachar should boldly clean up the portfolio to 2%, to represent the real state of loans that bear no income. The sale of the bank's holdings in Bezeq, Hot and Harel, along with capital gains from the rising capital markets, should provide a good cushion against the blow of more lost debt provisions. Even if it does that, Discount will likely need more capital. Bronfman was hoping to get extra cash through the liquidation of more assets, such as selling its stake in First International Bank of Israel and making an initial public offering for Visa-Cal. But both of these options are on hold - the first because of a dispute with FIBI owner Tzadik Bino; the second might be affected by a scandal haunting Visa's business in Europe. But there is something else Discount can do without selling more assets. It can preserve its capital if the owners stop distributing dividends, and it can raise more capital by issuing bonds for investors. These bonds will increase the bank's equity, and while conditions in local capital markets are still favorable, it shouldn't be difficult to lure investors with good yields. A decision to stop distributing dividends is never easy for shareholders. In fact, the Bank of Israel should stop banks from distributing dividends in such risky times for the financial system, but Governor Stanley Fischer is too busy buying dollars right now to care about it. The Bronfmans must understand that even without an official ban, preserving their bank's capital for future growth is in their own best interests. Whether they choose to do so is another question. It's up to Bachar to lead the way - for the benefit of his bosses and his customers - and turn his bank into a real alternative to the big two that rule local finance today.