Discount Bank of New York sets sights on local market

Executive VP Ehud Arnon told "Globes" that he is looking to leave behind the bank's troubled past.

In the very center of Manhattan, at the corner of Fifth Avenue and 42nd Street, sits the management of Israel Discount Bank of New York. An orange flag flutters above the entrance. Orange is the branch's color as well as the color of the business cards. But make no mistake: despite the orange color and its overseas location, Discount Bank of New York is an integral part of the green group - Israel Discount Bank (TASE: DSCT).

A few months ago, Discount Bank of New York Executive VP Ehud Arnon received a call from the bank's management office in Tel Aviv. Our main goal in the upcoming quarter is to meet the capital adequacy target, he was told. In order to achieve this, we will decrease risk assets, and your contribution will be to sell MBS (mortgage-backed security) bonds that aren't connected to the government enterprises Fannie Mae and Freddie Mac. Despite the fact that the bonds produced good income, Arnon understood that this was necessary and he sold them.

This may sound like a trivial story, but things didn't used to work this way in the past. Over the years, Discount Bank of New York - which was nicknamed the jewel in the crown - functioned as an independent entity with its own agenda, and the Israeli headquarters did not always know what the American branch was up to.

Discount Bank of New York is not just another branch of an Israeli bank. For all intents and purposes it is a completely independent bank with $783 million in equity and a balance sheet of $9.1 billion. It is ranked the 14th largest bank in New York, and in Israel's terms could be the 6th largest bank. It is larger than Union Bank of Israel (TASE: UNON) and Mercantile Discount Bank and is almost as large as First International Bank of Israel (TASE: FTIN). Needless to say it is the largest branch of an Israeli bank overseas.

But at the end of 2005, a fire broke out that threatened to consume the bank: the mind boggling $2.2 billion South America money laundering affair was exposed, which created an upheaval in the bank that led to the dismissal of its senior managers. Reuven Spiegel, who was the Discount Bank division head, was sent to oversee the New York branch's rehabilitation. The price for survival was close supervision by the Fed (Federal Reserve). The bank was under a cease and desist order that strictly curtailed its activity. And the Fed is not an Israeli regulator. It has no patience and it does not negotiate with the entities it supervises. Every instruction is an order that needs to be executed according to a strict schedule.

Spiegel did not despair and he rebuilt the bank, this time as a part of Israel Discount Bank. And when federal supervision ended in June 2009, Discount Bank of New York was ready to move forward. A few months ago, when Spiegel was promoted to CEO of the group, Head of the Business Division Ehud Arnon took his place. Arnon's task is to restore the jewel in the crown's brilliance.

Excellent opening point

Arnon's first problem is dealing with the bank's heritage. Historically, Discount Bank of New York relied on deposits from Latin American Jews. The bank has representatives in Chile, Brazil, Peru, Mexico, and Uruguay and funds from the region make up 58% of the banks' deposits.

But the amount of money in deposits is declining, and the money that is left is starting to move into direct investment in securities and portfolio management. The young generation of the Latin American Jewish community is not afraid like their parents, and they do not feel the need to deposit money overseas for a rainy day (although this can change overnight. The regime change in Peru and the introduction of a new president, who is a close to Venezuelan President Hugo Chavez, are already speeding up the flow of funds).

The solution that Spiegel found, and Arnon is continuing, is a transition to local banking. And the bank has an excellent point at which to begin. While American banks are maneuvering under the limitations of capital adequacy, Discount Bank has an extremely high core capital of 14% and is considered to be well-capitalized. In addition, Discount Bank was one of the few banks that did not show a loss at any point during the financial crisis.

The bank inaugurated a new branch in Staten Island in September, and by the end of 2012, the bank intends to open additional branches in Brooklyn and Long Island. Arnon's approach is simple: to find a management staff and to open the branch based on it. In light of the high adequacy, the bank does not have a problem with increasing credit limits, but in a situation where the banking system has excess liquidity and credit margins collapsed, it is not certain that growth in credit is the right direction. Therefore, Arnon is emphasizing private banking: the bank started managing portfolios already a month ago, and activity in this area has already increased.

Discount has a relative advantage in private banking since it is small. Whereas large banks do not offer personal assistance by a private bank representative to customers with less that $10 million, smaller customers receive VIP treatment at Discount. Telephone assistance is given by the customer's private bank representative, and not by a service call center in India.

Moreover, Discount does not manufacture products, and can therefore sell objectively. When a customer goes to Merrill Lynch, he leaves with a Merrill Lynch product. Discount uses an open architectural model, and sells all the products that are sitting on the financial shelves.

One subsidiary that is strengthening is Discount Bank Latin America (DBLA) in Uruguay, that deals with retail banking and has 15 branches spread throughout the country. They use the green Discount logo with the smile underneath. DBLA is the fifth largest bank in Uruguay, and is growing nicely. It already accounts for 10% of Discount Bank of New York's revenue.

Size of capital is a problem

Discount Bank of New York ended 2010 with a profit of $53 million and it is estimated that it will have a capital yield of 7-8%. If this is correct, why is Discount Bank of New York not achieving a two-digit yield as a result of its favorable growth? The problem lies with the size of its capital. In a normal situation, if the capital adequacy is so high, the bank distributes dividends, reduces the capital, and increases its yield. But distributing dividends will increase taxes, and no one at Discount wants to donate money to the IRS.

Another possibility is of course is a public offering, but here Discount has a problem. In the eyes of the American investor, a bank with 65% of its deposits offshore, ie. from foreign investors, is considered dangerous. Therefore, in order to maximize value and to enable an offering at a high capital multiple, Arnon needs to grow the base of deposits from local customers. At this rate, and with this direction of growth, holding an offering in a few years is a realistic goal.

Published by Globes [online], Israel business news - www.globes-online.com - on July 14, 2011

© Copyright of Globes Publisher Itonut (1983) Ltd. 2011

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