UNION BANK OF ISRAEL LTD. ANNUAL REPORT

Transcription

1 UNION BANK OF ISRAEL LTD. ANNUAL REPORT

2 THE BOARD OF DIRECTORS Mr. Zeev Abeles, Chairman of the Board of Directors Mr. Yeshayahu Landau, Vice Chairman of the Board of Directors Mr. Haim Almog Mr. Alberto Garfunkel Mr. Uzi Vardy-Zer Mr. Izhak Zisman Dr. Yaacov Lifshitz Mr. Yigal Landau Ms. Miri Lent Sharir Mr. Giora Morag Dr. Zalman Segal -2-

3 Bank of Israel Interest Rate percent Rate of GDP Growth percent Q1.12 Q2.12 Q3.12 Q4.12

4 Development of Net Operating profit NIS Million Ratio of Capital Adequacy percent * ** ** ** ** Overall Initial

5 Development of Credit to the Public NIS Billion Breakdown of Problematic Debts as at the End of 2012 percent 28% 15% 57% Impaired credit risk Substandard credit risk Credit risk under special supervision

6 Development of Income from Retail Sector NIS Million Development of Mortgage Performance NIS Million 2,000 1,500 1,

7 Contents Page Board of Directors Report to the Shareholders General Meeting 4 Management Review of Bank s Financial Position and Results of its Operations 236 Certifications of the President & C.E.O. and of the Chief Accountant 255 Board of Directors and Senior Management s Report About the Internal Control over Financial Reporting 257 Financial Statements for the Year Ended December 31, This is a translation from the Annual Report for 2012 in Hebrew, and has been prepared for convenience only. In case of any discrepancy, the Hebrew version will prevail. -3-

8 BOARD OF DIRECTORS' REPORT TO THE SHAREHOLDERS' GENERAL MEETING Table of Contents Page 1. Forward-looking Information 5 2. Economic Developments 5 3. Activity of the Bank and Description of Business Developments Profit and Profitability Developments in Balance-Sheet Items Objectives and Business Policy Controlling Interests in the Bank Investments in the Bank s Capital and Transactions in its Shares Dividend Distribution Material Agreements Licenses, permits and approvals Activity with Overseas Entities Legal Proceedings and Contingent Liabilities Fixed Assets and Facilities Activity of Investee Companies Human Capital Description of Tax Situation Description of the Bank s Business by Activity Segments Capital Adequacy Risk Exposure and Management Critical Accounting Policies and Estimates Legislative Developments Transaction with Controlling Shareholders Community activity and Donations Disclosure Regarding the Internal Auditor The Board of Directors Members of Management and Senior Officials Disclosure Regarding the Process of Approval of the Financial Statements Controls and Procedures Details of compensations for High Wage Recipients at the Bank Remuneration of Auditors

9 Board of Directors Report to the Shareholders' General Meeting At the meeting of the Board of Directors of the Bank held on February 28, 2013, it was resolved to approve the financial statements of the Bank and its subsidiaries as at December 31, The financial statements are prepared in accordance with directives issued by the Supervisor of Banks. Forward-looking Information Part of the information presented in the report of the board of directors, which does not relate to historical facts, constitutes forward-looking information as defined in the Securities Law The actual results of the Bank may be significantly different from those that were included in the forward-looking information, as a result of a number of factors. These factors include, but are not limited to, changes in legislation and the provisions of supervisory agencies, macro-economic developments, and in particular developments in the global financial crisis and the consequent uncertainty, extraordinary economic events, such as drastic changes in interest, exchange, and inflation rates, the behavior of competitors and specific changes to be detailed below. Forward-looking information is characterized by words or expressions such as "intend to", "expectation", "should", "forecast", "in the opinion of the Bank", "the Bank intends", "plan", and similar expressions such as: "may", "will be". These forward-looking expressions involve risks and uncertainty since they are based on management assessment of future events which may not materialize or materialize differently than expected. The information presented below relies on, among other things, future forecasts regarding matters pertaining to economic developments in Israel and abroad and on the work plans and budgets of the Bank for The Bank makes no commitment to publish an update to the forward-looking information included in these reports, including in respect of the effect on such information of circumstances and events that may occur after the publication of the reports. Economic Developments General Even though four years have passed since the eruption of the global economic crisis, the global economic data for 2012 continues to show weakness. Although, like in the past, developing economies were the main engine for global growth during 2012, their contribution weakened. In comparison, developed economies struggled during the year with the increasing concerns regarding the debt crisis and fiscal distress. At the end of November 2012, the OECD announced that the growth forecasts for 2013 regarding member states were updated downwards from 2.2% to 1.4%. The growth forecast for the United States was updated from 2.6% to 2.0%. Concurrently, during January, The World Bank lowered the global growth forecast to 2.4% compared to 3.0% in the last forecast. This was done after the global economy displayed 2.3% growth during 2012 and amid concerns from the "fiscal cliff" influence on the United States' economy and the prolonging of the crisis in Europe. In the United States the government managed to slightly decline the realization of the "fiscal cliff" after reaching an agreement regarding taxes. Nonetheless, the subject of debt reduction has been left open and with that, the concern -5-

10 for deceleration. Concurrently, the American economic data for the last quarter of 2012, indicates, for the first time since 2009, an annual rate shrinkage of 0.1%, especially due to reduction in investments in inventory in the private sector and in the public expense. This is after a 3.1% annual growth rate during the third quarter. Concurrently, The American Central Bank announced the increase of the quantitative expansion plan by 45 billion dollars each month for purchasing government bonds in addition to 40 billion dollars each month for purchasing mortgage-backed bonds. In Europe a 0.4% shrinkage was recorded during 2012 in the product, and in October, the unemployment rate in the Eurozone countries reached a 11.7% record. On the basis of forecasts for an additional shrinkage of 0.1% during 2013, the question regarding debt recycling is bound to be a main issue in the global economy. The uncertainty regarding the possible implications from the eruption of the debt crisis, harms the economic activity and the debt rating of the stronger Eurozone countries such as France and Germany, which absorb the effects of the recession in Eurozone countries such as Spain, Italy, Portugal and Greece. The bond purchasing plans, meant to prevent the financial collapse of the weak Eurozone countries, do not solve the problem the budget issues which are bound to continue to restrain the demands in the Eurovision even more. In Israel, the economic indicators for the third quarter of 2012, support the evaluation that the growth rate of the economy has moderated and is declining. The estimation for growth in the gross domestic product during the second half of 2012 points to an annual growth rate of 2.8% (the lowest rate since 2009), after a 2.9% growth in the previous half, a 3.3% growth in the corresponding half year and a 4.6% growth during The moderate growth rate and the low and even negative indexes in the last few months reflect the weakness in demands and the slowdown in the economy lately. The updated growth forecast of The Bank of Israel is 3.3% in 2012 and 3.8% in 2013 assuming that the gas production from drilling "Tamar" will begin in the second quaderent of the year. Without the effect of the gas, the production growth rate in 2013 is expected to be 2.8%. The growth in 2013 is expected to be effected mainly by the moderate global growth, by the need for restraining fiscal policy and on the other hand, by the effect of the beginning of the flowing of gas during the year. Employment and Private Consumption According to the manpower survey of the central bureau of statistics, the rate of unemployed during the last quarter of 2012 was 6.9% compared to 6.8% during the third quarter of 2012 and 7.0% in the second quarter of Data regarding acquisitions by credit cards indicate the continuing of the growth trend data regarding the fourth quarter of the year amount to a 6.4% increase in an annual calculation further to a 4.9% increase in the an annual calculation during the third quarter of the year. The revenue data of all marketing chains (including food chains) indicates a 2.6% decline in the annual calculation of the fourth quarter of the year, further to a 2.6% decline in the annual calculation during the third quarter of the year. After a record year for the number of departures in 2011, the data for 2012 indicates a 1.0% decline in the number of departures compared to the previous year, still, the number of people departing stayed similar. -6-

11 Foreign Trade, Capital Movements, and Exchange Rates The trade deficit totaled to NIS 70.2 billion in 2012 compared to a deficit of NIS 52.2 billion during all of The data regarding 2012 indicates a 6.3% increase in importing of goods (excluding diamonds, ships, airplanes and fuels) in an annual calculation. The increase in importing derived mainly from a 10% increase in the scope of raw material import (excluding diamonds and fuels) parallel to a slight growth in import of consuming products and investment products. During 2012, a 4.5% increase in the annual calculation in exporting goods (excluding ships, airplanes and diamonds) was recorded. The industrial export, which is a significant part of all export (excluding diamonds), increased during 2012 by 4.4%. Most of the increase in the industrial export is from the increase of export of high technology, at the rate of 5.5% in the annual calculation which was based on a 19.3% increase in an annual calculation in export of electronic components and 9.0% increase in the annual calculation in the export of equipment for control and supervision. During 2012, the NIS weakened (average rate) in comparison to most of the currencies traded in Israel. In comparison to the USD, the EURO and the YEN, the NIS rate became stronger during 2012, by 2.4%, 0.3% and 13.8% respectively, regarding end of the period rates. In comparison to the GBP and the CHF, the NIS weakened during 2012, by 2.4% and 0.4% respectively, regarding end of period rates. Fiscal Policy The actual performance data regarding the state budget indicates that the local deficit in 2012 totaled NIS 39.0 billion. The deficit for December was a negative surprise and amounted to NIS 12.8 billion. The deficit as a percent of the production was 4.2% in comparison to the budget deficit target of NIS 18.3 billion which is 2.0% of the production. The deficit deviation in relation to the original budget, is mainly due to lower than expected income from taxes in the amount of NIS 18.5 billion and somewhat higher expenses than the original budget (wage agreements, security expenses etc.) in the amount of NIS 2.2 billion. Nonetheless, the governments' decisions to raise taxes and VAT as of September are expected to increase the states' revenue by NIS 9 billion. The elections delayed the treatment of the budget for 2013, therefore the expected reduction scope as well as the target of the deficit for 2013, aren't clear at this stage. The delay in the approval of the budget for 2013 restricts the governments' monthly expense scope to 1/12 of the budget for Prices and Monetary Policy On December, the Bank of Israel decided to lower the interest by 0.25 percentage points to a level of 1.75%, for the fourth time during 2012 in light of the negative trend in the global economy and the forecasts regarding its continuation, and in order to give additional support to the economic activity in the absence of inflationary pressure. This was done continuing to the interest lowering trend as of the second half of During 2012 the annual inflation rate was 1.6%. According to the trend data for the last quarter of 2012, the annual growth rate of the CPI reached 1.4%. -7-

12 Capital Market The year of 2012 was characterized by a significant decline of 37% in daily trade turnovers in shares and convertibles compared with the average turnover last year, and by a 46% decline in the average daily trade turnover in short-term loans. Despite the decline in trade turnovers, most of the indicators increased since the beginning of the year. During the second half of 2012 there was an increase in security rates against the low point in June but still in low rates compared with the global increase trend. Overall in 2012 the TA 25 and TA 100 indices rose by 9.2% and 7.2% respectively. Overall in 2012 a positive trend in all indices was recorded excluding the trading and service stock index which recorded a decline of 11.3% in leading communication companies and given the impacts of the social protest on the big marketing chains. The indices of bank stocks and insurance stocks were particularly noteworthy with an increase rate of 25.4% and 15.1% respectively. Among the main positive factors that affected the trading trend in the local capital market, were the following: reduction of interest by the Bank of Israel and the increase trend in the global markets in general and in the U.S. in particular. In the initial stock market the slowdown in activity continued, and from the beginning of the year only NIS 3.4 billion was raised in comparison to NIS 5.1 billion last year and compared to NIS 13 billion during 2010, a 33% decrease compared with the parallel period last year. The bond market in 2012 was characterized by rate increases in all types of bonds. From the beginning of the year an 8.8% and 9.9% increase in rates was recorded in the general index of bonds and in the CPI linked bonds' index respectively, at the same time, the foreign currency linked bonds' index increased by 7.3%. From the beginning of 2012 the Tel Bond 20 index of corporate bonds rose by 7.9% in compared to 0.7% during From the beginning of the year the average daily turnover in bonds amounted to NIS 4.1 billion, 8.7% higher than the average daily turnover for 2011, contrary to the trend of trade volumes of securities. The increase in turnovers is due to an increase in trade turnovers in linked government bonds and to a 14% increase in trade turnovers in corporate bonds, which peaked at NIS 1.0 billion a day. In contrast, in the short-term loan activity a sharp decline occurred and since the beginning of 2012 the average daily turnover was NIS 0.6 billion. During 2012 the business sector raised NIS 39.7 billion from the public and from institutional investors by issues and allocations of bonds, slightly lower than the amount raised in Against the growing deficit in the government budget, the money raising and the activity in the government bond market increased, when during 2012 the net money raising amounted to NIS 22 billion compared to a NIS 3 billion during all of Construction and Real Estate The high level of demand for new apartments and the high volume of mortgages continued also during the fourth quarter of Yet the supply of apartments remained on the lowest level in months following a decrease in the construction starts data. This trend followed the continuous effect of the steps taken by the Bank of Israel regarding mortgages and the governments efforts to market lands. On the other hand, the increase in requirements regarding capital adequacy from the banking system, affects the scope of credit, including in the real estate sector. During the last quarter of -8-

13 the year the decrease in the interest of the Bank of Israel continued which contributed to the increase in demand for apartments especially by the buyers buying the apartments as an investment. On February 2013, the Bank of Israel published a guidelines draft regarding the raise of the weighted rate of housing loans by a financing rate higher than 45% for capital allocation and for increasing the group allowance for credit losses regarding housing loans to a minimal rate of 0.35%. on the other hand, the Bank of Israel eased the requirement for required capital regarding the Sales Law guarantee in case that the apartment was already given to the resident. These directives are in continuation to the directive of the Bank of Israel from November 2012, which includes restrictions on the financing rate the banks give for housing loans, and their purpose is to burden mortgage loaners for investment purposes in apartments so that the financing rate for such an investment won't exceed 50% of the apartments value. In addition, the directive states that a banking corporation will not permit a housing loan by a higher than 70% financing rate, excluding a housing loan for the purchasing of a first apartment, for which the maximum financing rate will be 75%. It's still too early to assess the impact of the directives on the housing market. -9-

14 Activity of the Bank and Description of Business Developments Union Bank of Israel Ltd. (hereinafter the "Bank") was founded in The Bank is a banking corporation and possesses a banking license under the provisions of the Banking Law (Licensing) The Bank was founded by the Eretz Israel Economic Company (U.S.A.) of New York and the Economic Company Ltd. of London, which in fact continued the operations of the banking division of the Eretz Israel Union which had commenced its operations in Israel already in From 1983 until May 17, 1993, control of the Bank was held by the State of Israel (through BLL Securities) and by Bank Leumi Le-Israel B.M., which purchased the shares of the Bank in 1954 and Further to the agreement to sell the controlling interest in the Bank, the controlling interest was transferred in 1993 to Shlomo Eliyahu Holdings Ltd., Yeshayahu Landau Holdings (1993) Ltd., and David Lubinski Properties (Holdings) 1993 Ltd. On October 29, 2012, Shlomo Eliyahu Holdings Ltd. Ceased to be part of the controlling interest following the completion of the acquisition of control of Migdal Insurance and Financial Holdings Ltd. By Mr. Shlomo Eliyahu through Eliyahu Insurance Company Ltd., as detailed in section "Investments in the Bank s Capital and Transactions in its Shares". The Banks shares are registered for trade in Tel Aviv stoke Exchange. The Bank has 36 branches and extensions across Israel and two centers for private banking (premium) clients. The Bank provides its customers with a variety of banking services. Based on the financial statements of the banking system as of September 30, 2012, the Bank is the sixth largest in the system. We present below details of the Bank's share in some areas in the banking system: September 30 December 31 December 31 * % % % Credit to the public Public deposits Shareholders' equity Net income * Relates to the first nine months of The Bank's business operations focus on a number of areas: - Financial brokerage between depositors and borrowers. The profit from this activity is reflected in the Bank's profit from financing activity and it constitutes the Bank's major source of income. - Financial and banking services that generate commissions, in a broad variety of activities, in the fields of foreign currency, international trade, securities, information services, banking and financial consultancy and management, derivative financial instruments, etc. - Investment of the Bank's shareholders' equity and market risk management. -10-

15 The board of directors of the Bank, in accordance with the risk appetite and risk tolerance that it establishes, delineates the business policies of the Bank and guides and directs the management of the Bank in accordance with these policies. As part of this process, the board of directors discusses and approves goals, objectives, resource allocation for work plans, and budgets. On March 18, 2012, "Midroog" announced that the rating and rating horizon of the Bank had remained unchanged relative to the preceding year, as follows: Long-term deposits and bonds Aa3 Short-term deposits P-1 Subordinated notes (lower Tier II capital) A1 Subordinated notes (upper Tier II capital) A2 Rating horizon Stable "Midroog" also announced an A1 rating for the recruitment framework of subordinated notes (bottom secondary capital) in up to the amount of NIS 500 million par value. On July 18, 2012, "Midroog" reaffirmed the Banks' rating as described above and approved an Aa3 rating in a stable horizon for the recruitment framework of bonds (series f) in up to the amount of NIS 400 million par value which will be carried out by Union Issuance Ltd. Regarding the issuance of bonds (series f) see section "Activity of Investee Companies".. Set below is a diagram of the Bank's main investee companies as at December 31, 2012: Union Bank Auxiliary corporation(1) Capital market (1) Consolidated auxiliary corporations in the Bank's reports(1) Equity-basis investee (non-financial corporation) (2) 20% holding Union Investments and Enterprise (A.S.Y) Ltd. Union Leasing Ltd. Union Bank Trust Co. Ltd. Union Issuances Ltd. Carmel Union Mortgages and Investments Ltd. Igudim Insurance Agency (1995) Ltd. Livluv Insurance Agency (1993) Ltd. Impact Portfolio Management Ltd. Union Capital Markets and Investments Ltd. (2) Union underwriting finances Ltd (3) Igudim Ltd. Union Systems Ltd. Kukerman Investments Ltd. (1) 100% holding, except for union underwriting & finances Ltd see (3) below. (2) Held by Union Investments and Enterprise (A.S.Y.) Ltd. (3) Held by union capital Markets and Investments Ltd at a rate of 75%. For more details - See section "Activity of Principal Investee companies". (4) For details regarding the principal investee companies of the Bank, their areas of activity, and their contribution to the profitability of the Bank, see Note 5 to the Financial Statements and in the section Activity of Investee Companies. -11-

16 The Bank's Organizational Structure Set below is a diagram of the Bank's organizational structure as of December 31, 2012: Chairman of the Board of Directors Internal Audit Secretary of the Bank President & C.E.O. of the Bank Resources Division Chief Accountant Division Financial Management Division Retail, Client Asset, and Advising Division Corporate Division Controls and Risk Management Division Legal Counsel The Bank's Branches (36) -12-

17 Description of Areas of Responsibility A brief description of the distribution of areas of responsibility at the Bank, based on the current organizational structure of the Bank, is set out below. A. Retail, Client Asset, and Advising Division - Responsible for the activity of all branches of the Bank with private customers (households and private banking) and small businesses (including credit to these customers); supervises units including branches, marketing, advertising and direct channels, mortgages, and client asset management and advising. The division also monitors the activity of the subsidiaries Impact Investment Portfolio Management Ltd., Union leasing Ltd. B. Corporate Division - Responsible for the routine management of credit (excluding privet customers credit, small businesses and mortgages, which are under the responsibility of the Retail, Client Assets, and Advising Division) and credit ratings. The division is also responsible for classifying and handling problematic debts and implementing debt collection proceedings through the special credit department, for Credit rating and for reports in the field of credit to various supervision entities. C. Financial Management Division - Responsible for the management of Banks operating liquidity, execution of transactions in Israeli and foreign securities the foreign currency execution unit, the Bank s proprietary activity, management of assets and liabilities in NIS, foreign currency, CPI and providing quotes for interest and original cost and for making a market with government bonds. The division supervises the, back-office systems, foreign currency, foreign and Israeli securities. The division also monitors the activity of the following subsidiaries: Union Investments and Enterprise (A.S.Y.) Ltd., Union Capital Markets and Investments Ltd., Union underwriting and finances Ltd., Union Bank Trust Company Ltd., Union Issuances Ltd. D. Resources Division Responsible for management of the Bank s resources in the areas of human capital, information systems, purchasing and logistics, information security, assets, construction and maintenance, and the Bank s operational expense budget. The division also monitors the activity of the following subsidiaries: Igud Systems Ltd. and Igudim Ltd. E. Chief Accountant Division Responsible for the financial reports of the Bank and its subsidiaries (to the public, to the board of directors, to management, and to the various supervisory agencies); financial analysis, including oversight of the Bank s work plans and budgets; for capital planning, for oversight of the system of internal control of financial reporting (SOX 404); and responsibility for the Israeli currency execution unit. F. Controls and Risk Management Division Responsible for the development of models and processes for the examination of risk and evaluation of risks in the Bank s diverse areas of activity. This responsibility includes submitting the quarterly exposure document, and overseeing the processes involved in formulating the Bank s ICAAP document. In addition, the division is responsible for risk-control processes, control over trading units, operational risk management, and monitoring exposures to foreign banks. G. Legal Counsel Responsible for the Banks' legal risk management, provides support and an answer to all legal aspects of the Banks' and its subsidiaries activities. Legal support takes the form of routine legal -13-

18 advice, preparation of legal opinions, formulation and preparation of documents and agreements, and concentration of prosecutions against the Bank and the supervision of professional authorities handling them on behalf of the bank. Compliance and public inquiries branch, consisting of the prohibition of money laundering unit, the compliance unit and the public inquiries unit, is subject to the legal counsel H. Secretariat Responsible for assisting the work of the board of directors according to the requirements of the relevant regulatory directives for public companies and banking corporations, the procedures of the Bank, and the resolutions of the board of directors; Reports on behalf of the Bank immediate reports to securities authority and to Stock Exchange and reports to the Bank of Israel according to the directives of the supervisor of Banks. The Secretariat also handles convening and preparing for general assemblies of the Bank and related reports required by law. The secretariat is also responsible for the secretarial services of the Banks' subsidiaries. I. Internal Audit Reports to the chairman of the board of directors; responsible for internal audits of the units of the Bank and its consolidated subsidiaries at the frequency established in the multi-year work plan, based on a risk survey updated on a regular basis. The internal audit is also responsible for the performance of independent review of ICAAP document. Profit and Profitability (Consolidated) Net profit totaled NIS 127 million in 2012, compared with net profit of NIS 132 million in 2011, a 3.8% decrease. Net return on equity (based on average capital base) reached 6.2% in 2012, compared with 6.7% in The return on equity was affected also by the increase in capital, both as a result of the increase in the capital target (as detailed in section " Capital Adequacy" and the increase in the capital reserve from the available for sale portfolio. Set below are the main changes in the net profit, in 2012 compared with 2011: An increase of NIS 10 million of the net interest income before provision for credit losses. An increase of NIS 41 million of non-interest income. An increase of NIS 38 million of provision for credit losses. An increase of NIS 13 million of operating and other expenses. An increase in tax provision rate from 13.2% to 16.4% (see further details below). The profit before taxes totaled NIS 152 million in 2012 similar to the profit before taxes in The return on equity of net profit before taxes (based on an average capital base) was 7.4% in 2012 compared to 7.7% in Developments in Income, Expenses and Provisions for Taxes Profit from net interest income totaled NIS 660 million in 2012, compared with NIS 650 million in 2011, a 1.5% increase. Following is a brief analysis of the interest gaps (the gap between interest income on assets and interest expenses on liabilities) by linkage basis (for detailed information see appendix C to the management review -14-

19 note that the presentation format, according to the directives of the Supervision of Banks, hasn't been adapted to the implementation of the directive regarding the new format of profit and loss statement): The unlinked shekel segment the interest spread including the effect of derivatives in 2012 is 1.18% compared to 1.41% in The CPI-linked shekel segment the interest spread including the effect of derivatives in 2012 is 0.77% compared to 1.02% in The decrease is affected by the measurement of the derivative instruments at fair value. Foreign currency the interest spread including the effect of derivatives in 2012 is 0.45% compared to 0.36% in The increase is affected by the measurement of the derivative instruments at fair value. Provision for credit losses (net after collection) totaled NIS 65 million in 2012, compared to NIS 27 million in 2011 a 140.7% increase. In 2012, the individual allowance, before offsetting debt collection provided in the past, totaled NIS 142 million (NIS 41 million of that is in respect of one client) compared to NIS 67 million in The collection of debts which were provided in the past totaled NIS 66 million in 2012 compared to NIS 56 million in Also, a decrease in the group allowance in the amount of NIS11 million was recorded in 2012 compared to an increase of NIS 16 million in The ratio of expenses in respect of provision for credit losses to the total credit to the public stood at 0.3% in 2012, compared to 0.1% in See more details in the sub-section " Development of Assets and Liabilities" further on. Net interest income after provision for credit losses totaled NIS 595 million in 2012 compared to NIS 623 million in 2011, a decline of 4.5%. Non-interest income totaled NIS 357 million in 2012 compared to NIS 316 million in 2011, an increase of 13.0%. Non-interest financing income totaled NIS 65 million in 2012 compared to NIS 4 million in The increase is mainly due to an increase of NIS 64 million in profit from realization and value adjustment of bonds. This increase was partly offset as a result of the effect of income (expenses) in respect of derivative financial instruments. The adjustment of derivative financial instruments according to their fair value (as required by accounting principals) resulted in expenses in the amount of NIS 13 million in 2012 compared to NIS 22 million in Income from fees totaled NIS 288 million in 2012 compared to NIS 310 million in 20ll, a 7.1% decrease, the decrease is mainly due to a decrease in fees from customers' security transactions due to a significant decrease in the stock markets' activity turnovers and to a decrease in commissions from foreign currency exchange differences. The other income totaled NIS 4 million in 2012 compared to NIS 2 million in Other income includes mainly profit from the sale of fixed assets. -15-

20 Operating and other expenses totaled NIS 800 million in 2012, compared with NIS 787 million in 2011, an increase of 1.7%. Payroll expenses in 2012 totaled NIS 455 million, compared with NIS 459 million in 2011, a 0.9% decrease. There was a decrease in salary expenses as a result of the actual implementation of the retirement plan and the change in the retirement policy (see details in section "Human Capital"). Likewise, there was a decline because profit from the main compensation fund was registered this year compared to losses in the previous year. Some of these decreases were offset mainly as a result of the implications of the update of the mortality tables (see details in section "Critical Accounting Policies and Estimates") and an increase in payroll tax (see details in section " Description of Tax Situation"). Also, in 2011 expenses in the amount of NIS 15 million were recorded in respect of the retirement plan, compared to expenses in the amount of NIS 20 million recorded in 2012 in respect of its expansion (see details in section "Human Capital"). Maintenance expenses and depreciation of buildings and equipment amounted in 2012 to NIS 147 million, compared with NIS 135 million in 2011, an increase of 8.9% due mainly to an increase in depreciation (especially computerization depreciation). Other expenses amounted to NIS 198 million in 2012, compared with NIS 193 million in 2011, an increase of 2.6%. The ratio of the operating and other expenses to the total income (net interest income and non-interest income) was 78.7% in 2012 and 81.5% in The provision for taxes in 2012 was 16.4%, compared with a statutory tax rate of 35.53% mainly due to the effect of the closure of tax assessments in respect of previous years and following an update of the VAT order regarding payroll tax and capital gains tax. In 2011 the tax provision was 13.2% compared with a statutory tax rate of 34.48%, mostly due to the effect of annulment of the future tax rate reduction on the balance of the long term deferred tax asset. See details in note 28.C. The fourth quarter of 2012 resulted in a net profit of NIS 27 million, compared to a net profit of NIS 34 million during the same quarter of last year-a decrease of 20.6%. The decrease is mainly due to an increase in provision for credit losses which was partly offset by profit from realization and value adjustment of bonds. Developments in Balance-Sheet Items The balance sheet of the Bank totaled NIS 38,825 million on December 31, 2012, compared with NIS 38,915 million at the end of 2011, a 0.2% decrease. Net credit to the public (after deduction of allowance for credit losses) totaled NIS 23,573 million as at December 31, 2012, compared with NIS 22,868 million at the end of 2011, an increase of 3.1%. The average balance of credit to the public stood at NIS 23,432 million in 2012, compared with NIS 23,191 million in 2011, an increase of 1.0%. The allowance for credit losses totaled NIS 285 million as at December 31, 2012 compared with NIS 272 million at the end of In addition, as at December 31, 2012 there is an allowance for credit losses of NIS

21 million due to off-balance-sheet credit, presented within the other liabilities item compared with NIS 44 million at the end of A. Total problematic credit risk*: Balance as at December 31, 2012 December 31, 2011 NIS millions Problematic commercial credit risk 1, Problematic credit risk in respect of private individuals Total problematic credit risk 1,135 1,076 * The data presented after the deduction of accounting write-offs and before the deduction of allowance for credit losses and do not include deduction of collaterals deductible for the purposes of the indebtedness of borrower and group of borrowers. B. Problematic credit risk 1 : December 31, 2012 Offbalance Balance sheet sheet NIS millions Total Balance sheet NIS millions December 31, 2011 Offbalance sheet Total Impaired credit risk Substandard credit risk Credit risk under special supervision Total , ,076 From this: unimpaired debts with arrears of 90 days or more Impaired credit risk, substandard credit risk or credit risk under special suoervision. 2 Including in respect of housing loans for which the provision is calculated according to the extent of the arrears and housing loans for which there is no provision according to the extent of the awears, which are in arrears of 90 days or more. -17-

22 C. Risk indices: December 31, 2012 December 31, 2011 Balance of impaired credit to the public as a percentage of the balance of credit to the public 2.4% 2.3% Balance of unimpaired credit to the public, in arrears of 90 days or more, as a percentage of the balance of credit to the public 0.3% 0.3% Balance of allowance for credit losses in respect of credit to the public, as a percentage of the balance of credit to the public 1.2% 1.2% Balance of allowance for credit losses in respect of credit to the public, as a percentage of the balance of impaired credit to the public 48.8% 51.9% Problematic credit risk in respect of the public, as a percentage of the total credit risk in respect of the public 3.0% 2.8% Ratio of provision for credit losses to the average recorded balance of credit to the public 0.3% 0.1% Ratio of net accounting write-offs in respect of credit to the public to the average balance of credit to the public 0.2% 0.3% Ratio of net accounting write-offs in respect of credit to the public to the allowance for credit losses in respect of credit to the public 16.5% 23.2% Nonperforming assets: Balance as at December 31, 2012 NIS millions Balance as at December 31, 2011 NIS millions Impaired debts Assets received in respect of credit repaid Deposits from the public totaled NIS 30,890 million as at December 31, 2012, compared with NIS 31,158 million at the end of 2011, a 0.9% decrease. The average balance of deposits from the public stood at NIS 30,764 million in 2012, compared with NIS 29,741 million in 2011, an increase of 3.4%. Securities totaled NIS 4,940 million as at December 31, 2012, compared with NIS 6,785 million at the end of 2011, a 27% decrease. The balance of securities as at December 31, 2012 is distributed as follows: Approximately 61% of the securities portfolio is invested in government bonds, approximately 18% is invested in bonds of banks, and approximately 13% is invested in corporate bonds, mainly of Israeli companies and approximately 6% in government companies. Approximately 92% of the securities portfolio are classified as available for sale (See additional details in Note 3 to the financial statements). The securities in the available-for-sale portfolio are stated in the balance sheet at fair value, with the difference between the fair value and the depreciated cost allocated to a capital reserve, with -18-

23 the exception of declines in value of other than temporary impairment, which are not allocated to a capital reserve but to the statement of profit and loss. In 2012, other than temporary impairments in the amount of approximately NIS 18 million in respect of bonds and in the amount of approximately NIS 3 million in respect of shares were charged to profit and loss, versus NIS 23 million and NIS 5 million in 2011, respectively. The net positive capital reserve as at December 31, 2012, stands at approximately NIS 112 million (before tax effect), consisting of a positive capital reserve in the amount of NIS 132 million, offset by a negative capital reserve in the amount of NIS 20 million. At the end of 2011, the net negative capital reserve stood at approximately NIS 7 million (before tax effect), consisted of a positive capital reserve in the amount of NIS 84 million, offset by a negative capital reserve in the amount of NIS 91 million. The following table shows the distribution of the capital reserve and of fair value in the available-for-sale portfolio as of December 31, 2012 (in NIS millions): Balance sheet value (constituting fair value) Negative capital fund (unrealized losses) Positive capital fund (unrealized gains) Net capital fund Shares (1) 100 (2) Bonds of Israeli government 2, Bonds of financial institutions in Israel (2) 726 (1) Bonds of foreign financial institutions (3) Corporate bonds: (4) Government companies (5) 261 (5) 9 4 The real estate industry (6) 150 (4) 9 5 Others (7) 473 (8) Total corporate bonds 884 (17) Total available-for-sale portfolio 4,563 (20) 132 * 112 * This capital reserve reflects net unrealized gains and is a part of the bank's equity, after tax effect, in the amount of approximately NIS 74 million; see the report on changes in equity - adjustments in respect of the statement of securities available-for-sale at fair value Including 25 issuers; the highest balance is NIS 30 million. Including 13 issuers; the highest balance is NIS 573 million in respect of Bank Hapoalim Bonds. Including 11 issuers. The issuers are Banks mainly from US, Britain, Holland, Germany and France; the highest balance is NIS 75 million. All corporate bonds are of Israeli companies, with the exception of a balance on NIS 23 million issued by a foreign issuer. Including 3 issuers; the highest balance is NIS 214 million. Including 54 issuers; the highest balance is NIS 15 million. Including 55 issuers; the highest balance is NIS 58 million. -19-

24 The following table shows the distribution of the negative capital reserve (unrealized losses), according to the rate of decrease below cost and periods of time* for which the fair value is lower than the cost as of December 31, 2012 (in NIS millions): Up to 6 months From 6 months to 9 months From 9 months to 12 months Over 12 months Total Bonds available for sale: Othersup to 20% (2) (1) - (14) (17) 20%-30% (1) (1) Total (2) (1) - (15) (18) Shares: up to 20% - (1) - (1) (2) - (1) - (1) (2) Total (2) (2) - (16) (20) * The reference point for determining the amount of time for which the investment was in a position of unrealized loss is the balance-sheet date of the reported period during which the first decline in value occurred, regardless of the rate of the decline. The policies and procedures of the Bank with regard to the examination of the need to perform provisions for other-thantemporary impairments are detailed in the section, Critical Accounting Policies and Estimates. -20-

25 The following table shows the distribution of the capital reserve and of fair value in the available-for-sale portfolio as of December 31, 2011 (in NIS millions): Balance sheet value (constituting fair value) Negative capital fund (unrealized losses) Positive capital fund (unrealized gains) Net capital fund Shares (1) 125 (3) 12 9 Bonds of Israeli government 3,778 (6) Bonds of foreign governments 3 (1) - (1) Bonds of financial institutions in Israel 828 (17) 8 (9) Bonds of foreign financial institutions 230 (8) 1 (7) Corporate bonds: Government companies (5) 186 (11) 1 (10) The real estate industry (6) 122 (10) 3 (7) Others (7) 458 (35) 11 (24) Total corporate bonds 766 (56) 15 (41) Total available-for-sale portfolio 5,730 (91) 84 *(7) * This capital reserve reflects net unrealized losses and is a part of the bank's equity, after tax effect, in the amount of approximately NIS (5) million; see the report on changes equity - adjustments in respect of the statement of securities available-for-sale at fair value Including 28 issuers; the highest balance is NIS 36 million. Including 14 issuers; the highest balance is NIS 624 million in respect of Bank Hapoalim Bonds. Including 11 issuers. The issuers are Banks from US, Britain, Germany, Holland, France and Australia; the highest balance is NIS 63 million. All corporate bonds are of Israeli companies, with the exception of a balance on NIS 26 million issued by a foreign issuer. Including 3 issuers; the highest balance is NIS 167 million. Including 55 issuers; the highest balance is NIS 13 million. Including 68 issuers; the highest balance is NIS 47 million. -21-

26 The following table shows the distribution of the negative capital reserve (unrealized losses), according to the rate of decrease below cost and periods of time* for which the fair value is lower than the cost as of December 31, 2011 (in NIS millions): Up to 6 months From 6 months to 9 months From 9 months to 12 months Over 12 months Total Bonds available for sale: Others - up to 20% %-30% %-40% Total Backed by assets: up to 20% Shares: up to 20% Over 40% Total * The reference point for determining the amount of time for which the investment was in a position of unrealized loss is the balance-sheet date of the reported period during which the first decline in value occurred, regardless of the rate of the decline. The following table shows more details in respect of the tradable portfolio as at (in NIS millions): -22- Balance sheet value (constitutes fair value) December 31, 2012 December 31, 2011 Shares (1): Israeli companies Foreign companies Israeli Government bonds 337 1,004 Other bonds ,026 Total tradable portfolio 377 1,055 (1) Mainly exchange traded Funds.

27 Assets in respect of derivatives as at December 31, 2012 totaled NIS 476 million, compared to NIS 846 million at the end of Liabilities in respect of derivatives as at December 31, 2012 totaled NIS 592 million compared to NIS 907 million at the end of The decrease in the fair value of derivative instruments is mainly the result of activity in foreign currency contracts and transactions in Maof derivatives. Other assets totaled NIS 1,123 million as at December 31, 2012, compared to NIS 1,041 million at the end of Other liabilities totaled NIS 1,978 million as at December 31, 2012, compared to NIS 1,710 million at the end of The fluctuation in other assets and other liabilities is mainly the result of activities in the Maof market in instruments that do not meet the definition of derivatives and from a short sale of securities. The Bank's equity totaled NIS 2,191 million as at December 31, 2012, compared with NIS 1,986 million at the end of The increase in equity is the result of the Banks' profits and of an increase in the net adjustments in respect of presentation of securities available for sale at fair value item (capital reserve).. Ratio of Capital to Risk-Weighted Assets December 31, 2012 December 31, 2011 Ratio of Tier I capital to risk-weighted assets 8.66% 8.09% Ratio of overall capital to risk-weighted assets 14.94% 13.82% For further details regarding the risk-weighted assets and capital - See Note 13 to the Financial Statements and the section "Capital adequacy". For details regarding the Bank's policy in respect of capital adequacy ratio see section "Capital adequacy", subchapter "capital adequacy targets". -23-

28 Objectives and Business Policy The Bank operates under a three-year ahead strategic plan, which gets updated near the end of every year.. The strategy is based on the risk appetite, risk capacity, and capital targets defined by the Board of Directors (For details in respect of the capital targets, see the section Capital Adequacy ). When determining the strategy for the economic slowdown was taken into account. The economic slowdown is expressed, among other forms, by a very low interest rate environment and by the continuation of the capital market slowdown, which might effect the risk level in the various economic sectors. In October 2012, the Board of Directors approved the three-year ahead strategic plan for these years. The main issues covered by the three-year strategy of the Bank are: Retail - Continued focus on the expansion of retail activity by recruitment new customers, concurrent with customer retention and expansion of activity with existing customers, while fostering the customers' loyalty, by the way of integrated marketing moves, unique product development, focusing on domains in which it's possible to accelerate the growth rate and leveraging of upgraded infrastructure of direct channels. Another focus was put on preserving the mortgage portfolio volume, considering the markets' condition, limitation of the risk-weighted assets and the spread and concurrently on detection of potential domains for increasing the volume of consumer credit, in appropriate spreads, directly, and through joint ventures with financial factors. In addition, emphasis was placed on building ongoing processes for increasing awareness and strengthening the brand status. Commercial Credit Maintaining the activity level in the core sectors and the enhancement of activity in the rest of the sectors, alongside detecting additional potential domains, including through collaborations with other entities, while maintaining the high quality of the credit portfolio and increasing its diversification, both in sectoral terms and in terms of borrower size, while also strictly maintaining the connection between returns and the totality of risks arising from the various activities. Capital market - Expansion of the activity while expanding the advised customers infrastructure and increasing the activity among existing customers, including through expansion and leverage of consulting activity, use of advanced trading systems, and increasing the existing product portfolio, subject to the regulatory requirements and the condition of the market.. Liquidity and dispersing of depositors Continued improvement of the structure of the resources and treatment of the concentration of the depositors while extending the average duration by raising retail deposits and reducing the dependence on large depositors, in accordance with the regulatory directives and the board of directors limitations for an effective management of the liquidity risk in the changing market conditions. Continued integration of corporate governance rules based on Basel rules, with emphasis on risk management and control processes. -24-