Contents. Report Of the Board of Directors 7 General Background Economic and Financial 186 Material Agreements

Transcription

1 ANNUAL REPORT 2013

2 Contents Report Of the Board of Directors 7 General Background Economic and Financial 186 Material Agreements Developments 189 Disclosure Regarding the Internal Auditor 11 Business developments at the First International at the Corporation Bank Group 192 Report on Directors with Accounting and 12 Principal Data Financial Expertise 13 Developments in income and expenses 194 Human Resources 20 Chart of Orgranizational Structure 198 Details of the Owners of Control in the Bank 21 Chart of Major Investee Subsidiaries 203 Transactions with Interested Parties 22 The History of the Banking Group 209 Disclosure of the process of approval 24 Description of the First International Group's Activity of the financial statements 29 The Bank Group's Segments of Activity 212 Other matters 70 Composition and Developments of the Bank Group's Assets and Liabilities 82 The Bank's Capital Resources 86 Accounting Principles and Estimations in Respect of Management Review of the Bank's Critical Matters Financial Position and Operating Results 96 Liquidity Position and Capital Sourcing Policy 97 Risk Exposure and Risk Management 231 Appendices to Management Review AH 154 Discussion of Risk Factors 258 Certifications of the Chief Excecutive Officer and 159 Basel II Chief Accountant 164 Activity of Principal Held Companies 261 Report of the Board of Directors and Management 170 Legislation and Supervision Affecting the on the Internal Control of Financial Reporting Banking System 263 Financial Statements 3

3 BOARD OF DIRECTORS Rony Hizkiaho, Chairman Zadik Bino David Assia Dan Arbel Pnina BitermanCohen Gil Bino Zeev Ben Asher Dr. Amnon Goldschmidt Joseph Horowitz Noga Yatziv Dalia Lev Giora Meyuhas Jacob Sitt The late Gideon Lahav (until ) 4

4 MEMBERS OF SENIOR MANAGEMENT AND THEIR FUNCTIONS Smadar BarberTsadik Ilan Batzri Yossi Levy Yoram Sirkis Nachman Nitzan, C.P.A. Aviel Sternschuss Benzi Adiri Yael Ronen, C.P.A Ella Golan (Since ) Yaacov Malkin (Until ) Aviad Biller, Adv. Chief Executive Officer Deputy Chief Executive Officer, Head of Corporate Division Executive Vice President, Head of Resources Division Executive Vice President, Head of Client Assets Management Division Executive Vice President, Head of Chief Accountant Division Executive Vice President, Head of Financial Division Executive Vice President, Chief Risk Officer & Head of Risk Management Division Chief Internal Auditor Executive Vice President, Head of Banking Division Executive Vice President, Head of Banking Division Corporate Secretary 5

5 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 BOARD OF DIRECTORS' REPORT FOR 2013 At the meeting of the Board of Directors' held on March 18, 2014, it was resolved to approve and publish the consolidated audited financial statements of the First International Bank of Israel Ltd. (hereinafterthe Bank) and its consolidated subsidiaries (hereinafter"the First International Group") for the year ending on December 31, The financial statements were compiled in accordance with directives of the Supervisor of Banks. Data therein are expressed in reported amounts. GENERAL BACKGROUND ECONOMIC AND FINANCIAL DEVELOPMENTS MAIN ECONOMIC DEVELOPMENTS IN ISRAEL Nonfinancial developments The growth rate of the Israeli economy, according to the Central Bureau of Statistics (hereinafter: "CBS") estimate, reflects a downturn in economic activity, and amounted to 3.3% in 2013 (including gaz production from the Tamar field estimated at 0.9%) compared with 3.4% in 2012 and 4.6% in Per capita GDP rose by 1.4% in 2013 compared with 1.5% in Per capita expenditure on private consumption increased by 2.3% compared with 1.4% in 2012 and 1.9% in Expenditure on public consumption expanded by 3.6% in 2013, similar to the increase in Business sector GDP grew by 3.5% in 2013 compared with 3.4% in 2012, against the background of increases in the commerce, telecom, transportation and particularly the electricity industries. However, commodities and services imports fell by 0.3% in 2013, after increase of 2.3% in The Bank of Israel Research Division's estimate for Israel's GDP growth rate in 2013 was reduced to 3.5% compared with 3.6% in the initial forecast (September 2013). Exclusive of the effect of the inflow of gas from the Tamar field, growth is expected to amount to 2.6%. The growth forecast for 2014 was reduced to 3.3% compared with 3.4% in the previous estimate. Exclusive of the effect of gas production from the Tamar field, the growth rate in 2014 is expected to reach 2.9%. The budget The cumulative budget deficit for 2013 amounted to NIS 33.2 billion or 3.15% of GDP compared with a deficit of NIS 39 billion in 2012, a decrease of 15%. The deficit target under the original budget plan for 2013 was NIS 45.6 billion or 4.33% of GDP. The difference between the actual deficit and the planned deficit resulted from a larger then expected increase in tax revenue (mainly from an increase in corporation tax and from collection in respect of trapped profits), and from a lower than planned increase in government spending. Inflation The consumer price index rose by 1.8% in 2013, slightly below the Bank of Israel's average inflation target, compared with 1.6% in The inflation rate in the second half of 2013 reached 2.1%. Inflation in 2013 was affected mainly by increases in the prices of food, fruit and vegetable, and housing prices. Government measures in the form of the VAT hike in 2013 and increases in electricity and water rates also contributed to the 7

6 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 rise in the index. At the beginning of 2014, inflation expectations for 12 months amounted to 1.6% according to capital market data and 1.8% according to the Bank of Israel forecast. The housing market According to the Central Bureau of Statistics apartment price estimate, apartment prices rose by 8.0% in 2013 compared with 6.6% in 2012 despite the new restrictions on mortgage loans which the Bank of Israel imposed at the end of On the supply side, private and public sector initiated building starts in 2013 totaled 44.3 housing units, 3.4% more than in Price trends in the housing market have a major impact on monetary policy and the Bank of Israel's interest rate decisions. In 2013 new mortgage loans in the banking system reached a record level of NIS 51.7 billion compared with NIS 46.6 billion in The risk characteristics of new mortgage loans (LVT ratio, debtincome ratio and the proportion of floatingrate mortgages) continued to decline as a result of the restrictions imposed by the Bank of Israel. The exchange rate The shekel strengthened by 7% against the dollar and by 2.8% against the euro in The shekel strengthened against the background of the improvement in the balanceofpayments current account and expectations of a further improvement as a result of the start to the production of natural gas from the Tamar field. In order to prevent the strengthening of the shekel from harming export industries' competitiveness and in order to reduce its impact on the exchange rate of the production of gas from the Tamar field, the Bank of Israel purchased Dollar 5.3 billion during (Of this amount, Dollar 2.1 billion constituted purchases in respect of the gas production program). According to an announcement from the Bank of Israel, in 2014 the central bank is expected to buy Dollar 3.5 billion, based on the estimated effect of gas production on the balance of payments in that year. Exchange rate as of Change in % Q Dollar (1.9%) (7.0%) Euro % (2.8%) The Bank of Israel interest rate The Bank of Israel interest rate was cut from1.75% at the end of 2012 to 1% in October At the end of February 2014, the Bank of Israel decided to cut the interest rate to a level of 0.75%. This was against the background of the continuing appreciation of the shekeldollar exchange rate and the decline in the inflation rate. The global environment Following a continuing period of downward adjustments in growth forecasts, the World Bank and the IMF upward adjusted their global growth forecasts to 3.7% compared with the 3.6% estimate published in October 2013 as a result of the rebound in the US economy. This rebound led to the Fed's decision to make gradual cutback in its purchase of US government bonds, which actually began in December In Europe a mixed picture is apparent, with a decline in the services components of the Purchasing Managers Index and unemployment remaining at a record level of 12.1%. However, a continuing improvement can be seen 8

7 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 in the manufacturing component of the PME, consumer confidence and retail sales. In Japan, the quantitative expansion program appears to be leading to a slight improvement, as reflected by an increase in exports and manufacturing output. In the emerging markets and particularly in Brazil, India and China, no significant rebound has yet been recorded in growth rates after these rates slowed in The capital market During 2013 the Tel Aviv 100 Index rose by 15%, the Tel Aviv 75 Index by 12% and the Yeter50 Index by 36%. The CPIlinked Corporate Bond Index advanced 9.5% in 2013 while the CPIlinked Government Bond Index gained 3%. In the USA, the S&P 500 Index rose by 29.6% and in Europe, the Euro Stoxx 600 Index went up by 17.3%. However, the EMMSCI emerging markets index fell by 5% during the year. Daily turnover on the Tel Aviv Stock Exchange averaged NIS 1.17 billion in 2013, 9% more than in This growth in turnover derived inter alia from the reduction in the Bank of Israel interest rate during the year resulting from gains recorded in world markets, principally in the USA. Rate of change Average daily turnover In % NIS million Q Q Tel Aviv 25 Index 5.09% 12.13% Tel Aviv 100 Index 5.70% 15.12% General bond index 1.48% 5.44% 4,017 4,340 Total issues (shares and bonds) in the local market fell by 14% in 2013 compared with Issues of shares and convertible securities increased by 86%. Amount raised NIS million Q Q Shares and convertibles 2,268 7, ,074 Government bonds 14,374 65,122 18,049 82,728 Corporate bonds (incl. institutional) 9,015 36,341 9,055 39,921 Total 25, ,047 27, ,723 PUBLIC INFORMATION The information presented in this report is based inter alia on publications issued by the Central Bureau of Statistics, the Ministry of Finance and Bank of Israel data, as well as on public information provided by entities operating in and connected with the capital and money markets. 9

8 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 FORWARDLOOKING INFORMATION Part of the information detailed in this report which does not refer to historical facts is forwardlooking information as defined in the Securities Law, Actual results are likely to be substantially different from those included in the context of forwardlooking information due to a large number of factors, including changes in legislation and supervisory directives, macroeconomic developments in Israel and abroad and their effect on the liquidity position and stability in the capital markets at business companies in Israel and abroad, exceptional economic developments such as extreme changes in interest rates, exchange rates and inflation, stock prices, bond prices, competitors' behavior and changes in the terms of competition. Forwardlooking information is notable for such words or expressions as: "forecast", "expected", "in the Bank's estimation" and "the Bank intends", as well as expressions such as "will be able", "might be" and "will be." These forwardlooking expressions involve risks and uncertainty because they are based on the Management's assessments regarding future events that may not occur or that may occur in a different manner than expected as the result inter alia of the aforementioned factors or as the result of the materialization of one or more of the risk drivers detailed in the table of risk drivers presented in this report. 10

9 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 BUSINESS DEVELOPMENTS AT THE FIRST INTERNATIONAL BANK GROUP Detailed below are the description of the main developments in the balancesheet and income statements items of the Bank group for year of Net profit attributed to the Bank's shareholders amounted to NIS 570 million compared with NIS 577 million in 2012, an decrease of 1.2%. Earnings before taxes amounted to NIS 947 million compared with NIS 872 million in 2012, an increase of 8.6%. Net return on equity attributed to the Bank's shareholders reached 8.6% compared with 9.5% in In the last five years, the average annual net return on equity amounted to 8.6%, as follows: %, %, %, %, %. Set out below are the main changes effecting the Group's profit in 2013, compared with 2012: 1. An increase of NIS 109 million (3.0%) in total income after expenses from credit losses, as detailed below: A NIS 13 million or 0.5% decrease in net interest income and noninterest financing income. The expenses from creadit losses amounted to NIS 37 million or 0.5% decrease. The expenses from credit losses includes an increase of NIS 24 million in the group provision due to implementation of the Supervisor of Banks directive regarding "update of the guidelines concerning housing loans" according to which the banking entities had to position the group provision regarding housing loans on a rate no less than 0.35% of the balance of such loans. The rate of provision for credit losses of the credit to the public amounted to 0.14% compared with 0.2% in An increase of NIS 85 million or 6.1% in commission and other income. 2. An increase of NIS 34 million or 1.2% in operating and other expenses. Earnings after taxes totaled NIS 561 million compared with NIS 548 million in 2012, an increase of 2.4%. Basic earnings per NIS 0.5 share amounted to NIS 5.69 compared with NIS 5.75 in In the fourth quarter of 2013, net earnings amounted to NIS 141 million compared with NIS 132 million in the fourth quarter of 2012, an increase of 6.8%. Net return on equity attributed to Bank's shareholders reched 8.5% in the fourth quarter, similar to the fourth quarter of The Bank Group's total assets on December 31, 2013 amounted to NIS 111,103 million compared with NIS 105,685 million on December 31, 2012, an increase of 5.1%. Net credit to the public totaled NIS 68,706 million on December 31, 2013, compared with NIS 67,879 million on December 31, 2012, an increase of 1.2%. Deposits from the public totaled NIS 89,122 million on December 31, 2013, compared with NIS 84,365 million on December 31, 2012, an increase of 5.6%. Capital attributed to shareholders totaled NIS 6,892 million on December 31, 2013, compared with NIS 6,563 million at the end of 2012, an increase of 5.0%. The core capital ratio amounted to 10.04% on December 31, 2013, compared with 9.65% at the end of

10 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 PRINCIPAL DATA Earnings and profitability For the year ended December Change NIS million in % Net interest income 2,187 2,250 (2.8) Noninterest income 1,682 1, Total income 3,869 3, Of which: Commission fees 1,418 1, Expenses from credit losses (27.6) Operating and other expenses 2,825 2, Earnings before taxes Net earnings attributed to shareholders (1.2) As of December 31 Balance Sheet Highlights Change NIS million in % Total assets 111, , Net credit to the public 68,706 67, Securities 10,799 9, Deposits from the public 89,122 84, Bonds and subordinated notes 5,702 5, Capital attributed to shareholders 6,892 6, Principal financial ratios Capital attributed to shareholders of the bank to total assets 6.2% 6.2% 5.7% Expenses from credit losses to credit to the public, net 0.14% 0.20% 0.14% Ratio of core capital to risk components 10.04% 9.65% 8.46% Ratio of Tier 1 capital to risk components 10.04% 9.65% 8.46% Ratio of total capital to risk components 14.96% 14.94% 13.09% Credit to the public, net to total assets 61.8% 64.2% 64.0% Deposits from the public to total assets 80.2% 79.8% 80.2% Deposits from the public to credit to the public, net 129.7% 124.3% 125.3% Operating and other expenses to total income 73.0% 73.5% 78.9% Net return on equity attributed to shareholders of the bank 8.6% 9.5% 8.5% Ratio of income to total weighted balance of risk assets 5.7% 5.6% 5.2% 12

11 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 DEVELOPMENTS IN INCOME AND EXPENSES Net interest income totaled NIS 2,187 million compared with NIS 2,250 million in 2012, a decrease of NIS 63 million or 2.8%. Noninterest financing income totaled NIS 200 million compared with NIS 150 million in 2012, an increase of 33.3%. Financing income deriving from all of the Bank's assets and liabilities includes net interest income together with noninterest financing income. Noninterest financing income includes financing income in respect of derivative instruments that form an integral part of the Bank's positions management. Income from derivative instruments includes the effects of the time value on derivatives' fair value, which form an integral part of the Bank's interest risk management, and the effect of the rate of increase in the known index on derivatives, which forms an integral part of CPIexposure management. Set out below is the composition of net financing earnings: Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 NIS million NIS million Interest income ,020 1, Interest expenses (176) (382) (320) (257) (224) (440) (517) (356) Net interest income Noninterest financing income Net financing earnings For the year ended December NIS million Interest income 3,322 3,787 Interest expenses (1,135) (1,537) Net interest income 2,187 2,250 Noninterest financing income Net financing earnings 2,387 2,400 13

12 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 Set out below is an analysis of net financing earnings: Q4 Q3 Q2 Q1 Q4 Q3 Q2 Q1 NIS million NIS million Earnings from current activity Reconciliations to fair value of derivative instruments (22) 42 Income from realization and reconciliations to fair value of bonds Earnings from investments in shares Provision for writedown of securities (2) (1) (24) (1) (9) (19) Financing income (expenses) deriving from the hedge of investments abroad (1) (4) 10 9 (6) (6) (1) Net financing earnings For the year ended December NIS million Earnings from current activity 2,082 2,152 Reconciliations to fair value of derivative instruments Income from realization and reconciliations to fair value of bonds Earnings from investments in shares Provision for writedown of securities (3) (53) Financing income (expenses) deriving from the hedge of investments abroad 5 (4) Net financing earnings 2,387 2,400 Set out below are details of the contribution of activity in the different linkage segments to net interest income as included in Appendix C to the Management Review: Activity volume Contribution to financing earnings including hedging and ALM Activity volume Contribution to financing earnings including hedging and ALM % NIS million % % NIS million % Nonlinked shekel segment 71 1, , CPIlinked segment Foreign currency and fc linked (including activity abroad) Total 100 2, ,

13 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 Set out below are interest spreads on the basis of average balances, attributed to activity in Israel, in the different linkage segments: Linkage segment For the year ended December Nonlinked shekel segment CPIlinked segment Foreign currency and fc linked Total % The nonlinked NIS segmentnet interest income in the nonlinked shekel segment decreased by NIS 69 million or 3.6% compared with 2012, and amounted to NIS 1,850 million. The interest spread in this segment amounted to 2.58% compared with 2.63% in The contraction of the interest spread derived from a decrease in the margin on deposit receipt activity, mainly as a result of the low interest rate environment. Activity volume increased by 4.5% due to an increase in the balance of deposits at the Bank of Israel. The CPIlinked NIS segmentnet interest income in the CPIlinked shekel segment totaled NIS 127 million, an increase of NIS 22 million compared with Most of the increase is attributed to the effect of the rate of increase in the index on income from the surplus of assets over liabilities in this segment compared with Interest spread in the segment amounted to 0.48%, similar to that in The foreigncurrency denominated and foreigncurrency linked segmentnet interest income in this segment fell by NIS 16 million or 7.1% compared with 2012, and amounted to NIS 210 million. Interest spread in the segment amounted to 1.82% compared with 1.73% in Expenses from credit losses were compiled on a conservative basis and amounted to NIS 97 million in 2013 compared with NIS 134 million in Expense on credit losses totaled NIS 43 million in respect of commercial credit, NIS 21 million in respect of credit to private individuals and NIS 33 million in respect of housing credit, which derived mainly from the application of the Supervisor of Banks' letter concerning "revision of directives regarding residential real estate". Pursuant to this letter, banking corporations were required to ensure that from the financial statements for the second quarter of 2013, the balance of the group provision for credit losses held in respect of housing loans does not decrease from 0.35% of the balance of the said loans on the report date. As a result, the said provision was increased by NIS 24 million, which was charged as an expense in the statement of income. In 2012, the expenses on credit losses totaled NIS 77 million in respect of commercial credit, NIS 43 million in respect of credit to private individuals and NIS 14 million in respect of housing credit. Expenses on credit losses as a ratio of total credit to the public amounted to 0.14% in 2013 compared with 0.20% in See the section on segments of activity below for details of the distribution of expenses on credit losses by segments of activity. 15

14 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 Set out below is the distribution of expenses (income) in respect of credit losses by principal sectors of the economy: Manufacturing Construction and real estate Commerce Hotels, accommodation and food services Transport and storage Communications and computer services Financial services Other business services Public and community services Private customers including housing loans Other sectors of the economy Total (5) 25 1 (1) (4) (7) (8) * NIS million (14) (1) 134 * Including Group provision in the amount of NIS 24 million from implementation of the Supervisor of Banks' directive regarding "guidelines concerning housing real estate" as detailed above. Commission income totaled NIS 1,418 million in 2013 compared with NIS 1,362 million in 2012, an increase of 4.1%. The increase derived mainly from the growth in commission income from securities activity and from activity in the capital market. Other income totaled NIS 64 million compared with 35 million in The increase derived from earnings for the realization of buildings, principally earnings of NIS 20 million from the sale of the FIBI London building. Set out below are details of commission income and other income: For the year ended December Change NIS million % Commission fees: Account management (3.9) Credit cards Transactions in securities Financial product distribution fees Management, operation and trusteeship for institutional investors Credit processing (2.4) Conversion differentials Foreign trade activity (2.1) Commission fees from financing transactions Other commission fees (9.8) Total commission fees 1,418 1, Other income Total commission fees and other income 1,482 1,

15 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 Operating and other expenses totaled NIS 2,825 million compared with 2,791 million in 2012, an increase of 1.2%. Set out below are details of operating and other expenses: For the year ended December Change NIS million % Salaries and related expenses 1,687 1, Maintenance and depreciation of premises and equipment Amortization of intangible assets Other expenses (4.7) Total operating and other expenses 2,825 2, Salaries and related expenses totaled NIS 1,687 million compared with NIS 1,633 million in 2012, an increase of 3.3%. This increase derived largely from adjustments in salaries and in salary reserves in respect of linkage to the salary agreement at Bank Leumi and from an increase in the rate of payroll tax. Expenses on depreciation and maintenance of premises and equipment totaled NIS 438 million compared with NIS 435 million in Amortizations of intangible assets totaled NIS 169 million compared with NIS 166 million in Amortization of the excess of cost of the acquisition attributed to customer relations which was included in this item amounted to NIS 51 million, similar to that in Since amortization of the excess of cost of the acquisition is not a recognized expense for tax purposes, it has the effect of reducing earnings by the full amount of the amortization. Other expenses totaled NIS 531 million compared with NIS 557 million in 2012, a decrease of 4.7%. The decrease derived mainly from a reduction in expenses on the provision for lawsuits. Set out below are details of other expenses: For the year ended December Change NIS million % Marketing and advertising (3.7) Communications (postage, telephone, shipping, etc.) (2.4) Computers Office Insurance 5 6 (16.7) Legal, audit and professional consulting (6.3) Compensation of Board members and attendance fees for Board meetings Instruction and professional training 6 6 Commission fees Provision for lawsuits, net 32 Other Total other expenses (4.7) 17

16 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 Set out below is the composition of operating expenses: For the year ended December Percent Salaries and related expenses Maintenance and depreciation of premises and equipment Amortization of intangible assets Communications and computers Marketing and advertising Other The provision for taxes on operating earnings amounted to NIS 386 million compared with NIS 324 million in The effective tax rate as a proportion of earnings before taxes amounted to 40.8% in 2013 compared with the statutory rate of tax of 36.2%. The factors that increased the rate of tax in comparison with the statutory rate of tax are as follows: a. Unrecognized expenses, mainly amortizations of intangible assets and tax and interest differential in respect of collections of impaired debts. b. The negative exchange rate differentials attributed to subsidiaries abroad resulting from the appreciation of the shekel against the pound sterling, which are not recognized as an expense for tax purposes. This effect was offset by noninterest financing income. However, the NIS 21 million effect of the increase in the statutory rate of tax as detailed above partially offset these effects. On June 3, 2013, a Value Added Tax Order (Rate of the Tax on NonProfit Institutions and Financial Institutions) was issued, revising the rate of profit tax and payroll tax applying to financial institutions, with the result that it amounted to 18% from June 2, As a result of the revision in profit tax, the statutory rate of tax applying to banking corporations rose in 2013 from 35.53% to 36.21%. In addition, on July 30, 2013, the Knesset plenum passed the Law for Changing National Orders of Priority (Legislative Amendments for Attaining the Budget Targets for the Years 2013 and 2014), Under this legislation, corporation tax was raised to 26.5% from January 1, As a result and on the basis of the Value Added Tax Order of June 3, 2013, which revised the rate of profit tax and payroll tax on financial institutions, the statutory rate of tax applying to banking corporations in 2014 onwards rose to 37.71%. The abovementioned changes had the effect of increasing the balance of deferred taxes at the date of the change by NIS 21 million. In 2012, the effective rate of tax reached 37.2% compared with the statutory rate of tax of 35.5%. The effective rate of tax in 2012 was affected by unrecognized expenses, principally amortizations of intangible assets and tax and interest differentials in respect of collections of impaired debts that were written off from the accounting aspect, which led to an increase in the rate of the tax, concurrent with the following factors, which partially offset these effects: 18

17 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 a. Positive exchange rate differentials attributed to income from the FIBI Bank (UK) subsidiary resulting from the depreciation of the pound sterling, and which do not constitute income for tax purposes. This effect was offset by noninterest financing income. b. Tax income of NIS 32 million in respect of previous years. The Bank s share in the operating earnings of investee companies after the tax effect amounted to NIS 30 million in 2013 compared with NIS 51 million in The decrease in the Bank's share in the operating earnings of investee companies is attributed to the decrease in the Bank's share in the earnings of the Israel Credit Cards company (hereinafter: "ICC"). This derived, among other things, from an increase in the rate of royalties paid to the Bank and to Israel Discount Bank (hereinafter: "Discount") as a result of the joint issue agreement that was signed with Discount. (For further details, see the section on principal held companies). CONTRIBUTION TO THE COMMUNITY At the end of 2006, the Bank established the Turning Point social project, in cooperation with Ashalima nonprofit organization founded by the Joint Distribution Committee and by Matan. The project is intended to promote and foster business entrepreneurship among youth at risk, in order to help them return to a normative lifestyle. Every year the Bank makes available to the project hundreds of volunteers from among its employees who contribute their time, experience and expertise to helping these young people. Since 2010, the Bank has increased its contribution to the community by means of the "Culture and Community at the First International" project, which is aimed at encouraging and promoting artistic endeavor from peripheral areas and providing artists with the opportunity for coverage in the heart of Tel Aviv. All cultural events in the project are held at the Bank's head office building on Rothschild Boulevard in Tel Aviv, and are open to the public free of charge. In addition, the Bank and its subsidiaries donate to various foundations and organizations. Total donations made at the Bank Group in 2013 amounted to NIS 3.6 million. 19

18 Internal Auditing Bank Secretariat Banking Division Chief Accountant Division Financial Division Customer Assets Division Resources Division Corporate Division Logistics Department Legal Department Credit Administration Department Risk Management Division

19 (E. 100% V. 100%) (E. 100% V. 100%) (E. 28.2% V. 21%) (E % V. 76.0%) (E. 100% V. 100%) (E. 100% V. 100%) (E. 100% V. 100%) (E. 75% V. 75%) (E. 51% V. 51%) (E. 100% V. 100%) (E. 100% V. 100%)

20 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 THE HISTORY OF THE BANK GROUP The Bank is a publiclytraded company that was incorporated under the provisions of the Companies Ordinance (New Version) 1983 (hereinafter: "Companies Ordinance"). The Bank is a banking corporation and holds a bank license under the provisions of the Banking Law (Licensing) 1981 (hereinafter: "Licensing Law"). The Bank was incorporated in 1972 and commenced business activity on October 1, Concurrent with the incorporation of the Bank, its parent company FIBI Holdings Ltd. (hereinafter: "FIBI") was established. Among the founders of FIBI were the Israel Government and foreign investors, including First Pennsylvania Corporation and Israel Investors Corporation. The business basis for the Bank's operations was a merger of the activity of two banks the Foreign Trade Bank Ltd., which owned the Mortgage and Savings Bank Ltd., whose name was changed to First International Mortgage Bank Ltd. and the Export Bank Ltd. In 1976 the Bank acquired control of the Israel Industrial Bank Ltd., whose activity including its branches was merged within the activity of the Bank, and its employees were absorbed by the Bank. The Israel Industrial Bank Ltd. changed its status from a commercial bank to an investment finance bank. In 1985 the Israel Industrial Bank Ltd. changed its name to the First International Bank for Financing Industry Ltd. This bank was later merged with the First International Bank and the merger order was issued in May 1995, effective from December 31, Bank Poalei Agudat Israel Ltd. was established in 1977 under the joint ownership of the Bank (65%) and the Histadrut Poalei Agudat Israel in Eretz Israel (35%). In 2010 the Bank completed acquisition of all outstanding shares of Bank Poalei Agudat Israel from the other shareholders. Since then, the Bank has owned 100% of capital and voting rights in Bank Poalei Agudat Israel. In 1978 the Bank acquired control of Bank Lemelacha Ltd., whose activity including its branches was merged with the activity of the Bank, and its employees were absorbed by the Bank. The purchased company changed its name to FIBI Lemelacha Ltd. and ceased to operate as a bank. In 2009, FIBI Lemelacha was merged with one of the Bank's assetholding companies. In 1982 the Bank issued shares of NIS 0.05 par value each to the public that were listed for trading on the Tel Aviv Stock Exchange. In 1982 FIBI Financial Trust Ltd. was established (now called: FIBI Bank (UK) plc) as a wholly owned subsidiary. The company began operations as a financial company and has held a bank license in the UK since In 1984 FIBI Bank Switzerland Ltd. was established as a wholly owned subsidiary that holds a bank license in Switzerland. In 1987 the Bank purchased the activity of the Bank of North America within the framework of the liquidation of that bank. 22

21 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 On December 11, 1992 the Bank floated a public offering by means of a prospectus of 353,500 ordinary shares, registered, of NIS 0.01 par value each, which are listed for trading on the Tel Aviv Stock Exchange. Since 1992, the Bank has held a controlling stake in InternationalSelective Investment Management and Consulting Ltd. As a result of the merger with Modus company, the company changed its name to Modus Selective Investment Management and Consulting Ltd in Since 2010, the Bank has held 100% of the company's equity. At the beginning of 1983 the First International Mortgage Bank purchased 50.5% of the control and ownership of Atzmaut Mortgage and Development Bank Ltd. (hereinafter: Atzmaut Bank ). From the time of this acquisition and until the end of 2004, the First International Mortgage Bank purchased additional shares that brought its holding to 88% of Atzmaut Bank's equity. At the end of 2005, the First International Mortgage Bank purchased the remaining holdings in Atzmaut Bank from the public under an offering circular. At the beginning of 2006, the Bank purchased the outstanding holdings in the First International Mortgage Bank from the public under an offering circular. The First International Mortgage Bank and Atzmaut Bank were merged within the Bank with effect from March In 2004 the Bank purchased the entire holdings in Ubank Ltd. (hereinafter: Ubank ). In 2006 the Bank purchased 68% of equity and 66% of voting rights in Bank Otsar Hahayal (hereinafter: Otsar Hahayal ). Following additional acquisitions in 2010 and 2012, the Bank's rate of holding in Otsar Hahayal increased to 75.99% of equity and 76.0% of voting rights, In 2000 the Bank purchased 20% of the equity and 15% of the voting rights in Israel Credit Cards Ltd. (hereinafter: "ICC ). Following additional purchases of ICC shares in 2006 and 2007, the Bank s rate of holding in ICC rose to 28.2% of equity and 21.0% of voting rights. In 2008 the Bank purchased a 51% holding in the issued and paidup share capital of Bank Massad Ltd. In 2010 the Bank consolidated its share capital in a manner whereby every five NIS 0.01 par value ordinary shares of the Bank was consolidated to one NIS 0.05 ordinary share of the Bank (hereinafter: "the capital consolidation"). Since September 20, 2010, only NIS 0.05 par value ordinary shares of the Bank have been traded. 23

22 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 DESCRIPTION OF THE FIRST INTERNATIONAL GROUP'S ACTIVITY The First International Group is one of the five largest banking groups in Israel. The business activities of the Group are centered in five main areas: Financial intermediation between depositors and borrowers, which forms the basis for commercial banking. Income from this activity is reflected in the Bank's net interest income, and constitutes the Group s main source of earnings. Commission generating financial and banking services in a wide range of activities, including in the areas of foreign currency, foreign trade, securities, information services, credit cards, derivative financial instruments and trust services. Investment consultancy and pension consultancy. The Bank's nostro investment and management of market and liquidity risks. Banking operational services in the area of provident fund and mutual fund activity. The Bank s Management is directed and guided by the Board of Directors and its committees regarding the Bank s business strategy and policy. Within this framework, the Board of Directors approves the Bank s quantitative and qualitative objectives and targets and areas of activity. On the basis of the Bank s multiyear strategic plans, the Management have submitted annual work plans and budgets to the Board of Directors, with quantitative and qualitative details of the composition of income, expenses and investments which the Bank s Management have determined as longterm targets and case specific targets for the current work year. The Board of Directors and its committees supervise and control the work of Management in all matters relating to the implementation of the business policy as approved by them, and the determination of limitations on exposure with respect to credit, market and liquidity risks. The Bank's branch and head office units operate in accordance with written procedures and circulars that guide them in their current activity. These procedures and circulars define inter alia the authorities of the bank s various units and the manner in which they are to operate. In addition to the First International Bank, the group also includes four commercial banks in Israel specializing in unique client bases: PAGI, Bank Poalei Agudat Israel which is the only bank in Israel with a main focus on the religious and the ultraorthodox sector; Ubank, purchased in 2004, is a bank specializing in private banking and sophisticated services in the capital market; Otsar Hahayal, purchased in 2006, which specializes in providing services to retail banking and commercial banking customers, with an emphasis on employees and pensioners of the defense forces; and Bank Massad, purchased in 2008, which specializes in providing services to members of the teaching profession in Israel. The Group has two overseas subsidiaries: FIBI Bank (Switzerland), located in Zurich, which specializes in private banking; and FIBI Bank (UK), located in London, which specializes in Israeli and local commercial banking (middle market) customers. On March 19, 2013, an agreement was signed for the sale of FIBI Bank (UK). For further details, see the section on principal held companies. 24

23 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 In 2005 the Bank adopted a corporate strategy that led to the acquisition of retail banks while increasing the proportion of income from private customers in the Group's total income. Following these acquisitions, a decision was taken to apply a shared services model for all the banks in the Group, with the aim of facilitating the exploitation of synergies and economies of scale. For this purpose, the bank integrated the computer systems of the acquired banks to its own computer systems, and amalgamated a large proportion of the service and operational units at the Group. When the integration process was complete, laying the foundations for the creation of an efficient banking group, in 2012 the Bank approved a new multiyear strategic program, which is a direct continuation of recent years' strategy. The program is based on prudent performance in all areas of activity with the aim of achieving stable and favorable profitability over time. Efforts at promoting the Group's retail activity will continue while increasing activity at the Bank, maintaining the subsidiaries' leading position in their respective unique activity niches, adopting streamlining measures, and making increased use of direct banking channels. In corporate and commercial banking, emphasis will be placed on continued expansion of the credit portfolio, mainly among mediumsized customers. In the area of capital market activity, the Bank will endeavor to maintain its leading position inter alia by continuing with the development of unique sophisticated products and services. These expectations and intentions include forwardlooking information. This form of information is uncertain information about the future that is based on information existing at the Bank as of the report date, and includes the Bank's assessments or its intentions as of the report date. The following is a description of the areas of activity and responsibility of the Bank's divisions and departments: The Corporate Division The Division s Corporate Department coordinates the entire range of activities of large and international corporate clients with an obligo of NIS 40 million and above, as well as the activities of borrowers with complex credit requirements, such as telecommunications, diamonds and project finance. The Commercial Banking Department processes customers of the Bank holding credit lines of between NIS 13 million and NIS 40 million. A Corporate Area operates within the Division, coordinating the activity of the Bank s main business branches. The Corporate Division also contains an International Banking and Foreign Trade Department and the International Trade Center, which provides services to all the banks in the Group. The division is also responsible for processing corporate and institutional clients operating in the investment area. The Head of the Division is a member of the Bank s Management, and serves as Board Chairman of Bank Massad and FIBI Bank (UK). The Banking Division is responsible for the Bank's branch network (except for the seven largest business branches, which are subordinate to the Corporate Division, and the Rothschild Branch, which is subordinate to the Customer Assets Division). The Division coordinates the activities of private banking customers, personal banking customers (households and small businesses) and small to mediumsized commercial customers. The Division is responsible for the Bank s marketing and advertising activity, and for the entire range of direct banking activities, including the Beinleumi Call Center. The collection department and the public enquiries unit are subordinated to this division. In addition, the Division is responsible for credit card activity and the Mortgage Department, which supports the mortgage activity of all the banks in the Group, and operates via 82 mortgage counters that are located throughout the country at branches of the Bank, Otsar Hahayal, Bank Poalei Agudat Israel and Bank Massad. The Head of the Division is a member of the Bank s Management. 25

24 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 The Customer Assets Division coordinates the Bank s activity in the area of capital market activity and deposit activity, including the dealing rooms specializing in activity with branches, professional customers and institutional entities in the areas of Israeli and foreign securities, and Israeli and foreign currency deposits and derivatives. The Division is in charge of a network of qualified investment consultants who are employed at the Bank's branches, the Bank s services to portfolio managers, the International Private Banking Unit, the private banking centers, initiated advice and the Rothschild Branch, which is a specialized private banking branch. At the Group level, the Division is responsible for pension advice activity, structured products and provident fund operational services, as well as the investment advice system and research services in the capital market. The Division is also responsible for the capital market subsidiaries: Modus Selective, Kidma Provident Fund Management (hereinafter: Kidma) and First International Insurance Agency (2005) Ltd. (hereinafter: International Insurance Agency). The Head of the Division is a member of the Bank s Management and serves as Board Chairman of Ubank. The Financial Division is responsible for the Bank s ALM management, nostro management, liquidity management and management of the Group s financial risks, money price quotations in the different linkage segments, and the raising of supplementary capital for the Bank. The Division is also responsible for the Group s foreigncurrency dealing room that works with large customers and the branches. Subordinate to the Division are the Insurance Unit and the Middle Office Unit, which is the first line of control in the supervisory and control mechanisms operating in the area of market and liquidity risk management. The Division is also professionally responsible for the Financial Institutions Department. The Head of the Division is a member of the Bank s Management. The Resources Division is in charge of the Human Resources Department, which is responsible for the management of human resources at the Bank and their welfare, including the assignment and advancement of the employees and managers of the Bank; and of the Training Department, which is responsible for the instruction and training of employees and managers at the Bank and at the Group. Subordinate to the Resources Division is foreign securities and foreign currency back office system, the capital market back office system, which includes the Securities Execution Unit, the Mutual Fund Operation Unit, the Management Engineering Department, the Strategy and Branding Department, and the Project Management Office. The Head of the Division is a member of the Bank s Management. The Chief Accountant's Division is responsible for accounting management, and financial and managerial reporting in various areas. The Division contains the Planning Department, which analyzes the Bank's results, exerts control over the profit centers and compiles the annual work program. The Division supports the activity of the entire Group in the management of regulatory projects. The Head of the Division is a member of the Bank s Management. The Risk Management Division is the central risk management function of the Group and acts as the main instrument for the development and promotion of risk management at the Group. The division's function is to instill an indepth understanding of the risks inherent in the Group's activity and to provide independent supervision of the management of the risks. The Division's authority and tasks include: assimilation of risk management culture in the entire Group, examination of policy and methodology in all areas of risk management, involvement in the compilation of tools and models for the assessment and management of risks 26

25 קובץ,eng01_finA.doc תאריך 18:19:13 24/03/2014 and positions, collation and analysis of information relating to risk management, and application of risk management processes at the Bank and the Group. The division contains the Market and Liquidity Risk Management Unit, the Credit Control Unit, the Credit Process Control Unit and Credit Risk Assessment Unit, the Compliance and AML Risk Management and Internal Enforcement Unit, the Basel Directives Management Unit, and the Subsidiaries Risk Management and Supervision Unit, and the Analytical Unit for the Validation, Application and Investigation of Models Unit. The Head of the Division is a member of the Bank s Management. Since January 1, 2013, the Operational Risk Management Unit has also been included in the division. Logistics subdivision Responsible for the Group Purchase Department, which coordinates all of the purchasing of goods and services and manages engagements with external suppliers at the group level. The Construction and Properties, the Security and the Safety Departments and the Vehicle Officer operate under this subdivision, and these also provide services to the entire Group. MATAF Computing and Financial Operation Ltd. (hereinafter: MATAF) is a whollyowned subsidiary providing computer and operational services systems to all of the Group s banks in Israel and the provident funds operated by the Bank. MATAF develops advanced technological systems and maintains the business applications at the Bank, while endeavoring to improve the effectiveness, quality and efficiency of the Group s computer services. A Methods and Banking Process Analysis Department operates within the company, and is responsible for the compilation and distribution of working procedures and circulars, and The Banking Operation Area. MATAF is also responsible for all information security matters and for combating cyber threats. Legal subdivision The Legal subdivision is responsible for the management of legal risks at the Bank in accordance with the risk management policy prescribed by the Board of Directors, and serves as the Group's head office unit in the matter of legal risk management. The subdivision's function is to detect, map and assess the legal risks in the entire range of the Bank's activities, and to prevent or minimize these risks. Internal Audit subdivision The Internal Audit subdivision is directly subordinate to the Board of Directors. The subdivision's function is to carry out current auditing of the business and administrative activities of the Bank and its subsidiaries in Israel. The head of the Internal Audit subdivision is the Bank's Chief Internal Auditor, who also serves as the Chief Internal Auditor of all the banking subsidiaries in Israel, as detailed below in the section on "Disclosure concerning the internal auditor in the corporation." The Chief Internal Auditor is a member of the Bank s Management. The head office divisions and departments that are subordinate to the CEO provide professional support for all the Bank s branches and other divisions in their areas of expertise. For example, the Corporate Division supports all the divisions in the area of credit operation and control; the Banking Division provides support in the areas of direct banking activity, such as Internet, the Beinleumi Call Center, mortgages, credit cards, marketing and collection; the Customer Assets Management Division provides professional support for services relating to borrowing activity, via private banking centers and dealing rooms specializing in foreign and Israeli securities and the deposits dealing room; and the Financial Management Division serves all the Bank's customers via foreigncurrency dealing rooms and the specialist desks working within them. As stated, following the adoption of the shared services model, most of these services are provided to all the banks in the Group. 27