ANNUAL REPORT 2011 U-BANK LTD.

Transcription

1 ANNUAL REPORT 2011 U-BANK LTD.

2 ANNUAL REPORT 2011 \ 2 Annual Report 2011 I Contents Report of the Board of Directors to the General Meeting of Shareholders 5 Management Review of the Bank s Financial Position and its Operating Results 133 Certifications of the General Manager and the Chief Accountant 153 Report of the Board of Directors and Management on Internal Control over Financial Reporting and the Report of the Auditors to the Shareholders of UBank Ltd. on Internal Control over Financial Reporting 157 Financial Statements as at December 31, This is a translation from the Hebrew and has been prepared for convenience only. In case of any discrepancy, the Hebrew will prevail.

3 3 Annual Report 2011 I Contents

4 ANNUAL REPORT 2011 \ 4 Description of the General Development of Bank s Business History of the Bank 6 Profit and Profitability 6 Developments in Balance Sheet items 8 Holdings Structure Chart 11 Principal Investee companies 12 Information about the Parent Company 12 Description of the Bank s Operating Segments 12 Dividend Distribution 13 The Banks' Rating by a Rating Agency 13 Human Capital 13 Restrictions and Supervision of the Bank s Activities 15 Material Agreements 16 Legal Proceedings 17 General Environment and Influence of External Factors on the Bank s Activity Economic Developments in Updates to Legislation relating to the Banking System in Description of the Bank s Business by Operating Segments 43 Fixed Assets and Facilities 56 Taxation 56 Additional Information Risk Management Policy 57 Accounting Policy on Critical Matters and Critical Accounting Estimates 108 Community Activities and Donations 113 Disclosure concerning the Bank's Internal Auditor 114 Procedure for Approval of the Financial Statements 116 Report on Directors with Accounting and Financial Expertise 117 Activity of the Board of Directors and Changes in Board Membership 118 Members of the Bank's Board of Directors 119 Members of the Bank's Management 121 Evaluation of Controls and Procedures concerning Disclosure in the Financial Statements 123 Details of the Amounts and Benefits paid to Recipients of the Highest Salaries in the Bank 124 Remuneration of the Auditors 129

5 5 Annual Report 2011 Report of the Board of Directors to the General Meeting of Shareholders

6 ANNUAL REPORT 2011 \ 6 At the meeting of the Board of Directors held on February 26, 2012 the Board of Directors of UBank Ltd. resolved to approve and publish the audited consolidated financial statements of the Bank and its consolidated companies for the year ended on December 31, The financial statements were prepared in accordance with the directives and guidelines of the Supervisor of Banks. Description of the General Development of the Bank s Business History of the Bank The Bank was incorporated in Israel in 1934 under the name Bank Eretz Israel le Toelet Ha ashrai Ltd. In 1965, the Bank was acquired by Baron Rothschild, who named it Israel General Bank Ltd. In 1978, the Bank s shares were issued to the public on the Tel Aviv Stock Exchange. In 1996, the Bank was acquired by the Investec World Banking Group, and in 1999, the Bank s name was changed to Investec Bank (Israel) Ltd. On December 22, 2004, ownership of the Bank was transferred to The First International Bank of Israel Ltd (hereinafter: FIBI ). Upon acquisition of the Bank by FIBI, and following the acceptance in full of a purchase offer made to the public, the Bank became a private company owned 100% by FIBI. Following the change in ownership, the Bank s name was changed to UBank Ltd. in March 2005, operating as a separate and independent bank, specializing in the personal banking and capital market segments. Profit and Profitability Net profit in 2011 amounted to 40.9 million, compared with 49.0 million in 2010, a decrease of 16.5%. Net operating profit in 2011 amounted to 39.4 million, compared with 49.0 million in 2010, a decrease of 19.6%. In 2011, a profit from extraordinary activities after tax was reported of 1.5 million see detailed information in Note 25 to the financial statements. Net profit in the fourth quarter of 2011 amounted to 6.8 million, compared with 11.0 million in the corresponding quarter last year, a decrease of 38.2%. The decrease derives mainly from a decline in operating and other income, mainly because of a decline in income from activities in various area of the capital market, which was partly offset by a rise in profit from financing activities resulting mainly from an increase in income due to the effect of fair value adjustments of derivative financial instruments. Operating profit before taxes amounted to 62.8 million in 2011, compared with 79.6 million in 2010, a decrease of 21.1%. The decrease derives mainly from a decrease of 3.1% in operating and other income ( 4.2 million), and an increase of 7.4% in operating and other expenses ( 12.8 million). which was partially offset by an increase of 2.2% in profit from financing activities ( 2.4 million) See details of the effect of the above in the analysis of income and expenses below.

7 DIRECTORS' REPORT 2011 / 7 Provision for taxes on operating profit amounted in 2011 to 23.3 million representing 37.1% of the profit before tax, compared with a provision of 29.3 million, representing 36.8% of the profit before tax in The net return on equity amounted to 9.8% compared with 9.7% in The net return on equity from ordinary operations amounted to about 9.4% compared with 9.7% in The return on equity from ordinary activities before taxes amounted to about 15.0%, compared with about 15.7% in Net profit per 1 par value of ordinary shares amounted in 2011 to 13.1, compared with 15.7 in Net operating profit per 1 par value of ordinary shares amounted in 2011 to 12.6, compared with 15.7 in Income and Expenses ( million) Change % Profit from financing activities Operating and other income (3.1) Operating and other expenses Of which: other expenses Of which: salary expenses Profit from financing activities before income in respect of credit losses amounted to million in 2011, compared with million in 2010, an increase of 2.2%. The increase derives mainly from a rise in financing income in light of the increase in total credit to the public and in the financing margin on deposits of the public, as well as a rise in income from the effect of fair value adjustments of derivative financial instruments. The increase was partially offset by a decrease in profits from activity in the Bank s trading portfolio, and a decrease in the current yield on bonds in the portfolio of Israeli securities available for sale, resulting mainly from a decline in the total portfolio and from a decrease in the realization of profits, net. In 2011, a provision was made for impairment of bonds of a nature other than temporary of 0.5 million. In 2010, there was no impairment of bonds of a nature other than temporary. Income in respect of credit losses in 2011 amounted to income in the amount of 5.0 million, compared with income in the amount of 7.2 million in The income in both years derives from a decrease in the individual provision for credit losses, due mainly to the collection of debts for which a provision was made previously. As of , the Bank applies the new directive on the measurement and disclosure of impaired debts. Regarding implementation of the directive, see Notes 1 and 4 to the financial statements. Operating and other income amounted to million in 2011, compared with million in 2010, a decrease of 3.1%. The decrease derives mainly from a decline in income from activity in various

8 ANNUAL REPORT 2011 \ 8 areas of capital market, and from a decrease in profits of the severance pay fund of the Bank, which were partially offset by an increase in commissions from foreign currency dealing room activity. In addition, a provision was included for impairment of a nature other than temporary in shares in the available for sale portfolio in 2011 of 2.7 million ( million). Operating and other expenses in 2011 amounted to million, compared with million in 2010, an increase of 7.4%. Salaries and related expenses in 2011 amounted to 75.7 million compared with 70.5 million in 2010, an increase of 7.4%, deriving mainly from the updating of salaries of the Bank s employees and losses by the severance pay fund in the current period compared with profits in the corresponding period last year. The increase was offset by a decrease in the provision for bonuses, due to the decline in profitability from 2010 to Maintenance expenses and depreciation of buildings and equipment, and amortization of intangible assets in 2011 amounted to 26.3 million, compared with 22.2 million during the corresponding period last year, an increase of 18.5%. The increase derives mainly from the updating of the lease agreement for the premises of the Bank in Tel-Aviv, the opening of new branches, and from a rise in expenses for amortizing intangible assets. Other expenses amounted to 82.6 million in 2011, compared with 79.1 million in 2010, an increase of 4.4%. The increase derives, among other things, from a rise in computer expenses and marketing and advertising that was partially offset by a decline in expenses for professional services. The percentage of cover of operating expenses by operating income was 71.5% in 2011, compared with 79.3% in The Bank s share in the results of companies included on equity basis amounted to a loss of 0.1 million in 2011, compared with a loss of 1.3 million in Developments in Balance Sheet Items Total assets at December 31, 2011 amounted to 7,506.0 million, compared with 7,629.0 million at December 31, 2010, a decrease of 1.6%. Cash and deposits with banks at December 31, 2011 amounted to 2,023.5 million, compared with 2,154.0 million at December 31, 2010, a decrease of 6.1%. Investments in securities at December 31, 2011 amounted to 2,433.9 million, compared with 2,750.8 million at December 31, 2010, a decrease of 11.5%. Investments in securities consists of: Government bonds and Makam in the amount of 2,093.5 million; Bonds of foreign banks ( Eurobonds ) in the amount of 48.7 million, spread over about 6 issuers; Bonds of Israeli financial institutions in the amount of million; Bonds of companies owned by the Israeli government in the amount of 32.3 million; Other corporate bonds in Israel and abroad in the amount of 99.4 million, spread over about 26 issuers.

9 DIRECTORS' REPORT 2011 / 9 Below is information regarding the duration and rate of the decrease of fair value of available for sale securities, below their adjusted cost, which were recognized direchy in equity and not charged in profit and loss, as at (in million): Rate of decrease Duration of decrease Up to Over 12 Total months months months months Up to 14.6% (3.6) (5.7) (1.2) (4.0) (14.5) 35% * (1.4) (1.4) (3.6) (5.7) (1.2) (5.4) (15.9) * The bank examined the need to make a provision for other-than-temporary impairment in the bond in accordance with the accounting policy on critical matters and critical accounting estimates, the Bank Management is of the opinion that there is no need to make a provision. In addition, the decrease in fair value of the available for sale bond declined, approaching the date of approval of the financial statements to 16% and in , 20% of the bond was redeemed. Below is information regarding duration and rate of decrease in the fair value of bonds available for sale, below their adjusted cost, which were recognized directly in equity and not charged to profit and loss, as at (in ): Rate of decrease Duration of decrease Up to Over 12 Total months months months months Up to 20% (1.5) (3.5) - (1.7) (6.7) 20.4% (1.7) (1.7) (1.5) (3.5) - (3.4) (8.4) The decrease in fair value of bonds as at includes: A decrease in fair value of 8.4 million of government bonds and government bonds traded abroad. The overall rate of decrease in value of government bonds is up to 20%. An amount of 2.2 million out of the decrease is for a period of up to 6 months, an amount of 5.4 million is for a period of between 6-9 months, and the remainder is for a period of over 12 months. A decrease of 0.7 million in the fair value of bonds of banks including foreign banks, rated A (see also the report on credit exposures to foreign financial institutions). The overall rate of decrease in value of bonds of banks is up to 20%. An amount of 0.1 million is for a period of 6-9 months and the remainder is for a period of over 12 months. A decrease in fair value of 6.8 million of corporate bonds. An amount of 5.4 million out of the decrease in fair value is up to 20%, and the balance is decrease of 35%. An amount of 1.4 million out of the decrease is for a period of up to 6 months, 0.2 million is for a period of 6-9 months, 1.2 million is for a period of 9-12 months, and the remainder is for a period of over 12 months. The negative capital reserve of the Bank increased from 8.4 million at to 15.9 million at The data are without the effect of a positive capital reserve and the effect of tax. The total capital reserve as at is negative in the amount of 8.5 million, including the effects mentioned above (see Note 3 Securities and the report on changes in shareholders equity).

10 ANNUAL REPORT 2011 \ 10 In an examination of the need to make a provision for impairment, in accordance with the accounting policy on critical matters and critical accounting estimates, a provision for impairment of a nature other than temporary was recorded in the Bank s books in the amount of 3.2 million (regarding the impairment, see Note 3 Securities). The examination for impairment was made in accordance with that set out in detail in the section on Accounting Policy on Critical Matters in the Directors Report and in accordance with the circular of the Supervisor of Banks from See the section dealing with Impairment of Assets in the Accounting Policy on Critical Matters. Credit to the public, net, amounted to 1,773.3 million at the end of 2011, compared with 1,751.4 million at the end of 2010, an increase of 1.3%. The average balance of credit to the public in 2011 was 1,874.2 million, compared with an average balance of 1,933.7 million in 2010, a decrease of 3.0%. Deposits of the public amounted to 5,715.1 million at the end of 2011 compared with 6,008.1 million on December 31, 2010, a decrease of 4.9%. The average balance of deposits of the public in 2011 was 5,958.1 million, compared with an average balance of 6,599.8 million in 2010, a decrease of 9.7%. Deposits from banks amounted to 34.9 million at the end of 2011, compared with 65.6 million at the end of 2010, a decrease of 46.8%. The changes in this item derive mainly from daily interbank activity. The capital of the Bank at December 31, 2011 amounted to million, compared with million at the end of The increase compared with the end of 2010 derives mainly from the net profit for 2011 in the amount of 40.9 million, which was partially offset by the implementation of the new directive on Measurement and Disclosure of Impaired Debts, which led to a decrease in capital in the amount of 20.5 million, and by a decrease in the capital reserve in respect of securities available for sale in the amount of 9.6 million. The ratio of capital to total balance sheet at the end of 2011 amounted to 5.7%, compared with 5.5% at the end of The total capital ratio at December 31, 2011, calculated in accordance with the provisional directive - Working Framework for Capital Measurement and Adequacy (Basel II), reached 19.6% compared with 18.4% at the end of The ratio of Tier 1 capital to risk assets reached 16.2% compared with 15.2% at the end of On December 22, 2010, the Board of Directors of the Bank decided on capital targets up until the completion of the SREP process by the Bank of Israel. According to this decision, the minimal overall capital ratio determined will be 15%, and the minimal Tier 1 capital ratio will be 10%.

11 DIRECTORS' REPORT 2011 / 11 Holdings Structure Chart * * Principal companies ** On May 1, 2011, the Bank sold all of its holdings in Manif Financial Services Ltd, a company included on equity basis.

12 ANNUAL REPORT 2011 \ 12 Principal Investee Companies A. "UBank Financial Assets Management Ltd." (hereinafter: the Company ) is engaged in providing investment portfolio management services for private and institutional customers. Total assets under management of the company as at December 31, 2011, is about 0.5 billion. The company ended 2011 with a profit of 0.3 million, compared with a profit of 1.0 million in B. "UBank Mutual Funds Ltd." (hereinafter: the Company ) is engaged in the management of a range of mutual funds. The company ended 2011 with a net profit of 0.2 million, compared with a profit 0.7 million in Total assets under management of the company as at December 31, 2011, is about 0.5 billion. C. "UBank Trust Company Ltd." (hereinafter: the Company ) is engaged mainly in providing trust services for mutual funds, and in addition, as a trustee for series of bonds of special purpose companies (SPC), as well as private trusteeships in a variety of areas. At December 31, 2011, the company served as trustee for mutual funds with assets totaling about 46.1 billion. The net profit of the company for 2011 amounted to 18.6 million, compared with 18.9 million in D. "UBank Underwriting & Consulting Ltd." (hereinafter: the Company ) dealt with underwriting issues and financial counseling. The company s profit amounted to 0.1 million in 2011, compared with a loss of 0.1 million in On , the board of directors of the company decided to change the status of the company to inactive, under the provisions of the Securities Regulations (Underwriting), E. "UBank Investments and Holdings Ltd." (hereinafter: the company ) is engaged mainly in renting out premises, equipment and furniture for the Bank and related companies. The loss of the company for 2011 amounted to 0.3 million (of which an operating loss in the amount of 1.8 million and a profit of 1.5 million from extraordinary activities of a company included on equity basis - Manif Financial Services Ltd), compared with a profit of 0.3 million in Information about the Parent Company The FIBI Group is one of the five largest banking groups in Israel. The Group operates in a wide range of financial activities: commercial banking, private banking, mortgages, activity in the various layers of the capital market, international financial activity, leasing financing, factoring, credit cards and various financial services. In addition to UBank, the FIBI Group owns three commercial banks in Israel - Otsar Hahayal Bank, Poaley Agudat Israel Bank and Massad Bank Ltd. - and 2 subsidiaries abroad, FIBI Bank (UK) plc in London and FIBI Bank (Switzerland) in Zurich. The Group has 176 branches and units in Israel, of which 80 branches and units of the parent company. Description of the Bank s Operating Segments The following is a short description of the operating segments of the Bank: Private Banking Segment - includes all the Bank s private customers and their businesses. These are both private customers belonging to the Personal Banking Division and also private customers in the Capital Market Division, whose principal activities are in securities. In addition, the segment includes the activity of the financial asset management company of the Bank, the mutual fund management company of the Bank, and the customers of the Bank s trust company, in the area of private and public trust services.

13 DIRECTORS' REPORT 2011 / 13 Corporate Banking Segment - includes all the institutional customers whose principal activity is in the financial area, such as groups engaged in the areas of insurance, pensions and provident funds, mutual funds, portfolio management companies, etc. These customers are allocated to the Capital Market Division. In addition, the segment includes customers of the trust company of the Bank in the area of trust services for mutual funds. Financial Segment - this segment incorporates the activities of the dealing rooms, the liquidity unit, and the Assets and Liabilities Management Department of the Bank. For detailed information, including financial analysis, see the chapter dealing with the description of the business of the Bank by operating segment. Dividend Distribution In 2011, no dividend was distributed. In December 2010, a dividend in the amount of 100 million was declared and distributed. In March 2010, a dividend in the amount of 75 million was declared and distributed. In 2009, no dividend was distributed. For further information, see Note 13A to the financial statements. The Bank's Rating by a Rating Agency The Midroog agency rated the Bank s deposits as Aa3, and the short-term deposits with a rating of P-1. Human Capital Description of the organizational structure and the number of staff employed Six managers are directly subordinate to the Bank's General Manager, as follows: The Manager of the Personal Banking Division, to whom the Bank s branches are subordinate. The average number of employees in the Personal Banking Division in 2011 amounted to 98 (in employees). The Manager of the Capital Market Division, to whom are subordinate the Israeli Securities and Foreign Securities Trading Departments, the Israeli Securities and Foreign Securities Back Office, and the banking team that provides services to the customers of the Division. The manager of the Capital Markets Division is also responsible for the following subsidiary companies: UBank Financial Assets Management Ltd., UBank Mutual Funds Ltd., and UBank Trust Company Ltd. The average number of employees in the Capital Market Division in 2011 amounted to 67 (in employees). The Manager of the Financial Division to whom the following departments are subordinate: Assets and Liabilities Management, the Liquidity Unit and the Dealing Room. The average number of employees in the Financial Division in 2011 amounted to 15 (in employees).

14 ANNUAL REPORT 2011 \ 14 The Manager of the Headquarters Division, to whom the following departments are subordinate: Human Resources and Administration, Risk Management, Regulation and Processes, the Legal Department, Planning and Marketing, and the Computerization Liaison Officer. The average number of employees in the Headquarters Division amounted in 2011 to 41 (in employees). On January 12, 2011, the appointment of the Manager of the Headquarters Division as Chief Risk Officer of the Bank was approved. As a result, on January 13, 2011, the Credit Department, headed by the manager responsible for credit in the Bank, was transferred and reports directly to the general manager of the Bank. The Risk Management function remains subordinate to the Chief Risk Officer in the Headquarters Division. The average number of employees in the Credit Department amounted in 2011 to 13 (in employees). The Manageress of the Chief Accountant s Division, to whom the following departments are subordinate: Accounting, International and Reconciliations and Bookkeeping and Payments. The average number of employees in the Chief Accountant s Division in 2011 amounted to 20 (in employees). In addition, internal audit services rely for the most part on the Group Internal Audit function. For further information, see the chapter dealing with disclosure with regard to the Internal Auditor of the Bank. Below are data on the number of employees in the Bank and its subsidiaries at the end of the year and the monthly average during the year: As at year end: Permanent Staff Other Staff* The Bank Subsidiaries Total Total Permanent Other Total Permanent Other Total Staff Staff* Staff Staff* Monthly average: * Includes hourly staff, staff from manpower agencies and outsourcing. Changes in Manpower 18% of the employees of the Bank commenced working for the Bank during Manpower turnover allows the Bank an influx of new professional personnel that suits its type of operations and the manpower requirements of the Bank. Employment Contracts All UBank employees are employed under personal employment contracts. These agreements afford the Bank maximum flexibility of employment, while providing a swift response to the needs and conditions of the market and the Banks business activity. For information on employees rights on retirement - see details in Note 12.

15 DIRECTORS' REPORT 2011 / 15 Training Raising the level of professionalism in the Bank is a result of quality and focused recruitment, as well as of a personal and organizational training program that matches the needs of the Bank, and defined in the annual work program. The training program in the Bank includes professional teaching and training in different fields of routine banking activity and the subjects of management and the development of managers. The training program is derived from various changing factors, among which are the business policy of the Bank, developments expected in the market in general, and in the banking sector in particular, regulatory changes, and others. For training purposes, the Bank uses the training function developed by the First International Bank, with courses, seminars, supplementary learning, and training. The training program provides, as a motivating factor for employees, a solution for the development of personal skills and allows for the personal development of employees in different subjects. At the same time, the Bank encourages personal and professional development by means of, among others, participating in the funding of academic studies suitable for the Bank s needs, and by assisting with vacation days during examinations. Remuneration programs for employees In accordance with the directives of the Supervisor of Banks from April 2009, the Board of Directors of the Bank discusses remuneration policy and the methodology for its implementation, with the aim of finding a balance between the desire to encourage motivation, creating identification among the managers with the long-term interests of the Bank, retaining and rewarding managers and their desire for achievement, together with the need to prevent exaggerated risk-taking. The policy relates to all Bank employees and is a part of Group policy that was put together with the participation of the parent company, in accordance with the directive of the Supervisor of Banks. In addition, the Bank strives to retain key employees and holders of key positions within the organization. Code of Ethics The Bank has a Code of Ethics that promotes ethics and social responsibility and incorporates appropriate norms of behavior among the Bank s employees and its managers. The writing of the Code of Ethics was carried out with the participation of the Banks employees. Ethics functions have been created and activities are carried out for assimilation of the Code of Ethics by every employee on an ongoing basis. Restrictions and Supervision of the Bank s Activities Proper Conduct of Banking Business Directive Restrictions on the Indebtedness of a Borrower and a Group of Borrowers, includes restrictions according to which the Bank is allowed to extend credit to a single borrower, to a group of borrowers and to the six largest borrowers. On , the Bank of Israel published an amendment to this Proper Conduct of Banking Business Directive, in which the restrictions set out in the directive were changed as of The changes comprise a number of elements: 1. Limits on a single borrower and group of borrowers - the limit of 30% of the Bank s equity was changed to 25% of the Bank s equity, or 250 million, whichever the higher. The limit on the indebtedness of the six largest borrowers (135% of the Bank s equity) was replaced with the limit that the indebtedness of all customers with indebtedness of over 10% of the

16 ANNUAL REPORT 2011 \ 16 Bank s equity, shall not exceed 135%. This percentage will decrease gradually by to 120% of the Bank s equity. 2. The inclusion of indebtedness of banks as customer indebtedness for single borrower purposes. 3. Changes occurred in the definition of indebtedness, for example futures transactions that were included in the past at the nominal value multiplied by 10%, are multiplied by the add on rate in accordance with the Capital Adequacy Directives of Basel II multiplied by Eligible deductions based partially on Basel II principles, both in recognition as eligible collateral and in changes in coefficients. The abovementioned changes result in changes in the examination for compliance with limits such as exposures to sectors of the economy and others. The changes obliged the Bank to make changes in its deployment, including among others a significant reduction in credit facilities of large customers and a reduction in exposures to banks. In Proper Conduct of Banking Business Directive Activity in the Maof Market there is a restriction, in accordance with which the total amount of the liabilities of a banking corporation vis-à-vis the Maof Clearing System (after eligible deductions) shall not exceed 30% of the Bank s equity. In light of the large volume of activity of customers of the Capital Market Division in the Maof market, the Bank checks the said restriction on a routine basis. In Proper Conduct of Banking Business Directive Supplementary Provision for Doubtful Debts, it is stipulated that a provision is to be made in respect of concentration of credit by sector. The Bank is exposed to such concentration in the financial services sector. This concentration is in accordance with the business policy of the Bank, in which the capital market customers segment is one of the principal operating segments. The Bank is meticulous in implementing the restriction. In 2010 and 2011, there were no exceptions to the concentration limit in the sectors. In addition, on the subject of the capital market reform, see details in the chapter dealing with operating segments with reference to the activity of UBank Mutual Funds Ltd. Other than the aforementioned, there are no other restrictions and supervision that are unique or apply to the Bank in the relevant years or which are expected to have a significant effect on the activities of the Bank in the future. Material Agreements a. Computer services agreement As part of FIBI Group strategy, computer services, including operational and programming services, are provided by means of a subsidiary company - Mataf. The services are provided directly by the staff of Mataf. As part of this strategy, the employees of the computer unit of the Bank became employees of Mataf in As a result, all of the Bank s computer services, including operations and programming services, are provided to the Bank by the Mataf Company. Mataf is engaged in developing advanced technology systems and maintaining the business applications of the Group and of the Bank, while striving to approve the effectiveness, quality, and efficiency of the Group s computer services. Within the company operates the Methods and Process Analysis Department, which is responsible for drawing up and distributing working procedures and circulars. In accordance with the principles of the undertaking between the Bank and Mataf, until the end of 2009, Mataf bore the costs of the process of unifying applications between the banks, and the Bank paid Mataf

17 DIRECTORS' REPORT 2011 / 17 for ongoing computer services, and bore its share in the development of regulatory and Group applications as agreed, with the addition of an agreed increase. Commencing in 2010, a model was formulated to determine current payments for computer services based on the relative share of the Bank in all computer activities carried out in the FIBI Group. b. See additional relevant information in the following Notes to the Financial Statements: With regard to agreements relating to the change of control in the Bank - see Note 17(E). With regard to the Bank s liabilities to the Maof Clearing System - see Notes 16(C)(2) and 16(C)(3). With regard to the Bank s liabilities to the Stock Exchange Clearing System - see Note 16(C)(4). With regard to the collateral agreement with Euroclear - see Note 16(C)(5). With regard to indemnification of office holders - see Note 16(C)(8). With regard to commitments between the Bank and the FIBI Group - see Note 16(C)(10). With regard to pledges - see Note 16(D). With regard to rental of buildings - see Note 16(C)(12). Legal Proceedings Set out below are details of claims against the Bank and its consolidated companies, in material amounts exceeding 1% of the Bank s equity. In the view of Management, based on legal opinions, appropriate provisions have been made in the financial statements, if necessary, to cover any damage resulting from the said actions. In the Bank s view, based on the opinion of its legal advisers (and in the view of Bank Management, based on the opinion of their legal advisers), the probability of additional risk exposure occurring to the Bank is very low, in all of the five actions specified below: 1. On July 25, 2002 an action was brought in the Tel Aviv District Court against a company which shares were traded on the Tel Aviv Stock Exchange (hereinafter: the company ), the Trust Company, Poalim Capital Markets and Investments Ltd., directors of the company, its controlling shareholders, the parent company of the company, and the accountants who audited the company s accounts. The amount of damage claimed by the plaintiff is about 32,000. Together with the action, a petition was filed in Court to recognize it as a class action on behalf of all the holders of the debentures issued by the company, in an estimated amount of some 40.8 million. In March 2011, the Court dismissed the claim against the Trust Company and against the auditors of the company (the petition against the remaining defendants was approved). The plaintiff submitted an appeal against the dismissal decisions. In the opinion of the Trust Company and its legal advisors, the Trust Company has valid claims, both against the suit being admissible to be judged as a class action, and also on the matter of the lawsuit against the Trust Company. 2. On July 27, 2003 two customers brought a claim in the Tel Aviv District Court for the award of a declaratory judgment to the effect that neither of the customers owes money to the Bank and that the pledge of shares of a company listed on the Stock Exchange that serves as collateral for both customers debts, which the Bank is seeking to realize, is invalid. The value of the dispute according to the statement of claim amounts to about 28.6 million. The claim is in the pre-trial stage. 3. On December 22, 2005 a claim was brought in the Tel Aviv District Court against UBank Trust Co. Ltd. (hereinafter: the company ) which was corrected on September 15, 2009 to an amount of some 34.6 million (as estimated at ) by three plaintiffs, which are companies related to each other. The plaintiffs held debentures for which the company served as trustee. Because of financial difficulties, the issuer of the debentures did not discharge its debts to the debenture holders. The company has submitted an amended defense plea. In the opinion of the company and its legal advisors, the company has a good defense against the lawsuit.

18 ANNUAL REPORT 2011 \ In October 2006, judgment was given by the Jerusalem District Court, according to which the counterclaim, submitted by a customer of the Bank, for a declaratory judgment that his losses in the amount of about 11.1 million resulted from the Bank s errors and negligence, was dismissed. The customer filed an appeal against the verdict in the Supreme Court. On , the Supreme Court dismissed the appeal. 5. On March 18, 2009, a claim was filed in the Tel Aviv District Court in Tel- Aviv against the Bank by a customer in the sum of 8.5 million. It was claimed that the Bank was negligent in honoring checks amounting to 5.0 million. The checks were forged by an employee of the customer, the Bank has submitted a defense plea and a third party declaration against the employee. Economic Developments in 2011 The Global Environment During the second half of 2011, the debt crisis in Europe worsened significantly, and led to a slowdown in real activity and a sharp increase of risk in global financial markets. The slowdown in Europe spread to other developed countries and to emerging countries (mainly India, China and Brazil) - which responded by undertaking an expansionary monetary policy (mainly reductions in interest rates). In the US, data for business activity improved, although the rate of growth there remained relatively low with a high burden of debt. Europe: In the second half of the year, GDP in the euro zone declined by about 0.3%, compared with a moderate positive growth of about 2% in the first half of the year. Growth forecasts were revised downwards under the concern of deepening recession. Towards the end of the second half of the year, the markets calmed down somewhat in light of the steps taken to enhance fiscal discipline in the euro zone and monetary measures to increase liquidity. At the beginning of 2012, ratings were lowered again for several European countries: France, Italy, Spain, Portugal, Greece, Austria, Malta, Slovakia and Slovenia - this downgrading may hinder the ability of these countries to raise debt, which may lead to further deterioration of the crisis. US: In the second half of the year there was a recovery in real activity in the US, which was reflected in an increase in the rate of growth compared to the first half, and a decline in the rate of unemployment. Nevertheless, despite these positive signs, it should be noted that growth relied heavily on public sector demand, and was supported also by the monetary measures of the Fed which mainly provided relief to the credit market. Emerging markets: Unlike most developed countries, emerging markets reported attractive growth figures until the fourth quarter of the year, with China leading the economies with growth rates of about 10%. However, in the fourth quarter, the global slowdown spread to the emerging markets and growth projections for them were revised downward. Economic developments in Israel Economic growth Despite moderation in the rate of growth in 2011, especially in the second half, the condition of the Israeli economy in 2011 was relatively good the level of real activity was high and most indicators pointed to a situation approaching full employment. The Israeli economy grew in 2011 at a rate of approximately 4.8%. All the components of the economy enjoyed relative expansion: exports increased by 4.5%, private consumption increased by 4.0%, investments in fixed assets grew by 14.8%, and public consumption by about 4.5%. It is important to note, as already mentioned, that the rate of growth continued to decline during the year from about 4.9% in the first quarter to an estimated level of 3% in the fourth quarter.

19 DIRECTORS' REPORT 2011 / 19 Bank of Israel forecasts of growth for 2012 were cut during the year to a forecast of 2.8% (similar to the OECD forecast). The unemployment level The level of unemployment rate dropped to a historic low and most of the indicators that support the assessment that the labor market is close to full employment. The growth of the economy in 2011 led to a rapid increase in the demand for workers. In the first nine months of 2011, employment grew by 3.3% (an increase of nearly a hundred thousand new employees). The unemployment rate fell from 6.5% at the end of 2011 to 5.5% in the second quarter, and to an estimate of some 5.4% in November. Although the Israeli economy is approaching a state of full employment, real wages in the economy rose from January-October by only about 0.3%. State Budget The budget deficit reached some 3.3%, slightly higher than the target of 3% set in the budget for In the second half there was a decrease in revenues from taxes as a result of the slowdown in activity. In 2011, the Ministry of Finance conducted an expansionary fiscal policy. Although total revenues from taxes increased by 8.1% (not far from the target of 9.2%), but most of the growth occurred by the middle of the year. Beginning in July the increase in taxes came almost to a halt, mainly due to reduced taxes on consumption from a reduction in imports of consumer goods in general, and cars in particular. Tax rebates for the whole of 2011 were lower by 2.5 billion compared with 2010 (about 0.3% of GDP). Funding the deficit of 23 billion was made by privatization revenues of 7.1 billion (mainly from the sale of land) and the net raising of funds in the domestic market of 12 billion. In addition, the Treasury took advantage of surplus funding from previous years totaling 3.8 billion. Government debt continued to decline from 76.6% of GDP in 2010 to an estimated 75% in The risk of an increase in the deficit in 2012 stems mainly from the possibility of a worsening of the slowdown in the real activity in the local economy leading to more moderate growth in tax revenues than forecast and/or the possibilities of increased defense spending against the backdrop of deterioration of the geo-political situation and the increasing expenses associated with the social protest. Inflation, monetary policy and the exchange rate The inflation rate in the Israel economy was affected by the slowdown that developed during By the second quarter, there was an acceleration in the rate of inflation from about 2.7% in December 2010 to about 4.2% in June After that, there was a consistent moderation every month to a level of 2.2% in December The core inflation rate dropped in the last months from about 3.6% in the first quarter to about 1.9% in December. The rate of increase in housing prices slowed in the second half of the year: the Housing Survey (which measures actual purchase prices according to purchase tax) indicated a cumulative decline of 1.5% in the three latest surveys of The change in the trend of housing prices stems from the raising of interest rates by the Bank of Israel, a sharp increase in construction starts, Bank of Israel restrictions on the percentage of mortgages at variable interest rates to one third of the total mortgage, and excess taxation on purchasing a second apartment. In view of the slowdown in economic growth in the second half, due to Europe slipping into recession and concerns of a more severe financial crisis and deepening of the global slowdown, the Bank of Israel, in the third quarter of the year, discontinued the trend of interest rate hikes that begin in mid From December 2010 to June 2011, the Bank of Israel raised the interest rate by 1.25%, to the level of 3.25%. The more the global environment continued to deteriorate, the more monetary policy changed to a reduction in interest rates, which led to two reductions in the last quarter of the year and a further reduction in late January The Bank of Israel interest rate at the end of January 2012 is 2.5%.

20 ANNUAL REPORT 2011 \ 20 After appreciation of some 5% in the effective exchange rate in the first half of the year, the trend reversed in the second half and a depreciation was recorded of about 4.7% against the dollar and about 4.2% against the euro. This moderate depreciation of the shekel supported the improvement in the competitiveness of the trading sector, (after erosion in 2010) without the development of inflationary pressure. The exchange rate was influenced by three main factors that gave less support to the appreciation of the shekel compared with previous years: The current account surplus disappeared in 2011; a deterioration in geo-political conditions in the area; and, in contrast, net real investments in 2011 were positive and supported the shekel. Foreign currency purchases by the Bank of Israel were halted in August 2011 after acquiring about $ 5.5 billion by July This policy was terminated as soon as conditions were created for the depreciation of the shekel. Financial markets Israel's financial markets were affected by the development of the crisis in Europe, as well as local factors, of which the main ones are a high level of political uncertainty in the Middle East. The decline in stock indices in Israel was more moderate than in Europe, but more intense than in most other countries. The stock market After a sharp rise in world capital markets in , 2011 was a year of declines in stock markets in Israel and overseas (except in the US, where the S&P index remains stable). The Israeli capital market (the TA-100 index) decreased by 20% in The MSCI index of emerging markets decreased by 20.4% compared with a decrease of only 7.6% in the MSCI index of developed countries. Local events in Israel did not support the stock market. Fear of the effects of the vote in the UN in September caused investors to reduce risks. The social protest also hit the stock markets because of the damage expected to the profitability of food companies, the media and marketing chains. The last quarter of the year was characterized by increases in share prices in Israel. The sentiment that the leaders of Europe are moving towards a process of fiscal integration and increasing involvement of the European Central Bank in providing liquidity eased the credit crunch. In addition, better than expected economic data in the US contributed to the positive atmosphere of the markets. The corporate bond market Like the stock market, the corporate bond market is sensitive to a slowdown in economic activity. The same trends that impacted the stock market in 2011 affected corporate bonds. The bond market fell by 1.8% in 2011, in particular the lower rated bonds. The Tel-Bond 20 index rose by 0.7% in 2011 compared with a 1.6% decline the Tel-Bond 40 index, with a widening of margins observed between corporate bonds and government bonds (index-linked) which rose by some 4.3% during the same period. A sharp rise in yields on bonds of a number of companies may make it harder for debt recycling in The Government bond market In 2011, the bond market responded to two major developments: the trend of the monetary policy of the Bank of Israel and the trend in stock markets (and its impact on foreign bond yields). In the first half of the year, the Bank of Israel surprised the market with rapid interest rate hikes from 2% in late 2010 to a level of 3.25% (by June). Concerns about a continued rapid rise impacted the bond market in the first months of the year. In the third quarter, changing the direction to that of reducing interest rates had a favorable effect on the bond market, and the bond market reacted with price rises in the second half of the year. The Israeli bond market was supported by long-term yields in the US, which declined mainly due to the flight from the stock market.

21 DIRECTORS' REPORT 2011 / 21 Updates in Legislation and Rulings affecting the Banking System in 2011 Legislation Joint Investment Trust Law (Amendment No. 14), 2010 This amendment became effective upon the rules coming into force on the conducting of the required tender, which were published on and came into force on , which is the effective date of coming into force of this amendment. On , an amendment was published to the law in the Official Gazette (Reshumot), which was mainly a change to section 69 of the Joint Investment Trust Law. The following are the main points: an obligation to conduct a tender was imposed on the fund manager concerning brokerage commissions with "a trading company" (member of the stock exchange); the board of directors of a fund manager is to establish a procedure for conducting a tender, which is to be approved by the trustee; entering into an engagement with a member of a foreign stock exchange can be done without a tender (under the terms of the law); the engagement of a fund manager in a brokerage agreement with a stock exchange member that controls the fund manager or fund trustee can be done without a tender subject to the following conditions: 1. Compliance by the stock exchange member with the threshold conditions set out in the tender. 2. The commission for each transaction type does not exceed the commission paid to the winner of a tender for making a similar transaction. 3. The engagement was approved by the audit committee and board of directors of the fund manager. A fund manager will not make payments out of the fund's assets to stock exchange members related to the fund manager or the trustee during the period of 12 months beginning on the date set out by the fund manager in the prospectus, for executing transactions in the fund for more than 20% of total commissions (of any kind) paid out of the fund's assets during that fiscal year. The Bank and UBank Trust Company Ltd. (a subsidiary company) completed preparations for the implementation of the legislation mentioned above. As a result of implementing the directive, the Bank anticipates a decrease in its income that will not significantly affect the Bank's ongoing operations. Regulations for conducting a tender for engagement with a trading company and conditions for engagement with a related company or an affiliated company with an affinity (hereinafter: the rules") The rules were published on and came into force on Following Amendment No. 14 of the Joint Investment Trust Law, rules were published for public comment according to which it is proposed to oblige the fund manager to carry out a tender for engagement in an agreement to receive brokerage services. It is proposed to exempt companies related to the fund manager from participation in the tender, but to limit the scope of brokerage transactions which can be paid for out of the fund's assets to related companies, so that the fund manager will be required to outsource most of the brokerage activity for which the consideration is paid out of the fund's assets to assets that are not related to him. These proceeds will be limited to 20%. A trading company related to a trustee shall be entitled to participate in the tender and in the event of its winning, it can receive proceeds up to 20% of the commissions that the fund pays per year, or alternatively to end the term of office of the trustee and serve as a trading company without restriction.