Israel Discount Bank Ltd.

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1 Primary Credit Analyst: Magar Kouyoumdjian, London (44) ; Secondary Contacts: Michal Gur Kagan, Tel Aviv (972) ; Beni Peer, Tel Aviv ; Table Of Contents Major Rating Factors Outlook Rationale Related Criteria And Research JANUARY 21,

2 SACP bb+ + Support +1 + Additional Factors 0 Anchor Business Position bbb Adequate 0 GRE Support 0 Issuer Credit Rating Capital and Earnings Moderate -1 Risk Position Moderate -1 Group Support 0 BBB-/Stable/A-3 Funding Liquidity Average Adequate 0 Sovereign Support +1 Major Rating Factors Strengths: Good home market position. Well-diversified funding base with adequate liquidity. Moderate systemic importance in the Israeli banking system. Weaknesses: Moderate capitalization and weak earnings capacity. High credit concentration risk. Limited growth opportunities. Outlook: Stable Standard & Poor's Ratings Services' stable outlook on Israel-based Israel Discount Bank Ltd. (IDB) reflects our view that the bank's business stability and risk profile will remain fairly unchanged in the next months despite potential economic turbulence including a slowdown in the Israeli economy, a correction in the residential real estate sector, and continued stress on few large domestic borrowers. Significant deterioration of the Israeli economy could impair the bank's asset quality or capitalization and trigger a negative rating action. In addition, considering the still-high credit concentration in the bank's loan portfolio continued financial stress for some of its largest borrowers could weaken the bank's asset quality and lead us to take a negative rating action. We are unlikely to take a positive rating action in the near term, but we might consider it if the bank's projected risk-adjusted capital (RAC) ratio before adjustments rose above 7% on a sustainable basis, which would improve its resilience to economic stress. We might also consider a positive rating action if economic prospects strengthened and removed our concerns over negative pressures on asset quality. JANUARY 21,

3 Rationale The ratings reflect IDB's 'bbb' anchor, as well as its "adequate" business position, "moderate" capital and earnings, "moderate" risk position, "average" funding, and "adequate" liquidity, as our criteria define these terms. We assess IDB's stand-alone credit profile (SACP) at 'bb+'. The long-term rating is one notch above the SACP, reflecting our view of the "moderate" likelihood that the State of Israel (A+/Stable/A-1) would provide extraordinary support to IDB in case of need, given its "moderate" systemic importance in Israel, which we view as "supportive" toward its banking sector. Anchor: 'bbb' for banks operating in Israel Our bank criteria use our Banking Industry Country Risk Assessment (BICRA) economic risk and industry risk scores to determine a bank's anchor, the starting point in assigning an issuer credit rating. Our anchor for a commercial bank operating in Israel is 'bbb'. While 18% of IDB's lending is outside of Israel--mainly in the U.S.--this has no impact on the anchor. The BICRA score is informed by our evaluation of economic risk; we view Israel's economic indicators as supportive of the banking sector, with adequate resilience and no major imbalances. However, the situation could deteriorate rapidly considering the high political risk in the country. We believe credit risk in the economy is still high due to significant, though reduced, borrower concentration and large exposure to real estate. In terms of industry risk, the Israeli banking sector has an adequate institutional framework and is underpinned by a high and stable share of core retail deposits. We expect stability to remain high, despite some distortion by non-bank competitors focusing on corporate lending. Table 1 Israel Discount Bank Ltd. Key Figures* --Year-ended Dec (Mil. NIS) 2013** Adjusted assets 199, , , , ,817.0 Customer loans (gross) 120, , , , ,640.0 Adjusted common equity 12, , , , ,235.0 Operating revenues 5, , , , ,003.0 Noninterest expenses 4, , , , ,441.0 Core earnings ,002.8 *Data is based on Standard & Poor's-adjusted numbers/ratios. **Data as of Sept. 30. NIS--New Israeli shekel. Business position: Good home market position, high geographical concentration Our assessment of IDB's business position as adequate reflects the bank's good home market position, as the third-largest banking group in Israel in terms of total assets. As of the third quarter of 2013, consolidated assets totaled 200 billion new Israeli shekels (NIS) (about $57 billion), representing 16% of total local banking industry assets. High geographical concentration, although lower than local peers', with 78% of credit attributed to domestic activity is partly offset by diversified business lines and a robust retail customer base, which supports business stability. As of the third quarter of 2013, retail banking revenues comprised 42% of total revenues, commercial banking including small JANUARY 21,

4 businesses comprised 33% of total revenues, and the rest was attributed to other activities including financial management. The bank's CEO, who was appointed in 2011, resigned in August 2013, and a new CEO was appointed from outside the bank. We assume that further changes in the bank's senior management are possible after the new CEO takes over in early 2014, as happened in In addition, the controlling stake holders in the bank announced at the beginning of December 2013, that they had sold 7% of the bank's shares and effectively ceased to be controlling stake holders, although they still hold 18%. According to a Bank of Israel (BOI) directive, they should sell the rest of their shares within a specified time frame. In our opinion, this shouldn't have a major effect on IDB, as the BOI has put in place a set of rules and directives regarding banks without controlling stake holders. We believe the main challenge for the bank's management still remains the need to address its capitalization and low operating efficiency, which constrain its growth and market position. The bank is currently considering its options with regard to capital constraints, and one of these is a full or partial divestment of its 100%-owned bank holding company subsidiary Discount Bancorp Inc., which had assets of $9.7 billion, or 17% of IDB's assets, as of the third quarter of We believe this sale could positively affect IDB's capital position, depending on the size of the transaction, but it would make the bank more geographically dependent on its home market. IDB is currently working on its five-year strategic plan, to be presented early in 2014, which we believe will focus on strengthening its local retail reach and increasing retail credit at the expense of corporate credit. This strategy is consistent with most local peers', so competition in the market is likely to heighten. Table 2 Israel Discount Bank Ltd. Business Position* --Year-ended Dec (%) 2013** Total revenues from business line (Mln. NIS) 6, , , , ,983.0 Commercial banking/total revenues from business line Retail banking/total revenues from business line Commercial & retail banking/total revenues from business line Return on equity *Data is based on Standard & Poor's-adjusted numbers/ratios. **Data as of Sept. 30. NIS--New Israeli shekel. Capital and earnings: Capital likely to benefit from low growth in risk assets, no dividend distribution, and possible divestment of U.S. subsidiary We assess IDB's' capital and earnings as moderate. Our RAC ratio projection before adjustments for the next months is 5.3%-5.8%, not taking into account possible effects of the U.S. subsidiary sale. This projection incorporates minor growth in risk-weighted assets and a zero dividend distribution assumption to meet increased regulatory capital demands. IDB's RAC ratio before adjustments stood at 5.1% as of Dec. 31, JANUARY 21,

5 The bank reported regulatory core tier 1 capital ratio of 9.3% as of the third quarter of 2013 in Basel II terms, or 8.9% in Basel III terms. According to a BOI directive, the bank should reach 9% core tier 1 capital in Basel III terms by Dec. 31, We assume the bank will reach the required capital level in a timely manner. We also assume IDB will not distribute dividends in to help strengthen its capitalization. The bank's last distribution was NIS250 million in Earnings capacity is weak, with the earnings buffer at about 0.15%, mainly because of low operational efficiency. We believe that fairly low operational efficiency will continue to weigh on IDB's performance in the next months. This is also a problem for the bank's local peers, although some measures have been taken to improve efficiency at IDB and in the overall industry. The bank had a cost-to-income ratio of 74% in the first nine months of 2013, similar to 2012, and higher than the local industry average of 67% in the first nine months of 2013 and 69% in The bank recorded a net profit of NIS802 million in the first nine months of 2013, or an annualized return on equity of 8.9%, compared with NIS633 million in the corresponding period in 2012, and NIS802 million in However, this improved profitability is mainly due to profits from sales of securities. We assume that credit losses will likely be under pressure in the next months, picking up from low levels and driven by the slower growth of the Israeli economy. Furthermore, we expect liquidity pressures on some of the highly leveraged big local conglomerates to continue, in light of their significant debt repayments. In addition, the continuing low interest rate environment may put further pressure on IDB's' net interest margin. Table 3 Israel Discount Bank Ltd. Capital And Earnings* --Year-ended Dec (%) 2013** Tier 1 capital ratio Adjusted common equity/total adjusted capital Net interest income/operating revenues Fee income/operating revenues Market-sensitive income/operating revenues Noninterest expenses/operating revenues Preprovision operating income/average assets Core earnings/average managed assets *Data is based on Standard & Poor's-adjusted numbers/ratios. **Data as of Sept. 30. Table 4 Israel Discount Bank Ltd. Risk-Adjusted Capital Framework Data (Mil. NIS) Exposure* Basel II RWA Average Basel II RW (%) Standard & Poor's RWA Average Standard & Poor's RW (%) Credit risk Government and central banks 54,384 1, , JANUARY 21,

6 Table 4 Israel Discount Bank Ltd. Risk-Adjusted Capital Framework Data (cont.) Institutions 20,610 3, , Corporate 105,853 81, , Retail 72,334 28, , Of which mortgage 18,809 7, , Securitization Other assets 6,645 5, , Total credit risk 260, , , Market risk Equity in the banking book 2, ,754 1,102 Trading book market risk -- 2, , Total market risk -- 2, , Insurance risk Total insurance risk Operational risk Total operational risk -- 12, , (Mil. ILS) Basel II RWA Standard & Poor's RWA % of Standard & Poor's RWA Diversification adjustments RWA before diversification 135, , Total Diversification/Concentration Adjustments -- 32, RWA after diversification 135, , (Mil. ILS) Tier 1 capital Tier 1 ratio (%) Total adjusted capital Standard & Poor's RAC ratio (%) Capital ratio Capital ratio before adjustments 12, , Capital ratio after adjustments 12, , *Exposure at default. Securitization exposure includes the securitization tranches deducted from capital in the regulatory framework. Exposure and Standard & Poor's risk-weighted assets for equity in the banking book include minority equity holdings in financial institutions. Adjustments to Tier 1 ratio are additional regulatory requirements (e.g. transitional floor or Pillar 2 add-ons). RWA--Risk-weighted assets. RW--Risk weight. RAC--Risk-adjusted capital. NIS--New Israeli shekel. Sources: Company data as of Dec. 31, 2012, Standard & Poor's. Risk position: Low growth prospects and limited changes in risk exposure; potential pressures on asset quality We assess IDB's risk position as moderate. We expect the bank's growth rates to be lower than the industry average and Israeli GDP growth of about 2%-3% in the next month, as the bank's main objective is to reach the new regulatory capital requirements at year-end Higher growth is possible in case of full or partial divestment of the U.S. subsidiary. We do not expect any significant change in the bank's risk exposure other than that relating to the possible sale of its U.S. subsidiary in the next months. In our opinion, IDB is highly exposed to the Israeli economy, but its loan profile is well-diversified by industry sector. A key risk for the bank, as well as for its domestic peers, is its highly concentrated loan book with large exposures to big JANUARY 21,

7 domestic conglomerates, which is a reflection of the concentrated Israeli economy and incorporated into our BICRA assessment. This concentration has decreased industry wide in recent years, owing to regulatory attention, although further decreases might take time considering the small size of the economy. IDB's top 20 borrower groups' exposures to adjusted total equity ratio stood at a still high level of 240% as of the first half of 2013, compared with 280% as of the first quarter of We assess IDB's exposure to holding companies and leveraged finance as higher than local peers. We believe that beneficial market conditions, including the low interest rate environment and capital markets' extensive corporate financing, contributed to IDB's' somewhat improved credit performance in the last months. We assume loan loss provisions will remain in the 0.5%-0.7% range in the near term. However, higher provisions are possible if the heavy refinancing needs of some local corporations are not fully satisfied by the banking system or capital markets. In addition, a meaningful stress event in the residential real estate market could put further pressure on the bank's, and the whole system's, asset quality. However, this scenario is not our base case for the near future. As of September 2013, the bank's nonperforming loans (NPLs) to total customer loans ratio was 4.2%, compared with 5.1% in December 2012 and a 2.9% average among the five biggest local banks. We believe this is mainly due to IDB's history of real estate and construction lending. IDB's new loan loss provisions to total customer loans ratio in recent years was higher than local peers', at 0.5% in the first nine months of 2013, and an average of 0.63% in , compared with the industry average of 0.4%. We consider the bank's coverage ratio--loan loss reserves as a share of NPLs--of 43% as of the third quarter of 2013 to be low compared with an average of 52% among the five biggest local banks. This might indicate higher credit losses in the future, but also a possible overestimation of capital and earnings. Table 5 Israel Discount Bank Ltd. Risk Position* --Year-ended Dec (%) 2013** Growth in customer loans (0.9) 1.2 (5.1) 3.1 (1.1) Total diversification adjustment / S&P RWA before diversification N.M. N.M. N.M N.M. Total managed assets/adjusted common equity (x) New loan loss provisions/average customer loans Net charge-offs/average customer loans Gross nonperforming assets/customer loans + other real estate owned Loan loss reserves/gross nonperforming assets *Data is based on Standard & Poor's-adjusted numbers/ratios. **Data as of Sept. 30. N.M.--Not meaningful. Funding and liquidity: Well-diversified funding base supporting adequate liquidity IDB's funding is average and its liquidity adequate, in our opinion, in line with local peers. We assume IDB's funding and liquidity measures will continue to be in line with peers' in the near future. JANUARY 21,

8 The bank's' funding base is well diversified, and as of September 2013 mainly relied on public deposits, which comprise 81% of total liabilities, and subordinated notes issued in local capital market, comprising 6% of total liabilities. Public deposits are comprised of retail depositors (67%) and corporate and small and midsize enterprise depositors (33%). Analyzing IDB's funding ratios as of September 2013 indicates that the loan-to-deposit ratio is about 77%, in line with 2012, compared with a range of 77%-101% for the local industry. IDB's long-term funding ratio was 95%, compared with the industry average of 98%, and its short-term wholesale funding-to-funding-base ratio was 5% compared with the 2.5% industry average. The bank's stable funding ratio was 121%, close to the industry average of 119%. Liquidity is adequate with cash and deposits at banks representing 11% of total assets and 15% of public deposits. Cash and deposits at banks together with Israel government bonds represent 27% of total liabilities and 33% of public deposits- higher than local peers' averages. As of September 2013, broad liquid assets to short term wholesale funding was 6x, and net broad liquid assets to short term customer deposits stood at 36%, compared with the 33% industry average. Short-term wholesale funding to total wholesale funding ratio is less relevant as the bank mainly relies on public deposits. Table 6 Israel Discount Bank Ltd. Funding And Liquidity* --Year-ended Dec (%) 2013** Core deposits/funding base Customer loans (net)/customer deposits Long term funding ratio Stable funding ratio N/A N/A Short-term wholesale funding/funding base Broad liquid assets/short-term wholesale funding (x) N/A N/A Net broad liquid assets/short-term customer deposits N/A N/A Short-term wholesale funding/total wholesale funding *Data is based on Standard & Poor's-adjusted numbers/ratios. **Data as of Sept. 30. N/A--Not applicable. Support: One notch of uplift above the SACP for potential government support The long-term rating on IDB is one notch higher than the SACP, reflecting its moderate systemic importance in Israel, which we classify as supportive to its banking sector. Consequently, we consider the likelihood of extraordinary government support to IDB, if needed, to be moderate. Additional rating factors: None No additional factors affect this rating. Related Criteria And Research Group Rating Methodology, Nov. 19, 2013 Banking Industry Country Risk Assessment: Israel, Dec. 5, 2012 Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, JANUARY 21,

9 Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011 Bank Capital Methodology And Assumptions, Dec. 6, 2010 Anchor Matrix Industry Risk Economic Risk a a a- bbb+ bbb+ bbb a a- a- bbb+ bbb bbb bbb a- a- bbb+ bbb+ bbb bbb- bbb- bb bbb+ bbb+ bbb+ bbb bbb bbb- bb+ bb bb - 5 bbb+ bbb bbb bbb bbb- bbb- bb+ bb bb- b+ 6 bbb bbb bbb- bbb- bbb- bb+ bb bb bb- b+ 7 - bbb- bbb- bb+ bb+ bb bb bb- b+ b bb+ bb bb bb bb- bb- b+ b bb bb- bb- b+ b+ b+ b b+ b+ b+ b b b- Ratings Detail (As Of January 21, 2014) Israel Discount Bank Ltd. Counterparty Credit Rating Counterparty Credit Ratings History 15-Dec Apr Feb-2008 Sovereign Rating Israel (State of) Related Entities Discount Bank Latin America S.A. Issuer Credit Rating Uruguay National Scale BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Negative/A-3 BBB/Stable/A-2 A+/Stable/A-1 BB/Stable/B uyaa/stable/-- *Unless otherwise noted, all ratings in this report are global scale ratings. Standard & Poor's credit ratings on the global scale are comparable across countries. Standard & Poor's credit ratings on a national scale are relative to obligors or obligations within that specific country. Additional Contact: Financial Institutions Ratings Europe; FIG_Europe@standardandpoors.com JANUARY 21,

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