UNION BANK OF ISRAEL LTD.
ANNUAL REPORT
2007
-1-
THE BOARD OF DIRECTORS
Mr. Zeev Abeles, Chairman of the Board of Directors Mr. Yeshayahu Landau, Vice Chairman of the Board of Directors Mr. Haim Almog Mr. Michael Herzberg Mr. Uzi Vardy-Zer Mr. Yigal Landau Mr. Giora Morag Mr. Izaac Manor Mr. Nathan Sharony Ms. Miri Lent–Sharir
-2- Contents Page
Board of Directors’ Report to the Shareholders’ General Meeting 5
Management Review of Bank’s Financial Position and Results of its Operations 89
Certifications 104
Board of Directors’ and Senior Management’s Declaration of Responsibility for the Annual Report 106
Financial Statements for the Year Ended December 31, 2007 108
-3- This is a translation from the Annual Report for 2007 in Hebrew, and has been prepared for convenience only. In case of any discrepancy, the Hebrew version will prevail.
-4-
BOARD OF DIRECTORS' REPORT TO THE SHAREHOLDERS' GENERAL MEETING
Table of Contents Page
Forward-looking Information 6 Economic Developments 6 Activity of the Bank and Description of Business Developments 9 Profit and Profitability 11 Developments in Balance-Sheet Items 14 Objectives and Business Policy 19 Controlling Interests in the Bank 20 Investments in the Bank’s Capital and Transactions in its Shares 20 Dividend Distribution 21 Material Agreements 22 Legal Proceedings 26 Fixed Assets and Facilities 27 Activity of Principal Investee Companies 27 Human Capital 28 Description of Taxation Status 29 Description of the Bank’s Business by Activity Segments 29 Risk Exposure and Management 48 Capital Adequacy 60 Critical Accounting Policies and Estimates 62 Legislative Developments 67 Community Involvement and Donations 72 Disclosure Regarding the Internal Auditor 72 The Board of Directors 75 Members of Management and Senior Officials 81 Controls and Procedures 84 Details of Payments and Benefits to Recipients of High Salaries at the Bank 86 Remuneration of Auditors 87
-5- Board of Directors’ Report to the Shareholders' General Meeting
At the meeting of the Board of Directors of the Bank held on February 27, 2008, it was resolved to approve the financial statements of the Bank and its subsidiaries as at December 31, 2007. The financial statements are prepared in accordance with directives issued by the Supervisor of Banks.
Forward-looking information
Part of information presented in the report of the board of directors, which does not relate to historical facts, constitutes forward-looking information as defined in the Securities Law - 1968. The actual results of the Bank may be significantly different from those that were included in the forward-looking information, as a result of a number of factors. These factors include, but are not limited to, changes in legislation and the provisions of supervisory agencies, macro-economic developments, extraordinary economic events, such as drastic changes in interest, exchange, and inflation rates, the behavior of competitors and specific changes to be detailed below.
Forward-looking information is characterized by words or expressions such as: "expectation", "should", "forecaste", "in the opinion of the Bank", "the Bank intends", "plan", and similar expressions such as: "may", "will be".
These forward-looking expressions involve risks and uncertainty since they are based on management assessment of future events which include, among other things, the impact of legislative and regulatory changes such as the converting of the Bank into an advisor, marketer, and distributor of mutual trust, provident, and pension funds, the Credit Information Law and the easing of restrictions regarding the transition of customers from one bank to another.
The information presented below relies on, among other things, future forecasts regarding matters pertaining to economic developments in Israel and abroad and on the work plans and budgets of the Bank for 2008. The Bank makes no commitment to publish an update to the forward-looking information included in these reports, including in respect of the effect on such information of circumstances and events that may occur after the publication of the reports.
Economic Developments
General
Figures for 2007 indicate continued growth at an impressive rate; this was the fourth consecutive year with a growth rate greater than 5%. Gross domestic product and the business product grew by 5.3% and 6.3%, respectively, in 2007. Concurrently, unemployment decreased significantly, to the lowest level since 1996. The main growth factors for economic activity were increases in private consumption and in exports. The composite index rose by 8.3%, further to a 7.5% increase in 2006, indicating continued expansion of economic activity.
The significance and scale of the subprime-market crisis in the United States began to become apparent in late 2007. The crisis affects real-estate markets in the US as well as financial markets. In early 2008, it emerged that the crisis had caused immense losses at US and European banks. As a result, international financial markets fell sharply, including the Israeli market; in some countries the declines were accompanied by a credit crunch and liquidity shortage. The Federal Reserve took significant steps to cope with the crisis and alleviate the condition of the markets, including a sharp reduction of the interest rate and an injection of resources to banks at relatively low interest rates. Congress also approved an expanded incentive plan to boost the American economy. Over time, indicators published in the US have shown the crisis escalating and spreading to other sectors, causing uncertainty in the financial and international markets. There are concerns over a possible recession in the US if the crisis persists, which would affect markets worldwide. The rate of exports to the US out of total Israeli exports was 35% in 2007 (versus 38.4% in 2006); as such, the Israeli economy’s dependence on the American economy may have an adverse effect on Israel.
As noted, the Federal Reserve interest rate was sharply reduced in three steps during the fourth quarter of 2007, to 4.25%, narrowing the spread against the Bank of Israel rate to 0.25 percentage points towards year end. In January 2008, the Federal Reserve carried out two additional rate cuts of a cumulative 1.25 percentage points, due to the growing worries over a recession in the US stemming from the subprime crisis, bringing the rate to 3%, its lowest level since June 2005. Consequently, 2008 opened with a negative interest-rate gap of 1.25 percentage points relative to the Bank of Israel rate.
-6- Developments in Economic Sectors
Business activity expanded in most sectors of the economy in 2007:
Real estate - 2007 was a good year for the real-estate industry, though not to an equal extent in all regions of Israel. The rise in demand continued in the housing market in the Jerusalem region and in Tel Aviv and the surrounding towns, contributing to an increase in prices. The luxury-home market also thrived in these cities. Most of the demand in Jerusalem and Tel Aviv originated with foreigners, whereas in peripheral regions farther from the center, as well as in Haifa, real-estate activity was low. Construction starts and completions decreased by 5.5% and 4.6% year-on-year, respectively, from January to October.
Industrial production increased by 5.3% year-on-year in January-November, a smaller increase than in the previous year. Revenues of the trade and service sectors grew by 8.9%, further to an 8.5% increase in 2006.
High-technology companies – 2007 was marked by an increase in capital-raising, particularly from foreign investors.
Tourism – 2007 was a strong year for incoming tourism in Israel. The number of incoming tourists increased by 25% compared to 2006 and was the highest since 2001. The number of tourists’ hotel stays rose by 23% year-on-year. These increases reflect the recovery in this industry following the Second Lebanon War, which ended in August 2006.
Employment and Private Consumption
The labor market remained robust, in line with the positive trends during the year. The unemployment rate in the civilian workforce trended down, reaching 6.6% in November, the lowest rate in more than a decade. In addition, the number of jobs of Israeli employees rose by 4.1% compared to the average in 2006, and average wages for employee positions increased by 2.4%. Demand for workers rose by 31% year-on-year. The positive trends in the labor market affected domestic demand, so that per-capita private consumption rose by 5.3% for the year, mainly due to an increase in consumption of durable goods. The volume of private consumers’ purchases by credit card grew by 10.5%, and total sales of retail chains grew by 6.4% year-on-year.
Foreign Trade, Exchange Rates and Capital Movements
2007 concluded with a trade deficit of USD 10.2 billion, up 34% from 2006. Most of the increase derived from imports being greater than exports, due to factors including the increase in private consumption and the effect of the global weakening of the dollar.
Imports of goods totaled USD 56.1 billion, up 18.6% from 2006. The increase was concentrated in imports of raw materials, consumer products, energy materials, and investment assets (mainly machines and equipment).
Exports of goods totaled USD 45.9 billion, an increase of 15.6% from 2006, with most of the increase accounted for by industrial exports. A sectoral breakdown shows increases of 14.7%, 12.1%, and 12.6%, respectively, in the chemicals, polished diamonds, and equipment (communications, control, medical scientific) sectors. The mixed-high technology and mixed-traditional technology industrial sectors posted 27% and 21% growth, respectively.
In the foreign-currency market, volatility in shekel exchange rates continued, especially against the dollar. The shekel strengthened significantly in the second half of the year, offsetting the slight depreciation of the first half. For the full year, the shekel appreciated by 9% against the dollar, by 7% against the pound sterling, and by 3.3% against the Japanese yen, but depreciated by 1.7% against the euro. Note that in early 2008 through mid-February, the dollar weakened by an additional 6.6%, due to the gap between the shekel and dollar interest rates, among other factors.
Concurrently, investments in Israel by non-residents totaled approximately USD 12 billion in 2007, compared with USD 26 billion in 2006. The majority of investments during the year were direct investments in the Israeli economy. Investments abroad by residents of Israel totaled approximately USD 15 billion for the year, versus USD 34 billion in 2006.
-7- Fiscal Policy
The downward trend in the government deficit continued, with the total deficit reaching NIS 0.1 billion in 2007, or 0.02% of GDP, versus a planned annual deficit of NIS 18.7 billion, or 2.9% of GDP. The decrease resulted primarily from higher revenues than planned in the original budget, but also from lower-than-expected expenditures. State tax revenues totaled NIS 186 billion, up 8.4% from 2006. The increase resulted from one-time revenues due to the completion of structural reforms in the economy, and from an increase in economic activity, despite the reduction in tax rates.
Prices and Monetary Policy
Consumer price index – The general index rose by 3.4% for the year, following almost no change in 2006 (down 0.1%) and a 2.4% increase in 2005. Towards the end of the first half, the CPI rose by 1% due to the weakening of the shekel against the dollar, among other factors. In the second half, despite the shekel’s appreciation against the dollar, the CPI rose by an additional 2.4%. The CPI increase this year was mainly influenced by the global rise in energy and food prices.
Interest rates – The Bank of Israel lowered the interest rate by one percentage point in 2007, from 5% to 4% by December. The rate was reduced during the first half, to 3.5% in June, and raised to 4% during August and September. In January 2008, the Bank of Israel raised the interest rate by an additional 0.25 points, due to concerns over an inflationary outbreak.
The Capital Market
The positive trend of the past four years prevailed in the Israeli capital market in 2007 as well. Foreign and local investors continued to provide an inflow of funds to the market. The optimistic atmosphere in the market, which was supported by the weakening of the dollar against the shekel, the interest-rate cuts during the year, and the positive economic data released, contributed to the favorable developments. Overall in 2007, the market value of securities listed on the TASE increased by 31% year-on-year.
The leading indices reached record levels. The TA-25 (Maof) index rose by 31.4%, and the TA-100 index gained 25%. On the other hand, the Tel-Tech index lost 5%. The Real Estate 15 index posted a minor increase of 1.5% (after gaining 23% in the first half of the year).
The industry index, the investment index, and the trade and services index rose by 33.9%, 31.5%, and 20.6%, respectively. The bank index rose by 6.8%, while the insurance index fell by 1.7%.
The average daily turnover in shares and convertibles reached NIS 2.1 billion in 2007, compared with NIS 1.5 billion on average in 2006.
The bond index rose by 4.03% for the year. CPI-linked bonds were up by 6% and unlinked bonds rose by 3%, while foreign-currency-linked bonds fell by 2.6%. The average daily turnover in bonds in 2007 was NIS 3.3 billion, compared with NIS 1.7 billion in 2006.
2007 was a record year in the corporate-bond market as well. Total capital raised reached NIS 78 billion, up 100% from 2006. Most of the issues were carried out in the first half of the year (NIS 50 billion).
In the exchange-traded fund market, some 150 funds were issued during the year. The value of the public’s holdings in ETFs reached NIS 23 billion. ETFs drew 18% of turnovers in equities and 10% of the turnover in non-government bonds.
As of 2008, investment houses commenced production and marketing of money-market funds with an exceptionally conservative mix, which are designed to serve as alternatives to bank deposits. The volume of deposits from the public at banks was NIS 788 billion in September 2007. In January, these funds raised approximately NIS 4 billion, concurrent with redemptions of NIS 9 million in equity funds. This product is in his earliest stages, and at this point it is difficult to estimate the extent of its impact on the activity of banks.
-8- Activity of the Bank and Description of Business Developments Union Bank of Israel Ltd. (hereinafter – the "Bank") was founded in 1951. The Bank is a banking corporation and possesses a banking license under the provisions of the Banking Law (Licensing) – 1981. The Bank was founded by the Eretz Israel Economic Company (U.S.A.) of New York and the Economic Company Ltd. of London, which in fact continued the operations of the banking division of the Eretz Israel Union which had commenced its operations in Israel already in 1922. From 1983 until May 17, 1993, control of the Bank was held by the State of Israel (through BLL Securities) and by Bank Leumi Le-Israel B.M., which purchased the shares of the Bank in 1954 and 1961. Further to the agreement to sell the controlling interest in the Bank, the controlling interest was transferred in 1993 to Shlomo Eliyahu Holdings Ltd., Yeshayahu Landau Holdings (1993) Ltd., and David Lubinski Properties (Holdings) 1993 Ltd., who are the present controlling shareholders of the Bank.
In 2000, the Bank issued 3,025,000 units on the Tel Aviv Stock Exchange. Each unit consisted of 3 ordinary shares, par value NIS 0.01 each, and 4 options, convertible into ordinary shares, par value NIS 0.01 each. For information regarding the conversion of the options into shares, see the chapter on "Investments in the Bank's Capital and Transactions in its Shares.
In February 2006, the rating agency Midroog Ltd. announced a rating of Aa3 for the deposits and subordinated notes of the Bank. In August 2007, Midroog assigned a rating of P-1 (prime1) to the Bank’s short-term deposits (short-term ratings range from P-1 to P-3, with P-1 indicating the best ability to repay short-term liabilities).
The Bank has 34 branches across Israel and it provides its customers with a variety of banking services. Based on the financial statements of the banking system as of September 30, 2007 the Bank is the sixth largest in the system. We present below details of the Bank's share in some areas in the banking system:
September 30 December 31 2007 2006
Credit to the public 2.7% 2.8% Public deposits 3.4% 3.3% Shareholders' equity 2.5% 2.8% Net income *1.2% 0.7% Net operating profit *1.5% 1.2%
* Relates to the first nine months of 2007.
The Bank's business operations focus on a number of areas:
- Financial brokerage between depositors and borrowers. This activity is reflected in the Bank's profit from financing activity and it constitutes the Bank's major source of income.
- Financial and banking services that generate commissions, in a broad variety of activities, in the fields of foreign currency, international trade, securities, information services, banking and financial consultancy and management, derivative financial instruments, etc.
- Investment of the Bank's shareholders' equity and market risk management.
The board of directors of the Bank directs Management on matters of business policy, approving the goals, objectives, resource allocations in accordance with the risk management policy and the risks to which the Bank is exposed, and the major principles for the Bank's activities, in accordance with the work plan and budget.
-9- Set below is a diagram of the Bank's investee companies as at December 31, 2007:
Union Bank
Auxiliary corporations Capital market Consolidated in the Equity-basis investees 100% holding 100% holding Bank’s reports (non-financial 100% holding corporations) (1) 20% holding
y Impact Portfolio y Igudim Ltd. y Kukerman Investments Ltd. y Union Investments and Enterprise (A..S.Y) Ltd. Management Ltd. y Union Systems Ltd. y Hanetz Ha’admonit Limited y Union Leasing Ltd. y Union Capital Markets and Partnership y Union Bank Trust Co. Ltd. Investments Ltd. y Union Issuances Ltd. y Carmel Union Mortgages and Investments Ltd. y Igudim Insurance Agency Ltd. y Livluv Insurance Agency (1993) Ltd. y Union Financial Operations Ltd. (in voluntary liquidation) y Union Finances Ltd. (formerly Union Mutual Funds (U.M.F.) Ltd.) (2) y Union Balances Ltd. (formerly Union Provident Fund Management Ltd.) (2)
(1) Held by Union Investments and Enterprise (A.S.Y.) Ltd. (2) The activity of these companies was sold in 2006. For further details, see the Review of Operations of Investee Companies in Note 5 to the Financial Statements, below. (3) For details regarding the principal investee companies of the Bank, their areas of activity, and their contribution to the profitability of the Bank, see Note 5C to the Financial Statements.
Changes in the Organizational Structure of the Bank
On June 28, 2007, the Board of Directors of the Bank approved a change in the organizational structure of the Bank, the key element of which is the establishment of the Control Division. The organizational change is consistent with regulatory objectives for the coming years and is aimed at enhancing controls while optimizing the Bank’s performance and improving its operations. The change was implemented gradually during the second half of 2007 and completed in January 2008.
The organizational change addressed the following areas: y Improvement of controls at the Bank under the designated division, along with improvement of controls within all divisions. y Focus of the divisions on core banking activities and enhancing synergies among the divisions. y Merging duplicate activities conducted at several divisions. y Centralizing activities to improve professional quality.
For further details, see the section Activity Segments.
-10- Profit and Profitability (Consolidated)
Net profit totaled NIS 126 million in 2007. After deducting profit from extraordinary transactions, after taxes, in the amount of NIS 3 million, net operating profit totaled NIS 123 million.
In 2006, net profit totaled NIS 121 million. After deducting profit from extraordinary transactions, after taxes, in the amount of NIS 42 million, which resulted from the sale of the activity of the Bank’s provident and mutual funds, net operating profit totaled NIS 79 million.
The 55.7% increase in net operating profit (from NIS 79 million in 2006 to NIS 123 million in 2007) resulted from several main factors: y An increase of 13.7% in profit from financing activity before provisions for doubtful debts. y A decrease of 2.4% in provisions for doubtful debts. y An increase of 6.8% in operating and other income. y A decrease in the provision for taxes, from 48.4% to 42.9%.
The aforesaid increase was partially offset by an increase of 5.3% in operating and other expenses.
Net return on equity reached 8.1% in 2007, versus 8.6% in 2006.
Net return of operating profit on equity reached 7.9% in 2007, versus 5.6% in 2006.
Pursuant to the Bank of Israel Public Reporting Directive published in May 2007, the capital base used to calculate return on equity was changed to an average capital base as of 2007. Returns for 2006 have also been restated in accordance with the directive, for comparison purposes.
Operating profit before taxes totaled NIS 217 million in 2007, versus NIS 153 million in 2006, an increase of 41.8%. Net return of operating profit, before taxes, on equity was 14% in 2007, versus 10.8% in 2006 (based on an average capital base, as noted above).
Developments in Income, Expenses and Provisions for Taxes
Profit from financing activities before provision for doubtful debts totaled NIS 613 million in 2007, compared with NIS 539 million in 2006, an increase of 13.7%.
The major factors that affected the Bank’s profit from financing activity were as follows:
- An increase of 18.2% in the average volume of income-bearing assets.
- An increase in the amount of NIS 23 million in other financing income, of which a total of NIS 14 million derived from growth in profit from realizations and value adjustments of bonds; a total of NIS 5 million derived from an increase in collection of interest on doubtful debts; and a total of NIS 4 million derived from an increase in collection of early-settlement fees.
- The presentation of the Bank's activity in derivative financial instruments according to their fair value generated a financing expense of NIS 2 million, compared with expense of NIS 21 million in 2006.
The provision for doubtful debts totaled NIS 80 million in 2007, compared with NIS 82 million in 2006, a decrease of 2.4%. The ratio of the provision for doubtful debts to total credit to the public was 0.46% in 2007, compared with 0.47% in 2006.
Overall credit risk of problematic borrowers amounted to NIS 651 million as at December 31, 2007 compared with NIS 1,028 million as at December 31, 2006, a decrease of 36.7%.
-11- The ratio of the balance sheet credit to the problematic borrowers to total credit to the public was 3.3% as at December 31, 2007, compared with 5.3% as at December 31, 2006.
Below is data on problematic debts in accordance with the classifications stipulated in the Supervisor of Banks’ directives (in NIS millions):(1)
December 31 2007 2006
Non- income bearing 194 213 Restructured (2) 43 59 Designated for restructuring 2 - In temporary arrears 26 35 Under special supervision (3) 315 602 Total balance-sheet credit to problematic borrowers (1) 580 909 Off-balance-sheet credit risk in respect of problematic borrowers (1),(4) 70 119 Bonds of problematic borrowers 1 - 651 1,028 Other assets in respect of derivative instruments of problematic borrowers - -
Total credit risk relating to problematic borrowers (1) 651 1,028
(1) Not including problematic debts covered by collateral, deductible for purposes of the restrictions on debts of individual borrowers or group of borrowers (Directive for Proper Banking Management No. 313).
(2) Credit restructured during the current year and credit that was restructured in prior years with a waiver of income. (Excluding credit restructured in past years without waiver of income - December 31, 2007 - NIS 51 million; December 31, 2006 - NIS 68 million).
(3) Of this amount, loans in respect of which there is a specific provision which was deducted from the indebtedness (excluding housing loans in respect of which there is a provision based on the extent arrears) – in the amount of NIS 153 million , compared with an amount of NIS 334 million at the end of 2006, and an amount of NIS 25 million of housing loans, in respect of which there is a provision based on the extent of arrears (December 31, 2006 - NIS 26 million).
(4) As calculated for purposes of the restrictions on debt of individual borrowers and group of borrowers, except in respect of guarantees given by the borrower to secure the indebtedness of a third party.
Profit from financing activities after provision for doubtful debts totaled NIS 533 million in 2007, compared with NIS 457 million in 2006, an increase of 16.6%.
Operating and other income totaled NIS 283 million in 2007, compared with NIS 265 million in 2006, an increase of 6.8%.
Operating commissions totaled NIS 236 million in 2007, compared with NIS 217 million in 2006, an increase of 8.8%. Revenues from handling fees in respect of credit and processing contracts increased by 39.1%. The Bank's income from securities activity increased by 19.2%.
Net income on investments in shares amounted in 2007 to NIS 30 million, compared with NIS 31 million in 2006. Income from a dividend from Bezeq in the amount of NIS 20 million was included in 2007, versus NIS 11 million in 2006 (for details, see Note 3). In addition, profit from the realization of non-financial investments by a consolidated company of the Bank in the amount of NIS 2 million was included in 2007, versus NIS 10 million in 2006.
Other income totaled NIS 17 million in 2007, similar to 2006. The cessation of income from mutual and provident funds whose activity was sold during the first and second quarters of 2006, led to a decrease in this item. The decrease was offset by an increase in distribution fees, among other factors.
-12- Operating and other expenses totaled NIS 599 million in 2007, compared with NIS 569 million in 2006, an increase of 5.3%.
Payroll expenses in 2007 totaled NIS 344 million, compared with NIS 329 million in 2006, an increase of 4.6%. The increase resulted from both an increase in manpower (mainly due to regulatory requirements) and an increase in provisions for various salary components.
In February 2007, the Chief Actuary of the Capital Market, Insurance, and Savings Division at the Ministry of Finance issued circulars to pension funds and insurance companies stating that pension and life-insurance reserves are to be assessed on the basis of new actuarial tables. The Bank adopted the new tables in the first quarter of 2007, and recorded payroll expenses in the amount of approximately NIS 5 million as a result. In the first quarter of 2006, an expense in the same amount was recorded due to the completion of implementation of an update of the previous actuarial tables.
For details regarding the actuarial assessment used by the Bank in connection with employee benefits, see the actuary evaluation by Mr. Dan Hershkovich attached on the MAGNA Electronic Fair Disclosure System of the Israel Securities Authority, and Note 14 to the Financial Statements.
Maintenance expenses and depreciation of buildings and equipment amounted in 2007 to NIS 95 million, compared with NIS 83 million in 2006, an increase of 14.5%. The increase resulted from an increase in maintenance expenses, due to an increase in manpower and in the number of branches, as well as from an increase in computer depreciation.
Other expenses amounted to NIS 160 million in 2007, compared with NIS 157 million in 2006, an increase of 1.9%.
The extension of the agreement for the provision of computer services by Bank Leumi led to a reduction of approximately NIS 14 million in computer expenses in 2007 (for further information regarding the agreement and the extension thereof, see the section Material Agreements). This reduction was partially offset by an increase in computer expenses, which mainly resulted from an increase in the Bank’s activity and from technological improvements.
The rate of coverage of operating and other expenses by operating and other income in 2007 was 47.2%, compared with 46.6% in 2006.
The provision for taxes in 2007 was 42.9% of pre-tax income, compared with 48.4% in 2006.
The statutory tax rate in 2007 was 38.5%, versus 40.6% in 2006. The provision for taxes in 2007 includes the effect of the implementation of the Adjustments for Inflation Law, which led to tax income in the amount of NIS 11.2 million, due to the increase in inflation, versus tax expenses of NIS 1.9 million in 2006, due to the decrease in inflation. For details, see the Legislative Developments section with regard to the legislative memorandum that proposes to rescind the Adjustments Law.
Profit from extraordinary transactions after taxes totaled NIS 3 million in 2007 (for details, see Note 28). In the previous year, this item totaled NIS 42 million and consisted of profit from the sale of the activity of the consolidated companies Union Mutual Funds and Union Provident Funds. For further details, see the section Material Agreements.
-13- Developments in Balance-Sheet Items (Consolidated)
The balance sheet of the Bank totaled NIS 31,622 million on December 31, 2007, compared with NIS 28,934 million at the end of 2006, an increase of 9.3%.
The following are developments in the main balance sheet items in NIS millions:
December 31 2007 2006 Change NIS millions NIS millions %
Total balance sheet 31,622 28,934 9.3 Securities 8,051 6,287 28.1 Credit to the public 17,503 17,270 1.3 Deposits from the public 26,713 25,340 5.4 Shareholders' equity 1,586 1,572 * 0.9
* Dividends in the amount of NIS 100 million were distributed in 2007.
The ratio of capital to risk assets amounted to 12% on December 31, 2007, compared with 11.6% at the end of 2006. The ratio of capital excluding subordinated notes to risk assets amounted to 8.2% on December 31, 2007, compared with 9% at the end of 2006. The Bank of Israel restriction stipulates a minimum capital ratio of 9%. The Bank of Israel stipulated for the Bank a minimum capital ratio, excluding subordinated notes, to risk assets of 7%. The Board of Directors directed the Management of the Bank to maintain a minimum ratio of capital to risk assets of 11% for the year 2007. For further details, see the "Capital Adequacy" section.
-14-
Rate of Inflation in Israel
(Percent)
Rate of GDP Growth
(Percent)
-15- Net Profit (NIS Million)
Net Operating Profit (NIS Million)
-16- Total Balance Sheet (NIS Billion)
Problematic Debts
(NIS Billion)
-17- Breakdown of Credit to the Public by Economic Sector (Including off-balance sheet items, percent)
REAL ESTATE
FINANCE
DIAMONDS
OTHER
Breakdown of Total Income by Segment Activity, percent
PRIVATE CUSTOMERS
CORPORATE
DIAMONDS
FINANCIAL MANAGEMEN
Of which: Of which: Capital market - 9.0% Housing loans - 5.8% Construction and Real Estate - 10.5% Private individuals-other - 31.7% Corporate-other - 25.3%
-18- Objectives and Business Policy
The Board of Directors of the Bank has approved the outline for a three-year strategic plan; implementation of the plan commenced in 2007. The plan focuses on substantially expanding the private-customer client base, through an increase in the number of customers and in revenues in this segment, with an emphasis on private-banking customers and mortgage activity; expanding in the business sector while maintaining stability in the financial sector; expanding in the construction and residential real-estate industry and maintaining leadership in the diamond sector. The Bank is preparing to attain these objectives through the organizational change carried out in the second half of 2007.
Within the expansion in the private-customer sector, the following activities will continue in 2008: y Positioning and branding of the Bank as “Your First Other Bank”
The Bank recognized that customers find it difficult to transfer from one bank to another. Accordingly, it has chosen a marketing approach of positioning itself as the customer’s “other bank.” The Bank offers competitive products and attractive services, with the aim of differentiating itself from other banks both in products and in quality of service. The strategy seeks to familiarize customers with the Bank, leading them to expand their activity and subsequently make Union Bank their primary, preferred bank. y Recruiting customers for the Bank through the following means:
- The Union Premium private-banking center, which opened in mid-2006, and an additional center to be opened in Haifa.
- New branches opened in Kiryat Motzkin and Modi’in. The Bank is considering further geographical expansion, based on locations congruent with its business policy. y Expanding the activity of existing customers, while examining risk premiums and improving revenue potential. y Expanding the activity of the direct channels as marketing arms for the Bank’s range of products, in conjunction with routine banking activity, as a complement to the geographical deployment of branches.
In addition, the following activities continue: y Continued implementation of a sales culture within the organization, with an emphasis on high levels of performance and quality. y Expansion of controls in the various areas of activity, taking into consideration the risk level inherent in each activity. y Improvement of budgetary discipline and strict adherence to operational expenditure limits. y Integration of corporate social responsibility into the Bank’s organizational culture.
Additional information regarding the objectives and business policy of each activity segment appears in the section Activity Segments.
-19- Forecasted Information
The work plan approved for 2008 is based on the assumption that the Israeli economy will continue on a positive trend, as well as on macro assumptions concerning currency exchange rates, interest rates, and inflation, among other things. Should actual conditions differ substantially from these assumptions, there will be implications for the execution of the Bank’s work plan.
The approved work plans of the Bank and the working assumptions upon which they are based refer to future activity of the Bank; as such, the information provided above in this section constitutes “forecasted information.”
Controlling interests in the Bank
The major shareholders of the Bank as of the issuance of the financial statements are as follows:
Shlomo Eliyahu Holdings Ltd. (*) 22.92% Yeshayahu Landau Holdings (1993) Ltd. (*) 19.63% David Lubinski Properties (Holdings) 1993 Ltd. and Cheroudar Properties Ltd. (*) 19.63% Eliyahu Insurance Company Ltd. 4.20% Bank Leumi Le-Israel B.M. 6.46%
(*) Constitute the controlling shareholders of the Bank, broken down equally among the members.
Investments in the Bank's Capital and Transactions in its Shares A. As part of the agreement between Shlomo Eliyahu Holdings Ltd. ("Eliyahu"), Cheroudar Properties Ltd. ("Cheroudar"), and Yeshayahu Landau Holdings (1993) Ltd. ("Landau") (hereinafter - the "Controlling Shareholders") and Bank Leumi Le-Israel B.M. (hereinafter – "Leumi"), dated November 18, 1999, Leumi was granted a Put option to force the Controlling Shareholders to purchase all of Leumi's holdings in the Bank, and Leumi granted the Controlling Shareholders a Call option to force Leumi to sell to the Controlling Shareholders the shares it holds. On November 17, 2003, Leumi partially exercised the Put option, regarding only the part of Eliyahu, for the sale of one third of its holdings in the Bank. After Eliyahu received the approval of the Supervisor of Banks on May 30, 2004 for the purchase from Leumi of 3.84% of the share capital of the Bank, on June 3, 2004, Eliyahu purchased from Leumi 1,901,206 ordinary shares of the Bank at a price of NIS 21.93 per share and a total amount of NIS 41,700,000, thereby increasing its share in the Bank to 27.7%. Bank Leumi's share in the Bank fell to 7.7%.
Concurrent with the notification of the exercise of the option, an agreement was signed between Leumi and Cheroudar and Landau (the "Extension Agreement"), whereby the Put and Call options granted in the November 18, 1999 agreement were extended to cover the rest of the shares of the Bank held by Leumi, for a period until November 17, 2010, at a price and at terms stipulated in the Extension Agreement. For details of current interests of the Bank's Controlling Shareholders, see the chapter on the controlling interests in the Bank above.
B. In April 2004, the arrangement with the holders of the Bank's option warrants (series 1) was approved, whereby the exercise period for the 12,099,996 option warrants (series 1) of the Bank was extended by another two years. The last date for the exercise of the options was May 31, 2006. In addition, the exercise price of the option warrants was reduced by 5% of the exercise price stipulated prior to the arrangement. Each option warrant may be exercised in shares at a price of NIS 19.95 per share, linked to the Consumer Price Index.
In the first five months of 2006 (up to and including the last date for exercising the option warrants), 9,393,650 options were exercised by the public for the cash equivalent of NIS 210 million. The remaining unexercised option warrants have expired. The balance of the issued and paid in capital of the Bank following the exercise of the options is 58,871,562 shares.
-20- C. In 2006, option notes were issued to the Chief General Manager of the Bank, Haim Freilichman, at a rate of 1.25% of the share capital as of March 31, 2006, to be exercised in two equal portions: the first portion during the period from the date when two years have elapsed from the issuance of the options to April 1, 2010, and the second portion from March 31, 2009 to two years from that date. For further information, see details in Note 14.A.
D. As part of meeting the requirements of the Directives for Proper Banking Management No. 311 - Minimum Capital Ratio, the Bank raises second-tier capital by issuing subordinated notes. In 2005 the Bank issued, through a wholly-controlled subsidiary company, Union Issuances Ltd. (hereinafter - "the Company"), subordinated notes with a par value of NIS 380 million. Of this, an amount of NIS 194 million par value was sold to the public in 2005. During the first quarter of 2006 additional subordinated notes were sold with a total value of NIS 36 million. At the end of April 2006, the validity of the Bank of Israel permit to include the unsold balance of the subordinated notes in the Bank's second-tier capital expired, and therefore the Bank does not intend to sell the balance of the above Series.
In January 2007, the company raised a total of NIS 200 million in subordinated notes with various terms, through a shelf prospectus. For details regarding the shelf prospectus, see the section Activity of Principal Investee Companies.
The Company raised an additional NIS 120 million in December 2007.
Total subordinated notes to be subtracted from Tier II capital during 2008 amount to approximately NIS 81 million.
In 2008, the company is expected to issue additional subordinated notes, according to the Bank’s needs in order to comply with minimum capital ratio requirements, and in reference to the objective in its work plan of maintaining an optimal capital structure. See further details in the section Capital Adequacy.
This declaration contains forward-looking information. With regard to the meaning of this term, see the section Forward-looking information.
E. On October 14, 2007, the Board of Directors of the Bank resolved to recommend that the general assembly of shareholders approve an increase of the Bank’s registered share capital, which currently stands at NIS 650,000 divided into 65,000,000 ordinary shares of NIS 0.01 par value each, by the addition of 18,000,000 ordinary shares of NIS 0.01 par value each, for a total of NIS 830,000. The addition to the registered capital of the Bank will be used in order to issue subordinated notes and/or capital notes convertible into shares by the Bank, subject to the approval of such notes by the Supervisor of Banks as Tier I capital (considered hybrid Tier I capital).
This matter was listed in the agenda of the general assembly convened on November 21, 2007. However, in light of the position of one of the controlling shareholders, the assembly resolved to postpone discussion of this matter to a later date, to be determined by the Board of Directors.
Dividend Distribution
The policy of the Bank is to declare a dividend each year, of at least 35% of the distributable profits of the Bank, subject to the provisions of the Law for permissible distribution. All dividend distributions are subject to the requirements of the Companies Law - 1999 which stipulates, among other things, that the Bank is permitted to make a distribution, as long as no reasonable fear exists that the distribution will prevent the Bank from meeting its existing commitments and its expected commitments when they come due. In addition, the Bank is required to comply with the restrictions stipulated by the Supervisor of Banks, such as: capital adequacy of not less than 9%. In addition, the Bank of Israel set for the Bank a minimum ratio of capital without the subordinated notes to risk components of 7%. The Bank must also fulfill the requirements of article 23A of the Banking Law (Licensing) - 1981, which set limits for the percentage of capital that a banking institution is permitted to invest in real entities. It also requires the Bank to comply with the limitations set by the Supervisor of Banks regarding the granting of credit as a percentage of capital, and limitations set regarding the distribution of dividends. These limitations include not -21- distributing a dividend if the non-monetary assets exceed capital or that the distribution of the dividend will cause such a situation, not distributing dividends from capital funds, or when one or more of the last three calendar years ended in a loss to the Bank. Since the Bank incurred a loss in 2003, it did not distribute a dividend until 2006.
In accordance with the permit granted in 1993 for the purchase of the controlling interest in the Bank, the Bank was prohibited from distributing a dividend from income accrued in the period prior to the purchase, without the express written consent of the Supervisor of Banks in advance. The amount of the retained earnings as of December 31, 2007 from which no dividends can be distributed is NIS 463 million.
Based on the business results for 2006, on February 28, 2007 the Board of Directors of the Bank resolved to propose a dividend in the amount of NIS 100 million. The proposal was approved by a special general assembly of shareholders on April 18, 2007. The aforesaid dividend was paid out on May 14, 2007.
Given the policy of the Bank and the position of the Bank of Israel with regard to the rate of the actual minimum capital ratio, no decision has been made at this stage with regard to additional dividend distribution. Certain declarations appearing in this section contains forward-looking information. For the significance of this term, see the section above on Forward-looking information.
Material agreements
Except for agreements made in the normal course of business, the agreements described below to which the Bank is either a party or in which it has an interest, may be considered to be material agreements not in the normal course of business.
Collective labor agreements
Labor relations at the Bank are based on labor laws, on additional collective labor agreements signed at the Bank, and on various work arrangements reached mainly through deliberations between Bank Management and representatives of the employees of the Bank.
The regular employee population at the Bank is divided up on the basis of job, as well as by applicability of labor agreements, into three categories: clerks, managers and authorized signatories, and employees who work under personal contracts.
We present below a summary of the major agreements that were signed with the representatives of the clerks, managers and authorized signatories:
-22- A. Clerks
The labor relations of clerks are based on a special collective agreement for employees of the Bank (hereinafter – the "Labor Constitution"), which is updated with ongoing salary agreements. The Labor Constitution was drawn up between the Bank and the General Workers Labor Federation in 1990. It regulates the infrastructure for labor relations with the clerks and includes such things as: the process for hiring employees, discipline at work, employee promotions, right to vacation and sick leave, various bonuses paid to employees and the terms of such payments, social benefits, the process for termination or resignation, severance pay, etc.
The Labor Constitution remains in force as long as neither of the parties announces its desire to cancel it or introduce changes therein. On August 22, 1996, a special collective agreement was signed regarding the admission of the clerks to the "Amit" pension fund, whereby the payments of the Bank to the pension fund from January 1, 1995 would replace the amounts the Bank would be required to pay the clerks by law in respect of severance pay for the same period.
On September 17, 1998, agreements were signed between the Bank and the National Committee of the Union Bank Employees Organization and between the Bank and the Organization of Managers and Authorized Signatories of the Bank, dealing with the transition to a five-day work week, commencing on November 1, 1998.
The New General Labor Federation and the Clerks Labor Federation/Bank Workers Division are parties to all of the agreements.
In addition to the above, timely agreements are also made to deal with updates to salaries and related benefits of the various levels of clerks, as well as other matters that have to be dealt with.
On September 10, 2007, a special collective agreement concerning labor terms for probationary employees was signed between the Bank, on one hand, and the New General Labor Federation and the national union of employees of the Bank, on the other hand. Under the agreement, various payments paid to new probationary employees as supplements to their wages were reduced. In addition, the trial period for probationary employees in certain positions was extended.
B. Managers and authorized signatories
Labor relations with managers and authorized signatories are regulated by a special collective agreement that was signed in 1979. The salary terms of this group were pegged to the salary terms of the managers and authorized signatories in Leumi. The agreement also grants members of this group the option of electing between receiving severance pay and the savings accumulated in a provident fund, or receiving a pension from the Bank. Such option is granted only to managers and authorized signatories who have reached retirement age and have worked at the Bank for at least 15 years (or in the event of disability or death if they have 5 years of employment).
In accordance with a special collective agreement dated February 24, 1997, the social insurance of the managers and authorized signatories of the Bank was transferred to the "Amit" pension fund, similar to the arrangement with the clerks mentioned above. This agreement treats the pension rights of the veteran managers and authorized signatories in accordance with Leumi and with the "Amit" pension fund. Newer members of this group have their pension rights only with "Amit". The agreement also stipulates that payments to "Amit" in respect of newer managers and authorized signatories replace the entire severance pay of those employees. In addition to the above, there are also local agreements made to handle specific matters that arise.
-23- C. Employees under personal contracts
All members of management and some other employees have personal employment contracts with the Bank.
Agreement to receive computer services from Bank Leumi Le-Israel B.M. (hereinafter – "Leumi")
On September 29, 2001, an operating and computer agreement was signed with Leumi for a period of 11 years, commencing in 1998, whereby Leumi provides operating services to the Bank, in respect of the banking infrastructure systems. In addition, the Bank is entitled to receive most of the information systems in operation at Leumi, most of which have been installed at the Bank (hereinafter: - "the Agreement").
The services that Leumi undertook to provide to the Bank through its Operation and Administrative Network (hereinafter: "OAN") or any other entity that replaces the OAN are based on computer services that OAN renders to its customers, plus other services detailed in the agreement. Leumi also provides the Bank with ongoing and full support and maintenance services and training services in connection with the systems that are used in providing the operating services. Operating, maintenance and system development services are provided by Leumi at the same level as the services granted to units and branches of Leumi.
Leumi undertakes in the agreement to provide the Bank with operating information relating to the systems, to maintain a level of data security regarding the Bank's data and, subject to receiving a special fee, to prepare the infrastructure for the conversion of systems and the migration of the systems to independent computer systems should the Bank decide to implement such systems. In addition, Leumi undertook by agreement to preserve the confidentiality of the Bank's data. The Bank's database is independent of the database of Leumi.
As the end date of its computer-services contract with Leumi approached, the Bank conducted a process of examination, analysis, and assessment of alternatives for its future computerized systems. At the conclusion of this process, on December 31, 2007, the Bank and Leumi signed an addendum to the agreement in which the term of the agreement was extended for ten years, starting January 1, 2007; the terms of the agreement were improved on the monetary level, via a decrease in the cost of routine services and the reduction of uncertainty related to uncontrolled increases in the cost of services in the future, as well as on the service-quality level, by the signing of a service-level agreement (SLA). Pursuant to the addendum to the agreement, the annual price of routine services is set at NIS 37-40 million in the first two years, rising gradually to NIS 42-45 million starting in the sixth year, according to the range of services to which the Bank is entitled under the agreement. These sums are linked to the consumer price index of December 2006, and may change in accordance with changes in the volume of activity of the Bank.
The addendum to the agreement covers systems that have not yet been transferred to the Bank’s use, and which can assist the Bank in complying with various regulatory requirements, among other things.
The Bank of Israel has approved the extension of the agreement; the approval is contingent upon various conditions, which are met by the Bank. The Antitrust Commissioner has granted an exemption from a restrictive arrangement permit, valid for seven years.
The direct monetary effect of the addendum to the agreement for 2007 is a decrease of NIS 14 million in current computer expenses for computer and operational services in 2007.
Indemnification of directors and senior officers
A. Commitment to indemnify senior officers of the Bank
On December 29, 2005, the general shareholders meeting of the Bank resolved to have the Bank grant a writ of indemnification to its senior officers and those of its subsidiaries, in respect of any monetary indebtedness that would be placed on any of the officers and in respect of reasonable litigation costs, in connection with a list of events that was attached to the writ. The maximum aggregate amount of indemnification for all senior officers will not exceed USD 35 million. The indemnification is contingent upon the fulfillment of conditions detailed in the writ. B. On February 8, 2000, an extraordinary shareholders meeting of the Bank resolved to grant the senior officers and directors of the Bank (hereinafter – the "Senior Officers"), severally, subject to the provisions of any law, a commitment in advance for indemnification in respect of monetary indebtedness to be placed on them -24- in favor of another person, as a result of a court decision, including court decisions rendered as part of a compromise or decision of an arbitrator approved by the court, and in respect of all reasonable litigation costs including attorney fees, that the senior officer incurred in connection with or as a result of one or more of the following matters and in all related matters, directly or indirectly:
1. A prospectus, offering securities of the Bank to the public and to employees of the Bank, under the prospectus that was issued in 2000 and any correction thereto, if any is made, and any draft prospectus offering securities that was submitted to the Israeli Securities Authority in 2000 (hereinafter – the "Prospectus").
2. Failure to make legally required disclosures in reports issued by the Bank after the date of the Prospectus regarding any matter that occurred prior to the date of the Prospectus, or in reports issued by the Bank after the date of the Prospectus in respect of any matter that occurred after the date of the Prospectus, and is related to the Prospectus directly or indirectly, under conditions and in amounts detailed in the writ of indemnification.
For more information, see Note 17.C(12) to the financial statements.
The sale of the operations of Union Provident Funds Management
On January 24, 2006 an agreement was signed for the sale of all of the operations of the provident funds that operate under Union Provident Funds Management, to Ayalon Provident Fund Management Company Ltd., a company under the control of Ayalon Insurance Company Ltd. (hereinafter – "Ayalon"). The transaction was consummated on June 28, 2006 after the fulfillment of all the conditions pending for its consummation. As part of the sale, the goodwill of the funds and of Union Provident Funds Management were transferred to Ayalon, and all of the rights and obligations of Union Provident Funds Management in connection with the funds, and all matters related to them and to their management, were assigned to Ayalon (including the right to receive management fees), commencing on the date the transaction was consummated, for which Union Provident Funds Management was paid the amount of NIS 29 million.
The Bank and Union Provident Funds Management undertook to indemnify Ayalon for any damage, loss or expense that Ayalon may incur in respect of the following events: a breach of representations, liabilities that were not recorded in the financial statements of the purchased funds, and claims to be filed against Ayalon in connection with the purchased funds, which are based in facts that existed prior to the date of the consummation of the transaction.
After consummation of the transaction, Ayalon undertook that it would do its best to have all of the purchases and sales of securities to be made by the funds, made through the Bank. For its part, the Bank undertook that for the five- year period subsequent to the consummation of the transaction, it would not transfer the employer funds under its control to any other provident fund, as long as the yield to be achieved by the severance pay fund is not less than the average of the severance pay funds during the same period. In the second quarter of 2006, the Bank recorded a profit of NIS 21 million from the sale under "After-tax income (loss) from extraordinary activities".
-25- The sale of the operations of Union Mutual Funds
On February 1, 2006 Union Mutual Funds Ltd. (hereinafter – "UMF") and the Bank signed an agreement for the sale of all of the Mutual Fund activity managed by UMF to Menorah Mutual Funds Ltd. (hereinafter – "Menorah"), a company controlled by Menorah Insurance Company Ltd. As part of the sale of the activity, the goodwill of the funds and all of the rights and obligations of UMF in connection with the sold funds were sold.
In accordance with the agreement, at the end of the five-year period subsequent to the consummation of the transaction, the consideration will be adjusted such that if the commissions in respect of distribution of the funds during the period are higher or lower than the distribution commissions that were known at the date the transaction was signed, an accounting will be made between the parties based on a mechanism stipulated between them in the agreement.
The Bank undertook not to compete with Menorah in the area of mutual fund management for a five-year period following the transaction, and undertook not to make further use of the name UMF. It also undertook not to make use of the name Union in connection with fund management for a five-year period.
Menorah engaged the Bank in a distribution agreement for a five-year period, in connection with the funds it manages, as well as an agreement to provide brokerage services by the Bank to the purchased funds for a period of five years.
The proceeds of the sale in the amount of NIS 34 million were received on March 30, 2006. In the first quarter of 2006, the Bank recorded a profit of NIS 21 million from the sale under "After-tax income (loss) from extraordinary activities ".
Legal Proceedings
Information concerning two legal claims against a consolidated company and one demand for payment against the Bank, which are in material amounts exceeding 1% of the Bank’s capital, is presented in the following sections.
A. Pending liabilities in connection with the consolidated company Carmel Igud Mortgages and Investments Ltd. (hereinafter - the “Company”):
1. On November 2, 1997, a claim statement was filed with the District Court of Tel Aviv against the Company and three other mortgage banks, in a total amount of approximately NIS 500 million. A petition to certify the claim as a class action was also filed. The claim concerns fees in respect of life and property insurance. For further details, see Note 17(C)(13)(b)(1) to the financial statements and the opinion statement of the auditors.
2. On July 6, 2003, a claim and a petition to certify the claim as a class action were filed by three plaintiffs with the District Court of Tel Aviv-Jaffa against the Company and against three other mortgage banks and the Customs and Stamp Duty Administration at the Ministry of Finance, in a total amount of NIS 300 million. The claim concerns the collection of stamp fees in respect of loans. In the opinion of the Bank’s management, based on assessments by the Company’s legal advisors, the chances of success of the legal claim, including all components, are remote. For further details, see Note 17(C)(13)(b)(2) to the financial statements.
B. Near the date of the financial statements, a demand for payment was submitted to the Bank for a total amount of USD 10 million, in connection with capital-market activity of a holder of power of attorney in an account. In view of the lack of details in the demand, the preliminary state of the examination of the demand, and the brief time elapsed since the demand was submitted, in the opinion of the Bank’s management, based on the opinion of its legal advisors, it is not yet possible to evaluate the probability of materialization of exposure to risk in respect of this demand.
-26- Fixed assets and facilities
The depreciated cost of buildings and equipment as of December 31, 2007 amounted to NIS 327 million, compared with NIS 328 million at the end of 2006. For information pertaining to the composition of the investment in buildings and equipment, see Note 6 to the financial statements. The Bank's business operates at different locations, some of which are owned by the Bank and some of which are leased. The Bank's real estate locations are operated through Igudim Ltd. (a wholly-owned subsidiary whose financial statements are consolidated with those of the Bank). The Bank implements Accounting Standard No. 15 of the Israeli Accounting Standards Board, which regulates the treatment of decline in asset value. For information on the provision for decline in value of the Bank's assets, see Note 28 to the financial statements.
Activity of Principal Investee Companies
The Bank’s principal investee companies are:
Union Investments and Enterprise Ltd. (A.S.Y.) – The Company serves as the Bank’s non-financial investment arm.
Union Capital Markets and Investments Ltd. - The Company manages and underwrites issues in the capital market.
Impact Portfolios Management Ltd. - The Company engages in investment portfolio consulting and management of customers.
Union Bank Trust Company Ltd. - The Company provides trust services for mutual funds, for the holders of securities issued and traded on the stock exchange and for private issues, and also provides private trust services.
Union Leasing Ltd. – The Company deals with leasing finance of vehicles and equipment. The balance of finance granted to the company’s customers as at the end of 2007 totaled NIS 332 million, compared with NIS 274 million at the end of 2006, an increase of 21.2%.
Union Issuances Ltd. - The company was established in order to issue subordinated notes and invest the proceeds of the issues at the Bank. On January 7, 2007, the company published a shelf prospectus for the issuance of a series of certificates of deposit and subordinated notes.
In 2007, the company carried out the following offerings through the aforesaid shelf prospectus:
- Subordinated notes in the amount of NIS 200 million were raised in January 2007.
- Certificates of deposit in the amount of NIS 250 million were raised in March 2007.
- Subordinated notes in the amount of NIS 120 million were raised in December 2007.
Union Finances (formerly Union Mutual Funds (U.M.F.)) and Union Balances (formerly Union Provident Fund Management) - The activity of these companies was sold in 2006. For further details regarding the sale, see the section Material Agreements, above, and Notes 5D and 5E to the Financial Statements.
The Bank's return on its investments in the principal investee companies in 2007 was 7%, compared with 31% in 2006.
For more details regarding principal investee companies, see Note 5 to the financial statements.
-27- HUMAN CAPITAL
At the end of 2007, total manpower at the Bank and its subsidiaries stood at 1,123 employees, compared with 1,084 employees at the end of 2006, with the following breakdown:
December 31 2007 2006 Executives 191 196 Permanent clerks 513 510 Temporary clerks 313 293 External employees and employees under personal contracts 106 85 1,123 1,084
The following are details with regard to the development of total manpower: December 31 2007 2006 Employees Positions Employees Positions The Bank 1,085 1,081 1,048 1,044 Consolidated companies 38 36 36 35 1,123 1,117 1,084 1,079 Annual average The Bank 1,060 *1,083 1,034 *1,055 Consolidated companies 37 *37 39 *39 1,097 1,120 1,073 1,094 * Including overtime.
Most of the increase in manpower occurred in the last quarter of 2007, and resulted primarily from the need to comply with regulatory requirements.
Labor relations and employee wages are regularized in collective labor agreements with the Histadrut General Federation of Labor and the unions of Bank employees: the executives’ union and the clerks’ union.
Wages of employees of the Bank are subject to labor agreements and are based on the Bank’s profitability (a three-year agreement ended in 2007, and a new agreement is due to be signed).
Special emphasis is placed on employee training and on development of human resources at the various levels. Almost all training and professional instruction is carried out at the Bank’s training center or in the workplace, and provided through the Bank’s professional staff. The team of internal instructors and content experts is composed of some 60 instructors who are employees and executives at the Bank.
Training and instruction in the areas of management, sales, executive development and organizational culture are provided by external instructors and organizational consultants. Training expenses totaled NIS 1.8 million in 2007, similar to 2006. Training focused on the following main subjects in 2007: development and training of management reserves; intake and implementation of information systems; financial advising, pension advising, and the capital market; and various regulatory subjects.
-28- An old declaration of a labor dispute, from early 2006, concerns demands by employees in the event of a change in the shareholders of the Bank.
Near the date of publication of the financial statements, an amendment to the Supervision of Financial Services (Provident Funds) Law was published; it is too early to assess the implications of the amendment. See details in the section Legislative Developments.
Description of the tax situation
1. According to the Income Tax Ordinance a gradual reduction has been decided for corporate tax rates. In 2006, the tax rate was 31%, in 2007 the tax rate was 29%, in 2008 the tax rate will be 27%, in 2009 – 26%, and in 2010 and thereafter, the tax rate will be 25%.
In addition, the Bank's provision for income taxes includes profit tax in accordance with the Value Added Tax law that taxes income. On June 27, 2006 a Value Added Tax Order was published in the Gazette, following which the rate of salaries tax and profit tax applicable to financial institutions were reduced from 17% to 15.5%. In view of the above, the statutory tax rate applicable to the Bank in 2006 is 40.6%, in 2007 – 38.5%, 2008 – 36.8%, 2009 – 35.9%, and in 2010 and thereafter – 35.1%.
2. The Bank has final tax assessments up to and including the tax year 2003. Its consolidated companies have final tax assessments up to and including the tax year 2002, with the exception of two consolidated companies, of which one has final tax assessments up to the tax year 2003, and the other has final tax assessments up to the tax year 2006. For further details, see Note 27 to the financial statements.
3. The Bank has the status of a Qualified Intermediary (Q.I.) as defined in the rules of the income tax authorities in the U.S.A. The significance of this status is that the Bank has entered into an agreement with the tax authorities in the U.S.A. by which the Bank will withhold tax with regard to U.S. securities activity of its customers who are not U.S. residents.
4. For additional information regarding the Bank's policy for recording taxes and the provision for taxes, see Notes 1(P) and 27 to the financial statements.
The Bank's Business by Activity Segments
The breakdown of activity into different segments assists Bank Management in making decisions and analyzing the results of the Bank's operations. Characterization of the segments is based mainly on the types of customers included in each segment. The results of operations of the segments were prepared in accordance with the directives of the Supervisor of Banks regarding “Principal Segments of Activity.” The accounting principles implemented in the presentation of this data are described in Note 29 to the financial statements.
During the second half of 2007, the Bank’s organizational structure was changed with the aim of improving controls at the Bank, focusing activities, and creating synergy in the operation of the divisions. For details, see the section Activity of the Bank and Description of Business Developments.
The Bank’s activity focuses on the activity segments listed below:
Private customers - The Bank provides banking services and financial products to households and people who are financially secure, including investment consulting services. In addition, the segment provides services to business checking account customers with frameworks of up to NIS 400,000. This segment includes also the housing financing segment.
-29- Business customers segment - This segment provides a range of banking services and financial products to business customers, whose main business is the receipt of credit, from large companies to business customers having an obligo over NIS 400,000.
Diamond Segment - The segment consists of customers operating in the diamond industry, most of whom are members of the Diamond Exchange in Ramat Gan.
Financial Management Segment - Includes the Bank’s activity on its own behalf in securities, asset and liability management, market and liquidity risk management, the activity of the Bank’s dealing rooms, and the activity of the consolidated company Union Investments and Enterprises (U.I.E.), which serves as the non-financial investment arm of the Bank.
Others and adjustments – This segment includes adjustments to inter-segmental transactions and activities which cannot be classified to any specific segment.
The following are the main rules applied in the division of results of operations among the different segments:
Profit from financing activity – In segments in which activity focuses on customers, this item includes a financial spread on customers’ loans/deposits. The spread is generally calculated against a transitional price representing the cost of resources, according to duration and in reference to the relevant type of linkage. This item also includes risk- free interest on weighted capital calculated for the purpose of the return on equity attributed to the segment. Shareholders’ equity is attributed based on the risk assets assigned to each segment.
Operating and other income – This relates to the segment to which the customer is classified.
Provision for doubtful debts – The provision for doubtful debts is charged to the segment to which the customer against whose debt the provision was recorded is classified
Operating and other expenses – Direct expenses are classified to a specific segment. The rest of the expenses are classified on the basis of various parameters and estimates.
Taxes on income - The provision for taxes on the business results of each activity segment is calculated according to the effective rate of tax, as a rule, with the exception of certain cases in which specific attributions can be made.
Rate of return on capital – This comprises the ratio between the net income of each segment and the shareholders' equity that is allocated to each segment. Shareholders' equity that is allocated to each segment is the average balances of risk components in each segment, multiplied by the ratio of first-tier capital to total capital.
The following is a summary of developments in net profit and total assets, by activity segment:
A. Net operating profit (loss)
For the year ended December 31 2007 *2006 NIS millions
Private customers 21 13 Corporate 78 51 Diamonds (4) 10 Financial management 28 9 Others and Adjustments - (4)
Total 123 79
* Reclassified.
-30- Net Profit (Loss) For the year ended December 31 2007 *2006 NIS millions Private Customers 23 **47 Corporate 79 **58 Diamonds (4) 10 Financial Management 29 10 Others and Adjustments (4) (1)
Total 126 121 * Reclassified. ** Includes profits from the sale of mutual and provident funds.
B. Total Assets (Average Balance) For the year ended December 31 2007 2006 NIS millions
Private Customers 4,713 4,058 Corporate 12,152 10,815 Diamonds 2,370 2,372 Financial Management and Other 8,187 12,010 31,245 25,432
Private Customer Segment
Segment Structure
The segment provides services to all private customers: retail and private banking, business current-account customers with total indebtedness of up to NIS 400,000, housing-finance activity and capital-market activity.
The Private Customer Segment is under the management of the Retail Banking, Client Asset, and Advisory Division. The division was reorganized in 2007 in order to centralize the entire range of activities related to private customers and achieve synergies among such activities, while tightening controls. As part of the change, all advisory activities at the Bank were transferred to the division, including pension advising, as well as the Analyst Unit. In addition, Impact Ltd., the Bank’s portfolio-management company, was brought under the responsibility of the head of the division.
Services are provided to customers of the segment through the branches of the Bank, in the Union Premium Private Banking Center, as well as through direct banking channels: the Internet and the Bank's call center – Union Direct. The major products of the segment include ongoing account management, investment consultancy, pension consultancy, securities investments, deposits, structured products, credit cards and consumer credit. The segment includes the granting of loans for the purchase, leasing, expansion, renovation or construction of residential housing, and the granting of loans for any purpose which are secured by a mortgage on residential housing. The segment also includes the activity of subsidiaries in the areas of portfolio management and trust services.
-31- Legislative Restrictions, Supervision, Regulations, and Special Constraints Applicable to the Segment
The Bank's operations are subject to laws, regulations, and regulatory guidelines that apply to the Israeli banking system through entities such as: the Supervisor of Banks, the Commissioner of the Capital Market, Insurance and Savings, the Commissioner of Restrictive Trade Practices, the Israeli Securities Authority, etc.
Proper Conduct of Banking Business Directive No. 325 took full effect on July 1, 2007 (with the exception of transitional directives). The directive concerns the prohibition on exceptions from approved credit limits in current accounts and requires that current-account credit limits be anchored in signed agreements with customers.
The Banking Rules (Customer Service) (Fees) - 2008 will apply to the segment in the second half of 2008. These rules primarily concern a reduction of the number of fees collected from retail customers and from small businesses with turnovers of up to NIS 1 million. According to the Bank’s estimation, based on an initial assessment, this legislation is expected to have the effect of decreasing the Bank’s revenues in the second half of 2008 by an estimated total of NIS 8 million, before tax effects. For further details, see the section Legislative Developments.
Housing-finance activity is conducted in accordance with Proper Conduct of Banking Business Directive No. 451 concerning “Procedures for Extending Housing Loans.”
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
Developments in the Segment’s Markets
2007 was marked by continued growth of the economy; an additional decrease in unemployment, to a ten-year low; and an increase in average income and disposable income. The capital market experienced a substantial rise in turnovers, while stock-market indices broke records. These conditions had a favorable effect on the segment.
Technological Changes with a Potential Material Effect on the Segment
A new website for trading on the Tel Aviv Stock Exchange was launched in 2006. Use of the system increased significantly in 2007. In 2008, the Bank is preparing to initiate an upgrade of its websites, encompassing the marketing site, the banking site, and the overseas site; the range of traded products will also be expanded. The first stage of the development of a direct-banking support system was completed in 2007, with a CRM system implemented in both the marketing and operational divisions of Union Direct; expansion of this project is planned in 2008. The Bank believes that these improvements will bring about an increase in the use of direct channels by customers, which will free branch workers for sales and marketing activities. Further enhancement of controls and supervision in the area of consumer credit is also planned, including the development of rating tools based on advanced models for the evaluation and rating of consumer credit, along with the improvement of control processes in this area.
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
-32- Critical Success Factors and Main Entry and Exit Barriers in the segment
● A variety of banking products and their adaptation to the customer, including unique products and services not offered by competitors. ● A broad deployment of branches, as well as development of direct channels. ● Manpower training. ● Setting up and maintenance of information and technology systems.
Alternatives to the segment's products and services and changes thereto
There is no perfect alternative to basic banking services and to the combination of direct and personal service provided by the banking system. Competition in the area of investments is provided by investment houses, private brokers and insurance companies. There is also competition in the area of private customer credit on the part of the credit card companies and other niche companies. Further to the reform of the capital market, a material change is expected in the investment activity of the financial market in the coming years. Until 2006, the banks were active both in making financial products, provident funds and mutual funds, as well as in the field of consulting, marketing and distribution. Since the date of implementation of the law, the bank has become a consultant, marketer and distributor in the area of mutual, provident, and pension funds. In early 2008, investment houses commenced production of money-market funds designed to compete with bank deposits. The Bank is studying the potential effects of these products on its operations.
Structure of competition in the segment
The Bank competes in this segment against the banking system as a whole, investment houses, private brokers, and insurance companies. The three largest banks hold a market share estimated at 80%. Customer mobility in the segment is low. Legislative and regulatory changes have been made in recent years concerning activity in the capital and money markets, aimed at increasing customer mobility and removing barriers to transitions. These measures are expected to enable the Bank to increase this sector’s share of its operations.
The policy of the Supervisor of the Capital Market, Insurance, and Savings with regard to pension advising is to apply “reverse discrimination” in favor of mid-sized banks, in preference to the larger banks. The Bank is taking advantage of its position as the first bank to receive a license to provide pension advice to self-employed customers in order to solidify its status in this field.
Competitors in the area of housing finance are the banks operating in Israel as well as insurance companies. The strong competition in this area intensified in 2007, to the point where mortgages were subsidized by certain banks. Given that the price component is the key factor in customers’ choice of a loan provider, the erosion of spreads and operational income in this segment has escalated.
Various declarations appearing above contain forward-looking information. For the significance of this term, see the section on Forward-looking information above.
New Services and Products in the Segment
For several years, extensive efforts have been invested in this segment in order to expand the customer base. In 2008, the Bank will continue to invest marketing efforts and resources in order to recruit new customers in the private-banking and households populations. An increase of the share of activity of Bank customers is also planned, through marketing activities tailored to customers. Accordingly, the Bank is in the process of expanding activities, focusing on target populations, and expanding infrastructures, in order to enlarge the scope of its activity with private customers.
Branch deployment - Three new branches and a mortgage office were opened in 2007, joining the nine branches opened from mid-2004 to the end of 2006. Additional branches are planned to open in 2008. The branches opened serve neighborhoods in residential areas with potential for retail banking, with a relatively low investment and cost structure. Branches were also opened in population centers of the Ultra-Orthodox community. Two new branches were opened in important areas for this community in 2007, with the aim of increasing the Bank’s penetration and activity in this sector: the Rimonim branch in Bnei Brak and the Geula branch in Jerusalem. The working format of the Bank’s new branches -33- was examined during 2007, and the decision was made to assign “parent branches” to some new branches in order to improve supervision and control in the new branches’ first years of activity.
Union Premium – In mid-2006, the Bank launched a luxurious private-banking center aimed at increasing activity and focus with private-banking customers of net worth greater than NIS 1 million. The center offers services of the highest quality to its customers. Top professional advisors were hired for the center in order to provide professional, personal, flexible service. Customer service at the center is grounded in a philosophy of providing solutions to the full range of customers’ needs, including tailoring of advanced financial products: structured deposits, investments in venture-capital funds, complex foreign-currency transactions, and comprehensive pension advising. In providing service to customers in this sector, special emphasis is placed on forging close long-term relationships. In 2007, the number of Union Premium customers grew by 72%, and the volume of assets and securities grew by 65%.
Another Union Premium center is scheduled to open in the Haifa area in 2008.
Concurrently, the Bank completed the Customer Focus project at its branches. The goal of the project is to provide high- quality personal service, tailored to each customer according to his or her characteristics. The Bank intends to complete implementation of the project at the branches during 2008. Completion of this process will allow branch private-banking units to carry out initiatives and active, focused marketing drives.
New products – In 2007, the Bank continued to develop and market innovative products in the area of structured deposits, which allow diversification of investments and risks.
Pensions – The pension-advising field has opened a new channel for marketing to customers for Union Bank. The Bank was the first in the banking system to obtain a license to provide pension advice to self-employed customers, starting in the third quarter of 2006. Accordingly, as of that date, the Bank began providing pension-advising services to self- employed customers. The advisory services address pension products provided by pension funds, study funds, and provident funds. The Bank has signed distribution agreements with most institutional entities, and continues to work to sign agreements with additional entities.
In 2007, the Bank prepared intensively for the expansion of its license, by adapting advisory and operational systems while continuing to train advisors and update the relevant procedures. Towards mid-December 2007, the Bank received a license from the Supervisor of the Capital Market, Insurance, and Savings to provide advisory services to customers who are employees of companies. Shortly thereafter, the Bank began to provide advisory service to employees, in addition to its pension-advising services to self-employed customers. At this stage, the revenues from this activity are insignificant.
It was recently published that in accordance with an agreement reached by the Chairman of the Knesset Finance Committee and the Supervisor of the Capital Market, Insurance, and Savings at the Ministry of Finance, as of January 1, 2008, the largest banks, Hapoalim and Leumi, are permitted to provide pension advice to self-employed customers, to employed customers residing in peripheral regions, and to employed customers residing in communities in the Arab sector, following completion of their preparations for entry into this field. The large banks will be permitted to provide pension advice to the remaining population of employed customers as of August 2010.
See the section Legislative Developments with regard to developments in the following areas: the Economic Arrangements Law; the Expansion Order for Comprehensive Pension Insurance under the Collective Agreement Law; and the amendment to the Supervision of Financial Services Law (Provident Funds). The Bank is studying the main points of these changes and their impact on its activity in this field.
Fee freeze – The Bank examines its policy in the area of fees from time to time. Accordingly, on November 16, 2006, the Bank announced a six-month fee freeze for private customers. The fee freeze was extended until the end of 2007.
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information above.
-34- Marketing and Distribution
Marketing is carried out through the following media: newspapers, billboards, television, radio, and the Internet, as well as through the segment’s channels: branches, Union Premium, the Bank’s website, and direct mailings to customers. Union Direct encompasses two channels: a marketing and sales channel complementing the Bank’s branches, and an operational banking channel. In 2007, campaigns were promoted through this marketing channel, which complements direct-banking services and supports the attainment of the objectives in the Bank’s work plan. As part of an upgrade of Union Direct, a sophisticated CRM (customer relationship management) system was implemented, with the aim of enhancing sales and marketing capabilities while shortening operational processes and improving control capability. Phase I, which was completed and implemented in 2007, is aimed at supporting sales capabilities in initiated and incoming calls at the Union Direct call center. Expansion of this project to branches is planned in 2008, in the area of campaign-management model development, with additional expansions designed to support sales. In addition, specialized models will be developed for private-banking units, Union Premium, and mortgages. This system has a key role in the realization of the “Your First Other Bank” strategy, as detailed below.
Since December 2005, marketing of life and property insurance as part of collateral for housing loans at the Bank has been conducted through an insurance agency, at unstaffed stations located at the Bank’s branches and used solely for that purpose. Collection is performed separately from the loan, by the insurance agency. Insurance for loans granted prior to that date may be continued or renewed in the previous format.
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
Human Capital
In 2007, the total number of employee positions in the segment was 560; the cost of these positions was charged to the segment. The branches, Union Premium, and Union Direct employ workers trained for various positions, in accordance with the Bank’s requirements and needs. Ongoing training and instruction are also provided in the areas of sales, marketing, and CRM, as well as in other professional fields. The Bank places an emphasis on strengthening control systems; towards that end, training in the area of the implementation of control systems and processes has been reinforced as well. The Bank views the Private Customer Segment as a key focal point for development of its activity in the capital market in the coming years. The Bank has therefore invested in instruction, training, qualification, and licensing of investment advisors, and continues to do so. Concurrently, financial advisors in the segment have been trained to provide pension advice alongside investment advice. There is significant competition for the services of investment advisors among investment houses, insurance companies, and banks; accordingly, the Bank is investing in the cultivation and development of this asset.
Legal Proceedings
For further details regarding legal proceedings related to housing-finance activity, see the section Legal Proceedings and the opinion statement of the auditors.
Objectives and Business Strategy
The Bank is viewed by the public as a commercial bank. The Bank therefore is taking significant strategic steps to change this image, in order to expand its private customer base and increase activity and revenues. The activities for carrying out this strategy are: y In view of the transition barriers that make it difficult for private customers to switch banks, the Bank will continue its “First Other Bank” campaign, with the aim of positioning and branding itself as customers’ other bank, offering competitive products and attractive services. The campaign is designed to differentiate the Bank from other banks, both in products and in quality of service, and to familiarize customers with the Bank, with the ambition that they will expand their activity and subsequently make Union Bank their primary, preferred bank. y A focus on increasing customers’ activity at branches through the CRM system, which is planned for expansion during 2008, as well as through additional information and measurement systems currently being implemented at branches. The segment’s spread policy will also be examined. -35- y Expansion of the activity of Union Direct as a marketing channel for the various products, alongside its routine banking activity. y Opening of new branches in Kiryat Motzkin and Modi’in, with further geographical expansion to be considered based on locations congruent with the Bank’s business policy. y Continued expansion of activity through the Union Premium private-banking center, and opening of an additional Union Premium center in Haifa. y Expansion of the activity in the Ultra-Orthodox sector through anchor points in population centers of the sector. y Leadership in pension advising, with the aim of expanding and completing the service offering for customers. y Allocation of advertising and marketing budgets.
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information above.
-36- The following table presents a summary of the results of the private customer segment for the year ended December 31: 2007 *2006 Private Business Household Capital Total Private Business Household Capital Total Customers Checking(2) Financing Market(1) Customers Checking(2) Financing Market(1)
NIS million NIS millions
Profit from financing activities before provision for doubtful debts - From outsiders 157 14 34 1 206 148 13 30 3 194 - Inter-segment ------
Operating and other income - From outsiders 90 11 18 11 130 77 9 19 13 118 - Inter-segment ------Total income 247 25 52 12 336 225 22 49 16 312
Provision for doubtful debts 14 2 (1) - 15 12 2 1 - 15
Operating and other expenses - From outsiders 211 23 45 7 286 197 22 45 9 273
Operating income (loss) before taxes 22 - 8 5 35 16 (2) 3 7 24 Provision for taxes on operating income 9 - 3 2 14 7 (1) 1 4 11 Operating income (loss) after taxes 13 - 5 3 21 9 (1) 2 3 13 After tax income (loss) from extraordinary activities - - - 2 2 - - - 34 34 Net income (loss) 13 - 5 5 23 9 (1) 2 37 47
Average balance of assets 1,185 428 3,100 - 4,713 947 286 2,825 - 4,058
Average balance of liabilities 13,229 13 53 - 13,295 11,945 12 69 - 12,026
Average balance of risk assets 1,336 404 1,942 - 3,682 1,271 224 1,774 - 3,269
Average balance of securities 6,167 - - 728 6,895 4,905 - - 548 5,453
Components of profit from financing activities before provision for doubtful debts: Margin from credit granting activities 27 4 20 - 51 26 4 19 - 49 Margin from deposit receipt activities 115 9 - - 124 107 9 - - 116 Other 15 1 14 1 31 15 - 11 3 29
Total profit from financing activities before provision for doubtful debts 157 14 34 1 206 148 13 30 3 194
* Reclassified. (1) Management fees from provident and mutual funds. (2) Business customers having frameworks of up to NIS 400 thousand.
-37-
Changes in the Volume of Activity and Net Profit of the Segment
Net operating profit totaled NIS 21 million in 2007, compared with NIS 13 million in 2006, an increase of 62%. Net return of operating profit on equity was 7% in 2007, compared with 4.9% in 2006. The segment’s revenues totaled NIS 336 million in 2007, compared with NIS 312 million in 2006, an increase of 8%. The increase in revenues resulted from financing income, mainly due to the increase in deposits in the segment, as well as operating income, mainly from capital-market activity. Provisions for doubtful debts in the segment totaled NIS 15 million in 2007, unchanged from 2006. The segment’s expenses totaled NIS 286 million in 2007, compared with NIS 273 million in 2006, an increase of 5%.
Net profit from extraordinary transactions after taxes in the amount of NIS 34 million was included in 2006 in respect of the segment’s share in the sale of the activity of the Bank’s mutual and provident funds.
The volume of the segment’s activity increased in 2007 compared with 2006. The average balance of assets (primarily credit to the public) totaled NIS 4.7 billion in 2007, compared with NIS 4.1 billion in 2006, an increase of 16%. The average balance of liabilities (primarily deposits from the public) totaled NIS 13.3 billion in 2007, compared with NIS 12.0 billion in 2006, an increase of 11%.
The growth in the segment’s results stems from the implementation of the Bank’s strategy to expand its activity in this segment, including in housing-finance activity. Housing-finance activity includes loans granted for the purchase, renovation, or construction of homes, and general-purpose loans secured by mortgages of homes.
Housing credit totaled NIS 3.3 billion on December 31, 2007, compared with NIS 2.8 billion on December 31, 2006, an increase of 18%. This amount does not include credit from Finance Ministry funds to entitled persons, which totaled NIS 0.8 billion on December 31, 2007, compared with NIS 0.9 billion on December 31, 2006.
The volume of activity increased in 2007 in comparison to 2006. Total new loans executed amounted to NIS 1,016 million, compared with NIS 656 million in 2006, an increase of 55%.
Information on new loans for the purchase of apartments, secured by mortgages, and the turnover of refinanced loans
Loans granted For the year ended December 31 2007 2006 NIS millions
Bank funds 910 579 Finance Ministry funds 25 20 Standing loans * - * -
Total new loans 935 599
Refinanced loans 81 57
Total loans granted 1,016 656
* Amounts up to NIS 500 thousand.
Net profit of housing-finance activity totaled NIS 5 million in 2007, compared with NIS 2 million in 2006, an increase of 150%. Revenues totaled NIS 52 million in 2007, compared with NIS 49 million in 2006, an increase of 6%. The growth resulted from an increase in financing income, which was partially offset by a decrease in operating income. In provisions for doubtful debts, income in the amount of NIS 1 million was recorded in 2007, as a result of collection of doubtful debts, compared with a provision of NIS 1 million in 2006. Expenses totaled NIS 45 million, similar to 2006.
-38-
Corporate Segment
Segment Structure The Bank's business segment is managed by the Business Division and comprises business customers in a variety of industries. The borrowers that belong to this segment have a range of credit of between NIS 400,000 and hundreds of millions of shekels. The Bank renders a variety of banking services to business customers, with the granting of credit comprising the major activity of the segment. The principle industries in which the segment specializes are: industry, trade, real estate, and customers engaged in the capital market.
Banking services are provided to customers of the segment in all of the Bank's branches. The products and services of the segment are adapted to customer needs and include mainly the following: financing ongoing operations, investment financing, real estate project accompaniment, financial services, foreign-trade transactions, derivative financial instruments transactions, investment consulting services at the branches and in the dealing rooms of the Bank, and leasing activity through the Union Leasing Ltd. subsidiary.
Legislative Restrictions, Regulations, and Special Constraints Applicable to the Segment The Bank carries out its operations in accordance with laws, regulations, and regulatory guidelines that apply to the Israeli banking system through entities such as: the Supervisor of Banks, the Commissioner of the Capital Market, Insurance and Savings, the Commissioner of Restrictive Trade Practices and the Israeli Securities Authority. The following represent specific restrictions that apply to the segment: as part of the Directives for Proper Banking Management, there is a restriction as to the amount of debt of an individual debtor, a group of debtors, the total amount of debt of the six largest debtor groups of the Bank and customers who are defined as "related persons" to the Bank. These restrictions may have ramifications on the manner and volume of activity in the business segment of the Bank with those same customers. The balance of credit and the credit risk attributable to the customers of this segment, pertaining to measurement for purposes of the restrictions of debt of a debtor or group of debtors, are sensitive to exogenous changes, such as: changes in foreign currency exchange rates, the Israeli Consumer Price Index, changes in interest rates, mergers and acquisitions of companies, changes in agreements between shareholders pertaining to characteristics of their control of companies, joint ventures and partnerships between various parties, etc.
In early January 2008, the Supervisor of Banks issued rules to corporations concerning “Measurement and Disclosure of Problematic Debts and Provisions for Doubtful Debts in Financial Statements of Banking Corporations.” The directive will apply as of 2010 and replaces the current directive; it primarily concerns the adjustment of the terminology and definitions customarily used in Israel to the common practice in global banking systems, especially in the United States. For details on this subject, see the section Legislative Developments.
The directive may cause an increase in the volume of debts for which interest income is recorded not on a current basis but only based on actual collection, as a result of the definition of the debts as impaired debts. This refers to debts presently defined as partially doubtful income-bearing debts, as well as debts currently defined as debts in temporary arrears, among others. The Bank is preparing to implement the required adjustments to its information systems.
In 2007, following the Hefziba incident, several legislative initiatives were submitted to the Knesset related to construction and real-estate activity. These initiatives, if legislated, may influence the activity of the Bank in the area of residential construction and its work methods. For details on this subject, see the section Legislative Developments.
In addition, near the date of publication of the financial statements, a directive of the Supervisor of Banks was published concerning the safeguarding of funds of home buyers in projects financed using the financial accompaniment method. The directive will take effect as of June 1, 2008 with regard to financing agreements between banks and contractors as of that date.
-39-
Developments in the Segment’s Markets
The activity of the Corporate Segment of the Bank is influenced by the growth rate of the economy, the level of demand in the domestic and global economy, monetary and fiscal policy, the security situation, security-related events that mainly affect the tourism industry, developments in the local real-estate industry, and developments in interest rates. 2007 was marked by financial stability, growth in economic activity, and an increase in investments in the sectors of the economy. The business product rose by 6.3% in 2007. The Bank of Israel interest rate decreased by one percentage point overall from the end of 2006, falling in the first half but rising to 4% in the third quarter. There was no change in the interest rate in the fourth quarter.
Growth was evident in most sectors of the economy. The resurgence that began in this sector in 2006, following a decade of stagnation, intensified during the year, particularly in the Dan region, the Jerusalem area, and satellite towns in the central region. Growth was accompanied by an increase in housing prices in certain areas, notably in luxury homes; however, in peripheral regions and northern towns, real-estate activity was low.
Technological Changes with a Potential Material Effect on the Segment
The information systems used by the Corporate Segment are designed to assist analysis, control, and marketing processes. The Corporate Segment routinely works to improve and update its technological systems. In 2007, a system for the location and identification of potential problematic credit was implemented. In addition, automated control processes were added for the implementation of Proper Conduct of Banking Business Directive No. 325 concerning the management of credit lines.
Critical Success Factors and Main Entry and Exit Barriers in the Segment y Management and control of credit risks, including a customer risk index – credit risk is the most significant risk in the segment's activity. Wisely risk management and due controls are vital for reducing risks and achieving satisfactory profitability in the segment. y Optimization of the capital ratio. y Compliance with regulatory limits applicable to the segment. y Correct pricing of the customer's risk premium. y Long term relationship with the customers. y Quality and skilled manpower. y Setting up and maintaining systems and technology.
Alternatives to the segment's products and services and changes thereto
Financing sources that are alternatives to bank credit are offered by non-bank financial institutions: public and private offerings of shares, bonds, and other securities in capital markets in Israel and abroad.
Structure of competition in the segment
The Bank competes in this segment against the other banks operating in Israel, as well as with foreign banks which are expanding their operations in Israel. In recent years, institutional entities have become noticeably more involved in this segment, such as insurance companies and pension funds. Competition is also evident in credit substitutes, through public and private bond offerings; this activity expanded significantly in 2007. A significant portion of the business customers maintain accounts in more than one bank and, against this background, there is intense competition in the business banking segment.
-40-
Competition is reflected both in the area of interest and commission rates offered to customers by competitor banks, and in the level of risk (the amount of credit granted versus the collateral required) that the competition is willing to approve. In the area of investments, competition is reflected in the level of service granted.
In capital market activity, the competition is comprised of other banks and members of the Stock Exchange that are active in this field. There is fierce competition in the area of prices in the segment, which increased in 2007.
Marketing and distribution
Business segment activity with customers is concentrated in the Business Division and the branches, who maintain constant contact with the customers in order to adapt finance solutions for individual transactions, to respond to banking requirements and to market the products of the Bank.
Human Capital
In 2007, the total number of employee positions in the segment was 455; the cost of these positions was charged to the segment. Employees regularly receive appropriate professional training at the Bank, including training in the area of the analysis of financial statements following the implementation of International Financial Reporting Standards (IFRS). In their work, employees are required to display analytical capabilities, handle complex transactions, and provide a high quality of service to the segment’s customers. Activity in the areas of the capital market and credit requires in-depth knowledge and familiarity with these fields. There is competition for employees in these areas; accordingly, resources are invested in employee cultivation and retention.
Objectives and Business Strategy
In 2008, the Bank will continue its policy of expanding its corporate credit portfolio, focusing on the residential- construction sector. This expansion is subject to risk-diversification policy. The Bank will also continue to improve the quality of its credit portfolio, while examining the level of risks inherent in the portfolio and customers’ risk premiums. y Activity in the construction and real-estate sector – Includes the business sectors in this field as well as the financing of residential projects. In 2007, the Bank strengthened the business unit responsible for financing residential projects, with an emphasis on increasing control in the Corporate Division. Note that the policy implemented by the Bank of expanding its mortgage activity and increasing its share of private customers is synergetic with its expansion strategy in the area of residential construction. The Bank continually examines the financed projects, with adequate diversification among geographical regions, mainly in terms of demand areas and the types of homes. y Activity in the capital market – The Bank intends to continue to be a leader in this area, with stability in the volume of credit and expansion of activity, chiefly in financial instruments. Also planned are the continued development of products and services at a high technological level, as well as the development of control mechanisms.
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
-41-
The following table presents a summary of the results of the corporate segment for the year ended December 31: 2007 *2006 Businesses Construction Capital Total Businesses Construction Capital Total & Real estate Market (1) & Real estate Market (1) NIS Millions NIS Millions
Profit from financing activity before provision for doubtful debts: - From outsiders 151 68 43 262 142 59 36 237 - Inter-segment 2 - 13 15 4 - 14 18 Operating and other income: - From outsiders 73 26 26 125 67 20 25 112 - Inter-segment - - (1) (1) - - (2) (2) Total income 226 94 81 401 213 79 73 365
Provision for doubtful debts 8 7 - 15 28 9 - 37
Operating and other expenses: - From outsiders 166 37 41 244 166 27 39 232 Operating income (loss) before taxes 52 50 40 142 19 43 34 96
Provision for taxes on operating income 28 20 16 64 8 21 16 45 Operating income (loss) after taxes 24 30 24 78 11 22 18 51 After-tax income (loss) from extraordinary activities - - 1 1 - - 7 7
Net profit (loss) 24 30 25 79 11 22 25 58
Average balance of assets 5,293 3,419 3,440 12,152 5,894 2,563 2,358 10,815
Average balance of liabilities 6,796 2,306 4,972 14,074 5,317 1,126 5,264 11,707
Average balance of risk assets 3,337 5,516 2,539 11,392 4,334 4,209 1,369 9,912
Average balance of securities 5,379 - 23,126 28,505 4,453 - 20,411 24,864
Components of profit from financing activities before provision for doubtful debts: Margin from credit granting activities 92 52 9 153 86 44 9 139 Margin from deposit receipt activities 28 8 15 51 24 6 14 44 Other 33 8 32 73 36 9 27 72 Total profit from financing activities before provision for doubtful debts 153 68 56 277 146 59 50 255
* Reclassified. (1) Including securities activity.
-42-
Changes in the Volume of Activity and Net Profit of the Segment
Net operating profit totaled NIS 78 million in 2007, compared with NIS 51 million in 2006, an increase of 53%. Net return of operating profit on equity was 8.6% in 2007, compared with 6.7% in 2006.
The segment’s revenues totaled NIS 401 million in 2007, compared with NIS 365 million in 2006, an increase of 10%, which resulted from financing profit and fees. Provisions for doubtful debts totaled NIS 15 million in 2007, compared with NIS 37 million in 2006, a decrease of 59%. The decrease in the provision for doubtful debts in 2007 was influenced by the improvement in economic conditions, and by the ongoing improvement of the credit portfolio and of corporate clients’ repayment capability. The segment’s expenses totaled NIS 244 million in 2007, compared with NIS 232 million in 2006, an increase of 5%.
Net profit from extraordinary activities after taxes in the amount of NIS 7 million was included in 2006 in respect of the segment’s share in the sale of the activity of the Bank’s provident funds.
The average balance of assets in the segment (primarily credit to the public) totaled NIS 12.2 billion in 2007, compared with NIS 10.8 billion in 2006, an increase of 13%. The average balance of liabilities in the segment (primarily deposits from the public) totaled NIS 14.1 billion in 2007, compared with NIS 11.7 billion in 2006, an increase of 20.5%.
Profit from activity in the construction and real-estate sector totaled NIS 30 million in 2007, compared with NIS 22 million in 2006, an increase of 36%. Revenues totaled NIS 94 million in 2007, compared with NIS 79 million in 2006, an increase of 19%, resulting from an increase in financing and operating income.
Credit for construction and real estate totaled NIS 3.6 billion on December 31, 2007, compared with NIS 2.7 billion on December 31, 2006, an increase of 33%.
The results for 2007 reflect the Bank’s strategy with regard to the financing of residential-construction projects and acquisition groups primarily in high-demand areas, while maintaining adequate diversification. As of the end of 2007, the Bank is handling some 120 projects, up 41% from the beginning of that year. The number of housing units financed increased by 110%. The project pipeline (projects approved by the Bank but in which activity has not yet commenced) also grew by 65%.
Diamond Segment Segment Structure The segment includes customers operating in the diamond industry, most of whom are members of the Diamond Exchange in Ramat Gan. This activity is conducted at the Bank’s branch in Ramat Gan and primarily consists of granting credit. A new organizational structure was instituted at the Diamond Department of the branch in the fourth quarter of 2007 (see details in the Human Capital section below).
The products and services of the segment are suited to customers’ needs: foreign-trade activity, investment financing, financial services, investment advisory services at the branch, and the Bank’s dealing rooms.
Legislative Restrictions, Regulations, and Special Constraints Applicable to the Segment
The Bank's operations are subject to the laws, regulations, and regulatory guidelines that apply to the Israeli banking system from the Supervisor of Banks, and the Supervisor of Diamonds in the Ministry of Trade and Industry. Following are restrictions applying specifically to the segment: as part of the Directives for Proper Banking Management, there is a restriction as to the amount of indebtedness allowed by industry, by an individual debtor, by group of debtors, the total amount of indebtedness of the six largest debtor groups of the Bank and customers who are defined as "related persons" to the Bank. These restrictions may have ramifications on the manner and volume of activity in the business segment of the Bank with these customers. The balance of credit and the credit risk attributable to the customers of this segment, pertaining to measurement for purposes of the debt restrictions of a debtor or group of debtors, are sensitive to exogenous changes, such as changes in foreign currency exchange rates, interest
-43- rates development index, mergers and acquisitions of companies, changes in agreements between shareholders pertaining to the characteristics of their control of companies, joint ventures and partnerships between various parties, etc.
For details regarding the directives of the Supervisor of Banks concerning “Measurement and Disclosure of Problematic Debts and Provisions for Doubtful Debts of Banking Corporations,” see the section on Legislative Restrictions in the review of the Corporate Segment above.
In addition, a government draft bill concerning the prohibition on money laundering refers to the imposition of duties related to money laundering on gem traders. For further details, see the section Legislative Developments.
Development in the Segment's Markets
The Bank's diamond segment activity is influenced by the level of global demand in the industry. Global and industry macro-economic processes affect the operations of the customers of the segment, mainly by reducing the volume of their activity, along with changes on the global level, such as: changes in foreign currency exchange rates, changes in prices of imported raw materials, etc.
Global activity grew in 2007. Israel continues to be an important center for the global diamond industry. Total net imports of raw and polished materials increased by 10% in 2007, compared to 2006. Total net exports of raw and polished materials increased by 12% in 2007, compared to 2006. Exports of polished materials to Far East countries grew in 2007, while the proportion of exports to the United States decreased in comparison to 2006.
The debt balance of the diamond industry to the Israeli banking system amounted to about USD 2.1 billion at the end of 2007, compared with USD 2 billion at the end of 2006.
Critical success factors for the segment / the major entrance and exit impediments of the segment
● An in-depth knowledge of the diamond industry in Israel and around the world. ● Risk control and management (with an emphasis on credit risk). ● Quality and skilled manpower. ● Setting up and maintaining systems and technology.
Alternatives to the segment's products and services and changes thereto
There are no non-bank credit alternatives in the segment.
-44-
Structure of Competition and Developments in the Segment
The Bank holds a market share of approximately 25% in this segment, significantly higher than its relative share of the general banking market. Concentration in this segment at the Bank stood at 11% of the balance- sheet credit portfolio as of December 31, 2007, compared with concentration of approximately 15% of the balance-sheet credit portfolio as of December 31, 2005. The Bank competes in this segment against banks operating in the industry in Israel, primarily Discount Bank and Leumi, as well as against foreign banks. Some customers maintain accounts with several banks. Competition in the segment is therefore high. Competition is reflected in the rates of interest and fees offered to customers by the competing banks, as well as in the level of exposure (amount of credit versus required collateral) which competitors are willing to approve.
The diamond industry has recently undergone changes that are reflected in a decrease in the output of mines, leading to a shortage of raw materials. This shortage may worsen as a result of changes in purchase and franchise terms in diamond-producing countries. The outcome of this situation is an increase in raw-material prices, which were up by 20% in 2007. The shortage affects diamond merchants’ ability to obtain raw materials for production. In contrast to raw materials, conditions in the market for polished diamonds (excluding large stones) are static and there has been no significant movement in price levels. The Bank is preparing to cope with the changes in the industry and adjusting its credit policy for the industry accordingly.
Marketing and distribution
The diamond segment activity is concentrated in the Ramat Gan branch. The segment's employees maintain constant contact with customers in order to provide tailored financing solutions and supplementary banking services. The Bank hosts periodic seminars for customers of the industry, and maintain constant contact with the customers in Israel and abroad.
Human Capital
In 2007, the total number of employee positions in the segment was 45; the cost of these positions was charged to the segment. The employees’ work requires analytical capabilities for the examination of financing applications and the financial stability of customers, as well as the ability to handle complex transactions and provide a high level of service to the segment’s customers.
In the fourth quarter of 2007, a new organizational structure was implemented in the Diamond Department at the Ramat Gan branch, encompassing most aspects related to this activity. The objectives of this change include increased controls and streamlining of work processes, improved efficiency and quality of the routine handling of credit, and better customer service. The structural change includes an update of job definitions for department employees as well as change and decentralization of authority hierarchies, freeing team leaders to focus on management and marketing, with the aim of supplying the full range of services to customers at a single point of contact with the branch. The change also addresses professional backup, reinforcement, and enrichment, along with focused training to expand the knowledge of department employees. Improvement of support from information systems for the required work processes is planned, with lateral controls to be added for the department’s activity. Accordingly, working procedures in this area are being upgraded.
Objectives and Business Strategy
Maintaining the Bank’s dominant standing in the diamond industry while coping with the changes underway in the industry and adapting the Bank’s credit policy for the industry accordingly.
-45-
Forward-looking Information
The expectation and the intentions mentioned above include forward-looking information. This information is uncertain in nature and is based on information in the possession of the Bank as of the date of the financial statements. In addition, it contains assessments made by the Bank or intentions of the Bank as of the balance sheet date. In the event of a worsening of the global economic situation should global economic conditions worsen, with a decline in private consumption in general and in luxury products in particular in the United States, which would affect other economies that are export markets for diamonds, and/or an impairment of the debt repayment capability of the Bank's customers in this segment, the actual results could be significantly different than the estimated results or the results that may be inferred from this information. An impairment such as the one mentioned above may derive from a number of factors, including: relatively high credit risks as a direct result of financing volumes that were placed at the disposal of an individual debtor or a group of debtors, a decline in profitability of the customer due to industry-specific or management reasons, the erosion in the value of the customer's collateral, a high level of dependency of the customer on his suppliers and/or customers whose financial position has worsened, regulatory influences, exposure to financial or operational risks, etc. Increased competition in bank financing to the segment, together with increased costs of long and short-term sources may result in erosion of financial margins and in a decrease in the profitability of the segment.
Changes in the Volume of Activity and Net Profit of the Segment 2007 concluded with a loss of NIS 4 million, compared with net profit of NIS 10 million in 2006. The segment’s revenues totaled NIS 69 million in 2007, compared with NIS 72 million in 2006, a decrease of 4%. The decrease mainly resulted from the appreciation of the shekel. Provisions for doubtful debts totaled NIS 50 million in 2007, compared with NIS 30 million in 2006, an increase of 67%. The segment’s expenses totaled NIS 26 million in 2007, compared with NIS 23 million in 2006, an increase of 13%.
Credit for diamonds totaled NIS 2.1 billion on December 31, 2007, similar to the total on December 31, 2006.
Financial Management Segment
Segment Structure
Activity in this segment is under the responsibility of the Financial Management Division. An organizational change was carried out in this division during 2007, aimed at centralizing all asset and liability management at the Bank, in local and foreign currency, under one office. Accordingly, the segment includes the Bank’s proprietary activity through investments in securities (mainly bonds), deposits with banks, transactions in derivative financial instruments, market making, management of market and liquidity exposure arising from Bank customers’ business, and the activity of the subsidiaries Union Capital Markets and Investments Ltd. and Union Investments and Enterprises Ltd.
The dealing room coordinates market-making activity in foreign currency and in bonds, liquidity management in shekels and in foreign currency, and the Bank’s investments in foreign government bonds. In accordance with a decision of the Ministry of Finance, the Bank was appointed a primary dealer in dollars and euros in 2005, and a primary dealer in bonds in 2006. These activities are conducted within the dealing room.
Legislative Restrictions, Regulations and Special Constraints Applicable to the Segment
The Bank's operations are subject to laws, regulations, and regulatory guidelines that apply to the Israeli banking system. These include the Supervisor of Banks, the Supervisor of Capital Markets, Insurance, and Savings, the Supervisor of Restrictive Trade Practices, the Israeli Securities Authority, etc.
-46-
Technological Changes with a Potential Material Effect on the Segment
The technology used by the Bank's dealing room is among the most advanced in Israel. The major investment made is in market making, with the goal of being the leader in this area.
In July 2007, the Bank of Israel’s Zahav real-time gross settlement (RTGS) system became operational. The system allows final intra-day monetary transfers among all banks. The operation of this system has improved the efficiency of the decision-making process regarding liquidity at the Bank.
Critical Success Factors and Main Entry and Exit Barriers in the Segment
● Knowledge of the market, identifying customer needs, adapting activity accordingly, and ability to respond quickly to changes in the market. ● Quality of human resources, with those employed in the segment having analytical capabilities and good commercial skills. ● High-level computerized systems, both in the area of transaction performance and in the area of information, analysis and risk control. ● A well-developed network of cooperation with banks and financial institutions around the world. These contacts enable the segment to serve a variety of customers and to carry out a large volume of transactions.
Alternatives to the segment's products and services and changes thereto
There are alternatives to most of the products and services rendered by the segment.
Structure of the competition and developments in the segment
The segment competes with the dealing rooms of the banks operating in Israel. There is also competition from banks and other financial entities abroad who allow customers to operate in a direct manner. The Bank's market share in terms of turnover in 2007 is relatively large for a bank of its size.
Human Capital
In 2007, the total number of employee positions in the segment was 36; the cost of these positions was charged to the segment. The Financial Management Segment requires high-quality employees. There is significant competition for the services of these employees from local and foreign banks, other financial entities, and business firms; accordingly, the Bank invests in the cultivation and development of human resources in this segment, through means including special remuneration of the segment’s employees, linked to performance.
Collaboration Agreements
During the normal course of its business, the Bank and its financial management segment maintain broad contacts with the leading banks and investment houses in the world. The business connections between the Bank and these entities in the various capital markets are based on, among other things, standard international arrangements such as: framework agreements that support dealing activities (ISDA). The Bank aims to increase the number of banks with which it signs agreements to offset transactions in the event of business failures. The Bank also aims to increase the number of agreements for the reduction of exposure to market risks (CSA agreements). In addition, activity is conducted through an international clearing house (CLS) to minimize clearing risks in foreign-currency swap transactions. The Bank intends to centralize foreign securities clearing activity in one bank which will serve as principal correspondent during 2008. This step is aimed at reducing risks inherent in clearing activity, and providing a better level of service to customers.
-47-
This paragraph contains forward-looking information. For a definition of this term, see the section Forward- looking information above.
Changes in the Volume of Activity and Net Profit of the Segment The segment's net income in 2007 amounted to NIS 29 million, compared with NIS 10 million in 2006, an increase of 190%. In 2007, the segment's revenues amounted to NIS 90 million, compared with NIS 55 million in 2006, an increase of 64%.
The increase in profitability resulted from an increase in the Bank’s activity in bonds on its own behalf (both government bonds and corporate bonds), which was partially offset by a decrease in income from the Bank’s non-financial investments through its subsidiary Union Investments and Enterprises (A.S.Y.).
Amounts not allotted and adjustments
The segment includes activities that cannot be classified to any specific segment.
Risk Exposure and Management
The Bank’s business activity entails credit risks, market risks and liquidity risks. These risks are accompanied by operational and legal risks.
Risk management policy assists the Bank in achieving its business objectives in the course of its various financial activities, while defining risk levels within the limits set by the Board of Directors.
Organizational Responsibility
Activity at the Bank is divided among exposure generators, risk management and measurement, and exposure control and management.
The management of exposure to market and liquidity risks is handled by the Financial Management Division, headed by Mr. Efraim Avraham. Exposures are mainly generated through the dealing rooms and the proprietary-trading units within the division. Credit risk arising from exposure to corporate bonds is also managed by the division.
Corporate credit risks, including credit risks in respect of customers operating in the financial sector and in the diamond sector, are managed by the Head of the Corporate Division, Mrs. Edna Peres-Lachish.
Credit exposure risks in the retail sector, including mortgages, are managed under the responsibility of the Head of the Retail Banking, Client Asset, and Advisory Division, Ms. Edith Luski.
Legal risks are managed by the Chief Legal Advisor of the Bank, Adv. Racheli Friedman.
Risk Management System – Responsible for the identification, definition and mapping of market and liquidity risks, risk measurement, and formulation of a general overview of risks. Develops internal models in all risk segments. The Head of the Risk Management System is Mr. Ami Shoshani.
Risk Control – On April 30, 2007, the Board of Directors of the Bank resolved to establish the Control Division. The division, headed by Dr. Akiva Sternberg, commenced operation in the second half of 2007. The division coordinates the control of market, liquidity, and credit risks as well as controls of the Bank’s trading activities.
The division is also responsible for the activity of the Compliance Officer. The Head of the Control Division also serves as the manager of operational risks.
-48-
Market Risks
Market risks are risks to the Bank’s revenues and shareholders’ equity arising from changes in prices and rates in the financial markets, primarily changes in interest rates, exchange rates, inflation, and share prices, and in the volatility of movements in these areas.
The Board of Directors of the Bank has defined limits and constraints for exposure to market risks in the different activity segments. These limits and constraints are summarized in an exposure document, which is discussed by the Board of Directors on a quarterly basis. Exposure management policy is aimed at the attainment of the Bank’s objectives in its various activities, while complying with the limits set by the Board of Directors.
The market-risk situation is examined in detail on a weekly basis in the Management Forum for Financial Matters. As part of this process, the Bank’s various exposures in all sectors are reviewed, with actual exposure compared against the approved limits. Recommendations of the Forum are submitted for discussion and approval by the management of the Bank.
The Bank measures market risks using the value-at-risk (VAR) model of potential risk (possible decline in value during a given time period), among other methods. The calculation is performed based on the parametric method, for a holding period of ten days, at a confidence level of 99%. Risk in the option portfolio is calculated using scenarios of change in exchange rates and in volatility, according to data from the past year.
Linkage-base risk – Refers to possible loss arising from changes in rates of currencies, linkage bases, or shares, when the linkage base of the assets is not parallel to the linkage base of the liabilities. Linkage-base risk management aims to maximize the Bank’s profitability while taking advantage of opportunities in the various markets, among other goals. As part of this activity, the Bank creates exposures in the local and international currency markets, as well as exposures in the CPI-linked market. The Bank’s management administers risks arising from linkage-based exposure in a controlled manner, within the limits set by the Board of Directors.
A. Foreign currency positions - The Bank’s activity as a market maker in the field of foreign currency makes it necessary to initiate deliberate exposures in the course of trading. Working procedures and restrictions have been defined for the extent of these trading positions and the method of managing them in the course of trading. In addition, from time to time, decisions are taken to initiate exposures on the basis of assessments of developments in the relative prices of different currencies. These exposures are conducted within the frameworks prescribed by the Board of Directors, which include restrictions on the maximum losses that may be incurred. The Bank operates a computerized system that provides an indication of all foreign currency exposures at any given point in time. The Board of Directors’ restriction on the total foreign currency/NIS exposure is a VAR of NIS 12 million. The actual exposure on December 31, 2007, was a VAR of NIS 3.2 million. The highest value at risk (at the end of the business day) in 2007 was NIS 3.2 million. The Bank's activity in foreign currencies is carried out mainly in U.S. Dollar, Euro, Yen, Sterling and Swiss Franc. The Bank's exposure to market risks in all other foreign currencies is not material.
B. CPI-linked exposure: The Board of Directors of the Bank has set a value-at-risk limit of NIS 12 million, and a limit on the rate of the surplus of assets over liabilities, in terms of the percentage of shareholders’ equity, at -30%/+50%. Actual exposure as of December 31, 2007 was a value at risk of NIS 5.7 million. The highest value at risk (at the end of the business day) in 2007 was NIS 6.3 million.
-49-
The following table shows sensitivities to changes in foreign-currency exchange rates and in the CPI, as of December 31, 2007, in NIS millions (measurements include both balance-sheet and off-balance-sheet activity):
CPI USD EUR GBP JPY CHF Other FX 5% increase 16.3 (0.2 ) (2.4) (0.3) (0.2) 0.3 (0.4 ) 10% increase 32.6 0.6 (6.8 ) (0.7) (0.4) 0.5 (0.7 ) 5% decrease (16.3 ) (2.5) (0.2) 0.3 0.2 (0.3 ) 0.4 10% decrease (32.6 ) (10.1) (0.3) 0.7 0.4 (0.5 ) 0.7
Summary of linkage balances, in NIS millions December 31, 2007 Foreign currency, including foreign Non-monetary Unlinked CPI-linked currency linked items Total Assets 17,201 4,608 8,996 817 31,622 Liabilities 16,132 4,049 9,665 190 30,036 1,069 559 (669) 627 1,586 Forward transactions, net (213 ) (284) 497 Options (delta value) (141) - 141 715 275 *(31)
* Of which, USD: NIS (2) million; other currencies: NIS (29) million.
December 31, 2006 Foreign currency, including foreign Non-monetary Unlinked CPI-linked currency linked items Total Assets 16,281 3,998 7,797 858 28,934 Liabilities 14,924 3,731 8,452 255 27,362 1,357 267 (655 ) 603 1,572 Forward transactions, net (723 ) (108) 831 Options (delta value) 33 - (33) 667 159 *143
* Of which, USD: NIS 126 million; other currencies: NIS 17 million.
For additional details of the break down of the Bank’s assets and liabilities by linkage bases, see Note 15 to the financial statements.
Interest-rate risk – Arises from the possible effect of changes in interest-rate curves on the fair value of assets and liabilities. Interest-rate risks to the overall portfolio of the Bank constitute the principal market risk to which the Bank is exposed. The Bank measures and manages interest-rate risk for its overall portfolio, encompassing instruments in the banking portfolio and the trading portfolio.
Interest-rate exposure management policy is aimed at maximizing the Bank’s profits while maintaining desirable exposure levels in each of the linkage segments to which the Bank is exposed, according to market
-50- forecasts and the targeted risk levels. The main exposures are taken in the unlinked shekel segment and in the CPI-linked shekel segment. There are immaterial interest-rate exposures in the major foreign currencies.
Interest-rate exposure is measured on a daily basis for the principal currency segments: unlinked shekel, CPI- linked shekel, U.S. dollar, euro, yen, Swiss franc, and pound sterling. Interest-rate exposure is measured using two main techniques:
A. DV1% (delta value 1%) – An estimate of the possible change in the portfolio given a 1% parallel shift in the interest-rate curve.
B. VAR (value at risk) – Measures the potential risk to the portfolio at a confidence level of 99%, and holding period of 10 days.
Interest-rate exposure in the CPI-linked segment takes into account, among other factors, working assumptions regarding the rate of early settlements in mortgages, and working assumptions regarding the rate of withdrawals at optional exit points in saving plans. These assumptions are based on past experience. Interest-rate exposure in the unlinked shekel segment takes into account, among other factors, working assumptions regarding the existence of a stable balance in some current accounts, and working assumptions regarding interest-rate exposure in Gilon bonds. The remaining current accounts are defined as having no settlement date and calculated as having a term to maturity of two days.
The Board of Directors of the Bank has set limits in terms of value at risk with regard to the possible effect of changes in interest rates. A limit has been set for total interest-rate risk, as well as for each linkage base, including each foreign currency separately.
The overall interest-rate exposure limit is a value at risk of NIS 60 million. Actual exposure as of December 31, 2007 was a value at risk of NIS 25 million. The highest value at risk (at the end of the business day) in 2007 was NIS 25 million. Calculation of interest-rate exposure, checking compliance of the exposure with the limits, and distribution of the findings are performed daily.
The following table shows actual exposure as of December 31, 2007, in NIS millions: Segment Type of limit Actual exposure Total VAR interest offset (including interest correlations) 25 CPI-linked VAR 17 DV1% 49 Unlinked VAR 10 DV1% 30 Foreign currency VAR for all currencies 2.3 VAR for each of the major currencies: USD group 1.3, EUR group 0.4, USD group, EUR group, JPY, CHF, GBP JPY 0.2, GBP 0.2, CHF 0.1
Option portfolio management - The Bank manages a portfolio of NIS/foreign currency and foreign currency/foreign currency options. In this activity, the Bank is exposed to the risk of changes in the volatility between the shekel and foreign currencies. The risks inherent in the portfolio of options managed by the Bank are examined via a Value at Risk (VAR) model based on a historical simulation of changes in volatility and exchange rates. The options portfolio is managed by means of a computerized system that makes it possible to analyze and examine risks in the portfolio in accordance with changes that occur in the market. The Board of Directors’ restriction on the risk of volatility in the management of the options portfolio is a VAR of USD 3.75 million. The actual position on December 31, 2007, was a VAR of USD 2.1 million. The highest VAR in 2007 was USD 2.1 million.
For information regarding the regulatory capital adequacy requirement in respect of market risks, see the section Capital Adequacy. -51-
Positions in Shares in the Banking Portfolio
The Bank has two main types of holdings in shares in its banking portfolio:
A. An investment in shares of Bezeq. In accordance with the directives of the Supervisor of Banks, the credit for which the collateral is a share of Bezeq was reclassified from the item “credit to the public” to the item “securities in the available-for-sale portfolio.” Dividends received from this company are included in the statement of profit and loss, under the item “Profit on investments in shares, net”. This investment is recorded in the balance sheet as of December 31, 2007 at a total of NIS 126 million, compared with NIS 127 million on December 31, 2006. See additional details in Note 3.
B. Investments through the subsidiary Union Investments and Enterprises (U.I.E.), which serves as the non- financial investment arm of the Bank. The company focuses on improving the Bank’s return on equity by investing in companies in various fields of activity other than banking and complementary activities to banking. Accordingly, the company carries out investments with the intention of participating in the investee companies’ profits over the long term, and in certain cases realizing the investment at a profit within a period of several years (through an offering or sale to a third party).
Investments are carried out in accordance with investment policies and work plans that establish limits and objectives, including preferred fields. A limit of up to 20% of the capital of a single company and up to 15% of the capital of the Bank in non-financial investments applies by law, with certain exceptions.
A decision is currently in effect according to which the Bank’s investment in non-financial corporations shall not exceed USD 45 million.
The Board of Directors of the Bank has restricted the company’s authority with regard to individual investment to NIS 12 million. Any individual investment greater than this amount requires additional approval by the Board of Directors of the Bank.
The balance-sheet balance of the investment in equity-basis investee companies as of December 31, 2007 totaled NIS 16 million, compared with NIS 42 million on December 31, 2006. See details in Note 5.
The balance-sheet balance of the investment in other companies as of December 31, 2007 totaled NIS 101 million, compared with NIS 67 million on December 31, 2006. These investments are classified as shares in the available-for-sale portfolio – see details in Note 3.
See additional information in the section Critical Accounting Policies and Estimates – Non-Financial Investments.
Liquidity Risk
Liquidity risk is the risk to the Bank’s revenues and shareholders’ equity as a result of an inability to supply liquidity needs, due to the non-availability of resources in shekels and in foreign currency, and due to difficulties in realizing assets within a short timeframe without incurring substantial losses. The Bank takes measures to routinely adjust the liquidity level to the financial environment and business circumstances of its activity.
As of 2005, the Bank has based its liquidity-risk management on an internal model. The model was approved by the Board of Directors and is routinely examined by the Management Forum for Financial Matters. In accordance with the working procedure of the Management Forum for Financial Matters, the internal liquidity ratio is discussed weekly, the structure of resources in shekels and foreign currency is discussed monthly, and liquidity policy is discussed annually. An analysis of the Bank’s liquidity position is provided within the exposure document presented to the Board of Directors each quarter.
The purpose of the internal liquidity model is to examine the Bank’s ability to settle its liabilities even when no substitute depositors are added or when there are difficulties in asset realization.
-52-
In quantitative terms, a ratio is calculated by dividing liquid assets that are realizable in practice in all segments by liabilities to be settled within one month. The model takes into account the actual realizability of the bond portfolio held by the Bank and the callability of on-call credit, and assumes a withdrawal forecast based on recent withdrawal history, taking into consideration the level of concentration in the deposit portfolio.
The Board of Directors has set a limit on the liquidity ratio based on the internal model, at a rate of at least two months of liquidity. The liquidity ratio based on the internal model is measured on a daily basis by the Risk Management System. In addition, extreme scenarios are examined.
In July 2007, the Bank of Israel introduced the Zahav real-time gross settlement (RTGS) system. The system allows final intra-day monetary transfers among all banks. The Bank of Israel has stipulated that all direct- payment orders by customers in amounts greater than NIS 3 million must pass through this system.
The operation of the RTGS system has improved the efficiency of decision-making regarding liquidity at the Bank, by providing current information in real time about the Bank’s balance with the Bank of Israel at every point in time throughout the day. However, the system also requires strict controls.
Credit Risks
Credit risk represents the risk that borrowers or debtors may not meet repayments and payments to the Bank under credit agreements. The Bank’s credit policy is based on diversification and controlled management of risks. This policy is reflected in the diversification of the credit portfolio among the different sectors of the economy, a large number of mid-sized and small borrowers, and the different linkage segments.
Principles and rules for providing, managing, and controlling credit have been established within the Bank’s credit policy, in order to improve credit quality and reduce the risk inherent in credit management.
Credit policy and policy regarding the rate of reliance on collateral are discussed and approved annually by the Board of Directors of the Bank. The Bank’s management receives a monthly review of credit developments and attainment of targets.
The Bank’s credit and collateral procedures and the relevant automated systems are continually updated and improved in order to adapt them to the changing business environment and regulatory directives. Concurrently, extensive means and effort are invested in updates and developments of automated control tools and information systems.
Economic sectors:
In general, the Bank’s credit policy is based on diversification of the credit portfolio among the different sectors of the economy.
The Board of Directors of the Bank holds discussions regarding credit to certain sectors, particularly those that are sensitive to fluctuations and those with a high level of sectoral risk compared to other sectors of the economy, and sets policy based on forecast developments in these sectors.
Credit to sectors which are a focus of the Bank’s activity, such as diamonds, residential construction and real estate, and finance, is handled by professional units specializing in these sectors. Specific working procedures and special controls are in place for each sector, in addition to the usual procedures and controls, in order to address the credit risks unique to these sectors.
For further information regarding the breakdown of credit by economic sectors, see Appendix E to the Management Review.
Borrowers size:
-53-
The Bank complies with the guidelines specified in Proper Conduct of Banking Business Directive No. 313, which stipulates that total credit to a single borrower shall not exceed 15% of the Bank’s capital; total credit to a group of borrowers shall not exceed 30% of the Bank’s capital; and the exposure to the six largest borrower groups shall not exceed 135% of the Bank’s capital. The Bank is compliant with these directives and does not deviate from these limits.
For further information regarding the breakdown of credit by borrower size, see Note 4.F.
Geographical distribution:
The Bank operates in the State of Israel. In the construction industry, the majority of credit is granted for residential construction in high-demand areas.
Credit management:
- Factors in granting credit Considerations in granting credit mainly concern the nature of the customer and the customer’s repayment capability, financial stability, liquidity, reliability, time in the industry, time with the Bank, and more. The Bank endeavors to match the type of credit to the customer’s needs and activity. In cases where the Bank relies on the customer’s financial stability, there may be various conditions, primarily the maintenance of various financial ratios.
- Credit-granting authority
Credit granting is based on credit authority at the various levels, up to the level of the Board of Directors’ Credit Committee. Credit-granting decisions that are beyond the personal authority of branch managers and the management of the Corporate Division are made at the level of credit committees, in order to minimize the risk involved in reliance on the judgment of a single individual.
Within credit authority, limits were set on the rate of credit without collateral which each authorized officer may approve.
- Credit control The Bank operates numerous, varied automated control tools, at its branches and headquarters, aimed at the earliest possible detection of changes in customer behavior, formation of collateral gaps, exceptions from approved credit limits, and breaches of authority. The Bank integrates information from external sources with its control tools in order to identify activities and events that may influence customers’ ability to repay their debts.
An automated system that identifies potential problems with customers who are not classified as having problematic debts is used for early detection of such problems.
- Training The Bank invests extensive resources in training employees involved in the area of credit, including training new employees in specially designed courses, advanced courses for experienced employees in this area, a forum of corporate department heads, analysis of lessons learned from various events, etc.
In addition, training and refresher courses are provided on the subject of regulation related to credit, including a review of International Financial Reporting Standards (IFRS), in order to improve employees’ ability to analyze financial statements.
Collateral: Collateral policy includes principles and rules regarding the types and volume of collateral. Collateral requirements and rates are derived from the risk level which the Bank is willing to undertake when providing
-54- credit. Special emphasis is placed on borrower ranking and customers’ repayment capability as criteria for granting credit, in addition to the weight accorded to the usual collateral.
Collateral is matched to the type of credit it secures, with reference to the timeframe, type of linkage, and nature and purpose of the credit. The security value of the different types of collateral is derived from their nature, liquidity, quality, and speed of realizability, including changes in value as a result of slowdowns or growth in the borrower’s business environment. The Bank verifies the value of collateral by obtaining current assessor estimates or valuations.
The Bank uses a computerized system to manage collateral in terms of collateral value and validity periods, production of various types of alert reports, and production of information.
In construction credit granted using the “project finance” method, the Bank usually relies on rights to the property involved in the credit as collateral, among other things, in addition to the volume of shareholders’ equity invested in the project.
Treatment of problematic credit and debt collection: The Special Credit Section at the Corporate Division coordinates the handling of problematic customers at the Bank. The process is aimed first and foremost at restructuring customers’ debt and improving their ability to repay the debt. In the absence of such capability, the Section acts to collect the debt, by attempting to reach an arrangement with the debtor, or by initiating legal collection proceedings and other measures to collect the debt and minimize the damage to the Bank. In order to identify borrowers whose risk and exposure level has increased, as early as possible, the Bank uses the “Red Flags” automated system to detect potential problems with customers whose debts are not classified as problematic. For further information, see the section Critical Accounting Policies and Estimates – Provision for Doubtful Debts.
Exposure to corporate bonds: As part of the Bank’s proprietary activity, the Board of Directors has approved investment limits for corporate bonds. The limits refer to the volume of exposure, the permitted bond types and ratings, maximum exposure to a single issuer, diversification limits, and minimum spread by rating. An authority hierarchy was also established for investments in specific bonds.
The investment activity is carried out by the Proprietary Trading Unit in the Financial Management Division. Limit control is performed routinely in corporate-bond investments.
Securitization: The Bank does not conduct securitization activity, except as part of its proprietary investments: securities issued by an SPC (special-purpose company) and other asset-backed securities in the amount of NIS 177 million have been purchased. See information in Note 3.A.
Settlement risk in financial derivatives: The Bank’s activity in derivative financial instruments is conducted with customers, banks in Israel and banks abroad. Activity limits are set for customers, and compliance with these limits is monitored routinely. This monitoring includes current revaluation of transactions with customers at market prices (mark to market), assessments of potential risk according to the type of instruments and market risks, and comparison against limits and collateral. Procedures and rules have been established for control and for working with customers.
The Bank has developed computerized models to measure exposure in derivative financial instruments on the transaction level and on the customer level. Computerized systems are also used to control credit risks in derivative financial instruments. Rules and working procedures have been established to determine the required level of collateral in such transactions, including the required actions to close exposures to transactions and customers.
Activity with banks abroad:
-55-
The Bank’s activity with banks abroad is based on limits approved annually. The Bank aims to increase the number of banks with which it has agreements to offset transactions in the event of a business failure (ISDA agreements), and agreements to reduce exposure to market risks (CSA agreements). The Bank has transaction-clearing arrangements through CLS (Continuous Linked Settlement) which minimize its exposure in clearing these transactions.
For information regarding regulatory capital requirements in respect of credit risks, see the section Capital Adequacy.
Legal Risk
According to the Bank of Israel’s definition, legal risk is the risk of loss resulting from an inability to judicially enforce agreements. Such inability may arise from various circumstances, such as: a lack of material, necessary details in agreements; lack of authority of a party to an agreement; and other legal defects.
The Bank takes a broad-based approach to legal risks and accordingly takes actions, including at its subsidiaries, to minimize risks arising from legislative directives, legal rulings of various judicial courts, and directives and instructions of regulatory authorities (the Israel Securities Authority, the Bank of Israel, etc.).
Within this framework, the Bank acts on several levels:
Opinion statements are prepared on various legal subjects; appropriate procedures are prepared for the implementation of directives arising from changes in legislation and in regulatory guidelines and directives, and as a result of lessons learned from events at the Bank, faults identified, and relevant judicial decisions.
In addition, based on such changes and events, documents and agreements used by the Bank are updated routinely, with regard to the Bank’s relationships with its customers as well as its relationships with other parties.
Further, an ongoing training program, which encompasses instruction in a range of legal subjects, including lessons learned from various events, is carried out at the Bank.
Operational Risk
Operational risk is defined as the risk of loss that may arise from faulty processes; system failures; external and internal events, including embezzlement and fraud; human errors; and a lack of adequate internal examination and control processes. The Control Division was established in 2007, with the aim of increasing the depth of control processes in various areas at the Bank. A comprehensive survey of embezzlement and fraud risks at the Bank was carried out in 2006. The Bank began the implementation of the recommendations of the survey during 2007, and intends to complete the implementation during 2008.
The Bank is preparing to carry out a comprehensive survey of operational risks. The survey will be based on the embezzlement and fraud survey, an examination of processes within the framework of SOX 404, and a survey of compliance with Proper Conduct of Banking Business Directive 357. The survey process and the related activities will be conducted in congruence with the directives of Basel II.
Preparation for Basel II
The Supervisor of Banks has notified banking corporations that they must prepare for the implementation of Basel II recommendations, including all three levels, by the end of 2009. The Supervisor intends to attain this objective through an upgrade of risk-management systems, controls, and corporate governance at banking corporations.
-56-
The Basel II directives are a detailed array of guidelines published over recent years by a committee within the BIS and summarized in 2004-2006. The recommendations of the committee have been adopted by many supervisory agencies, including those in Israel.
The directives are composed of three levels:
A. Allocation of capital against credit risks, market risks, and operational risks using a new method that ties the level of risks and the exposure to risks to regulatory capital requirements.
B. Expansion of supervision and control mechanisms at banks in the areas of risk management, and a requirement for internal capital allocation (ICAAP – Internal Capital Adequacy Assessment Process) in addition to regulatory capital.
C. Expansion of reporting to the public on risk management and control.
The definitions of Basel II, and correspondingly of the Bank of Israel, permit three methods of capital allocation in respect of credit risks: the standard method and two internal-rating methods, the basic (FIRB) method and the advanced (AIRB) method.
In the standard approach, capital allocation is determined according to weightings set by the regulator, based on risk levels; ratings by approved external rating agencies may be used. The Bank of Israel has stated that banks must implement the standard approach by the end of 2009, including compliance with requirements concerning internal capital, as detailed in the second level.
In the internal-ratings approach, banks assess the credit risk of individual borrowers based on models. In the FIRB approach, the bank generates an estimate of the probability of default by the customer (PD). In the AIRB approach, the bank additionally generates estimates of the loss given default (LGD) and the exposure at default (EAD). From these figures, the bank derives the volume of regulatory capital it must hold in respect of the credit exposure to a given borrower.
The Board of Directors of the Bank views the implementation of Basel II processes as a key objective for the coming years, and as an opportunity to maximize business benefits and upgrade control and risk-management processes. The Board of Directors has instructed the Bank’s management to work to implement the basic internal method in the area of credit, while applying the standard method within the timeframe set by the Bank of Israel.
Capital requirements in respect of operational risks will be calculated using the basic indicator method, at this stage.
In accordance with the directives of the Bank of Israel, the Bank is preparing for the production of a QIS (Quantitative Impact Study) delineating the expected capital requirement according to Basel II directives.
Certain disclosure requirements in the third level have already been implemented and integrated in the financial statements and the Board of Directors’ Report for 2007, in accordance with the directives of the Supervisor of Banks.
Preparations for the implementation of Basel II are guided by a steering committee headed by the Head of the Resources Division, and are applied in the work plan as a designated project by the Risk Management System. The management of the Bank monitors the progress of this project on a monthly basis, and the Board of Directors receives quarterly updates on its status. Below are the details of the Bank Management's evaluation of the effect of risk factors in the Bank as at December 31, 2007:
Risk factor Effect of the Risk (High, Medium, Low) 1 Overall Effect of Credit Risks Low 1.1 Borrowers and Collaterals Quality Risk Low -57-
1.2 Industry Concentration risk Medium 1.3 Borrowers/Groups of Borrowers Concentration Risk Medium 2 Overall Effect of Market Risks Low 2.1 Interest Risk Low 2.2 Inflation Risk Low 2.3 Exchange Rate Risk Low 2.4 Share Prices Risk Low 3 Liquidity Risk Low 4 Operational Risk Low 5 Legal Risk Low 6 Goodwill Risk Low
Note: The estimated ranking of the impact of risks is subjective, and therefore cannot be compared among different banks.
Risk levels in the different types of exposure were set with reference to the parameters used by the Bank to manage and measure risks. Different principles and threshold values were set for each type of exposure, derived from actual risk levels versus quantitative limits and values.
The following are details of the method for estimating the effects of the various risks on the Bank:
1. Credit risks –
1.1 Risk in respect of the quality of borrowers and collateral – Risks are classified by the rate of the provision for doubtful debts out of total credit at the Bank and by the effect of this provision on the results of operations of the Bank.
1.2 Risk in respect of sectoral concentration – Risks are classified by the rate of sectoral concentration out of total risk assets of the Bank.
1.3 Risk in respect of borrower/borrower group concentration – Risks are classified by the highest rate of concentration for a borrower group, relative to established thresholds.
Overall effect of credit risks – Classification is based on assessment of the effect of risk related to borrower and collateral quality.
2. Market risks – Risks, including each sub-type of risk and the overall effect, are classified by average daily VAR during the year and by the possible effect of the materialization of such values on the results of operation of the Bank.
3. Liquidity risk – Risks are classified by the actual liquidity ratio during the year relative to internal and regulatory limits.
4. Operational risk – Risks are classified by the actual expense in respect of the materialization of operational risks during the year, and the effect of such expenses on the results of operations of the Bank.
-58-
5. Legal risk – Risks are classified by the actual expense in respect of the materialization of legal risk or by the assessment of claims against the Bank.
6. Risk to reputation – Risks are classified based on past experience and based on the accumulation of all other risks.
Money laundering
The Unit for the Prohibition Against Money Laundering was set up in August 2002 and coordinates the overall handling of implementation of the legislation in the matter of money laundering. Adv. Racheli Friedman was appointed as the party responsible for implementation of the Law for the Prevention of Money Laundering and Financing of Terror.
During 2005, the Law for the Prohibition of Financing Terror – 2005 came into force, as well as Proper Banking Procedure Directive No. 411 in the matter of "The Prevention of Money Laundering, Financing Terror, and Identification of Customers". Further to these laws, the Bank developed a computerized system that scans all of the transactions conducted in the Bank and compares them against a list of terror organizations and activists. In addition, the Bank implemented a computerized system to identify irregular transactions and to monitor the accounts of high-risk customers.
Towards the end of 2006 an amendment of the Prohibition on Money Laundering (The Banking Corporations’ Requirement regarding Identification, Reporting, and Record-Keeping for the Prevention of Money Laundering and the Financing of Terrorism) Order - 2001 came into force. The Amendment includes, among other things, directives and exemptions concerning the actions and entities which the Bank must compare with the list of terror organizations and activists, and refers to additional matters such as changes in amounts to be reported to the Money Laundering Prohibition Authority on transactions carried out with a financial institution in a high-risk country or territory.
The Bank is continuously working on the assimilation of the matter of the Prohibition of Money Laundering and Financing Terror by all of the Bank's and subsidiaries' employees.
Within this process, automated systems at the Bank are continually developed and improved; working procedures are updated; new procedures are established, as necessary; and large-scale education and training processes are carried out among all employees and executives of the Bank. As part of this training, all Bank employees were required to complete a specially designed computerized tutorial on the subject of the prohibition on money laundering and terrorism financing, which was adapted to holders of various positions at the Bank, and to take a computerized test. This subject has also been integrated into the multi-year work plan of internal auditing, and special controls have been established.
Compliance officer
In order to fulfill the responsibility of the Bank to comply with consumer-related requirements of the laws and other regulations, and as a direct extension of the directive of the Supervisor of Banks, the Bank has employed the services of a compliance officer, whose major job it is to assist Bank employees and managers in their responsibility to comply with all of the consumer-related directives. The Compliance Officer acts in accordance with the compliance policy approved by the Board of Directors.
-59-
Capital Adequacy
Minimum Capital Ratio – Proper Conduct of Banking Business Directive 311
This directive is primarily based on the recommendations of the Basel Committee on Banking Supervision, published in July 1988, which establish a uniform format for the measurement of capital ratios and for determining the minimum required rate.
The capital ratio is the ratio of capital (as defined in the directive) to the weighted amount of risk components (as defined in the directive).
According to the directive, banking corporations in Israel are required to maintain an overall minimum capital ratio of 9% on a consolidated-reporting basis. The directive emphasizes that this minimum ratio should not be viewed as optimal. The Supervisor of Banks expects banking corporations to maintain higher ratios.
The Bank of Israel has set a minimum ratio of capital, excluding subordinated notes, to risk components of 7% for the Bank.
In 2007, the Board of Directors of the Bank established that the Bank must maintain an overall minimum capital ratio of no less than 11%.
The work plan for 2008, which has been approved by the Board of Directors of the Bank, assumes that as a rule, an overall minimum capital ratio of 11.5% will be maintained.
The following sections present summarized information regarding the calculation of the Bank’s capital and weighting of risks for the purposes of the implementation of the directive.
Measurement of capital :
The method of calculating capital for the purposes of this directive is based on the division of capital into primary (Tier I), secondary (Tier II), and tertiary (Tier III) capital; secondary capital is composed of two types, which cannot exceed a certain rate of primary capital. Tertiary capital is used to cover exposure to market risks only.
Components of the Bank’s capital are detailed in Note 13 to the financial statements. The Bank’s primary capital is composed of shareholders’ equity in the balance sheet, neutralizing the capital fund in respect of the available-for-sale portfolio, and net of unattributed goodwill.
Secondary capital consists of the general provision for doubtful debts and subordinated notes, as defined in the directive, which are issued from time to time, both by the Bank and by its wholly owned subsidiary Union Issuances Ltd. (the proceeds of the subordinated notes issued by the subsidiary are deposited in full with the Bank). These subordinated notes are included in accordance with the requirements of the directive, such that the term to maturity of the principal is at least five years from the date of issuance, with 20% deducted at the beginning of each of the last five years before maturity.
The Bank’s investments in shares of affiliated companies that are not non-financial corporations are also deducted from this capital.
-60-
Risk weighting:
Risk components defined in the directive refer to credit risks and market risks. Details of risk components and weightings, including conversion coefficients, are provided in Note 13 to the financial statements.
Credit risk – Balances of all assets in the Bank’s balance sheet and of off-balance-sheet items are weighted by credit-risk levels, as detailed in the directive.
Credit-risk ratings are based on the type of customer or counterparty to the transaction (taking into consideration the final responsibility for the debt). In transactions defined as off-balance-sheet items (guarantees, credit certificates, forwards, etc.), the balances of the transactions are multiplied by various conversion coefficients, prior to weighting by credit-risk rating.
Market risk – The Bank calculates the capital requirement in respect of market risks according to the standard model specified in Proper Conduct of Banking Business Directive 341, as follows:
A. Capital requirement in respect of interest-rate risk –
The calculation is performed based on the tradable portfolio. The tradable portfolio includes all off- balance-sheet products as well as bonds listed in the Bank’s proprietary trading portfolio. The calculation is carried out on the RiskPro system, using the duration system.
B. Capital requirement in respect of share-price risk –
Calculated based on the Bank’s total share holdings. In holdings of convertible bonds, the implied option in the convertible bonds is calculated, with the addition of the delta for share risk. In holdings of options, the delta is calculated and added to the holding as an underlying asset.
C. Capital requirement in respect of exchange-rate and inflation risk –
Risk is assessed based on fair value, separately for each of the currency segments: unlinked shekel, CPI- linked, USD, EUR, CHF, JPY, GBP, and other FX.
D. Capital requirement in respect of option risk –
The bank maintains option portfolios in several currency pairs. In each portfolio, the capital requirement is calculated based on the portfolio under management, including implied options under management, using the “delta plus” method.
The Bank routinely monitors its minimum capital ratio, as required in the directive. Note 13 to the financial statements provides detailed information regarding the measurement of capital and weighting of risks as of December 31, 2007 and December 31, 2006.
-61-
The following table summarizes data from Note 13, in NIS millions: December 31 2007 2006 Primary capital 1,560 1,530 Secondary capital 798 513 Total capital 2,358 2,043
Credit risk assets 19,126 16,974 Market risk assets 546 645 Total risk assets 19,672 17,619 Ratio of overall capital to risk assets 11.99 11.60 Ratio of overall capital excluding subordinated notes to risk assets 8.19 8.98
Capital Planning in 2008 Work Plan As noted above, the work plan for 2008 is based on a working assumption of attainment of a minimum capital ratio of 11.5% and a primary capital ratio of 7.8%. These ratios are stricter than required by the directives of the Supervisor of Banks and were set to comply with the requirements of the Board of Directors of the Bank, as described above. For further information regarding the Board of Directors’ recommendation to the general assembly regarding an offering of hybrid capital, see the section Investments in the Bank’s Capital and Transactions in its Shares, Section E. The plan includes expansion of secondary capital, as necessary, by raising capital notes (through the subsidiary Union Issuances Ltd., based on a shelf prospectus), in order to maintain an optimal capital structure for compliance with profitability and return targets. Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
Preparation for Basel II The Supervisor of Banks has notified banking corporations that they must prepare for the implementation of Basel II recommendations, including all three levels, by the end of 2009. The Basel II directives require an allocation of capital against credit risks, market risks, and operational risks using a new method that links the level of risks and risk exposure to regulatory capital requirements. For further information regarding the directive and the relevant preparations at the Bank, see the section “Risk Exposure and Management.”
Critical Accounting Policies and Estimates
The accounting policies used in preparing the Bank’s financial statements are set out in Note 1 to the financial statements. Implementation of these policies by Bank Management involves the use of various estimates and assumptions that affect the values of assets, liabilities, and the business results of the Bank. We present below various issues regarding which, the estimates and assumptions used in the preparation thereof are sensitive to changes in various variables that may affect the results of operations. Bank Management believes that the estimates and assumptions used in preparing the financial statements are fair and were arrived at on the basis of the best of its knowledge and professional discretion.
-62-
A. Provision for doubtful debts
The provisions for doubtful debts include specific provisions as well as a general and supplementary provision whose purpose is to adjust the value of the credit portfolio to the balance-sheet date, in accordance with the directives of the Supervisor of Banks and generally accepted accounting principles. For details of the amounts of the provisions, see Note 4C to the financial statements.
The specific provisions reflect the loss inherent in the credit portfolio, including indebtedness in off- balance-sheet items.
The Bank routinely examines the credit portfolio in order to identify, as early as possible, borrowers whose risk and exposure level has increased. An automated early-detection system identifies potential problems with customers whose debts are not classified as problematic. Customers flagged by the system are evaluated individually and discussed by the Special Credit Committee, which determines the method of handling each borrower, including the classification of debts as problematic and the need for provisions and/or special monitoring and accompaniment with the aim of improving the borrowers' condition.
The adequacy of the provision is calculated based on assessments of the customer’s ability to continue to endeavor to repay the debt, the ability to realize collateral (based on an assessor’s evaluation, when necessary), and the ability to collect from the debtor, according to a systematic methodology approved by the Board of Directors of the Bank.
Amounts of provisions are established and past provisions are updated regularly, based on renewed assessments (performed quarterly) of the problematic-debt cases at the Bank. These decisions are approved by the Head of the Corporate Division and by the General Manager of the Bank, and discussed quarterly by the Balance Sheet Committee of the Board of Directors of the Bank.
Information on debts, collateral, and proceedings underway to collect the debts of the main customers for whom provisions are required or provisions were made during the year is used as background material for the committee’s discussions.
The balance of the specific provision in the balance sheet is NIS 878 million as of December 31, 2007, compared with NIS 836 million on December 31, 2006.
The provision by extent of arrears comprises the specific provision for doubtful debts in respect of housing loans. This provision is determined in accordance with the directives of the Supervisor of Banks. The rate of the provision increases in proportion to the extent in arrears. The first period in arrears for which the provision must be made is in excess of six months for which the provision is 8%. For debts in arrears longer than 33 months, the provision will reach a rate of 80%.
The balance of the provision by extent of arrears in the balance sheet is NIS 25 million as of December 31, 2007, compared with NIS 28 million on December 31, 2006.
The supplementary provision is based on exceptional credit amounts and on risk characteristics in borrowers' portfolios, as determined in Proper Conduct of Banking Business Directive No. 315.
Criteria for the classification of debts as problematic and the division of such debts into different groups (under special supervision, in temporary arrears, in restructuring, and non-income bearing) are as determined in Proper Conduct of Banking Business Directive No. 314. Debts are routinely examined using automated systems that screen for exceptions, arrears or temporary arrears, and potential problems (as detailed in the section on specific provisions), among other things, as well as debt-restructuring arrangements signed with customers.
Debt classification decisions are made concurrently with the examination of the specific provision, and are submitted together for approval by the Head of the Corporate Division and the General -63-
Manager of the Bank and discussed on a quarterly basis by the Balance Sheet Committee of the Board of Directors of the Bank.
The balance of the supplementary provision in the balance sheet is NIS 15 million as of December 31, 2007, compared with NIS 18 million at the end of 2006.
The general provision for doubtful debts is 1% of the total customer indebtedness as of December 31, 1991. As of December 31, 2007 and 2006 it amounted to NIS 52 million.
The Supervisor of Banks has issued new directives regarding the “Measurement and Disclosure of Impaired Debts, Credit Risk, and Provisions for Credit Losses,” for implementation in the financial statements of banking corporations as of January 1, 2010.
For further information regarding the main points of the new directive and its impact, see details in the section Legislative Developments and in Note 1Y(3).
B. Derivative Financial Instruments
The Bank has extensive operations in derivative financial instruments, both in its activity for its customers and within its asset and liability management policy (closing or creating market exposures).
These instruments include futures, forwards, swaps, and options on interest rates, currencies, shares, commodities, and others. In accordance with the directives of the Supervisor of Banks, all derivatives are measured at fair value (see details of measurement principles in Note 1L). In derivative instruments traded in an active market, which have a market value, the market value represents the fair value. In derivative instruments not traded in an active market, which do not have a market value, fair value is estimated using commonly accepted pricing models, which take into account the risk inherent in the instrument (e.g. the current value of future cash flows expected from the instrument, the B&S model for options, etc.). Note 18 to the financial statements provides comprehensive information about the Bank’s activity in these instruments. Section (A)(2) of the note provides information regarding the fair value of the instruments by type of instrument.
The Bank’s activity in derivative financial instruments within its asset and liability management policy creates measurement gaps between the economic measurement, which is used for risk- management purposes, and the accounting measurement.
For the purposes of risk management, all financial instruments (including derivatives) are measured at fair value. For accounting presentation, financial instruments are usually measured on an accrual basis, whereas derivative financial instruments are measured at fair value, as noted above. This lack of symmetry caused a decrease of NIS 2 million in profit from financing activity in 2007, compared with a decrease of NIS 21 million in 2006.
C. Actuarial Calculations of Liabilities Related to Employee Benefits
Details regarding employee benefits are presented in Note 14 to the financial statements. In calculating the Bank’s liabilities in respect of these benefits, the Bank uses external actuarial calculations in the following areas:
Pension rights – Refers only to some employees, mainly executives and authorized signatories at the Bank, as well as retired executives who elected the pension track.
Seniority bonuses - Applicable to all permanent employees of the Bank.
The actuarial calculations were performed using the accrued benefit evaluation method, which reflects an actuarial assessment of expected benefits at the date of entitlement, spread linearly over the
-64-
period of employment, up to the reporting date, taking into account the forecast future increase in wages with respect to such benefits.
The actuarial calculations are sensitive to changes in the capitalization rate and in the forecast rate of annual wage increases, among other factors. For example, a change of 0.5 percentage points in the capitalization rate would change this liability by NIS 10 million; a similar change in the forecast rate of wage increases would change the liability by NIS 5 million. The amounts of the actuarial calculations are also sensitive to mortality tables. Changes in these tables usually have a material impact. In 2005, the Ministry of Finance issued a directive to insurance companies to begin using new tables with longer life expectancies. On November 23, 2005, the Supervisor of Banks instructed banks to implement these tables no later than the end of the first quarter of 2006. The Bank included an expense in the amount of NIS 9 million in its financial statements for 2005 in respect of the change in mortality tables. An additional expense in the amount of NIS 5 million was recorded in the first quarter of 2006.
In February 2007, the Chief Actuary of the Capital Market, Insurance, and Savings Division at the Ministry of Finance issued circulars to pension funds and insurance companies stating that pension and life-insurance reserves are to be assessed on the basis of new actuarial tables. The Bank adopted the new tables in the first quarter of 2007, and recorded payroll expenses in the amount of approximately NIS 5 million as a result.
D. Classification of investments in securities The Bank’s investments in securities are focused on government bonds. Securities are classified according to intended purpose; accordingly, different measurement rules have been established for each type of investment.
Trading Securities– are purchased with the intention of selling them in the short-term, taking advantage of changes in market price. Securities classified for trade are presented in the balance sheet at market value, and changes in market value are immediately recognized as income or expenses.
The balance of securities held for trading in the balance sheet as of December 31, 2007 is NIS 1,530 million, compared with NIS 1,221 million as of December 31, 2006.
Held to Maturity Bonds – are purchased with the intention and ability to hold them until redemption. Held to maturity bonds are presented in the financial statements at their adjusted value, and income derived there from is recognized on the accrual basis. As of the balance sheet date, the Bank does not have a portfolio of securities held to maturity.
Securities Available for Sale – include securities not classified into the previous two classes. These securities are presented in the financial statements at their fair value and the income there from is recognized on the accrual basis. The difference between market value and adjusted value of these securities is carried to a capital reserve. The balance of securities available for sale in the balance sheet as of December 31, 2007 is NIS 6,521 million, compared with NIS 5,066 million as of December 31, 2006. Note 3 to the financial statements provides details of unrealized profits and losses from adjustment to fair value, with a breakdown into securities available for sale and securities held for trading.
In securities available for sale (Section A in Note 3), the balance of securities that have accrued unrealized profits, less the balance of securities that have accrued unrealized losses, represents the amount allocated to a capital fund (before tax): a total of NIS 30 million as of December 31, 2007, versus NIS 53 million as of December 31, 2006. In securities held for trading (Section B in Note 3), the balance of securities that have accrued unrealized profits, less the balance of securities that have accrued unrealized losses, represents the amount allocated -65-
to profit and loss (before tax): a loss in the amount of NIS 5 million as of December 31, 2007, versus profit in the amount of NIS 1 million as of December 31, 2006.
E. Contingent liabilities Contingent liabilities are handled in accordance with the directives of the Bank of Israel regarding this matter. According to these directives, contingent liabilities are classified in accordance with the probability of the exposure to risk, based on the opinions of the Bank's legal counsel, as follows: A probable risk of more than 70% - requires that a full provision be made. Possible risk at a probability of 20% to 70% – No provision required. Requires disclosure if the aggregate amount of the claims is material. Remote risk at a probability of less than 20% – No provision required. Requires disclosure of the maximum possible loss, if the amount is highly material. For further information, see details in Note 17C(13) to the financial statements.
F. Non-financial investments The Bank’s non-financial investments are made through its subsidiary, Union Investments and Enterprise, Ltd. (A.S.Y.). Companies in which the Bank holds less than 20% are presented on the cost basis. The investment in affiliated companies is presented on the equity basis, on the basis of the financial statements of those companies. The excess of the cost of the investments over the fair value of the assets of the investee company is recorded as goodwill and amortized over the ten-year period following the date of acquisition – see Note 1.E(4) to the financial statements. In order to ensure that non-financial investments are not presented at amounts in excess of their recoverable value, the Bank implements the procedures as mandated in Israeli Accounting Standard No. 15. For more details, see Note 1U to the financial statements. For details of the Bank’s investments in affiliated companies, see Note 5 to the financial statements.
G. Buildings and Equipment Buildings and equipment are stated in the balance sheet at cost, less accrued depreciation and less losses from decline in value, if any. The Bank applies Accounting Standards 27 (Fixed Assets) and 30 (Intangible Assets), with the exception of areas in which the Supervisor of Banks has set forth specific directives. See details in Note 1.X to the financial statements. Depreciation percentages are based on the estimated economic life of the asset. The Bank uses the best available information, including past experience, to make such estimates. In addition, the Bank makes use of reasonableness tests performed by an external consultant. Costs of the development of software for internal use are capitalized as investments in equipment after the end of the initial planning stage, and depreciated from the date of operation of the software, according to an estimate of the period of time for which it will be used. The Bank implements procedures in order to ensure that the value of assets in the balance sheet does not exceed their fair value. When necessary, the Bank records a decline in value. The test for decline in value of assets is a comparison of the book value of the asset to its recoverable value, which is the higher of its exercise price and its exercise value. See details in Note 1U to the financial statements with regard to the implementation of Accounting Standard 15 (Impairment of Assets).
Legislative Developments Developments in Legislation and in Proper Conduct of Banking Business Directives:
Bank of Israel Public Reporting Directives – Measurement and Disclosure of Impaired Debts, Credit Risk, and Provisions for Credit Losses -66-
Main points of the directive are described in Note 1.Y(3) to the financial statements. On December 31, 2007, a circular was issued by the Bank of Israel amending the Public Reporting Directives of the Bank of Israel concerning the accounting treatment of provisions for credit losses and impaired debts, and the disclosure of these matters in reporting to the public by banks. The directive will be implemented in the financial statements of banking corporations from January 1, 2010 forward, a one-year postponement relative to the date in the previous draft published. The directive will not be applied retroactively to financial statements for previous periods. Adjustments of the balance of the provision for credit losses in respect of credit to the public and in respect of off-balance-sheet credit instruments as of January 1, 2010, as a result of the requirements of the directive, including the requirement to determine the provision as well as documentation requirements, will be included directly in the item “surpluses in shareholders’ equity.” The Bank is preparing to implement the directive and examining the effects of this implementation on its results of operations. The existing measurement systems at the Bank were constructed on the basis of assumptions and definitions that differ from those in the directive; they therefore cannot provide relevant information for estimating the effects of the implementation of the new directives on the financial statements of the Bank, including on the volume of problematic debts, on the provision for doubtful debts, and on profit from financing activity. At this stage it is therefore not possible to generate a quantitative estimate of the effects of the implementation of the directive on the Bank. However, it is already clear that the implementation of the directive will enlarge the volume of debts in respect of which interest income is recorded not on a current basis but only based on actual collection, as a result of the definition of the debts as impaired debts. This refers to debts presently defined as partially doubtful income-bearing debts as well as debts currently defined as debts in temporary arrears, among others. As part of the Bank’s preparations for the implementation of the directive, a committee headed by the Head of the Corporate Division was appointed to establish work methods, prepare for the installation of new automated systems, and adjust the Bank’s methodology for the calculation of specific and group provisions to the directive. The Bank relies on the automated systems of Bank Leumi and closely follows changes to these automated systems in order to implement the required work processes. In addition, the Bank is examining the required changes to its independent systems, or alternatively, the creation of information files from these systems, to be transferred to Bank Leumi systems for the calculation of the specific and group provisions, as required in the directive.
Banking Law (Customer Service) (Amendment No. 12) - 2007
On July 5, 2007, an amendment to the law regularizing the supervision of bank fees was published. The amendment to the law applies to individual customers as well as to businesses with a monetary turnover to be determined by the Governor of the Bank of Israel (hereinafter: the “Governor”).
The amendment grants the Bank of Israel authority in the following three main areas: supervision of the rates of fees; cancellation of fees found to be superfluous; and publication of periodic comparisons of the rates of fees at different banks.
Implementation of the law is divided into three stages. In the first stage, the Governor will be entitled to establish a list of banking services which will be the only services for which banks may charge fees. In the second stage, the Governor will be entitled to declare services to be under supervision, at his discretion, in accordance with his considerations and with market conditions. In the third stage, the Governor will be entitled to limit the price of any fee, as he sees fit, or to prohibit the collection of any fee.
The amendment incorporates some of the recommendations of the investigative committee appointed by the Economic Affairs Committee of the Knesset, which were published on June 19, 2007. In addition, in accordance with the amendment, the Banking Rules (Customers Service) (Fees) - 2008 were published on January 8, 2008. These rules implement the first stage of the amendment to the law and establish the full and reduced fee tables formulated by the Supervisor of Banks, which take effect on July 1, 2008.
-67-
The new fee tables reduce many fees, by canceling some fees and consolidating fees charged for services similar in essence and cost.
The Bank is preparing to implement the rules that have been published. In the opinion of the Bank, based on initial estimates, this legislation is expected to reduce the Bank’s revenues in the second half of 2008 by an estimated total of NIS 8 million (before tax effects).
Certain declarations in this section contain forward-looking information. For a definition of this term, see the section Forward-looking information.
Economic Arrangements Law (Legislative Amendments for the Attainment of the Objectives of the Budget and Economic Policy for the Fiscal Year 2008) - 2008
The Arrangements Law published on January 1, 2008 amends the Supervision of Financial Services Law (Engaging in Pension Advising and Pension Marketing), 2005 (hereinafter: the “Supervision of Financial Services Law”). The amendment permits banking corporations with shareholders’ equity of no more than NIS 10 billion to begin providing advisory services for pension-insurance products as of January 1, 2009, subject to receiving an appropriate license from the Supervisor of the Capital Market, Insurance, and Savings at the Ministry of Finance (hereinafter: the “Supervisor”). The amendment permits the expansion of the pension- advisory services of the Bank to pension-insurance products, pursuant to the Supervision of Financial Services Law. Banking corporations with shareholders’ equity greater than NIS 10 billion will be able to begin providing comprehensive pension-advisory services to the general population on all pension products (including pension-insurance products) at later dates, as stipulated in the Supervision of Financial Services Law and in agreements reached between the said banking corporations and the Supervisor, which have been announced in the media.
The Bank holds a license to provide pension advice on non-insurance products to self-employed customers. Its license was recently expanded to cover customers employed by companies as well.
Expansion Order for Comprehensive Pension Insurance under the Collective Agreements Law - 1957 On December 30, 2007, the Minister of Industry, Trade, and Labor signed an expansion order expanding some of the provisions of the general collective agreement dated November 19, 2007 between the Federation of Israeli Economic Organizations, on one hand, and the Histadrut New General Federation of Labor, the Professional Union Division, and the Pensions, Insurance, and Capital Market Division, on the other hand, which requires employers to provide comprehensive pension insurance for their employees, to apply to all employees and employers in Israel as of January 1, 2008.
The Bank is studying the main points of these changes and their effects on its operations.
-68-
Supervision of Financial Services Law (Provident Funds) (Amendment No. 3) - 2008
The amendment, published on January 28, 2008, institutes changes to the Supervision of Financial Services Law (Provident Funds) - 2005, some of which are derived from the legislation and proposed legislation in the area of compulsory pensions.
Under the amendment, there will be two types of pension funds providing allowances: “paying allowance pension funds,” which pay allowances directly, in accordance with their articles, and “nonpaying allowance pension funds,” where funds deposited cannot be withdrawn directly, with the exception of moneys from the compensation component, other than through transfer to a paying allowance pension fund.
The stated objective of the amendment is to allow clients to choose the entity to manage their pension savings, out of a broader range of long-term savings management entities, and to unify the taxation rules applicable to moneys deposited as savings for retirement.
The amendment of the law refers to additional implications arising from the division into the two aforesaid types of funds; the expansion of the choices to which employees are entitled; the terms for withdrawal and transfer of moneys from provident funds; the imposition of various duties on pension advisors; etc. Adjustments were also made to additional relevant legislative directives in the area of financial services.
The Bank is studying the main points of these changes and their effects on its operations.
Payment Systems Law - 2008
A law sponsored by the government and passed by Knesset on February 4, 2008. The law aims to regularize the system of inter-bank transfers in which large sums of money are cleared each day. Among other matters, the law addresses the role of the central bank in relation to these payments systems and stipulates appropriate legislative directives in order to ensure that payment orders in payment systems are final and certain and are carried out in real time (RTGS).
Among other matters, the law also addresses the manner of realization of securities given as a guarantee to secure credit for a banking corporation.
The Bank operates in accordance with the rules issued by the Bank of Israel on this subject. See also Note 17D(1) with regard to liens to secure this activity.
Legislative and Regulatory Initiatives:
Draft Proper Conduct of Banking Business Directive on Environmental Risks
A draft Proper Conduct of Banking Business Directive was issued by the Supervisor of Banks for comments by banking corporations on January 10, 2008. The background for the issuance of the draft is the emerging need for banking corporations to become aware of and manage possible exposures to environmental risks, including various aspects thereof. The draft imposes duties on banking corporations including the following: holding a discussion in the board of directors regarding the manner of management of exposure to environmental risks; defining responsible officers in this area; establishing mechanisms to monitor and control such exposure; and providing supporting means and tools, including relevant training and instruction for employees involved in the process. The Bank is studying the directives of the proposed draft.
Proposal for Rehabilitation of Contaminated Land Law - 2007
A private law proposal submitted to Knesset on October 22, 2007, aimed at protecting land and land reserves, water resources, and public health in Israel against contamination caused by the presence of dangerous substances in soil. Among other matters, the proposed legislation addresses the parties responsible for the evaluation and rehabilitation of contaminated lands, including the option of imposing responsibility on financial entities (including banking corporations) that aided the entity causing the soil contamination.
-69-
Proposal for Priority Rights for Home Buyers Law - 2007
A private law proposal submitted to Knesset on December 17, 2007, according to which in the event of bankruptcy of a contractor, “priority rights” (the status of a guaranteed creditor) would be granted to the buyers of the homes, rather than to the banks. If and as the proposed legislation is passed, banks will no longer enjoy the status of guaranteed creditors in the financing of construction for contractors; this will require the Bank to reconsider the feasibility of continuing this activity, or alternatively, examine the possibility of securing its rights by other means.
Proposal for Sale Law (Homes) (Security of Investments of Home Buyers) (Amendment No. 4) – (Responsibility of the Seller and the Bank and Appointment of a Supervisor) - 2008
A law proposal sponsored by Knesset, published on February 4, 2008, which aims to change the existing legislative arrangement in order to provide better protection to buyers of homes in situations in which the sellers of the homes are unable to meet their liabilities under the sale contract. Among other matters, the proposed legislation would regularize the financing of construction projects by banking corporations; adopt the “voucher system” established by the Supervisor of Banks; establish that buyers’ funds are to be secured by a guarantee under the Sale Law after payment of an amount exceeding 7% of the price of the home; and impose responsibility on banks to ensure that each buyer is given all collateral owed by law. The Bank is studying the main points of the proposal and its effects on the Bank’s manner of operation.
Proposal for Income Tax Law (Adjustments for Inflation) (Amendment No. 20) (Restriction of Application Period) - 2007
A law proposal sponsored by the government, published on December 11, 2007, which aims to rescind the Adjustments Law (the purpose of which was to neutralize the effects of inflation in calculating taxable income, so that the income obtained after adjustments is in real terms) as of the tax year 2008, due to the low rates of inflation in recent years, and due to the fact that the effect of adjustment for inflation at such rates is marginal, biased, and does not justify the cost and effort of complying with the directives of the law.
If the law is rescinded, an effect on the Bank’s results of operations is expected to result, such that every 1% of positive inflation will reduce net profit by approximately NIS 5 million (based on the tax rate and capital base for 2007).
Report of the Financial Instruments Committee of the Israel Securities Authority – Draft for Comments from the Public
On October 17, 2007, the Israel Securities Authority published a draft report which primarily proposes increased supervision of sophisticated financial products such as exchange-traded funds and structured deposits, within the Joint Investment Trust Law - 1994. The draft report also proposes tighter supervision of financial mediators.
The Financial Instruments Committee recommends that the directives of the proposed amendment should not apply to supervised issuance entities such as banking corporations, insurance companies, provident funds, etc. However, the Committee believes that action should be taken to definitively prevent potential conflicts of interest in the financial advisory system by allowing financial advisors to engage solely in investment advising and not in the production of financial products. The Committee therefore recommends that the directive prohibiting investment advisors (such as banking corporations) from issuing exchange-traded funds be fully implemented with regard to index-based products that serve as an economic alternative to these instruments, such as structured deposits, as well.
Given that the manner in which this recommendation, if accepted, may be implemented is not yet known, its effects on the results of operations of the Bank cannot be estimated.
Proposal for Anti-Money Laundering Law (Amendment No. 7) - 2007 -70-
A law proposal sponsored by the government, published on July 11, 2007 and passed in the first reading in Knesset on July 16, 2007. The proposed legislation includes amendments of the Anti-Money Laundering Law - 2000 (hereinafter: the “Law”), on matters including the following:
- Amendments related to the imposition of an anti-money laundering regime on the gem-dealer sector – proposed imposition of identification, recording, and reporting duties on gem dealers with respect to transactions executed in cash.
- Amendments related to criminal aspects of the Law – amendment of Section 3 of the Law, which concerns anti-money laundering offenses; amendments related to the confiscation of property; and amendments related to restrictions on disclosure of the identity of persons making a report. - Expansion of the definition of the term “control,” which appears in the Law. - Amendments related to providers of currency services, primarily the expansion of the currency service provider sector.
- Amendments related to the Israel Tax Authority – proposed expansion of the list of offenses under the Value Added Tax Law - 1975, which constitute original offenses under the Law, and authorization of Tax Authority investigators who are authorized to investigate the original offenses to also investigate all matters related to money-laundering offenses originating in such original offenses. The Bank is studying the law proposal and preparing to act in accordance with the proposal if and when it is legislated.
Draft Equal Rights of Persons with Disabilities Regulations (Accommodations for Accessibility of Services) - 2006; Draft Equal Rights for Persons with Disabilities Regulations (Accommodations for Accessibility of Existing Public Places) - 2006; and guidelines of the Supervisor of Banks on this subject
The regulations being formulated impose an obligation on the Bank to adapt all of its buildings and services for access by persons with disabilities.
In this context, on March 11, 2007, the Supervisor of Banks instructed banking corporations to begin preparing for full implementation of the amendment to the Equal Rights of Persons with Disabilities Law (Amendment No. 2) - 2005, which was passed by Knesset in March 2005 and concerns the prohibition on discrimination and the assurance of accessibility. The amendment stipulates that the banking system, as a provider of a public service, is obligated to make accommodations for accessibility for persons with disabilities of the full range of services provided, by carrying out arrangements and adjustments, including the installation of aid devices and the provision of assistance services.
The Bank is following the provisions of the draft regulations and the directives of the Supervisor and planning its preparations for the implementation of these changes accordingly. In addition, as part of its routine activity in physical planning, maintenance, and construction of new branches and in maintenance and improvements of its headquarters and existing branches, the Bank is also carrying out accommodations for accessibility to customers with disabilities.
-71-
Proposals for Banking Law (Customer Service) (Amendment – Interest on Positive Balance)
Private law proposals that would require banking corporations to pay interest to their customers on positive balances in current accounts; the Governor of the Bank of Israel would be authorized to determine the minimum rate of the interest paid.
Community Activity and Donations
The employees, management, and Board of Directors of the Bank are committed to activity contributing to the community. This activity is carried out both through designated monetary donations and through volunteering initiatives, community involvement, and social activities, mainly with populations with special needs and disadvantaged groups in Israeli society.
The Board of Directors and management of the Bank have established rules and procedures for donations. The bank donates to a variety of entities, with the aim of providing aid in the areas of community and society, education, and health care.
The Bank’s community involvement is expressed in Bank employees’ cooperation with organizations that distribute food baskets to families in need, especially before holidays. Bank employees also participate in fundraising events for community institutions and organizations.
The Bank’s involvement is carried out not only through direct donations of funds to the various organizations, but also through direct aid in the form of purchases of products manufactured by the organizations, within rehabilitation efforts that provide employment to persons in need with the aim of helping them serve in contributing and beneficial capacities and integrate into society.
In 2007, the management of the Bank decided to participate in the Maala Social Responsibility Rating project, which promotes social responsibility through the assimilation of social, environmental, and ethical values into the Bank’s business philosophy.
The total monetary contribution in 2007 amounted to NIS 437 thousand, compared with NIS 303 thousand in 2006.
Disclosure Regarding the Internal Auditor
About the Chief Internal Auditor
The internal auditor of the Bank and its subsidiaries is Mr. Yehuda Orbach. Mr. Orbach has been serving in this role since November 2000. Mr. Orbach is a certified public accountant, holds a degree in economics and accounting from the Hebrew University in Jerusalem, and has some twenty years of audit experience. His former positions include the following: Deputy Commissioner of State Revenues, member of management of the Income Tax and Property Tax Department (currently the Taxes Authority), the head of the computer department at the Finance Ministry's Tax system ("Shaam") (1990 – 1993), the CEO of a management service company at one of the leading CPA firms in Israel (1993), VP and head of the members and supervision department at the Tel Aviv Stock Exchange (1994 – 2000). Mr. Orbach is a lecturer on information systems auditing at the Hebrew University and at Tel Aviv University, and is the author of articles and books, including a book about computerized accounting information systems published by the Open University in 2007. In addition he serves as chairman of the sub-committee on control standards and procedures in computerized information systems at the Institute of Certified Public Accountants in Israel.
The Chief Internal Auditor is an employee of the Bank and meets the conditions specified in Section 3(A) of the Internal Audit Law, Section 146(B) of the Companies Law, and Section 8 of the Banking Rules. He has no material business relationships or other material relationships with the Bank or with any entity related to the Bank. Internal Audit Unit employees also comply with the directives of Section 8 of the Banking Rules.
Appointment Method and Organizational Hierarchy -72-
The Audit Committee and the Board of Directors of the Bank and its subsidiaries approved the appointment of Mr. Orbach in 2000. The Chief Internal Auditor reports organizationally to the Chairman of the Board of Directors of the Bank.
Internal Audit Work Plan
Internal auditing at the Bank follows a multi-year work plan that presents the entities and issues to be audited during the coming two to three years, and a comparison to the audits performed in the preceding three years. The multi-year work plan is based on a risk survey which is updated routinely by the Internal Audit Unit. The survey is also compared to risk surveys performed by the management of the Bank. The annual work plan is based on the Internal Audit Unit’s multi-year work plan; the work plan of the Bank; issues submitted for examination by the Board of Directors, the Audit Committee, and the management of the Bank; and the requirements of government agencies, including the Bank of Israel. The work plan also encompasses the Bank’s subsidiaries.
The work plan is approved by the Chairman of the Board of the Bank, after the Audit Committee has discussed the plan and recommended that the Chairman approve it. Work plans are also approved at consolidated companies, as relevant. The work plan grants the Chief Internal Auditor the discretion to diverge from the plan, subject to advance authorization by the Chairman of the Board of the Bank.
Within the agreement for the provision of computer and operational services between Bank Leumi and Union Bank, the Internal Audit Unit is perusing the audit reports of Bank Leumi that relate to the services provided to the Bank. A process has also been established for the immediate transfer of information referring to the Bank in exceptional cases in which the internal audit unit at Bank Leumi reports on material failures or defects to the audit committee of Bank Leumi.
Material transactions are reported to the Chief Internal Auditor and examined in accordance with the multi- year work plan.
Average Number of Positions in 2007
Chief Internal Auditor 1 Employees of the Internal Audit Unit at the Bank 13
Auditors at subsidiaries 1 This calculation does not include a risk-control position which was transferred to the Control Division mid- year, at the establishment of the division, as well as audits in the area of information technology, which are performed by Leumi for the systems operated by Bank Leumi and used by the Bank.
Performance of Audits
Internal auditing is carried out in accordance with the Internal Audit Law, the Banking Ordinance, the Banking Rules (Internal Auditing), and the professional guidelines of the Institute of Internal Auditors in Israel. The Audit Committee holds discussions from time to time concerning risk mapping and work procedures in internal auditing, with the aim of ensuring that the auditing complies with professional standards.
Access to Information
The Internal Auditor is granted free access, as stipulated in Section 9 of the Internal Audit Law - 1992, including continuous unmediated access to the Bank’s information systems, including financial data. -73-
Reports of the Chief Internal Auditor
Each audit report is submitted in writing to the Chairman of the Board of Directors, the Chairman of the Audit Committee, and the General Manager. A summary of each report is brought before the Audit Committee, which usually convenes once a month, for discussion. In cases of material reports or reports with exceptionally serious findings, the full report is brought before the committee. In addition, in accordance with the Banking Rules (Internal Auditing), the Internal Auditor submits semi-annual and annual reports on the performance of the auditing work plan, semi-annual and annual lists of all audit reports in the reported year, and a report summarizing internal audit activity to the Audit Committee. Discussions of the semi-annual reports for 2007 were held on July 19, 2007 and January 21, 2008.
Board of Directors’ Evaluation of the Activity of the Chief Internal Auditor
In the opinion of the Board of Directors and the Audit Committee, the volume, nature, and continuity of the activity of the Chief Internal Auditor and the internal audit staff and work plan are reasonable under the circumstances, and are sufficient to achieve the objectives of internal auditing at the Bank and its consolidated subsidiaries.
Remuneration
The following table lists payments to the Chief Internal Auditor and components of such payments in 2007, in accordance with the details required in the table of high wage recipients at the Bank:
NIS thousands Salaries and bonuses 814 Compensation, pension, advanced-study fund, vacation, and National Insurance 152 Supplement of provisions for incidental expenses due to changes in wages and retirement terms in the accounting year 27 Total salaries and incidental expenses (excluding wage tax) 993 Other payments (mainly value of vehicle usage) 27 Guarantees provided under ordinary terms 20
In the opinion of the Board of Directors, the payments made to the Chief Internal Auditor of the Bank have no effect on the exercise of his professional judgment.
-74-
The Board of Directors
Information regarding the Directors of the Bank is set out below:
Zeev Abeles, Chairman of the Board – Appointed on November 14, 1999. Chairman of the following committees of the Board of Directors: Executive, Insurance, Urgent Credit Approval, Payroll and Employment, Credit to the Diamond Industry, Computers. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has accounting and financial expertise. CPA; B.A. in Economics, Hebrew University of Jerusalem; B.A. in Accounting, Tel Aviv University. Occupation in the last five years: Chairman of the Board of Union Israel Bank Ltd. Director or officer at the following corporations: Chairman of the Board of the subsidiary Union Investments and Enterprises (A.S.Y.) Ltd. Director at the following companies: Zofnat Consulting Assets and Management (2002) Ltd.; Tchelet (Tel Aviv-Herzliya) Coast Development Co. Ltd.; Zur Shamir Holdings Ltd.; Edgar Investments and Development Ltd.; Melisron Ltd.; Tel Aviv-Jaffa Economic Development Authority Ltd. Chairman of the Administrative Board of the Open University.
Yeshayahu Landau, Vice Chairman of the Board - Appointed on June 15, 1993. Member of the following committees: Executive, Urgent Credit Approval, Payroll and Employment. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. A family member of another interested party of the corporation. Has professional qualification. High-school graduate. Occupation in the last five years: Manager of companies and Vice Chairman of the Board of Union Israel Bank Ltd. Director or officer at the following corporations: Chairman of the Board of Hiram Landau Ltd., the subsidiary Igudim Ltd., and Ratio Oil Prospecting Ltd. Chairman and Director of the Executive Committee of Supergas Ltd.; Member of the Board of Governors of the Technion. General Manager and Director at the following companies: Yeshayahu Landau Holdings (1993) Ltd.; Yeshayahu Landau Properties (1998) Ltd.; Riverton Corporation (Switzerland) Ltd.; Carlton Trading (Switzerland) Ltd. Director at the following companies: Sonol Israel Ltd.; Elok Ltd.; Supergas Ltd.; Bertura Development Ltd.; Carlton Trading (Ukraine); Proceed Venture Capital Fund Management Ltd.; Landlan Ltd.; Hotam Hiram Management (2002) Ltd.; Langat Ltd; Hiram-Epsilon Ltd.; Granit Hacarmel Ltd. and its subsidiaries; and foreign companies abroad.
-75-
Haim Almog – Appointed on September 25, 2001. Member of the following committees: Balance Sheet, Insurance, Credit to the Diamond Industry. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. A family member of another interested party of the corporation. Has accounting and financial expertise. B.A. in Economics, Tel Aviv University. Occupation in the last five years: Manager of businesses. Director or officer at the following corporations: General Manager and Director at the following companies: Bet Tzarfat (Deldar) Ltd.; Helka 197 Gush 7107 Co. Ltd. Director at the following companies: Union Investments and Enterprise (A.S.Y.) Ltd.; Dror Ad. Ltd.; David Lubinski Properties (1993) Ltd.; Cheroudar Properties Ltd.; Almozlino Ltd.; Bet Tzarfat (Management) 1995 Ltd.; Hanyon Bet Tzarfat Ltd.; Maon Ta’asiyati Eniaz Ltd.; Maon Ta’asiyati Apriel Ltd.; Maon Ta’asiyati Elad Ltd.; Maon Ta’asiyati Elpal Ltd.
Michael Herzberg – Appointed on February 17, 2004. Member of the following committees: Audit, Insurance, Computers, Credit to the Diamond Industry. External director under the Companies Law. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has professional qualification. M.Jur. in Law, Hebrew University of Jerusalem; Certificate in Business Administration, Hebrew University of Jerusalem. Occupation in the last five years: Partner at Y. Richter, Herzberg, Yogev, Sivan & Co. Law Offices and Notary. Director or officer at the following corporations: Director at the following companies: Finetrust (Trust & Management) Ltd.; Michael Herzberg Law Company Ltd.; Rahin Properties Ltd.; Munster Guiding Ltd.
Uzi Vardi-Zer – Appointed on April 30, 2006. Chairman of the Balance Sheet Committee. Member of the following committees: Audit, Executive, Urgent Credit Approval. External director under the Companies Law. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has accounting and financial expertise. B.A. in Economics and International Relations, Hebrew University of Jerusalem; Diploma in Business Administration. Occupation in the last five years: General Manager of Housing & Construction Holding Co. Ltd.; Chairman of the Board of Housing & Construction Holding Co. Ltd. and its subsidiaries. Director or officer at the following corporations: Ligat Holdings Ltd.; Gmul Investments Company Ltd.; B. Gaon Real Estate Ltd.; Big Shopping Centers Ltd.; Board of Trustees of the Hebrew University of Jerusalem, Hebrew University Properties; Member of the Governing Board and Administrative Board of the Open University. -76-
Chairman of the following companies: Ligat Holdings Ltd.; Ligat Industries Ltd.
Yigal Landau – Appointed on June 15, 1993. Member of the following committees: Balance Sheet, Computers, Credit to the Diamond Indurstry. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. A family member of another interested party of the corporation. Has accounting and financial expertise. M.B.A. in Business Administration, Tel Aviv University; B.Sc. in Civil Engineering, Technion, Haifa. Occupation in the last five years: Engineer, manager of companies. Director or officer at the following corporations: General Manager of Hiram Landau Ltd. General Manager and Director of Ratio Oil Exploration Ltd. Director at the following companies: H.A. (R&D) Ecological Ltd.; Union Systems Ltd.; Union Investments and Enterprise (A.S.Y.) Ltd.; Pro-seed Venture Capital Fund Ltd.; Hotam Hiram Management (2002) Ltd.; Hiram-Epsilon Ltd.; Dalia Power Energies Ltd.; Langat Ltd.; Landlan Ltd.
Miri Lent-Sharir – Appointed on January 1, 2006. Member of the following committees: Audit, Executive. External director under Proper Conduct of Banking Business Directive No. 301. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has accounting and financial expertise. B.A. in Economics, M.B.A. in Finance and Accounting, Tel Aviv University. Occupation in the last five years: Director at various companies; investment activities as a private investor. Director or officer at the following corporations: Director at the following companies: Taya Investment Company Ltd.; Queenco Leisure International Ltd.
Izaac Manor – Appointed on June 15, 1993. Member of the following committees: Executive, Balance Sheet, Payroll and Employment. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. A family member of another interested party of the corporation. Has accounting and financial expertise. M.B.A. in Business Administration, Hebrew University of Jerusalem. Occupation in the last five years: Manager of companies. Director or officer at the following corporations: Chairman of the Board of Odit Finance (1989) Ltd.; Deputy Chairman of the Board at I.D.B. Holding Corporation Ltd. Chairman and Director of the following companies: David Lubinski Ltd.; Cheroudar Ltd.; Adamit Jerusalem Industries and Car Services Ltd.; Lubex Trading Ltd.; Prime Lease Vehicle Fleet Management Ltd.; Lubit Insurance Agency (1997) Ltd.; Odit Investments Ltd.; Manor Holdings B.A. Ltd.; Manor Investments R.I. Ltd.; Euroman Investments Ltd.; Euroman Automotive Ltd.; D.T.M.S.
-77-
Investments Ltd.; Manor Investments I.D.B. Ltd.; D.L.B. MotoSport Ltd.; I.M.C. Foundries Ltd.; Prime-Rent Car Rental Ltd.; Morgan-Rimon Building Ltd. Joint CEO at David Lubinski Ltd. and Cheroudar Ltd., and Acting Chairman as of October 2000. Director at the following companies: David Lubinski Properties (Holdings) 1993 Ltd.; Lubinski Garage Tel-Aviv Ltd.; Cheroudar Properties Ltd.; Nesher Israel Cement Enterprises Ltd.; Properties and Building Company Ltd.; American Israeli Paper Mills Ltd.; Clal Industries and Investments Ltd.; Super-Sol Ltd.; Discount Investment Corporation Ltd.; Mashav Enterprise and Development Ltd.; I.D.B. Holding Corporation Ltd.; I.D.B. Development Corporation Ltd.; Clal Insurance Enterprises Holdings Ltd.; Cellcom Israel Ltd.; Olympia Morgan Projects Ltd.; Koor Industries Ltd.; Makhteshim Agan Industries Ltd.; Keren Moor International Real Estate Ltd.
Giora Morag – Appointed on October 29, 2006. Member of the following committees: Audit, Credit to the Diamond Industry. External director under Proper Conduct of Banking Business Directive No. 301. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has accounting and financial expertise. Studied Economics and Political Science at the Hebrew University of Jerusalem. Occupation in the last five years: General Manager of branches at Bank Hapoalim in England; Director of companies. Director or officer at the following corporations: Director at Delta Industries Galil Ltd.
Nathan Sharony – Appointed on July 1, 2003. Chairman of the Audit Committee; member of the following committees: Balance Sheet, Insurance, Computers, Payroll and Employment. External director under the Companies Law. Not an employee of the corporation or of a subsidiary or related company or interested party thereof. Not a family member of another interested party of the corporation. Has professional qualification. High-school graduate. Occupation in the last five years: Director of various companies. Director or officer at the following corporations: Director at the following companies: I.D.I. Direct Insurance Company Ltd.; Elbit Systems Ltd.; Genoa Color Technologies Ltd.; Israel Bonds International (I.B.I.); Trotech 21 Water and Wastewater Treatment; Yashir Provident Fund Management.
During 2007, the Board of Directors held 19 meetings in plenary session and 66 meetings of its various committees.
Mr. Yehuda Gil ended his term of service as an external director of the Bank under Proper Conduct of Banking Business Directive No. 301 on June 26, 2007.
The Board of Directors has appointed committees in the following areas, in accordance with its procedures: -78-
1. Executive Committee – deals with approvals of credit based on the authority it was granted. 2. Credit to the Diamond Industry Committee – deals with approvals of credit to diamond merchants based on the authority it was granted. 3. The Audit Committee – holds deliberations on audit reports of various authorities and of the internal auditor, as well as on transactions with interested parties. 4. The Balance Sheet Committee – deals with the gamut of issues relating to the financial statements. 5. The Payroll and Employment Committee – holds deliberations on wage agreements and manpower. 6. The Insurance Committee – holds deliberations on insurance proposals received by the Bank. 7. Urgent Credit Approval Committee – Handles the approval of credit applications classified as urgent, according to stipulated authority levels.
In addition, ad-hoc committees are occasionally appointed.
The Bank’s Board of Directors has stipulated that the minimum number of directors having financial and accounting expertise, in accordance with the provisions of the Companies Law – 1999 (according to Amendment No. 3 – 2005), and based on the criteria stipulated in the Companies Regulations (Conditions and Tests of a Director Having Financial and Accounting Expertise and a Director Having Professional Qualification) – 2005, will be 25% of the total number of directors serving on the Board. In relation to the total number of directors currently in office, ten in number, the required minimum of directors having the said expertise is three. The Board of Directors stipulated also that the minimum number of director having financial and accounting expertise who will serve on the Audit Committee and Balance Sheet Committee of the Bank will be two.
At present, there are seven directors with the required accounting and financial expertise: Zeev Abeles, Haim Almog, Yigal Landau, Izaac Manor, Uzi Vardi-Zer, Miri Lent-Sharir and Giora Morag.
The details of each of the aforementioned directors and their credentials as financial and accounting experts are presented below:
Mr. Zeev Abeles – Mr. Abeles’s professional experience includes his tenure as Supervisor of Banks and member of the senior management of Bank of Israel, member of the Israeli Securities Authority, Chairman of the Central Securities Company Ltd., and Chairman of the Bank’s Board since November 1999. His membership in the boards of directors of various companies, his educational background in economics, and his CPA qualification grant him an understanding of business issues and enable him to understand the financial statements of the Bank in depth and initiate discussions of the manner of presentation of the financial data of the Bank.
Mr. Haim Almog – Mr. Almog’s professional experience as an executive at various companies, such as his service as General Manager of Dror Paz Ltd. and as General Manager of ATNA Ltd., and as a director at various companies, as well as his education, which includes a degree in Economics, grant him an understanding of business issues and enable him to understand the financial statements of the Bank in depth and initiate discussions of the manner of presentation of the financial data of the Bank.
-79-
Mr. Yigal Landau – Mr. Landau’s professional experience as CEO of a number of companies, including Hiram Landau Ltd., Ratio Oil Exploration Ltd., and Pro-seed Venture Capital Fund Ltd, and as a director of various companies, together with his education that includes a Masters degree in Business Administration, provide him with the understanding of business issues and the expertise needed to have an in-depth understanding of economic matters and the Bank’s financial statements and put him in a position at meetings of the Board to raise issues and questions relating to the presentation of the Bank’s financial data. Mr. Izaac Manor – Mr. Manor’s professional experience as General Manager of David Lubinski Ltd. and Cheroudar Ltd. and as Acting Chairman of the Board of these companies, and as a director at various companies, as well as his education in Business Administration, grant him an understanding of business issues and enable him to understand the financial statements of the Bank in depth and initiate discussions of the manner of presentation of the financial data of the Bank.
Mr. Uzi Vardi-Zer – Mr. Vardi-Zer’s professional experience as deputy CEO of Bank Hapoalim Ltd. and as the CEO and chairman of the board of Housing & Construction Holdings Ltd. and other companies, together with his education which includes a degree in economics and in Business Administration, provide him with the understanding of business issues and the expertise needed to have an in-depth understanding of economic matters and the Bank’s financial statements and put him in a position at meetings of the Board to raise issues and questions relating to the presentation of the Bank’s financial data.
Ms. Miri Lent - Sharir – Ms. Sharir's professional experience as a vice president of Ampal Ltd. (an investment company), as an assistant CEO in Housing & Construction Holdings Ltd., and as a director in various financial companies, together with her education that includes a bachelors degree in economics and a masters degree in Business Administration provide her with the understanding of business issues and the expertise needed to have an in-depth understanding of economic matters and the Bank’s financial statements and put her in a position at meetings of the Board to raise issues and questions relating to the presentation of the Bank’s financial data.
Mr. Giora Morag – Mr. Morag's professional experience as a general manager of the branches of Bank Hapoalim in England and as general manager of American-Israel Bank, as director in Delta Industries Galil Ltd., and as chairman of its audit committee, together with his education in economics provide him with the understanding of business issues and the suitable expertise needed to have an in-depth understanding of the Bank’s financial statements and put him in a position at meetings of the Board to raise issues and questions relating to the presentation of the Bank’s financial data.
The Board of Directors believes that the minimum level it has stipulated places the Bank in a position to meet its obligations in general, and its obligations to examine the financial position of the Bank and examine and approve the financial statements in particular, on the basis of the following reasons:
1. The other members of the Board of Directors, not included in the number of directors having accounting and financial expertise, possess the education, experience and skills required of a director having professional qualification, as detailed in the Companies Regulations (Conditions and Tests of a Director Having Financial and Accounting Expertise and a Director Having Professional Qualification) – 2005. 2. The directives of the Supervisor of Banks regarding committees of the board of directors, allow for a minimum membership of three members of the Board in a subcommittee to which it delegates its authority. This testifies to the fact that the minimum number of directors having accounting and financial expertise on the Bank’s Board of Directors is adequate for purposes of conducting a professional and pertinent assessment of the financial statements. This number allows the Board to discuss matters and arrive at a decision even in the event of a difference of opinion.
-80-
Members of Management and Senior Officers
Members of Management:
Mr. Haim Freilichman President & C.E.O.
Mrs. Edith Luski Senior Deputy General Manager; Head of Retail Banking, Client Asset, and Advisory Division
Mrs. Edna Peres-Lachish Deputy General Manager; Head of Corporate Division
Mr. Efraim Avraham Deputy General Manager; Head of Financial Management Division
Mrs. Netta Avrahamov Bitan Deputy General Manager; Head of Chief Accountant Division
Dr. Akiva Sternberg Deputy General Manager; Head of Control Division
Mr. Hami Morag Deputy General Manager; Head of Resources Division
Other Senior Officers:
Adv. Racheli Friedman Deputy General Manager; Chief Legal Advisor
Mr. Yehuda Orbach Deputy General Manager; Chief Internal Auditor
Adv. Irit Makov-Yerushalmi Secretary of the Bank
Mr. Gil Kurtz resigned as Chief Accountant of the Bank on February 28, 2007. The Board of Directors of the Bank thanked Mr. Kurtz and wished him success in his future endeavors. Mr. Kurtz was replaced by Ms. Netta Avrahamov Bitan.
On April 30, the Board of Directors of the Bank resolved to establish the Control Division, effective July 1, 2007, headed by Dr. Akiva Sternberg, who served as Head of the Investment Division until that date. In this capacity, Dr. Sternberg will oversee controls in the various areas of the Bank’s operations.
Mr. Efraim Avraham, who served as Deputy Head of the Investment Division, was appointed to replace Dr. Sternberg as Head of the Financial Management Division (formerly the Investment Division) as of July 1, 2007.
On November 26, 2007, Adv. Irit Makov-Yerushalmi was appointed Secretary of the Bank, effective December 10, 2007. Adv. Racheli Friedman served as Secretary of the Bank until that date.
The Board of Directors wishes them success in their assignments.
-81-
Information regarding the members of management is set out below:
Mr. Haim Freilichman – President & C.E.O, appointed in 2006. Chairman of the subsidiary Union Systems Ltd.; Director at the subsidiary Union Investments and Enterprise (A.S.Y.) Ltd. Not a family member of another interested party of the corporation. CPA; B.A. in Economics and Accounting, Bar Ilan University, Ramat Gan; M.A. in Business Administration, Bar Ilan University, Ramat Gan. Occupation in the last five years: Financial consultant; Chairman of Kardan Real Estate; General Manager of Bank Tefahot.
Mrs. Edith Luski – Senior Deputy General Manager; Head of Retail Banking, Client Asset, and Advisory Division, appointed in 2004. Director at the following subsidiaries: Carmel Union Mortgages and Investments, Livluv Insurance Agency (1993) Ltd., Igudim Insurance Agency (1995) Ltd., Union Leasing Ltd., and Igudim Ltd. Not a family member of another interested party of the corporation. M.A. in Economics and Statistics; B.A. in Economics, Tel Aviv University. Occupation in the last five years: General Manager of Bank Mishkan Ltd.
Mrs. Edna Peres-Lachish – Deputy General Manager; Head of Corporate Division, appointed in 2004. Chairman of the subsidiary Union Leasing Ltd.; Director at the following subsidiaries: Igudim Ltd., Achuzat Yehuda Ltd., Kikar Zion Ltd. Not a family member of another interested party of the corporation. M.A. in Business Administration, B.A. in Economics, Tel Aviv University. Occupation in the last five years: Manager of the main branch of the Bank in Tel Aviv; Head of the Retail Banking and Risk Management Division at the Bank.
Mr. Efraim Avraham – Deputy General Manager; Head of Financial Management Division, appointed in 2007. Chairman of the subsidiary Union Finances Ltd. (formerly U.M.F.); Director at the following subsidiaries: Union Issuances Ltd., Union Financial Operations Ltd. Not a family member of another interested party of the corporation. High-school graduate. Occupation in the last five years: Deputy Head of the Investment Division at the Bank.
-82-
Mrs. Netta Avrahamov Bitan – Deputy General Manager; Head of Chief Accountant Division, appointed in 2007. Chairman of the subsidiaries Igudim Insurance Agency (1995) Ltd., Union Capital Markets Ltd., Union Issuances Ltd., Union Financial Operations Ltd., Carmel Union Mortgages and Investments Ltd., Livluv Insurance Agency (1993) Ltd. Director at the following subsidiaries: Union Systems Ltd., Union Bank Trust Company Ltd., Union Bank Nominees Ltd. Not a family member of another interested party of the corporation. CPA; B.A. in Business Administration, Management College, Tel Aviv. Occupation in the last five years: Member of management at Biobank – Chief Accountant and Head of Comptrolling Division. Chief Accountant and Head of Comptrolling Division, Biobank.
Dr. Akiva Sternberg – Deputy General Manager; Head of Control Division, appointed in 2007. Director at the following subsidiaries: Union Balances Ltd., Union Bank Trust Company Ltd. Not a family member of another interested party of the corporation. Ph.D. in Business Administration, Bar Ilan University, Ramat Gan; B.A. in Business Administration, Boston University Ben-Gurion University; B.A. in Economics, The Johns Hopkins University. Occupation in the last five years: Head of the Investment Division at the Bank.
Mr. Hami Morag – Deputy General Manager; Head of Resources Division, appointed in 2006. Chairman of the subsidiary Union Balances Ltd. (formerly Union Provident Funds); Director at the following subsidiaries: Igudim Ltd., Union Systems Ltd. Not a family member of another interested party of the corporation. M.A. in Political Science, Haifa University; B.A. in Political Science, Open University; graduate of Internal Auditing course, Management College, Tel Aviv; studied Economics and Accounting in Montgomery, MD. Occupation in the last five years: Head of the Human Resources Division at the Office of the Prime Minister in Tel Aviv; General Manager of Keren Shemesh for Encouragement of Young Entrepreneurs; General Manager of the Yaniv Initiative for Children and Youth at Risk.
Information about other senior officers is set out below:
Adv. Racheli Friedman – Deputy General Manager; Chief Legal Advisor, appointed in 2005. Director at the subsidiary Union Bank Nominees Ltd. Not a family member of another interested party of the corporation. Attorney; B.A. in Law, Tel Aviv University. Occupation in the last five years: Head of the Special Credit Division at the Bank.
Mr. Yehuda Orbach – Deputy General Manager; Chief Internal Auditor, appointed in 2000. Not a family member of another interested party of the corporation. CPA; degree in Economics and Accounting, Hebrew University of Jerusalem. Occupation in the last five years: Chief Internal Auditor of the Bank and its subsidiaries.
-83-
Adv. Irit Makov-Yerushalmi – Deputy Legal Advisor and Secretary of the Bank, appointed in 2007. Not a family member of another interested party of the corporation. Attorney; B.A. in Law, Tel Aviv University; M.A. in Business Administration, Bar Ilan University. Occupation in the last five years: Senior attorney in the legal advisory system at the Bank.
Controls and Procedures On November 15, 2004, the Supervisor of Banks issued a directive concerning a declaration to be attached to the quarterly and annual financial statements of banking corporations. Starting with the interim reports for June 30, 2005, the General Manager and the Chief Accountant of the Bank each separately sign a declaration regarding “Evaluation of Controls and Procedures Concerning Disclosure,” in accordance with the directives of Section 302 of the law known as the “Sarbanes- Oxley Act,” enacted in the United States (hereinafter: the “Disclosure Declaration”). The Disclosure Declaration refers to controls and procedures regarding disclosure established in order to ensure that information which the Bank is required to disclose in its financial statements is recorded, processed, summarized, and reported in accordance with the Supervisor of Banks’ Public Reporting Directives, and in accordance with additional reporting directives. The “controls and procedures concerning disclosure” are aimed, among other things, at ensuring that such information is accumulated and transmitted to the management of the corporation in a suitable manner in order to allow decisions to be made at the appropriate time with respect to the disclosure requirements.
At this stage, the Disclosure Declaration is not meant to cover the broader aspects of the evaluation of the “effectiveness of internal controls of financial reporting” established in Section 404, which include the planning of a process aimed at providing a reasonable degree of confidence in the evaluation of policies and procedures related to the accuracy and completeness of records, proper authorizations for the recording of receipts and payments, and the prevention and detection of unauthorized actions that may have a material effect on the financial reporting of the Bank.
On December 5, 2005, the Supervisor of Banks issued a circular specifying directives for the implementation of the requirements of Section 404 of the SOX Act. Directives concerning the responsibility of management for the internal control of financial reporting were set forth in Section 404 by the SEC and the Public Company Accounting Oversight Board.
The directives of the Supervisor of Banks in the aforesaid circular stipulate the following: - Banking corporations shall implement the requirements of Section 404 and the SEC directives issued in accordance thereto. - Adequate internal control requires the maintenance of a control system based on a defined, recognized system; the COSO model meets the requirements and can be used for the evaluation of internal control. - Implementation of the requirements of the directive requires the upgrade and/or setup of a system of internal-control infrastructures at the Bank; the development process of this system requires the Bank to make preparations and establish stages and milestones towards full implementation.
The Bank is currently preparing for the implementation of the directive, according to the schedule established, in cooperation with consultants hired for the project.
-84-
Evaluation of Controls and Procedures Regarding Disclosure The management of the Bank, in cooperation with the General Manager and the Chief Accountant of the Bank, have assessed the effectiveness of the controls and procedures regarding disclosure at the Bank as of the end of the period covered by this report. Based on this assessment, the General Manager and the Chief Accountant of the Bank have concluded that, as of the end of this period, the controls and procedures concerning disclosure at the Bank are effective in order to record, process, summarize, and report the information which the Bank is required to disclose in its quarterly report, in accordance with the Public Reporting Directives of the Supervisor of Banks, on the date stipulated in these directives.
Changes in Internal Control The Control Division, which coordinates control activities at the Bank, was established in 2007. The establishment of the division reflects the significance accorded by the Board of Directors and management of the Bank to maintaining adequate controls and tightening such controls, in accordance with the nature and volume of the Bank’s operations. For further information regarding the activity of the division, see the section Activity of the Bank and Description of Business Developments – Changes in Organizational Structure of the Bank. During the fourth quarter, ended on December 31, 2007, there was no change in the Bank’s internal control of financial reporting that had a material impact, or could reasonably be expected to have a material impact, on the Bank’s internal control of financial reporting.
-85-
Details of Payments and Benefits for High Wage Recipients at the Bank The following table lists payments and benefits paid or for which a provision was recorded in the reported year for recipients of the highest wages among the senior officers at the Bank, in thousands of NIS:
Severance Loans granted with benefit terms Loans and pay, Supplementary (benefit terms are identical for all guarantees compensation, provisions for Total employees of the Bank) granted pensions, incidental expenses salaries Other under study funds, due to changes in and payments ordinary Share- vacation, wages and incidental (mainly Average Benefit terms Salaries based jubilee grants, retirement terms expenses value of Balance as term to granted and payment National during the (excluding vehicle of December maturity in during the Name bonuses transactions Insurance accounting year wage tax) usage) 31 years year 2007 Z. Abeles, Chairman of the Board 2,549 650 - 3,199 59 H. Freilichman, President & C.E.O. 2,200 1,970 724 28 4,922 59 134 E. Luski 1,177 251 54 1,482 27 11 E. Peres-Lachish 968 288 218 1,474 32 69 0.8 5 750 E. Avraham (1) 653 * 593 * 1,294 2,540 28 273 1.7 11 11 R. Friedman (2) 737 * 625 *553 1,915 22 620 3.25 3 -
2006 Z. Abeles, Chairman of the Board 2,514 590 330 3,434 54 H. Freilichman, President & C.E.O. (3) 1,239 1,478 534 - 3,251 41 G. Kurtz (4) 970 209 (51) 1,128 30 85 2.4 5 E. Luski 1,120 197 67 1,384 27 14 E. Peres-Lachish 911 ** 474 123 1,508 31 81 0.7 6 D. Kotler (5) 478 14 88 - 580 15
(1) Appointed on July 1, 2007. (2) Transferred to a personal contract as of January 1, 2007. (3) Took office on April 1, 2006. (4) Resigned from the Bank on February 28, 2007. (5) Resigned from the Bank on March 31, 2006.
* Includes effects of the transition from a collective agreement to a personal contract. ** Restated.
Wages are based on personal work contracts. For details regarding the employment contract of the Chief General Manager, see Note 14E to the financial statements. The Board of Directors determined the wages and bonuses paid based on the contribution of the officers to the operations and profitability of the Bank. With regard to the wages of the Internal Auditor, see details in the Board of Directors’ Report, in the section concerning the Internal Auditor. -86-
Remuneration of Auditors(1)
The following table provides details of the remuneration of the external auditors of the Bank:
Consolidated The Bank 2007 2006 2007 2006 NIS thousands NIS thousands NIS thousands NIS thousands
For the audit activity: (2)(3) The external auditors 2,835 2,543 2,570 2,289 Other auditor 383 283 - -
Total 3,218 2,826 2,570 2,289
For additional services: For audit related services: The external auditors 825 567 825 490 Other auditor 14 - - - Tax services: The external auditors 129 86 129 86 Other auditor 1 - - - Other services: The external auditors 34 150 34 150 Total 1,003 803 988 726
4,221 3,629 3,558 3,015
(1) The remuneration of the external auditors includes payments to partnerships and corporations under their control, and payments in accordance with the Value Added Tax Law. (2) Includes audit of the annual financial statements and a review of the interim reports. (3) Includes remuneration paid and remuneration accrued.
-87-
The Board of Directors wishes to thank the Management of the Bank, its managers and all of the Bank’s employees for their dedicated work and efforts they have made in advancing the Bank and their contribution in improving the results of the Bank's operations.
Z. Abeles H. Freilichman Chairman of the Board of Directors President & C.E.O.
Tel Aviv, February 27, 2008
-88- Management Review of the Bank’s Financial Position and Results of its Operations
The financial statements were prepared in accordance with directives issued by the Supervisor of Banks. The data contained therein is in reported amounts and expressed in shekels of the end of December 2007. The accompanying data and exhibits are based on the Bank’s financial statements.
The following data and appendices are included in the Management Review:
Selected data from the financial statements
Appendix A Consolidated Balance Sheets as at the end of 2003 - 2007
Appendix B Consolidated Statements of Profit and Loss for 2003 - 2007
Appendix C Rates of Income and Expenses
Appendix D Analysis of Exposure to Interest Rate Fluctuations
Appendix E Overall Credit Risk to public by Economic Sector
Appendix F Consolidated Balance Sheet for the end of Quarter - Multi-quarter information
Appendix G Quarterly Consolidated Statements of Profit and Loss - Multi-quarter information
-89 - Selected Data from the Consolidated Financial Statements
Year ended December 31 2007 2006 Change NIS millions NIS millions %
Profitability Profit from financing activities before provision for doubtful debts 613 539 13.7 Provision for doubtful debts 80 82 (2.4) Profit from financing activities after provision for doubtful debts 533 457 16.6 Operating and other income 283 265 6.8 Operating and other expenses 599 569 5.3 Operating profit before taxation 217 153 41.8 Net operating profit 123 79 55.7 Net profit 126 121 4.1 Net return on the average shareholder's equity of the net profit 8.1% 8.6%
December 31 December 31 2007 2006 Change NIS millions NIS millions %
Balance sheet Credit to the public 17,503 17,270 1.3 Securities 8,051 6,287 28.1 Deposits from the public 26,713 25,340 5.4 Shareholders’ equity 1,586 1,572 0.9 Total assets 31,622 28,934 9.3
% %
Financial ratios Shareholders’ equity to total assets 5.0 5.4 Operating and other income to the total operating and other expenses 47.2 46.6 Operating and other income to total income 34.7 36.7 Provision for doubtful debts to credit to the public 0.46 0.47 Shareholders’ equity to risk components 12.0 11.6
- 90 - Appendix A
Year-End Consolidated Balance Sheets
December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2004 2003 Adjusted Reported amounts(1) amounts(2) NIS millions NIS millions NIS millions NIS millions NIS millions
Assets Cash on hand and deposits with banks 4,710 4,024 3,512 3,276 1,927
Securities 8,051 * 6,287 * 5,085 * 3,588 * 2,629
Credit to the public 17,503 * 17,270 *15,558 *14,731 *14,652
Credit to the Government - 31 61 56 57
Investment in investee companies 16 42 46 22 27
Bank premises and equipment 327 328 331 330 336
Other assets 1,015 *952 *1,249 *816 880
Total assets 31,622 28,934 25,842 22,819 20,508
Liabilities and Shareholders’ Equity Deposits from the public 26,713 *25,340 *21,957 *19,631 17,486
Deposits from banks 516 90 156 207 155
Deposits from the Government 2 35 8 10 15
Subordinated notes and deposit certificates 1,295 816 926 854 787
Other liabilities 1,510 1,081 * 1,573 * 992 974
Total liabilities 30,036 27,362 24,620 21,694 19,417
Shareholders’ equity 1,586 1,572 1,222 1,125 1,091
Total liabilities and shareholders’ equity 31,622 28,934 25,842 22,819 20,508
* Reclassified.
(1) Discontinuance of the adjustment to the effect of inflation according to the CPI of December 2003. (2) Amounts adjusted to the effect of inflation according to the CPI of December 2003.
- 91 - Appendix B
Statement of Consolidated Profit and Loss For the Year Ended
December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2004 2003*** Reported amounts NIS millions NIS millions NIS millions NIS millions NIS millions
Profit from financing activities before provision for doubtful debts 613 539 582 490 414 Provision for doubtful debts 80 82 149 169 215
Profit from financing activities after provision for doubtful debts 533 457 433 321 199
Operating and other income Operating commissions 236 * 217 221 210 203 Profit (losses) on investments in shares, net 30 31 10 (3) (4) Other income 17 *17 27 27 27 Total operating and other income 283 265 258 234 226
Operating and other expenses Salaries and related expenses 344 329 325 262 303 Maintenance and depreciation of bank premises and equipment 95 83 82 76 76 Other expenses 160 157 147 133 128 Total operating and other expenses 599 569 554 471 507 Operating profit (loss) before taxation in reported amounts 217 153 137 84 (82) Erosions and adjustments*** - - - - 11 Operating profit (loss) before taxation 217 153 137 84 ** (71) Provision for taxation on operating profit 93 74 54 46 **(25)
Operating profit (loss) after taxation 124 79 83 38 **(46) The Bank’s equity in net after- tax operating profits (losses) of investee companies (1) ****- 2 (1) **- Net operating profit (loss) 123 79 85 37 **(46) After-tax profit (loss) from extraordinary activities 3 42 (6) (1) **(4)
Net profit (loss) 126 121 79 36 **(50)
* Reclassified. ** Amounts adjusted to the effect of inflation according to the CPI of December 2003. *** Erosions and adjustments of income and expenses included in the operating profit before taxation in reported amounts according to the CPI of December 2003. **** Amounts up to 500 thousands NIS.
- 92 -
Appendix B (cont'd)
Statement of Consolidated Profit and Loss For the Year Ended (cont'd) Earnings per share data (NIS)
December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2004 2003* Adjusted Reported amounts amounts**
Basic profit: Operating profit (loss) 2.08 1.44 1.73 0.74 (0.94) Extraordinary profit (loss), net of related taxes 0.06 0.76 (0.13) (0.01) (0.08)
Total 2.14 2.20 1.60 0.73 (1.02)
Diluted profit: Operating profit (loss) 2.08 1.42 1.73 0.74 (0.94) Extraordinary profit (loss), net of related taxes 0.06 0.76 (0.13) (0.01) (0.08)
Total 2.14 2.18 1.60 0.73 (1.02)
* Erosions and adjustments of income and expenses included in the operating profit before taxation in reported amounts according to the CPI of December 2003. ** Amounts adjusted to the effect of inflation according to the CPI of December 2003.
- 93 - Appendix C
Rates of Financing Income and Expenses by Linkage Basis - Consolidated (1)
Reported amounts 2007 2006 Income (expenses) ratio Income (expenses) ratio Financing Without Including Financing Without Including average income derivatives derivatives average income derivatives derivatives balance (2) (expenses) effect effect(3) balance (2) (expenses) effect effect(3) NIS millions NIS millions % % NIS millions NIS millions % %
Israeli currency - Unlinked Assets (4) 16,546 850 5.14 * 12,626 806 6.38 Effect of derivates (3) 3,024 126 2,284 - Total 19,570 976 4.99 14,910 806 5.41
Liabilities 15,839 (599) (3.78) * 11,557 (512) (4.43) Effect of derivates (3) 3,074 (115) 2,225 (27) Total 18,913 (714) (3.78) 13,782 (539) (3.91) Financial margin 1.36 1.21 1.95 1.50
Local currency - CPI linked Assets (4) 4,369 281 6.43 * 3,729 168 4.51 Effect of derivates (3) 109 5 42 2 Total 4,478 286 6.39 3,771 170 4.51
Liabilities 3,964 (207) (5.22) 3,336 (136) (4.08) Effect of derivates (3) 137 (7) 170 - Total 4,101 (214) (5.22) 3,506 (136) (3.88) Financial margin 1.21 1.17 0.43 0.63
Foreign currency (5) Assets (4) 8,308 (31) (0.37) * 8,140 (117) (1.44) Effect of derivates (3) 8,514 801 9,068 * 726 Total 16,822 770 4.58 17,208 609 3.54
Liabilities 8,150 225 2.76 8,761 226 2.58 Effect of derivates (3) 8,452 (854) 8,980 *(698) Total 16,602 (629) (3.79) 17,741 (472) (2.66) Financial margin 2.39 0.79 1.14 0.88
- 94 -
Appendix C (cont'd)
Rates of Financing Income and Expenses by Linkage Basis - Consolidated (1) (cont'd)
Reported Amounts
Foreign currency - in nominal US dollars (5) 2007 Average Financing Income (expenses) ratio Balance(2) income without Including (expenses) derivatives derivatives effect Effect (3) $ millions $ millions % %
Foreign currency (5) Assets (4) 2,019 118 5.84 Effect of derivatives (3) 2,068 55 Total 4,087 173 4.23
Liabilities 1,982 (87) (4.39) Effect of derivatives (3) 2,054 (60) Total 4,036 (147) (3.64) Financial margin 1.45 0.59
2006 Average Financing Income (expenses) ratio Balance(2) income without Including (expenses) derivatives derivatives effect Effect (3) $ millions $ millions % %
Foreign currency (5) Assets (4) 1,819 99 5.44 Effect of derivatives (3) 2,027 * 40 Total 3,846 139 3.61
Liabilities 1,957 (69) (3.53) Effect of derivatives (3) 2,007 *(45) Total 3,964 (114) (2.88) Financial margin 1.91 0.73
* Reclassified. Note: Full details regarding rates of income and expenses in each segment, according to balance sheet items, are available upon request. (1) The data in this table is presented before and after the effect of derivative instruments (including off-balance sheet effects of derivative instruments). (2) On the basis of monthly opening balances, except for the unlinked Israeli currency segment in which the average balance is calculated on the basis of daily balances, and after deduction of the average balance of specific provisions for doubtful debts. (3) Hedging derivative instruments (excluding options), separated embedded derivatives and ALM derivatives which constitute a part of the Bank's asset and liability management system. (4) a) The average balance of the unrealized gains and losses from adjustment of bonds to fair value, was subtracted from/added to the average balance of the assets. In the year ended December 31, 2007, an amount of NIS 7.5 million was deducted in the unlinked segment, an amount of NIS 0.9 million was deducted in the CPI linked segment and an amount of NIS 4.3 million was added to the foreign currency segment (in the year ended December 31, 2006, an amount of NIS 0.6 million was added to the unlinked segment, an amount of NIS 7 million was added to the CPI linked segment and an amount of NIS 4.9 million was added to the foreign currency segment). b) Except for derivative instruments. (5) Including Israeli currency linked to foreign currency. (6) Including gains and losses on the sale of investments in bonds and the adjustment of trading bonds to fair value. (7) Average balance sheet balances of derivative instruments (not including average off-balance sheet balances of derivative instruments).
- 95 -
Appendix C (cont'd)
Rates of Financing Income and Expenses by Linkage Basis - Consolidated (1)
Reported Amounts 2007 2006 Income (expenses) ratio Income (expenses) ratio Financing Without Including Financing Without Including average income derivatives derivatives average income derivatives derivatives balance (2) (expenses) effect effect(3) balance (2) (expenses) effect effect(3) NIS millions NIS millions % % NIS millions NIS millions % %
Total Monetary assets generating financing income (4) 29,223 1,100 3.76 24,495 857 3.50 Effect of derivates (3) 11,647 932 11,394 728 Total assets 40,870 2,032 4.97 35,889 1,585 4.42
Monetary liabilities generating financing expenses 27,953 (581) (2.08) 23,654 (422) (1.78) Effect of derivates (3) 11,663 (976) 11,375 (725) Total liabilities 39,616 (1,557) (3.93) 35,029 (1,147) (3.27) Financial margin 1.68 1.04 1.72 1.15
In respect of options 38 * 27 Commissions from financing transactions and other financing income (6) 100 74 Profit from financing activities before provision for doubtful debts 613 539 Provision for doubtful debts (including general and supplementary provisions) (80) (82) Profit from financing activities after provision for doubtful debts 533 457
Total Monetary assets generating financing income (4) 29,223 24,495 Assets deriving from derivative instruments (7) 481 * 700 Other monetary assets 505 * 267 General and supplementary provisions for doubtful debts (70) (77) Total monetary assets 30,139 25,385
Total Monetary liabilities generating financing expenses 27,953 23,654 Liabilities deriving from derivative instruments (7) 491 * 672 Other monetary liabilities 781 * 290 Total monetary liabilities 29,225 24,616
Total excess of monetary assets over monetary liabilities 914 769 Non-monetary assets 1,115 * 1,013 Non-monetary liabilities 484 * 359 Total capital resources 1,545 1,423
- 96 -
Appendix D
Analysis of Exposure to Interest Rate Fluctuations as at December 31, 2007 - Consolidated
Reported amounts
Three 2007 2006 On demand One to months One to Three to Five to Ten to More than Without Total Internal Average Internal Average up to one three to one three five ten twenty twenty fixed rate of maturity rate of maturity month months year years years years years years maturity return return NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions % years % years
Israeli currency unlinked Total assets 8,678 3,358 1,628 1,390 320 685 203 17 922 17,201 5.78 0.8 5.67 0.8 Total liabilities 12,570 1,163 1,500 499 53 286 1 - 60 16,132 4.44 0.3 4.23 0.5 Difference (3,892) 2,195 128 891 267 399 202 17 862 1,069 1.34 0.5 1.44 0.3 Effect of forward transactions and special commitments (290) 39 47 (7) (2) - - - - (213) Options (63) (133) 27 23 5 - - - - (141) Exposure to interest rate fluctuations in the segment (4,245) 2,101 202 907 270 399 202 17 862 715 Cumulative exposure in the segment (4,245) (2,144) (1,942) (1,035) (765) (366) (164) (147) 715 -
CPI linked local currency Total assets 760 167 606 1,251 715 830 237 39 3 4,608 4.71 4.6 5.49 4.0 Total liabilities 48 191 509 978 968 1,184 141 18 12 4,049 4.39 4.2 4.57 2.9 Difference 712 (24) 97 273 (253) (354) 96 21 (9) 559 0.32 0.4 0.92 1.1 Effect of forward transactions and special commitments - (137) (147) ------(284) Exposure to interest rate fluctuations in the segment 712 (161) (50) 273 (253) (354) 96 21 (9) 275 Cumulative exposure in the segment 712 551 501 774 521 167 263 284 275 - Foreign currency - Total assets 5,616 839 556 131 91 163 - - 1,600 8,996 4.63 0.3 5.71 0.3 Total liabilities 6,144 1,873 1,404 127 12 105 - - - 9,665 3.10 0.2 3.94 0.1 Difference (528) (1,034) (848) 4 79 58 - - 1,600 (669) 1.53 0.1 1.77 0.2 Effect of forward transaction and special commitments 290 98 100 7 2 - - - - 497 Options 63 133 (27) (23) (5) - - - - 141 Exposure to interest rate fluctuations in the segment (175) (803) (775) (12) 76 58 - - 1,600 (31) Cumulative exposure in the segment (175) (978) (1,753) (1,765) (1,689) (1,631) (1,631) (1,631) (31) -
- 97 -
Appendix D (cont’d)
Analysis of Exposure to Interest Rate Fluctuations as at December 31, 2007 - Consolidated (cont'd)
Reported Amounts
Three 2007 2006 On demand One to months One to Three to Five to Ten to More than Without Total Internal Average Internal Average up to one three to one three five ten twenty twenty fixed rate of maturity rate of maturity month months year years years years years years maturity return return NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions % years % years
Aggregate exposure to interest rate fluctuations
Total assets 15,054 4,364 2,790 2,772 1,126 1,678 440 56 3,342 31,622 1.2 1.1 Total liabilities 18,762 3,227 3,413 1,604 1,033 1,575 142 18 262 30,036 0.8 0.6 Difference (3,708) 1,137 (623) 1,168 93 103 298 38 3,080 1,586 0.4 0.5 Effect of forward transactions and special commitments ------Exposure to interest rate fluctuations in the segment (3,708) 1,137 (623) 1,168 93 103 298 38 3,080 1,586 Cumulative exposure in the segment (3,708) (2,571) (3,194) (2,026) (1,933) (1,830) (1,532) (1,494) 1,586 -
Note: Full details regarding exposure to interest rate fluctuations in each segment, according to balance sheet items, are available upon request.
- 98 -
Appendix E
Overall Credit Risk to Public by Economic Sector - Consolidated
Reported amounts
December 31, 2007 Balance sheet Off-balance Total Annual expense Balance of credit risk (1) sheet credit risk for specific problematic credit risk (2) to public provision for debts(3) doubtful debts NIS millions NIS millions NIS millions NIS millions NIS millions
Agriculture 97 68 165 *- 15 Industry 1,638 2,653 4,291 2 115 Diamonds 2,057 1,574 3,631 50 116 Construction and real estate 3,629 2,889 6,518 7 175 Electricity and water 35 100 135 1 - Commerce 1,203 1,396 2,599 5 57 Food and hotel services 270 27 297 2 5 Transportation and storage 228 351 579 *- 3 Communication and computer services 335 250 585 - 5 Financial services 3,691 4,943 8,634 1 32 Other business services 809 534 1,343 4 13 Public and community services 338 217 555 *- 2 Private individuals - residential loans 3,312 - 3,312 (1) 60 Private individuals - other 1,148 1,473 2,621 12 53 Total 18,790 16,475 35,265 83 651
Credit risk included in the different sectors of the economy: Settlement movements (4) 94 - 94 - 15 Local authorities (5) 93 34 127 - -
* Amounts up to NIS 500 thousand.
(1) Credit to the public, including the public’s investments in bonds in the amount of NIS 797 million and other assets in respect of derivative instruments against the public in the amount of NIS 423 million. (2) Credit risk in respect of off-balance sheet financial instruments as calculated for the purpose of per borrower credit limitations. (3) Balance of problematic debts net of credit covered by collateral which is permitted as a deduction for purposes of individual and group borrower limits. Includes off-balance sheet credit risk components. (4) Kibbutzim and moshavim, regional and national organizations and associations controlled by the settlement movements. (5) Including associations controlled by them.
The credit risk and balances of problematic debts are presented net of the specific provisions for doubtful debts.
- 99 -
Appendix E (cont'd)
Overall Credit Risk to Public by Economic Sector - Consolidated
Reported amounts
December 31, 2006 Balance sheet Off-balance Total Annual expense Balance of credit risk (1) sheet credit risk for specific problematic credit risk (2) to public provision for debts(3) doubtful debts NIS millions NIS millions NIS millions NIS millions NIS millions
Agriculture 96 57 153 - 2 Industry 1,709 2,408 4,117 16 150 Diamonds 2,114 1,251 3,365 28 230 Construction and real estate 2,737 2,580 5,317 6 281 Electricity and water 84 83 167 - 1 Commerce 1,214 1,433 2,647 15 72 Food and hotel services 248 66 314 2 68 Transportation and storage 211 288 499 1 10 Communication and computer services 299 202 501 - 14 Financial services * 4,220 4,939 9,159 5 84 Other business services 666 497 1,163 4 18 Public and community services 381 221 602 1 2 Private individuals - residential loans 2,835 - 2,835 1 *70 Private individuals - other 1,123 1,271 2,394 13 *26 Total 17,937 15,296 33,233 92 1,028
Credit risk included in the different sectors of the economy: Settlement movements (4) 145 - 145 - 34 Local authorities (5) 99 - 99 - -
* Reclassified.
(1) Credit to the public, including the public’s investments in bonds in the amount of NIS 337 million and other assets in respect of derivative instruments against the public in the amount of NIS 260 million. (2) Credit risk in respect of off-balance sheet financial instruments as calculated for the purpose of per borrower credit limitations. (3) Balance of problematic debts net of credit covered by collateral which is permitted as a deduction for purposes of individual and group borrower limits. Includes off-balance sheet credit risk components. (4) Kibbutzim and moshavim, regional and national organizations and associations controlled by the settlement movements. (5) Including associations controlled by them.
The credit risk and balances of problematic debts are presented net of the specific provisions for doubtful debts.
- 100 -
Appendix F
Condensed Consolidated Balance Sheets at the End of Each Quarter for the Years 2007 and 2006
Reported amounts
Year 2007 2006 Quarter 4 3 2 1 4 3 2 1 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Assets
Cash on hand and deposits with banks 4,710 4,374 4,927 3,556 4,024 4,334 3,090 3,695 Securities 8,051 7,831 7,113 *7,061 *6,287 * 5,047 *5,298 *4,998 Lended securities - 63 35 39 - - - - Credit to the public 17,503 17,751 18,120 *18,089 *17,270 *16,057 *16,182 *15,778 Credit to the Government - - - - 31 - 59 61 Investment in investee companies 16 18 20 23 42 42 44 46 Bank premises and equipment 327 320 321 324 328 323 327 328 Other assets 1,015 *1,142 *916 *635 *952 *899 *1,441 *1,000
Total assets 31,622 31,499 31,452 29,727 28,934 26,702 26,441 25,906
Liabilities and Shareholders’ Equity
Deposits from the public 26,713 26,782 27,123 * 25,618 *25,340 *22,959 *21,913 *22,303 Deposits from banks 516 *339 256 194 90 157 436 140 Deposits from the Government 2 2 2 10 35 4 5 6 Subordinated notes and deposit certificates 1,295 1,194 1,148 1,170 816 838 851 928 Other liabilities 1,510 *1,630 *1,373 *1,225 *1,081 *1,204 *1,730 *1,266
Total liabilities 30,036 29,947 29,902 28,217 27,362 25,162 24,935 24,643
Shareholders’ equity 1,586 1,552 1,550 1,510 1,572 1,540 1,506 1,263
Total liabilities and shareholders’ equity 31,622 31,499 31,452 29,727 28,934 26,702 26,441 25,906
* Reclassified.
- 101 -
Appendix G
Condensed Consolidated Statements of Profit and Loss for Each Quarter for the Years 2007 and 2006
Reported amounts
Year 2007 2006 Quarter 4 3 2 1 4 3 2 1 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Profit from financing activities before provision for doubtful debts 154 144 165 150 125 137 145 132 Provision for doubtful debts 15 18 27 20 9 7 43 23 Profit from financing activities after provision for doubtful debts 139 126 138 130 116 130 102 109
Operating and other income Operating commissions 61 60 56 59 *52 54 * 55 56 Gains on investments in shares, net 7 2 3 18 19 ** - 10 2 Other income 4 5 5 3 *3 3 * 5 6 Total operating and other income 72 67 64 80 74 57 70 64
Operating and other expenses Salaries and related expenses 87 84 78 95 77 80 83 89 Maintenance and depreciation of bank premises and equipment 28 22 23 22 21 21 21 20 Other expenses 36 41 41 42 42 41 38 36 Total operating and other expenses 151 147 142 159 140 142 142 145
Operating profit before taxation 60 46 60 51 50 45 30 28 Provision for taxation on operating profit 30 9 25 29 32 20 11 11
Operating profit after taxation 30 37 35 22 18 25 19 17 The Bank's equity in net after-tax operating profits (losses) of investee companies (1) (2) **- 2 3 (1) (2) ** -
Net operating profit 29 35 35 24 21 24 17 17 Extraordinary gain (loss), net of related taxes - (3) 1 5 - - 20 22 Net profit 29 32 36 29 21 24 37 39
* Reclassified. ** Amounts up to NIS 500 thousand.
- 102 -
Appendix G (cont’d)
Condensed Consolidated Statements of Profit and Loss for Each Quarter for the Years 2007 and 2006 (cont’d)
Reported amounts
Earnings per share data (NIS)
Year 2007 2006 Quarter 4 3 2 1 4 3 2 1 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Basic profit: Operating profit 0.50 0.58 0.60 0.40 0.37 0.40 0.32 0.34 Extraordinary profit (loss), net of related taxes - (0.05) 0.01 0.09 - - 0.38 0.44
Total basic profit 0.50 0.53 0.61 0.49 0.37 0.40 0.70 0.78
Diluted profit: Operating profit 0.50 0.58 0.60 0.40 0.37 0.40 0.31 *0.33 Extraordinary profit (loss), net of related taxes - (0.05) 0.01 0.09 - - 0.38 *0.43
Total diluted profit 0.50 0.53 0.61 0.49 0.37 0.40 0.69 0.76
* Reclassified. ** Amounts up to NIS 500 thousand.
- 103 -
Certification I, Haim Freilichman, declare that: 1. I have reviewed the annual report of Union Bank of Israel Ltd. (hereinafter: the “Bank”) for the year 2007 (hereinafter: the “Report”). 2. Based on my knowledge, the Report contains no incorrect presentation of a material fact, and there is no presentation of a material fact missing from the Report that is necessary so that the presentations included in it, in light of the circumstances under which such presentations were included, are not misleading with regard to the period covered by the Report. 3. Based on my knowledge, the financial statements and other financial information included in the Report correctly reflect the financial condition, results of operations, changes in shareholders’ equity, and cash flows of the Bank, in all material aspects, for the dates and periods covered in the Report. 4. I, and others at the Bank making this certification, are responsible for the establishment and application of controls and procedures for the required disclosure in the Bank’s Report; furthermore: (A) We have established such controls and procedures, or caused such controls and procedures to be established under our supervision, aimed at ensuring that material information pertaining to the Bank, including its consolidated corporations, is brought to our knowledge by others at the Bank and at such corporations, in particular during the preparation of the Report; (B) We have assessed the effectiveness of the controls and procedures concerning disclosure at the Bank, and we have presented our findings with regard to the effectiveness of the controls and procedures concerning disclosure, as of the end of the period covered in the Report, based on our assessment; and (C) We have disclosed in the Report any change in the internal control of financial reporting at the Bank that occurred during the fourth quarter, and that had a material effect, or could reasonably be expected to have a material effect, on the internal control of financial reporting at the Bank; and 5. I, and others at the Bank making this certification, have disclosed to the external auditor, to the Board of Directors, and to the Audit Committee and the Balance Sheet Committee of the Board of Directors of the Bank, based on our most current assessment of the internal control of financial reporting: (A) Any significant deficiencies and material weaknesses in the establishment or application of internal control of financial reporting that can reasonably be expected to impair the Bank’s ability to record, process, summarize, or report financial information; and (B) Any fraud, whether material or immaterial, in which management was involved, or in which other employees were involved who have a significant role in the internal control of financial reporting at the Bank.
The aforesaid shall not detract from my responsibility, or from the responsibility of any other person, under any law.
Haim Freilichman President & C.E.O. February 27, 2008
- 104 -
Certification I, Netta Abrahamov Bitan, declare that: 1. I have reviewed the annual report of Union Bank of Israel Ltd. (hereinafter: the “Bank”) for the year 2007 (hereinafter: the “Report”). 2. Based on my knowledge, the Report contains no incorrect presentation of a material fact, and there is no presentation of a material fact missing from the Report that is necessary so that the presentations included in it, in light of the circumstances under which such presentations were included, are not misleading with regard to the period covered by the Report. 3. Based on my knowledge, the financial statements and other financial information included in the Report correctly reflect the financial condition, results of operations, changes in shareholders’ equity, and cash flows of the Bank, in all material aspects, for the dates and periods covered in the Report. 4. I, and others at the Bank making this certification, are responsible for the establishment and application of controls and procedures for the required disclosure in the Bank’s Report; furthermore: (A) We have established such controls and procedures, or caused such controls and procedures to be established under our supervision, aimed at ensuring that material information pertaining to the Bank, including its consolidated corporations, is brought to our knowledge by others at the Bank and at such corporations, in particular during the preparation of the Report; (B) We have assessed the effectiveness of the controls and procedures concerning disclosure at the Bank, and we have presented our findings with regard to the effectiveness of the controls and procedures concerning disclosure, as of the end of the period covered in the Report, based on our assessment; and (C) We have disclosed in the Report any change in the internal control of financial reporting at the Bank that occurred during the fourth quarter, and that had a material effect, or could reasonably be expected to have a material effect, on the internal control of financial reporting at the Bank; and 5. I, and others at the Bank making this certification, have disclosed to the external auditor, to the Board of Directors, and to the Audit Committee and the Balance Sheet Committee of the Board of Directors of the Bank, based on our most current assessment of the internal control of financial reporting: (A) Any significant deficiencies and material weaknesses in the establishment or application of internal control of financial reporting that can reasonably be expected to impair the Bank’s ability to record, process, summarize, or report financial information; and (B) Any fraud, whether material or immaterial, in which management was involved, or in which other employees were involved who have a significant role in the internal control of financial reporting at the Bank. The aforesaid shall not detract from my responsibility, or from the responsibility of any other person, under any law.
Netta Avrahamov Bitan Chief Accountant February 27, 2008
- 105 -
Report of the Board of Directors and Management on their Responsibility for the Annual Report The annual report was prepared by the management of the Bank, which is responsible for its fairness. This report includes financial statements prepared in accordance with generally accepted accounting principles and with the reporting rules prescribed by the instructions and guidelines of the Supervisor of Banks, additional information prepared in conformity with these principles and rules, as well as other information. The preparation of periodic financial statements also necessitates the preparation of estimates for the purpose of determining certain values and items contained in the reports. These estimates were made by management, to the best of its judgment. To ensure the fairness of the Bank’s financial reporting, the management of the Bank maintains a comprehensive system of internal control, designed to ensure that all transactions at the Bank are carried out on the basis of proper authorization, that the Bank’s assets are protected and their integrity is assured, and that the accounting records constitute a reliable basis for the preparation of the financial statements. The internal control system is, of its nature, limited in that it cannot give absolute assurance, but only reasonable assurance as to its ability to discover and prevent errors and irregularities. The principle of reasonable assurance is based on the awareness that the decision regarding the amount of resources to be invested in the implementation of control procedures must, as a matter of course, take into account the benefits to be derived from the implementation of such procedures. The Bank’s Board of Directors, which is responsible for the preparation and approval of the financial statements, in accordance with Section 92 of the Companies Law, establishes accounting policy and supervises its implementation. It also determines the structure of the internal control system, and supervises its operation. The General Manager is responsible for the day-to-day management of the Bank’s affairs, within the framework of the policy defined by the Board of Directors and subject to its guidelines. The management of the Bank acts in accordance with the policy prescribed by the Board of Directors. The Board of Directors, through its committees, meets regularly with the management of the Bank, the internal auditor, and the Bank’s external auditors for the purpose of reviewing the scope and results of their work. The Bank’s external auditors, Somekh Chaikin, have audited the Bank’s annual financial statements in accordance with generally accepted auditing standards, including standards prescribed by the Auditors Regulations (Manner of Auditors' Performance), and certain auditing standards published by the American Institute of Certified Public Accountants, the application of which has been mandated by the directives of the Supervisor of Banks. The purpose of the audit is to enable the auditors to express their opinion as to the extent to which these financial statements reflect, in accordance with generally accepted accounting principles and the reporting rules set forth in the guidelines and instructions of the Supervisor of Banks, the Bank’s financial position, the results of its operations, the changes in its shareholders’ equity, and its cash flows. In accordance with Section 170 of the Companies Law, the auditors are responsible to the Bank and to its shareholders for the content of their opinion statement with respect to the financial statements. The auditors’ opinion statement is attached to the annual financial statements. Furthermore, the information contained in the Board of Directors’ Report and in the Management’s Review (hereinafter: the “Accompanying Information”) was provided to the external auditors for their perusal so that they might indicate whether there is any material inconsistency between the information in the financial statements and the Accompanying Information, or whether the Accompanying Information contains information which is materially inconsistent with evidence or other information which has come to the knowledge of the external auditors in the course of their audit.
- 106-
No such indication has been received from the external auditors. For these purposes, the external auditors did not adopt any further auditing procedures other than those which they were obliged to adopt for the purpose of auditing the financial statements.
Zeev Abeles Haim Freilichman Netta Avrahamov Bitan Chairman of the Board of Directors President & C.E.O. Chief Accountant
Date of approval of the report for publication: February 27, 2008.
- 107-
Financial Statements as at December 31, 2007
Contents Page
Auditors’ Report to the Shareholders 109
Financial Statements:
Balance Sheets 111
Statements of Profit and Loss 113
Statements of Changes in Shareholders’ Equity 114
Statements of Cash Flows 115
Notes to the Financial Statements 117
108- -
Somekh Chaikin
Mail address Office address Telephone 972 3 684 8000 PO Box 609 KPMG Millennium Tower Fax 972 3 684 8444 Tel Aviv 61006 17 Ha'arba'a Street Israel Tel Aviv 64739 Israel
Auditors’ Report to the Shareholders of Union Bank of Israel Limited
We have audited the accompanying financial statements of Union Bank of Israel Limited (the Bank) as at December 31, 2007 and 2006 and the consolidated balance sheets of the Bank and its subsidiaries as at such dates, and the related statements of profit and loss, changes in shareholders’ equity and cash flows, for each of the three years, the last of which ended December 31, 2007. These financial statements are at the responsibility of the Bank’s Board of Directors and of its Management. Our responsibility is to express an opinion on these financial statements based on our audits.
We did not audit the financial statements of consolidated subsidiaries, whose assets constitute approximately 0.08% of the total consolidated assets as at December 31, 2007 and 2006, and whose profits from financing activities before provision for doubtful debts and operating and other income constitutes approximately 1.27%, 1.53% and 2.24% of the consolidated profit from financing activities before provision for doubtful debts and operating and other income for the three years, the last of which ended December 31, 2007. Furthermore, we did not audit the financial statements of affiliated companies, wherein the investment constitutes approximately 0.05% and 0.15% of the total consolidated assets as at December 31, 2007 and 2006, respectively, and the Bank’s share in the net profit (loss) thereof constitutes approximately (0.69%), 0.40% and 2.42% of the net profit for the three years, the last of which ended December 31, 2007. The financial statements of those companies were audited by other auditors whose reports thereon were furnished to us. Our opinion, insofar as it relates to amounts emanating from the financial statements of such companies, is based on the said reports of the other auditors. Furthermore, the data included in the financial statements relating to the net asset value of the Bank’s investments in investee companies and to its equity in their operating results is based on the financial statements of such companies, some of which were audited by other auditors.
We conducted our audits in accordance with generally accepted auditing standards, including standards prescribed by the Auditors Regulations (Manner of Auditors' Performance) - 1973 and auditing standards the application of which in the audit of a bank is prescribed by the directives of the Supervisor of Banks. Such standards require that we plan and perform the audit to obtain reasonable assurance that the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Board of Directors and by Management, as well as evaluating the overall financial statements presentation. We believe that our audits and the reports of the other auditors provide a reasonable basis for our opinion.
- 109 -
Somekh Chaikin, a partnership registered under the Israeli Partnership Ordinance, is a member of KPMG International, a Swiss cooperative.
In our opinion, based on our audits and on the reports of abovementioned other auditors, the financial statements referred to above present fairly, in all material respects, the financial position of the Bank and the consolidated financial position of the Bank and its subsidiaries, as at December 31, 2007 and 2006 and the results of their operations, the changes in the shareholders’ equity and their cash flows for each of the three years, the last of which ended December 31, 2007, in conformity with generally accepted accounting principles. Furthermore, in our opinion, the statements have been prepared in accordance with directives and guidelines of the Supervisor of Banks.
As explained in Note 1.C., the aforementioned financial statements are stated in reported amounts, in accordance with the accounting standards of the Israel Accounting Standards Board and the guidelines of the Supervisor of Banks.
Without qualifying our opinion, we draw attention to Note 17.C.(13)b(1) to the financial statements in respect of contingent liabilities in connection with the filing of a class action.
Somekh Chaikin Certified Public Accountants (Isr.)
February 27, 2008
- 110 -
Somekh Chaikin, a partnership registered under the Israeli Partnership Ordinance, is a member of KPMG International, a Swiss cooperative.
Balance Sheets as at December 31
Reported amounts
Consolidated The Bank 2007 2006 2007 2006 Note NIS millions NIS millions NIS millions NIS millions
Assets
Cash on hand and deposits with banks 2 4,710 4,024 4,710 4,024
Securities 3 8,051 *6,287 7,908 *6,176
Credit to the public 4 17,503 *17,270 17,436 *17,211
Credit to the Government - 31 - 31
Investment in investee companies 5 16 42 450 429
Bank premises and equipment 6 327 328 327 328
Other assets 7 1,015 *952 1,006 *943
Total assets 31,622 28,934 31,837 29,142
* Reclassified.
______Z. Aveles, Chairman of the Board
______Y. Landau, Vice Chairman of the Board
______H. Freilichman, General Manager and Chief Executive Officer
______N. Avrahamov Bitan Chief Financial Officer
Date approving financial statements for publishing: February 27, 2008
The accompanying notes are an integral part of the financial statements.
- 111 -
Consolidated The Bank 2007 2006 2007 2006 Note NIS millions NIS millions NIS millions NIS millions
Liabilities and Shareholders’ Equity
Deposits from the public 8 26,713 *25,340 27,605 *25,646
Deposits from banks 9 516 90 516 90
Deposits from the Government 2 35 2 35
Subordinated notes and deposit certificates 10 1,295 816 474 582
Other liabilities 11 1,510 *1,081 1,654 *1,217
Total liabilities 30,036 27,362 30,251 27,570
Shareholders’ equity 12 1,586 1,572 1,586 1,572
Total liabilities and shareholders’ equity 31,622 28,934 31,837 29,142
- 112 -
Statements of Profit and Loss for the Year Ended December 31
Reported amounts Consolidated The Bank 2007 2006 2005 2007 2006 2005 Note NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Profit from financing activities before provision for doubtful debts 21 613 539 582 586 520 562 Provision for doubtful debts 4.C. 80 82 149 80 81 147 Profit from financing activities after provision for doubtful debts 533 457 433 506 439 415
Operating and other income Operating commissions 22 236 *217 221 231 *212 215 Profit on investments in shares, net 23 30 31 10 27 19 5 Other income 24 17 *17 27 6 *4 4 Total operating and other income 283 265 258 264 235 224
Operating and other expenses Salaries and related expenses 25 344 329 325 336 321 316 Maintenance and depreciation of bank premises and equipment 95 83 82 94 82 81 Other expenses 26 160 157 147 161 154 140 Total operating and other expenses 599 569 554 591 557 537 Operating profit before taxation 217 153 137 179 117 102
Provision for taxation on operating profit 27 93 74 54 82 60 44 Operating profit after taxation 124 79 83 97 57 58
The Bank's equity in net after-tax operating profits (losses) of investee 5.C. (1) ** - 2 26 23 27 companies Net operating profit 123 79 85 123 80 85 After-tax income (loss) from extraordinary activities 28 3 42 (6) 3 41 (6) Net profit 126 121 79 126 121 79
Earnings per share data (NIS) 28.A.
Basic profit: Operating profit (loss) 2.08 1.44 1.73 2.08 1.46 1.72 Extraordinary profit (loss), net of related taxes 0.06 0.76 (0.13) 0.06 0.74 (0.12) Total 2.14 2.20 1.60 2.14 2.20 1.60
Diluted profit: Operating profit (loss) 2.08 1.42 1.73 2.08 1.45 1.72 Extraordinary profit (loss), net of related taxes 0.06 0.76 (0.13) 0.06 0.73 (0.12) Total 2.14 2.18 1.60 2.14 2.18 1.60 * Reclassified. ** Amount up to NIS 500 thousand. The accompanying notes are an integral part of the financial statements. - 113 -
Statements of Changes in Shareholders’ Equity Reported amounts
Adjustments to Benefits Dividend Share fair value of in respect of proposed capital Receipts available share-based subsequent Total and on account for sale payment Retained to balance Shareholders' premium of options securities (1) transactions earnings (2) sheet date equity NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions Balance as at January 1, 2005 559 34 (5) 24 513 - 1,125 Adjustments to fair value of available for sale securities - - *(14) - - - (14) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - *39 - - - 39 Related tax effect - - (7) - - - (7) Net profit for the year - - - - 79 - 79 Balance as at December 31, 2005 559 34 13 24 592 - 1,222
Exercise of stock options 236 (26) - - - - 210 Expired options 8 (8) - - - - - Benefit in respect of share - based payment transactions(3) - - - 1 - - 1 Adjustments to fair value of available for sale securities - - *(3) - - - (3) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - *37 - - - 37 Related tax effect - - (16) - - - (16) Net profit for the year - - - - 121 - 121 Dividend that was declared - - - - (100) 100 - Balance as at December 31, 2006 803 - 31 25 613 100 1,572
Benefit in respect of share - based payment transactions (3) - - - 2 - - 2 Adjustments to fair value of available for sale securities - - (73) - - - (73) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - 47 - - - 47 Related tax effect - - 12 - - - 12 Net profit for the year - - - - 126 - 126 Paid dividend - - - - - (100) (100) Balance as at December 31, 2007 803 - 17 27 739 - 1,586
* Reclassified. (1) See Note 1.G. 1(c). (2) Regarding the restriction on a dividend distribution, see Note 12.B. (3) See Note 14 (a). The accompanying notes are an integral part of the financial statements. - 114 -
Statements of Cash Flows for the Year Ended December 31 Reported amounts
Consolidated The Bank 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions Cash flows generated by operating activities Net profit for the year 126 121 79 126 121 79
Adjustments to reconcile net profit to net cash generated by operating activities: The Bank's equity in the not distributed operating losses (profits) of investees 4 - (2) (19) (18) (27) The Bank's equity in the extraordinary profits of investees - - - (1) (41) - Decline in value of Bank premises and equipment 2 - 6 2 - 6 Gain on sale of investment in an affiliated company (1) - - - - - Depreciation of bank premises and equipment 37 29 29 37 29 29 Provision for doubtful debts 80 82 149 80 81 147 Gain on sale of securities available for sale, net (47) (37) (39) (49) (31) (39) Realized and unrealized gain from adjustments to fair value of securities held for trading, net (5) (10) (10) (5) (10) (10) Gain on sale of bank premises and equipment (2) - - (2) - - Deferred taxes, net 9 29 27 9 29 27 Adjustment differences included in inserting and financing activities (18) *(37) *26 (31) *(38) *16 Severance pay - increase (decrease) in excess of provision over amounts funded 2 (2) (26) 2 (2) (26) Increase (decrease) in other assets, net (60) *252 *(467) (60) *244 *(461) Increase (decrease) in other liabilities, net 427 *(496) *604 435 *(509) *610 Benefit in respect of allotment of options 2 1 - 2 1 -
Net cash inflow (outflow) from operating activities 556 (68) 376 526 (144) 351
Cash flows used in activities in assets Purchase of securities available for sale (8,442) (5,758) (7,262) (8,360) (5,661) (7,186) Proceeds from sale of securities available for sale 6,422 5,112 5,814 6,399 5,010 5,753 Proceeds from redemption of securities available for sale 377 184 320 342 167 320 Deposits with banks, net 144 (134) (58) 144 (134) (58) Securities for trading, net (304) (567) (357) (305) (567) (344) Credit to the public, net (79) *(1,875) *(928) (71) *(1,859) *(919) Credit to the Government, net 31 30 (5) 31 30 (5) Proceeds from sale and redemption of investments in affiliated companies 16 4 - - - - Acquisition of bank premises and equipment (43) (22) (36) (43) (22) (36) Proceeds from sale of bank premises and equipment 7 2 3 7 2 3 Investment in investees - - (22) - (14) (32) Dividend received 1 4 5 - - - Dividend received from subsidiary - - - - 11 -
Net cash outflow used to activities in assets (1,870) (3,020) (2,526) (1,856) (3,037) (2,504) * Reclassified.
- 115 -
Statements of Cash Flows for the Year Ended December 31 (cont’d) Reported amounts
Consolidated The Bank 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Cash flows generated by activities in liabilities and capital Deposits from the public, net 1,373 *3,383 *2,326 1,959 *3,511 *2,518 Deposits from banks, net 426 (66) (51) 426 (66) (51) Deposits from the Government, net (33) 27 (2) (33) 27 (2) Issuance of subordinated notes and deposit certificates 615 49 224 45 14 35 Redemption of subordinated notes and deposit certificates (137) (137) (169) (137) (137) (169) Dividend paid to shareholders (100) - - (100) - - Exercise of stock options - 210 - - 210 -
Net cash inflow generated by activities in liabilities and capital 2,144 3,466 2,328 2,160 3,559 2,331
Increase in cash 830 378 178 830 378 178
Balance of cash at beginning of year 3,576 3,198 3,020 3,576 3,198 3,020
Balance of cash at end of year 4,406 3,576 3,198 4,406 3,576 3,198
* Reclassified.
Appendix A - Non-cash transactions:
1. In 2007 - securities in the amount of NIS 234 million, net, were transferred from the available for sale portfolio to credit to the public due to the lending of securities - consolidated and Bank (in 2006 - NIS 81 million and in 2005 - NIS 45 million). 2. In 2006 securities in the amount of NIS 47 million consolidated and NIS 32 million in Bank were transferred from the trading portfolio to the available for sale portfolio (in 2005 - NIS 29 million Consolidated and Bank). 3. In 2007 assets in the amount of NIS 6 million were purchased for a non-cash consideration (in 2006 - NIS 6 million and in 2005 - NIS 3 million).
The accompanying notes are an integral part of the financial statements.
- 116 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies
A. General
(1) The financial statements have been prepared in accordance with directives and guidelines of the Supervisor of Banks, as well as in accordance with generally accepted accounting principles in Israel.
(2) In some of the financial statement categories, where there is no material difference between the amounts for the Bank and those for the consolidated group, the relevant notes refer only to the consolidated amounts.
B. Definitions
(1) Subsidiary - a company whose financial statements are fully consolidated, directly or indirectly, with the financial statements of the Bank.
(2) Affiliated company - a company, the investment in which is included in the Bank's financial statements, directly or indirectly, on the equity basis.
(3) Investee company - a subsidiary or affiliated company.
(4) Related party - as defined in Opinion No. 29 of the Institute of Certified Public Accountants in Israel.
(5) Interested party - as defined in paragraph (1) of the definition of an "Interested party" in Section 1 of the Securities Law.
(6) Controlling shareholder - as defined in the Securities Regulations (Financial Statement Presentation of Transactions between a Company and its Controlling Shareholder) - 1996.
(7) CPI - The Consumer Price Index published by the Central Bureau of Statistics.
(8) Adjusted amount - the nominal historical amount adjusted to the CPI in respect of December 2003, pursuant to the provisions of the Opinions of the Institute of Certified Public Accountants in Israel.
(9) Reported amount - the adjusted amount as at the transition date (December 31, 2003), with the addition of amounts in nominal values that were added after the transition date and less amounts eliminated after the transition date.
(10) Adjusted financial reporting - financial reporting based on the provisions of the Opinions of the Institute of Certified Public Accountants in Israel
(11) Nominal financial reporting - financial reporting based on reported amounts
- 117 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) C. Financial statements in reported amounts
(1) In October 2001, the Israel Accounting Standards Board published Accounting Standard No. 12, with regard to cessation of Adjusting Financial Statements for Inflation. Pursuant to this standard and in accordance with Accounting Standard No. 17 that was published in December 2002, the adjustment of financial statements to the effect of inflation was discontinued as of January 1, 2004. Up to December 31, 2003, the Bank continued to prepare adjusted financial statements according to the directives of the Supervisor of Banks on the basis of the principles provided in Opinion No. 36 of the Institute of Certified Public Accountants in Israel.
The Bank implements the provisions of the Standard and therefore, as noted above, adjustments were discontinued as of January 1, 2004.
(2) In the past, the Bank prepared its financial statements on the basis of historical cost adjusted for the changes in the CPI. The adjusted amounts included in the financial statements as at December 31, 2003 constitute the starting point for the nominal financial report as of January 1, 2004. Any additions made during the period are included in their nominal values. Therefore, the financial statements to dates or reported periods after December 31, 2003 are stated at reported amounts according to Accounting Standards published by the Israel Accounting Standards Board.
(3) Amounts of non-monetary assets do not necessarily reflect their realizable value or current economic value, but only the reported amounts of such assets.
(4) The term "cost" in these financial statements means the reported amount of cost.
D. Reporting principles
(1) Balance sheets:
a. Non-monetary items are stated at reported amounts.
b. Monetary items are stated in the balance sheet at their nominal historical values as at balance sheet date.
c. The carrying value of investments in investee companies is determined on the basis of the reported financial statements of these companies.
(2) Statements of profit and loss:
a. The Bank's share in the results of operations of investee companies is determined on the basis of the reported financial statements of these companies.
b. Income and expenses deriving from non-monetary items or from provisions included in the balance sheet are derived from the difference between the reported amount of the opening balance and the reported amount of the closing balance.
c. All other operating items are stated at their nominal values.
- 118 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) D. Reporting principles (cont'd)
(3) Statement of changes in shareholders' equity:
Proposed dividend or dividends actually paid during the reported period are stated at their nominal values.
(4) The Bank's data in nominal historical value for taxation is reported in note 30.
E. Consolidation of financial statements
(1) The consolidated financial statements include the financial statements of the Bank and of companies over which the Bank has control. The financial statements of the Bank include the assets, liabilities and results of operations of the Bank's property and service companies that are wholly controlled by the Bank.
(2) For the purpose of the consolidation, the amounts appearing in the financial statements of the subsidiaries were taken after making adjustments required by the application of uniform accounting policies used by the Group.
(3) Material balances and mutual transactions between subsidiaries were cancelled.
(4) As of January 1, 2006, the Bank implements the provisions of Standard No. 20 (Amended) regarding "Accounting Treatment of Goodwill and Intangible Assets of Investees" (hereinafter, "the Standard"), with the exception of discontinuance of amortization of goodwill and with the exception of attributing negative goodwill generated upon the acquisition of a business to the statement of operations, as follows:
a. Goodwill is the excess acquisition cost of an investment in a subsidiary, charged at the fair value of the identifiable assets (including intangible assets), less the fair value of the identifiable liabilities (after specific attributions) on the acquisition date.
b. Pursuant to the guidelines of the Supervisor of Banks, goodwill is amortized over a period of 10 years unless the Supervisor of Banks provides otherwise.
- 119 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd)
F. Foreign currency and linkage
(1) Assets and liabilities are stated in the financial statements as follows:
y Those in foreign currency or linked thereto - at the representative rates of exchange published by Bank of Israel as at balance sheet date, or other appropriate date, in accordance with the terms of the transactions. y Differences arising from adjustment of assets and liabilities in foreign currency due to changes in the exchange rate are included in the statement of profit and loss in the relevant items. y Those linked to the Consumer Price Index are stated on the basis of either the latest Index published prior to balance sheet date or the Index of the last month of the year, depending on their contractual terms. y Those partially linked to the CPI are stated on the basis of their effective linkage rate.
(2) Income and expenses in foreign currency are stated, partly, at the representative rates of exchange which prevailed at the time they arose, and partly at the representative rates of exchange of the end of the month in which they were recorded on the statement of profit and loss, with the addition of the exchange rate differences on the asset or liability items with respect to which the income or expense was derived.
(3) Details of the representative rates of exchange and the Consumer Price Index are as follows:
December 31 Rate of change during 2007 2006 2005 2007 2006 2005 NIS NIS NIS % % %
Rate of exchange of the: U.S. dollar 3.846 4.225 4.603 (9.0) (8.2) 6.8 Euro 5.659 5.564 5.446 1.7 2.2 (7.3) GBP 7.710 8.288 7.941 (7.0) 4.4 (4.4) CHF 3.420 3.465 3.499 (1.3) (1.0) (8.1)
Points Points Points Consumer Price Index for the month of: November (index known”) 101.9 99.1 99.4 2.8 (0.3) 2.7 December (index "in respect of") 102.5 99.1 99.2 3.4 (0.1) 2.4
- 120 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) G. Securities
(1) In accordance with the directives of the Supervisor of Banks, the Bank’s securities are classified as follows:
a. Held to Maturity Bonds -
Bonds which the Bank intends and has the means to hold until maturity thereof. Such bonds are stated at their adjusted value, consisting of their par value together with interest, exchange or linkage increments and interest accrued, as well as the unamortized amount of premium or discount, which arose upon acquisition. Income from held to maturity bonds is reflected on the statement of profit and loss on the accrual basis.
b. Trading Securities -
Securities acquired and held with the intention of selling them in the short term. Such securities are stated at their market value. Unrealized gains or losses from adjustment to market value are reflected in the statement of profit and loss.
c. Available for Sale Securities -
Securities which are not included in the above two classifications. These include shares for which no market exists that are stated at adjusted cost and marketable bonds, structured securities and shares that are stated at their market value. Interest income and linkage differences are reflected on the statement of profit and loss on the accrual basis and the difference between the adjusted and market values, net of the related tax effect, is recorded as a separate item in the statement of changes in shareholders' equity “adjustments to fair value of available for sale securities”. A provision for decline in value which is not of a temporary nature is recorded on the statement of profit and loss.
(2) Decline in value of investments –
From time to time, the Bank determines whether a decline in value of an other-than-temporary nature has occurred in its investments in other companies (in shares and bonds). This examination is performed when there are signs indicating that the value of the investments may have been impaired, including declines in stock market prices, business difficulties at the investee company or in the industry to which it belongs, and other parameters.
Provisions for the adjustment of the value of such investments, which is based on an examination of all relevant aspects according to the assessment of management, with appropriate weight accorded to each, of an other-than-temporary nature, are allocated to the statement of profit and loss.
After a provision has been made for a decline in the value of an investment, increases in the value of the investment are not recognized until its realization.
- 121 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd)
G. Securities (cont'd) (3) Lending of Securities -
Lending of securities by the Bank for the purpose of covering a short sale of securities by a borrower is stated by the Bank as credit to the public so long as the securities have not been returned. Lending of securities from one customer to another where the Bank serves as a broker, is presented by the Bank in the “Credit to the public” and deposits from the public categories so long as the securities have not been returned. See also Section X(4) with regard to the first-time implementation of the circular of the Supervisor of Banks concerning “transfers and servicing of financial assets and extinguishment of liabilities.”
(4) Transactions for exchange of securities -
Transactions involving the exchange of Index linked Government bonds for short-term loans of Bank of Israel (MKM) within the framework of a bid on the MKM yield, were recorded as purchase of MKM at the bid price and sale of the bonds at market price.
(5) Collateral deposited with clearing houses in respect of customers’ activity –
Securities held by the Bank that have been deposited as collateral with the Maof Clearing House and the TASE Clearing House are stated in the item “securities,” in light of the letter on this subject issued by the Supervisor of Banks to banking corporations
H. Investments in investee companies
(1) Investments in affiliated companies are stated on the equity basis. In determining the net asset value of such investments the amounts taken into consideration are the amounts appearing in the financial statements of those companies, after adjustments required by the application of generally accepted accounting principles.
(2) See Paragraph E(4) above regarding the accounting policy for amortizing goodwill.
(3) See Paragraph U regarding impairment in value of investments in affiliated companies.
I. Fixed assets
(1) The fixed assets are stated on a cost basis, less accrued depreciation and less loss from declines in value, if any. The cost includes expenses directly attributable to the acquisition of the asset.
(2) Improvements and enhancements are added to the cost of the assets whereas maintenance and repairs are charged to expense as incurred.
(3) At the initial recognition of a fixed-asset item, the Bank estimates the costs incurred in respect of the obligation to dismantle and transfer the item and restore the space in which it is located at the current value, and includes such costs in the cost of the item. Changes in the said obligations, with the exception of changes arising from the passage of time, are added to or deducted from the cost of the asset at the time of their occurrence. The amount deducted from the cost of the asset shall not exceed its book value. Surplus reduction in the obligation over the book value of the asset is recognized immediately in the statement of profit and loss.
- 122 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) I. Fixed assets (cont'd)
(4) The Bank separately depreciates each part of a fixed asset with a significant cost relative to the total cost of the item, including the costs of significant periodic tests. Depreciation is calculated using the straight-line method, based on the estimated useful life of the assets.
(5) Improvements to rental properties are depreciated over the rental period, which does not exceed the economic life of the asset.
See also Section X(1) below with regard to the first-time implementation of Accounting Standard No. 27 concerning fixed assets.
J. Investment Property
See Section X(2) below with regard to the first-time implementation of Accounting Standard No. 16 concerning investment property.
K. Basis of recognition of income and expenses
Income and expenses are included on the accrual basis, except for interest on borrower delinquencies, which are recorded based on actual collection. Payment from the State Treasury for interest differences in respect of loans to parties eligible through the Ministry of Housing, are recorded on the statement of profit and loss during the loan repayment period on the basis of the “uniform yield” method.
As to recognition policy of income and expenses from derivative financial instruments, see L, hereunder.
L. Derivative financial instruments
(1) As an integral part of its asset and liability management, which is intended, inter alia, to control the exposure to financial risks, the Bank enters into transactions in derivative financial instruments. Such financial instruments include forward contracts, futures, financial swaps, options etc., intended mainly as a hedge against currency exchange rate fluctuations, linkage base exposure and interest rate fluctuations.
(2) In accordance with the directives of the Supervisor of Banks regarding "Accounting for Derivative Instruments and Hedging Activities" (hereinafter - the directives) all the derivatives are presented as assets or liabilities in the balance sheet and have to be measured according to fair value. Changes in the fair value of the derivative instrument will be recognized in the statement of profit and loss or be included in the shareholders’ equity as a component of the statement of profit and loss or as part of other comprehensive income, according to the designation of the derivative instrument.
Changes in the fair value of derivatives designated as hedging the exposure to changes in the fair value of an asset, liability or firm commitment, will be recognized in the statement of profit and loss in the period of the change, together with the change in the fair value of the hedged item attributable to the risk being hedged.
The accounting treatment of changes in the fair value of derivatives designated as hedging the exposure to variable cash flows generated by an asset, liability or forecasted transaction depends on the effectiveness of the hedging relations.
- 123 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) L. Derivative financial instruments (cont'd) (2) (cont'd)
- The effective portion of the change in the fair value of a derivative designated as a cash flow hedge is initially reported in the shareholders’ equity (outside of the statement of profit and loss) as a component of other comprehensive income, and subsequently when the forecasted transaction affects the statement of profit and loss it is reclassified to the statement of profit and loss.
- The ineffective portion of the change in the fair value of a derivative, the designation of which is as above, is immediately recognized in the statement of profit and loss. A gain or loss from a derivative not designated as a hedging instrument is recorded immediately in the statement of profit and loss.
M. Provision for doubtful debts
(1) Specific provisions for doubtful debts
The financial statements include specific provisions for doubtful debts which, in Management's opinion, adequately reflect the inherent loss in the loan portfolio including off-balance sheet debt. In determining the adequacy of the provisions, Management based itself upon an evaluation of the risks involved in the loan portfolio based upon the information available to it as to the financial position of the borrowers, the volume of their operations and on an evaluation of the collateral received therefrom.
A specific provision for doubtful debts in respect of residential loans is computed based on the extent of arrears, in accordance with the directives of the Supervisor of Banks. The Bank implements the Bank of Israel Circular published on January 1, 2006, concerning all aspects of the manner of calculating the provision for doubtful debts in respect of credit for residential purchases.
(2) Write off of bad debts
The write off of bad debts is effected only after all legal and other collection procedures have been exhausted and it has become clear beyond any doubt that the balance is not collectible.
(3) General provision and supplementary provision
The financial statements include a general provision and a supplementary provision for doubtful debts as follows:
According to directives of the Supervisor of Banks, the general provision which existed as at December 31, 1991, is to be maintained, in inflation adjusted terms, at an amount not greater than 1% of the related loan balances at such date. In addition, a supplementary provision for doubtful debts is to be set up, based on the quality of the credit portfolio measured by various risk characteristics. As of January 1, 2004 the balance of the general provision will remain at its reported amount.
The supplementary provision for doubtful debts is calculated on the basis of the excess amounts of credit, in accordance with the quality characteristics of the obligo, as provided in directives of the Supervisor of Banks. The supplementary provision for doubtful debts included in the balance sheet complies with the final target rates of this provision.
- 124 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) M. Provision for doubtful debts (cont'd) (3) (cont'd)
As at December 31, 2007 the cumulative balance of the general provision and the supplementary provision for doubtful debts constitutes 2% of the total credit (including the credit risk) to which the provisions relate (as at December 31, 2006 - 0.2%).
(4) See Section Y(3) below with regard to the circular of the Supervisor concerning “measurement and disclosure of impaired debts, credit risk, and provisions for credit losses.”
N. Contingent liabilities
The accounting treatment of contingent legal claims is based on an opinion received by management of the Bank from its legal counsel, on which management of the Bank relies, which provides the probability of occurrence of the exposure to risk relating to contingent liabilities. The claims were classified in accordance with the probability of occurrence of the exposure to risk as follows:
1) Probable - when the probability is over 70%. 2) Reasonably possible - when the probability is over 20% and less than or equal to 70%. 3) Remote - when the probability is less than or equal to 20%.
In rare cases the Bank states in the financial statements that on the basis of the opinion of its legal counsel, management of the Bank is unable to evaluate the probability of occurrence of exposure to risk in respect of an ordinary claim and a claim that was certified as a class action, in the four financial statements that are published after the filing of the claim and the request to have it certified as a class action. Note 17.C(13) separately presents the contingent liabilities in respect of which the risk of occurrence of the exposure cannot be reasonable estimated in the opinion.
The Bank has provided disclosure with respect to material legal proceedings pending against the Bank and subsidiaries.
O. Severance pay and pensions
(1) The commitment for severance pay and pensions is covered by adequate provisions. The Bank deposits funds in respect of its severance pay commitment with provident funds for annuities and severance benefits.
(2) The actuarially computed pension liability is computed based on the Estimation of Accumulated Benefits method. This method reflects the retirement benefit on the basis of the services provided by the employees up to the date of the financial statements and, thus, correspondence is created between the cost of the retirement benefits and the period in which the service was provided by the employee.
- 125 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) P. Taxes on Income
The Bank implements the Israel Accounting Standard Board "Accounting Standard No. 19 - Taxes on Income". With respect to certain matters relating to the accounting treatment of taxes on income, including the matter of recognizing a deferred tax asset in respect of carry forward losses and temporary differences, directives of the Supervisor of Banks contain additional restrictions. With respect to these matters, the Bank is subject to the directives of the Supervisor of Banks.
(1) Deferred taxes
The Bank and the group companies create deferred taxes in respect of temporary differences. Temporary differences are differences between the value of assets and liabilities for tax purposes and for financial reporting purposes.
Deferred tax balances (asset or liability) are calculated according to the tax rates expected to be in force when the deferred tax liability is utilized, or when the deferred tax asset is realized, on the basis of tax rates and tax laws, the legislation of which has been completed or essentially completed as at balance sheet date.
The main factors, in respect of which deferred taxes were not created, are as follows:
a. A temporary difference created upon the initial recognition of goodwill.
b. A temporary difference created upon the initial recognition of an asset or liability in a transaction which is not a business combination and, at the time of the initial recognition, there is no effect on the accounting profit or on the taxable income (tax loss).
c. Deferred tax liability in respect of the adjustment component of depreciable non- monetary assets defined as protected assets under the Income Tax Law (Taxation Under Inflationary Conditions) - 1982, which were acquired prior to the inception of this law, and have a depreciation period of at least 20 years from their date of operation.
d. Investments in part of investee companies regarding which the Bank has the intention and the ability to hold and not to sell them;
e. In respect of temporary differences where the probability of realization of the deferred tax asset is doubtful.
(2) Provision for taxation
The provision for taxation on income of the Bank, which is a financial institution for Value Added Tax purposes, includes profit tax that is imposed on income according to the VAT Law (VAT imposed on the payroll of financial institutions is included in the item “salaries and related expenses”).
- 126 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd)
Q. Share-based payments
The Bank implements Accounting Standard No. 24, "Share-based Payments" (hereinafter, "the Standard"). Pursuant to the provisions of the Standard, the Bank recognizes share-based payment transactions in its financial statements, including transactions with employees or other parties that are discharged in capital instruments, cash or other assets. Share-based payments transactions, in which goods or services are received for payment, are recorded at their fair value.
The Bank records the benefit created upon granting options to employees as a salary expense, with a corresponding increase in shareholders' equity, according to the fair value of the options at the grant date, using the Black & Scholes model. According to this policy, the arising benefit is distributed over the vesting period of the options, based on the Bank's assessment of the number of options anticipated to be vested.
In addition, the Bank implements the presentation and disclosure rules set forth in the Standard, with the required adjustments, as stipulated in the Public Reporting Directives of the Supervisor of Banks.
R. Earnings per share
As from January 1, 2006 the Bank implements Accounting Standard No. 21, “Earnings per Share (hereinafter - the Standard) of the Israel Accounting Standards Board. In accordance with the provisions of the Standard, the Bank calculates basic earnings per share with respect to earnings or loss, and basic earnings per share with respect to earnings or loss from continuing operations, which is attributable to the ordinary shareholders. The basic earnings per share is calculated by dividing the earnings or loss attributable to the ordinary shareholders with the weighted average number of ordinary shares outstanding during the period. In order to calculate the diluted earnings per share the Bank adjusted the earnings or loss attributable to the ordinary shareholders, and the weighted average number of outstanding ordinary shares, in respect of the effects of all the dilutive potential ordinary shares as convertible bonds and option notes. The Bank’s share in the earnings of investee companies was calculated according to its portion of earnings per share of such investee companies multiplied by the number of shares held by the Bank.
In addition, the Bank implements the presentation and disclosure rules set forth in the Standard, with the required adjustments, as stipulated in the Public Reporting Directives of the Supervisor of Banks.
S. Statement of cash flows
Cash flows generated by activities in assets and liabilities are stated in net amounts, with the exception of cash flows relating to non-monetary assets and securities. The item cash includes cash on hand, deposits with banks and deposits with Bank of Israel for an initial period of up to three months.
T. Use of estimates
Preparation of the financial statements in accordance with generally accepted accounting principles requires Management to use estimates and projections in respect of transactions or matters, the final effect on the financial statements is not precisely estimable at the time the financial statements are drafted. Although the estimates and projections are based on the Management's best judgment, the final affect of said transactions or matters may differ from the estimated or projected effects.
- 127 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd)
U. Impairment of assets
The Bank applies Accounting Standard No. 15 - Decline in Value of Assets (hereinafter - the Standard). The standard provides procedures which the Bank must apply in order to ensure that its assets in the consolidated balance sheet (to which the standard applies) are not presented at an amount which is in excess of their recoverable value, which is the higher of the net selling price or the use value (the present value of the estimated future cash flows expected to be derived from use and disposal of the asset).
The standard applies to all the assets in the consolidated balance sheet, except tax assets and monetary assets (excluding monetary assets which are investments in investee companies that are not subsidiaries). In addition, the standard provides rules for presentation and disclosure with respect to assets whose value has declined. When the value of an asset in the consolidated balance sheet is higher than its recoverable value, the Bank recognizes a loss from the decline in value in the amount of the difference between the book value of the asset and its recoverable value. The loss thus recognized will be cancelled only in the event of changes occurring in the estimates that were used to determine the recoverable value of the asset since the date on which the most recent loss from the decline in value was recognized.
In September 2003 the Israel Accounting Standards Board published Clarification No. 1 regarding the accounting treatment of a decline in value of an investment in an investee company that is not a subsidiary (hereinafter - the clarification). The clarification provides that in the periods following the period in which a provision was created for the first time in respect of the decline in value of an investee company that is not a subsidiary, the investment in the investee company should be presented at the lower of the recoverable value and the amount of the investment based on the equity method, with the recoverable amount being calculated in each reporting period in which there are indicators that there has been a change in the recoverable value.
In February 2005 the Israel Accounting Standards Board published Clarification No. 6 regarding the accounting treatment of impairment in value of the assets of an investee company that is not a subsidiary. This clarification requires determination of the recoverable value of each one of the cash generating units or identified assets of the affiliated company, for which there are indications of impairment in value or indications that a loss from impairment that was recognized in prior years no longer exists or has decreased. The decline or increase in value will be examined from the point of view of the holding company.
In addition, the Bank implements the presentation and disclosure rules set forth in the Standard, with the required adjustments, as stipulated in the Public Reporting Directives of the Supervisor of Banks.
V. Structured deposit
The Bank sells structured deposits to its customers. These deposits include combination options on various interest rates, bases and indices. These options were measured on the basis of rules of measurement for derivative financial instruments, in contrast to deposits stated on a cumulative basis. The deposits, including the combined options, are stated under the item "Deposits from the public". The value of the options is charged to the statement of profit and loss over the lifetime of the deposit.
W. Offsetting Financial Instruments
Financial assets and liabilities are stated in the balance sheet in net amounts only when the Bank has an enforceable legal right to offset them and there is an intention to settle the asset and liability on a net basis, or to realize the asset and settle the liability simultaneously.
- 128 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) X. First-Time Implementation of Accounting Standards and Directives of the Supervisor of Banks
(1) Accounting Standard No. 27, “Fixed Assets” -
As of January 1, 2007, the Bank has implemented Accounting Standard No. 27 concerning fixed assets (hereinafter: “Standard 27”) of the Israel Accounting Standards Board. Standard 27 sets forth rules for the recognition, measurement, and subtraction of fixed-asset items, and the disclosure required in respect thereto.
Standard 27 stipulates that a fixed-asset item that qualifies for recognition as an asset shall be measured at cost upon initial recognition. Standard 27 notes that the cost of a fixed-asset item includes the cost of its acquisition (including non-refunded import and purchase taxes, less commercial discounts), costs directly attributable to bringing the asset to the location and condition required in order for it to operate in the manner intended by management, as well as an initial estimate of the current value of the costs required to dismantle and remove the item and restore the space in which it is located (when the entity is obligated to do so). The cost of a fixed- asset item is the amount equal to its price in cash at the date of recognition. Accordingly, if payment for the asset is postponed beyond ordinary credit terms, the difference between the amount equal to the price in cash and the total payment is recognized as an interest expense over the period of the credit.
After the first recognition date, a bank that implements the rules established in Standard 27, with the adjustments established in the directives of the Supervisor of Banks, can measure fixed-asset items using the cost method alone. In the cost method, the fixed-asset item is stated at cost, less accrued depreciation and less accrued losses from decline in value.
Standard 27 states that for the purposes of depreciation of a fixed asset, the initial amount recognized with respect to the fixed-asset item shall be allocated to its significant parts, and each such part shall be depreciated separately; however, different parts of a fixed asset with identical useful lives and depreciation methods may be grouped. According to the directives of Standard 27, the residual value, useful life, and depreciation method of assets should be reviewed at least every fiscal year.
In August 2007, a guideline of the Supervisor of Banks was published establishing specific directives with regard to the manner of implementation of the Standard. According to the directives of the Supervisor, although Standard 27 does not apply to software items, software development and/or purchasing costs are to be presented under the item “buildings and equipment,” rather than under “other assets.” In addition, in cases where the Standard refers to other standards and/or uses definitions of terms that have not yet been adopted in the Public Reporting Directives, the rules and definitions set forth in the Public Reporting Directives will continue to apply. Furthermore, where the wording of the Standard differs from the international standard IAS 16, Fixed Assets, the sections will apply as worded in the international standard.
With the exception of the treatment of the recognition of first-time estimates of the costs of dismantling and transferring a fixed-asset item and restoring the space in which it is located, the Standard is to be adopted by retroactive implementation.
The first-time implementation of Standard 27 had no material impact on the Bank’s financial position and results of operations.
- 129 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) X. First-Time Implementation of Accounting Standards and Directives of the Supervisor of Banks (cont'd)
(2) Accounting Standard No. 16, "Investment Property" -
As of January 1, 2007, the Bank has implemented Accounting Standard No. 16 concerning investment property (hereinafter: the "Standard"). The Standard sets forth rules for the recognition, measurement, and subtraction of investment property, and for the disclosure required in respect thereto.
The Standard stipulates, among other things, that investment property is to be measured for the first time at cost, with the addition of transaction costs. In addition, according to the rules of the Standard, with the adjustments set forth in the guideline of the Supervisor of Banks, in subsequent periods, the Bank must apply the cost method alone with regard to all of its investment property items. In accordance with the cost method, investment property items are to be stated at cost, net of accrued depreciation and net of losses from decline in value. Investment property items are depreciated using the straight-line method, at an annual rate of 2% and 6.5%, based on their estimated period of use.
In August 2007, a guideline of the Supervisor of Banks was published establishing specific directives with regard to the manner of implementation of the Standard. Specifically, according to the guideline, in cases where the Standard refers to other standards and/or uses definitions of terms that have not yet been adopted in the Public Reporting Directives, the rules and definitions set forth in the Public Reporting Directives will continue to apply. Furthermore, where the wording of the Standard differs from the international standard IAS 40, Investment Property, the sections will apply as worded in the international standard.
The first-time implementation of Standard 16 had no material impact on the Bank’s financial position and results of operations.
(3) Accounting Standard No. 30, “Intangible Assets” -
As of January 1, 2007, the Bank has implemented Accounting Standard No. 30 of the Israel Accounting Standards Board regarding intangible assets (hereinafter: the "Standard"), with the required adjustments, as stipulated in the circular of the Supervisor of Banks. The Standard explains the accounting treatment of intangible assets, establishes the manner of measurement of the book value of such assets, and lists the required disclosures.
The Standard discusses the different cases in which entities may recognize an intangible asset, including: in a separate purchase, in a purchase as part of a combination of businesses, in a purchase using a government grant, in an exchange of assets, and in the formation of an internal intangible asset. With regard to the latter case, the Standard states that intangible assets arising from research are not to be recognized as assets, whereas intangible assets arising from development are to be recognized as assets only if the entity can demonstrate compliance with all of the following cumulative conditions: technical feasibility of the completion of the asset so that it is available for use or for sale; intent and ability of the entity to complete, use, or sell the asset; demonstration of the manner in which the asset is expected to generate future financial benefits; availability of technical, financial, and other resources needed to complete development and use or sell the asset; and the ability of the entity to reliably measure the expenses that can be attributed to the intangible asset during the course of its development.
- 130 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) X. First-Time Implementation of Accounting Standards and Directives of the Supervisor of Banks (cont'd)
(3) (cont'd)
In August 2007, a guideline of the Supervisor of Banks was published establishing specific directives with regard to the manner of implementation of the Standard. In particular, according to the directives, banks will be permitted to measure intangible assets only according to cost less accrued depreciation and less accrued losses from decline in value. Banking corporations shall not implement the rules set forth in the Standard with regard to the recognition of intangible assets acquired through combinations of businesses, until the adoption by banking corporations in Israel of the international standard IFRS 3, Business Combinations, or until the voluntary adoption of the American accounting standard FAS 141, Business Combinations, in full, with the approval of the Supervisor of Banks. Furthermore, despite the statements in the Standard, software costs recognized as intangible assets are to be presented in the Bank’s balance sheet under the item “buildings and equipment.”
In addition, in cases in which the Standard makes reference to other standards and/or uses definitions of terms that have not yet been adopted in the Public Reporting Directives, the rules and definitions set forth in the Public Reporting Directives will continue to apply. Furthermore, where the wording of the Standard differs from the international standard IAS 38, Intangible Assets, the sections will apply as worded in the international standard.
The Standard was implemented for the first time retroactively.
The first-time implementation of the Standard had no material impact on the Bank’s financial position and results of operations.
(4) Circular of the Supervisor of Banks on the subject of Transfers and Servicing of Financial Assets and Discharge of Liabilities
As from January 1, 2007 the Bank implements circular published by the Supervisor of Banks which provide an amendment to the provisions of reporting to the public regarding "transfers and servicing of financial assets and discharge of liabilities". The provisions set forth in this circular adopt the rules of measurement and disclosure provided in FAS 140, accounting rules for transfers and servicing of financial assets and discharge of liabilities, for the purpose of distinction between transfers of financial assets recorded as a sale and other transfers. Consequently, the principle was adopted under which a financial asset transferred shall be stated in the balance sheet of its controlling owner, whether it is the transferor or the transferee. In this matter, the provisions set forth in detail control tests that refer to buy-back transactions, loans of securities, securitization of loans, sales and participation in loans. The amendments to the provisions of reporting to the public apply to all banking corporations in respect of loans of securities, buy-back security transactions, securitization of financial assets, other transfers of financial assets, services rendered to financial assets, and discharge of liabilities, performed after December 31, 2006, which are administered in accordance with management rules, including the management of margin deposits, established on this subject in the United States, as published in the draft Proper Conduct of Banking Business Directive of the Supervisor of Banks. Transactions that do not comply with the said management rules were treated in accordance with the Public Reporting Directives from before the adoption of the rules of FAS 140.
- 131 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) Y. Disclosure of the Effect of New Accounting Standards and Directives of the Supervisor of Banks in the Period before Implementation
(1) Accounting Standard No. 23, “Accounting Treatment of Transactions between an Entity and its Controlling Party” -
In December 2006, the Israel Accounting Standards Board issued Accounting Standard No. 23, “Accounting Treatment of Transactions between an Entity and its Controlling Party” (hereinafter: the “Standard”). The Standard replaces the Securities Regulations (Statement of Transactions between a Corporation and its Controlling Party in Financial Statements) - 1996, as adopted in the Public Reporting Directives of the Supervisor of Banks. The Standard stipulates that assets and liabilities in respect of which a transaction has been executed between an entity and its controlling party shall be measured at the date of the transaction at fair value, with the difference between the fair value and the consideration allocated in the transaction to be allocated to shareholders' equity. A negative difference essentially constitutes a dividend and therefore reduces the balance of surpluses. A positive difference essentially constitutes an owner’s investment, and is therefore stated in a separate item under shareholders’ equity: “capital fund from a transaction between the entity and its controlling party.”
The Standard addresses three issues related to transactions between an entity and its controlling party, as follows: transfers of assets to the entity from the controlling party, or alternatively, transfers of assets from the entity to the controlling party; undertaking of a liability of the entity towards a third party, in full or in part, by the controlling party, or indemnification of the entity by its controlling party for expenses, or a waiver by the controlling party of a debt owed by the entity, in full or in part; and loans given to or received from the controlling party. In addition, the Standard stipulates the disclosure to be made in the financial statements in respect of transactions between an entity and its controlling party during the period.
The Standard will apply to transactions between an entity and its controlling party executed after January 1, 2007, and to loans given to or received from the controlling party before the inception date of the Standard, as of the inception date.
The Supervisor of Banks intends to apply the Standard to banking corporations from January 1, 2008 forward, with the required adjustments.
At the date of publication of the financial statements, the Supervisor of Banks has not yet issued directives with regard to the manner of adoption of the Standard by banking corporations.
(2) Accounting Standard No. 29, “Adoption of International Financial Reporting Standards (“IFRS”)”
In July 2006 the Israel Accounting Standards Board published Accounting Standard No. 29, “Adoption of International Financial Reporting Standards (“IFRS”)” (hereinafter - the Standard). The Standard provides that entities subject to the Securities Law - 1968 that are required to report according to the regulations of this law, are to prepare their financial statements for periods beginning as from January 1, 2008 according to IFRS. The aforementioned does not apply to banking corporations, the financial statements of which are prepared in accordance with directives and guidelines of the Supervisor of Banks. With regards to the implementation of the Standard by banking corporations, the Supervisor of Banks informed the banking corporations that: - 132 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) Y. Disclosure of the Effect of New Accounting Standards and Directives of the Supervisor of Banks in the Period before Implementation (cont'd)
(2) (cont'd)
- He intends to provide rules on an ongoing manner for the implementation of Israeli Standards published by the Israel Accounting Standards Board, based on IFRS, that do not involve the core banking business. - In the second half of 2009, the Supervisor of Banks will publish his decision regarding the implementation date of IFRS concerning the core banking business, taking into account the results of the adoption of these standards in Israel, on one hand, and the progress in the convergence of international reporting standards and US reporting standards, on the other hand. - Therefore, with regards to the core banking business, the financial statements of a banking corporation that are prepared in accordance with directives and guidelines of the Supervisor of Banks, will continue to be prepared according to the US standards set forth in the provisions of reporting to the public.
(3) Circular of the Supervisor of Banks concerning “Measurement and Disclosure of Impaired Debts, Credit Risk, and Provision for Credit Losses” -
A circular of the Supervisor of Banks on the subject of “Measurement and Disclosure of Impaired Debts, Credit Risk, and Provision for Credit Losses” (hereinafter: the “Circular” or the “Directive”) was issued on December 31, 2007. The Circular is based, among other things, on U.S. accounting standards and the related regulatory directives of banking supervision agencies and the Securities and Exchange Commission in the United States. The fundamental guiding principles of the Circular represent a substantial departure from the current directives on the classification of problematic debts and the measurement of provisions for credit losses in respect of such debts.
According to the Circular, banking corporations are required to make provisions for credit losses at an appropriate level in order to cover estimated credit losses with respect to their credit portfolio. In addition to the aforesaid, according to the Circular, provisions must be made in a separate liability account at an appropriate level to cover estimated credit losses related to off-balance-sheet credit instruments, such as contractual engagements to provide credit and guarantees.
The provision required to cover estimated credit losses with respect to the credit portfolio is to be assessed by one of two methods: “individual provisions” and “group provisions.”
For this purpose, “individual provisions for credit losses” are to be applied for all debts where the contractual balance (without deducting accounting write-offs that do not involve accounting waivers, unrecognized interest, provisions for credit losses, and collateral) is NIS 1 million or more, and for other debts identified by the banking corporation for individual assessment and for which the provision for decline in value is not included in the “specific provision for credit losses estimated on a group basis.” The individual provision for credit losses is to be assessed based on expected future cash flows, discounted at the effective interest rate of the debt; or, for debts contingent upon collateral, or when the banking corporation determines that seizure of an asset is expected, according to the fair value of the collateral placed under lien to secure the credit.
- 133 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) Y. Disclosure of the Effect of New Accounting Standards and Directives of the Supervisor of Banks in the Period before Implementation (cont'd) (3) (cont'd)
“Specific provisions for credit losses estimated on a group basis” are to be applied in provisions for the decline in value of large groups of small homogenous debts (such as credit- card debts, housing loans, and consumer debts repaid in installments), and in respect of debts examined individually and found to be unimpaired. The specific provision for credit losses in respect of debts evaluated on a group basis, excluding housing loans, for which a minimum specific provision was calculated based on the extent of arrears, is to be calculated in accordance with the rules stipulated in U.S. accounting standard FAS 5 – Accounting for Contingencies (hereinafter: “FAS 5”), based on a current estimate of the rate of past losses in respect of each homogenous group of debts with similar risk attributes. The required provision in respect of off-balance-sheet credit instruments is to be assessed in accordance with the rules stipulated in U.S. accounting standard FAS 5.
The Directive further stipulates various definitions and classifications of balance-sheet and off-balance-sheet credit risk, rules for the recognition of interest income from impaired debts, and rules for accounting write-offs of problematic debts. Among other things, the Circular states that accounting write-offs should be performed for any individually examined debt thought to be uncollectible, in amounts of such low value that their retention as assets is unjustified, or debts in respect of which the banking corporation has carried out prolonged collection efforts. With regard to debts evaluated on a group basis, write-off rules were established based on the period of arrears, depending on whether the debts are secured by residences, with the exception of housing loans for which a minimum provision is made according to the extent of arrears, debts secured by collateral other than residences, unsecured debts, debts of bankrupt borrowers, and debts created by fraud.
The Directive is to be implemented in the financial statements of banking corporations and credit-card companies from the statements dated January 1, 2010 (hereinafter: the “First Implementation Date”) forward. The Directive is not to be implemented retroactively in financial statements for previous periods. Alternatively, at the First Implementation Date, banking corporations will be required, among other things, to: - Perform accounting write-offs of all debts meeting the conditions for accounting write- offs on that date; - Classify all debts meeting the conditions for such classification as under special supervision, inferior, or impaired; - Cancel all accrued unpaid interest income in respect of all debts meeting the relevant conditions on that date; and
- Examine the need to adjust the balance of current and deferred taxes receivable and payable.
Adjustments of the balance of the provision for credit losses in respect of credit to the public and in respect of off-balance-sheet credit instruments as of January 1, 2010 to the requirements of the Directive, including the requirements to establish provisions and documentation requirements, are to be included directly in the item “surpluses in shareholders’ equity.”
- 134 - Notes to the financial statements as at December 31, 2007
Note 1 - Principal Accounting Policies (cont'd) Y. Disclosure of the Effect of New Accounting Standards and Directives of the Supervisor of Banks in the Period before Implementation (cont'd)
(3) (cont'd) In this context, it is clarified that despite the definition according to which restructured problematic debt is impaired debt, banking corporations are not required to classify debts restructured prior to January 1, 2007 as impaired, provided that the debt is not impaired based on the conditions stipulated in the restructuring agreement.
The Directive sets forth stricter documentation requirements and requirements regarding the evaluation and execution of provisions for estimated credit losses in respect of debts with different classifications (versus those currently stipulated in the Public Reporting Directives and in Proper Conduct of Banking Business Directive No. 314 concerning the treatment of problematic debts) and in respect of off-balance-sheet credit exposures, which is expected to have a material negative impact on the reported results and financial position of banking corporations. Specifically, as a result of the implementation of the Directive, the volume of problematic debts is expected to grow; balances of provisions for doubtful debts in respect of banks’ debts and off-balance-sheet exposures are expected to increase; the volume of debts reported in the credit portfolio is expected to decrease, due to accounting write-offs that do not involve legal waivers, and due to write-offs of accrued unpaid interest in respect of the impaired debts; and the balance of surpluses at the First Implementation Date in respect of the adjustment of the balances of the provisions required to cover estimated credit losses evaluated in accordance with the Directive, and in respect of the cancellation of said interest income, is expected to decrease.
The Bank is preparing to implement the Directive and examining the effects of its implementation on its results of operations. The existing measurement systems at the Bank were constructed on the basis of assumptions and definitions that differ from those in the Directive; they therefore cannot provide relevant information for estimating the effects of the implementation of the new directives on the financial statements of the Bank, including on the volume of problematic debts, on the provision for doubtful debts, and on profit from financing activity. In addition, the effect on the balance of credit in the group track cannot be estimated without constructing a system to determine the parameters leading to the creation of homogenous groups with similar risk attributes. At this stage it is therefore not possible to generate a quantitative estimate of the effects of the implementation of the Directive on the Bank. However, it is already clear that the implementation of the Directive will enlarge the volume of debts in respect of which interest income is recorded not on a current basis but only based on actual collection, as a result of the definition of the debts as impaired debts. This refers to debts presently defined as partially doubtful income-bearing debts as well as debts currently defined as debts in temporary arrears, among others.
As part of the Bank’s preparations for the implementation of the Directive, a steering committee headed by the Head of the Corporate Division was appointed, and subcommittees were appointed to establish work methods, prepare for the installation of new automated systems, and adjust the Bank’s methodology for the calculation of specific and group provisions to the Directive.
The Bank relies on the automated systems of Bank Leumi and closely follows changes to these automated systems in order to implement the required work processes. In addition, the Bank is examining the required changes to its independent systems, or alternatively, the creation of information files from these systems, to be transferred to Bank Leumi systems for the calculation of the specific and group provisions, as required in the directive. - 135 - Notes to the financial statements as at December 31, 2007
Note 2 - Cash on Hand and Deposits with Banks
Reported amounts
Composition: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions
Cash and deposits with Bank of Israel 374 799 Deposits with commercial banks 4,077 2,909 Deposits with specialized banking institutions 259 316
Total 4,710 4,024
Including cash on hand, deposits with banks and deposits with Bank of Israel for an initial period of up to three months 4,406 3,576
See Note 17.D. regarding liens on assets.
- 136 - Notes to the financial statements as at December 31, 2007
Note 3 - Securities Reported amounts Consolidated - composition (1): December 31, 2007 Adjusted Book cost (for Cumulative profit including other value shares-cost) Profit Loss Fair value (3) NIS millions NIS millions NIS millions NIS millions NIS millions A. Available for sale securities Bonds and loans: Marketable government bonds and loans 5,360 5,373 8 (21) 5,360 (4) Of others 934 943 8 (17) 934 6,294 6,316 16 (38) 6,294 Shares and other securities: (5) Of others (10) (11) 227 175 52 *- (6) 227 Total available for sale securities 6,521 6,491 (7) 68 (7) (38) 6,521
Unrealized Unrealized Adjusted gain loss Book cost (for on adjustment on adjustment value shares-cost) to fair value to fair value Fair value (3) NIS millions NIS millions NIS millions NIS millions NIS millions B. Trading securities Bonds and loans: Marketable government bonds and loans 1,435 1,437 *- (2) 1,435 Of others 54 57 *- (3) 54 1,489 1,494 - (5) 1,489 Shares and other securities: Of others 41 41 - - 41
Total trading securities 1,530 1,535 (8) - (8) (5) 1,530
Total securities 8,051 8,026 8,051
* Amounts up to NIS 500 thousand. (1) See Note 1.A.(2). (2) See Note 21.E. for details of results of activities in investment in bonds. See Note 23 for details of results of activities in investment in shares. (3) The fair value of securities is generally based on market price, which does not necessarily reflect the price obtained in the event of sale of securities in large quantities. (4) Including a provision for a decline in value of an investment in the amount of NIS 5 million. (5) Including a provision for a decline in value of an investment in the amount of NIS 20 million. (6) Including shares and other securities for which there is no ready fair value and which are stated at cost, in the amount of NIS 52 million. (7) Included in shareholders’ equity in the category "adjustments to fair value of available for sale securities”. (8) Reflected in the statement of profit and loss. (9) For bonds pledged as collateral, see Note 17.D. (10) On September 8, 2004 a subsidiary of the Bank purchased from a third party (hereinafter - the seller,) in an off-floor transaction, 5% of the shares of Melisron Ltd., a company traded on the Tel Aviv Stock Exchange, for the price of NIS 33 million. In the fourth quarter of 2006, an equity-based investee of the Bank sold a share of its holdings (app. 2%) in the shares of Melisron. During 2007, the company acquired additional shares of Melisron, raising its holding to 3.5%. (11) Including an amount of NIS 126 million in respect of an investment in shares of "Bezeq". In accordance with a directive issued by the Supervisor of Banks in July 2003, the credit to a certain customer was classified as an investment in shares in the available for sale portfolio instead of credit to the public. As from this date changes in the market value of the shares against the balance sheet credit net of specific provisions for doubtful debts are posted under a capital reserve, up to the sum of the loan. In 2007, the Bank received a dividend in the amount of approximately NIS 20 million in respect of "Bezeq" shares. This amount was included under "dividends from available for sale shares, net", see Note 23.
- 137 - Notes to the financial statements as at December 31, 2007
Note 3 - Securities (cont’d) Reported amounts Consolidated - composition (1): December 31, 2006 Adjusted Book cost (for Cumulative profit including other Fair value shares-cost) Profit Loss value (3) NIS millions NIS millions NIS millions NIS millions NIS millions A. Available for sale securities Bonds and loans: Marketable government bonds and loans * 4,589 * 4,589 10 * (10) *4,589 Of others * 283 (4) * 280 3 *- *283 4,872 4,869 13 (10) 4,872 Shares and other securities: Of others (10)(11) 194 (5)144 50 - (6)194 Total available for sale securities 5,066 5,013 (7) 63 (7)(10) 5,066
Adjusted Unrealized gain Unrealized loss Book cost (for on adjustment on adjustment value shares-cost) to fair value to fair value Fair value (3) NIS millions NIS millions NIS millions NIS millions NIS millions B. Trading securities Bonds and loans: Marketable government bonds and loans 1,165 1,163 3 (1) 1,165 Of others 45 46 **- (1) 45 1,210 1,209 3 (2) 1,210 Shares and other securities of others 11 11 -** - 11 Total trading securities 1,221 1,220 (8)3 (8)(2) 1,221 Total securities 6,287 6,233 6,287 * Reclassified, see note 4.A. ** Amounts up to NIS 500 thousand. (1) See Note 1.A.(2). (2) See Note 21.E. for details of results of activities in investment in bonds. See Note 23 for details of results of activities in investment in shares. (3) The fair value of securities is generally based on market price, which does not necessarily reflect the price obtained in the event of sale of securities in large quantities. (4) Including a provision for a decline in value of an investment in the amount of NIS 3 million. (5) Including a provision for a decline in value of an investment in the amount of NIS 15 million. (6) Including shares and other securities for which there is no ready fair value and which are stated at cost, in the amount of NIS 36 million. (7) Included in shareholders’ equity in the category "adjustments to fair value of available for sale securities”. (8) Reflected in the statement of profit and loss. (9) For bonds pledged as collateral, see Note 17.D. (10) On September 8, 2004 a subsidiary of the Bank purchased from a third party (hereinafter - the seller,) in an off-floor transaction, 5% of the shares of Melisron Ltd., a company traded on the Tel Aviv Stock Exchange, for the price of NIS 33 million. In this transaction the seller granted to the subsidiary a put option by which in the 36 months from the date of acquisition the subsidiary can force the seller, under certain circumstances, to buy back the shares from it. The exercise price of the option will be equal to the purchase price with the addition of annual interest of 5.75% less dividends as described in the agreement. Since before the transaction was executed the Bank had provided loans to the seller for financing the purchase of the shares, the Bank announced that upon exercise of the option it would favorably consider granting a loan to the seller, in order to finance the purchase of the transferred shares in accordance with the option, at the same terms as the loans granted in the past. In the forth quarter of 2006, an equity-based investee of the bank sold a share of its holdings (app. 2%) in the shares of Melisron. The proceeds from the sale were included in "proceeds from the sale of available for sale shares", see note 23. (11) Including an amount of NIS 127 million in respect of an investment in shares of "Bezeq". In accordance with a directive issued by the Supervisor of Banks in July 2003, the credit to a certain customer was classified as an investment in shares in the available for sale portfolio instead of credit to the public. As from this date changes in the market value of the shares against the balance sheet credit net of specific provisions for doubtful debts are posted under a capital reserve. In 2006, the Bank received a dividend in the amount of approximately NIS 11 million in respect of "Bezeq" shares. This amount was included under "dividends from available for sale shares net", see note 23. - 138 - Notes to the financial statements as at December 31, 2007
Note 3A - Asset-Backed Financial Instruments
Reported amounts
Consolidated composition:
The Bank has asset-backed financial instruments of the following types in its available-for-sale portfolio:
Mortgage-backed bonds (MBS) – Interest and principal payments are based on cash flows arising from the settlement of loans secured by mortgages.
Asset-backed bonds (ABS) – Settlement is based on cash flows from a specific group of assets.
The following table shows information regarding the depreciated cost and fair value of asset-backed bonds in the available-for-sale portfolio:
December 31, 2007 Depreciated Cumulative profit Balance- cost (in shares including other sheet value – cost) Profits Losses (4) Fair value NIS millions MBS - mortgage-backed bond (1) - (5) - - - - ABS - asset-backed bonds Backed by bank deposits (2) 148 146 2 - 148 Others (3) 29 (5) 30 - (1) 29 Total ABS available for sale 177 176 2 (1) 177
(1) Rating downgraded to CCC in 2007; as a result, a provision for decline in value was recorded in the amount of the holding (a total of NIS 0.9 million). (2) Bond rated AA+. The deposits are the assets backing the payments which the company is obligated to pay to the bond holders. (3) Of which: NIS 20 million – bonds rated AA. At the reporting date, the market value of the bonds was lower than the depreciated cost by NIS 1 million, constituting 2.4% of the par value. NIS 7 million – bonds rated AAA. The underlying assets are dollar-denominated bonds of the State of Israel. NIS 2 million – bonds, some of which are rated A+, and others of which are unrated. (4) Asset-backed bonds included in the available-for-sale portfolio in which the loss position is for a period of less than twelve months. These losses are of a temporary nature; unrealized losses were therefore allocated to shareholders’ equity. (5) In 2007, provisions for decline in value of asset-backed bonds of an other-than-temporary nature in the amount of NIS 2 million were recorded (see Note 21).
- 139 - Notes to the financial statements as at December 31, 2007
Note 3A - Asset-Backed Financial Instruments (cont`d) Reported amounts December 31, 2006 Cumulative profit including other Balance- Depreciated cost sheet value (in shares – cost) Profits Losses (3) Fair value NIS millions MBS (1) 1 1 * - - 1 ABS – others (2) 19 19 * - * - 19 Total ABS available for sale 20 20 - - 20 * Amounts up to NIS 500 thousand.
(1) Bond rated A- as of December 31, 2006, and downgraded to CCC in 2007; see Note (1) to the table above with regard to 2007. (2) Of which: NIS 10 million – bonds backed by second- or third-ranked liens, rated AA- (in 2007 the collateral was replaced, so that the bond no longer meets the definition of ABS; its rating was upgraded to AA). NIS 8 million – bonds rated AAA. The underlying assets are dollar-denominated bonds of the State of Israel. NIS 1 million – bonds rated A+. (3) Asset-backed bonds included in the available-for-sale portfolio in which the loss position is for a period of twelve months or more. These losses are of a temporary nature; unrealized losses were therefore allocated to shareholders’ equity.
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts)
Reported amounts
A. Consolidated - composition (1): December 31 December 31 2007 2006 NIS millions NIS millions
Credit 17,524 * 17,287 Customers' liabilities in respect of acceptances 46 53
Total credit (2) 17,570 17,340
Less - general provision and supplementary provision for doubtful debts 67 70
Total credit to the public 17,503 17,270 * Reclassified - Securities held by the Bank which were deposited as collateral with the Maof Clearing House and the TASE Clearing House were presented in the balance sheet under the item “credit to the public” in previous periods. In light of a letter on this subject issued by the Supervisor to banking corporations, this presentation was reexamined, and such collateral is now presented within the item “securities.” Comparison figures for past periods were reclassified accordingly, as follows: December 31, 2006 – NIS 1,135 million.
(1) See Note 1.A.(2). (2) The specific provision for doubtful debts has been deducted from the related loan item. - 140 - Notes to the financial statements as at December 31, 2007
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts) (cont'd) Reported amounts
B. Credit to the public includes: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions (1) Credit to problematic borrowers other than in the local authorities sectors regarding which an allowance for doubtful debts was not recorded based on the extent of arrears
a. Non-income generating problematic credit - in unlinked Israeli currency 137 161 - in linked to CPI Israeli currency 11 - - denominated in foreign currency 46 52
b. Credit restructured during the current year, involving a waiver of income:
Unlinked - Balance as at balance sheet date 6 5 - Average repayment period (years) 2 1 - Effective income rate: imputed in the expected repayments 6.12% 7.21% imputed in the original repayments 7.25% 10.81%
c. Credit restructured during the current year, not involving a waiver of income: - Balance as at balance sheet date - denominated in foreign currency 1 18 - linked to CPI 4 2 - Unlinked 9 11
d. Credit restructured in prior years, involving a waiver of income: - Balance as at balance sheet date: - denominated in foreign currency - 1 - linked to CPI 20 19 - unlinked 3 3
e. Credit to borrowers as to which there is a resolution of the management for the restructuring of their indebtedness, the implementation of which has not yet been effected: - Balance as at balance sheet date 2 -
f. Credit in temporary arrears: - Balance as at balance sheet date 26 35 - Related interest income recognized 5 5
g. Credit under special supervision: - Balance as at balance sheet date 315 602
(2) Credit to local authorities: - Balance as at balance sheet date 93 99 - Related interest income recognized 7 9
- 141 - Notes to the financial statements as at December 31, 2007
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts) (cont'd)
C. Provision for doubtful debts Consolidated (5) December 31, 2007 December 31, 2006 December 31, 2005 Specific provision Specific provision Specific provision According to According to According to the extent of Supplementary the extent of Supplementary the extent of Supplementary (1) (2) (3) (1) (2) (3) (1) (2) (3) arrears Other provision Total arrears Other provision Total arrears Other provision Total Reported amounts Reported amounts Reported amounts NIS NIS NIS millions millions NIS millions millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Balance of provision at beginning of year 28 836 70 934 28 810 80 918 25 855 81 961 Classification of balance of provision at beginning of year - - - - *2 *(2) ------Balance of provision at beginning of year after classification 28 836 70 934 30 808 80 918 25 855 81 961 Provision for current year 8 112 2 122 12 130 - 142 7 156 3 166 Reduction of provision (9) (27) (5) (41) (13) (36) (10) (59) (4) (8) (4)(4) (16) Less - collection of debts written-off in previous years - (1) - (1) - (1) - (1) - (1) - (1)
Amount charged to statement of profit and loss (1) 84 (3) 80 (1) 93 (10) 82 3 147 (1) 149 Less - write-offs (2) (42) - (44) (1) (65) - (66) - (192) - (192)
Balance of provision at end of year **25 878 67 970 ** 28 836 70 934 28 810 80 918
* Following the implementation of the Circular of the Supervisor of Banks dated January 1, 2006: (a) Amount of NIS 2 million in the opening balance as at January 1, 2006 was classified from other specific provisions to specific provisions according to the extent of arrears. (b) Specific provisions according to the extent of arrears were increased by NIS 0.5 million in the first quarter of 2006. ** Includes the balance of the specific provision beyond the amount required based on the extent of arrears as of December 31, 2007, in the amount of NIS 3 million (December 31, 2006: NIS 2 million). (1) For loans regarding which a provision was made according to the extent of arrears, no provision is included for interest with respect to the debt in arrears. (2) Does not include provision in respect of interest on doubtful debts, arising after the debts were determined to be doubtful. (3) Includes general provision for doubtful debts. (4) In accordance with a directive of the Supervisor of Banks, NIS 3.5 million of the supplementary provision was cancelled in respect of shares of "Bezeq". (5) See Note 1.A.(2).
- 142 - Notes to the financial statements as at December 31, 2007
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts) (cont'd)
Reported amounts
D. The arrears with respect to the loans for housing and the provisions with respect to doubtful debts according the extent of arrears
Consolidated - composition (1):
December 31, 2007 Balance in respect of 3 months to 6 months to 15 months to Above restructured 6 months 15 months 33 months 33 months loans Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Amount of the arrears 1 1 2 19 2 25 Of which: interest on arrears - - - 8 1 9 Provision for doubtful debts according to the extent of arrears (2) - 3 6 15 1 25 Balance of loans less provision 10 11 6 4 3 34
December 31, 2006 Balance in respect of 3 months to 6 months to 15 months to Above restructured 6 months 15 months 33 months 33 months loans Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Amount of the arrears 1 1 3 20 1 26 Of which: interest on arrears - - - 8 - 8 Provision for doubtful debts according to the extent of arrears (2) - 1 6 20 1 28 Balance of loans less provision 14 9 6 6 5 40
(1) See Note 1.A.(2). (2) Not including provision with respect to interest on the amount in arrears.
- 143 - Notes to the financial statements as at December 31, 2007
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts) (cont'd)
Reported amounts
E. Details on the manner of calculating the specific provision on loans for housing
Consolidated - composition (1):
December 31, 2007 Problematic housing debts Specific provision According to Balance of Amount in the extent of Credit debt Arrears ** arrears Other Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Housing loans on which the provision must be calculated according to the extent of arrears 2,805 34 25 25 - 25 “Large” loans* 321 6 3 - 2 2 Other loans 185 20 30 - 6 6
Total 3,311 60 58 25 8 33
December 31, 2006 Problematic housing debts According to Balance of Amount in the extent of debt arrears** arrears Other Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Housing loans on which the provision must be calculated according to the extent of arrears 2,455 40 26 28 - 28 “Large” loans* 186 7 4 - 2 2 Other loans 194 23 27 - 6 6
Total 2,835 70 57 28 8 36
* Housing loans the balance of each exceeds NIS 805 thousand (2006 - NIS 783 thousand). ** Including interest on the amount in arrears. (1) See Note 1.A.(2).
- 144 - Notes to the financial statements as at December 31, 2007
Note 4 - Credit to the Public (Net of Provision for Doubtful Debts) (cont'd)
Reported amounts
F. Classification of credit to the public (1) and off-balance sheet credit risk (2) according to size of debt per borrower: Consolidated - composition (3): Consolidated Consolidated December 31, 2007 December 31, 2006 Ceiling of debt per borrower Number of Credit Credit Number of Credit Credit (NIS thousands) borrowers (2) risk (4) borrowers (2) risk (4) From To NIS millions NIS millions NIS millions NIS millions
0 10 25,764 45 33 24,404 31 43 10 20 12,399 97 74 11,776 70 97 20 40 11,124 204 101 11,003 148 135 40 80 12,305 425 259 12,068 370 321 80 150 10,698 814 341 10,053 617 415 150 300 8,429 1,443 300 7,574 1,227 349 300 600 3,749 1,310 202 3,380 1,151 227 600 1200 1,400 825 310 1,230 737 273 1,200 2,000 543 511 289 449 482 205 2,000 4,000 465 811 494 446 754 468 4,000 8,000 324 997 731 356 1,150 891 8,000 20,000 287 1,791 1,698 237 1,592 1,684 20,000 40,000 149 1,961 1,986 144 1,898 2,082 40,000 200,000 139 4,867 5,542 137 5,206 5,483 200,000 400,000 22 1,751 3,814 15 870 2,860 400,000 586,000 1 141 301 2 1,059 1 87,798 17,993 16,475 * 83,274 *17,362 (5) 15,534 * Reclassified - See Note 4.A. (1) Net of specific provision for doubtful debts. (2) Number of borrowers based on total credit and credit risks. (3) See Note 1.A.(2). (4) Credit risk in off-balance sheet financial instruments as calculated for purposes of per-borrower credit limitations. (5) Including outstanding liabilities in respect of credit cards in the amount of NIS 238 million as at December 31, 2006.
- 145 - Notes to the financial statements as at December 31, 2007
Note 5 - Investments in Investee Companies and Details on such Companies
Reported amounts
A. Consolidated:
December 31, 2007 December 31, 2006 Affiliated Affiliated companies Subsidiaries Total companies Subsidiaries Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Investments in shares stated on The equity basis (including goodwill) 16 - 16 42 - 42
Details on goodwill: Rate of amortization 10 years 10 years Original amount 2 - 2 3 - 3 Unamortized balance 1 - 1 1 - 1
B. The Bank:
December 31, 2007 December 31, 2006 Affiliated Affiliated companies Subsidiaries Total companies Subsidiaries Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Investments in shares stated on The equity basis (including goodwill) - 450 450 - 429 429
Details on goodwill: Rate of amortization 10 years 10 years Original amount - 15 15 - 15 15 Unamortized balance - 6 6 - 8 8
- 146 - Notes to the financial statements as at December 31, 2007
Note 5 - Investments in Investee Companies and Details on such Companies (cont’d) Reported amounts C. Details of principal investee companies (1) Investments on equity basis As at December 31
Share in Dividend received Other items Main equity and Income (losses) since since the date of accumulated in the Bank's equity in the activity voting Cost of acquisition date of acquisition acquisition shareholders' equity (2) profits (losses) of investee companies 2007 2006 2007 2006 2007 2006 2007 2006 2007 2006 2005 Company name % NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
1. Subsidiaries
Union Investments and Enterprise Real (A.S.Y.) Ltd. (3) investments 100 135 104 (11) (8) - - 13 11 4 7 6
Impact Union Investment Portfolios (4) Management of investment Portfolios 100 10 10 5 2 - - 1 1 3 1 3
Union Finances Ltd. (5) See note D below 100 2 2 34 33 - - - - 1 21 3
Union Balances Ltd. (6) See note E below 100 1 1 36 35 - - - - 1 22 2
Union Issuances Ltd. (7) Issuance of subordinated notes 100 16 16 1 1 - - - - *- 1 * -
Carmel Union - Mortgages and Operating services to Investments Ltd.(8) the bank 100 138 138 20 14 (23) (16) - - 6 3 5
Livluv Insurance Agency (1993) Ltd. Real estate insurance 100 11 11 14 12 - - - - 2 2 3
Union Leasing Ltd. Leasing 100 1 1 19 11 - - - - 8 4 2
Union Bank Trust Company Ltd. Trustee services 100 2 2 10 7 - - *- *- 3 2 2
2. Affiliated companies
Taya Investment Company Ltd. (9) Holdings (9 )0 - 27 - (7) ------(1)
Hanetz Ha'Admonit Limited Partnership Hedge fund 20 18 20 1 2 (4) (1) - - (1) 1 1 * Amount up to NIS 500 thousand. (1) The data on the subsidiaries reflects the investment of the Bank in them less the investments of each company in other principal investee companies of the Bank Group, and the Bank’s equity in their results of operations less each company’s equity in the results of operations of other principal investee companies of the Bank Group. (2) Including mainly adjustments in respect of the presentation of available for sale securities of a subsidiary according to fair value, net. (3) The investment in the subsidiary includes capital notes in the amount of 139 million (as at December 31, 2006 - NIS 139 million). Regarding undertakings of the subsidiary, see Note 17.C.(3) below. (4) The investment in the subsidiary includes capital notes in the amount of NIS 5 million (December 31, 2006 - NIS 5 million). See Note 17.C.(7)(a) regarding guarantees provided by the Bank to the subsidiary’s customers. (5) Formerly - Union Mutual Funds (U.M.F.) Ltd. See Paragraph D below, regarding sale of the mutual funds activity. (6) Formerly – Union Provident Funds Management Ltd. See Paragraph E regarding sale of the activity of Union Provident Funds Management Ltd. (7) The investment in the subsidiary includes capital notes in the amount of NIS 16 million. (December 31, 2006 - NIS 16 million). See Note 10 regarding the issuance of subordinated notes by Union Issuances Ltd. (8) The amount of the investment includes goodwill created upon the acquisition. (9) With regard to the sale of the holding in Taya Investment Company Ltd., see Section F below.
- 147 - Notes to the financial statements as at December 31, 2007
Note 5 - Investments in Investee Companies and Details on such Companies (cont’d)
D. Union Mutual Funds (U.M.F.) Ltd and the Bank signed an agreement on February 1, 2006 to sell all the mutual fund operations managed by U.M.F. to Menorah Mutual Funds Ltd. (hereinafter, "Menorah"), a company controlled by Menorah Insurance Company Ltd. In the sale of the operations, the goodwill of the mutual funds and all the rights and liabilities of U.M.F in respect of the sold funds were sold. Pursuant to the agreement, within 5 years from the completion of the transaction, an adjustment of the consideration will be made, such that if the sales commissions in respect of the sales of mutual funds during the period exceed or fall below the sales commissions that were known on the date of the signing of the transaction, a reconciliation will be made between the parties according to a mechanism set forth in the agreement.
The Bank assumed upon itself a commitment to refrain from competing with Menorah in the area of mutual fund management for 5 years from the date of the agreement, and a commitment to refrain from making any further use of the name U.M.F or any use of the name Union with reference to mutual fund management for a period of 5 years.
Menorah undertook to enter into a selling agreement with the Bank for 5 years regarding the mutual funds under its management, and enter into an agreement for the provision of brokerage services by the Bank to the purchased mutual funds for a period of 5 years. Furthermore, Menorah undertook to appoint the trustee of the Bank as the trustee of the purchased mutual funds, subject to the provisions of all law.
In the first quarter of 2006, all the conditions precedent to complete the transaction obtained. On March 30, 2006, the consideration of the sale in the amount of approximately NIS 34 million was received, and the Bank recorded a net profit from the sale in the amount of NIS 21 million, stated under "After-tax income (loss) from extraordinary activities", see Note 28.
E. On January 24, 2006, an agreement was signed to sell all the provident fund operations managed under Union Provident Fund Management, to Ayalon Provident Fund Management Ltd, a company controlled by Ayalon Insurance Company Ltd (hereinafter, "Ayalon"). The transaction was completed on January 28, 2006, after all the conditions precedent for its completion obtained. In this sale, the goodwill of the funds and of Union Provident Fund Management was transferred to Ayalon, and all the rights and liabilities of Union Provident Fund Management in respect of the funds and any matter concerning the funds or the management thereof (including the right to receive management fees) were assigned to Ayalon, starting on the transaction completion date, and in consideration an amount of approximately NIS 29 million was paid to Union Provident Funds Management.
It should be noted that the Bank and Union Provident Fund Management undertook to indemnify Ayalon in respect of any damage, loss or expense incurred by Ayalon in respect of the following effects: breach of warranties, liabilities that were not recorded in the financial statements of the purchased funds, claims filed against Ayalon concerning the purchased funds in respect of causes of action rising prior to the transaction completion date.
After completion of the transaction, Ayalon undertook to exert its best efforts to ensure that the purchased operations and the sale of the funds' securities would be executed through the Bank. On its part, the Bank undertook that it would not transfer employer funds under its control to the management of any other provident fund management for a period of 5 years from the date of the agreement, provided that the returns achieved by the severance pay fund will equal, on average, the returns achieved by severance pay funds during the same period.
Income from the sale was recorded in the consolidated financial statements for 2006 under the item "After-tax income (loss) from extraordinary activities" in the amount of approximately NIS 21 million, see Note 28.
- 148 - Notes to the financial statements as at December 31, 2007
Note 5 - Investments in Investee Companies and Details on such Companies (cont’d)
F. On January 11, 2007, the consolidated company Union Investments and Enterprises (hereinafter: “U.I.E.”) sold 12.5% of the share capital of Taya Investment Company Ltd. (hereinafter: “Taya”). Subsequent to the sale, Taya is no longer an equity-basis investee company.
The Chairman of the Board of the Bank resigned from the board of directors of Taya.
Profit from extraordinary transactions in the amount of NIS 1.3 million was recorded in respect of this sale in 2007 – see Note 28.
The remaining holdings in shares of Taya were realized in several parts during the course of 2007.
Note 6 - Bank Premises and Equipment
Reported amounts
A. Consolidated and the Bank - Composition:
Cost Average depreciation rates December 31 December 31 December 31 December 31 2006 2007 2006 Additions Disposals 2007 % % NIS millions NIS millions NIS millions NIS millions
Buildings and real estate (including installations and leasehold improvements) 2.4 2.8 393 7 13 387
Equipment, furniture and motor vehicles 13.1 17.9 399 36 1 434
Total cost 792 43 14 821
Accumulated depreciation Deductions December 31 Current in respect of December 31 2006 provision disposals 2007 NIS millions NIS millions NIS millions NIS millions
Buildings and real estate (including installations and leasehold improvements) 146 16 8 *154
Equipment, furniture and motor vehicles 318 23 1 340
Total accumulated depreciation 464 39 9 494 Depreciated balance December 31 December 31 2006 2007 NIS millions NIS millions
Buildings and real estate (including installations and leasehold improvements) 247 233
Equipment, furniture and motor vehicles 81 94
Total depreciated balance 328 327
* Includes provision for deterioration in the amount of NIS 8 million (2006 - NIS 6 million), see note 28.
- 149 - Notes to the financial statements as at December 31, 2007
Note 6 - Bank Premises and Equipment (cont'd)
B. Bank premises include leasehold rights in real estate in the amount of NIS 145 million (December 31, 2006 - NIS 151 million). The lease period is for 34 to 48 years subsequent to the balance sheet date with an option to extend for an additional 99 years.
C. Rights in real estate in the depreciated amount of NIS 91 million have not yet been registered in the Bank's name at the Land Registry Office (December 31, 2006 - NIS 92 million).
D. Bank premises include property which is not occupied by the Bank in the amount (net of accumulated depreciation and provision for deterioration) of NIS 11 million, (December 31, 2006 - NIS 18 million).
E. Fair Value of Investment Property as of December 31, 2007:
Depreciated cost Fair value NIS millions
Group A (1) 9 11 Group B (2) 2 3 Total 11 14
(1) Fair value of investment property is measured based on discounted forecast cash flows, according to reliable estimates of future cash flows supported by terms of existing contracts and by external evidence, and by the use of discount rates reflecting current market estimates of uncertainty regarding the amount and timing of cash flows.
(2) Fair value of investment property is determined based on valuations performed by independent external assessors with suitable professional qualifications with respect to the location and type of investment property. Fair value is determined based on recent market transactions in similar properties at similar locations to the property owned by the company, if such transactions exist, and based on discounted forecast cash flows from the properties.
- 150 - Notes to the financial statements as at December 31, 2007
Note 7 - Other Assets
Reported amounts
Consolidated - composition (1): December 31 December 31 2007 2006 NIS millions NIS millions
Deferred tax assets, net (see Note 27.H) 60 68 Debit balances in respect of derivative financial instruments (2) 880 *600 Clearing balance net in respect of securities - 221 transactions Other receivables and debit balances (3) 75 *63
Total other assets 1,015 952
* Reclassified. (1) See Note 1.A.(2). (2) See note 11 - Credit balances of derivative financial instruments. (3) Includes NIS 13 million in respect of a loan with no scheduled maturity date, which was granted to Hof Hatehelet (Tel Aviv-Herzlyia) Development Company Ltd., in whose shares the Bank holds a 14% interest. The Bank and other shareholders in the company made loans for coverage of development expenses, which are to be returned out of the amounts the company will receive upon realization of its assets.
Note 8 - Deposits from the Public
Reported amounts
Consolidated - composition (1): December 31 December 31 2007 2006 NIS millions NIS millions
Demand deposits 4,616 4,769 Time deposits 21,875 * 20,147 Deposits in savings plans 222 424
Total deposits of the public 26,713 25,340
* Reclassified. (1) See Note 1.A.(2).
- 151 - Notes to the financial statements as at December 31, 2007
Note 9 - Deposits from Banks
Reported amounts
Composition: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions
Commercial banks:
Demand deposits 436 * 18 Time deposits 22 14 Acceptances 46 53 Special banking corporations: Demand deposits 12 * 5
Total deposits from banks 516 90
* Reclassified. See Note 17.D. regarding liens on assets.
Note 10 - Subordinated Notes and Deposit Certificates Reported amounts A. Composition: Consolidated Internal rate December 31 December 31 Average life (1) of return (2) 2007 2006 Years % NIS millions NIS millions
Subordinated notes and Deposit Certificates (3)
Subordinated notes: In NIS unlinked 6.3 6.9 102 - In NIS linked to the CPI 4.2 5.2 940 816
Deposit certificates: In NIS linked to the CPI 5.2 6.9 253 -
Total subordinated notes and deposit certificates 1,295 816
(1) The average life is the average period of the payments weighted based on the cash flow discounted at the internal rate of return. (2) The internal rate of return is the interest rate at which the anticipated future payments are discounted to arrive at the amount included in the financial statements. (3) The subordinated notes and deposit certificates are not convertible into shares.
- 152 - Notes to the financial statements as at December 31, 2007
Note 10 - Subordinated Notes and Deposit Certificates (cont'd) A. Composition (cont'd) The Bank Internal rate December 31 December 31 Average life (1) of return (2) 2007 2006 Years % NIS millions NIS millions
Subordinated notes (3) In NIS linked to the CPI 3.1 5.5 474 582
Total subordinated notes 474 582
(1) The average life is the average period of the payments weighted based on the cash flow discounted at the internal rate of return. (2) The internal rate of return is the interest rate at which the anticipated future payments are discounted to arrive at the amount included in the financial statements. (3) The subordinated notes and deposit certificates are not convertible into shares.
B. In 2007, the Bank issued non-marketable subordinated notes in the amount of NIS 45 million (2006 - NIS 14 million).
C. Publication of a shelf prospectus:
On January 7, 2007, Union Issuances Ltd., a wholly owned subsidiary of the Bank (hereinafter: the “Company”), published a shelf prospectus for the issuance of up to 12 series of debt certificates (series B through M), which may include series of certificates of deposit at an ordinary repayment ranking, equal to the repayment ranking of all deposits and/or series of subordinated notes at a repayment ranking subordinate to that of all other liabilities of the Bank that have not been assigned a repayment rank equal and/or inferior to that of the debt notes of that series.
Each of the series of debt certificates will have a par value of up to NIS 500 million. Debt certificates from each of the said issued series will mature in several payments: no less than one payment and no more than twenty annual payments or forty semi-annual payments. The linkage base and the type of interest borne by the principal of the debt certificates in each series issued will be determined in the offering report according to which each series is offered for the first time. The interest rate borne by the principal of the debt certificates will be determined in an auction, according to which the initial offering of debt certificates in that series will be performed.
D. Offering based on shelf prospectus:
1. On January 17, 2007, the Company completed an offering in the amount of NIS 200 million in subordinated notes.
The offering was carried out via two series:
A. Series B, in the amount of NIS 100 million, linked to the CPI, bearing an interest rate of 4.3% per year, paid once every six months. The principal of the series matures in three equal annual payments in 2015-2017.
B. Series C, in the amount of NIS 100 million, unlinked, bearing an interest rate of 6.2%, paid once every six months. The principal of the series matures in three equal annual payments in 2015-2017.
- 153 - Notes to the financial statements as at December 31, 2007
Note 10 - Subordinated Notes and Deposit Certificates (cont'd) D. Offering based on shelf prospectus (cont'd)
2. On March 12, 2007, the Company completed an offering in the amount of NIS 250 million in certificates of deposit (Series D), which are unlinked and bear an interest rate of 5.95% per year, paid once every six months. The principal of the series matures in three equal annual payments in 2013-2015.
3. On December 27, 2007, the Company completed an offering in the amount of approximately NIS 120 million, which constituted an expansion of Series B, with terms identical to those of the original series (see Section D.1.a. above).
Note 11 - Other Liabilities Reported amounts Composition: Consolidated The Bank December 31 December 31 December 31 December 31 2007 2006 2007 2006 NIS millions NIS millions NIS millions NIS millions
Excess of provision for severance pay, retirement, and pensions over amounts funded (see Note 14.B.) 124 122 124 122 Income received in advance 9 12 9 7 Employees - for salaries and related benefits 66 53 64 53 Credit balances of derivative financial instruments (1) 878 * 557 878 *557 Payables in respect of credit cards 262 238 262 238 Net clearing balance in respect of transactions in securities 107 - 107 -
Other payables and credit balances 64 99 210 240
Total other liabilities 1,510 1,081 1,654 1,217
* Reclassified. (1) See Note 7 - Debit balances in respect of derivative financial instruments.
- 154 - Notes to the financial statements as at December 31, 2007
Note 12 - Shareholders' Equity
A. Composition of share capital
In nominal values December 31 2007 2006
Authorized share capital Ordinary shares of NIS 0.01 each 65,000,000 65,000,000
Issued and paid-up share capital Ordinary shares of NIS 0.01 each 58,871,562 58,871,562
The shares are registered for trading on the Tel Aviv Stock Exchange. Each share confers upon its holder one vote in the general shareholders’ meeting of the Bank. Each share confers upon its holder the right to participate in earnings, and in the event of liquidation in the remaining assets of the Bank according to its proportionate par value.
B. According to the permit for the acquisition of means of control in a banking institution under the Banking Law (Licensing) - 1981, the Bank is not to distribute dividends out of earnings retained in the period prior to the acquisition of such control, without the prior consent in writing of the Supervisor of Banks. In addition, there are additional restrictions with respect to dividend distributions in accordance with the Companies Law - 1999.
The amount of the retained earnings out of which dividends may not be distributed, as at December 31, 2006, is NIS 463 million.
In the event of a distribution of dividends, the Bank is subject to the requirements of the Companies Law-1999, requirements of the Banking Law (Licensing)-1981 and the restrictions provided by the Supervisor of Bank, inter alia, concerning the absence of permission to distribute dividends when one or more than three calendar years have ended in a loss.
On February 28, 2007, the Board of Directors of the Bank resolved to propose a dividend for the years 2005 and 2006 in the amount of NIS 100 million. The proposal was approved by a special general assembly of shareholders on April 18, 2007. The aforesaid dividend was distributed on May 14, 2007.
C. In June 2000, the Bank issued 9,074,997 of its ordinary shares of NIS 0.01 par value each, and 12,099,996 registered options (for no consideration), which are exercisable for ordinary shares of NIS 0.01 par value each, on any trading day commencing with the date of their registration for trading on the stock exchange up to May 31, 2004. Each option is exercisable for one share of NIS 0.01 par value against a cash payment of the exercise premium of NIS 21, linked to the CPI.
- 155 - Notes to the financial statements as at December 31, 2007
Note 12 - Shareholders' Equity (cont'd) C. (cont'd)
In May 2004, it was decided to extend the exercise period by two additional years so that the last date for exercising the options will be May 31, 2006. The exercise price was reduced by 5% from the present exercise price, so that each option is exercisable against a cash payment of the exercise premium in the amount of NIS 19.95 per share, which is linked to the CPI. In the first five months of 2006 (up to and including the exercise date of the options), the public exercised 9,393,650 options for a monetary consideration of NIS 210 million. The balance of the unexercised options expired.
D. On October 14, 2007, the Board of Directors of the Bank resolved to recommend that the general assembly of shareholders approve an increase of the Bank’s registered share capital, which currently stands at NIS 650,000 divided into 65,000,000 ordinary shares of NIS 0.01 par value each, by the addition of 18,000,000 ordinary shares of NIS 0.01 par value each, for a total of NIS 830,000. The addition to the registered capital of the Bank will be used to issue subordinated notes and/or capital notes convertible into shares by the Bank, subject to the approval of such notes by the Supervisor of Banks as Tier I capital (considered hybrid Tier I capital).
This matter was listed in the agenda of the general assembly convened on November 21, 2007. However, in light of the position of one of the controlling shareholders, the assembly resolved to postpone discussion of this matter to a later date, to be determined by the Board of Directors.
Note 13 - Capital Adequacy under Directives of the Supervisor of Banks
Capital adequacy is calculated in accordance with Directives Nos. 311 (Minimum Capital Ratios) and 341 (Capital Allocation for Market Risks) issued by the Supervisor of Banks.
Pursuant to the Supervisor’s directives, as stated, a banking corporation’s capital may not be less than 9% of the weighted-average amount of the risk capital components of its balance sheet and off-balance sheet assets. In addition, Bank of Israel has set a minimum ratio of capital for the Bank (not including subordinated notes), to risk components of 7%.
Consolidated data:
Reported amounts
A. Capital for the purpose of calculating the capital to risk assets ratio December 31 December 31 2007 2006 NIS millions NIS millions
Tier I capital: Paid-up ordinary share capital 803 803 Surpluses and capital funds 783 769 Other amounts deducted from Tier I capital (26) (42) Total Tier I capital 1,560 1,530
Tier II capital : Upper Tier II capital (1) 52 52 Other Tier II capital 746 461 Total Tier II capital 798 513 Total capital 2,358 2,043
(1) The general provision for doubtful debts in the amount of NIS 52 million (December 31, 2006 - NIS 52 million) is part of the upper Tier II capital and is not deducted from the credit to the public.
- 156 - Notes to the financial statements as at December 31, 2007
Note 13 - Capital Adequacy under Directives of the Supervisor of Banks (cont'd)
Reported amounts
B. Weighted-average balances of risk
December 31, 2007 Weighted-Average rate Risk Capital Balances (2) 0% 20% 50% 100% Balances demand 9% NIS NIS NIS NIS NIS NIS NIS millions millions millions millions millions millions millions
Credit risk Assets: Cash on hand and deposits with banks 4,710 412 4,202 - 96 936 84 Securities 8,051 6,796 189 - 1,066 1,104 99 Credit to the public (1) 17,555 *3,971 **88 2,350 11,146 12,339 1,111 Investments in investee companies 16 - - - 16 16 1 Bank premises and equipment 327 - - - 327 327 29 Other assets 1,015 499 - - 516 516 46 Total assets 31,674 11,678 4,479 2,350 13,167 15,238 1,370
Off-balance sheet instruments: Transactions in which the balance reflects credit risk 2,005 - - - 2,005 2,005 180 Derivative financial instruments 3,759 27 2,491 - 1,241 1,739 157 Others 144 - - - 144 144 13 Total off-balance sheet instruments 5,908 27 2,491 - 3,390 3,888 350
Total credit risk assets 37,582 19,126 1,720
Market risk Interest risk 250 23 Stock risk 122 11 Rate of exchange of foreign currency and inflation risk 47 4 Stock options risk 127 11 Total market risk assets 546 49
Total risk assets 19,672 1,769
* Including: Secured credit in pledged deposits 3,276 Secured credit in government debentures 695 3,971
**Secured credit of banking guarantees 88
(1) The a general provision for doubtful debts in the amount of NIS 52 million, is part of the upper Tier II capital and is not deducted from the credit to the public. (2) Assets - balance sheet balances, off-balance sheet financial instruments - balances of the stated amounts weighted by credit conversion factors.
- 157 - Notes to the financial statements as at December 31, 2007
Note 13 - Capital Adequacy under Directives of the Supervisor of Banks (cont'd)
Reported amounts
B. Weighted-average balances of risk (cont.)
December 31, 2006 Weighted-Average rate Risk Capital Balances (2) 0% 20% 50% 100% Balances demand 9% NIS NIS NIS NIS NIS NIS NIS millions millions millions millions millions millions millions
Credit risk Assets: Cash on hand and deposits with banks 4,024 841 3,183 - - 637 57 Securities *6,287 5,682 64 - 541 554 50 Credit to the public (1) *17,322 **3,865 ***72 2,189 11,196 12,305 1,107 Credit to the government 31 31 - - - - - Investments in investee companies 42 - - - 42 42 4 Bank premises and equipment 328 - - - 328 328 30 Other assets *952 355 - - 597 597 54 Total assets 28,986 10,774 3,319 2,189 12,704 14,463 1,302
Off-balance sheet instruments: Transactions in which the balance reflects credit risk 1,127 - - - 1,127 1,127 101 Derivative financial instruments 2,733 37 1,813 - 883 1,246 112 Others 138 - - - 138 138 12 Total off-balance sheet instruments 3,998 37 1,813 - 2,148 2,511 225
Total credit risk assets 32,984 16,974 1,527
Market risk Interest risk 254 23 Stock risk 112 10 Rate of exchange of foreign currency and inflation risk 269 24 Stock options risk 10 1 Total market risk assets * 645 58
Total risk assets 17,619 1,585
* Reclassified ** Including: Secured credit in pledged deposits 2,386 Secured credit in government debentures 1,479 3,865
*** Secured credit of banking guarantees 72
(1) The a general provision for doubtful debts in the amount of NIS 52 million, is part of the upper Tier II capital and is not deducted from the credit to the public. (2) Assets - balance sheet balances, off-balance sheet financial instruments - balances of the stated amounts weighted by credit conversion factors.
- 158 - Notes to the financial statements as at December 31, 2007
Note 13 - Capital Adequacy under Directives of the Supervisor of Banks (Cont'd)
Reported amounts
C. Ratio of capital to risk components December 31 December 31 2007 2006 % %
The ratio of Tier I capital to risk components 7.93 *8.68 Total ratio of capital to risk components 11.99 *11.60 Total ratio of capital to risk components, not including subordinated notes 8.19 *8.98 Total minimum ratio of capital as required by the Supervisor of Banks 9.00 9.00 Total minimum ratio of capital as required by the Supervisor of Banks, excluding subordinated notes 7.00 7.00
* Reclassified.
Note 14 - Employee Benefits
A. Severance pay and pension (1) The liability of the Bank and its subsidiaries for severance pay and pensions to their employees is covered by appropriate provisions which, for the most part, are funded with recognized severance pay funds and by insurance policies. The provision for severance pay and pensions included in the balance sheet represents the balance of the provision which is not so funded. The liability for severance pay to the employees has been calculated on the basis of one month's salary for each year of service.
(2) In 1996, the Bank signed an agreement with those clerks of the Bank who are members of the basic pension fund "Amit Pension and Provident Fund Limited" (hereinafter - “Amit”), according to which, as from April 1, 1995, payments of the Bank to the said pension fund will relieve the Bank from any liability for payment of severance indemnities to which such employees may be entitled under the Severance Pay Law.
As from the above-mentioned date, the provision for severance pay does not include amounts in respect of severance pay to the said clerks and, as at the same time, amounts paid to the said pension fund are not included in the balance of fundings with severance pay funds.
(3) Managers and signatories of the Bank may opt to receive a pension upon retirement in lieu of severance pay, in which case they forego their rights to the severance pay and accumulated provident fund. In February 1997, the Bank signed an agreement with the organization of the Bank's managers and signatories (the "managers") relating to such managers who are members of the pension fund Amit. This agreement provides that for the period of employment prior to date of joining Amit, the managers will be entitled to the terms which were customary in the Bank up to the date of signing of the agreement. As to the period subsequent to date of joining Amit, if the manager elects the severance pay alternative, he will receive the amounts accumulated to his credit in the pension fund, but not less than the Bank's liability for severance pay under the Law. If the manager elects the pension alternative, he will receive as pension the amounts accumulated to his credit in Amit as provident contributions, but not less than the liability of the Bank according to the customary terms hitherto, as well as a pension in respect of the amounts accumulated in Amit to his credit in respect of severance pay, but not more than the liability of the Bank for pension derived from the severance pay.
- 159 - Notes to the financial statements as at December 31, 2007
Note 14 - Employee Benefits (cont'd)
A. Severance pay and pension (cont'd) (3) (cont'd)
The above terms will apply only to long service managers (as defined in the agreement). A new manager (anyone who is not a long service manager) is not entitled to a pension, and the contributions of the Bank to the pension fund will relieve the Bank from any liability to severance pay to which the new manager may be entitled under the Law.
The computation of the liability for pensions to managers is based on the present value of the liability, which is greater than the amount of the liability for severance pay and accumulated provident fund. The present value was computed by an actuary using a discount rate of 4% (2006 - 4%) in accordance with directives of the Supervisor of Banks. The computation also considered the factor of real future salary increases until retirement using a rate of 2% per year (2006 - 2%).
(4) The liability for pensions for retired employees who opted to receive pensions is covered by a provision for pensions calculated on the basis of the present value of the liability, by an actuary, at a capitalization rate of 4% (2006 - 4%) as stated above.
(5) In October 2005 the Head Actuary of the Minister of Finance published guidelines regarding the method of determining the mortality basis used in the calculation of pension coefficients and in order to value reserves relating to pension type life assurance policies. In his letter dated November 23, 2005, the Supervisor of Banks announced that he will adopt the guidelines for purposes of calculating reserves in respect of employee benefits as from January 1, 2006 and no later than the end of the first quarter of 2006. In its financial statements for December 31, 2005, the Bank recorded an expense in the amount of NIS 9 million in respect of this adjustment. In accordance with the letter of the Supervisor, the Bank recorded an additional expense in the amount of NIS 5 million in the first quarter of 2006.
In February 2007, the Chief Actuary issued circulars to pension funds and insurance companies according to which reserves for pensions and life insurance are to be assessed based on new mortality tables. The Bank adopted these tables in the first quarter of 2007, and consequently recorded payroll expenses in the amount of approximately NIS 5 million.
Details regarding the actuarial estimate on which the Bank relies with respect to employee benefits can be found in the estimate of the actuary Mr. Dan Hershkovitz which was attached to the Electronic Due Disclosure Reporting (Magna) system of the Securities Authority.
(6) Voluntary retirement
In the third quarter of 2005 the Bank offered a voluntary retirement plan to its employees. In accordance with the plan the employees received in respect of their retirement, amounts exceeding the rights accrued on the books of the Bank according to criterions of age and years of employment. Twenty employees retired from the Bank in the framework of the plan. The cost of the plan amounted to NIS 17 million and it was included in the statement of profit and loss under the item “salaries and related expenses”.
- 160 - Notes to the financial statements as at December 31, 2007
Note 14 - Employee Benefits (cont'd) B. Details relating to the provisions and fundings
The amounts of the provisions and fundings relating to employee severance benefits included in the balance sheet are as follows: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions
Provisions 247 242 Fundings 123 120 Excess of provisions over fundings (1) 124 122
The Bank may not withdraw amounts funded other than for the purpose of making severance payments.
(1) Included in "Other liabilities" (See Note 11).
C. Long service bonuses
Employees of the Bank, upon attaining 20, 30 and 40 years of service, are entitled to long service bonuses ("Jubilee Grant") amounting to a specified number of monthly salaries as well as to a special vacation period. As at the balance sheet date, the accumulated provision amounted to NIS 9 million (December 31, 2006 - NIS 6 million). The provision is included in "other liabilities".
The calculation is made on an actuarial basis using a capitalization rate of 4% (2006 - 4%), taking into account the probability, based on past experience, that the employee will still be employed by the Bank on the entitling date. In calculating the present value, an anticipated real salary increase of 3% (2006 - 2.5%) was taken into account.
D. Provision for vacation
Employees of the Bank and its subsidiaries are entitled to paid annual vacation as provided by the Annual Vacation Law - 1951, subject to a special labor contract with the Bank's employees, and according to the limits detailed in this contract. The liability is calculated on the basis of latest salary plus social benefits. The financial statements include a provision of NIS 19 million (December 31, 2006 - NIS 18 million) for unutilized vacation and special vacation entitlement (see C. above) which has already vested. The liability is included under "other liabilities".
- 161 - Notes to the financial statements as at December 31, 2007
Note 14 - Employee Benefits (cont'd) E. Personal contracts
(1) Beginning in 2004, all management members are employed under personal contracts. Four of the management members and senior officers have a personal contract providing them with enhanced severance pay should they be dismissed by the Bank. Furthermore, one management member has a personal contract that guarantees a minimal employment term. The maximum amount of the Bank’s additional expense is NIS 5.2 million (December 31, 2006 - NIS 3.4 million), which was not recorded on the books of the Bank as the Bank has no intention of dismissing abovementioned management members and senior officers.
(2) In the second quarter of 2006, Mr. Haim Freilichman was appointed the Chief Executive Officer of the Bank (hereinafter, "CEO") for a period of 3 years beginning on April 2, 2006. Pursuant to his employment contract, the CEO is entitled, inter alia, to an annual bonus in a varying amount based on the net earnings return of the Bank on its equity (excluding capital gains and/or one-off revenues in respect of the sale of mutual fund and provident fund operations) up to 1% of the Bank's net earnings. Furthermore, the agreement provides that the Bank will issue, within 30 days from the signing of the agreement, options for Bank shares - See note 14A.
In the event that the CEO's employment is terminated by the Bank or the CEO under special circumstances, as defined in the contract, the CEO will be entitled to receive from the Bank all the salaries and accompanying benefits (including profitability bonus in respect of his relative term of employment, excluding unvested CEO options) until the end of the contract term.
Since the Board of Directors does not intend to dismiss the CEO, no provision in respect of the above was recorded in the financial statements. Total liabilities noted above as at December 31, 2007 that were not recorded in the Bank's books, was NIS 3.1 million (December 31, 2006 - NIS 4.9 million).
Upon elapse of the three year period, the CEO will be entitled to an adjustment bonus equal to six monthly salaries.
(3) On April 30, 2006, the general shareholders' meeting approved change in the employment terms of the Chairman of the Board of Directors, as follows:
a. Salary raise of 15%, beginning with salary in respect of January 2006.
b. Bonus in the amount of NIS 500 thousand in respect of 2005.
c. Enhanced severance pay, if and when the Chairman retires, of 100%, in addition to the amount accrued in his favor in severance pay funds.
On April 18, 2007 the general shareholder' meeting approved a bonus in the amount of NIS 750 thousand for the Chairman of the Board of Directors in respect of 2006 (the bonus expense is included in the financial statements for 2007).
F. Change in definition of salary in the Value Added Tax Law
In April 2005 the Economic Policy Law for 2005 was approved, in which the definition of salary in the VAT Law was changed so as to include also a retirement grant or a death grant and any other amount paid by an employer to an advanced study fund or provident fund that is not a central severance pay fund. As a result of this amendment the salary expenses of the Bank increased in 2005 by the amount of NIS 2 million in respect of the additional payroll tax liability.
- 162 - Notes to the financial statements as at December 31, 2007
Note 14A - Share-Based Payment Transactions
A. Details of Share-Based Payment Transactions
The agreement between the Bank and its General Manager, as detailed in Note 14E(2), stipulates that the Bank shall issue option notes to the General Manager, within 30 days of the signing of the agreement, for the purchase of shares of the Bank constituting 1.25% of the share capital of the Bank as of March 31, 2006. The option notes were allocated to the General Manager in the name of a trustee, to hold for a period of no less than two years from the date of allocation in his name, in a capital-based track, in accordance with Section 102 of the Income Tax Ordinance. The General Manager is entitled to exercise the option notes in two equal portions: the first portion from the date when two years have elapsed from the issuance of the options to April 1, 2010; and the second portion from March 31, 2009 to two years from that date. The price per share at the exercise of the General Manager’s options shall be 90% of the closing price of the Bank’s share on April 2, 2006, linked to the CPI and subject to adjustments arising from the allocation of benefit shares and consolidations/splits of the Bank’s shares.
B. Estimated Fair Value
The theoretical amount of the benefit inherent in the aforesaid option notes, calculated according to the Black & Scholes method, totals approximately NIS 5 million. The calculation of the amount of the benefit is based on the following main parameters:
- Standard deviation of the annual return of the Bank’s shares – approximately 32%.
- Risk-free CPI-linked interest rate – 3.7%.
- Share price determined according to the closing price on April 2, 2006 – NIS 23.43.
This amount is spread over three years in the Bank’s statements of profit and loss, starting in the second quarter of 2006, according to the vesting period, against an increase of the capital fund.
C. Share-Based Payment Transactions – Share Options Consolidated and the Bank 2007 2006 Weighted Weighted Number of average Number of average exercise options exercise price options price NIS thousands NIS NIS thousands NIS In circulation at start of year 620 21.01 - - Granted during the year - - 620 21.09 In circulation at end of year 620 21.59 620 21.01
The weighted average fair value of the share options granted during 2006 at the measurement date was approximately NIS 5 million.
- 163 - Notes to the financial statements as at December 31, 2007
Note 15 - Assets and Liabilities According to Linkage Basis Reported amounts
Consolidated - composition(1): December 31, 2007 Israeli currency Foreign currency (2) Unlinked Linked to the U.S. dollar Euro Group Other Non-monetary Total Consumer items Price Index NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Assets Cash on hand and deposits with banks 378 137 2,638 1,235 322 - 4,710 Securities 6,628 966 89 100 1 267 8,051 Credit to the public (3) 9,807 3,505 3,271 302 547 71 17,503 Investments in investee companies - - - - - 16 16 Bank premises and equipment - - - - - 327 327 Other assets 388 - 215 48 228 136 1,015 Total assets 17,201 4,608 6,213 1,685 1,098 817 31,622
Liabilities Deposits from the public 14,787 2,978 6,200 1,522 1,111 115 26,713 Deposits from banks 168 21 33 16 278 - 516 Deposits from Government - 2 - - - - 2 Subordinated notes and deposit certificates 353 942 - - - - 1,295 Other liabilities 824 106 220 53 232 75 1,510 Total liabilities 16,132 4,049 6,453 1,591 1,621 190 30,036
Difference 1,069 559 (240) 94 (523) 627 1,586
Other transactions: Forward transactions (213) (284) 218 (233) 512 In the money options, net (in base asset terms) (109) - (14) 123 - Out of the money options, net (in base asset terms) (32) - 34 (2) - Total 715 275 (2) (18) (11) In the money options, net (in discounted stated amounts) (199) - 31 168 -
Out of the money options, net (in discounted stated (167) - 189 (22) - amounts)
(1) See Note 1.A(2). (2) Including linked to foreign currency. (3) The general and supplementary provisions for doubtful debts have been deducted proportionately from the various linkage bases in this category.
- 164 - Notes to the financial statements as at December 31, 2007
Note 15 - Assets and Liabilities According to Linkage Basis (cont'd)
Reported amounts
Consolidated - composition (1):
December 31, 2006 Israeli currency Foreign currency (2) Unlinked Linked to the U.S. dollar Euro Group Other Non-monetary Total Consumer items Price Index NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Assets Cash on hand and deposits with banks 1,340 147 1,491 971 75 - 4,024 Securities *5,399 416 161 100 5 206 6,287 Credit to the public (3) *9,052 3,395 3,756 398 552 117 17,270 Credit to the Government - 31 - - - - 31 Investments in investee companies - - - - - 42 42 Bank premises and equipment - - - - - 328 328 Other assets *490 9 *100 *106 *82 *165 952 Total assets 16,281 3,998 5,508 1,575 714 858 28,934
Liabilities Deposits from the public *14,310 2,762 6,096 1,405 613 *154 25,340 Deposits from banks 10 14 50 9 7 - 90 Deposits from Government 2 33 - - - - 35 Subordinated notes and deposit certificates - 816 - - - - 816 Other liabilities *602 106 *88 *105 *79 101 1,081 Total liabilities 14,924 3,731 6,234 1,519 699 255 27,362
Difference 1,357 267 (726) 56 15 603 1,572 Other transactions: Forward transactions *(723) *(108) 863 (24) (8) In the money options, net (in base asset terms) (31) - 25 6 - Out of the money options, net (in base asset terms) 64 - (36) (28) - Total 667 159 126 10 7 In the money options, net (in discounted stated amounts) (123) - 99 24 -
Out of the money options, net (in discounted stated amounts) 162 - (82) (80) -
* Reclassified. (1) See Note 1.A(2). (2) Including linked to foreign currency. (3) The general and supplementary provisions for doubtful debts have been deducted proportionately from the various linkage bases in this category. - 165 - Notes to the financial statements as at December 31, 2007
Note 16 - Assets and Liabilities according to Linkage Basis and Maturity Date (1)
Reported amounts
Consolidated - composition (2): December 31, 2007 Future expected contractual cash flows Balance-sheet balance (4) Upon From one From From two From From ten With no demand month to three From one years to three From four From five years to Over fixed and up to three months to year to three years to years to years to twenty twenty Total cash repayment one month months one year two years years four years five years ten years years years flows period (5) Total NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS millions millions millions millions millions million millions millions millions millions millions millions millions
Israeli currency unlinked Assets 3,785 2,702 3,968 1,833 2,117 1,307 361 1,302 486 46 17,907 922 17,201 Liabilities 12,379 1,185 1,746 429 110 35 31 412 3 1 16,331 60 16,132 Difference (8,594) 1,517 2,222 1,404 2,007 1,272 330 890 483 45 1,576 862 1,069 Derivative instruments (excluding options) (290) 39 47 (7) - (2) - - - - (213) - (213) Options (in terms of the underlying asset) (63) (133) 27 23 - 5 - - - - (141) - (141) Israeli currency linked to the Consumer Price Index Assets 54 155 568 750 636 526 527 1,698 811 139 5,864 3 4,608 Liabilities 52 190 516 612 440 503 643 1,590 263 42 4,851 12 4,049 Difference 2 (35) 52 138 196 23 (116) 108 548 97 1,013 (9) 559 Derivative instruments (excluding options) - (137) (147) ------(284) - (284) Options (in terms of the underlying asset) ------Foreign currency (3) Assets 4,975 364 870 313 186 242 144 435 189 28 7,746 1,600 8,996 Liabilities 6,108 1,825 1,359 150 158 18 - 102 - - 9,720 - 9,665 Difference (1,133) (1,461) (489) 163 28 224 144 333 189 28 (1,974) 1,600 (669) Derivative instruments (excluding options) 290 98 100 7 - 2 - - - - 497 - 497 Options (in terms of the underlying asset) 63 133 (27) (23) - (5) - - - - 141 - 141 Non-monetary items Assets 79 2 16 21 6 - - - - - 124 703 817 Liabilities 72 4 16 21 6 - - - - - 119 71 190 Difference 7 (2) ------5 632 627 Total Assets 8,893 3,223 5,422 2,917 2,945 2,075 1,032 3,435 1,486 213 31,641 3,228 31,622 Liabilities 18,611 3,204 3,637 1,212 714 556 674 2,104 266 43 31,021 143 30,036 Difference (9,718) 19 1,785 1,705 2,231 1,519 358 1,331 1,220 170 620 3,085 1,586
(1) Presented in this note are future expected cash flows in respect of assets and liabilities according to linkage base according to the outstanding expected maturity periods of each cash flow. The data is presented net of provisions for doubtful debts. (2) See Note 1.A.(2). (3) Including linkage to foreign currency. (4) As included in Note No. 15 “Assets and Liabilities according to Linkage Basis”, including off-balance sheet amounts in respect of derivatives. (5) Israeli currency unlinked - the amount of approved revolving credit is NIS 692 million and the amount of credit deviating from the approved facility is NIS 21 million. Foreign currency - the amount of approved revolving credit is NIS 1,600 million.
- 166 - Notes to the financial statements as at December 31, 2007
Note 16 - Assets and Liabilities according to Linkage Basis and Maturity Date (1) (cont'd)
Reported amounts
Consolidated - composition (2):
December 31, 2006 Balance-sheet balance (4) Upon From one From ten With no demand month to From three From one From two From three From four From five years to Over fixed and up to three months to year to years to years to years to years to twenty twenty Total cash repayment one month months one year two years three years four years five years ten years years years flows period (4) Total NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS NIS millions millions millions millions millions million millions millions millions millions millions millions millions Total Assets *9,361 *1,863 3,731 2,575 2,767 2,122 2,394 2,850 1,378 84 29,125 3,155 *28,934 Liabilities *17,674 *2,908 3,474 956 505 545 495 1,374 442 20 28,393 192 *27,362 Difference (8,313) (1,045) 257 1,619 2,262 1,577 1,899 1,476 936 64 732 2,963 1,572
* Reclassified. (1) Presented in this note are future expected cash flows in respect of assets and liabilities according to linkage base according to the outstanding expected maturity periods of each cash flow. The data is presented net of provisions for doubtful debts. (2) See Note 1.A.(2). (3) As included in Note No. 15 “Assets and Liabilities according to Linkage Basis”, including off-balance sheet amounts in respect of derivatives. (4) Israeli currency unlinked - the amount of approved revolving credit is NIS 630 million and the amount of credit deviating from the approved facility is NIS 21 million. Foreign currency - the amount of approved revolving credit is NIS 1,663 million.
- 167 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens Reported amounts
A. Off-balance sheet financial instruments: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions
Transactions where the balance reflects credit risk: Documentary credit 141 185 Guarantees securing loans 548 218 Guarantees to dwelling purchasers 927 570 Other liabilities and guarantees 515 418 Unutilized credit card limits 1,058 1,049 Unutilized revolving credit and on-call limits 753 738 Unutilized loan and revolving credit facilities of diamond dealers 1,503 1,145 Irrevocable credit approvals not yet utilized 9,789 9,870 Commitments to issue guarantees 462 314
B. Off-balance sheet undertakings with respect to activities based on the extent of collection (1):
Balance of credit from deposits based on the extent of collection (2) Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions
Israeli currency linked to the CPI 698 742
Cash flows with respect to collection commissions and interest margins for activities based on the extent of collection As at December As at December 31, 2007 31, 2006 Up to 1 year to 3 years to 5 years to 10 years to Over 1 year 3 years 5 years 10 years 20 years 20 years Total Total NIS NIS NIS NIS NIS NIS NIS NIS millions millions millions millions millions millions millions millions
Linked Segment Future contractual cash flows 7 11 9 20 15 - 62 69 Expected future cash flows after Management's estimate of early repayments 7 11 8 15 9 - 50 58 Discounted future cash flows after Management's estimate of early repayments (3) 6 10 7 12 6 - 41 47
2007 2006 NIS millions NIS millions
Information about loans extended during the year Loans out of deposits based on the extent of collections 25 20
(1) Credit and deposits the return of which to the depositor depends on collection of the credit (or deposits) with a margin or collection commission (instead of a margin). (2) Standing loans and government deposits made in respect thereof, in the amount of NIS 85 million (2006 - NIS 116 million) are not included in this table. (3) The discount was made at the rate of 3.6% (2006 - 3.8%).
- 168 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) Reported amounts C. Contingent liabilities and commitments: Consolidated and the Bank December 31 December 31 2007 2006 NIS millions NIS millions (1) Rentals for bank premises and equipment payable in future years: First year 11 9 Second year 7 7 Third year 6 4 Fourth year 5 3 Fifth year 4 2 Over five years 8 3 Total 41 28
(2) As at December 31, 2007, commitments to purchase and renovate bank premises and equipment totaled NIS 12 million, (December 31, 2006 - NIS 3 million) - consolidated and Bank.
(3) A subsidiary committed to invest NIS 5 million in additional non-banking corporations and in a hedge fund, this being upon fulfillment of certain conditions provided in agreements with those corporations.
(4) Agreement to receive computing services from Bank Leumi L'Israel Ltd. (hereinafter, "Leumi") -
On September 29, 2001, an operating and computing agreement was signed with Leumi for a period of 11 years, beginning in 1998, pursuant to which Leumi renders operating services to the Bank in respect of banking infrastructure services, in addition to the Bank's entitlement to receive the majority of information systems in operation in Leumi, most of which have been assimilated by the Bank (hereinafter: "The agreement").
The services which Leumi committed to provide through their operating and administration system or any entity replacing them (hereinafter, "Matam") are based on computing services that Matam renders to Matam clients in addition to other services set forth in detail in the agreement. Leumi also renders to the Bank complete ongoing support and maintenance services, and training services concerning the systems used to provide services, and operating services. Operating, maintenance and systems development services are rendered by Leumi at a standard of service that is similar to that rendered to Leumi's units and branches.
Under the agreement Leumi undertakes to transfer operating information concerning the system to the Bank, maintain a level of information security for Bank data and, subject to the receipt of a special consideration, prepare the foundation for systems conversion and migration to independent computing systems in the event that the Bank decides to implement these. Furthermore, Leumi undertook a contractual commitment to maintain confidentiality of Bank data. The Bank's database is maintained separately from Leumi's database.
Considering that the computing agreement with Leumi was close to termination, the Bank has initiated a review, analysis and evaluation of alternatives for its future computing system.
- 169 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd)
Reported amounts
C. Contingent liabilities and commitments (cont'd)
(4) (cont'd)
At the conclusion of this process, on December 31, 2007, the Bank and Leumi signed an addendum to the agreement in which the term of the agreement was extended for ten years, starting January 1, 2007; the terms of the agreement were improved on the monetary level, via a decrease in the cost of routine services and the reduction of uncertainty related to uncontrolled increases in the cost of services in the future, as well as on the service-quality level, by the signing of a service-level agreement (SLA). Pursuant to the addendum to the agreement, the annual price of routine services is set at NIS 37-40 million in the first two years, rising gradually to NIS 42-45 million starting in the sixth year, according to the range of services to which the Bank is entitled under the agreement. These sums are linked to the consumer price index of December 2006, and may change in accordance with changes in the volume of activity of the Bank.
The addendum to the agreement covers systems that have not yet been transferred to the Bank’s use, and which can assist the Bank in complying with various regulatory requirements, among other things.
The Bank of Israel has approved the extension of the agreement; the approval is contingent upon various conditions, which are met by the Bank. The Antitrust Commissioner has granted an exemption from a restrictive arrangement permit, valid for seven years.
The direct monetary effect of the addendum to the agreement for 2007 is a decrease of NIS 14 million in current computer expenses for computer and operational services in 2007.
(5) Guarantees to courts and others as at December 31, 2007 amounted to NIS 64 million, (December 31, 2006 - NIS 64 million) - consolidated and Bank.
(6) The Bank and an equity-based investee undertook to indemnify Ayalon Provident Fund Management Company Ltd. in respect of any damage, loss or expense incurred by Ayalon in respect of event set forth in Note 5E.
(7) a. In accordance with the Mutual Fund Investment Regulations (Capital and Insurance of a Manager and a Trustee of a Mutual Fund and the Qualifications of Directors and Employees Thereof) - 1995, the Bank issued guarantees in favor of holders of certificates of mutual funds of which an investee of the Bank act as trustees, in the amount of NIS 7 million. b. As demanded in the Arrangement of Investment Management and Advice Activities and Management of Investment Portfolios Regulations (Shareholders’ Equity and Insurance) - 1997, a consolidated company which serves as manager of investment portfolios, is covered by professional liability insurance. c. A consolidated company engaged in underwriting is covered by professional liability insurance, as required in the Securities Regulations (Underwriting) - 2007.
(8) Pursuant to the agreement signed on December 18, 2006 between a consolidated company and the Bank, the Bank undertook a commitment towards the trustees of the subordinated notes and the certificates of deposit issued by the consolidated company to fulfill all terms of payments noted in the subordinated notes and in the certificates of deposit.
- 170 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd)
C. Contingent liabilities and commitments (cont'd)
(9) Financial backing for a consolidated company has been approved by the Bank, as cover for the subsidiary's underwriting commitments, in an aggregate amount not to exceed 3% of the Bank's shareholders' equity. As at balance sheet date the said subsidiary had no underwriting commitments or any other liability to purchase securities.
(10) The Bank, which is a member of the Tel Aviv Stock Exchange, has undertaken, together with the other members of the Stock Exchange, to reimburse the clearing house of the Stock Exchange in the event that it suffers losses deriving from insufficient securities holdings or insufficient financial cover by any one of the members. For this purpose the clearing house established a risk fund in which all the members of the clearing house, including the Bank, will participate. As at December 31, 2007 the Bank’s share in the risk fund amounted to NIS 45 million (December 31, 2006 - NIS 39 million).
(11) The Ma'of Clearing House Ltd. (hereinafter - "The Clearing House") is operated by the Tel Aviv Stock Exchange Ltd. Its main activities are the issue of options, providing clearinghouse facilities for transactions in options and their exercise and providing related services to members of the Clearing House and to the trade in options. The Bank, as a member of the Clearing House, is responsible, jointly with the other members of the Clearing House for any financial indebtedness towards the Clearing House resulting from dealings in options executed on the Stock Exchange. For this purpose, the Clearing House established a risk fund (hereinafter - "the Fund"). Each member of the Clearing House is responsible for his share of the Fund, which is determined based on the relative share of his activities in options or the total amount of the collateral which he is required to provide to the Clearing House and based on the terms set by the Board of Directors of the Clearing House from time to time.
As at the balance sheet date, the Bank's share of the Fund was NIS 99 million, which is 9.14% of the total amount of the Fund. The Bank's share of the Fund may increase in the event that one or more of the other members of the Clearing House does not meet their obligations.
The Bank committed to the Clearing House to pay any monetary obligation stemming from transactions executed for its customers in connection with the writing of options traded within the framework of the Clearing House. As at December 31, 2007, the amount of the guarantees relating to transactions executed for customers, totaled NIS 131 million (December 31, 2006 - NIS 248 million). See also paragraph D.(3) regarding liens.
(12) The Bank purchased insurance policies covering the liability of directors and other officers of the Bank and the subsidiaries pursuant to the authority granted to it in the its Articles of Association.
a. On December 29, 2005, the general meeting of the Bank's shareholders approved granting a commitment in advance to indemnify Bank Officers and investees. The Letter of Commitment provides, inter alia, that the Bank undertakes, subject to terms set forth in the Letter of Commitment and the provisions of the Companies Law-1999, to indemnify Officer in respect of monetary liability or reasonable litigation costs imposed on the Officer due to his actions in the capacity of his office, all provided that said monetary liability or litigation costs concern events set forth in the appendix to the Letter of Commitment (hereinafter - "The Indemnify Desicion").
- 171 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) C. Contingent liabilities and commitments (cont'd) (12) a. (cont'd) "Officer" for the purpose of the indemnify decision resolution is defined as an individual who serves with the Bank and its wholly-owned subsidiaries from time to time as an Officer, as this term is defined in the Companies Law, starting on the date on which the Letter of Commitment was approved by the Bank's general meeting, and onwards.
The indemnification undertaking applies to any monetary liability imposed on officers in favor of another individual by court judgment or by arbitration judgment approved by a court, reasonable litigation costs incurred by the officer or imposed upon the officer by the court in an action filed against him, or in a criminal charge from which he was exonerated or a criminal charge in which he was convicted of a strict liability offense, reasonable litigation costs in an action concerning an event that is not included in the events set forth in the appendix and which was concluded without imposition of any monetary liability on the officer. Reasonable expenses incurred by the officer concerning an investigation or proceedings maintained against him by a competent authority and which ended without an indictment being filed against the officer and without the imposition of any monetary liability as an alternative for a criminal action, or in a proceeding or investigation as above in respect of a strict liability offense . The maximum amount of indemnification to be paid by the Bank (in addition to amounts received under insurance policies, as set forth in the Letter of Commitment) for all officers shall not exceed an amount equal in NIS to USD 35 million.
b. At the Bank's General Meeting, held on May 8, 2000, it was decided to give the Bank's officers (hereinafter - the Officers) - each one on a separate basis - indemnification with respect to a monetary liability imposed on one any of them deriving from an action taken within the scope of his duties as an officer of the Bank, in connection with a prospectus covering an offering of the Bank's securities to the public and the employees, which was published during 2000, see Note 12.C (hereinafter - the Prospectus), as well as for reasonable litigation expenses relating, directly or indirectly, to the Prospectus.
The cumulative amount of the indemnification for each officer, may not exceed NIS 500 million (linked to the CPI from the last index published prior to the date of the Prospectus up to the last index published prior to the payment). The said indemnification is provided solely for a monetary liability and/or expenses regarding which the law permits indemnification. Pursuant to the aforesaid decision, the Bank issued a written indemnification, as noted above, to the Bank's officers.
In addition, the Bank has committed that for a 10-year period from the date of approval of the written indemnification by the General Meeting, as noted, officers' insurance policy will be purchased and maintained which will insure the matters covered by the indemnification and that the amount thereof shall not be less than the amount provided.
- 172 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) C. Contingent liabilities and commitments (cont'd) (12) (cont'd)
c. The Bank has undertaken to indemnify the underwriters of its prospectus from May 2000 or any one of them, against any amount (plus expenses) that they are required to pay pursuant to a court judgment, or a compromise settlement to which the Bank has agreed, as well as for reasonable legal expenses actually incurred by the underwriters or any one of them in the course of handling the aforementioned claim, deriving from the existence of a misleading item in the Prospectus, or stemming from any detail which could be important to a reasonable investor considering acquisition of the securities being offered under the Prospectus, or in respect of any legal claim which is grounded in the Prospectus or emanates therefrom, and regarding which the underwriters are charged or make a compromise to which the Bank consents.
(13) a. Various claims for damages are pending against the Bank. Adequate provision has been made in respect of claims, which on the basis of legal opinions, management of the Bank believes will not be dismissed or withdrawn, even though it denies such claims. No provision has been made with respect to claims which in the opinion of management of the Bank and its legal counsel their chances are remote. The additional amount of exposure in respect of contingent claims the chances of which are not remote is NIS 18 million.
b. Claims against Carmel Union Mortgages and Investments Ltd. (1) On November 2, 1997, a petition was filed in the District Court of Tel Aviv against Carmel Union Mortgages and Investments Ltd. (formerly Carmel Bank, hereinafter - the Company) (a wholly owned subsidiary of the Bank), and three other mortgage banks in an aggregate amount of NIS 500 million, along with a plea for various forms of declaratory relief. In addition, a request was filed for approval of the petition as a class action. In the petition it was alleged, among other things, that the banks improperly collected from the borrowers and the guarantors, commissions in respect of borrowers' life insurance and assets pledged to the Bank, and that they are entitled to a return of the amounts of these commissions. The Company, as well as the other defendants, filed requests to summarily dismiss the request to confirm the claim as a class action. This request has not yet been heard.
During a preliminary hearing held in the District Court it was decided to delay the hearing on the case until a final decision is made with respect to the disposition of another request to certify a claim as a class action, which is being tried in the Supreme Court concerning a similar matter and regarding which the Company is not a party (hereinafter - the other request). No ruling has as yet been made on the other request.
In addition, it was decided to “freeze” the proceedings and the claim until the Supreme Court hands down an in-principle ruling on the matter of Regulation 29 of the Civil Procedural Regulations - 1984. The Supreme Court has recently handed down such an in-principle ruling by which Regulation 29 does not allow the filing of class actions. It is noted that the plaintiffs request that the claim be certified as a class action also on the basis of other laws.
- 173 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) C. Contingent liabilities and commitments (cont'd) (13) (cont'd)
(b) (1) (cont'd)
Subsequent to this decision, the claimants agreed to expunge all causes reliant on Standard 29 from the claim, but reserved the right to file an appropriate request if the law on this matter changes. Since that time, the Class Action Suits Law has been legislated, which sets forth arrangements for the filing of class action suits. With respect to the proceedings based on other arguments, the suspension stands until a ruling is made on the other request, which as aforementioned is pending with the Supreme Court.
In addition to the above mentioned, in the opinion of the Company’s legal counsel certain causes of action of the plaintiffs, who are borrowers of the Company, come under the law of limitation, the size of the group the plaintiffs request to represent in the class action cannot be evaluated and estimated, and the relief requested in the class action including the method of calculating the damages is unclear and indefinable, including the question which part of the amount is attributed to the Company.
The legal advisors believe that under these circumstances, the range of uncertainty concerning the proceeding, factual and legal, is wide to the extent that it is impossible to evaluate the risk in respect of the claim.
Since the aforesaid claim is still in its very early stages, and the request for certification of the claim as a class action has not yet been tried, the management of the company and the Bank, based on an opinion of its legal advisors, is unable, at this stage, to estimate the results of the claim.
(2) On July 6, 2003, a claim and a petition to certify the claim as a class action were filed with the District Court of Tel Aviv Jaffa by three claimants against Carmel Union Mortgages and Investments Ltd. (formerly Carmel Bank; hereinafter: the “Company”), against three other mortgage banks, and against the Customs and Stamp Duty Administration at the Ministry of Finance (hereinafter: the “Claim” / the “Petition”).
The personal Claim is in a negligible amount, whereas the claimed amount of the class action in respect of all claimants (including the claimants in the personal Claim) is NIS 300 million. The estimated number of members of the group, according to the Claim, is approximately 500,000. The Claim is filed on behalf of all persons who received loans during the period from July 6, 1996 until the filing of the Claim.
The Claim does not specify the manner of calculation of the amount of the Claim, nor the specific amount claimed from each defendant.
- 174 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) C. Contingent liabilities and commitments (cont'd) (13) (cont'd)
(b) (2) (cont'd)
The claimants allege that the mortgage banks collected stamp fees from them, for loans taken by them, in amounts allegedly greater than required under the Stamp Duty on Documents Law - 1961. The claimants allege that they were charged tax according to the total amount of the loan, including interest on the loan, over the entire period of the loan; whereas the defendants should have collected stamp fees according to the amount stated in the loan agreement, or alternatively, according to the present value of the loan, i.e. based on capitalization of the loan repayment amounts, as established in the ruling of the Supreme Court. The claimants demand a refund in the amount of the difference between the amount which they actually paid for stamp duty on the loan agreements and the required stamp fee under the aforesaid law, according to their argument. Proceedings in the Claim have been suspended until the Supreme Court rules in an additional discussion of the aforesaid ruling, on which the claimants rely in their Claim, among other things.
Shortly after the filing of the Claim described above, additional claimants filed four additional claims identical in content to the said Claim, including petitions to certify the claims as class actions, against additional banks and against the Customs and Stamp Duty Administration. The court assented to the claimants’ request to merge the discussions, with no impairment of rulings concerning the suspension of proceedings until a verdict is given in the additional discussion noted above. In accordance with this ruling, the court will eventually hear all of the claims jointly.
The discussion of the request and the date of submission of a response to the Claim were postponed several times, with the consent of all parties, as long as no ruling had been given in the aforesaid additional discussion; this ruling has now been given and the petition has been denied, with the reason that the deliberation has become theoretical subsequent to the cancellation of the stamp duty, with no ruling given on the substance of the petition. A submission date for the response to the petition has not yet been set.
In the opinion of the management of the Bank, based on the evaluation of the legal advisors of the Company, the probability that the Claim will be certified as a class action is not high, although it is highly dependent on the interpretation given in the courts’ rulings to the complex arrangements stipulated in the new law concerning class action suits. Furthermore, according to their evaluations, the probability that the Claim, including all its components, will succeed is remote, particularly in view of the fact that the stamp fees collected by the defendants were transferred in full to the Customs and Stamp Duty Administration.
(c) On June 19, 2006, a claim and a petition to certify the claim as a class action, were filed with the District Court of Tel Aviv in the aggregate amount of approximately NIS 233 million.
The claim was filed against the Bank and 31 additional defendants, including the State of Israel-Court Administration, banks, insurance companies and provident funds, concerning the automated system handling seizure orders of the Court Execution system.
- 175 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd)
C. Contingent liabilities and commitments (cont'd) (13) (cont'd) (c) (cont'd) At this stage, the Bank estimates that an amount of a magnitude of approximately NIS 2 million may be attributed to the Bank with regards to the claim.
The plaintiffs/petitioners are obliges in Court Execution cases who sought to collect the debts by imposing a third party seizure order on the defendants as lawful "possessors." They argued that the defendants are systematically misleading them by failing to provide the information required by law, and by collecting payment for services which were not effectively rendered, causing accrued damages. The defendants, including the Bank, filed a request to dismiss the Claim. In the recent ruling of the court, the request filed on behalf of the banks and provident funds was denied, while the request by the insurance companies was granted.
Concurrently, the defendants withdrew their claim against the State, in light of its announcement of the cessation of collection of its share of the payment referenced in the Claim, and the claim against the State has been expunged, at this stage.
In view of the preliminary stage of the action, the Bank's Management, based on the opinion of its legal counsel, is unable to assess the chance of this claim.
(d) Near the date of the financial statements, a payment demand in a total amount of USD 10 million was presented to the Bank in relation to capital market activity of an authorized signatory in an account. Given the lack of details in the demand, the early stage of its examination, and the brief period of time elapsed since its presentation, in the opinion of the management of the Bank, based on the opinion of its legal advisors, it is not yet possible to assess the probability of realization of exposure to risk in respect of the demand.
D. Liens
(1) In order to secure intraday credit to be allocated by the Bank of Israel to the Bank from time to time in connection with its activity on the Zahav RTGS (real-time gross settlement) system, which has operated in the banking system since late July 2007, the Bank created a current lien in July 2007 in favor of the Bank of Israel, in an unlimited amount, on the inventory of State bonds and short-term notes (Makams) held by the Bank. Under the terms of the lien, the lien is in effect as long as such bonds or short-term notes exist in the account in the name of and on behalf of the Bank of Israel maintained at the TASE Clearing House and designated for deposits and/or registration of collateral for the Bank of Israel, or in the Bank’s account at the Bank of Israel which is designated for monetary debits and credits of the TASE Clearing House. Subsequent to the registration of this lien, a current lien in the amount of NIS 1 billion, created by the Bank in February 2007 in favor of the Bank of Israel on its inventory of bonds, was removed in December 2007.
- 176 - Notes to the financial statements as at December 31, 2007
Note 17 - Contingent Liabilities, Commitments and Liens (cont'd) D. Liens (cont'd)
(2) The Bank is a member of the Euroclear clearinghouse, which clears securities that are traded on international markets. For the Bank's operations through the said clearinghouse, and to secure the credit effectively utilized by the Bank with the said clearinghouse from time to time, the Bank registered a charge on moneys and securities. The credit facility against which the Bank registered a charge on securities is in the amount of USD 6 million (December 31, 2006 - USD 6 million). (3) In accordance with the Bank’s agreement with the Maof Clearing House and the TASE Clearing House, and pursuant to the resolutions of the board of directors of the Maof Clearing House and the bylaws and guidelines of the Maof Clearing House, the Bank deposits securities in an account in the name of the Maof Clearing House as collateral for the Maof Clearing House, as well as cash in an account opened in the name of the clearing house at another bank, which will constitute payment to the clearing houses for any amount which the Bank may owe them in respect of transactions in Maof and in Israeli securities for which the Bank is liable towards them, against a commitment by the clearing houses to remit this amount to the Bank, pursuant to the agreement.
To secure these charges, the Bank created a first-rank permanent lien and floating lien in an unlimited amount on these accounts in favor of the Maof Clearing House.
The value of the collateral deposited in favor of the clearing houses as of December 31, 2007 is NIS 1,086 million (December 31, 2006: NIS 1,135 million); the average during 2007 was NIS 1,234 million. The maximum balance deposited is NIS 1,337 million. For further details, see Sections C.10 and C.11 above.
Customers of the Bank place liens on various types of assets in respect of their overall activity at the Bank, including Maof activity.
(4) To secure repayment of contingent liabilities and bonds issued by a subsidiary, the subsidiary recorded floating liens on all its assets.
- 177 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments
Reported amounts
A. Volume of activity on a consolidated basis
(1) Stated amounts of derivative instruments
December 31, 2007 Foreign Interest contracts currency Equity related Commodity and NIS-CPI Other contracts contracts other contracts NIS millions NIS millions NIS millions NIS millions NIS millions
a. ALM DERIVATIVES (1)(2) Futures contracts - - - 19 - Forward contracts 218 274 13,969 12 - Option contracts traded on an exchange Written options - - 274 1,048 - Purchased options - - 274 1,052 - Other options contracts Written options - 923 15,519 344 2,551 Purchased options - 923 15,215 344 2,551 Swaps - 4,126 - - -
Total 218 6,246 45,251 2,819 5,102
Of which swap interest rate contracts in which the Bank has agreed to pay a fixed interest rate - 2,357 - - -
b. CREDIT DERIVATIVES AND SPOT SWAP FOREIGN CURRENCY CONTRACTS Spot swap foreign currency contracts - - 2,527 - -
(1) Except for credit derivatives and foreign currency spot swap contracts. (2) Derivatives constituting part of the Bank’s asset and liabilities management, that have not been designated for hedging relationships.
- 178 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments (cont’d)
Reported amounts
A. Volume of activity on a consolidated basis (cont’d)
(2) Gross fair value of derivative instruments
December 31, 2007 Interest contracts Foreign currency Equity related Commodity and NIS-CPI Other contracts contracts other contracts NIS millions NIS millions NIS millions NIS millions NIS millions
a. ALM (2)(3) DERIVATIVES Gross positive fair value 1 178 453 198 54 Gross negative fair value 3 208 454 198 54
(2) Derivatives constituting part of the Bank’s assets and liabilities management that have not been designated for hedging relationships. (3) Except for credit derivatives.
B. Credit risk in respect of derivative instruments, according to counterparty (on a consolidated basis)
December 31, 2007 Governments Dealers/ and central Exchanges Banks brokers banks Others Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Positive gross fair value of derivative instruments (1) 80 378 3 - 423 884 Off-balance sheet credit risk in respect of derivative instruments (2) - 2,491 - 27 1,241 3,759 Total credit risk in respect of derivative instruments 80 2,869 3 27 1,664 4,643
(1) Of which the balance sheet balance of freestanding derivative instruments in the amount of NIS 880 million. (2) Off-balance sheet credit risk in respect of derivative instruments (including derivative instruments with negative fair value) as calculated for the purpose of per borrower credit limitations.
- 179 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments (cont’d)
Reported amounts
C. Repayment schedule - stated amounts: year-end balances on a consolidated basis
December 31, 2007 Up to three Three months One year to months to one year five years Over five years Total NIS millions NIS millions NIS millions NIS millions NIS millions
Interest rate contracts NIS-CPI - 218 - - 218 Other 246 1,371 708 3,921 6,246 Foreign currency contracts 37,614 8,216 1,948 - 47,778 Contracts in respect of shares 2,145 243 428 3 2,819 Commodities and other contracts 4,941 - 161 - 5,102
Total 44,946 10,048 3,245 3,924 62,163
- 180 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments (cont’d)
Reported amounts
A. Volume of activity on a consolidated basis
(1) Stated amounts of derivative instruments
December 31, 2006 Interest contracts Foreign currency Equity related Commodity and NIS-CPI Other other contracts contracts other contracts NIS millions NIS millions NIS millions NIS millions NIS millions
a. ALM DERIVATIVES (1)(2) Futures contracts - - - 14 - Forward contracts 190 512 5,610 10 - Option contracts traded on an exchange Written options - - 374 1,038 - Purchased Options - - *429 1,038 - Other options contracts Written options - - *13,820 286 939 Purchased options - - *13,913 *286 939 Swaps - 2,799 - - -
Total 190 3,311 34,146 2,672 1,878
Of which swap interest rate contracts in which the Bank has agreed to pay a fixed interest rate - 1,573 - - -
b. CREDIT DERIVATIVES AND SPOT SWAP FOREIGN CURRENCY CONTRACTS Spot swap foreign currency contracts - - 2,968 - -
* Reclassified.
(1) Except for credit derivatives and foreign currency spot swap contracts. (2) Derivatives constituting part of the Bank’s assets and liabilities management, that have not been designated for hedging relationships.
- 181 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments (cont’d)
Reported amounts
A. Volume of activity on a consolidated basis (cont’d)
(2) Gross fair value of derivative instruments
December 31, 2006 Interest contracts Foreign currency Equity related Commodity and NIS-CPI Other contracts contracts other contracts NIS millions NIS millions NIS millions NIS millions NIS millions
a. ALM (2)(3) DERIVATIVES Gross positive fair value 2 31 *307 *247 18 Gross negative fair value 1 54 *292 247 18
* Reclassified.
(2) Derivatives constituting part of the Bank’s assets and liabilities management that have not been designated for hedging relationships. (3) Except for credit derivatives.
B. Credit risk in respect of derivative instruments, according to counterparty (on a consolidated basis)
December 31, 2006 Governments Dealers/ and central Exchanges Banks brokers banks Others Total NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Positive gross fair value of derivative instruments (1) 103 *253 - 6 *243 605 Off-balance sheet credit risk in respect of derivative instruments (2) - *1,813 - *37 883 2,733 Total credit risk in respect of derivative instruments 103 2,066 - 43 1,126 3,338
* Reclassified
(1) Of which the balance sheet balance of freestanding derivative instruments in the amount of NIS 600 million. (2) Off-balance sheet credit risk in respect of derivative instruments (including in respect of derivative instruments with negative fair value) as calculated for the purpose of per borrower credit limitations.
- 182 - Notes to the financial statements as at December 31, 2007
Note 18 - Derivative Financial Instruments (cont’d)
Reported amounts
C. Repayment schedule - stated amounts: year-end balances on a consolidated basis
December 31, 2006 Up to three Three months One year to months to one year five years Over five years Total NIS millions NIS millions NIS millions NIS millions NIS millions
Interest rate contracts NIS-CPI 120 70 - - 190 Other 1,071 780 1,205 255 3,311 Foreign currency Contracts *32,206 3,853 *1,055 - 37,114 Contracts in respect of shares *2,137 *225 *310 - 2,672 Commodities and other contracts 1,878 - - - 1,878
Total 37,412 4,928 2,570 255 45,165
* Reclassified.
- 183 - Notes to the financial statements as at December 31, 2007
Note 19 - Balances and Estimates of Fair Financial Instruments
Reported amounts
A. Balances on a consolidated basis
December 31, 2007 Balance sheet value Fair value (1) (2) Total NIS millions NIS millions NIS millions NIS millions
Financial assets Cash on hand and deposits with banks 4,569 141 4,710 4,710 Securities 7,999 52 8,051 8,051 Credit to the public 13,341 4,162 17,503 17,463 Other financial assets 919 - 919 919 Total financial assets 26,828 4,355 31,183 31,143
Financial liabilities Deposits from the public 20,881 5,832 26,713 26,734 Deposits from banks 495 21 516 516 Deposits from the Government 1 1 2 2 Subordinated notes and deposit certificates - 1,295 1,295 1,311 Other financial liabilities 1,289 - 1,289 1,289 Total financial liabilities 22,666 7,149 29,815 29,852
December 31, 2006 Balance sheet value Fair value (1) (2) Total NIS millions NIS millions NIS millions NIS millions
Financial assets Cash on hand and deposits with banks 3,869 155 4,024 4,024 Securities *6,251 36 6,287 * 6,287 Credit to the public *12,352 4,918 17,270 * 17,224 Credit to the Government - 31 31 31 Other financial assets *846 - 846 *846 Total financial assets 23,318 5,140 28,458 28,412
Financial liabilities Deposits from the public *19,532 5,808 25,340 *25,353 Deposits from banks 75 15 90 90 Deposits from the Government 34 1 35 35 Subordinated notes and deposit certificates - 816 816 795 Other financial liabilities *838 - 838 *838 Total financial liabilities 20,479 6,640 27,119 27,111
* Reclassified.
(1) Financial instruments regarding which the balance sheet value is an estimate of the fair value - items presented in the balance sheet at market value or items having an original maturity of up to three months or on the basis of a variable market interest rate at up to three-month revision frequencies. (2) Other financial instruments.
- 184 - Notes to the financial statements as at December 31, 2007
Note 19 - Balances and Estimates of Fair Financial Instruments (cont'd)
B. Fair value of financial instruments
The note includes general information concerning estimation of the fair value of financial instruments.
It is not possible to quote a “market price” for most of the Bank’s financial instruments, since there is no active market in which they are traded. Therefore, their fair value is estimated by means of computing the present value of the future cash flows deriving therefrom, capitalized at an interest rate which reflects the level of risk intrinsic in the particular financial instrument.
Measurement of the fair value on the basis of the estimated future cash flows and determination of the interest rate to be used for discounting purposes is subjective and, accordingly, for most of the financial instruments, the attached fair value estimates are not necessarily an accurate indication of the item’s actual realization value on the date of the report. Estimation of the value of the capital was made based on the interest rates in effect at the report date, and does not consider the fluctuations thereof. Assumption of different interest rates would, quite naturally, produce different fair values, which might well vary materially from the amounts computed. This is the case, primarily, with respect to financial instruments having a fixed rate of interest and those which are non-interest bearing.
In addition, in determining the fair value, no account was taken of commissions to be received or paid in connection with the business operations, nor was the tax effect included. Moreover, the difference between the amount presented in the balance sheet and the computed fair value balance may not be realized since, in most cases, the Bank will probably hold the items until maturity. In light of the above, it must be stressed that the data included in this note does not purport to indicate the value of the Bank as a going concern. In addition, due to the wide range of computation techniques and the different possible estimates which may be applied in arriving at the fair value appraisal, care must be exercised when comparing the fair value data presented for different banks.
C. Main methods and assumptions for the purpose of estimating the fair value of financial instruments
Deposits in banks - capitalization of the future cash flows is based on the interest rates at which the Bank executed similar transactions at the date of the report.
Securities - based on market value or fair value. Shares having no market value, in the amount of NIS 52 millions (December 31, 2006 - NIS 36 million) are presented at their book value, that is adjusted cost as at the balance sheet date.
Credit to the public - the fair value of the credit to the public is estimated based on discounting the future cash flows using interest rates at which the Bank executed similar transactions at the date of the report. Each group was broken down into categories based on linkage basis and repayment period. In addition, for each category the value of the future receipts (principal and interest) was computed. Such receipts were capitalized using interest rates at which the Bank executed similar transactions at the date of the report.
In addition, a breakdown was made into several additional categories which reflect the level of risk implicit in the credit granted to different borrower groups, and which are reflected in the different capitalization rates based on the level of risk.
- 185 - Notes to the financial statements as at December 31, 2007
Note 19 - Balances and Estimates of Fair Financial Instruments (cont'd) C. (cont'd)
Pursuant to the directives of the Supervisor of Banks, when calculating the cash flows for purposes of the fair value estimation, the general and supplemental provisions for doubtful debts, in the amount of NIS 67 million (2006 - NIS 70 million), were not deducted from the amount of credit
The fair value of problematic debts, was computed using discount rates reflecting the high level of credit risk latent therein. In any case, the discount rates applied were not less than the highest interest rate used by the Bank in execution of its transactions at the report date. The future cash flows from problematic debts were computed after deduction of the specific provisions for doubtful debts. Additional disclosure was not made regarding the range of fair values in relation to the range of discount rates which, in Management’s opinion, would properly reflect the level of risk contained in the debt.
Deposits from the public, from banks and from the Government - using the capitalization of future cash flows method based on the interest rate which the Bank pays on similar deposits on the date of the report.
Subordinated notes - using the capitalization of future cash flows method based on the interest rate at which the Bank is able to raise funds through similar subordinated notes at the report date.
Off-balance sheet financial instruments where the balance reflects credit risk, contingent liabilities and extraordinary commitments - fair value was not computed. Presented at the balance sheet balance.
Derivative financial instruments - derivative financial instruments for which there is an active market were valued at their market value. Derivative financial instruments which are not traded in an active market were valued based on models which the Bank uses in its regular operations which take into account the risks intrinsic in the particular financial instrument (market risk, credit risk, etc.). See also Note 18.
Financial instruments (excluding derivative financial instruments and negotiable financial instruments) having original maturities of up to three months and variable market interest rates up to three-month revision frequencies - the amount presented in the balance sheet represents an approximate of the fair value, subject to adjustments for changes in the risks associated with the credit and the Bank’s margin on transactions at variable interest rates.
In calculating the fair value, no discounts with respect to early repayment were taken into account.
- 186 - Notes to the financial statements as at December 31, 2007
Note 20 - Interested and related Parties
Reported amounts
A. Balances with related parties Consolidated: December 31, 2007 Interested parties Related parties held by the Bank Shareholders Directors and CEO Others Interested parties at time Controlling shareholders Others of transaction Investee companies Balance Highest Balance Highest Balance Highest Balance Highest Balance Highest Balance Highest at balance balance at balance balance at balance balance at balance balance at balance balance at balance balance sheet during the sheet during the sheet during the sheet during the sheet during the sheet during the date year (1) date year (1) date year (1) date year (1) date year (1) date year (1) NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Assets - Deposits with banks - - 6 9 - - 10 12 - - - - Securities ------28 28 - - - - Credit to the public 18 20 - - *- *- 66 66 - - - - Investments in investee companies (2) ------16 42 Other assets - - 14 14 - - - 1 - - - -
Liabilities - Deposits from the public *- *- - - 2 4 346 575 - - - - Deposits from banks - - - 2 - - *- *- - - - - Other liabilities - - - 4 - - 1 1 - - - - Shares (included in shareholders' equity)(4) 986 986 102 102 - - 67 67 - - - - Credit risk on off- balance sheet financial instruments(3) - 37 153 153 * - * - 81 130 - - - -
* Amounts up to NIS 500 thousand. (1) Based on quarter-end balances. (2) See Note 5. (3) Credit risk on off-balance sheet financial instruments as calculated for purposes of per borrower credit limitations. (4) Holdings of interested parties and related parties in the Bank's equity.
- 187 - Notes to the financial statements as at December 31, 2007
Note 20 - Interested and related Parties (cont'd)
Reported amounts
A. Balances with related parties (cont'd)
Consolidated: December 31, 2006 Interested parties Related parties held by the Bank Shareholders Directors and CEO Others Interested parties at time Controlling shareholders Others of transaction Investee companies Balance Highest Balance Highest Balance Highest Balance Highest Balance Highest Balance Highest at balance balance at balance balance at balance balance at balance balance at balance balance at balance balance sheet during the sheet during the sheet during the sheet during the sheet during the sheet during the date year (1) date year (1) date year (1) date year (1) date year (1) date year (1) NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Assets - Deposits with banks - - 2 2 - - 11 13 - - - - Credit to the public 20 27 - - * - * - 60 60 - * - - - Investments in investee companies (2) ------42 46 Other assets - - 1 1 - - - *- - - - -
Liabilities - Deposits from the public * - 1 - - 4 6 508 508 - * - - - Deposits from banks - - 2 2 - - * - * - - - - - Other liabilities - - - 1 - - * - 1 - - - - Shares (included in shareholders' equity)(4) 977 977 102 102 - - 66 66 - - - - Credit risk on off- balance sheet financial instruments(3) 37 37 130 130 * - * - 63 63 - - - -
* Amounts up to NIS 500 thousand. (1) Based on quarter-end balances. (2) See Note 5. (3) Credit risk on off-balance sheet financial instruments as calculated for purposes of per borrower credit limitations. (4) Holdings of interested parties and related parties in the Bank's equity.
- 188 - Notes to the financial statements as at December 31, 2007
Note 20 - Interested and related Parties (cont'd)
Reported amounts
B. Summarized results of transactions with interested and related parties:
Consolidated: Year ended December 31, 2007 Related parties held by the Interested parties Bank Interested Shareholders parties Controlling Directors and at the time of Investee shareholders Others CEO Others the transaction companies NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Results of financing activities before provision for doubtful debts (1) *- 1 *- (18) - - Operating commissions *- - *- 2 - - Other income ------Operating and other expenses (2) *- (3) (46) (9) (7) *- - Income from extraordinary activities - 3 - - - -
Total *- (42) (9) (23) *- -
Year ended December 31, 2006 Related parties held by the Interested parties Bank Interested Shareholders parties Controlling Directors and at the time of Investee shareholders Others CEO Others the transaction companies NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Results of financing activities before provision for doubtful debts (1) 2 (20) * - **(15) - - Operating commissions * - - * - 2 - - Other income - - - 1 - - Operating and (3) other expenses (2) * - (49) (8) (8) (1) -
Total 2 (69) (8) (20) (1) -
* Amounts up to NIS 500 thousand. ** Reclassified.
(1) See C. below. (2) See D. below. (3) See Note 17.C(4).
- 189 - Notes to the financial statements as at December 31, 2007
Note 20 - Interested and related Parties (cont'd)
Reported amounts
B. Summarized results of transactions with interested and related parties (cont'd):
Consolidated:
Year ended December 31, 2005 Related parties held by the Interested parties Bank Interested Shareholders parties Controlling Directors and at the time of Investee shareholders Others CEO Others the transaction companies NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Results of financing activities before provision for doubtful debts (1) *- (8) - (12) 2 - Operating commissions *- - - 2 - - Other income - - - 4 - - Operating and other expenses (2) *- (3) (43) (5) (4) *- - Total *- (51) (5) (10) 2 -
* Amounts up to NIS 500 thousand.
(1) See C. below. (2) See D. below. (3) See Note 17.C.(4).
C. Results of financing activities, before provision for doubtful debts, with interested and related parties:
Consolidated:
Year ended Year ended Year ended December 31 December 31 December 31 2007 2006 2005 NIS millions NIS millions NIS millions
In respect of assets - From credit to the public 4 5 3 From deposits with banks 3 1 1 Net income (expenses) from ALM derivatives (1) (20) 3
In respect of liabilities - On deposits from the public (23) **(18) (24) On deposits from banks *- (1) (1)
(17) (33) (18)
* Amounts up to NIS 500 thousand. ** Reclassified.
- 190 - Notes to the financial statements as at December 31, 2007
Note 20 - Related Parties (cont'd)
Reported amounts
D. Payments to interested parties (from the Bank and its investee companies):
Consolidated: Year ended December 31, 2007 Interested parties at the Shareholders Directors and CEO time of the transaction Others Controlling shareholders Others Total Number of Total Number of Total Number of Total Number of Total Number of NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients
Interested parties employed by or on behalf of the Bank - - - - 8 2 - - - - Directors who are not Bank employees *- 2 - - 1 7 *- 1 - - Other interested parties who are not Bank employees - - 46 1 - - - - 7 8 Total *- 2 46 1 9 9 * - 1 7 8
Consolidated:
Year ended December 31, 2006 Interested parties at the Shareholders Directors and CEO time of the transaction Others Controlling shareholders Others Total Number of Total Number of Total Number of Total Number of Total Number of NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients
Interested parties employed by or on behalf of the Bank - - - - 7 2 1 1 - - Directors who are not * - 2 - - 1 8 * - 1 - - Bank employees Other interested parties who are not Bank employees - - 49 1 - - - - 8 6 Total * - 2 49 1 8 10 1 2 8 6
* Amounts up to NIS 500 thousand.
- 191 - Notes to the financial statements as at December 31, 2007
Note 20 - Related Parties (cont'd)
Reported amounts
D. Payments to interested parties (from the Bank and its investee companies) (cont'd):
Consolidated: Year ended December 31, 2005 Interested parties at the Shareholders Directors and CEO time of the transaction Others Controlling shareholders Others Total Number of Total Number of Total Number of Total Number of Total Number of NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients NIS millions recipients
Interested parties employed by or on behalf of the Bank - - - - 4 2 - - - - Directors who are not Bank employees *- 3 - - 1 5 *- 1 - - Other interested parties who are not Bank employees - - 43 1 - - - - 4 5 Total *- 3 43 1 5 7 * - 1 4 5
* Amounts up to NIS 500 thousand.
- 192 - Notes to the financial statements as at December 31, 2007
Note 21 - Profit from Financing Activities before Provision for Doubtful Debts
Reported amounts
Composition:
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
A. In respect of assets From credit to the public 760 *618 *1,147 750 *612 *1,142 From credit to the government - (1) 6 - (1) 6 From cash on hand and deposits with Bank of Israel (4) 1 12 (4) 1 12 From deposits with banks 27 (20) 143 27 (20) 143 From bonds 315 *259 *189 313 *255 *187 From borrowed securities 2 - - 2 - -
B. In respect of Liabilities On deposits from the public (491) (372) (930) (547) (391) (950) On deposits from the Government **- - (1) **- - (1) On deposits from Bank of Israel (4) (2) (1) (4) (2) (1) On deposits from banks (3) (2) (15) (3) (2) (15) On subordinated notes and deposit certificates (83) (46) (77) (42) (36) (70)
C. In respect of Derivative financial instruments Net income (expenses), in respect of ALM derivative Instruments (6) 30 19 (6) 30 19
D. Other Commissions from financing transactions 25 23 23 25 23 23 Other financing income (1) 75 52 67 75 52 67 Other financing expenses **- (1) - **- (1) -
Total profit from financing activities before provision for doubtful debts 613 539 582 586 520 562
Including exchange rate differences, net (19) 9 16 (19) 9 16
* Reclassified. ** Amounts up to NIS 500 thousand.
(1) Including collections on account of provisions for interest with respect to doubtful debts, in the amount of NIS 20 million (2006 - NIS 15 million, 2005 - NIS 9 million).
In those cases where interest income and expenses of the unlinked Shekel and foreign currency sectors were lower than the annual rate of increase in the Consumer Price Index, an expense is shown with respect to assets, and income with respect to liabilities.
- 193 - Notes to the financial statements as at December 31, 2007
Note 21 - Profit from Financing Activities before Provision for Doubtful Debts (cont’d)
Reported amounts
Composition (cont'd):
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
E. Results of investment activities in bonds Financing income from bonds, on accrual basis: Available for sale 247 *225 *166 245 *221 *164 Trading 68 34 23 68 34 23
Total included in profit from financing activities in respect of assets 315 259 189 313 255 187
Realized gains on sales of available for sale bonds 48 27 40 48 27 40
Realized losses on sales of available for sale bonds ** (2) - (1) (2) - (1)
Realized and unrealized gains (losses) from adjustments to fair value of trading securities, net 1 6 5 1 6 5
Total included in other financing income 47 33 44 47 33 44
Total from investment in bonds 362 292 233 360 288 231
* Reclassified. ** Including provision for decline in value.
- 194 - Notes to the financial statements as at December 31, 2007
Note 22 - Operating Commissions
Reported amounts
Composition:
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Account management fees (Israeli and foreign currency) 24 23 25 24 23 25
Payment system services (Israeli and foreign currency) 66 65 63 66 65 63
Income from credit cards 15 13 12 15 13 12
Income from activity in securities 62 * 52 60 61 * 52 60
Handling of credit and preparations of contracts 32 23 17 29 21 15
Computer services, information and confirmations 3 3 3 3 3 3
Foreign trade activity and foreign currency services 20 21 22 20 21 22
Margin and commissions on credit and deposits based on the extent of collection:
Collection commissions on credit from Treasury funds 6 6 6 6 6 6
Management fees and commissions from life assurance and residential insurance 6 8 9 5 6 6
Other commissions 2 3 4 2 2 3
Total operating commissions 236 217 221 231 212 215
* Reclassified.
- 195 - Notes to the financial statements as at December 31, 2007
Note 23 - Gains (Losses) on Investments in Shares, net
Reported amounts
Composition:
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Gains on sales of available for sale shares 5 14 1 3 4 - Losses on sales of available for sale shares* (4) (4) (1) - - - Realized and unrealized gains from adjustment to fair value of trading shares, net 4 4 5 4 4 5 Dividend from available for sale shares 25 17 5 20 11 - Total gains on investment in shares, net 30 31 10 27 19 5
* Including provision for decline in value.
Note 24 - Other Income
Reported amounts
Composition:
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Management fees from provident funds (1) 1 4 8 1 1 3
Management fees from mutual funds (2) - 1 10 - - -
Distribution commissions from mutual funds (2) 4 *2 - 4 *2 -
Others 12 10 9 1 1 1
Total other income 17 17 27 6 4 4
* Reclassified. (1) See Note 5E. (2) See Note 5D.
- 196 - Notes to the financial statements as at December 31, 2007
Note 25 - Salaries and Related Expenses
Reported amounts
Composition: Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Salaries 232 217 203 224 210 195 Expense arising from share- based payment transactions** 2 *1 - 2 *1 - Severance pay, advanced study fund, compensation, pensions and vacation 48 50 49 48 49 48 National Insurance and VAT on salaries 51 50 48 51 50 48 Other related expenses 11 *11 8 11 *11 8 Voluntary retirement Expenses *** - - 17 - - 17 Total salaries and related expenses 344 329 325 336 321 316
* Reclassified.
** Total expense arising from transactions treated as share-based payment transactions cleared in capital instruments - see Note 14A.
*** See Note 14.A(6).
Note 26 - Other Expenses
Reported amounts
Composition: Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Computer 58 60 51 58 60 51 Professional services 33 31 32 36 30 33 Marketing and advertising 15 13 11 15 12 10 Office expenses 11 10 9 11 10 8 Communications 9 7 5 9 7 5 Insurance 6 7 7 6 7 7 Commissions 10 8 9 10 8 9 Directors' fees and reimbursement of expenses meetings 2 1 2 1 1 1 Staff training and advanced study 2 2 2 2 2 2 Others 14 18 19 13 17 14
Total other expenses 160 157 147 161 154 140
- 197 - Notes to the financial statements as at December 31, 2007
Note 27 - Provision for Taxation on Operating Profit
Reported amounts
A. Composition: Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Current taxes - Relating to current year 81 44 27 70 31 17 Relating to previous years 3 1 - 3 - - Total current taxes 84 45 27 73 31 17
Deferred taxes - Relating to current year 9 29 31 9 29 31 Relating to previous years - - (4) - - (4) Total deferred taxes 9 29 27 9 29 27
Total provision for taxes on operating profit 93 74 54 82 60 44
B. Reconciliation between the theoretical tax that would have resulted if the operating profit would be subject to tax at the statutory rate applying to banks in Israel, and the actual tax provision on operating profit in the statement of profit and loss:
Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Statutory tax rate applying to banks in Israel 38.53% 40.65% 43.59% 38.53% 40.65% 43.59%
Theoretical tax at the statutory rate 84 62 60 69 48 45 Tax (tax savings) resulting from: General provision and supplementary provision for doubtful debts (1) **(4) - (1) **(4) - Unrecognized expenses, net of tax-exempt income and income at a different tax rate 11 **7 1 11 **4 1 Effect of change in tax rate* 2 3 6 2 3 6 Utilization of losses from prior years in respect of which deferred taxes were not created - (2) - - - - Addition (deduction) for inflation and adjustment of depreciation (14) 3 (12) (10) 2 (10) Effect of VAT on profits, on VAT on salaries, net 3 4 3 3 4 3 Prior years’ taxes 3 1 (4) 3 - (4) Others 5 - - 5 3 3 Provision for taxes on income 93 74 54 82 60 44 * See C and D below. ** Reclassified.
- 198 - Notes to the financial statements as at December 31, 2007
Note 27 - Provision for Taxation on Operating Profit (cont'd)
C. On July 25, 2005 the Knesset passed the Law for the Amendment of the Income Tax Ordinance (Amendment No. 147 and Temporary Order) - 2005 (hereinafter - the Amendment). The Amendment provides for a gradual reduction in the company tax rate: In 2006 the tax rate will be 31%, in 2007 the tax rate will be 29%, in 2008 the tax rate will be 27%, in 2009 the tax rate will be 26% and from 2010 onward the tax rate will be 25%. The Bank’s provision for income tax includes profit tax that is imposed on its income according to the VAT Law. Accordingly, the statutory tax rate that will apply to the Bank’s income is 41.0% in 2006, 39.3% in 2007, 37.6% in 2008, 36.7% in 2009 and 35.9% from 2010 onward. The current taxes and the deferred taxes balances as at December 31, 2005 were calculated in accordance with the new tax rates specified above. The effect of the change on the consolidated financial statements in 2005 was an increase in taxes on income in the amount of NIS 6 million.
D. On June 27, 2006, a VAT Order (tax rate on non-profit organizations and financial institutions)-2006 (hereinafter, "the Amendment") was published in the Official Israel Government Gazette, following which the salary tax rates and capital tax rates applicable to financial institutions were reduced from 17% to 15.5%.
The Amendment came into effect starting on July 1, 2006. As a result of the Amendment, the statutory tax rate applicable to the Bank in 2006 is 40.65%, in 2007 - 38.53%, in 2008 - 36.80%, in 2009 - 35.93%, and from 2010 onwards - 35.06%.
Current taxes and deferred tax balances as at December 31, 2007 were calculated according to the new tax rates provided in the Amendment. The impact of the change on the Bank's financial statements in 2007 was NIS 2 million (2006 - NIS 3 million).
E. On September 23, 2007, the Ministry of Finance issued a law memorandum which aims to rescind the Adjustments Law (the purpose of which was to neutralize the effects of inflation in calculating taxable income, so that the income obtained after adjustments is in real terms) as of the tax year 2008, due to the low rates of inflation in recent years, and due to the fact that the effect of adjustment for inflation at such rates is marginal, biased, and does not justify the cost and effort of complying with the directives of the law.
If the law is rescinded, an effect on the Bank’s results of operations is expected, such that every 1% of positive inflation will reduce net profit by approximately NIS 5 million (based on the tax rate and capital base for 2007).
F. The Bank has final tax assessments up to and including the tax year 2003. Its consolidated companies have final tax assessments (or assessments considered to be final) up to and including the tax year 2002, with the exception of two consolidated companies, of which one has final tax assessments up to the tax year 2003, and the other has final tax assessments up to the tax year 2006.
G. The Bank and two of its subsidiaries are completely transparent for tax purposes and accordingly their revenues and/or receipts and/or expenses are considered revenues and/or receipts and/or expenses of the Bank.
In accordance with an arrangement such companies are to have no activity other than the issuance and/or sale of subordinated notes to the Bank. Therefore the subsidiaries will not have any earnings or losses for tax purposes of any kind whatsoever. Furthermore, the subsidiaries are not allowed to hold assets or liabilities other than the subordinated notes and/or a deposit.
The subsidiaries will not engage in any activity and will not purchase subordinated notes on the stock exchange in Israel.
- 199 - Notes to the financial statements as at December 31, 2007
Note 27 - Provision for Taxation on Operating Profit (cont'd)
Reported amounts
H. Composition of deferred tax assets, net, in respect of:
Consolidated The Bank December 31 December 31 December 31 December 31 2007 2006 2007 2006 Average Average Average Average Balance tax rate Balance tax rate Balance tax rate Balance tax rate NIS NIS NIS NIS millions % millions % millions % millions %
Excess of provision for severance pay and pension over amounts funded 43 35.06 44 35.06 43 35.06 44 35.06
Provision for vacation pay and long service bonuses 10 36.30 9 37.80 10 36.30 9 37.80
Specific provision for doubtful debts 29 36.80 41 38.53 29 36.80 41 38.53
Adjustment of depreciable non- monetary assets (1) 35.06 (4) 35.06 (1) 35.06 (4) 35.06
Securities (20) 38.53 (21) 40.65 (13) 38.53 (15) 40.65
Gain on sale to controlling interest in subsidiary (against a capital reserve of a subsidiary) 2 36.80 3 36.80 2 36.80 3 36.80
Others (3) 36.80 (4) 38.53 (3) 36.80 (4) 38.53
Total 60 68 67 74
Realization of the deferred taxes is based on a forecast of that there will be taxable income in the foreseeable future.
- 200 - Notes to the financial statements as at December 31, 2007
Note 28 - After-tax Income (Loss) from Extraordinary Activities:
Reported amounts
Composition: Consolidated The Bank Year ended Year ended Year ended Year ended Year ended Year ended December 31 December 31 December 31 December 31 December 31 December 31 2007 2006 2005 2007 2006 2005 NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Gain from sale of provident funds, see Note 5.E. - 29 - - - - Gain from sale of mutual funds, see Note 5.D. - 33 - - - - Gain on sale of an affiliated company, see Note 5.F. 1 - - - - - Profit from an arrangement in respect of the Bank's share of management fees (1) 5 - - 5 - - Loss from impairment of fixed assets (2) (2) - (6) (2) - (6) Gain from sales of fixed assets 2 - - 2 - -
Gain (loss) before taxes 6 62 (6) 5 - (6)
Current taxes 3 20 - 3 - -
After-tax income (loss) 3 42 (6) 2 - (6)
The bank's equity in income from extraordinary activities of investee companies - - - 1 41 -
After tax income (loss) from extraordinary activities 3 42 (6) 3 41 (6)
(1) Profit in the amount of NIS 5 million resulting from an arrangement reached by the Bank in which it received a one-time amount in respect of its share of management fees of provident funds sold by the Bank Leumi Group. (2) The item "After-tax Income (Loss) from Extraordinary Acitvities" includes a loss from the impairment of assets in the amount of NIS 5 million in the year 2005, as a result of a write- down deriving from the estimate of the appraiser Mr. B. Appleboim regarding one of the Bank’s assets (the former branch in the Haifa bay), which no longer is used in its current operations. The estimate of the appraiser is based on a discount of the proper rent payments while taking into account the situation on the market and in the vicinity. Mr. B. Appleboim has agreed to the mentioning of his estimate in the financial statements for purposes of implementing Accounting Standard No. 15 of the Israel Accounting Standards Board. The valuation was attached to the Magna system, in the Bank's report for the second quarter of 2005.
- 201 - Notes to the financial statements as at December 31, 2007
Note 28A - Profit per Ordinary Share
Reported amounts
Composition:
Consolidated For the year ended December 31 2007 2006 2005 NIS millions Basic profit Net operating profit 123 79 85 Extraordinary profit (loss), net of related taxes 3 42 (6) Total net profit attributed to ordinary shareholders of the Bank 126 121 79 Diluted profit Net operating profit 123 79 85 Extraordinary profit (loss), net of related taxes 3 42 (6) Total net profit attributed to ordinary shareholders of the Bank 126 121 79
Consolidated For the year ended December 31 2007 2006 2005 Weighted average number of shares Weighted average number of ordinary shares used to calculate basic profit 58,872 55,213 49,478 Options exercised into shares during the year - 404 - Weighted average number of ordinary shares used to calculate diluted profit 58,872 55,617 49,478
- 202 - Notes to the financial statements as at December 31, 2007
Note 29 - Report on Business Segments
Management of the Bank uses the distinction between the segments in order to make decisions and to analyze the business results of the Bank. The characteristics of the segments are mainly based on the types of customers activity areas included in each segment.
The Bank’s activities are focused on the following business segments:
Private customers segment - This segment provides banking services and financial products to households and customers having financial wealth. Furthermore, the segment provides services to business customers having an obligo of up to NIS 400,000.
Business customers segment - This segment provides a range of banking services and financial products to business customers, whose main business is the receipt of credit, from large companies to business customers having an obligo over NIS 400,000.
Diamonds segment - This segment includes customers active in the diamond industry, the most of which are members of the Ramat Gan Diamond Exchange.
Financial management segment - This segment includes the Banks’ own activity in the area of securities, assets and liabilities management, market and liquidity risk management, dealing room activity and the activity of Union Investments and Enterprise (A.S.Y.), a subsidiary which serves as the non-financial investment arm of the Bank.
Others and adjustments - This segment includes activities which could not be specifically allocated to segments.
The main principles that were applied in order to split the results of operations between the various segments are as follows:
Profit from financing activities - In the customers' focused segments this item includes a financial margin on credit/deposits of customers. The margin is usually calculated above a transitional price that represents the cost of sources in accordance with the average life and the relevant linkage basis. This item also includes risk-free interest on the weighted capital calculated for the purpose of the return on equity attributed to the segment. Shareholders’ equity is attributed based on the risk assets assigned to each segment.
Operating and other income - These are attributed to the segment to which the customer belongs.
Provision for doubtful debts - The provision for doubtful debts is attributed to the segment to which the customer, regarding whom the provision was recorded, belongs.
Operating and other expenses - The direct expenses are attributed to the specific segment. The rest of the expenses are attributed according to parameters based on various estimates.
Taxes on income - The provision for tax on the business results of each business segment was calculated according to the effective tax rate, with the exception of certain cases where a specific attribution could be made.
- 203 - Notes to the financial statements as at December 31, 2007
Note 29 - Report on Business Segments (cont'd) Return on capital - The ratio between the net earnings of each segment and the shareholders’ equity attributed to the segment. The shareholders’ equity attributed to each segment is the relative average balance of risk components in each segment multiplied by the ratio of the core capital.
It is noted that the system being used to report the results of the Bank's segments is in the continuous process of data cleaning, and accordingly, reclassification of the results is applied from time to time, to the extent possible (in 2007, only the results of 2006 were reclassified; 2005 results were not reclassified, due to unavailability of data). Implementation of the TM1 activity segment system by Cognos Ltd. began during 2007 and is due for completion in the second quarter of 2008. The system allows automatic data capture from information systems and comptrollership data, along with process control and data analysis. The system will support the continued improvement of data quality in the future. Concurrently, the Bank has begun preparations for the installation of the Bachan (Banking, Accounting, Administration) system of Bank Leumi, which includes, inter alia, the adjustment of data in information systems to book data, starting on the transaction level.
- 204 - Notes to the financial statements as at December 31, 2007
Note 29 - Report on Business Segments (cont’d)
Reported amounts
Information on business segments - consolidated
For the year ended December 31, 2007 Private Business Diamonds Financial Amounts not Total customers segment segment management allocated segment segment and adjustments NIS millions Profit (loss) from financing activities before provision For doubtful debts: - From outsiders 206 262 52 93 - 613 - Inter-segment - 15 - (15) - - Operating and other income: - From outsiders 130 125 17 11 - 283 - Inter-segment - (1) - 1 - - Total income 336 401 69 90 - 896 Provision for doubtful debts 15 15 50 - - 80 Operating and other expenses: - From outsiders 286 244 26 41 2 599 Operating profit (loss) before taxation 35 142 (7) 49 (2) 217 Provision for taxation on operating profit 14 64 (3) 20 (2) 93 Operating profit (loss) after taxation 21 78 (4) 29 - 124 The Bank's equity in net operating profits of investee companies - - - (1) - (1) Net operating profit (loss) 21 78 (4) 28 - 123 After-tax income (loss) from extraordinary activities 2 1 - 1 (1) 3 Net profit (loss) 23 79 (4) 29 (1) 126
Net return on equity 7.7% 8.7% (3.7%) 11.2% - 8.1% Net return of operating profit on equity 7.0% 8.6% (3.7%) 10.8% - 7.9% Average balance of assets 4,713 12,152 2,370 11,471 539 31,245 Including: investments in affiliated companies - - - 19 - 19 Average balance of liabilities 13,295 14,074 287 924 504 29,084 Average balance of risk assets 3,682 11,392 1,421 3,250 - 19,745 Average balance of managed securities 6,895 28,505 29 - - 35,429 Components of profit from financing activities before provision for doubtful debts: Margin from credit granting activities 51 153 37 - Margin from deposit receipt activities 124 51 3 - Other 31 73 12 78 Total profit from financing activities before provision for doubtful debts 206 277 52 78
- 205 - Notes to the financial statements as at December 31, 2007
Note 29 - Report on Business Segments (cont’d)
Information on business segments - consolidated For the year ended December 31, 2006* Private Business Diamonds Financial Amounts not Total customers segment segment management allocated segment segment and adjustments NIS millions Profit (loss) from financing activities before provision For doubtful debts: - From outsiders 194 237 55 53 - 539 - Inter-segment - 18 - (18) - - Operating and other income: - From outsiders 118 112 17 18 - 265 - Inter-segment - (2) - 2 - - Total income 312 365 72 55 - 804 Provision for doubtful debts 15 37 30 - - 82 Operating and other expenses: - From outsiders 273 232 23 38 3 569 Operating profit (loss) before taxation 24 96 19 17 (3) 153 Provision for taxation on operating profit 11 45 9 8 1 74 Operating profit (loss) after taxation 13 51 10 9 (4) 79 The Bank's equity in net operating profits of investee companies ------Net operating profit (loss) 13 51 10 9 (4) 79 After-tax income (loss) from extraordinary activities 34 7 - 1 - 42 Net profit (loss)** 47 58 10 10 (4) 121 Net return on equity 18.5% 7.6% 8.6% 5.0% - 8.6% Net return of operating profit on equity 4.9% 6.7% 8.6% 4.4% - 5.6% Average balance of assets 4,058 10,815 2,372 7,592 595 25,432 Including: investments in affiliated companies - - - 44 - 44 Average balance of liabilities 12,026 11,707 270 464 364 24,831 Average balance of risk assets 3,269 9,912 1,557 2,871 - 17,609 Average balance of managed securities 5,453 24,864 28 - - 30,345 Components of profit from financing activities before provision for doubtful debts: Margin from credit granting activities 49 139 40 - Margin from deposit receipt activities 116 44 3 - Other 29 72 12 35 Total profit from financing activities before provision for doubtful debts 194 255 55 35
* Reclassified.
** Includes profit from extraordinary transactions after taxes in respect of the sale of the activity of provident and mutual funds: In the Private Customer Segment - NIS 34 million. In the Corporate Segment - NIS 7 million.
- 206 - Notes to the financial statements as at December 31, 2007
Note 29 - Report on Business Segments (cont’d)
Information on business segments - consolidated (cont'd)
For the year ended December 31, 2005 Private Business Diamonds Financial Amounts not Total customers segment segment management allocated segment segment and adjustments NIS millions Profit (loss) from financing activities before provision For doubtful debts: - From outsiders 173 218 58 133 - 582 - Inter-segment - 32 - (32) - - Operating and other income: - From outsiders 128 97 19 10 4 258 - Inter-segment - 5 - (5) - - Total income 301 352 77 106 4 840 Provision for doubtful debts 24 113 12 - - 149 Operating and other expenses: - From outsiders 265 229 22 39 (1) 554 Operating profit (loss) before taxation 12 10 43 67 5 137 Provision for taxation on operating profit 4 3 19 29 (1) 54 Operating profit (loss) after taxation 8 7 24 38 6 83 The Bank's equity in net operating profits of investee companies - - - 2 - 2 Net operating profit (loss) 8 7 24 40 6 85 After-tax income (loss) from extraordinary activities - - - - (6) (6) Net profit 8 7 24 40 - 79
Return on equity 3.7% 1.1% 17.3% 29.0% - 7.0% Average balance of assets 3,859 10,672 2,624 6,677 (1,229) 22,603 Average balance of liabilities 11,171 11,235 250 347 (793) 22,210 Average balance of risk assets 2,777 9,660 2,012 2,001 - 16,450 Average balance of provident and mutual funds assets 1,370 245 - - - 1,615 Average balance of managed securities 5,085 17,111 24 - 1 22,221 Components of profit from financing activities before provision for doubtful debts: Margin from credit granting activities 55 147 46 - Margin from deposit receipt activities 94 48 1 - Other 24 55 11 101 Total profit from financing activities before provision for doubtful debts 173 250 58 101
- 207 - Notes to the financial statements as at December 31, 2007
Note 30 - Data in Nominal Historical Values for Tax Purposes - The Bank
A. The accounting principles used to present the data in nominal historical values for tax purposes are as follows: (1) These financial statements were prepared on the basis of historical cost. (2) These financial statements include only data regarding the Bank, without presentation of consolidated financial statements as required by generally accepted accounting principles. (3) These financial statements do not include provisions for the impairment of fixed assets.
B. Nominal balance sheets as at December 31
2007 2006 NIS millions NIS millions
Assets
Cash on hand and deposits with banks 4,710 4,024
Securities 7,907 *6,174
Credit to the public 17,436 *17,211
Credit to the Government - 31
Investments in investee companies 443 423
Bank premises and equipment 299 295
Other assets 1,008 *947
Total assets 31,803 29,105
Liabilities and shareholders' equity
Deposits from the public 27,605 *25,646
Deposits from banks 516 90
Deposits from the Government 2 35
Subordinated notes and deposit certificates 474 582
Other liabilities 1,654 *1,218
Total liabilities 30,251 27,571
Shareholders' equity 1,552 1,534
Total liabilities and shareholders' equity 31,803 29,105
* Reclassified.
- 208 - Notes to the financial statements as at December 31, 2007
Note 30 - Data in Nominal Historical Values for Tax Purposes - The Bank (cont’d)
C. Statements of profit and loss for the year ended December 31
2007 2006 2005 NIS millions NIS millions NIS millions
Profit from financing activities before provision for doubtful debts 586 520 562
Provision for doubtful debts 80 81 147
Profit from financing activities after provision for doubtful debts 506 439 415
Operating and other income Operating commissions 231 *212 215 Profit from investments in shares, net 27 19 5 Other income 6 * 4 4
Total operating and other income 264 235 224
Operating and other expenses Salaries and related expenses 336 321 316 Maintenance and depreciation of bank premises and equipment 92 80 79 Other expenses 161 154 140
Total operating and other expenses 589 555 535
Operating profit before taxation 181 119 104
Provision for taxation on operating profit 84 59 47
Operating profit after taxation 97 60 57
The Bank's equity in net after-tax operating profits of investee companies 26 23 27
Net operating profit 123 83 84
After-tax income from extraordinary activities 7 41 1
Net profit 130 124 85
* Reclassified.
- 209 - Notes to the financial statements as at December 31, 2007
Note 30 - Data in Nominal Historical Values for Tax Purposes - The Bank (cont’d)
D. Statements of changes in shareholders' equity
Benefits in Share capital Receipts on Adjustments Respect of Retained Dividend proposed Total and premium account of to fair value of share-based earnings subsequent shareholders’ options available for payment to balance equity sale securities transactions sheet date NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions
Balance as at January 1, 2005 258 33 (5) 22 770 - 1,078
Adjustments to fair value of available for sale securities - - *(14) - - - (14) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - *39 - - - 39 Related tax effect - - (7) - - - (7) Net profit for the year - - - - 85 - 85
Balance as at December 31, 2005 258 33 13 22 855 - 1,181
Exercise of stock options 236 (26) - - - - 210 Expired options 7 (7) - - - - - Benefits in respect of share- based payment transactions (1) - - - 1 - - 1 Adjustments to fair value of available for sale securities - - *(3) - - - (3) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - *37 - - - 37 Related tax effect - - (16) - - - (16) Net profit for the year - - - - 124 - 124 Dividend that was declared - - - - (100) 100 -
Balance as at December 31, 2006 501 - 31 23 879 100 1,534
Benefits in respect of share- based payment transactions (1) - - - 2 - - 2 Adjustments to fair value of available for sale securities - - (73) - - - (73) Adjustments in respect of presentation of securities available for sale that were reclassified for profit and loss statement - - 47 - - - 47 Related tax effect - - 12 - - - 12 Net profit for the year - - - - 130 - 130 Paid dividend - - - - - (100) (100)
Balance as at December 31, 2007 501 - 17 25 1,009 - 1,552
* Reclassified. (1) See Note 14.A.
- 210 - Notes to the financial statements as at December 31, 2007
Note 31 - Legislation Concerning Fees – Banking Law (Customer Service) (Amendment No. 12) - 2007
On July 5, 2007, an amendment to the law regularizing the supervision of bank fees was published. The amendment to the law applies to individual customers as well as to businesses with a monetary turnover to be determined by the Governor of the Bank of Israel (hereinafter: the “Governor”).
The amendment grants the Bank of Israel authority in the following three main areas: supervision of the rates of fees; cancellation of fees found to be superfluous; and publication of periodic comparisons of the rates of fees at different banks.
Implementation of the law is divided into three stages. In the first stage, the Governor will be entitled to establish a list of banking services which will be the only services for which banks may charge fees. In the second stage, the Governor will be entitled to declare services to be under supervision, at his discretion, in accordance with his considerations and with market conditions. In the third stage, the Governor will be entitled to limit the price of any fee, as he sees fit, or to prohibit the collection of any fee.
The amendment incorporates some of the recommendations of the investigative committee appointed by the Economic Affairs Committee of the Knesset, which were published on June 19, 2007. In addition, in accordance with the amendment, the Banking Rules (Customer Service) (Fees) - 2008 were published on January 8, 2008. These rules implement the first stage of the amendment to the law and establish the full and reduced fee tables formulated by the Supervisor of Banks, which take effect on July 1, 2008.
The new fee tables reduce many fees, by canceling some fees and by consolidating fees charged for services similar in essence and cost.
The Bank is preparing to implement the rules that have been published. In the opinion of the Bank, based on initial estimates, this legislation is expected to reduce the Bank’s revenues in the second half of 2008 by an estimated total of NIS 8 million (before tax effects).
- 211 -