Table of Contents. 3 Letter from the CEO. 5 Boards of the company

Transcription

1 Annual Financial Report 2017

2 Table of Contents 3 Letter from the CEO 5 Boards of the company 6 Management report for the business year Economic framework 7 Significant events of the business year 13 Other material disclosures 15 Assets, financial position and income 18 Non-financial performance indicators 19 Branch offices 19 Research and development 19 Significant events after the balance sheet date 19 Participations 19 Risk reporting 36 Internal control system 39 Compliance and money laundering 40 Outlook 42 Report of the Supervisory Board to the Shareholders Meeting 44 Separate financial statements of KA Finanz AG for the business year Balance sheet of KA Finanz AG (pursuant to the Austrian Banking Act) 46 Income statement of KA Finanz AG (pursuant to the Austrian Banking Act) 47 Notes to the annual financial statements of KA Finanz AG for the business year Auditor s Report 97 Statement by the legal representatives

3 Letter from the CEO Letter from the CEO Ladies and Gentlemen, For KA Finanz AG (KF), the business year 2017 was marked by two major structural changes. In a first step, a framework agreement on the refinancing of KF was concluded with ABBAG (Abaumanagementgesellschaft des Bundes), a company wholly owned by the Republic of Austria and responsible for the management of wind-down entities. The agreement provides for refinancing facilities to be made available to KF in a total volume of EUR 8.2 billion, which are to fully replace KF s current funding raised in the money and capital markets. Subsequently, the Financial Market Authority (FMA) approved the application to operate KF as a run-off company pursuant to 162 of the Austrian Bank Recovery and Resolution Act ( de-banking ). As of the effective date of the corresponding administrative notice issued by FMA, KF s banking license lapsed. Operation as a run-off company enables KF to create an efficient and less costly structure in a changed regulatory environment. The increasingly stringent regulatory conditions and own funds requirements for credit institutions in the European Union are designed to be met by active commercial banks and would be difficult and expensive to comply with for a wind-down bank such as KF. The transformation into a run-off company also shortens the wind-down horizon for KF s portfolio. Originally, complete wind-down by 2040 was provided for in the restructuring plan. As a run-off company, KF now aims to reach this target within a period of ten years. While winding down its portfolio, KF is making every effort to take advantage of market opportunities and use any potential for the recovery of asset values. As a run-off company, KF continues to be supervised by FMA. As at 31 December 2017, KF s risk exposure amounted to EUR 7.9 billion. In the course of the past year, it was reduced by EUR 1.7 billion through active wind-down measures and redemptions. All in all, KF has wound down risk exposure in a total amount of EUR 27.1 billion since the beginning of the restructuring process. The average rating has improved to A+, while the non-performing-loan (NPL) ratio has dropped to 0.1%. In 2017, KF s total assets were reduced by approx. 18% to EUR 9.84 billion. 3

4 Letter from the CEO The after-tax result pursuant to the Austrian Company Code/Austrian Banking Act (Unternehmensgesetzbuch/Bankwesengesetz UGB/BWG) is negative at EUR million, primarily due to de-banking and the related reclassification and valuation effects of EUR million. Guarantee fees payable to the Republic of Austria, which in the meantime have been reduced through the new funding obtained, as well as contributions to the Bank Resolution Fund and the low-interest environment, also contributed to the negative result. On behalf of the Executive Board, I wish to thank the shareholder representatives and the Supervisory Board for their support in the transformation of KF into a run-off company in the year under review. My special thanks are due to all our employees for their commitment and their contributions to the preparation and implementation of this project as well as their ongoing professional work, all of which makes the successful wind-down of KF s portfolio possible. Our objective for 2018 is to continue the portfolio wind-down process efficiently and successfully within the framework of the new structures. Helmut Urban Chairman of the Executive Board 4

5 Boards of the company Boards of the company Helmut Urban Chairman of the Executive Board since 2 December 2015 (Member of the Executive Board since 1 September 2013) Bernhard Achberger Member of the Executive Board since 16 October 2015 Executive Board Stephan Koren Chairman of the Supervisory Board, Director General of immigon portfolioabbau AG since 18 May 2016 Bruno Ettenauer Deputy Chairman, Managing Director of Etterra Real Estate GmbH since 18 May 2016 Stefan Pichler Professor of Banking and Finance and Vice-Rector for Research at the Vienna University of Economics and Business until 1 September 2017 Franz Hofer (delegated by the Staff Council) until 3 May 2017 Supervisory Board Marion Khüny Member of the Supervisory Board of Erste Group Bank AG since 29 September 2017 Brigitte Markl (delegated by the Staff Council) since 19 October 2013 Werner Muhm Former Director of the Vienna Chamber of Labour and the Federal Chamber of Labour since 8 January 2009 Angelika Schlögel State Commissioner, Federal Ministry of Finance since 1 August 2014 Wolfgang Nitsche Deputy State Commissioner, Federal Ministry of Finance since 1 November 1994 State Commissioner Andrea Delfauro-Bischof Government Commissioner, Federal Ministry of Finance since 1 August 2013 Wolfgang Nitsche Deputy Government Commissioner, Federal Ministry of Finance since 1 November 2011 Government Commissioner for the cover pool for covered bonds 5

6 Management report Management report for the business year 2017 In 2017, the economy of the euro area grew at a rate of 2.4%, the highest ever since 2007 (after 1.8% in 2016). GDP (gross domestic product) increased by 2.2% in Germany (2016: 1.9%), and by 1.8% in France (2016: 1.2%). Economic growth was particularly high in Austria at 3.1% (2016: 1.5%), while the looming Brexit depressed economic activities in the UK, with GDP growing at a rate of only 1.8% (2016: 1.9%). 1 Economic framework For the euro area, in particular, 2017 was a year of robust economic recovery. Growth was seen on a broad basis, primarily due to private consumption and corporate investments. Other growth-promoting factors included rising private incomes and corporate profits as well as loan growth stimulated by favourable financing conditions. Economic growth was self-supporting and well-balanced across all countries and industries. Private consumption was driven mainly by a solid increase in disposable incomes and enhanced consumer confidence. The rate of unemployment in the euro area dropped from 9.6% at the end of 2016 to 8.7% at the end of 2017, the lowest level since January Over the same period, unemployment in Austria declined from 5.7% to 5.3%. The rate of inflation in the euro area remained constantly above 1.4% from August 2017 onward. The inflation rate for 2017 as a whole was 1.4% (2016: 1.1%). Inflation in Austria increased significantly to 2.2% (2016: 1.0%). Rising inflation had only a limited impact on the purchasing power of private households, given that the pace of new job creation continued to accelerate. This consumption-driven upswing stimulated the economy and resulted in profitability gains for businesses. 2 Economic developments in the euro area proved resistant to political risks in The economic consequences of the referendum in Catalonia in October 2017 were limited and the substantial delays in the formation of a new government in Germany after the parliamentary elections in September 2017 had practically no economic impact. Brexit and the possibility of Great Britain leaving the European Union without a new agreement, and thus faced with a legal vacuum, remains the biggest risk for the euro area. At its meeting in October 2017, the Governing Council of the European Central Bank (ECB) decided to prolong its Asset Purchase Programme (APP) by another nine months until September 2018, but with reduced monthly volumes of EUR 30 billion (previously EUR 60 billion/month). Interest rates and the forward guidance given by the ECB remain unchanged. In order to leave the option of a further prolongation of its 1 European Commission, Winter forecast, February Eurostat 6

7 Management report asset purchases after September 2018 open, the ECB did not indicate a date for the end of the programme. Taking stock of the continuing economic recovery, the Governing Council underlined its persisting concern over the medium-term inflation outlook despite the upward trend seen in recent months. 3 At its December meeting, the ECB Governing Council left its base rate unchanged at 0.0% and the interest on the deposit facility at -0.4%. The ECB s asset purchase programme has led to a build-up of excess liquidity of approx. EUR 2,000 billion, which has prolonged the period of low and negative interest rates. Despite extremely low yields, the low-interest environment boosted demand for fixed-interest products. Continuing demand from the asset purchase programme led not only to a significant intensification of bond market activities, especially in the government bond and covered bond segments, but also to a steady decline in volatility in the bond and equity markets. 4 Reacting to the positive labour market and inflation data in the USA, the Federal Reserve System (Fed) continued the step-by-step normalisation of its monetary policy. In 2017, it raised its federal funds rate three times, most recently in December to between 1.25% and 1.50%. Moreover, in the autumn of 2017, the Fed began to gradually reduce its total assets. As a consequence of the Fed s decision to phase out its bond purchasing programme announced in the autumn of 2017, the reduction of its total assets will accelerate until it reaches a maximum of USD 50 billion per month in Since September 2017, KF has been operated as a run-off company pursuant to 162 of the Austrian Bank Recovery and Resolution Act. The corresponding application for transformation ( de-banking ) was approved by the Financial Market Authority (FMA) by administrative notice dated 6 September KF s banking license lapsed as of the effective date of the administrative notice. Significant events of the business year Constitution as a run-off company pursuant to 162 of the Austrian Bank Recovery and Resolution Act and refinancing via ABBAG Operation as a run-off company enables KF to create an efficient and less costly structure in a changed regulatory environment. The increasingly stringent regulatory conditions and own funds requirements for credit institutions in the European Union are designed to be met by active commercial banks and would be difficult and expensive to comply with for a wind-down bank such as KF. Following KF s de-banking, the CRR 3 Austrian National Bank: Financial Stability Report, p.34 4 Austrian National Bank: Financial Stability Report, p.34 5 Board of Governors of the Federal Reserve System, press release 7

8 Management report requirements to be met by credit institutions and, consequently, the regulatory innovations (e.g. NSFR, Basel IV, CRR II) no longer apply, which KF would have been hardly able to comply with in the absence of any new business opportunities. Operation as a run-off company therefore reduces the complexity of operational business and enables KF to be run more economically, which ultimately serves the goal of minimizing the input of public resources. The transformation into a run-off company also shortens the wind-down horizon for KF s portfolio. Originally, complete wind-down by 2040 was provided for in the restructuring plan. As a run-off company, KF now aims to reach this target within a period of ten years. While winding down its portfolio, KF is still making every effort to take advantage of market opportunities and use any potential for the recovery of asset values. As a prerequisite for KF s constitution as a run-off company, funding until the end of the wind-down horizon had to be guaranteed. On 9 June 2017, a refinancing line was agreed upon with ABBAG, which replaces all of KF s previous funding sources. The agreement provides for funding to be made available in the amount of EUR 8.2 billion. KF was established on 28 November 2009 through the demerger of the former Kommunalkredit 6 and is the legal successor of the latter. As provided for in the restructuring plan approved by the European Commission/Directorate General for Competition on 31 March 2011, KF is responsible for the structured wind-down of the non-strategic portfolio. Purpose of the company Effective as of 6 September 2017, date of the administrative notice issued by the Financial Market Authority (FMA), KF is operated as a run-off company pursuant to 162 of the Austrian Bank Recovery and Resolution Act and continues to be supervised by FMA. KF s business purpose is to pursue targeted de-risking, while utilising any potential for the recovery of asset values and securing an adequate level of liquidity. KF is not engaged in any new asset-side business. KF s funding structure is designed to meet the objectives of a run-off company. Funding is provided by ABBAG. KF no longer raises funding in the money and capital markets. 8 In these financial statements the following names are used for the entities involved: - Kommunalkredit Austria AG prior to the 2009 demerger (until 28/11/2009): former Kommunalkredit - Kommunalkredit Austria AG since the 2009 demerger until the 2015 demerger for new incorporation (until 26/09/2015): Kommunalkredit Old - Kommunalkredit Austria AG, after the 2015 demerger for new incorporation (from 26/09/2015): Kommunalkredit - KA Finanz AG: KF 8

9 Management report In the course of 2017, KF s total exposure was reduced by EUR 1.7 billion, including EUR 0.5 billion through active run-off measures, EUR 0.9 billion through scheduled and early redemptions, and EUR 0.3 billion through the run-off of derivative positions and through foreign exchange effects. Compared to 2016, portfolio wind-down was pursued more actively, with assets being sold both in line with the defined wind-down plan and according to market opportunities. Assets of the securities portfolio accounted for the major part of early run-off (EUR million), including the complete run-off of the exposure to the US State of Illinois (EUR million), the continued reduction of the concentration risk of the Republic of Italy by EUR 97.5 million, and the complete run-off of the exposure to the Republic of Tunisia (EUR 19.7 million). The loan portfolio was reduced by a nominal amount of EUR million, mainly comprising loans to publicly-owned enterprises and project finance in the infrastructure and utilities sector. Portfolio wind-down measures and risk structure Asset-side redemptions (EUR million) are mainly accounted for by loan redemptions (EUR million, of which approx. 77% to Austrian and Swiss borrowers, most of them in the public-sector segment). With all remaining CDS against the Republic of Austria having matured in 2017 (EUR million), KF s entire relevant CDS risk portfolio has been closed out. The following tables show the reduction of risk exposure and the development of exposure indicators since the end of The figures are broken down by sale and redemption and by product category. Run-off of risk exposure since November 2008, in EUR million Run-off of risk exposure since November 2008 in EUR million Total * Total Securities - sold 6, ,087.8 Loans - sold CDS - sold 10, ,799.4 Total sold 18, ,863.8 Securities - redeemed 3, ,607.2 Loans - redeemed 2, ,261.8 CDS/guaranteed - matured ,365.0 Total redeemed 6, ,233.9 Total sold / redeemed 24, , ,097.7 * nominal values from 2017 onward, book values for earlier years 9

10 Management report Altogether, since the beginning of the restructuring process in November 2008, KF has wound down risk positions in a total amount of EUR 27.1 billion, the better part thereof, i.e. EUR 18.9 billion, through the active run-off of securities and CDS positions. Development of exposures since November 2008, in EUR million Development of exposures since November 2008 in EUR million 28/11/2008 / 31/12/ /12/2014 BEFORE merger KA Old 31/12/2015 AFTER merger KA Old 31/12/ /12/2017 Total exposure (year-end/month-end) 30,000/27,299 5, , , ,873.1 of which securities/loans 15,200/13,630 4, , , ,097.9 of which CDS and guarantees 12,200/10, of which other (money market/derivatives) 2,600/2, Total assets (Austrian GAAP) -/17,657 7, , , ,843.8 Reduction of total exposure (runoff, redemption, FX effects) 4, , ,676.9 As at 31 December 2017, KF s total exposure amounted to EUR 7.9 billion (total assets: EUR 9.8 billion), including loans in the amount of EUR 4.0 billion or 50.5% of the total exposure (31/12/2016: EUR 4.7 billion or 48.9%); these constitute the biggest product group in the KF portfolio. The securities portfolio came to EUR 3.1 billion or 39.6% of the total portfolio (31/12/2016: EUR 3.6 billion or 37.9%). The CDS and guarantee exposure amounted to EUR 0.1 billion or 1.4% of the portfolio (31/12/2016: EUR 0.5 billion or 5.6%). Other risk positions (money market, derivatives) amounted to EUR 0.7 billion. The majority of KF s debtors are Austrian and foreign territorial authorities (sovereigns, municipalities, local authorities), public-sector entities (PSEs) and quasi- municipal enterprises. Overall, KF has a portfolio of very high asset quality that is concentrated in the upper rating classes; as at 31 December 2017, EUR 7.4 billion or 93.4% (31/12/2016: 92.0%) of the total exposure was rated investment grade (BBB- or higher), and EUR 4.0 billion or 51.3% was rated AAA/AA (31/12/2016: 51.0%). The average rating improved to A+ (rating scale according to Standard & Poor s; 31/12/2016: A), while the non-performing-loan (NPL) ratio (definition of default according to Basel III) stood at 0.1%. Hidden burdens, i.e. the difference between book values and market values, amounted to EUR million. Hidden burdens were primarily due to the increase in credit spreads since the closure of the transactions, as a result of which the market value 10

11 Management report of the portfolio dropped below the book value. Due to the low level of interest, the negative market values of hedging transactions are also reflected in hidden burdens. However, hidden burdens do not represent a permanent impairment. For further details on the portfolio and risk structure, please refer to the Risk Report, page 19. As in 2016, KF did not require any capital support from the Republic of Austria in Through the payment of guarantee fees by KF, the total volume of capital support measures by the Republic of Austria was reduced from a net amount of EUR 2,091.9 million as at 31 December 2016 to a net amount of EUR 2,066.6 million as at 31 December Capitalisation support received by KF since its nationalisation can be broken down as follows: Capital measures taken by the Republic of Austria since nationalisation Overview of capital measures taken by the Republic of Austria (cumulative), in EUR million Overview of capital measures taken by the Republic of Austria in EUR million 31/12/ /12/ /12/ /12/2017 Capitalisation agreement of 17/11/2009 with debtor warrant 1, , , ,140.1 Shareholder contributions / Government surety , , ,138.0 Capital increase Total gross 2, , , ,667.1 Guarantee fees paid by KF / Return cash flows from guarantee fees / Guarantee fees paid by Kommunalkredit under debtor warrant structure / Total net 2, , , ,066.6 As at 31 December 2017, the Republic of Austria, having recapitalised KF via a debtor warrant structure within the framework of the restructuring of the former Kommunalkredit in 2009, is entitled to receive future annual profits (senior to profit participation rights and equity instruments) and/or future liquidation proceeds (senior to equity instruments) in the amount of EUR 1,412.4 million, until its claim under the debtor warrant is completely satisfied. 11

12 Management report By 31 December 2017, guarantee fees paid by KF since its takeover by the Republic of Austria amounted to a gross total of EUR million. After deduction of the restructuring contributions in the amount of EUR million made by the Republic of Austria up to the end of 2011, net guarantee fees paid amounted to a total of EUR million. In 2017, KF paid guarantee fees in a total amount of EUR 24.5 million, comprising EUR 10.2 million for the government-guaranteed commercial paper programme, EUR 13.9 million for issue guarantees and EUR 0.3 million for the surety granted by the Republic of Austria counting toward KF s eligible capital. The reduction in guarantee fees by EUR 16.4 million (31/12/2016: EUR 40.9 million) results from the fact that funding for KF is now provided by ABBAG. Guarantee fees paid to the Republic of Austria Guarantee fees payable in 2018 are expected to amount to EUR 13.9 million. Guarantee fees paid by KF 2008 to 2017, in EUR million Guarantee fees KF in EUR million Total Total Sureties (incl. original asset-side surety and debtor warrant surety) Issue guarantees Commercial paper guarantee Fees for clearing bank line* ELA guarantee Total KF Restructuring contributions of the Republic of Austria Total net KF * no longer utilised after 28/02/2011 As at 31 December 2017, the liquidity guarantees of the Republic of Austria granted under the Financial Markets Stability Act were down to EUR 1.1 billion (31/12/2016: EUR 4.5 billion), including a EUR 1.0 billion bond maturing in 2020 (coupon 0.375%) and a EUR 0.1 billion framework guarantee for the commercial paper programme. The liquidity guarantee for the commercial paper programme expired in January Liquidity guarantees of the Republic of Austria 12

13 Management report Development of liquidity guarantees, in EUR million Liquidity guarantees KF in EUR million 31/12/ /12/ /12/ /12/ /12/ /12/ /12/2017 IBSG guarantees* 4, , , Clearing bank line Guarantees under the Financial Markets Stability Act 2, , , , , , ,100.0 Total 7, , , , , , ,100.0 * based on exchange rates at the time of issue Depending on the term and the currency of the underlying funding instrument, the Republic of Austria receives an annual fee, on an arm s length basis, of between 0.80% and 1.37% for outstanding liquidity guarantees. KF is rated by Standard & Poor s (S&P). The ratings assigned in 2017 were upgraded from A-/A-2 (long-term/short-term) to AA+/A-1+. The rating outlook is stable. The Fitch rating was terminated as of the end of Rating For covered bonds S&P assigned a rating of AA+. S&P s rating of the government-guaranteed commercial paper programmes remained unchanged at A-1+. KF does not have a back-office structure of its own, but receives the required operational services from Kommunalkredit Austria (Kommunalkredit) on the basis of a service agreement (SA) and a service level agreement (SLA). As at 31 December 2017, 15 employees of Kommunalkredit worked exclusively for KF on the basis of a staff leasing agreement. These employees are responsible for portfolio management, treasury matters, risk management and the organisation of the company. Other material disclosures Service level agreement between Kommunalkredit Austria AG and KA Finanz AG 13

14 Management report KF has a detailed corporate governance and risk management structure in place, which is strictly adhered to. Corporate governance and risk management Four ordinary Supervisory Board meetings, four extraordinary Supervisory Board meetings and two ordinary Audit Committee meetings were held in Prior to de- banking, the Risk Committee and the Remuneration Committee met once each, and the Approvals Committee met twice. In the course of de-banking, the Nomination Committee, the Risk Committee, the Approvals Committee and the Remuneration Committee were dissolved. Most of their tasks were transferred to the newly established Portfolio Committee and/or the Personnel Committee, which held two meetings each. Supervisory Board The agendas of the weekly Executive Board and Credit Committee meetings comprise decision-making, reporting and follow-up items. Internal Audit reports to the Executive Board every month and directly to the Supervisory Board every three months. Compliance reports to the Executive Board and the Supervisory Board twice a year. Executive Board/Internal Audit/ Compliance Given that regulatory minimum capital requirements and the obligation to manage capital adequacy on the basis of economic capital no longer apply, KF, as a run-off company, does not have to implement an internal capital adequacy assessment process (ICAAP). Nevertheless, KF s risk strategy is aimed at the limitation and targeted reduction of risks in accordance with the wind-down plan. KF s risk strategy and methods are subject to an annual review. Issues relating to market risk, operational risk and other types of risk are dealt with on a structured basis at the monthly Risk Management Committee (RMC) meetings. Additional committees in charge of issues relating to credit, capital and liquidity meet at weekly or even shorter intervals. ICAAP (Internal Capital Adequacy Assessment Process) For details on legal proceedings, see Note 6.6. Legal proceedings 14

15 Management report Selected financial indicators, in EUR million Selected Balance Sheet/Income Statement figures in EUR million Total assets 9, ,949.6 Public-sector debt instruments and bonds 1, ,185.4 Loans and advances to banks 1, ,307.3 Loans and advances to customers 5, ,780.8 Amounts owed to banks ,699.5 Amounts owed to customers 6, ,037.0 Securitised liabilities 2, ,245.2 Contingent liabilities (off-balance-sheet) Assets, financial position and income Financial performance indicators of KA Finanz AG (KF) pursuant to the Austrian Company Code/ Austrian Banking Act Net interest income Guarantee fees for sureties and issue guarantees General administrative expenses (excl. Bank Resolution Fund) Contributions to Bank Resolution Fund Operating result Net result from valuations and realisations Profit on ordinary activities Extraordinary result Result for the year after tax Rating Long-term Fitch*/S&P/Moody's A+/AA+/n.a. BBB+/A-/n.a. Short-term Fitch*/S&P/Moody's F1+/A-1+/n.a. F2/A-2/n.a. Bank Bonds S&P AA+ AA- * The Fitch rating was terminated at the end of

16 Management report As at 31 December 2017, KA Finanz AG (KF) reported total assets in the amount of EUR 9.8 billion, down by 17.6% from the previous year (31/12/2016: EUR 11.9 billion). The reduction is due to active portfolio wind-down measures as well as scheduled redemptions. Balance sheet structure The most important asset items shown on the balance sheet are EUR 5.9 billion in loans and advances to customers (31/12/2016: EUR 6.8 billion), EUR 1.9 billion in loans and advances to banks (31/12/2016: EUR 2.3 billion), and EUR 1.6 billion in public-sector debt instruments and bonds (31/12/2016: EUR 2.2 billion). Contingent liabilities, reported as an off-balance-sheet item, decreased in 2017 by 77.6% to EUR 0.1 billion (31/12/2016: EUR 0.5 billion) through the run-off of CDSsell positions held against the Republic of Austria as the reference borrower and now exclusively comprise other guarantees. KF s funding structure changed in the second half of KF s funding needs are now met primarily by ABBAG. As a result, KF has withdrawn from the capital market as an issuer. Maturing bonds, Schuldschein loans and private placements issued by KF (legacy funding) are being progressively replaced by funding provided by ABBAG. Funding structure As at 31 December 2017, KF s portfolio of legacy funding amounted to EUR 3.1 billion (nominal values; including EUR 1.1 billion in covered bonds and a government-guaranteed bond of EUR 1.0 billion). Outstanding refinancing provided by ABBAG as at 21 December 2017 totalled EUR 6.2 billion (reported under Amounts owed to customers and other items). Altogether, KF s funding volume came to EUR 9.3 billion. KF s funding structure is as follows: Funding structure at book values, in EUR billion Funding structure in EUR billion 31/12/ /12/2016 Securitised liabilities of which government-guaranteed Amounts owed to banks of which money-market funding, incl. repos Amounts owed to customers

17 Management report For the business year 2017, KF reported an after-tax result pursuant to the Austrian Company Code/Austrian Banking Act of EUR million (2016: EUR million), which was influenced, in particular, by negative valuation effects in connection with the repositioning of KF as a run-off company. The essential factors contributing to the 2017 result were as follows: Income Net interest income The 2017 net interest result was positive at EUR 1.5 million, up by EUR 5.4 million from the previous year s result of EUR -4.0 million. The improvement is primarily due to the lower refinancing volume resulting from portfolio run-off and the change in KF s funding structure. Guarantee fees paid to the Republic of Austria Guarantee fees for sureties and issue guarantees of the Republic of Austria amounted to EUR 24.5 million in 2017 (2016: EUR 40.9 million). The total included EUR 10.2 million (2016: EUR 26.6 million) for the government-guaranteed commercial paper programme, EUR 13.9 million (2016: 13.9 million) for issue guarantees, and EUR 0.3 million (2016: EUR 0.4 million) in guarantee fees for sureties assumed by the Republic of Austria. The decrease compared to the previous year s value resulted from the lower utilisation of the commercial paper programme. General administrative expenses (excl. contributions to the European Bank Resolution Fund) KF s general administrative expenses in 2017 amounted to EUR 27.5 million (2016: EUR 17.7 million). The EUR 9.8 million increase is primarily due to the following special factors and one-off effects: Non-recurrent expenses of EUR 2.6 million related to the de-banking process, which will enable KF to create a more efficient and less costly structure for the future. Appropriation of provisions for legal proceedings in the amount of EUR 7.0 million. Other administrative expenses include expenses for the outsourcing of services for the operational management of KF to Kommunalkredit, including the staff leasing agreement covering 15 employees, in the amount of EUR 12.1 million (2016: EUR 10.9 million). Contributions to the European Bank Resolution Fund Contributions to the European Bank Resolution Fund paid in 2017 amounted to EUR 7.4 million (2016: EUR 3.7 million). Upon expiry of the banking license in the wake of the transformation into a run-off company, no more contributions are payable in the future. 17

18 Management report Net realisation and revaluation result De-banking was the main factor accounting for the 2017 result from realisations and revaluations, which was negative at EUR million (2016: positive at EUR 37.1 million). The material items are as follows: EUR million (2016: EUR 0.0 million) from the initial fair value measurement of positions to be wound down in the short term in accordance with the wind-down plan. This is a valuation loss not yet realised; the actual expense will be known after the underlying positions have been wound down. EUR million (2016: EUR +3.9 million) resulting from the run-off of securities, loan and derivative positions EUR +1.9 million (2016: EUR +3.1 million) from the buyback of equity instruments, including closure of the related hedging swaps EUR -6.1 million (2016: EUR +2.2 million) resulting from write-downs and valuations of securities EUR +0.2 million (2016: EUR -1.1 million) loan impairment result Extraordinary income Extraordinary income of EUR million (2016: EUR 0.0) resulted from the use of the fund for general banking risks pursuant to 57 (3) of the Austrian Banking Act. As at 31 December 2017, 15 employees (excl. the Executive Board) were working exclusively for KF on the basis of a staff leasing agreement concluded with Kommunalkredit; seven of them women and eight men. Non-financial performance indicators Employees KF has no back-office structure of its own, but receives the necessary operational services from Kommunalkredit on the basis of a service agreement (SA) and a service level agreement (SLA). The services provided by Kommunalkredit are invoiced on the basis of detailed records and paid for according to the arm s length principle; they are recognised in other administrative expenses. 18

19 Management report The main target of communication measures in 2017 was to provide thorough and comprehensive information for the customers, market partners and employees of KF. In personal talks, KF s market partners as well as rating agencies and other stakeholders were informed in detail on the status and the development of the bank. Communication KF has no branch offices. Branch offices Given the sector in which the company operates, statements on research and development do not apply. Research and development No significant events occurred at KF after the balance sheet date. Significant events after the balance sheet date KF does not hold any material participations in other companies. Participations The Executive Board of KF and the Risk Officer of KF are responsible for risk management, in particular for defining the bank s risk strategy, and for the adequate measurement, control and limitation of risks. Risk reporting Organisation The overall management and limitation of risks is performed within the framework of the monthly meetings of the Risk Management Committee (RMC). In addition to the RMC, other committees have been established that hold weekly or if need arises even more frequent meetings. These include, in particular, the Credit Committee (CC), which focuses on portfolio monitoring and the planning of measures relating to the risk portfolio, and the Asset-Liability Committee (ALCO), with its responsibility for operational liquidity, interest-rate and capital management. 19

20 Management report In operational and administrative terms, KF s system of risk management is supported by services provided by Kommunalkredit under the service level agreement (SLA), such as the drafting of limit and risk reports as well as portfolio analyses. Since 6 September 2017, KF has been operated as a run-off company without a banking license (de-banking) pursuant to the Austrian Bank Recovery and Resolution Act. Since KF s de-banking, the regulatory provisions for banks, especially the Capital Requirements Regulation (CRR) and the Capital Requirements Directive (CRD), are no longer applicable to KF; the provisions of the Austrian Banking Act only apply to a limited extent. In terms of risk management, de-banking results in significant easing of KF s reporting obligations compared to previous years and to licensed credit institutions. Apart from that, the strategic principles of risk management, especially with regard to credit, market and liquidity risks as well as operational risks, are upheld; the related responsibilities and processes as well as the measurement and management methods applied in previous years remain largely in place. The following risks are specifically monitored at KF: Specific risks of KA Finanz Credit risk Liquidity risk Market risk Operational risk The position of KF as regards these types of risk and the company s strategies for their measurement, monitoring and management are described in the following. Credit risk is the risk of financial losses arising from a counterparty not meeting its payment obligations. KF distinguishes the following types of credit risk: counterparty and/or default risk, rating risk, concentration risk and country risk. Credit risk 20

21 Management report KF s credit risk management is based on the following principles: Active credit risk monitoring is one of the core tasks of KF, especially against the background of its wind-down strategy. The development of existing credit risks is continuously monitored. The portfolio reduction measures taken include redemption upon maturity, disposals in accordance with the wind down-plan, and on an opportunistic basis when market prices recover or to avoid foreseeable credit risks in the event of probable default. Ratings by external rating agencies (Moody s, Standard & Poor s, Fitch) are available for the majority of exposures, which are continuously monitored and updated. All other customers are rated internally on the basis of their most recent balance sheet figures at least once a year. On the basis of an internal rating scale (master scale) certain probabilities of default are allocated to external as well as internal ratings. The master scale is reviewed regularly for its default forecasting quality and, if necessary, adjusted on the basis of unexpected losses incurred. Thus, all credit exposures can be fully classified on the basis of their probability of default and the type of collateral provided. Rating procedure For the on-balance-sheet portfolio, especially for securities and loans, the credit risk exposure corresponds to the book value (including accrued interest). For credit default swaps (CDS), the credit exposure corresponds to the nominal value less credit risk provisions, and for derivatives to the positive fair value plus maturity-specific and productspecific add-on factors; CDS and derivatives are part of the off-balance-sheet portfolio. Credit exposure Financial and personal forms of collateral (sureties and guarantees) are considered in credit exposures. Financial collateral taken into account primarily includes netting and cash collateral arrangements made to reduce the counterparty risk. Financial collateral received reduces the existing exposure. If other personal forms of collateral are available, the exposure can be counted towards the collateral giver. Depending on the assessment of the risk, the exposure is transferred to the collateral giver and included in the portfolio model and the limit system. 21

22 Management report As at 31 December 2017, KF s credit exposure totalled EUR 7.9 billion (31/12/2016: EUR 9.6 billion), distributed over 376 counterparties (31/12/2016: 430). EUR 3.1 billion (31/12/2016: EUR 3.6 billion) was accounted for by securities (bonds), EUR 4.0 billion by loans (31/12/2016: EUR 4.7 billion), EUR 0.1 billion by CDS and guarantees (31/12/2016: EUR 0.5 billion), and EUR 0.7 billion by derivatives (31/12/2016: EUR 0.7 billion). In 2017, KF s risk exposure was reduced by EUR 1.7 billion or 17.6%, of which EUR 0.5 billion through active run-off measures and EUR 0.9 billion through scheduled and early redemptions. The remaining reduction of the exposure was due to the closure of derivative positions and foreign exchange effects. The breakdown of credit exposures by rating shows that in 2017 the portfolio continued to be concentrated in the top rating classes. As at 31 December 2017, 93.4% of the exposure was rated investment grade BBB- or higher (31/12/2016: 92.0%), and 51.3% was rated AAA/AA (31/12/2016: 51.0%). The weighted average rating of the total exposure is A+ (according to Standard & Poor s/fitch s scale; 31/12/2016: A). Breakdown by rating Breakdown of exposure by rating as at 31/12/2017, in EUR 1,000 31/12/2017 in EUR Total exposure Proportion of which securities of which CDS/ guarantees of which loans Number of counterparties Total exposure as at 31/12/2016 Proportion as at 31/12/2016 AAA 590, % 230, , , % AA 3,445, % 923, ,000 2,384, ,253, % A 1,643, % 499,724 8, , ,377, % BBB 1,673, % 1,277, , ,535, % BB 251, % 76,926 4, , , % B 261, % 107, , , % CCC % % D 6, % 5, , % Unrated 0 0.0% % Total 7,873, % 3,120, ,023 3,977, ,550, % 22

23 Management report Broken down by sector, 64.0% of the exposure is accounted for by the public sector (31/12/2016: 64.8%), 8.1% by financial institutions (31/12/2016: 7.2%) and 28.0% by public-sector entities (PSE), quasi-public enterprises and securitisations (31/12/2016: 27.9%). Breakdown by sector Breakdown of exposure by sector as at 31/12/2017, in EUR 1,000 31/12/2017 in EUR Total exposure Proportion of which securities of which CDS/ guarantees of which loans Number of counterparties Total exposure as at 31/12/2016 Proportion as at 31/12/2016 Public sector 5,035, % 1,496,384 4,505 3,505, ,192, % Financial institutions 635, % 44, , , % Other 2,201, % 1,580, , , ,667, % Total 7,873, % 3,120, ,023 3,977, ,550, % Risk concentrations are identified prior to the closing of transactions (excluding hedging and refinancing transactions) and in the course of the monthly credit risk reports that are submitted to the RMC. The total portfolio is broken down according to different parameters (breakdown by country, region, top 30 borrowers, rating, sector). In addition, risk concentrations in individual sub-portfolios are identified through portfolio analyses and monitored accordingly. Portfolio analyses comprise correlating regional and/or sectorial risks or risk concentrations and permit the early detection, limitation and management of risk portfolios under current and future conditions. Concentration risk Depending on the risk assessment, reviews are performed at regular intervals. Event-triggered portfolio reviews can also be performed on an ad-hoc basis between the scheduled intervals. Given the fact that KF does not engage in any new lending business, limits for concentration risks are only set in the form of country limits. As at 31 December 2017, the exposure pertaining to the top 20 customers or groups of customers accounted for EUR 4.4 billion or 55.8% of the total exposure (31/12/2016: EUR 5.1 billion or 53.8%). Compared to the years after the restructuring process, concentration risks are low on account of the continued wind-down measures. Apart from the exposures to the Province of Upper Austria (EUR 1,059.6 million, direct and guaranteed exposure), KF had no single-name risks in excess of EUR 500 million on its books as at 31 December

24 Management report Exposures of subsidiaries and branch offices are recognised not in the country of the parent, but in the respective country of establishment. The country risk of KF is monitored by the RMC at least on a monthly basis and quarterly reports are submitted to the Supervisory Board. For each country, information on the country rating, exposure by product type, expected and unexpected loss, and limit utilisation is reported. Country risk Geographically, the major part of the exposure as at 31 December 2017 was accounted for by the euro area (EU-18, incl. Austria, 57.4%; 31/12/2016: 59.2%), of which Austria alone accounted for 36.2%. 17.8% (31/12/2016: 13.9%) of the exposure was to the remaining EU Member States, of which 14.2% to Great Britain and 3.6% to CEE. Non-EU Europe accounted for 4.2% of the exposure (31/12/2016: 4.4%), of which Switzerland accounted for 4.1%. The exposure to other states in the amount of 20.6% (31/12/2016: 22.5%) included 15.7% to the USA and Canada. Breakdown of exposure by region as at 31/12/2017, in EUR 1,000 31/12/2017 in EUR Total Exposure Proportion of which securities of which CDS/ guarantees of which loans Total exposure as at 31/12/2016 Proportion as at 31/12/2016 Austria 2,850, % 448, ,349,768 3,580, % EU-19 (euro area excl. Austria) 1,666, % 598,085 9, ,733 2,077, % Non-euro EU 1,402, % 575,070 3, ,171 1,328, % Non-EU Europe 331, % 9, , , % Other (esp. USA) 1,622, % 1,490, , ,144, % Total 7,873, % 3,120, ,023 3,977,305 9,550, % As at 31 December 2017, the ten biggest risks from exposure to the public sector (sovereigns, territorial authorities and government-guaranteed positions) amounted to EUR 4.7 billion or 60.0% of the total portfolio (31/12/2016: EUR 5.8 billion or 60.3%), broken down as follows: 24

25 Management report The ten biggest risks from exposure to sovereigns, territorial authorities and government-guaranteed positions, in EUR 1,000 # Counterparty in EUR Exposure as at 31/12/2016 Proportion of which sovereigns of which territorial authorities of which government-guaranteed of which securities of which CDS/ guarantees of which loans 1 Austria 2,640, % 55,006 2,435, , , ,178,145 2 Germany 583, % 0 582, ,598 3 Italy 374, % 300,214 74, , USA 244, % 7, , , UK 232, % 0 232, , ,707 6 Switzerland 217, % 0 217, ,033 7 Poland 137, % 136,151 1, , ,329 8 Croatia 105, % 0 2, , ,813 9 Qatar 91, % 91, , Canada 91, % 0 91, , Total top 10 4,720, % 591,148 3,874, ,323 1,387, ,303,626 Total portfolio 7,873, % 683,525 4,025, ,765 3,120, ,023 3,977,305 Of the ten biggest risks from exposure to the public sector in a total amount of EUR 4.7 billion, EUR 3.6 billion or 45.7% (31/12/2016: EUR 4.3 billion or 45.4%) was accounted for by the euro area, including an exposure of EUR 2.6 billion to Austria (31/12/2016: EUR 3.3 billion). The exposure to Austrian territorial authorities (EUR 2.4 billion) includes an exposure of EUR 2.2 billion to Austrian provinces (31/12/2016: EUR 2.3 billion). The major part of this exposure (EUR 1.3 billion) is accounted for by subsidised housing loans originated by the Austrian provinces and bought by the former Kommunalkredit (before the 2009 demerger). These low-volume loans are secured by mortgages and guaranteed by the provinces concerned. 25

26 Management report Exposure to Austrian provinces as at 31/12/2017, in EUR 1,000 Counterparty in EUR Exposure as at 31/12/2017 Proportion of which direct exposure of which guaranteed exposure excl. housing loans of which housing loans Upper Austria 1,036, % 0 426, ,252 Styrial 412, % ,791 Carinthia 268, % ,256 Burgenland 221, % 0 221,895 0 Vienna 188, % ,539 0 Lower Austria 66, % 16, ,692 Total 2,194, % 17, ,916 1,340,991 Total portfolio 7,873, % As at 31 December 2017, the risk-relevant CDS and guarantees exposure amounted to EUR 113 million (31/12/2016: EUR 535 million). CDS and guarantee exposure With all remaining CDS held against the Republic of Austria (EUR million) having matured in 2017, KF s entire risk-relevant CDS portfolio has been completely wound down. Provisions for risks in the lending business comprise impairments and provisions for all identifiable rating and country risks. Loan loss provisioning The portfolio is reviewed regularly for objective indications of impairments of customer exposures or exposures to groups of related customers. Impairment tests are performed either in the course of the annual rating updates or on an event-triggered basis. Loan loss provisions are determined by Risk Management (back office); they are subject to approval by the Executive Board and are reported to the Supervisory Board. Provisions for non-performing loans comprise specific loan loss provisions and portfolio loan loss provisions. As at 31 December 2017, specific loan loss provisions amounted to EUR 16.6 million (31/12/2016: EUR 18.4 million) for credit risks in the amount of EUR 19.6 million (31/12/2016: EUR 21.7 million). In addition, the Republic of Austria stands surety in the amount of EUR 3.3 million for a EUR 6.7 million exposure. Altogether, provisions in the amount of EUR 19.9 million (31/12/2016: 26

27 Management report EUR 22.6 million) have been booked for credit risks in the amount of EUR 26.2 million (31/12/2016: EUR 30.0 million), which corresponds to a provisioning ratio of 75.9% (31/12/2016: EUR 75.3%). In addition, portfolio loan loss provisions in the amount of EUR 1.0 million (31/12/2016: EUR 1.2 million) were set up. Provisions of EUR million set up pursuant to 57 (3) of the Austrian Banking Act (31/12/2016: EUR million) were released in accordance with the wind-down plan. Compared to 31 December 2016, the volume of specific loan loss provisions decreased by a net amount of EUR 1.8 million. The surety of the Republic of Austria was called as at 19 November 2017 and the payment obligation was deferred until 31 December The amount covered by the surety was reduced by EUR 0.8 million in 2017 (reversal for the Republic of Austria without the surety being called). At the end of the reporting period, KF had no financial assets that were past due more than 90 days but not impaired. A multi-stage risk control process is applied to identify and manage increased credit risks, with all counterparties being classified in four risk classes: Counterparties with increased credit risk (watch list) Level 0: Standard risk class for all counterparties not belonging to any of the following risk classes Level 1: Counterparties with slightly increased credit risk and/or a negative trend and therefore subject to close monitoring Level 2: Distressed exposures (payment arrears, credit impairment), except for distressed loans for which default according to Basel III has been identified Level 3: Default according to Basel III (receivables past due > 90 days or unlikely to be repaid in full unlikeliness to pay ) All counterparties on levels 1 to 3 are entered in the watch list of counterparties with increased credit risk, which is continuously updated and reported quarterly to the Credit Committee and the Supervisory Board of KF. The watch list primarily serves the purpose of providing qualitative information on the exposure at risk. Measures to be taken are decided in consultation with the Executive Board within the framework of the Credit Committee. Counterparties for which loan loss provisions are set up are classified as level 3. As described above, the credit risk exposures in the watch list classes are shown less existing credit risk provisions. 27