Financial Highlights. Income Statement. Balance Sheet. Regulatory own funds. Performance. Resources. Official Exchange Rate (BNB) Financial Highlights

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4 Financial Highlights Financial Highlights Monetary values in BGN Thousand 2010 Change Income Statement Net interest income after provisioning for possible loan losses 141,072 0% 141, ,815 Net commission income 52,896 8% 57,533 58,505 Trading profit (loss) 23,130 0% 23,020 29,055 Administrative expenses 183,095 5% 192, ,834 Profit before tax 48,175 13% 55, ,316 Profit after tax 43,949 14% 50, ,597 Balance Sheet Loans and advances to banks 907,439 11% 815,102 1,186,909 Loans and advances to customers 4,342,671 4% 4,529,761 4,044,215 Deposits from banks 471, % 45, ,970 Deposits from customers 4,125,204 5% 4,323,653 4,457,459 Equity 925,973 2% 907, ,455 Balance-sheet total 6,562,537 1% 6,642,200 6,882,171 Regulatory own funds Total own funds 884,906 4% 919, ,819 Own funds requirement/according to Local Regulations 563,123 11% 631, ,841 Excess cover 321,783 12% 288, ,978 Core capital ratio (Tier 1) 16.74% 11% 15.03% 13.99% Own funds ratio 18.86% 8% 17.48% 17.25% Performance Return of equity (ROE) before tax 5.5% 17% 6.6% 23.6% Cost/income ratio 47.6% 10% 52.9% 50.9% Return on assets (ROA) before tax 0.8% 11% 0.8% 2.3% Provisions for possible loan losses/risk-weighted assets/ According to Local Regulations Resources 296,315 72% 172,505 80,486 Number of staff on balance-sheet date 3,486 0% 3,478 3,703 Banking outlets on balance-sheet date 188 5% Official Exchange Rate (BNB) 1 EUR BGN BGN BGN Source: Audited Unconsolidated Financial Statements of bank (Bulgaria) EAD as of 31 December 2010

5 General Information General Information Establishment of the Bank bank (Bulgaria) EAD is the first greenfield foreign investment in the Bulgarian banking sector made in Main Shareholder bank (Bulgaria) EAD is a 100% subsidiary of Bank International AG, Vienna. Banking License bank (Bulgaria) EAD has a full banking license for domestic and overseas banking and financial operations. Profile bank (Bulgaria) EAD is a universal commercial bank, providing services to large corporate customers, small and medium-sized enterprises, retail clients, financial institutions and institutional clients. The Bank also performs bonds and securities trading on the local and the international money and capital markets, asset management, etc. The rating of bank (Bulgaria) EAD: Moody s Bank Financial Strength D+/Negative In foreign currency: Moody s Short-Term Foreign Currency Deposit P-3 Moody s Long-Term Foreign Currency Deposit Moody s Outlook In local currency: Baa3 Stable Moody s Short-Term local Currency Deposit P-3 Moody s Long-Term Local Currency Deposit Moody s Outlook Baa3 Stable Correspondent Banking bank (Bulgaria) EAD has established correspondent banking relations with 950 banks worldwide. The Bank maintains over 20 accounts in major currencies with first-class foreign banks.

6 General Information Branch Network As of 31 December 2010 the Bank operates through 188 branches, 44 outlets are located in Sofia. bank (Bulgaria) EAD has a mobile network of 100 consultants, operating in 10 towns in the country. Group in Bulgaria includes the following companies: Company bank (Bulgaria) EAD Services EAD Leasing Bulgaria OOD Auto Leasing Bulgaria EOOD Asset Management (Bulgaria) EAD Insurance Broker EOOD Real Estate EOOD Factoring EOOD Percentage of participation 100% ownership of Bank International AG, Vienna, Austria 100% ownership of bank (Bulgaria) EAD 24.5% ownership of bank (Bulgaria) EAD; 75.5% ownership of Leasing International GmBH, Austria 100% ownership of Leasing Bulgaria OOD 100% ownership of bank (Bulgaria) EAD 100% ownership of bank (Bulgaria) EAD 100% ownership of bank (Bulgaria) EAD 100% ownership of bank (Bulgaria) EAD

7 Market Shares Market Shares Market shares of the 10 biggest Bulgarian banks Total Assets In BGN Thousand 11,518,854 (16.25%) 11,275,640 (15.29%) 8,738,934 (12.33%) 8,151,629 (11.50%) 8,563,281 (11.62%) 7,460,917 (10.12%) 6,641,105 (9.37%) 6,562,135 (8.90%) 6,309,255 (8.56%) 6,026,126 (8.50%) 4,943,973 (6.71%) 4,095,287 (5.78%) 4,077,093 (5.53%) 3,625,050 (5.12%) 2,922,076 (3.96%) 2,888,736 (4.08%) 2,699,427 (3.66%) 2,035,862 (2.87%) 2,285,083 (3.10%) 1,839,424 (2.60%) Unicredit Bulbank DSK Bank United Bulgarian Bank bank (Bulgaria) Eurobank EFG Bulgaria First Investment Bank Piraeus Bank Bulgaria Societe Generale Expressbank Corporate Commercial Bank Central Cooperative Bank The percentages indicate the market share of the respective banks. Source: Bulgarian National Bank Total Deposits In BGN Thousand 6,539,298 (13.93%) 5,994,022 (12.77%) 6,417,995 (14.83%) 5,843,073 (13.50%) 4,641,511 (9.89%) 4,400,704 (9.38%) 4,331,662 (10.01%) 4,244,029 (9.81%) 4,205,020 (8.96%) 3,276,885 (7.57%) 4,311,688 (9.96%) 4,116,116 (8.77%) 2,260,483 (4.82%) 1,666,268 (3.85%) 1,924,786 (4.10%) 1,517,650 (3.51%) 1,697,449 (3.62%) 1,329,492 (2.83%) 1,399,964 (3.23%) 1,284,782 (2.97%) Unicredit Bulbank DSK Bank Eurobank EFG Bulgaria United Bulgarian Bank First Investment Bank bank (Bulgaria) Corporate Commercial Bank Central Cooperative Bank Societe Generale Expressbank Piraeus Bank Bulgaria The percentages indicate the market share of the respective banks. Source: Bulgarian National Bank

8 Market Shares Total Loans In BGN Thousand 8,054,337 (14.96%) 7,774,878 (14.82%) 7,543,642 (14.01%) 7,446,993 (14.20%) 6,768,068 (12.90%) 6,248,984 (11.60%) 4,702,820 (8.97%) 4,639,034 (8.61%) 4,456,373 (8.50%) 4,351,907 (8.08%) 3,479,170 (6.46%) 3,164,094 (5.88%) 3,019,012 (5.76%) 2,815,226 (5.37%) 2,454,979 (4.56%) 2,005,833 (3.82%) 1,712,013 (3.18%) 2,272,660 (4.33%) 1,847,674 (3.43%) 1,447,378 (2.76%) Unicredit Bulbank DSK Bank United Bulgarian Bank bank (Bulgaria) Eurobank EFG Bulgaria First Investment Bank Piraeus Bank Bulgaria Societe Generale Expressbank Alpha Bank Sofia Branch Corporate Commercial Bank The percentages indicate the market share of the respective banks. Source: Bulgarian National Bank Net Profit In BGN Thousand 210, ,002 (22.44%) 180, ,202 (20.02%) 150, ,744 (21.77%) 120,000 90, ,579 (17.91%) 100,145 (11.64%) 60,000 30,000 Unicredit Bulbank DSK Bank 74,367 (10.20%) 60,382 (7.02%) Corporate Commercial Bank 73,647 (10.10%) United Bulgarian Bank 50,150 (5.83%) 44,214 (6.06%) bank (Bulgaria) 45,901 (5.34%) 44,053 (6.04%) Piraeus Bank Bulgaria 34,942 (4.79%) 20,401 (2.37%) Eurobank EFG Bulgaria 32,019 (3.72%) 30,064 (4.12%) 30,838 (4.23%) 22,635 (2.63%) First Investment Bank Societe Generale Expressbank 28,740 (3.94%) 17,350 (2.02%) Bulgarian Development Bank The percentages indicate the market share of the respective banks. Source: Bulgarian National Bank

9 Contents Contents Chairman of the Management Board 10 Vision and Mission 11 Chairman of the Supervisory Board 12 Management 14 Bulgarian Economy in Key Figures 17 Operations 19 Human Resources 20 Segment s 21 Corporate Banking and SME 21 Retail Banking 22 Treasury and Investment Banking 24 Financial Institutions 26 Independent Auditors 27 Notes to the Financial Statements 34 Corporate Social Responsibility 87 The Bank s Management 89 Bank International at a Glance 90 Leasing Bulgaria OOD 92 Insurance Broker EOOD 93 Asset Management (Bulgaria) EAD 94 Factoring EOOD 97 Real Estate EOOD 98 Glossary 99 Addresses 101

10 Chairman of the Management Board Chairman of the Management Board Dear Ladies and Gentlemen, bank (Bulgaria) posted very good results for 2010 despite the tough economic situation, caused by the global financial and economic crisis. Profit after tax reached BGN 43.9 mln, compared to BGN 51 mln a year earlier. We managed to increase our operating income by 6% to BGN mln, by at the same time reducing operating expenses by almost 5% to BGN mln. As a result of this, our operating result grew by more than 17%, exceeding BGN 200 mln. In 2010 the Bank s net allocations to provisions for impairment losses amounted to BGN mln, the total amount of provisioning reaching BGN mln at year-end. Total assets amounted to BGN 6.56 bln, credit portfolio to BGN 4.64 bln, and the deposit base to BGN 4.12 bln. In 2010 we continued to focus on the quality of service, efficiency and the offering of innovative products and services. Proof of our successful business model is the reported growth in our customer base. In 2010 the number of our customers increased by more than 30,000 to 730,000. Momtchil Andreev Chairman of the Management Board At the end of 2010 the bank s total capital adequacy ratio (CAR) stood at 18.9%, significantly above the required minimum of 12% established by the Bulgarian National Bank and significantly over the European levels. Our sound liquidity, eased deposit rates, as well as the financing we manage to secure from abroad allowed us for the first time since 2008 to reduce the cost of funds and thus to support our customers in paying their loans. After the success of the first campaign for our large donation initiative Choose to Help, in 2010 the Bank carried out the second campaign, which went beyond the dimensions and the success of the first one. The initiative supported 30 significant healthcare, social, ecological, cultural and educational projects. The funds raised by the donations of 2,945 employees of the Group in Bulgaria and by the Bank, as well as by external donations exceeded BGN 390,000. In 2010 the subsidiaries of the Group in Bulgaria reported very good results and strengthened their positions as leaders in their respective markets. On behalf of the Management Board, I would like to thank all our customers and business partners for their trust in us. I also thank the employees of bank (Bulgaria) and its subsidiaries, who with their work contributed to our successful development. Momtchil Andreev Chairman of the Management Board 10 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

11 Vision and Mission Vision and Mission bank (Bulgaria) EAD is one of the leading universal banks in the country, offering bank services in all customer segments corporate and investment banking, small and middle sized enterprises and retail banking. We seek long-term customer relationships. We provide contemporary financial services to our customers meeting the highest professional standards and effectively satisfying the customers needs. We seek to be seen as a friendly and constructive partner for our customers and we are pro-active and quick in delivering our services. As a member of the RZB Group, we cooperate closely with Zentralbank, Bank International and its Network banks. We empower our employees to be entrepreneurial, to show initiative and we foster their development. We conduct our business with integrity and are committed to create a positive and stimulating working atmosphere. We want to attract and keep the best people whom we offer first class training and help to develop long term careers within our institution. We encourage initiative and reward concrete performance and success. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 11

12 Chairman of the Supervisory Board Chairman of the Supervisory Board Ladies and Gentlemen, Although most banking executives remember 2009 as an incredibly intensive year, 2010 raised the bar again for intensity. This time, however, the bulk of our efforts were internal, as we were working on a major reorganization of our Group. International, the former parent company of bank (Bulgaria), was merged with the principal business areas of Zentralbank (RZB) to form Bank International (RBI), which was entered in the commercial register in October. One of the goals of the merger was to combine the dense network of International in CEE with RZB s product development expertise in the field of corporate and investment banking, thereby generating added value for both our customers and shareholders. In addition, RBI now benefits from even better refinancing opportunities where International previously accessed the equities market and RZB used the debt market, the new RBI can now access both. Herbert Stepic Chairman of the Management Board of Bank International AG and Chairman of the Supervisory Board of bank (Bulgaria) EAD 2010 was also the year in which our home market Central and Eastern Europe (CEE) showed the first signs of improvement, after the outflow of liquidity at year-end 2008 and the resulting economic downturn. The sharp declines in growth in 2009 were replaced by a return to real gains in economic performance. Besides the growing stabilization in CEE, economists expect that these markets will return to a higher level of growth than in the eurozone. We expect economic growth in CEE to be around 2 percentage points greater than in the western European economies. The driver for this trend is the continuing high potential for catch-up in the region, which should reemerge in the long term as Europe s growth zone. Despite the merger and resulting expansion of our area of activity, CEE will continue to be the central focus of our strategy. Our result for 2010 shows that we took the right countermeasures during the crisis. Despite the continuing slight rise in nonperforming loans, which we expect to finally peak in the course of 2011, the RBI Group achieved a consolidated profit of EUR 1,087 mln. This represents growth of 142 per cent on the previous year, which is a strong performance even by international comparison. The emerging economic recovery, the measures initiated in the current year to improve our efficiency and competitiveness as well as the trust shown by our customers and shareholders give me confidence for our whole group for Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

13 Chairman of the Supervisory Board Regarding bank (Bulgaria) EAD, I am pleased to note that 2010 was another successful business year, despite the difficult conditions. During the year, the Supervisory Board met four times. It fully agrees with the Management Board s reports for the 2010 financial year and with the Management Board s proposal regarding the distribution of the profit. I am pleased to note that bank successfully met the still difficult economic conditions in With a strong capital base, a high liquidity level and its wide and innovative product portfolio, the bank continues to expand its client base and to be a reliable and strong partner for its clients. On behalf of the Supervisory Board, I thank all the bank s employees and its management for the business results achieved in I also extend our thanks to our clients for choosing bank and the other Group members in Bulgaria as their partners. Herbert Stepic Chairman of the Supervisory Board The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 13

14 Management Management The Bulgarian Economy in 2010 GDP The Management Board of bank (Bulgaria) EAD. From left to right: Evelina Miltenova Member of the MB and Executive Director, Tzenka Petkova Member of the MB and Executive Director, Momtchil Andreev Chairman of the MB and Executive Director, Nadezhda Mihailova Member of the MB and Procurator, Ani Angelova Member of the MB and Executive Director. In 2010 the Bulgarian economy started recovering and its GDP advanced by 0.3% 1 vs. 4.9% decrease in Economic growth was driven by the external sector: the export of goods and services increased by 12%, while imports picked up by only 2%. As a result of the slow economic recovery, reduced FDI inflows, and limited financing, investment decreased by 8% in Consumption also continued contracting (4.1%) as a result of the still high unemployment rate, diminishing household incomes and tighter lending conditions. Labour Market The labour market showed no visible signs of recovery in Moreover, in Q the rate of unemployment reached a record-high level for the last five years 11.2% 2. The number of unemployed persons reached 382 thousand. The increase in unemployment was the fastest for the youth in the age group the unemployment rate reached 26.5%, compared to 19.5% in Q The number of employed decreased in the last quarter of 2010 by 150 thousand YoY. The employment rate thus reached 46.3%, 2 p.p. lower than a year earlier. Inflation The inflation rate remained moderate for a second year in a row. The annual average inflation was 2.4% (2.8% in 2009), reflecting the very low price increases during the first half of the year. The yoy CPI increases started accelerating in the second half of the year, and were more pronounced in the last quarter of Therefore, the end-of-period inflation rate reached 4.5% (0.6% in 2009). The acceleration of inflation was determined predominantly by the high international prices of foods. The second important determinant was energy prices, especially fuels, whose demand has been steadily increasing due to the restructuring of the world economy and the expansion of new large markets. The higher inflation in the last months of 2010 increased the inflationary expectations for the first half of According to NSI s flash estimate. 2 For population aged 15+years. 14 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

15 Management Fiscal sector The initial 2010 budget targeted a zero deficit. After the significant revenue underperformance in the first half of the year, the government initiated a budget revision, which was adopted by the Parliament. It envisaged a cash deficit of 4.8% of GDP. Eventually, the budget ended with a cash deficit of 3.9% of GDP. On an accrual basis, the 2010 deficit is estimated at % which is a significant improvement compared to the 4.7% registered for 2009, although it is still above the Maastricht limit. The revised budget target for the fiscal reserve at the end of 2010 was BGN 4.5 bln. At the end of the year it stood at BGN 6 bln, due to domestic debt issues used as a source of deficit financing. Despite the 2010 increases in public debt, it still remained the third lowest in the EU as a share of GDP (after Estonia and Luxembourg) standing at 14.9%. The low public debt/gdp level provides the government with substantial flexibility of debt financing before the Maastricht limit of 60% is reached. On 21 January 2010 Moody s upgraded the outlook on Bulgaria s credit rating from "stable" to "positive". It affirmed this outlook on 31 August and 21 December. On 22 October JCRA upgraded the outlook on Bulgaria s credit rating from "negative" to "stable". Standard and Poor s followed suit on 17 December, also affirming its assessment for "stable" outlook. Current account The C/A deficit contracted to 0.8% of GDP, vs. 10% in 2010 and 23% a year earlier. The trade deficit, which had been the main reason for the C/A deficit, fell by 42.5% in This was a result of the favourable dynamics of export of goods, which stepped up by 33%, and of the slower pace of growth of import of goods (13.1%), which accelerated only in the last months of the year. Export of non-ferrous metals, petroleum products and raw materials for production of food brought the biggest positive contribution to the advance of export. The services balance amounted to EUR 1.9 bln in 2010 and improved by 46% compared to For the whole 2010 the balance on current transfers increased by 67% vs and reached EUR 1.5 bln, which contributed for the closing of the C/A deficit. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 15

16 Management Selected macroeconomic indicators Nominal GDP (EUR mln) 2010 Change 2010/ , % 35,043 35,430 30,772 Real GDP growth (%) 0.3% 5.2 ð.ð. 4.9% 6.2% 6.4% GDP per capita (EUR) 4, % 4,633 4,658 4,028 Unemployment rate (avg, %) 9.8% 3.0 ð.ð. 6.8% 6.3% 6.9% Inflation rate (eop, %) 4.5% 3.9 ð.ð. 0.6% 7.8% 12.5% Inflation rate (avg, %) 2.4% 0.4 ð.ð. 2.8% 12.3% 8.4% Current account balance (% of GDP) ð.ð Trade balance (EUR mln) 2, % 4,174 8,597 7,245 Foreign direct investment (EUR mln) 1, % 3, , ,838.1 FDI/Current account balance (%) 528.1% 331 ð.ð % 175.7% 214.0% FX reserves (EUR mln) 12, % 12,919 12,713 11,937 Source: NSI, BNB, RESEARCH 2010 Bulgarian Banking Sector Overview Despite the first positive signs for economic recovery in end-september in 2010, the banking sector s balance sheet suffered from the effects of the global financial downturn, with the real GDP slow down during the first and second quarters and the low credit activity in the second half of the year as the main holdback factors. Under the difficult macroeconomic conditions, the Banking system managed to maintain high level of flexibility and effectiveness and good profitability, capital adequacy (over 15%) and liquidity ratios (over 24%). As of year-end 2010 the Bulgarian banking system consisted of 24 commercial banks and 6 branches of non-resident banks. More than 96% of sector s total assets were controlled by private entities, while almost 81% of the system was owned by foreign financial institutions, mainly European banking groups. Sector s total assets kept growing to BGN bln as of end-2010, from BGN bln in 2009, or by 4.03% year-on-year. The slow down of credit growth remained in place in 2010 as the uncertainty of economic recovery and the tight lending policy of banks kept businesses and consumers from borrowing. In end-2010 the system recorded the lowest growth of gross loans in the past years (2.68% YoY). The gross loan portfolio reached BGN bln, or 73% of system s total assets. A more significant growth on a yearly basis was registered with the corporate sector (4.41%), while loans to households dropped by 0.46% compared to end As a result of the worsened macroeconomic environment consumption expenditures fell down while households propensity to save rose thus helping to boost the Bank deposit growth. The falling trend in the attracted funds from corporate clients in the first three quarters reversed to an increase by 2.40% YoY as of end At the same time deposits from retail customers grew much faster in 2010, (12.89% year-on-year) thus remaining the primary source of funding. For a second year in a row since the beginning of the crisis, although at a lower pace (2010/2009: %; 2009/2008: %), the system registered a decline in the net profit to BGN 617 mln from BGN 780 mln a year earlier. The weaker financial result was due 16 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

17 Management to the increasing provision expenses set aside by the local banks aimed at meeting potential unfavorable changes in the asset quality. Quality of assets significantly deteriorated due to the negative effects from the global financial downturn. In end-2010 the share of classified loans in gross loans stood at 20.42% including: 9.08% watch exposures (above 30 days past due), 3.07% non-performing loans (over 90 to 180 days past due) and 8.27% loss (above 180 days past due). At the end of the year return on average assets (ROA: 0.86%) and return on average equity (ROE: 6.7%) declined due to the lower financial result in the sector. The liquidity ratio, showing the ability of banks to repay their debts, significantly improved to 24.37% from 21.90% in Key Figures In 2010 bank (Bulgaria) EAD s activity was negatively affected by the consequences of the global financial downturn. Despite the destructive impact of the recession, the Bank reaffirmed its position among the leading banking institutions in the country maintaining good profitability and adequate financial indicators, which proves the effectiveness of Reiffeisen s business model in a complex market situation. Total Assets In BGN Thousand Loan portfolio In BGN Thousand 6,642,200 6,562,537 6,000,000 6,000,000 5,000,000 4,000,000 5,000,000 4,000,000 4,702,266 4,638,985 3,000,000 3,000,000 2,000,000 2,000,000 1,000,000 1,000, Source: Audited Unconsolidated Financial Statements of bank (Bulgaria) EAD As of end-2010, the total assets of the Bank reached BGN 6.6 bln decreasing by 1% YoY, driven by the general asset growth slow-down in the sector, while at the same time the leading banks registered a TA decline on a yearly basis. In 2010, Raiffesienbank (Bulgaria) EAD marked an insignificant drop of gross loans by 1% YoY to BGN 4.6 bln maintaining almost the same market share (8.61%) compared to At the same time the quality of the loan portfolio remained well above the average for the sector. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 17

18 Management Deposits from Customers Total Equity In BGN Thousand 5,000,000 4,000,000 4,323,653 4,125,204 In BGN Thousand 1,000, , , , ,973 3,000,000 2,000, , , ,679 1,000, , , , Source: Audited Unconsolidated Financial Statements of bank (Bulgaria) EAD As of end 2010 the Bank registered 5% lower amount of deposits from customers to BGN 4.1 bln from 4.3 bln a year ago. The decrease of the funds attracted from corporate clients was almost fully covered by the resources from retail customers, year-on-year. Bank s equity significantly rose to BGN 926 mln from BGN 907 mln a year ago. Тhe capital adequacy ratio is high (18.86%), growing up from 17.48% in end The total own funds exceeding the own funds regulatory requirement improved further by 11 b.p. YoY to 57% from 46%, the same period in Net Profit Cost/Income Ratio In BGN Thousand In % ,995 43, Source: Audited Unconsolidated Financial Statements of bank (Bulgaria) EAD Following sector s trend, driven by the negative effects from the global economic crisis, as of end- 2010, bank (Bulgaria) EAD accounted for a lower net profit, to BGN 43.9 mln from BGN mln due to the significantly higher amount of provisions for loan losses set aside by the Bank (+72% YoY), to BGN mln compared to BGN mln, a year earlier. At the same time the operating result grew by 18% to BGN mln from BGN mln in Despite the 14% lower profit driven by the more conservative provisioning policy, the 2010 net result is a confirmation for the stable operating activity and the business model of bank in a difficult market situation. As of end-2010 the cost/income ratio improved to 47.6% from 52.9% in 2009 due to the higher growth of the operating income compared to the increase of operating expenses. 18 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

19 Management Operations In 2010 bank (Bulgaria) EAD reported a 3% increase of operational income compared to the preceding year. The number of on-line and Multicash users increased by 48.6% compared to the year 2009 leading to a further increase of the electronic payments share in the total number of payment orders. Local Currency Payments Foreign Currency Payments 8,211, , ,941* 7,297, , , ,548 6,207, ,000 5,757, , ,272 90,000 60,000 30, In Out In Out In Out In Out Local Currency Payments * reported figure includes intrabank transactions unlike previous years. In 2010 the total number of local currency payments initiated by bank (Bulgaria) EAD clients decreased by 7.25% compared to The respective income from commissions in the same period decreased by 5%; the market share of the Bank in outbound payment numbers for 2010 was 7%. Real-time local currency payments processed via RINGS ensured bank (Bulgaria) EAD a market share of 12.8% throughout Foreign Currency Payments The total number of customer clean payments in foreign currencies increased by 55%, resulting in an increase of the respective income from commissions, i.e. 11%. Payments in euro (both inbound and outbound) continued to predominate in the total number of foreign currencies payments, the inbound ones reaching 91%, and the outbound 81%. The Bank enjoys access to European payment infrastructures thanks to its joining Target 2, Bisera 7 and Step 2 as a direct/indirect member in Documentary Transactions In 2010 the number of documentary transactions increased by 7% compared to 2009 as the growth was to the largerst extent contributed by the increase in the the volume of guarantees issued. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 19

20 Management Staff Number 3,004 3,478 3,487 Human Resources As of the end of 2010 the staff of bank (Bulgaria) EAD amounted to 3,487; 69% (2,385) of staff were employed in the branch network; 83% of the staff were university graduates and the average age was 34 years. 1,921 In 2010 the main focus was further enhancement of key competencies of the Bank s employees. The managerial staff was trained to improve managerial skills under a programme co-financed by the European Union funded Operational Programme Human resources, while the front office staff was trained for Superior Customer Service Quality, Negotiation Skills, Team work Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

21 Segment s Segment s Corporate Banking and SME Corporate Banking In 2010 bank (Bulgaria) EAD was focused on keeping the good relationship with its corporate clients and attracted new ones. As a universal Bank, bank (Bulgaria) EAD offers to small, medium and large companies the full range of banking products including lending, cash management, documentary operations, deposits, foreign exchange, structuring and placement of bond issues, etc. bank (Bulgaria) EAD is the third largest creditor to corporate clients with market share of 9.5%. The new loans in 2010 to corporate clients increased three times compared to bank (Bulgaria) EAD managed to keep the second place in terms of attracted funds with market share of 11.3%. Nadezhda Mihailova Member of the MB and Procurator SME In 2010 bank (Bulgaria) EAD has retained its leading position among the top Banks in SME segment. The Bank provided diversified lending and non-lending products and high-quality services to its SME customers. The focus was set on the personal attitude, branch and service excellence, optimization of internal processes and staff reorganization. In response to the Bank s efforts to meet the customer needs, the SME customer base has been extended with 1%. Due to the agreed credit lines and guarantee schemes of bank (Bulgaria) EAD with international and national financial institutions, the Bank managed to meet the specific needs of its clients from the SME segment. Public Sector and Institutional Clients In 2010, bank (Bulgaria) EAD kept the achieved results in the Public Sector, as of the end of the year the market share among the key clients of the sector remained 8%. To all budget and other organizations from the Public Sector the Bank offers a full range of Bank products, including municipal lending. As of the end of the year the credit portfolio of the Bank in this segment amounted to EUR 38.3 mln (Investment loans + issue bonds). bank (Bulgaria) EAD supports municipal projects and projects of companies performing activities in favour of Local Communities with an important social impact. The credit line from the European Investment Bank on lending to municipalities and companies performing municipal services, offers flexible lending schemes with a grant element. The Bank was active in attracting deposits from municipalities and other clients from the Public Sector. By the end of 2010 the attracted funds from these clients amounted to EUR 112 mln. The Bank has a specialized EU Funds Unit, which, in collaboration with specialists from Services EAD, offers qualified assistance during the development and implementation of EUfunded projects. In addition to its consulting activities the Bank offers different loan facilities to the EU-funded beneficiaries. In 2010, 12 projects amounting to EUR 11.4 mln were elaborated. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 21

22 Segment s Retail Banking In 2010 bank (Bulgaria) EAD continued to expand its market position in the Retail banking segment. At the end of 2010 the total amount of loans in the Retail banking segment reached BGN 1,268 mln. At the same time the total retail attracted funds reached BGN 1,938 mln. The number of retail customers increased by 4.92% in comparison to In 2010 over 44,000 new clients became users of the Bank s electronic banking service Online. In 2010 bank (Bulgaria) EAD continued to expand the range of products and services for private individuals introducing a number of new offers on the market, among which: 2010 Liabilities Structure Term Deposits (77%) Ani Angelova Member of the MB and Executive Director Rai Dom loan for young families and/or first home this new loan is designed for young families in which at least one of the spouses is not older than 35 years and/or families which will use the loan to purchase their first home. Borrowers that satisfy these conditions are entitled to tax relief under The Law on Income tax of Individuals. The Bank provides additional support enabling them to benefit from one of the most advantageous price conditions on the market with the product Rai Dom. European credit line for housing loans the product is offered through a joint initiative of Bank and the European Fund for Southeast Europe. Under the program, the bank granted loans for the improvement and expansion of current home or buying a new, under favorable interest rates linked to EURIBOR. Student Loan the product is part of a special lending program to university and postgraduate students by virtue of the Law on Lending to University Students and Postgraduates, implemented in cooperation with the Ministry of Education, Youth and Science. SMS confirmation for transactions conducted through Online the new service launched in February 2010 is an additional security protection for the customers online payments, allowing transactions from Online to take place only after customers enter a confirmation code received by them via SMS on their mobile phone. Cards (8%) Current Accounts (15%) 22 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

23 Segment s At the end of 2010 the total number of debit and credit cards issued by bank reached 500,000. The number of ATMs reached 605 during the year, marking an increase of 5% compared to the end of bank s POS terminals totaled more than 6,800. In the year 2010, with regard to the imposing of a uniform the brand for all banks in the Bank International Group concerning the service of VIP customers, EXCLUSIVE service was renamed to Premium Banking. Along with the new vision, Raiffeisnbank Bulgaria expanded the service, adding financial advice and set it as a basic working principle for serving customers with savings in the Bank exceeding BGN 50,000. At the end of the year Premium Banking was offered at 16 bank offices located in 8 cities, serving more than 6,500 VIP customers. Branch Network and Alternative Distribution Channels In 2010 bank (Bulgaria) EAD optimized its branch network and the offices totalled up to 188 by year end. The Bank has established an information centre Direct, which is an alternative channel for client servicing, launched with the aim to facilitate both existing and potential customers in their day-to-day communication with the Bank. At the call centre, clients can obtain detailed information and consultation on issues arrising in connection with the use of the Bank s products. The Bank also offers online banking to its customers. ONLINE provides access to personal and corporate bank accounts, conveniently giving access at any time and place for obtaining reference information about the Bank products, for ordering transfers in local and foreign currencies, for opening and terminating term deposits and other services. The corporate and retail customers of the Bank increased by 5% compared to In 2010 the Agent Network of bank (Bulgaria) EAD retained its position as one of the key channels of distribution of the Bank s retail products and services. The mobile bankers contributed approximately 20% of the sales of the Bank s priority products in retail. The service of the mobile bankers is offered by 100 consultants in 10 Bulgarian cities. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 23

24 Segment s Treasury and Investment Banking Evelina Miltenova Member of the MB and Executive Director Foreign Exchange Trading The year 2010 was successful for bank (Bulgaria) EAD on the local interbank and customer FX market, as the Bank kept its position as a leading market-maker. The global financial crisis reduced the traded FX volumes. The Treasury department concentrated its efforts on maintaining a good level of co-operation with its business counterparties, as well as its long-standing customer relationships. As a result of the tough Bank competition and unfavorable market conditions, the currency spreads continued to tighten and the FX turnover significantly reduced. bank (Bulgaria) EAD managed to generate a good FX income as a result of customer oriented services and diversified Treasury products derivative products (FX options, interest rate swaps, FX swaps and forwards, option forwards). Being an integral part of an international banking group, bank (Bulgaria) EAD successfully exploits the experience of the other network banks and proposes alternative solutions based on the wide range of the traded market products, thus providing comprehensive services and treasury products to its corporate and institutional clients. Capital Market Operations 2010 was another successful year for bank (Bulgaria) EAD on the local government debt market. The credit institution is a respected and preffered primary dealer and supports the Ministry of Finance, bidding regularly on the government debt auctions. The Bank maintains a substantial market share on the primary market and is an active market-maker on the secondary market. Holding positions in government securities is a key priority for the management and is supportive to the leading position of the Bank on the debt market in Bulgaria. bank (Bulgaria) EAD offers to its customers a wide scope of government debt instruments for trading and investment and aims at a professional and affordable service. In 2010 the market policy of bank (Bulgaria) EAD was widely recognized and the Bank was once again appointed a primary dealer for the next calendar year. In 2010 bank (Bulgaria) EAD confirmed its leading position on the local market of newly issued debt instruments corporate and mortgage bonds with a market share of 35% in the segment of structured and placed bond issues with a total nominal value of EUR 47 mln. 24 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

25 Segment s 2010 Share of Total Volume Newly Issued Corporate/Mortgage Bonds 2010 Share of Total Number Newly Issued Corporate/Mortgage Bonds Other Investment Intermediaries (65%) Other Investment Intermediaries (69%) bank (Bulgaria) EAD (35%) bank (Bulgaria) EAD (31%) The number of newly launched debt securities managed by bank (Bulgaria) EAD on the local market reached 4 out of 13. The total Bank turnover of brokerage services on local stock exchange reached nearly BGN 20 mln, placing bank (Bulgaria) EAD on 14th place ranked by total turnover on BSE-Sofia AD. The turnover realized on OTC segment exceeded BGN 90 mln. In 2010 bank (Bulgaria) EAD increased almost 1.25 times the total volume of brokerage services on foreign capital markets, reaching BGN 1.25 bln compared to BGN 1 bln the previous year. Custody Services In 2010 bank (Bulgaria) EAD further strengthened its position as one of the leading institutions providing Custody Services related to investments in domestic and foreign financial instruments. In 2010 annual survey conducted by the renowned magazine Global Custodian, we were awarded a TOP RATED status by our cross-border clients. With this score we clearly underlined our commitment and quality leadership in the custody services provided on the Bulgarian local market. In 2010 the volume of assets under custody grew by more than 10%, compared to the volumes in At the end of 2010 the market value of equities under custody amounted to BGN 1.6 bln, which ranked bank (Bulgaria) EAD among the leading providers of custody services. bank (Bulgaria) EAD provides Depository services for 16 REITs and 8 mutual funds. At the end of 2010, the Fund s assets under custody with bank (Bulgaria) EAD represented around 7% of the total assets administered by the asset management companies. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 25

26 Segment s Financial Institutions Correspondent Banking bank (Bulgaria) EAD constantly develops and optimizes its relations with numerous firstclass international and local financial institutions. As of the end of 2010 the number of banks, which bank (Bulgaria) EAD has established correspondent relations with, reached 950, while the number of the accounts in different currencies maintained by the bank was close to 20. The network of nostro accounts is subject to continuous improvement and top ranked banks are preferred, such as bank Bank International AG Vienna, Deutsche Bank AG Frankfurt, Commerzbank AG Frankfurt, Standard Chartered Bank New York, Wells Fargo Bank N. A. (formerly Wachovia Bank) New York, The Bank of Tokyo-Mitsubishi Tokyo, UBS AG Zurich, Danske Bank Copenhagen; HSBC Bank London, etc. Based on the excellent quality of tailor-made services provided to financial institutions and the confidence of the international financial community in bank (Bulgaria) EAD, almost 40 foreign mainly from Europe, North America and Asia and domestic banks, and foreign nonbanking financial institutions maintain accounts with bank (Bulgaria) EAD in local and foreign currencies. Funding bank (Bulgaria) EAD is one of the leading banks in terms of attracting mid- and longterm financing from international financial institutions and banks. As of 31 December 2010, Raiffesenbank had negotiated finance facilities totaling EUR mln, of which EUR 181 mln consisted of credit lines and EUR mln guarantee schemes with international financial institutions. In 2010 bank (Bulgaria) EAD signed 2 new Funding Agreements amounting to EUR 35 mln and increased the total amount under the existing Risk-Sharing Portfolio Guarantee with the National Guarantee Fund (NGF) for long and medium term SME financing, to EUR 8.95 mln. bank (Bulgaria) EAD and the European Fund for Southeast Europe (EFSE) signed a EUR 20 mln credit facility designed to support bank s prudent lending in the sphere of mortgages and housing loans to private individuals. EFSE is one of the largest microfinance investment funds worldwide, aimed at fostering economic development and prosperity in Southeast Europe. 26 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

27 Independent Auditors Independent Auditors The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 27

28 Independent Auditors 28 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

29 Income Statement The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 29

30 Balance Sheet 30 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

31 Statements of Cash Flows The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 31 Leasing Leasing Broker Broker Factoring Estate Glossary

32 Statements of Cash Flows 32 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

33 Statements of Changes in Shareholders Equity The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 33 Leasing Leasing Broker Broker Factoring Estate Glossary

34 Notes to the Financial Statements Notes to the Financial Statements 1. Basis of Preparation (а) ing entity bank (Bulgaria) EAD is the first green field foreign direct investment in the Bulgarian banking sector. The Bank has been entered in the company register of Sofia City Court on The Bank is fully owned by Raiffesien Bank International, Austria. The Bank has a general banking license issued by the Bulgarian National Bank (BNB) according to which it is allowed to conduct all banking transactions permitted by the Bulgarian legislation in the country and abroad, as well as to conduct all deals and services in its capacity of investment intermediary according to the Public offering of securities Act. The consolidated financial statements of the Bank for 2010 represent the financial statements of the Bank and its subsidiaries and associated companies as described in note 33, referred to as the Group. (b) Statement of compliance These consolidated financial statements have been prepared in accordance with the International Financial ing Standards (IFRS), as adopted by the European union. (c) Basis of measurement These financial statements have been prepared on the historical cost basis except for the following: derivative financial instruments are measured at fair value; trading instruments and other instruments designated at fair value through profit or loss measured at fair value, where such can be reliably determined; available for sale financial instruments measured at fair value, where such can be reliably determined; (d) Functional and presentation currency These consolidated financial statements are presented in Bulgarian leva (BGN), rounded to the nearest thousand, which is the Group s functional currency. (e) Use of estimates and judgments The preparation of these consolidated financial statements requires management to exercise its judgment in the process of applying the Group s accounting policies and the reported value of assets, liabilities, income and expense. Actual results may differ from these estimates and judgments. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the financial statements are disclosed in Note Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

35 Notes to the Financial Statements 2. Significant Accounting Policies These consolidated financial statements are prepared by applying one and the same accounting policy from the Bank and its subsidiaries. (a) Basis of consolidation These consolidated financial statements are prepared in accordance with IAS 27 Consolidated and Seperate Financial Statements and IAS 28 Investments in associates, whereby participations with more than 50% of the voting rights are fully consolidated and all participations with more than 20% of the voting rights are consolidated using the equity method. (b) Income recognition Interest income and expense Interest income and expense are recognized in the statement of comprehensive income for all interest bearing instruments on an accrual basis using the effective interest method. Interest income and expense presented in the statement of comprehensive income include: interest on financial assets and liabilities at amortized cost interest on investment securities carried at fair value through profit or loss Interest income and expense on all trading assets and liabilities are considered to be incidental to the Bank s trading operations and are presented together with all other changes in the fair value of trading assets and liabilities in net trading income. Fair value changes Fair value changes on derivatives are presented in net result from derivatives in the statement of comprehensive income. Fair value changes of investment securities carried at fair value through profit or loss, are presented in net income from investment securities carried at fair value through profit and loss in the statement of comprehensive income. Fees and commission Fees and commission income and expenses that are integral to the effective interest income on a financial asset or liability are included in the measurement of the effective interest income. Loan commitment fees for credit lines that are likely to be drawn down, are deferred and are recognized as an adjustment to the effective interest income on the loan. Loan syndication fees are recognized as revenue when the syndication has been completed and the Bank has recognized on its statement of financial position the respective part of the syndication. Commission and fees arising from negotiating, or participating in the negotiation of, a transaction for a third party such as the arrangement of the acquisition of shares or other securities or the purchase or sale of businesses are recognized on completion of the underlying transaction. Portfolio and other management advisory and service fees are recognized based on the applicable service contracts, usually on a time-apportionate basis. Other fees and commission income, including account servicing fees, sales commission, payments transfer fees, etc., is recognized as the related services are performed. Commission income from insurance brokerage and other consulting and intermediary services is recognized in the income statement on an accrual basis upon origination notwithstanding the time of cash flow. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 35 Leasing Leasing Broker Broker Factoring Estate Glossary

36 Notes to the Financial Statements Other fees and commission expense, which is not part of the effective interest expense, represents mainly transaction and service fees, which is expensed as the services are received. Dividends Dividends are recognized in the statement of comprehensive income when the Group s right to receive payment is established. Net trading income Net trading income comprises gains less losses related to trading assets and liabilities, and includes all realized and unrealized fair value changes, interest, dividends and foreign exchange differences. (c) Foreign currency transactions All transactions in foreign currencies are translated to the functional currency of the Group at exchange rates fixed by the Bulgarian Central Bank at the dates of the transactions. Monetary assets and liabilities denominated in foreign currencies at the reporting date are retranslated to the functional currency at the exchange rate fixed by the Bulgarian Central Bank at that date. (d) Financial assets The Group presents its financial assets in the following categories: trading assets, derivatives, loans and receivables, financial assets at fair value through profit or loss, held-to-maturity investments and available-for-sale financial assets. The Group determines the classification of its investments at initial recognition. (i) Trading assets and liabilities Trading assets and liabilities are those assets and liabilities that the Group acquires or incurs principally for the purpose of selling or repurchasing in the near term, or holds as part of a portfolio that is managed together for short-term profit or position taking. Trading assets and liabilities are initially recognized and subsequently measured at fair value in the statement of financial position with transaction costs taken directly to profit or loss. All changes in fair value are recognized as part of net trading income in profit or loss. Trading assets and liabilities are not reclassified subsequent to their initial recognition. (ii) Derivatives Derivatives are initially recognized at fair value on the date on which a derivative contract is entered into and are subsequently re-measured at their fair value. Fair values are obtained from quoted market prices in active markets, including recent market transactions, and valuation techniques, including discounted cash flow models, as appropriate. All derivatives are carried as assets when fair value is positive and as liabilities when fair value is negative. (iii) Loans and receivables Loans originated by the Group by providing money directly to the borrower or to a sub-participation agent at draw down, other than those that are originated with the intent of being sold immediately or in the short term which are recorded as trading assets, are categorized as loans originated by the Group. They are carried at amortized cost, which is defined as the fair value of cash consideration given to originate those loans as is determinable by reference to market prices at origination date. Transaction related expenses, like legal fees connected to loan collaterals, are treated as part of the deal value. All loans are recognized upon utilization. 36 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

37 Notes to the Financial Statements (iv) Financial assets at fair value through profit or loss The Group has designated financial assets and liabilities at fair value through profit or loss when either: the assets or liabilities are managed, evaluated and reported internally on a fair value basis; the designation eliminates or significantly reduces an accounting mismatch which would otherwise arise; or the asset or liability contains an embedded derivative that significantly modifies the cash flows that would otherwise be required under the contract. (v) Held-to-maturity Held-to-maturity investments are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group s management has the positive intention and ability to hold to maturity. These financial assets are recognized in the statement of financial position at settlement date and are carried at amortized cost with a subsequent test for impairment. If the Group sells other than an insignificant amount of held-to-maturity assets, the entire category would be tainted and reclassified as available for sale. (vi) Available-for-sale Available-for-sale investments are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. (e) Measurement Purchases and sales of financial assets at fair value through profit or loss, held to maturity and available for sale are recognized on the date of the actual delivery of the assets. Loans are recognized when cash is advanced to the borrowers. All financial assets except for trading assets are initially recognized at fair value plus transaction costs. Financial assets are derecognized when the rights to receive cash flows from the financial assets have expired or when the Group has transferred substantially all risks and rewards of ownership. Available-for-sale financial assets and financial assets at fair value through profit or loss are subsequently carried at fair value. Loans and receivables and held-to-maturity investments are carried at amortized cost. Gains and losses arising from changes in the fair value of the financial assets at fair value through profit or loss category are included in the statement of comprehensive income in the period in which they arise. Gains and losses arising from changes in the fair value of available-for-sale financial assets are recognized directly in equity, until the financial asset is derecognized or impaired at which time the cumulative gain or loss previously recognized in equity should be recognized in profit or loss. Interest income is recognized in the statement of comprehensive income. Dividends on available-for-sale equity instruments are recognized in the statement of comprehensive income when the entity s right to receive payment is established. The fair values of quoted investments in active markets are based on current bid prices. If the market for a financial asset is not active (and for unlisted securities), the Group establishes fair value by using valuation models and discounted cash flow analysis. (f) Fair values of financial assets and liabilities The determination of fair values of financial assets and financial liabilities is based on quoted market prices. For all other financial instruments fair value is determined by using valuation techniques. Valuation techniques include The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 37 Leasing Leasing Broker Broker Factoring Estate Glossary

38 Notes to the Financial Statements net present value techniques, the discounted cash flow method, comparison to similar instruments for which market observable prices exist, and valuation models. The Group uses widely recognized valuation models for determining the fair value of financial instruments like options and interest rate and currency swaps. For these financial instruments, inputs into models are market observable. For more complex instruments, the Group uses proprietary models, which usually are developed from recognized valuation models. Some or all of the inputs into these models may not be market observable, and are derived from market prices or rates or are estimated based on assumptions. When entering into a transaction, the financial instrument is recognized initially at the transaction price, which is the best indicator of fair value, although the value obtained from the valuation model may differ from the transaction price. At subsequent measurement this initial difference in fair value indicated by valuation techniques is recognized in income depending upon the individual facts and circumstances of each transaction and not later than when the market data becomes observable. The value produced by a model or other valuation technique is adjusted by a number of factors as appropriate, to allow the valuation techniques to appropriately reflect all factors market participants take into account when entering into a transaction. Valuation adjustments are recorded to allow for credit risks, bid-ask spreads, liquidity risks, as well as other factors. Management believes that these valuation adjustments are necessary and appropriate to fairly state financial instruments carried at fair value in the statement of financial position. (g) Derecognition The Group derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows on the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in transferred financial assets that is created or retained by the Group is recognized as a separate asset or liability. The Group derecognizes a financial liability when its contractual obligations are discharged or cancelled or expire. The Group enters into transactions whereby it transfers assets recognized on its statement of financial position, but retains either all risks and rewards of the transferred assets or a portion of them. If all or substantially all risks and rewards are retained, then the transferred assets are not derecognized from the statement of financial position. Transfers of assets with retention of all or substantially all risks and rewards include, for example, securities lending and repurchase transactions. In certain transactions the Group retains rights to service a transferred financial asset for a fee. The transferred asset is derecognized in its entirety if it meets the derecognition criteria. An asset or liability is recognized for the servicing rights, depending on whether the servicing fee is more than adequate to cover servicing expenses (asset) or is less than adequate for performing the servicing (liability)). (h) Cash and cash equivalents Cash and cash equivalents comprise cash balances on hand and in ATM, cash deposited with the Central Bank and placements with banks with original maturity of less than 3 months. (i) Deals with securities Securities borrowing and lending and repurchase agreements (i) Securities borrowing and lending Investments lent under securities lending arrangements continue to be recognized in the statement of financial position and are measured in accordance with the accounting policy for assets held for trading or at fair value through profit or loss. Cash collateral received in respect of securities lent is recognized as liabilities to either 38 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

39 Notes to the Financial Statements banks or customers. Investments borrowed under securities borrowing agreements are not recognized as assets of the Group. Cash collateral placements in respect of securities borrowed are recognized under loans and advances to either banks or customers. Income and expenses arising from the securities borrowing and lending business are recognized on an accrual basis over the period of the transactions and are included in interest income or expense. (ii) Repurchase agreements The Group enters into purchases (sales) of investments under agreements to resell (repurchase) substantially identical investments at a certain date in the future at a fixed price. Investments purchased subject to commitments to resell them at future dates are not recognized. The amounts paid are recognized in the statement of financial position as receivables under repurchase agreements. The receivables are shown as collateralized by the underlying security. Investments sold under repurchase agreements continue to be recognized in the statement of financial position and are measured in accordance with the accounting policy for either assets held for trading or at fair value through profit or loss as appropriate. The proceeds from the sale of the investments are reported in the statement of financial position as liabilities on repurchase agreements. The difference between the sale and repurchase considerations is recognized on an accrual basis over the period of the transaction and is included in interest. (j) Borrowings Borrowings are recognized initially at cost, being their issue proceeds (fair value of consideration received) net of transaction costs incurred. Borrowings are subsequently stated at amortized cost and any difference between net proceeds and the redemption value is recognized in the statement of comprehensive income over the period of the borrowings using the effective yield method. If the Group purchases its own debt, it is removed from the statement of financial position and the difference between the carrying amount of a liability and the consideration paid is included in net trading income. (k) Offsetting Financial assets and liabilities are offset and the net amount is reported in the statement of financial position when the Group has a legally enforceable right to set off the recognized amounts and the transactions are intended to be settled on a net basis. (l) Impairment At each date of preparation of statement of financial position the Group assesses whether there is objective evidence that financial assets not carried at fair value through profit or loss are impaired. Financial assets are impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the asset, and that the loss event has an impact on the future cash flows on the asset that can be estimated reliably. Objective evidence that financial assets (including equity securities) are impaired can include default or delinquency by a borrower, restructuring of a loan or advance by the Group on terms that the Group would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the disappearance of an active market for a security, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers in the group, or economic conditions that correlate with defaults in the group. The Group considers evidence of impairment at both a specific asset and collective level. All individually significant financial assets are assessed for specific impairment. All significant assets found not to be specifically impaired The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 39 Leasing Leasing Broker Broker Factoring Estate Glossary

40 Notes to the Financial Statements are then collectively assessed for any impairment that has been incurred but not yet identified. Assets that are not individually significant are then collectively assessed for impairment by grouping together financial assets (carried at amortized cost) with similar risk characteristics. In assessing collective impairment the Group uses statistical modeling of historical trends of the probability of default, timing of recoveries and the amount of loss incurred, adjusted for management s judgments as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical modeling. Default rates, loss rates and the expected timing of future recoveries are regularly benchmarked against actual outcomes to ensure that they remain appropriate. Impairment losses on individually impaired assets are measured as the difference between the carrying amount of the financial assets and the present value of estimated cash flows discounted at the assets original effective interest rate. Losses are recognized in profit or loss and reflected in an allowance account against loans and advances. Short-term balances are not discounted. When a loan is uncollectible, it is written off against the related allowance for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. When a subsequent event causes the amount of impairment loss to decrease, the impairment loss is reversed through profit or loss. Loans and advances are presented net of impairment losses. The increase of the impairment losses is recognized in the statement of comprehensive income. The Group reintegrates in its current year income impairment losses, which are released as a result of a partial or the total collection of the provisioned exposure, as well as in case of reclassifying the exposure into a lower credit risk group. Allowances for impairment losses on portfolio basis are allocated against regular exposures, to cover existing losses, which could not be identified for each individual loan according to the Group s provisioning policy. The Group s policy for allocation of portfolio based allowances for impairment losses determines the principles for reducing the statement of financial position amount of a portfolio of loans with similar credit risk characteristics to their recoverable amount as at the date of preparation of the statement of financial position. The recoverable amount of an equity instrument is its fair value. The recoverable amount of debt instruments and purchased loans re-measured to fair value is calculated as the present value of expected future cash flows discounted at the current market interest rate. (m) Property, plant and equipment Recognition and measurement Items of property and equipment are measured at cost less accumulated depreciation. Cost includes expenditures that are directly attributable to the acquisition of the asset. The cost of self-constructed assets includes the cost of materials and direct labour, any other costs directly attributable to bringing the asset to a working condition for its intended use, and the costs of dismantling and removing the items and restoring the site on which they are located. Purchased software that is integral to the functionality of the related equipment is capitalised as part of that equipment. When parts of an item of property or equipment have significant part in the total cost of the asset, they are accounted for as separate items (major components) of property and equipment. 40 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

41 Notes to the Financial Statements Subsequent costs The cost of replacing part of an item of property or equipment is recognised in the carrying amount of the item if it is probable that the future economic benefits embodied within the part will flow to the Group and its cost can be measured reliably. Depreciation Long-term assets are depreciated on a straight-line basis over the estimated useful lives. Leased assets are depreciated over the shorter of the lease term and their useful lives. Land is not depreciated. The estimated depreciation rates for the current and comparative periods are as follows: Assets % Buildings 4 Equipment Fixtures and fittings 15 Vehicles 25 Assets are not depreciated until they are brought into use and transferred from assets in the course of construction into the relevant asset category. (n) Intangible assets Recognition and measurement Intangible assets, which are acquired by the Group, are stated at cost less accumulated amortization and any impairment losses. Software acquired by the Group is stated at cost less accumulated amortisation and accumulated impairment losses. Expenditure on internally developed intangible asset is recognised as an asset when the Group is able to demonstrate its intention and ability to complete the development and use the intangible asset in a manner that will generate future economic benefits, and can reliably measure the costs to complete the development. Subsequent expenditure on intangible asset assets is capitalised only when it increases the future economic benefits embodied in the specific asset to which it relates. All other expenditure is expensed as incurred. Depreciation Amortization is calculated on a straight-line basis over the expected useful life of the asset. The annual rates of amortization are as follows: Assets % Licences 15 Computer software 20 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 41 Leasing Leasing Broker Broker Factoring Estate Glossary

42 Notes to the Financial Statements (o) Receivables under financial leases The leasing activity of the Group is basically financial lease of motor vehicles, industrial equipment, property and others. The financial lease is a contractual agreement, under which the lessor gives the lessee the usage right over an asset for a certain period of time and an agreed price. A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. The typical indicators, which the Group considers to evaluate whether all substantial risks and rewards are transferred, include: present value of the minimum lease payments compared to the fair value of the leased asset at the beginning of the lease agreement; the term of the lease agreement compared to the useful life of the leased asset, as well as whether the lessee will gain the right of ownership over the leased asset upon maturity of the financial lease agreement. All other lease agreements, which do not substantially transfer all the risks and rewards incidental to ownership of an asset, are classified as operational leases. Minimum lease payments Minimum lease payments are the payments over the lease term that the lessee is or can be required to make, excluding contingent rent, costs for services and taxes to be paid by and reimbursed to the lessor. The minimum lease payments also include for a lessor, any residual value guaranteed to the lessor by a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee. However, if the lessee has an option to purchase the asset at a price that is expected to be sufficiently lower than fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised, the minimum lease payments comprise the minimum payments payable over the lease term to the expected date of exercise of this purchase option and the payment required to exercise it. Commencement of the lease agreement and commencement of the lease It should be differentiated between the commencement of the lease agreement and the commencement of the lease term. The lease agreement commences on the earlier of the date of the lease agreement and the date on which the parties agree with the main conditions under the agreement. By that date: The lease agreement is classified as financial or operational lease; In the case of financial lease the amounts, which should be recognized at the commencement of the lease agreement are determined. The commencement of the lease term is the date from which the lessee is entitled to exercise its right to use the leased asset. It is the date of initial recognition of the lease (i.e. the recognition of the assets, liabilities, income or expenses resulting from the lease, as appropriate) Initial recognition and subsequent measurement The Group recognizes assets held under a finance lease in its balance sheets and presents them as a receivable at an amount equal to the net investment in the lease. Under a finance lease substantially all the risks and rewards incidental to legal ownership are transferred by the lessor, and thus the lease payment receivable is treated by the lessor as repayment of principal and finance income to reimburse and reward the lessor for its investment and services. The recognition of finance income is based on a pattern reflecting a constant periodic rate of return on the net investment in the finance lease. Subsequently the investment under finance lease agreements is recognized net, after deducting allowances for individual and collective impairment. 42 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

43 Notes to the Financial Statements (p) Provisions A provision is recognized in the statement of financial position when the Group has a legal or constructive obligation as a result of a past event, and it is probable that an outflow of economic benefits will be required to settle the obligation. Provisions are determined by discounting the expected future cash flows at a pre-tax rate that reflects current market assessments of the time value of money and, where appropriate, the risks specific to the liability. In accordance with IAS 19 Employee benefits the Group provides for short- as well as long-term employees benefits. Short-term employees benefits include additional remuneration in line with the actual valid bonus schemes and payments for unused annual leaves. The provision for long-term employees benefits represent the present value of future retirement compensations according to the local labour legislation. (q) Deposits, borrowings from banks and subordinated liabilities Deposits, borrowings from banks and subordinated liabilities are the Group s sources of debt funding. When the Group sells a financial asset and simultaneously enters into an agreement to repurchase the asset (or a similar asset) at a fixed price on a future date ( repo or stock lending ), the arrangement is accounted for as a deposit, and the underlying asset continues to be recognised in the Group s financial statements. Deposits, borrowings from banks and subordinated liabilities are carried at amortized cost. (r) Acceptances An acceptance is created when the Group agrees to pay, at a stipulated future date, a draft drawn on it for a specified amount. The Group s acceptances primarily arise from documentary credits stipulating payment for the goods to be made a certain number of days after receipt of required documents. The Group negotiates most acceptances to be settled at a later date following the reimbursement from the customers. Acceptances are accounted for as other liabilities. (s) Taxation Tax on the profit for the year comprises current tax and the change in deferred tax. Current tax comprises tax payable calculated on the basis of the expected taxable income for the year, using the tax rates enacted by the date of preparation of the statement of financial position, and any adjustment of tax payable for previous years. Deferred tax is provided using the balance sheet liability method on all temporary differences between the carrying amounts for financial reporting purposes and the amounts used for taxation purposes. Deferred tax is calculated on the basis of the tax rates that are expected to apply to the period when the asset is realized or the liability is settled. The effect on deferred tax of any changes in tax rates is charged to the statement of comprehensive income, except to the extent that it relates to items previously charged or credited directly to equity. The tax rate applicable for 2011 applied in the calculation of deferred income tax amount is 10% ( %). A deferred tax asset is recognized only to the extent that it is probable that future taxable profits will be available against which the unused tax losses and credits can be utilized. Deferred tax assets are reduced to the extent that it is no longer probable that the related tax benefit will be realized. (t) Segment reporting The Group applies IFRS 8 Operating segments which requires the Group to present operating segments based on the information that is internally provided to the Management. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 43 Leasing Leasing Broker Broker Factoring Estate Glossary

44 Notes to the Financial Statements (u) New standards and interpretations not yet adopted A number of new standards, amendments to standards and interpretations are effective for annual periods beginning after 1 January 2010, and have not been applied in preparing these financial statements. None of these is expected to have a significant effect on the financial statements of the Group. 3. Financial Risk Management (a) Introduction and overview The Group has exposure to the following risks from its use of financial instruments: credit risk liquidity risk market risks currency risks operational risk Risk management framework The Management Board has overall responsibility for the establishment and oversight of the Group s risk management framework. The Board has established the Group s Asset and Liability Committee (ALCO), Credit committee, Problem Loans Committee and Operational Risk committees, which are responsible for developing and monitoring Group risk management policies in their specified areas. All Board committees have both executive and non-executive members. The Group s risk management policies are established to identify and analyze the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions, products and services offered. The Group, through its training and management standards and procedures, aims to develop a disciplined and constructive control environment, in which all employees understand their roles and obligations. By its nature the Group s activities are principally related to the use of financial instruments. The Group accepts deposits from customers at both fixed and floating rates and for various periods and seeks to invest these funds in high quality assets. The Management places trading limits on the level of exposure that can be taken in relation to both overnight and intra-day market positions. A. Credit risk The Group is permanently exposed to credit risk, arising from the probability that counterparties might default on their contractual obligation under loans and advances when due or in full. Credit risk is the most important risk for the Group s business; management therefore carefully manages its exposure to credit risk. The Group has a set of policies and procedures in relation to credit approval and credit exposures management. In addition, the Group is exposed to off-balance sheet credit risk through commitments under unutilized extended credit lines and issued guarantees. Concentrations of credit risk (whether on or off-balance sheet) might arise from risk exposures to one borrower or group of borrowers, with similar economic characteristics, that might be affected in equal terms by changes in economic or other circumstances in meeting their contractual obligations. 44 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

45 Notes to the Financial Statements The Group is exposed to credit risk also in result of its trading and investment activities, as well as in result of its activities as an investment intermediary for its customers or for third parties. The credit risk arising on trading and investment activities is managed through the management of market risk. The risk that counterparts to financial instruments might default on their obligations is monitored on an ongoing basis. In monitoring credit risk exposures related to trading instruments, consideration is given to instruments with a positive fair value and to the volatility of the fair value of trading instruments. Credit risk measurement In measuring credit risk of loans and advances to customers and to banks at a counterparty level, the Group reflects three components (i) the probability of default by the client or counterparty on its contractual obligations; (ii) current exposures to the counterparty and its likely future development, from which the Group derives the exposure at default ; and (iii) the likely recovery ratio on the defaulted obligations (the loss given default). These credit risk components, which reflect expected loss are compliant with the regulatory requirements of BNB and the European Directive for capital adequacy and are embedded in the Group s daily operational management. However, when determining the impairment losses to reduce the carrying amount of the exposure, are applied the requirements of IAS 39, which are based on losses that have been incurred at the date of preparation of the statement of financial position. The Group assesses the probability of default of individual counterparties using internal rating tools tailored to the various categories of exposures and counterparty. They have been developed internally and combine statistical analysis with judgment and are validated, where appropriate, by comparison with externally available data. Clients of the Group are segmented into rating classes, reflecting the range of default probabilities defined for each rating class. This means, that in principle, exposures migrate between classes as the assessment of their probability of default changes. The rating tools are kept under review and upgraded as necessary. The Group regularly validates the performance of the rating and their predictive power with regard to default events. The Group uses the assessments of recognized external credit assessment institutions where available to benchmark the internal credit risk assessment. Exposure at default is based on the amounts the Group expects to be owed at the time of default. For example for a loan this is the outstanding principal. For a commitment, the Group includes any amount already drawn plus the further amount that may have been drawn by the time of default, should it occur. Loss given default or loss severity represent the Group s expectation of the extent of loss on a claim should default occur. It varies by type of counterparty, type of seniority of claim and availability of collateral or other credit mitigation. For debt securities or other bills, both internal and external ratings are used for managing of the credit risk exposures, as most of the securities are not rated by external Rating Agencies. The investments in those securities and bills are viewed as a way to gain a better credit quality mapping and maintain a readily available source to meet the funding requirement at the same time. Risk limit control and mitigation policies The Group manages limits and controls concentrations of credit risk wherever they are identified in particular, to individual counterparties and groups, and to industries and countries. The Group structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower, or group of borrowers, and to geographical and industry segments. Such risks are monitored on a revolving basis and subject to regular reviews, when considered necessary. Exposure to credit risk is also managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 45 Leasing Leasing Broker Broker Factoring Estate Glossary

46 Notes to the Financial Statements Collateral The Group employs a range of policies and practices to mitigate credit risk. The most traditional of these is taking security for funds advances. The Group implements guidelines on the acceptability of specific classes of collateral or credit risk mitigation. The principal collateral types for loans and advances are: mortgages over residential properties; cash deposits; pledge of business assets such as premises, inventory and accounts receivable; corporate or bank guarantees; pledge of financial instruments such as debt securities and equities. Longer-term finance and lending to corporate entities are generally secured; consumer loans for individual persons are generally unsecured. In addition, in order to minimize the credit loss the Group might seek additional collateral from the counterparty when impairment indicators are noticed for the relevant individual loans and advances. Derivatives The Group maintains strict control limits on net open derivative positions (i.e. the difference between the purchase and sale contracts), by both amount and term. At any one time, the amount subject to credit risk is limited to the current fair value of instruments that are favorable to the Group (i.e. assets, where their fair value is positive), which in relation to derivatives is only a small fraction of the contract, or notional values used to express the volume of instruments outstanding. The credit risk exposure is managed as part of the overall lending limits with customers, together with potential exposures from market movements. Collateral or other security is not usually obtained for credit risk exposures on these instruments. Settlement risk arises in any situation where a payment in cash, securities or equities is made in the expectation of a corresponding receipt in cash, securities or equities. Daily settlement limits are established for each counterparty to cover the aggregate of all settlement risk arising from the Group s market transactions on any single day. Credit-related commitments The primary purpose of these instruments is to ensure that funds are available to a customer as required. Guarantees and standby letters of credit carry the same credit risk as loans. Documentary and commercial letters of credit which are written undertakings by the Group on behalf of a customer authorizing a third party to draw drafts on the Group up to a stipulated amount under specific terms and conditions are collateralized by the underlying shipments of goods to which they relate and therefore carry less risk than a direct loan. Commitments to extend credit represent unused portions of authorizations to extend credit in the form of loans, guarantees or letters of credit. With respect to credit risk on commitments to extend credit, the Group is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments, as most commitments to extend credit are contingent upon customers maintaining specific credit standards. The Group monitors the term to maturity of credit commitments because longer-term commitments generally have a greater degree of credit risk than shorter-term commitments. However, any commitments that are unconditionally cancelable at any time by the Group without prior notice, or that effectively provide for automatic cancellation due to deterioration in the borrower s creditworthiness, are considered by the Group to bear no risk. 46 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

47 Notes to the Financial Statements Management of credit risk The Supervisory Board has delegated responsibility for the management of credit risk to the Management Board. The Management Board defines the credit policy based on analysis of the business situation and the assessment of the risk associated with credit business. The scope of the Corporate Lending Policy is to present a clear picture in which direction the Group s corporate credit portfolio shall develop within the next year. The approval of the Corporate Lending Policy by Supervisory Board ensures, that the steps proposed by the Group with regards to targeted industries, products, etc. and the subsequent impacts of those steps on the corporate credit portfolio are in line with the plans of the Supervisory Board and therefore in line with the basic strategy of RBI Group. The credit risk management is performed by the Risk Management Division. The main responsibilities of the Division are: Recommend and manage portfolio concentration limits Provide independent review of limit applications; Perform proactive risk management of transactional and portfolio activities; Ensure that risk management standards, policies, practices and tools of the RBI Group are adhered to by all business units in the credit process; Assist the Risk Originating Units/Account Managers in establishing business-specific risk management practices (not contradicting standard tools introduced by RBI Group) for the approval, measurement, reporting, monitoring, limiting and analysis of credit risk of corporate customers; Assist in the identification, classification and management of problematic exposures; Ensure that early warning signs reported by the Risk Originating Units are considered properly and internal actions (e.g. downgrading of Customer Rating, Review and establishment of action plans for potential problematic exposures) are initiated quickly; Cooperate with the Risk Originating Unit in establishing the Credit Policy, review the final Credit Policy paper and recommend amendments whenever necessary as well as monitor the compliance of the Group with the approved Credit Policy. Policy for risk exposures assessment and allocation of provisions for credit risk The internal and external rating systems focus more on credit quality mapping from the inception of the lending and investment activities. In contrast, impairment provisions are recognized for financial reporting purposes only for losses that have been incurred at the date of preparation of the statement of financial position based on objective evidence of impairment. Due to the different methodologies applied, the amount of incurred credit losses provided for in the financial statements are usually lower than the amount determined from the expected loss model that is used for internal operational management and banking regulation purposes. The Group applies different approaches with regard to assessment of impairment and determination of the credit loss, depending on the customer segment and product type. Allowances for impairment of 100% of the exposure net from the value of the residential real estate mortgages for retail customers (including private individuals and micro SMEs) are recognized if: exposure is past due more than 180 days exposure is identified as uncollectible The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 47 Leasing Leasing Broker Broker Factoring Estate Glossary

48 Notes to the Financial Statements Impairment that cannot be identified for exposures to retail customers on an individual loan basis may still be identifiable on a portfolio basis. Hence, all accounts without objectively significant evidence of impairment are included in a group of similar financial assets for the collective assessment. Allowances for impairment are based on previous loss experience for assets with similar credit risk characteristics (product, customer type, collateral type, past-due status) with consideration of the current portfolio performance. Accounts that are individually assessed for impairment and identified as impaired are excluded from a collective assessment of impairment, but they may enter into the model, which determines loss factors used for collective allowances for impairment. Exposures to corporate customers are evaluated and classified based on the credit risk level, the period of delay of amounts due, the assessment of the debtor s financial state and the main sources for repayment of the debtor s obligations. The Group applies a policy for determining of provisions for collective impairment of exposures to corporate customers. Exposures to large, middle and small corporate customers, for which no individual impairment has been identified, are grouped together in pools according to their internal rating. The collective impairment of each pool is measured according to the historic default rate for the respective rating class. The historic default rate represents the number of defaulted customers by the end of the observation period as percentage from total number of customers in the respective pool. The observation period is 12 months and considers only customers with existing exposures at the beginning and by the end of the period. The collective impairment is determined by multiplying the net exposure after deduction of the high liquid collateral by the historic default rate, which corresponds to the rating class of the customer. 48 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

49 Notes to the Financial Statements Credit risk exposures In BGN Thousand Individually impaired: Excellent credit standing Very good credit standing Good credit standing Average credit standing Mediocre credit standing Weak credit standing 1 1 Very weàk credit standing 2 2 High probability of default 1,412 2 Default 269, ,335 Unrated Retail 137,190 80,630 Gross amount 407, ,981 Allowance for impairment (231,256) (107,303) Carrying amount 176, ,678 Collectively impaired: Excellent credit standing Very good credit standing Good credit standing Average credit standing Mediocre credit standing , , , ,548 11,441 41,291 98, , ,610 Weak credit standing 289, ,537 Very weàk credit standing 448, ,148 High probability of default 322, ,274 Default Unrated 8,271 4,373 Retail 1,522,755 1,681,252 Gross amount 3,253,651 3,874,483 Allowance for impairment (65,059) (65,202) Carrying amount 3,188,592 3,809,281 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 49 Leasing Leasing Broker Broker Factoring Estate Glossary

50 Notes to the Financial Statements In BGN Thousand Past due but not impaired: Excellent credit standing Very good credit standing Good credit standing Average credit standing Mediocre credit standing Weak credit standing 468 Very weàk credit standing 1,313 1,681 High probability of default 3,239 Default 2,487 5,297 Unrated Retail 8,808 4,808 Gross amount Past due comprises: days 15,847 2,976 12,254 1, days 2,693 1, days 2, day + 7,231 7,870 Carrying amount 15,847 12,254 Neither past due nor impaired: Excellent credit standing 2,294 1,197 Very good credit standing 27,917 18,112 Good credit standing 52,116 18,728 Average credit standing 142,023 94,699 Mediocre credit standing 146, ,127 Weak credit standing 155,637 75,781 Very weàk credit standing 214, ,708 High probability of default 47,639 38,771 Default 2, Unrated 1,979 9,385 Retail 108,087 25,240 Gross amount 900, ,029 Total portfolio 4,578,167 4,611,747 Total provision for impairment (296,315) (172,505) Net amount 4,281,852 4,439, Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

51 Notes to the Financial Statements Set out below is an analysis of the gross and net (of allowances for impairment) amounts of individually impaired assets by risk grade: In BGN Thousand Gross amount Net amount 31 December 2010 Weak credit standing Very weàk credit standing High probability of default Default Unrated Retail Total 31 December 2009 Weak credit standing Very weàk credit standing High probability of default Default Unrated Retail Total The following table illustrates the collateral by type of impairment: In BGN Thousand Against individually impaired: Cash deposit Guarantees Mortgages Inventory Other Unsecured Against collectively impaired: Cash deposit Guarantees Mortgages Inventory Other Unsecured , ,967 5,073 10, , ,263 20,219 23,967 21, ,412 1, , , ,190 43, , , ,335 86, ,630 22, , ,678 3,448 2,295,501 2,272, , ,413 5,993 14, ,168 1,252,668 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 51 Leasing Leasing Broker Broker Factoring Estate Glossary

52 Notes to the Financial Statements In BGN Thousand Past due but not impaired: Cash deposit 92 Guarantees 135 Mortgages 14,964 11,226 Inventory Other 1 Unsecured Neither past due nor impaired: Cash deposit 38,218 21,697 Guarantees Mortgages 1, , ,856 Inventory 5, Other 7 9,514 Unsecured 59,926 44,136 Total 4,578,167 4,611,747 Upon initial recognition of loans and advances, the fair value of collateral is based on valuation techniques commonly used for the corresponding assets. In subsequent periods, the fair value is updated by reference to market price or indexes of similar assets where the update frequency depends on the asset type and the market conditions. Concentration of risks of loans and advances by industry sector The following table breaks down the Group s main credit exposures at their carrying amounts, as categorized by the industry sectors of our counterparties. in BGN Thousand 2010 % 2009 % Manufacturing 984,997 22% 999,999 22% Construction 244,919 5% 292,816 6% Transport 83,035 2% 103,922 2% Trade 1,032,070 22% 1,061,866 23% Real estate 634,536 14% 603,106 13% Other 330,910 7% 317,688 7% Individuals 1,267,700 28% 1,232,350 27% Total hereof mortgages 704,903 15% 733,133 16% 4,578,167 4,611, Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

53 Notes to the Financial Statements Trading assets An analysis of the credit quality of the maximum credit exposure for trading assets, based on Standard & Poor s ratings where applicable, is as follows: in BGN Thousand Bulgarian government securities BBB 153,650 59,947 Bulgarian corporate bonds BB BBB 8,608 BB 7,725 Baa3 5,261 Ca 3,232 Unrated 20,332 25,078 Foreign government securities AAA 6,709 18,859 Foreign corporate bonds AAA 32,517 25,062 Equities Unrated 99 Total 225, ,131 B. Liquidity risk Liquidity risk is the risk that the Group is unable to meet its payment obligations associated with its financial liabilities when they fall due. Liquidity risk management process The Group is exposed to daily calls on its available cash resources from overnight deposits, current accounts, maturing term deposits, loan drawdown and guarantees. The Group does not maintain cash resources required to meet all possible outgoing cash flows as experience has shown that there is a minimum level of reinvestment of maturing funds that can be predicted with a high level of certainty. The correlation between assets and liabilities, as well as the outgoing and incoming cash flows are managed to guarantee the regular and timely fulfillment of current obligations for the going concern scenario as well as for liquidity shortage. The maturity of assets and liabilities and the ability to replace, at an acceptable cost, interest bearing liabilities as they mature, are important factors in assessing the liquidity of the Group and its exposure to changes in interest rates and exchange rates. The diversification of deposits by type and customer segment, and the past experience of the Group give reason management to believe that deposits are a long-term and stable source of funding for the Group. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 53 Leasing Leasing Broker Broker Factoring Estate Glossary

54 Notes to the Financial Statements Liquidity Stress Tests Treasury Risk Management Department performs various numbers of scenarios simulating Liquidity Crisis under which of them are also the regulatory required ones: idiosyncratic, market specific, and a combination of the two. The results are reviewed on on-going basis and also are reported to the Managing Board for further countermeasures, if needed. The Group maintains a certain amount of Liquidity Buffers composed of cash and core liquid assets to ensure, to the maximum extent possible, that they will be available in times of stress. Therfore the Group constantly strives for improvement of the Net liquid assets to the total Group s liabilities ratio. For this purpose net liquid assets are considered as including cash and cash equivalents, balances with the Central Bank, Bulgarian government bonds, nostro accounts and placements with banks with a remaining maturity up to 7 days, government treasury bills and investment grade debt securities for which there is an active and liquid market. Liquid assets do not include pledged assets. The amount of the pledged assets as at 31 December 2010 and 31 December 2009 is BGN 223 mln. and BGN 396 mln. respectively. The table below illustrates the ratio for the past two years. Net liquid assets to total Group s liabilities ratio Average for the period 19.7% 19.3% Maximum for the period 27.4% 27.9% Minimum for the period 14.4% 13.8% As at 31 December 27.4% 13.8% Monitoring and reporting take the form of cash flow measurement and projections for the next day, week and month respectively, as these are key periods for liquidity management. The starting point for those projections is an analysis of the contractual maturity of the financial liabilities and the expected collection date of the financial assets. The Groupk s Treasury also monitors unmatched medium term assets, the level and type of undrawn lending commitments, the usage of overdraft facilities and the impact of contingent liabilities such as standby letters of credit and guarantees Funding approach Sources of liquidity are regularly reviewed by Treasury to maintain a wide diversification by currency, geography, provider, product and term. Cash flows from non-derivative liabilities The maturity of non-derivative liabilities is expressed as the cash flows payable by the Group under financial liabilities by remaining contractual maturities at the date of preparation of the statement of financial position. The amounts disclosed in the table are the contractual undiscounted cash flows, whereas the Group manages the inherent liquidity risk based on expected undiscounted cash inflows. Cash flows from derivative liabilities 54 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

55 Notes to the Financial Statements The Group s derivatives will be settled on a gross basis and include: Foreign exchange derivatives currency forwards, currency swaps Interest rate derivatives single currency interest rate swaps, cross currency interest rate swaps. The maturity table analyses the Group s derivative financial instruments that will be settled on a gross basis into relevant maturity groupings based on the remaining period at the date of preparation of the statement of financial position to the contractual maturity date. As at 31 December 2010 In BGN Thousand Less than 1 month 1-3 months 3 months to 1 year 1-5 years More than 5 years Total inflow/ outflow Carrying amount Non derivative liabilities Deposits from banks (471,167) (471,167) 471,144 Deposits from customers (2,349,103) (843,654) (908,187) (69,076) (4,170,020) 4,120,952 Borrowings from banks (46) (22,717) (232,374) (534,119) (59,646) (848,902) 805,783 Subordinated liabilities (1,169) (3,508) (18,709) (179,150) (202,536) 178,813 Provisions (11,267) (5,062) (1,182) (17,511) 17,512 Deferred tsx liabilities 529 (529) 529 Other liabilities (32,371) (5,509) (37,880) 37,880 Total non-derivative instruments Derivative liabilities (2,853,856) (877,638) (1,154,640) (622,433) (239,978) (5,748,545) 5,632,613 Foreign exchange derivatives 28 Outflow (912) Inflow 856 Interest rate derivatives 382 (912) 856 Outflow (8,876) (251) (9,127) Inflow 8, ,773 Total derivative liabilities 352 (58) (410) 410 Loan commitments (61,413) (277,792) (261,927) (60,764) (661,896) Total financial liabilities (contractual maturity dates) (2,854,208) (939,109) (1,432,432) (884,360) (300,742) (6,410,851) 5,633,023 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 55 Leasing Leasing Broker Broker Factoring Estate Glossary

56 Notes to the Financial Statements As at 31 December 2009 In BGN Thousand Less than 1 month 1-3 months 3 months to 1 year 1-5 years More than 5 years Total inflow/ outflow Carrying amount Non derivative liabilities Deposits from banks (41,966) (4,170) (46,136) 45,709 Deposits from customers (2,417,452) (918,849) (865,931) (186,666) (4,388,898) 4,320,918 Borrowings from banks (6,531) (18,454) (831,619) (286,851) (40,117) (1,183,572) 1,148,237 Subordinated liabilities (1,002) (3,007) (16,039) (178,983) (199,031) 178,701 Provisions (13,376) (5,182) (752) (19,310) 19,310 Other liabilities (14,626) (1,843) (16,469) 16,469 Total non-derivative instruments (2,481,577) (950,679) (1,711,752) (489,556) (219,852) (5,853,416) 5,729,344 Derivative liabilities Foreign exchange derivatives 3,203 Outflow (839,094) (537) (800) (840,431) Inflow 839, ,458 Interest rate derivatives 456 Outflow (1,307) (34) (83,131) (664) (85,136) Inflow 1, , ,481 Total derivative liabilities 384 (2) (4) (6) 372 3,659 Loan commitments (12,712) (37,363) (327,265) (300,341) (83,395) (761,076) Total financial liabilities (contractual maturity dates) (2,493,905) (988,044) (2,039,021) (789,903) (303,247) (6,614,120) 5,733, Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

57 Notes to the Financial Statements C. Market risk The Group takes on exposure to market risks, which is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Market risks arise from open positions in interest rate, currency and equity products, all of which are exposed to general or specific market movements and changes in the level of volatility of market rates or prices such as interest rates, credit spreads, foreign exchange rates and equity prices. The Group separates exposures to market risk into either trading or non-trading portfolios. All marked-to-market instruments are subject to market risk. The instruments are recognized at fair value based on quoted bid prices, and all changes in market conditions directly affect net trading income (through trading instruments) or equity value (through available for sale instruments). The Group manages its trading portfolios in accordance with the changes in market conditions, as well as through setting of respective limits for the relative instruments. Market risk measurement techniques As part of the management of market risk, the Group undertakes various hedging strategies for market risk exposure s minimization. The Group also enters into interest rate swaps to match the interest rate risk associated with the fixed-rate long-term debt securities and loans to which the fair value option has been applied. The major measurement techniques used to measure and control market risk are outlined below. Value at risk The Group applies a value at risk methodology (VAR) to its trading and non-trading portfolios, to estimate the market risk of positions held and the potential losses expected, through appropriate analytical method, supported by empirical conditions and documented analyses. This method is applied consecutively and with a certain level of conservatism, which is usually higher if there is only limited data available. The Board sets limits on the value at risk that may be accepted for the Group, trading and non-trading separately, which are monitored on a regular basis by the Group s Treasury Risk management department. VAR is a statistically based estimate of the potential loss on the current portfolio from adverse market movements. It expresses the maximum amount the Group might lose, but only to a certain level of confidence (99%). There is therefore a specified statistical probability (1%) that actual loss could be greater that the VAR estimate. The VAR model assumes a certain holding period until positions can be closed (1 day). It also assumes that market moves occurring over this holding period will follow a similar pattern to those that have occurred in the past. The Var approach used in the Group since the beginning of 2010 is a hybrid one, i.e. both aspects of historical simulation and of a parametric approach are combined and extreme events resulting from a period of stressed risk factors are added. Volatility regimes are taken into consideration via rescaling of historic returns (used volatility is a weighted average of 80% of the recent 20 business days and 20% of the past two years). Actual outcomes are monitored regularly to test the validity of the assumptions and parameters/factors used in the VAR calculation. The use of this approach does not prevent losses outside of these limits, but to a certain extent the application of the hybrid model takes into consideration extreme events of significant market movements. The quality of the VAR model is continuously monitored by back-testing the VAR results for trading books. All backtesting exceptions and any exceptional revenues on the profit side of the VAR distribution are investigated, and all back-testing results are reported to the Management board. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 57

58 Notes to the Financial Statements VAR summary for By risk type In BGN Thousand (1d, 99 %) Average High Low 31 December Trading portfolio VAR 3,780 10,154 1,215 1,584 Non-trading portfolio VAR 2,587 5,852 1,124 3,184 Total Diversfied VaR 2,413 6,321 1,364 2,443 Stress tests Stress tests provide an indication of the potential size of losses that could arise in extreme conditions. The stress tests include risk factor stress testing, where stress movements are applied to each risk category; emerging market stress testing, where emerging market portfolios are subject to stress movements; and ad hoc stress testing, which includes applying possible stress events to specific position or regions. The results of the stress tests are reviewed by Management on an on-going basis. The stress testing is tailored to the business and typically uses scenario analysis. Interest rate risk The Group s operations are subject to the risk of interest rate fluctuations to the extent that interest-earning assets and interest-bearing liabilities mature or re-price at different times or in differing amounts. In comparison to the other risks the interest rate risk could be minimized trough the mutual management of assets and liabilities. The policy of the Group to minimize interest rate risk is to grant floating rate loans against the received floating rate external financings. Interest rate risk is also managed through the balanced use of different funding sources (borrowings from other local banks, long-term borrowings from foreign banks, customer deposits etc.), as well as through purposeful credit policy, providing for increasing return. It is of crucial importance for the Management of the Group to control the interest rate sensitivity of assets and liabilities. Due to the nature of banking an absolute matching in maturities or in periods of re-pricing of contracted interests on financial assets and liabilities is not possible. The Group s interest rate exposures are monitored and managed by generating interest rate sensitivity reports. The majority of the Group s interest bearing assets and liabilities are structured to match either short-term assets and short-term liabilities, or long-term assets and liabilities with re-pricing opportunities within one year, or long-term assets and corresponding liabilities whereby re-pricing is performed simultaneously. For most interest-bearing assets and liabilities exists a possibility of re-pricing at a relatively short notice and any interest rate sensitivity gaps are considered immaterial. 58 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

59 Notes to the Financial Statements The following table indicates the periods in which interest bearing financial assets and liabilities re-price as at 31 December 2010: In BGN Thousand Assets Up to 3 months From 3 months to 1 year From 1 year to 5 years More than 5 years Loans and advances to banks 966, ,331 Loans and advances to customers 4,281,852 4,281,852 Receivables under repurchase agreements 26,521 26,521 Investment securities 76,115 2, ,432 77, ,459 Total assets 5,350,819 2, ,432 77,436 5,782,163 Liabilities Deposits from banks 471, ,144 Deposits from customers 2,352,901 1,146, ,866 4,120,952 Borrowings from banks 666, , ,783 Subordinated liabilities 178, ,813 Total liabilities Net position Total 3,669,259 1,285, ,866 5,576,692 1,681,560 (1,283,091) (270,434) 77, ,471 The following table indicates the periods in which interest bearing financial assets and liabilities re-price as at 31 December 2009: In BGN Thousand Assets Loans and advances to banks Loans and advances to customers Receivables under repurchase agreements Investment securities Total assets Liabilities Deposits from banks Deposits from customers Borrowings from banks Subordinated liabilities Total liabilities Net position Up to 3 months From 3 months to 1 year From 1 year to 5 years More than 5 years Total 658, , ,730 4,439,242 4,439, , ,032 24, ,277 5,441, ,800 24,492 5,889,860 41,715 3,994 45,709 3,312, , ,932 4,320,918 1,055,824 92,413 1,148, , ,701 4,588, , ,932 5,693, ,132 (514,397) (142,440) 196,295 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 59

60 Notes to the Financial Statements The management of interest rate risk against interest rate gap limits is supplemented by monitoring the sensitivity of the Group s financial assets and liabilities to various standard and non-standard interest rate scenarios. Standard scenarios that are considered on a monthly basis include a 100 basis point (bp) parallel fall or rise in all yield curves worldwide and a 50 bp rise or fall in the greater than 12-month portion of all yield curves. This analyses is presented in the table below for the year 2010, respectively in BGN Thousand +100 bp parallel increase 100 bp parallel decrease +50 bp parallel increase after 1 year 50 bp parallel decrease after 1 year as at 31 December (13,164) 13,625 (8,556) 8,815 Average for the period (14,808) 15,504 (8,830) 9,111 Maximum for the period (11,956) 18,239 (6,968) 10,413 Minimum for the period (17,349) 12,432 (10,074) 7, in BGN Thousand +100 bp parallel increase 100 bp parallel decrease +50 bp parallel increase after 1 year 50 bp parallel decrease after 1 year as at 31 December (9,975) 10,592 (5,607) 5,790 Average for the period (11,576) 12,081 (6,169) 6,394 Maximum for the period (9,971) 14,719 (5,607) 6,955 Minimum for the period (13,885) 10,589 (6,698) 5,790 The potential loss will not materialize with its whole amount, as stop loss limits are effectively in place. Early warning limits To support the operative steering of risk-based limits and structural limits, different boundary values for the limit utilization are defined. Such early warning limits serve as a warning signal when risk exposures approach the limit in certain business areas or risk types. A violation of these early warning limits leads to intensified monitoring and closer supervision of the respective exposure. Hence these limits are not considered as a separate and independent type of limit but rather serve the purpose of supporting operative limit management. Stop-loss limits All Risks (including interest rate risk) are limited effectively through stop loss processes which lead to an automatic reduction in exposure if the portfolio loss exceeds a predefined amount. Such a stop loss limit figuratively truncates the loss distribution at the stop loss level (plus a small loss amount for transaction costs for closing open positions). Stop loss limits typically are used in trading book operations but can be employed for banking book positions as well if a fairly liquid market for these assets exists or if hedging instruments are available. Currency risk The Group is exposed to currency risk through transactions in foreign currencies. The Group operates in the main currencies: US dollars, Euro, GB pounds, Swiss franks and others. 60 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

61 Notes to the Financial Statements As a result of the currency Board in place in Bulgaria, the Bulgarian currency is pegged to the Euro, therefore currency risk arises from changes in the exchange rate Euro/US dollar. The Group is not exposed to substantial currency risk due to the fact that it monitors and maintains the proportion between amounts and terms of its US dollar assets and liabilities. The Group s transactional exposures give rise to foreign currency gains and losses that are recognized in the statement of comprehensive income. These exposures comprise the monetary assets and monetary liabilities of the Group that are not denominated in the functional currency of the Group. Foreign currency position of the Group as of 31 December 2010: in BGN Thousand Assets In Bulgarian Levs EUR Other foreign currency Cash and balances with central banks 424,377 13,831 6, ,402 Trading assets 109,584 97,874 17, ,048 Derivatives Loans and advances to banks 85, ,673 50, ,331 Loans and advances to customers 1,077,041 3,179,743 25,068 4,281,852 Receivables under repurchase agreements 13,560 12,961 26,521 Investment securities 63, , , ,434 Investments in associates 6,868 6,868 Tangible and intangible fixed assets 77,603 77,603 Current tax assets Other assets 16,066 2, ,919 Total assets 1,874,370 4,461, ,392 6,569,794 Liabilities Derivatives Deposits from banks 53, ,146 6, ,144 Deposits from customers 1,951,326 1,948, ,868 4,120,952 Borrwings from banks 805, ,783 Subordinated liabilities Provisions Total 178, ,813 16, ,512 Deferred tax liabilities Other liabilities 7,495 24,836 5,549 37,880 Total liabilities 2,029,315 3,370, ,379 5,633,023 Net position (154,945) 1,090,703 1, ,771 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 61

62 Notes to the Financial Statements Foreign currency position of the Group as of 31 December 2009: in BGN Thousand Assets In Bulgarian Levs Cash and balances with central banks 140, ,123 6, ,368 Trading assets 73,282 43,571 25, ,131 Derivatives 3, ,794 Loans and advances to banks 109, ,427 31, ,730 Loans and advances to customers 1,099,864 3,310,656 28,722 4,439,242 Receivables under repurchase agreements Investment securities 83, , , ,860 Investments in associates 6,590 6,590 Tangible and intangible fixed assets 89,535 89,535 Current tax assets 1,979 1,979 Deferred tax assets Other assets 14,746 4, ,589 Total assets 1,623,173 4,785, ,952 6,650,773 Liabilities Derivatives 3, ,659 Deposits from banks 24,540 12,661 8,508 45,709 Deposits from customers 1,734,758 2,355, ,971 4,320,918 Borrwings from banks 1,148,237 1,148,237 Subordinated liabilities Provisions 178, ,701 19,310 19,310 Other liabilities 6,264 9, ,469 Total liabilities 1,788,032 3,704, ,410 5,733,003 Net position (164,859) 1,081,087 1, ,770 EUR Other foreign currency Total Management of Market risk Exposure to market risk is formally managed in accordance with risk limits set by senior management by buying or selling instruments. Overall authority for market risk is vested in ALCO. The Risk Management Division is responsible for the development of detailed risk management policies (subject to review and approval by ALCO) and for the day-to-day review of their implementation. D. Operational risk Operational risk is the risk of direct or indirect loss arising from inadequate or failed internal processes, personnel and systems or from external factors. Operational risk includes also those issues related to legal and regulatory requirements and generally accepted standards of corporate behavior. 62 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

63 Notes to the Financial Statements The Group s objective is to manage operational risk so as to balance the avoidance of financial losses and damage to its reputation with overall cost effectiveness and to avoid control procedures that restrict initiative and creativity. The Group operates a comprehensive internal operational risk control system with clearly defined objectives and responsibilities documented in the internal regulation framework of policies, principles and Group standards. The Senior management, supported by the Operational Risk Committee and the Audit Committee, are responsible for the oversight of operational risks. In 2010 continued the improvement and development of the overall operational risk management framework, emphasizing on the following: appropriate segregation of duties, including the independent authorization of transactions; observation of the requirements for the reconciliation and monitoring of transactions; compliance with regulatory, legal and internal requirements and standards; elaboration of operative controls mechanisms, process and procedure improvement; periodic assessment of operational risks faced, and the adequacy of controls and procedures; proposals on risk reduction mechanisms of all new projects, product and services; loss data collection and registration within common Group database, regular reporting and implementation of proper risk mitigation actions; early identification of potential risks and incidents by analyzing the trend of Key Risk Indicators (KRIs); assessment of operational risk exposure and determination of required economic capital; risk mitigation, including insurance where this is effective; improvement of corporate culture and training of the staff. Compliance with Group standards is verified by regular reviews undertaken by Internal Audit. The results of Internal Audit reviews are discussed with the business units to which they relate, with summaries submitted to the senior management. The Group is applying the Basic Indicator Approach for regulatory capital calculation, under the provisions of Ordinance No.8 of the Bulgarian Central Bank for capital adequacy of credit institutions. Capital adequacy management The Group s objective when managing capital, which is broader concept than the equity on the face of the statement of financial position are: To comply with the capital requirements set by the local banking regulator; To safeguard the Group s ability to continue as a going concern so that it can continue to provide returns for shareholders; To maintain a strong capital base to support the development of Group s business. Capital adequacy and the use of regulatory capital are monitored on a regular basis by the Group s management, employing techniques based on the requirements of European Directive for capital adequacy 2006/48/EC and implemented by the Bulgarian Central Bank (the Authority), for supervisory purposes. The required information is filed with the Authority on a quarterly basis. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 63

64 Notes to the Financial Statements The Authority requires each bank or banking group to (a) hold the minimum level of regulatory capital of BGN 10 Mio, and (b) maintain a ratio of total regulatory capital to the risk-weighted assets at or above 12%. The Group s regulatory capital is divided into two tiers: Tier 1 capital: share capital and profit reserves Tier 2 capital: qualifying subordinated loan capital The regulatory capital is deducted by the following items: Investments in associates Intangible assets Specific provisions for credit risk, which represent the excess of the exposure s carrying amount determined according to the applicable accounting standards over its risk as defined in the special Regulation of the Bulgarian Central Bank. As of December 31, 2010 the Capital base of the Group comprises as follows: in BGN Thousand 2010 Tier 1 capital Ordinary share capital 603,448 Retained earnings 287,864 Total 891,312 Tier 2 capital Qualifying subordinated liabilities 177,980 Total 177,980 Deductions Less intangible assets (17,769) Less investments in companies (6,073) Specific provisions (150,463) Total Capital base (Own funds) 894,987 The risk-weighted assets are measured by means of groups of risk weights classified according to the nature of and reflecting an estimate of credit, market and other risks associated with each asset and counterparty, taking into account any eligible collateral or guarantees. A similar treatment is adopted for off-balance sheet exposures, with some adjustments to reflect the more contingent nature of the potential losses. Capital requirements for credit risk cover credit risk and dilution risk in the banking book, counterparty risk in the overall business and settlement risk in the trading book. Capital requirements for market risk cover market risk in the trading book, foreign-exchange and commodity risks in the overall business. Operational risk is calculated on applying the Basic Indicator Approach and represents 15% of the Group s average annual gross income for the last three years (2009, 2008 and 2007). 64 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

65 Notes to the Financial Statements The additional capital requirements, presented in the table below, are subject to National Discretion of Bulgarian Central Bank. They are calculated as 50% of the total capital requirements for credit risk, market risk and operational risk. During the financial year the Group complied with all requirements of regulatory capital and maintained its adequacy ratios above the required regulatory minimum. As of December 31, 2010 the capital requirements for credit, market and operational risks are as follows: in BGN Thousand 2010 Capital requirements for credit risk Exposures to: Central Governments and Central Banks Regional Governments or local authorities 4,835 5,962 Institutions 18,615 Corporates 207,268 Retail 52,747 Exposures secured on real estate property 26,490 Mutual funds Other exposures Total capital requirements for credit risk Capital requirements for market risk Own funds ratio Core capital ratio (tier I ratio) , ,139 4,077 Capital requirements for operational risk 48,357 Total capital requirements for credit risk, market risk and operational risk 381,573 Additional capital requirements subject to National Discretions from the Regulator 190,786 Total regulatory capital requirements Own funds (Capital Base) there of Tier I Free equity (own funds) 572, , , , % 16.67% 4. Use of Estimates and Judgments Key sources of estimation uncertainty Financial assets accounted for at amortised cost are evaluated for impairment on a basis described in accounting policy. At each date of preparation of the statement of financial position financial assets are reviewed for the presence of indications of impairment. The specific counterparty component of the total allowances for impairment applies to financial assets evaluated individually for impairment and is based upon management s best estimate of the present value of the cash flows that are expected to be received. In estimating these cash flows, management makes judgements about the counterparty s financial situation and the net realisable value of any underlying collateral. Financial assets carried at amortized cost, are presented in the statement of financial position net of provisions for impairment losses. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 65

66 Notes to the Financial Statements Collectively assessed impairment allowances cover credit losses inherent in portfolios of loans and advances with similar credit risk characteristics when there is objective evidence to suggest that they contain impaired loans and advances, but the individual impaired items cannot yet be identified. The Group s policy for allocation of portfolio based allowances for impairment losses determines the principles for reducing the statement of financial position amount of a portfolio of loans with similar credit risk characteristics to their recoverable amount as at the date of preparation of the statement of financial position. In assessing the need for collective loss allowances, management considers factors such as credit quality, portfolio size, concentrations and economic factors. In order to estimate the required allowance, assumptions are made to define the way inherent losses are modeled and to determine the required input parameters, based on historical experience and current economic conditions. The accuracy of the allowances depends on the estimates of future cash flows for specific counterparty allowances and the model assumptions and parameters used in determining collective allowances. Determining fair values The determination of fair value for financial assets and liabilities for which there is no observable market price requires the use of valuation techniques as described in accounting policy, as for example determining the net present value, discounting of future cash flows or comparison with similar financial instruments, for which reliable market prices exist. For financial instruments that are traded infrequently and have little price transparency, fair value is less objective, and requires varying degrees of judgment depending on liquidity, concentration, uncertainty of market factors, pricing assumptions and other risks affecting the specific instrument. Valuation of financial instruments The Group s accounting policy on fair value measurements is discussed under note 2 (e). The Group measures fair values using the following fair value hierarchy that reflects the significance of the inputs used in making the measurements: Level 1: Quoted market price (unadjusted) in an active market for an identical instrument. Level 2: Valuation techniques based on observable inputs, either directly (i.e., as prices) or indirectly (i.e., derived from prices). This category includes instruments valued using: quoted market prices in active markets for similar instruments; quoted prices for identical or similar instruments in markets that are considered less than active; or other valuation techniques where all significant inputs are directly or indirectly observable from market data. Level 3: Valuation techniques using significant unobservable inputs. This category includes all instruments where the valuation technique includes inputs not based on observable data and the unobservable inputs have a significant effect on the instrument s valuation. This category includes instruments that are valued based on quoted prices for similar instruments where significant unobservable adjustments or assumptions are required to reflect differences between the instruments. Fair values of financial assets and financial liabilities that are traded in active markets are based on quoted market prices or dealer price quotations. For all other financial instruments the Group determines fair values using valuation techniques. Valuation techniques include net present value, discounted cash flow models and comparison to similar instruments for which market observable prices exist. The Group uses widely recognized valuation models for determining the fair value of common and more simple financial instruments, like interest rate and currency swaps that use only observable market data. For these financial instruments market conditions enable the use of valuation models. For more complex instruments, the Group uses proprietary valuation models, which usually are developed from recognized valuation models. Some or all of the significant inputs into these models may not be observable in the 66 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

67 Notes to the Financial Statements market, and are derived from market prices or rates or are estimated based on assumptions. When entering into a transaction, the financial instrument is recognized initially at the transaction price, which is the best indicator of fair value, although the value obtained from the valuation model may differ from the transaction price. This initial difference, usually an increase, in fair value indicated by valuation techniques is recognized in statement of comprehensive income depending upon the individual facts and circumstances of each transaction and not later than when the market data becomes observable. The value produced by a model or other valuation technique is adjusted to allow for a number of factors as appropriate, because valuation techniques cannot appropriately reflect all factors market participants take into account when entering into a transaction. Valuation adjustments are recorded to allow for model risks, bidask spreads, liquidity risks, as well as other factors. Management believes that these valuation adjustments are necessary and appropriate to fairly state financial instruments carried at fair value on the Group s statement of financial position, so that they are as close as possible to a market price, which would be determined on an arms length principle between not related parties. The determination of fair values is monitored by the Group s Treasury risk management department and is independent of trading and investment operations. Specific controls include: verification of observable pricing inputs and re-performance of model valuations; a review and approval process for new models and changes to models. The table below analyses financial instruments measured at fair value at the end of the reporting period, by the level in the fair value hierarchy into which the fair value measurement is categorised: in BGN Thousand Level 1 Level 2 Assets Trading assets 225,048 Derivatives 642 Investment securities 103,353 Liabilities Level 1 2,199 Derivatives 410 Total 225, , Segment Analysis The Group is divided into four main business segments: Retail customers incorporating private banking services, private customer current accounts, savings, deposits, credit and debit cards, consumer loans and mortgages; Large corporates incorporating current accounts, deposits, overdraft facilities, loan and other credit facilities, real estate financing, foreign currency and derivative products; SMEs - incorporating current accounts, deposits, overdraft facilities, loan and other credit facilities, micro lending, foreign currency and derivative products; Proprietary business incorporating business transactions conducted on own account and risk of the Group that are originated from managing market risk positions like FX-dealing, securities and derivatives trading, money market trading, liquidity management and funding, strategic positioning (investment portfolio), interest rate gapping (maturity transformation). The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 67

68 Notes to the Financial Statements As at 31 December 2010 In BGN Thousand Retail customers Làrge corporates and budgetary companies SMEs Proprietary business Other Total Segment operating income 54,292 89, ,175 54,539 8, ,279 Segment net assets 1,185,430 1,552,838 1,543,585 2,093, ,398 6,569,794 Segment liabilities 1,958,442 1,640, ,547 1,277, ,733 5,633,023 Impairment charge (43,066) (44,149) (66,393) (153,608) Operating expenses (86,338) (33,076) (59,267) (4,000) (2,600) (185,281) Profit before tax (75,113) 12,256 55,515 50,539 6,193 49,390 As at 31 December 2009 In BGN Thousand Retail customers Làrge corporates and budgetary companies SMEs Proprietary business Other Total Segment operating income 55,324 68, ,434 56,157 (13,392) 360,829 Segment net assets 1,177,228 1,522,367 1,739,647 1,994, ,615 6,650,773 Segment liabilities 1,959,137 1,818, ,332 1,195, ,227 5,733,003 Impairment charge ( 42,072) (23,042) (51,160) (116,274) Operating expenses ( 90,895) (32,785) (65,765) (5,003) (704) (195,152) Profit before tax (77,643) 12,479 77,509 51,154 (14,096) 49, Financial Assets and Liabilities Accounting Classifications and Fair Values The table below sets out the carrying amounts and fair values of the Group s financial assets and financial liabilities. The fair value of cash and cash equivalents, deposits and other current receivables and liabilities is approximately equal to the book value given, because of their short-term maturity. The Group changes interest rates applicable on customers deposits with floating interest rate in accordance with market conditions. Given the fact that the majority of the Group s financial assets and financial liabilities are contracted at floating rates, which reflect market fluctuations, their fair value should not significantly differ from the reported carrying amounts. 68 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

69 Notes to the Financial Statements As at 31 December 2010 In BGN Thousand Assets Fair value through profit or loss Held-tomaturity Loans and receivables Available for sale Other amortised cost Total carrying amount Fair value Cash and balances with central banks 444, , ,402 Trading assets 225, , ,048 Derivatives Loans and advances to banks Loans and advances to customers Receivables under repurchase agreements 966, , ,331 4,281,852 4,281,852 4,281,852 26,521 26,521 26,521 Investment securities 105, , , ,438 Investments in associates 6,868 6,868 6,868 Tangible and intangible fixed assets 77,603 77,603 77,603 Current tax assets Other assets 18,919 18,919 18,919 Total 331, ,882 5,719, ,564 6,569,794 6,576,798 Liabilities Derivatives Deposits from banks 471, , ,144 Deposits from customers 4,120,952 4,120,952 4,120,952 Borrowings from banks 805, , ,783 Subordinated liabilities 178, , ,813 Provisions 17,512 17,512 17,512 Deferred tax liabilities Other liabilities 37,880 37,880 37,880 Total 410 5,632,613 5,633,023 5,633,023 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses 69 Leasing Leasing Broker Broker Factoring Estate Glossary

70 Notes to the Financial Statements As at 31 December 2009 In BGN Thousand Assets Cash and balances with central banks Trading assets Derivatives Loans and advances to banks Loans and advances to customers Receivables under repurchase agreements Investment securities Investments in associates Tangible and intangible fixed assets Current tax assets Deferred tax assets Other assets Fair value through profit or loss Held-tomaturity Loans and receivables Available for sale Other amortised cost Total carrying amount Fair value 485, , , , , ,131 3,794 3,794 3, , , ,730 4,439,242 4,439,242 4,439, , , , ,218 6,590 6,590 6,590 89,535 89,535 89,535 1,979 1,979 1, ,589 19,589 19,589 Total 308, ,762 5,829, ,037 6,650,773 6,653,131 Liabilities Derivatives Deposits from banks Deposits from customers Borrowings from banks Subordinated liabilities Provisions 3,659 3,659 3,659 45,709 45,709 45,709 4,320,918 4,320,918 4,320,918 1,148,237 1,148,237 1,148, , , ,701 19,310 19,310 19,310 Other liabilities 16,469 16,469 16,469 Total 3,659 5,729,344 5,733,003 5,733, Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

71 Notes to the Financial Statements 7. Net Interest Income In BGN Thousand Interest income Loans and advances to banks 10,458 Loans and advances to customers 430,290 Investment securities 23,664 Total interest income 464,412 Interest expense Deposits from banks (347) Deposits from customers (145,972) Debt securities issued Long-term borrowings (18,792) Subordinated liabilities (4,292) Total interest expense (169,403) Net interest income 295,009 14, ,527 32, ,817 (10,123) (194,546) (4,223) (17,828) (5,760) (232,480) 258,337 Included within the net interest income for the year ended 31 December 2010 is a total of BGN 24,581 thousand accrued on impaired financial assets. 8. Net Fee and Commission Income In BGN Thousand Fee and commission income Payment transactions 20,609 Card transactions 18,255 Cash transactions 6,184 Opening and maintenance of accounts 10,956 Other loan fees 3,424 Documentary transactions 1,958 Securities business 2,325 Asset management 1,364 19,669 20,253 6,985 12,816 4,808 2,166 3,434 1,107 Other 1, Total fee and commission income 66,349 72,190 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 71

72 Notes to the Financial Statements In BGN Thousand Fee and commission expense Payment transactions (1,841) Card operations (domestic and foreign card operators) (6,937) Guarantees (1,019) Securities business (1,484) Other (4) Total fee and commission expense (11,285) Net fee and commission income 55,064 (1,505) (8,116) (1,053) (1,955) Included above is fee and commission income and fee and commission expense other than fees included in determining the effective interest income. (12,629) 59, Net Trading Income In BGN Thousand Debt securities 10,038 Equities 5 Foreign exchange 13,087 Net trading income 23,130 11, ,775 23,020 Fixed income trading comprises of realized and unrealized dealers margins from changing in market prices of Government treasury bills and corporate bonds, as well as interest rate futures. Trading result from foreign exchange represents the net result arising from purchases and sales of foreign currencies, as well as translation gains arising from the translation of assets and liabilities, denominated in foreign currencies into Bulgarian levs. 10. Net Result from Derivatives In BGN Thousand Foreign exchange instruments Interest rate instruments 3,659 Net result from derivatives 3, ,342 11,413 Foreign exchange instruments represent FX forwards and cross currency swaps. Interest rate instruments are basically interest rate swaps. 72 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

73 Notes to the Financial Statements 11. Net Result from Investment Securities Carried at Fair Value Through Profit or Loss In BGN Thousand Net valuation result (1,300) (693) Net proceeds from disposal 3,341 (63) Net result 2,041 (756) 12. General Administrative Expenses In BGN Thousand Personnel expenses (80,624) (88,298) Materials and services (65,252) (69,811) Depreciation and amortization charge (21,449) (19,344) Deposit insurance instalments (17,956) (17,699) Total general administrative expenses (185,281) (195,152) Personnel costs include salaries, social and health security contributions under the provisions of the local legislation. In 2010 the cost for audit, legal and advisory services amounts to BGN 250 thousand. 13. Allowances for Impairment In BGN Thousand Impairment Allowance Balance as àò January 1 172,505 80,486 Additional allowances for impairment losses 172, ,642 Reversals (16,169) (16,632) Written off receivables (32,581) (24,991) Balance as at December , ,505 In BGN Thousand Additional allowances for impairment (172,560) (133,642) Reversal of write downs 16,169 16,632 Recoveries from non performing loans previously written off 2, Impairment losses (153,608) (116,274) The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 73

74 Notes to the Financial Statements The following tables illustrate the breakdown of impairment losses into individual and collective allowances for impairment. In BGN Thousand Individual allowances for impairment Balance as àò January 1 107,303 Additional allowances for impairment losses 166,624 Reversals (10,054) Written off receivables (32,581) Balance as at December ,292 In BGN Thousand Collective allowances for impairment Balance as àò January 1 65,202 Additional allowances for impairment losses 5,936 Reversals (6,115) Balance as at December 31 65,023 Total 296,315 34, ,316 (12,146) (24,991) 107,303 46,362 23,327 (4,487) 65, , Income Tax Expense In BGN Thousand Current tax expense (4,090) Deferred tax (expense)/income related to origination and reversal of temporary differences (873) Total tax (expense)/income (4,963) (4,705) (269) (4,974) Current income tax expense represents the amount of due corporate tax to be paid under Bulgarian law. Deferred tax income or expense results from the change in the carrying amounts of deferred tax assets and deferred tax liabilities. The relationship between tax expense and accounting profit is as follows: In BGN Thousand Accounting profit 49,390 Tax at the applicable tax rate (10% for 2009, 10% for 2010) (4,939) Tax effect on permanent differences (24) Total tax expense (4,963) Effective tax rate 10.05% 49,402 (4,940) (34) (4,974) 10.07% 74 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

75 Notes to the Financial Statements ed deferred tax liabilities at December 31, 2010 and 2009 comprise the following: In BGN Thousand Assets Liabilities Net (Assets)/Liabilities Fixed assets 2,125 1,575 2,125 1,575 Unused leave of personnel (512) (525) (512) (525) Other provisions (1,239) (1,394) (1,239) (1,394) Investments Net (Assets)/Liabilities (1,751) (1,919) 2,280 1, (344) Deferred income taxes are calculated on all temporary differences under the liability method using a principal tax rate of 10%. Movements in temporary differences during the year are recognized in statement of comprehensive income on the following items: Movements during the year: Deferred taxes In BGN Thousand Fixed assets 2,125 Unused leave of personnel (512) Other provisions (1,239) 2010 Changes comprehensive income loss/(profit) Investments (155) ,575 (525) (1,394) (344) 15. Cash and Balances with the Central Bank In BGN Thousand Cash on hand 49,044 ATM cash 41,791 Balances with Central Banks 353,567 Total 444,402 56,123 39,845 65, ,368 Balances with Central Banks include the current account with the Bulgarian Central Bank, used for direct participation in the money and treasury bills markets and for settlement purposes, as well as the accounts for holding the obligatory minimum resereves. The current account balances also partially cover the required by the Central Bank minimum reserves. Since February 2010 the Bank is a direct participant in TARGET 2. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 75

76 Notes to the Financial Statements 16. Trading Assets In BGN Thousand Bulgarian government securities 153,650 59,947 hereof pledged securities 8,262 46,752 Bulgarian corporate bonds 32,172 38,164 hereof pledged securities Foreign government securities 6,709 hereof pledged securities Foreign corporate bonds 32,517 hereof pledged securities Equities Total trading assest 225,048 18,859 25,062 24, , Derivatives The Group uses the following derivative instruments for both hedging and non-hedging purposes. Currency forwards represent commitments to purchase foreign and domestic currency, including undelivered spot transactions. Currency and interest rate swaps are commitments to exchange one set of cash flows for another. Swaps result in an economic exchange of currencies or interest rates (for example fixed interest for floating rate) or a combination of all these (i.e. cross currency interest rate swaps). No exchange of principal takes place, except for certain currency swaps. The Group s credit risk represents the potential cost to replace the swap contracts if counterparties fail to fulfill their obligations. The risk is monitored on an ongoing basis with reference to the current fair value, a proportion of the notional amount of the contracts and the liquidity of the market. To control the level of credit risk taken, the Group assesses counterparties using the same techniques as for its lending activities. The following table indicates all derivative instruments held by the Group: In BGN Thousand Contract /notional amount Fair values As at 31 December 2010 Assets Liabilities Currency forwards 209, Forex swaps 187,503 Interest rate swaps 206, As at 31 December 2009 Currency forwards Forex swaps Interest rate swaps 603, , ,403 3,093 3, , ,060 3,794 3, Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

77 Notes to the Financial Statements 18. Loans and Advances to Banks (а) Analysis by currency In BGN Thousand Bulgarian levs 85,505 Foreign currency 880,826 Total 966, , , ,730 (b) Geographical analysis In BGN Thousand Domestic banks 115,092 Foreign banks 851,239 Total 966,331 95, , , Loans and Advances to Customers In BGN Thousand Individual (retail customers): Overdrafts 5,555 Credit cards 102,256 Consumer loans 454,986 Mortgages 704,903 Corporate entities: Large corporates 1,633,869 SMEs 1,676,598 Gross loans and advances 4,578,167 Less: allowance for impairment (296,315) Net 4,281,852 6, , , ,133 1,559,337 1,820,060 4,611,747 (172,505) 4,439,242 Interest sensitivity Interest rates on most loans are calculated at the cost of funds plus a set margin. Cost of funds depends on the interest-fixing period and of the respective currency of the loan. Loan margins vary and are based on the loan term and on the credit risk associated with the borrower. In case of overdue loan interest and principal penalty interest is applied. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 77

78 Notes to the Financial Statements 20. Receivables Under Repurchase Agreement Receivables under repurchase agreements represent securities purchased under agreements to sell them back to the counterparty on a future fixed date at a contracted fixed price. As of December 31, 2010 the receivables under repurchase agreements amount to BGN 26,521 thousand, whereby the fair value of received securities as pledge on such agreements amounts to BGN 29,177 thousand, (2009: BGN 611 thousand fair value of securities received as pledge for receivables under repurchase agreements in the amount of BGN 916 thousand). 21. Investment Securities А. Securities at fair value through profit and loss In BGN Thousand Bulgarian government securities 14,974 42,330 Bulgarian corporate bonds 32,031 65,794 Bulgarian corporate shares 2, Foreign corporate bonds 44,571 44,422 Foreign corporate shares 417 Other Total 11, ,552 8, ,098 B. Securities held to maturity In BGN Thousand Bulgarian government securities 340,125 Bulgarian corporate bonds 25,502 Bulgarian municipal bonds 50, ,882 Total Investment securities 521, ,501 61,011 50, , ,860 Long-term securities held to maturity represent debt investments that the Group has the intent and ability to hold to maturity. 78 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

79 Notes to the Financial Statements 22. Tangible and Intangible Assets In BGN Thousand Cost Total Premises Computer Office Equipment Furniture Motor Vehicles Software and licenses Office reconstruc. January 1, ,217 6,360 33,535 50,992 2,187 30,164 40,979 Additions/(disposals) 9, ,078 6, Write offs (2,671) (146) (181) (1,205) (754) (385) December 31, ,411 6,655 34,096 51,865 1,433 36,276 41,086 Accumulated Depreciation and amortization January 1, , ,663 26,063 1,889 13,803 14,526 Charge for the period 21, ,433 6, ,678 5,807 Depreciation of write offs (2,323) (1) (180) (1,198) (562) (382) December 31, , ,916 31,049 1,413 18,481 19,951 Net Book Value December 31, 2010 Net Book Value December 31, ,603 5,657 12,180 20, ,795 21,135 89,535 5,622 15,872 24, ,361 26, Other Assets In BGN Thousand Prepayments and other deferrals 9,578 10,054 Other 9,341 9,535 Total 18,919 19,589 The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 79

80 Notes to the Financial Statements 24. Deposits from Banks in BGN Thousand Money market deposits Domestic commercial banks 79,453 Foreign commercial banks 317, ,475 13,267 21,244 34,511 Current accounts Domestic commercial banks 41,808 Foreign commercial banks 32,861 74,669 Total 471,144 2,655 8,543 11,198 45, Deposits from Customers in BGN Thousand Large corporate customers and budget entities Current accounts 615,897 Term deposits 1,025, ,494 1,278,954 SMEs Current accounts 381,192 Term deposits 140, , ,158 Retail customers Current accounts 452,169 Term deposits 1,506,273 Total 4,120, ,355 1,564,783 4,320, Borrowings from Banks Borrowings from banks include long-term loans attracted from international financial institutions for financing small- and medium-sized companies in the field of environmental protection, energy savings, industry, services and tourism as well as municipalities and private individuals. To finance its credit activities, the Group also attracts syndicated and other loans from foreign credit institutions. 80 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

81 Notes to the Financial Statements In BGN Thousand Credit line from International financial institutions 232,420 Other borrowings from foreign banks 573,363 Total 805, , ,719 1,148, Subordinated Liabilities With the permission of the Bulgarian Central Bank, in March 2001, the Bank received a subordinated debt in the form of debt-capital hybrid instrument. These funds are a supplementary capital reserve and increase the capital base of the Group for regulatory purposes. As at December 31, 2008 the nominal value of the subordinated debt amounts to EUR 91 Mio. Considering accrued interest the carrying amount in the statement of financial position as at December 31, 2010 is BGN 178,813 thousand. The repayment of the debt is not bound by any maturity. Management believes that the use of this instrument will be for a term of over 5 years. The treatment of these liabilities for capital adequacy purposes is in accordance with the requirements of local legislation. Any prepayment of subordinated debt prior to its final maturity is subject to written approval from the Bulgarian Central Bank. 28. Provisions In BGN Thousand Provisions for bonus payments 11,514 13,388 Provisions for overdue vacations 4,854 4,995 Provisions for defined contributions to employees 529 Other provisions 615 Total 17, ,310 The Group recognizes a provision for unused holidays, which is the undiscounted amount of the expected short-term income of its employees for the work performed during the current period. Provision is recognized also for other liabilities to its employees, such as bonus payments for the current year. The Group has prepared actuarial calculations to determine the present value as at December 31, 2010 of the defined contributions to employees according to IAS 19. The long-term liability of the Group is assessed at BGN 529 thousand and represents its future retirement payments in line with the Bulgarian labour code. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 81

82 Notes to the Financial Statements 29. Other Liabilities in BGN Thousand Transfers in process 20,460 Other liabilities 17,420 Total 37,880 6,586 9,883 16,469 Transfers in process represent customers money transfer orders with value date after 31 December, Equity (a) Share capital As of December 31, 2010 the registered and fully paid-in capital of the Group comprised of 603,447,952 registered shares with a par value of BGN 1 each. (b) Statutory reserve Statutory reserves comprise amounts appropriated for purposes defined by the local legislation. Under the Bulgarian Commercial code, the Group is required to set aside one tenth of its profit in a statutory reserve until it reaches 10% of its equity. (c) Retained earnings The Group presents under retained earnings section all distributable reserves in excess of the statutory reserves under (b). 31. Commitments and Contingent Liabilities The Group provides financial guarantees and letters of credit to guarantee the performance of customers to third parties The contractual amounts of commitments and contingent liabilities are set out in the following table by category. The amounts reflected in the table for guarantees and letters of credit represent the maximum accounting loss that would be recognized at the date of preparation of the statement of financial position if counterparts failed completely to perform as contracted. in BGN Thousand Letters of guarantee and letters of credit issued 181,280 Unused credit lines 661,896 Total commitments and contingencies 843, , , , Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

83 Notes to the Financial Statements These commitments and contingent liabilities have off balance-sheet credit risk because only organization fees and accruals for probable losses are recognized in the statement of financial position until the commitments are fulfilled or expire. Many of the contingent liabilities and commitments will expire without being advanced in whole or in part and therefore do not represent expected future cash flows. 32. Cash and Cash Equivalents For the purposes of the cash flow statement, cash and cash equivalents comprise the following balances with less than 3 months original maturity: In BGN Thousand Cash on hand and nostro accounts 144,796 Current account with the Central Bank 353,567 Placements with banks with original maturity of less than 3 months 912,370 Total 1,410,733 99, , , , Group Members Subsidiaries Subsidiaries are these entities, which are controlled by the Group. Control is the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities. In preparing consolidated financial statements, an entity combines the financial statements of the parent and its subsidiaries line by line by adding together like items of assets, liabilities, equity, income and expenses. In order that the consolidated financial statements present financial information about the group as that of a single economic entity. Income and expenses of a subsidiary are included in the consolidated statements from the date of acquisition until the Group ceises to exercise control over the entity. Intragroup balances and transactions, including income, expenses and dividends, are eliminated in full. Profits and losses resulting from intragroup transactions that are recognised in assets, such as inventory and fixed assets, are eliminated in full. The subsidiaries controlled by the Bank as at December 31, 2010 and included in the consolidated financial statements are: Services EAD 100% ownership Services EAD was established in 2001 as Services EOOD with a paid in capital of BGN 5 thousand, increased in 2003 to BGN 50 thousand. Through a contribution in kind in 2005 the entity s capital was increased to BGN 3,000 thousand. With court decision from November 23, 2005 Services EOOD was discontinued without liquidation due to transfer of its assets and liabilities to the sole owned joint-stock company registered under Services EAD. The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 83

84 Notes to the Financial Statements The company s scope of activity are financial, accounting and legal advisory services, accounting services, appraisal of property, equipment, financial assets and enterprises, electronic data processing and analysis, information services, cash collection, factoring, leasing and any other activity permitted by law. Asset Management (Bulgaria) EAD 100% ownership Raifeisen Asset Management (Bulgaria) EAD was entered in the company s register of Sofia City Court in The paid in share capital amounts to BGN 250 thousand, comprised of 2,500 registered shares with a par value of BGN 100 each. The entity is controlled by Supervisory and Management board, each of them with a mandate of three years. The scope of activity of asset management companies in Bulgaria is regulated by the Financial Supervision Commission. Raifeisen Asset Management (Bulgaria) EAD has been granted a permission for its activities by the Financial Supervision Commission in The entity is licensed to exercise the activities per art. 202, (1), pp. 1, 2, 3 of the Law on public offering of securities and treasury bonds, namely managing of mutual funds and investment companies, management of individual portfolios in its own name, advisory services on investments in securities. Insurance Broker EOOD 100% ownership Insurance Broker EOOD was established in 2006 with 100% ownership of bank (Bulgaria) EAD. The company has been entered in the register of the insurance brokers on 30, March 2006 with decision 250-ЗБ of the Financial Supervision Commission. The company s activity is related to intermediation between its customers and the insurance companies. Insurance Broker EOOD analyses and researches the insurance market, offers insurance products, which meet the individual requirements of its customers, administers the insurance contracts and lends support in case of insurance events. Customers of Insurance Broker EOOD are the borrowers of bank (Bulgaria) EAD, the lessees of е на Leasing Bulgaria OOD and Auto Leasing Bulgaria OOD, Real Estate EOOD, as well as customers outside the Group. Real Estate EOOD 100% ownership Real Estate EOOD was registered in 2007 as a real estate intermediary fully owned by bank (Bulgaria) EAD. Real Estate EOOD offers intermediary and consulting services to private individuals and companies for home, as well as business property office and commercial building plots, land and terrains. Besides its intermediary in sales, purchase and rent of property, the company also offers investment consultations, market researches and analyses, as well as marketing services for its strategic partners. Factoring EOOD 100% ownership Factoring EOOD was registered in 2007 with a paid in capital of BGN 1,000 thousand and scope of activity local and international factoring services with and without recourse. The company s activities include transfers of commercial receipts, arising from the delivery of goods or rendering of services, settling of invoices with payment deferrals, managing and collection of commercial receipts, credit risk coverage, financial and business consulting. 84 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

85 Notes to the Financial Statements Associates An associate is an entity, including an unincorporated entity such as a partnership, over which the investor has significant influence, but not the control, and that is neither a subsidiary nor an interest in a joint venture. The investments in associates are consolidated in the Group s financial statements by using the equity method. Under the equity method, the investment in an associate is initially recognised at cost and the carrying amount is increased or decreased to recognise the investor s share of the profit or loss of the investee after the date of acquisition. The investor s share of the profit or loss of the investee is recognised in the investor s profit or loss. Distributions received from an investee reduce the carrying amount of the investment. Adjustments to the carrying amount may also be necessary for changes in the investor s proportionate interest in the investee arising from changes in the investee s equity that have not been recognised in the investee s profit or loss. Such changes include those arising from the revaluation of property, plant and equipment and from foreign exchange translation differences. The investor s share of those changes is recognised directly in equity of the investor. Leasing Bulgaria OOD Leasing Bulgaria OOD was entered in the companies register of Sofia City Court in The entity s scope of activity is finance and operational lease, services and trade activity connected with acquisition, management and lease of property and equipment, construction, consultancy services. Leasing Bulgaria OOD is the sole owner of its subsidiary Auto Leasing Bulgaria EOOD. With regards to these consolidated financial statements, Auto Leasing Bulgaria EOOD is fully consolidated in the financial statements of Leasing Bulgaria OOD. The Group s participation in the capital of Leasing Bulgaria OOD is 24.5% and it is consolidated by using the equity method Leasing Bulgaria OOD actively participates in the Bulgarian leasing business since five years and the main products offered to its customers are: leasing of new and used motor vehicles, building and agricultural machines, light and heavy-freight trucks, trailers and motor trucks, leasing of machines and equipment, property and yachts. Cash collection company In 2009 the Bank became shareholder in the Cash collection company, with 20% participation. The table below illustrates the consolidation methods by entities: Participation as at December 31, 2010 Participation as at December 31, 2009 Services EAD 100% 100% Raifeisen Asset Management (Bulgaria) EAD 100% 100% Insurance broker EOOD 100% 100% Real Estate EOOD 100% 100% Factoring EOOD 100% 100% Leasing Bulgaria OOD 24.5% 24.5% Consolidation method 2010 Full consolidation Full consolidation Full consolidation Full consolidation Full consolidation Equity method Consolidation method 2009 Full consolidation Full consolidation Full consolidation Full consolidation Full consolidation Equity method Cash collection company 20% 20% Equity method Equity method The Bank's Insurance Insurance Asset Asset Real Real RZB RBI Group Addresses Leasing Leasing Broker Broker Factoring Estate Glossary 85

86 Notes to the Financial Statements 34. Related Party Transactions Parties are considered to be related if one party has the ability to control or exercise significant influence over the other party on making financial or operational decisions, or the parties are under common control with the Group. A number of banking transactions are entered into with related parties in the normal course of business. These include loans, deposits and other transactions. Related party Type of transaction Balance as of 31.Dec.2010 In BGN Thousand Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Companies within the Group Associated companies Associated companies Associated companies Associated companies Associated companies Associated companies Associated companies Associated companies Loans and advances to banks Loans and advances to customers Positive fair value of derivatives Tangible and intangible assets Other assets Deposits from banks Borrowings from banks Deposits from customers Provisions Negative fair value of derivatives Other liabilities Subordinated liabilities Interest income Interest expense Fee and commission income Fee and commission expense Net result from derivatives Administrative expenses Positive fair value of derivatives Deposits from customers Interest expense Fee and commission income Net result from derivatives Administrative expenses Other operating income Dividend income 280, , , ,643 77, , ,813 6,338 19, ,917 1,569 7, , Subsequent Events There are no events after the statement of financial position that would require either adjustments or additional disclosures in these consolidated financial statements. 86 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility

87 Corporate Social Responsibility Corporate Social Responsibility In 2010 bank (Bulgaria) expanded the scope of its corporate responsibility policy by supporting a wide range of projects of governmental and nongovernmental organisations following s mutual help principle and the support for practices, which are important for the development of society. Choose to Help the initiative spreads The second campaign of the Choose to Help initiative spread out involving more donors and media partners and raising more funds that a year earlier. It backed 20 healthcare, social, environmental and educational projects, to which the employees added 10 more as their personal choice. The initiative includes the Group employees who make personal donations for significant projects and the bank adds BGN 100 to each donation. A total of 2945 employees took part in the campaign and the funds donated by them and by the bank reached BGN 372,623. With the external donations, the funds raised stood at BGN 391,540. The possibility of donating by sending SMS messages was introduced for facilitating the donors. The web portal Dir.bg was again bank s main partner in the Choose to Help campaign and its employees also made donations for projects of their choice. The media and the agencies that partnered the initiative were the Bulgarian National Radio, the Bulgarian National Television, Standart daily, Nova Televisia TV station, Treta Vazrast weekly, Trud daily, 24 Chasa daily, Darik Radio, Blitz.bg web news agency, IDEA Comm outdoor agency, Chuchkov brothers production studio and Ogilvy ad agency. The campaign was also joined by some celebrities the TV hosts Gala, Nikki Kanchev and Deo, and the actor Deyan Donkov. They participated in the TV spot for the initiative for free and promoted the projects, each one of them supporting one of the spheres social, healthcare, environment protection and culture and education, during their TV shows and the events organised by the bank. In 2010 bank (Bulgaria) received several awards for its initiative Choose to Help. At its Annual Awards ceremony the Bulgarian Business Leaders Forum decorated the bank with the Investor in Community prize. At the same ceremony bank also took the ENGAGE award from the International Business Leaders Forum for engaging its employees in the realisation of its active social policy. Choose to Help was announced The Most Transparent Donation Programme by the Bulgarian Donors Forum at the Forum s Largest Corporate Donor 2010 awards. For successfully engaging its employees its active social policy bank (Bulgaria) also received the award for Donation Encouragement of the Human Resources in Bulgaria and the Eurointegration Foundation at the Manager Social Services 2010 awards. The Bank's RBI Leasing Insurance Broker Asset Factoring Real Estate Glossary Addresses 87

88 Corporate Social Responsibility Bulgarian-Austrian Projects in 2010 bank s sponsorship policy was again focused on Bulgarian-Austrian projects. For the third year in a row the Bank supported the Austrian Music Weeks in Bulgaria, organized by the Austrian Embassy in Sofia. Within a month the event presented 28 concerts in 6 towns. Apart from classical music, the programme for the first time included other jenres folklore, jazz and rock. In 2010 the Austrian Music Weeks in Bulgaria also celebrated the 150th anniversary of Gustav Mahler s birth. In 2010 bank sponsored the Austria Showcase Tourism infrastructure, organized by the Austrian Embassy in Sofia. At the forum Austrian companies presented their products with application in trourism and tourist infrastructure. Chernorizets Hrabar 2010 The Annual Awards for Journalism Chernorizets Hrabar, which are granted by the Union of Publishers in Bulgaria, were sponsored by bank for the second time. For the seventh year in a row the Union awarded the press journalists with contribution to the country s social life. Man of the Year In 2010 bank supported the Man of the Year 2010 competition organised by the national Darik Radio. After the traditional nominations from journalists and the vote on the Internet that followed them, the 20th edition of the awards distinguished the Man of the Year, who according to society contributed the most to the socio-political life of the country. 88 Chairman of the MB Vision and Mission Chairman of the SB Management Segment s Auditors' Corporate Social Responsibility