ATLAS BANKA AD, PODGORICA. Separate financial statements 31 December 2014 and Independent Auditor s report

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1 ATLAS BANKA AD, PODGORICA Separate financial statements 31 December 2014 and Independent Auditor s report

2 ABCD KPMG d.o.o. Podgorica Svetlane Kane Radević Podgorica Montenegro Tel./Fax: Internet: info@kpmg.me TRANSLATION TO THE SHAREHOLDERS ATLAS BANKA AD, PODGORICA Independent Auditor s Report We have audited the accompanying separate financial statements of Atlas banka AD, Podgorica ( the Bank ), which comprise the separate balance sheet as at 31 December 2014, separate statement of profit and loss, separate statement of changes in equity and separate cash flow statement for the year then ended, and notes, comprising a summary of significant accounting policies and other explanatory information. Management s Responsibility for the Separate Financial Statements Management is responsible for the preparation and objective presentation of these separate financial statements in accordance with Law on Accounting and Audit applicable in Montenegro and regulations of the Central Bank of Montenegro that regulate financial reporting of banks, and for such internal control as management determines is necessary to enable the preparation of separate financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these separate financial statements based on our audit. We have conducted our audit in accordance with Law on Accounting and Audit applicable in Montenegro and International Standards on Auditing. Those standards require that we comply with relevant ethical requirements and plan and perform the audit to obtain reasonable assurance whether the separate financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the separate financial statements. The procedures selected depend on our judgment, including the assessment of the risks of material misstatement of the separate financial statements, whether due to fraud or error. In making those risk assessments, we consider internal controls relevant to the entity s preparation and objective presentation of the separate financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting principles used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the separate financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our qualified opinion KPMG d.o.o. Podgorica, a Montenegrin limited liability company and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ( KPMG International ), a Swiss entity. All rights reserved. Hipotekarna banka a.d. Podgorica, račun Erste Bank a.d. Podgorica, račun PIB PDV 30/

3 ABCD TRANSLATION Basis for qualified opinion According to our estimate, the calculated allowances for impairment of financial assets of the Bank as at 31 December 2014 are understated at least in the amount of EUR 5,164 thousand, in accordance with regulation of Montenegro that regulates financial reporting of banks (EUR 2,881 thousand, as at 31 December 2013), and the net result of the period and the Bank s capital are overstated in the same amount. The estimated difference could also affect regulatory requirements relating to the Bank s own funds and exposure limits defined by the Law on banks and other relevant regulations of the Central bank of Montenegro, which are disclosed by the Bank in Note Our opinion on the financial statements of the Bank for the previous year was also modified on the same basis. As disclosed by the Bank in Note 2.3, the Bank reported equity investments in the amount of EUR 5,277 thousand and deposits held in the amount of 10,400 in its subsidiary Atlas bank Ltd, Moscow, Russia, as at 31 December 2014, whose license for banking operations was revoked and temporary administration appointed by the Central bank of Russian Federation on 5 May The legal proceeding in which Atlas bank Ltd, Moscow has been trying to reclaim the license for banking operations and continue its business is ongoing. As a result of the lack of relevant information,at the date of this report it is not possible to estimate the outcome of this process, neither real nor potential losses that the Bank could face on this basis and consequentlythe effect that this issue could have on the result of the period, capital of the Bank, the Bank's own funds and exposure limits defined by the Law on banks and other relevant regulations of Central bank of Montenegro. Our audit opinion for the previous year contained emphasis of matter paragraph in respect of this issue. As disclosed by the Bank in Note 2.3, the Bank reported deposits held with Bobar banka a.d. Bijeljina in the amount of EUR 3,351 thousand, as at 31 December 2014, against whom the liquidation process have been initiated on 23 December The Bank has not calculated and recorded allowances for impairment with respect to these deposits, even though according to our estimation there is a significant uncertainty regarding the collection of these deposits. In accordance with our estimate, the amount of deposits held with Bobar banka a.d. Bijeljina in liquidation is overstated at least in the amount of EUR 2,346 thousand as at 31 December 2014, and the result of the period and capital of the Bank are overstated in the same amount. The difference could also affect regulatory requirements relating to the Bank's own funds and other relevant regulations of Central bank of Montenegro, which are disclosed by the Bank in Note Qualified opinion In our opinion, except for the effects and potential effects of the matters described in the Basis for Qualified Opinion paragraph, separate financial statements present truly and objectively unconsolidated financial position of the Bank as at 31 December 2014, unconsolidated financial performance and unconsolidated cash flows for the year then ended in accordance with the Law on Accounting and Audit applicable in Montenegro and the regulations of the Central Bank of Montenegro that regulate financial reporting of banks. Emphasis of matter Without further qualifying our opinion, we draw attention to following: 2

4 ABCD TRANSLATION - Note 2.3. to the financial statements, which explains material uncertainties faced by the Bank in its business activities, as well as the measures undertaken on this basis, by the Management of the Bank; - Note to the financial statements, in which it is disclosed that Bank has deviated from the prescribed limit of total exposure towards its shareholders that have qualified participation in the Bank, including the exposure to legal entities that are under control of those shareholders, as well as the prescribed limit of total exposure to legal entities controlled by the same person who is also in charge to control the Bank, as at 31 December Besides, the amount of the investments in properties made by the Bank, exceeds the prescribed maximum of the 40 % of the Bank's own funds, and such excess amount is treated as a deductible item when calculating the amount of the Bank s own funds. Podgorica, 16 June 2015 KPMG d.o.o. Podgorica (L.S.) Branko Vojnović Certified Auditor This is a translation of the original Independent Auditors Report issued in the Montenegrin language. All due care has been taken to produce a translation that is as faithful as possible to the original. However, if any questions arise related to interpretation of the information contained in the translation, the Montenegrin version of the document shall prevail. We assume no responsibility for the correctness of the English translation of the Company s financial statements. Podgorica, 16 June 2015 KPMG d.o.o. Podgorica (L.S.) Branko Vojnović Certified Auditor 3

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7 Separate financial statements STATEMENT OF CHANGES IN EQUITY FOR THE YEAR ENDED 31 DECEMBER 2014 In thousands of EUR Share capital Other reserves Retained earnings Total Balance as at 1 January , ,555 25,839 Adjustment of opening balance Provision for estimated losses under regulatory requirements recorded as at 1 January Adjusted balance as at 1 January , ,555 26,545 Share issue 2, ,400 Dividend payment to preference shareholders - - (270) (270) Current year profit Other Balance as at 31 December , ,457 28,848 Balance as at 1 January , ,457 28,848 Fair value adjustment of securities available for sale Dividend payment to preference shareholders - (80) (80) Current year profit Transfer of retained earnings on 1,705 other reserves - (1,705) - Balance as at 31 December ,659 2, ,292 6

8 Separate financial statements STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2014 In thousands of EUR Cash flows from operating activities Inflows from interest and similar income 10,280 10,238 Outflows based on interest and similar expenses (5,536) (5,549) Inflows from fees and commissions 6,791 4,986 Outflows from fees and commissions (2,796) (1,850) Outflows based on employee benefits and supplier costs (8,290) (8,494) (Increase) / decrease of loans and other assets (24,968) (13,683) Inflows / outflows based on deposits and other liabilities (1,577) 28,346 Taxes paid (28) (41) Other inflows (857) (665) Net cash inflows/(outflows) from operating activities (26,981) 13,288 Cash flow from investing activities Property and equipment purchase (576) (1,507) Intangible assets purchase (85) (119) T-Bills and other securities (385) 878 Net cash inflows/(outflows) from investing activities (1,046) (748) Cash flow from financing activities Increase / (decrease) in borrowings 3,070 5,468 Outflows based on dividends (80) (270) Net cash inflows/(outflows) from financing activities 2,990 5,198 FX translation effects on cash and cash equivalents 245 (77) Net increase / (decrease) in cash and cash equivalents (24,792) 17,661 Cash and cash equivalents at the beginning of period 75,229 57,568 Cash and cash equivalents at end of period 50,437 75,229 7

9 1. Bank s establishment and operating policy Atlasmont banka a.d. Podgorica was established in 2002 and entered into the Registry maintained by the Commercial Court in Podgorica. As at July 1, 2002, Atlasmont banka a.d., Podgorica took over Beranska banka a.d. Berane. Since the aforesaid date, Beranska banka a.d. Berane has operated as a branch office of Atlasmont banka a.d. Podgorica. The merger of Beranska banka a.d., Berane was ratified through the Decision enacted by the Central Bank of Montenegro no / dated December 17, The Central Bank of Montenegro issued an operating license to the Bank under Decision no. 64 dated April 2, Pursuant to the Enterprise Law, as at April 2, 2002 the Bank was entered into the Central Registry maintained by the Commercial Court in Podgorica based on Decision no. Fi- 812/02. At the session held as at January 18, 2010, the Board of Directors of Atlasmont banka enacted a Decision on the shutdown of Atlasmont banka representative office in Bahrain until January 31, Atlasmont banka a.d., Podgorica changed its name into Atlas banka a.d., Podgorica (hereinafter the Bank ). The change of business name was duly registered under Decision issued by the Central Registry of the Commercial Court in Podgorica as at November 9, The Bank is registered to perform the following activities: credit, deposit and guarantee operations, payment transactions and operations with retail customers. Other registered activities include guarantee issuance, opening letters of credit and performance of other banking operations. The Bank is domiciled in Podgorica at the street address of: Vaka Đurovića, no number. As at December 31, 2014, the Bank was comprised of Head Office in Podgorica, eleven affiliates (Podgorica two affiliates, Bar, Nikšić, Herceg Novi, Budva, Kotor, Tivat, Berane, Bijelo Polje, and Pljevlja), five branch offices (Podgorica, Mojkovac, Andrijevica, Plav and Ulcinj) and eight sub-branches (Podgorica three sub-branches, Žabljak, Kolašin, Topla, Rožaje and Petnjica). As at December 31, 2014, the Bank had 229 employees (31 December 2013: 218 employees). The Bank is a member of Atlas Group, which operates in Montenegro, Serbia, Cyprus and Russia. The following companies based in Montenegro are also members of this Group: Atlas Centar d.o.o., Podgorica, Atlas life a.d., Podgorica, Atlas banka a.d., Podgorica, Atlas penzija a.d., Podgorica, Aqua Monte d.o.o., Podgorica, CG Broker-diler a.d., Podgorica, Atlas Invest d.o.o., Podgorica, HTP Atlas Hotel Group a.d., Bar, Invest Banka Montenegro a.d., Podgorica, Jadranski sajam a.d., Budva, Montenegro express a.d., Budva, RTV Atlas d.o.o., Podgorica and Mediteran University. As at December 31, 2014, the Bank had control and significant influence over the following legal entities, which were not consolidated in the presented stand-alone financial statements: Entity % Equity interest Atlas bank Ltd., Moskva - Russian Federation 100% Atlas Life a.d., Podgorica 30.92% 8

10 Board of Directors members as at 31 December 2014: Name Manolina Bašović Đorđe Đurđić Hasan Hanić Pero Vujović Dragoljub Janković Function Chairman Deputy Member Member Member Audit Committee members as at 31 December 2014: Name Ratimir Jovićević Dragica Đekić Predrag Vujović Function Chairman Member Member Executive directors as at 31 December 2014: Name Đorđe Đurđić Dijana Zečević Branislav Todorović Ljiljana Dragičević Duško Đukanović Function Chief Executive Officer Deputy Chief Executive Officer, Executive Director for Assets Management and payment transaction Executive Director for Support Executive Director for International affairs Executive Director of Commercial Services As at 31 December 2014 Director of Compliance Department is Veselin Koprivica. As at 31 December 2014 Internal Auditor is Mladen Dašić. 2. Basis of preparation and presentation of financial statements 2.1. Basis of preparation and presentation of the financial statements The Bank is obliged to record transactions and to prepare the financial statements in accordance with Law on Accounting and Auditing (Official Gazette of Montenegro 69/05, 80/08 and 32/11), Law on Banks (Official Gazette of Montenegro No. 17/08, 44/10 and 40/11 and other relevant bylaws. These financial statements include only receivables, payables, operating results, changes in equity and cash flows of the Bank, excluding its subsidiaries. Pursuant to the regulations of Montenegro, the Bank shall prepare consolidated financial statements and submit them to the Central bank of Montenegro and Securities Commission. In the preparation of the accompanying financial statements, the Bank has adhered to the accounting policies described in Note 3, which are in conformity with the accounting, banking and tax regulations prevailing in Montenegro. The official currency in Montenegro and the Bank s functional currency is Euro (EUR). 9

11 During 2012 Council of the Central Bank of Montenegro adopted several bylaws that entered into force on 1 January The main changes of the banking legislation relate to: new form of financial statements, changes in chart of accounts, valuation of assets and off-balance sheet items in accordance with International Financial Reporting Standards, introduction of the concept of potential reserves for loan losses, definition of adequate collateral, connections between two or more clients, introduction of internal records, defining the difference between potential reserves and allowance for impairment as a deduction from equity in the calculation of own funds Use of estimates The presentation of financial statements requires from the Bank s management to make best estimates and reasonable assumptions that affect the assets and liabilities amounts, as well as the disclosure of contingent liabilities and receivables as of the date of the preparation of the financial statements, and the income and expenses arising during the accounting period. These estimations and assumptions are based on information available as of the financial statements preparation date, and mostly relate to: assessments of provisions against loans and interest, provisions against deposits placed with other banks, provisions against permanent investments and off-balance sheet items Going concern concept The financial statements for 2014 have been prepared on the going concern basis, which assumes that the Bank will continue to operate for an indefinite period in the foreseeable future. The Bank in its operations faces several material uncertainties, based on which the Bank's management undertakes certain measures, as disclosed below: As at 31 December 2014, the Bank reported equity investments in the amount of EUR 5,277 thousand and deposit in the amount of EUR 10,400 in its subsidiary Atlas Bank Ltd. Moscow, Russia. As at 5 May 2014, the Central Bank of the Russian Federation has suspended the banking license and appointed a temporary administration of Atlas Bank Ltd. Moscow. Management of Atlas Bank has hired lawyers and has started legal proceedings to restore the license in Russia since the management believes that the license is suspended without any legal basis. At this moment, it is not possible to estimate the final outcome of the ongoing legal process, neither actual nor potential losses of the Bank. Based on the current facts and circumstances, the Bank s Management believes in the positive outcome of the legal process. As at 31 December 2014, the Bank reported deposits in the amount of EUR 3,351 thousand in Bobar Banka ad Bijeljina over which is initiated liquidation proceedings on 23 December As a result of the fact that there is not enough information available, at this moment, it is not possible to estimate the outcome of the liquidation process, and neither actual nor potential losses that the Bank may have until completion of the liquidation process. Management of Atlas Bank has started negotiations with representatives i.e. family Bobar, majority owner of Bobar Bank in liquidation, in order to collect deposits outside the normal liquidation procedure. Unfavorable macroeconomic environment which is created as a result of the global economic crisis and its effects on the economy of Montenegro, has caused problems in terms of loan collection by the Bank, growth in non-performing loans, and consequently, the growth in impairment of loans and receivables from customers, which have an effect on the solvency ratio of the Bank. The solvency ratio disclosed by the Bank as at 31 December 2014 is 10.13%, which is slightly above the prescribed minimum of 10%. The management has plan to increase 10

12 the solvency ratio by issuing new shares to existing shareholders. As at 29 April 2015, the Board of Directors has adopted a decision on capital increase through the issuance of ordinary shares in the amount of EUR 10 million. Shares will be offered to existing shareholders, deadline for completion of this process is 3 months from date of issue and the emission will be considered successful if it is registered and paid at least 50% of issued shares. The process is ongoing. Nevertheless, the Management actively trying to improve the collection of nonperforming loans by undertaking a number of activities including taking collateral and loan restructuring The Bank has been subject of regular comprehensive control of the Central Bank of Montenegro in the period that included the 4th quarter 2014 and first quarter of 2015, for the period ended 30 September 2014, which also identified above mentioned problems and issues and defined the solvency ratio of 10.00% as at 30 September The Bank regularly, each month, reports to the Central Bank of Montenegro on its financial position and the measures taken in order to resolve the above issues. Considering above mentioned activities and measures implemented by the Bank, the Bank s management believes that requirements are fulfilled in order to enable Bank to operate in the foreseeable future and prepare financial statements in accordance with going concern. 3. Summary of significant accounting policies 3.1. Consolidation These financial statements are Bank s separate financial statements in which are not consolidated financial statements of related and associated legal entities: Equity Interest % 31 December 31 December Subsidiary/Associate Domicile Core Activity Atlas bank Ltd., Moscow - Russian Federation Moscow 100% 100% Banking operations Atlas Life a.d., Podgorica Podgorica 30.92% 30.92% Life insurance Atlascapital Financial Investment services Services Limited, Nicosia Nicosia % and operations Bank did not consolidate financial statements of related parties because, in accordance with legislation, Bank is obliged to prepare both separate and consolidated financial statements. Bank prepares consolidated financial statements. The Bank has sold the equity investment in Atlascapital Financial Services Limited, Nicosia headquartered in Cyprus in the amount of EUR 1,078 thousand on the basis of the Preliminary Contract on transfer of shares concluded in Podgorica on 15 October The sale is conducted on 30 December

13 3.2. Interest, fee and commission income and expense recognition Interest income and interest expense, including penalty interest and other operating income and expenses related to interest bearing assets and liabilities, are accounted for on an accrual basis. Fee and commission income and expenses from banking services are recognized and recorded within statement of comprehensive income when realized, i.e. when due. Loan origination fees are considered to be an integral part of an ongoing involvement with the resultant financial instrument; accordingly, they are deferred and recognized as an adjustment to the yield by applying the pro rata method Foreign exchange translation (a) Foreign currency transactions Transactions denominated in foreign currencies (currencies other than the functional currency) are translated into the functional currency by applying the official middle exchange rates, as determined at the interbank foreign exchange market and effective at the transaction date. Net foreign exchange gains or losses arising upon the translation of transactions denominated in foreign currencies are credited or charged to the statement of comprehensive income. (b) Functional and presentation currency Items included in Bank s financial statements are measured using currency of Bank s primary environment (functional currency) These financial statements are presented in Euro ( EUR ) which represents functional and presentation currency of Bank s financial statements (reporting currency) 3.4. Provisions and allowance for impairment In accordance with the Decision of the Central bank of Montenegro on Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro No. 22/12, 55/12, 57/13) as of 01 January 2013, the Bank applies its own methodology for assessment of balance sheet allowance for impairment and off-balance sheet probable loss. According to this Decision, the Bank recorded allowance for impairment of assets and provision for losses of off-balance sheet items against expenses in the Income statement Leases The Bank's lease operations are classified as operating leases. Lease payments based on the operating lease contracts are recognized on a straight-line basis as expenses over the lease terms Taxes and contributions Taxation is conducted in accordance with the laws of Montenegro. Bank pays income tax, property tax, taxes and contributions on salaries and other taxes. Tax base is taxable profit of the taxpayer. Taxable profit is determined by adjusting profit in the income statement. Income tax rate is proportional at 9% of the tax base. Montenegrin tax regulations do not envisage that any tax losses of the current period be used to recover taxes paid within a specific carryback period. However, any current year losses reported in the annual corporate income tax returns may be carried forward and used to reduce or eliminate 12

14 taxes to be paid in future accounting periods, but only for a period of a maximum of five ensuing years. Deferred income tax is determined using the balance sheet liability method, for the temporary differences arising between the tax bases of assets and liabilities and their carrying values in the financial statements. The currently-enacted tax rates at the balance sheet date are used to determine the deferred income tax amount. Deferred tax liabilities are recognized for all taxable temporary differences. Deferred tax assets are recognized for the deductible temporary differences, and the tax effects of income tax losses and credits available for carry forward, to the extent that it is probable that future taxable profit will be available against which deferred tax assets may be utilized Cash and cash equivalents For the purposes of the cash flow statement, cash and cash equivalents include cash on hand and balances on the current accounts held with the Central Bank of Montenegro, including obligatory reserves and funds held with other domestic and foreign banks Loans Loans originated by the Bank are stated in the statement of financial position at amounts approved net of principal repaid and allowance for impairment, which is based on an evaluation of the specifically-identified exposures in accordance with Methodology for calculation of allowance for impairment and provision for losses on off-balance sheet items. For the purpose of determining the amortized value, contractual interest rate is used, which discounts future value of cash flows to nominal value of loans approved reduced for repayments of principal. Decisions on loans are based on information about debtor, his creditworthiness, with consideration of its total exposure. Receivables collateral are determined by specific article of contract between Bank and customer. As receivables collateral Bank accepts bills of exchange, guarantees, pledges, mortgages and movables. Potential losses Bank assesses, creates and reviews provisions on the basis of risks to which it is exposed in business, particularly provisions relating to losses that may arise on the basis of credit risk. In accordance with the Decision of the Central bank of Montenegro on Minimum Standards for Credit Risk Management in Banks (Official Gazette of Montenegro No. 22/12, 55/12, 57/13) as of 01 January 2013, the Bank applies its own methodology for assessment of balance sheet allowance for impairment and off-balance sheet probable loss. Bank loans are presented in the amount reduced for potential losses which are estimated by Bank own methodology on calculation of allowance for impairment for balance sheet items. Assessment is performed on individual and group basis. These impairment on balance sheet items and provision of off-balance sheet items are recorded against expenses in income statement. Loans and group of loans are considered partly or fully uncollectable if there is objective evidence of default which is result one or multiple incidents, in which these events have a measurable impact on the estimated future cash flows generated by the collection of these receivables. 13

15 In order to provide reasonable, prudent and timely determination of losses, Bank identifies receivables and off-balance sheet items for which calculation of allowance for impairment for balance sheet items and provision for off-balance sheet items will be performed on single basis (individual assessment) and on collective basis (note 4.1.1). According to Decision on Minimum Standards for Credit Risk Management in Banks, when the conditions have been met for excluding a receivable from the bank s balance sheet, the bank shall write off such receivable and show it in interim records up to the level of indebted amount until the finalization of collection process. Conditions for exclusion of a receivable from the bank s balance sheet shall be deemed to be met if the bank estimates in the collection process that the value of receivable measured at amortized cost shall not be compensated and that all conditions under IAS/IFRS have been met for terminating the recognition of the financial asset, including the following cases: for unsecured receivable when bankruptcy proceedings has been initiated against the debtor which shall last more than one year, or for secured receivable, when the debtor defaults more than four years or if the bank has not received any of payments from collateral foreclosure during such period Provision for potential losses In addition to the valuation of assets and off-balance sheet based on its own methodology, the Bank is obliged (depending on probability of achieving loss) to classify assets in one of the following categories: 1. Group A - "quality assets" comprises the assets which are expected to be fully collected; 2. Group B - "assets with special note" - with subgroups B1 and B2, comprises the assets for which it is unlikely that the loss would incur, and those assets require special attention due to the fact that potential risk, unless adequately monitored, could lower the probability of collection 3. Group C "substandard assets" - with subgroups C1, C2, comprises items for which there is a high probability of incurring loss, due to clearly identified weaknesses, jeopardizing collection of those assets; 4. Group D - "doubtful assets" comprises assets for which the collection, taking into consideration the debtor s creditworthiness, value and marketability of collaterals, is highly unlikely 5. Group E - "loss" comprises the assets which will not be collected at all or will be collected in the insignificant amount. Estimated amount of provision for potential losses is calculated using 0% for asset classified in group A, 2% and 7% for asset classified in group B, from 20% to 40% for asset classified in group C, 70% for asset classified in group D and 100% for asset classified in group E. According to the Decision on Minimum Standards for Credit Risk Management, Bank shall determine the difference between the amount of loan loss provisions calculated in accordance with Decision and the sum of the amount of allowances for impairment and provisioning for offbalance sheet items calculated in accordance with the provisions of this decision regulating the manner of valuation of asset items by applying International Accounting Standards. The positive difference between the amount of calculated loan loss provisions and the sum of the amount of allowances for impairment and provisioning for off-balance sheet items shall be deductible item from the bank s own funds. 14

16 3.10. Securities held to maturity Held-to-maturity securities are non-derivative financial instruments with fixed or determinable payments and maturities, for which the Bank has the positive intention and ability to hold to maturity. These securities are initially carried at amortized cost net of estimated impairment losses. In case the Bank sells more than an insignificant amount of securities held to maturity, the entire category of securities is selected and reclassified into securities available for sale Trading securities Trading securities comprise securities which are held for the purpose of earning profit through sales in the near term. Trading securities are comprised of closed investment fund shares and investment units of the open investment fund held for trading, which are initially recognized at cost. As of the statement of financial position date, these securities are recorded at market (fair) value. All realized and unrealized gains and losses arising on sale, and any changes in their fair values are included in the statement of comprehensive income Equity investments in subsidiaries and related parties and securities available for sale Investments in equity instruments without quoted prices in an active market whose fair value cannot be reliably measured are recognized at cost of investment less impairment, if any, which impairment reflects decrease in value due to losses incurred in the third party's operations. Securities available-for-sale represent securities which cannot be classified as trading securities or securities held-to-maturity and comprise equity investments in third parties. Following the initial recognition, securities available for sale are stated at fair value. The fair value of securities quoted on the market is based on the current bid prices. Unrealized gains and losses on securities available-for-sale are recorded within revaluation reserves, until such security is sold, collected or otherwise realized or until it is permanently impaired. When securities available for sale are disposed of or their value is impaired, the accumulated adjustments of fair value are recognized within equity on the face of the statement of comprehensive income. Securities available for sale for unlisted companies are measured at fair value unless circumstances are such that the fair value cannot be reliably determined in which case they are measured at cost net of allowance for impairment Property, plant and equipment and intangible assets Property, plant and equipment as at December 31, 2014 were stated at cost less accumulated depreciation/amortization. Cost represents the prices billed by suppliers together with all costs incurred in bringing the respective asset to the location and condition necessary for its intended use. 15

17 Depreciation of property and other fixed assets, i.e. amortization of intangible assets are provided for on a straight-line basis to the cost of such assets in order to write them off over their expected useful lives by applying the following depreciation/amortization rates: Buildings 2% Computers 30% Furniture and equipment 7% - 20% Intangible assets 20% - 33% The calculation of depreciation and amortization commences when an asset is placed into use. There were no changes in depreciation/amortization rates as compared to the previous (comparative) reporting period Impairment of tangible and intangible assets If there is any indication that such assets have been impaired, the recoverable amount of the asset is estimated in order to determine the extent of the impairment loss. If the recoverable amount of an asset is estimated to be less than its carrying value, the carrying amount of the asset is reduced to its recoverable amount. An impairment loss is recognized as an expense of the current period and is recorded under other operating expenses. Where an impairment loss subsequently reverses, the carrying amount of the asset is increased to the revised estimate of its recoverable value. However, this is performed so that the increased carrying amount does not exceed the carrying value that would have been determined had no impairment loss been recognized for the asset in prior years. The Bank s management assesses that the total value of tangible and intangible assets as at December 31, 2014 was not overestimated Acquired assets Land, buildings and equipment which became a property of the Bank on basis of collection of loan receivables (that does not meet the requirements of recognition within the position assets intended for sale in accordance with IFRS 5) secured by afore mentioned assets are presented within Acquired assets. Bank records Acquired assets by the value of outstanding principal and related interest and other charges at the time of the acquisition of rights. In accordance with Decision on the Minimum Standards for Banks' Investments in Property and Fixed Assets (Official Gazette of Montenegro, no. 24/2009, 66/2010, 58/2011, 61/2012, 13/2013 and 51/2013), total Bank investments in immovable property and fixed assets shall not exceed 40% of bank s own funds. Exceptionally, Bank investments in immovable property and fixed assets may exceed 40% of own funds provided that the following requirements have been met: - Bank treats the investment exceeding 40% of own funds as a deductible item in the calculation of bank's own funds; - After the deduction from Bank's own funds in line with point 1 above, the level of own funds and the solvency ratio shall be higher than the prescribed minimum. 16

18 3.16. Provisions Provisions are recognized when: - Bank has a present legal or constructive obligation as a result of past events; - When it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; - Reliable estimate of the amount of the obligation can be made. Provisions are measured at the present value of expected outflows of resources necessary to settle the obligation. Provisions are considered at each financial position statement date, and they are adjusted to reflect the best estimate possible at the given moment. If it is unlikely that an outflow of economic benefits will be required to settle the obligation, and provision should be reversed through the statement of comprehensive income. Bank does not recognize provision on the basis of potential losses while there is confirmation it has a present obligation that could lead to outflow of resources which represent economic benefits or if a reliable estimate cannot be made, and in this case it is disclosed Employee benefits Employee taxes and contributions for social security Pursuant to the regulations effective in Montenegro, the Bank has an obligation to pay contributions to various state social security funds. These obligations involve the payment of contributions on behalf of an employee, by the employer in the amounts calculated by applying the specific, legally prescribed rates. The Bank is also legally obligated to withhold contributions from gross salaries to employees, and on their behalf to transfer the withheld portions directly to the appropriate government funds. These contributions payable on behalf of the employee and employer are charged to expenses in the period to which they relate. Retirement benefits Pursuant to the Labor Law, the Bank is bound to pay employee retirement benefits. Long-term liabilities related to provisions for retirement benefits payable once the legally prescribed conditions for retirement have been met represent the present value of expected future payments to employees as determined pursuant to the actuarial valuation, which is based on the following assumptions:: the discount rate of 10 expected salary growth rate of 3%, employee turnover rate of 5% (2013: discount rate of 10%, expected salary growth rate of 3%, employee turnover rate of 5%) Financial liabilities - borrowings Liabilities arising from borrowings are recognized at fair value less transaction costs. Borrowings are subsequently measured at amortized cost; all the differences between the realized inflow (net of transaction costs) and the value of repayment installments are recognized within the statement of comprehensive income over the borrowing usage period using the effective interest method Fair value In accordance with IAS 13, Financial Instruments: Disclosures and Presentation, the fair value of financial assets and liabilities is to be disclosed in Notes to the financial statements. For these purposes, the fair value is defined as an amount at which an asset can be exchanged, or a liability 17

19 settled, between knowledgeable willing parties in an arm s length transaction. The Bank should disclose the fair value information of those components of assets, receivables and liabilities for which published market information is readily available, and for which their fair value is materially different from their recorded amounts. In Montenegro, sufficient market experience, stability and liquidity do not exist for the purchase and sale of receivables, investments and other financial assets or liabilities, for which published market information is presently not readily available. Fair value cannot readily be determined in the absence of active capital and financial markets, as generally required under the provisions of IFRS/IAS. In the opinion of the management, the reported carrying amounts are the most valid and useful reporting values under the present market conditions. In the amount of the identified estimated risk that the carrying value will not be realized, a provision is recognized based on a relevant decision of the Bank s management Related party transactions According to IAS 24 related parties are parties comprising: - the parties which directly, or indirectly through one or more intermediaries, control, or are controlled by reporting entity, or the entity is under common control of those parties; - parties in which the Bank has significant influence that are neither related parties nor joint venture; - private individuals who directly or indirectly have voting power in the Bank that gives them significant influence over the Bank, or any other subject which is expected to influence or be influenced by a related party of the Bank; - members of the key management personnel i.e. individuals with authorizations and responsibilities for planning, managing and controlling the Bank s operations, including directors and key management When considering each possible transaction with a related party, attention is focused on substance of relationship not just legal form. In accordance with the Law on Banks (Official Gazette of Montenegro no. 17/08, 44/10 and 40/11) bank s related parties are as follow: - members of the bank governing bodies, shareholders, bank employees, as well as their immediate family members (spouse and children), - legal entity with which entity that holds qualified interest in a Bank, also has a qualified interest, - legal entity in which one of the entities from paragraphs 1 and 2, of this section holds a significant influence or entity from paragraph 1 of this section is a director or member of the board of director or another body of that legal entity, - an entity holding at least 50% of shares or voting rights of legal entity that has a qualified interest in the bank. 18

20 4. Financial instruments (risk and capital management) 4.1. Risk management A bank shall continuously manage all risks it has been exposed to in its operations. The basis of risk management is defined in Bank s strategies, policies, procedures and methodologies. By these acts, Bank establishes system of identification, measurement, monitoring and reporting of inherent risks in business, and define appropriate limits and controls to manage them. Risk management internal acts are subject of regular inspections and updates in order to adequately respond to changes within the Bank's operations, and the competitive market of banking products and terms. Risk Management Department is responsible for monitoring the Bank s exposure to individual risks and compliance with the risk management internal methodology, and reports on a monthly basis Board of Directors. In addition, Audit Committee and ALCO (Assets and Liabilities Management Committee) are also responsible for monitoring individual risk management system, as well as executive directors in their field. The Bank recognizes the following categories of risk: Credit risk Credit risk Market risk Interest rate risk Liquidity risk Operational risk Country risk Concentration risk Other risks Credit risk is defined as a probability of complete or partial loss arising from the debtors inability to fulfill contractual obligations. This definition includes counterparty risk, risk of issuer and placement risk. By its credit policy, Bank establishes criteria under conducts its business, as well as key parameters regulating the manner in which credit services and products are structured, granted, collateralized and recorded, ensuring adequately monitoring, maintenance and management of the Bank s loan portfolio. Bank grants loans to legal entities, individuals, public sector, Government, state institutions, funds, judicial and administrative authorities, and to other organizations and communities which meet the legal requirements and the conditions stipulated by the credit policy and other acts of the Bank. In operations with legal entities, the Bank is focused on large and significant economic and noncommercial entities, as well as small and medium enterprises (SMEs). In business with private individuals Bank grants loans to individuals who meet the requirements related to individual products. 19

21 The Bank approves loans to residents and non-residents. Based on decision on minimum standards for credit risk management in banks, The Bank is obligated to, for items of balance sheet assets on the basis of which is exposed to credit risk, perform estimation of impairment as well as to classify those items in the appropriate classification group in the gross amount. Also, The Bank has an obligation to perform classification of off-balance sheet items (guarantees, given credit obligations, sureties, other guarantees, letters of credit and other off-balance sheet liabilities) by separate classification categories and in total amount. Overview of balance sheet items and off-balance sheet items for 2014 is presented in following table: 20

22 Balance sheet items Cash collateral Other collateral Classification A B C D E (000 EUR) Total loans and receivables 4, , ,831 35,552 7,892 2,244 1, ,202 Loans from banks and clients 4, ,236 94,669 33,909 7,255 1,591 1, ,856 Assets and deposits in banks 44, ,249 Interest 7 1,196 1, ,335 Factoring I forfeiting Receivables due to outstanding acceptances, guarantees and bills of exchange Accruals 1 (410) 0 (5) 0 0 (415) Investment securities 7,416 7,416 Investments in associates and joint ventures under equity method and into subsidiaries Total 7,820 7,820 Other asset items in assets on witch provisions are allocated Assets on which provisions are allocated for potential loss 4, , ,218 35,572 7,895 2,245 1, ,614 Total regulatory provisions calculated for losses on loans and other items in assets ,052 1,920 1,572 1,684 6,228 Total impairment for loans and other assets items , ,755 Total required regulatory reserves from profit for estimated losses on loans and in assets 0 0 (826) ,188 2,473 Specific regulatory reserves from profit for estimated losses in assets (account 3025) ,161 3,380 The amount of the missing reserves ** ,330 Balance sheet assets on witch reserves for potential losses are not allocated 43,838 43,838 Total assets : 4, , ,056 35,572 7,895 2,245 1, ,452 TOTAL ASSETS TOTAL IMPAIRMENT 4, , ,230 34,944 6,807 1,528 1, ,697 Collateral by categories A B C D E TOTAL Loans or part of the loan secured with cash deposit 4,472 4,472 Loans or part of the loan secured with other collateral with code 164,699 59,935 14,331 1,713 3, ,236 21

23 (000 EUR) Classification Off-balance sheet items Cash collateral Other collateral Total A B C D E Guarantees ,546 11,208 1, ,104 Given credit obligations (approved undisbursed loans) 760 7, ,037 Sureties and acceptances of bills of exchange 0 Other guarantees 0 Uncovered letters of credit 0 Other balance items on witch provisions are allocated 0 Off-balance on witch provisions for potential losses are allocated 1,435 20,546 19,117 1, ,141 Calculated regulatory reserves on off-balance items Provisions for losses on off-balance items Required regulatory reserves for losses on off-balance items (219) (129) Specific regulatory reserves for losses on off-balance items (account 3025) The amount of the missing reserves by off-balance** Other balance items on witch provisions for potential losses are not allocated 276, ,773 Total off-balance 1,435 20, ,890 1, ,914 Collateral by categories A B C D E TOTAL Off-balance items secured with cash deposit 1,435 1,435 Off-balance items secured with other collateral (code) 19,149 1, ,546 22

24 Overview of exposures by loan categories for 2014 and 2013 is presented in following table: Provision for Net loans Net loans Provision for Gross potential loan (gross loansprovisionimpairment) exposure losses Impairment (gross loans- Gross potential loan exposure losses Impairment E 1,683 1, ,187 1,155 1, (1) 1,027 D 2,244 1, ,527 2,428 1, ,685 C 7,892 1,919 1,087 5,973 6,805 8,295 1,890 1,036 6,405 7,259 B 35,552 1, ,500 34,924 25, ,523 24,561 A 139, , , , , , ,202 6,225 3, , , ,067 5,399 3, , ,823 Risk category In thousands EUR 31 December December 2013 Net loans Net loans (gross (gross loansprovisions) loansimpairment) Overview of loans and guarantees issues coverage with related collaterals (mortgages, pledges and securities): 31 December December 2013 Exposure Gross exposure Estimated collateral Coverage Gross exposure Estimated value collateral value Coverage ACTIVE LOANS Corporate 144, , % 152, , % Retail 37,565 24, % 33,951 23, % Overdraft 1, , Credit cards 4, % 4, % 187, , % 192, , % GARANTEES 13,104 16, % 14,824 23, % TOTAL: 200, , , ,429 23