AS PAREX BANKA ANNUAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2005 TOGETHER WITH INDEPENDENT AUDITORS REPORT

Transcription

1 AS PAREX BANKA ANNUAL REPORT FOR THE YEAR ENDED 31 DECEMBER 2005 TOGETHER WITH INDEPENDENT AUDITORS REPORT

2 Table of Contents Management Report 3 Economic and Banking Environment in Latvia 6 Management of the Bank 8 Statement of Responsibility of the Management 10 Financial Statements: Statements of Income 11 Balance Sheets and Memorandum Items 12 Statements of Changes in Shareholders Equity 13 Statements of Cash Flows 15 Notes 16 Auditors Report 57 AS Parex banka Smilšu 3, Riga, LV-1522, Latvia Phone: (371) Facsimile: (371) Registration number:

3 Management Report The year 2005 was another year of success and significant developments for Parex banka. Facing a demanding market, we managed to steadily improve our position. The net profit for the Bank has reached another record level amounting to LVL 30.2 million demonstrating almost double growth from year Parex banka s assets have increased by 29%, total shareholders equity have grown by 23.1% and the volume of attracted deposits has increased by 18.3%, including an increase in local retail deposits by 41.5%. The loan portfolio has demonstrated strong growth, increasing by 24.9%, including growth in mortgage lending by 47%. As at 31 December 2005, Parex banka has the largest market share in terms of deposits comprising 19.8%. In terms of assets and capital and reserves Parex banka remains among the leading credit institutions in Latvia with a respective market share of 16.3% and 18.1%. Parex banka maintains leading positions in the banking sector in the Baltics and continues strong and stable growth. The Bank s developments are largely affected by the trends in the national economy. The stability of performance of Parex banka is rooted in deep understanding of the Bank s customers in the Baltic region, based on more than 13 years experience servicing them, as well as on the Bank s Management s ability to seize the opportunities on the market while effectively managing risks. Lending is one of the key growth areas for Parex banka. The Bank continues to strengthen its positions in mortgage lending in the Baltic States and is planning to increase its market share in this segment by launching new services on the market. In 2005, Parex banka has introduced a unique product Mini-payment giving an opportunity to acquire larger, better and more expensive real estate in a combination with comparatively low monthly payments on credit. Individual service, competitive product offers, attractive interest rates and fees for services, broad network of representative offices, branches and subsidiaries all these factors will strengthen the position of Parex banka in the retail banking sector in the Baltics. Payment cards are still another high-growth area for Parex banka, which is active in issuing payment cards in all three Baltic countries. At the end of the reporting period there were more than 242 thousand active cards and, during 2005 alone, more than 68 thousand active cards have been added. In 2005, Parex banka has become the first and only issuer of American Express credit cards in Latvia by launching American Express Platinum and Gold cards. In October, Parex banka introduced a new credit card, Blue from American Express, thus meeting the customers growing needs. During the reporting period, Parex banka continued to diversify its funding base: the total share of syndicated loans in Bank s liabilities increased from 6.7% to 11.3%. In July 2005, Parex banka successfully closed the largest syndicated loan with one of the lowest margin ever taken by a Latvian private institution. The amount of the syndicated facility reached EUR million at a margin of 0.6% over EURIBOR has been also the debut year for Parex banka in issuing local public notes and Eurobonds. The debut Eurobond transaction was joint-led by JP Morgan and Credit Suisse First Boston, raising EUR 100 million with a three-year maturity and was significantly oversubscribed. The Eurobond was listed on the London Stock Exchange and received great interest from European investors as well as secondary market support. In March 2005, Parex banka successfully completed its public offering of LVL notes. The total volume of the issue was fixed at the level of LVL 5 million. The securities were listed on Riga Stock Exchange. Parex banka is well on track to become the leading provider of investment banking services in the Baltics, which is evidenced by the volume and scope of its services. During 2005, the total amount of Parex banka s participation in syndicated lending deals reached USD 41 mln, and the number of transactions constituted 21. Parex banka acted as Co-Manager in the issue of loan-participation notes by the City of Kiev, raising USD 250 mln with a ten-year maturity for financing of different municipal projects, including the construction of a new bridge over the Dnieper. The Bank has a dedicated securities brokerage desk offering its customers a broad range of services, constantly bringing new products and opening new markets for clients, as well as providing 24 hr service and pan-baltic and CIS/CEE equity and credit research. With its new OTC platform for energy-related derivatives, Parex banka continues to be a knowledge base in the Baltics offering global commodity derivatives for local investors, particularly for energy-related derivatives. 3

4 Management Report Parex banka continues to be internationally acknowledged, and various awards document the competitiveness of our product range. This year Parex banka has been named the Best Bank in Latvia in 2005 by Global Finance Magazine, the Best Bank in the Baltic Region by the Caspian Integration Business Club, the Best Bank in Corporate Lending by business newspaper Business & Baltia and the Best Bank in Latvia in 2005 by Euromoney Magazine. Parex banka is one of the leading banks in the area of AML/KYC international standard and best practice implementation. It can be demonstrated by the fact, that in June 2005, the Bank has commissioned the international auditing company Deloitte to perform an independent review of the Anti-Money Laundering and Combating Terrorist Financing (AML/CFT) Program existing at Parex banka. The review has confirmed that the Bank s AML/CFT program is in a compliance with the legal and regulatory requirements. Parex banka continued the international expansion by opening a branch in Berlin (Germany) and becoming the first financial institution of the new EU member countries to start operating in Western Europe. The main services provided by Parex banka s Berlin branch include: servicing customer accounts, offering deposits with competitive rates, emission of payment cards, providing internet banking and asset management advisory. Parex banka is also planning to start operations in Stockholm (Sweden) through its branch in spring of The subsidiaries of the Bank have demonstrated outstanding results during 2005, and their achievements are reflected in their key financial indicators further. During 2005, Parex Bankas, the Lithuanian subsidiary of Parex Group, has shown net profit of LTL 7.2 million, which is by 31% more than a year ago. Furthermore, the volume of deposits rose by 42% in 2005, rising to LTL 311 million as at 31 December At the end of the reporting period, the volume of loans issued was LTL million, an increase of 16% as to the corresponding figure from Total assets grew by 9% reaching LTL 483 million at the end of the period. During 2005, Parex Bankas has completed visual changes in its distribution network in order to comply with the Group s identity guidelines. Significant improvements have been made to the e-banking platform by enhancing the web site and Internet banking portal. Parex Internet bank is one of the best services in this segment in Lithuania. A new mortgage product Flexible loan, new design of VISA Classic credit card and several new types of deposits are only few of the changes in the Bank s services delivered to the increasingly demanding customers. The total volume of assets of the Estonian branch together with the Estonian subsidiary Parex Leasing and Factoring comprised EUR 79 million and have grown by 86% during the year, thus surpassing the volume of assets in the two smallest Estonian banks. In 2005, Parex lending portfolio in Estonia reached EUR 50 million and was driven by 37% increase for private individuals and 42% for legal entities. Many customers have shifted their deposits from other banks to the Parex banka Estonian branch. The total volume of deposits at the end of the year 2005 reached EUR 30 million, which is 11 times more than by the end of the previous year. Parex Estonian subsidiary Parex Leasing and Factoring achieved 15% market share in the segment of railway rolling stock leasing by the end of Parex Express Kredīts (previously, Parex līzings) is a subsidiary of Parex bank operating in high-margin sector mostly in consumer lending. During 2005, the total loan portfolio of the subsidiary increased by 44%, reaching LVL 8.7 million. Parex Express Kredīts has significantly strengthened its positions in this segment accelerating client identification procedure, improving administration of non-payers and collection of debts. The subsidiary has a broad distribution network in all regions of Latvia 239 association agreements with business partners, including Internet shops, have been signed. Services of Parex Express Kredīts are also available in six branches of Parex banka in the largest Latvia s cities. The Group s subsidiary Parex Asset Management (PAM) has been growing remarkably strong in size, scope and performance. In 2005, subsidiaries of PAM in Russia, Ukraine and Lithuania obtained licences, which expanded a distribution platform for PAM products in these countries. In December 2005, Parex Asset Management founded a subsidiary Parex Dzīvība, which is planning to start offering a wide range of life insurance services in the second quarter of With over USD 1 bln of assets under management, from which 71% are assets owned within Parex Group, PAM remains the largest asset management company in the Baltic States and the second largest in Eastern Europe with a global outreach from 16 countries, including Japan, Switzerland, Germany and Sweden. After merger between PAM and Parex Investment Company at the end of 2005, the total number of Parex funds reached 8 with returns ranging from 2.9% for Parex Conservative Fund to 65.4% for Parex Russian Equity Fund. Total volume of funds more than doubled and the market share reached 48% 4

5 Management Report (excluding money market funds market share reached 89%). During 2005, Parex Open Pension Fund has shown a dynamic growth. Total assets of pension plans grew by 52.4% reaching LVL 6.8 million. At the end of the reporting period, the number of participants exceeded 19.5 thousand, and the market share of Parex Open Pension Fund in terms of participants comprised 37%. Pension system funds are managed and advised by Parex Asset Management. During the first half of 2005, Parex banka established and acquired several leasing companies in CIS countries and currently operates Parex Leasing, Moscow ("Парекс Лизинг"); Extroleasing, Moscow ("Экстролизинг"), Ekspress leasing, St. Petersburg ("Экспресс лизинг"), Lasca Leasing, Kiev ("Ласка Лізинг") and Parex Leasing, Minsk ("Парекс Лизинг"). A new leasing company named Parex Leasing and Factoring ("Парекс Лизинг энд Факторинг") was founded in Baku, Azerbaijan. Parex banka selectively operates on CIS markets through its new subsidiaries and adheres to a very cautious policy by concentrating on leasing of transport vehicles as a safe form of credit exposure. We were able to fulfil our performance aspirations with respect to institutional and private investors and clients. We are building on our proven strengths and our reputation as a leading financial institution in the Baltics. The performance and service quality, and thus our esteemed clientele, always remain at the centre of our attention. Valery Kargin President/ Chairman of the Board Riga, 3 March 2006 Viktor Krasovitsky Chairman of the Council of Directors Guntars Grīnbergs Chairman of the Council 5

6 Economic and Banking Environment in Latvia The well-considered and balanced monetary and fiscal policies have facilitated improvements in the Latvian economy. Thus Latvia has become one of the most successfully developing countries in Central and Eastern Europe. Lat (LVL), the only legal tender of the Republic of Latvia, is fully convertible against hard currencies without exchange controls. As of 1994, the Bank of Latvia has pegged Lat to the International Monetary Fund Special Drawing Right (SDR), thereby implementing the policy of a fixed national currency exchange rate. Following Latvia s accession to the European Union in 2004, Lat has been pegged to Euro at the rate of 1 EUR = LVL effective from 1 January Since 2 May 2005, Latvia has joined European currency exchange mechanism II. Latvia will have to participate in this mechanism for at least two years, while proving its compliance with the Maastricht criteria. As soon as the Council of the European Union allows Latvia to join the Economic and Monetary Community, Euro will replace the national currency of Latvia for everyday transactions, and the Bank of Latvia will discontinue its independent monetary policy. According to the schedule approved by the Cabinet, Latvia is to be admitted to the Economic and Monetary Community at the beginning of 2008, until then Lat will be the only legal tender of the Republic of Latvia. The current peg mechanism allows for relative stability and predictability of the national currency, mitigates the foreign currency risks and creates a stable basis for corporate planning and pricing. Official exchange rates of the Bank of Latvia are as follows: As at 31 December 2005 As at 31 December 2004 LVL 1.00= LVL 1.00= USD EUR GBP RUB At the end of October 2005, the cash base (cash in circulation and deposits with the Bank of Latvia) coverage of net foreign assets constituted 114.5%, and net foreign reserves were equivalent to 3-4 months volume of state commodity and non-factored service imports. In 2005, the economy of Latvia continued to exhibit upward development in almost all the significant economic sectors. During the first three quarters of 2005, the GDP of Latvia has grown by 10.1% compared to the respective period in It is projected that the total GDP growth in 2005 will be close to or even exceed the 10% level. More than 4/5 of the growth was generated by the development of five industries: trade, manufacturing, transport and communications, commercial services, and construction. The rapid economic growth and integration into the European Union resulted in an increase in the inflation pressure. During 2005, the consumer price index grew by 7.0%; however the average inflation rate for the year constituted mere 6.7%. The registered unemployment level reduced from 8.5% of the economically active population at the beginning of the year to 7.5% in the end of November. Starting from 1996, and the only exception being the year 1999, the budget deficit has been lower than 3.0% of the GDP. According to provisional data in 2005, the fiscal deficit has reached the lowest level over the last seven years, with 1% of the GDP. One of the few weaknesses of Latvian economy is still the current account deficit, which in 2005 most probably will amount near to or even exceed 13% of the GDP. Along with the development of the Latvian economy, the foreign trade volume has also grown significantly. Thus, in 2005, the export volume has increased by 33.6% with the import volume also growing by 27.1%. The current account deficit for the time being is covered by foreign direct investments. During the first nine months of 2005, accumulated foreign direct investments increased by 11.8%. The success of economic reforms in Latvia is reflected in the credit ratings assigned by leading foreign rating agencies. The ratings assigned by international credit ratings agencies Standard & Poor s, Moody s and Fitch Ratings are A-, A2 and A- respectively for Latvia s long-term liabilities in foreign currency, and A-, A2 and A respectively in Lats. The international finance community already for a while has been assessing Latvia as a safe and prospective place for investment. The growing trust of investors in Latvia is proved by the falling risk premium difference of return on government bonds of Latvia and return on the highest quality debt securities of European governments. 6

7 Economic and Banking Environment in Latvia Banking sector in 2005 As at 31 December 2005, in Latvia there were 22 banks, 1 branch of a foreign bank - the Latvian branch of Nordea Bank Finland Plc (Finland). The Latvian banking sector is characterized by its stability. There is a gradual growth in assets, deposits and loans, and commercial banks are operating with profit. Further improvements in the banking system s efficiency are closely linked to the development of the economy, structural reforms, and the development of capital and real estate markets. The banking sector is one of the most developed economic sectors in Latvia and is particularly attractive to foreign investors. This is evidenced by investments of several foreign banks in the share capital of Latvian banks: Swedbank, Skandinaviska Enskilda Banken, Vereins- und Westbank, Norddeutsche Landesbank and Sampo Bank. The restructuring of the Latvian banking sector is nearly completed. Most of the banks are privately owned. At the end of 2005, the state s share in the share capital of banking sector was only 5.3%. Only one bank is fully stateowned. Five major banks held assets comprising two thirds of the total assets of all Latvian banks. According to a number of foreign experts, banking supervision in Latvia is among the strictest in all Central and Eastern Europe. The supervisory authority is vested in the Financial and Capital Market Commission, which has been established to ensure protection of investors, depositors and insured persons, as well as to enhance the development and stability of financial and capital markets. Many of the regulations on the operations of Latvian credit institutions are stricter than in the EU Member States. 7

8 Management of the Bank Council of the Bank as at the date of signing these financial statements: Guntars Grīnbergs Andris Bērziņš Karīna Pētersone Gints Poišs Hans Eberhard Berndt Chairman of the Council Deputy Chairman of the Council Member of the Council Member of the Council Member of the Council During the reporting year, there have been no changes in the Council of the Bank. Board of Directors as at the date of signing these financial statements: Valery Kargin Viktor Krasovitsky Alexander Kvasov Arnis Lagzdiņš Jānis Skrastiņš Vladislavs Skrebelis Gene Zolotarev President and Chairman of the Board of Directors Deputy Chairman of the Board of Directors Member of the Board of Directors Member of the Board of Directors Member of the Board of Directors Member of the Board of Directors Member of the Board of Directors By the decision of the Bank s Council on 23 March 2005, Viktor Krasovitsky has been appointed as the deputy chairman of the Board of Directors (previously member of the Board of Directors). During the reporting year, there have been no other changes in the Board of Directors. 8

9 Management of the Bank Council of Directors as at the date of signing these financial statements: Viktor Krasovitsky Alexander Kvasov Arnis Lagzdiņš Ēriks Brīvmanis Līga Puriņa Gene Zolotarev Chairman of the Council of Directors Senior Vice President Responsible for Operations Division, covering client service (retail and corporate), card operations, settlements and branch management. Senior Vice President Responsible for the Group s Compliance with Regulations and Internal Procedures. Vice President Responsible for the Bank s and the Group s financial management, asset and liability management, information technology strategic development and implementation and the Bank s and the Group s accounting systems. Vice President Responsible for Lending Operations, covering all lending, credit and leasing facilities to retail and corporate clients. Vice President Responsible for Capital Markets, Trading & Treasury, Investment Banking, Corporate Finance, Investment Products, Trust and Asset Management. Also responsible for managing the Group s strategic development covering investor relations, debt and equity financing, and relationships with international financial institutions. 9

10 Statement of Responsibility of the Management The Management of AS Parex banka (hereinafter the Bank) are responsible for the preparation of the financial statements of the Bank as well as for the preparation of the consolidated financial statements of the Bank and its subsidiaries (hereinafter the Group). The financial statements set out on pages 11 to 56 are prepared in accordance with the source documents and present fairly the financial position of the Bank and the Group as at 31 December 2005 and 2004 and the results of their operations, changes in shareholders equity and cash flows for the years then ended. The financial statements are prepared in accordance with International Financial Reporting Standards issued by the International Accounting Standards Board on a going concern basis. Appropriate accounting policies have been applied on a consistent basis, except for changes as disclosed in Note 2. Prudent and reasonable judgements and estimates have been made by the Management in the preparation of the financial statements. The Management of AS Parex banka are responsible for the maintenance of proper accounting records, the safeguarding of the Group s assets and the prevention and detection of fraud and other irregularities in the Group. They are also responsible for operating the Bank in compliance with the Law on Credit Institutions, regulations of the Financial and Capital Market Commission and other legislation of the Republic of Latvia applicable for credit institutions. Valery Kargin President/ Chairman of the Board Riga, 3 March 2006 Viktor Krasovitsky Chairman of the Council of Directors Guntars Grīnbergs Chairman of the Council 10

11 Statements of Income for the years ended 31 December 2005 and Notes Interest income 4 78,899 72,515 58,518 54,096 Interest expense 4 (32,425) (31,581) (19,848) (19,153) Net interest income 46,474 40,934 38,670 34,943 Commission and fee income 5 32,528 30,049 23,897 21,612 Commission and fee expense 5 (6,794) (7,058) (5,074) (5,098) Net commission and fee income 25,734 22,991 18,823 16,514 Profit on trading with financial instruments, net 6 15,484 13,833 13,227 12,190 Other operating income 7 2,135 1,625 1,920 1,287 Net operating income 89,827 79,383 72,640 64,934 Administrative expense 8,9 (47,722) (41,539) (38,800) (33,933) Depreciation and amortisation expense 21,22 (6,347) (5,773) (6,318) (5,580) Other operating expense (804) (340) (344) (340) Impairment of financial assets 10 (2,722) (2,674) (9,109) (8,672) Reversals of impairment of financial assets 10 5,347 5,229 1, Profit from investments in subsidiaries (419) - Profit before corporate income tax and minority interest 37,579 34,286 18,660 17,124 Corporate income tax 11 (4,365) (4,111) (2,206) (2,020) Profit before minority interest 33,214 30,175 16,454 15,104 Minority interest - - (2) - Net profit for the year 33,214 30,175 16,452 15,104 The financial statements have been approved by the Management of the Bank and signed on their behalf by: Valery Kargin President/ Chairman of the Board Riga, 3 March 2006 Viktor Krasovitsky Chairman of the Council of Directors Guntars Grīnbergs Chairman of the Council The accompanying notes are an integral part of these financial statements. 11

12 Balance Sheets and Memorandum Items as at 31 December 2005 and 2004 Assets 31/12/ /12/ /12/ /12/2004 Notes Cash and deposits with central banks , ,835 70,781 63,748 Balances due from credit institutions , , , ,259 Loans and advances to customers 14,15,16 879, , , ,349 Fixed income securities 17,18 432, , , ,122 Shares and other non-fixed income securities 19 30,467 29,104 11,512 11,429 Investments in subsidiaries 20-21,547-18,559 Derivative financial instruments ,405 1,414 Intangible assets 21 2,805 1,223 3,497 1,914 Fixed assets 22 23,771 19,788 23,169 19,452 Prepayments and accrued income 23 10,340 9,338 8,334 8,006 Current income tax prepayment Other assets 24 6,404 3,860 1,733 1,533 Total assets 1,842,336 1,757,009 1,424,481 1,361,442 Liabilities Balances due to credit institutions and central banks , , , ,663 Deposits from customers 27 1,317,924 1,252,015 1,105,571 1,058,256 Issued debt securities 25 74,070 74, Derivative financial instruments 30 2,366 2,376 3,310 3,322 Accrued expense and deferred income 7,695 6,849 4,354 3,510 Current income tax liability Deferred income tax liability Provision for liabilities and charges Other liabilities 28 17,705 7,497 11,648 7,574 Total liabilities 1,684,245 1,602,888 1,298,094 1,236,282 Shareholders equity Paid-in share capital 29 65,027 65,027 65,027 65,027 Share premium 12,694 12,694 12,694 12,694 Fair value revaluation reserve 2,358 2,503 3,867 3,717 Retained earnings 78,000 73,897 44,786 43,722 Total shareholders equity attributable to shareholders of the Bank 158, , , ,160 Minority interest Total shareholders equity 158, , , ,160 Total liabilities and shareholders equity 1,842,336 1,757,009 1,424,481 1,361,442 Memorandum items Contingent liabilities 30 21,115 21,281 25,900 25,888 Financial commitments , , , ,825 Foreign exchange contracts , , , ,745 Other financial instruments , ,013 25,592 25,592 Funds under trust management ,053 3, , ,829 The financial statements have been approved by the Management of the Bank and signed on their behalf by: Valery Kargin President/ Chairman of the Board Riga, 3 March 2006 Viktor Krasovitsky Chairman of the Council of Directors The accompanying notes are an integral part of these financial statements. Guntars Grīnbergs Chairman of the Council 12

13 Statements of Changes in Shareholders Equity for the years ended 31 December 2005 and 2004 Changes in the Group s shareholders equity are as follows: Paid-in share capital Attributable to shareholders of the Bank Fair value Share revaluation Retained premium reserve earnings Total Minority interest Total shareholders equity Balance as at 1 January ,327 9,226 4,270 31, , ,168 Issue of new shares 1,700 3, ,168-5,168 Dividends paid (3,000) (3,000) - (3,000) Fair value revaluation reserve charged to statement of income - - (5,611) - (5,611) - (5,611) Changes in fair value of available for sale securities - - 5,550-5,550-5,550 Deferred income tax charged directly to equity - - (342) - (342) - (342) Changes in minority interest Net profit for the year ,452 16,452-16,452 Balance as at 31 December ,027 12,694 3,867 44, , ,387 Fair value revaluation reserve charged to statement of income - - (4,284) - (4,284) - (4,284) Changes in fair value of available for sale securities - - 2,621-2,621-2,621 Deferred income tax charged directly to equity Changes in minority interest (1) (1) Net profit for the year ,214 33,214-33,214 Balance as at 31 December ,027 12,694 2,358 78, , ,091 The accompanying notes are an integral part of these financial statements. 13

14 Statements of Changes in Shareholders Equity for the years ended 31 December 2005 and 2004 Changes in the Bank s shareholders equity are as follows: Paid-in share capital Share premium Fair value revaluation reserve Retained earnings Total Balance as at 1 January 2004 (as previously reported) 63,327 9,226 4,270 31, ,157 Effect of adoption of revised standards (Note 2) - - (150) Balance as at 1 January 2004 (adjusted see Note 2) 63,327 9,226 4,120 31, ,291 Issue of new shares 1,700 3, ,168 Dividends paid (3,000) (3,000) Fair value revaluation reserve charged to statement of income - - (5,611) - (5,611) Changes in fair value of available for sale securities - - 5,550-5,550 Deferred income tax charged directly to equity - - (342) - (342) Net profit for the year ,104 15,104 Balance as at 31 December ,027 12,694 3,717 43, ,160 Fair value revaluation reserve charged to statement of income - - (4,112) - (4,112) Changes in fair value of available for sale securities - - 2,751-2,751 Deferred income tax charged directly to equity Net profit for the year ,175 30,175 Balance as at 31 December ,027 12,694 2,503 73, ,121 The accompanying notes are an integral part of these financial statements. 14

15 Statements of Cash Flows for the years ended 31 December 2005 and Notes Cash inflow from operating activities Profit before taxation and minority interest 37,579 34,286 18,660 17,124 Amortisation of intangible assets, depreciation of fixed assets 6,347 5,773 6,318 5,580 Change in impairment allowances (2,625) (2,555) 8,189 7,938 (Profit) from investments in subsidiaries Increase in cash and cash equivalents before changes in assets and liabilities 41,301 37,504 33,586 30,642 (Increase) in prepayments and accrued income (2,006) (1,332) (3,069) (2,900) Change in derivative financial instruments (1,079) (1,206) (43) (69) Decrease/ (increase) in other assets (3,213) (1,013) 1, Increase in accrued expense and deferred income 3,341 3,339 1, Increase/ (decrease) in other liabilities 3,396 (1,925) 4,690 4,904 Decrease/ (increase) in trading investments (26,231) (24,785) 18,305 18,202 Decrease/ (increase)in balances due from credit institutions 32,228 58,623 (144,081) (144,318) (Increase) in loans and advances to customers (185,154) (168,373) (223,647) (202,096) Increase/ (decrease) in balances due to credit institutions 131, ,172 66,564 59,382 Increase in deposits from customers 212, , , ,278 Increase in cash and cash equivalents from operating activities before corporate income tax 206, ,763 24,754 21,811 Corporate income tax (paid) (2,441) (2,357) (3,440) (3,181) Net cash and cash equivalents from operating activities 204, ,406 21,314 18,630 Cash (outflow) from investing activities (Purchase) of intangible and fixed assets (6,257) (5,418) (6,165) (5,631) Acquisitions and investments in subsidiaries - (2,988) (6,710) (10,178) Sale/ (purchase) of equity investments and other nontrading investments (126,791) (131,556) 34,568 31,874 (Decrease) in cash and cash equivalents from investing activities (133,048) (139,962) 21,693 16,065 Cash inflow from financing activities Proceeds from issue of new shares - 5,168 5,168 Dividends (paid) - (3,000) (3,000) Proceeds from debt securities issue 75,046 75, Increase in cash and cash equivalents from financing activities 75,046 75,046 2,168 2,168 Net cash inflow for the year 146, ,490 45,175 36,863 Cash and cash equivalents at the beginning of the year , , ,465 98,180 Cash and cash equivalents at the end of the year , , , ,043 Interest received/ paid by the Bank and the Group during the reporting year is not materially different from interest income/ expense recognised in the statement of income. The accompanying notes are an integral part of these financial statements. 15

16 NOTE 1. INFORMATION ON THE BANK (Figures in parenthesis represent amounts as at 31 December 2004 or for the year then ended.) AS Parex banka (hereinafter the Bank) was registered as a joint stock company on 14 May The Bank commenced its operations in June The Bank s head office and three main branches are located in Riga, Latvia. As at 31 December 2005, the Bank was operating a total of 90 (95) branches and client service centres in Riga and throughout Latvia and two branches in Tallin (Estonia) and Berlin (Germany). The Bank operates 8 representative offices: in Frankfurt (Germany), Stockholm (Sweden), Tokyo (Japan), Kiev and Dnipropetrovsk (Ukraine), Baku (Azerbaijan), Tashkent (Uzbekistan) and Sofia (Bulgaria), as well as a subsidiary Parex Group Representation Limited in London (United Kingdom) acting as the Bank s representative office. The Bank owns also 25 other subsidiaries which operate in various financial markets sectors as described in Note 20. The Bank s main areas of operation include accepting deposits from customers, granting short-term and long-term loans to the State Treasury, local municipalities, corporate customers, private individuals and other credit institutions, issuing and servicing payment cards, dealing with finance lease and foreign exchange transactions. The Bank offers its clients also trust management and investment banking services, performs local and international payments, as well as provides a wide range of other financial services. As at 31 December 2005, the Bank had 2,120 (1,970) employees, 20,710 (20,630) loan and finance lease customers, 136,006 (104,524) settlement card holders and 199,700 (167,450) deposit customers. The main shareholders of the Bank are Latvian citizens Mr. Valery Kargin and Mr. Viktor Krasovitsky (see Note 29). NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES These financial statements have been prepared in accordance with International Financial Reporting Standards (IFRS), which comprise standards and interpretations approved by the International Accounting Standards Board (IASB), and International Accounting Standards and Standing Interpretations Committee interpretations approved by the International Accounting Standards Committee (IASC), effective as at 31 December Certain disclosures are prepared in the format required by the Financial and Capital Market Commission (FCMC). A summary of the Group s principal accounting policies, all of which have been applied consistently throughout the years ended 31 December 2005 and 2004, except that the Group has adopted those new/ revised standards mandatory for financial years beginning on or after 1 January 2005, is set out below. Changes in Accounting Policies In 2005 the Group adopted those IFRS that were amended in 2004 and are mandatory for financial years beginning on or after 1 January The adoption of those standards did not result in substantial changes to the Group s accounting policies, except for: - IFRS 3, IAS 36 and IAS 38, which have affected the treatment of goodwill; - IAS 27, which has changed the measurement of investments in subsidiaries. The principle effects of these changes in policies are described below. IFRS 3 Business Combinations The adoption of IFRS 3 and related IAS 36 (revised 2004) and IAS 38 (revised 2004) has resulted in a change in the accounting policy for goodwill. Until 31 December 2004, goodwill had been: - Amortised on a straight-line basis; and - Assessed for an indication of impairment at each balance sheet date. In accordance with the provisions of IFRS 3: - The Group ceased amortization of goodwill from 1 January 2005; - Accumulated amortization as at 31 December 2004 has been eliminated with a corresponding decrease in the cost of goodwill; 16

17 - From the year ended 31 December 2004 onwards, goodwill is tested annually for impairment, as well as when there are indications of impairment. IAS 27 Consolidated and Separate Financial Statements Starting from 2005 investment into subsidiary companies is no longer accounted for under equity method. Retained earnings of subsidiaries has been reversed to the equity of the Bank so that the net book value of investment as at 31 December 2004 reached its nominal value of LVL 18,559 thousand. Comparative figures were restated retrospectively in accordance with IAS 8. The effect of adoption of the new and revised standards on the corresponding figures can be summarised as follows: 31/12/2004 (comparative) figures, the Bank As reported Restatements Restated Balance sheet Investment into subsidiaries 18, ,559 Intangible assets 3,318 (1,404) 1,914 Total shareholders equity Fair value revaluation reserve (3,867) 150 (3,717) Unappropriated retained earnings (28,334) (284) (28,618) Net profit for the year (16,452) 1,348 (15,104) Statement of income Net result 16,452 1,348 15,104 Depreciation and amortization expense 5,841 (261) 5,580 Profit from investments in subsidiaries (1,609) 1,609 - IFRSs and IFRIC Interpretations not yet effective The Group has not applied the following specific provisions of IFRSs and IFRIC Interpretations that have been issued but are not yet effective: IAS 1 (amended 2005) Presentation of Financial Statements (Capital Disclosures); IAS 19 (amended 2004) Employee Benefits (Actuarial Gains and Losses, Group Plans and Disclosures); IAS 39 (amended 2005) Financial Instruments: Recognition and Measurement (Cash Flow Hedge Accounting of Forecast Intragroup Transactions, Fair Value Option, Insurance Contracts regarding Financial Guarantuee Contracts); IFRS 7 Financial Instruments: Disclosures ; IFRIC 4 Determining whether an Arrangement contains a Lease ; The Group expects that the adoption of the pronouncements listed above will have no significant impact on the Group s financial statements in the period of initial application, except for IFRS 7 Financial Instruments: Disclosures and the amendment to IAS 1. IFRS 7 Financial instruments: Disclosures and IAS 1 amendment Capital Disclosures IFRS 7 introduces new disclosures to improve the information about financial instruments. It requires the disclosure of qualitative and quantitative information about exposure to risks arising from financial instruments, including specified minimum disclosures about credit risk, liquidity risk and market risk, including analysis of sensitivity to market risk. It replaces IAS 30, Disclosures in the Financial Statements of Banks and Similar Financial Institutions, and disclosure requirements in IAS 32, Financial Instruments: Disclosure and Presentation. It is applicable to all entities that report under IFRS. The amendment to IAS 1 introduces disclosures about the level of an entity s capital and how it manages capital. The Group assessed the impact of IFRS 7 and the amendment to IAS 1 and concluded that the main additional disclosures will be the sensitivity analysis to market risk and the capital disclosures required by the amendment of IAS 1. The Group will apply IFRS 7 and the amendment to IAS 1 from annual periods beginning 1 January a) Comparative figures 17

18 Where necessary, comparative figures have been adjusted to conform with changes in presentation in the current year. b) Reporting Currency The accompanying financial statements are reported in thousands of Lats (). c) Error Corrections The Group shall correct material prior period errors retrospectively in the first set of financial statements authorised for issue after their discovery by restating the comparative amounts for the prior period(s) presented in which the error occurred or if the error occurred before the earliest prior period presented, restating the opening balances of assets, liabilities and equity for the earliest prior period presented. When it is impracticable to determine the period-specific effects of an error on comparative information for one or more prior periods presented, the entity shall restate the opening balances of assets, liabilities and equity for the earliest period for which retrospective restatement is practicable (which may be the current period). d) Basis of Consolidation As at 31 December 2005 and 2004, the Bank had a number of investments in subsidiaries, in which the Bank held directly and indirectly more than 50% of the shares and voting rights, and accordingly, had the ability to exercise control. More detailed information on the Bank s subsidiaries has been presented in Note 20. The Bank s subsidiaries are accounted in the Group s financial statements under the equity method. The financial statements of AS Parex banka and its subsidiaries are consolidated in the Group s financial statements on a line by line basis by adding together like items of assets and liabilities as well as income and expenses. For the purposes of consolidation, intra-group balances and intra-group transactions, including interest income and expense as well as unrealised profits and loss resulting from intra-group transactions, are eliminated in the Group s financial statements. e) Income and Expense Recognition Interest income and expense items are recognised on an accrual basis using the effective interest rate. Commissions in respect of financial assets or financial liabilities are deferred and recognised as an adjustment to the effective yield on the respective asset or liability. Other commissions and fees are credited and/ or charged to the statement of income as earned/ incurred. f) Foreign Currency Translation Transactions denominated in foreign currencies are recorded in Lats at actual rates of exchange effective at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into Lats at the official rate of exchange prevailing at the end of the year. Any gain or loss resulting from a change in rates of exchange subsequent to the date of the transaction is included in the statement of income as a profit or loss from revaluation of foreign currency positions. g) Taxation For the year ended 31 December 2005 corporate income tax is applied at the rate of 15% (15%) on taxable income generated by the Bank for the taxation period. Deferred corporate income tax arising from temporary differences in the timing of the recognition of items in the tax returns and these financial statements is assessed using the liability method. The deferred corporate income tax is determined based on the tax rates that are expected to apply when the timing differences reverse. The principal temporary timing differences arise from differing rates of accounting and tax depreciation on the Bank s fixed assets, revaluation of securities, as well as the treatment of general provision and provision for vacation pay reserve. 18

19 The carrying amount of deferred corporate income tax asset, if any, is reviewed at each balance sheet date and reduced to the extent that it is no longer probable that sufficient taxable profit will be available to allow all or part of the deferred income tax asset to be utilised. h) Leases Finance Group as lessor Finance leases, which confer rights and obligations similar to those attached to owned assets, are recognised as assets and liabilities at amounts equal at the inception of the lease to the fair value of the leased property or, if lower, at the present value of the minimum lease payments. The finance income is allocated to periods during the lease term to produce a constant periodic return on the net investments outstanding in respect of the finance leases. For the purposes of these financial statements, finance lease receivables are included in loans and advances to customers. Operating Group as lessor The Group presents assets subject to operating leases in the balance sheets according to the nature of the asset. Lease income from operating leases is recognized in statement of income on a straight-line basis over the lease term as other income. The aggregate cost of incentives provided to lessees is recognized as a reduction of rental income over the lease term on a straight-line basis. Initial direct costs incurred specifically to earn revenues from an operating lease are added to the carrying amount of the leased asset. The depreciation policy for depreciable leased assets is consistent with the lessor s normal depreciation policy for similar assets, and depreciation is calculated in accordance with accounting policies, used for the Group s property, plant and equipment. Operating Group as lessee Leases of assets under which the risks and rewards of ownership are effectively retained by the lessor are classified as operating leases. Lease payments under an operating lease are recognized as expenses on a straight-line basis over the lease term and included into other administrative and operating expenses. i) Impairment of loans and receivables The Group has granted commercial and consumer loans to customers throughout its market area. The economic condition of the market area may have an impact on the borrowers ability to repay their debts. The Management of the Group have considered both specific and portfolio-level risks in determining the balance of impairment allowance for possible credit losses. Impairment allowance for possible credit losses is established to represent the estimated amounts of probable losses that have been incurred at the balance sheet date. The specific element of the impairment relates to credits that have objective evidence of impairment. The specific impairment loss is determined after individual review of all credits with objective indications of potential impairment. The collective impairment of the loan portfolio relates to the potential losses, which experience indicates are present in the Group s portfolio of loans and receivables, but have not yet been specifically identified through the specific review of those financial assets. The specific impairment for possible credit losses is assessed as a difference between the present value of expected future cash flows discounted at the loans original effective interest rate and the loan s outstanding balance. The value of collateral held in connection with loans is based on the estimated realisable value of the asset and is taken into account when estimating present values of expected future cash flows. The collective impairment allowance is estimated based upon historical pattern of losses in the loan portfolio, as well as taking into account credit concentration risk, changes in collateral values, current economic conditions and general market or operating events that have occurred prior to the balance sheet date and might negatively impact the future cash flows from certain loans and receivables balances outstanding, but for which a specific credit risk provision is not yet quantifiable. Non-performing loans and receivables from customers, including banking institutions, are defined as loans and other credit balances in which contractually due principal is 14 days or more overdue, contractually due interest is 90 days 19

20 or more overdue, or the Management otherwise believe that the contractual interest or principal due will not be collected. When loans and advances cannot be recovered, they are written-off and charged against impairment allowance. They are not written-off until all the necessary legal procedures have been completed and the amount of the loss is finally determined. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss is reversed. Any subsequent reversal of an impairment loss is recognised in the statement of income, to the extent that the carrying value of the asset does not exceed its amortised cost at the reversal date. j) Financial assets The Group recognises financial asset on its balance sheet when, and only when, the Group becomes a party to the contractual provisions of the instrument. Financial assets in the scope of IAS 39 are classified as either financial assets at fair value through profit or loss, loans and receivables, held-to-maturity investments, or available-for-sale financial assets, as appropriate. When financial assets are recognised initially, they are measured at fair value, plus, in the case of investments not at fair value through profit or loss, directly attributable transaction costs. The classification of investments between the categories is determined at acquisition based on the guidelines established by the Management. All regular way purchases and sales of investments are recognised using settlement date accounting. The settlement date is the date when an asset is delivered to or by the Group. Settlement day refers to the recognition of an asset on the day it is transferred to the Group and to the derecognition of an asset, on the day that it is transferred by the Group. All other purchases or sales are recognised as derivative instruments until settlement occurs. Financial assets at fair value through profit and loss Financial assets classified as held for trading are included in the category financial assets at fair value through profit or loss. Financial assets are classified as held for trading if they are either acquired for generating a profit from short-term fluctuations in price or dealer s margin, or are included in a portfolio in which a pattern of short-term profit taking exists. Held for trading financial assets are initially recognised at cost and subsequently re-measured at fair value based on available market prices. The result of re-measuring trading financial assets at fair value is charged directly to the statement of income. Held to maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturity are classified as held to maturity if the Group has both the positive intent and ability to hold these investments to maturity. Held to maturity financial assets are carried at amortised cost using the effective interest rate method, less any allowance for impairment. A financial asset is impaired if its carrying amount is greater than its estimated recoverable amount. The amount of the impairment loss for assets carried at amortised cost is calculated as the difference between the asset s carrying amount and the present value of expected future cash flows discounted at the financial instrument s original effective interest rate. Loans and receivables Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Such assets are carried at amortised cost using the effective interest method. Gains and losses are recognised in income when the loans and receivables are derecognised or impaired, as well as through the amortisation process. Loans and receivables are recognised at their settlement date. From the date of signing a contractual agreement till the settlement date they are accounted for as off balance sheet items. When the loans and advances cannot be recovered, they are written-off and charged against impairment for possible 20