As at 31 December 2006, NLB Group comprised 59 members operating in 15 countries or 16 markets, of which:

Transcription

1 Annual Report 2006

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3 Key financial data of the NLB Group SIT EUR SIT EUR Profit and loss account indicators (in millions) Net interest income 77, , Net non-interest revenues 39, , Total expenses 76, , Profit before tax 25, , Minority interest 2, , Profit after tax 16, , Balance sheet indicators (in millions) Total assets 2,966,781 12,383 3,452,933 14,409 Loans to non-banking sector 1,658,182 6,921 2,069,035 8,634 Deposits by the non-banking sector 1,573,462 6,568 1,749,982 7,303 Capital 181, , Minority interest 29, , w/o BoS prudential filter 13.2% 12.7% Key indicators Return on equity (ROE) before tax 12.4% 16.7% Return on average total assets (ROA) before tax 0.9% 1.2% Cost/income ratio (CIR) 66.1% 63.1% Capital adequacy 11.0% 10.8% International credit ratings Moody s A2 A2 Capital Intelligence A- A Fitch A- A- Exchange rate EUR 1 = SIT Illustration 1: International rating of NLB AA- (Aa3) A+ (A1) A (A2) A - (A3) BBB+ (Baa1) BBB (Baa2) Moody s Fitch Capital Intelligence BBB - (Baa3) Investment grade BB+ (Ba1)

4 Key financial data of the NLB SIT EUR SIT EUR Profit and loss account indicators (in millions) Net interest income 46, , Net non-interest revenues 27, , Total expenses 51, , Profit before tax 15, , Profit after tax 11, , Balance sheet indicators (in millions) Total assets 2,219,320 9,264 2,496,041 10,416 Loans to non-banking sector 1,155,561 4,823 1,398,180 5,835 Deposits by the non-banking sector 1,197,292 4,998 1,286,435 5,368 Capital 145, , Key indicators Return on equity (ROE) before tax 10.7% 15.8% Return on average total assets (ROA) before tax 0.7% 1.0% Cost/income ratio (CIR) 69.0% 60.2% Market share in terms of total assets 31.8% 30.9% Capital adequacy 11.7% 11.3% w/o BoS prudential filter 13.7% 13.1% Key indicators per share Number of shares 7,682,015 7,682,015 Nominal value 2, , Book value 18, , Net earnings per share (EPS) 1, , Dividends payout Exchange rate EUR 1 = SIT Illustration 2: Net profit growth Illustration 3: Balance sheet growth % % % % in billion SIT in billion SIT NLB Group NLB NLB Group NLB

5 Table of Content Statement by the President of the Management Board of the NLB Statement by the Chairman of the Supervisory Board of the NLB Business Report The NLB Group NLB Group Strategy Key Events Performance Analysis Macroeconomic Environment Financial Review Retail Banking Corporate Banking Financial Markets International Operations Information Technology Risk Management Basel II Introduction of the Euro Management and Corporate Social Responsibility Corporate Governance of the NLB Group Corporate Governance of the NLB Human Resource Management Internal Audit Sponsorships and Donations Statement on Compliance With the Corporate Governance Code Financial Statements Audited Consolidated Financial Statements for the NLB Group Independent Auditor s Report Consolidated Income Statement Consolidated Balance Sheet Consolidated Statement of Changes in Equity Consolidated Cash Flow Statement Statement of Management s Responsibilities Notes to the Consolidated Financial Statements Audited Financial Statements for the NLB Independent Auditor s Report Income Statement Balance Sheet Statement of Changes in Eguity Cash Flow Statement Statement of Management s Responsibilities Notes to the Financial Statements

6 Statement by the President of the Management Board of the NLB Marjan Kramar President of the Management Board & CEO Borut StaniË Member of the Management Board Matej Narat Member of the Management Board Andrej Hazabent Member of the Management Board Dear business partners, shareholders and employees of the NLB Group! The NLB performed well in 2006 and managed to implement most of its goals, while some of them were even exceeded. The growth in the volume of operations and profit before tax, which exceeded EUR 100 million at the level of the Bank and EUR 150 million at the level of the Group, prove that the NLB is in good shape and on the right track. In our strategy we defined the further growth and consolidation of the NLB Group, as it represents our answers to the basic development questions: what, where and how. The buyers of our services and other business partners in 15 countries are provided a complete banking and financial range. The operations of the Group, i.e. its banks, financial companies and insurance companies, is a reflection of the needs and our abilities to keep expanding the domestic market in the EU as well as in SE Europe, the Russian Federation and some neighbouring countries. It is our pleasure to say that, at this stage of the NLB Group s development, the NLB has managed to achieve its presence in all principal target markets and become an important player in some of them. The excellent financial results achieved in 2006 are even more brilliant if we consider that the lion s share of the NLB s activities was focused on further expansion of the NLB Group and the simultaneously ongoing consolidation and harmonisation processes. The intensity of the transition to the euro together with the very demanding introduction of the International Accounting Standards was a decisive technical and substantial factor in last year s modernisation of processes and the information technology in NLB d.d. and in other Slovenian parts of the NLB Group. The test we passed with flying colours required enormous financial and work inputs which however never jeopardised the achievement of an excellent performance. The firm and uniform organisation of the Group in the banking area and the areas of leasing, factoring and forfeiting, which represent the traditional core of our activity, and in other activities such as asset management and insurance operations which are also gaining importance, is a precondition for planning and efficiently managing the development of the entire NLB Group. Of course, this process will not stop now although 2

7 The NLB Group Statement by the President of the Management Board of the NLB Business Report it will give way to the processes of consolidation, the construction of efficient models of optimal management, control over the quality of operations and the overall assurance of business excellence. Optimistic forecasts of economic growth and the related social standards of the population in practically all markets where the NLB Group is present provide a sound basis for the forecast of its successful development, connected with adequate profitability of the shareholders equity and appropriate earnings of its more than 8,000 employees. On behalf of all members of the Management Board, allow me to thank all of you who helped us, with your own work or positive attitudes to our work and co-operation, to make 2006 one of the most successful years in the entire history of the NLB Group. Whenever we are asked about the key advantages of the NLB in a situation of tough competition and the great challenges that await us, our answer is as follows: The advantage of the NLB Group lies in the fact it has excellent knowledge of the history of our clients in individual markets, knows their current needs and can foresee their future. Marjan Kramar President of the Management Board & CEO NLB Group Annual Report

8 Statement by the Chairman of the Supervisory Board of the NLB In 2006, the Supervisory Board of the NLB was composed of the following members: Chairman Žiga LavriË, Member Andrijana Starina Kosem (until 28 June 2006), Member Marko Rus (until 28 June 2006), Member Igor Marinšek, Member Peter Ješovnik, Member Zvonko IvanušiË, Member Christian Defrancq (until 28 June 2006), Member Katja BožiË (as of 28 June 2006), Member Riet Docx, Member Andre Bergen (until 28 June 2006), Member Tomaž Rotar (as of 28 June 2006), Member Frans Florquin, Member Jan Vanhevel (as of 28 June 2006), Member John Hollows (as of 28 June 2006) and Member Anne Fossemalle. The substitute members were appointed at the regular General Meeting of Shareholders of NLB d.d., which was held on 28 June The Supervisory Board works in accordance with the established corporate governance principles. Its supervisory function contributes to the assurance of the expected efficiency and transparency of the Bank s operations. The work of the Supervisory Board of NLB d.d. is based on the interests of the Bank s clients, shareholders and employees and is in accordance with the applicable liabilities and responsibilities of the supervisory boards laid down in the Banking Act, the Companies Act and the other regulations which regulate the Bank s operations. Support for the adoption of decisions made by the Supervisory Board was provided by its four expert committees, namely: the Development Committee, the Audit Committee, the Risk Committee and the Remuneration Committee. Activities in 2006 In 2006, the Supervisory Board met at five regular and four correspondence meetings at which the members discussed the operations of NLB d.d. and its subsidiaries, or the NLB Group as a whole. The Supervisory Board adopted the 2005 Annual Report and assessed its achievements as having been successful, especially in terms of the improved profitability and cost efficiency of operations, maintenance of the market share in Slovenia and the improved presence in the target foreign markets. The members approved all the proposals submitted by the Management Board which were adopted at the General Meeting of Shareholders. In the area of the set strategic goals of the NLB, and in particular the development of the NLB Group, the Supervisory Board discussed and supported all the proposed resolutions of the Management Board in relation to expansion of the Group and the implementation of certain specific transactions. Special attention was paid to the management or assurance of the Bank s capital adequacy as a key precondition for realisation of the set operational and development goals. For this purpose, it also supported the proposals submitted by the Management Board to raise specific loans or issue debt instruments with the status of equity. By discussing and approving the plan of development and operations of the NLB and the NLB Group for the next period, which was submitted by the Management Board, the Supervisory Board confirmed the NLB s commitment to achieving further growth in the volume of its operations and improved performance. With the assistance of its expert committees, the Supervisory Board monitored the risk and equity management, acknowledged the findings of the internal audit, confirmed the annual plan and monitored its implementation, paying particular attention to the expansion of operations within the scope of the NLB 4

9 The NLB Group Statement by the Chairman of the Supervisory Board of the NLB Business Report Group. With its decisions the Supervisory Board actively supported the further growth and development of NLB d.d. and the NLB Group in the framework of the adopted strategy, while it also took care of improving all the processes of management and supervision of the NLB Group. A series of decisions was connected with the process of the consolidation and harmonisation of operations in the framework of the NLB Group, especially in the SEE markets. The Supervisory Board also paid special attention to monitoring the process of introducing the euro as the domestic currency and the carrying out of key projects aimed at assuring the safe development of the Bank, especially those related to introduction of the IFRS and preparations to introduce the Basel II Standards. Besides the reports compiled by the external auditor, the Supervisory Board also regularly discussed the reports on the inspections of operations conducted in NLB d.d. as well as in the entire NLB Group, which were prepared by the Internal Audit on the basis of the approved work programme Annual Report On 16 May 2007, the Management Board of the NLB submitted to the Supervisory Board the 2006 Annual Report, including the audited financial statements of the NLB, the consolidated financial statements of the NLB Group and the auditor s opinions. In the auditor s opinion, the financial statements give a true and fair view of the financial position of the NLB and the NLB Group as at 31 December 2006 in compliance with the International Financial Reporting Standards. It is also established on the basis of a review of the business report whether the information contained in the business section of the Annual Report is in compliance with the financial statements of the Bank and the NLB Group. On this basis, the Supervisory Board approved the 2006 Annual Report and the Management Board s proposal on the use of the net distributable profit, which will be submitted for adoption by the General Meeting of Shareholders of the NLB in August The Supervisory Board of the NLB has established that the operations of the NLB in 2006 were very successful and that the Bank achieved, and in many cases even exceeded, the goals set out in the annual action plan. In accordance with the adopted development strategy, the NLB improved all the key parameters of its operations, in particular its cost efficiency and profitability. Therefore, the Supervisory Board commends the Management Board of the Bank and the employees for their achievements in Žiga LavriË predsednik Nadzornega sveta NLB NLB Group Annual Report

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11 The NLB Group Predstavitev Business Report Business 1Report NLB Group Annual Report

12 The NLB Group

13 NLB Group The NLB Group is the largest Slovenian banking and financial group which, as at 31 December 2006, comprised NLB d.d., Ljubljana, 58 banks and companies, 1 branch office and 2 representative offices. Banking is the most important activity within the NLB Group. However, the position of non-traditional banking activities such as leasing, factoring, forfeiting, insurance, asset management has recently grown significantly. The NLB Group covers 16 markets with the following members: 15 banks and 1 branch office, 10 leasing companies, 11 factoring and forfeiting companies, 3 insurances, 1 asset management, and 19 members performing other activities. The intensive expansion of the NLB Group was followed by processes of merging banks within individual countries in Matrix of activities of NLB Group members by country as at 31 December

14 The NLB Group NLB Group Business Report Table 1: Matrix of activities of NLB Group members by country as at 31 December 2006 Southeastern Europe Western and Central Europe Slovenia Bulgaria BiH Croatia Macedonia Serbia Montenegro Austria Czech Republic Italy Germany Slovakia Switzerland NLB Group Annual Report 2006 Banks NLB, Ljubljana; NLB Koroška banka, Slovenj Gradec; NLB Banka Zasavje, Trbovlje; NLB Banka Domžale, Domžale; NLB Banka Celje, Celje; SIB - in liquidation, Ljubljana NLB West East Bank, Sofia NLB Razvojna banka, Banja Luka; NLB Tuzlanska banka, Tuzla NLB Tutunska banka, Skopje NLB LHB Banka Beograd, Belgrade; NLB Continental banka, Novi Sad NLB Montenegrobanka, Podgorica Adria Bank, Vienna Trieste Branch* LHB Internationale Handelsbank, Frankfurt * NLB presence in Italy as Trieste branch office Leasing NLB Leasing, Ljubljana; NLB Leasing, Koper; NLB Leasing, Maribor; NLB Leasing, Velenje; NLB Leasing, Murska Sobota NLB Leasing, Sarajevo Optima Leasing, Zagreb NLB Lizing Skopje, Skopje NLB Leasing, Belgrade NLB Leasing, Podgorica Factoring and forfeiting Prvi faktor, Ljubljana; LHB Finance, Ljubljana Prvi faktor, Sarajevo Prvi faktor, Zagreb Prvi faktor, Skopje NLB InterFinanz, Belgrade; Prvi faktor, Belgrade NLB InterFinanz, Prague; NLB Factoring, Ostrava NLB Factor, Bratislava NLB InterFinanz, Zürich Life and pension insurance NLB Vita, Ljubljana; Skupna pokojninska družba, Ljubljana Nov penziski fond, Skopje Asset management NLB Skladi, Ljubljana; Other activities Prospera Plus, Ljubljana; NLB Propria, Ljubljana; Bankart, Ljubljana; FIN-DO, Domžale; ICJ, Domžale WEB Servicies, Sofia Plan, Banja Luka; CBS Invest, Sarajevo LHB Trade, Zagreb NLB Tutunska broker, Skopje Conet, Novi Sad; Convest, Novi Sad; LHB Consult, Belgrade; TEXIBA, Belgrade; BTB, Belgrade; NLB Real Estate, Belgrade; NLB d.o.o., Belgrade; Tekig-Invest, Belgrade LHB Immobilien, Frankfurt 11

15 The NLB Group NLB Group Business Report Chart of NLB Group as at 31 December 2006 NLB Companies Financial institutions Banks Slovenia Abroad Slovenia Abroad Slovenia Abroad Prospera Plus 100% 100% NLB Skladi 100% 100% NLB Interfinanz Zürich 100% 100% 1.42% NLB Koroπka banka 65.54% 65.54% 51.48% 49% NLB Tutunska banka 48.23% 83.44% NLB Propria 100% 100% NLB Vita 50% 50% NLB Interfinanz Praha 100% 100% 0.65% NLB Banka Zasavje 71.97% 71.97% NLB Tutunska broker 100% 100% Bankart 36.74% 39.45% Prvi faktor 50% 50% NLB Interfinanz Beograd 100% 100% 0.64% NLB Banka Domæale 74.41% 74.41% 39.04% NLB Montenegrobanka 35.49% 86.97% Prvi faktor Zagreb 100% 100% NLB Beograd 100% 100% FIN-DO 100% 100% LHB AG, Frankfurt 56.01% 56.01% 35.21% Prvi faktor Beograd 100% 100% NLB Factoring Ostrava 100% 100% ICJ Domæale 50% 50% LHB Trade Zagreb 100% 100% 32.30% Prvi faktor Sarajevo 100% 100% Prvi faktor Skopje 100% 100% NLB Factor Bratislava 100% 100% NLB Lizing Skopje 100% 100% 5.66% SIB - in liquidation 80.78% 80.78% Banka Celje 49.42% 49.42% LHB Finance Ljubljana 100% 100% LHB Consult Beograd 100% 100% NLB Leasing Velenje 100% 100% NLB Leasing Koper 25.03% 100% NLB Leasing Maribor 55% 100% NLB Leasing Ljubljana % 100% 24.99% 24.99% 24.99% 8% 16% 21% % 24.99% 24.99% Nov penziski fond 51% 100% 51% LHB Immobilien GmbH 100% 100% NLB LHB Banka Beograd 24.90% 75.90% BTB 100% 100% TEXIBA 100% 100% NLB Leasing Podgorica 100% 100% Teking-Invest Beograd 24.61% 24.61% Optima Leasing Zagreb 75.1% 75.1% 28.99% NLB Razvojna banka 52.51% 81.50% NLB Leasing Beograd 100% 100% Plan AD Banja Luka 48.99% 81.29% NLB Leasing Murska S. 100% 100% Adria bank 28.46% 28.46% NLB Leasing Sarajevo 100% 100% NLB West East Bank 97.01% 97.01% NLB Real Estate Beograd 100% 100% WEB Services 100% 100% Legend Skupna pokoj. druæba 28.01% 28.01% 2.46% NLB Continental banka 99.50% 99.50% Subsidiaries % direct share in voting rights of NLB % total share in voting rights of NLB Group Conet 84.68% 84.68% Associates % direct share in voting rights of NLB % total share in voting rights of NLB Group Convest 100% 100% Joint venture % direct share in voting rights of NLB % total share in voting rights of NLB Group Note: Shares are defined as shares in voting rights. NLB Tuzlanska banka 56.81% 95.85% CBS Invest 40% 100% 60% NLB Group Annual Report 2006

16 Strategy The NLB Group s vision is to become one of the leading banking and financial groups in its target markets. The strategic goals of the NLB Group in the mid-term period up until 2009 are the following: Further expansion in the target markets The target markets of the NLB Group are: Slovenia, SE Europe, the existing EU markets and the territory of the former Soviet Union. Growth of the group mainly organic and to a smaller extent through new acquisitions. Group consolidation Continued processes of merging individual subsidiaries. Increasing the stakes in subsidiaries. Adapting the ownership structure in subsidiaries (also through the selective integration of minority owners). Development of corporate governance in the NLB Group Transfer of know-how and best practices within the Group. Ensuring conditions for further growth in the volume of operations of subsidiaries. Improving the cost-efficiency and financial performance of the subsidiaries, including through the use of synergies inside the Group. Target financial indicators of the Bank for the period until 2009: ROE before tax >19 %, CIR < 60 % In view of the relatively low level of stability of individual target markets, a great emphasis in the achievement of financial goals will be on guaranteeing the safety of operations and risk management. 14

17 The NLB Group Key Events Business Report Key Events 2006 Increasing the share in Slovenian subsidiary banks and adopting a decision on starting the process merging them with the NLB d.d. Merger in Montenegro (Euromarket banka and NLB Montenegrobanka), the Republic of Srpska (Razvojna banka JugoistoËne Evrope and LHB Banka) and the BiH Federation (CBS Bank and NLB Tuzlanska banka). Acquisition of a % stake in NLB West East Bank, Sofia. Increasing the stake of the NLB Group in NLB LHB Banka Belgrade, NLB Razvojna banka and NLB Tutunska banka. Establishment of three new companies: Prvi Faktor, Sarajevo; NLB Real Estate, Belgrade; Prvi faktor, Skopje. Increasing the capital of companies: Nov penziski fond, Skopje; NLB Vita, Ljubljana; Skupna pokojninska družba, Ljubljana; NLB Leasing, Murska Sobota; NLB Leasing, Ljubljana; NLB Leasing, Koper; NLB Leasing, Beograd; Prvi faktor, Beograd. Winding up of the company LB Maksima. The Banker nominated the NLB as Bank of the Year in Slovenia in Further, the Banker nominated the NLB Tutunska banka Bank of the Year in Macedonia in 2006, while the Finance Central Europe magazine nominated it the best bank according to the criteria of gross profit for Global Finance nominated the NLB The Best domestic Bank Award in 2006 and The Best Bank of CE Europe in 2006 Euromoney nominated the NLB Best Bank in Slovenia In May 2006, the KBC informed the Supervisory Board of the NLB that it intends to transform its investment in the Bank from a strategic to a portfolio investment. Until further decisions are adopted, the KBC will continue participating in the management bodies of the Bank, as agreed in the Shareholder Agreement, with the exception of its participation on the Management Board, from which Erik Luts and Pierre Van Keirsbilck resigned in accordance with the notice periods. In spite of considerable changes related to new solutions that support the Bank s operations and the adaptations for introduction of the euro, the Bank managed to maintain a high level of availability of its on-line systems (99.67 % at the annual level). An improved rating assigned to the NLB Group by Capital Intelligence from A- to A. In April 2006 the NLB signed, together with a group of with 35 foreign banks, the largest syndicated loan for any Slovenian bank and one of the largest for any financial institution in Central and Eastern European markets NLB successfuly introduced the euro. The process of merging three Slovenian banks with the NLB. The expiry of the term of office of three members of the Management Board of the NLB. At the beginning of 2007, two new companies were entered in the Register of Companies: NLB Leasing, Sofia (Bulgaria) and NLB Nova penzija, Belgrade (Serbia). In February 2007, the company NLB InterFinanz Zurich opened a representative office in the Ukraine. Capital entrance in the banking market of Kosovo. NLB Group Annual Report

18 Performance Analysis

19 Macroeconomic Environment Slovenia and the European Monetary Union At the time of adopting the single European currency, Slovenia was recording favourable macroeconomic developments that confirmed its readiness to enter the European monetary system and strengthen its position as the most developed new EU member state. Gross domestic product per capita is slightly below 14,000 EUR. In the last decade, Slovenia has been recording relatively high, namely 4.0 %, average annual economic growth which also continued last year. In the first three quarters of 2006 compared to the same period of 2005, GDP grew by 5.2 % which is more than expected. In the first half of 2006, foreign trade was the principal driver of growth while, in the third quarter, economic growth was primarily based on domestic demand and the contribution of foreign trade was negative. The high growth of domestic demand was the result of the extremely high increase in gross investments in fixed assets which rose by 14.5 % at the annual level the highest growth since A rise in investments was also noticed in housing construction and infrastructure projects. Favourable developments were also seen in services, especially trade, transport and business services. In 2005 and 2006, the interim growth rate of the harmonised index of consumer prices (HICP) stood at 2.5 % which represented the successful completion of the disinflation process that started in The interim inflation rate was 2.8 %. In Slovenia, inflation has been quite stable since November 2005 when it dropped to the level of the Maastricht criterion, and then fell below this level where it still stands. The most significant inflationary factor in Slovenia is the prices of oil on which the Government of the Republic of Slovenia has no influence in the form of economic policy measures. Excise duties on liquid Illustration 4: GDP movements by quarter in the period 7 Quarterly real GDP Source: Statistical Office of the Republic of Slovenia Yearly growth (in %) Quarters

20 Performance Analysis Macroeconomic Environment Business Report fuels were at the minimum level in the period July 2005 to August In 2006, the Government continued with its gradual harmonisation of excise duties on tobacco and tobacco products with the agreed EU levels, which is expected to be completed in the middle of The lag in the growth in salaries behind productivity growth prevented potential pressures stemming from higher demand or increased labour costs. Slovenia has an adequate national budget status. In spite of fulfilling the fiscal criteria for adopting the euro, the main goal of fiscal policy in Slovenia is to eliminate the structural public finance deficit. In accordance with the current plans of the Government, the budget deficit in 2006 is expected to drop to 1.1 %. As well as the budget deficit, the national debt in the previous period will also be primarily generated at the level of the central state. It dropped from 28.3 % in 2002 to 27.7 % of GDP in According to the estimates and forecasts, the non-consolidated debt of the central state will reach 28.8 % of GDP at the end of Total national debt fell from 29.1 % of GDP in 2002 to 28.0 % of GDP in 2006, while the forecasts for 2006 say that it would reach 29.4 % of GDP. SE Europe We could say that the SE European countries had quite a few common points in the previous year in terms of political situations, economic development and related problems. There were several elections and referendums which ensured there was always something going on in politics, while the economies were characterised by strong economic growth, relatively high inflation, a high unemployment rate, an imbalance in goods trade and a significant deficit on the current account of the balance of payments. Illustration 5: Inflation changes in the period from July 2004 to February EMU price convergence index, Slovenia Convergence criterion Source: Statistical Office of the Republic of Slovenia Indeks Growth rasti index Juy-04 Sep-04 NLB Group Annual Report 2006 Nov-04 Jan-05 Mar-05 May-05 July-05 Sep-05 Nov-05 Ëetrtletja Jan-06 Mar-06 May-06 July-06 Sep-06 Nov-05 Jan-06 19

21 Table 2: Changes in selected Slovenian and EMU macroeconomic indicators for the period Real growth (in %) Slovenia GDP Inflation (l-xii/l-xii) Inflation (XII/XII) Unemployment rate Average gross salary (l-xll/l-xll) EMU GDP Inflation (XII/XII) Unemployment rate Source: IMAD, Eurostat in Nordea (IMAD - INSTITUTE OF MACROECONOMIC ANALYSIS AND DEVELOPMENT) 2007 forecast Table 3: Overview of macroeconomic data by SE European countries Real growth GDP (in %) Bosnia and Herzegovina Republic of Srpska BiH Federation Macedonia Serbia Montenegro Bulgaria Croatia December 2006 n.a. n.a Inflation (in %) December Current Account of the balance of payments (in mio EUR) December 2006 n.a , , , , , , , , , , , , , , ,

22 Performance Analysis Financial Review Business Report Financial Review In 2006, the operations and financial results of the NLB Group were good or very positive if analysed as part of the sequence of the last three years, in which a lot of attention was put on development of the Group (takeovers, mergers, harmonisations etc.) and, accordingly, on ensuring the conditions for future growth and successful operations. The financial result of the NLB Group is still predominantly influenced by the NLB, which contributed 51 % to the pre-tax profit of the Group in Banking remains the most important activity of the NLB Group since 87 % of the total pre-tax profit is generated by banks, 7 % by factoring and forfeiting companies and 4 % by leasing companies. In the total assets of the NLB Group banks account for 94 %, factoring and forfeiting for 3 % and leasing for 3 %. The NLB Group is active in the following key markets: especially Slovenia, Italy, Austria, Germany, the Czech Republic, Slovakia, in SE Europe, the Russian Federation and Switzerland. Even though other markets are gaining in importance Illustration 6: NLB Group s profit before tax structure in 2006 Illustration 7: NLB Group s balance sheet structure as at 31 December 2006 Other 2 % Other 0.3 % F&F 7 % F&F 3 % Leasing 4 % Banks 87 % Leasing 3 % Banks 94 % SLO 83 % SEE 12 % WCE 5 % SLO 79 % SEE 11 % WCE 10 % NLB Group Annual Report

23 with the intensive expansion of the NLB Group, the lion s share of the Group s profit, i.e. 83 %, is still generated by the Slovenian members. Profit and Loss Account The NLB Group generated SIT 36.9 billion of profit before tax with a minority stake (EUR million), which is 47 % more than the year before. Profit after tax totalled SIT 25.3 billion (EUR million). The NLB generated more than one-half of the Group s profit in 2006, namely SIT 24.1 billion in profit before tax (EUR million), which is 59 % more than the year before. Besides the NLB, the Slovenian subsidiary banks, NLB Tutunska banka and NLB InterFinanz contributed the most to the high profit of the NLB Group. The NLB Group s successful operations in 2006 are confirmed by its operating income which totalled SIT billion (EUR million), namely 18 % more than in the same period of the previous year. Both interest and non-interest income yielded good results. Net interest income of the NLB Group totalled SIT 87.2 billion (EUR million) which is an increase of 13 % over the previous year, mainly as a result of the quick growth seen in the lending activity. The interest margin in the Slovenian market has been falling for some time but is currently stabilising, while the margins achieved by banks in SE European markets are slightly bigger. It must also be mentioned that the central bank in Serbia introduced a high (40 % and 60 %) level of mandatory reserves on foreign currencies, which poses a serious limitation for banks in their future growth and represents a considerable loss of interest income. In terms of total assets, the compound interest margin at the NLB Group level stood at 2.6 % in 2006 which means it Table 4: Key profit and loss account items The NLB Group NLB 2006 Index 2006 Index in millions SIT EUR growth SIT EUR growth Net interest 87, , Net non-interest income 49, , Net fees and commissions 35, , Dividends received 1, , Net income from financial operations 6, , Net other income 6, , Total net income 136, , Total expenses 86, , Impairments and provisions 15, , Profits from capital investments in associated and 2, joint ventured companies (capital method) Profit before tax 36, , Corporation taxes 8, , Profits of minority shareholders 3, Profit after tax 25, , Exchange rate: EUR 1 = SIT

24 Performance Analysis Financial Review Business Report fell by 0.1 of percentage point compared to the previous year. In 2006, the interest margin in the NLB fell by 0.26 of a percentage point and the Bank tried to compensate for this through the considerable 17 % growth in interestbearing assets, achieving 5 % higher net interest income compared to The NLB Group s net non-interest income rose by 27 % to reach SIT 49.6 billion (EUR million). The lion s share of non-interest income was generated in the Slovenian market. The companies in SE Europe have great growth potential in the area in terms of the development of new and upgrading of existing products. The highest absolute growth was recorded in income arising from net fees which grew by SIT 7.4 billion (EUR 20.6 million). Almost one-half of these are fees arise from payment transactions. In the NLB, dividends received reached SIT 5.8 billion (EUR 24.3 million) which is significantly above the Group s level; this is reflected by the fact that the majority of income from dividends in the NLB is dividends received from companies in the NLB Group. Income from financial transactions totalled SIT 6.9 billion (EUR 28.9 million). Of this income, the greatest share resulted from favourable trends in the securities market realised in the NLB where as much as 80 % of the total portfolio is concentrated. Other net income of the NLB Group totalled SIT 6.4 billion (EUR 26.8 million) and mainly arose from the sale of IT services and the provision of cash transactions for other banks, as well as from rents. In 2006, the NLB Group was preparing for introduction of the euro, the merging of banks, restructuring and harmonising of the Group itself, which required a lot of activities and funds. Thus, the Group s costs including depreciation grew by 12 % over the previous year to total SIT 86.4 billion (EUR million). In spite of this, the overall cost efficiency of the NLB Group improved. This especially applies Illustration 8: Profit after tax of the main NLB Group members in SIT billion ,0 LHB Frankfurt NLB Tutunska banka The NLB Leasing Group NLB Banka Domžale NLB Koroška banka NLB Tuzlanska banka NLB InterFinanz NLB Razvojna banka NLB Continental Banka NLB Banka Zasavje NLB Montenegrobank Podgorica NLB Factoring Ostrava LHB Bank Beograd NLB West East Bank NLB Group Annual Report

25 to the NLB, where the cost/income ratio (CIR) dropped below 60.2 % in In 2006, the NLB Group formed SIT 16.0 billion (EUR 66.8 million) in additional provisions and impairments, which is 6 % more than in Thus, the average coverage rate of the portfolio with provisions was 3.9 % for the entire Group at the end of the year. It should be taken into account that the target coverage rates in the banks of SE Europe are quite high and that some banks (NLB Tutunska banka, NLB LHB Belgrade and NLB Tuzlanska banka) have already reached them while others are moving ever closer. In 2006, the NLB formed SIT 11.4 billion (EUR 47.8 million) additional provisions and impairments and maintained the principle of conservative portfolio management. The biggest share was additional provisions for credit risks due to the increased volume of operations, so that the portfolio coverage indicator remained at the level of the previous year, namely 3.1 %. The profits of associated and jointly controlled entities, which totalled SIT 2.5 billion (EUR 10.4 million), represent 6.6 % of the NLB Group s pre-tax profit. The results confirm the good performance of these companies whose relative shares in the volume of operations and profit are expanding. Balance Sheet Following its intensive expansion in the previous year, the NLB Group mainly focused on its organic growth in In 2006, total assets of the NLB Group grew by 16 %, reaching SIT 3,453 billion (EUR 14,408.8 million). Total assets of the NLB grew by 12 % to SIT 2,496 billion (EUR 10,415.8 million) at the end of Key Items of the Balance Sheet The key growth generators were loans to the non-banking sector which rose by 25 % or SIT billion (EUR 1,682.6 million) in the NLB Group. Besides the NLB, the NLB Leasing Group Ljubljana, NLB Montenegrobanka, NLB Tutunska banka, NLB Factoring and NLB Table 5: Key balance sheet items The NLB Group NLB Index Share in total assets Index Share in total assets in millions SIT EUR growth (in %) SIT EUR growth (in %) Total assets 3,452,933 14, ,496,041 10, Loans to banks 243,364 1, ,022 1, Loans to non-banking sector 2,069,035 8, ,398,180 5, Financial assets 744,371 3, ,293 2, (securities and derivatives) Deposits by the non-banking sector 1,749,982 7, ,286,435 5, Bank deposits 293,069 1, , Debt securities 95, , Loans raised 834,062 3, ,484 2, Subordinated liabilities 153, , Capital 203, , Capital including minority interest 230, Exchange rate: EUR 1 = SIT

26 Performance Analysis Financial Review Business Report InterFinanz contributed the most to the high profit levels of the NLB Group. Non-bank deposits of the NLB Group increased by 11 % or SIT billion (EUR million). In view of the slower growth compared to the growth in lending activity, this segment was among others also financed by bank loans. The NLB was the entity that borrowed the most in the international market; among others, it took out a syndicated loan in the amount of SIT 167 billion (EUR 700 million) in May This loan was partly used to repay old, more expensive loans. Besides direct financing within the Group, the banks and the other - NLB Group members - co-ordinated by the NLB were financed by raising sources from banks outside the NLB Group. Capital and Capital Adequacy of the NLB Group Both the NLB and the entire Group managed to guarantee sufficient capital needed for the growing volume of operations and increasing capital investments in 2006 by reinvesting part of the profit and raising subordinated loans. The capital used for managing risks in the NLB Group totalled SIT billion at the end of 2006 (EUR 1,177.5 million), while the capital adequacy was 10.8 %. The capital required for managing risks in the NLB reached SIT billion (EUR million) at the end of the year, while the capital adequacy was 11.3 %, which is above the regulatory requirement of the Bank of Slovenia and the minimum set in the Bank s own internal policy. Besides the Bank, NLB Banka Domžale and LHB Frankfurt also took out a subordinated loan for maintaining capital adequacy, namely SIT 42 billion (EUR million). Within NLB Group, subordinated loans were raised by NLB LHB Banka Belgrade, NLB Tutunska banka and NLB Tuzlanska banka. Illustration 9: Total assets of the main NLB Group members in SIT billion 50 0 LHB Frankfurt NLB Group Annual Report 2006 NLB Tutunska banka The NLB Leasing Group NLB Banka Domžale NLB Koroška banka NLB Tuzlanska banka NLB InterFinanz NLB Razvojna banka NLB Continental Banka NLB Banka Zasavje NLB Montenegrobank Podgorica NLB Factoring Ostrava LHB Bank Beograd NLB West East Bank 25

27 Retail Banking The main objective of the NLB Group s retail banking remains the provision of a high-quality and comprehensive range of services to all its clients in all markets. The NLB Group offers its clients both classic banking and specialised financial services such as asset management, bancassurance, pension insurance, mutual and other investment funds, stockbroking, leasing and factoring. The NLB Group branch network comprises 218 branch offices in Slovenia and 255 in the SE European markets. The NLB, together with the other banks belonging to the Group, operates 44.5 % of all personal accounts in Slovenia. In 2006, the market shares of subsidiary banks in Slovenia in their respective regional markets were retained. The subsidiaries in the SE European markets rank among the best in their respective markets in terms of the number of clients, the extent of the branch network and volume of operations. Clients can also use various modern distribution channels ATMs, electronic and telephone banking, which have been gaining ground with the clients of those NLB Group members operating in SE Europe. In 2006, the latter significantly encouraged retail operations, thereby achieving high growth rates in their operations. Illustration 10: Structure of NLB retail customers Personal and private banking 7 % Mass market 62 % Youth 20 % Seniors 11 % 26

28 Performance Analysis Retail Banking Business Report Private Persons The NLB Group is trying to adapt both the manner of treating its clients and its range of products offered to the different segments of complexity of its clients, thereby upgrading its overall approach to an individual client. It is thus intensely developing private banking intended for the most demanding and prosperous clients, supplementing the range of products offered in the area of personal banking, as well as those intended for young and senior clients. In 2006, the Bank recorded 23 % growth in loans in that segment, with the growth rate in the last two years coming in at 52 %. In 2006, this growth was only accounted for by foreign exchange so that at the end of the year foreign exchange loans already represented 40 % of all loans. Such dynamics were due to the clients expectations at the time of introducing the euro as the domestic currency and, of course, to the interest relations. As regards long-term loans, growth was especially intense in mortgage loans, with their level at the end of 2006 being up by 62 % relative to Also in deposit operations the growth recorded in 2006 was relatively high (6 %). A significant share of clients savings was also channelled into other types of investments as the diversity of products offered there constantly fuels clients interest in such products. In 2006, the NLB Group supplemented its saving and investment facilities with six mutual funds, one guarantee fund and four unit-linked life assurance products. NLB Naložba Vita Mega is the first investment life assurance product to be developed in full by the NLB Group (a result of cooperation between NLB, NLB Vita and NLB Skladi). A broad range of payment cards is provided by the NLB Group. In comparison to 2005, card operations went up by 6.6 %. Also growing was the use of cards by clients of the NLB Group outside Slovenia. The majority of cards is still accounted for by debit cards, with considerable growth also being seen with credit cards (16 %). Electronic and telephone banking, encompassing both classic telephonic banking and mobile phone banking, is used by 247,670 clients of the NLB. Major growth in 2006 was recorded in those clients using the NLB Klik electronic banking, i.e. by 24 %. The majority of Illustration 11: Growth in deposits in the last three years Illustration 12: Growth in loans in the last three years 1, in billion SIT Retail SME in billion SIT Retail SME NLB Group Annual Report

29 retail operations in the NLB are carried out by using modern distribution channels. Improved entrepreneurship, the development of financial markets and changes in the saving habits of retail clients are all reflected in the increasingly prosperous client segment. Responding to those changes, the Bank has become the first in Slovenia to introduce new private banking services. Thus, the total assets managed under private banking schemes went up by 80 % in Banking Operations With Small and Medium-sized Enterprises (SMEs) As regards corporate and private deposits, 13 % growth was recorded in 2006, and a 29 % increase during the last two years. In the area of business cards, the NLB s sales promotion activities resulted in a higher number of users. Compared to 2005, the growth stood at 19 %. The Proklik NLB electronic banking service is intended for corporate clients and is used by 28,621 clients, accounting for 54 % of business account holders. Every month, over 80 % of all transactions debiting business accounts are carried out using this service. There are 17 NLB branch offices specialising in SMEs in Slovenia. In order to enhance the overall development of the SME sector, the Bank organises various informative-training events intended for companies and co-operates with institutions such as funds, corporate and small business development centres, chambers of crafts and industry, and municipalities. The volume of loans extended to SMEs and sole proprietors through the branch network grew by 22 % in 2006, with the growth in the last two years having reached 47 %. The emphasis was on the promotion of long-term loans and loans funded by the EIB. In 2006, FX loans were more popular among the Bank s clients. Their structural share at the end of 2006 stood at 70 %. 28

30 Performance Analysis Corporate Banking Business Report Corporate Banking Despite the tough competition in the Slovenian banking, it may be said 2006 was one of the more successful years in terms of corporate banking. The key features of 2006 were the preparations to introduce the euro and the strong credit activity due to favourable economic trends in both domestic and international environments. In these circumstances, the NLB succeeded in maintaining a stable corporate portfolio. The growth trend in lending activities was preserved. In 2006, loans in this segment recorded growth of 19%. In anticipation of introducing the euro, corporate demand for FX loans was larger and so was the demand for long-term funding, which account for 65% of the loan structure. The NLB s role in the market is that of a bank providing its clients full-scope banking and financial services. The Bank s objective, which can be met successfully by the Bank s adaptability and increased sensitivity to its clients needs, is to offer both Slovenian and foreign companies a broad range of solutions under competitive terms and conditions. In the area of corporate bankning, the NLB s role in the Slovenian banking was further enhanced in the past year. A number of significant investments were completed in which the NLB participated in all investment phases from consulting, preparing the documents through to the financing itself along with followup and after-sales activities. The main projects in which the NLB was proactively engaged were in the fields of trade, telecommunications, food industry, construction and tourism. Much attention in 2006 was also paid to the financing of leasing and factoring. Whilst enhancing its leading position in the Slovenian banking, the NLB is also consolidating its position in foreign markets. The Bank is in a position to take advantage of the synergy enabled by the presence of the Group banks in other countries. The Bank thus enjoys successful co-operation in foreign markets, mainly in Serbia, Montenegro, Bosnia and Herzegovina, and Macedonia. Many significant projects were accomplished in those countries, which also received strong local support. In the last year, cash management services have gained ground within the NLB Group, by providing full-scope solutions to companies with international operations. Illustration 13: Increase in loans to non-bank sector Illustration 14: Structure of loans to non-bank sector 1, Short-term 35 % in billion SIT Long-term 65 % NLB Group Annual Report 2006 Dec 2004 Dec 2005 Dec

31 Financial Markets Liquidity management Drawing on the general situation of the Slovenian market, the NLB was acquiring substantial tolar funds stemming from temporary sales of foreign exchange (swaps) to the Bank of Slovenia. By the end of 2006, they were finally sold to the Bank of Slovenia. In addition to this source, the Bank obtained funds in the interbank market by means of deposits, temporary sales of securities and through auctions of the Ministry of Finance. Most of the funds acquired had a short-term maturity. Surpluses in tolar funds were placed in the inter-bank market, in central bank bills, treasury bills and government securities of the EU member states. The main activities of the Slovenian banks belonging to the NLB Group in 2006 focussed on preparations to introduce the euro. In the process of moving towards euro-denominated operations, the banks belonging to the Group entered into a framework agreement with the NLB which regulates the new relations in payment transactions, the terms and manner of conducting treasury operations and trading in financial instruments, as well as the terms and ways of engaging in documentary and credit operations. Towards the end of the year, a growing number of activities was designed to formulate common guidelines for transforming financial assets from tolar-denominated investments into euro-denominated ones. Compliance with the Bank of Slovenia s regulations In 2006, the Bank complied with the regulation on statutory reserves. The percentage of meeting the statutory reserve requirements ranged from % to %. The Bank also complied with the prescribed measure on minimum liquidity. Organisation and implementation of securities issues for other issuers In 2006, the NLB organised and implemented three issues of securities on Illustration 15: Liquidity ratio movements in days days Value of the ratio

32 Performance Analysis Financial Markets Business Report behalf of and for the account of other issuers: in February 2006, an issue of bonds with a par value of EUR 12.5 million was conducted for a Slovenian bank, in December 2006, the first sale of preferential shares with a par value of EUR 10 million and the first sale of bonds with a par value of EUR 10 million were carried out for an Italian financial company; the NLB issued a guarantee to the company for the successful issue of preferential shares worth EUR 5 million. NLB bond issue Three series of bonds were issued by the NLB in 2006: NLB20, NLB21 and NLB22, with a total par value of SIT 19.8 billion (EUR 82.7 million). The bonds were issued in a non-public offering and admitted to the organised market of the Ljubljana Stock Exchange. Implementation of syndicated loans in domestic and foreign markets Together with the banks of the NLB Group and other Slovenian banks, the NLB organised several transactions for major Slovenian companies in The total value of newly granted syndicated loans in 2006 in which the NLB acts as an organiser and agent was EUR 241 million. All syndicated loans were extended in euros. Acquisitions In 2006, the NLB acted as the acquiring agent in the implementation of seven public offers for the purchase of shares of companies, with the value of the offers reaching a record level of EUR million. The value of realised purchases within the framework of the said offers was as much as EUR 44 million. Among the abovementioned offers, the NLB also accomplished the management buyout of two large Slovenian companies. It is this market segment, in which the Bank is engaged during the early phases of structuring transactions, that is becoming a significant specialty of the NLB. Major transactions conducted for clients in the field of acquisitions which were carried out by the NLB in 2006: LIV Postojna d.d. (metal-processing industry): EUR 23.8 million, Primorje d.d. (construction): EUR 15.3 million, Skupina Viator Vektor d.d. (transport): EUR 22.1 million. Dealing in securities The NLB was again ranked first among members of the Ljubljana Stock Exchange, measured in terms of both transactions made through the stock exchange trading system and registered blocks, generating a turnover of SIT 97.4 billion. Moreover, the Bank was also active in the OTC market where it was engaged in providing its clients with those securities not listed on the Ljubljana Stock Exchange. The Bank also increased its volume of operations in foreign markets. By means of a network of foreign executive partners, the NLB is capable of dealing in all significant developed and the majority of developing capital markets. Asset management Since 1993, the NLB has been providing individual asset management services; during that period, it has obtained experience in the developed capital markets and, in particular, the confidence of its clients. By individually managing over SIT 23 billion (EUR 96 million) of clients assets, the NLB ranks first among Slovenian service providers, holding a market share of nearly 30 % among Slovenian banks and stockbroking companies. The favourable situation in capital markets, adequate approach to asset management and increasing client NLB Group Annual Report

33 32 trust are the key factors that boosted the volume of managed assets in the recent period. The average value of an individual client s assets that are managed rose by 14.7 %. Thanks to the asset management services, the income generated by the NLB in 2006 was 63 % above that earned in the preceding year. Custody services The upward trend in the number of transactions and volume of assets in custody in 2006 was maintained. Compared to the preceding year, the volume of assets rose by 67 % whilst the net income grew by over 49 %. In order to meet the interest of prospective investors, in 2006 the NLB offered an improved range of custody services which was further supplemented by services involving securities in 72 global markets. The custody area is being further developed in banks belonging to the Group and in the Balkan markets. Trading with clients In addition to raising the number of transactions (which exceeded 25,000), efforts were made to expand the range of financial instruments offered to strategic clients. Besides classic conversions of currencies and deposits, in 2006 the Bank provided its clients with forward transactions, currency exchanges, synthetic forward transactions and two new depositcurrency investment products. Currency trading Approximately 12,000 conversions totalling over EUR 6.3 billion were concluded by the NLB in The majority of transactions were denominated in the world s leading currencies. In addition to those currencies, trading in the currencies of former Yugoslavia (the Serbian dinar, Bosnian convertible mark, Macedonian denar and Croatian kuna) are on an upward trend as are the Eastern European currencies (the Russian rouble and Bulgarian lev). In anticipation of introduction of the euro and abolition of the domestic currency in 2007, there was much trading in the domestic tolar currency, amounting to EUR 1.87 billion. Trading in cash In 2006, the volume of operations involving temporary sales of securities REPO operations grew significantly. The turnover equalled EUR 1.5 billion. In certain periods, the volume of concluded REPO transactions stood as high as EUR 300 million. By using this instrument, the NLB was able to lend FX assets in the money market on more favourable conditions than apply to classic interbank deposits. In comparison to the preceding year, turnover with currency swaps also increased. It amounted to EUR 9.0 billion, with the currency pairs of most interest being EUR/SIT and USD/SIT. Debt securities trading In 2006, the NLB acted as a primary subscriber to bonds of the Republic of Slovenia and was successful in the area of maintaining bond liquidity in the secondary market. It was ranked first by its market share. Within the framework of the trading portfolio of debt securities, the largest segment is accounted for by government bonds and state-guaranteed bonds. Apart from that, there is active trading in bonds issued abroad. Trading in government bonds from the territory of former Yugoslavia is on an upward trend as well. Derivatives trading 2006 saw a continuation of the growth trend in the use of interest derivatives. What especially increased is the demand for more structured interest swaps and hedging by means of interest options. In the field of currency derivatives, operations involving currency options grew whilst forward transactions were used to a somewhat smaller extent. In 2006, the Bank started to trade in interest rate futures and interest rate swaps (IRS) for the hedging of its own portfolios.

34 Performance Analysis International Operations Business Report International Operations For several years, the NLB Group has been well respected in the international banking arena. This is mainly due to its strategy, direction and tradition of international operations, extensive experience in international operations, as well as its wide network of commercial banks and representative offices abroad. Current account network The NLB is open to its clients interests and business opportunities, thereby enabling their smooth international operations via a network of 300 accounts in different currencies and over 1,300 cases where the Bank acts as a correspondent bank for banks from all across the globe. International payment transactions The total volume of payment transactions of the NLB Group in Slovenia in 2006 exceeded EUR 17 billion. Two-thirds of the total volume of international payment transactions was performed using the electronic banking channel Proklik NLB. What especially marked international payment transactions in 2006 were the preparations to introduce the euro. Apart from all the necessary technological changes, the Bank paid special attention to training its clients. In 2006, the NLB also started with preparations to launch the Single Euro Payment Area (SEPA) which will enable the effecting and receiving of euro-denominated payments on the same terms and conditions and with the same rights and obligations and business practices regardless of whether such payments are effected within an individual country or between EU member states. Documentary operations The NLB is maintaining the growing trend of guarantee operations which reflects the large and complex projects undertaken in the fields of infrastructure, construction and acquisition of ownership shares abroad as well as the intensified NLB Group Annual Report 2006 operations of the banks belonging to the NLB Group. Compared to the year before, the number of guarantees granted in 2006 grew by over 10 %. Operations involving letters of credit and documentary collection, for both imports and exports, remained at the level of the preceding year with a markedly growing trend being seen in special versions of those instruments such as documentdependent transfers and documentary payments of funds made from fiduciary accounts. The volume of operations by value is above the 2005 level, which is mainly due to the intensive use of instruments in the operations of financing international trade. The NLB s long-term borrowing in foreign financial markets In 2006, the NLB mainly borrowed longterm funds in foreign financial markets by raising loans, which is due to the more favourable conditions applicable to borrowing compared to other ways of borrowing. For the NLB, the 2006 conditions for borrowing funds abroad were even more favourable than in the preceding years which reflects its long-standing business co-operation with foreign banks and the NLB s high international ratings. They all demonstrate the NLB s recognition in the international arena. Most financing sources were obtained by borrowing from foreign commercial banks, whilst one portion of the funds intended to finance clients specific- 33

35 purpose projects was raised in the form of credit lines with multilateral financial institutions. Borrowing from commercial banks For its general financing purposes, in 2006 the NLB took out a syndicated loan equalling EUR 700 million and issued debentures (Schuldschein) amounting to EUR 15 million. To date, this syndicated loan is the largest international loan raised by any Slovenian bank and one of the biggest loans taken out by financial institutions in Central and Eastern European markets. For the purposes of improving the Bank s capital adequacy ratio, the NLB made two borrowing transactions abroad. Early in 2006, it raised a subordinated loan amounting to EUR 75 million and later in the same year a hybrid financing instrument totalling EUR 100 million. Borrowing from multilateral financial institutions Multilateral financial institutions as nonprofit development institutions offer favourable sources of financing for the projects pursued in the member states of those institutions. The funds intended to finance minor projects are provided through financial intermediaries, i.e. commercial banks. For several years now, the NLB has been co-operating with the European Investment Bank (EIB), the European Bank for Reconstruction and Development (EBRD), the Council of Europe Development Bank (CEB) and the International Financial Corporation (IFC). In order to finance the projects undertaken by Slovenian SMEs, municipalities and major projects in Slovenia, in 2006 funds amounting to EUR 50 million were raised from multilateral financial institutions by the NLB. Export financing and export insurance The NLB is the leading commercial bank in the fields of export financing and export insurance, offering its clients a full-scope range of services for monitoring their international trade operations, i.e. from documentary letters of credit, service and payment agencies to the financing of more complex trade operations in the form of structured export and financial loans to those buying the goods and services provided by NLB clients. Services are tailored to the needs of individual Illustration 16: Structure of NLB s long-term borrowing in foreign financial markets 34 Syndicated loan 74 % Borrower s notes (Schuldschein) 2 % Subordinated loan 8 % Hybrid instruments 11 % Credit lines of multilateral institutions 5 %

36 Performance Analysis International Operations Business Report clients. The main part of export financing and export insurance is accounted for by the transactions financially supporting the exports of Slovenian companies. The NLB pays special attention to those export markets with a strategic significance for its clients; those markets comprise Russia, Ukraine, Belarus, Kazakhstan, Croatia, Bosnia and Herzegovina, Serbia, Montenegro and Macedonia as well as markets in the Middle and Far East. A special role in the NLB s operations in foreign markets is played by the Slovenian Export and Development Bank (SID). The NLB co-operates with it in all major projects where the SID provides insurance against commercial and non-commercial risks. In 2006, export insurance transactions exceeding EUR 100 million were realised. Apart from export financing, the NLB has been paying much attention in recent years to harmonising the international operations of the entire NLB Group, individual members of the NLB Group and their strategic clients. In this way, the NLB supports the subsidiary banks and financial organisations, especially for financing international trade and investments. Besides that, it wants to train them, by providing assistance and advice, for independent operation on foreign financial markets. Moreover, the NLB is active in the area of financing the strategic clients of individual banks members of the NLB Group by means of participating in the risks and loans. The NLB s goal is to actively monitor the blue chip companies on the Group s markets and provide for them the entire range of financial and other services needed for successful operation. The result of the synergy is evident in the increased investment activity and fullscope monitoring of important strategic clients at the NLB Group level. In 2006 the aggregate volume of investments, including export finance transactions to the abovementioned markets and other financial loans, exceeded EUR 420 million. The total volume of confirmed letters of credit and letters of guarantee and other forms of assumed risk in 2006 exceeded EUR 200 million. The credit portfolio grew from over EUR 300 million at the end of 2005 to over EUR 420 million at the end of Russian Federation 22.2 % Illustration 17: Total credit exposure of the NLB abroad in 2006 Macedonia 8.0 % Kazakhstan 2.4 % Croatia 1.2 % Montenegro 13.8 % Czech Republic 3.5 % NLB Group Annual Report 2006 Slovakia 1.7 % Serbia 19.4 % Ukraine 7.7 % Belarus 1.9 % Bulgaria 1.9 % BIH 16.3 % 35

37 Information Technology In 2006, the Bank continued to implement the IT strategy it adopted, despite the complex preparations to introduce the euro. 36 In retail banking, the NLB developed and put to use state-of-the-art web solutions for the front and more complex products for the retail back office system, which enabled the Bank to abandon the previous front office IT solution, retire the technical equipment used in Slovenia for up to 25 years and stop using several outdated applications for managing individual products. In addition, the support to new loan products, card payments, web services and the marketing of non-banking products was updated. In corporate banking, the NLB continued to introduce the integrated Globus system while it provided multicurrency transaction accounts, the gradual migration of loans and deposits, and uniform connectivity with modern distribution channels and domestic payment transactions. The project is continuing in As regards solutions supporting payment systems the technical architecture was streamlined and the introduction of new solutions resulted in the significantly greater capacity of systems enabling the inclusion of banks from the NLB Group in Target directly via the NLB and the abandoning of a direct connection with domestic settlement systems. The connection of the new counter solution and upgrading of the back office domestic payment transactions was the core of service guide as the central strategic platform of the service-oriented architecture. The Bank introduced the Kondor+ system, integrated with the back office systems, in order to ensure the better quality of risk management in securities trading. The NLB regularly upgraded its IT support because of the amended legislation, notably as regards reporting to external institutions, e.g. the ECB, tax legislation, introduction of the International Accounting Standards and Basel II. In spite of the considerable changes in 2006 related to the new solutions supporting the Bank s operations and the adaptations relating to introduction of the euro, the Bank managed to maintain a high level of availability of its on-line systems (99.67 % at the annual level). Significant progress was made in managing the introduction of changes due to the adopted measures of system operation control and internal control procedures. For the purposes of managing uninterrupted operations, the plans for operation without support were supplemented in relation to newly introduced solutions and the identified risks specific to the transition to the euro with a big bang model. The existing disaster recovery plans were regularly tested. In 2006, the NLB continued to implement the strategy of strategic partnership with local companies in software development in order to ensure sufficient capacity for the next two to three years. In this way, the Bank will be able to cover more of its development needs, ensure support that will be in compliance with the applicable legislation, reduce its dependence on key suppliers and carry out the urgent activities for the simplification of IT support. With regard to IT, the NLB carried out activities related to the standardisation of IT systems in the NLB Group and participated in the development and implementation of specific projects in individual members in The process of the harmonisation of IT support in the banking part of the Group thus started in This will enable the creation of competency centres for individual solutions and provide better quality relationship with suppliers at the Group level. IT experts in the NLB are actively involved in projects of upgrading the information systems as well as defining and introducing security and other IT-related standards. Group level. IT experts in the NLB are actively involved in projects of upgrading the information systems as well as defining and introducing security and other IT-related standards.

38 Performance Analysis Risk Management Business Report Risk Management Risk management is crucial in activities for achieving the strategic objectives of the NLB Group. The use of standard risk management methods enables a quality assessment of all types of risk, a timely response and reduction of risk exposure. The NLB and its subsidiary banks primarily comply with the regulations of the Bank of Slovenia, while risk management is also regulated by its own internal rules. NLB Group Annual Report 2006 Credit risk management Prior to loan approval or entering into a contract which would expose the Bank to a credit risk, every client receives a rating and an individual borrowing ceiling. The client s rating depends on their financial standing, business performance, relationship with the Bank to date, the ability to provide a sufficient cash flow to meet future obligations as well as on the country risk stemming from loans to clients with a registered office in a foreign country. The client s borrowing ceilings are established on the basis of their creditworthiness, the feasibility of the transaction, as well as other elements which might influence their ability to repay the loan. They are determined separately for long- and short-term loans. In addition to determining borrowing ceilings for individual clients, the Bank also establishes ceilings for client and country groups. After a loan has been approved the Bank regularly monitors the client s performance and settling of its obligations. With regard to risk inherent to individual transactions and any evidence of impairment, the Bank establishes impairments and provisions in accordance with the International Accounting Standards. In line with decisions adopted by the Bank of Slovenia, in 2006 the NLB no longer calculated provisions in accordance with the Slovenian Accounting Standards. The calculation is made on an individual basis for the bulk of the portfolio with an individual review of receivables. Impairments for the remaining receivables are established on the basis of historical data. In 2006, the NLB strengthened its control over subsidiary banks and financial institutions by performing regular checks of their business practices and investment portfolios. Further, the Bank adopted a programme for 37

39 developing risk management in the banking group (minimum standards). This approach ensured that uniform and standard procedures are applied in client ratings and the forming of provisions for credit risk. Market risk management The NLB manages market risks at the general level and separately by position in its banking and trading books. The market risk exposure was relatively small in In line with the adopted risk management development programme in the banking group, the NLB introduced guidelines regarding the monitoring of market risk. This resulted in a substantial harmonisation of business policies, procedures and methodologies as well as the standardisation of reporting. In line with the requirements of the Bank of Slovenia, the NLB Group provides sufficient capital to cover any unexpected losses which may arise from exposure to foreign exchange and other market risks. Reporting to the Bank of Slovenia is made on a monthly and quarterly basis using a standardised approach. Foreign exchange risk Foreign exchange risk is monitored and managed on a daily basis. By closing open FX positions within the set limits on a daily basis the Bank minimises its foreign exchange exposure and thereby Table 6: Migration matrix of the NLB, weighted by exposure based on annual transitional matrices for the period BON_06 BON_95 A B C D E Exposure Average Rating* A % 2.25 % 0.22 % 0.05 % 0.01 % 13,595,246, B % % 3.08 % 1.28 % 0.12 % 2,182,296, C 8.87 % % % % 0.85 % 338,399, D 0.08 % % % % % 201,593, E 1.33 % 0.45 % 0.19 % 1.51 % % 197,467, *Note: A=5,,E=1 Illustration 18: Credit portfolio structure by client segments as at 31 December Retail clients 14 % Banks from abroad 9 % Financial organisations from abroad 4 % Companies from abroad 5 % Bank of Slovenia 8 % Foreign governments 6 % Republic of Slovenia 6 % Sole proprietors 2 % Slovene banks 3 % Slovene companies 39 % Slovene financial organisations organizacije 4 %

40 Performance Analysis Risk Management Business Report adheres to its relatively conservative policy of managing foreign exchange risk. The NLB regularly monitors exposure at the banking group level. The Bank uses the internal VAR (Value at Risk) model in addition to the standardised methodology for foreign exchange risk calculation. The daily calculation of the VAR value is adjusted to the Basel standards (99 % confidence interval, a monitored period of 250 business days, a 10-day holding of a position) and based on the historical simulation method. In addition, backtesting is carried out regularly to confirm the accuracy of the model and calculation of stress scenarios. The model is used for internal purposes only. Interest rate risk The Bank s interest rate risk exposure is monitored and managed by using the methodology of interest spreads. The reports contain an analysis of interest rate sensitivity by individual time period. The NLB regularly monitors exposure to interest rate risks at the banking group level. The NLB has upgraded its interest rate sensitivity analysis with the separate management of interest rate risks of two sub-positions in its banking book. The first sub-position involves investing stable sources without a known maturity in debt securities for the purpose of providing adequate secondary liquidity of the Bank. The Bank manages the Table 7: Poorly performing loans in the NLB Bad loans (in thousand SIT) 20,399,117 17,208,403 Bad loans / total loans 1.44 % 1.01 % Table 8: Banking book position of the NLB (in mio SIT) GPV (-10 bp) NII* (-10 bp) *NII Up to one-month interest rate gaps, multiplied by the change in the interest rate NLB Group Annual Report

41 second sub-position, which includes financial instruments with a known maturity arising from transactions with clients, within the set limits. When determining exposure to interest rate risks, the Bank also performs sensitivity analyses. The table below gives an estimate of the degree to which a drop of 10 base points (-0.10 %) in the interest rate impacts net interest income (NII) in the current year and the change in portfolio value (GPV) for its banking book position. Trading book The NLB adopted a framework trading policy as regards its trading book. The Bank has several branches engaged in money and capital market trading. They primarily focus on providing services to clients, asset management and trading for own account. Trading is carried out in currencies, interest rates, securities and derivatives, while trading in options is limited to FX and interest rate options and is primarily performed upon the request of a client. The Bank does not trade in derivatives on loans and goods. The trading volume by members of the NLB Group except the NLB does not exceed the regulatory criteria regarding capital requirements concerning market risks. Debt securities portfolio The monitoring and measuring of risks related to the foreign bonds portfolio are based on the variance-covariance method of calculating VAR. The basis Illustration 19: VAR of currency positions VAR Monthly average in thousand SIT

42 Performance Analysis Risk Management Business Report of the model is the same as with the currency risk model. The exposure of domestic and foreign government bonds portfolios is also monitored on the basis of the GPV and gap methods. The NLB has adopted debt securities trading policies. The policies specify the allowed structure of investments within the portfolio, the monitoring and management of risks and possible forms of portfolio hedging. and possible forms of portfolio hedging. The major part of the portfolio was relatively stable in The Bank applies the historical VAR method, adjusted to requirements of the Basel standards, to monitor and measure the share portfolio risks. Equity securities portfolio As regards investments in equity securities, the Bank adopted the investment management policy approved by the Management Board. The policies specify the allowed structure of investments within the portfolio, monitoring and management of risks Table 9: VAR and GPV for debt securities in the NLB Tolar bonds Foreign bonds GPV (-10 bp) (in mio SIT) VAR (in mio SIT) VAR as % of market value 1.02% 0.32% Table 10: VAR for the portfolio of equity securities (in mio SIT) Average VAR Minimum VAR Maximum VAR First half of Second half of , , NLB Group Annual Report

43 Basel II In 2006, Slovenia was carrying out preparations for the new legislation regulating risk management and the calculation of capital and capital requirements arising from the European Capital Adequacy Directive (CAD). The NLB actively took part in the creation of the said legislation within the Bank Association of Slovenia by participating in the making of comments and observations related to decisions of the Bank of Slovenia. 42 As regards implementation of the changes expected to arise from the said regulations, in 2006 the Bank focused on the development of operating risk management and testing of the point model for assessing companies credit risk. The latter will in the initial phase not be used for the calculation of capital requirements as it was prepared with a consideration of the requirements applying to the internal classification of clients and establishing the probability of a default according to approaches based on internal credit ratings. In the area of operating risks a suitable decision-making structure was set up in line with the requirements of the standardised approach to operating risk management. This was followed by the development of operating risk management methodologies. The NLB has developed the application for recording and reporting loss events, which comprises all data about loss events occurring since In 2006, the Bank started identifying and assessing operating risks to find suitable measures for controlling essential risks with the aim of preventing and reducing future loss events. The Bank places special emphasis on the training and education of its employees and raising awareness of the importance of operating risks. Knowledge is also gradually being transferred to members of the NLB Group. In line with the known decisions of the Bank of Slovenia, before the end of the year the NLB revised the implementation plan of the Basel II project and incorporated some additional activities in it. Thus, the Basel II project now consists of 11 substance sets covering activities from the following areas: calculation of capital and capital requirements for all types of risks according to Pillar 1 of the Basel document, Pillar 2, including the internal capital calculation, and disclosures. A great emphasis is put on the treatment of risks and preparation of calculations at the NLB Group level. The NLB has decided to implement the new legislation on 1 January 2008, with the exception of one part which enters into force already in In the light of this decision, the project implementation schedule has been established which is why already in 2006 the Bank started developing the application support for calculation of its capital and the redesign of the calculation of the capital requirement for market risks.

44 Performance Analysis Introduction of the Euro Business Report Introduction of the Euro On 1 January 2007 the NLB flawlessly carried out the changeover to the euro and thereby further consolidated its reputation and trust in Slovenia and abroad. The changeover to the euro was without doubt the project of the decade for the Bank both in terms of the scope and complexity of preparations, as well as the related exceptional public interest. The successful transition is the result of more than two years of intensive systematic work, mainly involving the adjustment of IT support, preparations for the cash transition and public communications. The introduction of the new currency represented an important test of the IT system s stability in the NLB. More than 130 applications had to be adjusted, linked to individual systems supporting business processes in the Bank and the environment, together forming a complex IT architecture. Owing to the co-dependence between IT systems, the risks involved in the adjustments were greater. These risks were reduced by extensive tests conducted almost throughout the entire 2006 and completed with four cycles of full integration testing. It turned out that during the changeover and after it all IT systems were stable and functioned without problems. The changeover to the euro also represented an exceptional organisational and logistic task related to the extensive and thorough preparations, training of employees, provision of logistical capacities and so on. The NLB had to withdraw from circulation and put into circulation more than 1,000 tons of tolar and euro cash respectively, and already on 1 January 2007 it has arranged for 98 % of ATMs under its management to start dispensing euro cash. Cash exchanges in the branches were conducted smoothly, the supply of cash was always sufficient. Credit for the smooth and fast changeover to the euro can be attributed to the Bank s sufficiently early and systematic communication with its various publics, especially via the media. The NLB s clients were well informed and prepared. Thus, the Bank recorded no problems or clients complaints in the first days following the opening of the branches despite the rise in clients visits and increased use of ATMs and internet banking services. The media response was also extremely positive, with all stressing that the Bank was well prepared and had provided for a smooth changeover to the new currency. The bulk of direct expenses arising from the euro s introduction in Slovenia are clearly being borne by the commercial banks which engaged a significant share of their human and material resources in the preparations. The entire project cost the NLB about EUR 20 million, slightly less than half of which is accounted for by the opportunity costs of Bank employees. More than 1,700 staff participated in the preparations and implementation of the changeover to the euro. The cost of investments in IT and other equipment (ATMs, transport vehicles, cash counters, POS devices etc.) totalled about EUR 6 million, whereas other project expenses amounted to a good EUR 3 million. NLB Group Annual Report

45 Managment and Corporate Social Responsibility