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Performance Analysis

Financial Review of Business Performance

Financial Review of Business Performance

Excellent business, financial, as well as organizational results, characterized the NLB Group in 2007. The Group successfully met its set goals by following its strategic guidelines.

The trend that led to increased profits and improvement in the indicators of cost efficiency and return on investment continued in 2007. NLB Group’s profit before tax amounted to €183.0 million, and profit after tax €131.3 million. The trend of sustained progress, measured by all absolute and relative indicators of business performance, continued in spite of unfavorable conditions in international markets in the second half of the year. Thus, return on equity (ROE) reached 17.8% and the cost/income ratio 60.3%. The value of the cost/income ratio indicator improved by 2.9 percentage points compared to 2006, and return on equity by 1.1 percentage points. A somewhat smaller increase of the ROE was influenced by the increasing capitalization of the NLB.

Commendable business results in 2007 were a combination of favorable market conditions, expansion of the portfolio offerings and the continuation of the business optimization processes; further consolidation of the Group, improvements of processes and optimization of expenses. All these accomplishments were as a whole the consquence of the organic growth and development of the Group, since the two new acqusitions (Kosovo) did not materially affect the business performance of the Group.

Unquestionably, one of the key factors that influenced these good results was the large increase in the volume of business in the past year in practically all business segments and markets despite the restrictive legislation of central banks that curtailed growth in some countries (Serbia, Bulgaria).

In the changed circumstances following the outbreak of financial crisis in the second half of 2007, the key factor in achieving good results was also revenue structure. The prevalent income of the Group’s revenue has been the type that by its nature is more stable and in recent years displayed constant growth. The main generator of revenue was interest income, which represented 63%of total earnings. The second largest category was fees, while financial business, which by its nature tends to be more volatile, accounted for almost 7%of total earnings. In 2007, the Group realized a one time gain of €15 million from a real estate sale.

Strong business growth and the financial crisis are certainly factors that increase risk in business operations. It is necessary to stress that the degree of risk for the NLB Group portfolio is low. The Group continues to operate following an approved conservative policy that is risk adverse and in conjunction with a policy that features the formation of adequate reserves. The share of nonperforming loans to total assets has steadily decreased and in 2007, it reached its lowest level in the last 10 years.

Income Statement

The NLB Group generated a €183.0 million profit before tax including a minority interest, 19% more than last year. The profit after tax was €131.3 million. Without non-recurring transactions, the profit before taxes with minority interest would have been €168.0 million.

Better than half of the entire Group’s profit was generated by NLB, which in 2007 earned a before tax profit of €143.0 million, up 42%from the previous year. The after tax profit amounted to €118.8 million. Apart from the NLB, the companies that contributed most to this high profit return were NLB Tutunska Banka, NLB Koroška Banka, NLB Banka Domžale, NLB Leasing Group Ljubljana and NLB Propria (one time transaction – real estate sale).

The net interest income of the NLB Group rose to €428.9 million, up 18% from 2006, primarily due to the robust growth of credit activities and stable interest margins.

The cumulative interest margin of the NLB Group, considering NLB total assets, was 2.4% in 2007, down by 0.2 percentage points from the previous year. In 2007, the NLB interest margin was 2.07%, which is 0.13 percentage points lower than in 2006. In the last quarter of the year, due to changing conditions in international markets, the increase in passive interest rates and a different timeline bringing higher active interest rates caused additional pressure on interest margins.

Net non-interest income of the NLB Group rose by 23%, and reached €254.3 million. The major portion of this income was realized in the Slovenian market, generated mostly by fees (payment and credit card transactions). Businesses in SE Europe still have great growth potential in this area by developing new products and upgrading the existing ones.

The greatest absolute growth was seen in net income from other sources, which increased by 81% from last year and rose to €48.6 million. The major part of this income (€15 million) came from the sale of the TR3 office building. The rest of the net income was generated by the sale of IT services and fees from cash transactions for other banks as well as earnings from rentals. In spite of unfavorable developments in global markets in the last months of 2007, high growth was also achieved in net income from financial transactions and dividends. These increased 44% from last year to total €41.2 million. The major share of these earnings was generated by the NLB, in which 73% of the total portfolio was concentrated. The dividends received by the NLB totaled €51.9 million, of which dividends received from subsidiaries represented €48.0 million.

Earnings from net fees totaled €160.3 million. Almost half of them came from payment transaction charges.

Compared to 2006, business expenses together with depreciation, rose by 14% and totaled €411.9 million by the end of 2007. Despite this increase, the NLB Group’s cost efficiency actually improved. This is especially true for the NLB, whose cost/income ratio for 2007 dropped below 60% to 53.3%. Increase in expenses was due primarily to the increase of development costs and the previously mentioned introduction of the Euro. Meanwhile current operating expenses held steady.

In 2007, the NLB Group set aside €101.7 million in additional provisions and impairments, 53% more than in 2006. Thus, the average rate of coverage for the portfolio with provisions for the NLB Group reached 3.3% by the end of the year. It should be noted that the target coverage rates in the companies of SE Europe are very high and that some banks (NLB Tutunska Banka, NLB LHB Beograd and NLB Continental Banka) have already reached them, while the rest are nearly there. The average rate of coverage in these companies was 5.1% at the end of the year. In 2007, the NLB set aside €60.3 million in additional provisions and impairments and maintained its conservative approach. The largest amount was held as additional provisions to cover credit risks due to the increased volume of business. The coverage rate for the NLB portfolio was 2.4% at the end of 2007.

The profits of associated and joint ventures amounted to €13.4 million and represented 7.3% of the NLB Group’s pretax profit. The results prove that these companies performed well and that their operations account for an ever-greater share of the business, as well as, the profits of the Group.

Contribution of Segments to the Group Results

Banking remains the NLB Group primary activity, given that banks bring in 79.3% of pre tax profit. Banks in the SE European markets generate 9.4% of this figure, the other 20.7% is evenly distributed among the following activities: leasing, factoring and forfaiting and other non-strategic operations. The large share of profits from non-strategic activities in 2007 was due to one-time, non-recurring transactions.

Relative to the entire NLB Group, banks represented 93.1%, factoring and forfaiting 3.5%, and leasing 3.1% of the total assets.

While intensive expansion made other markets more important, it still remained true that group members in Slovenia bring in 84.0% of total profits. Without the one-time transaction, their contribution to the total profit was 82.5%, the contribution of the companies in SE European markets 12.1%.

Balance Sheet

In 2007, the NLB Group, after the intensive capital expansion of previous years, focused primarily on organic growth. The Group total NLB assets grew by 27% to €18,308.1 million in 2007. The NLB total assets increased by 26% to €13,093.6 million by the end of 2007.

The key engines of growth were loans to the non-banking sector, which increased by 37% in the NLB Group to €11,943.3 million. The growth was to a large extent the consequence of stepped up economic activities in the NLB Group’s key markets, particularly in Slovenia. After the NLB, NLB Leasing Group Ljubljana, NLB Montenegrobanka, NLB Tutunska Banka and NLB Interfinanz Zürich contributed most to the total increase in volume of credit portfolio.

Deposits from the non-banking sector of the NLB Group grew by 25% to €9,169.3 million. Because growth in deposits lagged behind growth in lending, the amount borrowed in international markets by the NLB Group increased considerably in 2007. Characteristic of the banks in the SE European markets is that since these markets are less developed, the ratios between credits and deposits are more favorable and the need for refinancing is less. Most of the borrowing was done to cover the increased volume of credit raised for the NLB, even though, under the coordination of the NLB, other members in markets outside the group also incurred increased debt.

Capital and Capital Adequacy of NLB Group

At the end of 2007, NLB Group’s regulatory capital amounted to €1,468.0 million, and NLB’s, €1,039.6 million.

Using internationally accepted methodology for calculating capital adequacy, the NLB Group capital adequacy ratio was 10.8%, the NLB 11.3%.

The capital adequacy ratio required to comply with the Bank of Slovenia’s regulations, which is more restrictive, was 9.8% for the Group and 10.9% for NLB.

In 2007, the NLB and NLB Group as a whole secured capital adequacy by partially reinvesting profits, raising subordinated loans and other instruments that helped raise additional regulatory capital and capitalization.

In June 2007, the NLB raised a subordinated loan of €190 million to maintain capital adequacy; €90 million of that sum was set aside to pay off the subordinated loan from 2002. In July, the NLB took out hybrid instruments that totaled €120 million. LHB Internationale Handelsbank also took out a subordinated loan of €11 million.

In September 2007, in order to increase equity capital, the NLB issued 325,733 new shares, valued at €100 million. Shares were distributed in two rounds. In the first round, the shares were offered to existing shareholders with preferential rights, and the remaining shares were offered in the second round to the general public. The newly issued shares carry the same privileges as the existing NLB labeled shares, and belong to the same class. NLB shares are not traded in organized markets.

The share of the equity capital in the NLB Group balance sheet total is 6.2%, down 0.4 percentage points in 2007.

NLB Group
Annual Report 2007