Financial Review of Business Performance

In the first half of 2009, the NLB Group’s business operations were mainly characterized by more difficult conditions in obtaining sources, whereas in the second half of the year the negative trends in the global economy caused a decline in the Bank’s portfolio quality. Furthermore, falling interest rates, volatile security rates, and some falling currency rate values additionally negatively influenced business operations.

However, by taking adequate business policy measures, the Group largely managed to successfully neutralize these effects. It should be pointed out that:

• Despite adverse conditions, the Group recorded favorable results from income from net interest and net fees and commissions, which represent the main generators of the NLB Group’s aggregate income;
• Numerous measures were taken that resulted in lower costs;
• Deposits from the non-banking sector increased;
• The Group continuously fulfilled the liquidity requirements, and
• Great attention was paid to controlling credit risk exposure by means of selective approval of loans, stricter criteria, and consistent implementation of the Bank’s collateral policy.

In spite of the conditions, the NLB Group recorded a solid result before provisions totaling €229.6 million, but due to the deteriorating credit portfolio the volume of created impairments and provisions exceeded the generated profit. In addition, negative extraordinary business events totaling €35.2 million net at the Group level and €46.6 million at the NLB level had a considerable effect on the result.

In 2009, the Group’s result after tax totaled −€86.8 million or −€51.6 million after the deduction of extraordinary business events. NLB ended the year with a loss in the amount of €23.6 million, but its current business result without extraordinary business events was positive and equaled €23.0 million.

The extended profit, which also includes evaluated securities and cash flow recognized in equity amounted to −€17.3 million at the Bank level and −€56.0 million at the Group level.

Income Statement

Net interest income amounted to €249.5 million in 2009 and fell by 13% against the previous year. The NLB Group followed a similar trend by recording a net interest income in the amount of €423.2 million, or 11% less compared to 2008. The decline in income was due to a decreased interest margin. The problems in accessing sources on the international financial markets, which began back in 2008, resulted in higher prices of both bank and non-banking sources, which, with some delay, affected investment transactions and thus negatively influenced the interest margin. Moreover, the fall in reference interest rates at the beginning of the year influenced the decrease in the margin. Compared to the previous year, the interest margin dropped both at NLB and for banks on SE European markets, so that the cumulative interest margin at the entire NLB Group level amounted to 2.3% and was 0.3 percentage points lower than in 2008. The interest margin of NLB in 2009 was 1.7% and 0.3 percentage points lower than the previous year.

Regarding non-interest income, fees and commissions, and thus net income from payment transactions, represented the most important source of income. Income from net fees and commissions totaled €157.4 million in 2009 and were 5% lower compared to the previous year, which is due to the decline in economic activity and the drop in the amount of payment and card transactions connected with this.

In 2009, the Group’s dividend income amounted to €2.1 million.

Once the conditions on the capital markets stabilized, after the loss generated by the financial transactions in the previous year and in the first quarter of 2009, the Bank recorded a profit in the last three quarters of the year, so that the total income from financial transactions amounted to €20.6 million in 2009.

Net income from other sources totaled €37.7 million. The major part of this income came from the sale of IT services and fees from cash transactions for other banks, as well as from rentals.

Business expenses together with depreciation in the NLB Group amounted to €417.6 million in 2009, which is €5.6 million or 1% less compared to the previous year. Despite adjusting salaries in compliance with legal and contractual requirements, personnel costs, which represent 51% of all corporate costs, were 1% lower than in 2008, which is due to the lower number of employees. Numerous business economizing and cost-management measures positively resulted in reduced operative costs, which were 2% lower compared to the previous year. Amortization/depreciation costs stayed at the same level as the previous year.

The cost-income ratio (CIR) was 65.2% for the NLB Group and 59.4% for NLB.

The aggravated crisis in the real sector strongly affected exposure to credit risk or resulted in impairment of loans. Therefore, the NLB Group set aside as much as €291.5 million in additional impairments and provisions, which is twice as much as in the previous year. The rate of the portfolio coverage with provisions amounted to 5.2% at the Group level and 3.8% at the NLB level, which represents an increase by 1.5 and 1.0 percentage points, respectively.

In addition to impairments and provisions for credit risk, €24.0 million of other impairments and provisions were created at the NLB Group level. The major part of those referred to the impairment of goodwill and intangible fixed assets recognized separately from goodwill at NLB Tuzlanska Banka (€6.5 million) and NLB Banka Sofia (€3.2 million), totaling €9.8 million, as well as the valuation of the business premises in Frankfurt, which, considering deferred taxes, amounted to €7.5 million at the NLB Group level.

The negative trends in the business environment no longer allowed some of the banks in the Group to achieve the results expected upon acquisition of these companies. Thus, NLB impaired capital investments in three banks (LHB Frankfurt, NLB Tuzlanska Banka, and NLB Razvojna Banka) in the amount of €35.8 million. The aforementioned impairments did not have any effect on the financial statements of the Group because capital

investments and equity are consolidated at a Group level, and the results of individual companies are directly included in the result of the Group.

Profits of the associated and joint venture companies amounted to €6.2 million and represented 2.7% of the profit realized by the NLB Group before provisions.

The result minority owners are entitled to was positive and amounted to €0.8 million in 2009.

Statement of Financial Position

At the end of 2009, the NLB Group balance sheet total reached €19,605.6 million and increased by 4% compared to the same period in 2008, and the NLB balance sheet total with 7% growth reached a total of €15,509.1 million at the end of 2009.

The decline in credit activity that had already begun in 2008 continued. To a large extent, credit activity depends on the possibility of providing sources through borrowing on international financial markets and the growth of deposits from the non-banking sector. On the other hand, due to the Group’s precaution and stricter criteria regarding credit approval, credit activity was much more selective. Thus, at the end of the year, NLB Group gross loans to the non-banking sector totaled €13,212.4, million which is €302.7 million or 2% less than at the end of the previous year. NLB and companies in the non-banking activities saw the largest decrease, whereas banks on the SE European markets increased their credit volume. Corporate loans fell by €404.9 million, whereas household loans grew by €62.0 million and credits to the government grew by €40.3 million.

Deposits from the non-banking sector of the NLB Group grew by €1,276.4 million or 13% and amounted to €10,741.2 million at the year end. At the Bank level, growth totaled 16%. Due to the extraordinary conditions on the market, the state intervened by taking measures and acting as the Bank’s depositor. Thus, government deposits contributed as much as €916.3 million to the total increase in deposits from the non-banking sector. Household deposits also increased by 8% or €459.1 million. Changed preferences of the population in insecure conditions, which directed its savings towards more secure and liquid investments, as well as several marketing actions of the Group to increase deposits, affected growth. On the other hand, as expected, due to the crisis in the real sector corporate deposits decreased by €99.0 million or 4%.

In 2009, the loan/deposit ratio decreased by 20 percentage points and totaled 123% at the year end.

Furthermore, the NLB government-guaranteed bond issued in July 2009 in the amount of €1.5 billion represented an important source for the Group.

The majority of acquired sources in 2009 were earmarked to settle liabilities from due long-term financing on international financial markets. Thus, compared to 2008, loans taken decreased by €1,557.1 million or 27% and in June the subordinate instrument in the amount of €50 million was called and paid prior to its expiry.

Due to the conditions on the international financial markets, in 2009 the Bank’s conservative policy in providing secondary liquidity reserves, which totaled €3.8 billion at the year end, was even more apparent.

Capital and Capital Adequacy

At the end of 2009, the regulatory capital for the NLB Group totaled €1,735.4 million and was €171 million less than at the end of 2008. Apart from the Group’s loss in 2009, which largely resulted in the decrease, exercising the call option on the subordinate instrument in the amount of €50 million, the decrease in minority owner capital due to the purchase of banks in the Group (€26 million), and discount of subordinate instruments falling due within the next five years (€20 million) affected the reduction.

The capital adequacy for the NLB Group was 10.7% and the Tier 1 ratio was 7.2%. The reduced capital adequacy compared to the previous year is mainly a consequence of the reduction in capital because capital requirements remained at the level from the previous year.

At the end of 2009, the regulatory capital for NLB totaled €1,261.9 million and was €145.6 million less than at the end of 2008. The capital adequacy was 10.4% and was 1.5 percentage points lower than at the end of December 2008.

NLB Group
Annual Report 2009