Segment analysis

NLB Group monitors its operations by various segments that are defined in accordance with its strategy and the internal organizational structure of NLB Group. NLB Group’s operations are monitored to the level of pre-tax profit for the following segments:

• retail banking in Slovenia, which includes operations with individuals, SMEs and sole traders included in NLB’s business network, and asset management via NLB Skladi. This segment includes the contributions to results from the joint venture NLB Vita and the associates Skupna pokojninska družba and Bankart;
• corporate banking in Slovenia, which includes NLB’s operations with medium and large enterprises;
• financial markets, which include all treasury operations, NLB’s transactions with financial institutions and investment banking;
• strategic foreign markets, which include NLB Group’s complete operations on the strategic markets of Bosnia and Herzegovina, Montenegro, Kosovo, Macedonia and Serbia (excluding leasing companies);
• non-strategic foreign markets and activities, which include NLB Group’s complete operations on the non-strategic markets of Croatia, Germany, Switzerland and the Czech Republic, and all leasing companies. This segment also includes the results of the non-financial companies NLB Propria and Prospera Plus, and the contributions to results from the joint venture Prvi faktor and the associates Adria Bank and Banka Celje; and
• other, which includes bank’s categories whose operating results cannot be allocated to individual segments.

Corporate banking in Slovenia

The negative effects of the financial crisis, which are reflected in the operations of NLB Group as a deterioration in the quality of the portfolio, are even more evident in the operating results of the corporate banking segment, which generated a loss of EUR 332.5 million in 2012, an increase of 61.9% on the loss generated the previous year. The main reason for the aforementioned loss is the level of provisions created. Additional credit impairments in the amount of EUR 359.7 million were created in this segment in 2012, representing 70.4% of all credit impairments and provisions created within NLB Group. The majority of impairments and provisions were created for customers from the sectors of financial holdings, trade, construction, manufacturing, services and finance.

Contributing further to the loss generated was the impairment of equity securities received by NLB in the redemption of collateral. Impairments totaling EUR 30.5 million were created in 2012 owing to falling share prices.

Operating results prior to provisions were also down. The main reason was a decline in interest income resulting from a contraction in operations. Total investments were down as the result of low economic activity and the active reduction of riskweighted assets, which is one of the key elements in the implementation of NLB Group’s strategy. The deteriorating structure of the credit portfolio and the lowering of reference interest rates also contributed to the decline in interest income.

The volume of loans to the non-banking sector in this segment was down EUR 184.1 million or 2.9% compared with the previous year, to stand at EUR 6,247.8 million at the end of 2012.

The volume of guarantee transactions was also down slightly relative to 2011, as was the balance of the guarantee portfolio, which is primarily linked to the situation in the construction sector. There was no decline in guarantee transactions with the rest of the world in the scope of the guarantee portfolio. The volume of import letters of credit and collection transactions indicates an increase in the value of transactions. There was also an increase in terms of value in export letters of credit, while export collection transactions were up merely in terms of quantity.

Stagnation in the volume of international check transactions continues, confirming the prevailing global trend.

The deposit portfolio was down EUR 28.7 million or 5.0% in value terms at the end of 2012 compared with the previous year, to stand at EUR 540.6 million.

The deepening of the economic crisis has resulted in the initiation of numerous insolvency proceedings against companies, 308 of which were NLB customers and the bank's exposure to them totals EUR 643.1 million.

In 2012, NLB continued to upgrade its comprehensive customer management system for shared NLB Group customers. It has thus improved the conditions for achieving synergistic effects at NLB Group level on strategic markets, which ensure support for Slovenia’s traditionally export-oriented economy.

NLB’s only tool in the direct financing of strategic foreign customers is the restructuring of existing loans. No new loans were approved, primarily owing to the adoption of NLB’s strategy regarding the financing of the rest of the world and also due to limited financial resources and the uncertain economic conditions.

NLB focused on the markets where its exportoriented customers operate in the financing and insuring of export transactions. NLB follows the market flows in these countries in its financing of export transactions. In the financing of major, long-term projects, NLB works with SID banka, which insures transactions against commercial and non-commercial risks. In previous years, the Bank mainly cooperated with SID banka in the financing of exports to Russia and other markets of the former Soviet Union.

Retail banking in Slovenia

The Slovenian retail banking segment generated a profit of EUR 11.4 million in 2012, a decrease of 82.4% on the previous year. The scope of additional provisions was one of the reasons for the lower profit. Additional provisions of EUR 21.3 million were created in 2012, while the effect of provisions on 2011’s result was positive in the amount of EUR 13.8 million. Impairments totaling EUR 26.6 million and relating to the portfolio of retail customers were also released in 2011 owing to methodological changes.

Interest income was down nearly one quarter in 2012 relative to the previous year, primarily owing to lower interest rates and a contraction in the scope of lending and deposit operations. The value of loans in the retail banking segment was down EUR 236.5 million or 8.2% on the previous year, to stand at EUR 2,631.8 million. Long-term loans account for the majority of the portfolio. Contributing most to the decline in lending activity was the reduced borrowing activity on the part of households. The value of deposits was down EUR 378.0 million or 6.3% compared with the previous year, to stand at EUR 5,601.2 million.

Contributing somewhat to the deteriorating results was a drop in non-interest income, which is primarily linked to a decline in the number of payment transactions and the number of accounts under management, as the result of lower domestic economic activity. Favorable trends were seen in payment card operations due to the inclusion of a new retailer and in bankinginsurance services, an indication of the effective marketing of the savings-insurance products of NLB Vita in NLB’s business network. The reduction of costs had a positive effect on this segment’s results.

The total value of assets under management stood at EUR 297.7 million at the end of 2012, a drop of 0.5% relative to 2011. NLB Skladi generated a profit of EUR 1.2 million in 2012. The contribution made by associates and joint ventures that operate primarily in the retail banking sector was positive in 2012 in the amount of EUR 3.4 million, an increase of EUR 1.0 million relative to 2011.

Despite the declining scope of operations, NLB remains the leading bank with the highest market shares in all key segments. Partially implemented in 2012 were a new strategy and retail banking restructuring program for the period 2011 to 2015, which are based on a range of comprehensive, high-quality and comfortable financial solutions for households and SMEs with the aim of increasing value for both customers and the Bank’s owners. The Bank has taken steps to strengthen and expand cooperation with existing customers and to introduce more appropriate customer segmentation. It has also continued with crosssales and the development of contemporary market channels.

Transaction with households

Customers were offered a full range of innovations in 2012 in the scope of existing products, services and added value.

NLB continued to offer comprehensive financial advisory services to personal banking and mass market customers, resulting in a notable increase in customer satisfaction. The financial literacy of customers was improved throughout Slovenia with the introduction the NLB Events concept, which includes financial workshops for customers.

Customers were offered a modified range of NLB Progressive Savings, with more flexible forms of savings. NLB offered households two long-term structured deposits, a relatively safe investment that offers the possibility of exploiting the potentially higher returns associated with a selected sub-fund, while guaranteeing the 100% repayment of principal.

Additional attention was also given to verifying the quality of loan collateral, particularly on loans secured by real estate collateral. The Bank offered loans to customers who suffered damage during flooding under more favorable terms in order to repair damages.

NLB Klik e-banking was also upgraded with additional functionalities, including the possibility of concluding an agreement on progressive savings or the opening a savings account. The most important new features are the introduction of My Financial Picture (a comprehensive overview of financial assets, costs and income, and an overview of changes to assets and cash flow), the possibility of securities trading and the upgrading of payment systems with elements of SEPA rules.

The Bank upgraded the NLB Web Portal, revamped the e-notification system, updated the NLB Stock Exchange portal with a map of global stock markets, set up a PDF viewer for publications, upgraded customer contact management and revamped the frequently asked questions and answers system. The NLB Web Portal received an average of more than 900,000 visits a month in 2012.

The NLB SMS-messaging service was upgraded to offer secure NLB SMS-messaging regarding financial transactions in NLB Klik, and NLB SMSmessaging to facilitate the management of personal finances (SMS-messaging regarding the maturity of overdraft limits and deposits).

In card operations, NLB is the only bank in Slovenia to offer holders of deferred payment cards (MasterCard, Visa and Karanta) the new service of NLB Installment Payments (from 2 to 12 installments) at selected retailers. NLB MasterCard and NLB Visa cardholders were offered the possibility of designing cards with their own motifs, while the Bank rewarded its loyal cardholders throughout the year via activities carried out in cooperation with partners in the Enka benefit program. The Bank also began development activities to introduce socalled contactless technology.

Another innovation is NLB Welcome, the offer of primary banking assistance to NLB Group customers in the case of unpleasant events, such as the theft, loss and malfunctioning of cards, etc.

SMEs

In 2012, NLB began activities to update its segmentation of corporate customers with the aim of ensuring the highest-quality handling of the entire portfolio in the context of comprehensive risk management. Consequently, NLB began implementing a new organizational model in the corporate centers of its business network, the result of which will be the improved quality and accessibility of services. Through the reorganization and optimization of its business network, NLB continues to strive for a more rapid and effective decision-making process. The primary focus in the future will be on improving customer satisfaction and increasing trust in the Bank.

In 2012, the SME segment was once again defined as one of the most important customer segments at the Bank. For that reason, the Bank earmarked special loans under more favorable conditions totaling EUR 100 million to the aforementioned segment with the aim of stimulating lending to the best corporate projects.

As part of its cost rationalization activities, NLB introduced new features in the NLB Proklik ebanking system that are linked to the replacement of all paper notifications for the corporate customer segment to electronic forms and free access to such notifications via NLB Proklik, and to the simultaneous termination of paper notifications. NLB Proklik remains the most widely used e-banking system among corporate customers. The majority of payment transactions and an increasing number of other banking services are executed and provided via the aforementioned system.

In the area of business accounts, activities were carried out relating to the electronic management of corporate customers’ documentation. The gradual rationalization of the network of day and night deposit boxes began with the introduction of automated deposits at ATMs for corporate customers. Development in card operations was focused on increasing the Bank’s competitive advantage in attracting points of sale.

Asset management

Part of the core of NLB Group’s strategy is its model for linking banking and asset management services. Positive returns on equity markets characterized 2012 and were not reflected in net inflows to mutual funds, with the Slovenian equity market recording high net outflows of EUR 114.2 million. Total assets under management at NLB Skladi stood at EUR 297.7 million, down EUR 1.6 million on the end of the previous year. Despite the negative conditions on the mutual fund market, NLB Skladi’s market share was up 0.9 percentage points to stand at 21.9% in terms of mutual fund assets from nonprivatization sources. The company’s total market share was 16.4%, a decrease of 0.3 percentage points. NLB Skladi ended the 2012 financial year with a net profit that was higher than the net profit generated the previous year.

Financial markets in Slovenia

NLB Group generated a pre-tax profit of EUR 244.5 million in the financial markets segment in 2012, compared with a profit of EUR 12.1 million generated in the same segment in 2011.

The segment’s favorable results were driven by an increase in income from financial transactions, which include the one-time positive effect of the early repurchase of a discounted hybrid instrument in the amount of EUR 179.9 million and the recall of a deposit in the amount of EUR 9.9 million for hedge accounting purposes. This segment generated a positive result, even if extraordinary income is excluded.

Net interest income in this segment was up on the previous year primarily owing to a decline in losses from liquidity reserves, less expensive forms of refinancing (e.g. ECB funds) and the improved effects of the Bank’s balance sheet management.

The costs recorded in this segment were at the previous year’s level. No impairments of investments in securities or loans were recorded in 2012, while impairments in the amount of EUR 22.4 million were created in 2011.

Total investments, which primarily comprise investments in securities, were down 22.0% in 2012, while liabilities were down 16.0% on account of early repurchases, the maturing of issued debt securities and maturing government deposits.

Transactions in financial instruments

Despite the adverse conditions on the financial markets, the Bank’s turnover in financial instruments with customers was positive, with turnover in the majority of products remaining at the levels from previous years in the context of improved economic results. Individual transactions in foreign currencies with customers, forward FX transactions and the deposits of non-banking financial institutions (including the Ministry of Finance) continued to account for the highest proportion of turnover.

Corporates are increasingly aware of risks and the need to hedge against them, thus piquing their interest in FX derivatives. The number of concluded underlying derivatives aimed at hedging against currency risk was up as a result. On the other hand, the number of interest-rate hedges was down due to relatively low interest rates.

In 2012, the Bank concluded more than 41,000 spot currency transactions, which account for the majority of currency trading, with a total value of more than EUR 9 billion. The Bank cooperates with all major global banks in this area, and has its own NLB Trade trading platform. The majority of transactions were concluded in major global currencies, while special attention was also given to trading in the currencies of South-eastern Europe (e.g. the Croatian kuna, Serbian dinar, the Bosnian convertible mark and the Macedonian denar). The Bank concluded more than 8,500 FX purchase and sale transactions totaling more than EUR 760 million, representing a 12% increase in terms of the number of transactions and a 123% increase in terms of total value.

NLB continued to maintain liquidity on the MTS Slovenia trading platform. Nine government bonds were listed on the MTS Slovenia platform in 2012, while market makers undertake to be prepared at all times to buy and sell at least EUR 2 million of each bond. NLB is an active market participant. Total turnover on the entire market reached EUR 2.5 billion in 2012, just one third of the total turnover recorded the previous year.

Trading in synthetic forwards with customers was completely abolished in 2012. Activities continued to introduce new, more interesting instruments for customers (e.g. the hedging of commodity prices via cash-settled futures). NLB is following market trends through these types of activities and expanding the range of instruments available to customers for every day hedging activities.

The Ljubljana Stock Exchange recorded growth in 2012. Similar to other stock indices on foreign capital markets, the Ljubljana Stock Exchange ended the year higher, as some level of optimism returned to the domestic capital market, where the SBI TOP recorded growth of 7.1% to end the year at 635 points. NLB provided stock broking services to close to 15,000 customers who executed more than 23,000 transactions with a total value of EUR 465 million.

In terms of asset management, 2012 was a record year for NLB in all respects. Net inflows totaled nearly EUR 38 million, while assets under management were up by more than 60%. The Bank expanded its range of portfolios with a global real estate portfolio and a portfolio of Slovenian bonds. Fifty new investors entrusted their assets to the Bank.

NLB trades daily in interbank deposits in all major global currencies. Total turnover comprising more than 3,300 transactions amounted to around EUR 22.9 billion.

The Bank is also one of the primary service providers for Ministry of Finance treasury bills. Having successfully purchased (for customers and its own portfolio) around EUR 800 million in treasury bills of varying maturities, the Bank accounted for 51.5% of the total amount of treasury bills issued by the Ministry of Finance at initial public offerings in 2012.

NLB is the only Slovenian bank among the 43 international financial institutions that comprise the EFSF Market Group and participate in the initial public offerings of EFSF bonds. The Bank continued its active role in initial public offerings in 2012, and thus maintained its position among primary service providers.

Corporate financing

NLB was active in 2012 in projects linked to providing various forms of financing to corporates on the domestic and foreign markets. It participated in several issues of securities by Petrol in the nominal amount of EUR 30 million and in two issues of commercial paper in the total nominal amount of EUR 96 million. The Bank was also active in the sale of corporate participating interests.

In the scope of securing and organizing sources of financing on foreign markets for investment projects in which NLB is involved, procedures continued aimed at financing the construction of Unit 6 of the Šoštanj thermal power plant (funds from the EIB and EBRD) and financing the second phase of reconstruction of the HE Doblar 1 hydroelectric power plant at Soške elektrarne Nova Gorica.

NLB also provides syndication services for private equity projects and infrastructure projects of national importance. In cooperation with NLB Group banks and other Slovenian and foreign banks, NLB secured sources of financing for major Slovenian companies, and carried out activities in the restructuring processes.

Custody services

The adverse conditions on the capital markets were reflected in a slight decline in assets in custody in 2012. Assets invested on foreign markets in the amount of EUR 2.5 billion remained at the previous year’s level, while the Bank recorded a decline in assets invested on the domestic market of nearly 10%.

Nevertheless, the value of financial instruments on the domestic market exceeded EUR 4 billion, thus accounting for 54% of the entire portfolio. The total value of assets in custody was down 7.5% on the end of previous year to stand at EUR 7.6 billion at the end 2012. Notwithstanding the changing market conditions, custody services generate positive operating results.

The year 2012 was characterized by preliminary adaptations deriving from U.S. tax legislation (e.g. the Foreign Account Tax Compliance Act or FATCA) and the harmonization of domestic legislation. Here, the characteristics of the market infrastructure in the scope of the adaptation of operations due to the coming introduction of TARGET2-Securities should also be noted.

The focus in terms of investment funds in custody was the continuing consolidation of the investment fund management market. The growing trend of sales and acquisitions by fund managers led to the merging and transformation of funds in custody. There is still a notable decline in trading in financial instruments, while relatively high payments to investment coupon holders continue. The trend of payments from the cover funds of pension and insurance companies also continues. There are 25 investment funds, seven cover funds with 10 pension plans, three foreign pension funds and one mutual pension fund in custody, with total assets of EUR 928.8 million.

Strategic foreign markets

NLB Group’s focus on strategic markets is banking, as the primary activity, while the medium-term emphasis is on retail banking. The Group will ensure customer satisfaction and improve profitability by continuing to develop products, while at the same time enhancing the collection of claims and the management of nonperforming loans.

The economic situation on strategic markets deteriorated relative to 2011. Liquidity problems faced by customers and limited capital sources forced NLB Group companies to limit their scope of lending and thus reduce their risk-weighted assets over the last two years to ensure that existing capital was sufficient to meet capital adequacy requirements. The value of loans was down EUR 35.8 million or 1.6% in 2012 relative to the previous year, to stand at EUR 2,201.8 million. Primarily corporate lending was down, by EUR 60.4 million, while lending to households was up slightly, by EUR 22.6 million. Only NLB Prishtina and NLB Razvojna banka recorded overall growth in loans.

An outflow of deposits was recorded by all banks, except NLB Prishtina, in 2012. The value of deposits was down EUR 44.2 million or 1.8% compared with the previous year, to stand at EUR 2,380.1 million. Primarily corporate and government deposits were down, while household deposits were up at all banks.

NLB Group generated a pre-tax loss of EUR 43.8 million on strategic foreign markets in 2012, compared with a profit of EUR 2.3 million the previous year.

The revenues generated in 2012 by NLB Group banks on strategic foreign markets were down EUR 18.6 million on the previous year as the result of limited growth in the credit portfolio and fewer good investment opportunities owing to the adverse economic conditions. Banks reduced costs in response to the situation. However, all banks except NLB Razvojna banka recorded poor operating results prior to provisions due to a more rapid decline in revenues than in costs.

The additional impairments created by banks on strategic markets were up EUR 32.1 million on 2011, primarily at NLB banka, Belgrade and NLB Montenegrobanka. The creation of additional impairments and lower revenues resulted in a significantly worse net operating result for the segment relative to 2011.

NLB Banka Tuzla, NLB Prishtina and NLB Razvojna banka generated a profit that was higher than the previous year. NLB Tutunska banka also generated a net profit that was down one quarter on the profit generated in 2011. NLB banka, Belgrade and NLB Montenegrobanka generated a net loss in 2012.

NLB Group companies will continue to operate prudently in the near future. The emphasis remains on managing risks, the collection of claims and cost control.

Non-strategic markets and activities

Divestment activities are being carried out at NLB Group companies that operate on non-strategic markets and in non-strategic activities. Divestment takes the form of the gradual closure or sale of the aforementioned companies, which affects their operating results. The limited operations of certain Group companies had a negative impact on this segment’s net revenues, which were actually negative in 2012. Total costs were higher than in 2011, as certain costs accompanying the winding up of companies, such as severance and pension payments, were incurred, while the scope of additionally created impairments was down in 2012.

The contribution made by non-strategic associates and joint ventures was negative in 2012 in the amount of EUR 10.5 million, a deterioration of EUR 5.3 million relative to 2011.

Non-strategic banks (LHB Internationale Handelsbank, Adria Bank and Banka Celje) generated losses in 2012. Negative results were also achieved by leasing and factoring companies, except NLB Leasing, Belgrade and the Prvi faktor Group, which generated a profit.

Leasing companies operate on local markets in line with the adopted strategy, while alternative methods for exiting the aforementioned activity are being analyzed.

The primary focuses on other non-strategic activities and markets are the servicing of existing transactions, maintaining the regulatory level of capital and other parameters, and actively searching for opportunities to divest investments. In December 2012, LHB Internationale Handelsbank fulfilled the conditions for the return of its banking license, re-registered its activity and was renamed LHB, which has the status of financial company, while its subsidiary LHB Immobilien was also sold. NLB Penzija, which was 51% owned by NLB Montenegrobanka, was liquidated in 2012, while NLB Factoring is formally in liquidation as of January 1, 2013.

Other

This segment includes bank’s categories whose operating results cannot be allocated to individual segments. In terms of content, these are expenses for taxes on total assets, the costs of unoccupied business premises and provisions and impairments for the costs of reorganization and unresolved legal matters. The segment of other generated a pre-tax loss of EUR 11.7 million, a deterioration of EUR 4.7 million relative to the previous year.