Notes to the financial statements

1. GENERAL INFORMATION

Nova Ljubljanska banka d.d. Ljubljana (hereinafter: NLB) is a joint stock entity providing universal banking services. The NLB Group operates in twelve countries.

NLB is incorporated and domiciled in Slovenia. The address of its registered office is Trg Republike 2, Ljubljana. NLB’s shares are not listed on the stock exchange.

NLB’s largest shareholders as at December 31, 2012 are the Republic of Slovenia, owning 40.21% of shares (December 31, 2011: 45.62%), and KBC Bank N.V. Brussels, owning 22.04% of shares (December 31, 2011: 25.00%). The Republic of Slovenia and its controlled entities exceed 50% ownership in NLB. The Republic of Slovenia together with its related entities is the ultimate controlling party of NLB.

All amounts in the financial statements and in the notes to the financial statements are expressed in thousands of euros unless otherwise stated.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The principal accounting policies adopted for the preparation of the separate and consolidated financial statements are set out below. Policies have been consistently applied to all the years presented.

2.1. Statement of compliance

The principal accounting policies applied in the preparation of the separate and consolidated financial statements have been prepared in accordance with the International Financial Accounting Standards (hereinafter: the IFRS) as adopted by the European Union (hereinafter: EU). Additional requirements under the national legislation are included where appropriate.

The separate and consolidated financial statements comprise the income statement and statement of comprehensive income, the statement of financial position, the statement of changes in equity, the statement of cash flows, significant accounting policies and the notes.

2.2. Basis of presentation of financial statements

The financial statements have been prepared on a going concern basis, under the historical cost convention as modified by the revaluation of available for sale financial assets and financial assets and financial liabilities at fair value through profit or loss, including all derivative contracts, and investment property.

The preparation of financial statements in accordance with IFRS requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Although these estimates are based on management’s best knowledge of current events and activities, actual results may ultimately differ from those estimates. Accounting estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised. Critical accounting policies and estimates, including the factors considered by management in making their judgement that the NLB and the NLB Group are a going concern, are disclosed in note 2.32.

2.3. Comparative amounts

Except when a standard or an interpretation permits or requires otherwise, all amounts are reported or disclosed with comparative amounts. Where IAS 8 applies, comparative figures have been adjusted to conform to changes in presentation in the current year.

Exchange differences from allowance for impairment of financial assets measured at amortized cost were in previous periods reported in income statement in line impairment charge. In 2012 the NLB Group changed the accounting policy and these exchange differences are shown in line foreign exchange translation gains less losses. In NLB positive exchange differences from allowance for impairment of financial assets measured at amortized amount to EUR 2,876 thousand (2011: EUR 783 thousand negative exchange differences) and to EUR 2,845 thousand in the NLB Group (2011: EUR 979 thousand negative exchange differences).

In the 2012 annual report, NLB and the NLB Group disclosed debt instruments classified as loans and advances in the statement of financial position as a separate item “debt securities”, and other financial assets as the separate item “other financial assets”.

In the 2011 annual report, NLB and the NLB Group disclosed debt instruments classified as loans and advances as at December 31, 2011 in the amount of EUR 84,429 thousand as follows: loans to banks in the amount of EUR 4,426 thousand and loans to non-bank customers in the amount of EUR 80,003 thousand. In the 2011 annual report, NLB and the NLB Group disclosed other financial assets in the statement of financial position in the category other assets in the respective amounts of EUR 32,744 thousand and EUR 57,821 thousand.

On the liability side in the 2012 annual report, NLB and the NLB Group disclosed the Bank’s liabilities for outstanding payments in the statement of financial position in the category of financial liabilities measured at amortized cost in the separate line, other financial liabilities. In 2011, NLB and the NLB Group disclosed the aforementioned liabilities as at December 31, 2011 in the total amount of EUR 13,047 thousand among bank deposits in the amount of EUR 8 thousand and due to customers in the amount of EUR 13,039 thousand.

2.4. Consolidation

In the consolidated financial statements subsidiary undertakings, which are those entities in which the NLB Group, directly or indirectly, has an interest of more than one half of the voting rights and has the power to exercise control over operations, have been fully consolidated. Subsidiaries are consolidated from the date on which effective control is transferred to the NLB Group and are no longer consolidated from the date that control ceases. Where necessary, the accounting policies of subsidiaries have been amended to ensure consistency with the policies adopted by the NLB Group. The financial statements of consolidated subsidiaries were prepared as of the parent entity’s reporting date. Non-controlling interests are disclosed in the consolidated statement of changes in equity. Non-controlling interest is that part of the net results and of the equity of a subsidiary attributable to interests which are not owned, directly or indirectly, by NLB. The NLB Group measures non-controlling interest on a transaction by transaction basis, either at fair value, or the non-controlling interest's proportionate share of net assets of the acquiree.

Inter-company transactions, balances and unrealized gains on transactions between NLB Group entities are eliminated. Unrealized losses are also eliminated unless the transaction provides evidence of impairment of the asset transferred.

The NLB Group treats transactions with non-controlling interests as transactions with equity owners of the NLB Group. For purchases from non-controlling interests, the difference between any consideration paid and the relevant share acquired of the carrying value of net assets of the subsidiary is deducted from equity. Gains or losses on sales to non-controlling interests are also recorded in equity. For sales to non-controlling interests, the differences between any proceeds received and the relevant share of non-controlling interests are also recorded in equity.

The NLB Group’s subsidiaries are presented in note 5.13.

2.5. Investments in subsidiaries, associates and joint ventures

In the separate financial statements, investments in subsidiaries, associates and joint ventures are accounted for at cost. Dividends from subsidiaries, joint ventures or associates are recognized in income statement when NLB’s right to receive the dividend is established.

In the consolidated financial statements, investments in associates are accounted for using the equity method of accounting. These are undertakings in which the NLB Group generally holds between 20% and 50% of voting rights, and over which the NLB Group exercises significant influence, but does not have control. The NLB Group’s share of its associates’ post-acquisition profits or losses is recognized in the income statement, its share of other comprehensive income is recognized in other comprehensive income. The cumulative postacquisition movements are adjusted against the carrying amount of the investment. When the NLB Group’s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the NLB Group does not recognize further losses, unless it has incurred obligations or made payments on behalf of the associate.

Joint ventures are those entities over whose activities the NLB Group has joint control, as established by contractual agreement. In the consolidated financial statements investments in joint ventures are accounted for using the equity method of accounting.

The NLB Group’s associates and joint ventures are presented in note 5.13.

2.6. Goodwill and bargain purchases

Goodwill is measured by deducting the net assets of the acquiree from the aggregate of the consideration transferred for the acquiree, the amount of non-controlling interest in the acquiree and fair value of an interest in the acquiree held immediately before the acquisition date. Any negative amount (“negative goodwill”) is recognized in profit or loss, after management reassesses whether it identified all the assets acquired and all liabilities and contingent liabilities assumed and reviews appropriateness of their measurement.

The consideration transferred for the acquiree is measured at the fair value of the assets given up, equity instruments issued and liabilities incurred or assumed, including fair value of assets or liabilities from contingent consideration arrangements but excludes acquisition related costs such as advisory, legal, valuation and similar professional services. Transaction costs incurred for issuing equity instruments are deducted from equity; transaction costs incurred for issuing debt are deducted from its carrying amount and all other transaction costs associated with the acquisition are expensed.

The goodwill of associates and joint ventures is included in the carrying value of investments.

2.7. A combination of entities or businesses under common control

A merger of entities within the NLB Group is a business combination involving entities under common control. For such mergers the NLB applies merger accounting principles and uses the carrying amounts of merged entities, as reported in the consolidated financial statements. No goodwill is recognized on mergers of NLB Group entities.

Mergers of entities within the NLB Group do not affect the consolidated financial statements.

2.8. Foreign currency translation

Functional and presentation currency

Items included in the financial statements of each of the NLB Group's entities are measured using the currency of the primary economic environment in which the entity operates (i.e. the functional currency). The financial statements are presented in euros, which is the NLB Group’s presentation currency.

Transactions and balances

Foreign currency transactions are translated into the functional currency at the exchange rates prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation of monetary assets and liabilities denominated in foreign currencies are recognized in the income statement, except when deferred in other comprehensive income as qualifying cash flow hedges.

Translation differences resulting from changes in the amortized cost of monetary items denominated in foreign currency and classified as available for sale financial assets, are recognized in the income statement.

Translation differences on non-monetary items, such as equities at fair value through profit or loss, are reported as part of the fair value gain or loss in the income statement. Translation differences on non-monetary items, such as equities classified as available for sale, are included together with valuation reserves in the valuation (losses)/gains taken to other comprehensive income and accumulated in revaluation reserve in equity.

Gains and losses resulting from foreign currency purchases and sales for trading purposes are included in the income statement as gains less losses from financial assets and liabilities held for trading.

NLB Group entities

The financial statements of all the NLB Group entities that have a functional currency different from the presentation currency are translated into the presentation currency as follows:

• assets and liabilities for each statement of financial position presented are translated at the closing rate at the reporting date;
• income and expenses for each income statement are translated at average exchange rates;
• components of equity are translated at the historic rate; and
• all resulting exchange differences are recognized in other comprehensive income.

Goodwill and fair value adjustments arising from the acquisition of a foreign entity are treated as assets and liabilities of the foreign entity and translated at the closing rate.

During consolidation, exchange differences arising from the translation of the net investment in foreign operations are transferred to other comprehensive income. When control over a foreign operation is lost, the previously recognized exchange differences on translations to a different presentation currency are reclassified from other comprehensive income to profit and loss for the year as part of the gain or loss on disposal. On partial disposal of a subsidiary without loss of control, the related portion of accumulated currency translation differences is reclassified to non-controlling interest within equity.

2.9. Interest income and expenses

Interest income and expenses are recognized in the income statement for all interest-bearing instruments on an accrual basis using the effective interest rate method. The effective interest rate method is a method used to calculate the amortized cost of a financial asset or financial liability and to allocate the interest income or interest expense over the relevant period. The effective interest rate is the rate that precisely discounts estimated future cash payments or receipts over the expected life of the financial instrument or a shorter period when appropriate, to the net carrying amount of the financial asset or financial liability. Interest income includes coupons earned on fixed-yield investments and trading securities and accrued discounts and premiums on securities. The calculation of the effective interest rate includes all fees and points paid or received between parties to the contract and all transaction costs, but excludes future credit risk losses. Once a financial asset or a group of similar financial assets has been impaired, interest income is recognized using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss.

2.10. Fee and commission income

Fees and commissions are generally recognized when the service has been provided. Fees and commissions consist mainly of fees received from credit cards and ATMs, customer transaction accounts, payment services and commissions from guarantees. Fees and commissions that are integral to the effective interest rate of financial assets and liabilities are presented within interest income or expenses.

2.11. Dividend income

Dividends are recognized in the income statement when the NLB Group’s right to receive payment is established and inflow of economic benefits is probable. In consolidated financial statement dividends received from associates and joint ventures reduce the carrying value of the investment.

2.12. Financial instruments

a) Classification

The classification of financial instruments on initial recognition depends on the instruments’ characteristics and management’s intention. In general, the following criteria are taken into account:

Financial instruments at fair value through profit or loss

This category has two sub-categories: financial instruments held for trading and financial instruments designated at fair value through profit or loss at inception. A financial instrument is classified in this group if acquired principally for the purpose of selling in the short term or if so designated by management.

The NLB Group designates financial instruments at fair value through profit or loss if:

• it eliminates or significantly reduces a measurement or recognition inconsistency that would otherwise arise from measuring assets or liabilities on a different basis;
• a group of financial assets, financial liabilities or both is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and information about the group is provided internally on that basis to the NLB Group’s key management; or
• a financial instrument contains one or more embedded derivatives that could significantly modify the cash flows otherwise required by the contract.

Derivatives are also categorized as held for trading unless they are designated as hedging instruments.

Loans and advances

Loans and advances are non-derivative financial instruments with fixed or determinable payments that are not quoted on an active market, other than: (a) those that the NLB Group intends to sell immediately or in the short term, which are classified as held for trading, and those that the NLB Group, upon initial recognition, classifies at fair value through profit or loss; (b) those that the NLB Group, upon initial recognition, classifies as available for sale; or (c) those for which the NLB Group may not recover substantially all of its initial investment, for reasons other than deterioration in creditworthiness.

Held to maturity financial assets

Held to maturity financial assets are non-derivative financial instruments that are traded in an active market with fixed or determinable payments and a fixed maturity that the NLB Group has both the intention and ability to hold to maturity. An investment is not classified as held to maturity financial asset if the NLB Group has the right to require that the issuer repays or redeems the investment before its maturity, because paying for such a feature is inconsistent with expressing an intention to hold the asset until the maturity.

Available for sale financial assets

Available for sale financial assets are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices.

b) Measurement and recognition

Financial assets are initially recognized at fair value plus transaction costs for all financial assets not carried at fair value through profit or loss.

Financial assets carried at fair value through profit or loss are initially recognized at fair value, and transaction costs are expensed in the income statement.

Regular way purchases and sales of financial assets at fair value through profit or loss, and assets held to maturity and available for sale, are recognized on the trade date. Loans and advances are recognized when cash is advanced to the borrowers.

Financial assets at fair value through profit or loss and available for sale financial assets are subsequently measured at fair value. Gains and losses from changes in the fair value of financial assets at fair value through profit or loss are included in the income statement in the period in which they arise. Gains and losses from changes in the fair value of available for sale financial assets are recognized in other comprehensive income until the financial asset is derecognized or impaired, at which time the cumulative amount previously included in other comprehensive income is recycled in the income statement. However, interest calculated using the effective interest rate method and foreign currency gains and losses on monetary assets classified as available for sale are recognized in the income statement.

Loans and held to maturity financial assets are carried at amortized cost.

c) Day one gains or losses

The best evidence of fair value at initial recognition is the transaction price (i.e. the fair value of the consideration given or received), unless the fair value of that instrument is evidenced by comparison with other observable current market transactions in the same instrument (i.e. without modification or repackaging) or based on a valuation technique whose variables include only data from observable markets.

If the transaction price on a non-active market is different than the fair value from other observable current market transactions in the same instrument or is based on a valuation technique whose variables include only data from observable markets, the difference between the transaction price and fair value is recognized immediately in the income statement (“day one gains or losses”).

In cases where the data used for valuation is not fully observable in financial markets, day one gains or losses are not recognized immediately in the income statement. The timing of recognition of deferred day one gains or losses is determined individually. It is either amortized over the life of the transaction, deferred until the instrument’s fair value can be determined using market observable inputs or realized through settlement.

d) Reclassification

Financial assets that are eligible for classification as loans and advances can be reclassified out of the held for trading category if they are no longer held for the purpose of selling or repurchasing them in the near term. Financial assets that are not eligible for classification as loans and receivables may be transferred from the held for trading category only in rare circumstances. Additionally, instruments designated at fair value through profit and loss cannot be reclassified.

e) Derecognition

A financial asset is derecognized when the contractual rights to the cash flows from the financial asset expire or the financial asset is transferred and the transfer qualifies for derecognition. A financial liability is derecognized only when it is extinguished, i.e. when the obligation specified in the contract is discharged, cancelled or expires.

f) Fair value measurement principles

The fair value of financial instruments traded on active markets is based on the current bid price at the reporting date, excluding transaction costs. If there is no active market, the fair value of the instruments is estimated using discounted cash flow techniques or pricing models.

If discounted cash flow techniques are used, estimated future cash flows are based on management’s best estimates and the discount rate is a market based rate at the reporting date for an instrument with similar terms and conditions. If pricing models are used, inputs are based on market based measurements at the reporting date.

g) Derivative financial instruments and hedge accounting

Derivative financial instruments, including forward and futures contracts, swaps and options, are initially recognized in the statement of financial position at fair value. Derivative financial instruments are subsequently re-measured at their fair value. Fair values are obtained from quoted market prices, discounted cash flow models or pricing models, as appropriate. All derivatives are carried at their fair value within assets when the derivative position is favourable to the NLB Group and within liabilities when the derivative position is unfavourable to the NLB Group.

The method of recognizing the resulting fair value gain or loss depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. The NLB Group designates certain derivatives as either:

• hedges of the fair value of recognized assets or liabilities or firm commitments (fair value hedge),
• hedges of highly probable future cash flows attributable to a recognized asset or liability, or a highly probable forecasted transaction (cash flow hedge) or
• hedges of a net investment in a foreign operation (net investment hedge).

Hedge accounting is used for derivatives designated in this way provided certain criteria are met.

The NLB Group documents, at the inception of the transaction, the relationship between hedged items and hedging instruments, as well as its risk management objective and strategy for undertaking various hedge transactions. The NLB Group also documents its assessment, both at hedge inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. The actual results of a hedge must always fall within a range of 80% to 125%.

Fair value hedge

Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recognized in the income statement, together with any changes in the fair value of the hedged asset or liability that are attributable to the hedged risk. Effective changes in the fair value of hedging instruments and related hedged items are reflected in “fair value adjustments in hedge accounting” in the income statement. Any ineffectiveness is recorded in “Gains less losses on financial assets and liabilities held for trading”.

If a hedge no longer meets the hedge accounting criteria, the adjustment to the carrying amount of the hedged item for which the effective interest rate method is used is amortized to profit or loss over the remaining period to maturity. The adjustment to the carrying amount of a hedged equity security is included in the income statement upon disposal of the equity security.

Cash flow hedge

The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges is recognized in other comprehensive income. The gain or loss relating to the ineffective portion is recognized immediately in the income statement in “Gains less losses on financial assets and liabilities held for trading”.

Amounts accumulated in equity are recycled as a reclassification from other comprehensive income to the income statement in the periods when the hedged item affects profit or loss.

When a hedging instrument expires or is sold, or when a hedge no longer meets hedge accounting criteria, any cumulative gain or loss existing in other comprehensive income and previously accumulated in equity at that time remains in other comprehensive income and in equity and is recognized in profit or loss only when the forecasted transaction is ultimately recognized in the income statement. When a forecasted transaction is no longer expected to occur, the cumulative gain or loss that was reported in other comprehensive income is immediately transferred to the income statement.

Hedge of a net investment in a foreign operation

Hedges of net investments in foreign operations are accounted for similarly to cash flow hedges. Any gain or loss on the hedging instrument relating to the effective portion of the hedge is recognized directly in equity. The gain or loss relating to the ineffective portion is recognized immediately in the consolidated income statement in “Gains less losses on financial assets and liabilities held for trading”. Gains and losses accumulated in other comprehensive income are included in the consolidated income statement when the foreign operation is disposed of as part of the gain or loss on the disposal.

In the separate financial statements the hedge of the net investment in foreign operation is accounted for as fair value hedge.

2.13. Impairment of financial assets

a) Assets carried at amortized cost

The NLB Group assesses impairments of financial assets individually for all individually significant assets where there is objective evidence of impairment; all other financial assets are impaired collectively. According to the Regulation on credit risk loss assessment of the Bank of Slovenia financial asset or off-balance sheet liability is individually significant if total exposure to the client exceeds 0.5% of bank’s equity. In years 2012 and 2011 all exposures to banks, all exposures to other legal entities with A and B rating whose exposure exceeds EUR 6,500 thousand, all legal entities rated C, whose exposure exceeds EUR 500 thousand and all exposures to D and E legal entities, whose exposure exceeds EUR 10 thousand are considered individually significant assets by NLB. If the NLB Group determines that no objective evidence of impairment exists for an individually assessed financial asset, it includes the asset in a group of financial assets with similar credit risk characteristic and collectively assesses them for impairment.

The NLB Group assesses at each reporting date whether there is objective evidence that a financial asset or group of financial assets is impaired. A financial asset or group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset and that event has an impact on the future cash flows of the financial asset or group of financial assets that can be reliably estimated.

The criteria that the NLB Group uses to determine that there is objective evidence of an impairment loss include:

• delinquency in contractual payments of principal or interest;
• cash flow difficulties experienced by the borrower;
• breach of loan covenants or conditions;
• initiation of bankruptcy proceedings;
• deterioration of the borrower’s competitive position;
• deterioration in the value of collateral; and
• downgrading below investment grade level.

If there is objective evidence that an impairment loss on loans and advances or held to maturity financial assets has been incurred, the amount of the loss is measured as the difference between the asset’s carrying amount and the present value of estimated future cash flows. The carrying amount of the asset is reduced through an allowance account and the amount of the loss is recognized in the income statement. The calculation of the present value of the estimated future cash flows of collateralized financial assets reflects the cash flows that may result from foreclosure, less cost of obtaining and selling the collateral. Off-balance sheet liabilities are also assessed individually and where necessary related provisions are recognized as liabilities.

For the purpose of collective evaluation of impairment, the NLB Group uses migration matrices, which illustrate the expected migration of customers between internal rating classes. The probability of migration is assessed on the basis of past years’ experience, i.e. annual migration matrices for different types of customers. These data may be adopted for the predicted future trends since historic experience does not necessarily reflect the actual economic movements. Exposures to individuals are additionally analyzed with regard to type of products. Based on the expected migration of clients to D and E rating class and assessment of average repayment rate for D and E rated customers, the NLB Group recognizes collective impairments.

The NLB Group assess that an average of three to six months passes from the moment a debtor experiences problems that prevent it from fulfilling its obligations until the NLB Group becomes aware of those problems. The losses that arise in the interim period and which the NLB Group is not yet aware of are covered by collective impairments for credit risk.

If the amount of impairment subsequently decreases due to an event occurring after the write down, the reversal of the loss is recognized as a reduction in the allowance for loan impairment.

Based on the Bank of Slovenia’s request, NLB amended its accounting policy regarding the write off of loans in 2012. The Bank of Slovenia issued its request as an amendment to the Regulation on the Assessment of Credit Risk Losses of Banks and Savings Banks. In 2012, NLB wrote off EUR 167,604 thousand in financial assets measured at amortized cost. Of total write-offs in 2012, EUR 167,535 thousand relates to write-offs due to the accounting policy amended in 2012. The aforementioned change did not have any effect on the revenues disclosed in the income statement. Write-offs of financial assets are disclosed in note 5.17.

NLB writes off financial assets measured at amortized cost if during collection it assesses that the assets in question will not be repaid and that the conditions for such recognition are no longer met.

b) Assets classified as available for sale

The NLB Group assesses at each reporting date whether there is objective evidence that available for sale financial assets are impaired. In the case of equity investments classified as available for sale, a significant or prolonged decline in the fair value of a security below its cost is considered in determining whether the assets are impaired. If any such evidence exists for available for sale financial assets, the cumulative loss is reclassified from other comprehensive income and recognized in the income statement as an impairment loss. Impairment losses recognized in the income statement on equity instruments are not reversed through the income statement; subsequent increases in their fair value after impairment are recognized in other comprehensive income.

If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognized, the impairment loss is reversed through the income statement.

The following factors are considered in determining impairment losses on debt instruments:

• default or delinquency in interest or principal payments,
• liquidity difficulties of the issuer,
• breach of contract covenants or conditions,
• bankruptcy of the issuer,
• deterioration of economic and market conditions and
• deterioration in the credit rating of the issuer below the acceptable level.

Impairment losses recognized in the income statement are measured as the difference between the carrying amount of the financial asset and its current fair value.

The current fair value of the instrument is its market price or discounted future cash flows, when the market price is not obtainable.

c) Renegotiated loans

Loans that are subject to either collective or individual impairment assessment and whose terms have been renegotiated due to deterioration of the borrower’s financial position are no longer considered to be past due but are treated as new loans. Such loans continue to be discounted using the original effective interest rate. The renegotiated asset is then derecognized and a new asset is recognized at its fair value only if the risks and rewards of the asset substantially changed.

d) Repossessed assets

In certain circumstances, assets are repossessed following the foreclosure on loans that are in default. Repossessed assets are initially recognized in the financial statements at their fair values and are sold as soon as practical in order to reduce exposure (note 7.1.h). After initial recognition, repossessed assets are measured and accounted for in accordance with the policies applicable for the relevant assets categories.

2.14. Offsetting

Financial assets and liabilities are offset and the net amount reported in the statement of financial position when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or to realize the asset and settle the liability simultaneously.

2.15. Sale and repurchase agreements

Securities sold under sale and repurchase agreements (repos) are retained in the financial statements and the counterparty liability is included in financial liabilities associated with the transferred assets. Securities sold subject to sale and repurchase agreements are reclassified in the financial statements as pledged assets when the transferee has the right by contract or custom to sell or re-pledge the collateral. Securities purchased under agreements to resell (reverse repos) are recorded as loans and advances to other banks or customers, as appropriate.

The difference between the sale and repurchase price is treated as interest and accrued over the life of the repo agreements using the effective interest rate method.

2.16. Property and equipment

All items of property and equipment are initially recognized at cost. They are subsequently measured at cost less accumulated depreciation and any accumulated impairment loss.

Each year, the NLB Group assesses whether there are indications that assets may be impaired. If any such indication exists, the recoverable amounts are estimated. The recoverable amount is the higher of the fair value less costs to sell and value in use. If the recoverable amount exceeds the carrying value, the assets are not impaired. If the carrying amount exceeds the recoverable amount, the difference is recognized as a loss in the income statement.

Items of property and equipment, which do not generate cash flows that are largely independent, are included in cash generating unit and later tested for possible impairment.

Depreciation is calculated on a straight-line basis over the assets’ estimated useful lives. The following annual depreciation rates were applied:

Depreciation does not begin until the assets are available for use.

The assets' residual values and useful lives are reviewed, and adjusted if appropriate, on each reporting date.

Gains and losses on the disposal of items of property and equipment are determined as a difference between the sale proceeds and their carrying amount, and are recognized in the income statement.

Maintenance and repairs are charged to the income statement during the financial period in which they are incurred. Subsequent costs that increase future economic benefits are recognized in the carrying amount of an asset and the replaced part, if any, is derecognized.

2.17. Intangible assets

Intangible assets include software licenses, goodwill (note 2.6.) and customer relationships. Intangible assets are stated at cost, less accumulated amortization and impairment losses.

Amortization is calculated on a straight-line basis at rates designed to write down the cost of intangible asset over its estimated useful life. The core banking system is amortized over a period of ten years, other software over a period of three to five years and customer relationships over a period of twelve to fifteen years.

Amortization does not begin until the assets are available for use.

2.18. Investment property

Investment property includes buildings held for leasing and not occupied by the NLB Group. Investment property is stated at fair value determined by a certified appraiser. Fair value is based on current market prices. Any gain or loss arising from a change in fair value is recognized in the income statement. If there is a change in use due to the commencement of owner occupation, investment property is transferred to owner occupied property.

2.19. Non-current assets and disposal group classified as held for sale

Non-current assets and disposal group are classified as held for sale if their carrying amount will be recovered through a sale transaction rather than through continuing use. This condition is deemed to be met only when the sale is highly probable and the asset is available for immediate sale in its present condition. Management must be committed to the sale, which should be expected to qualify for recognition as a completed sale within one year from the date of classification. Non-current assets and disposal group classified as held for sale are measured at the lower of the assets’ previous carrying amount and fair value less costs to sell.

During subsequent measurement, certain assets and liabilities of disposal group that are outside the scope of IFRS 5 measurement requirements are measured in accordance with the applicable standards (e.g. deferred tax assets, assets arising from employee benefits, financial instruments, investment property measured at fair value and contractual rights under insurance contracts). Tangible and intangible assets are not depreciated. The effects of sale and valuation are included in the income statement as a gain or loss from non-current assets held for sale.

Liabilities directly associated with disposal groups are reclassified and presented separately in the statement of financial position.

2.20. Accounting for leases

A lease is an agreement whereby the lessor conveys to the lessee, in return for a payment or series of payments, the right to use an asset for an agreed period of time. Lease agreements are accounted for in accordance with their classification as finance leases or operating leases at the inception of the lease. The key classification factor is the extent to which the risks and rewards incidental to ownership of a leased asset lie with the lessor or lessee.

The NLB Group as lessee

Leases in which a significant portion of the risk and rewards of ownership are retained by the lessor are classified as operating leases. Payments made under operating leases are charged to the income statement on a straight-line basis over the period of the lease. When an operating lease is terminated before the lease period has expired, any payment required to be made to the lessor by way of penalty is recognized as an expense in the period in which termination takes place.

Finance leases are recognized as an asset and liability at amounts equal to the fair value of the leased asset or, if lower, the present value of the minimum lease payments. Leased assets are depreciated in accordance with the NLB Group’s policy over the shorter of the estimated useful life of the asset and the lease term, if there is no reasonable certainty that the NLB Group will obtain ownership by the end of the lease term. Lease payments are apportioned between interest expenses and the reduction of the outstanding liability so as to produce constant periodic rate of interest on the remaining balance of the liability.

The NLB Group as lessor

Payments under operating leases are recognized as income on a straight-line basis over the period of the lease. Assets leased under operating leases are presented in the statement of financial position as investment property or as property and equipment.

The NLB Group classifies a lease as a finance lease when the risks and rewards incidental to ownership of a leased asset lie with the lessee. When assets are leased under a finance lease, the present value of the lease payments is recognized as a receivable. Income from finance lease transactions is amortized over the lifetime of the lease using the effective interest rate method. Finance lease receivables are recognized at an amount equal to the net investment in the lease, including the unguaranteed residual value.

Sale-and-leaseback transactions

The NLB Group also enters into sale-and-leaseback transactions (in which the NLB Group is primarily a lessor), under which the leased assets are purchased from and then leased back to the lessee. These contracts are classified as finance leases or operating leases, depending on the contractual terms of the leaseback agreement.

2.21. Cash and cash equivalents

For the purpose of the statement of cash flows, cash and cash equivalents comprise cash and balances with central banks, debt securities held for trading, loans to banks and debt securities not held for trading with an original maturity of up to 90 days. Cash and cash equivalents are disclosed under the cash flow statement.

2.22. Borrowings, with characteristics of debt

Loans and deposits received are initially recognised at fair value, which is typically equal to historical cost less transaction costs. Loans and deposits received are subsequently measured at amortized cost. The difference between the value at initial recognition and the final value is recognized in the income statement as interest expense, applying the effective interest rate.

Repurchased own debt is disclosed as a reduction in liabilities in the statement of financial position. The difference between the book value and the price at which own debt was repurchased is disclosed in the income statement.

2.23. Other issued financial instruments with characteristics of equity

Upon initial recognition, other issued financial instruments are classified in part or in full as equity instruments, if the contractual characteristics of the instruments are such that the NLB Group must classify them as equity instruments in accordance with IAS 32 Financial Instruments: Disclosure and Presentation. An issued financial instrument is only considered an equity instrument if that instrument does not represent a contractual obligation for payment.

Issued financial instruments with characteristics of equity are recognized in equity in the statement of financial position. Transaction costs incurred for issuing such instruments are deducted from equity reserves. The corresponding interest is recognized directly in profit reserves. In 2012, NLB recognized EUR 16,044 thousand in accrued interest, disclosed in the item other in the statement of changes in equity.

The entire book value of an issued financial instrument with characteristics of equity can be seen in the statement of changes in equity in the item other equity instruments.

2.24. Provisions

Provisions are recognized when the NLB Group has a present legal or constructive obligation as a result of past events and it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate of the amount of the obligation can be made.

2.25. Contingent liabilities and commitments

Financial and non-financial guarantees

Financial guarantees are contracts that require the issuer to make specific payments to reimburse the holder for a loss it incurs because a specific debtor fails to make payments when due, in accordance with the terms of debt instruments. Such financial guarantees are given to banks, financial institutions and other bodies on behalf of the customer to secure loans, overdrafts and other banking facilities.

The issued guarantees covering non-financial obligations of the clients represent the obligation of the bank (guarantor) to pay if the client fails to perform certain works in accordance with the terms of the commercial contract. Such guarantees are issued mainly on behalf of the construction companies to secure the performance of the construction contracts.

Financial and non-financial guarantees are initially recognized at fair value, which is normally evidenced by the fees received. The fees are amortized to the income statement over the contract term using the straight-line method. The NLB Group’s liabilities under guarantees are subsequently measured at the greater of:

• the initial measurement, less amortization calculated to recognize fee income over the period of guarantee or
• the best estimate of the expenditure required to settle the obligation.

Documentary letters of credit

Documentary (and standby) letters of credit constitute a written and irrevocable commitment of the issuing (opening) bank, on behalf of the issuer (importer) to pay the beneficiary (exporter) the value set out in the documents by a defined deadline:

• if the letter of credit is payable on sight; and
• if the letter of credit is payable for deferred payment, the bank will pay according to the contractual agreement, when and if, the beneficiary (exporter) presents to the bank documents that are in line with the conditions and deadlines set out in the letter of credit.

A commitment may also take the form of a letter of credit confirmation, which is usually done at the request or authorization of the issuing (opening) bank and constitutes a firm commitment by the confirming bank, in addition to that of the issuing bank, which independently assumes a commitment to the beneficiary under certain conditions.

Other contingent liabilities and commitments

Other contingent liabilities and commitments represent commitments to extend credit, uncovered letters of credit and other commitments.

2.26. Inventories

Inventories are measured at the lower of cost and net realizable value. Cost is determined using the weighted average cost method.

2.27. Taxes

Corporate income tax in the NLB Group is calculated on taxable profits at the applicable tax rate in the respective jurisdiction. If entities disclose a tax loss, the tax rates that will be valid when the entities in question will again pay corporate income tax are applied. The corporate income tax rate for 2012 in Slovenia was 18% (2011: 20%). Rates of 17% and 16% will apply in 2013 and 2014 respectively, while a rate of 15% will apply from 2015 onwards.

Deferred income tax is calculated, using the balance sheet liability method, for all temporary differences arising between the tax bases of assets and liabilities and their carrying amounts for financial reporting purposes.

Deferred tax assets are recognized if it is probable that future taxable profit will be available against which the temporary differences can be utilized.

Deferred tax related to the fair value re-measurement of available for sale investments and cash flow hedges is charged or credited directly to other comprehensive income.

Deferred tax assets and liabilities are measured at tax rates enacted or substantively enacted at the end of the reporting period that are expected to apply to the period when the asset is realized or the liability is settled. At each reporting date, the NLB Group reviews the carrying amount of deferred tax assets and assesses future taxable profits against which temporary taxable differences can be utilized.

Deferred tax assets for temporary differences arising from investments in subsidiaries, associates and joint ventures are recognized only to the extent that it is probable that:

• the temporary differences will be reversed in the foreseeable future; and
• taxable profit will be available.

In 2012, the NLB Group recorded a net loss. The deferred tax assets recognized at December 31, 2012 are based on future profitability assumptions and business plans for future years. Tax assets may be adjusted in the event of changes to these assumptions. Tax base for balance sheet tax is balance sheet volume, which represents value of assets in statement of financial position. It is calculated as the average value of monthly values on the last day of each month in the calendar year. Tax rate for balance sheet is 0.1%. Calculated tax may be reduced by 0.167% of loans granted to nonfinancial firms and independent entrepreneurs. Loans are calculated as the average value of monthly net balances without allowances for impairments or change in fair value on the last day of each month in the calendar year. Tax expense is recognized in other operating expenses (note 4.7.).

2.28. Fiduciary activities

The NLB Group provides asset management services to its clients. Assets held in a fiduciary capacity are not reported in the NLB Group’s financial statements, as they do not represent assets of the NLB Group. Fee and commission income charged for this type of service is broken down by items in note 4.3.b). Further details on transactions managed on behalf of third parties are disclosed in note 5.27.

Based on the requirements of Slovenian legislation, the NLB Group has additionally disclosed in note 5.27. assets and liabilities on accounts used to manage financial assets from fiduciary activities, i.e. information related to the receipt, processing and execution of orders and related custody activities.

2.29. Employee benefits

Employee benefits include jubilee long service benefits, retirement indemnity bonuses and termination benefits. Provisions for employee benefits are calculated by an independent actuary. The main assumptions included in the actuarial calculation are as follows:

According to legislation, employees retire after 35-40 years of service, when, if they fulfil certain conditions, they are entitled to a lump-sum severance payment. Employees are also entitled to a long service bonus for every ten years of service in bank.

These obligations are measured at the present value of future cash outflows considering future salary increases and then apportioned to past and future employee service based on benefit plan terms and conditions. All gains and losses arising from changes in assumptions and experience adjustments are recognized immediately in the income statement. The NLB Group pays contributions to the state pension schemes according to the local legislation. NLB contributes 8.85% of gross salaries. Once contributions have been paid, the NLB Group has no further obligation. Contributions constitute costs in the period to which they relate and are disclosed in employee costs in the income statement.

2.30. Share capital

Dividends on ordinary shares

Dividends on ordinary shares are recognized in equity in the period in which they are approved by NLB’s shareholders.

Treasury shares

If NLB or other member of the NLB Group purchases NLB’s shares, the consideration paid is deducted from total shareholders’ equity as treasury shares. If such shares are subsequently sold, any consideration received is included in equity. If NLB's shares are purchased by NLB itself or other NLB Group entities, NLB creates reserves for treasury shares in equity.

Share issue costs

Costs directly attributable to the issue of new shares are recognized in equity as a reduction in the share premium account.

2.31. Segment reporting

Operating segments are reported in a manner consistent with internal reporting to the management board which is the executive body that makes decisions, regarding the allocation of resources and assesses the performance of a specific segment.

All transactions between business segments are conducted on a normal course of business with intra-segment income and costs eliminated. Income and expenses directly associated with each segment are included in determining segment’s performance. Income taxes are not allocated to segments (note 8.1.). The amount of net income arising from transactions between segments is disclosed in the item intersegment net income. Net income from external customers corresponds to the consolidated net income of the NLB Group.

In accordance with IFRS 8, the NLB Group has the following reportable segments: Corporate banking Slovenia, Retail banking Slovenia, Financial markets Slovenia, Foreign strategic markets, Foreign non-strategic markets and Other activities.

2.32. Critical accounting estimates and judgments in applying accounting policies

The NLB Group's financial statements are influenced by accounting policies, assumptions, estimates and management judgment. The NLB Group makes estimates and assumptions that affect the reported amounts of assets and liabilities within the next financial year. All estimates and assumptions required in conformity with IFRS are best estimates undertaken in accordance with the applicable standard. Estimates and judgments are evaluated on a continuing basis, and are based on past experience and other factors, including expectations with regard to future events.

a) Preparation of financial statements on a going concern basis

The NLB and NLB Group have suffered significant losses in the last two years arising from the ongoing impact of loan loss provisions (note 4.11) following a decline in the Slovenian economy. The NLB's shareholders in this time have contributed additional capital to ensure the NLB and NLB Group met their minimum regulatory capital requirements. Whilst the Bank of Slovenia has a minimum capital adequacy ratio of 8% for the NLB and the NLB Group, the European Banking Association ("EBA") set a target core tier 1 ratio of 9% for the NLB Group, which the NLB Group met at the measurement date of June 30, 2012. At December 31, 2012 the NLB and NLB Group were in compliance with the minimum requirements of the Bank of Slovenia, whilst the consolidated core tier 1 ratio of the NLB Group was less than the 9% target set by EBA (note 5.24).

From the perspective of liquidity, the NLB Group has available primary and secondary liquidity reserves to cover liabilities. The majority of primary liquidity reserves are comprised of cash, funds on settlement accounts at central banks and sight and short-term funds at other banks. NLB's secondary liquidity reserves are of exceptional importance in meeting liquidity needs and complying with regulations governing this area. These mainly comprise prime debt securities issued by EU countries and eligible for ECB transactions, while one third of secondary liquidity reserves are accounted for by loans that meet ECB eligibility criteria in full. As at December 31, 2012 available liquidity reserves of the NLB are EUR 2.074 billion (December 31, 2011: EUR 3.621 billion) and the NLB Group are EUR 3.263 billion (December 31, 2011: 4.865 billion) (note 7.2(e)).

As described in the accompanying Statement by the Management Board of NLB, in the paragraphs headed “State aid programme, initiated by the European Commission” in the “Operations of NLB Group in 2012” section of the accompanying Management Report, following the contributions of additional capital by the Bank's majority shareholder (the government of Slovenia) the NLB and NLB Group are currently operating under a state aid programme. In that context the NLB and NLB Group have certain restrictions imposed on their operations, especially concerning the payment of dividends and returns on capital instruments, commercial strategies and business expansion activities. In addition the NLB had to prepare a restructuring plan that was approved by its Supervisory Board, and formally submitted, in January 2013, by the Slovene Ministry of Finance to the European Commission for approval. The aim of the restructuring plan is to ensure the long-term, sustainable operations of the restructured NLB and NLB Group, without state aid.

Given the further forecast losses in 2013 the NLB will require an additional capital injection from its majority shareholder during 2013, which has not yet been provided. The government of Slovenia has committed to support the banking sector through a combination of providing additional capital and to continue with the establishment of the Bank Asset Management Company legally set up last year to take over the non-performing assets of the banks.

The above combines, at the present time, to give rise to an uncertainty, the impact of which would be material, surrounding the necessary injection of additional capital to the NLB in 2013, the absence of which may cast significant doubt on the NLB’s ability to continue as a going concern. However, notwithstanding the conditions and uncertainties mentioned above, the Management Board of NLB, given the successful implementation of the actions anticipated in the restructuring plan, and the expected ongoing support of the government of Slovenia as the NLB Group’s major shareholder, have a reasonable expectation that the minimum capital requirements of the NLB and NLB Group will continue to be met and hence are satisfied that the financial statements of the NLB Group can be prepared on a going concern basis.

b) Impairment losses on loans and advances

The NLB Group reviews its loan portfolio to assess impairment. In determining whether an impairment loss should be recorded in the income statement, NLB Group verifies whether there are any data indicating that there is a measurable decrease in the estimated future cash flows from the portfolio of loans. This evidence may include observable data indicating that the solvency of borrowers has deteriorated or that economic conditions and circumstances have deteriorated. Future cash flows in a group of financial assets are estimated based on past experience and losses on assets with credit risk characteristics similar to those assets in the group. Individual estimates are based on projections of future cash flows taking into account all relevant information regarding the financial position and solvency of a borrower. Projected cash flows are verified by risk department. Low-value exposures, including the majority of loans to individuals, are verified collectively. The methodology and assumptions used to estimate future cash flows are reviewed regularly to reduce differences between estimated and actual losses.

The NLB Group uses a sensitivity analysis to assess the impact of less probable negative events on impairments and provisions. Results of the simulation are based on the balance of loans and impairment as at December 31, 2012 and provide an assessment of required impairments within one year assuming the realization of the defined scenario.

Stress test using transition matrices and decrease in market value of real-estate collateral

In the scenario historical transition matrix from the time of recession was used for individuals and legal entities. Exposure to institutions and the central government was not subject to the stress test. The scenario assumes that total credit exposure will not change in the one year period and the rating structure deterioration reflected through migration matrices will require additional impairments. In addition to that the scenario assumes decrease in the market value of real-estate collateral for both segments, which also requires additional provisions.

As a result of the stress scenario, NLB will require additional impairments of EUR 456 million (2011: EUR 451 million) and the loan loss reserves to gross loan ratio will increase by 4.5 percentage points. For the NLB Group, the same stress scenario results in an increase in impairments of EUR 594 million (2011: EUR 609 million) and an increase in the coverage of the credit portfolio by impairments by 4.5 percentage points.

c) Fair value of financial instruments

The fair values of financial investments traded on the active market are based on current bid prices (financial assets) or offer prices (financial liabilities).

The fair values of financial instruments that are not traded on the active market are determined by using valuation models. These include a comparison with recent transaction prices, the use of a discounted cash flow model, valuation based on comparable entities and other frequently used valuation models. These valuation models pretty much reflect current market conditions at the measurement date, which may not be representative of market conditions either before or after the measurement date. Management reviewed all applied models as at the reporting date to ensure they appropriately reflect current market conditions, including the relative liquidity of the market and applied credit spread. Changes in assumptions regarding these factors could affect the reported fair values of financial instruments held for trading and available for sale financial assets.

The fair values of derivative financial instruments are determined on the basis of market data (mark-to-market), in accordance with the methodology for the valuation of derivative financial instruments. The market exchange rates, interest rates, yield and volatility curves used in valuation are based on the market snapshot principle. Market data is saved daily at 4 p.m. and later used for the calculation of the fair values (market value, NPV) of financial instruments. NLB applies market yield curves for valuation.

Fair value hierarchy of financial instruments is disclosed in note 5.6.

d) Available for sale equity instruments

Available for sale equity instruments are impaired, if there has been a significant or prolonged decline in fair value below historical cost. The determination of what is significant or prolonged is based on assessments. In making these assessments, the NLB Group takes into account several factors, including share price volatility. Impairment may also be indicated by evidence regarding deterioration in the financial position of the instrument issuer, deterioration in sector performance, changes in technology, and a decline in cash flows from operating and financing activities.

Had all the declines in fair value below cost been considered significant or prolonged, NLB would not have incurred additional impairment losses (2011: EUR 8,441 thousand), while the NLB Group would have incurred additional impairment losses of EUR 891 thousand (2011: EUR 9,705 thousand) from the reclassification of the negative valuation from the statement of comprehensive income to the income statement for the current year.

e) Held to maturity financial assets

The NLB Group classifies non-derivative financial assets with fixed or determinable payments and a fixed maturity as held to maturity financial assets. Before making this classification, the NLB Group assesses its intention and ability to hold such investments to maturity. If the NLB Group is unable to hold these investments until maturity, it must reclassify the entire group as available for sale financial assets. The investments would therefore be measured at fair value, resulting in a increase in the value of investments of EUR 12,570 thousand (December 31, 2011: decrease by EUR 30,350 thousand) and a corresponding other comprehensive income.

f) Impairment of investments in subsidiaries, associates and joint ventures

The process of identifying and assessing the impairment of goodwill and other intangible assets is inherently uncertain, as the forecasting of cash flows requires the significant use of estimates, which themselves are sensitive to the assumptions used. The review of impairment represents management's best estimate of the factors such as:

• Future cash flows from individual investments depend on estimated cash flow for those periods for which formal plans are available and on assumptions regarding sustainability of and growth in cash flows in the future. The cash flows used represent management's assessment of future performance at the time of testing. Estimated cash flows are based on five-year financial plan and approved by the Management and Supervisory Boards. Growth rate in cash flows is in the amount of 1%. A target capital adequacy ratio of an individual bank is between 13% to 17%.
• The discount rate derived from the capital asset pricing model and used to discount future cash flows is based on the cost of equity allocated to an individual investment. The discount rate reflects the impact of range of financial and economic variables, including the risk-free rate and risk premium. The value of variables used is subject to fluctuations outside management's control. A pre-tax discount rate is between 11% and 13%.

Majority of impact relates to effects derived from financial crisis, larger impairment provisions, lower interest rates margins, large decline in GDP for Balkans region and change in capital regulation which requires additional capital increases.

If recoverable amount is value in use, the discounted cash flow method is used (NLB banka, Beograd, NLB Leasing, Ljubljana, NLB Leasing, Beograd and NLB Leasing, Sarajevo). When the recoverable amount is fair value less costs to sell, the value was determined based on binding offers and the estimated liquidation value (LHB, Frankfurt, FIN-DO, Domžale).

If the discount rates in the discounted cash flows model differ by +/- 1 percentage point, the estimated value in use of the equity investments would be lower in case of increased discount rate by a maximum of EUR 5.6 million (December 31, 2011: EUR 3.5 million) and in case of decreased discount rate the value in use of equity investments would be higher by a maximum of EUR 6.7 million (December 31, 2011: EUR 4.7 million).

If the forecasted cash flows in the discounted cash flows model differ by +/- 10%, the estimated value in use of the equity investments would be higher in case of increased forecasted cash flows by a maximum of EUR 6.5 million (December 31, 2011: EUR 2.2 million) and in case of decreased forecasted cash flows the value in use of equity investments would be lower by a maximum of EUR 6.5 million (December 31, 2011: EUR 2.2 million).

g) Goodwill and other intangible assets

In the consolidated financial statements, goodwill and other intangible assets are allocated to cash-generating units (hereinafter: CGUs), which represent the lowest level within the NLB Group at which these assets are monitored by management. Each NLB Group entity presents a separate CGU. The recoverable amount of each CGU was determined based on value-in-use calculations. The calculation of value in use is based on cash flow projections in the three-year financial plans approved by management. The NLB Group performed a test for impairment of goodwill and other intangible assets at the end of the year for all subsidiaries.

Additional information regarding impairment testing of goodwill and other intangible assets is disclosed in note 5.12.

The goodwill for NLB Prishtina, Prishtina, represents an individually significant amount of goodwill in the NLB Group and amounts to EUR 9,466 thousand (December 31, 2011: EUR 9,738 thousand). When testing for possible impairment, the following assumptions were used: a discount rate of 13% and a growth rate for residual value of 1% p.a.. According to the test, goodwill was not impaired. If the discount rate increased by more than 6 percentage points (December 31, 2011: 6 percentage points), the whole carrying amount of goodwill in NLB Group would have to be impaired.

h) Taxes

The NLB Group operates in countries governed by different laws. The deferred tax assets recognized at December 31, 2012 are based on profits forecasts and take into account expected manner of recovery of the assets, that is, whether the value will be recovered through use, sale or liquidation. Changes in the assumptions as to the likely manner of recovery of assets could lead to the recognition of currently unrecognized deferred tax assets or to derecognition of previously created deferred tax assets. In case of changed assumptions of future operations the NLB Group will adequately adjust deferred tax assets (note 4.12.). The majority of deferred tax assets relates to tax losses which, in accordance with the Slovenian Corporate Income Tax Act, can be carried forward indefinitely.

i) Classification of issued financial instruments as debt or equity

NLB Group issues non-derivative financial instruments, where specific judgment is required to determine whether these instruments are classified as liability or as equity. When the delivery of cash is dependent of the outcome of uncertain future events that are beyond the control of the NLB Group and management anticipates that these future events are extremely rare, highly abnormal and unlikely to occur, these instruments are classified as equity.

2.33. Implementation of new and revised International Financial Reporting Standards

During the current year, the NLB Group adopted all new and revised standards and interpretations issued by the International Accounting Standards Board (hereinafter: the IASB) and the International Financial Reporting Interpretations Committee (hereinafter: the IFRIC) and endorsed by the EU that are effective for annual accounting periods beginning on January 1, 2012.

Accounting standards and amendments to existing standards effective for annual periods beginning on January 1, 2012 that were endorsed by EU and adopted by us

• IFRS 7 (amendment) - Disclosures, Transfers of Financial Assets (effective for annual periods beginning on or after July 1, 2011). The amendment requires additional disclosures in respect of risk exposures arising from transferred financial assets. The amendment includes a requirement to disclose by class of asset the nature, carrying amount and a description of the risks and rewards of financial assets that have been transferred to another party yet remain on the entity's statement of financial position. Disclosures are also required to enable a user to understand the amount of any associated liabilities, and the relationship between the financial assets and associated liabilities. Where financial assets have been derecognized but the entity is still exposed to certain risks and rewards associated with the transferred asset, additional disclosure is required to enable the effects of those risks to be understood. The amendment impacts disclosure.
• Other revised standards and interpretations: amendments to IFRS 1 - Fist time Adoption of IFRS, relating to severe hyperinflation and removal of fixed dates for first-time adopters and amendment to IAS 12 - Income Taxes, relating to the recovery of underlying assets – investment property measured at fair value. The amendments do not have an impact on financial statements on the NLB Group.

Accounting standards and amendments to existing standards issued that were endorsed by EU but not early adopted by the NLB Group:

• IAS 19 (amendment) - Employee Benefits (effective for annual periods beginning on or after January 1, 2013, with earlier application permitted). Amendment to standard relates to the recognition and measurement of defined benefit obligations and to the disclosure to all employee benefits. The amendment will not have an impact on financial statements on the NLB Group.
• IAS 1 (amendment) - Presentation of Financial Statements (effective for annual periods beginning on or after July 1, 2012, with earlier application permitted). The amendments retain the option to present profit or loss and other comprehensive income in either a single statement or in two separate but consecutive statements. However, the amendments require additional disclosures to be made in the other comprehensive income section, such that items of other comprehensive income are grouped into two categories: items that will not be reclassified subsequently to profit or loss; and items that will be reclassified subsequently to profit or loss when specific conditions are met. Income tax on items of other comprehensive income must be allocated on the same basis. The amendment impacts presentation aspects.
• IFRS 7 (amendments) - Offsetting Financial Assets and Financial Liabilities (effective for annual periods beginning on or after January 1, 2013). The amendment requires disclosures that will enable users of an entity’s financial statements to evaluate the effect or potential effect of netting arrangements, including rights of set-off. The amendment will have an impact on disclosures of financial instruments on the NLB Group.
• IAS 32 (amendments) - Offsetting Financial Assets and Financial Liabilities (effective for annual periods beginning on or after January 1, 2014). The amendment added application guidance to IAS 32 to address inconsistencies identified in applying some of the offsetting criteria. This includes clarifying the meaning of ‘currently has a legally enforceable right of set-off’ and that some gross settlement systems may be considered equivalent to net settlement.
• IFRS 10 Consolidated Financial Statements, IFRS 11 - Joint Arrangements, IFRS 12 - Disclosures of Interests in Other Entities, a revised version of IAS 27 - Separate Financial Statements, which has been amended for the issuance of IFRS 10 but retains the current guidance for separate financial statements, and a revised version of IAS 28 - Investments in Associates and Joint Ventures, which has been amended for conforming changes based on the issuance of IFRS 10 and IFRS 11. Standards are effective for annual periods beginning on or after January 1, 2014, with earlier application permitted as long as each of the other standards is also applied early. However, entities are permitted to include any of the disclosure requirements in IFRS 12 into their consolidated financial statements without the early adoption of IFRS 12. The NLB Group is currently evaluating the potential impact that the adoption of the standards will have on its consolidated financial statements.
• IFRS 10 (new standard). The new standard replaces the parts of IAS 27 - Consolidated and Separate Financial Statements that deal with consolidated financial statements. SIC 12 Consolidation - Special Purpose Entities has been withdrawn upon the issuance of IFRS 10. Under IFRS 10, there is only one basis for consolidation, that being control. In addition, IFRS 10 includes a new definition of control that contains three elements: control over an investee, exposure, or rights to variable returns from its involvement with the investee, and the ability to use its control over the investee to affect the amount of the investor's returns. Extensive guidance has been added in IFRS 10 to deal with complex scenarios.
• IFRS 11 (new standard). The new standard replaces IAS 31 - Interests in Joint Ventures. IFRS 11 deals with how a joint arrangement, over which two or more parties have joint control, should be classified. SIC 13 Jointly Controlled Entities - Non-monetary Contributions by Venturers has been withdrawn upon the issuance of IFRS 11. Under IFRS 11, joint arrangements are classified as joint operations or joint ventures, depending on the rights and obligations of the parties to the arrangements. In contrast, under IAS 31, there are three types of joint arrangements: jointly controlled entities, jointly controlled assets and jointly controlled operations. In addition, joint ventures under IFRS 11 must be accounted for using the equity method of accounting, whereas jointly controlled entities under IAS 31 may be accounted for using the equity method of accounting or proportionate accounting.
• IFRS 12 (new standard). The new standard is a disclosure standard and is applicable to entities that have interests in subsidiaries, joint arrangements, associates and/or unconsolidated structured entities. In general, the disclosure requirements in IFRS 12 are more extensive than those in the current standards.
• IFRS 13 (new standard) - Fair Value Measurement (effective for annual periods beginning on or after January 1, 2013, with earlier application permitted). The standard establishes a single source of guidance for fair value measurements and disclosures about fair value measurements. The standard defines fair value, establishes a framework for measuring fair value, and requires disclosures about fair value measurements. The scope of the standard is broad; it applies to both financial instruments and non-financial instruments for which other standards require or permit fair value measurements and disclosures about fair value measurements, except in specified circumstances. In general, the disclosure requirements in IFRS 13 are more extensive than those required in the current standards. For example, quantitative and qualitative disclosures based on the three-level fair value hierarchy, currently required for financial instruments only under IFRS 7 Financial Instruments: Disclosures, will be extended by IFRS 13 to cover all assets and liabilities within its scope. The NLB Group is currently evaluating the potential impact that the adoption of the standard will have on its consolidated financial statements.
• Other revised standards and interpretations: amendment to IFRIC 20 - Stripping Costs in the Production Phase of a Surface Mine. The amendment will not have an impact on financial instruments on the NLB Group.

Accounting standards and amendments to existing standards issued but not endorsed by EU:

• IFRS 9 - Financial Instruments IFRS 9 issued in November 2009 replaces those parts of IAS 39 relating to the classification and measurement of financial assets. IFRS 9 was further amended in October 2010 to address the classification and measurement of financial liabilities. Key features of the standard are as follows:
• Financial assets are required to be classified into two measurement categories: those to be measured subsequently at fair value, and those to be measured subsequently at amortized cost. The decision is to be made at initial recognition. The classification depends on the entity’s business model for managing its financial instruments and the contractual cash flow characteristics of the instrument.
• An instrument is subsequently measured at amortized cost only if it is a debt instrument and both (i) the objective of the entity’s business model is to hold the asset to collect the contractual cash flows, and (ii) the asset’s contractual cash flows represent only payments of principal and interest (i.e. it bears only “basic loan features”). All other debt instruments are to be measured at fair value through profit or loss.
• All equity instruments are to be measured subsequently at fair value. Equity instruments that are held for trading will be measured at fair value through profit or loss. For all other equity investments, an irrevocable election can be made at initial recognition, to recognize unrealized and realized fair value gains and losses through other comprehensive income rather than profit or loss. There is to be no recycling of fair value gains and losses to profit or loss. This election may be made on an instrument-byinstrument basis. Dividends are to be presented in profit or loss, as long as they represent a return on investment.
• Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward unchanged to IFRS 9. The key change is that an entity will be required to present the effects of changes in own credit risk of financial liabilities designated as at fair value through profit or loss in other comprehensive income.
• Adoption of IFRS 9 is mandatory from January 1, 2015, while earlier adoption is permitted, but the EU has not yet endorsed it. The NLB Group is considering the implications of the standard, the impact on the NLB Group and the timing of its adoption.
• Amendments to IFRS 10 - Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosures of Interests in Other Entities - Transition Guidance (effective for annual periods beginning on or after January 1, 2014, with earlier application permitted). Amendments were issued to ease transition to new standards by restrictions of requirements regarding assurance of adjusted comparable data for comparable period.
• Amendments to IFRS 10 Consolidated Financial Statements, IFRS 11 Joint Arrangements, IFRS 12 Disclosures of Interests in Other Entities – Investment Entities (effective for annual periods beginning on or after January 1, 2014, with earlier application permitted). Amendments include the creation of a definition of an investment entity, the requirement that such entities measure investment in subsidiaries at fair value through profit and loss instead of consolidating them, new disclosure requirements for investment entities and requirement for an investment entity’s separate financial statements.
• Annual improvements to IFRS 2009-2011 cycle. The improvements consist of a mixture of substantive changes and clarifications and are effective for annual periods beginning on or after January 1, 2013. Amendments to IFRS 1 Fist time Adoption of IFRS include explanations of additional comparative information disclosures. If additional comparative information is provided, the information should include disclosure of comparative information for any additional statements included beyond the minimum comparative financial statement requirements. Presenting additional comparative information voluntarily would not trigger a requirement to provide a complete set of financial statements. Amendments to IAS 16 Property, plant and equipment classifies spare parts, stand-by equipment and servicing equipment as property, plant and equipment when they meet the definition of property, plant and equipment in IAS 16 and as inventory otherwise. Amendments to IAS 32 Financial instruments: Presentation require that income tax relating to distributions to holders of an equity instrument and to transaction costs of an equity transaction should be accounted for in accordance with IAS 12 Income Taxes. Amendments to IAS 34 Interim Financial Reporting require separate disclosure of total assets and total liabilities for a particular reportable segment in interim financial reporting only when the amounts are regularly provided to the chief operating decision maker and there has been a material change from the amounts disclosed in the last annual financial statements for that reportable segment. Amendments to MRS 1 First-time Adoption of International Financial Reporting Standards require that borrowing costs incurred on or after the date of transition to IFRSs that relate to qualifying assets under construction at the date of transition should be accounted for in accordance with IAS 23 Borrowing Costs.
• Other revised standards and interpretations: IFRS 1 - Fist time Adoption of IFRS, relating to prospective application related to government loans are not expected to affect the NLB Group’s financial statements.

3. CHANGES IN SUBSIDIARY HOLDINGS

Changes in 2012

a) Capital increase:

• The increase of share capital by cash in total amount of EUR 141,438 thousand was registered in LHB, Frankfurt, NLB Montenegrobank, Podgorica, NLB Leasing, Sarajevo, NLB Leasing, Ljubljana and in NLB banka, Beograd.
• With increase of share capital in NLB Montenegrobank, Podgorica NLB increased its ownership interest from 89.95% to 96.71%.
• The increase of share capital by cash in total amount of EUR 10,500 thousand has not yet been registered in NLB Montenegrobank, Podgorica.
• The increase of share capital by cash from NLB Leasing, Ljubljana in total amount of EUR 42,356 thousand has not yet been registered in Optima Leasing, Zagreb and OL Nekretnine, Zagreb.
• The increase of share capital by loan conversion in total amount of EUR 15,350 thousand was registered in NLB banka, Beograd and LHB Trade, Zagreb.

b) Other changes:

• NLB Tuzlanska Banka, Tuzla was renamed to NLB Banka, Tuzla.
• NLB Leasing Koper, Koper and NLB Leasing Maribor, Maribor are merged with NLB Leasing, Ljubljana. Merger is formally registered on 3rd May 2012 with accounting date of merger as at December 31, 2011.
• NLB Leasing, Ljubljana sold its 100% ownership interest in NLB Leasing, Podgorica to NLB.
• NLB has by the called collateral acquired 75% ownership interest in Argo, Horjul. However according to contractual agreement NLB does not have control, but only significant influence and therefore the entity is accounted as an associate.
• LHB Internationale Handelsbank, Frankfurt returned its banking licence, changed its legal form of the entity and was renamed to LHB, Frankfurt.
• On General meeting of shareholders of Banka Celje, Banka Celje obtained approval to change the preferred shares into ordinary shares, therefore NLB’s voting rights decreased from 49.42% to 41.11%.

c) Disposal of subsidiary:

• LHB, Frankfurt sold its 100% ownership interest in LHB Immobilien, Frankfurt outside of NLB Group.

The details of the assets and liabilities of NLB Group at the date of disposal and disposal consideration are as follows:

Changes in 2011

a) Capital increase:

• The increase of share capital by cash in total amount of EUR 44,696 thousand was registered in NLB Leasing, Ljubljana, NLB Leasing, Sarajevo, Optima Leasing, Zagreb, LHB International Handelsbank, Frankfurt, NLB Factoring, Ostrava, NLB Leasing Maribor, Maribor, NLB Nov penziski fond, Skopje and LHB Trade Zagreb.
• The increase of share capital by loan conversion in total amount of EUR 9,216 thousand was registered in NLB Srbija, Beograd and NLB Factor, Bratislava.

b) Other changes:

• NLB Leasing, Ljubljana sold its 100% ownership interest in NLB Leasing, Sarajevo to NLB.
• NLB Interfinanz, Zürich sold its 26.72% ownership interest in NLB Tutunska banka, Skopje to NLB.
• NLB Nova Penzija, Beograd, NLB Factor, Bratislava and NLB Tutunskabroker, Skopje were liquidated.
• NLB sold its 97.10% ownership interest in NLB Bank Sofia, Sofija (see note 5.9.b).
• Kreditni biro Sisbon, Ljubljana was established. The cost of establishing the entity amounted to EUR 3.5 thousand. Ownership interest in Kreditni biro Sisbon, Ljubljana is 29.68%.

4. NOTES TO THE INCOME STATEMENT

Analysis by type of assets and liabilities

In 2012, interest income on individually impaired loans amounted to EUR 66,319 thousand for NLB (2011: EUR 58,573 thousand) and to EUR 87,905 thousand (2011: EUR 77,600 thousand) for the NLB Group.

a) Fee and commission income and expenses relating to activities of the NLB and the NLB Group

Income from other services include fees from non-banking deposit valuables and safe custody and other agency services.

Expenses from other services include insurance for holders of personal accounts and golden cards.

b) Fee and commission income and expenses relating to fiduciary activities

Item financial liabilities measured at amortized cost of NLB and NLB Group includes gains of repurchasing subordinated loans in amount of EUR 76,361 thousand (2011: EUR 41,500 thousand) and subordinated bonds in amount of EUR 103,585 thousand (2011: EUR 1,327 thousand).

Net foreign exchange translation gains on financial assets and liabilities not classified as at fair value through profit or loss amounted to EUR 2,071 thousand at NLB in 2012 (2011: net losses EUR 3,582 thousand) and to EUR 247 thousand in the NLB Group (2011: net losses EUR 2,318 thousand).

Gains from financial liabilities measured at amortized costs in amount of EUR 179,946 thousand refer to realized gains from repurchased subordinated instruments at a discount in total amount of EUR 426.4 million.

The NLB Group uses currency derivatives to hedge its currency exposure. Therefore, their effects need to be considered in relation to foreign exchange differences in the income statement. From a business perspective, these derivatives represent effective hedging instruments that are not accounted for using hedge accounting principles. They are accounted for in the NLB Group’s financial statements as financial instruments held for trading.

In item other services are included asset maintenance and asset management costs, software maintenance costs, licenses costs and communication costs.

External audit services include payments to NLB’s statutory auditor in the amount of EUR 423 thousand (2011: EUR 365 thousand), while the NLB Group made payments to the auditor in the amount of EUR 1,206 thousand (2011: EUR 1,232 thousand).

In 2011 the NLB Group released the impairment charge from loans to individuals due to a change of accounting estimate for loss in defaulted loans (LGD) in group E.

Income tax differs from the amount of tax determined applying the basic tax rate as follows:

Tax rates within the NLB Group range from 9% to 30%. A tax rate of 18% was applied in Slovenia in 2012. That rate will be reduced gradually each year by 1% until it reaches 15% from 2015 onwards. NLB calculated tax at a rate of 15%, i.e. the rate that the NLB will apply when it covers previous tax losses in full and begins to pay corporate income tax again.

NLB disclosed EUR 19.9 million in expenses due to the change in the tax rate in Slovenia, while the NLB Group disclosed EUR 20.7 million.

The majority of non-taxable income relates to dividend income. NLB excluded EUR 9.4 million in dividend income from its tax base in 2012 (2011: EUR 1.3 million).

Deferred tax assets were not recognized on temporary differences arising on impairment of investments in subsidiaries amounting to EUR 320.47 million as at December 31, 2012 (December 31, 2011: EUR 84.37 million). The NLB has no intention of disposing of these subsidiaries in foreseeable future.

NLB Group did not recognize deferred tax assets for tax losses where there is uncertainty whether the tax losses can be utilized. Effects of unrecognized deferred tax assets on tax losses consist of EUR 7.9 million relates to subsidiary for which it is not probable, that future taxable profits will be available gains which the deferred tax assets can be utilized and EUR 12.8 million on two subsidiaries where the ulitization of unused tax losses is limited on 5 years.

Basic earnings per share is calculated by dividing the net result by the weighted average number of ordinary shares in issue, less treasury shares. Diluted earnings per share is calculated by dividing the net result by the weighted average number of ordinary shares and dilutive potential shares, less treasury shares. Diluted earning per share considers subordinated loans and issued debt securities have future conversion options and consequently dilutive potential ordinary shares which is issued financial instrument with characteristics of equity (CoCo).

Diluted profit is the same as net profit of the NLB and the NLB Group; NLB recognizes interests from issued financial instrument with equity characteristics, directly from profit from reserves, as part of equity (note Statement of changes in equity).

5. NOTES TO THE STATEMENT OF FINANCIAL POSITION

Slovenian banks are required to maintain an obligatory reserve with NLB of Slovenia, relative to the volume and structure of its customer deposits. Other banks in the NLB Group maintain an obligatory reserve in accordance with local legislation. NLB and other banks in the NLB Group fulfill their mandatory reserve deposit requirements.

The notional amounts of derivative financial instruments are disclosed in note 5.26.b).

During the year 2009 NLB and the NLB Group reclassified certain bonds from the trading category to loans and receivables. NLB and the NLB Group reclassified high quality corporate bonds that are not traded in the market and for which it has a positive intent and ability to hold for the foreseeable future or until maturity rather than trade in the short term. Reclassified bonds meet the definition of loans and receivables.

The following table illustrates the carrying values and fair values of the assets reclassified:

The effective interest rates, determined on the day the bonds were reclassified, range from 4.15% - 4.23%.

a) Financial assets designated at fair value through profit or loss

b) Financial liabilities designated at fair value through profit or loss

In NLB financial assets in amount of EUR 3,161 thousand (December 31, 2011: EUR 2,074 thousand) are designated at fair value through profit or loss, to reduce the accounting mismatch that would otherwise arise. Financial liability, designated at fair value through profit or loss in amount of EUR 3,160 thousand (December 31, 2011: EUR 2,074 thousand) is the structured deposit from customers, from which the returns depend on the returns from private equity funds, classified as financial asset, measured at fair value through profit or loss.

In NLB Group, in addition to the above mentioned, financial assets that are designated at fair value through profit or loss, represent investments in other funds that are managed and evaluated on a fair value basis.

a) Analysis by type of available for sale financial assets

b) Analysis of movements

As at December 31, 2012, the value of equity instruments that the NLB and the NLB Group obtained by taking possession of collateral held as security and recognized in the statement of financial position is EUR 89,379 thousand (December 31, 2011: EUR 113,032 thousand).

Due to a significant decline in fair values, NLB impaired equity securities in the amount of EUR 30,504 thousand (2011: EUR 32,591 thousand), while the NLB Group impaired equity securities in the amount of EUR 30,504 thousand (2011: EUR 32,601 thousand).

c) Revaluation reserve related to available for sale financial assets

NLB Group entities measure exposure to interest rate risk using a repricing gap analysis and by calculating the sensitivity of statement of financial position and off-balance-sheet items in terms of the economic value of equity. Portfolio duration is used as a measure of risk in the management of securities in the banking book.

NLB Group entities also use various derivatives, such as interest rate swaps, forward rate agreement (FRA), overnight indexed swap (OIS) and currency interest rate swap (CIRS) to close open positions in an individual maturity bucket. Micro and macro fair value hedges are used for that purpose, i.e. the swapping of a fixed interest rate on a hedged item for a variable interest rate. Micro cash flow hedges are also used, i.e. the swapping of a variable interest rate on a hedged item for a fixed interest rate. All cash flow hedges were made on liability items, while fair value hedges were used on both liability and assets items. Hedged liability items (e.g. issued securities, government deposits, etc.) accounted for the majority in nominal terms.

Hedge accounting rules (fair value and cash flow hedging) were applied in the hedging of interest rate risk using interest rate swaps. These hedge relationships are created in such a way that the characteristics of the hedge instrument and those of the hedged item match (i.e. the principal terms match), while the dollar-offset method is used to regularly measure hedge effectiveness retrospectively. Prospective testing of hedge effectiveness is carried out regularly for macro hedges, where the characteristics of both items in the hedge relationship do not fully match, by comparing the change in the fair value of both items with the shift in the yield curve.

Hedge accounting rules were not applied in economic hedges using FRA and CIRS. Thus, the effects of valuation are disclosed in the income statement.

In accordance with hedge accounting rules, the NLB Group hedged a capital investment in a foreign subsidiary (net investment hedge) during the second half of 2011. Similar to cash flow hedging, retrospective and prospective hedge effectiveness testing is carried out regularly.

a) Fair value hedge

In 2012 net losses on hedging instruments amounted to EUR 26,516 thousand in NLB and EUR 26,526 thousand in the NLB Group (2011: net losses to EUR 10,777 thousand in NLB and EUR 11,710 thousand in the NLB Group), net gains on hedged items were in NLB and in NLB Group EUR 26,869 thousand (2011: net gains to EUR 11,108 thousand in NLB and EUR 11,947 thousand in NLB Group).

b) Cash flow hedge

Future cash flows

c) Hedge of a net investment in a foreign operation

Hedge of a net investment in a foreign operation is shown in NLB as fair value hedge, while in the NLB Group it is accounted for using the same principles as for cash flow hedge. Net gains from net investment hedge in amount of EUR 11 thousand (2011: EUR 94 thousand) are in NLB included in income statement in line fair value adjustments in hedge accounting, while in the NLB Group in other comprehensive income.

d) Revaluation reserve related to cash flow hedging

There was no hedge ineffectiveness that neither NLB nor the NLB Group should have recognized in the income statement.

IFRS 7 specifies a fair value hierarchy with respect to the inputs and assumptions used to measure financial instruments at fair value. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the assumption of NLB and the NLB Group. The fair value hierarchy comprises the following levels:

• Level 1 – Quoted prices (unadjusted) on active markets. This level includes listed equity securities, debt instruments, financial derivatives and units of investment funds.
• Level 2 – Inputs other than the quoted prices included in Level 1 that are observable for an instrument, either directly (i.e. prices) or indirectly (i.e. derived from prices). The source of input parameters, such as yield curves and counterparty credit ratings, is Reuters.
• Level 3 – Inputs for an instrument that are not based on observable market data. This level includes nontradable shares and bonds and derivatives associated with these investments.

This hierarchy requires the use of observable market data when available. The NLB Group considers relevant and observable market prices in its valuations where possible.

a) Financial instruments, measured at fair value in the financial statements

b) Significant transfer of financial instruments between levels of valuation

NLB reclassified financial instruments held for trading and financial assets available for sale that became quoted on active market from Level 2 to Level 1. Financial assets available for sale were reclassified from Level 1 to Level 2 due to deteriorating liquidity on the financial markets.

Available for sale financial instruments reclassified from Level 1 ceased to be traded on an active market in June 2011 due to deteriorating liquidity on the financial markets, and were reported as Level 2 instruments in the above analysis as at December 31, 2011.

In August 2011, financial instruments held for trading were listed on stock exchange and were, therefore, reclassified from Level 3 and reported as Level 1 instruments in the above analysis as at December 2011.

c) Financial instruments in 3rd level regarding the fair value hierarchy

In year 2012 the NLB Group recognized the following effects for financial instruments that are in Level 3 as at December 31, 2012:

• for financial instruments measured at fair value through profit or loss, a positive valuation in the amount of EUR 4,347 thousand (December 31, 2011: EUR 45 thousand), recognized in income statement; and
• for available for sale financial instrument, a valuation loss in the amount of EUR 2,577 thousand (December 31, 2011: EUR 8,787 thousand) and negative valuation in the amount of EUR 1,022 thousand (December 31, 2011: positive valuation EUR 840 thousand) recognized in other comprehensive income.

The sensitivity to valuation assumptions disclosed in the table below represents by how much fair value of equity instruments in 3rd level would increase or decrease if management had used reasonably possible alternative valuation assumptions that were not based on observable market data.

Free cash flow method

Comparable Companies Market Multiples Method

Analysis by type of loans and advances

a) Debt securities

Analysis by sector

b) Loans and advances to banks

Analysis by type of advance

The NLB Group received securities received under repurchase agreements as a collateral (it becomes the legal owner of said securities), while the borrower is entitled to the associated coupon interest and dividends. The NLB Group did not sell or pledge any of the securities it received as collateral during the financial years presented. The fair value of these securities amounted to EUR 9,895 thousand (December 31, 2011: EUR 10,046 thousand).

c) Loans and advances to customers

Analysis by type of advance

The NLB Group received securities received under repurchase agreements as collateral (it becomes the legal owner of said securities), while the borrower is entitled to the associated coupon interest and dividends. The NLB Group did not sell or pledge any of the securities it received as collateral during the financial years presented. The fair value of these securities amounted to EUR 1,522 thousand (December 31, 2011: EUR 1,990 thousand).

Analysis by sector

Finance leases

Loans and advances to customers in the NLB Group include finance lease receivables:

The allowance for unrecoverable finance lease receivables included in the provision for loan losses amounted to EUR 94,216 thousand (December 31, 2011: EUR 83,842 thousand).

Finance and operating lease transactions are carried out by the NLB Group through specialized subsidiaries that offer a wide range of financing such as car leasing, real estate leasing, leasing of commercial and production equipment and others.

The majority of the lease agreements entered into by NLB Group as lessor contracts are finance lease agreements (operating leases account for less than 10% of all lease agreements). The majority of agreements are concluded for a non-cancellable period of between 48 and 60 months, with an unguaranteed residual value representing a purchase option typically between 1.6% and 2% of the gross investment.

Finance and operating leases of motor vehicles and operating leases of business premises represent the majority of agreements in which the NLB Group act as lessee.

d) Other financial assets

Analysis by type of other financial assets

Receivables in the course of collection are temporary balances which are transferred to the appropriate item in the days following their occurrence.

Analysis of other financial assets by sector

e) Movement of called non-financial guarantees

Fee income from all issued non-financial guarantees amounted to EUR 6,951 thousand (2011: EUR 7,225 thousand) at NLB, and to EUR 7,718 thousand (2011: EUR 8,124 thousand) at the NLB Group.

a) Analysis by type of held to maturity financial assets

b) Analysis of movements

In 2011 NLB decreased the exposure from sovereign debt securities to Greece, Portugal, Spain and Ireland with a sale prior to maturity due to a significant deterioration of the creditworthiness of the issuers.

a) Analysis by type of non-current assets classified as held for sale

Despite its 23.51% participating interest, NLB recorded its investment in Pivovarna Laško as an available-for-sale financial asset owing to the absence of significant influence. It obtained significant influence over the aforementioned entity in the third quarter of 2012 due to the reinstatement of its voting rights. For this reason, the NLB began treating the investment as an investment in an associate. Because NLB has already taken steps to sell its investment in Pivovarna Laško and because there is a high probability that the sale will go forward, the investment was reclassified as a non-current asset held for sale. The aforementioned reclassification was carried out at the market price valid on September 30, 2012, calculated as the number of shares multiplied by the market price per share on the stock exchange. The sale is expected to take place within one year. The investment in Pivovarna Laško is included in the segment Financial markets in Slovenia (note 8.1).

In July 2011 the NLB Group sold 97.01% of interest in subsidiary NLB Bank Sofia, Sofia to a third party. When the investment was sold, NLB realized a further loss in the amount of EUR 1,570 thousand.

b) Disposal of subsidiary by the NLB Group

The details of the assets and liabilities of the NLB Group at the date of disposal and disposal consideration are as follows:

c) Analysis of movements

In 2011 the NLB Group has reclassified repossessed assets from non-current assets held for sale to other assets (note 5.14).

Assets leased under finance leases in the NLB Group as at December 31, 2012 amounted to EUR 60 thousand for motor vehicles (December 31, 2011: EUR 64 thousand) and EUR 1,211 thousand for land (December 31, 2011: EUR 1,198 thousand). NLB has no assets held under finance leases as at December 31, 2012 and December 31, 2011.

The value of assets received by taking possession of collateral and included in property and equipment by NLB and NLB Group amounted to EUR 7 thousand (December 31, 2011: EUR 7 thousand).

The net carrying value of assets leased out by the NLB Group under operating leases was EUR 21,956 thousand as at December 31, 2012 (December 31, 2011: EUR 20,572 thousand). Majority of assets (December 31, 2012: 64.2% December 31, 2011: 78.4%) leased out relates to motor vehicles.

The NLB Group has no interests in properties held under operating leases that were classified and accounted for as investment property. The NLB Group incurred operating expenses arising from investment properties leased to others in amount of EUR 235 thousand in its 2012 income statement (2011: EUR 112 thousand).

The value of assets received by taking possession of collateral and included in investment property by NLB and NLB Group amounted to EUR 13,319 thousand (December 31, 2011: EUR 3,888 thousand).

In 2012 and 2011, the NLB Group did not impair any goodwill or additionally identified intangible assets as the impairment test showed no signs for possible impairments (note 2.32.g).

a) Analysis by type of investment in subsidiaries

In 2012 NLB recognized an impairment loss in the amount of EUR 200,662 thousand (note 4.11). Impaired investments in LHB, Frankfurt, FIN-DO, Domžale, NLB Leasing, Ljubljana, NLB Leasing, Sarajevo, NLB Leasing, Beograd in Argo, Horjul are included in segment Non-strategic markets and activities, NLB banka, Beograd is included in segment Foreign strategic markets.

In 2011 NLB recognized an impairment loss in the amount of EUR 53,884 thousand (note 4.11). Impaired investments in NLB Leasing, Ljubljana, NLB Leasing Maribor, Maribor, NLB Leasing, Sarajevo, NLB Factoring, Ostrava, NLB Factor, Bratislava, NLB Srbija, Beograd and LHB Internationale Handelsbank, Frankfurt are included in segment Non-strategic markets and activities.

Data of subsidiaries according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2012:

Data of subsidiaries according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2011:

Ownership interest and voting rights are calculated after the deduction of treasury shares.

b) Analysis by type of investment in associates and joint ventures

Data of associates according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2012:

ICJ d.o.o., Domžale is not treated as a joint venture as there is no contractual agreement between shareholders for joint control.

According to contractual agreement NLB does not have control in Skupina Argo, Horjul, but only significant influence and therefore the entity is accounted as an associate.

Skupina Laško, Laško is classified as non-current assets held for sale.

Data of associates according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2011:

Ownership interest and voting rights are calculated after the deduction of treasury shares.

Data of joint ventures according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2012:

Data of joint ventures according to IFRS as included in consolidated financial statements of NLB Group as at December 31, 2011:

c) Movements of investments in associates and joint ventures

Assets, received as collateral consist real estates, motor vehicles and equipment.

a) Loans and advances to individuals

b) Loans and advances to legal entities

NLB purchased claims in the total amount of EUR 173,543 thousand from LHB in 2012. NLB treated the purchase of claims from LHB in 2012 as a business combination under common control using the combination method, such that the NLB combined the book values of the purchased claims of the acquiring and acquired entities, as reported in the consolidated financial statements. For this reason, NLB increased gross purchased claims by EUR 173,543 thousand and created value adjustments in the amount of EUR 61,517 thousand. The increase in value adjustments due to the purchase of claims from LHB Frankfurt is disclosed in the item other.

c) Other financial assets

The notional amounts of derivative financial instruments are disclosed in note 5.26.b).

Analysis by type of financial liabilities, measured at amortised cost

a) Deposits from banks and amounts due to customers

b) Borrowings from banks and other customers

c) Debt securities in issue

Debt securities issued by NLB relate to issued bonds and are denominated in EUR. Of these, 79.11% bear fixed interest rates (December 31, 2011: 93.66%), while 20.89% bear floating interest rates (December 31, 2011: 6.34%). All issued bonds with a carrying amount of EUR 104,567 thousand (December 31, 2011: EUR 1,234,987 thousand) were traded on active markets as at December 31, 2012.

Debt securities issued by the NLB Group relate to issued bonds and are all denominated in EUR. Of these, 80.43% bear fixed interest rates (December 31, 2011: 93.65%), while 19.57% bear floating interest rates (December 31, 2011: 6.35%). All issued securities with a carrying amount of EUR 111,620 thousand were traded on active markets as at December 31, 2012 (December 31, 2011: EUR 1,232,934 thousand).

In comparison with December 31, 2011, issued bonds decreased by EUR 1.1 billion. Decrease is due to early redemption of the issued bonds in nominal value of EUR 257 million and redemption of mature bonds in total nominal value of EUR 856 million. Effects are shown in income statement in position gains less losses from financial assets and liabilities not classified as at fair value through profit or loss (note 4.4.).

During the years presented there were no defaults on the securities in issue.

d) Subordinated liabilities

To ensure Core Tier 1 ratio of 9%, the implemented activities for restructuring of existing subordinated instruments were exercised at the end of June and beginning of July 2012. The instruments were repurchased at a discount or exchanged into new senior unsecured debt. NLB has repurchased a total of EUR 426.4 million of existing subordinated instruments. NLB’s repurchase at a discount resulted in a gain before tax totalling EUR 179,946 thousand. Effects from repurchase are shown in income statement in line gains less losses from financial assets and liabilities not classified as at fair value through profit or loss (note 4.4.). At the same time, part of the repurchased amount of EUR 136.8 million were exchanged into new senior unsecured debt with a maturity of 3 years. Because of these transactions, issued subordinated liabilities have decreased in comparison with December 31, 2011 in NLB for EUR 429,794 thousand or 57.2% and in NLB Group for EUR 440,668 thousand or 56.2%.

In 2011, NLB made an early repurchase of subordinated loan in the nominal amount of EUR 100 million.

In 2011 NLB recalculated the amortized costs of subordinated loans of nominal amount of EUR 190,000 thousand and EUR 75,000 thousand and subordinated securities in nominal amount of EUR 130,000 thousand as a result of a change in expected future cash flows. The aforementioned recalculation resulted in higher amortized costs for subordinated loans in the amount of EUR 7,434 thousand and lower amortized costs for subordinated securities in amount of EUR 1,184 thousand.

As at December 31, 2011 in accordance with the Regulation on the Calculation of the Capital of Banks and Savings Banks, a subordinated loan in the amount of EUR 130 million is included in the NLB Group’s Tier I capital, all other subordinated loans and issued securities are included in the NLB Group’s Tier II capital.

Subordinated liabilities do not contain any provisions for conversion to capital or any other liabilities. During the years presented, there were no defaults on subordinated liabilities.

e) Other financial liabilities

a) Analysis by type of provisions

b) Movements in provisions for guarantees and commitments

Financial guarantees

Non-financial guarantees

Other credit commitments

c) Movements in employee benefit provisions

Post-employment benefits

Other employee benefits

Other employee benefits include the NLB Group’s obligations for jubilee long-service benefits and unused annual leave.

d) Movements in provisions for premiums from National Housing Saving Scheme

According to the covenants of the National Housing Saving Scheme, the Housing Fund of the Republic of Slovenia was required in previous years to contribute one monthly premium per year for all depositors included in the scheme. NLB is required to refund the invested premiums to the Housing Fund for all depositors that decide not to take a loan after the conclusion of the scheme. NLB has created provisions for the expected amount of such premiums.

e) Movements in restructuring provisions

Cash flows associated with the restructuring provisions are expected in next two years.

f) Movements in other provisions

Other provisions in NLB in amount of EUR 2,715 thousand (December 31, 2011: EUR 2,758 thousand) relate to claims for additional interest relating to retail savings and deposits.

a) Analysis by type of deferred income taxes

Changes of deferred income tax also include effects from tax rate decrease in Slovenia.

Slovenian law does not set limits or deadlines by which uncovered tax losses must be utilized. Because the NLB plans to generate a profit after restructuring has been completed, it calculated deferred tax assets for the entire tax loss.

b) Movements in deferred income taxes

Deferred income tax assets

Deferred income tax liabilities

In July 2012 NLB increased capital in the amount of EUR 61,000 thousand. Share capital increased for EUR 12,417 thousand and share premium for EUR 48,583 thousand. As at December 31, 2012 NLB’s share capital amounted to EUR 104,731 thousand (December 31, 2011: EUR 92,314 thousand), and is divided into 12,548,930 ordinary shares (December 31, 2011: 11,061,125).

Movements in share of numbers

All shares are ordinary, freely transferable no-par value shares, with voting rights, issued in non-material form and registered in the accounts of shareholders at the Central Securities Clearing Corporation. All shares are of the same class and subscribed and paid up. Shareholders have the right to participate in the governance of NLB, to receive dividends, and they are entitled to an appropriate portion of assets in the event of the winding-up of NLB, as determined by law. All shares are paid-up in full.

As at December 31, 2012 there were 1,989 shareholders (December 31, 2011: 1,990) of which 272 are legal entities, 1,692 are individuals and 25 are non–residents. Compared to year-end 2011 the number of shareholders has decreased by 1. One share is held by NLB’s subsidiary (December 31, 2011: 1 share). NLB has 34,926 treasury shares (December 31, 2011: 34,924), for which it has created reserves in the amount of EUR 2,048 thousand (December 31, 2011: EUR 2,048 thousand).

The basic book value of a NLB share as at December 31, 2012 was EUR 58.4 (December 31, 2011: EUR 86.8) and on a consolidated level it was EUR 63.0 (December 31, 2011: EUR 88.5). It is calculated as the ratio of net assets book value without other equity instruments issued and the number of shares without treasury shares.

The diluted book value of the NLB’s share as at December 31, 2012 was EUR 49.3 (December 31, 2011: EUR 86.8) and on consolidated level it was EUR 51.9 (December 31, 2011: EUR 88.5). It is calculated by dividing whole net asset book value with the number of ordinary shares and potential shares without treasury shares.

Pursuant to the decision of the annual General Meeting, NLB did not pay a dividend in 2012 and 2011 for previous years.

The share premium comprises paid-up premiums in the amount of EUR 725,267 thousand (December 31, 2011: EUR 678,398 thousand) and the revaluation of share capital from previous years in the amount of EUR 49,205 thousand (December 31, 2011: EUR 49,205 thousand). The share premium is not distributable.

Profit reserves in the amount of EUR 164,204 thousand (December 31, 2011: EUR 180,248 thousand) comprise retained earnings that were transferred to reserves in accordance with the decision of NLB’s Annual General Meeting and cannot be distributed in the form of dividends.

NLB recorded a net loss in the amount of EUR 304,876 thousand (2011: net loss EUR 233,201 thousand), and thus no distributable profit is available for 2012.

Capital adequacy and capital are monitored in conformity with the guidelines developed by the Basel Committee and European Community Directives, as implemented by the Bank of Slovenia. The required information on capital adequacy is filed with the Bank of Slovenia on a quarterly basis. The Bank of Slovenia requires each bank and banking group to maintain capital adequacy ratio at or above 8%.

At the end of 2012, a change in Slovenian capital legislation came into force, which affected the calculation of capital ratios at the bank level, but not at the level of the group. The Bank of Slovenia applied the discretion according to current European legislation and allowed parent banks, when calculating capital on an individual basis, not to include deduction items for equity investments in subsidiaries, which are subject to banking supervision on a consolidated basis. This change caused growth of capital by EUR 433 million and growth of capital requirements for credit risk by EUR 87 million, resulting in improvement of capital adequacy ratio by 3.6 percentage points.

Capital adequacy calculations for the NLB Group are based upon the consolidated financial reports, prepared in line with the Regulation on the supervision of banks and savings banks on a consolidated basis, which differs from the consolidation made in line with IFRS. According to IFRS, all the group’s subsidiaries, associates and joint ventures are included in consolidation: subsidiaries using the full consolidation method whereas associates and joint ventures using the equity method.

According to the Regulation on the supervision on a consolidated basis, only credit institutions, financial institutions, ancillary services undertakings and asset management entities are included in consolidated financial reports (insurance companies, pension funds and non-financial entities are excluded: NLB Nov penziski fond, Skopje, Skupna pokojninska družba, Ljubljana, NLB Vita, Ljubljana and Argo, Horjul). Furthermore, joint ventures (Prvi Faktor Group, Ljubljana) are included in consolidated reports using the proportional method of consolidation.

Characteristics of each capital component are described in the Regulation on the calculation of own funds of banks and savings banks (Ur.l.RS 85/2010, 97/2010, 100/11 and 100/12). Tier I capital is of highest quality and is primarily composed of equity (shares and related reserves) and to a limited amount also of several high-quality hybrid instruments. Tier II capital includes hybrid instruments (Tier I eligible instruments that exceed the limitation for inclusion in Tier I capital, as well as Tier II eligible instruments), subordinated debt and revaluation reserve from available for sale securities and from investment property. The extent of subordinated debt included in Tier II capital is gradually decreasing with 20% cumulative discount in the last five years before maturity.

The current capital legislation considers Tier 1 capital as a single category, but the European Banking Authority (EBA) introduces the subcategory Core Tier 1, which includes only share capital related items, but no hybrid instruments. The only exceptions to this rule are convertible capital instruments (so-called CoCo instruments) which fulfil all the required criteria for inclusion in top-quality core capital. At the request of EBA, NLB Group was obliged to increase the Core Tier 1 ratio to 9% until the end of June 2012.

In 2012, NLB carried out a series of activities aimed at both increasing the capital as well as reducing the capital requirements. Direct increase of available capital was achieved by the capital increase of EUR 61 million and the issue of convertible capital instrument (subordinated loan, which has all the characteristics required by the EBA to include in Core Tier 1 capital) of EUR 320 million, both carried out in June 2012. With the early redemption of existing capital instruments in June and July in total amount of EUR 426 million, NLB generated EUR 153 million of profit after calculated taxes, which contributed to improvement of the capital structure quality (Core Tier 1 and Tier 1 ratios), and on the other hand caused deterioration in capital adequacy due to a reduction of the total amount of capital. As a result of an active approach to reducing risk-weighted assets in the whole NLB Group, the need for capital in 2012 decreased by EUR 175 million. Measures to improve capital adequacy ratio are disclosed in paragraphs headed State aid programme, initiated by the European Commission.

In accordance with the contract, convertible capital instrument (CoCo) in the amount of EUR 320 million issued in June 2012, is to be converted into common equity in the event of deterioration in the capital position of the NLB below a pre-determined level. The condition for conversion was fulfilled as at December 31, 2012, identified in January 2013.

NLB has a branch in Trieste with total assets amounting to EUR 67,214 thousand as at December 31, 2012 (December 31, 2011: EUR 109,647 thousand) and net loss for 2012 of EUR 9,856 thousand (2011: EUR net gain 83 thousand).

a) Contractual amounts of off-balance sheet financial instruments

Commitments to extend loans can be realized within one year. The NLB Group has no financial guarantees, for which the first possible payment date would be later than within one year.

b) Analysis of derivative financial instruments by notional amounts

The notional amounts of derivative financial instruments that qualify for hedge accounting at NLB and NLB Group amount to EUR 446,816 thousand (December 31, 2011: EUR 1,830,782 thousand). Derivatives that qualify for hedge accounting are used to hedge interest rate risk.

The fair values of derivative financial instruments are disclosed in notes 5.2., 5.5. and 5.16.

c) Operating lease commitments

The future minimum lease payments under non-cancellable operating leases are as follows:

d) Operating lease income

Future minimum operating lease income:

e) Capital commitments

As at December 31, 2012 the NLB Group had capital commitments for the purchase of property and equipment in the amount of EUR 715 thousand (December 31, 2011: EUR nil) and commitments in the amount of EUR 1,547 thousand (December 31, 2011: EUR 290 thousand) in respect of intangible assets (software and licenses).

As at December 31, 2012 the NLB Group had capital commitments for the purchase of property and equipment in the amount of EUR 715 thousand (December 31, 2011: EUR 19 thousand) and commitments in the amount of EUR 1,611 thousand (December 31, 2011: EUR 362 thousand) in respect of intangible assets (software and licenses).

Funds managed on behalf of third parties are accounted for separately from the NLB Group’s funds. Income and expenses arising with respect to these funds are charged to the respective fund, and no liability falls on the NLB Group in connection with these transactions. The NLB Group charges fees for its services.

Funds managed on behalf of third parties

Fee income for funds managed on behalf of third parties

6. EVENTS AFTER REPORTING DATE

After December 31, 2012 the NLB increased the equity in total amount of EUR 321,712 thousand thereof in amount of EUR 320,000 thousand from conversion of hybrid financial instrument (CoCo). Share capital increased for EUR 74,530 thousand and share premium for EUR 247,182 thousand.

KBC Bank N.V. Brussels sold its share in banks equity to Republic of Slovenia. The new share of Republic of Slovenia in banks equity after these two transactions is 76.91%.

Rating agency Moody’s downgraded NLB’s long-term deposit to Caa2.

Mr. Nima Motazed became a Management Board member, responsible for the bank’s operations (Chief Operating Officer) covering IT, organization, supportive functions, procurement and facitlity & propery management.

7. RISK MANAGEMENT

The primary aim of risk management in the NLB Group is to proactively monitor and manage risks that arise during the achievement of planned operating results and strategic objectives, which is thus reflected in the more economical use of the NLB’s capital. The NLB Group has risk management policies and procedures in place that take into account Bank of Slovenia regulations and other legislation, and the current guidelines and best practices of banks in this area. The overall strategy and the most important internal policies of the NLB Group, which are approved by the Management Board and discussed by the Supervisory Board, define in detail the objectives, approaches and methodologies for monitoring, measuring and managing different risks.

The protracted economic and financial crisis had a negative impact in 2012 on the operations of NLB Group’s customers. The conditions that have led to new insolvency proceedings persisted during the year. Increased insolvency, a decline in economic activity and a drop in spending were reflected in the continuing deterioration in the quality of the investment portfolio and a decrease in the NLB’s capital strength. The adverse conditions had the most significant impact on the operations of the NLB Group in terms of credit risk, the main risk to which the Group is exposed. The Group was also heavily exposed to liquidity risk, which was further exasperated by the downgrading of Slovenia and NLB, and the general lack of confidence among financial institutions.

The NLB Group responded to the adverse economic conditions by strengthening internal procedures, controls and the organizational structure of risk management. New approaches were introduced in 2012, and the methodology for identifying, monitoring and managing risks supplemented. These procedures and methodologies facilitate the early and more detailed recognition of increased risk to which the NLB Group is exposed. The NLB established a system for the early detection of an increase in all types of risks, introduced additional controls of investment approval activities, reorganized the intensive care and recovery activity, and updated existing databases and the reporting system with the aim of proactively managing the risks to which the Group is exposed.

In addition, organizational changes were introduced in the broader area of risk management. The department responsible for monitoring risks took on new additional responsibilities and was reorganized into two units: the Risk Department and the Credit Analysis and Control Department. The Risk Department is responsible for formulating and controlling the implementation of risk management policies and monitoring the NLB Group’s exposure to all types of commercial risks. The Credit Analysis and Control Department prepares credit analyses, proposals for classification to credit rating categories and maximum borrowing limits for all customers and groups of related parties, and controls the conclusion and execution of credit transactions and transactions on the financial markets in accordance with internal and external risk management rules.

The organizational structure of the intensive care and recovery activity was changed with the establishment of two separate organizational units within the Corporate Intensive Care and Non-Performing Loan Department. The Corporate Intensive Care and Recovery Sector deals with the handling of the NLB’s active customers that encounter problems in their operations, while the Non-Performing Loan Management Sector finds the optimal solutions in the form of collection activities for the problematic portfolio of investments and customers.

NLB believes that activities to date and the new approaches introduced in 2012 will improve the control and management of risks. Credit and liquidity risk will remain the main risks to which the NLB Group will be exposed in the future, while the intensive and proactive handling of problematic customers and the stabilization of economic conditions will lead to the gradual mitigation of the aforementioned risks.

In its operations, the NLB is especially exposed to credit risk or the risk of losses due to the failure of a debtor to settle its liabilities to the NLB. For that reason, it carefully monitors and assesses the aforementioned risk. In that process, NLB Group follows International Financial Reporting Standards and regulations issued by the NLB of Slovenia. This area is governed in greater detail by the internal methodologies and procedures set out in internal acts.

Credit risk has risen significantly during the period of adverse economic conditions and was even more evident in 2012. As a result, NLB created an increased level of additional impairments of financial assets and provisions for off-balance-sheet items in the total amount of EUR 376.3 million and EUR 510.6 million for the NLB Group overall.

The following factors in particular had an impact on the level of credit risk losses incurred by NLB in 2012:

• due to the tightening of liquidity conditions, customers settled their liabilities to the NLB in arrears and were downgraded to lower credit rating categories, which increased the balance of non-performing loans for which higher impairments had to be created;
• bankruptcy proceedings were initiated against certain customers with a high level of exposure;
• the value of some existing collateral declined owing to the illiquid real estate market;
• NLB assumed the portfolios of certain NLB Group entities due to planned closures; and
• due to poor operations of certain NLB Group entities NLB created impairments and provisions for loans and contingent liabilities.

Once again, the most significant increase in losses was recorded by the construction sector in 2012, followed by the trade sector, manufacturing and financial corporations. The most significant increase in arrears, and as a result in non-performing loans, was likewise recorded by the construction sector. Last year, NLB limited maximum exposure to an individual customer to 10% (previously 25%) of capital and established a clear downward trend in exposure to the aforementioned sector. Through the proactive monitoring and management of projects, the NLB partly slowed the redemption of guarantees issued to problematic customers. The NLB also took steps to sell off real estate.

The NLB’s effort to manage credit risks continued to be aimed at implementing measures to prevent growth in non-performing loans in other sectors, with an emphasis on the intensive care of customers in distress and the securing of quality collateral on investments. To that end, materially significant customers were handled centrally at the NLB Group level.

Nevertheless, non-performing loans were up 39% at NLB in 2012 to reach 26% of the credit portfolio. Also having a significant impact on the growth in the proportion of non-performing loans was a contraction in the loan portfolio due to a drop in investment demand and limits on the NLB’s capital.

It should be noted that the NLB introduced additional early warning systems and systems for the prompt identification of problematic customers, and continuously verifies and updates procedures for assessing the appropriateness of impairments and provisions in order to respond to changes in the financial position of customers in a cost-efficient and timely manner. Among its other consequences, the economic crisis has accelerated the following trends and activities in the area of credit policy:

• the securing of the highest quality collateral for existing and new transactions, with the consistent application of established ratios and the consistent monitoring of contractual obligations;
• the precursory assessment of additionally required impairments of claims and provisions for commitments in the context of unfavourable trends, and the creation of impairments and provisions when objective evidence thereof exists;
• the establishment of an early warning system to detect increased credit risk, and the associated transfer of monitoring of individual customers to the watch list or intensive care list;
• the gradual updating of the credit rating classification methodology, with an emphasis on decreased risk assumption; and
• the centralized monitoring and the expression of opinions on the approval of individually material investments at NLB Group entities.

Through regular reviews of business practices and the credit portfolios of Group entities, NLB ensures the credit risk management of those entities functions in accordance with the NLB Group’s risk management standards in order to ensure meaningfully uniform procedures at the consolidated level. Capital requirements for credit risk at the NLB Group level are calculated monthly according to the standardized approach.

The NLB Group manages credit risk at two levels:

• at the level of the individual customer, where appropriate procedures are followed in various phases of the relationship with a customer, prior to, during and after the conclusion of an agreement. Prior to the conclusion of an agreement, a customer’s performance, financial position and past cooperation with the NLB are assessed. The results of such an assessment also serve as the basis for assigning a credit rating. The securing of quality collateral is of central importance. This is followed by various forms of monitoring a customer, in particular an assessment of its ability to generate sufficient cash flows for the regular settlement of liabilities and contractual obligations; and
• at the level of the overall portfolio of NLB and/or the NLB Group. The portfolio is regularly monitored by segments with regard to the type and size of a customer, its rating, arrears (i.e. bad/overdue claims), collateral, activity, country, currency exposure, etc. Monitoring comprises an analysis of changes and the identification of trends in movements, risks and concentration of the credit portfolio on the basis of time factors. Increasing emphasis is also placed on stress tests that forecast the effects of negative movements in the portfolio on the level of impairments and provisions, and on capital adequacy.

NLB and other NLB Group entities assess the level of credit risk losses on an individual basis for material claims, which are reviewed individually, and at the Group level for the rest of the portfolio.

The primary aim of an individual review is to determine whether objective evidence of impairment exists. Such evidence includes information regarding significant financial problems encountered by a customer, regarding actual breaches of contractual obligations, such as arrears in the settlement of liabilities to the NLB, regarding whether financial assets will be restructured for economic or legal reasons, and regarding the likelihood that a customer will enter bankruptcy or financial reorganization. Expected future cash flows (from ordinary operations and the possible redemption of collateral) are assessed following an individual review. If their discounted value differs from the book value of the financial asset in question, impairment must be recognized.

Collective impairments are made for the remainder of the portfolio, which is not assessed on an individual basis. To that end, the portfolio is broken down into groups of similar claims, and then further into sub-groups with respect to their credit rating. Here, impairments are created with respect to probability of default (PD) and with respect to the average rate of default or loss given default (LGD) associated with non-performing claims. Probability of default is determined by transition matrices, which illustrate the migration of customers between rating categories, using a moving average of a transition matrix for the last 10 years. The average rate of default or loss given default, which indicates how much the NLB will lose on average when a claim becomes non-performing, is determined based on the amount of impairments created for non-performing loans. When creating collective provisions for commitments, NLB also determines, on the basis of empirical data regarding the redemption of guarantees in the past, the probability of the redemption of guarantees, which is taken into account when creating collective provisions.

Among the most important tools for assessing the quality of the credit portfolio, the characteristics of the internal rating system and the level of exposure to systemic risk (i.e. to a risk that affects both a large number of customers and financial instruments) are:

• transition matrices, which illustrate the migration of customers between rating categories, and the related methods for determining time-sensitive portfolio changes and
• the level of concentration or diversification of the credit portfolio. NLB appropriately diversifies its portfolio to mitigate specific components of credit risk (i.e. the risk deriving from transacting with a specific customer, positions in financial instruments or specific events).

NLB migration matrix for corporate clients based on annual transitional matrices for the years 2002-2012

a) Internal rating system and authorizations

The Bank of Slovenia’s Regulation on the Assessment of Credit Risk Losses of Banks and Savings Banks serves as the legal basis for rating each customer and the associated claims, and for creating impairments. The aforementioned regulation prescribes five rating categories (from "A" to "E") for customers and claims. An “A” credit rating is given to first-class customers, who are not expected to encounter difficulties in repaying their obligations. A credit rating of “B” indicates customers with a slightly worse financial position, which is temporary in nature and does not indicate difficulties in repaying obligations. A credit rating of “C” indicates customers who are undercapitalized and highly indebted, or those customers that generally do not generate sufficient cash flows to repay their obligations, and so thus may pay their obligations in arrears. Credit ratings of “D” and “E” indicate customers with evident financial difficulties, or those who are in the process of compulsory settlement or bankruptcy. It is expected that these clients will not be able to repay most or even any of their obligations from their operating cash-flow. Customers with a “C” credit rating or worse must provide additional collateral. The regulation also prescribes the impairment of claims and the creation of provisions for commitments in accordance with the IFRS, with respect to the risk of a specific transaction and existence of evidence of impairment.

Authorizations, procedures and the detailed rating methodology, as well as the setting of a maximum borrowing limit and the impairment of claims, are formalized in the NLB Group’s internal acts. A standard customer rating methodology, with the prescribed set and quality of input data and elements of a rating analysis, applies to all NLB Group entities. Here it should be noted that decisions regarding materially significant customers of the NLB Group is solely the responsibility of the NLB Credit Committee.

NLB regularly reviews the business practices and credit portfolios of NLB Group entities to ensure that they are operating in accordance with the minimum risk management standards of the NLB Group. This ensures appropriate standard processes for managing and reporting credit risks at the consolidated level.

b) Maximum exposure to credit

The maximum exposure to credit risk represents the worst case scenario relating to credit risk exposure. For assets, the exposures set out above are based on net carrying amounts as reported in the statement of financial position, while off-balance sheet items amounts are based on nominal values.

The NLB has 64.7% (December 31, 2011: 71.5%) loans and advances neither past due nor impaired, 1.1% (December 31, 2011: 2.9%) loans and advances past due but not impaired, 27.4% (December 31, 2011: 20.8%) individually impaired loans and 6.8% (December 31, 2011: 4.8%) collectively impaired loans. The NLB Group has 63.2% (December 31, 2011: 65.7%) loans and advances neither past due nor impaired, 5.4% (December 31, 2011: 7.1%) loans and advances past due but not impaired, 26.4% (December 31, 2011: 22.8%) individually impaired loans and 5.0% (December 31, 2011: 4.8%) collectively impaired loans.

In 2012 and in 2011 the quality of the credit portfolio deteriorated due to the financial crisis. This resulted in an increase in impairment and provisions for credit loss for customers who were collectively assessed and for customers who were individually assessed.

For this reason the coverage of the credit portfolio by allowances for impairment in NLB has been steadily increasing (2011: increasing) to stand at the end of the year 2012 at 15.6% (2011: 11.4%). 56.4% (2011: 67.0%) of the portfolio is considered to be a quality portfolio. The coverage of the portfolio by allowances for impairment at the NLB Group level has also risen and stood at 16.7% (December 31, 2011: 12.6%) at the end of 2012. 57.9% (December 31, 2011: 65.1%) of the portfolio is considered as quality portfolio (A and B ratings).

c) Collateral from loans and advances

The NLB Group accepts different types of collateral to mitigate credit risk. The decision regarding the type and value of collateral depends on an analysis of customer data. The NLB Group strives to obtain high-quality collateral, which facilitates the more rational use of the NLB Group’s capital and results in lower impairments and provisions for financial assets and commitments. In 2012 the quality of collateral has decreased.

The main types of collateral are as follows:

• for houses and flats to individuals, real estate collateral,
• for consumer loans to individuals, claims secured by insurance company,
• for loans to other customers, real estate collateral.

NLB Group tends to collaterize long term investments with adequate real-estate. The NLB Group regularly monitors the value of collateral over the entire loan repayment period and requires that the customer provides additional collateral if the value of collateral decreases.

d) Loans and advances neither past due nor impaired

e) Loans and advances past due but not impaired

f) Individually impaired loans and advances

g) Loans and advances analysis

h) Repossessed assets

NLB and the NLB Group received the following assets by taking possession of collateral held as security and held them at reporting date:

i) Analysis of loans and advances by industry sectors

Analysis of loans and advances by industry sector excludes other financial assets.

j) Analysis of loans and advances by geographical sectors

Analysis of loans and advances by geographical sector excludes other financial assets

k) Analysis of debt securities, treasury bills, other eligible bills and derivative financial instruments by geographical sectors

l) Internal rating of derivatives counterparties

No derivatives in the banking book are entered into with counterparties with an external rating less than “AA”. When derivatives are entered into on behalf of customers all such transactions are covered through back-to-back transactions involving third parties with an external rating of “AA” or above.

m) Debt securities in NLB’s and the NLB Group’s portfolio that represent subordinated liabilities for the issuer

Securities in NLB represent subordinated bonds of domestic issuer with internal rating “B” (December 31, 2011: A). Other members of the NLB Group do not have debt securities that represent subordinated liabilities for the issuer.

n) Presentation of financial instruments by measurement category

As at December 31, 2012 and December 31, 2011 all of the Group’s financial liabilities except for derivatives designated as hedging instruments, trading liabilities and financial liabilities designated at fair value through profit or loss were carried at amortised cost.

Market risk is the risk that the market or fair value of financial instruments could fluctuate due to changes in specific market parameters, such as exchange rates, interest rates and securities prices. The NLB Group maintains a conservative policy for market risks as demonstrated by substantially closed positions, relatively low limits and a detailed control environment. The conclusion of transactions in financial instruments at NLB is aimed primarily at servicing customers and hedging the NLB’s own positions. Pursuant to the provisions of the Strategy for Trading in Financial Instruments at the NLB Group, trading by other NLB Group entities is very limited. The NLB Group’s exposure to market risk is relatively low and primarily derives from structural imbalances or arises as the result of credit risk.

Market risks include liquidity risk, which relates to the NLB’s ability to secure a sufficient level of liquidity to settle all of its obligations. With regard to structural liquidity, the NLB Group has created relatively high secondary liquidity reserves in the form of investment-grade debt securities that facilitate refinancing via the ECB or on the interbank market. In the current situation, the Group also strives to follow as closely as possible a long-term trend of diversification on both the liability and asset sides of the balance sheet.

Monitoring and managing the NLB Group's exposure to market risks are not carried out on a consolidated level. However, uniform guidelines and exposure limits for each type of risk are set for individual Group entities. Methodologies are in line with regulatory requirements on an individual and consolidated level, while current reporting to the regulator on a consolidated level is carried out using a standardized approach. Pursuant to the relevant policies, Group entities must monitor and manage exposure to market risks and report to NLB accordingly. The exposure of individual Group entity is regularly monitored and reported to the Assets and Liabilities Committee of the NLB Group (NLB Group ALCO).

The NLB Group strengthened internal controls and updated methodologies and internal policies relating to market risks in 2012 with the aim of more effectively identifying, measuring, monitoring and thus managing market risks. The results of the Group’s efforts have been seen in a reduction in capital requirements for market risks. The NLB Group also gave special attention to performing the most varied stress tests in the area of market risks in 2012. The Group uses a tool (stress tests) that comprises various methodologies for determining vulnerability to exceptional but probable events. The main objective of stress tests is to calculate potential losses, from which the identification of the Group’s own risk profile also derives.

a) Capital markets summary

Slovenia

Total turnover on the Ljubljana Stock Exchange amounted to EUR 360 million (including the equity market, bond market, investment funds, treasury bills and commercial paper) in 2012, down EUR 109 million or 23.3% on the turnover achieved in 2011, and down EUR 132 million or 26.8% on the total turnover recorded in 2010. The majority of turnover comprised equity transactions, which amounted to EUR 303 million or 84% of total turnover, followed by bonds at 15.4% and investment funds at 0.5% of total turnover. The total number of transactions in 2012 was down 42% on 2011 and amounted to 56,620, mainly due to a smaller number of transaction on the equity market. Nevertheless, after two years of negative yields, the LJSE’s benchmark SBI TOP index was up 7.8% in 2012, although its annual growth was down 8.6 percentage points compared to the performance of the Central and Eastern European CEESEG composite index.

On the last trading day of 2012, the SBI TOP’s value stood at 635.5 points, while market capitalization rose by almost EUR 300 million to EUR 3.99 billion. The growth recorded in 2012, however, was not enough to absorb the previous year’s losses, as the index’s market capitalization was still down on the end of 2009, when it stood at EUR 5.2 billion. Despite higher market capitalization compared to 2011, liquidity continued to diminish in 2012.

The most liquid share in 2012 was Krka (KRKG), which generated more than half (52%) of total equity turnover. The second largest contributor to overall annual equity turnover was Mercator (MELR), which accounted for 16.3% of all equity transactions, while the third most traded company was Petrol (PETG), which accounted for 9.4% of all equity transactions.

The Ljubljana Stock Exchange also offered a more varied range of investment opportunities in 2012. The LJSE recorded two new bond listings (Petrol and Factor banka), which were issued in the total amount of EUR 40 million. Shares of Pozavarovalnica Sava RE (POSR) were transferred to prime market. In addition, there were seven capital increases in the total amount of EUR 17 million. Moreover, a new type of security, namely commercial paper, was introduced on the LJSE in 2012, as five issues of commercial paper were listed on the LJSE in the total amount of EUR 124 million.

Foreign markets

Although 2012 was still marked primarily by the ongoing debt crisis, we witnessed a mild recession in Europe, economic growth in the U.S. and a gradual but steady slowdown in China without steep declines. Expectations for global economic growth consistently deteriorated throughout 2012. After global GDP growth of 2.7% in 2011, global GDP growth is now expected to ease to an estimated 2.6% in 2012, very close to the global recession threshold of 2.5%. Inflation was quite low last year mainly due to weakening consumption. Despite the expansionary monetary policy of central banks and increased fiscal spending to boost consumption, global demand remained unsatisfactory on developed markets because of high unemployment. The euro area unemployment rate stood at a record high level of nearly 12% at the end of 2012.

The primary driver of bond market performance was the policy of ultra-low interest rates being pursued by the U.S. Federal Reserve, the ECB and other major global central banks. Consequently, we have seen a general decline in the yields on government and corporate bonds (and supported prices). The bond market is also highly influenced by the slowing U.S. economy, the continued recession in Europe and Japan and a decline in economic growth in China. Year 2012 was also influenced by two very important factors. The first and most important factor was the announcement by the U.S. Federal Reserve that it does not intend to start raising its key interest rate until unemployment reaches 6.5% or inflation rises above 2.5%. Representing the second factor is the European Central Bank's Outright Monetary Transactions or OMT program, which in short facilitates easier debt restructuring and the implementation of necessary reforms. Because bonds are still considered a safe investment haven, demand for bonds has increased, thus driving down expected yield to maturities. Having stood at around 1.78% at the beginning of the year, the yield on 10-year German government bonds had fallen to 1.57% by the end of the year. U.S. government bonds recorded similar dynamics, with the yield to maturity on 10-year government treasuries falling from 1.85% at the beginning of the year to 1.80% at the end of the year.

Most predictions for 2012 on the stock market came true. Annual returns on developed markets amounted to about 10%, while the S&P 500 rose by 13.4%, the German DAX by 29.1%, the UK FTSE 100 by 5.8% and the French CAC 40 by 15.2%. On some more specialized markets and in specialized industries, yields were very high. Examples include Turkey, where the Turkish ISE 100 index jumped by 55%, and the biotechnology industry, where a similar trend was seen. However, it should be noted that investors opted to assume relatively high risk on the investment markets in 2012. High returns therefore represented their reward for assuming such risk. Here, we are talking about the European debt crisis and the so-called PIIGS counties, where the list of problems only continues to lengthen, particularly in Greece and Spain, the fiscal cliff in the U.S., where the given solution is only temporary, and about the economy of Japan, where government debt has exceeded 200% of GDP.

b) Value at Risk methodology

NLB’s exposure to currency and other market risks in the trading book (interest rate risk and the changing securities prices) is monitored using the “Value at Risk” (VAR) methodology.

In the area of interest rate risk in the banking book, an analysis is performed of the sensitivity of interest income, which is estimated on the basis of the net interest income methodology. For equity securities in the banking book, exposure to risks is measured using a VAR calculation and sensitivity analysis.

Currency risk

NLB uses an internal “Value at Risk” (VAR) model to calculate currency risk arising from open positions. The calculation of the VAR value is adjusted to Basel standards (99% confidence interval, monitored period of 300 business days, 10-day holding position period), and is based on the historical simulation method. VAR is calculated for currency risk for the whole open bank position (e.g. the position of the trading and banking book together), as NLB’s total open position is managed by the Treasury department.

The main factor in currency risk exposure in 2012 was the open position in Serbian Dinars (RSD). The open RSD position was the result of restructured loans and the related currency conversion. Also contributing to currency exposure in 2012 was the CZK position, where the rate was relatively volatile. The highest VAR value was recorded in November due to the high open position in CZK. In 2012, the NLB introduced a net principle that has facilitated the more efficient management of open currency positions.

The methodology for measuring currency risk at the NLB Group level is based on the net open foreign exchange position principle and the monitoring of the nominal limits (for the total open position by currency), related to the capital size of the NLB Group entity. The internal VAR method described above is used for the illustration below of exposure to currency risk, which derives from the quarterly net open positions of NLB Group entities.

The decrease in VAR for currency risk in the NLB Group is the result of the monthly reporting of the open positions of subsidiaries, which has facilitated the improved closing of net positions. VAR was the result of the harsh conditions on the financial markets in 2012 and exchange rate volatility, which consequently affected potential loss or the level of VAR.

Other market risks in the trading book

NLB uses an internal VAR model based on the variance-covariance method for other market risks. The daily calculation of VAR value is adjusted to Basel standards (99% confidence interval, monitored period of 250 business days, 10-day holding position period).

In 2012, interest rate risks in the trading book amounted to an average of EUR 272 thousand (2011: EUR 198 thousand) and remained on a relatively similar level compared with the previous year. At the end of 2012, the market value of the debt securities portfolio amounted to EUR 14 million (2011: EUR 13 million), while exposure from derivatives trading derives primarily from bond future contracts.

The risk of changing securities prices (debt securities portfolio) in the trading book fluctuated between EUR 2.1 and 3.6 million in 2012 (2011: between EUR 2.9 and 4.0 million). The principal part of exposure arose from the redemption of collateral received for loans in the long-term trading portfolio.

The average, maximum and minimum values in the upper table are calculated on the basis of daily VAR calculations, which are based on daily open positions and movements in market data during the past monitored period (300 or 250 working days). The “average” value represents the arithmetic mean of daily VAR values in 2012, while the “maximum” and “minimum” values represent the highest and lowest values of daily VAR calculations in 2012 respectively.

Interest rate risk in the banking book

NLB’s exposure to interest rate risk is monitored and managed by using an interest rate gap methodology and duration. The same methodology is also used to calculate the sensitivity of the NLB Group’s interest income. The analysis of interest income sensitivity assumes a change in interest rates of 50 basis points in the short term. The analysis is based on the assumption that the positions used remain unchanged and that the yield curve shift is parallel. The assessment of the impact of a change in interest rates of 50 basis points (+/- 0.5%) on the value of net interest income for the banking book position:

In 2012, the value of interest income sensitivity remained relatively stable, but was slightly more volatile than in the previous year. Exposure to interest rate risks primarily derives from the portfolio of investment-grade debt securities (ECB-eligible), which represent a source of secondary liquidity. The exposure arising from traditional loan-deposit transactions was relatively low owing to the active management of these positions. The long-term interest rate positions of other NLB Group entities, from which the majority of interest rate risk derives, are relatively closed.

The values in the table have been calculated on the basis of monthly calculations of short-term interest rate gaps, where the applied parallel shift of the yield curve by 50 basis points represents a realistic and practical scenario. The “average” value represents the arithmetic mean of monthly calculations, while the “maximum” and “minimum” values represent the highest and lowest values calculated during the period.

Risk of a change in prices in the portfolio of equity securities in the banking book

In terms of equity security investments, NLB has adopted policies for the management of these investments that were approved by the Management Board and the Supervisory Board. The policies cover the permitted investment structure of the portfolio, its diversification, and the monitoring and measurement of risks. In addition to a standardized methodology NLB also uses an internal model, which has been adapted to the requirements of the Basel standards, for monitoring and measuring the risks related to the equity portfolio.

The value of the equities portfolio in the banking book in NLB amounted to EUR 113 million at the end of 2012 (December 31, 2011: EUR 133 million) of this EUR 89 million (December 31, 2011: EUR 113 million) represented realized collateral, the long-term portfolio represented in amount of EUR 21 million (December 31, 2011: EUR 18 million) as available for sale financial asset and in amount of EUR 3 million (December 31, 2011: EUR 2 million) as financial asset designated at fair value through profit or loss.

The value of VAR for the equities portfolio in the banking book amounted to EUR 13.51 million at the end of 2012 (December 31, 2011: EUR 14.75 million). Assuming a fall in stock market indices or individual securities prices of 15% (December 31, 2011: 15%), the value of the portfolio would decrease by EUR 18.55 million (December 31, 2011: EUR 19.96 million).

Guidelines were prepared for the effective management of risks in the investment banking sector in the scope of the NLB Group's financial instruments trading strategy. Trading in equity securities by subsidiaries is not permitted. Only stock broking services are provided. The majority of the equity securities portfolio in the banking book derives from NLB's position, while smaller positions are also disclosed by certain NLB Group entities. The value of equity portfolio in the NLB Group stood at EUR 117 million at the end of 2012 (December 31, 2011: EUR 137 million) of this EUR 89 million (December 31, 2011: EUR 113 million) represented realized collateral, the long-term portfolio represented in amount of EUR 23 million (December 31, 2011: EUR 20 million) as available for sale financial asset and in amount of EUR 5 million (December 31, 2011: EUR 4 million) as financial asset designated at fair value through profit or loss.

c) Currency Risk (FX)

The NLB Group manages currency risks in accordance with the adopted currency risk management policy adopted by NLB’s Assets and Liabilities Committee. The positions of all currencies in the NLB’s statement of financial position for which a daily limit has been set are monitored daily.

Exposure to currency risks is monitored and managed by the Assets and Liabilities Management Department on the basis of daily data obtained from the Risk Management Department. Assets and Liabilities Management Department manages exposure to currency risks by currency, so that they are always within the limits.

Exposure to currency risks is discussed at daily liquidity meetings and monthly meetings of the NLB’s Assets and Liabilities Committee.

The amount of financial instruments denominated in euros and in foreign currency

Sensitivity analysis for currency risk

d) Managing interest rate risk

The management of interest rate risks in the NLB banking book is separated from the measurement and monitoring of these risks. In the past, the NLB implemented an interest rate risk management policy that reflects a conservative strategy for assuming interest rate risks and is based on general Basel risk management standards.

The NLB manages interest rate risks in conjunction with credit, currency and liquidity risks, as there is a close correlation between those risks that can have a significant impact the on stability of the interest rate margin. The stability of the interest rate margin presents one of the primary goals of interest rate risk management.

The management of interest rate risks arising from banking book transactions is facilitated by managing the interest rate maturity of all on- and off-balance sheet items in individual maturity buckets. The maturity calculation model for interest-insensitive liability items and interest-sensitive items without maturity (e.g. available capital and stable sight deposits) was approved by the national regulator. An important part of managing interest rate risk is the securities portfolio of the banking book, which is subject to strict internal rules and policies. The primary purpose of the portfolio is to maintain adequate secondary liquidity reserves. By determining the upper limit of modified duration and limits for credit and market risks, it contributes also to the stability of the interest rate margin.

Several analyses are performed in the management of interest rate risks (limited positions in individual maturity buckets, modified duration, BPV limits, etc.). The BPV (basis point value) method helps to estimate changes in the market value of a banking book position due to a parallel shift in the yield curve. BPV is calculated for different segments of the banking book and for the banking book as a whole.

The basic tool for the managing interest rate risk in the banking book is the management of the NLB’s statement of financial position items. The strategies that foresee adequate adjustments to the statement of financial position items are discussed and adopted at the executive level of the NLB or in the scope of the NLB's Assets and Liabilities Committee (ALCO). The NLB primarily uses the following methods for managing its statement of financial position positions:

• managing the portfolio of debt securities in the banking book,
• issuing own securities and other funding, and
• managing the interest rate risk associated with existing statement of financial position items.

The NLB’s ALCO regularly discusses and supervises the adaptation of the offered range and price ratios of banking products in order to limit interest rate risk exposure.

More precise management of interest rate risk in the banking book is carried out by transactions in derivatives, using the following instruments:

• interest rate swaps,
• overnight index swaps,
• cross currency swaps, and
• forward rate agreements.

The management of the NLB Group’s interest rate exposure is not performed at the consolidated level. However, the NLB regularly monitors the risk positions of individual Group entities in accordance with the Development Program and Minimum Standards for Risk Management in the NLB Group. The aforementioned document comprises guidelines for uniform and effective interest rate risk management. Interest rate risk exposure is monitored on the basis of maturity gaps, BPV analyses and limits. Guidelines regarding the limitation and management of interest risks at individual NLB Group entities are approved by the ALCO.

Analysis of financial instruments according to the exposure to interest rate risk

Illustrated below are the carrying amounts of financial instruments, categorized by the earlier of contractual repricing or residual maturity. The balance shown as non-interest bearing from debt financial instruments are interests.

Sensitivity analysis for interest rate risk

e) Liquidity risk

Liquidity risk is monitored and managed in the NLB Group in accordance with the relevant policies and strategies, which set out rules and a hierarchy of responsibility. Standard liquidity risk monitoring and management guidelines were implemented at NLB Group entities in accordance with the NLB Group Liquidity Risk Management Strategy. Liquidity risk management is decentralized, with each entity ensuring its own liquidity via the necessary sources of funding and their appropriate diversification and maturity, and by managing liquidity reserves and fulfilling the requirements of regulations governing liquidity. A standardized reporting system functions within the NLB Group and ensures adequate control over the provision of operational and structural liquidity at all NLB Group entities.

The NLB Group places special emphasis on ensuring an appropriate level of long-term or structural liquidity in the current conditions on the financial markets.

The objectives of liquidity risk monitoring and management in the NLB Group are as follows:

• ensuring a sufficient level of liquid assets;
• minimizing the costs of maintaining liquidity;
• optimizing the balance of liquidity reserves;
• ensuring an appropriate level of liquidity for different situations and stress scenarios; and
• anticipating emergencies or crisis conditions, and implementing contingency plans in the event of extraordinary circumstances.

Liquidity is managed at three levels in the NLB Group: operational, structural and strategic.

Operational level

Liquidity management at the operational level means managing liquidity for a period of several days or weeks, based on the planning and monitoring of cash flows. Liquidity management at the operational level in the NLB Group is decentralized, meaning each NLB Group entity is responsible for its own liquidity position and carries out the following activities:

• planning and monitoring cash flows;
• monitoring and complying with the liquidity regulations of the central bank;
• adopting business decisions; and
• creating and managing a portfolio of liquidity reserves.

As the parent bank, NLB regularly monitors and provides liquidity to its subsidiaries, as required.

Structural level

Liquidity management at the structural level means managing liquidity over a longer time frame, and includes the following activities:

• defining structural liquidity indicators, and the regular calculation and monitoring thereof;
• defining optimal values or thresholds for individual selected structural liquidity indicators;
• monitoring trends in the selected structural liquidity ratios;
• preparing analyses and proposals for changes in the structure of the statement of financial position that affect the liquidity position and liquidity risk; and
• preparing static liquidity gaps.

The objective of liquidity management at the structural level is to achieve a statement of financial position structure that ensures the NLB Group’s long-term liquidity based on the criteria of maturity matching, the forms and concentration of sources of funding, and the realization and rating of investments.

Strategic level

NLB Group entities perform the following activities in the context of liquidity management at the strategic level:

• stress testing under different scenarios;
• defining liquidity reserves and the required scope thereof;
• liquidity projections under various assumptions; and
• monitoring liquidity gaps for each maturity bucket, preparing analyses and proposals for changes in the structure of a bank’s statement of financial position that affect the bank’s liquidity situation;

When preparing liquidity management stress test scenarios, NLB considers several factors that may affect the liquidity situation at an individual entity and at the Group level (e.g. internal and external factors or a combination of both). Each Group entity is responsible for establishing and maintaining an adequate level of liquidity reserves. Available liquidity reserves and cash outflows are monitored on a regular basis using a liquidity stress testing tool. NLB also exercises adequate supervision over the liquidity situation of each Group entity.

In crisis conditions, the NLB Group also maintains a sufficient level of high-quality available liquidity reserves, with which it can cover unexpected cash outflows in exceptional circumstances. Liquidity reserves comprise primary (e.g. cash, settlement account at the central bank, sight deposits and short-term deposits at banks) and secondary liquidity reserves (e.g. debt securities and loans eligible as collateral for Eurosystem claims). The structure is shown in table below.

Structural liquidity reserves for NLB and NLB Group

On the basis of liquidity management stress test scenarios, the NLB Group has defined a liquidity management plan for exceptional circumstances that lays down guidelines and a plan of activities for recognizing problems, searching for solutions and handling exceptional circumstances. It also provides for the establishment of a system of liquidity management that ensures the maintenance of the NLB Group’s liquidity and protects the commercial interests of customers and shareholders.

Non-derivative cash flows

The tables below illustrate the cash flows from non-derivative financial instruments by residual maturities at the end of the year. The amounts disclosed in the table are the undiscounted contractual cash flows, determined on the basis of spot rates at the end of the reporting period.

When determining the gap between the financial liabilities and financial assets in the maturity bucket of up to 1 month, it is necessary to take into account the fact that financial liabilities include total demand deposits, and that NLB may apply a stability weight of 50% to demand deposits when ensuring compliance with the central bank regulations concerning the calculation of the liquidity position. To ensure NLB’s and the NLB Group’s liquidity and based on its approach to risk, the NLB Group compiled in previous years a substantial amount of high-quality liquid investments, mostly government securities and selected loans, which are accepted as adequate financial assets by the ECB.

Subordinated liabilities with no contractual maturity are included in maturity buckets based on when the NLB expects their redemption. Other liabilities and credit related commitments are included in maturity buckets based on their residual contractual maturity.

An analysis of the statement of financial position by residual maturity based on discounted cash flows is presented in table below.

Derivative cash flows

The NLB Group’s derivatives are settled on a gross basis, except for interest rate swaps. The table below illustrates cash flows from derivatives, broken down into the relevant maturity buckets based on residual maturities. The amounts disclosed in the table are the contractual undiscounted cash flows, prepared on the basis of spot rates on the reporting date.

Managing secondary liquidity reserves

The NLB Group has available primary and secondary liquidity reserves to cover liabilities. Primary liquidity reserves must be available very soon following the realization of a stress test scenario (immediately, i.e. within one week). This is the ability to generate and secure rapidly realizable and highly liquid assets in the short term. The majority of primary liquidity reserves are accounted for by cash, funds on settlement accounts at central banks and sight and short-term funds at other banks. NLB's secondary liquidity reserves are of exceptional importance in meeting liquidity needs and complying with regulations governing this area. These mainly comprise prime debt securities issued by EU countries and eligible for ECB transactions, while one third of secondary liquidity reserves are accounted for by loans that meet ECB eligibility criteria in full. ECB eligible loans are loans secured by a government guarantee and loans to government agencies.

NLB considers high-quality securities and ECB-eligible loans, on the basis of which it is possible to raise liquid assets on the market or at the central bank, as secondary liquidity reserves. The extent of secondary liquidity reserves depends on the liquidity needs of NLB and the NLB Group.

The NLB Group also gives a great deal of attention to the monitoring and compliance of structural liquidity indicators, which indicate the appropriate maturity and structure of sources of funding in connection with the credit portfolio. A more detailed overview of the NLB Group’s structural liquidity is facilitated by liquidity gaps and their short-, medium- and long-term projections of relevant cash flows. The NLB Group’s sources of funding are appropriately diversified in the current conditions, and ensure an appropriate proportion of long-term sources of funding with respect to its credit portfolio.

The debt securities portfolio of the banking book is also used simultaneously for providing secondary liquidity, stabilizing the interest rate margin and managing NLB’s interest rate risk. Securities in the banking book are classified as “available for sale” or “held to maturity”. When managing the portfolio, NLB uses conservative principles, particularly with respect to the structure of the portfolio in terms of issuers’ ratings and the maturity of the portfolio. The framework for managing the securities of the banking book is the policy for managing debt securities in the banking book, which clearly defines the objectives and characteristics of the associated portfolio.

The basic provisions of the policy for managing debt securities in the banking book are as follows:

• the majority of the securities must comprise securities that can be pledged with the ECB, i.e. are on the list of eligible financial assets at the ECB; a maximum of EUR 200 million in securities can be outside aforementioned list;
• modified portfolio duration is calculated semi annually and may not exceed 3 years;
• interest rate risk is managed by using interest rate derivatives; and
• a maximum of 70% of the total value of the portfolio can be classified as “held to maturity”.

As at December 31, 2012, the balance of debt securities in the banking book of NLB was EUR 1,918 million (December 31, 2011: EUR 2,447 million) and in the banking book of NLB Group EUR 2,363 million (December 31, 2011: EUR 2,907 million). Of these, 87% were government securities (December 31, 2011: 83%), 8% were government-guaranteed bank bonds (December 31, 2011: 8%) and 5% bank and corporate securities (December 31, 2011: 6%).

Geographical analysis of debt securities portfolio

In comparison to 2011, there has been a decrease in exposure to bonds of PIIGS countries (Portugal, Italy, Ireland, Greece and Spain) for EUR 1.5 million. As at December 31, 2012 exposure to bonds of PIIGS countries amounted to EUR 20 million of nominal value.

Operational risk

To ensure quality risk management, the NLB Group established a system to collect data regarding loss events, and to identify and assess operational risks. As the highest authority in the area of operational risk management, NLB appointed an Operational Risk Committee to serve as the decision-making body of NLB's Management Board. Relevant operational risk committees were also appointed at other NLB Group banks. The management board serves in this role at other subsidiaries. The task of the aforementioned bodies is to discuss the most significant operational risks and loss events, and to monitor and support the effective management of operational risks at an individual entity.

An upper tolerance limit to operational risk permitted by an individual bank or leasing entity in its operations, has been defined. A net loss exceeding that limit must be treated individually and additional measures taken, as necessary, to prevent the same or similar loss events. The implementation of measures to address the most significant loss events is also monitored. The relevant provisions are created for expected major loss events, the material consequences of which are appropriately assessed.

Special attention is given to the reporting of potential (i.e. possible future) loss events for which operational risks were identified in order to prevent the occurrence of a loss.

Future losses can be determined by assessing identified operational risks. An operational risk profile is drafted once a year on the basis of these assessments. The most significant risks are managed actively through measures to mitigate those risks.

Knowledge and methodologies are transferred within the NLB Group to Group entities included in consolidation (except small entities). All entities have adopted relevant documents that are in line with NLB standards. These documents are updated in line with the development of operational risk management. Thus, NLB’s operational risk management model was implemented throughout the entire NLB Group. NLB strives to constantly update the aforementioned model, which is also supported by the relevant, uniform software support.

Capital requirements for operational risk are calculated using the standardized approach at NLB and using the basic indicator approach at the NLB Group level.

Management of other types of non-financial risks – capital risk, strategic risks, reputation risk and profitability risk

The NLB includes other non-financial risks, such as capital risk, strategic risk, reputation risk and profitability risk, in the calculation of internal capital at the NLB Group level according to the internal capital adequacy assessment process (ICAAP). To that end, it has established the relevant methodologies for identifying and assessing specific types of risk defined in internal policies. The aforementioned risks are assessed quarterly. If the NLB assesses that the NLB Group is significantly exposed to a specific risk, it creates capital requirements accordingly.

The portfolio of debt securities in the banking book is intended to provide secondary liquidity and manage the NLB Group’s interest rate risk. When managing the portfolio, the Group uses conservative principles, particularly with respect to issuers’ ratings and the maturity of the portfolio.

Structure of the banking book according to Fitch ratings:

Most of securities with no external rating are high quality treasury bills (Germany, Netherland, France, Belgium and other European countries) and Slovenian securities with the guarantee of the Republic of Slovenia. Relatively small part presents bank and corporate securities.

The value of bonds in NLB's trading book amounted to EUR 14,022 thousand as at December 31, 2012 (December 31, 2011: EUR 13,016 thousand) and the same in the NLB Group amounted to EUR 14,022 thousand (December 31, 2011: EUR 13,757 thousand). NLB also holds certificates of deposits from domestic banks that as at December 31, 2012 amounted to EUR nil (December 31, 2011: EUR 2,001 thousand). As at December 31, 2011 NLB shows in item debt securities commercial bills of banks with rating AA in amount of EUR 32,940 thousand, which were later in 2012 sold (note 5.2.).

Structure of the trading book according to internal ratings:

Loans and advances to banks

The estimated fair value of deposits is based on discounted cash flows using prevailing money market interest rates for debts with similar credit risk and residual maturities. The fair value of overnight deposits equals their carrying value.

Loans and advances to customers

Loans and advances are net of the allowance for impairment. The estimated fair value of loans and advances represents the discounted amount of estimated future cash flows expected to be received. Expected cash flows are discounted at current market rates to determine their fair value.

Deposits and borrowings

The fair value of sight deposits and overnight deposits is equal to their carrying value. However, their actual value for the NLB Group depends on timing and amounts of cash flows, current market rates and the credit risk of the depository institution itself. A portion of sight deposits is stable, similar to term deposits. Therefore, their economic value for the NLB Group differs from the carrying amount.

The estimated fair value of other deposits and borrowings from customers is based on discounted cash flows using interest rates for new deposits with similar residual maturities.

Held to maturity financial assets and issued debt securities

The fair value of held to maturity financial assets and issued debt securities is based on their quoted market price or value calculated by using a discounted cash flow method and prevailing money market interest rates.

Loan commitments

For credit facilities that are drawn soon after the NLB Group grants the loans (drawn at market rates) and loan commitments to those clients that are not impaired, the fair value is close to zero. For loan commitments to clients, that are impaired, the fair value represents the amount of the created provisions.

Other financial assets and liabilities

The carrying amount of other financial assets and liabilities is a reasonable approximation of their fair value, as they relate mainly to short-term receivable and payables.

8. OTHER DISCLOSURES

a) Segments

Segment reporting is presented in accordance with the strategy on the basis of the organizational structure used in management reporting of Group’s results.

The NLB Group’s segments are business units that focus on different customers and markets. They are managed separately because each business unit requires different strategies and service level.

Business activities of NLB are divided into several segments. Interest income is reallocated between segments on the basis of the multiple internal transfer rates (fund transfer pricing - FTP). FTP are defined by the Assets and Liabilities Management Department, and are determined by reference to market interest rate benchmarks, bid/ask spread, liquidity premium and ALM subvention. FTP are set on individual deal bases considering the interest rate variability, currency and contractual maturity of the deal. FTP stay fixed till the final maturity date of the deal (in the case of fixed interest rate) or is changed at respective repricing date (in the case of variable interest rate).

Other NLB Group members are, based on their business activity, included in only one segment.

Description of segments:

• Retail banking in Slovenia represents banking with individuals, commercial banking for small and medium enterprises and sole traders in NLB and assets management – NLB Skladi. It also includes the contribution to financial result of joint venture NLB Vita and associates Skupna pokojninska družba and Bankart;
• Corporate banking in Slovenia represents commercial banking in NLB with medium and large enterprises;
• Financial markets in Slovenia represent all treasury activities, operations with financial institutions and investment banking in NLB;
• Foreign strategic markets represent all business activities from NLB Group members on strategic markets in the NLB Group (Bosnia and Herzegovina, Montenegro, Kosovo, Macedonia and Serbia), except leasing entities;
• Non-strategic markets and activities represent total activities from the NLB Group members on non-strategic markets in the NLB Group (Croatia, Germany, Switzerland and Czech Republic) and all leasing entities. It also include the operating result of non financial entities (NLB Propria, Prospera Plus) and the contribution to financial result of joint venture Prvi Faktor and associated banks Adria Bank and Banka Celje; and
• Other represents items of NLB income statement that are not related to reportable segments.

Since NLB Group is primarily a financial group and interest income represents the majority of the NLB Group’s main indicator of a segment’s efficiency is net profit before tax.

There was no income from transactions with a single external customer that amounted to 10% or more of the NLB Group’s income.

b) Geographical information

Geographical analysis includes a breakdown by geographical segments with respect to the country in which individual NLB Group entities are located.

None of the countries of South East Europe and Western Europe represents more than 10% of the NLB Group’s revenue.

A number of banking transactions are entered into with related parties in the normal course of business. The volume of related-party transactions and the outstanding balances are as follows.

NLB discloses all transactions with the ultimate controlling party. The ultimate controlling party as at December 31, 2012 and December 31, 2011 was the Republic of Slovenia. For transactions with other governmentrelated entities, the NLB Group discloses individually significant transactions and the characteristics thereof.

In year 2012 NLB entered into transactions with government related entities under usual terms and market prices. In 2012 the total amount of individually significant transactions for long-term loans (6 transactions) in the amount of EUR 600,553 thousand (December 31, 2011: 7 transactions in amount of EUR 657,129 thousand), long-term debt securities in amount of EUR 51,609 thousand (December 31, 2011: EUR 200,803 thousand), deposits in the amount of EUR 40,073 thousand (1 transaction) (December 31, 2011: EUR nil), short-term loans in amount of EUR nil (December, 31, 2011; EUR 50,026 thousand), long-term borrowings (6 transactions) in the amount of EUR 334,282 thousand (December 31, 2011: 11 transactions in amount of EUR 598,539 thousand) and interest rate swaps (9 transactions) in the amount of EUR 380,898 thousand (December 31, 2011: 11 transactions in amount of EUR 468,352 thousand).

For long-term loans, NLB recognized interest income in the amount of EUR 15,389 thousand (2011: EUR 21,207 thousand), for long-term debt security interest income in amount of EUR 1,718 thousand (2011: EUR 2,930 thousand), for deposit interest expense in the amount EUR 1,196 thousand (2011: EUR nil), for shortterm loan interest income in amount of EUR nil (2011: EUR 26 thousand), for long-term borrowing interest expense in the amount of EUR 9,451 thousand (2011: EUR 13,190 thousand) and for interest rate swaps net interest income together with net valuation result in the amount of EUR 6,588 thousand (2011: EUR 62,711 thousand). Interest rates for loans and borrowings present 6 months EURIBOR and margin under usual terms.

In year 2012 NLB has increased share capital with government related entities in amount of EUR 61 million.

Key management compensation

In accordance with competence of the Supervisory Board, as defined by the Articles of Association of NLB, the Supervisory Board adopted the criteria for remunerating the members of the Management Board.

The bases for the collective remuneration of members of the Management Board are several quantitative indicators that compare:

• the operations of NLB and the NLB Group with respect to the plan;
• the operations of NLB and the NLB Group with respect to the previous year;
• the operations of NLB with respect to banks in Slovenia during the same year; and
• the operations of the NLB Group with respect to comparable banking groups during the same year.

The bases for the individual remuneration of members of the Management Board (qualitative part) are individual assignments from the work program for individual year.

Short-term benefits include:

• monetary benefits (gross salaries, supplementary insurance, holiday allowances, other bonuses); and
• non-monetary benefits (company cars, health care, apartments, etc.).

The reimbursement of cost comprises food allowance and travel expenses.

Post-employment benefits include additional pension insurance and annuity savings.

Accrued earnings of individual members of the Management Board

Accrued earnings of individual members of the Supervisory Board