The Financial Crisis and Its Effect on Business Operations

The Financial Crisis

Among other things, the financial crisis that emerged from the real estate crisis in the US affected NLB Group business operations during the last year. Although the reasons for today’s financial crisis and the imminent economic recession date back decades, the immediate cause lies in the collapse of real estate prices in the US in 2006. The first indications of the financial crisis became apparent in spring 2007. First, the signs emerged gradually with intervals of a few months and there was an impression that the signs were only appearing in isolation or in some countries. Later, however, the signs of the imminent catastrophe emerged at shorter intervals. Thus, the burst of the real estate or mortgage bubble in April 2007 was followed a few months later by the first bankruptcies of large financial institutions and the US’s attempt to restore its economy through tax incentives. In midsummer 2008, fuel and other raw material prices, especially agricultural and food prices, reached a high. The American dollar hit a record low against the euro. Starting at the beginning of September 2008, serious events in the financial sector started to occur in rapid succession. The consequences were also felt in the real economic sector.

For many, the key cause for the final collapse of the global financial system was the bankruptcy of the American investment bank Lehman Brothers in September 2008. The American government did not want to save the bank with a cash injection in order to warn other agents on the financial market not to count on state help in similar situations. As a consequence, the government triggered fear, distrust, and panic on the stock markets. The global financial sector was seized by illiquidity, and many institutions gradually went bankrupt. Three out of five of the largest investment banks in the US or globally collapsed, and the two remaining banks are joining up with commercial banks to establish universal banks. Investment banking in the form we knew it disappeared.

The global crisis, which started in the US as a realestate crisis and later seized the financial sector, is expanding in two directions: via the US to Europe and other parts of the world and back via the financial markets to the real economic sector, where it had initially started with spreading mortgage loans. Of course, Slovenia and SE Europe as the most important strategic markets of the NLB Group are not insensitive to events in the US. In Europe, the first indications of the financial crisis appeared in summer 2008. Only a few months later, in October, were numerous measures adopted and taken across Europe to solve or minimize the crisis.

The real estate bubble grew in the real economic sector, but was burst by financiers. The crisis in the financial sector was caused by the bursting of the bubble, but is not restricted to the financial sector. Due to a lack in liquidity and thus less loan support to the economy, it also affects the global economy’s real sector. The recession, which was already in sight back in 2007, is only intensifying and prolonging the financial crisis, with the only question being to what extent.

Slovenia is also affected by the signs of the financial crisis and the economic recession; for example, in slower economic growth, a decelerated inflation rate, lower international exchange and slower trade growth, decrease in raw material prices, decrease in the amount of new real estate construction, decrease in automobile sales, paralysis of the loan and money market, the fall of stock-exchange indexes and hedge funds, and so on. For the time being, Slovenia is affected to a lesser extent than is characteristic for some economically and financially more developed countries. The effects will, however, undoubtedly also affect the essentially weaker economic and financial environment in the future. Certainly, SE Europe will not escape the effects of the global crisis.

The Effect of the Financial Crisis on Business Operations

The changed external circumstances were also reflected in the business operations of NLB in 2008. NLB additionally reinforced all activities for planning and ensuring operational and structural liquidity. The perception of risks grew and the approach towards the management of available resources became even more conservative. The outbreak of the financial crisis drastically weakened banks’ mutual trust, which in turn affected inter-bank financing activities so that they practically ceased in 2008. Remaining business was conducted at an essentially higher interest rate.

NLB reacted to the changed situation as follows:

• Accelerated acquisition of non-banking sector resources, in which the bank achieved very good results, reflected in an increase in the volume and market share in long-term deposits.
• Restriction of credit activities in accordance with disposable resources and shortening of maturity terms of granted loans in compliance with the structure of resource maturity.

The positive effects of the policy of the structural liquidity management in the Bank have been recorded in the past years, when the Bank increased the volume of placements of quality debt securities of the state and prime banks that meet the ECB's pledging requirements and thus enable the Bank to access the ECB's instruments for providing current operating liquidity.

Due to more expensive borrowing, the changed conditions regarding financing activities negatively influenced the result of NLB’s business operations. In order to neutralize this effect, the Bank gradually adapted its investment price policy. Due to the shift in time, the positive effects of these measures were only reflected in the results in the fourth quarter of 2008.

Lower revenues from financing activities, which after a long cycle of increase reached a negative value in 2008, also directly influenced the result. Due to these activities, at the NLB level a loss of €11.8 million was generated, arising mainly from negative effects of valuating domestic, predominantly equity shares, classified in the trading book. In addition, in 2008 NLB recorded an impairment of national equity shares, classified in the held-for-sale portfolio, in the amount of €60.2 million. In its security investment portfolio, NLB has investments in derivatives that are entirely intended as risk insurance or to meet the requirements of insuring client risks. The portfolio of NLB or the NLB Group does or did not include investments in derivatives for trading or opening speculative positions. The volume of investments in CDO (collateralized debt obligation; nominal value) amounted to €3 million. Therefore, the Bank did not suffer any material losses for this reason.

In 2008, NLB impaired investments in the amount of €202 million, which is a 99% increase compared to the same period last year. This is a consequence of NLB’s precaution, as well as of proactively monitoring its individual customers or projects. NLB thereby further increased the large volume of provisions, which, together with various forms of quality insurances (mortgages, deposits, securities, insurance), ensure a very high level of insurance of NLB’s credit portfolio.

Furthermore, in 2008 NLB formed additional impaired available-for-sale securities. We would like to point out that NLB and the NLB Group did not make use of securities categorized as held-tomaturity securities in 2008, on the basis of which the negative effect on the current result would essentially be lower.

NLB Group
Annual Report 2008