•S)3 Banka ANNUAL REPORT OF SID BANK AND THE SID BANK GROUP 2012 Annual report of SID Bank and the SID Bank Group 2012 2 2 Annual report of SID Bank and the SID Bank Group 2012 3 Contents I. BUSINESS REPORT 7 A WORD FROM THE PRESIDENT OF THE MANAGEMENT BOARD 9 SUPERVISORY BOARD REPORT ON THE REVIEW AND APPROVAL OF THE ANNUAL REPORT OF SID BANK AND THE SID BANK GROUP 2012 13 1. MAJOR FINANCIAL DATA AND PERFORMANCE INDICATORS OF SID BANK AND THE SID BANK GROUP 15 2. ABOUT SID BANK AND THE SID BANK GROUP 17 2.1 About SID Bank 17 2.2 About the SID Bank Group 22 3. GOVERNANCE OF SID BANK 25 3.1. Organisational structure 25 3.2. CORPORATE GOVERNANCE STATEMENT 26 4. STRATEGY OF SID BANK 34 5. CORPORATE SOCIAL RESPONSIBILITY 38 6. PERFORMANCE IN 2012 47 6.1 INTERNATIONAL ENVIRONMENT AND THE SLOVENIAN ECONOMY IN 2012 47 6.2 Financial results 52 6.3 Financial position 54 6.4 Risk management 57 6.5 SID Bank's performance in key areas 59 6.6 PERFORMANCE OF THE SID BANK GROUP 71 4 | Annual report of SID Bank and the SID Bank Group 2012 II. FINANCIAL STATEMENTS 77 DECLARATION BY THE MANAGEMENT BOARD ON THE FINANCIAL STATEMENTS OF SID BANK AND THE SID BANK GROUP 79 INDEPENDENT AUDITOR'S REPORT ON THE FINANCIAL STATEMENTS OF SID BANK AND THE SID BANK GROUP 81 1. FINANCIAL STATEMENTS OF SID BANK AND THE SID BANK GROUP 83 1.1 Income statement 83 1.2 Statement of comprehensive income 84 1.3 STATEMENT OF FINANCIAL POSITION 85 1.4 Statement of changes in equity 86 1.5 Statement of cash flows 88 2. notes to the financial statements 89 2.1 Basic information 89 2.2 Statement of compliance 89 2.3 Significant accounting policies 89 2.4 Notes to the income statement 104 2.5 Notes to the statement of financial position 108 2.6 OTHER NOTES TO THE FINANCIAL STATEMENTS 116 3. risk management 123 3.1 Credit risk 123 3.2 Liquidity risk 133 3.3 Interest rate risk 136 3.4 Currency risk 138 3.5 Operational risk 138 3.6 Capital management 139 3.7 Fair value of financial assets and liabilities 142 4. segment reporting 144 Annual report of SID Bank and the SID Bank Group 2012 5 5. OTHER DISCLOSURES 147 5.1 Total exposure amount minus impairments and provisions excluding credit protection effects, AND AVERAGE EXPOSURE AMOUNT IN REPORTING PERIOD BROKEN DOWN BY EXPOSURE CLASS 147 5.2 Breakdown of exposures by major geographical region itemised into major exposure classes 148 5.3 Breakdown of exposures by economic sector or type of client itemised into major exposure CLASSES 149 5.4 ITEMISATION OF ALL EXPOSURE CLASSES IN TERMS OF RESIDUAL maturity OF UP to 1 YEAR AND MORE THAN 1 YEAR 150 5.5 Past-due exposures, impaired past-due exposures and value adjustments for impairments and PROVISIONING FOR MAJOR ECONOMIC SECTORS 150 5.6 Past-due exposures, impaired past-due exposures and value adjustments for impairments and PROVISIONING FOR MAJOR GEOGRAPHICAL REGIONS 151 5.7 Illustration of change in impairments and change in provisions by type of assets 151 5.8 Additional disclosures by bank using standardised approach 152 5.9 Investments in equities not included in trading book 152 5.10 Significant business relationships 153 5.11 Credit protection 153 Annual report of SID Bank and the SID Bank Group 2012 6 6 Annual report of SID Bank and the SID Bank Group 2012 7 I. BUSINESS REPORT Annual report of SID Bank and the SID Bank Group 2012 8 8 Annual report of SID Bank and the SID Bank Group 2012 9 A word from the president of the management board To our stakeholders, As in previous years, the SID Bank performed well in 2012, despite the difficult situation in the Slovenian economy, however the business conditions had an impact on our activities. The Bank's solid performance, bearing in mind the economic recession, was evidence of our robustness and of our reliability to generate earnings and develop new products even in problematic circumstances. In 2012 the Slovenian economy faced a further downturn in investment, a decline in household consumption and a contraction in government spending. The positive contribution made by net trade failed to compensate for the shrinkgae in domestic demand, which left the GDP to decline by 2.3%. For an open economy such as Slovenia's, alongside the rise in unemployment to 12% and the renewed decline in foreign investment this is an unsatisfactory indication for competitiveness and the ability to overcome the current recession. In terms of forecasts for the economic environment and the implementation of our strategy, the SID Bank has reduced its exceptionally high long-term growth, and recorded growth of just 1.5% in total assets to EUR 4.1 billion during the course of last year. Here we acted in accordance with the market needs of the economy, although we were unable to mitigate the adverse developments in the Slovenian economy to the extent of the impact made in previous years. Contraction in almost all sectors of the economy continued throughout 2012 and was reflected in our lending operations, and above all in our insurance segment. The main factor was the deterioration in the Slovenian banking system, which is the most important financial intermediary. Almost all Slovenian banks underwent significant downgradings last year. Their total assets contracted continuously, by a total of more than EUR 3 billion during the year to EUR 46 billion. The banking sector's credit portfolio recorded a notable decline in lending to non-financial corporations. The number of loans to NFCs was down 10.3% in year-on-year terms. At the same time the banks were mostly occupied with problematic, non-developmental investments, the proportion of bad claims in the banking system exceeding 14%, while the stock of impairments and provisions increased by EUR 1.6 billion in 2012 to EUR 4 billion. Interest income declined by 13%, all of which was reflected in a loss before taxation of EUR 769 million across the banking system, and the virtual breakdown of the interbank market. These developments significantly increased the credit risk faced by Slovenian banks. In our direct corporate financing, the same factors caused a reduction in corporate lending opportunities, as a result of which the stock of loans declined by 7%. In addition, corporate demand was primarily for refinancing and working capital, and not for investment or development, which are our primary tasks. It should be noted that the credit crunch suffered by Slovenian firms last year was primarily the result of a capital crunch caused by excessive indebtedness and a chronic lack of capital. Despite the negative trends mentioned above, the SID Bank used its financing and insurance products to continue its promotion of the developmental parts of the Slovenian economy. As a result of the aforementioned economic and banking situation, interest rates in the Slovenian financial system rose, in contrast to their overall fall in the euro area, while loan maturities shortened. One of our main tasks was therefore to provide long-term development financing to the corporate sector at favourable terms. The most noted product last year was the financial engineering mechanism for promoting technological development projects in the corporate sector as part of the promotional-development platform set up in previous years in conjunction with the Ministry of Economic 10 | Annual report of SID Bank and the SID Bank Group 2012 Development and Technology. With this product the Bank supported 15 firms and several of their technological development projects in a total value of almost EUR 100 million. A special venture credit fund for technological R&D projects was created for this specific higher-risk form of financing. In 2012 we directly and indirectly financed more than 1,000 firms, of which approximately 800 were SMEs, within the framework of existing environmental protection and energy efficiency programmes, programmes to develop economic competitiveness, internationalisation programmes and programmes to develop the knowledge society. A total of EUR 765 million was earmarked for these firms, while the eligible costs of all the investments that we financed totalled more than EUR 1.1 billion. In the financing of international business transactions in 2012, our financial and insurance products helped more than 450 firms to establish a presence on international markets, as despite undergoing a slowdown exports offered the only basis for economic development, which was promoted as part of the development of economic competitiveness. Last year the financing of infrastructure and environment projects was also adjusted to the market situation, whereas local government projects were eligible for support in the form of direct financing with a maturity of 20 years. The aforementioned adverse economic situation also brought a decline of 22% in insurance operations for non-marketable risks on behalf of and for the account of the state. The volume of business amounted to EUR 942 million. Alongside the economic recession, the main factors in the decline in operations were the collapse of certain construction and engineering firms that in previous years had carried out investment work, and the cancellation of insurance of investments because of firms' crisis measures and the general austerity measures. Nonetheless, we issued more insurance policies than in the previous year, achieved a positive technical result for the account of the state, and increased contingency reserves to EUR 132 million. In relation to risk management the SID Bank primarily managed, just as in previous years, credit risk and operational risk while minimising other risks, taking account of all the specifics of its promotional development tasks, both on its own behalf and on behalf of and for the account of the state. We also adjusted the risk management system to the change in the economic and regulatory conditions in a manner that ensures that the risk profile and the internal capital adequacy assessment process reflect the Bank's capacity to mitigate risks. The quality of the credit portfolio decreased significantly, in line with the aforementioned trends in banking and the economy. Impairment and provisioning costs amounted to EUR 79 million, EUR 21 million of which related to the aforementioned venture credit fund for technological development loans. Regardless of the latter we were able to retain our capital strength, maintaining a capital adequacy of more than 14%, as in 2011, although there was an increase in the general risk level of assets as a result of the aforementioned adverse conditions for asset management. The Bank's liquidity remained high in 2012, as was our refinancing capacity, although the first signs of the recession were already noticed. Our borrowing felt the consequences of Slovenia's sovereign downgrading last year, which had a direct impact on the costs of borrowing on international markets. In contrast to previous years, when eurobonds were regularly issued, we borrowed from the ECB in 2012 via its 3-year LTROs, and then issued a short-term note with a nominal value of EUR 210 million in a private placement at the end of the year. Despite the adverse trends, the statement of financial position was within the planned framework, as total assets increased by approximately 2%, and there was no significant change in the asset and liability structure. The ratio of direct financing (20%) to indirect financing via banks (80%) remained at the level of the previous year, while total financing amounted to EUR 3.3 billion. The income Annual report of SID Bank and the SID Bank Group 2012 905 statement was also within the planned framework, as net interest income increased by 15.7% to EUR 63 million and net non-interest income recorded growth of 688% from gains on financial assets and liabilities, largely as a result of the revaluation of the liabilities of the aforementioned loan fund to the Ministry of Economic Development and Technology. Costs amounted to less than those forecast in the plan, and showed signs of effective cost management and asset management, the cost-to-income ratio namely fell from 13.1% in 2011 to 8.7% in 2012. Profit before tax amounted to EUR 5.8 million, while net profit amounted to EUR 5 million. I would also like to pay special tribute to all of our staff, who worked to adapt our internal and external behaviour to the changes in the environment. Thus instead of quantitative external growth, 2012 was a year of significant qualitative internal growth and even better risk management by means of upgraded business processes and products, and computerisation (the electronic business application project). In this way we diversified our previous business model, thereby reducing certain risks. In a stable environment this will allow the SID Bank to undergo further high-quality development, enabling it to continue promoting job creation and increasing the added value and competitiveness of the economy and thus sustainable development. The SID Bank Group also performed well, in line with the planned targets. SID - Prva kreditna zavarovalnica was successful, recording a net profit of EUR 2.7 million, despite operating in a very uncertain environment. This was also true of Prvi faktor, whose net profit of EUR 600 thousand was mostly generated in the tough markets of south-eastern Europe, where Pro Kolekt and the CMSR likewise did most of their business. Under the circumstances, this level of performance by all the companies of the Group was a solid achievement. Given the challenges of the environment, we can be very proud of the majority of our achievements in 2012. We are not proud merely of the created profit and earnings, but of our continual growth, our job creation, and all that we have created and achieved in recent years in tough conditions. The SID Bank Group's performance is not measured solely by its good economic results, but also by its achievement of various environmental and social effects in keeping with its mission of sustainability. The SID Bank measures these effects by means of the independent evaluation of its activities. The last evaluation for 2007-2011 revealed that more than 5,500 firms that received our financing and insurance generated almost EUR 45 billion of additional sales, EUR 18 million of additional GDP, EUR 20 billion of additional exports and 40,000 new jobs, as well as preserving 80,000 other jobs. In addition, our financing of development projects helped produce over 200 technological innovations and patents, leading to reductions in CO2 emissions of roughly five million tonnes a year. The added value of our financial services lies primarily in the diversity of the financial resources and their long-term maturities and lower costs, or in equalisation with the conditions enjoyed by global competitors. We always pass this added value on to the final beneficiary in the economy, as only in this way can we contribute to the sustainable development of the Slovenian economy. The financial and economic crisis has given the Bank a special role and position in society. The SID Bank approaches its role and mission of working in market gaps for the sustainable development of Slovenia with great responsibility and commitment. We are convinced that our path of action is the most fitting, and that it brings added value to all stakeholders, from business, owners and commerce, to staff and society at large. The outlook for the Slovenian economy in 2013 remains negative, for which reason we see significant risk of volatility in our environment, be it of an economic or socio-political nature. There has been no significant shift from non-refundable to refundable forms of financing for the economy, or to European financial engineering instruments, which given the current constraints on the fiscal position is vital for financing the development of the Slovenian economy. The SID 12 | Annual report of SID Bank and the SID Bank Group 2012 Bank is well prepared to manage these risks, and to exploit any opportunity that sents itself at this volatile yet significant time. We can, however, only be sustainably successful if we enjoy the confidence of all stakeholders, business in particular. This confidence must be earned and strengthened anew each day. At the SID Bank we therefore work with a sober awareness of what we have achieved in the past, and what we intend to prove in the future. I am convinced that we will be flexible and creative enough to reach our objectives. I would like to thank all stakeholders for their loyalty and support of SID Bank thus far. Annual report of SID Bank and the SID Bank Group 2012 907 Supervisory board report on the review and approval of the Annual report of SID Bank and the SID Bank Group 2012 In 2012 the performance of SID banka d.d, Ljubljana and the SID Banka Group was monitored by the supervisory board in two different compositions: from 1 January to 5 April it comprised Andreja Kert (president), Samo Hribar Milič (deputy-president), Dr Aleš Berk Skok, Dr Marko Jaklič, Gregor Kastelic, Dr Peter Kraljič and Hugo Bosio, while from 5 April it comprised Matej Runjak (president), Janez Tomšič (deputy-president), Marjan Divjak, Štefan Grosar, Martin Jakše, Robert Ličen and Milan Matos. The supervisory board regularly monitored and supervised the Bank's performance from the point of view of the attainment of its strategic, business and financial objectives, in accordance with its own rules of procedure and the Bank's articles of association, upholding the supervisory board powers and responsibilities stipulated by law in so doing. Expert support was provided for the supervisory board's work by the audit committee, which discussed the relevant issues and drew up positions in the areas of accounting and financial information, risk management and the Bank's risk profile, internal and external auditing, and the functioning of internal controls in particular. The remuneration and HR committee provided the supervisory board with expert support in 2012 in the discussion of matters in connection with the remuneration of external members of the supervisory board committees and in the discussion of issues in connection with the management board, such as the adoption of rules for concluding employment contracts with members of the management board and the evaluation of the management board's work. In 2012 the supervisory board held ten ordinary sessions and three correspondence sessions, at which it discussed the annual and interim reports on the performance of the Bank and the affiliates of the SID Banka Group, internal audit reports, reports by the compliance management department and other departments at the Bank, the assessment of the Bank's risk profile, and other general and specific matters relating to the Bank's operations, and also made decisions on transactions subject to its authority. The major issues discussed and/or decided on by the supervisory board in 2012 were: - the annual report for 2011 with the auditor's report, and the proposal for the use of the distributable profit for 2011; - the Bank's action strategy for 2013-2015 and the realisation of the strategic objectives in 2012; - the annual operational plan and financial plan for 2013; - the internal audit department's plan of work for 2013 and strategic plan of work for 2013 and 2014, the annual internal audit report for 2011 and the quarterly reports by the internal audit department; - the compliance management reports and programme of work - risk management bylaws and the assessment of the Bank's risk profile for 2012 - an evaluation of SID banka activities between 2007 and 2010 - the execution of the Bank's borrowing transactions - policy in connection with the ownership of the affiliates in the SID Banka Group. Annual report of SID Bank and the SID Bank Group 2012 908 In its monitoring and supervision of the Bank's management and operations, the supervisory board obtained all the requisite information, based on which it was able to regularly assess the performance and work of the management board and to make decisions subject to its authority. In its session of 10 April 2013 the supervisory board discussed and reviewed the annual report of SID banka d.d., Ljubljana and the SID Banka Group for 2012, and the proposal for the use of the distributable profit for 2012 submitted by the management board. The supervisory board also discussed the independent auditor's report, in which KPMG Slovenija, podjetje za revidiranje, d.o.o. issued an unqualified opinion of the financial statements of SID banka d.d., Ljubljana and the SID Banka Group for 2012. In the opinion of the auditor, the financial statements present in all materially significant aspects a true and fair picture of the financial position of SID banka d.d., Ljubljana as at 31 December 2012 and its income and cash flows for the year then ended in accordance with the International Financial Reporting Standards as adopted by the EU, and the information in the business report fully accords with the audited financial statements. The annual report for 2012, including the independent auditor's report, was discussed by the audit committee, the compilation of the annual report was assessed as satisfactory, and the annual report was submitted to the supervisory board for approval. The supervisory board had no reservations or comments with regard to the report by KPMG Slovenija, podjetje za revidiranje, d.o.o. After reviewing the annual report of SID banka d.d., Ljubljana and the SID Banka Group for 2012, the supervisory board had no reservations or comments, and approved the report unanimously. Annual report of SID Bank and the SID Bank Group 2012 15 1. Major financial data and performance indicators of SID Bank and the SID Bank Group SID Bank SID Bank Group i EUR thousands 2012 2011 2010 2012 2011 2010 Statement of financial position Total assets 4,088,662 4,029,216 3,895,541 | 4,258,813 4,219,093 4,086,080 Borrowings from banks 1,924,619 1,966,530 2,023,693 2,030,232 2,091,001 2,143,572 Deposits by non-banking sectors 5 5 5 5 5 5 Shareholder eguity 340,224 332,007 327,816 363,175 352,439 344,855 Loansto banks 3,031,156 2,997,154 2,955,894 3,057,451 3,018,972 2,976,328 Loans to non-banking sectors 649,294 701,410 796,980 738,831 810,720 913,201 Impairments of financial assets measured at amortised cost and provisions for offbalance-sheet liabilities 194,944 120,165 77,304 212,008 136,917 90,549 Off-balance sheet items 1,185,531 1,134,900 802,473 1.186.046 1,136,856 803,798 Income statement Net interest income 63,142 54,372 40,149 | 67,074 60,235 44,875 Net non-interest income 30,358 3,852 4,322 37,986 12,471 11,625 - of which net income from insurance operations - - - 4,933 7,274 3,554 Labour costs, general and administrative costs (7,585) (7,017) (6,101) (14,116) (13,258) (11,582) Amortisation and depreciation (575) (588) (616) (1,009) (930) (848) Impairments and provisioning (79,478) (43,131) (30,576) (80,877) (44,347) (29,649) -of which change in liabilities from insurance contracts - - - 873 2,114 7,465 Pre-tax profit 5,862 7,488 7,178 vo t_n oo 14,171 14,421 Corporate income tax (821) (1,034) (1,452) (2,235) (3,108) (3,272) Net profit forthefinancial year 5,041 6,454 5,726 6,823 11,063 11,149 Shares - number of shareholders 1 1 1 - number of shares 3,121,741 3,121,741 3,121,741 -nominal value of one share, EUR 96.10 96.10 96.10 - bookvalueofone share, EUR 109.63 106.99 105.63 Headcount as at 31 December1 124 112 94 351 331 303 International credit rating (Moody's) as at 31 December Baa2 A1 Aa2 The headcount for the SID Bank Group includes all employees at PKZ, the Prvi Faktor Group, the Pro Kolekt Group and the CMSR, in addition to the headcount at SID Bank. 16 | Annual report of SID Bank and the SID Bank Group 2012 Selected indicators2 SID Bank SID Bank Group (%) 2012 2011 2010 2012 2011 2010 Capital - overall capital adequacy (total capital 1423 1435 13.53 ÏÎ83 ÏÏ78 13.08 ratio)3 Quality of assets in the statement of financial position and assumed commitments - impairments of financial assets 491 HI 203 5.23 3.2Ô 2.23 measured at amortised cost and provisions for assumed commitments / rated on-balance-sheet and off-balancesheet items Profitability - interest margin 1.53 1.36 1.14 | 1.55 1.43 1.23 -financial intermediation margin4 2.27 1.46 1.27 2.43 1.73 1.78 -return on assets before tax 0.14 0.19 0.20 0.21 0.34 0.40 -return on eguity before tax 1.72 2.23 2.20 2.51 4.02 4.25 - return on eguity aftertax 1.48 1.93 1.76 1.89 3.14 3.29 Operating costs - operating costs / average assets 0.20 0.19 0.19 | 0.35 0.34 0.34 - operating costs / net income 8.73 13.07 15.10 14.40 19.51 23.48 2 The indicators are calculated using Bank of Slovenia methodology. 3 The calculation of capital adequacy and the ratio of impairments to rated items for the SID Bank Group takes account of 50% of the assets of the Prvi Faktor Group (the SID Bank banking group) in addition to SID Bank itself. 4 The calculation of the financial intermediation margin for the SID Bank Group does not take account of PKZ's income from insurance operations. Annual report of SID Bank and the SID Bank Group 2012 17 2. About SID Bank and the SID Bank Group 2.1 About SID Bank History and legal status SID Bank was established in 1992 as Slovenska izvozna družba, družba za zavarovanje in financiranje izvoza Slovenije, d.d., Ljubljana (hereinafter: SID) as a special private financial institution for insuring and financing Slovenian exports. SID's business activities were regulated by the Slovenian Export Finance and Insurance Company Act. February 2004 saw the entry into force of the Insurance and Financing of International Commercial Transactions Act (hereinafter: the ZZFMGP), which regulates the system for insuring and financing international commercial transactions as instruments of national trade policy. The ZZFMGP stipulated that SID was to bring the insurance operations that it pursues on its own behalf and for its own account into line with the regulations governing insurance corporations by the end of 2004, and was to bring its non-insurance operations not regulated by the ZZFMGP into line with the regulations governing banking by the end of 2006. SID established an insurance corporation on this legal basis, to which it transferred its portfolio of marketable insurance that had been provided on its own behalf and for its own account by the end of 2004. SID - Prva kreditna zavarovalnica d.d., Ljubljana is 100%-owned by SID and began trading on 1 January 2005. SID obtained an authorisation to provide banking services and other financial services from the Bank of Slovenia in October 2006, and an order from Ljubljana District Court registering the change in business name to SID - Slovenska izvozna in razvojna Bank, d.d., Ljubljana (with an abbreviated name of SID Bank Inc., Ljubljana)5 at the end of that year, before it began trading as a specialist bank on 1 January 2007. On 21 June 2008 the Slovene Export and Development Bank Act (hereinafter: the ZSIRB) entered into force, and began to be applied on the day when the Republic of Slovenia (the Slovenian state) became the sole shareholder in SID Bank, i.e. 18 September 2008. The ZSIRB grants SID Bank two powers: it is authorised to act as Slovenia's specialist promotional, export and development bank in the pursuit of activities under the ZSIRB, and is the authorised institution for all transactions under the ZZFMGP. Article 13 of the ZSIRB also defines the state's responsibility for SID Bank's liabilities, stipulating that as the sole shareholder the Republic of Slovenia bears irrevocable and unlimited liability for SID Bank's liabilities from transactions undertaken in its pursuit of the activities specified in Articles 11 and 12 of the aforementioned law. If SID Bank fails to settle a past-due liability to a creditor at the latter's written request, the Republic of Slovenia must settle the liability at the creditor's request without delay. This allows SID Bank to borrow on the financial markets without needing to obtain a government guarantee for each transaction. Henceforth in the annual report any use of "SID Bank" or "the Bank" refers to SID Bank, Inc., Ljubljana, irrespective of the time and the change in business name, while the SID Bank Group may be referred to as "the SID Bank Group" or simply "the Group". 18 | Annual report of SID Bank and the SID Bank Group 2012 The Act Amending the Banking Act6 further refined the status of SID Bank, expressly stipulating that SID Bank is authorised as Slovenia's promotional, export and development bank, and is not allowed to accept deposits from the public. It further laid down that any authorisations issued in connection with SID Bank on the basis of the law governing banking remain in force, with the exception of those parts relating to the acceptance of deposits from the public. It also stipulates that other laws applying to banks also apply to SID Bank, unless stipulated otherwise by law. The legal status of SID Bank was also defined in 2010 because of European banking legislation, when the European Commission adopted Commission Directive 2010/16/EU of 9 March 2010 amending Directive 2006/48/EC of the European Parliament and of the Council by which it confirmed, in accordance with the opinion of the European Banking Committee, that SID Bank is an institution involved in specific activities in the public interest and is thus eligible for inclusion on the list of institutions excluded from the scope of application of Directive 2006/48/EC pursuant to Article 2 of that directive. As stated, SID Bank carries out incentive and development tasks and provides financial services in areas where market gaps can arise or have been identified, including financial services, counselling and education in areas such as international trade and international cooperation, economic incentives for SMEs, research and development, regional development, and commercial and public infrastructure. Role and purpose Given the fundamental laws governing the methods of development activity and actions to identify market gaps and other (allowed) interventions and aid, and the role of the state and its institutions in meeting the objectives of the national development strategy, SID Bank's role, purpose and tasks are to promote the following, in the general economic and public interest, primarily by means of appropriate financial instruments and services: - sustainable and balanced economic development in Slovenia, through the financing and insurance of international business transactions; - research and innovation, and other forms of economic development activity that increase the competitiveness and excellence of businesses in Slovenia; - close-to-nature environmental development with a high degree of protection for the environment and habitat, public infrastructure and utilities, and energy efficiency in particular; - social progress, education and employment in Slovenia, and in the rest of the world through international development cooperation; - other forms of economic activity that contribute to growth, development and prosperity, where in keeping with its strategic guidelines the management and supervisory bodies of SID Bank will meet the requirements of the users of these services and will provide and continually improve these services by introducing and implementing systems for the comprehensive assessment and management of specific development risks, quality management systems, and corporate and social responsibility. The ZSIRB also gives SID Bank powers in connection with EU funds and other funding from the EU budget. On the basis of contracts concluded with individual ministries and other national bodies or with other persons SID Bank may also extend various types of development funding and provide various programmes of national measures and other programmes and projects in line with EU rules, and may work with various European financial institutions in various forms in so doing. In providing its services SID Bank may use all financial instruments available under EU and Slovenian legislation, such as loans, guarantees and other forms of surety, purchase of receivables, finance leasing, concessionary loans and other instruments of international development Official Gazette of the Republic of Slovenia No. 79/10 of 8 October 2010 Annual report of SID Bank and the SID Bank Group 2012 19 cooperation, other forms of financing, capital investments and other methods for taking up risks, and integrate these into development and promotional financing programmes. The Act Amending the Public Finance Act7 stipulated that SID Bank may be awarded budget funds for promoting technological development projects directly, without a tendering process. Banking services In accordance with its aforementioned role, purpose and tasks, SID Bank primarily provides financial services within the framework of authorisations issued by the Bank of Slovenia. The main service is the provision of loans, which largely flow via banks, in cooperation with other commercial banks in bank syndicates in certain instances, but the Bank also lends directly to final beneficiaries to a lesser extent. The Bank provides its financial services with regard to identified market gaps, carrying out developmental and promotional tasks of a financial nature and meeting the objectives of long-term development policy in the following areas (according to the ZSIRB): - the development of small and medium-size enterprises (SMEs) and entrepreneurship; - research, development and innovation (RDI); - environmental protection, energy efficiency and climate change; - international business transactions and international economic cooperation; - regional development; - economic and public infrastructure. As at 31 December 2012 SID Bank held a Bank of Slovenia authorisation to provide the following mutually recognised financial services under Article 10 of the ZBan-1 : - acceptance of deposits from informed persons; - provision of loans, including: • mortgage loans, • purchase of receivables with or without recourse (factoring), • financing of commercial transactions, including export financing based on the purchase at a discount without recourse of non-current non-past-due receivables collateralised with a financial instrument (forfaiting); - issue of guarantees and other sureties; - trading on own account or for the account of clients: • in foreign legal tender, including currency-exchange transactions, • in futures and options, • in currency and interest rate financial instruments; - trading on own account: • in money-market instruments; - credit rating services: collection, analysis and dissemination of information about creditworthiness. ZJF-F, Official Gazette of the Republic of Slovenia No. 107/10 of 29 December 2010. 20 | Annual report of SID Bank and the SID Bank Group 2012 SID Bank's activities under the Republic of Slovenia's authorisation SID Bank provides insurance for international business transactions against non-marketable risks, and carries out an interest rate equalisation programme on behalf of and for the account of the Republic of Slovenia, as an agent of the state. The requisite funding for the effective provision of insurance operations under the ZZFMGP is provided to SID Bank by the state in the form of contingency reserves, which are used to settle liabilities to the insured (claims payouts) and to cover losses on these operations. If the claims cannot be settled from the aforementioned reserves, the funding for payouts is provided by the state. Contingency reserves are created primarily from premiums, fees and commissions, recourse from paid claims and other income generated by SID Bank from insurance and reinsurance against non-marketable risks. Under the Republic of Slovenia Guarantee Scheme Act,8 SID Bank was authorised to provide a guarantee scheme for corporates on behalf of and for the account of the state. The law was adopted as part of the EU stimulus package, and was not renewed after its expiry at the end of 2010. SID Bank's activities now focus on the processing of claims for the payout of guarantees, the exercise of recourse claims, and monitoring of the dedicated use of loans and other prescribed requirements. Under the Act on the Natural Persons Guarantee Scheme of the Republic of Slovenia,9 in 2009 SID Bank was authorised to provide a guarantee scheme for private individuals on behalf of and for the account of the state. The legal deadline for the issue of government guarantees under this law was the end of 2010. SID Bank's activities now focus on the processing of claims for the payout of guarantees, the exercise of recourse claims, and monitoring of the dedicated use of loans and other prescribed requirements. Under the Republic of Slovenia Guarantees for Financial Investments by Companies Act,10 SID Bank is authorised to conclude contracts in connection with the issue of guarantees on behalf of and for the account of the state, and to carry out other operations under this act. Under the Act Amending the Environmental Protection Act,11 in 2010 SID Bank was authorised to act as a state auctioneer at emission allowance auctions and to carry out the Kyoto units and emission allowances programme on behalf of and for the account of the state, and any related transactions. SID Bank's activities for the account of the state are described in detail in Section 6.5. 8 Official Gazette of the Republic of Slovenia No. 33/09 of 30 April 2009 and Official Gazette of the Republic of Slovenia No 42/09 of 5 June 2009. 9 Official Gazette of the Republic of Slovenia No. 59/09 of 30 July 2009. 10 Official Gazette of the Republic of Slovenia No. 43/10 of 31 May 2010. Official Gazette of the Republic of Slovenia No. 108/2009 of 28 December 2009. Annual report of SID Bank and the SID Bank Group 2012 21 Share capital The Bank's share capital is divided into 3,121,741 no-par-value shares. These are ordinary registered shares, issued in dematerialised form. The central share register and all procedures for trading the shares are administered at the Central Securities Clearing Corporation in Ljubljana. There were no changes to the share capital in 2012, which amounted to EUR 300 million as at 31 December 2012. On 5 July 2012 the SID Bank general meeting passed a resolution allocating the distributable profit for 2011 of EUR 3,065,827.55 to other profit reserves. Total shareholder equity amounted to EUR 340.2 million as at 31 December 2012. As at 31 December 2012 the audited book value of one share stood at EUR 109.63, compared with EUR 106.99 as at 31 December 2011. There are no constraints on shareholder voting rights: each SID Bank no-par-value share entitles its holder to one vote. The financial rights attached to shares are not separated from the ownership of the shares. Under Article 4 of the ZSIRB, the Republic of Slovenia is the sole shareholder in SID Bank. Shareholders as at 31 December 2012 Number of shares Holding of share capital (%) Republic of Slovenia 3,103,296 99.4 SID Bank (own shares) 18,445 0.6 Total 3,121,741 100 Company information Business name Registered office Registration number Tax number VAT identification number Transaction account SWIFT Tel Fax Email Internet SID - Slovenska izvozna in razvojna banka, d.d., Ljubljana Ulica Josipine Turnograjske 6, 1000 Ljubljana 5665493 82155135 SI82155135 0100 0000 3800 058 SIDRSI22 + 386 1 200 75 00 + 386 1 200 75 75 info@sid.si http://www.sid.si Annual report of SID Bank and the SID Bank Group 2012 916 2.2 About the SID Bank Group SID Bank Group As at 31 December 2012 the SID Bank comprised: Company Role Holding of SID Bank (%) SID Bank Inc., Ljubljana Controlling bank - SID - Prva kreditna zavarovalnica d.d., Ljubljana Subsidiary 100 Pro Kolekt, družba za izterjavo, d.o.o. Subsidiary 100 Prvi faktor, faktoring družba d.o.o. Joint venture 50 Centre for International Cooperation and Development (CMSR) Joint foundation - The SID Bank Group's consolidated financial statements include SID - Prva kreditna zavarovalnica d.d., Ljubljana under the full consolidation method, and the Prvi Faktor Group under the proportionate consolidation method. Given its insignificant impact on the financial position and profit or loss of the SID Bank Group, the Pro Kolekt Group is not included in consolidation. Pro Kolekt and the CMSR are covered in Section 6.6. About the companies included in consolidation SID - Prva kreditna zavarovalnica d.d., Ljubljana SID established SID - Prva kreditna zavarovalnica d.d., Ljubljana (hereinafter: PKZ) as the sole owner in 2004. PKZ was entered in the companies register on 31 December 2004, and commenced its insurance operations on 1 January 2005. On this date short-term insurance contracts that had been concluded by SID for its own account by the end of 2004 were transferred to PKZ. The company's share capital as at 31 December 2012 stood at EUR 8.4 million, and was equal to the nominal value of SID Bank's interest in the company. PKZ provides insurance for current receivables from private-sector customers (usually suppliers' receivables with a maturity of up to 180 days, or exceptionally up to 1 year). The company provides insurance against commercial and non-commercial risks for companies selling goods and/or services inside and outside Slovenia on deferred payment, usually on open account. The contracts are renewable, and generally cover the policyholders' entire turnover on foreign and/or domestic markets. In addition to the insurance of the full sales of companies of varying size, PKZ's services also include insurance of pre-supply risks, factoring insurance and individual insurance operations. Insurance of pre-supply risks comprises additional coverage expanded to the production period. Factoring insurance comprises coverage of risks in the purchase of receivables from factoring companies, and is tailored very specifically to this activity with regard to the nature of the transaction. Individual insurance operations cover the monitoring of individual policies, insurance for projects of up to 2 years' duration, and insurance for engineering deals. The company also provides indirect insurance operations: it uses facultative quota reinsurance to cover credit insurance provided by export credit agencies. The indirect insurance operations are identical to direct insurance operations, and were negligible in 2012 compared with the amount of direct insurance. Annual report of SID Bank and the SID Bank Group 2012 23 The company is headed by a two-person management board comprising Mr Ladislav Artnik (the president) and Dr Rasto Hartman. The supervisory board comprises Mr Jožef Bradeško (the president) and Mr Leon Lebar (the deputy-president) from SID Bank, and Mr Ivan Štraus as a workers' representative. Prvi faktor, faktoring družba d.o.o. Prvi faktor, faktoring družba d.o.o. (hereinafter: Prvi faktor, Ljubljana) is the leading factoring company in Slovenia. SID acquired a 50% interest in the nominal capital and half of the voting rights of Prvi faktor, Ljubljana in 2002. The other partner is Nova Ljubljanska banka d.d., Ljubljana. The nominal value of SID Bank's interest in the company stood at EUR 1.6 million as at 31 December 2012. The company's principal line of business is factoring for clients established inside and outside Slovenia in connection with receivables from the sale of goods and services. The company primarily provides the following services: - the purchase, or takeover in return for consideration, of receivables from the sale of goods and services with or without payment risk; - financing of assumed receivables; - administrative management of assumed receivables; - redemption and recovery of assumed receivables; - trading in assumed receivables; - intermediation and brokerage of factoring transactions inside and outside Slovenia. Prvi faktor, Ljubljana is the founder and 100% owner of four companies: - Prvi faktor, društvo s ograničenom odgovornošču za faktoring, Zagreb, Croatia (hereinafter: Prvi faktor, Zagreb); - Prvi faktor - faktoring, društvo s ograničenom odgovornošču, Belgrade, Serbia (hereinafter: Prvi faktor, Belgrade); - Prvi faktor, društvo sa ograničenom odgovornošču za finansijski inžinjering, Sarajevo, Bosnia and Herzegovina (hereinafter: Prvi faktor, Sarajevo); - Prvi faktor d.o.o.e.l., Skopje (hereinafter: Prvi faktor, Skopje). The company's governance bodies are the general meeting and the director. SID Bank was represented at the general meeting in 2012 by Ms Barbara Bračko and Mr Leon Lebar. The company directors are Mr Ernest Ribič and Mr Matej Špragar. Information about the individual companies is given below. Prvi faktor, Prvi faktor, Prvi faktor, Prvi faktor, Zagreb Belgrade Sarajevo Skopje Line of business Factoring Factoring Other financial Company Intermediation not trading Established 17 December 2003 24 February 2005 27 February 2006 2006 Nominal capital EUR 2.6 million EUR 2.7 million EUR 1.5 million EUR 5 thousand Director Tomaž Kačar Jelena Tanaskovlc Denan Bogdanlc Ernest Ribič Make-up of general Representatives of Representatives of Representatives of Representatives of meeting Prvi faktor, Ljubljana Prvi faktor, Ljubljana Prvi faktor, Ljubljana Prvi faktor, Ljubljana 24 | Annual report of SID Bank and the SID Bank Group 2012 The nominal value of Prvi faktor, Ljubljana's participating interests in individual companies in the Prvi Faktor Group as at 31 December 2012 was equal to the nominal capital of the individual companies on that date, with the exception of Prvi faktor, Sarajevo, where the carrying amount of the investment is EUR 1 million as a result of impairment. Annual report of SID Bank and the SID Bank Group 2012 919 3. Governance of SID Bank 3.1. Organisational structure Organisational structure of SID Bank as at 31 December 2012 Annual report of SID Bank and the SID Bank Group 2012 920 Organisational structure of the SID Bank Group as at 31 December 2012 SID Bank Inc., Ljubljana SID - Prva kreditna zavarovalnica d.d., Ljubljana Pro Kolektd.o.o., Skopje 80% Pro Kolektd.o.o., Zagreb 3> Pro Kolektd.o.o., Belgrade 100% Pro KolektCMS S.R.L, Bucharest 51.02% 62.5% Pro Kolekt 00D, Sofia Pro Kolektd.o.o., Sarajevo 100% Centre for International Cooperation and Development, Ljubjlana 3.2. Corporate governance statement Corporate Governance Code As a public company, in the 2012 financial year SID Bank applied the Corporate Governance Code for Joint-Stock Companies (hereinafter: the Code), which was drafted and adopted in its updated form by the Ljubljana Stock Exchange, the Slovenian Directors' Association and the Managers' Association of Slovenia on 8 December 2009. The Code is available at http://www.ljse.si/. At the end of 2011 the management board and supervisory board approved the Governance Policy, thus formally confirming the decision that the Corporate Governance Code for Companies with State Capital Investments, which was adopted by the Capital Assets Management Agency on 18 January 2011, would also be applied. Annual report of SID Bank and the SID Bank Group 2012 27 With regard to information about governance that exceeds the requirements of the Companies Act, the main focus is on regulations governing corporate governance at banks. The Banking Act (Title 2) and the Regulation on the diligence of members of the management and supervisory boards of banks and savings banks both contain provisions summarising the recommendations of the Code mutatis mutandis. Of further relevance is the ZSIRB, which contains special provisions on corporate governance, e.g. the make-up of the supervisory board. All the aforementioned regulations have been published in the Official Gazette of the Republic of Slovenia. Corporate governance also takes account of the articles of association (available at http://www.sid.si), the strategy and various policies adopted by the management and supervisory bodies. The following recommendations of the Code are not applied in the corporate governance of SID Bank: - Points 1 and 2 (Corporate governance framework): In contrast to commercial banks and other joint-stock companies, SID Bank's basic objective is not to maximise the company's value, but to provide promotional and developmental financial services and to carry out tasks aimed at maintaining or increasing the value of the equity without the objective of maximising profit (c.f. Article 9 of the ZSIRB and the articles of association). - Points 4 and 5 (Relations between the company and the shareholders): The recommendations are applied mutatis mutandis, as this matter is regulated by law. The sole shareholder is the Republic of Slovenia (c.f. Article 4 of the ZSIRB), and the appointment of members of the supervisory board is regulated by law (Article 18 of the ZSIRB). - Point 7 (Supervisory board): The procedure for appointing members of the supervisory board is carried out in accordance with the ZSIRB and other legal acts governing the appointment of persons to the supervisory bodies of companies under majority government ownership. - Point 8 (Supervisory board) and point 17.1 (Independence and loyalty): Members of the supervisory board sign and disclose a statement containing all the requisite information to assess their independence in terms of the criteria stated in Appendix C of the Code, but the signed statements are not published on the Bank's website, as they contain confidential information that it requires on the basis of banking regulations. Functioning and key powers of the general meeting The Republic of Slovenia (the Slovenian state) has been the sole shareholder in SID Bank since September 2008. The Bank's general meeting convenes at least once a year, after the end of the financial year, in accordance with the Companies Act. The powers of the general meeting were exercised in 2012 by the Capital Assets Management Agency, and its representative with the relevant written authorisation. The entry into force of the Slovenian Sovereign Holding Company Act on 28 December 2012 abolished the CAMA. The management of the government-owned capital assets previously managed by the CAMA was taken over by Slovenska odškodninska družba, which is to be converted into the sovereign holding company under the aforementioned law. In accordance with the ZSIRB the members of the supervisory board are appointed by the Slovenian government. 28 | Annual report of SID Bank and the SID Bank Group 2012 Make-up and functioning of management and supervisory bodies and their committees The management and supervisory board are appointed according to regulations, although the additional conditions and procedures set out in Article 18 of the ZSIRB need to be taken into account. The Bank has a two-tier system of governance: it is managed by the management board, while its operations are supervised by the supervisory board. SID Bank's supervisory board The supervisory board monitors and supervises the management and operations of the Bank. It has seven members, who are appointed by the Slovenian government in accordance with the ZSIRB. Members of the supervisory board are appointed for a term of five years. The supervisory board consisted of Ms Andreja Kert (president), Mr Samo Hribar Milič (deputy-president), Dr Aleš Berk Skok, Mr Hugo Bosio, Dr Marko Jaklič, Mr Gregor Kastelic and Dr Peter Kraljič until 5 April 2012. From 5 April 2012 the supervisory board consisted of Mr Matej Runjak (president), Mr Janez Tomšič (deputy-president), Mr Marjan Divjak, Mr Štefan Grosar, Mr Martin Jakše, Mr Robert Ličen and Mr Milan Matos. The supervisory board operates on the basis of its rules of procedure, which set out in detail the principles, procedures and work methods, while its principal powers and responsibilities are set out by the Bank's articles of association and laws governing the Bank's operations, most notably the Companies Act, the Banking Act and the ZSIRB. The supervisory board's role includes approving the Bank's strategic policy, reviewing the Bank's annual reports and other reports and formulating an opinion thereof, explaining to the general meeting its opinion of the annual report by the internal audit department and its opinion of the annual report by the management board, approving the Bank's annual report and the management board's proposal for the use of the distributable profit, and discussing any findings made in supervisory procedures by the Bank of Slovenia, tax inspectors and other supervisory authorities. In addition, the supervisory board is responsible for approving the management board in its determination of the Bank's business policy, the financial plan, the organisation of the system of internal controls and the internal audit department's annual programme of work. The supervisory board also provides guidance and consent to the Bank's policy for operating in accordance with development guidelines based on EU and Slovenian long-term development documents. The supervisory board has established an audit committee, and a remuneration and HR committee as consultative bodies. Each committee's duties and responsibilities are set out by its own rules of procedure. The supervisory board's audit committee The audit committee is appointed by the supervisory board. Until 5 April 2012 the audit committee consisted of Mr Gregor Kastelic (chairman), Dr Aleš Berk Skok and Ms Blanka Vezjak. From 5 April 2012 the audit committee consisted of Mr Martin Jakše (chairman), Mr Marjan Divjak (deputy-chairman), Mr Robert Ličen and Ms Blanka Vezjak. In connection with its powers of monitoring and supervision, the committee primarily discusses material relating to the Bank's annual and interim financial statements, the activities of the internal Annual report of SID Bank and the SID Bank Group 2012 29 audit department, the organisation of the system of internal controls and any findings by supervisory authorities in procedures of supervision. The committee also participates in procedures to select an external auditor, and reviews and monitors the auditor's work and impartiality. The audit committee also compiles an annual report of its work within 30 days of discussing the Bank's annual report. Remuneration and HR committee The remuneration and HR committee is a standing working body and consultative body of the supervisory board. The supervisory board appoints the chairman and deputy-chairman of the committee. Until 5 April 2012 the remuneration and HR committee consisted of Ms Andreja Kert (chairman), Mr Samo Hribar Milič, Mr Gregor Kastelic and Ms Alenka Stanič. Since 5 April 2012 the committee has consisted of Mr Matej Runjak (chairman), Mr Janez Tomšič (deputy-chairman), Mr Milan Matos and Ms Alenka Stanič. The committee's duties and responsibilities relate to employee remuneration and the discussion of issues relating to the management board. Its main tasks are assessing whether the methodologies put in place are the basis for a remuneration system that encourages proper management of risks, capital and liquidity, reviewing the relevance of the general principles of remuneration policy and the level to which remuneration policy complies with the Bank's business policy over the long term, assessing and evaluating the work of the management board, and drawing up recommendations for the supervisory board in respect of the implementation of remuneration policy., International trade promotion commission The government has appointed an international trade promotion commission to coordinate the actions of the relevant government bodies and other bodies and institutions in the implementation of the ZZFMGP, and to ensure the effective implementation of the insurance and financing of international trade and investment. The commission decides on the Bank's proposals to conclude insurance transactions in excess of EUR 5 million, and has the power to rule on other matters related to risk management, such as approvals for: - the policy of insurance operations in individual countries or groups of countries, which together with the limits on insurance already set out in the ZZFMGP act to limit potential claims; - the formulation and conclusion of special insurance terms for individual insurance policies and other transactions; - the management of the contingency reserves and the risks taken up in insurance operations; - agreements and relations with financial institutions and other institutions; - the reprogramming, recovery and liquidation of claims, and other transactions under government authorisation including an opinion thereon. The international trade promotion commission regularly monitors the Bank's operations in areas regulated by the ZZFMGP, discussing performance reports and providing an opinion of the Bank's exercise of authorisations under the ZZFMGP for the Ministry of Finance. In 2012 the commission consisted of Mr Marjan Hribar (chairman), Ms Sabina Koleša (deputy-chairman), Ms Monika Pintar Mesarič (until 4 October), Mr Matej Čepeljnik (from 4 October), Mr Janez Krevs, Mr Boris Sovič (until 24 May), Dr Stanislav Raščan (from 24 May) and Mr Jože Renar. 30 | Annual report of SID Bank and the SID Bank Group 2012 Management board The Bank's operations are directed by the management board, which represents it in public and legal matters. The management board is appointed by the supervisory board for a term of five years, and may be reappointed. The management board is to have no more than three members. The number of board members is determined by the supervisory board. The management board of SID Bank consists of the president Mr Sibil Svilan (M.Sc.) and Mr Jožef Bradeško. The management board directs the Bank's operations independently and at its own liability. The actions of the management board are regulated by its rules of procedure. The management board generally sits in session on a weekly basis, where material concerning the Bank's operations is discussed. The management board regularly briefs the supervisory board of the most important issues in the Bank's operations, on its business policy, its financial position and other significant issues relating to its performance and activity. The management board may transfer certain decision-making rights to collective decision-making bodies such as the credit committee, the liquidity committee and the asset/liability committee. Credit committee The credit committee's principal main powers and responsibilities and its methods of work are set out in its rules of procedure. At its sessions the credit committee decides on approvals of investments and guarantees in line with SID Bank's business policy, on the classification of individual investments, on the raising of funding with a maturity of more than 1 year, on the treasury investment policy and on exposure limits for individual clients. For transactions that SID Bank is concluding for the account of the Republic of Slovenia under the ZZFMGP, the committee makes decisions on matters including financing for international business transactions from the contingency reserves, and approves the policy for contingency reserve investments and the exposure limits for individual clients. It also discusses reports relating to credit risk drawn up by the backoffice and payments department, the risk management department and the distressed investment management department. The credit committee had six members at the end of 2012. Liquidity committee The work of the liquidity committee is regulated by its rules of procedure, which sets out its powers, responsibilities and methods of work. The committee generally sits in weekly sessions to monitor the Bank's liquidity position, to monitor the fulfilment of Bank of Slovenia regulations and guidelines, and to put forward principles and guidelines in relation to the raising of funding and placement of assets on the money and capital markets, the utilisation of Bank of Slovenia and ECB instruments, the fulfilment of Bank of Slovenia regulations and guidelines, the administration of exchange rate and interest rate policy and the management of the portfolio of securities and other financial instruments. The liquidity committee had seven members at the end of 2012. Annual report of SID Bank and the SID Bank Group 2012 31 Asset liability committee The asset/liability committee analyses the stock of, changes in and trends in the Bank's on-balance-sheet items, and formulates decisions to achieve a balance sheet structure that is in keeping with the Bank's business policy and that facilitates normal operations and the implementation of the Bank's plans. The committee's powers and responsibilities include discussing the Bank's performance from the point of view of its commercial objectives, discussing the Bank's balance sheet structure with a view to credit risk and market risks, defining the content of the indicators used to monitor balance sheet structure, discussing reports on capital adequacy and the Bank's exposure to individual risks, discussing the Bank's draft business plan and proposing changes to the plan in the event of a significant change in business conditions. The committee's work is regulated by its rules of procedure, which set out its powers and responsibilities. The committee meets in monthly sessions, and had 11 members at the end of 2012. Main features of internal control systems and risk management in relation to the financial reporting procedure Via bylaws the Bank has put in place various internal controls in relation to the financial reporting procedure, which are primarily implemented at the organisational units responsible for risk management, accounting, and planning and controlling. The functioning of internal controls and risk management at the Bank is subject to internal auditing, which is carried out by a dedicated organisational unit. In addition, in order to more effectively exercise its functions the supervisory board has established an audit committee, whose work focuses on financial reporting and risk management. Part of the system of internal controls at the Bank consists of legal compliance management, which is the responsibility of a dedicated organisational unit. Compliance management The compliance management department remained fully responsible for independent compliance management in 2012. The purpose of compliance management is to identify and assess the compliance risks to which the Bank is or could be exposed, i.e. the risk of legal or regulatory sanctions, significant financial losses or a loss of reputation as a result of the Bank's operations failing to comply with the relevant regulations and standards of good practice. The compliance management department exercises its supervisory role by means of regular and extraordinary audits of operations from the point of view of compliance, focusing on those areas where analysis of the risk profile12 suggests that the risk of non-compliance is highest. In conducting its audits the compliance management department works with the internal audit department to exchange information and findings to ensure that the two departments complement each other's activities instead of duplicating them. Compliance management includes monitoring and reporting on compliance risk, and providing advice and training on the management of compliance risk. It also encompasses a supervisory role, 12 The Bank's risk profile is drawn up in line with the internal risk profile assessment methodology, which is based on the Bank of Slovenia's risk assessment process (RAP) methodology. 32 | Annual report of SID Bank and the SID Bank Group 2012 particularly in the sense of regular reviews of the implementation of the internal control mechanisms introduced by the Bank to ensure compliance. As part of the Bank's system of internal controls, compliance management is one of the interconnected elements of a comprehensive, robust and reliable risk management system at the Bank. Irrespective of the establishment and implementation of compliance management, the Bank's management board remains primarily responsible for managing compliance risk and for ensuring that the Bank's operations comply with regulations. By putting independent compliance management in place the management board has primarily met the required standards of diligence in accordance with banking regulations. In accordance with its bylaws all the Bank's employees are responsible for ensuring compliance, with regard to their role and level of responsibility, for which reason they are obliged to train themselves to identify and manage compliance risk. The heads of organisational units are also responsible for monitoring the realisation of compliance risk in their areas, and to report accordingly to the compliance management department and the management board. The compliance management department issues a written report for every half-year, which is submitted to the management board and then to the supervisory board for discussion. The report encompasses a report of the work during the half-year just ended, the findings regarding the current state of compliance relative to the required state, any recommendations for the management board and a follow-up review of recommendations from previous periods. Internal auditing The internal audit department is an independent and impartial organisational unit that is separate from the Bank's other organisational units in terms of functioning and organisation, and is answerable directly to the management board. Internal auditing is conducted in accordance with the international standards and principles for the professional practice of internal auditing, and the code of ethics of internal auditors. In addition to the aforementioned standards it also upholds the provisions of the Banking Act relating to internal auditing rules. The functioning of internal auditing is based on the internal audit charter, while a more detailed description of internal audit procedures is given in the internal audit department's rules of procedure and the internal auditing manual. The internal audit department plans its activities in a strategic plan defining the content and focus of internal auditing work for a period of two years, and in an annual plan of work. The annual and strategic plans are drawn up on the basis of the Bank's risk profile, and include audits based on the regulator's requirements from mandatory auditing of individual areas of the Bank's operations. The two plans are adopted by the management board, subject to the supervisory board's approval. In addition to internal auditing, the internal audit department provides advice and coordinates reporting to external supervisory institutions. The internal audit department reports on its work to the management board, the supervisory board and the audit committee, which monitor the department's activities on the basis of the quarterly reports and annual report on the department's work, and the quarterly reports on the implementation of recommendations. The management board also monitors the work of the internal audit department when discussing individual reports of internal audits. In 2012 the internal audit department was staffed by two internal auditors with current licensing from the Slovenian Institute of Auditors as a certified internal auditor and a certified auditor. Because of a lengthy absence on the part of one of the auditors, in 2012 the internal audit work was conducted by one staff member alone. To conduct audits of information technology and Annual report of SID Bank and the SID Bank Group 2012 33 systems in 2012 the department employed the services of external contractors (certified IT auditors) with the requisite expertise in conducting these types of audit. In 2012 the internal audit department completed four audits planned for 2011, and conducted eight regular audits. One ad hoc audit was also conducted. The main areas audited were: - the methodology and procedures for rating banks; - the system for managing distressed investments; - the system for assessing the Bank's internal capital requirements; - the compliance of the management of national contingency reserves with legislation and bylaws; - the compliance and quality of the business continuity plan; - the remuneration system; - the use of common codes to ensure the integrity, security and availability of data; - the implementation of procedures for using bank loans as Eurosystem collateral. In its audits the internal audit department focused on the assessment of the Bank's business processes from the point of view of thoroughness, transparency, orderliness, the level of documentation and the establishment of effective internal controls for risk management. A major part of the internal audit department's work was monitoring the realisation of recommendations submitted as part of previous internal audits and audits conducted previously by the external auditor. 34 | Annual report of SID Bank and the SID Bank Group 2012 4. Strategy of SID Bank In accordance with the established strategic planning process, which envisages a "sliding" strategy (strategic period (start and end) is each year prolonged for another year), SID Bank's strategic plans were reviewed at the end of 2012. SID Bank's action strategy for 2013-2015 was adopted on this basis. The key external circumstances taken into account by SID Bank when revising its strategy were the malfunctioning of the financial markets and Slovenia's fiscal problems on one side, and the implementation of European crisis measures and the mounting problems in the Slovenian economy and banking system on the other side. The key internal factors encouraging a revision of the action strategy were the elimination of weaknesses in the business model based on the assumption of functioning financial markets, an increase in activity in connection with Slovenian corporate sector restructuring, and an overhaul of the lending process and a corresponding reorganisation. Another integral part of the action strategy is the risk profile, via which SID Bank also manages risks at the strategic level. The Bank reviews on at least a quarterly basis whether the planned activities to meet its long-term strategic objectives are being carried out, and in the event of major changes in the external factors updates the action strategy and takes corrective measures. Mission statement, vision and values As Slovenia's central financial institution in the areas of promotion and development, SID Bank develops and provides long-term financial services to complement the financial market, thereby promoting economic competitiveness, job creation and sustainable development. The increased financial value of services for final beneficiaries, in particular SMEs with high potential for development, the implementation of the national development strategy and the effective exercise of its public authorisations are the foundation on which SID Bank pursues its objective of being an effective and valued partner in development. The Bank endeavours to ensure that its operations are transparent, efficient and socially responsible, with concern for its staff and for its own internal growth. Values such as responsibility, expertise, commitment, cooperation and creativity are the fundamental principles that guide SID Bank staff in their everyday work, in their mutual relations, and in their dealings with clients and other interest groups. Key strategic policies Financial aspect The Bank will continue endeavouring to diversify its long-term funding and to use new instruments to provide long-term funding. Where funding is also provided from the budget, the Bank could combine it with non-refundable funds to offer final beneficiaries more favourable financing terms. Combining non-refundable funds from the budget and other refundable funds can increase the financial value of SID Bank's services, and can also ensure the efficient allocation of diminishing non-refundable funds in the economy. Annual report of SID Bank and the SID Bank Group 2012 35 SID Bank will ensure that all risks are managed to a degree that ensures the required level of security while achieving adequate performance. From the point of view of risk mitigation the Bank will reduce its exposure to certain sectors, and will compensate by intensifying activities in other areas, including direct financing. SID Bank will remain committed to increasing the value of its equity and maintaining capital adequacy, including from the point of view of the anticipated regulatory changes in this area and its role as a systemically important bank. Cost-efficiency is also vital in the sense of increasing equity, and the Bank tries to maintain it at a high level. In its insurance operations on behalf of and for the account of the Republic of Slovenia the Bank will remain committed to achieving the break-even that is its long-term target and is one of the key criteria for the satisfactory financial performance of public export credit schemes. Market aspect The most important objective in this aspect is to tailor the business model to SID Bank's new business situation in the upcoming strategic period. The Bank is developing a new generation of financial services to increase the financial value for final beneficiaries. In this context the Bank will accelerate the development of suitable development-oriented products while parallelly providing simple instruments for securing liquidity in the economy if so required as part of the crisis measures. SID Bank will in particular increase its turnover and market share where market gaps are significant, and support from commercial banks has withered. In so doing it will focus on SMEs with high potential for development or growth potential that will result in job creation. SID Bank will thus continue to act primarily in the segment of indirect financing via banks on the basis of specially designed development programmes and promotional development programmes and, in market gaps where banks are not active in general, will increase its share of direct financing. SID Bank will particularly develop products with banks based on the sharing of final risk. This will allow banks to finance transactions that they would otherwise be unable to finance alone because of their lack of capacity and/or excessive risk. One of the key market policies will be the development of products and intensive marketing in other final beneficiary segments such as private individuals and local authorities. The evolving business model in all four basic areas of the its business activities (development of competitiveness, development of a society of knowledge and innovative enterprise, development of an environment-friendly society, regional and social development) will allow the Bank to focus especially on promoting corporate research, development and innovation and linking the academic realm (research) with the commercial realm (production and marketing) in specific projects. In the future great emphasis will be on the actual development of new products over the entire corporate lifecycle. In this context the development capital fund and mezzanine financing will have particular importance, while the Bank will endeavour to expand its product-based cooperation with other public promotional institutions in Slovenia. 36 | Annual report of SID Bank and the SID Bank Group 2012 Internal aspect The strategic priorities from the internal point of view are to put in place a quality system enabling the efficient management of internal growth, and to mitigate operational risks. The organisational culture at the Bank will be developed in line with the established ethical values and high professional standards, while the optimisation of the business process of financing will be completed as the appropriate changes are made to the organisational structure with regard to the needs of the economy. The introduction of a competency model and model for managing on-the-job performance is also being completed. The development of the IT system will be balanced between efficiency, flexibility and stability, while the process of designing an effective data model will continue. The strategic guidelines emphasise system integrity, data integrity and data availability to ensure proper services and support even after an increase in turnover. The Bank will continue working to maintain internal cohesion and cooperation in the implementation of its strategic tasks and business processes. The Bank will also achieve internal growth by increasing the efficiency of business processes, by better identifying the needs of clients and by maintaining a high quality of services. Internal structures will be tailored to the new economic reality, as set out in the objectives in the financial and market aspects. Another of the Bank's strategic guidelines is the effective governance of the SID Bank Group and the exploitation of process synergies in the Group and the right organisational structure. Learning and development aspect The key strategic guideline from the point of view of learning and development is the maintenance of the network of expertise that SID Bank has built in the past in financial, technical, technological and institutional areas, primarily as a result of the transfer of good practice. Of particular importance to the development of the business model are relations with the government, in which the Bank will aim to influence the development of an advanced Slovenian model of development financing, primarily via the strengths of its established instruments and concepts. SID Bank will continue to apply advanced concepts of responsible lending, and will try to exercise its strategy outwards and use its power to have an impact on wider society in the sense of sustainable development. Annual report of SID Bank and the SID Bank Group 2012 37 Realisation of strategic objectives SID Bank regularly monitors the implementation of the action strategy, and revises the strategy at least once a year with regard to changes in internal and external circumstances. This ensures that the strategic guidelines are up-to-date, which given the volatility of the environment in which the Bank operates, is vital to its further development. The adopted strategic guidelines and objectives form the basis for drawing up the Bank's annual operational plan and financial plan, which provide support for the pursuit of the strategic objectives at an operational level. The effective implementation of the plans is ensured by monitoring the realisation of the objectives and by taking the requisite corrective measures. 38 | Annual report of SID Bank and the SID Bank Group 2012 5. Corporate social responsibility SID Bank's mission The mission and activities of SID Bank focus on meeting the wider social objectives defined by all three components of sustainable development in Slovenia, namely economic growth, social security and environmental concerns. SID Bank's activities are based on long-term development documents issued by the EU and by Slovenia, which set out the priority areas with the requisite social consensus. In providing its financial services SID Bank works in line with the long-term development guidelines relating to economic, environmental and social development set out in: - the National Development Strategy 2005-2013 (adopted in June 2005 by the Slovenian government and the Institute of Macroeconomic Analysis and Development), which was coordinated with the Slovenian Exit Strategy 2010-2013 (adopted in February 2010 by the government); - the Europe 2020 Strategy (European Commission report, March 2010), which is implemented via flagship initiatives, and whose implementation became a commitment for Slovenia under the annual national reform programmes (adopted in April 2011 and April 2012 by the Slovenian government). In line with the guidelines for long-term development in the EU and in Slovenia and the needs of the economy, SID Bank's financial services are divided into four main aims: - development of a society of knowledge and innovative enterprise, - development of an environment-friendly society and environment-friendly production, - development of a competitive economy, and - regional and social development. SID Bank's role is intermediation in financing and insurance in areas where there are market gaps, and the resulting creation of wider social benefits in terms of: - sustainable and balanced economic development in Slovenia; - research and innovation, and other forms of economic development activity that increase the competitiveness and excellence of businesses in Slovenia; - close-to-nature environmental development with a high degree of protection for the environment and habitat, public infrastructure and utilities, and energy efficiency in particular; - social progress, education and employment in Slovenia, and in the rest of the world via international development cooperation; - other economic activities contributing to growth, development and prosperity. The Bank sees its role and activities from two points of view. While the external activity focused on the environment is pitched at national level and in the direction of support for sustainable projects by individual investors, its internal socially responsible actions by all employees help it in its pursuit of its core business activities and mission. When SID Bank invests time and resources in the economy for a specific purpose, it is investing permanently in the realisation of its vision and success on one hand, and in wider social development and a reduction in adverse impacts on the environment on the other hand. The end objective of the Bank's work is to ensure equal opportunities for future generations. The Bank will also gradually commit its subsidiaries to this objective by passing on its social responsibility policy. Annual report of SID Bank and the SID Bank Group 2012 39 Outward effects of socially responsible activities Effects of the Bank's activities The primary role of SID Bank is to promote the sustainable development of Slovenia in accordance with its long-term development policies, with the aim of ensuring long-term, stable economic growth and improving the development financing system. The expansion of operations to all four major areas of activities, the active implementation of assigned tasks and the resulting rapid growth of the Bank were also reflected in the socioeconomic effects of SID Bank's activities. The results of an independent evaluation of SID Bank's activities in the 2007 to 2010 period,13 completed in April 2012, illustrates the important economic role that SID Bank plays. Nearly EUR 35 billion in additional sales, generated by the SID Bank Group through its services during the period observed, nearly EUR 14 billion in additional GDP, more than EUR 15 billion in additional exports and more than 20,000 new jobs represent the key effects that derive from the aforementioned study. Using the same methodology and specific assumptions, the SID Bank Group's services facilitated EUR 9.3 billion in sales by Slovenian companies, EUR 3.8 billion in GDP, EUR 4.3 billion in exports and more than 22,000 jobs in 2011. A total of 2,168 Slovenian companies received direct support in 2011. Through its operations, SID Bank achieves more than economic effects; it also achieves social and environmental effects, depending on the projects that it supports and the development-promotional programs that it implements. In terms of specific tendered programmes, the financing of projects in the automotive industry were very successful in the past: a reduction in CO2 emissions by around 4.7 million tonnes annually was achieved based on the patenting of 31 innovative solutions with the support of development projects. The Bank also expects similar effects from a financial engineering programme and measures to promote technological-development projects in the 2011 to 2013 period, in the scope of which 163 technological innovations and 890 new jobs were identified in the first half of 2012 alone, on the basis of 11 projects financed in the total amount of EUR 90 million. International comparisons also show that SID Bank is not only comparable with other development banks and/or export credit agencies in an internationally comparable assessment, but in many aspects exceeds them in terms of the intensity of activities. Crisis-related activities SID Bank played an important role in crisis and counter-cyclical activities at the onset of the global financial and economic crisis. From the outbreak of the crisis in autumn 2008 until the end of 2011, the SID Bank Group supported close to 4,500 Slovenian companies or around one tenth of all active companies, merely through financing and insuring, as its primary activities, with new loans in the total amount of EUR 3.8 billion and EUR 13.4 billion in insurance of export credits and investments. It thus played an important role in limiting the decline in economic growth, the contraction in demand, the credit crunch at banks and companies and the capital crunch. No other Slovenian bank increased its lending as intensively during the crisis as did SID Bank. At times, when the crisis 13 Evaluation of the activities of SID Bank in the 2007 to 2010 period, with an assessment of the impact of the crisis on the future development of market gaps, done by the Faculty of Economics of the University of Ljubljana. 40 | Annual report of SID Bank and the SID Bank Group 2012 was at its peak, the enhanced level of financing accounted for as much as 90% of all new net inflows of loans into the economy. Primarily due to its enhanced role during the crisis, when SID Bank became the third largest bank in terms of total assets and capital and second largest bank in terms of lending, SID Bank was recognised as a systemically important bank in accordance with a decision from the Bank of Slovenia, which could have an impact on the refinancing of commercial banks, and maintaining the financial market and its liquidity. Responsible lending SID Bank upholds the principles of responsible lending in practice, which in addition to an economic and financial assessment encompasses an assessment of five borrower balance sheets (intellectual capacity, raw materials, environment, energy efficiency and innovation). In addition to the planned adjustment in its lending activities, SID Bank is also developing and introducing systemic solutions and is tailoring its range of services in substantive and technical terms to the changes in the lending activities of final beneficiaries and commercial banks (e.g. adjusting financing conditions and introducing the possibility of securing loans to banks with loans). SID Bank is aware of the importance of ethical, responsible and sustainable activities, particularly in the scope of the development-promotional and financial system. It spreads these principles and values in the environment and functions as a unique catalyst of the development of responsible lending. SID Bank invested a great deal in the past in the development of a practical concept of responsible lending, and in 2012 updated its concept and integrated it into the internal decision-making process. As a development bank, it above all follows the principles of sustainability and self-sufficiency, and not profitability at all costs. In accordance with the ZSIRB, SID Bank reinvests and earmarks all profits for the additional financing of the economy. SID Bank's role is thus not to support all transactions, but only those transactions that are economically and financially justifiable, and that include a component of sustainable development and bring users higher added value. Transactions are evaluated on the basis of a thorough assessment of a wider range of risks and established economic criteria of profitability. In addition to an economic-financial assessment, this also includes an assessment of five balance sheets. In this way, it is possible to ensure in the long term the sustainable development of the economy and the financial sustainability of SID Bank, and to maintain or increase its level of capital. Alongside responsible lending, the principles that SID Bank takes into account in its operations include non-competitiveness, complementarity and subsidiarity, non-discrimination, the coverage of the entire corporate lifecycle with financial services and transparency. The concept of responsible lending is also seen in ensuring the added value of the Bank's services using the following levers: - diversity of financial resources, - longer maturities, - lower prices of services and other more favourable terms and conditions, - more efficient use and allocation of funds, - promotion of the functioning of the private sector in the direction of sustainable development and an increase in its capacities, - transfer of added value to final beneficiaries, - positive external effects (socially benefits), Annual report of SID Bank and the SID Bank Group 2012 41 - links with other public-promotional institutions and combination of refundable and nonrefundable funds, and - development of new financial instruments tailored to the needs of the Slovenian economy, and advisory services. Accessibility to services With the aim of facilitating access by final beneficiaries to financial services for sustainable development projects, SID Bank once again pursued the concept of covering the entire corporate lifecycle in the development of products and programmes in 2012 - throughout the entire production chain, from start-up capital all the way to sales on domestic and foreign markets, and even until the final repayment of claims that have arisen. The Bank thus established the bases for a development capital fund in 2012. It also introduced the following new products and programmes as a response to the current urgent needs of the highly indebted corporate sector: - a programme to finance local government infrastructure and environment projects; - a programme to finance small businesses, taking account of the small businesses act and the national reform programme; - a programme to finance renewable energy and energy efficiency, with an emphasis on SMEs; - a pre-export loan insurance product for individual long-term export transactions; and - the introduction of the OECD's sustainable lending policy in practice in the area of export credit insurance. Professional commitments and cooperation Interbank agreements and recommendations that enhance the best practices, rules and principles of the banking profession contribute to healthy operations, responsible lending, and security and liquidity in the banking sector and beyond. The Bank therefore ascribes the appropriate relevance to such agreements with financial institutions at both the national and international levels, and actively participates in the exchange of information, best business practices and the establishment of professional values. Of particular importance for SID Bank are agreements with the Bank Association of Slovenia, and with other domestic and foreign associations of which it is a member. The Bank is also a member of several international associations of financial institutions, including the EAPB, the ISLTC Club, the NEFI14 and the Berne Union. Together with more than 50 other members of the Berne Union, the Bank signed a special declaration by which it undertakes to strive to achieve the high ethical standards and values of the association, and to perform its activities professionally and in a financially responsible manner, while respecting the environment. At the prompting of the Government Office for Climate Change, the Bank began participating in the LOCSEE15 project as an observer in 2012. Support for other sustainable development initiatives SID Bank supported events in 2012 aimed at promoting the described concepts to the wider professional public and other audiences, including: 14 EAPB: European Association of Public Banks; ISLTC Club: Club of Institutions of the European Union Specialising in Long-Term Credit; NEFI: Network of European Financial Institutions for SMEs. 15 LOCSEE: Low Carbon South East Europe. 42 | Annual report of SID Bank and the SID Bank Group 2012 - sponsorship of an award given by the Chamber of Commerce and Industry of Slovenia for outstanding economic and entrepreneurial achievements; - participation in the Entrepreneurial Forum; - sponsorship of the Gazele event; - sponsorship of the Slovenian Business Portal and the print publication Doing Business in Slovenia, which provides information to potential foreign investors; - participation in a public debate at the Brdo Technology Park regarding the new EU framework programme for research and innovation, Horizon 2020; - participation in the round table discussion, Social Responsibility and Financing Rapid Growth (DOBA 2012); - participation in the Sustainable Development Academy (Faculty of Economics in Ljubljana); - participation in a study of social responsibility at Slovenian companies under the auspices of the Chamber of Commerce and Industry, - participation in research into the impact of factors of socially responsible behaviour on business models, etc. Communication with external audiences As a promotional and development bank, SID Bank gives a great deal of attention to the transparency of its operations and accordingly open communications. Because the need for SID Bank's activities relating to market gaps has increased during the financial and economic crisis, its role in the Slovenian economy has increased significantly in recent years. In addition to informing the public about promotional and development programmes, the Bank has also provided continuous information about crisis-related activities. Due to the expiration of the majority of crisis measures, SID Bank has again reinforced communications regarding its core activities of development and promotion. The primary focus of external communications is on the business public, in particular business partners and the media. SID Bank provides comprehensive information about its programmes and opportunities to receive its funds. In addition to press conferences and press releases and notification via its website, SID Bank organised presentations of new and existing products for companies and local government in 2012, and provided regular information and enhanced business relationships with companies and banks that provide SID Bank's funds to companies. In 2012 the Bank organised the Contact Point for Knowledge event for the second time on the topic of developing new business models in the commercial sector. The event is a meeting of renowned Slovenian and foreign economists with representatives of companies, banks, economic associations, government institutions and the media, where knowledge, experiences, opinions and views regarding current economic topics are exchanged during lectures and round table discussions. Internal socially responsible activities SID Bank is aware that socially responsible activities cannot be properly developed without the development of the personal responsibility of every individual in the organisation. For this reason, awareness about personal and social responsibility is promoted at all levels at SID Bank as the lifestyle of the individual and organisation as a whole in all aspects of its activities. This is also taken into account in SID Bank's policy of social responsibility, which was adopted in the broadest and most comprehensive sense. The formally binding document emphasises the role of Annual report of SID Bank and the SID Bank Group 2012 43 the entire collective in the implementation of the policy, while the bases for the systematic management of the policy's content have also been laid down. The Bank constantly updates measures in the area of social responsibility through the strategic-operational planning process (action strategy, annual operational plans). Exceptionally rapid growth in the past demanded balancing with the Bank's internal growth, which is an essential precondition for the appropriate continued development in all areas of operations. In that respect, SID Bank continued to establish a quality system in 2012 for the effective management of internal growth, which will in part facilitate the improved recognition of clients' needs, the maintaining of a high quality of service and comprehensive risk management, with the aim of maintaining the security of operations and the capital contributed by the state. The Bank adopted a governance policy that takes account of corporate values, reference governance codes, cooperation with all stakeholders, the policy of transactions between the company and related parties, the commitment to identify conflicts of interest and the independence of management and supervisory bodies, and the assessment of the efficiency and protection of interests of employees. Business ethics A code of ethics and standards, which governs in detail the principles and rules by which the Bank, its bodies and its employees act in the performance of their tasks in relation to clients, other banks, the economic environment and within the Bank, confirms the established practice of promoting the appropriate organisational culture, and the positive behaviour and attitude of employees in the performance of their tasks. The code also places special emphasis on social and environmental responsibility. Special attention is given to preventing corruption in transactions with clients and in specific projects (similar to elsewhere in the world, corruption threatens the rule of law and public confidence in government institutions) and to the environmental protection policy of the OECD. The Bank is also aware of its special position with respect to the potential distortion of free competition, and therefore does not typically compete with other financial institutions on the market in the performance of its activities, but attempts to complement the existing market to the greatest extent possible. Customer relations SID Bank provides all of its services with the aim of directly and indirectly generating added value for users. If an indirect activity is involved, services via financial intermediaries using the appropriate leverage ensure the transfer of financial value to final beneficiaries. The primary focus of SID Bank's role is on long-term transactions, as the period of return on investments in the area of sustainable development is typically longer. In this respect SID Bank also formulates its range of services for final beneficiaries. Owing to its public functions, the Bank pursues the principle of equal access and the equal treatment of all users of its services, meaning the same services under the same conditions for all equally entitled entities (principle of non-discrimination). Special attention is also given to the appropriate regional allocation of development funds. 44 | Annual report of SID Bank and the SID Bank Group 2012 The satisfaction of final users is seen in indicators that measure the level of satisfaction with the Bank's services. Based on the most recent measures from 2011, satisfaction averaged 4.27 (out of a maximum score of 5). Environment-friendly company SID Bank also upholds internal social responsibility in terms of environmental protection and energy efficiency. In 2012 it enhanced its socially responsible practices by compiling its first energy-environmental balance sheet, calculating its carbon footprint and establishing an index of social responsibility. Using the aforementioned index, the Bank monitors the implementation of measures and the achievement of objectives in fulfilling social responsibility. Q4 2012 Q4 2011 Consumption of energy for heating per employee 182,660 kWh 1,547.97 kWh/employee 199,110 kWh 1,933.11 kWh/employee Electricity consumption per employee 142,451 kWh 1,207.21 kWh/employee 130,500 kWh 1,266.99 kWh/employee Consumption of water per employee 257 m3 2.18 m3/employee 264 m3 2.56 m3/employee Carbon footprint/remissions per employee 140.75 t 1.19 t/employee 150.48 t 1.46 t/employee Use of office paper per employee 1.25 t 10.57 kg/employee 1.25 t 12.11 kg/employee Value of other office supplies per employee 4,279 EUR 36.26 EUR/employee 4,544 EUR 44.12 EUR/employee Size of business premises per employee 19.35 m2/employee 22.17 m2/employee SID index of social responsibility2012= 103.50 points The index shows that employees are increasingly aware of their responsibility to the environment and that SID Bank has made great strides in this area in the last year. An established system of separate collection and disposal of waste, measures to reduce electricity consumption in offices, the introduction of paperless operations and the replacement of certain print publications with electronically accessible versions are just a few of the measures the Bank has employed with the aim of functioning as an environment-friendly company. SID Bank ceased the practice of giving business partners gifts, and redirects the funds saved to Umanotera, the Slovenian Foundation for Sustainable Development, which supports various environmental and sustainability campaigns in the scope of the Krilca (Wings) project. The need to renovate the commercial building that houses its offices represents a special challenge for the Bank. SID Bank has decided to carry out the renovation in line with sustainable development principles. This entails the reconstruction of the existing building instead of the construction of new surface areas, taking into account the principles of historic preservation, energy efficiency, the impact on the environment and the optimal working environment. Annual report of SID Bank and the SID Bank Group 2012 45 Internal communications SID Bank performs a highly specialised activity. It is therefore crucial to its successful functioning that employees understand and support its actions. Effective and open communications can contribute to that end. Various forms of notifying and communicating with employees are in place at the Bank. They include direct communication between management and employees, such as regular internal meetings and meetings between employees and the management board, access to electronic data collections, notification via an internal electronic newsletter and the quarterly publication of the in-house newsletter, Cekin. An assessment of the work of superiors was carried out at the end of 2011, based on a survey that the Bank conducts every two years. The aim of the survey is to get feedback on employee satisfaction. The result of employee satisfaction was very good, as the established target of 70% was exceeded. The results represent a good basis for improvement for all employees, particularly management staff, and also represent a major commitment for the future. Concern for employees Work and leisure time are complementary components of life, which SID Bank takes into account when organising the work environment. Special attention is also given to the basic rights of employees, their safety and health, working conditions, social security, personal and professional development, social dialogue and mutual relationships. In the area of employee health and safety in 2012, SID Bank continued the practice of paying voluntary health insurance, and facilitating periodic medical examinations for all employees and regular ophthalmologic examinations. It also conducts regular professional training in the area of occupational health and safety and fire safety, which all employees must attend. SID Bank facilitates flexible working hours, making it easier to achieve work-life balance. An innovation system and a process for managing improvements were activated in 2012. The latter takes into account improvements in the area of social responsibility and its popularisation among the entire collective. SID Bank gives special attention to employee development with the aim of maintaining an education and qualification structure appropriate for the Bank's development and strategic objectives, the effective adaptation of employees to changes and challenges within the organisation and the environment, and providing employees with a sufficiently stimulating work environment that will also offer enough professional challenges in the future. Annual career development interviews were conducted with employees, as well as half-yearly interviews to determine the achievement of established objectives. Annual career development interviews represent the basis for assessing the development potential of individuals, the definition of key staff members and the drafting of annual training plans. In this way, the Bank is able to identify needs for new knowledge in a timely manner, and plan targeted training and education programmes for individuals and groups of employees. The Bank has been creating new jobs for many years, and opens new employment opportunities through its growth and development. Employment was conducted in line with the annual employment plan again in 2012 and in line with guidelines from the action strategy, which is based 46 | Annual report of SID Bank and the SID Bank Group 2012 primarily on the adjustment of employment to growth in the scope of operations and the development of new products, on the employment of experts with specific skills and experience and on maintaining competent and perspective employees at the bank. Promoting the acquisition of additional knowledge and skills and their practical use represents one of the guidelines of SID Bank's action strategy. A total of 109 employees participated in various forms of training in 2012, representing 93.4% of the average number of employees during the year. The average number of training hours per employee was 28. A great deal of emphasis is also placed on the internal transfer of newly acquired knowledge and the evaluation of training programmes. Wages and other labour costs are paid to employees in accordance with valid legislation and the collective agreement for the banking sector, while remuneration for performance and advancement are governed by a bylaw. SID Bank hired 15 new employees in 2012. The Bank had 124 employees at the end of the year, of which 81 were women and 43 were men. The average number of employees in 2012 was 117. SID Bank_ SID Bank Group Qualification level number proportion, % number proportion, % Level V or lower 15 12.1 60 17.1 Level VI 12 9.7 39 II.1 Level VII 87 70.1 234 66.7 Level VIII 9 7.3 16 4.5 Level IX 1 0.8 2 0.6 Total 124 100.0 351 100.0 Annual report of SID Bank and the SID Bank Group 2012 941 6. Performance in 2012 6.1 International environment and the Slovenian economy in 2012 International environment16 After a rise in global economic growth in the first quarter of 2012, which alongside certain other positive trends produced signs of a gradual emergence from the crisis, the global economy cooled again until the summer before renewing minimal growth in the second half of the year. Emerging economies were the engine for the majority of the positive trends, although of the BRIC17 countries growth is sluggish in Brazil and India. Developed economies as a whole entered a phase of approximately zero growth. The final quarter of 2012 in particular brought poor economic growth in the majority of the major economies; the USA managed to maintain minimal growth despite the declining trend, but in Europe the economy began to contract again. The adverse trends are expected to continue in the first half of 2013, or even for the whole year. Further evidence comes from the short-term economic indicators: industrial production for example recorded negative growth throughout almost the whole of 2012, in the euro area overall including Germany as the engine of the European economy. Despite the adverse trends in economic growth, international trade recorded continual growth throughout 2012, particularly in emerging economies. Growth reached up to 12% in annual terms, higher than just before the outbreak of the crisis in 2008. Of Slovenia's main trading partners, Germany, Austria and Russia continued to record growth last year, while the situation was worse in other countries (e.g. France, Italy). Initial estimates put year-on-year economic growth at 0.1% in Germany, while according to the January forecasts growth in Russia in 2012 was estimated at 3.3%. A weak recession continued in the countries of south-eastern Europe (an overall decline of 0.1 %), although the decline in GDP was significantly larger in Croatia, Serbia, and Bosnia and Herzegovina. The situation on the financial markets improved slightly, primarily as a result of the increasingly interventionist role of the ECB (an extra 3-year LTRO, a cut in the key interest rate to 0.75%, the announcement of unlimited purchases of government bonds provided that the country officially applies for an international bailout) and its statement that it would do whatever it takes to defend the euro. There has been a sharp decline in risk on the international capital markets, although the spread between the core and periphery euro area countries remains large, which can be attributed to the negative economic and fiscal position of the latter. By contrast, the situation on the interbank market remains unfavourable. According to the figures of the Bank for International Settlements, the second quarter of 2012 saw the largest decline in interbank lending since 2008, at almost USD 600 billion or just over 3% of the entire international interbank market. The main reasons were the withdrawal of American banks from the European market, and the switching of investments of euro area banks into German and French government securities. 16 Unless stated otherwise, the figures are taken from the following sources: - IMAD, Slovenian Economic Mirror, January 2013; - Bank of Slovenia, Eurosystem Bulletin, January 2013. 17 Brazil, Russia, India and China. 48 | Annual report of SID Bank and the SID Bank Group 2012 As one of the key central bank monetary policy factors, inflation in the euro area was manageable, and ended 2012 with a trend of further decline. Payment indiscipline is a major problem for EU countries, and in the fight against late payments in trade transactions the European Commission adopted a directive on late payments. In Europe 57% of firms stated that they have problems with liquidity as a result of late payments in 2012, an increase of 10 percentage points on 2011, and the forecasts for 2013 are also not promising. International financial regulations are continuing to be tightened in response to irresponsible practice in the past. This has for example seen the foundations put in place for unified European banking supervision (the banking union), while there were also moves at the level of the European Commission to introduce a tax on financial transactions. The Basel Committee on Banking Supervision slightly relaxed the timing of the requirement to introduce Basel III measures: banks are not required to meet the new liquidity requirements until between 2015 and 2019. Slovenian economy in 201218 Slovenia's GDP fell by almost 3% at the quarterly level in 2012, other than in the first quarter, when the economy responded to the positive trends in the wider economic environment. After recording positive growth in 2010 and the majority of 2011, the economy thus again moved into recession. Exports slowed in particular, and lessen their role as the engine of the Slovenian economy (growth was just 0.3% in year-on-year terms). Private consumption fell (retail sales by 7.5%), primarily as a result of a fall in wages in the public sector and a decline in household disposable income. Gross fixed capital formation is continuing to decline as well (for the 17th consecutive quarter), while a decline in government expenditure (public investment in particular) and an increase in inventories also contributed to the negative growth. One of the rare positive factors of economic growth in 2012 was the significant narrowing of the current account deficit as a result of the decline in imports (by 2.4%). Almost all the short-term economic indicators declined in 2012 (merchandise exports, industrial production and trends in manufacturing, turnover in the retail sector), but the decline in the amount of construction put in place was particularly notable, construction activity having declined since autumn 2008. The amount of construction put in place in Slovenia in December was down almost 14% on the previous year. The deterioration in the economic climate and, other adverse factors, the poor outlook for recovery and the decline in growth in the stock of foreign investments have also brought a fall in the workforce in employment, which has been falling towards 800,000, while the number of pensioners exceeded 600,000 for the first time in 2012. At the end of 2012 unemployment stood at more than 118,000 in Slovenia, up 1.7% on the end of 2011. The decline in employment eased temporarily in the first half of the year, but the number of unemployed began rising again in September. The government succeeded in reducing the budget deficit through its austerity measures, primarily thanks to successful negotiations with the public sector unions and the resulting wage falls. Public opposition, protests and strikes towards the end of the year meant that readiness for 18 Unless stated otherwise, the figures are taken from the following sources: - IMAD, Slovenian Economic Mirror, January 2013; - Bank of Slovenia, Eurosystem Bulletin, January 2013. - Eurostat, database. Annual report of SID Bank and the SID Bank Group 2012 49 further urgent reforms began to wane, which is increasing the risk to the resolution of economic and budgetary problems. The key remains reform of the labour market and an increase in its flexibility. Reform is vital from the point of view of an increase in the poor overall competitiveness of the Slovenian economy. At the end of 2012 the Constitutional Court ruled that the postponement of the entry into force and the overturning of the Slovenian sovereign holding company act and the measures to strengthen bank stability act in referendums would have anti-constitutional consequences. This ruling by the Constitutional Court finally confirmed the possibility of establishing the sovereign holding company and the bad bank. The Constitutional Court ruling also indirectly prevented a referendum on the implementation of the budgets for 2013 and 2014. The adoption of the pension reform in early December was accompanied by the adoption of certain key economic reforms and laws vital to the transparent management of government-owned assets, the stabilisation of the banking system and fiscal consolidation. The average gross wage began to fall in 2012, in both the public sector and the private sector, the decline amounting to approximately 2%. Growth in nominal unit labour costs fell to below the European average, both in manufacturing and in the total economy. Despite the favourable developments in the last two years, Slovenia has remained in the group of euro area and EU countries with a larger deterioration in cost competitiveness during the crisis, primarily as a result of a pronounced deterioration in 2008 and 2009. The cost competitiveness of the economy improved for the third consecutive year, primarily as a result of a decline in the euro exchange rate, but the structure of Slovenia's foreign trade means that competitiveness has remained among the worst in the euro area. The trend reversed at the end of the year as the euro strengthened, and the competitiveness of Slovenian exports began to decline, like that of the euro area economy as a whole. Additional uncertainty in this respect has recently been caused by individual cases of devaluation of national currencies, which could eventually even turn into a currency war. Consumer prices rose by 3.1% in Slovenia last year, more than in the euro area overall and 1 percentage point more than in 2011. As in the euro area overall, the key factors in Slovenia were rises in energy prices (liquid fuels in particular), food prices and services prices. Another major factor in last year's inflation was tax changes, most notably higher excise duties on tobacco products, liquid fuels and alcoholic beverages, while rises in certain environmental charges were also significant to a lesser extent. The movement in industrial producer prices was steady in 2012. Growth in industrial producer prices on the domestic market was low (at 1.0%). The net external debt increased to record levels in the first half of the year (although still low in relative terms), at almost EUR 15 billion, but then displayed a trend of gentle decline in the second half of the year, primarily driven by the private sector and debt repayments to the foreign creditors. Slovenian banks lowered their debts by EUR 3.8 billion last year (primarily repayments at foreign banks, and also bond repayments), while the domestic non-banking sector lowered their debts by EUR 1.3 billion. From EUR 15.6 billion at the end of 2008, Slovenian banks' liabilities to foreign banks had almost halved by the end of 2012. Loans to non-financial corporations were down 10.5% in year-on-year terms in 2012, and the partial compensation by means of Eurosystem funding was unable to end the decline. Household financing via consumer loans continued to decline in reflection of the deterioration in their economic position and their reluctance to spend. The stock of lending to corporates and other non-financial institutions declined by EUR 1.6 billion in 2012, while lending to households was 50 | Annual report of SID Bank and the SID Bank Group 2012 down around EUR 190 million. The stock of household savings also declined last year (by EUR 45 million) as a result of a decline in disposable income. The continuing debt repayments to the foreign creditors on one side and the contraction in the credit portfolio (primarily to corporates and other NFIs) on the other brought a decline in the banking system's total assets, which fell by 6.1% in 2012. The position of the Slovenian economy deteriorated significantly in 2012, as a result of which the banking system recorded a pre-tax loss of EUR 769 million during the year according to Bank of Slovenia figures, the largest factor in which was increased impairment and provisioning costs (EUR 1.6 billion, slightly more than the banking system's gross income in 2012). The banks' loan portfolios are still deteriorating, and interest income is also declining (by 13%), not being tracked at the same tempo by operating costs. The latter declined last year, but by significantly less than needed, thus increasing their ratio to interest income by 7 percentage points in 2012 to 83%. The proportion of bad and non-performing claims and the creation of impairments and provisions in the Slovenian banking system are continuing to increase. Bad claims accounted for 14% of total claims in the banking system towards the end of 2012. Payment discipline is still deteriorating, the average number of legal entities with outstanding past-due liabilities exceeding 7,000 by the end of 2012, while the average daily amount of outstanding past-due liabilities exceeded EUR 700 million. The number of deletions of firms and sole traders from the companies register because of bankruptcy also rose last year, to more than 400. According to provisional figures the state budget deficit amounted to EUR 1.1 billion last year, or 3.1% of forecast GDP. As a result of fiscal consolidation measures and a reduction in expenditure (of EUR 369 million), the deficit was significantly smaller than in 2011 (by EUR 420 million or 27.5%). Total state budget revenue in 2012 was EUR 58 million less than forecast in the revised budget. Slovenia received EUR 841.6 million from the EU budget in 2012, EUR 29.4 million more than in the previous year. The disbursement in 2012 was 80.1% of that forecast in the original budget, and 94.7% of that forecast in the revised budget, similar to 2011. There were certain shifts in mergers in Slovenia's public promotional system in 2012, which is still based primarily on non-refundable budget subsidies. Despite theirs significant decline (less than EUR 500 million in 2012), in practice there was no major shift towards greater use of refundable forms of state aid and financial engineering instruments as envisaged in the new European financial perspective 2014-2020. This has continued the practice of non-optimal allocation and inefficient use of state aid, which at 1.35% of GDP according to the figures for 2010 was almost double the European average. Borrowing costs on foreign markets fel, primarily as a result of the general positive trends and the adoption of the pension reform; the premiums on 10-year Slovenian government bonds over the German benchmarks fell from the record level of just over 6 percentage points in August (after downgradings by all three major rating agencies) to under 4 percentage points by the end of the year, which given further reform and a reduction in political instability could reduce the downward pressure on the competitiveness of the Slovenian economy from this source (price segmentation between euro area countries remains high) and debt servicing in the future (given further reductions in the budget deficit). The borrowing costs of the government and SID Bank are highly correlated. A rise in Slovenia's sovereign borrowing costs led to a rise in SID Bank's borrowing costs in 2012. Annual report of SID Bank and the SID Bank Group 2012 51 The rise in interest rates in Slovenia in 2012 and the fall in interest rates across the euro area widened the interest spread in 2012 to the detriment of the Slovenian economy. This further reduced the Slovenian economy's poor competitiveness on global markets, thereby limiting the possibility of attaining higher added value on products made in Slovenia and exported. Given the current balance sheet structure, low euro area interest rates did not have a significant impact on SID Bank, as the largest proportion of asset and liability items have variable interest rates tied to the Euribor. The number of composition proceedings initiated between business entities in 2012 was up almost a tenth on the previous year. The largest number of composition proceedings initiated between companies and cooperatives was in manufacturing (more than a third of the total), in the manufacture of non-metallic mineral products, furniture, food products, and rubber and plastic products. Business entities in the construction sector accounted for more than a quarter of the total. The largest numbers of short-term defaulters were in wholesale and retail trade and in construction (each sector accounting for a fifth of the total), while the highest average daily amounts of outstanding past-due liabilities per legal entity were recorded by the sectors of financial and insurance activities, real estate activities and construction. Bad business models meant that before the crisis many Slovenian firms were operating on the wings of the economic boom and cheap borrowing, which in the crisis proved to be unsustainable (over-leveraging), and given the owners' inability to recapitalise these firms has also been reflected in deeper problems in the banking sector. Impact of the external environment on the performance of SID Bank and the SID Bank Group The position of the Slovenian economy deteriorated in 2012, which had an impact on the performance of SID Bank and the SID Bank Group. The banking system was subject to drastic downgradings in 2012, and faced major pressures and certain fundamental challenges. SID Bank responded to the decline in bank lending activity related to below-average capital adequacy, the increase in non-performing and bad claims in the recession environment and the maturing of liabilities to the rest of the world and the need for refinancing by modifying its products. This encompassed a change in the mechanism for regulating relations between banks, including the terms of financing, in the direction of greater flexibility and the maximum possible adaptability in the price terms of financing with regard to the adverse situation on the international financial markets from the point of view of Slovenia's sovereign downgrading. The proportion of financing via Slovenian banks thus remained at the level of the previous year. The proportion of direct lending to the corporate sector declined because of the recession. The rising uncertainty surrounding economic activity reduced demand for investment credits, but increased the need for lending for working capital. This resulted in reduced demand for SID Bank's services, as only loans for investment and development are allowed under its mandates. Another factor in the decline in the net portfolio of loans made to corporates by SID Bank was the deterioration in the financial and asset position of firms, most of which were over-leveraged and lacking in capital. This resulted in downgradings for these firms and a consequent increase in loan impairments. 52 | Annual report of SID Bank and the SID Bank Group 2012 As a result of the renewed recession in the Slovenian economy and the financial sector and the subsequent increased difficulty in obtaining new export business, there was no sign of increased demand among exporters for non-marketable insurance, in particular of medium-term export credits in south-eastern Europe. The majority of the major construction and engineering firms that used to carry out investment work in the rest of the world collapsed in the crisis. At the same time firms are reducing the insurance costs of their investments in the rest of the world or cancelling contracts previously concluded. The trend of decline in medium-term insurance operations is also related to the loss of construction work in Russia, which is the most important country for non-marketable insurance. The increase in payment indiscipline meant that PKZ operated in a very uncertain environment in 2012. The most important factor in PKZ's performance is the economic situation in the countries that account for the largest proportions of its portfolio in terms of premium, insurance value and exposure. Alongside Slovenia, these are Germany, Italy, Russia and Croatia. The adverse economic situation in south-eastern Europe in 2012 also had an impact on the performance of the Prvi Faktor Group, which nevertheless generated a profit. Of all the markets in which the Prvi Faktor Group operates, the most problematic is Bosnia and Herzegovina. In addition to a very high external exposure, low GDP and a large budget deficit, the complexity of its administrative arrangements also has an impact on performance there. 6.2 Financial results SID Bank_ SID Bank Group amount EUR thousands index 2012/2011 amount EUR thousands index 2012/2011 Net interest income 63,142 116.1 67,074 111.4 Net non-interest income 30,358 /88.1 37,986 304.6 Operating costs (8,160) I0/.3 ( 15.125) 106.6 Impairments and provisioning (/9,478) 184.3 (80,87/) 182.4 Pre-tax profit 5,862 /8.3 9,058 63.9 Corporate income tax (821) /9.4 (2,235) 71.9 Net profit for the financial year 5,041 /8.1 6,823 61.7 Financial results of SID Bank Net interest income amounted to EUR 63.1 million in 2012, up 16.1% on 2011. Interest income was down 0.5%, while interest expenses were down 9.3%. Net interest income accounted for 67.5% of total net revenue in 2012 (2011: 93.4%). Net non-interest income amounted to EUR 30.4 million in 2012, up sharply on 2011, primarily as a result of gains on financial assets and liabilities measured at fair value through profit or loss. Net non-interest income comprised: - dividend income in the amount of EUR 1.6 million; - net fee and commission income in the amount of EUR 1.1 million; - gains on financial assets and liabilities not measured at fair value through profit or loss in the amount of EUR 1.7 million; - revaluation income from the loss made by the Loan Fund in the amount of EUR 21.1 million; Annual report of SID Bank and the SID Bank Group 2012 53 - changes in fair value in hedge accounting in the amount of EUR 2.6 million; - other net income in the amount of EUR 2.3 million. SID Bank received a loan of EUR 50 million from the Ministry of Economic Development and Technology at the end of 2011, which together with its own funding allowed the creation of the Loan Fund. SID Bank creates impairments and provisioning for loans approved on this basis. The resulting expenses amounted to EUR 21.2 million in 2012. Under the contract, a loss is covered first by funding from the state budget via a reduction in SID Bank's liabilities to the Ministry of Economic Development and Technology, which resulted in SID Bank realising revaluation income of EUR 21.1 million in the income statement. The aforementioned income led to an increase in the financial intermediation margin, which stood at 2.3% in 2012 (2011: 1.5%). The Bank continued to manage costs effectively in 2012, as illustrated by a CIR of 8.7% (2011: 13.1%). The ratio of operating costs to assets remained at 0.2%. The Bank's costs in 2012 were up 7.3% on the previous year at EUR 8.2 million, of which administrative costs amounted to EUR 7.6 million, amortisation and depreciation to EUR 0.6 million. Labour costs amounted to EUR 5.5 million, up 11.7% on 2011. The rise in labour costs was the result of the recruitment of new employees, as the headcount at the end of 2012 was 12 higher than a year earlier. Costs of material and services amounted to EUR 2.1 million. Impairment and provisioning costs amounted to EUR 79.5 million in 2012, of which impairments amounted to EUR 69.4 million and provisioning to EUR 10.1 million. The total was up 84.3% on 2011, partly as a result of the deterioration in the Bank's portfolio. As stated previously, a portion of the impairment costs (EUR 21.2 million) related to loans from the Loan Fund. The Bank recorded a pre-tax profit of EUR 5.9 million in 2012, equal to 78.3% of its profit in 2011. Financial results of the SID Bank Group Net interest income amounted to EUR 67.1 million in 2012, up 11.4% on 2011. Interest income was down 2%, while interest expenses were down 9.3%. Net non-interest income amounted to EUR 38 million in 2012, up EUR 25.5 million on 2011. Net non-interest income comprised: - dividend income in the amount of EUR 0.4 million; - net fee and commission income in the amount of EUR 4.6 million; - gains on financial assets and liabilities not measured at fair value through profit or loss in the amount of EUR 1.8 million; - gains on financial assets and liabilities measured at fair value through profit or loss in the amount of EUR 21.1 million; - changes in fair value in hedge accounting in the amount of EUR 2.6 million; - net income from insurance operations in the amount of EUR 4.9 million; - other net income in the amount of EUR 2.6 million. The SID Bank Group's costs amounted to EUR 15.1 million in 2012, up 6.6% on 2011. Labour costs amounted to EUR 10.1 million, up 7.9% on the previous year. The main factor in the rise in costs was recruitment, as the headcount in the SID Bank Group at the end of 2012 stood at 20 more than at the end of 2011. Costs of material and services amounted to EUR 4 million, up 3% on 2011. Amortisation and depreciation were up 8.4% at EUR 1 million. The SID Bank Group's impairment and provisioning costs were just EUR 1.4 million higher than those of SID Bank. The figure was up 82.4% on 2011. 54 | Annual report of SID Bank and the SID Bank Group 2012 The SID Bank Group recorded a pre-tax profit of EUR 9.1 million in 2012, equal to 61.7% of its profit in 2011. 6.3 Financial position The Bank's total assets stood at EUR 4,088.7 million at the end of 2012, up 1.5% or EUR 59.4 million on 2011. The Bank accounts for 96% of the SID Bank Group's total assets, and the structure of the Group's assets and liabilities is thus very similar to those of the Bank. The SID Bank Group's total assets in 2012 were up 0.9% at EUR 39.7 million. Assets SID Bank SID Bank Group amount EUR thousands breakdown (%) index 2012/2011 amount EUR thousands breakdown (%) index 2012/2011 Loansto banks 3,031,156 74.1 101.1 3,057,451 71.8 101.3 Loansto non-banking clients 649,294 15.9 92.6 738,831 17.3 91.1 Financial assets 310,304 7.6 146.2 335,759 7.9 137.7 Other assets 97,908 2.4 82.7 126,772 3.0 98.5 Total assets 4,088,662 100.0 101.5 4,258,813 100.0 100.9 Assets of SID Bank Loans to banks, which includes loans and deposits at banks, increased by 1.1% in 2012 to end the year at EUR 3,031.2 million. Long-term loans to banks account for 89% of the total, and short-term bank deposits for the remainder. Loans to banks account for 74.1% of SID Bank's total assets. Loans to non-banking clients declined by 7.4% in 2012 to end the year at EUR 649.3 million. The stock of loans declined by EUR 52.1 million, primarily as a result of an increase in loan impairments, which were up EUR 40 million in 2012. Loans to non-banking clients accounted for 15.9% of SID Bank's total assets at the end of 2012. Financial assets increased by 46.2% or EUR 98 million in 2012. The proportion of the Bank's total assets that they account for increased from 5.3% to 7.6%. Available-for-sale securities account for the vast majority of financial assets (EUR 309.8 million). Other assets comprise: - balances in accounts at the central bank (EUR 0.4 million), which were down EUR 41.3 million at the end of 2012; - derivatives used for hedging (EUR 78 million), which includes the fair value of interest rate swaps (EUR 60.4 million) and accrued interest thereon (EUR 17.6 million), and was up EUR 19.2 million on the end of the previous year; - interests in undertakings in the Group (EUR 11.9 million), which remained unchanged in 2012; - capital investments held for sale (EUR 2.7 million), which comprise an investment that the Bank obtained during loan restructuring; - non-current assets in the amount of EUR 4.2 million; Annual report of SID Bank and the SID Bank Group 2012 55 - corporate income tax assets and other assets in the total amount of EUR 0.7 million, which were down EUR 1.1 million, primarily as a result of a decline in deferred tax assets. Assets of the SID Bank Group Loans to banks at the end of 2012 were up 1.3% or EUR 38.5 million on the end of 2011. The increase was primarily the result of an increase in the stock of loans to banks at SID Bank. Loans to non-banking clients declined by 8.9% or EUR 71.9 million in 2012 to end the year at EUR 738.8 million. Loans and guarantees were down EUR 20.6 million, factoring receivables were down EUR 10.7 million and value adjustments were up EUR 40.7 million. Financial assets at the end of 2012 were up 37.7% or EUR 91.9 million on the end of 2011. Within this item available-for-sale financial assets were up 37% or EUR 90.2 million. Other assets include: - cash and balances in accounts at the central bank in the amount of EUR 0.4 million; - derivatives used for hedging in the amount of EUR 78 million; - long-term interests in subsidiaries, associates and joint ventures in the amount of EUR 0.4 million, whose value was unchanged in 2012; - capital investments held for sale in the amount of EUR 2.7 million; - investment property in the amount of EUR 0.8 million, up EUR 0.6 million on 2011 ; - non-current assets in the amount of EUR 9 million, up EUR 1 million on the end of 2011;. - corporate income tax assets in the amount of EUR 3 million, down EUR 0.8 million on 2011 ; - other assets in the amount of EUR 32.5 million, the largest item of which is reinsurers' assets and receivables from insurance operations (EUR 31.8 million), which were down EUR 0.5 million in 2012. Liabilities SID Bank SID Bank Group amount amount EUR breakdown index EUR breakdown index thousands (%) 2012/2011 thousands (%) 2012/2011 Financial liabilitiesto central bank 206,592 5.1 413.1 206,592 4.9 413.1 Borrowings (loans) 2,074,682 50.7 98.0 2,180,295 51.2 97.3 Deposits 44,306 1.1 37.1 44,306 1.0 37.1 Debt securities 1,406,725 34.4 100.1 1,406,725 33.0 100.1 Provisions 14,713 0.4 318.4 44,587 1.0 121.7 Other liabilities 1,420 0.0 97.3 13,133 0.3 91.0 Shareholder eguity 340,224 8.3 102.5 363,175 8.5 103.0 Total equity and liabilities 4,088,662 100.0 101.5 4,258,813 100.0 100.9 Liabilities of SID Bank Financial liabilities to the central bank consist of non-current liabilities with a maturity of 3 years. They increased by EUR 156.7 million or 413.1% in 2012. 56 | Annual report of SID Bank and the SID Bank Group 2012 Borrowing via loans amounted to EUR 2,074.7 million, or 50.7% of SID Bank's total liabilities. The Bank reduced these liabilities by EUR 42 million or 2% in 2012. Loans from banks account for 92.8% of the total liabilities from borrowings via loans, loans from other financial institutions and government-owned undertakings accounting for the remainder. Deposits amounted to EUR 44.3 million at the end of 2012, down EUR 75.2 million. All liabilities on this basis are current liabilities to banks. Issued debt securities remain the second most important source of funding for SID Bank, and account for 34.4% of its total liabilities. In 2012 the Bank succeeded in replacing its bond maturing in October in the amount of EUR 150 million with a new one-year bond with a nominal value of EUR 210 million. Provisions amounted to EUR 14.7 million at the end of 2012, up EUR 7.6 million during the year. The increase was primarily the result of provisions for approved but unused loans. Other liabilities in the total amount of EUR 1.4 million include financial liabilities held for trading, liabilities for corporate income tax and miscellaneous liabilities. SID Bank's shareholder equity was up 2.5% or EUR 8.2 million in 2012. Profit reserves increased by EUR 5.7 million and the revaluation surplus for available-for-sale financial assets by EUR 3.2 million, but retained earnings including the net profit for the financial year were down EUR 0.7 million. Shareholder equity accounted for 8.3% of SID Bank's total liabilities. Liabilities of the SID Bank Group The SID Bank Group's financial liabilities to the central bank were the same as those of SID Bank. Borrowings via loans accounted for the largest proportion of the Group's total liabilities (51.2%). They declined by EUR 60.9 million or 2.7% in 2012. The Group's deposits were the same as SID Bank's liabilities from deposits. The Group's liabilities from issued securities were also the same as those of the Bank. Provisions amounted to EUR 44.6 million. The largest proportion related to liabilities from insurance contracts (EUR 28.9 million), followed by provisions for banking operations in the amount of EUR 14.5 million, deferred income from insurance premiums in the amount of EUR 0.8 million and provisions for employee benefits in the amount of EUR 0.4 million. Provisions were up 21.7% on the end of 2011. Other liabilities comprised accrued reinsurers' recourse expenses in the amount of EUR 9.3 million, liabilities for corporate income tax in the amount of EUR 0.3 million and miscellaneous liabilities in the amount of EUR 3.5 million. The SID Bank Group's shareholder equity increased by 3% in 2012 to end the year at EUR 10.7 million. Profit reserves increased by EUR 7.2 million and the revaluation surplus for available-for-sale financial assets by EUR 4.1 million, but retained earnings including the net profit for the financial year were down EUR 0.6 million. Shareholder equity accounted for 8.5% of the SID Bank Group's total liabilities. Annual report of SID Bank and the SID Bank Group 2012 57 6.4 Risk management The main risks faced by SID Bank are credit risk, interest rate risk, liquidity risk, currency risk and operational risk. SID Bank's attitude to taking up risks is defined such that the Bank focuses on credit risk and operational risk, while minimising other risks (interest rate risk, currency risk, liquidity risk). Risk management at SID Bank additionally needs to take account of the specific attributes of the implementation of promotional and development tasks and services of importance to Slovenia's development, and segmentation of operations into those involving the Bank's own resources and those on behalf of and for the account of the Republic of Slovenia, including the management of the contingency reserves and the reserves in the IREP.19 The main purpose of risk management is to reduce the likelihood of risks being realised and to reduce losses in the event of an individual risk being realised. Risk management includes identifying, measuring or assessing, managing and monitoring risks, and internal and external reporting of risks. In risk management SID Bank prioritises the security and stability of its operations, which help to increase the value of its equity in the long term, the maintenance of the Bank's reputation and the maximisation of benefits for users of its services and other stakeholders. Risk management begins in the establishment of an appropriate organisational structure and work processes, allowing for business targets to be met while operations remain secure and compliant with regulations. In the implementation of risk management measures the key objective is to achieve proper awareness of risks at all levels of the Bank's activities. Risk management begins in commercial organisational units, and continues in organisational units separate from the commercial units, and proceeds all the way up to the management board, thereby ensuring its independence. The following bodies and organisational units are responsible for the direct implementation of risk management: - credit committee: management and monitoring of credit risk and large exposures; - liquidity committee: liquidity risk and currency risk; - asset liability committee: balance sheet structure, capital adequacy, aggregate risks; - risk management department: preparation of risk management strategy and policy, monitoring of risks; - credit rating department: assessment of clients' financial position and projections of their performance, assessment of soft factors, selection of appropriate indicators for determining financial commitments; - backoffice and payments department: daily monitoring of currency risk and liquidity risk in accordance with internal limits. SID Bank assesses its risk profile each year, and compiles a report on the implementation of the internal capital adequacy assessment process. In accordance with the risk management strategy and the capital risk and capital management policy, SID Bank has put in place an internal capital adequacy assessment process, which: - is based on the identification, measurement or assessment of risks, the formulation of an aggregate assessment of risks and the monitoring of significant risks that the Bank takes up in its operations; - ensures adequate internal capital in relation to the Bank's risk profile; - is properly incorporated into the governance system. 19 IREP: Interest Rate Equalisation Programme. 58 | Annual report of SID Bank and the SID Bank Group 2012 A comprehensive internal capital adequacy assessment process, tailored to the risks taken up, ensures that the risks taken up remain within the limits of SID Bank's risk absorption capacity. SID Bank also conducts stress tests on the basis of its own scenarios and scenarios suggested by the supervisor. On the basis of the results of these tests SID Bank is able to identify in advance and in good time those areas where it is most vulnerable, and to mitigate the risks and improve its performance by means of appropriate measures. SID Bank also provides credit and investment insurance against non-marketable risks of a commercial and non-commercial nature on behalf of and for the account of the Republic of Slovenia. Claims payouts are covered from the contingency reserves, although an increase in claims could lead to the contingency reserves depleting to a level that under the ZZFMGP requires funding to be provided from the state budget, and policyholders are paid indirectly via the contingency reserves. To prevent conflicts of interest and to maximise efficiency, credit and investment insurance operations are provided in a special department that is organisationally separate from banking operations all the way to the level of the management board. The right to conclude insurance operations is defined similarly to banking operations, whereby all transactions of EUR 5 million or more are decided on by the international trade promotion commission. The commission has the power to make decisions in other areas related to risk management, such as approvals for the policy of insurance operations in individual countries or groups of countries, which together with the limits on insurance already set out in the ZZFMGP act to limit potential claims. In addition, SID Bank uses a risk management model (a value-at-risk technique) to calculate potential claims on the basis of data on insurance concluded on behalf of and for the account of the Republic of Slovenia, to assess whether the contingency reserves are adequate to cover these claims, and to estimate the maximum potential claim and the impact of new insurance operations on potential claims. For more on risk management, see Section 3 of the accounts. Annual report of SID Bank and the SID Bank Group 2012 59 6.5 SID Bank's performance in key areas 6.5.1 Financing SID Bank upholds the principles of responsible lending in practice, which in addition to an economic and financial assessment encompasses an assessment of borrowers' records and practice (balance sheets) with regard to innovation, intellectual capacity, raw materials, environment, and energy efficiency. In addition to the planned adjustment in its lending activities, SID Bank is also developing and introducing systemic solutions and is tailoring its range of services in substantive and technical terms to the changes in the lending activities of final beneficiaries and commercial banks. SID Bank has provided funds to target groups of final beneficiaries either directly, or indirectly via commercial banks, and has designed all its financing services to complement the activities of other financial institutions on the market. The complementary financing services were based on established financing instruments such as loans, purchase of receivables, take-up of risks, project financing and export credits, and on a new instrument: loans classed as state aid. This is the key to eliminating market gaps in areas where SID Bank can operate, and to product integration in the public promotional system, in which non-refundable incentives dominate (e.g. research, development and innovation). Via its engagement and inclusion of separate long-term dedicated funding from the European Investment Bank, the Council of Europe Development Bank, Germany's development bank (KfW) and the Ministry of Higher Education, Science and Technology in its programmes, in 2012 SID Bank realised its transformational role, thereby creating new value for its target groups of final beneficiaries. The maturity breakdown of SID Bank's credit portfolio is in line with its focus on the activities set out by the ZSIRB and the ZZFMGP, long-term loans accounting for 99.8% of the credit portfolio at the end of 2012. In line with the European business model for development banks, the largest segment consists of SID Bank programmes whose funds are accessed via banks. Commercial banks in the role of intermediaries remained SID Bank's most important partners in the area of financing in 2012, accounting for 80.6% of the credit portfolio (2011: 80.2%). Lending to non-banking clients accounted for 19.4% of the credit portfolio as at 31 December 2012 (2011: 19.8%). The stock of SID Bank's credit portfolio at the end of 2012 reflected the decline in economic activity and investment. In 2012 SID Bank placed a total of EUR 533.6 million in new assets in the form of loans (2011 : EUR 965.9 million). The net stock of loans granted stood at EUR 3,345.2 million at the end of 2012 (2011: EUR 3,545.1 million), down 5.6% on the end of 2011. Index EUR thousands 2012 2011 2012/2011 Loans to banks Loans to non-banking clients Total as at 31 Dec 2,695,877 2,843,690 94.8 649,294 701,410 92.6 3,345,171 3,545,100_9-L4 60 | Annual report of SID Bank and the SID Bank Group 2012 The reasons for these developments in the credit portfolio are directly linked to the macroeconomic situation, the economic and financial position of the corporate sector, the performance of the Slovenian banking system and the lending activity of the commercial banks. As expected, in 2012 the absorption capacity of the commercial banks and final beneficiaries for SID Bank's dedicated funds revealed: - the rising uncertainty surrounding economic activity; - a decline in demand and a consequent deterioration in corporate financial and asset positions; - a decline in investment in development, higher energy efficiency, environmental protection, etc., and thus reduced demand for the dedicated loans that can be provided by SID Bank under its assigned mandates; - increased demand in the economy for working capital to maintain existing turnover, which is not in keeping with SID Bank's mandates; - extensions and delays in project implementation, and corresponding deferrals in disbursements; - higher borrowing costs, which increased as ratings were downgraded, and were passed on by the banks in the form higher interest rates on loans; - high exposure to individual sectors and segments on the part of the banks; - high corporate indebtedness and a lack of internal capital for (co-)financing investment in the corporate sector; - a lack of eligible collateral for corporate loans; - a shortfall of capital at certain banks as a result of current regulations and new Basel III regulations raising capital requirements. Irrespective of the deterioration on the financial markets, in 2012 SID Bank maintained the quality of its products measured as a combination of maturity, amounts, cost terms and the actual logistics of the approval process, and provided dedicated funds in accordance with its role, mission and mandates. Despite the high indebtedness in the Slovenian economy and the capital crunch, SID Bank intensively introduced new products and upheld the concept of responsible lending, thereby improving the quality of financial solutions for economic competitiveness. In 2012 the Bank also upgraded its programme of financing local government infrastructure and environment projects in the form of a direct loan from SID Bank to the local authority in question, which was first presented and offered to banks and local authorities in 2011. With this programme the Bank embarked on the independent financing of local government infrastructure and environment projects. SID Bank also offered complementary financial services to encourage development projects aimed at improving living conditions in urban and rural areas, economic and social cohesion and environmental protection. By providing favourable long-term financing (the maturity of the loans ranges from 5 to 20 years) for these purposes, SID Bank has indirectly brought an increase in the amount of public contracts awarded, which is a significant stimulus to economic growth. The local authorities are able to combine the funds from SID Bank's programme with funding from the European cohesion policy for the 2007-2013 period. The new financial structures offered by SID Bank under this programme are vital to the optimal allocation of financing in terms of maturity (and thus a reduction in financing costs), which should have a positive impact on decisions to go ahead with investment projects, and thus indirectly on the generation of demand for the products and services of the economic sectors in question, including those that are prioritised. In upgrading the programme SID Bank wanted to close on the specific attributes that would impact local authorities' capacity to absorb dedicated long-term funds. Annual report of SID Bank and the SID Bank Group 2012 61 Target groups of final beneficiaries SID Bank financed a total of 904 legal entities established in Slovenia in 2012, either directly or indirectly via banks, in the total amount of EUR 725 million. The eligible costs of the investments and projects financed by SID Bank totalled EUR 835 million, its funds accounting for 86.8% of the total. The funds were earmarked primarily for job preservation and job creation, corporate growth, reduction of pollution and greater environmental protection. In terms of the primary purpose, development of economic competitiveness accounted for 67.5% of new loans in total value terms. In terms of corporate size, a total of 715 SMEs established in Slovenia (86.2% of all borrowers) received support in the amount of EUR 227.2 million (31.3% of total new loans), of which 134 were sole traders (18.7% of all SMEs), who received EUR 14.6 million (6.4% of total new loans for SMEs). In the regional breakdown of loans approved for borrowers established in Slovenia, borrowers from Central Slovenia accounted for the largest proportion (34.5%), followed by borrowers from Savinjska (22.5%), Podravska (10.7%), Gorenjska (8.2%), Goriška (7.4%), Pomurska (3.7%) and other regions (13%). Firms in the manufacturing sector were prevalent among borrowers (51.9% of new loans in value terms), followed by wholesale and retail trade (11.4%), financial and insurance activities (9.5%) and other sectors. In the manufacturing sector 20.8% of all new loans went to firms involved in the manufacture of fabricated metal products except machinery and equipment, followed by the manufacture of electrical equipment (19.8%), the manufacture of chemical and chemical products (8.4%), the manufacture of food products (8.2%), the manufacture of computer, electronic and optical products (6.5%) and the manufacture of basic metals (5.8%). Promotional-development platform The promotional-development platform is a technology developed by SID Bank to carry out financial measures under national and European public policy based on basic and derivative refundable forms of promotion (e.g. loans with or without elements of state aid). In 2012 the Bank undertook a pilot project in the promotional-development platform, and agreed on the provision of microfinance in the amount of EUR 10 million with the Ministry of Economic Development and Technology as part of the third package of the Economic Promotion Programme. This is the first example of product integration in the public promotional system, the first effects of which are anticipated in 2013. The implementation of the financial engineering measure to promote technological development projects in 2011 -2013 as a pilot project in the promotional-development platform was a success in 2012 from the point of view of the realisation of the measure, and from the point of view of the initial assessment of the anticipated effects of the projects financed. The portfolio of loans made to firms on this basis amounted to EUR 98.4 million as at 31 December 2012, EUR 32.8 million of which comprised funds from the Ministry of Economic Development and Technology. SID Bank supported 19 projects with a total value of EUR 154.3 million with such funds. The weighted average maturity of the loans was 9.2 years. The weighted average nominal annual interest rate on the loans was 2.86%. The ministry funding and the funding from the European Investment Bank played a key part in reducing financing costs for final beneficiaries. Every euro of funding from the Ministry of Economic Development and Technology yielded 3 euros of primary lending potential, and 4.7 euros of project support, or if the first loss mechanism is taken into account, one fiscal euro 62 | Annual report of SID Bank and the SID Bank Group 2012 secured 7.3 euros of project support, which according to calculations suggests savings of public funds as a result of the promotional-development platform compared with traditional subsidies. The Bank thereby improved access to long-term financing for development projects based on in-house research and development activities by firms to increase their innovative and competitive capacities, including their entry into new markets and new links. By introducing refundable forms of financing and combined funding, the Bank is ensuring more favourable lending terms (maturity, interest rate, collateral) and a multiplier and revolving effect on state budget funds. 6.5.2 Asset liability management For liquidity management reasons, in 2012 SID Bank primarily invested in short-term deposits at domestic and foreign commercial banks and in other short-term and medium-term debt instruments of issuers with high credit ratings. Securities transactions were concluded as an alternative investment to complement the core line of business, for the needs of liquidity management, not for trading purposes. In its investing the Bank gives priority to investments that it can use as collateral for repo transactions, and investments that count towards the first-bucket liquidity ratio on the basis of Bank of Slovenia regulations or allow access to ECB liquidity. SID Bank operates on the financial markets of EEA and OECD members,20 and trades with foreign counterparties with an international rating of at least BBB-21 and with Slovenian banks. SID Bank does not usually hold investments where settlement is not undertaken by an independent institution. SID Bank's liquidity management investments amounted to EUR 645 million at the end of 2012, or 15.8% of total assets. Half of this comprised the securities portfolio in the amount of EUR 309.8 million, and the other half investments in deposits in the amount of EUR 335.2 million. The investments mostly consist of Slovenian and foreign government bonds, marketable bonds of other issuers and deposits. The majority of the investments are euro-denominated. SID Bank's investment policy is to invest in investment-grade assets. Almost 75% of its investments had a rating of at least A- as at 31 December 2012. The deposits are placed with foreign commercial banks with a suitable international credit rating, and with Slovenian banks. Investments with a fixed interest rate accounted for more than 93% of total investments for liquidity management purposes as at 31 December 2012. For more on the management of liquidity risk and interest rate risk, see Section 3 of the accounts. The currency breakdown of the investments is matched with the currency breakdown of SID Bank's funding, and is coordinated with the set limits. The Bank's policy in this area is for a foreign exchange position that is as closed as possible. The Bank uses currency derivatives in a very limited extent, solely for hedging currency risk. Borrowing As a specialist banking institution under the ZSIRB SID Bank primarily obtains long-term funding on the international and domestic financial markets. In raising its funding SID Bank chooses borrowing instruments that allow for greater adaptability to the needs of financing. Its borrowing is therefore 20 EEA: European Economic Area; OECD: Organisation for Economic Co-operation and Development. 21 Rating by S&P or comparable rating by another agency. Annual report of SID Bank and the SID Bank Group 2012 63 diversified in terms of maturity, size and issue/disubursement dynamics. The Bank endeavours to obtain long-term funding that is comparable in price terms to government funding, allowing for appropriate premiums over sovereign borrowing. EUR thousands 2012 2011 Index 2012/2011 Deposits 44,306 119,503 37.1 Borrowings (loans) 2,074,682 2,116,704 98.0 Issued securities 1,406,725 1,404,906 100.1 Total as at 31 Dec 3,525,713 3,641,113 96.8 In order to be able to offer firms and commercial banks long-term financing at the most favourable terms, SID Bank borrowed via various financial instruments in 2012, raising the vast majority of its funding on the international financial markets. Having cooperated successfully with the European Investment Bank in the past, SID Bank concluded two long-term loans in the amount of EUR 50 million with it in 2012, the funds being fully disbursed by the end of the year. In 2012 the Bank also raised funding from long-term loans under agreements concluded in previous years with the Council of Europe Development Bank, Germany's development bank (KfW) and the European Investment Bank. The total disbursement of these loans was EUR 126 million. In September SID Bank issued a one-year bond with a nominal value of EUR 150 million. In October it increased the size of the bond issue to EUR 210 million. The bond was issued on the international financial market, and is listed on the Vienna stock exchange. The Bank was thus the first Slovenian issuer to enter the international capital market since the sovereign downgrading and the resulting downgrading of SID Bank in summer 2012. The bond was issued at very favourable terms, although the market situation in 2012 was adverse, and deteriorated further during the year as a result of the global crisis and Slovenia's sovereign downgrading. SID Bank raised favourable funding, which it redirected into long-term loans made for the purposes set out in the ZSIRB, while raising its own profile among foreign investors. In addition to issuing a one-year bond, SID Bank raised EUR 155 million of funding in the 3-year LTRO tender at the ECB. On the foreign capital market it extended the bilateral loan from one of the commercial banks in the amount of EUR 20 million. SID Bank also borrowed from commercial banks in Slovenia on the interbank money market in smaller amounts. SID Bank also devotes much attention to managing its banking liabilities, primarily to mitigate refinancing risk. In 2012 SID Bank thus prepaid certain issued short-term and long-term bonds on the domestic capital market and on the foreign capital market. 6.5.3 Operations under the Republic of Slovenia's authorisation Insurance against non-marketable risks As an authorised institution, on behalf of and for the account of the Republic of Slovenia SID Bank insures against commercial and non-commercial or political (non-marketable) risks that given their nature and level of risk the private reinsurance sector is not willing to take up or has limited capacity to take up. EU regulations class commercial and political risks with a maturity of more than 2 years in OECD countries and all risks in non-OECD countries as non-marketable. The role of state is crucial in the area of non-marketable risks, as the majority of export transactions, particularly 64 | Annual report of SID Bank and the SID Bank Group 2012 medium-term, would not be undertaken without such insurance. Exporters and investors can also mitigate their operational risks in higher-risk countries by means of appropriate insurance, thereby creating economic security. EUR thousands 2012 2011 Index 2012/2011 Volume of insurance operations 942,324 1,203,430 78.3 Net exposure (31 Dec)22 689,273 747,571 92.2 Premiums 6,941 9,130 76.0 Potential claims 3,467 805 430.6 Claims under consideration 10,309 3,972 259.6 Claims paid (6,679) (1,171) 570.6 Number of claims 4 4 100.0 Recourse 490 94 521.7 Surplus of income over expenses 2,122 5,530 38.4 Contingency reserves 131,870 129,749 101.6 In carrying out its insurance operations on behalf of and for the account of the Republic of Slovenia against non-marketable risks, the Bank has consistently disclosed an increase in the volume of insurance in recent years. The crisis saw a reversal in the growth trend in 2011, and the volume of insurance in 2012 again declined relative to the previous year. Although the volume of insurance operations declined in 2012, SID Bank provided appropriate support to the economy, thereby achieving satisfactory results, which was reflected primarily in a rise in the number of policies issued. The number of policies issued in 2012 was up 33% on the previous year. This was an indication of lower-value policies being concluded, even as their number rose. Volume of insurance operations The volume of insurance operations against non-marketable risks amounted to EUR 942.3 million in 2012, down 21,7% on the previous year. This was 10.8% of the limit on potential new annual liabilities defined in the ZZFMGP.23 The weak position of the Slovenian economy brought a reduction in the volume of insurance operations. The financial and economic crisis resulted in reduced export volume, and made it more difficult to obtain financing for such transactions. In addition it should be noted that the majority of the major construction and engineering firms that used to carry out investment work in the rest of the world collapsed in the crisis. At the same time firms are reducing the insurance costs of their investments in the rest of the world or cancelling contracts previously concluded. Insurance of outward investments in the amount of EUR 488.7 million accounted for the largest proportion of the volume of insurance operations (51.9%), followed by reinsurance of short-term export credits (renewable insurance of non-marketable risks) and insurance of short-term guarantees in the total amount of EUR 441.8 million (46.9%). 22 Exposure takes account of all firm commitments to issue insurance policies. 23 Under the limit prescribed by the ZZFMGP in connection with new liabilities (new insurance operations) assumed in a particular calendar year, the liabilities may not exceed one-third of the most recent officially determined value of Slovenia's annual exports of merchandise and services (exports stood at EUR 26,104 million in 2011; source: IMAD 2012). Annual report of SID Bank and the SID Bank Group 2012 65 The fluctuation in the volume of insurance operations is very similar to that at a global level. It is the result of the decline in corporate investment and investment cycles, the collapse of certain major firms that undertook such transactions in the rest of the world, particularly in the construction sector, and the convergence of certain countries (Croatia, Serbia) with the EU, which has reduced their risk. Another factor has been the increased competitiveness of the Chinese economy, which is superseding Slovenian exporters. Russia accounted for the largest proportion of insurance of short-term export credits, investments and secured medium-term loans in 2012, followed by Serbia, Bosnia and Herzegovina, Croatia, Ukraine, Kazakhstan, Macedonia, Belarus, the USA, and other countries. Insurance of short-term export loans/credits and guarantees In the insurance and reinsurance of export credits, guarantees and preparations for exports, the volume of short-term insurance stood at EUR 441.8 million, up 0.7% on 2011. The increase was partly the result of the decision by private insurance corporations to exit certain markets and sectors because of the crisis, and partly the result of the increased risk of customer default faced by exporters. Another factor in the increase was the renewed growth in exports and the resulting increase in credits insured with primary insurers. The withdrawal of the private reinsurers meant that their place was taken by SID Bank as the authorised institution, which brought an increase in the volume of reinsurance of short-term credits against non-marketable risks. Reinsurance of non-marketable short-term credits where SID Bank acts as the reinsurer of such credits for Slovenian insurance corporations when they are unable to obtain reinsurance coverage on the private market frees up reinsurers' capacities. The majority of short-term insurance relates to insurance of short-term revolving export credits on the basis of reinsurance contracts. On the basis of these contracts SID Bank only covers those risks that private reinsurers are unable to accept for reinsurance because of a shortfall in available capacity (non-marketable risks). A small proportion relates to insurance of individual export transactions. Insurance of medium-term export credits The small number of projects realised each year and their size means that the volume of medium-term export credits insured varies from year to year. The volume of insurance of medium-term export transactions (credits and guarantees) amounted to EUR 11.9 million in 2012, down 66.3% on the previous year. The main reason for the relatively small number of individual projects supported that require medium-term insurance, and also financing in general, was the change in the structure of the Slovenian economy. A major factor in the decline in medium-term insurance was the decline in construction in Russia. The decline in business recorded by Slovenian firms was also the result of the more competitive lending offered by Russian banks compared with Slovenian banks. As a result of the slow recovery of the Slovenian economy and the financial sector and the subsequent increased difficulty in obtaining new export business, there has been no sign of increased demand among exporters for insurance of medium-term export credits in south-eastern Europe. 66 | Annual report of SID Bank and the SID Bank Group 2012 Insurance of outward investments The volume of outward investments insured amounted to EUR 488.7 million in 2012; this amount comprises renewals of previously insured investments, which actually entail newly insured investments, and newly insured outward investments. The volume was down 33% on the previous year, primarily as a result of the downturn in corporate investment cycles, certain key countries' convergence with the EU and the consequent reduced risk of servicing insured loans and, above all, the premature cancellation of certain major insurance policies. New insurance relates exclusively to the insurance of non-shareholder loans or loans to subsidiaries of Slovenian investors in the rest of the world, within which commercial and non-commercial risks may be covered. In 2012 there were newly insured investments in construction and metal processing, in manufacturing, food and tourism, textiles, clothing, cars, electronics and telecommunications, in trade in motor fuels, and in domestic appliances. The diminishing risk of the target countries is reducing the demand for insurance of equity holdings. There is also a cost impact, as loan insurance is rising in price. There were thus no new insurance operations for equity holdings in 2012. The decline in the volume of insured investments in 2012 was the result of regular expiries of insurance policies, both the insurance of equity holdings and non-shareholder loans. Cost cutting meant that the largest insurance policy in the investment insurance portfolio (EUR 226 million) was cancelled a year prematurely, and three policies with a total value of approximately EUR 67 million were not renewed at the policy anniversary. Their size meant that they had a significant impact on the volume of insured investments, exposure and premiums. The regular servicing of insured loans is also having an impact, as a result of which both volume and exposure are declining. Despite the crisis, the volume of investment insurance is expected to increase in 2013 as a result of non-shareholder loans. Alongside the traditional countries for investment insurance (the former Yugoslav republics and the countries of south-eastern Europe), the regional dynamics of investments by Slovenian investors suggest that there is potential for new insurance outside the previously typical countries. Thanks to the crisis, demand for loan insurance can also be seen in lower-risk countries, and in 2012 insurance was taken out in the USA and Turkey. Exposure Exposure from current insurance policies amounted to EUR 686.5 million at the end of 2012. Exposure from firm insurance commitments, which under the ZZFMGP is included in the total net exposure, amounted to EUR 2.8 million. Total exposure from insurance operations for the account of the state and from issued firm insurance commitments amounted to EUR 689.3 million at the end of 2012, down 7.8% on the end of 2011. The decline in exposure is the result of regular expiries of insurance policies (secured medium-term credits, equity holdings and non-shareholder loans), and also from premature cancellations. The main reasons are in the diminishing risk of the target countries, which is reducing the demand for insurance of equity holdings. There is also a cost impact, as loan insurance is rising in price. Annual report of SID Bank and the SID Bank Group 2012 67 The exposure amount represents 27.6% of the limit defined in State Budget 2012 Implementation Act and 2.6% of the limit defined in the ZZFMGP.24 The largest exposures in the insurance portfolio in 2012 were disclosed against Russia (27.3%) and Serbia (23.6%), which required additional monitoring of the political and economic situation in these countries. Insurance technical result and items Premium from insurance against non-marketable risks amounted to EUR 6.9 million in 2012, down 24% on 2011. The decline in insurance premium was primarily the result of a decline in the volume of insurance of outward investments. Income from processing fees is negligible, because SID Bank refunds the amount or includes it in the premium in the case of individual export transactions or investments in accordance with its business policy and current price lists. Claims paid in 2012 were 5.7 times higher than in the previous year at EUR 6.7 million. The majority of claims paid related to insurance of a bank guarantee against the risk of the guarantee being called without entitlement (Bosnia and Herzegovina) and to insurance of a loan to a foreign bank (Kazakhstan), while a lesser proportion (18.7%) related to claims from reinsurance of short-term export credits (Serbia, Uzbekistan, Ukraine , Croatia, Romania, Macedonia, Bosnia and Herzegovina, and Iran). Claims under consideration (claims filed) amounted to EUR 10.3 million as at 31 December 2012. The majority of claims under consideration comprises medium-term transactions in the total amount of EUR 10 million, while a figure of EUR 0.3 million comprises claims from receivables covered by short-term reinsurance. At EUR 3.5 million, potential claims in 2012 were 4.3 times higher than the 2011 figure of EUR 0.8 million, while the majority of potential claims relates to reinsurance and insurance of short-term receivables. The technical result for the account of the Republic of Slovenia was positive, despite claims payouts. The surplus of income over expenses amounts to EUR 2.1 million, down 61.6% on the previous year. Contingency reserves The contingency reserves constitute important capacity for SID Bank and for the Republic of Slovenia in insurance against non-marketable risks, before claims from insurance for the account of the Republic of Slovenia are paid out from the state budget. The aim of the investment policy for the contingency reserves is to maintain the ability to settle insurance claims. The contingency reserves are held in liquid assets equivalent to the sum of potential claims and claims under consideration from non-marketable insurance, or at least 20% of the invested funds. Liquid assets comprise debt securities quoted on a regulated market, and all 24 The limit on the Bank's exposure from insurance against non-commercial, medium-term commercial and short-term commercial non-marketable risks set out under the ZIPRS, i.e. the exposure from current insurance and commitments, is EUR 2,500 million. Under the limit prescribed by the ZZFMGP in connection with the amount of assumed valid liabilities from insurance operations, active reinsurance and retrocession, other operations, guarantees and other sureties, the figure may not exceed the most recent officially determined value of Slovenia's annual exports of merchandise and services (exports stood at EUR 26,104 million in 2011; source: IMAD 2012). 68 | Annual report of SID Bank and the SID Bank Group 2012 other forms of investment whose residual maturity is less than one year. The amount of liquid assets varies, and depends primarily on the projected payout of claims and the resulting liquidity position for the contingency reserves. The positive result generated in insurance operations in 2012 thus brought an increase in the contingency reserves, which amounted to EUR 131.9 million at the end of 2012. Contingency reserve assets amount to EUR 136.7 million in total. Interest Rate Equalisation Programme In accordance with the ZZFMGP and on behalf of and for the account of the Republic of Slovenia, as an authorised institution SID Bank provides the Interest Rate Equalisation Programme (IREP) for export credits that comply with the OECD arrangements. SID Bank holds a contract with the Ministry of Finance for the provision of the IREP and the management of its assets. The IREP facilitates the provision of export credits at fixed interest rates that are lower than the market rates. SID Bank concludes interest rate swaps with the participating banks, thereby providing them with funding at fixed interest rates. SID Bank covers the interest rate risk arising in the IREP by means of reverse interest rate swaps concluded with banks whose international credit rating is no lower than BBB- at S&P. The purpose of the interest rate swap is to protect the participating bank's exposure to interest rate risk arising from the approval of an export credit at a fixed interest rate. Because of the fixation of the interest rate, the participating bank is entitled to an equalisation factor of up to 1% (expressed as an annual interest rate and dependent on the maturity of the credit), which the lending bank transfers in full to the final borrower. The interest rate for the final borrower (a foreign customer of Slovenian goods or services) is no lower than the OECD's reference interest rate, the CIRR.25 Guarantee scheme for corporates The Republic of Slovenia Guarantee Scheme Act (hereinafter: the ZJShemRS) set up a system in 2009 for issuing government guarantees for the liabilities of companies rated A, B or C from long-term loans raised at commercial banks. The purpose of the law was to relieve the credit crunch resulting from the global financial crisis, which reduced access to commercial banks' resources, thereby reducing the inflow of cash into the Slovenian economy. Of the total guarantee quota of EUR 1.2 billion, a total of EUR 809.4 million had been assigned to banks in 15 auctions by 31 December 2010, when the legal deadline for issuing guarantees under the scheme passed. In line with its legal authorisations SID Bank again managed the portfolio deriving from the ZJShemRS in 2012. As a result of the deterioration in business conditions, which meant that companies were unable to consolidate their performance as expected when the measure was introduced, the vast majority of companies embarked on a restructuring of the credit portfolio. The commercial banks therefore discussed the restructuring of loans with government guarantees, and verified and coordinated their proposals with SID Bank in line with the legal requirements. When the companies failed to consolidate their performance, the commercial banks made use of their legal possibilities and exercised the credit protection, i.e. the government guarantee. In line with its authorisations SID Bank obtained, reviewed and coordinated the documentation for modifying the terms of government-guaranteed loans and processed the claims for calling guarantees. Where it identified breaches resulting in a loan agreement being declared null and void, the repayment of a 25 Commercial Interest Reference Rates. Annual report of SID Bank and the SID Bank Group 2012 69 called guarantee or the payment of a contractual penalty, SID Bank filed motions with the State Attorney's Office for a voiding suit, a suit for the repayment of a called guarantee or a suit for the payment of a contractual penalty. In 2012 SID Bank received and diligently reviewed 174 applications for the modification of loan terms. It issued 129 approvals for modifying the terms of government-guaranteed loans. It rejected 22 applications where breaches of law were identified, while 23 applications were still being processed at the end of 2012 because of requests for extra documentation. SID Bank received 96 requests for issued guarantees to be called in 2012. A total of 69 requests for calling were granted to commercial banks by the Ministry of Finance in 2012 having met the conditions under the ZJShemRS, based on which a total of EUR 23.3 million was paid out. A total of EUR 46.7 million was paid out to banks by the Ministry of Finance between 2009 and 2012 on the basis of 141 requests for calling. At the end of 2012 there were 336 loan agreements secured by government guarantee still active at the commercial banks, the stock of principal amounting to EUR 323.3 million as at 31 December 2012. Guarantee scheme for private individuals The Act on the Natural Persons Guarantee Scheme of the Republic of Slovenia (hereinafter: the ZJShemFO) allowed private individuals to obtain a government guarantee for loans of up to EUR 100,000 or up to EUR 10,000 depending on the category of borrower. As a government anti-crisis measure the guarantee scheme for private individuals covered four categories of borrower: temporary employees, first-time home buyers, young families and the unemployed. The total guarantee quota to be allocated under the ZJShemFO between 2009 and the end of 2010 was EUR 350 million, of which EUR 50 million was earmarked for unemployed borrowers. The legal deadline for issuing government guarantees under this law was 31 December 2010. There were 310 loans outstanding as at 31 December 2012, and the total stock of principal was EUR 6.8 million. SID Bank received five requests for guarantees to be called in 2012 (bringing the total between 2010 and 2012 to 73). Seven requests for calling (five received in 2012 and two in 2011) were granted to commercial banks by the Ministry of Finance in 2012 having met the conditions under the ZJShemFO, based on which a total of EUR 32 thousand was paid out. All the guarantees paid out related to the category of unemployed borrowers. SID Bank initiates a recovery procedure for the guarantees paid out, provided that the conditions have been met. Guarantees for investments The aim of the Republic of Slovenia Guarantees for Financial Investments by Companies Act (ZPFIGD) is to ease corporate access to working capital and to funds for investment, which will strengthen the development and competitiveness of Slovenian companies. As prime credit protection, a government guarantee is an instrument for improving access to financing corporate development projects. On the basis of the announcement of the second tender of government guarantees for corporate liabilities from loans raised at banks and savings banks earmarked for financing investments in development projects, SID Bank received two applications for the issue of guarantees in the total amount of EUR 2.2 million in 2012. The guarantees were issued for two investments by companies in Central Slovenia, with a total value of EUR 4.5 million. The investments were in tourism 70 | Annual report of SID Bank and the SID Bank Group 2012 development and the construction of a retirement home, and were expected to generate new jobs and increased added value per employee. The total stock of loans supported by government guarantee was EUR 17.5 million at the end of 2012, within the framework of which the government guarantee amounted to EUR 13.1 million. Amendments to the ZPFIGD entered into force in July 2012. Because the new arrangements for the implementation of the ZPFIGD were only published at the end of 2012, the amendments had no impact on the implementation of the measure in 2012. The amended law is expected to have an impact in 2013. Management of emission allowances and Kyoto units Pursuant to Article 126c of the Environmental Protection Act (ZVO-1), in the second half of 2012 SID Bank began acting as the official auctioneer of greenhouse gas emission allowances in accordance with Commission Regulation 1031/2010 on the timing, administration and other aspects of auctioning of greenhouse gas emission allowances pursuant to Directive 2003/87/EC of the European Parliament and the Council establishing a scheme for greenhouse gas emission allowances trading within the Community, amended by Commission Regulation 1210/2011. In auctions organised by the joint auctioning system of 24 EU members (the European Energy Exchange), SID Bank sells quantities of emission allowances on behalf of the Republic of Slovenia (set out by the aforementioned regulation, the relevant European Commission decisions and the auction timetable) and transfers the proceeds to the account of the Republic of Slovenia. Having carried out all the requisite activities for beginning the implementation of this function on time (e.g. opening all the necessary accounts for the cash leg of the transaction, concluding the requisite agreements with the Ministry of Agriculture and the Environment, the joint auctioning system and the clearing and settlement system), SID Bank participated in the first auction of emission allowances, which only ten EU members succeeded in doing, and met all of its obligations with the diligence of a good expert. Under Article 142 of the ZVO-1, SID Bank is also authorised to carry out the Kyoto units and emission allowances programme on behalf of and for the account of the state. The authorisation is not yet being exercised, as the government has not yet approved this programme. Transparency of financial relations between SID Bank and the state To ensure the separate recording of the individual activities pursued by SID Bank under Republic of Slovenia authorisation, the Bank has put in place a system of cost centres and cost drivers against which transactions occurring in the pursuit of individual business activities are recorded. This is also the basis for determining the direct expenses of an individual activity. For insurance against non-marketable risks and the Interest Rate Equalisation Programme, in which the Bank also manages assets allocated for management, a separate statement of financial position is compiled (point 2.6.2 of Section II). The table discloses the total (direct and indirect) revenues and expenses for individual activities generated in 2012. The revenues for an individual activity represent the fees that SID Bank receives for pursuing the activity on the basis of contracts or provisions of law. The indirect expenses for an individual activity are determined on the basis of criteria set out in a bylaw, the Criteria for allocating indirect costs of activities under Republic of Slovenia authorisation. Annual report of SID Bank and the SID Bank Group 2012 965 Activity EUR thousands_Income Expenses Insurance against non-marketable risks 1,910 (1,923) Interest Rate Equalisation Programme 277 (515) Guarantee scheme for corporates 9 (95) Guarantee scheme for private individuals 54 (41) Guarantees for investments 17 (142) Auctions of emission allowances 3 (12) 6.6 Performance of the SID Bank Group 6.6.1 SID - Prva kreditna zavarovalnica d.d., Ljubljana For information about SID - Prva kreditna zavarovalnica d.d., Ljubljana, see point 2.2. EUR thousands 2012 2011 Index 2012/2011 Total assets 65,398 67,911 96.3 Shareholder equity 24,058 22,857 105.3 Gross claims incurred 12,752 19,070 66.9 Loss ratio 62% 91% Net profit 2,689 5,607 48.0 Volume of insurance operations 5,241,155 5,225,603 100.3 The economic crisis and debt crisis, which began to mount again in the middle of 2011 and continued in 2012, had a major impact on the environment in which PKZ operates. The low activity of the Slovenian economy and its foreign trade partners affected the volume of insurable business in 2012. As GDP fell in Slovenia, Italy and Croatia, grew slowly in Germany and recorded high growth in Russia alone, PKZ succeeded in maintaining its level of insurance business from 2011. The increase in payment indiscipline meant that PKZ operated in a very uncertain environment in 2012. Payment discipline recorded its largest improvement in 2012 in Russia, was unchanged in Germany, and deteriorated in Slovenia, Italy and Croatia, which PKZ took into account when approving limits for these countries. There was further evidence in 2012 of the level to which credit insurance depends on economic fluctuations, the volume of business having remained at the level of 2011 while premium declined by 3%. Non-life insurance premium of insurance corporations established in Slovenia increased by 0.2% in 2012. By expanding certain contracts and by attracting new policyholders, PKZ succeeded in maintaining its volume of insurance business at the 2011 level in the harsher economic climate in 2012. In 2012 healthy growth was again limited by low corporate credit ratings (insurance risks) compared with the pre-crisis levels. 72 | Annual report of SID Bank and the SID Bank Group 2012 PKZ did not fully meet its expectations of the volume of insurance business and premiums in 2012, as the macroeconomic economic assumptions were expected to be more favourable than when the plans were being drawn up. The forecasts of the relevant institutions were envisaging a further increase in GDP in Slovenia when the plans were drawn up in 2012. Premium levels remained high, in keeping with the risks, but were down on 2011, which resulted in the 3% decline in premium. These developments were the result of the expansion of contracts to insurance for customers in markets with lower risks and thus lower average premium levels, the expansion of contracts with lower average contractual levels and adjustments in contractual premium levels. In the adverse liquidity situation PKZ managed to maintain a stable loss ratio, primarily by applying stricter conditions for insurance of credits and by following the guidelines and resolutions of anticrisis measures adopted in the past. The number of claims fell, while incurred claims were down on 2011. Claims payouts and the favourable claims history brought a reduction in the outstanding claims reserve. This was largely the result of the development of claims in 2010 and 2011 being less unfavourable than could be estimated at the end of 2011. As a result of these developments, net income from premiums exceeded net expenses for claims by EUR 4.2 million (2011: EUR 7 million, when the decline in the reserve was larger). The loss ratio was more favourable than planned, both for previous years and for 2012. The claims payout was relatively large last year, but because the filed claims and announced arrears in payment do not indicate any deterioration compared with 2011, PKZ assesses the loss ratio for 2012 as stable. Because the actual claims situation is only revealed after several months of delay, and because this is affected by future uncertain economic developments, this uncertainty is to a certain extent captured in the estimated loss ratio. Net profit was also significantly larger than forecast in 2012, mostly as a result of the more favourable development of previous claims years than originally expected. Given the continuing uncertainty, when the report was compiled PKZ had already earmarked a portion of its profit for the reserves and strengthened its capital, thereby preparing for the difficult business conditions anticipated in 2013. Net profit after taking account of the mandatory change in the credit risk equalisation reserve amounted to EUR 1.7 million (2011: EUR 4.6 million), while the credit risk equalisation reserve increased by EUR 0.9 million during the year (2011: EUR 1 million). When the report was compiled the net result for 2012 had already been used to increase other profit reserves (EUR 0.9 million). In 2013 PKZ will again explore its market opportunities for new and upgraded forms of credit insurance, partly in combination with existing reinsurance programmes (launched in 2009, some of which remained in effect in 2012 and will continue to do so in 2013) and with those that it could acquire via the controlling company. PKZ introduced a special simplified programme for small businesses in 2012. It is also planning to improve its services for medium-size companies on this basis. After Croatia joins the EU, and other conditions are put in place, PKZ intends to begin providing insurance operations directly on that market. Annual report of SID Bank and the SID Bank Group 2012 73 6.6.2 Prvi Faktor Group For more about the Prvi Faktor Group, see point 2.2. Prvi faktor, Ljubljana Index EUR thousands 2012 2011 2012/2011 Total assets 135,223 137,176 98.6 Shareholder equity 4,812 4,209 114.3 Net profit 603 962 - Purchased receivables 267,238 236,902 112.8 Prvi Faktor Group Index EUR thousands 2012 2011 2012/2011 Total assets 315,038 338,485 93.1 Shareholder equity 8,722 6,443 135.4 Net profit 1,090 1,859 - Purchased receivables 929,303 908,217 102.3 The adverse economic situation in south-eastern Europe had an impact on the performance of the Prvi Faktor Group in 2012. The liquidity position and the quality of the credit portfolio deteriorated slightly in 2012 compared with the previous year. Purchased receivables at the Prvi Faktor Group amounted to EUR 929.3 million in 2012. The figure was up 2.3% on 2011, and was 22.3% higher than the forecast in the annual plan. The subsidiaries accounted for 71.2% of the turnover of the Prvi Faktor Group. All the companies exceeded their forecast turnover in 2012. Prvi faktor, Zagreb continues to generate the largest proportion of the group's turnover. It accounted for 39.6% of the total in 2012, down 2.3 percentage points on the previous year. The majority of the receivables financed by the Prvi Faktor Group arose on the basis of the delivery of goods or the rendering of services between entities in Slovenia. Domestic factoring accounted for 84.9% of total turnover last year (2011: 87.9%), export financing for 9.9% and import financing for 5.3%. The group's total assets at consolidated level amounted to EUR 315 million as at 31 December 2012, down 6.9% on 31 December 2011. According to total assets, the largest company in the Prvi Faktor Group is Prvi faktor, Zagreb, whose total assets at the end of 2012 amounted to EUR 140.8 million. The increase in total assets was slightly less than the increase in turnover, which points to a slight improvement in the efficiency of asset management. The total assets of Prvi faktor, Ljubljana amounted to EUR 135.2 million at the end of 2012, down 1.4% on the previous year. Despite the adverse situation all companies in the group generated positive operating results in 2012, while the group's overall result was also positive. The performance of the Prvi Faktor Group can be assessed as good. 74 | Annual report of SID Bank and the SID Bank Group 2012 6.6.3 Pro Kolekt Group Pro Kolekt, družba za izterjavo, d.o.o. (hereinafter: Pro Kolekt, Ljubljana) was established by SID in 2004 and is under its 100% ownership. The company's nominal capital amounted to EUR 418.8 thousand as at 31 December 2012. The nominal value of SID Bank's equity holding in Pro Kolekt, Ljubljana was EUR 418.8 thousand. Pro Kolekt, Ljubljana specialises in extra-judicial recovery. The company was established primarily for the extra-judicial recovery of cases for the needs of the SID Group. Today the company accepts cases of Slovenian creditors and foreign creditors from the rest of the world. Foreign export credit agencies and recovery agencies are increasingly acting as agents for Pro Kolekt, Ljubljana. Pro Kolekt, Ljubljana also represents creditors in judicial recovery, composition and bankruptcy proceedings, and provides credit rating information. The company's director is Mr Leon Zalar. SID Bank's management board acts as the company's general meeting. The Pro Kolekt Group consists of the parent company Pro Kolekt, Ljubljana and a network of the following subsidiaries in south-eastern Europe: - Pro Kolekt d.o.o., Zagreb; - Pro Kolekt d.o.o., Skopje; - Pro Kolekt, društvo za naplatu duga d.o.o., Belgrade; - Pro Kolekt Credit Management Services Bucuresti S.R.L., Bucharest; - Pro Kolekt Sofia OOD, Sofia; - Pro Kolekt d.o.o., društvo za financijsko posredovanje, Sarajevo. Pro Kolekt, Ljubljana EUR thousands 2012 2011 Index 2012/2011 Total assets 584 469 124.5 Shareholder equity 255 294 86.7 Net profit (39) 26 (150.0) Value of debts recovered 5,064 8,818 57.4 Pro Kolekt Group EUR thousands 2012 2011 Index 2012/2011 Total assets 4,275 4,211 101.5 Shareholder equity 272 343 79.3 Net profit (22) 10 (220.0) Net profit/(loss) of majority interest (31) (15) - Value of debts recovered 12,294 17,643 69.7 The continuing deterioration in the liquidity position reduced the chances of successful recovery in 2012, and sharply constrained the value of transactions between companies. This had an impact on the Pro Kolekt Group, and resulted in a rise in the number of recoveries ordered, but a significant decline in the total value of debt recovered. There was also a rise in the number of cases successfully closed, but a decline in the average value of the closed cases. The actual amounts recovered were down approximately 10% on the previous year. Annual report of SID Bank and the SID Bank Group 2012 75 In 2012 the Pro Kolekt Group again focused on intensively marketing the products and services that it offers to its clients, which strengthened its profile in south-eastern Europe and also further afield in Europe. In keeping with clients' requirements, particular attention was given to a personal approach in handling individual cases, which deepened relations with clients and with local external partners in the form of recovery agencies. In the credit rating field the company was particularly successful in south-eastern Europe, where it has a permanent presence on the ground and a large database of debtors. The company has developed its PK-NET online portal to this end, with a debtors' blacklist, online monitoring or recoveries, and credit rating information using SID Bank methodology. The Pro Kolekt Group accepted 3,033 new cases for recovery in 2012 with a total value of EUR 40.2 million. A total of 1,128 cases were successfully closed, with a total value of EUR 12.3 million. The amount actually recovered totalled EUR 9.4 million. 6.6.4 Centre for International Cooperation and Development In 2006 SID Bank officially became the joint holder, alongside the state, of the Centre for International Cooperation and Development (the CMSR), with which it had previously worked closely. The foundation's core activities are macroeconomic, political and other analysis of sovereigns, assessments of country risk and publicity activities. In recent years, on the basis of government authorisation, the CMSR has become Slovenia's main institution for technical and operational work in the field of international development cooperation. The CMSR's governance bodies are the director and the council. The foundation is represented by its director, Mr Gašper Jež. The council has six members. SID Bank's representatives on the council are Mr Sibil Svilan (M.Sc.), who is also the chairman of the council, and Mr Bojan Pecher. In 2012 the CMSR continued its many years of cooperation with SID Bank, its co-founder and most important business partner. Index EUR thousands 2012 2011 2012/2011 Operating revenues 358 388 92.3 Total project value 6,873 5,198 132.2 The CMSR met the majority of its targets in 2012. Its priority was bilateral development cooperation. The CMSR maintained and expanded its network of contacts with countries receiving development assistance and Slovenian contractors that are potential providers of development assistance. The CMSR allocated all available grants in 2012. It proved itself to be an institution capable of wisely investing budget funds, which were reduced last year, in development projects in the rest of the world via the instrument of official development assistance. This helped to secure export deals for Slovenian companies, generating economic growth and employment, and increasing budget revenues. Its Doing Business in Slovenia publication, available in print form and online on the Slovenian Business Portal, was the main source of income from sales and advertising. The CMSR also published a journal, International Business Law, in 2012. In light of an ongoing fall in the number of subscribers, it attempted to end this trend via direct marketing. The CMSR's smaller projects included further online sales of brief analyses via the ISI Emerging Markets portal run by Euromoney magazine. Annual report of SID Bank and the SID Bank Group 2012 Annual report of SID Bank and the SID Bank Group 2012 971 II. FINANCIAL STATEMENTS Annual report of SID Bank and the SID Bank Group 2012 Annual report of SID Bank and the SID Bank Group 2012 973 Declaration by the management board on the financial statements of SID Bank and the SID Bank Group On 26 February 2013 the management board hereby approves the financial statements of SID Bank and the SID Bank Group, and the annual report for the year ending 31 December 2012. The financial statements have been compiled in accordance with the International Financial Reporting Standards (IFRS) as adopted in the EU. The management board believes that SID Bank and the SID Bank Group have sufficient resources to operate as going concerns. The management's responsibilities are: - to employ relevant accounting policies, and to ensure that they are consistently applied, - to make use of reasonable and prudent accounting estimates and judgements, - to appropriately disclose and clarify any material deviations from the accounting standards applied, - to ensure that the financial statements are compiled on a going-concern basis for SID Bank and the SID Bank Group, unless the winding-up of operations can reasonably be anticipated. The management board is responsible for maintaining accounting documents and records to disclose the financial position of SID Bank and the SID Bank Group with reasonable accuracy at any time. The management board is also responsible for ensuring that the financial statements have been compiled in accordance with the legislation and regulations of the Republic of Slovenia. The management board must do everything possible to safeguard the assets of SID Bank and the SID Bank Group, and must undertake all necessary action to prevent or detect any fraud or other irregularities. The tax authorities may audit a bank's operations at any time in the five years after the date that tax was due to be levied, which may result in additional tax liabilities, penalty interest and fines in connection with corporate income tax or other taxes and levies. The management board is not aware of any circumstances that could give rise to any significant liability on this account. Management board of SID - Slovenska izvozna in razvojna banka, d.d., Ljubljana Jožef Bradeško member Sibil Svilan, M.Sc. president Annual report of SID Bank and the SID Bank Group 2012 Annual report of SID Bank and the SID Bank Group 2012 975 Independent Auditor's Report To the Shareholders of SID - Slovenska izvozna in razvojna banka, d,d. Report on the Financial Statements We have audi Led the accompanying financial statements of SID Slovenska izvozna in razvojna banka, d.d. which comprise the statement of financial position its at 71 December 2012. the income staiement and the slatemetil of connpreli ens ive income, the statement of changes in et|tiity and the statement of cash flows for the year thee! ended, and a summary of significant accounting policies and other explanatory iniiomtation. Management Responsibiiity for the Financial Statements Management is (^sponsible for the preparation and fair prcscntalion of these financial statements in accordance with International riminci&J Reporting Standards as adopted by EL\ and for such internal control as management determines is necessary1 to enable the preparation of financial statements thai are free from material misstatement, whether due to fraud or error. . i a ilitorRt'spoil nihility Otir responsibility is to express an opinion on these financial statements based on onr audit.. We conducted ouratidil in accordance with International Standards, on Auditing. Those standards require that we comply with el h teal ret|tiircments and plan and perform the audil to obi a in reasonable assurance about whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about (he amounts and disclosures in the financial statements. The procedures selected depend on the auditor's judgment, including llic assessment of 1 lie risks of material misstatement oft Ik financial statements, whether due to (fatid or error. In making (hose risk assessments, the auditor considers internal control relevant to the entity's preparation and lair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not lor the purpose of expressing an opinion on the effectiveness of the entity's internal control An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe llial the audit evidence we have ohtained is sufficient and appropriate lo provide a basis for our audit opinion. Opinion In our opinion, the financial statements present lairly. in all material respecls, the financial position of SID Sloven ska izvozna in razvqjna banka. d.d. asai 31 December 2012, and ils financial performance and ils cash Hows for the year then ended in accordance with International Tinaneial Reporting Standards as adopted by EU. Report on Other Legal and Regulatory Requirements As required by the Slovenian Companies Aet we herewith confirm that the information m the management repoii is iri conformity with the accompanying financial statements. KPMG SLOVEN1JA+ ¿a rp^iitu'jiLjjf, rl.if.ii_ J mag. Sinionii Kofoiec Lavrii Certified A uditor Ljubljana. 2 Apri 12013 HPMG Sioueniie, d-O.a. ITk IiilI.-1