Central and Eastern Europe (CEE)

For the Central Eastern Europe (CEE) Division of BA-CA, 2006 was marked by continued growth of operations, integration in UniCredit Group and integration within those countries where we are merging banking subsidiaries.

First and foremost, our CEE banking subsidiaries pursued further expansion of their operating activities in 2006 across all areas, following the principle of “volume and revenue growth at stable costs and risks”. We also made preparations in 2006 for assuming the holding company function for all CEE subsidiaries of UniCredit Group (except Poland and Ukraine) and we carried out the first transfers, at arm’s length, of operations in this region. This had no impact on current business activities. Year-end 2006 marked the transition from the first to the second stage of this project: sales on market conditions effected in 2006 will be followed in 2007 by the transfers of the CEE subsidiaries of UniCredit and HVB. These large-volume transfers have a strong effect on the financial statements for 2006. This means that the performance of our subsidiaries is reflected more clearly at the individual bank level rather than in the CEE segment result. The sale of HVB Splitska banka to a third bank, effected to comply with merger control requirements (as reported on several occasions), was completed on 30 June 2006. The closing of the sale of Bank BPH took place at the beginning of November 2006. The capital gains on these transactions at arm’s length are included in the Corporate Center’s net income from investments.

Despite the disposal of previously consolidated companies, the CEE business segment’s operating profit for 2006 rose by 10 % to € 808 m. A linear projection of income statement figures for HVB Splitska banka and Bank BPH for the year as a whole gives an increase of about one-quarter (24 %) in operating profit.

Total revenues in 2006 (€ 1,725 m) were up by 11 % on the previous year (or 24 % higher, on the basis of projected full-year figures for Splitska banka / Bank BPH). The reported increase of € 165 m was mainly driven by net interest income (up by € 115 m or 12 %). This reflects the continued expansion of classic banking business – both loans and deposits – as financial intermediation in CEE advances; expansion is still proceeding at comparatively good margins, despite the convergence process. Net fee and commission income also rose at a double-digit rate (by € 69 m or 13 %). Contributions to this growth came from classic banking services (payment transactions, account maintenance), electronic banking, the expanding securities business and the increasing use of derivatives in corporate business. Net trading income (€ 106 m) declined as a result of consolidation effects and especially because of the difficult market situation in Hungary. Moreover, this item in the segment’s income statement also includes the costs associated with hedging transactions for annual profits. Operating expenses increased by 11 % to € 917 m. At 53.2 %, the cost/income ratio was almost unchanged, yet significantly lower than the average for the bank as a whole (57.9 %).

The items between operating profit and profit before tax are distorted by one-off effects. Net writedowns of loans (€ 141 m after € 116 m) include the amount of almost € 25 m which resulted in the CEE business segment from the application of higher risk standards based on improved methodologies in retail lending (IBNR effect). Adjusted for this effect, net writedowns of loans (€ 116 m) would have been unchanged despite the 3 % increase in risk-weighted assets. The adjusted risk/earnings ratio of 11.0 % (not adjusted: 13.4 %) demonstrates that business in CEE is still expanding with a low default rate, benefiting from risk management put in place at an early stage.

Net income from investments was € 5 m, down by € 121 m from the previous year’s level, which reflected the capital gain of € 123.5 m recorded in 2005 in connection with the acquisition of Banca Tiriac via an exchange of shares. Integration costs in 2006 were € 11.5 m, higher than in 2005 (€ 7.2 m). Although operating profit rose by 10 % to € 808 m, profit before tax was € 655 m, down by 12 % on 2005. Adjusted for one-off effects in 2006 and 2005, profit before tax improved by 7 % to € 680 m. On the basis of inclusion of projected figures for the missing profit contributions from the banks which were sold, profit before tax would have improved by 22 %.

The combined profit before tax of the subsidiaries was € 707 m, up by 13 % (or 23 % on the basis of projected figures for Bank BPH / HVB Splitska banka). Results in the Czech Republic improved substantially, mainly on the revenue side, reflecting the successful restructuring of retail banking business and the continued good development of business with corporate customers. The banks in Romania and in Bosnia achieved the strongest revenue growth while also recording the largest increase in costs due to integration-related expenses; in Bulgaria, strong growth of revenues fed through to profit before tax as costs rose more slowly.

Outlook: In the current year we will complete the mergers which are being prepared in the various countries and we will thereby expand our market position. Economic developments suggest a steady upward trend and continued acceleration of financial intermediation. We will use this together with our growth policy aimed at enhancing revenues while keeping capital requirements at a low level.

From BA-CA’s perspective, 2007 will be marked especially by the assumption of the CEE holding company function for the CEE business segment. The significant expansion of the scope of consolidation will substantially increase business volume and earning power, more than offsetting the disposals in 2006. A pro-forma comparison for 2006 (old versus new perimeter) gives a very clear idea of the resulting boost to the bank’s size: at the level of subsidiaries, average risk-weighted assets of the new group of consolidated companies will be almost 80 % higher than in the old structure, the number of employees will triple, profits (operating profit, profit before tax, net profit) will exceed the previous levels by about 50 %. Above all, prospects for the future improve with the young and large economies newly added to the perimeter of BA-CA’s activities. Once the transfers of HVB’s banking subsidiaries in the Baltics and in Russia, and of the UniCredit banking subsidiaries in Croatia, the Czech Republic, Slovakia, Bulgaria, Romania and Turkey, have been completed, BA-CA will be responsible for the integration of well-established subsidiaries in EU member states and for business in the high-growth markets of Russia and Turkey.