PREFACE BY THE
CHAIRMAN OF THE MANAGING BOARD

Strong Momentum in the Core Austrian Business despite Turbulent Market Conditions

In 2008, BAWAG P.S.K. continued to make good progress in executing the multi-year Transformation Programme to improve operational performance and drive profitable growth agreed with the Supervisory Board in 2007. The primary focus for the Bank remains unaltered: to modernise the core Austrian retail and commercial banking business in order to deliver outstanding service to our customers.

The financial results for 2008 were heavily influenced by two factors: the progress made in improving profitability in the core Austrian business; and the combined net adverse impact arising from the re-structuring of the balance sheet and the reduction in the fair value of the Bank’s financial assets as a consequence of the global financial crisis.

Underlying pro-forma pre-tax profits for 2008 grew by 82 per cent over the comparable result in 2007, market share gains were recorded in the core retail business, lending and income momentum accelerated in the commercial business, non-core assets were successfully sold and the balance sheet continued to be re-structured in line with the Bank’s reduced risk appetite. The consequence of these actions was a significant growth in the Bank’s liquidity and capital resources that allowed BAWAG P.S.K. to withstand the impact of the global economic crisis.

Aggressive actions were taken throughout the year to reduce risk. However, the bankruptcy of Lehman Brothers Inc. on 15 September 2008 caused market conditions to worsen dramatically in the fourth quarter of 2008 leading to significant mark-to-market valuation losses arising in the legacy structured credit portfolio. The Bank recorded a consolidated loss after tax of EUR 452 million in the period from September to December 2008, following the dramatic change in market conditions after the bankruptcy of Lehman Brothers. This resulted in a full year loss of EUR 548 million for 2008.

Underlying pre-tax operating profit up 82 per cent

Underlying pre-tax profit, excluding the impact of the global financial crisis, grew by 82 per cent. Total underlying income grew by 4 per cent, with particularly strong gains recorded in net interest income, up 13 per cent.

Performance was particularly strong in the core retail franchise:

• Customer numbers increased by 10 per cent;
  
• Retail savings balances across the Group increased by EUR 1.1 billion, or 8 per cent;
• Premium income from new insurance contracts rose by EUR 320 million, or 19 per cent;
• Gains were recorded in market share, client satisfaction and willingness to recommend;  
• easybank sales, balances and income were all at record levels.

Progress was also evident in the commercial business: lending increased by 11 per cent, notwithstanding higher margins and a difficult environment. This customer segment offers significant potential for future profit growth.

The Bank took a very defensive stance to deploying liquidity in the second half of 2008. This strategy, whilst prudent given the economic environment, was a drag on earnings in the period as investments were made of very short-term duration in a time when market interest rates were falling rapidly.

Underlying expenses fell by 3 per cent, after accounting for higher investment in the on-going business. Significant changes were made to the business model, with implementation of a clear separation between front-office sales and service activities, back-office operations and risk management. These changes lay the foundation for future operational, productivity and service improvements. Underlying risk provisions were flat.

Sale of non-core business activities largely complete

A central part of the Bank’s new strategy announced in 2007 was the sale of all non-core businesses. Implementation of the strategy was largely completed in 2008 with the sale of the Bank’s subsidiaries in Slovakia and the Czech Republic, as well as the sale of real estate assets. The decision to dispose of the Bank subsidiaries operating in Central and Eastern Europe reflected the desire to concentrate scarce resources on the core Austrian market, as well as a focus on building liquidity and capital. The sale process proved to be both well timed and highly successful. As a consequence, the Bank has reduced its exposure to Central and Eastern Europe to less than 5 per cent of total assets.

Strong liquidity position

The turmoil in the global financial markets emphasised the crucial importance of liquidity management. During 2008, BAWAG P.S.K. took further steps to maximise its available liquidity. Total cash and unutilised collateral resources at 31 December 2008 amounted to EUR 6.2 billion. This strong liquidity position represents a source of competitive advantage for the Bank, offering the opportunity to acquire high-margin banking assets that become available in the market, whilst supporting the Bank’s strategy of supporting Austrian retail and commercial customers.

Continued mark-to-market fair value adjustments and write-downs on financial assets and liabilities, particularly in the structured credit portfolio

In the period from 2003 to 2005, BAWAG P.S.K. built a sizeable investment in products collectively known as “structured credit”. BAWAG P.S.K. accounts for 62  per cent¹ of these investments under the accounting standard “fair value through profit or loss”. This standard means that all valuation changes, irrespective of the quality of the underlying assets, are charged through the profit and loss account. No accounting re-classifications according to the revised IAS 39 took place during 2008. Significant actions were taken during the year to mitigate risk. Hedging strategies, both of the overall portfolio and individual securities, were implemented, assets were re-structured and securities were sold. The total cost of these risk management actions charged through the profit and loss account during the year amounted to EUR 145 million. 

1) This excludes investments attributable to minority shares.

The global economic crisis has impacted the value of financial assets and liabilities very significantly, as credit spreads have widened and liquidity premia increased. As a consequence, the Bank has charged significant mark-to-market fair value losses through the profit and loss account. The net loss from financial assets and liabilities, including mark-to-market fair value adjustments in 2008, was EUR 596 million.

Actual impairment charges for structured credit financial assets recognised at amortised cost during the period amounted to EUR 82 million.

The Bank will continue to be subject to the impact of valuation changes in 2009.

Consolidated loss after tax of EUR 548 million arising from net impact of the financial crisis and a significant re-structuring of the balance sheet

Overall, BAWAG P.S.K. recorded a consolidated loss of EUR 548 million for 2008. This result arose from the adverse impact of the global financial crisis on the valuation of the Bank’s structured credit portfolio as well as the net impact of the re-structuring of the balance sheet undertaken in 2008.

The key drivers for the 2008 results were:

Net interest income increased by 8 per cent, which shows the success of the strategy of focusing on BAWAG P.S.K.’s core areas of business. Net fee and commission income remained stable, but especially commission income from lending rose considerably.

The losses on financial assets and liabilities for the financial year amounted to EUR 596 million. This resulted from mark-to-market fair value adjustments and losses relating to the structured credit portfolio as well as from the valuation of other securities and derivatives. These valuation adjustments were offset by the net gain from the sale of business activities outside of the Bank’s core business (especially foreign subsidiaries) and changes in the fair value of the Bank’s issued securities because of wider spreads and the value of the associated derivatives.

The increase of administrative expenses was principally due to investment in staff to support growth of our business, staff restructuring costs and increased marketing expenses to improve our domestic customer business.

The Bank’s consolidated assets totalled EUR 41,578 million on 31 December 2008, EUR 3,269 million or 7.3 per cent less than at the end of 2007. This decline can primarily be attributed to the sale of the subsidiaries Istrobanka and BAWAG Bank CZ, which reduced the Bank’s assets by EUR 2.5 billion.

The development of our customer business is reflected in the line item “Loans to and receivables from customers”. We are very pleased that this position grew by EUR 674 million or 3.4 per cent to EUR 20,697 million in the reporting period. While these receivables increased overall, the development of business in the individual customer segments varied. Receivables from public-sector borrowers, primarily the Republic of Austria, fell by over EUR 500 million (-60.4 per cent) in 2008, contrasting a nearly EUR 1 billion (+10.8 per cent) increase in loans to corporates. The majority of these new loans were granted to Austrian customers, thereby improving the flow of credit in the domestic economy. Retail lending also grew significantly by more than EUR 300 million (+4.9 per cent).

The development of customers’ deposits was also very favourable. Payables to customers including saving deposits measured at fair value grew by EUR 824 million or 3.7 per cent to EUR 22,931 million by year-end.

Agreement-in-principle reached with shareholders and Republic of Austria to inject capital

Active management of the balance sheet together with the capital raised from the sale of non-core businesses has supported the Bank in adopting a prudent approach to the valuation and provisioning for future impairment of all assets adversely impacted by the global financial crisis. The Group’s Tier I capital ratio at 31 December 2008 was 6.9 per cent.

In line with the objectives set out in the Republic of Austria’s Financial Market Stability Act, BAWAG P.S.K. has chosen to strengthen its capital to ensure it can support its customers, and compete effectively, in the current economic climate. As a consequence, the Bank has reached an agreement in principle with its existing shareholders and the Republic of Austria to increase the capital of the Bank. The breakdown of the capital contribution is:

Shareholder consortium   

EUR 205 million, split between a EUR 150 million equity contribution and EUR 55 million Tier I qualifying participation capital

Republic of Austria   

EUR 550 million Tier I qualifying participation capital

The terms of the participation capital follow those agreed between the Republic of Austria and the European Commission, namely a non-cumulative coupon of 9.3 per cent post-tax. 

Furthermore, agreement has been reached with the Republic of Austria such that the Republic will issue an asset guarantee for EUR 400 million in support of certain assets held on the Bank’s balance sheet. The guarantee has a duration of five years. In addition, the Bank will issue Tier II qualifying bonds at a total of EUR 50 million.

This agreement in principle, which is subject to contract and approval by the EU, further supports the Bank’s chosen strategy of focusing on the core Austrian banking market.

Strategy maintained – focus on Austrian retail and commercial banking

The global financial crisis has not changed the Bank’s strategy. BAWAG P.S.K. remains committed to building a powerful banking business centred in Austria. The centre of our strategy remains a deep commitment to our customers and our employees. We will continue to modernise the Bank and ensure we remain an attractive place to bank and work. The combination of a relentless focus on operational improvements, new products, improved marketing and investment in our people has led to increases in volumes and market share and improvements in image and customer satisfaction. This allied with the financial benefits of strong liquidity and strong capital resources means the Bank is well placed to execute its strategy and deliver long-term value for our customers and shareholders.

Changes in the Managing Board

On 31 December 2008, Jochen Bottermann retired from the Bank. He has served the Bank with distinction and made a significant contribution to the re-building of BAWAG P.S.K. On behalf of the Bank, I would like to wish him well in his retirement. I am however also pleased that he has agreed to remain associated with the Bank, acting as an advisor to the Managing Board, as well as chairing a number of the Supervisory Boards of the Bank’s major participations.

In 2008, Alois Steinbichler decided to relinquish his position on the Managing Board following the disposal of the Bank’s CEE subsidiaries. I would like to thank him for his contribution, and wish him well in his new role.

I am delighted to welcome Regina Prehofer (Chief Executive, Austrian Banking) and Byron Haynes (Chief Financial Officer) to the Managing Board. They both bring a wealth of experience and skills to the team and will help the Bank accelerate implementation of our strategy.

Outlook

The year 2009 will be challenging for BAWAG P.S.K. as the global economic slowdown continues to impact directly the real Austrian economy as well as the global financial sector. The structured credit portfolio has been valued conservatively as of 31 December 2008; nevertheless, against the background of the current market development, further fair value changes could still result in negative impacts for the Bank.

The Bank is using the Basel II standardised approach to determine its risk weighted assets, which are taken to calculate capital ratios and own funds. In line with the economic development, rating agencies have begun to adjust downwards individual ratings of banks, corporates, and structured credits to reflect higher risks on the balance sheet and risk to future earnings. The Bank is expecting and has already experienced rating downgrades of financial assets since the beginning of this year.

The proposed capital injection by the shareholders and the Republic of Austria provides the foundation for the further development of the Bank in the years to come. Because of the Bank’s financial strength, the development of its core business and the strong liquidity position, BAWAG P.S.K. is prepared to weather the worsening market conditions.

Our focus and priorities for 2009 include:

• Pro-active risk management in response to the challenging market environment,
• Continue to improve productivity and stringent cost optimisation with focus on non-personnel costs,
  
• Continue to invest and develop our core Austrian retail and commercial customer franchises to build further sustainable profitability over the medium term, and
• Redeploy our liquidity to support households, small and medium enterprises and commercial customers and companies.

On behalf of the Managing Board, I would like to conclude by thanking all our employees for their hard work, commitment to the Bank and skills in serving our customers. As can be seen from the underlying performance and the progress made in executing the Transformation Programme, they have performed very well in 2008.

David Roberts, CEO
Chairman of the Managing Board
Vienna, April 2009

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