PREFACE BY THE
CHAIRMAN OF THE MANAGING BOARD

The Year 2012Byron Haynes

The last several years have been marked by fundamental structural changes to the global banking industry. These changes have been in response to the quickly escalating credit and sovereign debt crisis throughout the financial world triggered by the collapse of large banks particularly in 2008. The significant decline in economic growth across the majority of Europe as well as low market and base interest rates over the last three years have also posed further challenges for the industry.

Apart from the European Central Bank (“ECB”) providing liquidity to banks to facilitate investments and lower interbank lending rates, the regulators decided to put a clearer focus on bank regulations, particularly with regard to stricter capital and liquidity requirements, which has resulted in the pending introduction of the Basel III regulations. Further future initiatives include the implementation of the single rule book targeting maximum harmonisation between the EU countries including topics such as the joint bank deposit guarantee schemes or bank resolution regimes.

The operating economic environment continued to deteriorate with little or no economic growth while interest rates fell to record low levels and costs of bank regulation increased. As in recent years, BAWAG P.S.K. proactively and successfully continued a disciplined capital and liquidity management, to ensure investment to and support for the sustainable growth of our core franchises in line with our business strategy.

Capital Optimisation

The first of these capital optimisation measures was successfully concluded in March 2012, when the Bank bought back the majority of hybrid preference shares from the holders (EUR 262 million nominal value; 65 per cent of issuance). The Financial Market Authority (“FMA”) approved the buyback of these hybrid instruments and requested the issuance of Basel III compliant replacement capital by the end of the year 2012. These actions improved the Bank’s core equity Tier I (“CET I”) ratio by approximately 50 basis points.

In addition, the Bank’s risk-weighted asset optimisation programme was continued in 2012, which further intensified the disciplined allocation of risk-weighted assets (RWA) in support of its customers in the Retail and Corporate franchises. Total RWAs were reduced by EUR 2.6 billion during 2012.

In the Austrian Corporate segment, the Bank has created even greater focus on its customers across Austria and continued the successful Business Solution Partner concept. The Austrian corporate banking business remains an integral part of the Bank’s business model and franchise. As in the past, however, the Bank’s responsibility is to ensure that the allocation of capital resources in support of its customers is in line with prudent business criteria. With this in mind, we will continue to invest our financial resources in the areas where we can establish and maintain long-term customer relationships that are stable and profitable. In order to better service our customers, the Bank merged its sales and product teams into one centralised organisation which is committed to delivering capital and financing solutions to its customers to address their full financing needs.

In September 2012, the Managing Board made the decision to substantially close the Bank’s proprietary trading activities as continued changes and incremental costs in the regulatory environment made the return of these activities less profitable despite the very consistent and strong performance of the trading desks in recent years. This freed-up capital is being reinvested in support of our customer franchises. The decision to close this business activity will also benefit our strategic lending and investing businesses, and it does not represent an exit from our overall trading activities, which remain critical for the Bank. Our remaining trading focus will be on balance sheet interest rate hedging and strategic rate activities, currency activities related to managing currency risk and especially the continued support of our corporate customers in their balance sheet, interest rate and currency management.

Capital Raise and Simplification of Holding Structure

On 28 December 2012, BAWAG P.S.K. announced an equity capital raise of EUR 200 million from current shareholders and investors. Cerberus Capital Management, L.P. and its affiliates (“Cerberus”) remain the controlling shareholders with 51.78 per cent. Cerberus underwrote the capital raise and provided the largest share of new cash equity to the Bank. GoldenTree Asset Management L.P. and its affiliates (“GoldenTree”, a U.S. based asset management company) also underwrote and participated in the capital raise and became a significant minority shareholder with 39.46 per cent. At the time of the capital raise, shareholders and investors in the BAWAG P.S.K. holding companies undertook to streamline and simplify the credit institution group’s capital structure which now fully complies with the forthcoming regulatory requirements under Basel III. Austrian investors, including Österreichische Post AG, Generali Holding Vienna AG and Wüstenrot Wohnungswirtschaft registrierte Genossenschaft mit beschränkter Haftung, continue to indirectly hold stakes in the Bank’s share capital at a reduced level.

This capital investment is a strong sign of the continued financial commitment of the shareholders and investors and demonstrates substantial confidence in BAWAG P.S.K.’s ability to further drive sustainable profitability in the future as it executes its business plans.

The capital injection of EUR 200 million to BAWAG P.S.K. was executed effective 31 December 2012 and therefore also served as the required replacement capital, thereby fulfilling the FMA’s requirements under the redemption of the hybrid instrument approval in March 2012.

This capital raise together with the capital optimisation measures further improved the Bank’s capital ratios. As at 31 December 2012 BAWAG P.S.K.’s CET 1 capital ratio based on RWAs according to Basel 2.5 is 11.0 per cent (2011: 7.8 per cent), the Tier I capital ratio (according to Basel 2.5) is 11.7 per cent (2011: 9.6 per cent) and the own funds ratio is 13.8 per cent (2011: 12.3 per cent). The Bank therefore already more than fulfils the Basel III requirements at all levels within the BAWAG P.S.K. credit institution group.

Subject to authorities’ approvals, BAWAG P.S.K. consequently plans to redeem participation capital from the Republic of Austria in a nominal amount of EUR 50 million by 30 June 2013. This would make BAWAG P.S.K. the first bank to partly pay back participation capital in Austria.

Core Businesses – Retail

The Bank successfully continued growing and investing in its retail franchise, including the optimisation and refurbishment of the branch network. Over 90 per cent of the planned joint branches with Österreichische Post AG have already been opened and launched. The branch initiative will be completed in the first half of 2013, resulting in the largest centrally steered multi-channel network of around 500 cutting-edge branches in Austria.

A strong focus of BAWAG P.S.K. remains the provision of transparent and understandable products and services for our retail customers, such as the popular KontoBox and the KreditBox and SparBox launched in 2012. In line with the innovative box concept, these products complement the Bank’s retail product line. In order to continue along the path towards becoming the leader in intuitive banking, BAWAG P.S.K. further invested in its e-banking services and mobile applications during 2012. easybank, the fully owned subsidiary of BAWAG P.S.K., had a record year with over EUR 2.2 billion of deposits.

Core Businesses – Corporates

The Austrian Corporate business faced a difficult and challenging economic environment in 2012. Customer demand for new loans was weak as investment programmes were postponed under the pending improvement in the economic environment while interest rates fell to exceptionally low levels. Funding costs, however, continued to rise throughout the year.

In light of these challenges the Austrian Corporate business was very successful in repositioning and refocusing on its customers, freeing up capital for future investment in support of these customers and aligning our coverage and product managers to further improve our services.

In 2012, the International Business lending portfolio expanded and was able to achieve record revenues while at the same time meeting stringent risk-adjusted return requirements.

During the year 2012, the Bank also continued to dispose of a number of non-core corporate businesses and assets including BAWAG Banka d.d. (Slovenian bank subsidiary) which was merged into BAWAG P.S.K. in December. Leasing businesses in CEE continue to be in run-off, such as the CEE leasing business in Poland which was sold in February 2013. The Bank has recently announced that it is in the process of selling its fleet management leasing business. Going forward the Bank will be focusing on its vehicle leasing business which originates attractive assets for the Bank with efficient operating resources.

Efficiency and Productivity Programme

Another part of the Bank’s strategy is proactive and prudent cost management as well as the creation of a flexible cost operating model to meet the ongoing needs and requirements of our customers. The efficiency and productivity programme, which started in 2010 and focuses on the reduction of operating and personnel costs, was accelerated during 2012 in response to the deteriorating economic environment and the fundamental structural changes in the banking industry over the past years.

The streamlining of the organisation and end-to-end process optimisation remains the focus for 2013. In order to develop a more flexible business model, the Bank carefully evaluated the option of near shoring and found a reliable partner during 2012.

New Managing Board Structure

Christoph Raninger announced in September to leave the Bank by the end of the year (his Managing Board responsibilities ended as of 31 October 2012),   and Sanjay Sharma announced in December to leave the Bank as of 31 March 2013 (his Managing Board responsibilities ended as of 31 December 2012). I would like to take this opportunity to thank Sanjay Sharma and Christoph Raninger for their support and contribution over the last years and wish them both all the best for the future.

On 21 December 2012, a new Managing Board structure was announced effective from 1 January 2013. The head of Strategy and Economics of BAWAG P.S.K., Corey Pinkston, was appointed as the new Managing Board member responsible for the Corporate & Financial Markets businesses (including International Business and Leasing). Wolfgang Klein took over the Chief Operating Officer (“COO”) duties on an interim basis and will be responsible for enhancing the end-to-end processes within his remit, focusing on service delivery front-end to back-office functions in support of the retail business.

Furthermore, Wolfgang Klein was appointed Deputy Chairman with effect from 1 January 2013 reflecting the continued strategic importance of retail banking to BAWAG P.S.K.

This new Managing Board structure is very much in line with the simplification of our organisation and business model with focus on our core businesses including the delivery of improved services through end-to-end process efficiency and productivity.

I am very pleased to welcome Corey Pinkston and Wolfgang Klein with his additional responsibilities as Deputy Chairman and interim COO to the Managing Board of BAWAG P.S.K.

Operating Performance of BAWAG P.S.K.

In light of these challenging times, BAWAG P.S.K. has delivered solid results for 2012.

Profit before tax (without restructuring expenses and excluding minorities) for the financial year 2012 of EUR 153.4 million is in line with the profit before tax for 2011 of EUR 156.0 million (without restructuring expenses and excluding minorities). This shows BAWAG P.S.K.’s strength in realising solid profit considering the very difficult economic environment.

  • Core revenues of EUR 792.1 million (comprising net interest income of EUR 597.4 million and net commission income of EUR 194.7 million) decreased by 7.2 per cent (EUR 61.7 million) compared to 2011. Net interest income decreased due to significantly lower interest rates and RWA optimisation measures. Despite the lower core revenues, the operating income for 2012 amounted to EUR 931.8 million and was EUR 8.1 million higher than in 2011. This can be attributed to significantly higher income from gains and losses on financial instruments.
  • The Bank’s tight cost management continues to show satisfactory results. Total operating expenses (without bank levy and restructuring expenses) of EUR 604.5 million were only EUR 11.6 million or 2.0 per cent higher than the costs of the previous year, despite the significant continued investment made in 2012 in our core growth businesses including the “branch initiative”.
  • The cost-income ratio (excluding restructuring expenses and bank levy) is in line with the year-end 2011 at 64.9 per cent.
  • Restructuring expenses for 2012 amounted to EUR 43.2 million (2011: EUR 20.3 million) which represents a necessary key step for BAWAG P.S.K. to realise sustainable profits over the next years. These restructuring expenses will allow the Bank to substantially complete its restructuring programme by the end of 2013.
  • Provisions and impairment losses amounted to EUR 150.1 million, which is 3.0 per cent lower than the amount for the previous year (EUR 154.8 million). The decrease in loan loss provisions, despite the difficult economic environment, shows the continued relatively conservative risk profile of the Bank’s loan portfolio. An impairment charge of EUR 26 million relating to our investment in MKB, a Hungarian bank, is included.
  • Profit after tax 2012 of EUR 153.2 million (before restructuring expenses of EUR 43.2 million) is EUR 5.7 million higher than the profit after tax for the full year 2011 of EUR 147.5 million (before restructuring expenses of EUR 20.3 million).
  • Total regulatory liquidity increased considerably to EUR 7.7 billion (31 December 2011: EUR 5.2 billion).

Outlook

We expect the economic environment to gradually improve over the coming years. The banking industry will remain very competitive, especially in Austria, and banks will continue to face an unfavourable market environment characterised by low interest margins, decreasing volumes and regulatory constraints.

Looking ahead to 2013, I am confident that BAWAG P.S.K. is on the right path for the future. The Bank’s capital and liquidity base is strong and stable, ready to serve as a basis for new business growth. Furthermore, BAWAG P.S.K. in early 2013 has already paid back the liquidity provided by the ECB through its long-term refinancing operations (“LTRO”) programme. In another important step, BAWAG P.S.K. plans to start the repayment of part of the participation capital provided by the Republic of Austria in the second quarter of the year.

The Bank’s focus in 2013 will remain on serving our customers and improving our processes and boosting efficiency and productivity in order to further improve services and to lower our cost base. In the current environment, one major challenge and opportunity for the Bank will be the successful optimisation of advanced end-to-end processes and the development of an even more flexible operating model.

The upcoming year will also be marked by the Bank’s next steps with regards to our legal case against the City of Linz. The Bank’s strong legal position remained unchanged over the last year. The Managing Board of BAWAG P.S.K. strongly believes that it is in the interests of all parties to find an acceptable solution to resolve this matter. If no acceptable solution can be found for BAWAG P.S.K., we will continue to actively pursue our claim through all legal proceedings.

The year 2012 has been challenging for the Bank and its employees. However, with all of the accomplishments of our employees, we enter 2013 with a very solid capital and liquidity position that will allow us to further develop our core franchises and to build further on our successful results. Therefore, I would like to take this opportunity to especially thank all of our employees for their dedication throughout the past year. The achievements outlined here would not have been possible without the constant support of BAWAG P.S.K.’s employees.

 

Byron Haynes

Byron Haynes
Chairman of the Managing Board and CEO
Vienna, March 2013

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