EESTI ÜHISPANK

ANNOUNCEMENT

15.03.99

 

 

COMMENTS TO THE FINANCIAL STATEMENTS OF EESTI ÜHISPANK GROUP

 

Eesti Ühispank group ended 1998 with  a loss of 383.4 million EEK  (in

1997, the  group made  a profit  of 211  million EEK).  The result was

affected by the financial crisis of the emerging markets of  Southeast

Asia in the  second half of  1997 and by  the collapse of  the Russian

economic and financial  system in August  1998. In addition  to a fall

in  liquidity,  this  triggered  a  drop  in share prices in the stock

markets both  in Estonia  and the  countries of  Eastern Europe.  As a

result, the group's dealing  and investment securities portfolio  made

a loss  of approximately  320 million  EEK, due  to a  loss of  sales,

reavaluation of securities and  write offs

 

The  stock  market  crash  in  1997  was  coupled  with  an outflow of

short-term portfolio investments from  Estonia. As a result,  interest

rates  began  to  rise  significantly  at  the end of 1997. Additional

pressure on the  money market came  from the requirements  of the Bank

of  Estonia  to  increase   mandatory  reserve  and  extra   liquidity

requirement  in  Central  Bank.  The  financial  situation of Estonian

exporters,  mainly  food  producers,  deteriorated  when  the   export

markets of Russia and  other CIS countries fell  apart as a result  of

the  financial  collapse  in  Russia.  Furthermore,  domestic interest

rates  almost  doubled.  This  affected  public  income and employment

levels, deteriorating the group's  deposits and the quality  of loans,

and increasing loan provisions up sharply.

 

GROUP                                                1998       1997

 

Average assets (millions EEK)                    13,419.8    7,101.6

Average shareholders' equity (millions EEK)       1,291.4      512.3

 

Return on equity (ROE)                              -29.7%      41.2%

Return on assets (ROA)                               -2.9%       3.0%

 

Asset yield                                           5.2%       9.1%

Profit margin                                       -55.2%      32.7%

 

Operating expenses / total income

(except loss from securities in 1998)                68.4%      52.9%

Leverage                                             10.4       13.9

 

The losses had a destructive  impact on the efficiency of  Ühispank in

1998. Key efficiency ratios were  as follows: EPS -8.7 EEK,  ROE 29.7%

and ROA 2.9%.  The respective ratios  in 1997 were:  EPS 7.4 EEK,  ROE

41.2% and ROA 3.0%.

 

Although the  ratio of  operating income  to total  income (except for

the  loss  from  securities  in  1998) increased notably in comparison

with  year-end  1997,  the  share  of  income from securities in total

income for 1997  was relatively high.  Therefore, this ratio  is fully

comparable to earlier periods.

 

RESULTS OF THE SUBSIDIARIES OF EESTI ÜHISPANK

 

(thousands of  EEK)

Saules Banka                            -39,226

Leasing companies                        -3,870

Asset management and fund management     -4,546

Brokerage                                -3,749

Property management                      -2,139

Other                                       292

 

The  abovenamed  reasons   also  affected  notably   the  results   of

subsidiaries. Saules Bank that had  a large exposure in Russia  and in

other  CIS  countries  was  among  those who suffered especially badly

from  the  financial  crisis  in  Russia.  As  a result of the crisis,

Saules Banka  provisioned its  portfolio of  Russian government  bonds

(GKOs) by 90%  in the amount  of 8.1 million  EEK. The bank  also lost

13.8 million EEK in derivatives  to hedge risks of the  CIS currencies

when its  counterparts in  Russia became  insolvent. As  the volume of

ruble  transactions  plummeted,  the  fee  income of Saules Banka also

fell notably.

 

The loss of  the leasing business  of Ühisliising, TP  Leasing and the

leasing firms set up  in St.  Petersburg,  Vilnius and Riga came  from

the provisions of capital and operating lease contracts in the  amount

of 102.5 million  EEK. In Russia,  the leasing business  suffered from

the fourfold loss of value of  the Russian ruble, resulting in a  loss

of 12 million EEK from changes of exchange rates.

 

The group's  brokerage firms  in Moscow,  Riga and  Vilnius ended  the

year with a  negative result, suffering  from a fall  in stock trading

and  in  earned  commissions  and  fees.  As  recent  startups,  their

operating expenses were higher than income levels.

 

A drop in share prices had a similar effect on subsidiaries  providing

asset management  and fund  management services  (Ühispanga Fondijuht,

TP  Asset  Management,  TP  Private  Finance).  As  a  result,  client

portfolios under  management and  investment funds  contracted, taking

along earned fees. An additional burden was placed on the funds  whose

clients defaulted.

 

The operating results of subsidiaries specialising in real estate  and

equipment  rental  services  such  as  PT  Investments,  Bangalo,   AS

Tornimägi,  PF  Koda  was  near  a  breakeven  point.  These companies

administer real  estate and  let equipment  owned by  the group. Since

the office space is mainly subrented to group members, these firms  do

not  focus  only  on  profit-making.  The  loss  was mainly due to the

transfer of  the 50%  stake owned  by Hüvitusfond  in AS  Tornimägi, a

subsidiary of PF Koda.

 

NET INTEREST INCOME AND LOAN PROVISIONS

 

Net  interest  income  earned  by  the  group  in 1998 amounted to 650

million EEK (356 million in 1997).  Interest income was 1,377  million

EEK and interest expenses were 728 million EEK.

 

GROUP (mio. EEK)                           1998           1997

 

Net interest income                       649.7           355.7

Other operating income                     44.3           290.1

Average interest-earning assets        10,150.8         5,286.4

Average interest-bearing liabilities   11,416.8         6,207.9

 

Net interest margin                        4.3%            5.0%

Credit-loss adjusted interest margin       2.5%            4.0%

Net non-interest margin                   -4.3%           -0.7%

Return on interest-earning assets         12.4%           12.1%

Cost of interest-bearing liabilities      -6.0%           -4.6%

Spread                                     6.5%            7.5%

 

Interest income  doubled during  the year,  mainly because  of the 58%

growth  in  interest-earning  assets  as  a  result of the merger with

Tallinna  Pank  group  and  partly  because  of a relative rise in the

yields of interest-earning assets.  80% of interest income  was earned

on  loans,  including  operating  and  capital  lease  and  factoring.

Although interest rates remained  relatively high all throughout  1998

and  average  lending  rates  varied  from  15%  to 18%, it had little

effect  on  the  weighted  average  interest  rate  of  the group loan

portfolio, 13.2% (13.1% at the  end of 1997). This is  attributable to

the low share of new loans in the total loan portfolio.

 

Interest-bearing liabilities increased 47% for the year. As there  was

no real growth  in group deposits  in spite of  the 49% increase  as a

result of the merger with Tallinna  Pank, they did not reach the  same

level with interest-earning assets.  The growth of the  remaining loan

portfolio and other  interest-earning assets was  offset by a  rise in

own funds.  It should  be noted  that there  was no  growth in  demand

deposits and the pro forma  fall in group demand deposits  amounted to

21%. A growth in time deposits brought about changes in the  structure

of  deposits.  This  in  turn  notably  increased  the price of  funds

raised by Ühispank. Interest rates  of time deposits were affected  by

the speculations against the kroon in  the second half of 1998 and  by

a  lack  of  resources  in  the  Estonian  money  market. As a result,

interest rates  payable by  the group  increased significantly  faster

than   earned   interest   rates.   In   addition,   the   price    of

interest-bearing liabilities went up sharply, amounting to 6% in  1998

(4.6%  in   1997).    These  factors   contributed  notably   to   the

consolidated net interest income  that remained 100 million  EEK lower

than  expected.  As  a  measure  of  the  group's capacity to earn net

interest income on its assets, net interest margin dropped from 5%  to

4.3%. The ratio of earned  interest rates to paid interest  rates (i.e

spread) fell similarly from 7.5%  to 6.5%. Income earned from  futures

exceeded notably the 1997 level  as a result of the  swap transactions

in  the  amount  of  65  million  USD  (872  million  EEK) for hedging

interest  and  exchange  rate  risks  of  the dollar-denominated bonds

issued by Ühispank.

 

The quality of the group loan porftolio deteriorated as result of  the

impact of the Russian crisis on  the Estonian economy and the fall  in

exports to the CIS countries  that triggered a rise in  the provisions

for  credit  losses.  In  comparison  with  1997  when the cost of the

group's  provisions   were  95.3   million  EEK   (including   general

provisions of 23.5 million  EEK), the respective figure  increased 3.6

times  in  1998  to  345  million  EEK (including 209.1 million EEK in

general  provisions).  The  probability   to  recover  these   general

provisions  remains  high  provided  that  there  is  a revival in the

region's economies.

 

Net interest  margin adjusted  to credit   losses (special  provisions

and  credit  instruments  directly  written  off less recoveries) fell

from  4%  in  1997  to  2.5%  at  the  end of 1998. This is due to the

changes in  the structure  of deposits,  a rise  in deposit  rates and

significant  loan  provisions).  This  gives  an indication of how the

group has to restrict its  operating expenses and is looking  for ways

to increase fee income.

 

OTHER INCOME

 

Net income earned by the  group in 1998 from commission  fees totalled

155 million EEK (up 48% in comparison with 1997). Fee income  amounted

to  271  million  EEK  whereas  fees  paid  totalled  117 million EEK.

Approximately one-third of  fees, 90.8 million  EEK, were earned  from

processing various credit contracts (loans, guarantees and letters  of

credit).  Income  fromsecurities  market  services  grew modestly as a

result of the fall in the trading volumes. The contribution of  Saules

Banka of 8.7 million EEK  helped to double income earned  from payment

cards to 47.4 million EEK.

 

Two-thirds of the  loss of 45  million EEK earned  from the securities

investment portfolio came from the revaluation of the investment  made

in the  stock of  Leks Insurance.  Although Leks  was an  associate of

Tallinna Pank, in  the balance sheet  of Tallinna Bank  the investment

was divided into the investment portfolio and dealing portfolio. As  a

result,  the  shares  of  Leks  remained  initially  in the investment

portfolio also after the merger with Tallinna Pank.

 

Dealing in securities produced a  loss of  170 million  EEK (including

a provision of  5 million EEK  against a fall  in securities' prices).

The underlying  reasons for  the loss  are described  above, including

falling stock prices in the Baltic States and Russia as well as  wrong

assessment of the risk of securities' markets. The income earned  from

the  dealing  of  privatization  vouchers  (EVPs) to clients helped to

reduce the loss by 22.4 million EEK.

 

Income from  foreign exchange  dealing earned  a profit  of 41 million

EEK.  The  result  was  affected  notably  by  the  devaluation of the

Russian  ruble   and  the   resulting  exchange   rate  loss   of  two

subsidiaries, Saules Banka and Russian Union Leasing. The  derivatives

contracts of  Saules Banka  with selected  banks of  the CIS countries

produced additional  losses when  the CIS  banks defaulted  because of

insolvency.  The termination  of derivatives contracts with  the banks

of CIS countries by  the end of 1998  means that such losses  will not

occur in the future.

 

Other income in the amount  of 58.4 million EEK include  mainly rental

income on assets and property  as well as penalties, overdue  payments

and benefits.

 

OPERATING EXPENSES

 

Consolidated  operating  expenses  were  622  million  EEK (342 EEK in

1997).  The  82%  rise  in  operating  expenses is attributable to the

merger  with  the  Tallinna  Pank  group  and the costs related to the

merger process such as  costs on information technology  and personnel

cutbacks).  Pro  forma  operating  expenses  increased  only  by   7%.

Ühispank is determined to ensure  that the rise in operating  expenses

remains below  the increase  in the  consumer price  index also in the

future.

 

Salaries increased 57% as the  number of group employees went  up from

1,228 at the beginning of  1998 to 1,942 employees at  year-end. These

changes  were  mainly  due  to  the  merger  with  Tallinna  Pank.   A

comparison of the workforce of both banking groups at the end of  1998

shows  that  the  number  of  employees  has  actually  fallen  by 125

persons.

 

The depreciation  cost of  tangible assets  increased as  a result  of

higher depreciation rates applied in October 1998 and higher IT  costs

including a procurement of new  servers in the acquisition cost  of 38

million EEK.

 

The availability  of foreign  low cost  funds in  1996 and 1997 helped

Estonian  commercial  banks  to  double  the  volume  of  their   loan

portfolios.  To  win  new  clients,  banks significantly lowered their

credit worthiness requirements.  In connection with  the wave of  bank

mergers in 1998, banks took a  fresh look at their balance sheets.  As

part of the process,  the net asset value  of the Tallinna Pank  group

became negative. In the course  of the merger process the  goodwill of

Tallinna Pank had increased to 576 million EEK in acquisition cost  to

be  depreciated  in  the  course  of  ten  years.  The amortisation of

goodwill  which  in  1998  amounted  to  24  million  EEK  has  put an

additional strain on the operating expenses of Ühispank.

 

Other operating  expenses include  such extraordinary  expenses as the

17.4  million  EEK  contribution  made  by  Ühispank  to  the  Deposit

Guarantee Fund.

 

ASSETS

 

As of 31 December 1998,  assets of Eesti Ühispank group  totalled 16.5

billion EEK  (up from  10.3 billion  EEK on  a year  earlier and  15.1

billion EEK  in pro  forma value  including the  Tallinna Pank group).

Most of the 60% rise in assets was contributed by the merger with  the

Tallinna Pank group (a pro forma rise of 9%). As a result, the  market

share of  Ühispank in  Estonia increased  from 24.5%  to 33.2%. In the

Baltic  States,  the  group  of  Ühispank and Saules Banka represented

11.6%  of  the  market  at  the  end of 1998. The consolidated balance

sheet of Estonian commercial banks increased 5.8% in 1998.

 

As a result of losses on the securities market, Ühispank cut back  its

investments  to  the  equity  dealing   portfolio  by  12  times   and

terminated  repurchase  transactions.  This  has significantly lowered

the risks involved in securities investments.

 

The group's net  loan portfolio increased  57% by 3.7  billion EEK for

the year (a rise of 16.2% in pro forma value). By the end of 1998  the

net  loan  portfolio  was  10.3  billion  EEK, accounting for 62.4% of

assets. Due to  a significant rise  in the volume  of loan provisions,

the share of bad  or doubtful loans amounted  to 4% of the  total loan

portfolio (2.1% at the end of 1997).

 

The sale of the holding in Seesam International Insurance Company  and

Seesam Life  Assurance Company  had an  impact on  the investments  to

associates companies.  The stake  in Leks  Insurance was  increased to

42%. Investments to subsidiaries  increased as a result  of purchasing

50%  of  PF  Koda's  subsidiary  AS  Tornimäe share capital from state

owned  Compensation  Fund  and  the  following  increase  of the share

capital  of  Tornimäe  by   89.5  million  EEK.  Another   development

concerned  the  foundation  of  AS  Ühispanga  Elukindlustus,  a  life

insurance company.

 

Tangible assets  increased by  one-third in  pro forma  value. The new

building of Eesti Ühispank accounted for 271 million EEK in the  total

increase of  tangible assets  of 350  million EEK.  Information on the

goodwill of 552 million EEK is provided under "Operating expenses".

 

LIABILITIES

 

The volume of deposits of Eesti Ühispank group was 8.2 billion EEK  at

the end of 1998. The annual  growth in deposits is 2.7 billion  EEK or

49%. A comparison of  the deposits of Tallinna  Pank group at the  end

of 1997 reveals  that deposits have  not grown in  real terms. Because

of the worsening of the economy  in 1998, the money supply shrunk  and

there was no real increase  in deposits in Estonian banking.  Deposits

held by central  and local governments  fell approximately 30%  by one

billion  kroons.  This  was  a  result  of the underperformance in tax

collection, especially in the second half of the year, resulting in  a

year-end  deficit  of  the  national  budget.  As  the market share of

Ühispank  in  this  deposit  category  is  65%, its impact on the bank

business  was  significant.   The  deposits  of   central  and   local

governments in Ühispank fell 13%  by 233 million EEK (420  million EEK

in pro forma).

 

Deposits of  private individuals  increased 2.1  times by  1.1 billion

EEK, mainly as a result of the merger with Tallinna Pank.  Liabilities

to financial institutions amounted to 926 million EEK including  loans

from various development  banks (EBRD, EIB).  A 40 million  DEM credit

line opened for housing loans by EBRD should also be noted

 

There  were  significant  differences  in  the  structure  of deposits

towards  more  expensive  and  long-term  resource.  The share of time

deposits in total deposits was 48%  at the end of 1998, in  comparison

with 39% at the end of 1997. Liabilities to other credit  institutions

increased four times  by 1.7 billion  EEK (a pro  forma rise of  25%),

mainly as short-term money market loans.

 

OWN FUNDS AND CAPITAL ADEQUACY

 

Shareholders' equity  of Eesti  Ühispank increased  in connection with

the issue of GDRs in March 1998 and to a share issue to  Skandinaviska

Enskilda Banken (SEB) in November and December 1998. In the course  of

a share replacement arranged as part of the merger with Tallinna  Pank

9.7 million  new shares  were issued.  As a  result of  issues and the

loss, the  shareholders' equity  of the  group increased  2.8 times by

1.2  billion  EEK  for  the  year.  Additional  own funds grew by 42.5

million  EEK  in  the  course  of  a  subordinated  issue  of bonds to

Hüvitusfond (Compensation Fund).

 

Capital adequacy  is an  internationally accepted  ratio for measuring

the solvency and an indication of  the adequacy of own funds to  cover

credit, transfer  and market  risks (involving  currency, interest and

share positions). The regulations set  by the Central Bank of  Estonia

require the capital adequacy  figure to be at  least 10%. As a  result

of  various  issues,  the  growth  of  own  funds of Eesti Ühispank is

outperforming  the  rise  in  liabilities.  This  shows  that,  as  of

December 31, 1997, the capital adequacy ratio of the group was  12.45%

(11.03% at the end of 1997).

 

DEFINITIONS OF KEY INDICATORS

 

Return on equity (ROE) = net profit (loss) divided

                         by average equity

 

Return on assets (ROA) = net profit (loss) divided

                         by average total assets

 

Asset yield = total income divided by average total assets

 

Profit margin = net profit (loss) divided by total income

 

Financial leverage = average assets divided by average equity

 

Net interest margin = net interest income (except futures)

                      divided by average assets

 

Credit-loss adjusted

net interest margin = net interest income (except futures)

                      less credit losses divided by average assets

 

Net non-interest margin = total income less operating expenses

                           divided by average assets

 

Return of interest-earning assets = interest income (except futures)

                                    divided by average

                                    interest-earning assets

 

Cost of interest-bearing liabilities = interest expenses

                                       (except futures) divided by

                                       average interest- bearing

                                       liabilities.

 

 

Additional information:

Ülo Suurkask

Vice-President

Eesti Ühispank

Tel + 3726110350