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1 Pohjola Bank plc ANNUAL REVIEW 2008


3 Contents Group 2 Pohjola in Brief 4 Letter to Shareholders 6 Year Operating Environment 16 Strategy 19 Humar Resources 24 Corporate Responsibility 25 Capital Adequacy and Risk Exposure Business Lines Corporate Governance and Management 45 Corporate Governance Statement 52 Board of Directors 54 Executive Committee and Organisation Investor 56 Shares Information and Shareholders 56 Shares and Shareholders 59 Debt Investors 60 Information for Shareholders 61 Contact Information 27 Business Lines in Brief 30 Banking 35 Asset Management 38 Non-life Insurance 42 Group Functions Financial reports This Annual Review 2008 and the Report by the Board of Directors and the Financial Statements 2008 constitute Pohjola Bank plc s Annual Report 2008 available in Finnish, Swedish and English. The Report by the Board of Directors and the Financial Statements 2008 can be found at > Media. Annual Reviews can be ordered at the same address. OP-Pohjola Group s Annual Review 2008 and Corporate Responsibility Report can be found at > OP- Pohjola Group > Media. Given that all figures in the Annual Report have been rounded off, the sum total of individual figures may deviate from the presented sums. Interim reports 2009 Pohjola Bank plc will publish the following three interim reports in 2009: Q1 on 7 May, Q1 2 on 6 August and Q1 3 on 5 November. Available in Finnish, Swedish and English, interim reports can be found at and their printed copies can be ordered by telephone (tel (0) ) or by POHJOLA ANNUAL REVIEW

4 Pohjola in Brief Pohjola Group is a Finnish financial services company providing banking, asset management and non-life insurance services. Serving businesses, institutions and private individuals, the Group provides an extensive package of services which are convenient for customers while supporting corporate customers business. With over 30,000 shareholders, Pohjola Bank plc Series A shares have been quoted on the Helsinki Stock Exchange (NASDAQ OMX Helsinki) since Pohjola aims to strengthen its market position further in all of its business divisions. The company places a strong emphasis on profitability throughout its operations and is also committed to effective capital management and a shareholder-friendly dividend policy. Pohjola Group operates through the following three business segments: Within Banking, Pohjola has the goal of becoming Finland s leading corporate and investment bank. The Group provides its domestic customers with a diverse range of financial, investment and payment transfer solutions, also at international level, and foreign customers with banking services for business needs in Finland and neighbouring regions. Asset Management aims at the leading market position in Finland. Pohjola is already Finland s leading provider of asset management services for institutions. Within Non-life Insurance, Pohjola is Finland s leading non-life insurer in terms of premiums written and has the aim of reinforcing its market share among private customers in particular. Earnings before tax, million Balance sheet total, billion Earnings per share, POHJOLA ANNUAL REVIEW 2008

5 Core Values People-first approach We are approachable and accessible. Our service is based on friendliness, initiative and promptness. We appreciate our customers, partners and co-workers. Responsibility We deliver on our promise and perform consistently. We aim at long-term customer relationships based on mutual trust. We foster our competencies and good organisational climate. We ensure that our business is in the interests of our shareholders and meets high ethical standards. Prospering Together We prosper together with our customers. We establish networks in Finland and at international level on an extensive basis. Pohjola Group comprises Pohjola Bank plc, the parent company, and its subsidiaries. The Group has a staff of almost 3,000 and its major operating subsidiaries are as follows: Pohjola Insurance Ltd A-Insurance Ltd Eurooppalainen Insurance Company Ltd Seesam non-life insurance companies in the Baltic countries Pohjola is part of OP-Pohjola Group, the leading financial services group in Finland. OP-Pohjola Group is made up of independent member cooperative banks and the Group s central institution, OP-Pohjola Group Central Cooperative, with its subsidiaries and closely related companies. With over four million customers, the Group provides an extensive range of banking, investment and insurance services. Pohjola Asset Management Ltd Pohjola Property Management Ltd Pohjola Capital Partners Ltd Pohjola Private Equity Funds Ltd Pohjola Corporate Finance Ltd POHJOLA ANNUAL REVIEW


7 Letter to Shareholders Drastic change in the operating environment Problems that began to afflict global financial markets in 2007 turned into a crisis in the autumn of 2008, with the result that credit spreads widened sharply and trading in a number of debt instruments came to a complete standstill due to the lack of confidence. In October, confidence collapsed in the stock market and stock prices plummeted. The financial crisis was also reflected in our client companies operations: money-market and capital-market funding dried up and demand in export markets, in particular, came to an abrupt standstill during the last few months of the year. In these exceptional circumstances, Pohjola Group strengthened considerably its role as a partner and financier for Finnish companies. The rapid change in the market situation and competition provided us with a good opportunity to enhance our customer relationships, thanks to our expertise, and we are confident that we will benefit from our conscious commitment to our customers in the long term too. Good profitability of customer business As a result of the more difficult operating environment, Pohjola Group posted earnings that were markedly lower than the record earnings reported a year ago. Our businesses directly dependent on market conditions Non-life Insurance investment operations and Markets showed a poorer financial performance, whereas the balance on technical account and the overall financial performance shown by Corporate Banking and Asset Management remained at the previous year s good levels, i.e. our customer business made steady progress. In addition to Banking, we strengthened our market position in Non-life Insurance and Asset Management. Our excellent cooperation with OP-Pohjola Group member banks contributed to Non-life Insurance s favourable development. When it comes to asset management, we are a leading player in Finland. Building the future with a long-term approach The current market situation involves business opportunities but will also necessitate providing for higher credit risks. The corporate funding market will not necessarily perform normally this year either. Moreover, a significant number of Finnish companies syndicated loans will arrive at maturity in This situation provides a well-capitalised financial services provider with profitable financing opportunities without compromising risk management. Against this background, the simultaneous economic recession will probably be reflected in mounting impairments on loans and downgraded client credit ratings. Pohjola Group s capital adequacy was strong at the year end. In order for the Group to be able to fully capitalise on any new business opportunities, the Board of Directors has deemed it appropriate to take measures aimed at strengthening the share capital. Accordingly, we seek to do so during the spring of According to its strategy, Pohjola is committed to effective capital management so as to be in the interest of its shareholders. This will be our uncompromising guiding principle when we seek capital from our shareholders. We have a strong position as a provider of financial services for Finnish customers. Indeed, we will continue to have the advantage of being the only large financial services provider with its strategic decisions made in Finland, providing us with a solid foundation to serve our customers effectively and on a long-term basis. We should like to take this opportunity to express our warmest thanks to our shareholders, customers and partners for their trust, and the Group personnel for their excellent performance in difficult conditions. Helsinki, 12 February 2009 Reijo Karhinen Chairman of the Board of Directors Mikael Silvennoinen President and CEO POHJOLA ANNUAL REVIEW

8 Year 2008 The Group s customer business made good progress during Banking showed strong growth in the loan and guarantee portfolio, net interest income and market share. Within Non-life Insurance, insurance premium revenue continued its vigorous growth, the balance on technical account was excellent and our market position as Finland s largest non-life insurer continued to strengthen further. Although the investment market turbulence led to a reduction in assets managed by Asset Management, we strengthened our market position. Despite the favourable development in our customer business, the Group s earnings were markedly lower than in Earnings before tax amounted to EUR 119 million (288). Earnings per share stood at EUR 0.44 (1.04), while equity per share was EUR 8.07 (9.19). Within Banking, the loan portfolio increased by 23%. Assets managed by Asset Management decreased to EUR 25.3 billion (31.5), due to money-market fund redemptions and the bearish equity market. Asset Management strengthened its market position. Within Non-life Insurance, insurance premium revenue rose by 8% (8) and the balance on technical account, excluding changes in reserving bases, was the best ever reported. The operating combined ratio was 91.5% (93.8). Non-life Insurance return on investments at fair value stood at 7.0% (4.8). In line with the valid dividend policy, the Board of Directors proposes that 51% of earnings be distributed as dividends, or a per-share dividend of EUR 0.23 be paid on Series A shares and EUR 0.20 on Series K shares. Consolidated earnings, million Net interest income Impairments of receivables Net interest income after impairments Net income from Non-life Insurance Net commissions and fees Net trading income Net investment income Other operating income Total net income Total expenses Earnings before tax POHJOLA ANNUAL REVIEW 2008

9 Highlights Jan. 1 March 11 March 27 March 1 April 25 April 6 May 17 June 22 Aug. Pohjola Group became the owner of K-Finance Ltd shares. On 21 December 2007, Pohjola announced that it would buy all of the shares of K-Finance Ltd (currently Pohjola Finance Ltd), a Kesko Corporation subsidiary, for around EUR 30 million. Pohjola Finance Ltd provides corporate customers with financing services in Finland, Estonia, Latvia and Lithuania. As a result of this acquisition, Pohjola expanded considerably its banking operations in the Baltic region. OKO Bank plc began to operate under the new name Pohjola Bank plc. At the same time, the name of many subsidiaries began with Pohjola, coinciding with the opening of Pohjola s new website. Pohjola Bank plc decided to launch an issue of EUR 170 million in Lower Tier 2 perpetual subordinated notes with a maturity of ten years, in order to strengthen its capital base. The Annual General Meeting approved alterations of the Articles of Association, relating to the Company s line of business, dividend distribution and the Board s composition. Timo Ritakallio, Deputy CEO of Pohjola Bank plc, announced that he would depart Pohjola on 1 August. Pohjola signed a partner agreement with ICICI Bank Limited of India, covering payment transfer and other banking services for companies in India. On 4 November, Pohjola signed an equivalent agreement with Bank of China. The Board of Directors decided to reorganise the Group into three business segments and the Group Functions. These three business segments comprise Banking, Asset Management and Non-life Insurance. Reima Rytsölä was appointed Executive Vice President, Banking, and member of the Group Executive Committee, and Mikko Koskimies, who already sat on the Committee, Executive Vice President, Asset Management. Tomi Yli-Kyyny continued as Executive Vice President, Non-life Insurance. In addition, a new area of responsibility specified for Ilkka Salonen, CFO, covered Finance, Actuarial Function, Corporate Planning, Central Banking and Group Treasury, and Investor Relations. CRO Jouko Pölönen was appointed member of the Group Executive Committee, with risk management within his remit. November 25th saw a technical change made in Pohjola Group s financial targets by segment. Pohjola Bank plc launched an issue of EUR 50 million in Tier 1 perpetual bond and Pohjola Insurance Ltd an issue of EUR 50 million in the so-called perpetual hybrid bond included in upper Tier 2. These bonds are aimed at enhancing Pohjola Group s capitalisation and supporting the business lines growth. The Helsinki District Court issued its verdict in the redemption dispute between Pohjola Bank plc s and Pohjola Group plc s minority shareholders, confirming the redemption price of one Pohjola Group plc share at EUR The dispute has been submitted to the Court of Appeal. 24 Sept. 25 Sept. 1 Oct. 20 Oct. 23 Oct. 11 Nov. Pohjola Insurance Ltd decided to adopt a modernised organisational structure as of 1 January 2009 that better meets the needs of its current business model. The company decided to change the operations, reporting and control involving its field organisation, Corporate Customer business division and Private Customer business division. As part of the change, Helena Walldén, Senior Executive Vice President of Corporate Customers and member of Pohjola Bank plc s Group Executive Committee, submitted a letter of resignation. Her service contract with the company will terminate in the spring of The Financial Supervision Authority granted permission to OP-Pohjola Group to use the Internal Ratings Based Approach (IRBA) in its capital adequacy measurement for credit risks as of 30 September This applies to exposures to Pohjola Bank plc s corporate and institutional customers, accounting for around two-thirds of Pohjola s minimum capital requirement. Pohjola Insurance Ltd and a number of OP-Pohjola Group member cooperative banks adopted a new operating model for banking and non-life insurance product sales to private customers. Accordingly, Pohjola Insurance's field staff for private customers joined the payroll of local cooperative banks. The Unico Banking Group, to which Pohjola belongs, announced that it would restore confidence in the European interbank funding market by agreeing on reciprocal unsecured interbank credit lines of up to three months. Global Finance, a financial magazine, chose Pohjola Bank plc as the best bank in Finland. Ilkka Salonen, Pohjola Bank plc s CFO and Deputy CEO, announced that he would depart Pohjola by 31 January 2009 and join another company. 25 Nov. Jouko Pölönen was appointed Pohjola s new CFO. 1 Dec. 23 Dec. The Banker, an esteemed international finance magazine, elected OP-Pohjola Group as Bank of the Year in Finland. This was already the fifth time the Group won the award, the previous years being 2007, 2006, 2004 and Pohjola Bank plc issued EUR 100 million in lower Tier 2 subordinated notes under its EMTN programme. Early 2009 events 23 Jan. 12 Feb. Petri Viertiö was appointed Pohjola s CRO and member of the Executive Committee, effective as of 2 March The Board of Directors decided on measures to be taken to strengthen the company s capital base in such way that the related measures could be implemented during the spring of Pohjola announced that it was preparing a rights issue of some EUR 300 million offered to its existing shareholders. POHJOLA ANNUAL REVIEW

10 Pohjola Bank plc s key figures and ratios Earnings before tax, million Profit for the financial year, million Return on equity at fair value, % Balance sheet total, billion Loan portfolio, billion Assets under management, billion Non-life Insurance premium revenue, million Capital adequacy ratio, %* Tier 1 ratio, %* Earnings/share (EPS), Series A share Series K share Equity/share, Dividend/share, Series A share ** Series K share ** Dividend/earnings (dividend payout ratio), % ** Effective dividend yield, % ** Price/earnings ratio (P/E) Market capitalisation (Series A and K shares), million 1,022 2,386 2,583 2,658 1,983 Share trading volume (Pohjola A), million % of all Series A shares Number of shares (Series A and K shares) year end, million Average personnel 1,246 1,668 3,030 3,006 2,986 * The figure for 2007 and 2008 in accordance with Basel II, only shareholding included with respect to insurance companies ** As proposed by the Board of Directors OP-Pohjola Group s key figures and ratios Earnings before tax, million , Bonuses granted to customers Return on equity at fair value, % Average personnel 9,136 9,839 12,148 12,378 12,615 Balance sheet total, billion Capital adequacy ratio, % Tier 1 ratio, % Capital adequacy ratio under the Act on Supervision of Financial and Insurance Conglomerates, % Market share, % Of total loans Of total deposits Of capital invested in mutual funds Of premiums written within non-life insurance* Of insurance savings through life and pension policies * Figure for 2008 is not yet available 8 POHJOLA ANNUAL REVIEW 2008

11 Year 2008 Pohjola Group s earnings before tax fell to EUR 119 million (288) and loss before tax at fair value came to EUR 133 million (earnings of EUR 234). Earnings per share were EUR 0.44 (1.04), while equity per share was EUR 8.07 (9.19). Return on equity at fair value stood at 5.6% (9.3). Net interest income rose by over 50% to EUR 174 million (115) while net commissions and fees remained almost at the previous year s level, standing at EUR 108 million (115). However, consolidated net income fell by 19% to EUR 589 million (728), due to negative mark-to-market valuations of liquidity reserves and Non-life Insurance investments. As a result of Lehman Brothers Holdings Inc. s bankruptcy, net trading income decreased by EUR 9 million and impairments of receivables increased by EUR 10 million. Other impairments of receivables totalled EUR 18 million. Negative mark-to-market valuations of liquidity reserves totalled EUR 74 million. Expenses rose by 7% to EUR 470 million (440), with EUR 7 million attributable to growth in depreciation on leases. Excluding this depreciation, expenses increased by 5%. Group expenses include EUR 6 million in expenses related to the ICT service system integration. As a result of testing Group goodwill for any impairment, an impairment charge of EUR 3 million was recognised related to the Seesam brand. There was no need for impairments of other goodwill. As a result of a drastic fall in equity prices and widening credit spreads, the fair value reserve before tax decreased by EUR 252 million. On 31 December, the capital adequacy ratio stood at 11.7% (11.2) and Tier 1 ratio at 9.4% (10.7). Despite the challenging market situation, the customer business of both Banking and Non-life Insurance made good progress, with the loan portfolio, net interest income and lending margins showing favourable development and non-life insurance premium revenue and the number of loyal customer householder rising according to targets. Pohjola strengthened its market position in all of its business lines: Banking, Nonlife Insurance and Asset Management. The integration process related to OKO Bank s acquisition of Non-life Insurance operations in 2005 is proceeding according to plan. The results so far support earlier estimates of annual revenue synergies coming to EUR 17 million by the end of 2010 and cost synergies reaching 35 million by the end of Savings based on decisions on streamlining measures underway during will amount to an estimated EUR 33 million during the current year. From 2009, savings from the integration are expected to reach an annual level of EUR 36 million. The revenue synergies resulting from growth in the number of loyal customer households by the end of 2008 reached an annual level of EUR 12 million and the management is targeting EUR 17 million by the end of Integration costs related to the Pohjola acquisition totalled EUR 33 million between September 2005 and December In May, Pohjola Bank s parent institution, OP-Pohjola Group Central Cooperative, and TietoEnator signed an agreement to integrate and reorganise OP-Pohjola Group s ICT services. Integrating all of Pohjola Bank Group s ICT services within this joint venture will result in major efficiency gains of an annual estimated EUR 3 million from The related integration costs paid in advance by Pohjola in December came to EUR 6 million. The number of loyal customer households within Non-life Insurance rose by 34,400 in 2008, totalling almost 390,000 on 31 December The Group s strategic aim is to increase this number to 450,000 by the end of Since November 2007, customers have also been able to use OP bonuses earned through banking transactions to pay Pohjola insurance premiums. This represents a major benefit to the year-end number of 993,000 OP-Pohjola Group loyal customers who have concentrated their purchases of banking and insurance services. In 2008, bonuses used to pay insurance premiums totalled EUR 18 million. Pohjola Insurance Ltd and a number of OP-Pohjola Group member cooperative banks adopted a new operating model for banking and non-life insurance product sales to private customers. According to this plan, Pohjola Insurance s field staff for private customers (294 employees) joined the payroll of local cooperative banks on 1 October POHJOLA ANNUAL REVIEW

12 People-first Approach The People-first Approach means that we appreciate our customers, partners and co-workers. Our service is based on friendliness, initiative and promptness. We are also approachable and accessible. In 2008, Pohjola Insurance received around 350,000 loss reports, roughly 100,000 of which related to motor vehicles. We are easily accessible by telephone, via the internet and our extensive branch network.

13 Jenni Hälvä within Telephone Service takes some telephone calls on a normal working day. The number of incoming calls to Pohjola Insurance s Telephone Service totals around 5,000 per day. Around 95% of the reported damage or loss leads to the payment of compensation. Pohjola has entered into partnership with firms representing over 20 industries, such as healthcare services providers, car repair shops, building renovation firms and household appliance retailers, with the aim of ensuring the easy availability of services. Falck Oy is one of the partners. Pohjola s Motor Vehicle Cover is a flexible package consisting of motor liability insurance and a supplementary and voluntary Crisis Cover together with voluntary comprehensive motor vehicle insurance. Super Motor Insurance is the most extensive and flexible policy among motor vehicle insurance policies. In addition to motor liability policies, the main policies for private customers include household, accident, medical treatment expenses and travel policies. The opportunity to pay non-life insurance premiums using OP bonuses has boosted sales of Extrasure contracts home and family insurance policies. Pohjola introduced motor vehicle and motor liability insurance as early as at the beginning of the 1920s. Finland had only 1,131 passenger cars in 1922, well over 160,000 in 1962 and up to some 2.5 million in 2008.

14 Operating Environment The global financial market got into a serious crisis in Problems originating from the US housing market spread to other countries and other sectors, resulting in falling GDP figures in many countries. Finland is not immune to this contagious global recession and the economic outlook for 2009 is even bleaker. The global financial crisis came to a head in autumn 2008 when Lehman Brothers, an investment bank, filed for Chapter 11 protection, bringing down liquidity in financial markets, and the lack of confidence increased short-term market rates and intensified equity and currency market swings. To attempt to combat the crisis, national central banks took considerable measures to support the financial markets, such as increasing market liquidity to prevent a loan slump, and also reducing their benchmark interest rates to exceptionally low levels. Many countries also put in place considerable stimulus packages. Many financial institutions in various countries suffered massive losses and had to rely on state support, which led to a number of restructuring measures in the financial sector. In October 2008, the Finnish government alongside the other EU governments agreed to guarantee interbank lending, if necessary, and make fixed-term capital investments in banks. The support actions taken by central banks and governments alleviated the acute crisis, with the short-term market rates being cut and interbank trading picking up a little. The long-term effects, however, are difficult to predict. Finland drifting into recession in 2009 The global financial crisis has weakened economic outlooks everywhere. Both the US and major EU countries have veered into recession and emerging economies too are experiencing slowing growth, for weaker export prospects will be only partly offset by sustained domestic demand. Finland s economic outlook deteriorated rapidly in the latter half of 2008, bringing GDP growth to a standstill and resulting in a downturn of exports as a result of the global recession. Growth in consumer spending slowed down as households became more and more wary in the wake of dismal economic and business news. Incomes continued their upward trend, but so did unemployment. Capital spending was up for most of the year, as construction projects started earlier were completed, but the number of building permits applied gives reason to believe that capital spending will be falling sharply. It would appear that Finland alongside other industrial countries is drifting into a recession in 2009, with industry and especially construction showing a drastic downturn, while the service sector is expected to fare better than other sectors. Consumer confidence is as weak as it was during the slump in the 1990s, and the only thing people have faith in is that they will be able to save up money. In 2008, consumer prices at their highest rose at an accelerating pace of 4.1%, due mostly to higher food prices and housing costs. The stagnating economy is expected to markedly decelerate the inflation rate in Interest rates may fall further Owing to lack of confidence in financial markets, the Euribor rates rose until autumn Moreover, the European Central Bank raised its benchmark interest rate further in July to 4.25%, basing its decision on high inflation. As the financial crisis came to a head in the autumn, the ECB cut its benchmark interest rate three times by the end of 2008, finally coming to 2.5% and to 2.0% in January, bringing the Euribor rates down in its wake. With the euro area in recession and the lower inflation rate, interest rates are expected to fall further in Loans and deposits continued to grow briskly in the banking market in The growth rate of the loan portfolio of financial institutions remained unchanged, 11.7%, over the previous year. Because the financial markets were jammed up, the growth rate of corporate loans in particular rose to 19%, whereas the home mortgage growth rate slowed down to 8.7% despite the falling interest rates and housing prices in the latter half of the year. However, households loan portfolio increased faster than their income, resulting in higher indebtedness. The deposit growth rate rose to a record 12.9% in 2008, as many savings were channelled to deposits due to the steep fall in the equity market. Banking market growth is forecast to slow down in Slower growth in household income and a lower return on term deposits as a result of lower interest rates are expected to dampen growth in deposits. A rise in home loans is also expected to slow down, although the average interest rates of new home loans will fall. 12 POHJOLA ANNUAL REVIEW 2008

15 In 2008, capital market performance was exceptionally poor and stock performance was one of the worst ever experienced, with the OMX Helsinki Cap index a measure of stock prices in Finland falling by 50%. Mutual fund assets shrank by 37.4% owing to considerable net subscriptions and negative returns. Despite the weaker economy, non-life insurance premiums written rose by 4.2% in The non-life insurance business is not so badly affected, because statutory insurance accounts for such a high percentage of the policies. On the other hand, the stagnating economy is expected to slow down growth in claims expenditure. Capital markets Originating from the securitised sub-prime home loans in the USA, the financial crisis intensified in 2008 in a way that exceeded the most pessimistic estimates. The prices of risky securities, such as equities and corporate bonds, fell periodically and trading in many investment instruments decreased or practically came to a standstill. In particular, risk premiums in bond markets rose to exceptionally high levels. As recently as the first half of 2008, both long-term and short-term interest rates were on the rise, because higher rawmaterial and energy prices boosted inflation and inflationary expectations while interbank lending risk premiums increased. Some banks ran into liquidity problems and national authorities and central banks took over banks in a number of countries. Central banks and governments had to present a variety of bailout packages to calm down the situation. For example, the Federal Reserve has massively increased the amount of money in circulation. With falling asset prices, raw-material prices too began to drop sharply in the autumn, which alleviated inflationary pressures considerably in the short term, and many national central banks took measures to stimulate the economy through drastic interest rate cuts. Market rates also began to fall, but for example the spread between the Euribor rates, based on the average interest rate at which banks offer to lend unsecured funds, and interest rates in secured markets (repo markets) has persistently remained wide. There is no sign of any rapid drop in risk margins to their normal levels on the horizon. Based on their collective decision, governments of various countries have agreed to ensure money market operations. As a result, concerns over banks running short of liquidity have waned. However, large-scale revival programmes are expected to increase government debt, which has been reflected in strongly widening yield spreads of government bonds between various countries. Yield spreads also widened exceptionally strongly within the euro zone. Business confidence in Finland, balance figure Euribor rates and ECB benchmark rate, % Share indices in Finland and the US ,000 6,000 5,000 4,000 3,000 2, ,100 1,800 1,500 1, Services Industry Construction Source: Confederation of Finnish Industries EK Euribor (3-month) Euribor (12-month) ECB benchmark rate Source: Bank of Finland OMX Helsinki CAP (left scale) Standard & Poor s 500 (right scale) Source: NASDAQ OMX, Standard & Poor s POHJOLA ANNUAL REVIEW

16 Operating Environment Equity prices plunged by 40 50% in various markets during 2008 and the price of many shares were exceptionally low at the end of the year, in terms of valuation indicators proportioned to companies predicted financial results and dividends. At the same time, however, the rapidly fading growth rate of the real economy has made earnings forecasts less reliable. The steep fall in stock prices has reflected gloomier outlook for the real economy. However, markets have also been affected by psychological factors and investors desire for deleveraging. According to a number of estimates, the pricing of securities reflects an improbably weak future economic development. On the other hand, the weak market situation as such has also undermined the real economy. Measures taken by central banks and governments and changes in consumer and investor sentiment will have an effect on future market developments. Any institutional changes will also play a major role in this respect. Large American investment banks that used to dominate investment markets have lost their position. J.P. Morgan Chase acquired Bear Stearns in the spring of In the autumn, Lehman Brothers filed for bankruptcy and Bank of America bought Merrill Lynch. The two remaining large investment banks, Goldman Sachs and Morgan Stanley, gave up their investment banking status and became commercial banks subject to more rigorous supervision by US regulators. Suffering sinking confidence among investors due to the financial market turmoil, hedge funds also saw a substantial decrease in their assets and their reputation was also dented by the Madoff hedge fund fraud case. Due to the losses reported by investment banks and hedge funds, major players in the investment market will, to a significant extent, be different institutions than before. At the same time, the reputation of credit rating agencies has deteriorated and there has been clamour for more rigorous regulatory efforts governing both investors and other players. Consequently, we can expect major changes in market policies and practices. Legislative amendments in the financial sector Since the beginning of 2008, it has been possible to apply new capital adequacy regulations, in compliance with Basel II framework under the Act on Credit Institutions, and advanced measurement techniques based on those regulations. These new regulations enhance credit institutions risk management and enable, to a greater extent, the correlation of various types of risks and the capital adequacy requirement that they require. In September 2008, the Financial Supervisory Authority granted permission to Pohjola Bank plc to use the Internal Ratings Based Approach (IRBA) for corporate exposures in its capital adequacy measurement for credit risks. Entering into force in November 2007, new legislation governing investment services altered procedures in 2008 used in client relationships. This new legislation extended banks and investment firms obligation to request information on clients financial standing and previous investment experience while increasing their obligation to disclose information on their investment services. Entering into force at the beginning of August 2008, the amended Act on Preventing and Clearing Money Laundering and Funding of Terrorism is based on the so-called risk-based approach. Accordingly, financial institutions must have sufficient risk management methods in place by 1 August 2009, which enable them to monitor their client relations and any associated risks of money laundering. Entering into force on 1 October 2008, the amended Insurance Companies Act takes account of the reformed Companies Act to the applicable extent and also contains provisions pertaining to the idiosyncrasies of the insurance business. On 1 January 2009, Finnish financial and insurance regulatory bodies merged to form a new financial and insurance supervisory entity, the Financial Supervisory Authority, which assumed most of the duties and powers previously belonging to the Financial Supervision Authority and the Insurance Supervisory Authority. The Financial Supervisory Authority operates administratively under the Bank of Finland. Autumn 2008 saw an issue of a number of national and international rules and regulations due to the financial crisis, aimed at mitigating and fighting the adverse effects of the crisis. The maximum compensation payable to a depositor by the Deposit Guarantee Fund due to the depositor s claims from a bank was temporarily raised from EUR 25,000 to EUR 50,000. In addition, based on a temporary authorisation, the Finnish Government may grant state guarantees for unsecured funding of viable banks. The Ministry of Finance has legislative projects underway aimed at safeguarding banking operations and bank funding in difficult market conditions. According to this legislative proposal in progress during the spring of 2009, the Finnish State would offer banks interest-bearing subordinate loans. On 27 January 2009, the Cabinet Committee on Economic Policy proposed measures it had recommended and the terms 14 POHJOLA ANNUAL REVIEW 2008

17 and conditions governing the state guarantee to the refunding of banks and capital investment in banks. On the basis of this proposal, the amount of state guarantee that OP-Pohjola Group and Pohjola Bank plc as its central financial institution could use, at will, in its funding totals EUR 10 billion. OP-Pohjola Group could make use of government capital investments of some EUR 770 million, Pohjola accounting for around EUR 260 million, if it chooses to do so. The European Commission has made a proposal for the amendment to the Capital Requirements Directive, with its key amendments pertaining to credit institutions high client risks and more stringent securitisation rules and more intensified cross-border supervision of financial institutions. During 2008, the Ministry of Finance prepared a new act on the amalgamation of deposit banks. The new act is aimed at updating the key norms governing OP-Pohjola Group s structure. The government bill will be presented before the parliament in Amendments to the Cooperative Societies Act are also underway, with the aim of harmonising the related provisions so as to align with those of the Companies Act issued in A proposal for amendments to the Insurance Contracts Act should be presented before the parliament in The purpose of this amendment is to simplify the previous regulatory framework and the new Act will not establish any major new rights or obligations for insurers or policyholders. Bringing the regulatory framework up to date also applies to the Motor Liability Insurance Act and the Employment Accidents Act, and the related legislative initiatives are currently underway and the actual amended laws should enter into force during the first few years of the 2010s. EU legislation and the supplementary national legislation enabling the Single Euro Payments Area (SEPA) will come into force in Within SEPA, consumers and businesses can make and receive euro payments within countries and across borders under the same conditions, rights and obligations. Banks should initially perform cross-border credit transfers within three working days and from early 2012 within one working day. OP-Pohjola Group is among the first European banks to offer SEPA services to its customers. The Consumer Credit Directive issued in 2008 is aimed at enabling the creation of an open and effective consumer credit market in the EU. The directive contains harmonised EU-wide regulations governing, for example, the lender s duty to provide information to consumers in consumer credit marketing and when concluding the related agreements. The directive will be transposed into Finnish law by the end of Consumer credit also involves incorporating special provisions governing the so-called payday loans into consumer credit legislation at national level. The draft framework directive Solvency II, currently under discussion in EU bodies, has the purpose of providing insurance companies with new, harmonised solvency requirements in such a way that they take better account of insurance company risks and enable insurance companies to employ solvency requirements adapted to a company-specific risk assessment. If implemented, the new legislation would be likely to converge the risk management and regulatory principles of the insurance sector and those of the rest of the financial sector. The new legislation is scheduled to come into force in A legislative initiative regarding the reform of the Securities Markets Act is currently underway in the Ministry of Finance. This legislative reform is aimed at modernising the current act, which has undergone several amendments and revisions over the years, taking account of changes in the operating environment and the internationalisation of and developments in securities markets. POHJOLA ANNUAL REVIEW

18 Strategy Pohjola Group confirmed its strategy in the autumn of Pohjola s integrated operating model forms the core of its business concept, the related cornerstones including Pohjola s and OP-Pohjola Group s strong brands, extensive service network and customer base. Effective capital management, proactive risk management and people and competencies occupy a key role in the strategy. Vision The most preferred financial services partner. Mission Creating economic value for our customers and shareholders. The strategic core includes strengthening the market position ever-intensified business integration In 2008, the Group adopted a new organisational structure, its business segments currently comprising Banking, Asset Management and Non-life Insurance. Within Banking, we have the strategic goal of becoming the Finnish market leader as a bank for large and mediumsized companies and, together with the rest of OP-Pohjola Group, the market leader as a bank for SMEs. Asset Management aims at the leading market position in Finland. Non-life Insurance aims to strengthen its position as the Finnish market leader achieved some time ago. In particular, the aim is to reinforce the market share among private customers, underpinned by close cooperation with OP-Pohjola Group member banks and the revised customer loyalty scheme. Exploiting the shared customer potential and service network of business lines Growth potential created by the integration of banking and non-life insurance services can be seen in a variety of fields. In 2008, we updated our service concept for major customers in such way that responsibility for customer relationship coordination within both banking and insurance services is currently managed under the same roof. Cooperation in non-life insurance with OP-Pohjola Group s member cooperative banks has begun extremely smoothly, as evidenced by vigorous growth in the number of new loyal customer households between 2006 and With the progress made in information system development, Pohjola s businesses will make use of more extensive shared databanks with a view to improving customer service and creating a more efficient risk-based premium rating system. New value-adding services Our competitive advantage over most of our competitors lies in our ability and opportunity to provide a package of banking and insurance services on a one-stop shop basis. The opportunity of OP bonus customers since 2007 to utilise bonuses they have earned from their banking transactions in paying Pohjola insurance premiums serves as an example in this respect. International service capabilities We will place a heavier emphasis on our international service offering according to customer needs. In both Banking and Non-life Insurance, the development of international services is based on carefully selected partnerships, without ruling out company acquisitions. In the next few years, we aim to continue to expand and improve our Baltic operations. Benefits from loyalty Pohjola Insurance Ltd s loyal customers enjoy a 7% discount on home, property, motor liability, accident, travel and motor insurance policies, and OP bonus customers receive a further 3% discount on these policies. Loyal customer households are households who have taken out Pohjola policies within at least three non-life insurance product lines. We aim to increase the number of loyal customer households to 450,000, or by almost 20%, by the end of Pohjola Group s financial targets by the end of 2010 By the end of 2010, the Group aims to record a 15% return on equity (ROE) at fair value. We seek to maintain the Tier 1 ratio at a minimum of 8.5%. The adoption of the new capital adequacy framework and profitable business growth will enable more effective capital management. We aim to maintain our current high credit ratings. 16 POHJOLA ANNUAL REVIEW 2008

19 Dividend policy Group profitability, growth and capitalisation needs determine the annual dividend distribution. We aim to distribute at least 50% of our earnings per share in dividends, provided that the Tier 1 ratio stands at a minimum of 8.5%. Tools for achieving strategic goals Customer focus with a long-term approach Exploiting customer data shared by banking and insurance services to improve service Best loyal customer benefits for households OP-Pohjola Group s diversified and extensive service network Competent personnel with high job satisfaction Effective, proactive risk management Effective capital management A single Pohjola business name and brand Financial targets Target by end Group Return on equity at fair value, % Tier 1, % >8.5 Banking Operating return on equity, % >14 Operating cost/income ratio, % <40 Asset Management Operating cost/income ratio, % <50 Non-life Insurance Operating return on equity, % >20 Operating combined ratio, % Operating expense ratio, % <20 Solvency ratio, % Credit rating information can be found on page 59. Dividend payout ratio, % Market position Strategic target Corporate bank 2nd 2nd 1st Asset manager 2nd 2nd 1st Non-life insurer 1st 1st 1st * Actual Long-term target * Dividend payout as proposed by the Board of Directors POHJOLA ANNUAL REVIEW

20 Strategy Management s strategic analysis 2008 In 2008, the Group strengthened its market position in line with its strategy. Pohjola monitors developments in its market position, based on both external and in-house analyses, and the results show that the Group strengthened its position as a corporate bank in The market share of corporate loans rose by 1.7 percentage points to 19.0%. Showing a considerable improvement in its position as an asset manager, Pohjola is clearly the largest institutional asset manager in Finland. Within non-life insurance, Pohjola s premiums written increased markedly above the market average. Pohjola s business model is based on the close integration of its Banking and Non-life Insurance operations. We created an integrated offering of banking and investment services for the Group s major customers in 2008 and will deepen the model further in In October 2008, around 250 Pohjola Insurance Ltd s employees serving private customers joined the payroll of OP-Pohjola Group member cooperative banks. Together with the member banks, we have the aim of providing ever-more integrated banking and insurance services for private customers. When Pohjola Group acquired its non-life insurance business in the autumn of 2005, it set an annual target to achieve cost synergies of EUR 35 million by the end of We met this target in It appears that we will also achieve the annual target of EUR 17 million set for revenue synergies by the end of The Group aims to improve its international service capabilities. In 2008, we began finance-company operations in all Baltic States and also made arrangements to establish a branch office in Tallinn. The aim is to open the branch office during In India and China, we entered into partnership with major local banks in order to improve services for corporate customers in these markets. During the financial year, we also continued to further develop cooperation between Unico Banking Group members in the European market. The year saw a drastic deterioration in the Group s operating environment. For this reason, Non-life Insurance reported negative investment returns and, especially during the first half, liquidity reserves became subject to substantial impairments. During the latter half of the year, the Group increased impairments recognised on corporate loans. As a result of these developments, the Group s earnings and return on equity were markedly lower than targeted according to the strategy. The business lines recorded operational profitability that was close to the set targets. Given that the Group s year-end capital adequacy was strong and at the level specified in the strategy, the Board of Directors will propose to the Annual General Meeting that dividends be distributed according to the strategy. Considering that the operating environment and nearterm outlook have changed considerably, the Group will review its strategic goals and targets during Revenue synergies, million Cost synergies, million Revenue synergies Target Banking Non-life Insurance Asset Management Group Functions Target 18 POHJOLA ANNUAL REVIEW 2008

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