MFB Hungarian Development Bank Private Limited Company

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1 Consolidated annual report

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3 MFB HUNGARIAN DEVELOPMENT BANK PRIVATE LIMITED COMPANY Consolidated Financial Statements and Independent Auditor s Report

4 Contents page Independent Auditor s Report 1 Consolidated Financial Statements Consolidated Statement of Financial Position as at 31 December Consolidated Statement of Comprehensive Income for the year ended 31 December Consolidated Statement of Changes in Shareholder s equity for the year ended 31 December Consolidated Statement of Cash Flows for the year ended 31 December Notes to the Consolidated Financial Statements 6-59

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10 1. PRINCIPAL ACTIVITIES MFB Hungarian Development Bank Private Limited Company (the Bank or HDB ) is registered as a limited liability company under Hungarian law and is licensed to conduct specialized banking activities. The legal status and the activities of the Bank are regulated by Act XX of 2001 ( HDB Law ) which came into force on 15 June The Bank s role is to participate independently or together with other domestic or international organizations in a) the sourcing and mediation of medium and long term domestic and foreign funding and subsidies to achieve economic development aims; b) financing development loans and development capital in case of from a national economic aspect preferential state and local government developments or investments, and other related developments, investments and enlargements of these; c) financing loans and capital for companies resident in Hungary primarily small and medium enterprises sector -, holding funds established by law, agricultural businesses and farmers; d) the financial execution of state and local government developments and investments related to EU membership, and according to the method regulated in separate law the Bank participates in tasks related to the drawing of European Community funds (including mediation of subsidies and sourcing and mediation of resources from international economic or financial institutions); e) attend in tasks related to state, communal and international development disbursements (especially management of mediation and use of development disbursements and subsidies, attend in relating contributory tasks, settlement and valuation of used disbursements); f) the excercising of owners rights in the name of the Hungarian State, and in case of State owned companies - determined by the law - participate in the realization of significant developments, investments, expansion, increasing of effectiveness and improvement of competitiveness (see Note 36.) and other roles defined in HDB Law to ensure sufficient development funding to achieve the economic development aims determined by the Government s medium and long term economic strategy. The Bank s registered office is located at 31 Nádor Street, Budapest, Hungary. The Bank is 100% owned by the Hungarian State. In 2013, the rights of ownership were exercised by the Ministry for National Development. 6

11 1. PRINCIPAL ACTIVITIES (CONTINUED) In these consolidated financial statements the Bank and its subsidiaries together are called the Group. Members of the Group (subsidiaries): Corvinus Első Innovációs Kockázati Tőkealap The venture capital fund grants capital, regardless of the industry segment, mainly to small and medium size enterprises, which develop and/or apply innovation technologies. ELAN European Tőkealap Performs middle and long term investment mainly in rapidly growing businesses in Hungary and Middle and East Europe, that are about implementing developed technologies. MAG - Magyar Gazdaságfejlesztési Központ Zrt. The primary activity of MAG - Magyar Gazdaságfejlesztési Központ Zrt. is to intermediate and provide additional services in connection with reimbursable and non reimbursable financial aid of Hungary and the European Union, and the effective operation of companies in the aid mediator group. MFB Fejlesztési Tőkealap The venture capital fund manages the capital investment (by purchasing the determined middle and long term, mainly development aimed capital investments from the Groups portfolio) and loan portfolio (by refinancing the related member loans) applying the unchanged legal contents of association, cooperation and loan contracts in effect. MFB-Ingatlanfejlesztő Zrt. The company is assigned to minimize loan and investment losses. MFB Invest Zrt. In the course of the reorganisation of the Bank s equity funding activities, MFB Invest Zrt. integrates the Group s domestic and international development and venture capital funding activities. MKK Magyar Követeléskezelő Zrt. A Financial institution which provides supplementary financial services as a special business (e.g. debt purchase, debt management, factoring etc.) that connect directly or indirectly to the economic development aims set by the Bank. MMBF Földgáztároló Zrt. The company provides legally required safety natural gas storage, performs commercial natural gas storage and carbohydrogen exploitation. MV-Magyar Vállalkozásfinanszírozási Zrt. The company operates since the second half of 2007 in order to develop and operate financial programs that help to expand the financing potential of Hungarian micro, small and medium sized enterprises in the EU budget periods. The source of these financial programs is mainly provided by the EU (Jeremie). 7

12 1. PRINCIPAL ACTIVITIES (CONTINUED) RFH Informatikai Kockázati Tőkealap The main task of the Fund is to help in the development of domestic information and telecommunication affected micro-, small- and medium enterprises with high expansion potencial by using classical venture capital tools, mainly in the early period of the operation. Szalók Holding Zrt. f.a. The company operates a hotel and spa resort in Hungary. VÁTI Nonprofit Kft. VÁTI is a non-profit organisation that provides complex professional services relevant to decision preparing and competition managing to help public tasks according to international and national development programs, regional and development politics and settlement development. 2. BASIS OF PREPARATION a) Statement of compliance These consolidated financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ) issued by the International Accounting Standards Board ( IASB ) as adopted by the EU and interpretations issued by the International Financial Reporting Interpretations Committee ( IFRIC) as adopted by the EU. These Consolidated Financial Statements were approved by the Board of Directors on 22 nd April b) Basis of measurement These consolidated financial statements have been prepared on historical cost basis except for the following items, which are measured at faire value: - derivative financial instruments, - other financial assets or liabilities at fair value through profit or loss, and - available for sale financial assets (except for unquoted equity instrument that are not carried at fair value because their fair value cannot be measured reliably). These consolidated financial statements are presented in million Hungarian Forints ( HUF million ). c) Functional currency Items included in the consolidated financial statements are measured using Hungarian Forint, the currency of the primary economic environment in which the Bank and the other Group entities operate ( the functional currency ). Foreign exchange rates used in these consolidated financial statements were HUF/USD, HUF/EUR, HUF/JPY and HUF/GBP as at 31 December 2013: (31 December 2012: HUF/USD, HUF/EUR, HUF/JPY and HUF/GBP). 8

13 2. BASIS OF PREPARATION (CONTINUED) d) Use of estimates and judgements The Group makes judgements, estimates and assumptions that may affect the application of accounting policies and the reported amounts of assets, liabilities, income, expenses and the fair value of collateral and other security enhancements. Estimates and judgements are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Main estimates used by the Group are the following: According to the legal regulations the Group reviews its loan portfolios to assess impairment losses, if objective evidence exists that an impairment loss has been incurred and on a quarterly basis. In determining whether an impairment loss should be recorded in the statement of comprehensive income, the Group makes judgements as to whether there is any observable data indicating that there is a measurable decrease in the estimated future cash flows from a portfolio of loans before the decrease can be identified with an individual loan in that portfolio. This evidence may include observable data indicating that there has been an adverse change in the payment status of borrowers in a group, or national or local economic conditions that correlate with defaults on assets in the group. The Group uses estimates based on historical loss experience for assets with credit risk characteristics and objective evidence of impairment similar to those in the portfolio when scheduling its future cash flows. The methodology and assumptions used for estimating both the amount and timing of future cash flows are reviewed regularly to reduce any differences between estimated and actual loss. The amount of provision is the best estimate of the expenditure required to settle the present obligation and it is reviewed quarterly. In case of exposures in relation to loans or investments the basis of the calculation is the evaluation prepared quarterly. When the Bank brings an action against debtors, the amount of the provision or impairment is determined considering the amount of the receivables and the chances of winning the case. In presenting deferred tax assets an estimation uncertainty exists from the future existence of the taxable income, from which the accrued tax losses can be used up. The Bank recognizes deferred tax asset in accordance with the future income presented in the approved middle- and long-term business plan (see Note 31). 3. SIGNIFICANT ACCOUNTING POLICIES a) Basis of consolidation Subsidiaries Subsidiaries are enterprises controlled by the Group. Control exists when the Group has the power, directly or indirectly, to govern the financial and operating policies of an enterprise so as to obtain benefits from its activites. The financial statements of subsidiaries are included in the consolidated financial statements from the date that control effectively commences until that control effectively ceases. 9

14 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Jointly controlled entities and associates Jointly controlled entities are those enterprises over whose activities the Group has joint control, established by contractual agreement. Associates are those enterprises in which the Group has significant influence, but not control, over the financial and operating policies. Investments in jointly controlled entities and associates are accounted for under the equity method, whereby the investment is initially recorded at cost and adjusted thereafter for the post acquisition change in the Group s share of the net assets of the investee. Statements of comprehensive income reflects the Group s share of the profit or loss and other comprehensive income of the investee from the date that significant influence or joint control commences until the date that influence or joint control ceases. Transactions eliminated during consolidation Intercompany balances and transactions, and any unrealised gains arising from intercompany transactions are eliminated in preparing the consolidated financial statements. Goodwill Goodwill arising in a business combination is measured initially as the excess of the cost of the business combination over the acquirer s interest in the net fair value of the acquired identifiable assets, liabilities and contingent liabilities recognized. Goodwill is subject to an annual impairment test. Negative goodwill Negative goodwill arising in a business combination is measured initially as the excess of the net fair value of the acquired identifiable assets, liabilities and contingent liabilities recognized over the cost of the business combination. Negative goodwill that arose during the year has been credited to the comprehensive income. According to schedule no. 1 of HDB Law the Bank exercises the owners rights in the name of the Hungarian State at the companies determined by the supplement of the law (Note 36). Income and expenses arising from the managing of State property forms the income and expenses, or financing income and expenses of the central budget, therefore these investements where the Bank exercises the owners rights are not consolidated. b) Foreign currency transactions Foreign currency transactions are translated into the functional currency using the exchange rates of the National Bank of Hungary ( NBH ) prevailing at the dates of the transactions. Foreign exchange gains and losses resulting from the settlement of such transactions and from the translation at year-end exchange rates of monetary assets and liabilities denominated in foreign currencies are recognised in the comprehensive income. Monetary assets and liabilities denominated in foreign currencies at the balance sheet date are translated to HUF at the foreign exchange rates quoted by the National Bank of Hungary at that date. 10

15 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) c) Financial assets and liabilities Classification Financial assets or financial liabilities at fair value through profit or loss are financial assets and financial liabilities that are classified as held for trading mainly for the purpose of profit-taking, are derivative instruments that are not designated and not effective hedging instruments or upon initial recognition are designated as at fair value through profit or loss. Financial assets or liabilities at fair value through profit or loss contain derivative instruments that are not designated as hedging instruments. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. Loans and receivables contain cash and balance with the National Bank of Hungary, placements with other banks and loans and advances to customers net of allowance for impairment losses. Held-to-maturity financial assets are non-derivative assets with fixed or determinable payments and fixed maturity that the Group has the positive intent and ability to hold to maturity. Held-to-maturity financial assets contains government bonds and some other securities. Available for sale financial assets are non-derivative instruments that are not designated as another category of financial assets. Available for sale financial assets contain investments, NBH bonds, treasury bills and some other securities. Other liabilities contain all financial liabilities that were not classified as at fair value through profit or loss. Other liabilities contain placements and loans from other banks, deposits from customers, issued securities if the interest rate risk is not hedged with swap deals and subordinated debt. The classification and fair value of financial instruments is detailed in Note 35. Recognition Financial assets and liabilities are entered into the Group s books on the settlement day, except for derivative assets, which are entered on the trade day. Financial assets or financial liabilities are initially measured at fair value plus (for an item not subsequently measured at fair value through profit or loss) transaction costs that are directly attributable to its acquisition or issue. 11

16 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Derecognition Financial assets are derecognised when the rights to receive cash flows from the financial assets expire or the Group transfers substantially all risks and rewards of ownership of the financial asset. Reclassification For presentation purposes if necessary certain items previously reported in the prior years consolidated financial statements are restated and reclassified to provide consistency. During 2010 the Group reclassified its held-to-maturity financial assets to available for sale assets. Accordingly, all held to maturity assets must be classified as available for sale assets or financial assets at fair value through profit or loss in the next two financial years (2011 and 2012). In 2013 the Bank has revised its security portfolio and reclassified some securities from available for sale category into the held-to-maturity category. The changed initial cost is the fair value of the securities as at 31 December The reclassification was made in line with IAS Previously recognised fair value gain is amortised to profit or loss over the remaining life of the securities. Measurement Subsequent to initial recognition, all financial assets or financial liabilities at fair value through profit or loss and all available for sale assets are measured at fair value. If no quoted market price exists from an active market, the Group uses valuation techniques to determine fair value. All financial liabilities other than at fair value through profit or loss, held to maturity financial instruments and originated loans and receivables are measured at amortised cost less impairment. Premiums and discounts and initial transaction costs, are included in the calculation of effective interest rate of the related instrument and amortised to profit or loss using the effective interest rate method. A gain or loss on a financial asset or financial liability classified as at fair value through profit or loss shall be recognised in profit or loss. A gain or loss on an available-for-sale financial asset shall be recognised in other comprehensive income, through the statement of changes in equity, except for impairment losses and foreign exchange gains and losses which are recognized to profit or loss, until the financial asset is derecognised, at which time the cumulative gain or loss previously recognised in other comprehensive income shall be reclassified to in profit or loss. For financial assets and financial liabilities carried at amortised cost, a gain or loss is recognised in profit or loss when the financial asset or financial liability is derecognised or impaired, and through the amortisation process. 12

17 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Fair value measurement The Bank measures fair value using the following fair value hierarchy: Level 1: The fair value of financial instruments is based on their quoted market price in active markets for identical instruments that are available for the Bank at the balance sheet date. Level 2: The fair value of financial instruments is based on directly or indirectly observable data other the quoted market price. The followings can be used for the valuation: quoted market prices in active markets for similar instruments, quoted prices for identical or similar instruments in markets that are considered less than active, or other valuation techniques in which all significant inputs are directly of indirectly observable from market data. Where discounted cash flow techniques are used, estimated future cash flows are based on the Bank s economic estimates and the discount rate is a market related rate at the balance sheet date for an instrument with similar terms and conditions. Where valuation models are used, inputs are based on market related measures at the balance sheet date. Level 3: The fair value of financial instruments is based on inputs other than observable market data. The valuation is based on quoted prices for similar instruments for which significant unobservable adjustments or assumptions are required to reflect differences between the instruments. Amortised cost measurement The amortised cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured at initial recognition minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount, and minus any reduction for impairment or uncollectibility. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Group shall estimate cash flows considering all contractual terms of the financial instrument but shall not consider future credit losses. Impairment of financial assets If there is objective evidence that an impairment loss on loans and receivables or held-tomaturity investments carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the assets carrying amount and the present value of estimated future cash flows discounted at the financial asset s original effective interest rate. The amount of the loss is recognised in profit or loss. 13

18 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Objective evidence that financial assets are impaired can include default or delinquency by a borrower, restructuring of a loan or advance by the Group on terms that the Group would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the disappearance of an active market for a security, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers in the group, or economic conditions that correlate with defaults in the group. In addition, for an investment in an equity instrument, a significant or prolonged decline in its fair value below its cost is objective evidence of impairment. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised, the previously recognised impairment loss shall be reversed through profit or loss. When a decline in the fair value of an available-for-sale financial asset has been recognised in other comprehensive income and there is objective evidence that the asset is impaired, the cumulative loss that had been recognised in other comprehensive income is reclassified from in other comprehensive income to profit or loss, even though the financial asset has not been derecognised. The amount of the cumulative loss that is removed from equity and recognised in profit or loss shall be the difference between the acquisition cost and current fair value, less any impairment loss on that financial asset previously recognised in profit or loss. Impairment losses recognised in profit or loss for an investment in an equity instrument classified as available for sale shall not be reversed through profit or loss. If, in a subsequent period, the fair value of a debt instrument classified as available for sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in profit or loss, the impairment loss shall be reversed, with the amount of the reversal recognised in profit or loss. Financial assets are assessed individually or collectively. All individually significant financial assets (above HUF 100 million) are assessed for specific impairment. Assets that are not individually significant (under HUF 100 million) and loans relating to loan programs settled in the internal policy are then collectively assessed for impairment by grouping together financial assets (carried at amortised cost) with similar risk characteristics. Impairment of non-financial assets If there is any indication that the carrying amount of a non-financial (within the scope of IAS 36) asset exceeds its recoverable amount, the Group makes estimates for the recoverable amount of the asset. The Group considers external and internal information in assessing the amount of impairment. Impairment loss is recognised or reversed according to the individual rating of the asset. 14

19 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) Inventories within the scope of IAS 2 are measured at the lower of cost and net realisable value. The Group makes estimates for the realisable amount on a quarterly basis. Write-downs are recognised or reversed according to these estimates. If the carrying amount/cost of the non-financial asset exceeds its recoverable amount/realisable value, a write-down shall be recognised, if not, write-down shall be reversed to increase the carrying amount of the asset. The carrying amount of the asset after reversal can not exceed the original net carrying amount. d) Cash and cash equivalents Cash and cash equivalents include notes and coins in hand, unrestricted balances held with central bank and highly liquid financial assets with original maturities of less than three months, which are subject to insignificant risk of changes in their fair value, and are used by the Group in the management of its short-term commitments. Cash and cash equivalents are carried at amortised cost in the statement of financial position. e) Placements with other banks, loans and advances to customers The Bank s credit activities can be grouped by method (indirectly through commercial banks in the form of refinancing loans and directly) and by type (program and non-program loans). In 2013 program loans were granted to four types of clients: small and medium sized entities local governments, agricultural entities households (solely for improvement of energy efficiency) A significant part of the balance of Placements with other banks is refinancing program loans granted through commercial banks. The balance also contains the interbank placements. Loans and advances to customers net of allowance contain receivables against solely legal entities. Agricultural loans with mainly fixed interest rate are also recognized as loans and advances to customers. The Bank takes part in the NBH s Funding of Growth Scheme, where the NBH grants refinancing loans to the Banks attended. Banks can refinance these loans to small and medium size entities as loan or financial lease. Placements with other banks and loans and advances to customers are carried at amortised cost in the statement of financial position. 15

20 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) f) Securities Securities contain government bonds, treasury bills, compensation warrants, other debt securities, interest bearing or discounted treasury bills, bonds issued by the National Bank of Hungary, debt securities, including fixed-income securities interest bearing or discounted bills - that are entered on stock exchange, or traded on approved, controlled market (controlled by regulation or by stock exchange), other debt securities regardless its name, including debt securities took over in return for receivables to minimize loss. Securities classified as financial assets at fair value through profit or loss are measured at fair value through profit or loss. Securities classified as available for sale are measured at fair value through other comprehensive income. The basis of measurement is the average of best bid and ask prices published on the website of Government Debt Management Agency Ltd. on the balance sheet date. Securities classified as held to maturity are measured at amortised cost. The amount of amortisation is calculated using effective interest rate method. g) Investments Equity investments classified as controlling interest comprise those investments where the Bank through its direct ownership interest has the power to govern the financial and operating policies of the investee so as to obtain benefits from its activities. These investments are eliminated in the consolidated financial statements. Equity investments classified as significant interest comprise those investments where the Bank through its direct ownership interest has the power to participate in the financial and operating policies of the investee, but not to control those activities. These investements are accounted for under the equity method. Other equity investments comprise other share holdings, which do not meet the preceding criteria. The investment portfolio includes investments that the Bank intends to hold long term. The HDB Law determines the companies in which the Bank can obtain controlling interest. Other equity investments are accounted for in accordance with IAS 39 at fair value, unless there is no quoted market price in an active market and fair value cannot be reliably measured, when investments are measured at cost. The Group does not hold equity investments for trading purposes. 16

21 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) h) Derivative financial instruments The Group uses derivative financial instruments, interest rate swaps, foreign exchange swaps and forward exchange contracts to manage its exposure to foreign exchange and interest rate risks arising from business activities. The recognition of income/expenses relating to derivative transactions is on a mark-to-market basis. Fair value changes are immediately recognised in the statement of comprehensive income. The Group does not hold or issue derivative financial instruments for trading purposes. The fixed interest rate of a part of the EUR issued bonds is replaced to changing interest rate. The interest swap deals are accounted for as fair value hedges. The realized fair value changes on the hedging and hedged instruments are presented on a net basis. The Bank exchanged the USD 750 million income from the issued USD bond for EUR, and the fix interest rate payable after the bond for changing interest rate in the course of cross currency interest rate swap deals (CCIRS) on the fixed interest rate USD issued bonds. The CCIRS deals are designated as at fair value through profit or loss upon initial recognition. These deals are covered by the foreign exchange guarantee agreement (see page 29), therefore the income or expense on valuation is totally compensated. The Bank takes part in the III. Construction of the NBH s Funding of Growth Scheme, under which the NBH provides EUR liquidity by currency interest rate swap deals against HUF. These deals are designated as at fair value through profit or loss upon initial recognition. These CCIRS deals are not covered by the foreign exchange guarantee agreement. Foreign exchange swap deals are the replacement of different foreign exchanges on a predetermined exchange rate. Foreign exchange swaps deals are concluded solely with risk management purposes, and presented as Derivative assets or liabilities held for risk management. i) Property and equipment Property and equipment contains investments, capitalized or material assets in normal use that serves directly or indirectly the financial activities or banking, rights of property connected to real estate that serves the business activities permanently for more than one year and the production rights, special equipments (used in natural gas storage, carbohydrogen exploitation, etc.) and strategic and commercial storage contracts of the new subsidiary that represent a significant amount. Items of property, plant and equipment are stated at historical cost less accumulated depreciation and accumulated impairment losses. Depreciation is charged to the comprehensive income on a straight-line basis over the estimated useful lives of items of property, plant and equipment. Freehold lands, works of art, asset under construction, tangibles out of operating are not depreciated. 17

22 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) The estimated useful lives of property and equipment are the following: Property Rights in immovables Investment on leased property Hotel infrastructure Production machinery Strategic and commercial storage contracts Machinery Other equipment Mobiles Motor vehicles Computer equipments 2-50 years years years years 3-42 years 42 years 2 7 years 3-10 years 2 years 4 5 years 2 6 years j) Intangible assets Intangible assets contain rights, intellectual properties (software and other intellectual properties), goodwill arises on the acquisition of a company. There are no intangible assets with indefinite useful life. Intangible assets are carried at historical cost less accumulated amortization. Intangible assets are reviewed periodically and items which are considered to have no further value are amortised in full. The estimated useful lives of intangible assets are the following: Software Other intangible assets 3 8 years 3 6 years k) Bonds issued Obligations arising from issued bonds contain the Bank s own issued bonds. Issued bonds are measured using two methods. That part of the issued EUR bonds of which interest rate risk is hedged using interest rate swaps, are measured at fair value. The other part, which is not hedged, and the issued USD bonds denominated in EUR are measured at issue price, adjusted by the amortisation of the issuance cost and premium or discount. In this case, the risk is hedged by the FX state guarantee frame (see page 29). l) Provisions A provision is recognised, when the Group has a present obligation (legal or constructive) as a result of a past event,it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation. Provisions are reviewed quarterly and adjusted to reflect the best estimate of the expenditure required to settle the present obligation.. If it is no longer probable that an outflow of resources embodying economic benefits will be required to settle the obligation, the provision is reversed. A provision should be used only for expenditures for which the provision was originally recognised. 18

23 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) m) Statutory reserves General reserve In accordance with Section 75 of Act No. CXII of 1996, a general reserve equal to 10% of the net after tax income is required to be made in the Hungarian statutory accounts. The general reserve, as calculated under Hungarian accounting and banking rules, is treated as appropriations against retained earnings. General risk reserve Under Section 87 of Act No. CXII of 1996, a general risk reserve of maximum 1.25% of the risk weighted assets of credit institutions may be made up to 31 December In the Statutory financial statements the financial institution members of the Group sets up general risk reserve to cover risks arising from unforeseeable and undeterminable possible loan losses. The general risk reserve is treated as appropriations against retained earnings. n) Commitments and contingencies Commitments and contingencies are a probable obligation that derives from a past event, and its existence will be confirmed by the occurrence or non-occurrence of one or more uncertain future events that are not entirely controlled by the Group, or a present obligation that derives from a past event, but is not recognised because it is not likely that an outflow of resources embodying economic benefits will be required to settle the obligation or the amount of the obligation can not be reliably estimated. o) Interest and fee income and expense Interest income and expense include: - interest income or expense for financial assets and liabilities at amortised cost (including interest received or paid to banks or customers, interest received or paid on securities), - interest income or expense on financial assets and liabilities at fair value (including interest received or paid on securities). p) Transaction costs Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or financial liability. Transactional costs are included in initial cost. q) Dividend income Dividend income is recognised when the amount of dividend has been determined and approved. 19

24 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) r) Income and other taxes The amount of income tax payable is based on the tax obligations determined in accordance with Hungarian laws and it is adjusted by the deferred tax. Income tax and deferred tax are recognised in the comprehensive income, except to the extent that deferred tax relates to items recognised directly in equity, in which case it is recognised in equity. Current tax is the expected tax payable on the taxable income for the year using tax rates enacted or substantially enacted at the balance sheet date. The base of the income tax is the profit before tax adjusted by the tax base modifying items, the rate was 10% up to HUF 500 million tax base and 19 % above that in 2013 and Tax payable is modified by the released deferred tax of the previous year and the charged deferred tax of the current year. Deferred tax is calculated using the balance sheet liability method, providing for temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for taxation purposes. The amount of deferred tax provided is based on the expected manner of realisation or settlement of the carrying amount of assets and liabilities, using tax rates enacted or substantially enacted at the balance sheet preparation date, which was 19% for 2013 (2012: 19%). Deferred tax is presented on a net basis. The special tax of financial institutions is presented among other expenses. The tax is in effect from The base of the special tax is the adjusted balance sheet total of 2009, the rate was 0.15% under HUF 50 billion, and 0.53% above HUF 50 billion in 2013 (2012: 0.15% and 0.53% respectively). s) Statement of cash flows Information about the cash flows of the Group is useful in providing users of financial statements with a basis to assess the ability of the Group to generate cash and cash equivalents and the needs of the Group to utilise those cash flows. For the purposes of reporting cash flows, cash and cash equivalents include cash, balances and placements with the National Bank of Hungary except those with more than three months maturity. t) Events after the balance sheet date Events after the balance sheet date are those events, favourable and unfavourable, that occur between the balance sheet date and the date when the financial statements are authorised for issue. These events are adjusting and non-adjusting events. All adjusting events after balance sheet date have been taken into account in the preparation of the consolidated financial statements of the Group. The material non-adjusting events after the balance sheet date are presented in Note

25 3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED) u) Operating segments The reportable segments - strategic business units - offer different products and services, and are managed separately. Description of reportable segments: Banking: Includes loans, deposits and other transactions and balances with banks and customers. Investment: Includes transactions and balances with securities and investments. Subsidy mediation: Contains the activities of those members of the Group, which operate as an intermediate of EU sources. Debt management: Contains activities related to debt purchase, debt management, factoring. Other: Items not included in the preceding segments. Information about operating segments is presented in Note FINANCIAL RISK MANAGEMENT The most significant risks arising from financial instruments to which the Group is exposed are credit, interest rate, liquidity and foreign exchange risks. Risk management policies are set by the Board of Directors of the Bank within the rules established by the regulations in force, the National Bank of Hungary and the Hungarian Financial Supervisory Authority (from 1 st October 2013 together the National Bank of Hungary). The application and observation of these policies is supervised by the Board. The Bank has established reporting systems, which permit the monitoring of risk exposures. A. CREDIT RISK a) Management of credit risk Credit risk is the risk of financial loss to the Group if the client fails to meet its contractual obligations. Credit risk arises principally from the Group s loans and advances to customers and other banks, investments and other activities. The Group reviews its loan and investment portfolio for objective evidence that impairment loss should be recognised and due to statutory regulations - on a quarterly basis. The Group prepared and applies internal policies approved by the Board of Directors to implement its credit strategy. These policies are intended to ensure the established and transparent risk exposure, the control of assessment and decrease of risks. The risk management policies prepared to ensure safe management and prudent operation of the Group are based on international and domestic professional practice, the relevant legal regulations and the former directions of supervisory authority. i) Client evaluation Qualification of clients must be completed during the preparation of decision for every client against who the Group undertakes risk. Beyond that, the Group reviews its clients at least once per year and performs extra reviews for good cause. Clients are classified into categories according to the scores attained considering objective and subjective factors. 21

26 4. FINANCIAL RISK MANAGEMENT (CONTINUED) The applied qualification methods are differs in case of - project companies, - businesses already in operation, - local government, - simplified evaluation by objective and subjective criterions (under HUF 50 million, not for new businesses or project companies), - simplified evaluation by subjective criterions (for new businesses, or for businesses not obliged to prepare financial statement or simplified financial statement). ii) Measurement of collateral The main types of collateral accepted by the Group are: surety of the State, bank guarantee and surety of guarantee institutions, mortgage on chattel and property, cession of income, government bonds. It is the Group s policy that the collateral value in case of loans to customers is at least 100% of capital at the moment of approval plus annual interest, regardless of the evaluation category of the client, the risk exposure and the type of business. In case of collateral types, where collateral risk does not exist (e.g. state guarantee), the expected collateral is 100% of capital plus semiannual interest. The market value of the collateral is adjusted by the cover ratio. This ratio expresses the probable amount of recovery from the collateral, and besides it is the amount of collateral that is considered in the collateral registry and during the evaluation of assets. The Group performs the examination and if needed the remeasurement of collaterals during the evaluation of assets, on a quarterly basis. The remeasured collaterals are recognised in the collateral registry. iii) Limit of Client/Group of Clients, limit of sector The Bank determines risk limits for all clients, which are the maximum amounts of the undertaken risk. An upper limit for each client and group of clients is also determined. The limit amount depends on the statements of the evaluation procedure, the audited amount of capital (share capital) and interest bearing liabilities, and the financial position of the client s sector. The Bank classifies the sectors into eight risk groups by their financial position, and determines limits for these groups. The limit of sector is the upper limit of undertaken risk against clients classified into a risk group. 22

27 (in million HUF) 4. FINANCIAL RISK MANAGEMENT (CONTINUED) iv) Evaluation of transaction If there is objective evidence that an impairment loss or provision shall be recognised on loans and receivables at amortised cost, on investments held to maturity or on off balance sheet liabilities, the amount of impairment or provision is calculated as the difference between the carrying amount and the present value of estimated future cash flows using the original effective interest rate. For reporting purposes, the Group groups its receivables and off-balance-sheet liabilities into categories according to the calculated impairment loss or provision: Problem-free 0 % Special mention 1 10 % Below average % Doubtful % Bad % b) Exposure to credit risk The gross exposure to credit risk of the loan portfolio evaluated in accordance with risk management policies grouped by categories is shown below: Placements with other banks Loans and advances to customers Total % Placements with other banks Loans and advances to customers Total % Problem-free 278, , , % 399, , , % Special mention - 17,486 17, % - 13,810 13, % Below average - 7,327 7, % - 9,503 9, % Doubtful - 52,081 52, % - 51,817 51, % Bad 1 49,272 49, % ,186 64, % Total: 278, , , % 399, , , % The table below sets out the exposure to credit risk grouped by technical considerations (individually or collectively impaired) and by due date (past due but not impaired or neither past due nor impaired). Loans with renegotiated terms are shown as a separate category. 23

28 (in million HUF) 4. FINANCIAL RISK MANAGEMENT (CONTINUED) b) Exposure to credit risk (continued) Loans and advances to Placements with other banks customers Carrying amount 278, , , ,693 Individually impaired Special mention - - 6,403 3,350 Below average - - 3,416 4,722 Doubtful ,486 34,534 Bad ,528 63,403 Gross carrying amount , ,009 Impairment (1) (303) (60,579) (75,627) Net carrying amount ,254 30,382 Collectively impaired Problem-free - - 5,284 6,183 Special mention - - 2,732 3,705 Below average - - 2,466 3,219 Doubtful Bad Gross carrying amount ,016 13,832 Impairment - - (1,225) (1,493) Net carrying amount - - 9,791 12,339 Past due but not impaired Net carrying amount - - 6,459 7,004 Past due comprises: 1-9 days days days days days days days - - 6,118 6,131 Net carrying amount - - 6,459 7,004 Neither past due nor impaired Net carrying amount 278, , , ,355 Loans with renegotiated terms Gross carrying amount ,771 25,834 Impairment - - (12,630) (8,221) Net carrying amount ,141 17,613 Total gross carrying amount 278, , , ,034 Total impairment (1) (303) (74,434) (85,341) Total net carrying amount 278, , , ,693 24

29 4. FINANCIAL RISK MANAGEMENT (CONTINUED) b) Exposure to credit risk (continued) Impaired loans Impaired loans are loans for which the Group determines that it is probable that it will be unable to collect all principal and interest due according to the contractual terms of the loan agreement. Past due but not impaired Loans where contractual interest or principal payments are past due, but the Group did not charge impairment, because amounts recoverable from the available collateral cover the total expected loss. The past due but not impaired category contains the receivables of MKK Magyar Követeléskezelő Zrt. The company - according to its activities buys past due receivables at their recoverable value. Loans with renegotiated terms Loans with renegotiated terms are loans that have been restructured due to deterioration in the borrower s financial position and where the Group has made concessions that it would not otherwise consider. Once a loan is restructured it remains in this category, until the contract is cancelled. 25

30 (in million HUF) 4. FINANCIAL RISK MANAGEMENT (CONTINUED) c) Collateral and other security enhancements Collateral against placements Collateral against loans and with other banks advances to customers Against individually impaired Property ,214 25,590 Surety of State and State owned companies - - 3,874 1,389 Cash collateral Bank guarantee Other - - 4,706 8, ,794 35,216 Against collectively impaired Property - - 5,784 7,262 Debt securities Surety of State and State owned companies Cash collateral Bank guarantee Other - - 4,660 5, ,772 13,539 Against past due but not impaired Property - - 1,840 2,040 Debt securities Surety of State and State owned companies Cash collateral Bank guarantee Other - - 2,433 3, ,461 5,949 Against neither past due nor impaired Property ,393 21,395 Debt securities 9,415 15, Surety of State and State owned companies 29,691 58,258 78,617 76,215 Cash collateral - - 3, Bank guarantee - - 1,168 1,359 Other ,595 45,726 39,106 73, , ,487 Against loans with renegotiated terms ,411 15,834 Total 39,106 73, , ,025 An estimate of the fair value of collateral and other security enhancements (up to the amount of receivables) is shown in the table above. In case of project loans the main part of the collateral is materialized during the project in line with the loan disbursement, the collateral is taken into consideration after the realization or capitalization of the project. 26

31 (in million HUF) 4. FINANCIAL RISK MANAGEMENT (CONTINUED) c) Collateral and other security enhancements (continued) After the Bank s asset side exposure to credit risk and liability side obligations the central budget determined a state guarantee frame. The amount and utilization of the state guarantee frame was the following: Asset side state guarantee frame Utilization Liability side state guarantee frame 1,800 1,750 Utilization d) Concentrations of credit risk An analysis of concentrations of credit risk by sector is shown below: Loans and advances to customers, net of allowance for impairment losses Property development, economic services 89, ,456 Industry 32,653 35,197 Agriculture 13,741 16,972 Other services (local governments, health-care, other serivces) 70,107 77,601 Construction (including motorway financing) 49,839 50,151 Transport, storage, post, telecoms 43,944 8,682 Accommodation, catering 2, Trade 6,433 7,813 Total: 309, ,693 Placements with other banks contains refinancing loans (2013: HUF 226,333 million; 2012: HUF 325,088 million), other refinancing loans (2013: HUF 29,698 million; 2012: HUF 58,730 million) other placements with banks, settlement accounts (2013: HUF 18,741 million; 2012: HUF 11,678 million ) and receivables from financial activities (2013: HUF 4,037 million; 2012: HUF 4,073 million). Refinancing loans are long term loans granted through loan programs, where the credit risk is borne by the refinanced credit institution. B. LIQUIDITY RISK a) Management of liquidity risk The Group s principal objective is to carry out secure and established course of business, and the prevention of liquidity situations which could threaten the Group to meet its obligations. The management of liquidity is determined by the characteristics of the business, the strategy, the yearly business plan, the legal regulations and the regulatory activities of National Bank of Hungary. 27