Notes to the Financial Statements for the Year Ended 31 December 2009

Name of the Company: Modrá pyramida stavební spořitelna, a.s.
Registered Office: Bělehradská 128/222, 120 21 Praha 2
Legal Status: Joint Stock Company
Corporate ID: 60192852
Bank’s Code: 7990
Principal Activities: Construction Savings

1. General Information

1.1 Incorporation and Description of the Business

Modrá pyramida stavební spořitelna, a.s., corporate ID: 60192852, registered at Bělehradská 128/222, 120 21 Prague 2, was formed by a Deed of Foundation on 10 June 1993 and was incorporated following its registration in the Register of Companies held at the Municipal Court in Prague, Volume B, File 2281, on 9 December 1993. Modrá pyramida stavební spořitelna, a.s. (henceforth the “Bank” or the “Company”) is a specialised bank and its activities and operations are defined in the Construction Savings and Construction Savings State Support Act 96/1993 Coll., as subsequently amended (the “Construction Savings Act”). The Bank operates a construction savings scheme involving the acceptance of deposits from, and the issuance of loans to, participants in the construction savings scheme, the acceptance of deposits from financial institutions, provision of guarantees in Czech crowns for loans issued from the construction savings, for loans provided pursuant to Section 5 (5) of the Construction Savings Act and for loans defined in Section 9 (1) (a) of the Construction Savings Act, proprietary trading with mortgage bonds and bonds, execution of the payment and settlement system in connection with the operation of the Bank, and conclusion of trades for the purpose of hedging the currency and interest rate risks. The Bank conducts its business only on the territory of the Czech Republic.

During the year ended 31 December 2009, no changes were made to the shareholder structure. The sole shareholder of the Bank is Komerční banka, a.s., corporate ID: 45317054, with its registered office at Na Příkopě 33, Prague 1, entered in the Register of Companies maintained by the Municipal Court in Prague, Volume B, File 1360.

1.2 Board of Directors and Supervisory Board

Changes in the Composition of the Bank’s Board of Directors in 2009

The term of office of the member of the Board of Directors, Jiří Šperl, ended on 19 April 2009. Pursuant to the resolution of the sole shareholder dated 13 January 2009, he was reappointed as member of the Board of Directors with effect from 20 April 2009. The old entry was removed from the Register of Companies on 11 May 2009 and a new entry was made to reflect the new term of office on 13 May 2009. At the meeting of Board of Directors of the Bank held on 20 August 2009, Jiří Šperl resigned from the position of the member of the Board of Directors with effect from 1 September 2009. He was removed from the Register of Companies on 16 October 2009.

As of 31 December 2009, André Léger resigned from the position of the Chairman and member of the Board of Director. He was removed from the Register of Companies on 1 February 2010.

During 2009, the Board of Directors had four members from 1 January to 31 August 2009 and three members from 1 September to 31 December 2009.

Pursuant to the resolution of the sole shareholder dated 22 December 2009, Jan Pokorný was appointed member of the Board of Directors with effect from 1 January 2010. The Board of Directors appointed him Chairman of the Board of Directors at its meeting held on 4 January 2010. The appointment was recorded in the Register of Companies on 1 February 2010.

Changes in the Composition of the Bank’s Supervisory Board in 2009

Zdeněk Mojžíšek resigned from the position of the member of the Supervisory Board as of 30 June 2009, he was removed from the Register of Companies on 16 October 2009. As of 10 September 2009, Laurent Goutard resigned from the position of member and Chairman of the Supervisory Board. He was removed from Register of Companies on 24 November 2009.

Pursuant to the resolution of the sole shareholder dated 1 September 2009, Henri Bonnet was appointed a new member of the Supervisory Board with effect from 11 September 2009. At its meeting held on 10 September 2009, the Supervisory Board appointed Henri Bonnet Chairman of the Supervisory Board. The appointment was recorded in the Register of Companies as of 24 November 2009.

Pursuant to the resolution of the sole shareholder dated 8 December 2009, Tomáš Tomiczek was appointed member of the Supervisory Board with effect from 8 December 2009. The appointment was recorded in the Register of Companies on 7 January 2010.

Composition of the Board of Directors and the Supervisory Board as of 31 December 2009

	Position	Name
Board of Directors	Chairman	André Léger
	Vice Chairman	Libor Löfler
	Member	Miroslav Hiršl
Supervisory Board	Chairman	Henri Bonnet
	Vice Chairman	Peter Palečka
	Member	Patrice Taillandier-Thomas
	Member	Milan Orkáč
	Member	Josef Květoň
	Member	Tomáš Tomiczek

1.3 Significant Events in the Year Ended 31 December 2009

In 2004, the Anti-monopoly Office initiated administrative proceedings regarding the coordinated approach of construction savings banks to determining fees relating to the construction savings scheme. Based upon a ruling passed by the Antimonopoly Office, a penalty was imposed on the Bank and the Bank was also instructed to reverse and adjust the level of certain fees as appropriate. The Bank filed an appeal against the ruling. The Anti-monopoly Office allowed the appeal and the original ruling was reversed. In new proceedings in 2005 and 2006, the Anti-monopoly Office issued two rulings on the reduction of the penalty.

The Bank filed a complaint with the Administrative Court against the final ruling. The fine was paid and the redundant reserve was released. The verdict of the Regional Court in Brno dated 8 January 2008 revoked the ruling of the Anti-monopoly Office and the fine was refunded to the Bank. On 11 February 2008, the Anti-Monopoly Office filed a complaint based on cassation against the ruling. The Bank recognised a reserve.

In February 2009, the cassation complaint of the Anti-Monopoly Office was dismissed by the court and the case was returned to the Anti-Monopoly Office for a new hearing and ruling.

2. Basis of Preparation

(a) Accounting Principles

The financial statements have been prepared on the basis of the underlying accounting books and records maintained in accordance with Accounting Act 563/1991 Coll., and relevant directives and regulations applicable in the Czech Republic. These financial statements have been prepared on the accruals basis of accounting and under the historical cost convention, the only exception being assets that are measured at fair value. Comparative figures for the previous financial reporting period are reported reflecting the conditions that existed in the period for which the financial statements are prepared.

The financial statements have been prepared in accordance with Regulation of the Czech Finance Ministry 501/2002 Coll., which provides implementation guidance on the composition and substance of the items in the financial statements and scope of information to be disclosed by banks and certain financial institutions (hereinafter “Regulation no. 501”), as amended, and in accordance with Czech Accounting Standards for Financial Institutions.

The Bank is subject to the regulatory requirements of the Czech National Bank (henceforth the “CNB”). These regulations include those pertaining to minimum capital adequacy requirements, classification of loans and off balance sheet commitments, credit risk connected with clients of the Bank, liquidity, interest rate risk and foreign currency position.

The financial statements include the balance sheet, the profit and loss account, the statement of changes in equity and notes to the financial statements. These financial statements are unconsolidated. These financial statements are presented in thousands of Czech crowns.

(b) Transaction Recognition Date

The date of the recognition of transactions is the date of payment or receipt of cash, the day of purchase or sale of securities, the date on which a payment is made or an amount is collected from the client’s account, the day of issuing an order to the correspondent to make a payment, the day of settlement of the Bank’s orders with the CNB Clearing Centre, the trade date and the settlement date relating to transactions with securities, the day on which ownership title to assets originates or expires, the day when a receivable or payable originates, changes or is extinguished, a deficit, shortfall, surplus, damage or transfer of assets within the Company are identified or other events that are subject to accounting.

Purchases and sales of financial assets are retained off balance sheet in the period between the trade date and the settlement date. At settlement, the off balance sheet entry is reversed and the settlement is brought onto the face of the balance sheet.

(c) Foreign Currency Translation

Receivables and payables denominated in foreign currencies are translated into Czech crowns using the exchange rate of the Czech National Bank prevailing on the transaction date. Income and expenses denominated in foreign currencies are recorded in Czech crowns in the underlying accounting system of the Bank and are therefore reported in the financial statements at the Czech National Bank’s exchange rate prevailing on the transaction date.

(d) Provided Loans and Provisions against Loan Losses

Amounts receivable arising from loans provided to clients are stated at the outstanding principal amount and accrued interest and fees, net of provisions. Accrued interest income is included in the carrying amount of these receivable balances.

Receivables are reviewed for recoverability. Based on such reviews, provisions are created for individual receivables. The level of provisioning is established in accordance with CNB Regulation 123/2007, as amended, stipulating rules for the assessment of receivables arising from financial activities and the creation of provisions and reserves, and rules for the acquisition of certain classes of assets. The guidance used in recognising provisions for the period is set out in Note 28 (a) of these financial statements. Provisions charged against expenses are presented in ‘Write-offs, charge for and use of provisions and reserves for receivables and guarantees’ in the sub-ledger accounts for income tax liability reporting purposes.

The tax-deductible portion of the period’s charge for the recognition of reserves and provisions for loan losses is calculated in accordance with the requirements of Section 5 (‘Banking Reserves and Provisions’) of the Provisioning Act 593/1992 Coll.

The write-off of irrecoverable receivables is accounted for as ‘Write-offs, charge for provisions and reserves for receivables and guarantees’ in the profit and loss account as well as the relevant balance of provisions and reserves. Recoveries from receivables previously written off are included in ‘Release of provisions and reserves for receivables and guarantees and recoveries of receivables previously written off’.

(e) Securities

Pursuant to Section 9 of the Construction Savings and Construction Savings State Support Act 96/1993 Coll., the Bank acquires Government bonds or bonds guaranteed by the Government, bonds issued by the CNB, mortgage bonds issued by the member states of the Organisation for Economic Cooperation and Development (OECD), bonds issued by the OECD states, the central banks and financial institutions of these states and banks seated in these states, and bonds issued by the European Investment Bank (EIB), Nordic Investment Bank (NIB), and the European Central Bank (ECB).

Securities held by the Bank are categorised into portfolios in accordance with the Bank’s intent on the acquisition of the securities and pursuant to the Bank’s security investment strategy.

Purchases and sales of securities are retained off balance sheet in the period between the purchase or sale trade date and the settlement date. At settlement, the off balance sheet entry is reversed and the securities are brought onto the face of the balance sheet.

At settlement, debt securities, treasury bills and mortgage bonds are recognised at cost which comprises the net purchase cost, the proportionate part of the discount or premium and direct transaction costs attributable to the acquisition of securities. Accrued interest income is reflected in the carrying amount of these securities.

Securities Available for Sale

Securities available for sale are measured at fair value with the changes in fair values being recognised through the balance sheet in equity. If there is objective evidence that a security may be impaired, the amount corresponding to the impairment is included in the profit and loss account with a corresponding entry to gains or losses from revaluation.

The fair value of securities is determined by reference to the market value prevailing at the fair value measurement date if the Bank proves that the security can be sold at the market value.

The fair values of publicly tradable securities are equal to the reference prices of the debt securities published by the Prague Stock Exchange at the fair value measurement date. In circumstances where this price is not readily obtainable, the fair value is equal to the value published by the market maker.

Transactions under which securities are sold with the commitment to repurchase the securities (repo transactions) for a pre-determined price or are purchased with the commitment to sell the securities (reverse repo transactions) are treated as collateralised received or provided loans. Ownership title underlying these securities passes to the entity issuing the loan. Securities transferred under repo transactions continue to be reported within the relevant securities accounts on the Bank’s balance sheet, with the amount acquired through the transfer of securities under repo transactions being included in ‘Amounts owed to banks’. Securities acquired under reverse repo transactions are maintained off balance sheet in the line ‘Received collateral’. Loans provided under reverse repo transactions are presented within ‘Amounts due from banks and savings associations’.

Income/expenses arising under reverse repo transactions/repo transactions representing the difference between the cost and the selling price are accrued over the life of the transaction and are reported in the profit and loss account lines ‘Interest income and similar income’ or ‘Interest expense and similar expense’ as appropriate.

Publicly non-tradable debt securities acquired in primary placements

Upon initial recognition, publicly non-tradable debt securities acquired in primary placements are carried at the acquisition cost which includes direct transaction costs. The valuation from the purchase settlement date to maturity or the sale settlement date is gradually increased (decreased) to reflect accrued interest income (expenses). If debt securities acquired in primary placements not held for trading are sold, the difference between the accrued amount not adjusted for provisions and the selling price at the sale/sale settlement date is recognised in income or expenses as profit or loss from the sale of securities.

(f) Tangible and Intangible Fixed Assets

Tangible fixed assets include tangible assets with a cost greater than CZK 40,000 and an estimated useful life exceeding one year.

Intangible fixed assets include assets with the cost of individual components greater than CZK 60,000 and an estimated useful life exceeding one year.

Tangible and intangible fixed assets are stated at cost less accumulated depreciation and are depreciated over their estimated useful lives. Depreciation periods of individual classes of tangible and intangible fixed assets are as follows:

Assets with a cost lower than CZK 60,000 and CZK 40,000 are not treated as intangible and tangible fixed assets, respectively, and are expensed in the period of acquisition, except for the collectively acquired licences with a cost greater than CZK 60,000. Assets with a cost greater than CZK 1,000 are maintained in the underlying operating records.

External costs of technical improvements in respect of tangible and intangible fixed assets are capitalised and increase the acquisition cost of the related fixed asset. Asset maintenance costs are charged directly to the profit and loss account when the expenditure is incurred. Internal (staff) costs incurred in respect of the project involving software development are also capitalised.

Assets held under finance leases are depreciated by the lessor.

(g) Reserves

The Bank recognises reserves for liabilities with uncertain timing and amount in the event that:

• It has an obligation (legal or constructive);
• It is more likely than not that an outflow of resources embodying economic benefits will be required to settle the obligation; “likely” means the likeliness higher than 50%; and
• An appropriately reliable estimate can be made of the amount of the obligation.

Reserves are used only for the purposes for which they were recognised. If there is no longer a reason for maintaining the reserve, the Bank releases the reserve to income.

(h) Provisioning

The Bank recognises provisions for assets that are not remeasured at fair value in circumstances where the carrying amount of the assets as stated in the books is temporarily impaired. Provisions are recognised in respect of amounts due from clients, tangible and intangible assets and other assets. The recognition of provisions is charged to expenses and credited to the relevant provisioning account. The recognition, use and release of provisions is reported in the relevant profit and loss account lines.

(i) Income and Expense Recognition

Interest income and expense are recognised on the accruals basis of accounting in the period to which they relate, irrespective of when they are paid or received, the only exception being default interest. Accrued interest income and expenses related to assets and liabilities are included in the aggregate balances of those assets and liabilities.

Commission and fee income and expenses, other operating income and expenses, and administrative expenses are recognised on the accruals basis of accounting in the period to which they relate, irrespective of when they are paid or received.

Past due interest or interest where management of the Bank expects that it is not likely to be recovered, is recognised in income and provisions in the corresponding amount are recorded and charged to the profit and loss account.

Default interest is recognised when collected.

(j) Use of Estimates

The presentation of unconsolidated financial statements in conformity with the accounting regulations applicable in the Czech Republic requires the Bank’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the balance sheet date and their reported amounts of revenues and expenses during the reporting period. These estimates, which specifically relate to the determination of fair values of financial instruments, valuation of intangible assets, impairment of assets and provisions, are based on the information available at the balance sheet date.

The current global economic crisis and market turbulence increase the risk that the actual results and outcomes may significant differ from these estimates. Key areas with a potential for significant differences between the actual results and the estimates principally include loan provisioning and fair values of securities. Information about the key assumptions concerning the future, and other key sources of estimation uncertainty at the balance sheet date that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities are disclosed in individual notes as appropriate.

Management of the Bank has determined these estimates and assumptions by reference to the relevant information available to it.

The Bank recognises an estimated receivable also reported as a payable to clients as equal to the amount of the estimated state subsidy which will be added to the deposit accounts of clients in the following year.

(k) Finance Lease

A finance lease is the acquisition of a tangible fixed asset such that, over or after the contractual lease term, ownership title to the asset transfers from the lessor to the lessee; pending the transfer of title the lessee makes lease payments to the lessor for the asset that are charged to expenses.

The initial lump-sum payment related to assets acquired under finance leases is amortised and expensed over the lease period.

Leasehold improvements are depreciated over the lease term. Following the transfer of ownership title to the leased asset to the lessee, the cost of improvements is added to the value of acquired assets and the depreciation of this increased amount continues.

(l) Income Taxes

The income tax base is calculated using the profit for the period adjusted by adding tax non-deductible expenses and deducting non-taxable income. The income tax base is additionally adjusted to reflect tax relief and tax credits, if any. Taxation is calculated at the period-end in accordance with the Income Taxes Act 586/1992 Coll., as subsequently amended. The currently enacted tax rate is 20% for 2009.

Deferred tax is accounted for using the balance sheet liability method. Deferred tax is provided using the balance sheet liability method on all temporary differences between the tax base of an asset or liability and the carrying amounts stated in the balance sheet. The amount of deferred tax asset or liability is calculated as equal to the resulting difference multiplied by the income tax rate effective pursuant to the Income Taxes Act 586/1992 Coll., or the income tax rate that is expected to apply in the period when the tax liability is settled or the asset realised. The tax base of an asset or liability is the amount that will be deductible for tax purposes in the future.

A deferred tax liability is always recognised. A deferred tax asset is recognised only to the extent that there is no doubt about its future recoverability and only up to the amount of likely future taxable income.

Deferred tax assets and liabilities are offset and reported on a net basis in ‘Other assets’ or ‘Other liabilities.’

(m) Year-on-year Changes in Valuation, Depreciation and Accounting Methods

There were no changes in the year ended 31 December 2009.

3. Net Interest Income

During the year ended 31 December 2009, the Bank collected default interest of CZK 24,242 thousand (2008: CZK 21,860 thousand). The increase is principally the result of a greater volume of withdrawn receivables and collections. The Bank did not charge default interest on outstanding individual repayments prior to the withdrawing. The amount of waived default interest for the year ended 31 December 2009 was approximately CZK 1,085 thousand (2008: approximately CZK 2,039 thousand). Outstanding default interest which is maintained off balance sheet amounted to CZK 49,492 thousand as of 31 December 2009 (2008: CZK 34,326 thousand).

4. Net Fees and Commissions

5. Net Profit or Loss on Financial Operations

As of 31 December 2009, the Bank recorded no transactions with securities available for sale (2008: a profit of CZK 315 thousand).

6. Staff Costs

Average Headcount

7. General Operating Costs

Administrative Costs

Other Operating Income

The increase in ‘Other’ in 2008 principally includes the fine returned by the Anti-Monopoly Office in the amount of CZK 9,000 thousand.

Other Operating Expenses

In accordance with the Banking Act, the contribution to the Deposit Insurance Fund amounted to 0.05% from the amount of insured deposits in both the years ended 31 December 2008 and 2009.

8. Write-offs, Impairment of Assets

9. Write-offs, Charge for, Use and Release of Provisions for Receivables and Recoveries of Receivables Written off

Provisions for Classified Receivables

The Company created non-tax deductible provisions for interest in the year ended 31 December 2009 in the amount of CZK 1,138 thousand (2008: CZK 1,902 thousand).

Release of provisions and reserves against receivables and guarantees, income from receivables previously written off

Write-offs, recognition and release of provisions and reserves against receivables and guarantees

10. Income Tax

Refunds of taxes as of 31 December 2009 include the settlement of the corporate income tax for the year ended 31 December 2008 in the amount of CZK 902 thousand.

11. Allocation of Profit

The Bank’s profit for the year ended 31 December 2009 amounted to CZK 739,668 thousand. In the year ended 31 December 2008, the Bank’s profit amounted to CZK 580,255 thousand and the General Meeting approved the transfer of the total profit for 2008 into retained earnings.

12. Cash in Hand and Balances with the Czech National Bank

Cash in hand includes cash in transit of CZK 3,217 thousand. Balances with the Czech National Bank represent mandatory minimum reserves. These mandatory minimum reserves with the Czech National Bank bear interest. At the end of 2009, the interest rate was 1% (the 2008 year-end: 2.25%).

As of 31 December 2009, the Bank reported treasury bills of the Czech National Bank received in reverse repurchase transactions reported off-balance sheet in “Received collateral” of CZK nil (2008: CZK 700,525 thousand).

13. Amounts due from Banks

Current accounts and term deposits

Non-tradable debt securities issued by banks which are not acquired with a view to their sale in the immediate or short future and are not measured at fair value

Non-tradable debt securities issued by banks consist of a security in the certificate form in the aggregate amount of CZK 3,194,679 thousand and securities in the certificate form with a variable interest rate fixed for determined periods; as of the fixing date, both the investor and the issuer have the possibility to sell/repurchase the securities in the aggregate amount of CZK 8,265,542 thousand.

14. Loans and Amounts due from Clients

Classification of amounts due from clients

Since 1996, the Bank has been providing clients with both bridging loans until they become entitled to receive a construction savings loan and loans arising under the Construction Savings Act.

Amounts due from clients

Granted loans

Bridging loans

Analysis of granted loans and bridging loans to clients by type of collateral

The collateral values presented above represent types of collateral accepted by the Bank but only to the amount of loan balances. If collateral is combined, the loan is split into portions and reported on several lines based on the collateral quality.

Analysis of loans to clients by sector – gross balance

Amounts due from clients written off and recoveries of receivables written off

Restructured receivables

In 2009, 150 receivables from clients totalling CZK 73,282 thousand were restructured (2008: 141 receivables from clients totalling CZK 19,275 thousand). The increase in the volume of restructured receivables is due to a new restructuring in the form of a short-term postponement of principal payments (additional payments) in duly paid or minor delinquent receivables realised since October 2009.

15. Securities Available for Sale

State zero-coupon bonds and other securities eligible for refinancing with the central bank

Debt securities

The amount of valuation differences charged against equity amounted to CZK 589,507 thousand (2008: CZK 232,548 thousand) as of 31 December 2009.

All securities available for sale held by the Bank at the balance sheet date are listed on the Prague Stock Exchange.

16. Deferred Expenses and Accrued Income and Other Assets

Deferred expenses and accrued income

Other assets

17. Intangible Assets

Summary of intangible fixed assets

18. Tangible Assets

Summary of tangible assets

At the balance sheet date, the Bank reported ten cars acquired under a long-term finance lease contract; the acquisition cost of the cars is CZK 6,016 thousand.

19. Equity Investments

The Bank held no equity investments in other companies.

20. Amounts Owed to Banks

As of 31 December 2009, the Bank reported amounts owed to banks arising from term deposits, received repurchase loans and subordinated debt (31 December 2008: only subordinated debt). The Bank does not provide other banks with guarantees for loans to its clients and does not accept any bills of exchange.

Amounts owed to Banks

The balance as of 31 December 2009 of subordinated debts which were provided to the Bank in 2004 was as follows:

The subordinate debt totalling CZK 550,000 thousand bears interest at PRIBOR 3M + 2.5% which applies to the relevant three-month period.

21. Amounts Owed to Clients

Total amounts owed to clients

The level of state support arising under construction savings schemes as of 31 December 2009 is estimated on the basis of the client deposit balance at the end of the month. The state support for 2009 will be credited to client accounts after its level is approved by the Czech Finance Ministry during 2010.

22. Accrued Expenses and Deferred Income and Other Liabilities

The estimate for advantageous interest to clients represents accrued expenses for client deposits in respect of the Profit tariff (construction savings contracts concluded prior to 30 June 2001) which are recognised on an ongoing basis and to which the clients become entitled under certain conditions.

Other liabilities

23. Reserves

Development of the reserve and the recognition of other tax non-deductible reserves in 2009 were as follows:

24. Deferred Tax

Deferred tax is calculated from temporary differences between the tax base and carrying value using tax rates effective in period when the use of temporary tax difference is estimated, i.e. 19% applicable in 2010 and used for 2009.

The deferred income tax for the year ended 31 December 2009 reflects a difference between the accounting and tax net book values of assets and the cost of social security and health insurance on planned bonuses for managers and an estimate made in respect of outstanding vacation days for 2009. The deferred tax liability with an impact on equity represents a difference on the fair value remeasurement of the portfolio of securities available for sale. The change in the revaluation of securities is due to the decrease in market interest rates during 2009 and the related increase in the prices of securities.

Deferred tax asset and liability

Development of deferred tax asset and liability

25. Equity

The Bank’s share capital is CZK 500,000 thousand composed of 5,000 registered shares that are not tradable with a nominal value of CZK 100 thousand each. The sole shareholder of the Bank with the 100% equity investment is Komerční banka, a.s. with its registered office at Na Příkopě 33, Prague 1.

As of 31 December 2009, the Banks carries the statutory reserve fund of CZK 100,000 thousand, general reserve fund of CZK 1,007,138 thousand and valuation differences of CZK 477,501 thousand (CZK 589,507 thousand on a gross basis and the relating deferred tax of CZK −112,006 thousand), in the year ended 31 December 2008: CZK 186,038 thousand (CZK 232,548 thousand on a gross basis and the relating deferred tax of CZK −46,510 thousand).

26. Contingent Assets and Liabilities

The Bank reported no contingent assets and liabilities as of the balance sheet date.

Legal Disputes and Administrative Proceedings

As of 31 December 2009, the Bank was not involved in any legal dispute, the resolution of which would have a material impact on the Bank.

27. Related Party Transactions

Transactions with the Komerční banka, a.s. financial group

Remuneration and receivables from members of the Board of Directors and the Supervisory Board

The salaries of the members of the Supervisory Board elected by the Bank’s employee have not been reflected in the above table.

As of 31 December 2009, the Bank records no loan receivable from the members of the Board of Directors.

28. Risk Management

The inclusion of the Bank into the Société Générale/Komerční banka Group requires a gradual introduction of risk management standards adhered to by the whole Group which has a positive impact on the quality of management of all risks to which the Bank is exposed. The cooperation involves for example the implementation of tools for managing operational risks developed within the Group, introduction of scoring models in the area of retail receivables, and implementation of the IRB approach based on the model established in SG with respect to exposures on the financial market, etc.

Capital Management

The Bank manages its capital with the objective of maintaining a strong capital base to support its business activities and to meet capital regulatory requirements in the current period and going forward. As part of the capital planning process, the Bank takes into account both internal and external factors which are reflected in the corresponding internal targets expressed in targeted Tier 1 values and the capital adequacy ratio. The Bank’s capital level planning process is based on a regular capital structure analysis and a forecast which takes into account future capital requirements generated by increasing business volumes and future risks as expected by the Bank. This analysis principally leads to adjustments of the level of the Bank’s dividend pay-out, identification of future capital needs and maintenance of a balanced capital composition.

The Bank uses the Internal Rating Based Advanced Approach for the credit risk capital requirement calculation in respect of amounts due from banks, central banks and central governments. The Bank uses the Standardised Approach for the credit risk capital requirement calculation in respect of other exposures.

For amounts due from banks the Bank will use a central economic rating model developed by Société Générale. The model is based on variables of a qualitative questionnaire, including quantitative financial criteria, and country support questionnaire. Central models have also been developed for sovereigns (central banks and central governments).

The Bank uses the Standardised Approach for the operational risk capital requirement calculation.

(a) Credit Risk

Credit Risk Arising from Construction Savings (bridging and granted loan)

In the credit risk management process, the roles of individual departments are established so as to comply with the CNB’s regulatory requirements. Risk management and loan approval is separate from business activities at the level of the members of the Board of Directors. Any important decisions in the area of credit risk management are adopted by the Credit Risk Management Committee.

In addition to construction savings loans, the Bank provides ‘bridging loans’ to clients who have not yet met the criteria to be eligible to receive the construction savings loan. The bridging loans are designed to bridge the period over which the client is not yet entitled to receive a construction savings loan. The client drawing a bridging loan pays interest to a bridging loan account and, at the same time, makes mandatory additional payments to a savings account. The additional payments made to the savings account represent the credit risk indicator and make the client eligible for state support. Once the terms and conditions for the provision of a loan from the construction savings are met, the bridging loan is repaid partly from the amount accumulated on the savings account and partly from the newly provided loan from the construction savings.

Pursuant to the Construction Savings Act, loans advanced to the participants in the construction savings scheme must be used to accommodate their housing needs. The purpose of each loan is subject to the Bank’s review.

The Construction Savings Act places a limit on the proportion of loans entered into with legal entities. A similar restriction is put in place in respect of the volume of bridging loans granted to clients. The volume of bridging loans, together with loans to persons whose products and services are designed to meet housing needs, must not exceed 20% of the sum of the target amounts of the concluded contracts. In addition to these regulatory limits, the Bank maintains a system of internal limits which, among others, comprises solvency and collateral requirements.

Individuals (‘fyzicke osoby’)

The provision of loans to individuals represents the principal business of the Bank. As such, the loan portfolio is composed of a significant number of loan transactions of a relatively small volume and similar characteristics. With a view to limiting situations where the debtor is unable repay the loan as required, the Bank specifically refers to the following information (depending on the product type) in making a loan underwriting decision:

• Assessment of a client’s repayment ability based on documented income which is anticipated to be sustained in the future (after taking into account the expenses of a client);
• Assessment of a client using the scoring models that reflect both the savings and credit history of the client in the Bank and other available information on clients;
• Assessment of negative information on a client (the Bank uses Bankovní registr klientských informací (Client Data Banking Register) operated by CBCB and the register operated by SOLUS as well as other internal or freely available negative information); and
• Assessment of the quality of provided collateral.

Internal rules set out requirements to be followed in collateralising the provided loans. The Bank uses the following forms of collateral: collateral by guarantors, real estate, deposits and bank guarantees. Loans collateralised by real estate are largely issued up to 80% of the market value arrived at on the basis of an expert valuation report, for Hypoúvěr 100 mortgage loans up to 100% of the value arrived at on the basis of an expert valuation report. The Bank applies a conservative approach with respect to uncollateralised loans which are advanced only to clients with a history with the Bank or using the application scoring. Synergies within the KB Group have been reflected in the area of provided loans where the Bank employs the scoring models developed in close cooperation with KB.

Legal Entities (‘pravnicke osoby’)

Loans to legal entities are provided specifically to groups of owners of flats and housing associations. Loans provided to legal entities are assessed with reference to the financial position, debt service and payment health of the client at regular intervals.

Recovery, Restructuring and Write-Offs of Receivables from Debtors

The loan recovery process has three phases involving the prevention of the origination of classified loans, the out-of-court recovery phase and the court recovery phase. Classified loan receivables are recovered by the Distressed Loan Management Department and each overdue loan transaction is assessed on an individual basis.

At any phase of the loan recovery process, a loan restructuring can be performed. The restructuring is primarily effected by writing a bailiff’s deed. Since October 2009, the Bank has also used restructuring in the form of a short postponement of principal payments (additional payments).

A loan receivable is written off when the Bank determines that the receivable has become irrecoverable specifically through its assessment of a debtor’s financial and economic position and hence court recovery of the loan cannot be expected to be successful. The amount of receivables written off is disclosed in Note 14.

Credit Risk Monitoring

The Bank regularly monitors the development of the loan portfolio and, as part of its regular monitoring activities, it analyses the loan portfolio by individual types of products, collateral, individual classification grades of receivables and other criteria.

The Bank uses the standard methodology of monitoring according to default rates, i.e. by client default to repay the loan in particular periods. This approach makes it possible to identify early indications of portfolio quality impairment as well to compare the quality of the Bank’s portfolio to the quality of the parent company’s portfolio.

Loan Portfolio Quality

The proportion of classified loans increased from 3.74% as of the 2008 year-end to 3.85% as of 31 December 2009. As part of this category, the proportion of distressed exposures increased from 1.80% as of 31 December 2008 to 2.34% as of 31 December 2009. The increase in the volume of distressed loans to the detriment of watch loans is partially due to the tightening of rules for the transfer of the classification from KB under which clients classified as distressed in KB were classified at least as watch in the Bank in 2008; since 2009, they have been classified at least as substandard. The increase in the volume of substandard loans was also due to the volume of the above noted restructuring in the form of a short-term postponement of principal payments (additional payments).

Loan Categorisation

The Bank classifies loans primarily by reference to the number of past due days. The calculation of the number of the past due days reflects both the outstanding past due amounts on the loan account (interest on bridging loans and annuity repayments of loans under a construction savings scheme) and the savings debts in respect of bridging loans.

The savings debts have been reflected in the classification of loans since the end of 2007. Special rules for classification of receivables are applied to loans which are restructured by the Bank.

The classification of the receivable may also be impacted by ‘default transfers’, i.e., downgrading in circumstances where the debtor or co-debtor in the assessed loan participates in another classified loan at the Bank either as a debtor, co-debtor or guarantor. The default transfer is partially applied to clients that default on their loans provided by Komerční banka, a.s.

The amount of loans categorised by classification grades is provided in Note 14.

Provisioning

The Bank recognises provisions against classified exposures arising from provided loans. In charging the provisions, the Bank does not apply the portfolio approach; provisions are recognised in respect of individual receivables.

Loans are categorised into individual classification grades in accordance with the Czech National Bank Regulation 123/2007 Coll. The Bank categorises its loans into standard exposures and classified exposures (watch, substandard, doubtful and loss). The substandard, doubtful and loss exposures are collectively referred to as distressed loans. The Bank recognises provisions against classified receivables.

In determining coefficients to arrive at provisioning for individual classification grades, the Bank refers to its own statistical measurements and reflects the mandated coefficient ranges applicable to individual classification grades according to the CNB Regulation. The Bank is very prudent in setting the coefficients at almost the maximum level outlined in the Regulation 123/2007 Coll., which leads to a high level of provisioning for classified exposures. In determining the provisions, the Bank additionally takes into account the level and quality of loan collateral. For provisioning purposes, the nominal value of the collateral is adjusted for a discount reflecting the risk of realising the relevant type of collateral. This adjusted value is offset against the total loan exposure and the adjusted loan exposure serves as a basis for provisioning. The setting of discount coefficients for individual types of collateral is assessed on an ongoing basis by reference to the information regarding the recovery rates of individual forms of collateral.

Credit Risk Associated with Financial Markets

Available funds are primarily invested in zero-risk Government bonds. As such, credit risk is monitored solely in respect of investments in mortgage bonds and transactions in the interbank market. The Bank does not hold any assets issued by any other entity and has no financial markets exposures to any other entities than the Czech state and Komerční banka, a.s. The Czech state and Komerční banka are the only entities for which the Bank maintains a credit limit.

(b) Market Risks

Given that the Bank complies with the Construction Savings Act 96/1993 Coll., the possibilities of using financial instruments are limited. In 2009, in addition to bridging loans and construction savings loans, the Bank used the following financial instruments: depository transactions on the interbank market, investment in government bonds, and mortgage bonds, and it conducted repo transactions and securities transactions carrying the repurchase or sale commitment. The Bank does not include any of these instruments in the trading book. The Bank makes these investments to appreciate available funding while seeking to achieve the same interest rate profile as in passive client transactions. The Bank additionally carries no open currency, commodity or other positions that would depend on the development of market prices.

As the Bank does not hold foreign currency assets and liabilities, it does not present an analysis of assets and liabilities by balance sheet categories and principal currencies.

(c) Assets and Liabilities Management – Interest Rate Risk

Interest Rate Characteristics of the Bank’s Assets and Liabilities

Given the structure of assets and liabilities which show a timing mismatch and have different maturities or repricing dates, the Bank is exposed to interest rate risk. The bulk of liabilities consist of client deposits bearing a fixed interest rate throughout the entire life of the construction savings contract. In respect of the contracts entered into subsequent to 2004, the Bank has the option to revise interest rates on deposits provided that the participant meets the conditions for being granted a loan under the construction savings scheme and assuming that more than six years have elapsed. With regard to the contracts entered into prior to 2004, the interest rate remains valid throughout the contract term.

Provided construction savings loans and the bulk of securities held by the Bank in its portfolio also bear interest at fixed interest rates. The Bank may review the interest rate attached to long-term bridging loans after the lapse of six years. The possibility of reviewing interest rates attached to bridging loans relates only to contracts entered into subsequent to 1 July 2004. This fact is also reflected in the Bank’s interest rate model.

Interest Rate Risk Management

The Bank manages interest rate risk through its investment policy, changes in the setting of interest rate terms underlying new construction savings contracts and adjustments of client contractual arrangements. In an effort to improve the possibilities of interest rate risk management, the Bank sought to expand its banking licence to include hedging derivatives. The Czech National Bank approved the expanded licence in early 2008. The Bank has not yet utilised the option of entering into hedging derivatives to manage interest rate risk and effected no derivative transaction. All investment/hedging transactions are approved by the Assets and Liabilities Management Committee which also approves the rules and techniques used in developing the interest rate and liquidity positions. Cooperation with Komerční banka in assets and liabilities management involves Komerční banka’s representatives taking part in the Assets and Liabilities Management Committee meetings and assistance in modelling the development of balance sheet balances for client products.

Interest Rate Risk Measurement Techniques

Interest rate risk is the risk that net interest income will fluctuate due to changes in market interest rates. The basic instrument for monitoring and measuring interest rate risk is a gap analysis which represents an analysis of the difference in maturities of individual assets and liabilities. The substance of this technique involves comparing how quickly assets and liabilities respond to changes in market interest rates and how these changes impact the Bank’s net interest income. The technique is based on the allocation of assets and liabilities into time bands according to the period of their repricing (contractual change of the interest rate) or maturity.

In measuring interest rate risk, the Bank uses the polo-dynamic model which reflects both the existing balance sheet amounts and the future increase in deposits and loans, but only in respect of the existing construction savings contracts. In addition to the basic scenario, this polo-dynamic model is developed in two stress scenarios envisaging the rise and drop of interest rates and their impact on client behaviour.

The Bank additionally uses the sensitivity indicator to quantify the level of interest rate risk taken. The sensitivity indicator quantifies the impact of a parallel shift of the yield curve by 1%. The sensitivity indicator is calculated for all time periods. The Bank has established an internal limit in respect of this indicator.

The below table describes balances allocated to individual time buckets at the balance sheet date (static model which does not reflect the increase in the balance sheet amounts in respect of the existing contracts and which the Bank uses only as a supporting model for interest rate risk measurement).

Interest Rate Sensitivity of the Bank’s Assets and Liabilities

(d) Liquidity Risk

Liquidity risk is the risk that the Bank will not be able to meet its financial commitments when they fall due or will not be able to refinance its assets. The principal objective of liquidity management is to ensure the Bank’s ability to settle its payables at any point of time. The Bank has developed a liquidity management strategy which was approved by the Board of Directors.

The Bank monitors and controls liquidity in the context of managing the mandatory minimum reserves placed on the account in the CNB Clearing Centre. Current liquidity is monitored on a daily basis. The monitoring is performed with no less than a three month forecast.

The Bank outsources short-term liquidity management to KB which enables further drawing from the KB synergy potential as KB is in a better position to deposit and/or lend cash on financial markets.

As part of its risk management strategy, the Bank maintains a proportion of its assets in highly liquid instruments such as interbank market deposits with maturity less than three months, reverse repo transactions, treasury bills, and government securities. For measurement purposes, the Bank uses, inter alia, the quick assets ratio which represents the proportion of highly liquid assets net of loan commitments to total assets and to the amount of deposits where the blocking period expired.

The Bank additionally uses liquidity gaps as a supporting liquidity management tool. The Bank prepares two liquidity scenarios. The first scenario is based on a dynamic model, which shows the anticipated volume of renewed assets and liabilities (including anticipated new transactions), thereby indicating the most likely development of future cash flows. The second scenario is based on a semi-dynamic model. This scenario shows the situation that would occur if the Bank ceased entering into new construction savings contracts and providing bridging loans, thereby simulating a state in which the Bank would only settle the current contracts and all payables arising therefrom. The semi-dynamic model foresees the acceptance of new deposits and conclusion of new construction savings loans but only as part of the already existing construction savings contracts. In managing its liquidity risk, the Bank applies both scenarios; however, the limit is set only for the
semi-dynamic model which is prepared on a monthly basis.

For liquidity risk management purposes, the Bank uses the limits specified in its internal regulations.

The below table shows the allocation of balances to individual time buckets as of the balance sheet date (using a static model which does not reflect the increase in balances of the existing contracts and which serves only as a liquidity risk measurement supporting tool). In 2009, the Bank introduced a product for which clients undertake to maintain funds on savings accounts after the blocking period. For conservative reasons, balances of these clients are presented as other deposits after the blocking period expires.

The remaining maturity of the bank’s assets and liabilities

(e) Operational Risk

All significant decisions relating to operational risk management are adopted by the Operational Risk Management Committee.

The Bank collects data on losses arising from operational risks and data on loan fraud which also relates to credit risks. The loss data are forwarded to KB who uses them in calculating capital requirements under the Advanced Measurement Approach (AMA) developed by the Bank and applicable to the whole KB Group. However, the capital requirements are calculated by reference to the standard method (TSA) on the Bank’s level.

Other advanced instruments that the Bank uses for operational risk management involves monitoring the Key Risk Indicators (KRI), First Level Control (FLC) and the Risk Control Self Assessment (RCSA). The RCSA implementation started in 2009 but was not completed in 2008. Key Risk Indicators were regularly monitored during 2009 and First Level Controls were performed in the entire Bank.

The Bank’s internal regulations define practices and procedures to be followed in recovering IT systems in disaster situations (disaster recovery planning) and IT security management principles. In 2009, new plans for business continuity were developed under the applicable methodology of the SG group, principles were documented in guidelines and work procedures.

The Bank eliminates operational risk through internal operating controls existing within processes and activities, such as liquidity management and trading on financial markets. Internal regulations define responsibilities for individual processes and the approach to monitoring, record-keeping and dealing with events that trigger damage.

29. Post Balance Sheet Events

Pursuant to the resolution of the sole shareholder dated 22 December 2009, Jan Pokorný was appointed member of the Board of Directors with effect from 1 January 2010. The Board of Directors appointed him Chairman of the Board of Directors at its meeting held on 4 January 2010. The appointment was recorded in the Register of Companies on 1 February 2010.

As of 31 December 2009, André Léger resigned from the position of Chairman and member of the Board of Director. He was removed from the Register of Companies on 1 February 2010.

Pursuant to the resolution of the sole shareholder dated 8 December 2009, Tomáš Tomiczek was appointed member of the Supervisory Board with effect from 8 December 2009. The appointment was recorded in the Register of Companies on 7 January 2010.