BANKING CLIMATE IN BULGARIA -BANKING CLIMATE IN BULGARIA -access to finance, corporate sector funding access to finance, corporate sector funding sources and loan conditions sources and loan conditions

Kristofor Pavlov, Kristofor Pavlov, Chief Economist Chief Economist Bulbank member of UniCredit GroupBulbank member of UniCredit GroupSofia, 08Sofia, 08thth June 2005 June 2005

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BANKING MARKET – SIZE, DEPTH, PENETRATION AND ACTIVITIES

2004 2001 2002 2003 2004

9,731 15,2 16,5 17,7 19,4382 7,9 7,9 7,8 7,8

25,462 1,925 2,107 2,264 2,504

n.a. 41% 45% 50% 66%94% 15% 20% 27% 37%72% 30% 32% 36% 43%n.a. 0,03% 0,03% 0,07% 0,15%

BULGARIANE(12) EU (15)

Size of the marketGDP (in billion Euro) 807Population (million) 179Per capita GDP 4,499 Banking sector volumesTotal Assets / GDP n.a.Total Loans / GDP 29%Total Deposits / GDP 40%Total AUM / GDP n.a.

2004

Banking activitiesBranches per mln inhabitant Number of employees (thousands)Share FX DepositsShare FX Loans n.a. n.a. 35 41 42 47

n.a. n.a. 56 52 46 44

234* 513** 81 110 120 135n.a. n.a. 21 21 22 23

Strong growth drives intermediation levels quickly to approach NE standards Still room for branch banking expansion Large share of FX activities, due to openness of the economy and monetary

arrangement chosen.

Source: BNB, Bulbank & UCI database*Data for NE12 for 2001. ** Data for EU is and EU15 is for 2000.

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SUCCESSFUL STRUCTURAL TRANSFORMATION

Source: New Europe Research Network, based on Central Bank Statistics.(1) Data as of 2003

0.4% 0.4% State ownedState owned

82.9% 82.9% Foreign Foreign ownedowned

60.6% 60.6% State ownedState owned

16.7% 16.7% Other Other

32.3% 32.3% Foreign Foreign ownedowned

7.1% 7.1% Other Other

19981998 20042004

6

96.3

36

58.2

67.8

95.6

47.2

83.382.3

96 97.390

0

10

20

30

40

50

60

70

80

90

100

BG CZ EST HR HU LAT LIT PL ROM SK SL TK

Foreign ownership in NE12as % of total assets¹

With privatization completion market structure in terms of key players is fixed. Market liberalisation and restructuring achieved indirectly via foreign banks entry. Foreign banks impact on local market:

Inflow of capital and new market behaviour; New segment and product development; Transfer of experience, new practices and competencies; IT and Human Resources enhancement

Bulgaria Total assets by ownership

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* Bulbank’s estimate based on BNB data

Bank’s importance for Bank’s importance for investment assets investment assets acquisitionacquisition

Bank’s share in Bank’s share in financing the residential financing the residential property marketproperty market

Bank’s funding of Bank’s funding of household consumption household consumption expenditure expenditure

8,1% 7,4%10,7% 11,5%

18,0%

26,0%

32,8%

0%

10%

20%

30%

40%

1998 1999 2000 2001 2002 2003 20040%

15%

30%

45%

60%

75% Newly extended long-term corporate loansfrom local banks* /Gross fixed capitalformation (left scale)Gross fixed capitalformation/GDP (rightscale)

9,7%5,5% 4,9% 6,3% 7,2%

10,4% 12,0%

0%

10%

20%

30%

40%

1998 1999 2000 2001 2002 2003 20040%

15%

30%

45%

60%

75% Newly extendedmortgage loans/Residential propertymarket turnover*

Residential propertymarket turnover*/GDP (right scale)

2,6% 1,4% 1,7% 2,5% 3,2% 6,1%9,5%

0%

10%

20%

30%

40%

1998 1999 2000 2001 2002 2003 20040%

15%

30%

45%

60%

75% Newly extended consumerloans/ Householdconsonsumptionexpenditure (left scale)

Household consumptionexpenditure/GDP (rightscale)

LOANS EXTENDED BY LOCAL BANKS – KEY DRIVER OF DOMESTUIC DEMAND

5

2,8

7,2

5,2

2,62,02,62,74,04,54,4

7,98,6

9,910,310,8

12,412,5

2,01,91,31,31,31,71,7 1,7

6,06,9

8,69,19,510,610,8

0,0

2,0

4,0

6,0

8,0

10,0

12,0

14,0

2000 2001 2002 2003 2004 2005f 2006f 2007fBasic Interest Rate (avg) Avg Lending (BGN+FX)Avg. Deposit (BGN+FX) Spread (BGN+FX)

2,5

6,0

8,59,5

11,2

13,3

15,216,016,917,0

2,32,21,81,71,41,81,9

7,29,0

11,6

13,514,715,215,1

0,02,04,06,08,0

10,012,014,016,018,0

2000 2001 2002 2003 2004 2005f 2006f 2007f

Retail lending Retail deposit Retail Spread

6,46,56,98,69,0

9,9

11,612,0

2,12,01,71,01,01,31,71,6

4,34,55,2

7,68,08,6

9,910,4

0,02,04,06,08,0

10,012,014,0

2000 2001 2002 2003 2004 2005f 2006f 2007fCorporate Lending Corporate Deposit Corporate spread

Average Interest Rate

Retail Interest Rate

Corporate Interest Rate

INTEREST RATES – FAST REDUCTION IN COST OF BOOROWING

General methodology note – applicable interest rates are on newly extended loans and newly contracted deposits

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LENDING BOOM – MORE OR LESS STANDARD PHENOMENON FOR TRANSITION COUNTRIES; IN BULGARIA – OVERDUE CATCH UP

Yearly change in Loans-to-GDP ratio (1999-2004)

Source: Data for Estonia, Lithuania, Hungary, and Slovenia is taken from EuroStat.

Lending boom determinants:strong capital inflow and access to international funding market;cutback in borrowing costs;local savings growth recovery;risk reduction due to improving operating environment; newly privatized bank’s owners search for profit maximization opportunities; rising investment demand to close the technology and productivity gap with EU;demand for consumer durables recovers from the depressed levels in 1997, households confident in their improved debt service capacity;crowding-in effect, due to prudent fiscal policy and reduced borrowing needs of the pubic sector.

-6%

-4%

-2%

0%

2%

4%

6%

8%

10%

12%

14%

Bulgaria Croatia Poland Romania Estonia Lithuania Slovenia

199920002001200220032004

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Lending growth impact on external accounts and inflation

LENDING BOOM - MACROECONOMIC IMPLICATION & RISKS

Source: National Statistics Office and Central Bank* Real estate prices refer to average selling price of apartments in Sofia town

10,5 11,9 12,319,9

27,5

36,8

15,2

1,4-8,8-8,4

15,5

-4,2

41,0

71,2

- 20- 10

01020304050607080

1998 1999 2000 2001 2002 2003 2004

CA / GDP

Customer Loans / GDP

Growth in real estate prices*

CPI Inflation

6,2

Sharp rise in the availability of financing undergird economic expansion since 2002. However, fast lending growth:

fuels internal demand which in turn exercise pressure on import causing CA deficit to widen - a standard phenomenon for a transition country. no impact on prices inflation as CPI is rather driven by supply side determinants no assets price bubbles so far. Rising real estate prices - another overdue catch up process.

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LENDING BOOM – BANKING SECTOR STABILITY IMPLICATIONS AND RISKS

Credit quality indicators (2001 – 2004)

Source: BNB reported data.

  2001 2002 2003 2004

NPLs Non-performing Loans * 356 320 372 493 Substandard Loans 153 140 139 212 Loss Loans 203 180 233 281

Coverage Ratio      NPLs ratio over gross loans 7,9% 5,0% 3,9% 3,5%

Total Provisions / Total Gross Loans 7,9% 5,5% 3,8% 3,4%Total Provisions / NPLs 101% 112% 97,5% 95,3%

Net provisions (flow) / Total Operating Income -10,5% -1,4% 1,0% -8,8%

* Before 2004 NPL also include doubtful loan classification category.

Credit quality is a relevant concern.

Some smaller banks seems to lack adequate:

risk management skills; discipline; experience and financial strength.

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1 time 2 times more than 3 times not once

How many times has your company applied for a bank credit in 2004? 24,2% 21,1% 31,9% 31,9%How many times has your company applied for a bank credit for the last 2 years? 36,3% 17,6% 22,0% 24,2%

Application for banking credit

Frequent changes in legislation 24,2%Complex and over-beurocratic licensing procedures 19,8%Unsufficient demand 12,1%Cumbersome administrative procedures for start-up businesses 8,8%High taxes and insurance contribution payments 7,7%Corruption 4,4%Inefficient legal system 4,4%Difficult access to credit 3,3%Non-guaranteed property rights 2,2%Others 8,8%No reply 4,4%

Major hurdles for real sector development

ACCESS TO LENDING IS NOT A SETBACK FOR LARGE COMPANIES

Substantial loans concentration – 1100 companies control 60% of outstanding loans. Generally these are large companies with sales revenues above BGN 5mln. Despite its rising significance for the economy SME sectors still remains relatively isolated from bank lending. Looking forward SME’s will become increasingly a focus of attention of banks.

* Data are from poll conducted by Alpha Research in early 2005 among 130 regular corporate bank borrowers

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borrowers' responses

I ncresed substaintially 11,0%I ncreased moderately 42,9%Stayed the same 19,8%Decreased moderately 12,1%Decreased substaintially 5,5%Cannot determine 4,4%No reply 4,4%

LOANS DEMAND ON THE RISE IN 2004. STILL LARGE RELEVANCE OF ALTERNATIVE FUNDING SOURCES STRUCTURE

Although, all polled Although, all polled companies have already used companies have already used 1 or more loans, only some 1 or more loans, only some one third has never used one third has never used alternative funding sourcesalternative funding sources Leasing

37,2%

No alternative

credit sources used

32,9%

Credits from partners and shareholders

22,0%

Credits from other

companies 19,8%

Credits from friends and relatives 3,3%

Other5,5%

* As percent of the number of companies in the poll.

Alternative funding sources*

In what way has the In what way has the need for banking credit need for banking credit for your company for your company changed in 2004?changed in 2004?

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Borrowers eligibility requirements changes in 2004

borrowers' responses

Tightened substantially 5,5%Tightened moderately 7,7%Stayed the same 48,4%Loosened moderately 28,6%Loosened substaintially 5,5%No reply 4,4%

(in % )

maximum amount of the

loanloan

durationcost of

borrowingrisk

premiumsize of

collateralliquidity of collateral others

Tightened substantially 4,4 3,3 4,4 5,5 6,6 4,4 1,1Tightened moderately 4,4 4,4 5,5 5,5 16,5 14,3 -Stayed the same 42,9 50,5 40,7 48,4 47,3 45,1 8,8Loosened moderately 28,6 24,2 31,9 14,3 14,3 14,3 3,3Loosened substaintially 4,4 3,3 3,3 2,2 1,1 1,1 -No reply 14,3 14,3 14,3 24,4 14,3 20,9 86,8

How have borrowers How have borrowers eligibility requirements eligibility requirements applied by banks changed applied by banks changed in 2004?in 2004?

BANKS HAVE LOOSENED BORROWERS ELLIGIBILITY REQUIREMENTS

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EU AND EMU ACCESSION HIGHLIGHT THE NEED OF ADDITIONAL INVESTMENT, …

IMPROVING MACROECONOMIC FUNDAMENTALS

IMPROVING OPERATING ENVIRONMENT – enforcement of contracts, property rights, corporate governance - all driving risk level down

COMPETITIVENESS – low cost of inputs and especially labour

INTERNATIONAL SPECIALISATION – still large share of low value added exports

TECHNOLOGY TRANSFER – import of investment goods, FDI and imitation

STRUCTURAL RIGIDITIES REDUCTION – still fundamental prerequisite;

ALL LEADING TO NEED OF STRONG INVESTMENT ACTIVITY AHEAD OF EU

ACCESSION

SOPHISTICATION OF DOMESTIC DEMAND – requiring high quality in customer service and fast reaction to changes in the customers’ needs

and preferences; EU STRUCTURAL FUNDS – lead to rising

incomes in some sectors as agriculture but could disguise loss maker and harm efficiency;

INCREASING COST OF LABOUR – requires to develop and sustain other competitive advantages

FOLLOWING EMU ENTRY – better access to external finnacing, no exchange rate risk and substatial bonus in terms of country risk reduction. Cope with monetary policy rather targeted at core EU countries;

ALL SUGGESTING IMPROVEMENT IN OPERATING CONDITIONS IN ACCESS TO

FINANCING AND RISK REDUCTION

CURRENT MARKET TRENDS

CHALLENGES AND OPPORTUNITIES

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ThankThank you!you!