Erste Bank : Management Report 2022

Management report

BUSINESS PERFORMANCE AND ECONOMIC SITUATION

Economic environment

After a robust rebound in 2021 economic growth slowed markedly in 2022 primarily on the energy supply shock resulting from the Russia- Ukraine war, fiscal measures to curb inflation and China's ongoing Covid restrictions. Inflation soared to multidecade highs leading to monetary policy tightening across the world. In addition, Covid remained a headwind to growth, even after most countries lifted restrictions on economic and social activities in the course of the year. Supply chain issues continued to impact the recovery of manufacturing production, albeit to a diminishing extent. Labour markets, on the other hand, remained robust. Overall, global real GDP increased by 3.4%, at the beginning of 2022 it had been forecast at 4.4%.

Among the world's advanced economies, both the United States and the euro zone saw declining real GDP growth rates. Economic effects of Russia's invasion of Ukraine, a short-lived hit from the Omicron wave, tighter financing conditions, declining real disposable income driven by fiscal normalisation and high inflation all had an impact on the global economic performance.

The military conflict between Russia and Ukraine and resulting sanctions disrupted exports from the region for commodities like metals, food, oil and gas, pushing up inflation to levels not seen in decades. Against the backdrop of the high dependency of Austria and some core markets on Russian gas natural gas prices declined after summer due to high levels of gas storage and reduced supply from Russian gas. As a response to high inflation non euro central banks already started monetary tightening in 2021, the European Central Bank (ECB) followed in 2022. In addition, governments implemented measures such as price caps, subsidies and tax cuts. Similar to other advanced economies, labour markets in the euro zone remained very strong with unemployment rates declining in most countries. Overall, the euro area economy grew by 3.5%.

Central banks have to cope with the trade-off - intensified by the ongoing geopolitical crisis - between fighting inflation and working to stabilise the economy, financial and public debt. To bring down persistently high inflation rates, the central banks issued clear signals and ended their previously expansionary monetary policies. After rates had been raised in a number of CEE countries and in the United Kingdom, the US Federal Reserve (Fed) likewise started its rate-hike cycle in mid-March. With some time lag, the European Central Bank (ECB) likewise ended its zero-interest-rate policy after more than six years in July by embarking on its first rate hike in 11 years. Overall, the ECB raised its benchmark rate four times to 2.5% at year-end and revised the terms of the targeted longer-term refinancing operations (TLTROs). Rising interest rates and higher volumes in its markets had a positive impact on Erste Group's net interest income. The revised terms and conditions of TLTRO resulted in an adverse impact on net interest income.

Austria's economic performance was better than expected during the year, it outperformed the European Union average. Economic growth, visibly more pronounced in the first half of the year, was supported by almost all sectors of the economy, in particular transportation, hospitality, services and manufacturing. In most sectors pre-pandemic levels were reached or even exceeded. Austria's well developed tourism sector continued to recover as travel restrictions significantly eased. Trade was also a key contributor to this development. The second half of the year, however, saw an economic slowdown in Austria. Growth was significantly impacted by a decline in disposable income due to high inflation. In addition, supply chain disruptions had a negative impact on investments and industrial activity. While most Covid related measures expired during the year, the government launched support packages aimed at easing the effects of surging inflation. Measures included in particular tax benefits and one-off payments, such as climate bonuses. Austria's gas storage level increased rapidly and was among the highest in the European Union by the start of the winter. Inflation peaked in October at 11.0% while average inflation amounted to 8.6% in 2022. The Austrian labour market proved its resilience once again, the unemployment rate stood at 5.8% and the number of registered long-term unemployed people by the end of 2022 was the lowest since 2014. Overall, the Austrian economy grew by 4.7%.

The Central and Eastern European economies also performed better than expected. Growth expectations were upgraded during the year including countries with - prior to the Russian-Ukrainian war - heavy dependencies from Russian gas, such as the Czech Republic, Slovakia or Hungary. Romania and Croatia, on the other hand, which rely significantly less on Russian natural gas, achieved highest growth rates in the region. Household consumption, which was one of the main drivers of the economic growth, slowed down visibly in the second half of the year. Despite supply chain disruptions, exports grew dynamically. The automotive sector, with its significant volume of backlogs, contributed visibly to economic growth. Croatia was supported by the rebound of its tourism sector.

Inflation rates continued to climb throughout the year with many of the CEE countries exceeding 15% in autumn. In response to soaring prices, central banks moved forward with monetary tightening. Key interest rates went up by more than 3% points in the Czech Republic, almost 5% points in Romania and Poland and 15% points in Hungary. Monetary conditions were also affected through other tools such as reduction of balance via FX intervention in case of the Czech Republic or stricter liquidity management and higher reserve requirements in case of Hungary. Labour markets remained very robust in the region, with unemployment rates at or close to historically low levels in most of the CEE countries. Czech Republic and Hungary were among the countries with the lowest unemployment rates in the European Union.

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CEE governments introduced a range of measures to support households and businesses. These measures included a cap on electricity prices or direct energy subsidies. Windfall profits taxes were also introduced in a number of CEE countries, such as Hungary and Croatia. As for the currency market, the Hungarian forint clearly underperformed regional peers, weakening more than 10% in 2022. Other CEE currencies, such as the Romanian leu or the Czech korona remained broadly stable against the euro. On 1 January 2023, Croatia became the 20th member of the eurozone. Overall, CEE economies achieved GDP growth rates ranging from 1.7% in Slovakia to 6.0% in Croatia in 2022.

Analysis of performance

In the group management report P&L data of 2022 is compared with data of 2021, balance sheet data as of 31 December 2022 is compared to data as of 31 December 2021. The entire development is presented in detail in the notes to the consolidated financial statements.

Profit and Loss Statement

in EUR million	2021	2022	Change
Net interest income	4,975.7	5,950.6	19.6%
Net fee and commission income	2,303.7	2,452.4	6.5%
Net trading result and gains/losses from financial instruments at FVPL	231.8	-47.3	n/a
Operating income	7,742.0	8,570.6	10.7%
Operating expenses	-4,306.5	-4,574.9	6.2%
Operating result	3,435.5	3,995.8	16.3%
Impairment result from financial instruments	-158.8	-299.5	88.6%
Other operating result	-310.5	-398.5	28.3%
Levies on banking activities	-73.5	-187.1	>100.0%
Pre-tax result from continuing operations	2,933.4	3,222.4	9.9%
Taxes on income	-525.2	-556.1	5.9%
Net result for the period	2,408.1	2,666.3	10.7%
Net result attributable to non-controlling interests	484.8	501.6	3.5%
Net result attributable to owners of the parent	1,923.4	2,164.7	12.5%

Net interest income

Net interest income rose significantly in both private and corporate business. The increase in retail business was due to higher market rates in the Czech Republic, Hungary, Romania, Austria and Slovakia as well as growth of loan volumes predominantly in the Czech Republic, Slovakia and Austria driven by housing loans. In the corporate business it improved markedly on the back of continued loan growth in all markets and, most importantly, higher interest rates in particular in the Czech Republic, Hungary and Romania. Group Market's net interest income also increased due to higher market interest rates, favorable market positioning in interest rate derivatives and higher volumes of money market placements.

Despite one-off effects from the take-up of TLTRO III funds in the amount of EUR -123.2 million (EUR +93.0 million), net interest income was also up in Austria and Slovakia. The net interest margin (calculated as the annualised sum of net interest income, dividend income and net result from equity method investments over average interest-bearing assets) stood at 2.21% (2.05%).

Net fee and commission income

Growth was recorded across all core markets and nearly all fee and commission categories. In all markets, the strongest rises were seen in payment services (based on a higher number of trans-actions as well as price increases) and in asset management, most significantly in Austria and the Czech Republic.

Net trading result & gains/losses from financial instruments measured at fair value through profit or loss

Net trading result as well as the line item gains/losses from financial instruments measured at fair value through profit or loss (fair value result) are materially affected by the fair value measurement of debt securities issued. The related valuation is shown in the fair value result, while the valuation of corresponding hedges is shown in the net trading result.

Due to valuation effects resulting from interest rate developments in the derivatives business, net trading result deteriorated to EUR 778.6 million (EUR 58.6 million). Gains/losses from financial instruments measured at fair value through profit or loss trended in the opposite direction and rose to EUR 731.3 million (EUR 173.2 million). With long-term interest rates up, losses from the valuation of the securities portfolio in Austria (in the Savings Banks segment) and the loan portfolio measured at fair value in Hungary were offset by significantly higher gains from the valuation of debt securities in issue.

General administrative expenses

in EUR million	2021	2022	Change
Personnel expenses	2,578.1	2,668.0	3.5%
Other administrative expenses	1,180.3	1,356.2	14.9%
Depreciation and amortisation	548.0	550.7	0.5%
General administrative expenses	4,306.5	4,574.9	6.2%

Personnel expenses increased most significantly in the Czech Republic but also in Romania and Croatia. General administrative expenses rose across all cost categories. In addition to markedly higher IT expenses in Austria on the back of continuing digitalisation efforts, expenses

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for office space were up in all core markets due to significantly higher energy costs. Contributions to deposit insurance systems increased to EUR 142.9 million (EUR 122.4 million). In Hungary, expenses rose to EUR 18.2 million (EUR 7.1 million) mainly due to a deposit insurance case (Sberbank Europe AG). In Romania, contributions increased to EUR 9.3 million (EUR 3.4 million), in Croatia to EUR 7.5 million (EUR 1.9 million). In Austria, contributions declined to EUR 79.7 million (EUR 85.5 million). The cost/income ratio improved to 53.4% (55.6%).

Gains/losses from derecognition of financial instruments not measured at fair value through profit or loss

Losses from derecognition of financial instruments not measured at fair value through profit or loss amounted to EUR 75.3 million (EUR 32.8 million). This line item includes primarily losses from the sale of securities in the Czech Republic.

Impairment result from financial instruments

The impairment result from financial instruments amounted to EUR -299.5 million (EUR -158.8 million). Net allocations to provisions for loans and advances rose, primarily on the back of allocations in Austria, to EUR 336.4 million (EUR 119.1 million). Positive contributions came from continued high income from the recovery of loans already written off in all segments - primarily in the Czech Republic, Austria and Croatia - in the amount of EUR 82.1 million (EUR 90.8 million). Net allocations for commitments and guarantees declined to EUR 27.6 million (EUR 104.8 million). Net allocations to credit loss allowances were driven mainly by updated credit risk parameters based on the latest macro-scenarios (FLIs) as well as portfolio stage overlays for cyclical and energy intense industries. At the end of December, crisis-induced performing risk provisions stood at EUR 928 million.

Other operating result

Other operating result was largely affected by levies on banking activities in the amount of EUR 187.1 million (EUR 73.5 million). Banking levies payable in Austria were up at EUR 63.0 million (EUR 10.5 million). Half of this rise is due to a one-off effect in 2022. Regular Hungarian banking tax rose marginally to EUR 15.1 million (EUR 15.0 million). Together with financial transaction tax in the amount of EUR 59.1 million (EUR 47.9 million) and a new windfall profit tax of EUR 49.9 million based on the net revenues of the preceding year, banking levies in Hungary totalled EUR 124.1 million (EUR 63.0 million).

The balance of allocations/releases of other provisions improved to EUR 46.3 million (EUR 5.1 million). Legal risks relating to the Roma- nian building society resulted in expenses in the amount of EUR 46.9 million. In addition, a provision in the amount of EUR 20.1 million was set aside following the held-for-sale classification of a Romanian subsidiary. These negative effects in Romania were partly offset by the release of provisions in the amount of EUR 54.3 million for risks resulting from consumer protection claims. In addition, other operating result also reflects the annual contributions to resolution funds in the amount of EUR 139.1 million (EUR 108.6 million). Increases were recorded above all in Austria, to EUR 73.9 million (EUR 51.5 million), and in the Czech Republic, to EUR 39.2 million (EUR 31.9 million).

Balance sheet

in EUR million	Dec 21	Dec 22	Change
Assets
Cash and cash balances	45,495	35,685	-21.6%
Trading, financial assets	53,211	59,833	12.4%
Loans and advances to banks	21,001	18,435	-12.2%
Loans and advances to customers	180,268	202,109	12.1%
Intangible assets	1,362	1,347	-1.1%
Miscellaneous assets	6,090	6,456	6.0%
Total assets	307,428	323,865	5.3%
Liabilities and equity
Financial liabilities held for trading	2,474	3,264	31.9%
Deposits from banks	31,886	28,821	-9.6%
Deposits from customers	210,523	223,973	6.4%
Debt securities issued	32,130	35,904	11.7%
Miscellaneous liabilities	6,902	6,599	-4.4%
Total equity	23,513	25,305	7.6%
Total liabilities and equity	307,428	323,865	5.3%

Cash and cash balances declined to EUR 35.7 billion (EUR 45.5 billion), mostly due to the early repayment of TLTRO III funds. Trading and investment securities held in various categories of financial assets increased to EUR 59.8 billion (EUR 53.2 billion).

Loans and advances to banks (net), including demand deposits other than overnight deposits, declined to EUR 18.4 billion (EUR 21.0 bil- lion). Loans and advances to customers (net) increased - primarily in Austria and the Czech Republic - to EUR 202.1 billion (EUR 180.3 bil- lion). Loan loss allowances for loans to customers amounted to EUR 4.0 billion (EUR 3.9 billion). The NPL ratio - non-performing loans as a percentage of gross customer loans - improved to 2.0% (2.4%), the NPL coverage ratio (based on gross customer loans) rose to 94.6% (90.9%)

Financial liabilities - held for trading increased to EUR 3.3 billion (EUR 2.5 billion). The decline in de-posits from banks to EUR 28.9 billion (EUR 31.9 billion) is primarily due to the early repayment of TLTRO III liabilities, the end-of-year carrying value of which was

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EUR 15.6 billion (EUR 20.9 billion). Deposits from customers rose to EUR 224.0 billion (EUR 210.5 billion), mostly on the back of strong growth in term deposits. The loan-to-deposit ratio stood at 90.2% (85.6%). Debt securities in issue increased to EUR 35.9 billion (EUR 32.1 billion).

Total assets rose to EUR 323.9 billion (EUR 307.4 billion). Total equity increased to EUR 25.3 billion (EUR 23.5 billion). This includes AT1 instruments in the amount of EUR 2.2 billion from four issuances (April 2017, March 2019, January 2020 and November 2020). After regulatory deductions and filtering according to the Capital Requirements Regulation (CRR) common equity tier 1 capital (CET1, CRR final) rose to EUR 20.4 billion (EUR 18.8 billion) as were total own funds (CRR final) to EUR 26.2 billion (EUR 24.8 billion). Total risk - risk-weighted assets including credit, market and operational risk (CRR final) - increased to EUR 143.9 billion (EUR 129.6 billion).

The total capital ratio, total eligible qualifying capital in relation to total risk (CRR final), declined to 18.2% (19.1%), but remained well above the legal minimum requirement. The tier 1 ratio stood at 15.8% (16.2%), the common equity tier 1 ratio stood at 14.2% (14.5%) (both ratios CRR final).

Cash earnings per share amounted to EUR 4.85 in 2022 (EUR 4.18). Earnings per share are EUR 4.83 (EUR 4.17).

The cash return on equity, i.e. the return on equity adjusted for non-cash expenses such as goodwill amortization and straight-line depreciation for the customer relationships, was 12.7% (return on equity: 12.6%) after 11.7% (return on equity: 11.6%) last year.

Branches

Erste Group Bank AG maintains branches in New York, Hong Kong and Germany (Berlin and Stuttgart) that provide commercial lending to foreign banks, leasing companies and sovereign debtors as well as institutional sales.

EXPECTED DEVELOPMENT AND RISKS OF THE GROUP

Long-term growth trends in Central and Eastern Europe

In line with growing economic performances disposable income have risen significantly, in particular in the Czech Republic. In addition, most countries of Central and Eastern Europe have human resources that are at least equivalent to those of Western European countries and have labour markets that are considerably more flexible. These advantages are complemented by - on average - highly competitive export industries that benefit from wage costs that are low relative to workforce productivity and from investor-friendly tax and welfare systems.

A comparison of per capita private debt levels in Central and Eastern Europe with those of advanced economies reveals the gap that exists between these markets. Private debt levels, and particularly household debt, are substantially lower than in the advanced economies. Erste Group firmly believes that credit expansion accompanied by economic growth in this region will prove to be a lasting trend rather than a short-term process that has already peaked.

Over the upcoming 15 to 20 years, on average, the countries of the eastern part of the European Union are therefore expected to experience higher growth rates than the countries of Western Europe, even though periods of expansion may alternate with times of economic stagnation or even setbacks on this long-term path of sustainable growth.

Customer banking in Central and Eastern Europe

The of Erste Group's banking business are essentially the business segments of retail business, corporate business and the capital markets business. For further information on the business segments, we refer to Note 1 in the consolidated financial statements.

Retail business

Erste Group's key business is the retail business, covering the entire spectrum from lending, deposit and investment products to current accounts and credit cards. Erste Group's core competence in retail banking has historical roots. In 1819, wealthy Viennese citizens donated funds to establish Erste Group's predecessor, the first savings bank in Central Europe. It was their aim to bring basic banking services such as safe savings accounts and mortgage loans to wide sections of the population. Today, the bank serves some 16.1 million customers in its markets and operates about 2,100 branches. Wealthy private clients, trusts and foundations are served by the bank's private banking staff and benefit from services that are tailored to the needs of this target group.

In addition, the bank uses and promotes digital distribution channels such as internet and mobile banking not only to meet the increasing importance of digital banking but to actively shape the digital future. George, Erste Group's digital platform, is already available in Austria, the Czech Republic, Slovakia, Romania, Croatia and Hungary. It will also be rolled out in Serbia.

Retail banking is attractive to Erste Group for a number of reasons: It offers a compelling business case that is built on market leadership, an attractive risk-reward profile and the principle of self-funding. In addition, it benefits from a comprehensive range of products that are simple and easy to understand and provide substantial cross-selling potential. Erste Group takes advantage of these factors in all core markets and makes best use of its resulting position of strength by pursuing an omni-channel strategy. Erste Group's omni-channel approach

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integrates the various sales and communication channels. Customers decide on how, when and where they do their banking business. Contact centers serve as interfaces between digital banking and traditional branch business. These contact centers offer advice and sales, thus going far beyond the traditional help desk function.

In addition to the expansion of digital sales channels, the branch network remains an important component of the business strategy. Only a retail bank that offers modern digital services and operates an extensive distribution network is able to fund loans in local currency mainly from deposits made in the same currency. In short, Erste Group's retail banking model supports sustainable and deposit-funded growth even in economically more challenging times. Another positive factor is the diversification of the retail business across countries that are at differing stages of economic develop-ment, such as Austria, the Czech Republic, Romania, Slovakia, Hungary, Croatia and Serbia.

Corporate business

The second main business line, which also contributes significantly to Erste Group's earnings, is business with small and medium-sized enterprises, regional and multi-national groups and real estate companies. Erste Group's goal is to enhance relationships with its clients beyond pure lending business. Specifically, the bank's goal is for SMEs and large corporate customers to choose Erste Group as their principal bank and also route their payment transfers through the Group's banking entities and, in fact, regard Erste Group as their first point of contact for any kind of banking service.

Catering to their different requirements, Erste Group serves small and medium-sized enterprises locally in branches or separate commercial centres, while multinational groups are serviced by the Group Corporates' units. This approach permits Erste Group to combine industry- specific and prod-uct expertise with an understanding of regional needs and the experience of the bank's local customer relationship man- agers. In view of regulatory interventions, advising and supporting corporate customers in capital market transactions is becoming increasingly important.

Capital markets business

Client-driven capital markets activities are also part of the comprehensive portfolio of products and services that Erste Group offers to its retail and corporate customers. The strategic significance of the bank's centrally governed and locally rooted capital markets operations consists in supporting all other business areas in their dealings with the capital markets and, hence, in providing the bank's customers with professional access to the financial markets. Erste Group, therefore, views its capital markets business as a link between financial markets and its customers. As a key capital markets player in the region, Erste Group also performs important functions such as market making, capital market research and product structuring.

The capital markets business serves the needs of Erste Group's retail and corporate customers as well as those of government entities and financial institutions. Due to Erste Group's strong network in the eastern part of the European Union, the bank has a thorough understanding of local markets and customer needs. In Erste Group's capital markets business, too, the bank concentrates on core markets of the retail, SME and large corporate business: Austria, the Czech Republic, Slovakia, Romania, Hungary, Croatia and Serbia. For institutional custom- ers, specialised teams have been established in Germany and Poland as well as in Hong Kong and New York that offer these customers a tailor-made range of products.

In many countries where Erste Group operates, the local capital markets are not yet as highly developed as in Western Europe or in the United States of America. That means Erste Group's banking subsidiaries are pioneers in some of these markets. Therefore, building more efficient capital markets in the region is another strategic objective of Erste Group's capital markets activities.

Outlook

Erste Group's goal for 2023 is to achieve a return on tangible equity (ROTE) in the range of 13 to 15%. Four key factors will support achievement of this goal: firstly, positive economic growth in all core markets (Austria, Czech Republic, Slovakia, Romania, Hungary, Croatia and Serbia) despite significant geopolitical and political risks, which, should they materialise, would likely negatively impact economic performance; secondly, an interest rate environment that is characterised by broadly stable central bank rates in such countries as the Czech Republic, Romania and Hungary, as well as euro zone interest rates that rise in line with market expectations (as per mid-February 2023); thirdly, a credit risk environment marked by low default rates as in 2022; and, finally, the continuous ability of Erste Group to innovate and successfully expand its digital offering. Assuming that these conditions are met, operating result and the cost/income ratio are projected to improve, putting Erste Group on a path to achieve its cost/income ratio target of approximately 52% by 2024.

The current expectation (as per mid-February 2023) by economists is for Erste Group's core markets to avoid recession in 2023 and, in fact, to post real GDP growth in the order of 0 to 3% in 2023. Inflation-ary pressures are expected to subside in 2023, following double digit- levels in 2022 as a result of exceptionally high energy prices. Continued strong labour markets should be supportive of economic performance in all of Erste Group's markets. Current account balances, which suffered significantly during 2022 on the back of exceptionally high energy prices, are expected to improve again in 2023 benefiting from a reversal in energy prices. Fiscal balances should likewise consolidate again after significant budget deficits in 2022. Public debt to GDP in all Erste Group markets is projected to be broadly stable, and hence remain materially below the euro zone average.

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