24th Mar 2006 14:58
Bank Pekao SA24 March 2006 BANK POLSKA KASA OPIEKI SPOLKA AKCYJNA Annual Financial Statements of Bank Pekao S.A. for 31st December 2005 Warsaw, March 2006 TABLE OF CONTENTS INCOME STATEMENT FOR THE YEAR 2005 (*) 3 BALANCE SHEET AS AT 31 DECEMBER 2005(*) 4 STATEMENT OF CHANGES IN EQUITY.. 5 STATEMENT OF CASH FLOW... 6 NOTES TO THE FINANCIAL STATEMENTS. 8 1. General Information. 8 2. Accounting Policies. 10 3. Purposes and rules of financial risk management 27 4. Interest income and expense. 39 5. Fee and commission income and expense. 39 6. Dividend income. 40 7. Result on financial instruments at fair value. 40 8. Result on investment securities. 40 9. Changes in fair value - hedge accounting. 40 10. Other operating income and expenses. 41 11. Overhead costs. 41 12. Net impairment losses on financial assets and net provisions for guarantees and commitments 42 13. Impairment 43 14. Discontinued operations. 45 15. Income tax. 45 16. Earnings per share. 47 17. Dividends paid and proposed for payment 47 18. Cash and amounts due from Central Bank. 48 19. Amounts due from banks. 48 20. Financial assets held for trading. 49 21. Derivative financial instruments. 51 22. Other financial instruments at fair value through profit and loss. 58 23. Loans and advances to customers. 60 24. Investment securities. 61 25. Non-current assets held for sale. 67 26. Investments in subsidiaries entities. 68 27. Investment in associates entities. 71 28. Intangible assets. 73 29. Tangible fixed assets. 74 30. Investment property. 76 31. Other assets. 77 32. Assets used to pledge liabilities. 77 33. Amounts due to the Central Bank. 78 34. Amounts due to other banks. 78 35. Financial liabilities held for trading. 78 36. Amounts due to customers. 79 37. Debt securities in issue. 79 38. Other liabilities. 80 39. Provisions. 80 40. Lease transactions. 81 41. Employee benefits. 81 42. Contingent liabilities. 83 44. Reserves, current year end prior year profit 86 45. Additional information for the cash flow statement 86 46. Transactions with related entities. 86 47. Mergers. 91 48. Repo and reverse - repo transactions. 91 49. Company's Social Benefits Fund ("ZFSS") 91 50. Acqusition of HVB shares by UniCredito Italiano S.p.A. 92 51. First time adoption of International Financial Reporting Standards. 92 52. Events after the balance sheet date. 100 INCOME STATEMENT FOR THE YEAR 2005 (*) Notes 2005 2004 Interest income 4 3 814 563 3 705 863Interest expense 4 (1 563 907) (1 591 139)Net interest income 2 250 656 2 114 724 Fee and commission income 5 1 513 310 1 512 065Fee and commission expense 5 (154 615) (142 227)Net fee and commission income 1 358 695 1 369 838 Dividend income 6 96 746 41 081Result on financial instruments at fair value 7 64 871 46 645Result on investment securities 8 74 153 13 569Foreign exchange result 263 026 284 094 Other operating income 10 104 459 129 976Other operating expenses 10 (70 857) (80 547)Net other operating income 33 602 49 429 Net impairment losses on financial assets and 12 (234 267) (340 172)net provisions for guarantees and commitmentsand commitmentsOverhead costs 11 (2 165 330) (2 152 088)Operating profit 1 742 152 1 427 120 Profit before income tax 1 742 152 1 427 120 Income tax expense 15 (302 736) (190 208)Net profit for the period 1 439 416 1 236 912 Earnings per share (in PLN per share) - basic for the period 16 8,65 7,44- diluted for the period 16 8,64 7,44 (*) Income Statement for 2005 and the comparative data 2004 were preparedapplying the accounting policies consistently in both the periods. The two areasof IAS 39 are exemptions from this rule: estimation of impairment of financialassets and valuation of loans and advances at amortized cost using the effectiveinterest method. BALANCE SHEET AS AT 31 DECEMBER 2005(*) as at as at Notes 31.12.2005 31.12.2004 ASSETSCash and amounts due from Central Bank 18 3 573 613 3 935 112Debt securities eligible for rediscounting 6 106 8 768at the Central BankAmounts due from banks 19 7 000 770 5 956 598Financial assets held for trading 20 2 217 887 2 939 203Derivative financial instruments 21 499 290 503 481Other financial instruments at fair value 22 1 781 317 1 336 721through profit or lossLoans and advances to customers 23 28 727 143 26 533 709Investment securities 24 14 490 374 15 028 4571. Available for sale 11 902 500 10 098 484 2. Held to maturity 2 587 874 4 929 973 Non-current assets held for sale 25 37 650 -Shares in subsidiares 26 514 666 544 801Shares in associates 27 42 234 28 690Intangible assets 28 636 048 617 982Tangible fixed assets 29 1 422 389 1 520 209Investment property 30 58 170 48 556Income taxes 15 152 008 66 9661. Current tax assets - 11 009 2. Deferred income tax assets 152 008 55 957 Other assets 31 285 547 463 194TOTAL ASSETS 61 445 212 59 532 447 LIABILITIES L i a b i l i t i e s Amounts due to the Central Bank 33 1 950 710 2 151 743Amounts due to other banks 34 1 993 601 1 350 796Financial liabilities held for trading 35 545 930 438 219Derivative financial instruments 21 607 689 623 683Amounts due to customers 46 849 748 45 860 364 Debt securities in issue 36 17 23 205Current income tax liabilities 37 4 427 -Provisions for deferred income tax - - Provisions 39 105 013 344 075Other liabilities 38 1 191 819 844 266T o t a l l i a b i l i t i e s 53 248 954 51 636 351 E q u i t y Share capital 43 166 482 166 482Reserves 44 6 522 997 6 126 790Prior and current year profits 44 1 506 779 1 602 824T O T A L E Q U I T Y 8 196 258 7 896 096 TOTAL LIABILITIES 61 445 212 59 532 447 (*) Balance Sheet as of 31st December 2005 and the comparative data wereprepared applying the accounting policies consistently in all periods. The twoareas of IAS 39 are exemptions from this rule: estimation of impairment offinancial assets and valuation of loans and advances at amortized cost using theeffective interest method STATEMENT OF CHANGES IN EQUITY Share Reserves - of which - of which Prior and Total capital revaluation foreign current equity reserves exchange year profit differences from translation of foreign entitiesEquity as at 1 166 122 5 798 863 (138 699) 921 1 285 727 7 250 712January 2004Share issues 360 23 137 - - - 23 497Dividend payments - - - - (747 548) (747 548)Profit - 172 267 - - (172 267) -distributionCurrent year net - - - - 1 236 912 1 236 912profitRevaluation of - 127 253 127 253 - - 127 253available-for-saleinvestments net ofdeferred taxRevaluation of - 4 800 - - - 4 800management optionsForeign exchange - 449 - 449 - 449differences fromtranslation offoreign entitiesOther - 21 - - 21 Equity as at 31 166 482 6 126 790 (11 446) 1 370 1 602 824 7 896 096December 2004Adjustments - - - (192 460) (192 460)related to IAS 39adoptionEquity as at 1 166 482 6 126 790 (11 446) 1 370 1 410 364 7 703 636January 2005Dividend payments - - - (1 065 483) (1 065 483) Profit - 277 518 - (277 518) -distributionCurrent year net - - - 1 439 416 1 439 416profitRevaluation of - 107 282 107 281 - - 107 282available-for-saleinvestments net ofdeferred taxRevaluation of - 11 893 - - - 11 893management optionsForeign exchange - (486) - (486) - (486)differences fromtranslation offoreign entitiesEquity as at 31 166 482 6 522 997 95 835 884 1 506 779 8 196 258December 2005 STATEMENT OF CASH FLOWfor the year 2005 and 2004 year STATEMENT OF CASH FLOW 2005 2004 Cash flow from operating activities - indirectmethodNet profit (loss) 1 439 416 1 236 912Adjustments: (1 012 177) (4 471 801)Depreciation 300 855 298 685Foreign exchange differences (125 087) 578 021(Profit) loss on investing activities (81 686) (11 547)Impairment 8 056 16 158Interest and dividend (963 612) (991 917)Change in loans and advances to banks 229 092 180 634Change in financial assets as held for trading 276 720 (1 656 226)and other financial instruments at fair valuethrough profit or lossChange in derivative financial instruments 4 191 (248 188)Change in loans and advances to customers (2 661 255) (1 219 932)Change in investment securities available for (3 638) (4 608)saleChange in income tax assets (78 897) (70 204)Change in other assets 180 947 462 098Change in amounts due to banks 441 772 (706 546)Change in liabilities as held for trading 107 711 438 219Change in derivative financial instruments and (15 994) 184 451other financial liabilities at fair valuethrough profit or lossChange in amounts due to customers 989 384 (1 408 654)Change in provisions 9 392 (33 215)Change in other liabilities 353 009 (330 626)Income tax paid (377 430) (197 674)Current tax 394 293 249 270Net cash from operating activities 427 239 (3 234 889) Cash flows from investing activitiesInvesting activity inflows 51 115 931 24 073 106Sale of shares in associates 3 400 93 107Sale of investment securities 50 447 356 23 319 405Proceeds from sale of intangible assets and 11 300 5 300tangible fixed assetsOther investing inflows 653 875 655 294Investing activity outflows (49 542 734) (20 561 287)Purchase of associates (30 307) (61 851)Purchase of investment securities (49 268 354) (20 260 963)Purchase of intangible assets and tangible (244 073) (236 525)fixed assetsOther investing outflows - (1 948)Net cash used in investing activities 1 573 197 3 511 819 Cash flows from financing activitiesFinancing activity inflows 17 45 976Issue of debt securities 17 22 479Issue of normal shares - 23 497Financing activity outflows (1 088 688) (1 260 306)Redemption of debt securities (22 479) (510 512)Dividends and other payments to shareholders (1 065 483) (747 548)Other financing outflows (726) (2 246)Net cash from financing activities (1 088 671) (1 214 330) Total net cash flow 911 765 (937 400)Net change in cash and cash equivalents 911 765 (937 400)Cash and cash equivalents at the beginning of 6 776 809 7 714 209the periodCash and cash equivalents at the end of the 7 688 574 6 776 809period NOTES TO THE FINANCIAL STATEMENTS 1. General Information Financial statements of Bank Pekao Kasa Opieki Spolka Akcyjna ("Bank PekaoS.A.") have been prepared in accordance with International Financial ReportingStandards as adopted by the European Union, and with respect to matters that arenot regulated by the above standards, in accordance with the requirements of theAccounting Act dated 29 September 1994 (Official Journal from 2002, No. 76, item694 with amendments) and respective bylaws and regulations, as well as therequirements for issuers of securities admitted or sought to be admitted totrading on an official stock-exchange listing market. Bank Polska Kasa Opieki S.A. head quartered in Warsaw, 00-950, Grzybowska 53/57Street - is one of the oldest Poland's long established banks. The Bank operatesas a joint stock company under Polish legal code including the Bank Law Act andCode of Commercial Companies and under its own articles of association.Bank Pekao S.A. is a part of the UniCredito Italiano S.p.A capital group. The parent entity of Bank Pekao S.A is UniCredito Italiano S.p.A with its seatin Genoa, Italy Into Commercial Register was entered on 29 October 1929 on the basis of theRegional Court in Warsaw and since then has been continuously operating.Regional Court in Warsaw National Court Register managed by the 19th CommercialDepartment is entered into the Bank Pekao S.A. with office in Warsaw toentrepreneurs under the reference number KRS 0000014843.Shares of the Bank are quoted on the Warsaw Stock Exchange. Securities of theBank recognize on regulated market turnover are classified in bank's sector.The Bank is a universal commercial bank offering a wide scope of services to anindividual and commercial customers in accordance with the scope of services setout in the Banks articles of association, undertaking operations both in zlotyand foreign currency on territory of Poland and abroad through the network ofdomestic branches and a branch in Paris. The Bank actively participate inturnover on domestic and foreign financial market. The financial statements of the Bank for the year ended 31 December 2005 containfinancial data of all branches performing activities. Comparable financial data concerns period beginning 1 January 2004 and ended 31December 2004. Bank prepares also consolidated financial statements of theCapital Group of Bank Pekao S.A. Members of the Management Board of Bank Pekao S.A. 31.12.2005 31.12.2004 1. Jan Krzysztof Bielecki 1. Jan Krzysztof Bielecki President, CEO President, CEO2. Luigi Lovaglio 2. Luigi Lovaglio Deputy President , COO Deputy President, COO3. Sabina Olton 3. Sabina Olton Deputy President Deputy President Chief Accountant Chief Accountant4. Przemyslaw Figarski 4. Przemyslaw Figarski Member of the Management Board Member of the Management Board5. Irene Grzybowski 5. Irene Grzybowski Member of the Management Board Member of the Management Board6. Paolo Iannone 6. Paolo Iannone Member of the Management Board Member of the Management Board7. Christopher Kosmider 7. Christopher Kosmider Member of the Management Board Member of the Management Board8. Marian Waynski 8. Marian Waynski Member of the Management Board Member of the Management Board During the period covered by the financial statements there were no changes inthe Management Board of the Bank Members of the Supervisory Board of Bank Pekao S.A. 31.12.2005 31.12.2004 1. Jerzy Woznicki 1. Alessandro Profumo Chairman Chairman2. Paolo Fiorentino 2. Paolo Fiorentino Deputy Chairman, Secretary Deputy Chairman, Secretary3. Andrea Moneta 3. Jerzy Woznicki Deputy Chairman Deputy Chairman4. Pawel Dangel 4. Pawel Dangel5. Fausto Galmarini 5. Fausto Galmarini6. Oliver Greene 6. Oliver Greene7. Enrico Pavoni 7. Enrico Pavoni8. Leszek Pawlowicz 8. Leszek Pawlowicz9. Jerzy Starak 9. Jerzy Starak During the period from 01.01 2005 till the day of publication the changes tookplace in the Management Board of the Bank: • on 19.01.2004 Alessandro Profumo resigned as Chairman of the Supervisory Board effective, • as of 20.01.2005 Jerzy Woznicki vice Chairman of the Supervisory Board was appointed as Chairman of the Supervisory Board of Bank, • as of 20.01.2005 Andrea Moneta was appointed as a Member and Vice Chairman of the Supervisory Board. Approval of the financial report This financial report was approved by the Management Board of the Bank forpublishing on 21st March 2006. 2. Accounting Policies Statement of Compliance Financial statements of the Bank Pekao S.A were prepared in compliance withInternational Accountant Standards, International Financial Reporting Standardsand involve interpretations published as the Decree of the European Union followcalled IFRS EU. This report is the first annual financial report, containing acomplete set of financial statements, prepared in accordance with IFRS 1. Basis of preparation of financial statement 31st December 2005 is the close of the first full accounting period in which theBank is obliged to present its annual financial report in compliance with International Financial Reporting Standards The date of adoption of IFRS is the date of the opening balance sheet of theearliest of the periods presented, i.e. January 1st, 2004. Previously publishedfinancial statements of the Bank, along with statements for 2004, were preparedin accordance with the Polish Accounting Standards (PAS). Reconciliations ofequity as at 1st January 2004, 31st December 2004 and 1st January 2005 as wellas net profit ended 31st December 2004 prepared in accordance with PAS and IFRS,are presented in Note 51. The Bank applied the same accounting policies in preparing the opening balancesheet according to IFRS for 1st January 2004, and throughout all presentedperiods apart from the exemptions allowed by IFRS. • Combining business units (IFRS 1.15, Appendix B). The Bank has taken advantage of the exemption related to combining of businessunits. Therefore, the Bank did not apply IFRS 3 in relation to business unitscombinations implemented before the date of moving to IFRS, i.e. by 1stJanuary2004 • Fair value or re-valuation as deemed cost (IFRS 1.16-19). Taking advantage of the exemption allowed by IFRS 1, the Bank has measuredselected items of tangible fixed assets at the fair value as of the date ofadopting the IFRS, and used that fair value as deemed cost at that date. • Cumulated differences due to foreign currency recalculation (IFRS 1.21-22). Taking advantage of the exception allowed by IFRS 1, the Bank assumed thataccumulated differences due to foreign currency translation for units operatingabroad have zero value for the day of adopting IFRS. • Designation of previously recognized financial instruments (IFRS 1.25A). The Bank performed the designation of financial instruments as assets orfinancial liabilities reported at fair value through profit and loss account oras available for sale for the date of adoption of IFRS, i.e. in the case of IAS39 - for the 1stJanuary 2005. • Share-based payment transactions (IFRS 1.25B). The Bank applied the standard of IFRS 2 with reference to the equity instrumentsthat were granted after 7 November, 2002, if such equity instruments were notvested before 1stJanuary 2005. Additionally, the Bank used the exemption from the requirement of restatingcomparatives regarding IAS 32 and IAS 39. For these standards, the date ofmigration to IFRS is 1stJanuary 2005. Comparatives pertaining to those standardsare prepared using previously applied accounting policies. The Bank financialstatements includes all International Accounting Standards, InternationalFinancial Reporting Standards and related Interpretations, except for theStandards and Interpretations described below, having influence on Bank'sfinancial statements which will be subject to the approval of the EuropeanUnion, as well as Standards and Interpretations which have been approved by theEuropean Union, but are not in force. The Bank has not elected to early adopt any new Standards and Interpretations,which have been published and approved by the European Union, and which will bein force after the balance sheet date. Moreover, as of the balance sheet datethe Bank has not completed the assessment of the impact of the Standards andInterpretations, which will be in force after the balance sheet date, on theBank financial statements for the period, in which they will be adopted for thefirst time. Awaiting EU endorsement Issued / Revised / Amended (effective date) Amendment to IAS 1 Capital Disclosures August 2005 (Effective 1January 2007) Amendments to IAS 39 and IFRS 4: August 2005 (Effective 1 Financial Guarantee Contracts January 2006) IFRS 7 Financial Instruments: Disclosures August 2005 (Effective 1 January 2007) IFRIC 6 Liabilities arising from September 2005 (Effective 1 Participating in a Specific Market-Waste December 2005)Electrical and Electronic EquipmentEndorsed but not yet effective Amendments to IAS 19 Employee Benefits - December 2004 (MandatoryActuarial Gains and Losses, Group Plans requirements effective 1and Disclosures (including consequential January 2006)amendments to IAS 1, IAS 24 and IFRS 1) Financial Instruments: Recognition and April 2005 (Effective 1Measurement - Cash Flow Hedge Accounting January 2006)of Forecast Intragroup Transactions Amendments to IAS 39 June 2005 (Effective 1 JanuaryFinancial Instruments: Recognition and 2006)Measurement- The Fair Value Option (includingconsequentialamendments to IAS 32 and IFRS 1 IFRIC 4 Determining whether an December 2004 (Effective 1Arrangement Contains a Lease (including January 2006)consequential amendments to IFRS 1) IFRIC 5 Rights to Interests arising from December 2004 (Effective 1Decommissioning, Restoration and January 2006)Environmental Rehabilitation Funds(including consequential amendments toIAS 39) The financial statements are prepared in accordance with the historical costmethod, except for derivative financial instruments, financial assets availablefor sale, and financial assets at fair value through profit or loss, which aremeasured at fair value. The financial statements are presented in Polish Zloty, and all amounts, unlessindicated otherwise, are stated in thousands (PLN thousand). Continuity of activities (going concern) The financial statements for the year 2005 were prepared on the basis of theassumption that the Bank will continue its business operations, in a scope andscale that will not be substantially limited, during a period not shorter thanone year from the balance sheet date. As at the date of signing the financialstatements, the Management Board of the Bank is not aware of any facts orcircumstances that would indicate a threat to the Bank's continued activity inat least the twelve months following the balance sheet date due to an intendedor compulsory withdrawal from or limitation in its activities. The financial statements are prepared in accordance with the historical costmethod, except for derivative financial instruments, financial assets availablefor sale, and financial assets at fair value through profit or loss, which aremeasured at fair value. The financial statements are presented in Polish Zloty, and all amounts, unlessindicated otherwise, are stated in thousands (PLN thousand). Accounting estimates and judgement applying accounting polices Preparing financial statements in accordance with IFRS requires the ManagementBoard of the Bank to make certain estimates and to adopt certain assumptions,which affect the amounts presented in the financial statements and inexplanatory notes. The estimates which were made as of the date of migration to IFRS, i.e. for the1stJanuary 2004, and for each balance sheet date, reflect the conditions whichexisted at those dates (e.g. market prices, interest rates, foreign exchangerates). While the estimates are based on the best knowledge regarding currentconditions and activities which the Bank will undertake, the actual results maydiffer from such estimates. Principal assumptions/subjective judgments adopted in making estimates by theBank pertain, primarily, to: • Impairment of financial assets The assumptions regarding measurement of impairment of credit and loans aredescribed in this note, in the Note 13 titled "Impairment of financial assets". • Impairment of investments in subsidiaries For each balance sheet date, the Bank assesses the existence of premises toindicate whether impairment of investments in subsidiaries has occurred. If suchpremises exist, the Bank estimates the value-in-use of the investment. Thisrequires assumptions to be adopted regarding, among others, future cash flows,which the Bank may obtain from dividends or cash inflow from a potential sale ofthe investment. Adoption of a different measurement assumption could affect thecarrying value of some of the investments. • Impairment of non-current assets For each balance sheet date, the Bank reviews its assets for indications ofimpairment. Where such indications exist, the Bank makes a formal estimation ofthe recoverable value. In the event of the carrying value of a given asset beingin excess of its recoverable value, its impairment is stated, and a write-off ismade to adjust its value to the level of recoverable value. Recoverable value is the lower of the following two values: fair value of thegiven asset or cash generating unit less costs of disposal, or the value in use,determined for each asset separately. If there are indications of impairment of common property, i.e. assets which donot generate cash independently from other assets or groups of assets, and therecoverable value of the individual asset included among common property cannotbe determined, the Bank determines the recoverable value at the level of thecash generating unit, to which the given asset belongs. Estimation of value-in-use of a non-current asset (or cash generating unit)requires assumptions to be adopted, regarding, among others, future cash flows,which the Bank may obtain from the given non-current asset (or cash generatingunit), any changes of amounts or times of occurrence of these cash flows, andother factors such as lack of liquidity. Adoption of different measurementassumption could affect the carrying value of some of the investments. • Measurement of derivatives and debentures available for sale that do not have a quoted market price The fair value of non-optional derivatives and debentures available for salethat do not have a quoted market price on an active market are measured usingvaluation models based on discounted cash flows. Options are valued using optionvaluation models. Variables used for the valuation include, where possible, datafrom observable markets. However, the Bank also adopts assumptions which affectthe valuation of instruments. Adoption of a different measurement assumptioncould affect the carrying value of financial instruments. • Measurements of management options The assumptions adopted, regarding measurement of management options, aredescribed in the note of "employment benefits". • Calculation of retirement and sick pension severance payments provision The severance payments provision is determined on an individual basis,separately for each employee. The reserve is valued on the basis of the currentvalue of future, long-term liabilities of the Bank for retirement and sickpension severance payments. The basis for the calculation of a provision for an employee is the expectedamount of retirement or pension severance pay which the Bank undertakes to payunder the Group Bargaining Agreement (GBA). The expected severance pay amount iscalculated as the product of the following factors: • expected amount of the basis of calculation of severance pay, in accordance with provisions of the GBA, • expected increase of the calculation basis until the retirement age, • percentage factor depending on the amount of years of employment, in accordance with the GBA. The amount calculated as above is discounted using an actuarial technique. Thediscounted amount is reduced by amounts of annual reserve write-offs actuariallydiscounted for the same date, which the Bank effects in order to increase theemployee's provision. Amounts of annual write-offs are calculated using the projected unit creditmethod. Actuarial discount is the product of the financial discount and of theprobability of the given person's reaching retirement age as an employee of theBank. The probability mentioned above has been determined using the competing risksmethod, with the following risks taken into account: • possibility of abandoning employment, • risk of complete disability for work, • risk of death. Valuation of the foreign currency items • The functional currency and the presentation's currency The items contained in presentations of particular units of the Bank, includingthe Bank's branch in Paris, are priced in the functional currency, i.e. in thecurrency of the basic economic environment in which a given entity operates.The financial report is presented in Polish Zloty. Zloty is the functionalcurrency and the presentation currency of the parent business entity.As the closing exchange rate, the Bank adopted the fixing NBP exchange rate asof the balance sheet date. • Transactions and balances Transactions expressed in foreign currency are translated into the functionalcurrency by applying the exchange rate at the date of the transaction. Exchangerate profits and losses due to settlements of these transactions and to thebalance sheet valuation of assets and monetary commitments expressed in foreigncurrency are accounted for in the profit and loss account. Exchange rate differences due to non-monetary items, such as equity instrumentsclassified to financial assets designated for fair value valuation through theprofit and loss account, are accounted for together with those changes in thefair value of the profit and loss account. Exchange rate differences due to non-monetary items, such as equity instrumentsclassified to financial assets available for sale, are included in therevaluation reserve update. • Bank' branch in Paris Assets and liabilities of foreign business entities are translated into thePolish currency, i.e. to the presentation currency, as per the closing exchangerate for the balance sheet date. Revenues and costs in the profit and lossaccount are recalculated as per average exchange rates calculated on the basisof the exchange rates from particular days of the reporting period, except forthe situations when exchange rates fluctuate significantly and the averageexchange rate is not an acceptable approximation of the exchange rate from thetransaction date. In such a situation, income and costs are translated on thebasis of the exchange rate from the date of transaction. The data of the Bank's Paris branch is converted into PLN from the functionalcurrencies of this entity, using the following exchange rates: • for conversion of balance sheet items, average exchange rates announced by the National Bank of Poland which were: +---------------------+-------------------------+-----------------------+| | 31.12.2005 | 31.12.2004 |+---------------------+-------------------------+-----------------------+|PLN for 1 EUR | 3,8598| 4,0790|+---------------------+-------------------------+-----------------------+ • for conversion of profit and loss account items, arithmetic means were used of average exchange rates on the last day of each ended month for 12 months of 2005 and 2004, which were: +-------------------+--------------------------+------------------------+| | 2005 | 2004 |+-------------------+--------------------------+------------------------+|PLN for 1 EUR | 4,0233| 4,5182|+-------------------+--------------------------+------------------------+The foreign exchange differences from the conversion of foreign entities resultsat average exchange rates set at balance date due to average exchange ratesannounced by the National Bank of Poland recognize as revaluation reserveupdate. Derivative instruments The Bank conducts operations in derivative financial instruments: currencytransactions (spot, forward, currency swap, and currency options), exchange ratetransactions (FRA, IRS), derivative transactions based on securities prices,exchange rates and stocks indices. Bank do not apply hedge accounting,therefore, all the above mentioned instruments are classified to the tradingportfolio. Derivative financial instruments are initially recorded at fair valueas of the transaction date, and subsequently valued to the fair value. The fairvalue is established on the basis of quotations of the instruments in activemarkets, including prices of recent transactions, as well as on the basis ofvaluation techniques, including the models based on discounted cash flows andoptions valuation models, depending on which of the valuation models isappropriate. Positive valuation of derivative financial instruments is presentedin the balance sheet in the item of "Derivative financial instruments" on assetsside, and on the liabilities side, if the fair value is negative. Changes in thefinancial instruments valuation to fair value are reflected in the profit andloss account. In case of purchasing a financial instrument which has embedded derivativecomponent, the whole or part of cash flows related to such a financialinstrument changes in the way similar to what would be the case with theembedded derivative instrument on its own. The embedded derivative instrument isreported separately from the basic contract. This happens when the followingconditions are met jointly: • the financial instrument is not included in assets for trading or in assets designated for fair value valuation through the profit and loss account, whose revaluation results are reflected in financial income or cost of the reporting period, • the nature of the embedded instrument and the related risks are not closely tied to the nature of the basic contract and to the risks resulting from there, • a separate instrument, whose characteristics correspond to the features of the embedded derivative instrument, would meet the definition of the derivative instrument, • it is possible to reliably establish the fair value of the embedded derivative instrument. In case of contracts that are not financial instruments with a component of aninstrument meeting the above conditions, the built-in derivative instrument isclassified in accordance with assets or liabilities of derivatives financialinstruments with respect to profit and loss account in harmony of derivativefinancial instruments valuation. Interest income and expense The Bank recognizes interest income and expense related to financial instrumentsmeasured at amortized cost using the effective interest rate method. Also,interest income on financial assets available for sale is recognized using theeffective interest method. The effective interest rate is the rate which exactly discounts the estimatedfuture cash inflows and payments made in the expected period until expiry of thefinancial instrument, and in a shorter period where justified, to the netcarrying value of the financial asset or liability. The calculation of theeffective interest rate includes all commissions paid and received by parties tothe agreement, points which are an integral part of the effective interest rate,transaction costs, and all other premiums and discounts. The interest income contains interest itself, as well as commissions received ordue for credits, inter-bank deposits, and securities held-to-maturity andavailable for sale, recorded in calculation of the effective interest rate.Upon finding an impairment of a financial asset measured at amortized cost andfinancial assets available for sale, interest income is still recognized in theprofit and loss account, but is calculated from the newly determined fair valueof the financial instrument (from the new, lower value of theinstrument, (i.e. value decreased by the revaluation write-off). For thecalculation of interest income on the newly determined fair value, that interestrate is used, according to which future cash flows were discounted for thepurpose of impairment measurement. Costs of the reporting period applicable to payables due to interest on customeraccounts and to commitments for issuing the Bank's securities are accounted forin the profit and loss account using the effective interest rate Fee and commissions income Commission income and costs received from banking operations on client accounts,from operations on payment cards, as well as from brokerage, factoring andselling operations are recognized as revenue at the time the service isrendered, other fees and commissions are deferred and recognized as revenue overtime. The Bank recognizes two basic types of commissions related to credit operations: - preparing fees and commissions;- commitment fees. Commitment fees are recognized on the accrual basis throughout the life of thefacility they relate to. In case of loans and advances without a defined repayment schedule and withoutan interest rate changes schedule (e.g. overdraft facilities and credit cardproducts) commissions are recorded over time throughout the life of thefacility, using the straight line method. Foreign exchange result Foreign exchange result is calculated taking into account foreign exchange gainsand losses, both realised and unrealised, arising from daily valuation of assetsand liabilities denominated in foreign currencies and recorded under foreignexchange income and cost. The exchange rate used for valuation of a givenforeign currency used for valuation is the average exchange rate set by thePresident of NBP on the balance sheet day. Other operating income and expenses Other operating income include mainly gains realized on sale/liquidation ofitems of fixed assets and assets repossessed for debt, amounts of uncollectibledebts recovered, amounts of received damages, penalties, fines, income on rentalof real estate, write backs of provisions for court litigations and repossessedassets. Other operating costs comprise primarily: the costs of sold orliquidated tangible fixed assets and assets seized for debts; debt collectioncosts; provisions for receivables under dispute and assets seized for debts anddonations Financial assets Financial assets are classified in the following categories: • financial assets valued at fair value through the profit and loss This category comprises two sub-categories: financial assets held for tradingand financial assets designated at initial recognition for fair value valuationthrough the profit and loss. Financial assets held for trading include in particular: debt and equitysecurities, loans, and receivables purchased or classified in this category withthe aim of selling in the short term. The Bank also classifies derivativeinstruments in this category. • held-to-maturity. These are financial assets of identified or identifiable payment terms and duedates, that were purchased with the aim of holding them until their due date andthe Bank intends and has the ability to hold them until that date.The financial assets of that category are valued at amortized cost using theeffective interest rate. Recognition of amortized cost, taking into account theeffective interest rate, is recorded in interest income. • loans and receivables Loans and receivables are financial assets not quoted on the active market,characterized by payments that are constant or identifiable, other thanderivative instruments. This category contains both the debt securities boughtfrom the issuer, for which there is no active market, credits, loans and otherreceivables received and granted. Loans and receivables are measured atamortized cost, using effective interest rate and considering impairment. • available for sale These are the financial assets with a non-defined holding period. The portfoliois composed of debt and equity securities, as well as loans and receivables notaccounted for in other categories. Interest on assets available for sale iscalculated using the effective interest rate method and accounted for in theprofit and loss account. Financial assets available for sale are measured at fair value, and profits andlosses resulting from a change of fair value in relation to amortized cost arecharged to the revaluation reserve. The revaluation reserve item is carried tothe profit and loss account upon sale of asset or its impairment. In the eventof impairment of the asset, previously recognized surpluses from fair valuemeasurement decrease the revaluation reserve. If the amount of previouslyrecognized increases is insufficient to cover permanent impairment, thedifference is charged to the profit and loss account, under the heading "Reservewrite-offs and revaluation". Dividends from equity instruments are accounted for in the profit and lossaccount at the moment of establishing the entity's right to receive payments.Standardized purchase and sale transactions of financial assets valued at fairvalue through the profit and loss statement, held for trading (with theexclusion of derivative instruments), held to maturity and available for saleare recognized and excluded from the books by the Bank on the day of thetransaction settlement, i.e. the day of the receipt or delivery of the asset.Changes in the fair value of the asset to be received between the date of thetransaction and the date of the settlement are recognized in the same way, asfor the possessed asset. Loans are recognized at the time of disbursement to the debtor. Derivative instruments are recognized or excluded from the books at the date ofthe transaction. Financial Liabilities The Bank's financial liabilities are classified to the followings category: • financial liabilities at fair value through profit and loss carried at fair value • financial liabilities not at fair value through profit and loss are carried at amortised cost using the effective interest rate. Financial liabilities not at fair value through profit and loss consist ofamounts due to banks and customers, loans from other banks own debts securitiesissued. Sale and re-purchase agreements Repo and reverse-repo transactions, as well as sell-buy back and buy-sell backtransactions, are security sale or purchase operations with promise ofrepurchase or resale at an agreed date and price. Sales transactions with the repurchase promise granted (repo and sell-buy back)are recorded, at the transaction date, in payables to other banks or incustomers deposits, depending on the transaction counterparty. The purchasedsecurities with the resale promise granted (reverse-repo and buy-sell back) arerecorded as receivables from banks or as credits and loans granted to customers,depending on the transaction counterparty. The difference between the selling and buying price is treated as interestexpense / income, respectively, and accounted for over the duration of thecontract, using the effective interest rate.Securities borrowed by Bank are not included in the financial statements andsecurities loaned to other entities are included in the financial statements. Impairment of financial assets For each balance sheet date, the Bank assesses, whether there is objectiveevidence of impairment of a given financial asset or of a group of such assets. Impairment of a financial asset or of a group of financial assets is incurredonly if there is objective evidence for the impairment due to events thatfollowed the initial recording of the specific asset ("the loss event"), andwhen the events affect the expected cash flows relating to these assets, and theflows may be estimated in a reliable way. The objective evidence for impairment of financial assets includes - as per theBank's principles - information on the following loss events: • substantial financial problems of the issuer or debtor; • failure to keep to the contract terms, e.g. failing to repay or delay in the repayment of interest or part of the capital; • the Bank's granting concessions or privileges to the debtor, for economic and legal reasons following financial problems of the debtor, which in other circumstances would not be granted; • high probability of bankruptcy or of another financial reorganization of the debtor; • disappearance of the active market for the particular financial assets due to financial difficulties. • observable data indicating a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including: - adverse changes in the payment status of borrowers in the group or- national or local economic conditions that correlate with defaults on the assets in the group. The Bank classifies credit receivables by size of engagement, into theindividual and group portfolios. In the individual portfolio, each particular credit exposure is subjected to animpairment test. If there is objective evidence of impairment, the carryingamount of the receivable is reduced. If for a given exposure no objectiveevidence of impairment exists, the exposure is included in the credit portfoliosubject to group assessment. In a group portfolio, groups of similar credit risk characteristics areidentified, which are then assessed collectively for the impairment.If there is any objective evidence of impairment of financial assets classifiedas loans and receivables, or as investments held-to-maturity, then the amount ofthe impairment is the difference between the carrying amount of an asset and thecurrent value of estimated future cash flows (excluding future credit lossesthat were not incurred), discounted using an original effective interest rateestablished with the initial recognition of a given financial asset. Thecarrying amount of the asset is then reduced through use of the allowanceaccount, and the amount of loss is recognized in the profit and loss account.Calculation of the present value of estimated cash flows related to the impairedcollateralized financial asset also takes into consideration the cash flowsresulting from the liquidation of the collateral reduced by the costs ofrepossession and disposal. Expected future cash flows related to the group of financial assets forimpairment on a group basis are estimated on the basis of the historical cashrecoveries recorded for assets of similar risk characteristics. Historical parameters of recoveries are adjusted on the basis of the data comingfrom current observations, so as to take into consideration the influence ofcurrent conditions and to exclude the influencing factors in the historicalperiod, that are not presently valid. If in the next period the amount of impairment is lower due to an event takingplace after the impairment (e.g. an improvement in the debtor's credit rating),then the reduction of impairment is reversed through an appropriate adjustmentof an amount on the allowance account. The amount of the reversal is recognizedin the profit and loss account. Derecognition of financial instruments A financial instrument is derecognized when the law agreements of cash flowsexpires or the Bank transfers all the advantages and risk of particularfinancial instrument to other entity. Most often, the Bank derecognizes loans in the event of: • discontinuation of execution proceedings, • death of borrower, • conclusion of bankruptcy procedures, • unconditional cancellation of a part of the loan. Investment in subsidiaries Subsidiaries Subsidiaries are entities in which the Bank directly and indirectly has a suchcontrol. The control is ability to manage financial and operating policies inorder to gain economic profits. Control basically is involved with larger numberof votes in governing bodies. Associates Associated entities are entities in which the Bank has significant influence andare not subsidiaries or joint venture entities. The Bank usually determinessignificant influence by possession of 20 % to 50 % of the total number of votesin governing bodies Joint ventures Join venture are entities, in which contractually agreed and exist only when thestrategic financial and operating decisions relating to the activity require theunanimous consent of parties sharing control Recognition and valuation Investments in subsidiaries , associates and join ventures are recorded at costless any provision for impairment. The carrying value is subjected to testsimpairment in accordance with IAS 39. Any impairment is recognized in the profitand loss account as "Other operating costs". Dividents are recognized in theprofit and loss account when the Bank obtains legal rights to receipt. Moreover equity investments in foreign entities represent non-monetary assets.Non-monetary are measured in accordance with historical cost express in theforeign currency and translated on the base of exchange rate from thetransaction date.. In this case the purchase price is calculated on the basis ofbalance sheet value as of the day of the transition into IFRS, for the purposesof recalculation of the equity investment in foreign entities. Result of employ IFRS by Bank for the first time "Prior and current period" andpresented in further part of the report with change compartment in capital. Equity investments - shares in other entities Shares in other subsidiaries the Bank are classified in financial assetscategory available to sell. Intangible assets Intangible assets are deemed to include assets which fulfil the followingrequirements: • they can be separated from an economic entity and sold, transferred, licensed or granted for use for a fee to third parties, both separately, and together with their accompanying contracts, assets or liabilities, or • arise from contractual titles or other legal titles, irrespective of whether those are transferable or separable from the business entity or other rights and obligations. Other intangible assets Intangible assets are assets controlled by the Bank, which do not have aphysical form, which are identifiable and represent future economic benefits forthe Bank, directly attributable to such assets.These are mainly: • computer software licenses, • copyrights, • costs of completed development work, Intangibles acquired in a separate transaction are recognized at cost.Intangibles acquired in transactions of acquisition of a business entity arerecognized at fair value as of the date of acquisition. After initialrecognition, this category of intangibles is treated using the historic costmodel. The useful life of intangible assets is assessed and considered to belimited or indefinite. In the case of amortisation being calculated from assetswith limited useful life, such costs are indicated in the profit and lossaccount under the heading "Overheads". Amortization write-offs are not made forintangible assets with indefinite useful life. With the exception of development costs, intangible assets generated by the Bankon its own resources are not recognized in assets, and outlays incurred fortheir generation are recognized in the profit and loss account for the year inwhich they were incurred. As regards intangible assets with limited useful life, the Bank makes a judgmentas to whether there are indications of their impairment. Where it is found thatsuch indications exist, the Bank estimates the recoverable value of suchintangible assets and make impairment. Useful lives are also subject to reviewannually, and where necessary, adjusted starting from the next financial year.In the case of intangible assets of an indefinite useful life and investments ontangible assets, the Bank performs, on an annual basis, a test for impairment,irrespective of whether there are indications of impairment. The research costs are charged to the profit and loss account at the time whenthey are incurred. Outlays for development work performed within the givenproject are carried forward to the next period, if it can be acknowledged thatthey will be recovered in the future. After the initial recognition of outlaysfor development work, the historic cost model is applied, which requires thatassets be recognized at cost less accumulated amortisation and accumulatedimpairment write-offs. All outlays carried forward to the next period areamortized throughout the expected period of obtaining profits from selling thegiven project. Costs of development work are reviewed for any impairment on an annual basis -if an asset has not yet been commissioned, or more often - when during areporting period indications of impairment appear, indicating that theircarrying value may not be recoverable. Loss or profit due to derecognition of intangible assets are measured as thedifference between the net sales income and carrying value of the given asset,and are recognized in the profit and loss account upon derecognition of theasset. Tangible fixed assets Tangible fixed assets are the controlled fixed assets and outlays made to buildsuch assets. Tangible fixed assets include fixed assets with an expected periodof use above one year, maintained to be used to serve the Bank's needs or to betransferred to other entities, based on the lease contract or for administrativepurposes. Tangible fixed assets are recorded at historical costs reduced by depreciation/amortization and impairment write-downs. The historical costs are made up of thepurchase price/cost of creation, and costs directly related to the purchase ofassets. Each component part of property, plant and equipment items, whose purchasingprice or generation cost is material in comparison with the purchasing price orgeneration cost of the entire item, is depreciated separately. The Bankallocates the initial value of the property, plant and equipment items into itssignificant parts. Costs of modernization of property, plant and equipment increase their carryingvalue or are recognized as a separate item of property, plant and equipment onlywhen it is probable that such expenditures will ensue with an inflow of economicbenefits to the Bank, and the cost of such expenses can be reliably measured. Costs of repairs and maintenance of property, plant and equipment are charged tothe profit and loss account in the reporting period in which they were incurred.The cost of external financing for the purchase or construction of fixed assetsis recognized as a cost in the period in which it is incurred.. Depreciation and amortization charge Depreciation charge of tangible fixed assets and amortisation charge ofintangible fixed assets is applied using the straight line method, using defineddepreciation rates throughout the period of their useful lives. Depreciationrates defined for balance sheet purposes are periodically verified, with resultsof verification effective starting from the year following the year ofverification. Fixed assets and intangible assets for tax purposes aredepreciated in compliance with tax regulations. Balance sheet depreciation and amortisation rates applied to the basic groups offixed assets, and to intangible assets, are as follows: a/ depreciation rates used for fixed assets Buildings; cooperative ownership right to an 1,5 % - 10,0%apartment, cooperative right to non-residentialproperty Technical equipment and machines 2,5% - 30,0% Means of transport 12,5% - 20,0%b/ amortisation rates for intangible assets Software licenses, copyrights 14,0% - 50,0% Costs of completed development works 33,3% Know-how and other intangible assets 20,0%c/ depreciation rates for investment properties Buildings 1,5% - 10% Assets that are not depreciated include land, fixed assets and intangibles underconstruction and, certain intangible assets. Depreciation and amortisation value increases the overhead costs of the Bank'soperations, while the write-off for impairment is included in other operatingcosts. Investment properties Initially, investment property assets are recognized at cost, including thetransaction costs. After the initial entry, investment property assets aremeasured in accordance with requirements of the purchasing price model.Investment property assets are derecognized when disposed of, or in the case ofpermanent decommissioning of a property, when no further benefits from its saleare expected. Any profits or losses due to derecognition of an investmentproperty are charged to the profit and loss account in the period in which suchderecognition occurred. Non-current assets held for sale Non-current assets held for sale include assets whose carrying value is to berecovered by way of their resale, and not in their continued use. Only thoseassets are classified as held for sale that are available for immediate sale intheir present condition, whose sale is highly probable, i.e. the decision hasbeen made to fulfil the plan of selling the given asset, an active programme hasbeen launched to find a buyer and to complete the selling plan. Also, such anasset is offered for sale at a price which is rational in reference to itspresent fair value, and it is expected that the sale will be treated as salecompleted within one year from the date of the asset's classification in thiscategory. Non-current assets held for sale are recognized at the lower of carrying valueand fair value less the costs of selling such assets. For assets classified inthis category, depreciation is not applied. Leasing The Bank is a party to lease contracts, on the basis of which it grants for paiduse non-current assets or intangible assets for an agreed period of time.The Bank is also a party to lease contracts, under which it takes for paid useor drawing benefits another party's non-current assets or intangible assets foran agreed period. Operating lease In the case of lease contracts, which result in transferring substantially allthe risks and rewards incident to ownership of the asset under lease, thesubject of lease is derecognized. A receivable amount is recognized, however, inthe amount equal to the present value of minimum lease payments. Lease paymentsare divided into financial income and reduction of the balance of receivables insuch way as to enable reaching a fixed rate of return from the outstandingreceivables. Lease payments for contracts which do not fulfill qualifications of financelease are recognized as income in the profit and loss account, using thestraight-line method, throughout the period of the lease. Financial lease In the case of lease contracts, under which essentially all risks and rewardsincident to ownership of the lease are transferred, the subject of lease isrecognized in assets as a non-current asset, and a liability is recognized inthe amount equal to the present value of minimum lease payments as of the dateof commencement of the lease. Lease payments are divided into financial costsand reduction of the balance of the liability in such way as to enable obtaininga fixed rate of interest on the outstanding liability. Financial costs arerecognized directly in the profit and loss account. Fixed assets which are the basis of the finance lease contract are depreciatedin the manner defined for the Bank's non-current assets. However, if it isuncertain whether the ownership of the subject of the contract has beentransferred, then non-current assets used pursuant to finance lease contractsare depreciated over the shorter of: the expected useful life or the period oflease. Lease payments for contracts which do not fulfill qualifications of a financelease agreement are recognized as costs in the profit and loss account in astraight-line method throughout the period of the lease. Income tax and other taxes Income tax For purposes of financial reporting, the income tax provision is establishedusing the balance-sheet liabilities method in reference to all temporarydifferences as at the balance sheet date between the taxable amount of assetsand liabilities, and their carrying value as presented in the financialstatements. The deferred tax provision is recognized in reference to all positive temporarydifferences: • except for situations where the deferred income tax provision arises from amortisation of goodwill or from the initial recognition of an asset or liability in a transaction other than merger of entities, and at the point of the transaction they have no influence on the gross financial result, nor for the taxable income or deductible loss, and • in the case of positive temporary differences resulting from investments in subsidiaries or associates and participation in joint ventures - except for situations where the dates of reversal of temporary differences are subject to control and where it is probable that in the foreseeable future the temporary differences will not be reversed. The carrying value of a deferred tax asset is reviewed at each balance sheetdate, and is reduced accordingly to the extent that it is no longer probablethat the taxable income will be achieved sufficient for partial or fullrealization of a deferred income tax asset. • except for situations where deferred tax assets concerning negative temporary differences originate from initial recognition of an asset or liability in a transaction other than merger, and at the point the transaction has no influence on the gross financial result, nor for the taxable income or deductible loss, and • in the case of positive temporary differences resulting from investments in subsidiaries or associates and participation in joint ventures, the deferred tax asset is recognized in the balance sheet only in such an amount, in which it is probable that the above temporary differences will be reversed and taxable income will be achieved which will allow the negative temporary differences to be deducted. The carrying value of a deferred tax asset is reviewed at each balance sheetdate, and is reduced accordingly to the extent that it is no longer probablethat the taxable income will be achieved sufficient for partial or fullrealization of a deferred income tax asset. Deferred tax assets and deferred tax provisions are measured at tax rates whichare predicted to be in force in the period in which an asset is realized or aprovision is dissolved, assuming as the basis the tax rates (and taxregulations) which are legally or actually in place as of the balance sheetdate. The income tax regarding items directly recognized in equity is recognized inequity. The Bank offsets deferred tax assets and deferred tax provisions, where it haslegal title to effect such offsetting, and the deferred assets and provisionspertain to the same taxpayer. Current income tax is assessed at the tax rate in force and is calculated on thebasis of the gross profit determined on the basis of relevant accountingregulations, adjusted by non-taxable income and non-deductible expenses. Other taxes Incomes, costs, and assets are recognized and reduced by the amount of VAT, taxon civil law acts, and other taxes on sales, except where: • the tax on sale, paid upon purchase of goods and services, is not recoverable from the tax authorities; in that case, the sales tax is recognized accordingly as a part of the cost of acquisition of an asset, or as part of a cost item, and • receivables and payables are presented with the amount of sales tax taken into account. The net amount of sales tax recoverable from or payable to the tax authorities is recognized on the face of the balance sheet as a part of receivables or liabilities. Prepayments Prepayments refer to particular expenditure types that will be recognized in theprofit and loss proportionally to time elapsed in the future reporting periods. Prepayments are presented in the balance sheet as "other assets". Provisions Provisions are established when the Bank has an obligation (legal orconstructive) resulting from past events, and where it is probable that thefulfilment of such obligation will cause a necessity of transfer of assetsrepresenting economic benefits, and it is possible to reliably estimate theamount of such liability. In the event that the time value of the money-in-timeis significant, the amount of provisions is established by discountingforecasted future cash flows to the present value, using a rate of discountreflecting current market evaluations of money-in-time, and any risk related tothe given obligation. Also, this item includes provisions related to actuarial long-term employeebenefits. All provisions are charged to the profit and loss account. Employee benefits provisions The amount of provision for retirement payment is established on the basis of anactuarial valuation performed by an independent actuary at least every twoyears. The provision for restructuring costs is established when general criteria forrecognition of provisions are met, as well as detailed criteria for theobligation to establish restructuring provisions as per IAS 37.The amount of employment restructuring provision is established by the Bank onthe basis of the best available estimates of direct outlays, which necessarilyresult from restructuring and are not connected with the Bank's currentactivities. Provisions established are recognized on the liabilities side under the"Provisions" heading, and accordingly in the profit and loss account, asremuneration costs. Deferred income and accrued expenses (liabilities) This item mainly covers the income of commissions settled using the straightline method, and other income charged in advance; types that will be recognizedin the profit and loss in the future reporting periods Costs accounted for over time include reserves for material costs resulting fromthe services provided for the Bank by contractors, which will be settled in thefollowing periods, as well as reserves for payables to employees (incl. annualbonus and holiday bonus, extra payments, awards, and unused holiday allowance).Deferred income & accrued expenses are presented in the balance sheet in theitem of "other payables". Equity of the Bank Shareholders' equity is comprised of the capital and funds created by the Bankin accordance with the binding legal regulations and the Articles ofAssociation. The Bank's equity also includes retained profits (losses) and thecurrent profit (loss) for the year. Presented below are descriptions of selected items of the equity: a) Statutory capital may be increased by the issuance of new bearer shares or byan increase in the nominal value of the previously issued shares. The GeneralShareholders Meeting may increase the statutory capital by dedicating part ofthe supplementary capital or other capitals created from the profit inaccordance with the Code of Commercial Companies and Statutes of Association, b) Reserve capital is created from yearly appropriations of the net profit. Thiscapital is designated to cover the losses that may result from the Bank'sactivities. These annual appropriations should constitute at least 8% of netprofit and should be made until the value of the reserve capital reaches atleast one third of the statutory capital. In addition, the reserve capital iscreated with the surplus of the selling price of the issued shares over theirnominal value once the costs of the shares issue have been covered, c) Revaluation reserve includes: the accumulated amount of revaluation of fixedassets; the effects of revaluation of financial assets available for sale;foreign exchange differences arising from the revaluation of the net assets offoreign entities, foreign exchange differences arising from revaluation of theforeign branch's result at the average weighted exchange rate established as atthe balance sheet date in relation to the average NBP exchange rate and thevalue of deferred tax for items that comprise temporary differences reflected inrevaluation reserve. Revaluation reserve is presented net in the balance sheet, d) Other reserve capital utilized in accordance with the purposes definedin the Statute is created from appropriations of profits, e) Bonds convertible into equity includes the equity fair value offinancial instruments issued as part of transactions settled in equityinstruments in accordance with IFRS 2, f) General banking risk provision represents accumulated appropriations of netprofit in accordance with the terms of the Banking Law of 29 August 1997, g) Retained earnings comprises the total retained profits and uncoveredlosses, h) Net profit/loss which constitute profit/loss presented in profit andloss statement for period which concerns. Net profit includes income tax. Share-based Payments The Bank conducts an employee participation program, under which senior andlower management staff are granted pre-emptive rights to buy shares of the Bank(see Note 38). The Bank used transitional provisions of IFRS 2 in respect to share-basedpayments, and applied IFRS 2 only to share-based payments granted after November7th, 2002, the rights to which were not vested until December 31st, 2004,inclusively. Transactions settled in equity instruments The cost of transactions settled with employees in equity instruments ismeasured by reference to the fair value as of the granting date. The fair valueis established on the basis of the Black-Scholes model for appraisal ofdividend-yielding stock options, according to expectations of the ManagementBoard concerning the number of rights to be exercised. The amount of theemployee share program is adjusted as of every balance sheet date ifexpectations of the Management Board change concerning the number of rights tobe exercised. No efficiency/results data except those related to the price ofshares ("market conditions") are taken into account in the assessment oftransactions settled in capital instruments. The cost of share-based payments is recognized together with the accompanyingincrease of the value of equity in the period in which effectiveness/performanceconditions were fulfilled, ending on the date when certain employees acquirefull rights to the benefits ("vesting date"). The accumulated cost recognizedfor transactions settled in equity instruments for each balance sheet date untilthe vesting date reflects the extent of elapse of the vesting period and thenumber of rights to shares, the rights to which - in the opinion of the Bank'sManagement Board for that date, based on best available estimates of the numberof equity instruments - will be eventually vested. In the event of modifications of conditions for granting remuneration settled inequities, as part of fulfilment of the minimum requirement, costs are recognizedif such conditions have not changed. Also, costs are recognized resulting fromeach increase in the value of the transaction, resulting from modifications,measured for the date of change. In the event a right is cancelled, it is treated in such way as if the rightswere acquired on the date of cancellation, and any unrecognized costs resultingfrom such rights are immediately recognized. In the case, however, where thecancelled share right is replaced by a new share right, the cancelled right andthe new right are treated as if they are a modification of the original right.The diluting effect of options issued is taken into account when establishingthe amount of earnings per share, as additional dilution of shares. Contingent liabilities and promises The Bank enters into transactions which are not recognized in the balance sheetas assets or liabilities upon signing, but they cause contingent liabilities andpromises . Contingent liabilities are characterized as being: • a potential obligation, whose existence will be confirmed upon occurrence or non-occurrence of uncertain future events that are beyond control of the Bank (e.g. disputes in progress); • a current obligation, which arises as a result of past events, but is not recognized in the balance sheet, as it is improbable that it will be necessary to make expenses to fulfil the obligation, or the obligation amount cannot be reliably measured (mostly: unused credit lines and guarantees and letters of credit issued). Cash and cash equivalents Cash and cash equivalents in the Cash Flow Statement include "Cash-in-hand, duefrom the Central Bank" (except for the NBP bonds) and amounts current amountsdue from banks with maturity up to three moths. 3. Purposes and rules of financial risk management The policy risk management of Bank Pekao S.A. has a goal of optimizing thestructure of the balance sheet and off-balance sheet positions considering ofall risks including (interest rate risk, liquidity risk, foreign exchange raterisks), which Bank encounters in conducting its daily activity. Risks aremonitored and controlled with reference to profitability and equity coverage areregularly reported in accordance with rules briefly presented below.The Bank's Management Board is responsible for achieving the strategic goals setwithin the risk management policy. The Asset and Liability Management Committee controls the capital adequacy ofthe Bank, as well as the liquidity risk and the market risk (interest rate andforeign exchange rate risks) within the external banking supervision limits andto the internal limits of the Bank. The accounting policy for derivative instruments were presented at Note 2 Credit risk Credit risk is one of the basic risks associated with the activities of theBank. The percentage share of loans in the Bank's balance sheet requires thatthis risk is maintained at a safe level for the result of the activities carriedout by the Bank. The credit risk is minimized due to the Bank's procedures, in particular thoserelating to the rules of transaction risk evaluation, establishing collateral,setting authorization limits for granting loans, and limiting of exposure tosome areas of business activity. To increase security the Bank's lendingactivity is limited by the restrictions of the Banking Law as well as internalsafety norms set by the Bank, including in particular concentration limits forspecific sectors of the economy, share of large exposures in the loan portfolioof the Bank, and exposure limits for particular foreign countries, banks, anddomestic financial institutions. Protection of the quality of the Bank's loan portfolio is also ensured byperiodical reviews and on-going monitoring of loan repayments and the financialcondition of the borrowers. The Banking Law establishes maximum exposure limits for banks. The Bank, in cooperation with UniCredito Italiano, has undertaken activities tostable rationalizing credit process to improve effectiveness and security.Advancement particularly procedures and measurement tools and risk monitoring.Concentration of credit risk According to article 71.1 of the Law the total balance sheet and off-balancesheet exposure of a bank to the risks associated with a single borrower or agroup of related borrowers may not exceed 20% of the bank's equity when at leastone of those entities is related to the bank or 25% when no relation betweenthose entities and the bank exists. Moreover, article 71.2 of the Law specifies a maximum total exposure limit withentities whose individual exposure exceeds 10% of the bank's equity, at a levelof 800% of this equity. As of 31 December 2005 no exposures exceeded the limit set forth by article71.2, whereas one exposure of the Bank exceeded the limits specified in article71.1 in the case of one group of related entities. This exposure resulted mainlyfrom the financing of central state investment. Loans granted for the centralstate investment are guaranteed by the surety of State Treasury. According toarticle 71.3.3. such exposure is excluded from calculations of exposure limitsand as a consequence the maximum exposure limits set forth in the Banking Lawwere not exceeded. a) Concentration by entity: as of 31.12. 2005 Exposure to 10 largest clients of the Bank % of portfolio Client 1 4,9Client 2 1,9Client 3 1,8Client 4 1,7Client 5 1,6Client 6 1,4Client 7 1,4Client 8 1,4Client 9 1,2Client 10 1,1 Total 18,4 In the table above 42,4% of the balance represents credit to or guaranteed bythe Polish State Treasury. Other exposure is due to transactions with localgovernments 6,3% and large corporate customers 51,3%. None of the exposuresmentioned above were classified as irregular. b) Concentration by capital group: as of 31.12. 2005 Exposure to 5 largest capital groups which are the % of portfolio Bank's clients Group 1 5,7Group 2 2,2Group 3 1,9Group 4 1,8Group 5 1,8 Total 13,4 c) Concentration by industrial sector: In order to minimize credit risk associated with industrial sectorconcentration, the Bank employs a system monitoring the sector structure of itscredit exposure. The system involves setting concentration limits for particularsectors, monitoring the loan portfolio and gathering appropriate information. The system is based on the lending exposure in particular types of businessactivity according to the classification applied by the Polish Classification ofEconomic Activities (Polska Klasyfikacja Dzialalnosci - PKD). Concentrationlimits are determined on the basis of investment risk, quality of the Bank'slending exposure, current economic trends in particular sectors, the Bank'sequity, and the total exposure to particular sectors. A monthly comparison ofthe Bank's exposure to particular sectors with the current limits allows timelyidentification of the sectors in which the concentration of sector risk maybecome excessive. If such a situation arises, an analysis of the economicsituation of that sector is performed considering the current and predictedtrends and the quality of the current exposure to that sector. These measuresenable the Bank to develop policies that reduce sector risk and allow for atimely reaction to a changing environment. The table below sets out the structure of the credit exposure by industrialsectors. % of portfolio Sector description 31.12.2005 31.12.2004 Wholesale and retail trade, repair of motor 14,5 15,8vehicles and motorbikes, articles for personal useand household goodsProduction and supply of utilities (electricity, 14,2 14,4gas, water)Public administration and national defence, 10,8 11,0guaranteed social insuranceFinancial services 16,2 11,0Other manufacturing activities and waste management 7,1 7,5Construction and real estate management 6,0 5,8Production of food, beverages and tobacco products 5,2 5,4Transport, storage and communication 4,7 5,2Production of metals and processed metal products 3,6 3,9Production of electrical and optical equipment 3,2 3,3Production of transport equipment 1,9 2,3Production of celluloid pulp, paper and paper 3,3 3,4products, publishing and printingRental and other business, IT services, education 2,3 2,4Production of chemicals 1,9 2,0Other sectors 5,1 6,6 Total 100,0 100,0 Market risk In its trading, the Bank is exposed to market risk, i.e. the interest rate,foreign exchange rate, and equity price risks of the securities held by theBank, as well as other risks resulting from changes in market conditions. Interest rate risk The table below presents the classification of assets and liabilities accordingto their exposure to interest rate risk: Assets and financial liabilities exposed to fair value risk related to interest rate - debt securities with fixed interest rate- Loans with fixed interest rate- Client deposits with fixed interest rate- Liabilities due to the issue of securities Assets and liabilities exposed to Cash flow risk related to interest rate - Debt securities with variable interest rate- Loans with variable interest rate- Client deposits with variable interest rate Assets and financial liabilities not directly exposed to the interestrate risk - Equity securities The Bank is also exposed to the interest rate risk arising on certain offbalance sheet transactions, including derivative transactions, Forward RateAgreements (FRA), Interest Rate Swaps (IRS), currency swaps, and foreigncurrency forward contracts . In managing interest rate risk, the Bank is aiming at maximizing the economicvalue of capital employed and achieving the planned interest result within theaccepted limits. The financial position of the Bank is monitored with respect tochanging interest rates by application of interest revaluation gap analyses,duration analysis simulation analysis, and stress testing. The sensitivity of the interest result to the interest rate changes andsensitivity of the economic value of the equity of the Bank was within theinternally accepted limits in the reported periods. The table below presents the assets, liabilities and off-balance sheet exposuresof the Bank classified as of 31 December 2005 by interest rate risk criterion: up to1 month from 1 month from 3 months from 1 year to 5 above 5 years Non Total inclusive to 3 months to 1 year years inclusive interest inclusive inclusive bearings assets/ liabilities Book value % Book % Book % Book % Book % Book value Book % value value value value valueBalance sheet items Assets: 25 360 435 6,70 7 804 249 6,13 9 253 176 5,40 7 274 840 7,13 4 197 624 6,84 7 554 888 61 445 212 5,90 Cash and amounts due from - - - - - - - - - - 2 192 483 2 192 483 -Central Bank Debt securities eligible 2 483 8,66 3 623 8,66 - - - - - - - 6 106 8,66for rediscounting in theCentral Bank Amounts due from banks 5 483 385 4,11 396 381 4,34 1 120 9534,25 - - - - - 7 000 719 4,15 Loans and advances to 19 214 385 7,60 4 507 208 6,82 1 363 9639,78 1 238 827 16,71 602 664 17,18 1 711 574 28 638 621 8,21customers Debt securities* 660 182 1,78 2 897 037 5,32 6 768 2604,71 6 036 013 5,16 3 594 960 5,10 - 19 956 452 4,91 Others - - - - - - - - - - 3 650 831 3 650 831 - Liabilities: 39 767 828 1,61 5 159 931 3,06 3 785 570 2,60 1 723 336 11,05 768 336 12,52 10 240 211 61 445 212 1,92 Amounts due to banks 1 633 742 3,64 141 482 9,90 485 103 2,74 1 122 656 15,56 561 328 15,56 - 3 944 311 8,84 Amounts due to customers 38 134 086 1,52 5 018 449 2,87 3 300 450 2,58 376 155 1,33 20 608 - - 46 849 748 1,74 Liabilities arising from - - - - 17 - - - - - - 17 -securities issued Other - - - - - - 224 525 4,80 186 400 4,76 10 240 211 10 651 136 0,18 Gap (14 407 393) 2 644 318 5 467 606 5 551 504 3 429 288 (2 685 323) - Off-balance sheet exposures Assets 8 773 323 11 298 531 21 851 370 5 970 617 929 495 - 48 823 336 Liabilities 7 008 306 11 726 890 21 191 197 6 825 488 2 073 364 - 48 825 245 Gap 1 765 017 (428 359) 660 173 (854 871) (1 143 869) - (1 909) Total Gap (12 642 376) 2 215 959 6 127 779 4 696 633 2 285 419 (2 685 323) (1 909) */ This item contains unquoted debt instruments presented in the balance sheetunder Cash-in-hand, amounts due from the Central Bank, dues from banks, loansand advances to customers up to1 month from 1 month from 3 months from 1 year to 5 above 5 years Non Total inclusive to 3 months to 1 year years inclusive interest inclusive inclusive bearings assets/ liabilities Book value % Book % Book % Book % Book % Book value Book % value value value value valueBalance sheet items Assets: 19 652 004 8,10 6 776 958 6,99 12 662 162 6,45 8 492 898 8,26 3 233 210 9,07 8 715 215 59 532 447 6,51 Cash and amounts due from - - - - - - - - - - 2 557 524 2 557 524Central Bank Debt securities eligible 1 933 8,66 6 835 8,66 - - - - - - - 8 768 8,66for rediscounting in theCentral Bank Amounts due from banks 3 967 926 4,86 743 267 5,42 1 244 931 3,71 219 - - - - 5 956 343 4,69 Loans and advances to 14 751 052 9,14 2 892 099 7,52 3 849 015 8,24 1 290 782 16,28 867 071 17,51 2 321 740 25 971 759 8,64customers Debt securities* 931 093 5,40 3 134 757 6,89 7 568 216 5,99 7 201 897 6,82 2 366 139 5,98 - 21 202 102 6,38 Others - - - - - - - - - - 3 835 951 3 835 951 - Liabilities: 38 874 461 2,26 5 356 813 4,20 3 684 635 4,16 1 323 082 10,28 830 204 12,22 9 463 252 59 532 447 2,51 Amounts due to banks 1 162 806 5,03 112 590 9,89 705 537 10,51 869 489 15,56 652 117 15,56 - 3 502 539 10,86 Amounts due to customers 37 711 655 2,17 5 244 223 4,08 2 800 893 2,77 103 593 0,68 - - - 45 860 364 2,42 Liabilities arising from - - - - 23 205 6,40 - - - - - 23 205 6,40securities issued Other - - - 155 000 - 350 000 - 178 087 - 9 463 252 10 146 339 - Gap (19 222 457) 1 420 145 8 977 527 7 169 816 2 403 006 (748 037) - Off-balance sheet exposures Assets 7 060 837 - 6 312 509 - 12 836 526 - 3 488 679 - 513 289 - - 30 211 840 Liabilities 6 362 169 - 6 038 867 - 12 740 609 - 4 032 487 - 1 060 592 - - 30 234 724 Gap 698 668 273 642 95 917 (543 808) (547 303) - (22 884) Total Gap (18 523 789) 1 693 787 9 073 444 6 626 008 1 855 703 (748 037) (22 884) */ This item contains unquoted debt instruments presented in the balance sheetunder Cash-in-hand, amounts due from the Central Bank, dues from banks, loansand advances to customers The below table presents the effective interest rates pertaining to each classesof financial assets and liabilities to which it applies, analysed by majorcurrencies: as of 31st December 2005 PLN EUR USD Others % % % %AssetsCash, amounts due from Central Bank 4,28 - - -Due from banks 4,51 2,38 4,25 3,50Loans and advances to customers* 8,78 4,06 5,96 6,05Debt securities 4,80 3,46 4,78 6,87 LiabilitiesDue to Central Bank** 15,56 - - -Due to banks 3,76 2,36 3,91 2,50Due to customers 3,50 1,24 1,73 1,87Debt securities in issue - - - - * Position Include loans for central state investment, which effective interest is 17,51%. Effective interest excluding loans for central state investment is 8,02% ** Refinance credit interest of central state investment Following the exemption allowed by IFRS 1 the Bank does not present the 2004comparative data relating to effective interest rates. Currency risk The objective of the currency risk management is to create a currency profile ofthe balance sheet and off-balance items which will remain within the externaland internal limits. In 2004, the currency risk was low. The Bank's exposure tothe currency risk is measured for internal purposes on a daily basis by means ofthe Value at Risk (VaR) model, as well as extreme conditions testing analysisthat is supplementary to the VaR method. The table below presents foreign currency exposure by the separate asset,liability and off balance-sheet liability types related to financial obligationsgranted and guarantees granted. as of 31.12.2005 Currency PLN EUR USD Others Total Assets:Cash and amounts due 1 788 832 187 099 101 755 114 797 2 192 483from Central Bank Debt securities 6 106 - - - 6 106eligible forrediscounting in theCentral Bank Receivables from banks 2 890 676 850 305 2 992 622 267 116 7 000 719 Loans and advances to 22 827 699 4 258 468 1 070 222 482 232 28 638 621customers Debt securities* 14 969 730 877 305 3 719 136 390 281 19 956 452 Investments in 529 270 50 933 26 647 56 900associatedundertakings Others 2 876 579 126 459 43 938 11 525 3 093 931 Total 45 924 322 6 299 686 7 928 606 1 292 598 61 445 212 Liabilities: Amount due to Central 1 950 710 - - - 1 950 710Bank Amounts due to banks 1 461 794 218 016 283 273 30 518 1 993 601 Amounts due to 33 961 639 4 439 741 7 566 129 882 239 46 849 748customers Liabilities arising 17 - - - 17from securities issued Provisions 96 739 594 7 197 483 105 013 Others 10 109 873 202 466 215 442 18 342 10 546 123 Total 47 580 772 4 860 817 8 072 041 931 582 61 445 212 Net exposure (1 656 450)1 438 869 (143 435) 361 016 - Off-balance sheet 10 005 711 1 982 696 656 009 265 571 12 909 987liabilities related to finacial obligationsgaranted and guranteesgranted */ This item contains unquoted debt instruments presented in the balance sheetunder Cash-in-hand, amounts due from the Central Bank, Due from banks, Loans andadvances to customers As of 31.12.2004 Currency PLN EUR USD Others Total AssetsCash and amounts due from 2 129 982 209 324 109 970 108 248 2 557 524Central Bank Debt securities eligible 8 768 - - - 8 768for rediscounting in theCentral Bank Receivables from banks 3 050 402 428 240 1 839 848 637 853 5 956 343 Loans and advances to 19 840 976 4 073 232 1 223 791 833 760 25 971 759customers Debt securities* 17 370 365 709 052 2 959 049 163 636 21 202 102 Investments in associated 546 701 61 5 389 21 340 573 491undertakings Other 3 031 977 215 207 767 14 509 3 262 460 Total 45 979 171 5 635 116 6 138 814 1 779 346 59 532 447 Liabilities Amounts due to the Central 2 151 743 - - - 2 151 743Bank Amounts due to banks 966 636 230 726 119 741 33 693 1 350 796 Amounts due to customers 33 149 307 4 414 509 7 503 198 793 350 45 860 364 Liabilities arising from 23 205 - - - 23 205securities issued Provisions 335 894 2 630 5 551 - 344 075 Other 9 437 608 186 000 164 148 14 508 9 802 264 Total 46 064 393 4 833 865 7 792 638 841 551 59 532 447 Net exposure (85 222) 801 251(1 653 824) 937 795 - Off-balance sheet 9 205 711 1 243 505 1 060 063 160 737 11 670 016liabilities related to finacial obligationsgaranted and guranteesgranted */ This item contains unquoted debt instruments presented in the balance sheetunder Cash-in-hand, amounts due from the Central Bank, dues from banks, Loansand advances to customers Liquidity risk The objective of managing liquidity risk is: • to ensure and maintain the Bank's solvency with respect to current and future planned payables, taking into account the cost of acquiring liquidity and return on the Bank's equity, • to prevent any crisis situation, and • to outline solutions that would allow the Bank to overcome such a situation in case the latter occurred. The Bank invests primarily in treasury securities of the Polish government,financial instruments of countries and financial institutions with the highestratings, and those with high levels of liquidity. Due to their to theirliquidity characteristics, regularly monitored, the financial instruments wouldassist the bank to overcome crisis situations. According to the Banking Supervisory Board recommendations, the Bank introducedinternal liquidity indices that reflect the ratios of total adjusted maturatingassets to total adjusted maturing liabilities. In addition, the Bank employs the appropriate procedures protecting both againstthe liquidity risk increase and against a substantial deterioration of theBank's financial liquidity. The emergency plan in case of deterioration of financial liquidity of the Banktakes into consideration four levels of liquidity risk, depending on the amountand duration of cash outflow from the non-banking client accounts. The plan alsodetermines the sources from which the expected cash outflows will be covered andstates to what extent the Bank's Management is responsible for making necessarydecisions in order to restore the required liquidity level. Both the emergencyplan and the possibility of obtaining cash from sources specified in this planare subject to periodical verification. The table presents assets and liabilities of the Bank as of 31.12.2005 by maturity: Balance sheet items up to1 month from 1 from 3 from 1 year above 5 Total inclusive month to 3 months to 1 to 5 years years months year inclusive inclusive inclusive Assets 15 755 382 4 026 045 11 370 688 12 788 797 17 504 300 61 445 212 Cash and amounts due from 2 192 483 - - - - 2 192 483 Central Bank Debt securities eligible 2 483 3 623 - - - 6 106 for rediscounting in the Central Bank Amounts due from banks 4 914 430 715 075 1 217 264 108 828 45 122 7 000 719 Loans and advances to 3 863 993 3 026 234 6 117 889 6 072 656 9 557 849 28 638 621 customers Debt securities* 4 554 639 281 113 4 035 535 5 848 494 5 236 671 19 956 452 Others 227 354 - - 758 819 2 664 658 3 650 831 Liabilities 17 845 655 11 253 892 15 263 521 10 638 620 6 443 524 61 445 212 Amounts due to banks 2 383 372 94 409 473 572 616 761 376 197 3 944 311 Amounts due to customers 13 501 845 11 028 818 14 789 932 3 308 391 4 220 762 46 849 748 Liabilities arising from - - 17 - - 17 securities issued Other 1 960 438 130 665 - 6 713 468 1 846 565 10 651 136 Gap (2 090 273) (7 227 847) (3 892 833) 2 150 17711 060 776 - Off-balance sheet items Assets 7 760 484 2 348 665 3 191 364 316 562 - 13 617 075 Liabilities 10 975 225 2 357 500 3 232 106 103 337 3 984 157 20 652 325 Gap (3 214 741) (8 835) (40 742) 213 225 (3 984 157)(7 035 250) Gap total (5 305 014) (7 236 682)(3 933 575) 2 363 402 7 076 619 (7 035 250) */ This item contains unquoted debt instruments presented in the balance sheetunder Cash and amounts due from the Central Bank, Due from banks, Loans andadvances to customers The table presents assets and liabilities of the Bank as of 31.12.2004 by maturity: Balance sheet items Up to1 month from 1 from 3 from 1 year above 5 Total Inclusive month to 3 months to 1 to 5 years years months year inclusive inclusive inclusive Assets: 19 784 791 2 617 035 7 865 353 9 245 159 20 020 109 59 532 447 Cash and amounts due from 2 557 524 - - - - 2 557 524 Central Bank Debt securities eligible for 1 933 6 835 8 768 rediscounting in the Central Bank Amounts due from banks 3 546 475 446 375 744 884 1 130 787 87 822 5 956 343 Loans and advances to 1 302 326 1 267 404 5 048 797 5 245 628 13 107 604 25 971 759 customers Debt securities* 12 369 844 895 378 2 071 672 2 868 744 2 996 464 21 202 102 Others 6 689 1 043 - - 3 828 219 3 835 951 Liabilities: 13 763 321 11 586 207 13 571 605 5 062 556 15 548 758 59 532 447 Amounts due to banks 2 050 544 46 443 48 653 56 990 1 299 909 3 502 539 Amounts due to customers 11 533 771 11 539 764 13 499 747 5 005 566 4 281 516 45 860 364 Liabilities arising from - - 23 205 - - 23 205 securities issued Other 179 006 - - - 9 967 333 10 146 339 Gap 6 021 470 (8 969 172) (5 706 252) 4 182 603 4 471 351 - Off-balance sheet items Assets 10 183 911 547 792 1 662 031 164 111 51 395 12 609 240Liabilities 14 933 503 675 863 1 783 152 238 950 114 979 17 746 447 Gap (4 749 592) (128 071) (121 121) (74 839) (63 584) (5 137 207) -4 749 592 -128 071 -121 121 -74 839 -63 584 -5 137 207 Gap total 1 271 878 (9 097 243)(5 827 373) 4 107 764 4 407 767 (5 137 207) */ This item contains unquoted debt instruments presented in the balance sheetunder Cash and amounts due from the Central Bank, Due from banks, Loans andadvances to customers Exposure to credit risk and market risk The tables below present the exposure of the Bank to credit risk and particulartypes of market risk. The amounts have been calculated on the basis of BankingSupervisory Board Resolution No 4/2004 dated 8 September 2004. The risk weighted value to credit risk of the balance sheet receivables iscalculated as the product of the carrying amount and the risk weight appropriatefor the client and the type of collateral. The risk weighted exposure of derivatives to credit risk is calculated on thebasis of a balance sheet equivalent of a derivative. The balance sheetequivalent of a derivative instrument is calculated according to originalexposure method for transactions in the banking portfolio. In the case of other off-balance-sheet liabilities the credit risk exposure iscalculated as the product of the balance-sheet equivalent (product of thenominal value of off-balance sheet liability and percentage risk weight) and theappropriate risk weight for the given client and the type of potentialcollateral. Capital requirements resulting from credit risk are calculated by adding up therisk weighted assets and off-balance-sheet liabilities in the banking portfolioand multiplying this sum by 8%. In the case of the instruments classified to trading portfolio, capitalrequirements are calculated for the individual types of market risk.Credit and market risk at 31.12.2005 Instrument Balance value Risk weighted assets Cash 1 112 052 -Receivables 38 355 303 25 002 691Debt securities 14 451 799 110 477Other securities, shares 74 829 74 829Fixed assets 1 484 989 1 484 989Other 762 044 101 034 Total banking portfolio 56 241 016 26 774 020Clearing collateral KDPW 1 332 -Investment securities 3 999 205 16 122Reverse repo transactions 567 904 - Total trade portfolio 4 568 441 16 122 Total 60 809 457 26 790 142 Off balance sheet instruments Instrument Replacement Balance sheet Risk weighted cost equivalent amount amountDerivates Interest rate instruments: -IRS 323 995 430 070 94 904-FRA 3 941 3 941 788-CIRS 18 988 61 070 24 363-Futures - on government bonds - - --call options- securities 9 859 10 049 2 010instrumentsCurrency instruments: Forward 49 413 81 861 40 894Spot 276 276 61Swap I leg - -- -Swap II leg 40 141 69 628 13 926Options 47 888 56 869 17 583Other instruments: Warrants - 9 5 Total: 494 501 713 773 194 534 Including: banking portfolio - - -trading portfolio 494 501 713 773 194 534Other off-balance sheet banking portfolio Instrument Off-balance Balance sheet Risk weighted sheet value equivalent amount amountCredit line 10 954 301 2 475 482 2 370 873Warranties granted 1 366 408 748 289 685 325Letters of credit 215 561 107 781 79 373Other 440 142 440 142 157 429 Total banking portfolio 12 976 412 3 771 694 3 293 000 Issue guarantees - - -Forwards on securities 184 437 82 872 - Total trade portfolio 184 437 82 872 - Off-balance Balance sheet Risk weighted sheet value equivalent amount amount Total banking portfolio (credit 69 217 428 30 067 020 2 405 362risk) Capital requirements for tradingportfolio (Market risk)Market risk 58 204 In this: Currency risk - Commodity price risk - Equity price risk 24 Debt instrument specific risk 2 296 Total interest rate risk 55 884 Settlement risk - delivery and 15 528contractorOther - Total capital requirement 2 479 094 Fair value of balance sheet financial instruments In the absence of quoted market values for certain financial instruments; thepresented fair values have been estimated on the basis of various valuationmethods, including estimation of the present value of future cash flows. There are certain financial instruments, which are not recognized at fair valuein the financial statements of the Bank. Fair value represents the amount forwhich an asset could be exchanged or a liability settled between knowledgeable,willing parties in an arm's length transaction. In the case of certain groups of financial assets, held on the basis of theamount of the payment due, it has been assumed that fair value is equal to bookvalue. This applies, in particular, to cash and cash equivalents, currentreceivables and client liabilities as well as other assets and liabilities. As no quoted market price readily available for the Bank's customer loans, thepresented fair value of loans has been estimated at a high level using internalvaluation techniques (DCF)Fair value of non impaired loans is equal to the sumof future expected cash flows discounted to the balance sheet date. Thediscounting rate is the sum of appropriate market risk free rate and creditspread which relates to default probability and expected recovery rate adequatefor each loan agreement. Fair value of impaired loans is equal to the sum ofexpected recoveries discounted to the balance sheet date using market risk freerate as the credit risk is incorporated into the average expected recoveries. The fair value of investment securities held to maturity amounts to PLN2 643 271 ths. (as at 31.12.2004, PLN 5 003 823 ths.). and fair value of loans to customersamounts to PLN 29 230 129 ths. as at 31.12.2005. Custodial activities The Bank offers custodial services on the basis of the decision of theSecurities and Exchange Commission. The Bank's clients include domestic andforeign financial institutions, banks offering depository and investmentservices, insurance companies, investment and pension funds, as well asnon-financial institutions. The Bank offers services involving settlement oftransactions on domestic and foreign markets, client's custody assets,maintaining securities and cash accounts, assets valuation, and servicingdividend and interest payments. In 2005 the Bank achieved 33% increase of assets under custody. The mostsignificant ( c.a. 42%) increase was reached in the domestic clients segment.The growth of assets under custody was due to higher investment activity ofclients. Turnover generated by clients in 2005 was 2 times higher than in 2004and number of transactions increased by 65%. In 2005 the Bank signed a custody contract with a 7 newly created investmentfund and first time with investment fund with exhaled sub funds (fund umbrellatype) Continues also foreign financial institutions attend for the custodial servicesby the Bank on the territory of Poland and lending of securities in order toensure the liquidity of settlements. The Bank maintained the leading position inthe area of servicing depositary notes programmes, servicing more than 50% ofthese programmes. 4. Interest income and expense Interest income 2005 2004 Income on placements in other banks 285 362 252 374Income on other placements on money market 55 304 46 028Income on loans to customers 2 421 126 2 289 330Income on investment securities 912 444 1 006 604Income on financial assets valued at fair 140 327 111 527value through profit and loss Total 3 814 563 3 705 863 Interest expense 2005 2004Expense on other bank's deposits 65 377 69 223Expense on other deposits on the money 107 545 71 700marketExpense on amounts due to customers 1 014 212 1 012 548Expense on other liabilities 329 787 363 957Expense due to the amortization of premium 46 310 48 963on investment securitiesExpense on debt securities in issued 676 24 748 Total 1 563 907 1 591 139 Interest income for the 2005 includes income from impaired financial assets inthe amount of PLN 127 685 ths. Total amount of interest income for the 2005, measured at amortized cost usingthe effective interest rate method, with reference to financial assets which arenot valued at fair value through profit and loss, amounted to PLN 2 543 416 ths.Interest Expense, calculated at amortized cost using the effective interest ratemethod, with reference to financial liabilities which are not valued at fairvalue through profit and loss, amounted to PLN 1 360 888 ths. 5. Fee and commission income and expense Fee and commission income 2005 2004Accounts maintenance 600 350 595 085Payment cards 360 626 333 089Acquisition services 304 552 241 612Credits and loans granted 132 318 178 888Guarantees and similar operations 15 230 13 117Securities operations 26 939 26 324Other 73 295 123 950 Total 1 513 310 1 512 065 Fee and commission expense 2005 2004Payment cards 125 744 120 864Securities operations 5 029 4 768Acquisition services 4 129 2 162Accounts maintenance 3 288 2 695Other 16 425 11 738 Total 154 615 142 227 6. Dividend income 2005 2004Dividend income from the issuers:Subsidiaries 73 858 36 730Associates 22 714 4 351Other 174 - Total 96 746 41 081 7. Result on financial instruments at fair value a/ Result on assets and liabilities held for trading 2005 2004Derivative instruments (2 003) (36 709)Debt Instruments 93 967 87 275 Total 91 964 50 566 b/ Result on financial assets and financial liabilities at fair value throughprofit and loss 2005 2004Debt Instruments (27 093) (3 921) Total (27 093) (3 921) Total result on financial instruments valued 64 871 46 645at fair value (a+b) Total change in the fair value of financial instruments valued at fair valuethrough profit and loss established using valuation techniques (where noestablished quotations were published on the active market) in 2005 was PLN2 746 ths. (in 2004: minus PLN 34 630 ths. respectively). 8. Result on investment securities Realized result on assets and financial liabilities other than valued at fairvalue through profit and loss 2005 2004Realized profitsFinancial assets available for sale 74 113 13 897Investments held to maturity 98 453 Total 74 211 14 350 Realized lossesFinancial assets available for sale 37 567Investments held to maturity 21 214 Total 58 781Net realized profits 74 153 13 569 Change in the fair value of financial assets available for sale recognized in2005 directly in equity amounted to PLN 140 172 ths. (increase of equity) (in2004 PLN 157 572 ths. - increase of equity). Profits and losses from financial assets moved in 2005 from equity to profit andloss account amounted to PLN 74 076 ths. PLN (profit) (in 2004, PLN 13 330 ths.(profit). 9. Changes in fair value - hedge accounting The Bank Pekao S.A. does not apply hedge accounting. 10. Other operating income and expenses 2005 2004Other operating incomeRent and other revenue 27 640 28 352From the sale or liquidation of fixed assets, 12 645 3 266intangible assets and assets for disposalFrom the recovered overdue, lost and 13 900 14 464written-off receivablesReceived damages and penalties 1 674 1 063Recovered debt recovery expenses 3 320 5 822Release of provisions for the disputed and 1 656 18 187other receivablesWrite-backs 2 868 6 602Other revenue 40 756 52 220 Total 104 459 129 976 2005 2004Other operating expensesDebt recovery costs 12 722 13 812Provision costs for disputed and other 10 378 8 377receivablesImpairment charges on other assets 7 737 9 039From the sale and liquidation of the fixed 4 473 10 955assets, intangible assets, and assets for saleFrom the written off receivables 7 371Paid damages and penalties 378 681Donations made 4 526 4 129Amortization of start-up costs 2 990 2 990Other costs 27 646 30 193 Total 70 857 80 547 11. Overhead costs 2005 2004Payroll/Employee benefits 1 094 534 1 075 027including :Wages and salaries 924 942 891 025Insurance and other charges related with 157 699 179 202employeesCost of share-based payments 11 893 4 800Administrative costs 741 968 739 602Depreciation and amortisation 300 855 298 685Taxes and charges 21 778 28 529Annual Bank Guarantee Fund fee 6 195 10 245 Total 2 165 330 2 152 088 12. Net impairment losses on financial assets and net provisions for guaranteesand commitments 2005 2004Impairment chargesImpairment charges on loans 1 354 161 1 278 943Impairment charge on investment hold to 191 316maturityImpairment charge on investment in the 9 741 35 763associate and join venture entities valuedusing the equity methodImpairment charges on other financial assets 2 086 7 684 Writedowns on provisionProvisions created for off-balance sheet 54 847 38 965liabilities Total charges 1 421 026 1 361 671 Writebacks on impairmentWritebacks on impairment on loans 1 129 443 969 379Writebacks on impairment on financial assets 460 -available for saleWritebacks on impairment on investment hold to 1 783 316maturityWritebacks on impairment on investment in - 1 261associates and join venture entities valuedusing the equity method Writebacks on provisionRelease of the provisions for off-balance sheet 55 073 50 543liabilities Total revenues 1 186 759 1 021 499 Net impairment and provision charge 234 267 340 172 13. Impairment Impair- IAS 39 Adjust- Increase Decrease Balance Influence ment Adjust- ment at the on the ments for Impair- Foreign Other Write Release Foreign Other end of profitYear 2005 at the the ment exchange off of exchange period and loss end of begin- charges differ- of the differ- statement previous ning during ences assets pro- ences for year period of period period from visions 2005 the balance sheetImpairment of thefinancial assetsnot valued at thefair valuethrough theprofit and loss: Financial instrumentsvalued at cost(non quotedequityinstruments and linked derivativeinstru-ments) 16 811 - 16 811 - 2 646 - - - (1 438) (6 503) 11 516 - Financial assets available for sale valued atfair valuethrough equity. 860 - 860 - - - - (460) - - 400 (460) Loans to clients and recei-vables from banks valuedat amortized cost 3 701 731 287 504 3 989 235 1 354 161 51 902 12 933 (76 711)(1 129 443)(52 235) (263)4 149 579 224 718 Financial leasereceivables Invest-ments held to maturityvalued Atamortised cost 1 788 - 1 788 191 - - - (1 783) (32) - 164 (1 592) Impairment of:Tangible fixed assets 8 529 - 8 529 - - - - - (135) (26) 8 368 - Investment real estate property 3 775 3 775 - - 15 - - (202) - 3 588 - Impairment of the invest-ments in the associate and joint ventureentities -valuedusing the equitymethod 36 655 - 36 655 9 741 - - - - (2) 46 394 9 741 Other 108 896 - 108 896 9 823 1 690 143 - (2 868) - (11 956)105 728 6 955 Total 3 879 045 287 504 4 166 549 1 373 916 56 238 13 091 (76 711)(1 134 554) (54 044) (18 748) 4 325 737 239 362 Year 2004 Impair- Increase Decrease ment Balance Influence at the Impair- Foreign Other Write Release Foreign Other at the on the end of ment exchange off of of the exchange end of profit previous charges differ- assets provisions differences the and loss period during ences from the in period statement period balance the period for year sheet 2005Impairment of thefinancial assets notvalued at the fair valuethrough the profit and loss: Financial instru-ments valued at cost (nonquoted equity instrumentsand linked derivativeinstruments) 20 974 - 2 060 - - (171) (6 052) - 16 811 (171) Financial assets available for sale valuedat fair value throughequity. 918 - - - - - - (58) 860 - Loans to clients and receivables from banksvalued at amortized cost* 3 596 815 1 278 943 10 623 610 (108 472) (969 208) (105 645) (1 935) 3 701 731 309 735 Investments held to maturity valued Atamortised cost 2 068 316 - - - (316) (280) - 1 788 - Impairment of:Tangible fixed assets 9 950 1 681 - 2 561 - - (390) (5 273) 8 529 1 681 Investment real estate property 4 366 - - - - - (591) - 3 775 - Impairment of the investments in theassociate and jointventure entities -valuedusing the equity method 22 637 35 763 - - - (1 261) (3) (20 481) 36 655 34 502 Other 104 081 15 042 4 566 - - (6 602) (1 672) (6 519) 108 896 8 440 Total 3 761 809 1 331 745 17 249 3 171 (108 472) (977 558) (114 633) (34 266) 3 879 045 354 187 (*) Due to the applied exemptions, allowed by IFRS 1, data for the year 2004 isnot comparable to data for 2005. . Write-downs and write-backs related to impairment of loans, advances and otherfinancial assets and impairment reverse are presented in the profit and lossaccount under "Impairment losses on financial assets and net provisions forguarantees and commitments". Write-downs for depreciation of other assets arepresented under other operating expenses, reversals of write-downs fordepreciation of other assets are presented under other operating income. 14. Discontinued operations In 2005 and 2004 the Bank did not discontinue any of its operations. 15. Income tax Reconciliation between tax calculated by applying the current tax rate toaccounting gross profit and the actual tax charge presented in the profit andloss account. 31.12.2005 31.12..2004 Gross Profit 1 742 152 1 427 120 1 742 152 1 427 120 Tax at applicable tax rate of 19% 331 009 271 153Tax effect of permanent differences (28 273) (80 945)Non taxable income (40 413) (34 651)Non tax deductible costs 6 049 3 552Impact of other tax rates applied under a (1 206) (4 631)different tax jurisdictionTax allowances not included in the profit and 3 933 (44 694)loss accountOther 3 364 (521)Income tax 302 736 190 208 The applicable tax rate at 19% is the binding in Poland corporate income taxrate. The basic components of income tax charge presented in the profit and lossaccount. 2005 2004 Profit and loss accountCurrent income tax (394 293) (249 270)Current tax charge (375 658) (245 813)Adjustments related to the tax from previous 683 4 392yearsOther taxes (for example: withholding tax, (19 318) (7 849)income tax relating to foreign branches)Deferred income tax 91 557 59 062Due to the occurrence and reversal of timing 91 557 14 062differencesDue to the changes in the tax rates and new 45 000tax charges Tax charge disclosed in the profit and loss (302 736) (190 208)accountDeferred income tax (25 076) (30 261)Due to the occurrence and reversal of timing (25 076) (30 261)differences Tax charge disclosed in the consolidated (25 076) (30 261)equityTotal (327 812) (220 469) Deferred income tax assets/liabilities Balance sheet Profit and loss account 31.12.2005 31.12.2004 31.12.2005 31.12.2004 Deferred taxliabilityIncome receivable 139 206 221 523 (82 316) 17 161from the securitiesIncome receivable 266 715 281 955 (15 240) (4 332)from the loans givenUpward revaluation 101 243 68 465 9 684 (41 305)of the financialassetsAccelerated 108 507 78 376 30 131 32 707depreciationInvestment relief 7 382 8 537 (1 155) (5 329)Other 8 145 6 275 1 870 (165)Gross deferred tax 631 198 665 131 (57 026) (1 263)liability Zobowiazanie bruttoz tytulu podatkuodroczonegoDeferred tax assetFuture costs related 20 972 14 118 6 854 8 682to securitiesFuture costs related 229 666 249 873 (20 207) (16 994)to deposits andloans receivedUnrealized losses on 102 581 86 853 17 711 (9 591)financial assetsIncome received to 61 316 25 313 6 433 25 313be accounted forover time from theloans and currentaccountsCosts due to the 286 513 263 769 22 744 63 589loan provisionschargesPersonnel costs 52 110 46 526 5 584 3 457provisionsAccruals 6 519 1 104 5 415 (7 785)Uncovered losses 23 529 18 721 4 808 (2 928)from previous yearsOther - 14 811 (14 811) (5 944)Gross deferred tax 783 206 721 088 34 531 57 799assets Deferred tax charge X X 91 557 59 062 Net deferred tax 152 008 55 957 X Xassets As at 31 December 2005 and 31 December 2004 there were no temporary differencesrelated to investments in subsidiaries, branches, affiliates, and jointventures, for which no deferred tax liability was created due to meeting thecondition to control the timing of reversal of the differences and existence ofhigh probability that the differences will not reverse in a foreseeable future. As at 31 December 2005 and 31 December 2004 there were no temporary differences,unused tax losses and tax credits that were not included in the deferred taxasset. 16. Earnings per share Base earnings per share Base earnings per share is calculated on the basis of net profit by dividingprofit by the average weighted number of ordinary shares listed during a givenperiod. Earnings per share 2005 2004 Net profit (ths PLN) 1 439 416 1 236 912Weighted average number of ordinary shares 166 481 687 166 261 457in theEarnings per each share (PLN per share) 8,65 7,44Diluted earnings per shareDiluted earnings per share is calculated based on the profit by dividing theprofit by the average weighted number of ordinary shares listed during a givenperiod, adjusted by all potentially diluting ordinary shares. There are diluting instruments in the Bank in the form of convertible bonds. Forcalculation purposes, it is assumed that those will be converted into shares. 2005 2004 Net profit (ths PLN) 1 439 416 1 236 912Weighted average number of ordinary 166 481 687 166 261 457shares in the periodAdjustments to the number of shares for 77 253 -the purpose of calculating the dilutedprofitWeighted average number of ordinary 166 558 940 166 261 457shares for the calculation of dilutedprofitDiluted profit per each share (PLN per 8,64 7,44share) 17. Dividends paid and proposed for payment Bank Pekao S.A. prepares a separate financial statement in compliance with IFRSand the net profit recognized in that statement is divided. Dividends declared after the balance sheet date are not recognized asliabilities existing as of the balance sheet date. During the ordinary Shareholders Meeting of Bank Pekao S.A. on 5 th April 2005 aresolution was made to pay out dividends for 2004 in the amount of PLN 6,40 pershare. Management Board of Bank Pekao S.A. puts forward to Shareholders' GeneralMeeting a proposal of dividend payment for the 2005 year in amount of 7,40 zlotyper one share to consider. The amount of the dividend tax resulting from the dividends proposed by theBank's Management Board amounts to PLN 1,41 per share, (on the basis of 19%dividend tax rate), except for dividends due to shareholders taxed by lower taxrates or tax-exempted 18. Cash and amounts due from Central Bank 31.12.2005 31.12.2004 Cash 1 108 788 1 080 019Current account and deposits in the 1 078 090 1 474 673Central BankNBP bonds * 1 313 116 1 313 120Interests 70 354 64 524Other funds 3 265 2 776 Total 3 573 613 3 935 112 (*) The NBP bond is a non-quoted debt security with maturity on 1st March 2012,issued in relation to reduction of the obligatory reserve rate. The bond is notincluded under "cash" in the statement of cash flows. In the course of the day the Bank may use funds in the mandatory reserve accountfor ongoing payments pursuant to an instruction submitted to the National Bankof Poland. It must, however, ensure that the average monthly balance in suchaccounts comply with the requirements described in the mandatory reservedeclaration. Funds in the mandatory reserve account bear interest in the amount of 0,9 of therediscount rate for bills of exchange amounts as of 31 December 2005 4,75%.As of31 December 2005 this interest amounted to 4,28%. 19. Amounts due from banks 31.12..2005 31.12.2004 Current account 808 069 1 423 587 Deposits in other banks 4 921 224 3 608 831 Loans given 683 320 411 693 Unlisted securities 1 127 7 203 Repo transactions 567 791 486 093 Funds in transit 70 767 60 440 Interest 32 931 34 739 Total 7 085 229 6 032 586 Provision for the impairment of (84 459) (75 988)receivables Total net 7 000 770 5 956 598 The variable interest rate due from banks amounts to PLN 6 228 859 ths. (as of31.12.2004: PLN 4 578 502 ths.), fixed interest rate due from banks amounts toPLN 752 672 ths. (as of 31.12.2004: PLN 1 358 905 ths.). Receivables from banks according to maturities According to remaining residual maturities at the balance sheet date 31.12.2005 31.12.2004 Current accounts 808 069 1 423 587Term deposits by the repayment period:up to 1 month 3 999 008 2 641 891from 1 to 3 months 689 015 639 901from 3 months to 1 year 1 192 274 841 273from 1 to 5 years 175 508 304 968above 5 years 38 598 -receivables after the due date 79 059 85 787Funds in transit 70 767 60 440Interest 32 931 34 739 Total 7 085 229 6 032 586 Provision for the impairment of receivables (84 459) (75 988) Total net 7 000 770 5 956 598 20. Financial assets held for trading 31.12.2005 31.12.2004 Debt securities- issued by the State Treasury 2 201 765 2 939 203- issued by other non - financial entities 16 122 - Total financial assets held for trading 2 217 887 2 939 203 31.12.2005 31.12.2004 (%) (%) Average Average yield yield Fixed interest debt securitiesTreasury bills 387 407 4,31 996 553 6,59Treasury bonds 1 456 495 4,58 1 895 123 6,51Treasury bonds- RP Eurobonds (EUR 53 692 3,41 36 012 3,82denominated)Treasury bonds- RP Eurobonds (USD 18 451 5,00 715 4,70denominated)Polish Brady ( "London Club") bonds 13 455 4,82 9 089 5,13Foreign government bonds (USD 9 945 4,37 - -denominated)Issued by other non - financial 16 122 4,73 - -entitiesTotal fixed interest debt securities 1 955 567 4,50 2 937 492 6,50Variable interest debt securitiesTreasury bonds 213 561 4,58 - -Treasury bonds - RP Eurobonds (EUR 48 759 2,52 957 2,23denominated)Treasury bonds - RP Eurobonds (USD - - 754 2,93denominated)Total variable interest debt 262 320 4,20 1 711 2,54securities Total securities held for trading 2 217 887 4,46 2 939 203 6,50 Financial assets held for trading according to residual maturities: - up to 1 - between 1 - between 3 - between 1 - above 5 Undefined Total month and 3 months months and and 5 years years maturity 1 year31 December 2005 Book Average Book Average Book Average Book Average Book Average Book Book Average value yield. value yield. value yield. value yield. value yield. value value yield. (%) (%) (%) (%) (%) (%)Debt securities - issued by the State Treasury 62 964 4,30 208 227 4,30 737 189 4,11 764 536 4,78 428 849 4,61 - 2 201 765 4,46 - issued by other non - financial entities 10 052 4,72 6 070 4,74 - - - - - - - 16 122 4,73 Total financial assets held for trading 73 016 4,36 214 297 4,31 737 189 4,11 764 536 4,78 428 849 4,61 - 2 217 887 4,46 Including interest - 223 9 970 12 884 6 672 - 29 749 Financial assets held for trading according to residual maturities: - up to 1 - between 1 - between 3 - between 1 - above 5 Undefined Total month and 3 months months and and 5 years years maturity 1 year31 December 2004 Book Average Book Average Book Average Book Average Book Average Book Book Average value yield. value yield. value yield. value yield. value yield. value value yield. (%) (%) (%) (%) (%) (%)Debt securities - issued by the State Treasury 207 008 6,60 522 260 6,61 1 453 535 6,67 704 025 6,22 52 375 4,27 - 2 939 203 6,50 Total financialassets held for trading 207 008 6,60 522 260 6,61 1 453 535 6,67 704 025 6,22 52 375 4,27 - 2 939 203 6,50 Including interest - 3 145 9 614 23 614 1 555 - 37 928 - 21. Derivative financial instruments Derivatives used by the Bank In its operations the Bank uses different financial derivatives for managing therisk involved in the Bank's business. The majority of derivatives used by theBank are over-the-counter contracts. Regulated stock exchange contracts (mainlyfutures) represent a small part of those derivatives. Derivative foreign exchange transactions include either obligation or right topurchase or sell foreign and domestic currency assets. Forward operations arebased on the exchange rate specified during the transaction for a predefineddate in the future. The Bank concludes forward transactions to manage itsforeign exchange position and to satisfy its customers' demand for hedgingfuture foreign currency payments. Transactions of this type are measured by adiscounted cash flow model. Foreign exchange swaps combine the exchange of specific currencies as of thespot date and a reverse transaction as of the forward date, with the exchangerates specified in advance during the conclusion of the contract. While thosetransactions are being accounted funds are transferred. Foreign exchange swaptransactions are mostly concluded in the process of managing the Bank's currencyliquidity. These transactions are measured using the discounted cash flow modelsForeign exchange options are contracts where one of the parties, the optionbuyer, purchases from the other party, the option issuer, at a so-called premiumprice, the right without the obligation to buy or sell at a specified point inthe future, or during a specified time range, a foreign currency amountspecified in the contract at the exchange rate set during the conclusion of theoption. Foreign exchange options concluded by the Bank are over-the-countercontracts, concluded with the Bank's customers in order to hedge the riskinvolved in future foreign currency payments. The Bank acts both as optionissuer and buyer. Transactions of this type are measured by a Garman-Kohlhagenoption measurement models Derivatives relating to interest rates enable the Bank and its customers totransfer, modify or limit the interest rate risk. Interest rate swaps are contracts where parties swap between themselves interestcash flows calculated on a specified nominal value of the base instrument. In atypical swap contract, fixed rate interest flow will be swapped for a floatingrate interest flow. Both flows will be calculated on the basis of the samenominal value of the base instrument, with no actual funds being transferredduring the swap of the base instrument. Transactions of this type are measuredby the discounted cash flow models. Forward Rate Agreements involve both parties undertaking to pay interest on apredefined nominal amount, for a specified period starting in the future andcharged according to the interest rate determined on the day of the agreement.As the basis for settlements, the Parties will use the interest rate difference,which will be in proportion to the nominal amount of the agreement anddifference between the FRA rate (term rate as of the date of the transaction)and the reference rate applicable two business days before the settlement date.Transactions of this type are measured by the discounted cash flow models. Cross currency IRS involves both parties swapping capital and interest flows indifferent currencies in a specified period. Such transactions are used forinterest rate and foreign exchange risk management. Transactions of this typeare measured by the discounted cash flow models. Forward transactions on securities are based on prices of securities defined atthe conclusion of the transaction for a specified date in the future. The Bankuses securities forward transactions to manage its investment portfolio and tosatisfy customer demand. Transactions of this type are measured by thediscounted cash flow models. Stock options, stock market indexes and prices of investment fund units arecontracts where one of the Parties, the option buyer, purchases from the otherparty, the option issuer, at a so-called premium price, the right without theobligation to buy or sell a specific base instrument (shares, share marketindices, investment fund units or their baskets) at a price specified during theconclusion of the option. The Bank uses such transactions to manage securitiesrisk and to satisfy customer demand. These transactions type are measured usingthe enhanced Black-Scholes models or based on available price received fromdealer, quoted on active market, to which Bank has immediate access . Interest rate futures transactions refer to standardized forward contractspurchased on stock markets in order to ensure protection against the interestrate risk involved in the securities portfolio owned. Warrants are securities issued by the company, entitling the holder to subscribeto a specified number of shares at a predefined price. They are listed on stockexchanges and do not give the holder any entitlements to vote in ShareholdersMeetings. These contracts are valued on the basis of direct quotations availablefrom Stock Exchange. Derivatives embedded in other instruments The Bank uses derivatives embedded in complex financial instruments, i.e. suchas including both a derivative and base agreement, which results in part of thecash flows of the combined instrument changing similarly to cash flows of anindependent derivative. Derivatives embedded in other instruments cause part orall cash flows resulting from the base agreement to be modified as per aspecific interest rate, price of a security, foreign exchange rate, price indexor interest rate index. Brady bond options are derivatives embedded in balance sheet financialinstruments. In this case, embedded financial instruments are closely related tothe base contract and thus the embedded derivative does not need to be isolatedor recognized and measured separately. Derivatives are also embedded in deposit agreements. The Bank has deposits onoffer which include embedded derivatives. Such derivatives are not by theirnature closely related to their respective deposit agreements. The instrument isisolated and classified in the portfolio to be traded and it is subject tomeasurement. The measurement of that instrument is recognized in the profit andloss account. Embedded derivatives are also option for shares, markets sharesindex, unit price of investment funds and currency options. Options for shares, markets shares index and unit price of investment fundsmeasured in basis on spread Black-Scholes model or basis on available price fromdealer, quoted on active market which the Bank has immediate access.Currency option are measured based on the Garman-Kohlhagen model.The Bank analyzed the loan agreement portfolio and the ordinary agreementportfolio in order to isolate embedded derivatives and decided that suchagreements do not require isolation and separate treatment of embeddedinstruments. Risk involved in financial derivatives Market risk and credit risk are two main categories of derivatives-related risk.At the beginning, financial derivatives usually have a small market value or nomarket value at all. This is due to the fact that derivatives require no initialnet investment or require only minor net investments as compared with otheragreements which react to changes in market conditions in a similar way. Derivatives gain positive or negative value as a result of change in specificinterest rates, prices of securities, prices of commodities, currency exchangerates, price index, credit standing or credit index, or another marketparameter. This results in derivatives becoming more or less advantageous thaninstruments with similar residual maturity available on the market at the sametime. Credit risk related to derivative contracts is a potential cost of concluding anew contract on the original terms and conditions if the other party to theoriginal contract fails to meet its obligations. In order to assess thepotential cost of replacement, the Bank uses the same method as for credit riskassessment. In order to control its credit risk levels, the Bank performsassessments of other contract parties using the same methods as for of creditdecisions. Credit risk involved in derivatives is presented in Note 3. The following tables present nominal amounts of financial derivatives and fairvalues of such derivatives. Nominal amounts of certain financial instruments areused for comparison with balance sheet instruments, but need not necessarilyindicate what future cash flow amounts will be or what the current fair value ofsuch instruments is, and therefore do not reflect the Bank's credit or pricerisk level. Derivatives become advantageous (assets) or disadvantageous (liabilities) due tofluctuations of market interest rates, indices, or foreign exchange rates ascompared with their terms. Financial derivatives as of 31 December 2005 Nominal values of base instruments and fair value of financial derivatives: - up to 1 - between 1 - between 3 - between 1 - above 5 Total Fair value Fair value month and 3 months months and 1 and 5 years years (negative) (positive) year Currency transactionsCurrency swaps 4 366 983 2 077 942 1 682 893 - - 8 127 818 (21 089) 40 203Currency purchase 2 187 785 1 038 718 859 678 - - 4 086 181Currency sale 2 179 198 1 039 224 823 215 - - 4 041 637Currency forward 2 769 453 2 631 206 3 047 737 7 787 - 8 456 183 (73 991) 49 689contractsCurrency purchase 1 382 459 1 317 667 1 508 535 3 927 - 4 212 588Currency sale 1 386 994 1 313 539 1 539 202 3 860 - 4 243 595Currency options 1 413 292 1 834 338 4 670 850 78 076 - 7 996 556 (47 923) 47 923Purchase 706 646 917 169 2 335 425 39 038 - 3 998 278Sale 706 646 917 169 2 335 425 39 038 - 3 998 278Cross Currency IRS - - 15 878 259 555 947 016 1 222 449 (18 800) 18 988Purchase - - 7 939 129 780 473 508 611 227Sale - - 7 939 129 775 473 508 611 222Interest ratetransactionsInterest rate swaps 980 998 2 074 764 5 181 399 12 323 455 2 963 854 23 524 (432 035) 324 019(IRS) 470Purchase 665 499 1 175 000 3 220 670 6 537 757 2 063 321 13 662 247Sale 315 499 899 764 1 960 729 5 785 698 900 533 9 862 223Forward Rate Agreement - 600 000 14 400 000 - - 15 000 (3 818) 3 941(FRA) 000Purchase - 300 000 7 250 000 - - 7 550 000Sale - 300 000 7 150 000 - - 7 450 000 Nominal values of base instruments and fair value of financial derivatives: - up to 1 - between - between - between - above 5 Total Fair value Fair value month 1 and 3 3 months 1 and 5 years (negative) (positive) months and 1 years year Interest rate transactionsFutures for debt - 200 18 113 - - 18 313 - -securitiesPurchase - - - - - -Sale - 200 18 113 - - 18 313Other transactionsSecurities forward 321 377 - - - - 321 377 (176) 154Purchase 184 437 - - - - 184 437Sale 136 940 - - - - 136 940Options related to equity - - - 511 747 - 511 747 (9 857) 14 373securitiesPurchase - - - 256 075 - 256 075Sale - - - 255 672 - 255 672Warrants - - - 151 - 151 - -Purchase - - - 151 - 151Sale - - - - - -Total derivative instruments 9 852 103 9 218 450 29 016 870 13 180 771 3 910 870 65 179 064 (607 689) 499 290 Financial derivatives as of 31 December 2004 Nominal values of base instruments and fair value of financial derivatives: - up to 1 - between - between - between 1 - above 5 Total Fair value Fair value month 1 and 3 3 months and 5 years years (negative) (positive) months and 1 yearCurrency transactionsCurrency swaps 7 104 346 849 215 1 752 055 - - 9 705 616 (201 235) 197 870Currency purchase 3 540 875 426 800 882 078 - - 4 849 753Currency sale 3 563 471 422 415 869 977 - - 4 855 863Currency forward contracts 2 267 284 882 644 1 498 734 127 570 - 4 776 232 (63 247) 46 419Currency purchase 1 126 896 437 763 744 134 68 411 - 2 377 204Currency sale 1 140 388 444 881 754 600 59 159 - 2 399 028Currency options 278 114 528 620 579 010 - - 1 385 744 (14 376) 14 376Purchase 139 057 264 310 289 505 - - 692 872Sale 139 057 264 310 289 505 - - 692 872Cross Currency IRS 171 080 - - 114 220 662 616 947 916 (82 560) 74 895Purchase 85 540 - - 57 112 331 308 473 960Sale 85 540 - - 57 108 331 308 473 956Non Delivery Forward 17 870 37 040 - - - 54 910 (2 128) 2 128Purchase 8 935 18 520 - - - 27 455Sale 8 935 18 520 - - - 27 455Interest rate transactionsInterest rate swaps (IRS) 608 158 44 147 2 172 910 7 093 594 1 566 024 11 484 833 (246 383) 155 526Purchase 404 079 25 068 1 122 772 3 833 327 1 056 024 6 441 270Sale 204 079 19 079 1 050 138 3 260 267 510 000 5 043 563Forward Rate Agreement 1 850 000 4 300 000 4 745 000 - - 10 895 000 (8 624) 7 162(FRA)Purchase 1 050 000 2 600 000 2 300 000 - - 5 950 000Sale 800 000 1 700 000 2 445 000 - - 4 945 000 Nominal values of base instruments and fair value of financial derivatives: - up to 1 - between - between - between - above 5 Total Fair value Fair value month 1 and 3 3 months 1 and 5 years (negative) (positive) months and 1 years yearInterest rate transactionsFutures for debt - 45 653 - - - 45 653 - -securities Purchase - - - - - -Sale - 45 653 - - - 45 653Other transactionsSecurities forward 371 532 - - - - 371 532 (228) 273Purchase 192 979 - - - - 192 979Sale 178 553 - - - 178 553Options related to equity - - - 322 328 322 328 (4 902) 4 832securitiesPurchase - - - 160 000 - 160 000Sale - - - 162 328 - 162 328 - -Warrants - - - 151 - 151Purchase - - - 151 - 151Sale - - - - - -Total derivative 12 668 384 6 687 319 10 747 709 7 657 863 2 228 640 39 989 915 (623 683) 503 481instruments 22. Other financial instruments at fair value through profit and loss 31.12.2005 31.12.2004Debt securities- issued by other financial entities 767 892 741 528- issued by non-financial entities - 21 842- issued by the State Treasury 1 013 425 573 351 Total other financial instruments at fair 1 781 317 1 336 721value through the financial result 31.12.2005 31.12.2004 (%) (%) Average Average yield yieldFixed interest debt securitiesTreasury bonds - RP Eurobonds (EUR 466 586 3,63 181 755 3,83denominated)Treasury bonds - RP Eurobonds (USD 546 839 4,95 391 596 4,58denominated)Other securities issued by the 732 015 5,01 703 174 4,24financial entities (USDdenominated)Other securities issued by the 35 877 4,11 38 354 3,37financial entities (EURdenominated)Other securities issued by the non - 21 842 3,37- financial entities (EURdenominated)Total fixed interest debt 1 781 317 4,61 1 336 721 4,24securities Total debt securities at fair value 1 781 317 4,61 1 336 721 4,24through profit and loss Other financial instruments at fair value through profit and loss according toresidual maturities: - up to 1 - between 1 - between 3 - between 1 - above 5 Undefined Total month and 3 months months and and 5 years years maturity 1 year31 December 2005 Book Average Book Average Book Average Book Average Book Average Book Book Average value yield. value yield. value yield. value yield. value yield. value value yield. (%) (%) (%) (%) (%) (%)Debt securities- issued by other financial entities - - - - 35 877 4,11 732 015 5,01 - - - 767 892 4,97 - issued by the StateTreasury - - - - - - - - 1 013 425 4,34 - 1 013 425 4,34 Total - - - - 35 877 4,11 732 015 5,01 1 013 425 4,34 - 1 781 317 4,61 Including interest - - 1 482 8 059 27 484 - 37 025 Other financial instruments at fair value through profit and loss according toresidual maturities: - up to 1 - between 1 - between 3 - between 1 - above 5 Undefined Total month and 3 months months and and 5 years years maturity 1 year31 December 2004 Book Average Book Average Book Average Book Average Book Average Book Book Average value yield. value yield. value yield. value yield. value yield. value value yield. (%) (%) (%) (%) (%) (%)Debt securities- issued by other financial entities - - - - - - 741 528 4,20 - - - 741 528 4,20 - issued by other non - financialentities - - - - - - 21 842 3,37 - - - 21 842 3,37 - issued by the State Treasury - - - - - - - - 573 351 4,34 - 573 351 4,34 Total - - - 763 370 4,17 573 351 4,34 - 1 336 721 4,24 Including interest - - - 9 188 17 466 26 654 23. Loans and advances to customers 31.12.2005 31.12.2004 Loans 32 217 808 28 781 493 Payment cards receivables 118 571 84 416 Purchased receivables 199 529 368 842 Realized guarantees and commitments 44 812 40 833 Unlisted securities 96 657 565 779 Repo transactions - 196 282 Receivables in transit 138 8 624 Interest 126 263 129 993 Total 32 803 778 30 176 262 Impairment provisions (4 076 635) (3 642 553) Total net 28 727 143 26 533 709 As of 31 Gross Gross Individual Collective Total net FairDecember 2005 value of value of impairment impairment value value not - impaired charges charges* impaired loans loans Loans given to state budget 2 571 758 12 458 (10 000) (18 119) 2 556 097 2 546 848entities non-banking 1 794 967 65 532 (21 657) (58 832) 1 780 010 1 686 564financial entities non-financial 16 103 712 4 062 940 (1 658 881)(1 494 034) 17 013 737 17 145 299entities general public 7 088 075 978 073 (35 160) (779 952) 7 251 036 7 725 155 Interest 126 263 - - - 126 263 126 263 Total 27 684 775 5 119 003 (1 725 698)(2 350 937) 28 727 143 29 230 129 * Position includes the estimated impairment for losses incurred but notreported (IBNR) Following the exemption allowed by IFRS 1 the Bank does not present thecomparative data related to loans and advances to customers. Fixed interest rate loans and lending facilities extended to customers as of 31December 2005 represented 10,74% % of the total loans and advances portfolio orPLN 3 508 683 ths. Changes in impairment balances in the reporting periods ended 31st December 2005and 31st December 2004 are presented in the Note 14. 24. Investment securities 31.12.2005 31.12.2004Securities available for sale 11 902 900 10 099 344Debt securities 11 899 670 10 056 411- issued by central banks 87 631 -- issued by other banks 45 535 120 270- issued by other financial entities 32 940 28 918- issued by non financial entities 396 078 395 322- issued by the State Treasury 10 830 636 8 948 163- issued by local governments 506 850 563 738Stock and shares in other entities 3 230 42 933Securities held to maturity 2 588 038 4 931 761- issued by central banks 193 155 -- issued by other financial entities 60 180 60 439- issued by the State Treasury 2 334 703 4 836 513- issued by local governments - 34 809Total investment securities gross 14 490 938 15 031 105Impairment of securities available for (400) (860)saleImpairment of securities held to (164) (1 788)maturity Total investment securities net 14 490 374 15 028 457 Changes in investment securities 31.12.2005 31.12.2004Securities available for saleBalance at the beginning of the period 10 098 484 9 650 369Increase(purchase) 43 127 073 14 590 657Decrease (sale and redemption) (41 634 248) (13 776 132)Impairment charges during period 460 -Changes in the fair value 132 261 162 049Exchange rate differences 134 465 (519 549)Other 44 005 (8 910)Balance at the end of the period 11 902 500 10 098 484Securities held to maturityBalance at the beginning of the period 4 929 973 8 501 853Increase(purchase) 6 141 280 5 717 306Decrease (sale and redemption) (8 612 798) (9 449 877)Impairment charges during period 1 592 -Changes in the fair value 31 4 272Exchange rate differences (9 796) (58 018)Other 137 592 214 437Balance at the end of the period 2 587 874 4 929 973Total investment securities net 14 490 374 15 028 457 Debt Securities available for sale 31.12.2005 31.12.2004 (%) (%) Average Average yield yieldFixed interest debt securitiesNBP bills 87 631 4,50 - -Treasury bills 212 174 4,30 740 743 6,54Treasury Bonds 7 064 487 4,74 5 984 221 6,34Polish Brady ( "London Club") bonds 464 037 4,85 401 908 5,02Foreign government bonds (HUF 390 281 6,87 163 636 8,27denominated)Foreign government bonds (USD 800 911 4,35 340 785 3,59denominated)Other securities issued by other 45 535 4,24 44 982 7,04banksOther securities issued by - - 28 918 6,84financial entitiesOther securities issued by non - 116 942 4,74 115 957 6,59financial entitiesOther securities issued by non - 2 806 5,14 - -financial entities(USD denominated)Total fixed interest debt 9 184 804 4,79 7 821 150 6,22securitiesVariable interest debt securitiesTreasury Bonds 757 079 4,51 122 448 6,48Treasury Bonds - RP Eurobonds (EUR - - 143 089 2,23denominated)Treasury Bonds - RP Eurobonds (USD 1 107 317 4,83 1 014 116 2,93denominated)Foreign government bonds (EUR 34 349 2,90 37 217 3,58denominated)Local authorities bonds 506 850 5,04 563 738 7,27Other securities issued by other - - 75 288 1,70banks (USD denominated)Other securities issued by 32 940 2,71 - -financial entities (EURdenominated)Other securities issued by non - 276 331 4,89 279 365 7,19financial entitiesTotal variable interest debt 2 714 866 4,74 2 235 261 4,54securities Total debt securities available for 11 899 670 10 056 411saleStock and shares in other entities 2 830 42 073Total securities available for sale 11 902 500 4,77 10 098 484 5,85Securities held to maturity This information is provided by RNS The company news service from the London Stock Exchange MORE TO FOLLOWRelated Shares:
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