BANKING CLIMATE IN BULGARIA - access to finance, corporate sector funding sources and loan conditions Kristofor Pavlov, Chief Economist Bulbank member of UniCredit Group Sofia, 08th June 2005

BANKING MARKET – SIZE, DEPTH, PENETRATION AND ACTIVITIES EU (15) BULGARIA Size of the market GDP (in billion Euro) 807 Population (million) 179 Per capita GDP 4,499   Banking sector volumes Total Assets / GDP n.a. Total Loans / GDP 29% Total Deposits / GDP 40% Total AUM / GDP 2004 2004 2001 2002 2003 9,731 15,2 16,5 17,7 19,4 382 7,9 7,8 25,462 1,925 2,107 2,264 2,504 n.a. 41% 45% 50% 66% 94% 15% 20% 27% 37% 72% 30% 32% 36% 43% 0,03% 0,07% 0,15% Banking activities Branches per mln inhabitant Number of employees (thousands) Share FX Deposits Share FX Loans 234* 513** 81 110 120 135 n.a. 21 22 23 n.a. 56 52 46 44 n.a. 35 41 42 47 Strong growth drives intermediation levels quickly to approach NE standards Still room for branch banking expansion Large share of FX activities, due to openness of the economy and monetary arrangement chosen. Source: BNB, Bulbank & UCI database *Data for NE12 for 2001. ** Data for EU is and EU15 is for 2000.

SUCCESSFUL STRUCTURAL TRANSFORMATION Foreign ownership in NE12 as % of total assets¹ Bulgaria Total assets by ownership 1998 2004 7.1% Other 0.4% State owned 16.7% Other 32.3% Foreign owned 60.6% State owned 82.9% Foreign owned With privatization completion market structure in terms of key players is fixed. Market liberalisation and restructuring achieved indirectly via foreign banks entry. Foreign banks impact on local market: Inflow of capital and new market behaviour; New segment and product development; Transfer of experience, new practices and competencies; IT and Human Resources enhancement Source: New Europe Research Network, based on Central Bank Statistics. (1) Data as of 2003

LOANS EXTENDED BY LOCAL BANKS – KEY DRIVER OF DOMESTUIC DEMAND Bank’s importance for investment assets acquisition Bank’s share in financing the residential property market Bank’s funding of household consumption expenditure * Bulbank’s estimate based on BNB data

INTEREST RATES – FAST REDUCTION IN COST OF BOOROWING Retail Interest Rate Average Interest Rate Corporate Interest Rate General methodology note – applicable interest rates are on newly extended loans and newly contracted deposits

Yearly change in Loans-to-GDP ratio (1999-2004) LENDING BOOM – MORE OR LESS STANDARD PHENOMENON FOR TRANSITION COUNTRIES; IN BULGARIA – OVERDUE CATCH UP Yearly change in Loans-to-GDP ratio (1999-2004) Lending boom determinants: strong capital inflow and access to international funding market; cutback in borrowing costs; local savings growth recovery; risk reduction due to improving operating environment; newly privatized bank’s owners search for profit maximization opportunities; rising investment demand to close the technology and productivity gap with EU; demand for consumer durables recovers from the depressed levels in 1997, households confident in their improved debt service capacity; crowding-in effect, due to prudent fiscal policy and reduced borrowing needs of the pubic sector. Source: Data for Estonia, Lithuania, Hungary, and Slovenia is taken from EuroStat.

Lending growth impact on external accounts and inflation LENDING BOOM - MACROECONOMIC IMPLICATION & RISKS Lending growth impact on external accounts and inflation 6,2 Sharp rise in the availability of financing undergird economic expansion since 2002. However, fast lending growth: fuels internal demand which in turn exercise pressure on import causing CA deficit to widen - a standard phenomenon for a transition country. no impact on prices inflation as CPI is rather driven by supply side determinants no assets price bubbles so far. Rising real estate prices - another overdue catch up process. Source: National Statistics Office and Central Bank * Real estate prices refer to average selling price of apartments in Sofia town

Credit quality indicators (2001 – 2004) LENDING BOOM – BANKING SECTOR STABILITY IMPLICATIONS AND RISKS Credit quality indicators (2001 – 2004) Credit quality is a relevant concern. Some smaller banks seems to lack adequate: risk management skills; discipline; experience and financial strength.   2001 2002 2003 2004 NPLs Non-performing Loans * 356 320 372 493 Substandard Loans 153 140 139 212 Loss Loans 203 180 233 281 Coverage Ratio   NPLs ratio over gross loans 7,9% 5,0% 3,9% 3,5% Total Provisions / Total Gross Loans 5,5% 3,8% 3,4% Total Provisions / NPLs 101% 112% 97,5% 95,3% Net provisions (flow) / Total Operating Income -10,5% -1,4% 1,0% -8,8% Source: BNB reported data. * Before 2004 NPL also include doubtful loan classification category.

ACCESS TO LENDING IS NOT A SETBACK FOR LARGE COMPANIES Application for banking credit Major hurdles for real sector development Substantial loans concentration – 1100 companies control 60% of outstanding loans. Generally these are large companies with sales revenues above BGN 5mln. Despite its rising significance for the economy SME sectors still remains relatively isolated from bank lending. Looking forward SME’s will become increasingly a focus of attention of banks. * Data are from poll conducted by Alpha Research in early 2005 among 130 regular corporate bank borrowers

Alternative funding sources* LOANS DEMAND ON THE RISE IN 2004. STILL LARGE RELEVANCE OF ALTERNATIVE FUNDING SOURCES STRUCTURE In what way has the need for banking credit for your company changed in 2004? Alternative funding sources* Although, all polled companies have already used 1 or more loans, only some one third has never used alternative funding sources * As percent of the number of companies in the poll.

Borrowers eligibility requirements changes in 2004 BANKS HAVE LOOSENED BORROWERS ELLIGIBILITY REQUIREMENTS How have borrowers eligibility requirements applied by banks changed in 2004? Borrowers eligibility requirements changes in 2004

CHALLENGES AND OPPORTUNITIES EU AND EMU ACCESSION HIGHLIGHT THE NEED OF ADDITIONAL INVESTMENT, … CURRENT MARKET TRENDS CHALLENGES AND OPPORTUNITIES IMPROVING MACROECONOMIC FUNDAMENTALS IMPROVING OPERATING ENVIRONMENT – enforcement of contracts, property rights, corporate governance - all driving risk level down COMPETITIVENESS – low cost of inputs and especially labour INTERNATIONAL SPECIALISATION – still large share of low value added exports TECHNOLOGY TRANSFER – import of investment goods, FDI and imitation STRUCTURAL RIGIDITIES REDUCTION – still fundamental prerequisite; ALL LEADING TO NEED OF STRONG INVESTMENT ACTIVITY AHEAD OF EU ACCESSION SOPHISTICATION OF DOMESTIC DEMAND – requiring high quality in customer service and fast reaction to changes in the customers’ needs and preferences; EU STRUCTURAL FUNDS – lead to rising incomes in some sectors as agriculture but could disguise loss maker and harm efficiency; INCREASING COST OF LABOUR – requires to develop and sustain other competitive advantages FOLLOWING EMU ENTRY – better access to external finnacing, no exchange rate risk and substatial bonus in terms of country risk reduction. Cope with monetary policy rather targeted at core EU countries; ALL SUGGESTING IMPROVEMENT IN OPERATING CONDITIONS IN ACCESS TO FINANCING AND RISK REDUCTION How the changing operating environment (as a consequence of EU and EMU convergence) is likely to affect the corporate sector in the region? We list a number of challenges and opportunities (see in the slide), which are both related to EU and to EMU convergence. All point to need of additional transformation and investment. This in turns points to the need for access to additional financing.

Thank you! How the changing operating environment (as a consequence of EU and EMU convergence) is likely to affect the corporate sector in the region? We list a number of challenges and opportunities (see in the slide), which are both related to EU and to EMU convergence. All point to need of additional transformation and investment. This in turns points to the need for access to additional financing.