Good case practices in lending and loan portfolio management Milan Dobe š

1. Conference on Lending StandardsJanuary 31st, 2014 Good case practices in lending and loan portfolio management Milan Dobeš

2. Main observations on Georgian market Deposit market: • Relatively low saving tendencies of the population • High dollarization of the savings – some 40% of deposits in the domestic currency and only ¼ of that amount in form of time deposits – mostly up to 1 year • Rather limited alternative savings options in financial instruments – which apart from negative effects, has also some positive ones for the Georgian economy

3. Main observations on Georgian market Loans: • Last available data indicate ca 37% of loans being granted in GEL, approximately 1/3 of that amount with maturity under 1Y. Share of GEL denominated loans is up by 6 points during last 2 years • On the other side, only ca 1/6 of foreign currency denominated loans is granted for short term, proportion having slight downward trend

4. Retail portfolio

5. Major trends • Moderate increase of payment to income (PTI) ratio on the new production in 2013 • Change of the product mix on the market in favor of secured and (mainly) unsecured consumer lending • Recent major wave of refinancing of mortgage loans from USD denomination into GEL • So far good performance of the BR retail portfolio across the board, nonetheless due to changes in the product mix the average 12 month default rate on BR portfolio increased by 20 bp y/y in 2013

6. Recent steps taken by Bank Republic • Elimination of highest income bracket from set of granting rules, thereby effectively decreasing PTI ceiling for this category of customers by 5 points • Introduction of the minimum income level for the customers from lowest income brackets based on number of dependent family members • Increase of minimum limit for loans for segment of very small businesses and professionals – this measure was mainly targeted on internal efficiency rather than cost of risk reduction on the segment being exited The net effect of the steps above is however overlapping with effect of the economic slowdown and deflation threat on the market, therefore the analysis of the effects of the specific factors is not giving conclusive results

7. Examples of other measures being applied • Progressive PTI limits from 25%/35% for lowest income category to 50%/60% to the highest income bracket • 10% reduction of PTI limit for loans where client undertakes FX or IR risk • Increased LTV requirement for the high volume mortgage loans • Limitation of overall volume on specific types of unsecured products

8. Early warning indicators • Early warning indicators application on retail portfolio, giving good view on performance of new production and possibility to predict future default rates

9. Vintage analysis and default rate prediction Vintage analysis of BR retail portfolio and respective product and product groups helped us to better manage and forecast default rate and by extension also Net Cost of Risk of the portfolio and better measure impact of specific actions or changes in strategy on the production and NCR levels BR is still in phase of building sufficient database of statistical data in order to build a robust enough model, however the available data are already quite beneficial in areas of portfolio performance forecasting and risk based pricing

10. Vintage analysis and default rate prediction Source: BR portfolio analysis

11. Non-retail portfolio

12. Major trends • Non-retail lending is still rather inclined towards collateral based lending strategies, which has some positive effects in terms of reduction of LGD and limiting growth of the Debt/EBITDA levels in the non-retail segment • Working capital needs are often financed by amortized MT loans instead of ST revolving lines following the actual working capital need of the company • Overall quality of financial accounting and reporting standards on the market still needs improvement • Despite improved client screening, default rate on BR non-retail portfolio increased by 63 bp y/y in 2013. Increase of PD is so far being compensated by reduction of LGD.

13. Steps taken by Bank Republic In view of performance of portfolio of BR, but also other comparable SG subsidiaries, following criteria (among other) are being applied: • Debt/EBITDA is to be maintained under 3.0 • Gearing on non-trading activities is to be below 100% • Limiting working capital financing to equivalent of 3 months of sales In the current environment of rapidly changing interest rates, the ICR data and covenants has proven to be of limited utility so far in the effort to reduce the default rate on the new production

14. Lessons learned from other markets • Need of strict control of Debt/EBITDA levels, especially on new investment projects with unproven CF generating capability

15. Conclusion • While the lending standards on the market are still rather relaxed, the trend is visibly positive in this regard • The significant issue which remain to be solved is not the definition of the standards, but willingness and ability of the banking sector to enforce those rules • Especially the ability to enforce the lending conditions and especially financial covenants is still impaired by the quality of financial accounting and reporting on the side of the corporate clients

16. Thank You BR/Risk 31.1.2014