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AS LHV Group Consolidated Annual Report 2018 (Translation of the Estonian original) 2 Consolidated Annual Report 01.01.2018 – 31.12.2018 Legal name AS LHV Group Commercial Registry no. 11098261 Legal address Tartu mnt 2, 10145 Tallinn Phone (372) 6800400 Fax (372) 6800410 E-mail [email protected] Main activities Activities of holding companies Banking Security brokerage Financial advisory Finance lease and other lending Management Board Madis Toomsalu Supervisory Board Rain Lõhmus Andres Viisemann Tiina Mõis Heldur Meerits Raivo Hein Tauno Tats Sten Tamkivi Shares Listed on the Nasdaq Tallinn Stock Exchange Auditor AS PricewaterhouseCoopers AS LHV GROUP TARTU MNT 2, 10145 TALLINN 6 802 670 [email protected] LHV.EE 3 Table of contents Statement of the Managing Director 4 Business environment 7 Management report 10 Governance of the Group 15 Financial results 19 Corporate Governance report 29 Social responsibility in LHV 38 CONSOLIDATED FINANCIAL STATEMENTS 49 Consolidated statement of profit or loss and other comprehensive income 49 Consolidated statement of financial position 50 Consolidated statement of cash flows 51 Consolidated statement of changes in equity 52 Notes to the consolidated financial statements 53 NOTE 1 General information 53 NOTE 2 Summary of significant accounting policies 54 NOTE 3 Risk management 74 NOTE 4 Significant management estimates and assumptions 124 NOTE 5 Business segments 124 NOTE 6 Subsidiaries and goodwill 126 NOTE 7 Net interest income 128 NOTE 8 Net fee and commission income 129 NOTE 9 Operating expenses 130 NOTE 10 Due from central bank, credit institutions and investment companies 130 NOTE 11a Available-for-sale financial assets 131 NOTE 11b Equity and debt instruments at fair value through other comprehensive income 131 NOTE 12 Financial assets and liabilities at fair value through profit or loss 132 NOTE 13 Loans and advances to customers 133 NOTE 14 Receivables from customers 134 NOTE 15 Other assets 134 NOTE 16 Tangible and intangible assets 135 NOTE 17 Deposits from customers and loans received 136 NOTE 18 Accounts payable and other liabilities 136 NOTE 19 Operating lease 137 NOTE 20 Subordinated debts 137 NOTE 21 Shareholders’ equity in the public limited company 138 NOTE 22 Assets under management 140 NOTE 23 Contingent assets and liabilities 140 NOTE 24 Transactions with related parties 141 NOTE 25 Basic earnings and diluted earnings per share 143 NOTE 26 Discontinued operations 143 NOTE 27 Separate financial statements of parent company 144 Signatures of the management board to the consolidated annual report 147 Independent Auditor’s Report 148 Proposal for profit distribution 155 Signatures of the supervisory board to the annual report 156 Allocation of income according to EMTA classificators 157 AS LHV GROUP TARTU MNT 2, 10145 TALLINN 6 802 670 [email protected] LHV.EE 4 Statement of Managing Director Dear LHV investor, characterisation of the surrounding business environment and cannot be deemed an indication of our loan portfolio, LHV has had a strong, industrious year. A year character- which continues to stand strong. ised by good results, a strong growth in customer base, various new products and recognitions. At the beginning of To enhance corporate banking offers, we started to July, LHV was declared the best Estonian bank by the inter- contribute trade-financing products at the beginning of the national Euromoney magazine. This was a follow-up to the year. Above all, mention must be made of factoring. Our title of the best private banking service provider, awarded pursuit of growth in business volumes requires a credit to LHV by Euromoney at the beginning of the year. rating. At the end of the year, Moody's gave LHV Bank a credit rating of Baa1. A credit rating will ensure the accepta- The recognition, as well as the achievements described bility of the guarantees provided by LHV Bank to guarantee below, must be attributed to the 380 staff members of LHV. beneficiaries beyond Estonian borders. We also concluded Our employees are making a daily effort to further enhance a EUR 20 million agreement with the Nordic Investment the position of LHV as an Estonian capital-based company Bank, aiming to improve the credit capacity of small and in the local financial services market, while also contrib- medium-sized enterprises. uting to LHV's success as an exporter of financial services. We take pride in our supportive working environment, as In retail banking, we focused on housing loans, enhance- evidenced by the highest ever results of the end-of-year ment of investment services and development of custom- employee satisfaction survey. er-oriented services. As a major innovation, we imple- mented the e-identification system, which allows customers LHV posted record-breaking results in all business areas to open a bank account via internet bank, without leaving in 2018. LHV Bank's customer numbers grew by 28 thou- the comfort of their home. We also expanded LHV's ATM sand, and the volume of loans by EUR 199 million to EUR network, which now includes 21 ATMs all over Estonia. We 919 million. Even though the total volume of deposits of will continue installing new ATMs in 2019. LHV Bank decreased by EUR 99 million, the volume of standard customer deposits grew by EUR 314 million, if In our housing loan offers, we focused on big-city we do not include the planned reduction in the volume of customers who value a smooth, swift and collaborative deposits of financial intermediaries. Pension funds grew by service. The housing loan portfolio grew by EUR 61 million, EUR 115 million, amounting to EUR 1,204 million as at the amounting to EUR 139 million as at the end of the year. We end of the year. We also achieved record levels of customer offer housing loans at a price, which serves to secure the activity in payments, card transactions and conclusion of return on equity promised to the shareholders. new investment agreements. At the end of August, we launched the Youth Bank offer, LHV’s net profit amounted to EUR 27.2 million in 2018. providing a specially designed youth card, student loan This constitutes a EUR 5.0 million increase from last year, and micro-investment service. Our micro-investment generating a 19.3% return on equity before taxes and an service targets all those, who wish to start investing without 19.0% return on equity on net profit basis for the share- any previous knowledge in the field, favourably, with holders of LHV. We exceeded our financial forecasts by low-level regular contributions and a near-zero time cost. EUR 1.1 million. Profit was supported by customer activity We contributed to the launch of mTasku (a new payment and revenue from capital market transaction consulting. platform developed by Telia) and launched the health and Business volumes and profits increased in all core busi- home repair loan. ness areas. In the business area of financial institutions, we focused Corporate banking witnessed a one-third growth in busi- on searching new customers and expanding the product ness loans. Our loan stock has shown the swiftest growth portfolio. There is great interest in flexible banking services on the market. We are able to make progressively better among financial institutions, with new customers constantly offers for large loan amounts. The economic environment joining up. Nonetheless, the process of becoming a has remained favourable, but we continue monitoring customer takes time - on the one hand, financial insti- domestic and external economic developments affecting tutions must often complete a time-consuming licence Estonian enterprises. More than in previous periods, application procedure; on the other hand, we pay special corporate banking results were affected by write-downs attention to AML and KYC principles. Our business in associated with a single customer. Nonetheless, this is no United Kingdom is profitable, with revenue generated from AS LHV GROUP TARTU MNT 2, 10145 TALLINN 6 802 670 [email protected] LHV.EE 5 payments, currency exchange, card payment mediation, Business environment credit services and maintenance fees. Our greatest concern with respect to the long-term The total volume of investment funds managed by LHV economic outlook lies in the difference in the dynamics Asset Management exceeded EUR 1.2 billion in 2018. A of different European regions, as well as over-regulation, bulk of the fund volume is composed of actively managed which adds to stagnation. There is no reward without risk pension funds, where LHV's investment strategy clearly – it is the core principle of market economy. The ever-in- differs from that of competing pension funds. creasing tendency to avoid risk and produce red tape is bound to hamper potential development and curb reve- 2018 was a difficult year for investors, with only a few nues. Our concerns are further fuelled by the fact that markets generating a positive yield. European shares lost Europe is falling behind, compared to United States and 10.6% and developing markets 10.3% of their value. LHV China. has previously decided to direct pension investments in alternative asset categories and the local market. This In the short-term perspective, however, the base scenario choice can be attributed to the elongated rise in interna- still revolves around an annual economic growth of a few tional securities markets, which LHV Asset Management percentages in the euro area. LHV's trends of growth are deems too expensive to invest in. The chosen strategy also supported by the Estonian economic environment. helped LHV to maintain the assets of the actively managed The Estonian economy has shown good growth, with funds in 2018, with the corresponding yield falling between domestic risks mitigated by the balanced state budget, low -0.1% and 1.1%.

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