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Eik Banki DKK 82 28 May 2009 A Refreshingly Free From Major Problems – Initiation of Coverage

Share Price: DKK 82

350 FO-EIK-C SE.C O Eik Banki P/F Eik is a small bank by international standards, but it accounts for .UKX rebased to FO-EIK-CSE.CO 300 50% of the Faroese market and it is a full service bank, taking deposits and advancing commercial and domestic loans and 250 mortgages. It has avoided most of the problems that have plagued 200 its larger competitors. Its loans to deposits ratio is conservative. Both its full year 2008 and its Q1 2009 results statements have 150 been refreshingly free from major problems. It is one of the few 100 not to have had to raise fresh equity capital during the past

50 year. Q2-2008 Q3-2008 Q4-2008 Q1-2009 Source: Fidessa 12m High: DKK 328 Eik Banki will take advantage of the Danish Government’s Credit 12m Low: DKK 78 Package II for the banking community. This will boost its solvency Market Cap: DKK 667m (€90m) and core capital ratios, at a short term cost to profits and dividends Shares in Issue: 8.13m but without requiring any equity dilution. Post the Package, Eik Banki has solvency and Core Capital ratios that should give Core Capital: 7% (group) 13.1% Eik Banki P/F comfort to depositors and shareholders alike. both before Credit Package II. Solvency: 10% (13.4% after Government Because of Eik’s market position in the Faroe Islands its shares Credit Package II). 17.4% pre-package for Eik give exposure to the Faroese economy in general. In Denmark Banki P/F the bank is exposed to the interbank market and lending against Nav/share: DKK 203 residential property and corporate real estate. The Faroe Islands is EPIC Code: FO-EIK CSE, Copenhagen a self-Governing territory within Denmark. The country has been FO-EIK, IcelandSEDOL No.: B28ZYK8 sensibly run, experiencing none of the difficulties of its neighbour ISIN No.: FO 0005702340 Iceland. Sector: Regional Banks Market: Nasdaq OMX Copenhagen & Iceland We believe that future asset write downs and fair value Investor Relations: Finn Danberg, Director, adjustments will be modest, and that the company will return to CFO +298 548 610 profit in 2010 after a decent result in full year 2009. Websites: www.eikbank.com, www.eik.fo Description: Eik Banki is the largest bank in The current share price is less than 20% of its peak, and Eik Banki the Faroe Islands. It provides loans to Faroese Group is trading on less than 2X peak earnings, 6X the earnings businesses, mortgages on Faroese housing and consistently produced in the earlier years of the decade. The has an important internet banking activity in shares are also trading at only 40% of their net asset value. Denmark. Analyst: Thomas Dam, Spf. DamCo, Torshavn Eik Banki tends to be overlooked by buyside sector specialists Tel: +298 59111, +44 020 7929 3399 because of its remote physical location, the fact that it has not Email: [email protected]; previously attracted any investment research, and has no ratings [email protected] on Moody’s or Standard & Poors. Yet it makes a very interesting and, in our opinion, a relatively safe addition to the investment choice in this sector.

This is an undiscovered asset that deserves to be recognised.

Total Declared Pre- Adjusted After- Adjusted Adjusted P/E Divi Yield Y/E Income* Tax Profit Tax Profit** After-Tax EPS** ratio December DKKm DKKm DKKm DKK DKK % 2007A 676 465 310 31.2 2.6 10.67 13.0 2008A 796 -416 384 36.8 2.2 0 - 2009E 661 69 249 23.8 3.4 0 - 2010E 743 313 323 31.0 2.6 0 - ** Before impairments and * Net interest income + fees etc market value adjustments

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The Faroese and Danish Economy

Economic Conditions

In common with every other country in Europe, economic growth slowed in Denmark in 2008 because of the financial crisis, a decline in activity in the housing market and lower consumer spending. This followed several years of strong growth.

The Faroe Islands are one of the three constituents of the Kingdom of Denmark, the others being Greenland and the Danish mainland. The global economic slowdown also affected the Faroe Islands. There has been a reduction of activity in the housing market, and consumers have been holding back on spending due to the uncertain economic outlook. The largest single industry in the Faroe Islands – fishing – has also experienced challenging conditions. There has been a reduction in the stock of fish in Faroese waters, especially cod and haddock, combined with lower market prices. The high oil prices in 2008 also caused difficulties for the Faroes as a whole and for the fishing industry in particular. While there has been a significant correction in the price of crude, the market price of cod and haddock remains at the bare minimum necessary for parts of the fishing industry to operate. It is possible that parts of the fishing industry will face bankruptcy (only the trawlers fishing for cod and haddock have these problems).

Unemployment Unemployment Increases in unemployment have been reported both in Denmark and the Faroe Islands – will increase but see figure 1. The rate of unemployment has increased in the Faroe Islands from 1.4% levels are not average in 2008 up to 3.4% in the end of April 2009. In Denmark the rate has increased extreme from an average of 2.3% in 2008 up to 3.2% in March 2009. Unemployment is estimated to increase up to 4% by year-end 2009 in the Faroe Islands, and the Danish Central Bank has estimated that unemployment in Denmark will likewise be almost 4% in 2009.

However, these levels of unemployment are not extreme when compared to 2003-4.

Figure 1

The Housing Market

House price trends in Denmark and the Faroe Islands have exhibited similar trends. Prices in both countries have followed the general European (and North American) trend over the past eighteen months and have been weaker.

From their peak in mid 2007 the prices of one-family homes and holiday cottages in Denmark have dropped by 13% and 15% respectively. The prices of apartments started to fall in mid 2006, and have fallen about 24%. These figures are shown in figure 2 and are up to and including 2008. The statistics also show that the number of transactions in the housing market has fallen by more then 40% compared to one year ago. Hardman & Co. Leaders in Corporate Research 2 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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Figure 2

The statistics for the Faroese housing market are reported differently to those on the mainland. Faroese house statistics are grouped by province, towns and the capital. The trends are shown in figure 3.

The average Faroese house owner is much less indebted than the average Danish house owner

Figure 3 The Faroe Islands experienced an economic crisis in the early ‘nineties, and the effects of this can be seen clearly in the house price graph, Figure 3. One consequence of this was that the Faroese housing prices started the current decade at a low level compared to those in Denmark, and were therefore probably less vulnerable when they peaked in 2007. When housing prices from 1st Quarter 2009 are compared with the corresponding prices from mid 2007, prices in the province and the capital Torshavn have dropped by 10% but prices in the towns have dropped by 25%. The number of transactions in the Faroese housing market has not fallen by as much as in Denmark – only by 12%.

The drop in the number of transactions in the housing market has been a feature common to every European country, and reflects uncertainty in the direction of the market. Buyers hope that prices will go further down and sellers wait because they hope prices will increase. We believe that the economy will need to worsen considerably for us to see a further major drop in house prices.

When comparing the housing market in Denmark and the Faroe Islands it is necessary to bear in mind that the Faroese house owner is much less indebted than the Danish house owner. Comparing the debt of house owners and organisations to GDP is one indicator of this difference. Hardman & Co. Leaders in Corporate Research 3 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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Debt in houses compared to GDP Faroe Islands 72% Denmark 121% Sweden 71% Germany 67% Figure 4

It is therefore not possible to compare directly the asset quality of banks who are mainly exposed to the Danish house market and banks that also are exposed to other markets. Figure 4 shows that the Faroese housing market is in some respects more comparable to the housing markets in Sweden and Germany than it is to that of Denmark.

The Gross Domestic Product

The GDP of the Faroe Islands is estimated to fall 3-5% in 2009 and 1-6% in 2010. In Denmark the Central Bank has estimated the GDP of Denmark to fall 1.1% in 2009 and increase by 1.0% in 2010. The Faroese economy tends to be more volatile than that of

Denmark, and also less predictable, which is why the Central Bank’s range of forecasts for the Faroes in both years is so wide, while it feels confident enough to be able to predict Danish trends to within one decimal point.

The Faroes have Ratings of the Faroese and Danish Economy an Aa2 rating, In October 2008 Moody’s Investors Service released a Credit Opinion on the Government Denmark is Aaa of the Faroe Islands. They were accorded an Aa2 rating with a stable outlook. It was given a Baseline Credit Assessment (BCA) of 5 and a high likelihood that the Kingdom of Denmark would act to prevent a default by the islands. Denmark has an Aaa rating with a stable outlook.

The major challenge for the Faroe Islands is, according to Moody’s, the volatility of the fishing industry which is exposed to boom and bust on price and volume. In addition, there are substantial challenges in the management of commercial exploitation of its fishing grounds. Moody’s also points out the fact that the trade balance has moved sharply negative and would be further weakened by any decline in fishing, which makes up almost all of its exports.

But the Faroe Islands' BCA of 5 reflects a number of other factors, including the economic strength and increasing diversification of the Faroese economy. The BCA also reflects the government's powers to raise revenues through taxation and fees and to control spending as well as the strong financial results achieved since 1995. The Faroese government maintains ample reserves, while the debt level is moderate and decreasing and the interest burden falling. The BCA takes into account the Islands' relationship within the Kingdom of Denmark and the subsidies it receives, which it administers in conjunction with the Kingdom of Denmark. The support (see below) also takes into account the settled relationship the Faroese have with Denmark in the consideration of further autonomy and potential independence.

Support For The Banking Community In January 2009 the Danish Government announced a DKK 100 billion (€14 billion) support package for Danish and Faroese banks. This has been given the title ‘Credit Package II’.

The scheme involves making available a form of hybrid core capital loan to those banks that want to join the scheme. No equity will be involved; the loans will bear an average interest rate of 10% - although the precise rate, and the size of the loan made available, will vary from bank to bank. The banks have until June 30 2009 to apply for the capital injection. They will have the option to repay the loan after three years, but apparently not before this date. Any bank joining the scheme will therefore be committing to a significant increase in its cost base.

Unlike the support schemes operated by the US and UK Governments, this scheme is not intended to rescue failed banks, it is a mechanism intended to prevent the spread of panic

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to banks that are otherwise financially sound. Banks and mortgage lenders must be solvent before they are permitted to take the loans. The way the scheme is structured, with the Government maintaining control over which banks are permitted to join, the size of the loan and the interest rate charge, rather suggests that the Government intends to limit its risks.

As a further condition of the loans, participating banks will not be permitted to implement new stock option schemes, or to extend existing ones. The banks will neither be permitted to pay out any dividends to shareholders in 2009 and 2010. The variable element of executive pay is not permitted to exceed 20% of the total package. Also, only 50% of executive pay will be deductible from taxable income, so the Corporate Tax yield to the Government is likely to increase over the life of the scheme – an interesting way of ensuring that the support process damages the interests of the Danish taxpayer as little as The Credit possible. This final provision will act as a major incentive to profitable banks to pay back Package the Government loans quickly. schemes do not come ‘free’ to The scheme has a target of taking the core capital ratio of participating banks above 12%. the banks The Danish Minister for Economic Affairs stated that “What we have strived for is to ensure that society does not come to a standstill. We think this is enough to create some room (for banks) to keep lending money to sound projects”.

The Danish Government had previously offered an unlimited Government backed guarantee to Danish and Faroese bank deposits and on banks’ debt to creditors, other than subordinated debt and equity. This took effect in October 2008 originally with a two year life, but this has subsequently by ‘Credit package II’ been possible under certain conditions to be prolonged by up to additional three years. This scheme, known as ‘Credit Package I’, does not come ‘free’ to the banks either; the banks are being charged for participation, and also have to provide a guarantee for any losses made by other banks in the scheme.

The Eik Banki Group

Background The history of Eik Banki dates back to 24 August 1832, making Eik Banki one of the oldest financial institutions in the Kingdom of Denmark and the oldest on the Faroe Islands. In 1991, the Bank was made into a Guarantor Savings Bank, and in 2002 became a Limited Liability Company.

Since 2002, Eik Banki has developed from being a local business operating entirely within the Faroe Islands, and now has an international presence, engaging itself in foreign activities beyond the Faroes, mostly in Denmark.

The Management Marner Jacobsen has been Chief Managing Director of Eik Banki since 1999. In 1998 he was Managing Director and in 1997 Deputy Managing Director. Marner Jacobsen is also Chairman of the Board of Directors in Eik Bank Danmark and The Faroese Securities Market. Previously, he has been a member of the Economic Council to the Faroese Government.

The Managing Director, Bjarni Olsen, joined Eik Banki in 1999. Prior to this, he was the Managing Director of The Statistical Institute of the Faroe Islands. Bjarni Olsen has chaired the Economic Council to the Faroese Government.

The Eik Banki Group

Eik Banki Group offers services to individuals and corporate business customers primarily on the Faroe Islands and in Denmark.

The Group´s Head Office is located on the Faroe Islands where it operates as a full service bank. It has a network of 15 branches throughout the islands. Eik Banki has a market share of approximately 50 percent on the Faroe Islands. In Denmark, the Group offers its banking Hardman & Co. Leaders in Corporate Research 5 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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services through its wholly owned subsidiary Eik Bank Danmark A/S, the largest internet bank in Denmark.

The Group's services comprise corporate and retail banking, including a range of e-banking services, , capital market services, treasury services, asset management and wealth management for Private Banking clients. The Group also offers real estate brokerage services in the Faroe Islands through its wholly owned subsidiary P/F Inni.

Eik Banki Group has been dual listed on Nasdaq OMX Nordic Exchange in Copenhagen and Iceland since 11 July 2007. The dominant market in the shares is in Copenhagen.

Recent Group History

For the four years before the 2008 international banking crisis, Eik Banki’s management had driven its strategy with a view to maximising growth, development and profitability, but crucially at the same time spreading risk and refusing to become involved in the type of dangerous speculative activities that have caused such problems for banks in the US and elsewhere.

The acquisition of Eik Bank Danmark in 2004 was an important step for Eik Banki as for the first time it was able to generate a significant part of its income from activities abroad. This had the combined effect of increasing profits, broadening the portfolio of products that Strategic could be offered to customers, and diversifying group risk. objectives are

unchanged On the Faroese market, the bank strengthened its position, when it in 2005 reached a trading agreement with the Danish mortgage credit institution BRF Kredit. Eik Banki is still the only bank on the Faroe Islands to offer mortgage credit loans. The bank also launched the so called e-kort, differentiating the bank as being the only bank to offer a credit card loyalty concept on the Faroe Islands.

Another important step was taken in May 2007, with the acquisition of the Danish bank SkandiaBanken, which was merged with Eik Bank Danmark. SkandiaBanken was the largest internet bank in Denmark, providing its services exclusively over the internet. The bank had some 110,000 retail customers. SkandiaBanken was competing with the Danish mortgage credit institutions (MCI’s) by providing first charge mortgage loans for private houses and apartments.

In December 2007 Eik Banki acquired part of ’s Faroese operation, increasing the market position and in particular consolidating the areas of Investment Banking and Asset Management, where Eik Banki today holds a strong position on the Faroe Islands.

That same year, two companies, Privestor and Finansnyt, were acquired and merged with Eik Bank Danmark, in order to strengthen the analysis and asset management divisions of the bank. The auto financing department was divested later in the year in order to minimise risk in relation to car financing.

During 2008, the underlying long term strategic objectives remained unchanged, but attention was very much focussed upon minimising the impact of the world banking crisis and ensuring that Eik Banki was insulated, as much as possible, from the traumas that were affecting the international banking community.

The Immediate Future

The Faroe Islands is still the largest single field of operation for the Eik Bank Group but despite the current gloomy prospects it maintains its objective to expand and diversify its overseas activities to increase income and spread risk. On the one hand, the possibilities to expand operations on the Faroe Islands are limited as Eik Banki already has 50% of the market. On the other hand, since the Faroese economy, measured by standard deviation of GDP growth, has tended to be less stable than for example the economy of Denmark, diversification of activities overseas is a sensible strategy.

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The bank states that it now seeks to reap the benefits of synergies within the group. There will therefore be focus on reducing the number of double functions within the business and reorganising the leadership structure in a way that it invites further and closer cooperation within the Group. There will also be much greater focus on information Technology. The bank has decided to centralise all IT activities with Skandinavisk Data Centre (SDC), an IT provider for banks in Denmark, Norway and Sweden. This IT platform is relatively new and has a critical advantage for Eik in that it provides the systems to operate internationally. This common platform will enable greater synergies to be achieved between Eik Banki and Eik Bank Danmark and improve the bank’s competitive position.

In the Faroese market, the objective is to retain the present market share. An expansion of the existing branch network on the Faroe Islands is not part of Eik Banki´s strategy, as the core geographic areas are already adequately covered. The aim for the Danish market is to It would not be increase market share by increasing the customer base and also by increasing sales to prudent to present customers. Over time, Eik Bank Group aims to establish internet banking on the abstain from the Nordic market. If the opportunity presents itself, the bank will consider strategic acquisitions in order to achieve this. Credit Package

The Danish Government Guarantee Scheme Eik Bank has taken advantage of ‘Credit Package I’ and will join ‘Credit Package II’ of the Danish Government bank support scheme. These have had considerable benefits, but have come at a cost to the bank.

‘Credit Package I’ is the scheme in which the Government guarantees the deposits of investors and business partners in participating banks. As part of membership of this scheme, Eik Banki was having to provide a guarantee of DKK of 179m for the potential losses of other banks.

Eik Banki’s First Quarter Report revealed that the charge to the bank in relation to Danish Private Contingency Association in the quarter was DKK 17m, and that the total cost of participation in ‘Credit Package I’ would be DKK 134m. Therefore the total theoretical cost for ‘Credit Package I’ could amount to DKK 313m over the two year life of the scheme.

In terms of ‘Credit Package II’, Eik’s management has applied for an injection of hybrid core capital. This will involve an injection of DKK 550 million, and strengthen Group solvency by 3.4 percentage points. The cost of this scheme, in terms of interest paid to the Danish Government on the loans that are being made at above the market rate, will be ‘slightly over DKK 20m’ in the financial year 2009.

Eik’s CEO stated at the time that ‘it would not be prudent to abstain from this security’. Given the substantial uncertainties that still exist in the European financial markets, few would disagree with him. Eik’s agreement to the core capital loan, however, brings with it an implicit requirement to continue to keep loan facilities available to Faroese and Danish businesses that can justify them, so in addition to bearing the financial cost of relatively high (c. 10%) interest on the capital, acceptance of the scheme also means accepting certain restraints on corporate behaviour.

Another aim of the combined Credit Packages is to enable banks to issue new loans in the commercial markets. Eik Bank has already taken advantage of this, issuing one new debt instrument in January 2009, with a small top-up in February. Both months were very difficult months for capital raising in the financial markets, and the fact that Eik was able to get the issue away we find encouraging. The new bonds are quoted on the Nasdaq OMX in Copenhagen.

Acquisitions and their Impact on Group Financial Performance Eik Bank Danmark A/S was acquired on 31 December 2004 so 2005 was the first year that the income statement included Eik Bank Danmark’s operations. The acquisition of the Danish bank resulted in higher net interest income and higher fees and commissions – Hardman & Co. Leaders in Corporate Research 7 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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figure 5. This was useful for the group P&L account at the time, because local competition between the Faroese banks in 2005 had resulted in a narrower interest margin on Eik’s Faroese operations. NII still increased, therefore, but not as much as would have been the case without the margin pressure on the Faroese part of the business.

The growth in income in 2005 and 2006 was due to increased lending both in the Faroe Islands and abroad, mainly in Denmark.

The year 2007 benefited from a major acquisition, Skandiabanken A/S. There was also growth in lending by the core Faroese and Danish businesses that year. The year’s other acquisitions, Privestor Fondsmæglerselskab and the periodical Tidsskriftet Finansnyt, were included with effect from 7 August 2007. The acquisitions in 2007 produced a significant increase in fees and commissions.

The acquisition of Kaupthing Bank’s Faroese operations were made with accounting effect as of 31 December 2007 and therefore didn’t affect on the income statement that year. It cannot be emphasised heavily enough that Eik only took 1.0bn of the 1.8bn Kaupthing Eik only took portfolio in the Faroes. This was the part of the portfolio that Eik Banki could see was the profitable profitable or that could become so quickly. part of the portfolio Income statement DKK 1,000 2004 2005 2006 2007 2008 Interest income 267,208 340,533 485,388 915,252 1,381,411

Interest expenses -68,385 -108,239 -210,426 -539,289 -869,276

Net interest income 198,823 232,294 274,962 375,963 512,135 Dividends from shares and 2,353 5,318 16,613 69,226 26,932 other holdings

Fee and commission income 22,614 61,028 91,990 159,530 251,519

Fee and commission expense -828 -882 -2,979 -8,338 -12,462 Net interest and fee income 222,962 297,758 380,586 596,381 778,124 Market value adjustments 87,666 46,221 85,785 191,814 -245,994 Other operating income 12,870 13,022 15,034 19,683 25,692 Profit on financial operations 323,498 357,001 481,405 807,878 557,822 Staff costs and administrative -123,185 -180,447 -229,049 -340,731 -370,625 expenses Depreciation and write-down of -8,677 -15,249 -25,768 -25,117 -21,637 intangible and tangible assets Other operating expenses -1,475 - -863 -43 -19,458 Impairment of loans and other -86,869 -5,925 33,733 -36,605 -553,677 claims Income from associated and 8,429 8,833 47,700 59,923 -7,975 subsidiary undertakings Profit before taxes 111,721 164,213 307,158 465,305 -415,550 Taxes -4,520 -37,604 -56,681 -72,260 101,475

Net profit for the year 107,201 126,609 250,477 393,045 -314,075

Figure 5

Earnings

In 2008, almost 50% of the bank's earnings were derived from sources that can be regarded as stable, such as retail banking and transaction services. The bank’s net result for 2008 was a deficit of DKK 314m. In common with all mainstream banks, Eik was forced to absorb negative value adjustments and large impairments of loans and other claims.

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Figure 6

The main items of the income statements back to 2004 are shown in figure 6. The acquisitions of Eik Bank Danmark, SkandiaBanken and Kaupthing’s operations in the Faroe Islands have resulted in increased net interest and net commission income. The composition of revenues has changed from being mainly net interest income to a relatively higher proportion of commissions and fees. This is both a result of the increase in commission and fee based operations, and the fact that a growing number of the bank’s customers are converting their loans from direct loans with mortage credit conditions to mortgage credit loans from BRF Kredit, where Eik Bank Group charges a fee for guaranteeing the loan. This is expected to continue in 2009.

Eik Banki has established a tradition in its annual reports of giving guidance on the likely outcome for the coming financial year. In the Annual Report for 2008 Eik Banki Group’s management stated that it expected the result before market value adjustments, impairments and taxes but including the guarantee cost for Credit Package I to be DKK 350 million against DKK 384 million in 2008. This estimate was subsequently lowered to DKK 300 million in the 1st Quarter report 2009, including a cost of DKK 20 million for ‘Credit Package II’.

The Group achieved a Return On Equity of almost 24% in 2006 and 2007, which was high compared to other Danish banks in 2007. It was especially impressive when compared to the Danish mid cap banks – figure 8.

Key figures 2004 2005 2006 2007 2008 ROE reported 13.6% 14.5% 23.6% 23.8% -16.6%

RoRWA reported 2.2% 2.0% 2.8% 2.5% -2.0%

C/I ratio 55% 61% 58% 54% 52% Figure 7

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ROE 2006 2007 2008 Danish Large Cap Danske Bank 17.5% 15.1% 1.0%

Jyske Bank 22.3% 17.9% 9.7%

Sydbank 26.7% 26.2% 8.8% Danish Mid Cap Spar Nord Bank 24.8% 17.5% 2.3% Vestjyske Bank 15.6% 13.2% 13.2% Amagerbanken 27.5% 18.1% -25.8% Basic Eik Bank Group 23.6% 23.8% -16.6% operations Føroya Banki 13.7% 11.1% 11.8% appear strong Figure 8 and stable

The expansion resulted in a reduction in the Group’s solvency ratio but the 4 year period from 2004 to 2007 in figure 7 shows that the net result compared to the risk weighted assets has been stable or increased slightly.

Examining the profit before market value adjustments, impairments and taxes compared to

RWA shows that the basic operations of the bank appear strong and stable in relation to the risk to which the bank is exposed. There has also been an improvement in the cost/income ratio from basic operations (without value adjustments and loan losses). The acquisitions suggest that there are possibilities for rationalisation.

In common with almost every other central banking authority, Denmarks Nationalbank has lowered its leading interest rate and the discount rate since 3rd quarter of 2008. Figure 9 shows the movement of the discount rate since 2007. One of the key factors, both in Denmark and throughout Europe, has been the fact that until recent weeks CIBOR (Copenhagen Inter-Bank Offered Rate) and LIBOR remained stubbornly immune to the trend that state banking bodies everywhere were trying to introduce, of a general reduction in interest rates for the end consumer. Together with the widening of the interest margins in 2008 between loans and deposits this has given Eik Bank Group an increased net interest income compared to 2007.

Figure 9

In figure 10 the pre-provision profits as percentage of risk weighted assets (PPP%RWA) is calculated together with profit of basic operations (profit before value adjustments and impairments) as a percentage of RWA. It shows that profit of basic operations has been stable and even growing as a percentage of RWA. The increase in PPP%RWA in 2004 and again in 2006 and 2007 is mainly due to positive market value adjustments of bonds and shares. Hardman & Co. Leaders in Corporate Research 10 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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2004 2005 2006 2007 2008 Profit of basic operations % RWA year avg. 2.5% 2.1% 2.4% 2.5% 2.5%

PPP % RWA year avg. 4.6% 2.9% 3.5% 4.1% 0.9%

Figure 10 Consistently strong basic banking operations, a needed widening of interest margins in 2008 and good cost control have proved beneficial to the group.

Liquidity The bank’s liquidity is strong. The Liquid Assets/Total Assets ratio was 23% at the year end 2008, and the (Market Funds minus Liquid Assets)/Total Assets ratio was 2.5%. The liquid assets are mainly in interbank deposits and Danish mortgage bonds.

2004 2005 2006 2007 2008

Deposit coverage 83.0% 68.4% 74.0% 84,9% 90,2% Loans, advances and impairments in proportion to 130.6% 152.5% 138.7% 119,5% 115,5% deposits (Market Funds - Liquid Assets) 3.4% 15.0% 10.4% 3,9% 2,5% % Total Assets Solvency is Liquid Assets % Total Assets 16.5% 19.7% 25.3% 23,3% 23,0% comfortably Excess liquidity cover relative to above the 71.3% 80.1% 125.1% 118,7% 164,5% statutory requirement minimum and Figure 11 liquidity is high

The deposit to loan ratio is high and was at 90.2% at year end 2008 compared to 84.9% a year earlier. The acquisition of SkandiaBanken in 2007 strengthened deposits in relation to other sources of financing, because SkandiaBanken had a surplus of deposits amounting to DKK 1.6 bn.

Figure 12

Figure 12 shows when the bank’s long term debt to Credit Institutions must be repaid or refinanced. Some of these loans have been repaid since end-December 2008, the last date for which we have material available for this comparison.

In early 2009 Eik issued new fixed rate bonds with a total nominal amount of DKK 960 m. These bonds are categorised as unsecured senior debt, but are covered by the Danish Government backed guarantee scheme.

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Capital Adequacy The solvency ratio of Eik Bank Group has been narrowing over the past five years, but nevertheless it remains comfortably above the minimum regulatory rate of 8%. Figure 13 shows the development of the solvency in the years from 2004, when the bank acquired Eik Bank Danmark, to the present.

2004 2005 2006 2007 2008 Solvency 15.2% 11.0% 11.0% 12.0% 10.6% Core Capital ratio (T1-ratio) 14.9% 13.3% 10.8% 9.3% 7.6% Figure 13 The Core Capital ratio has decreased each year as the bank has expanded its operations in the Faroe Islands and abroad. Solvency (which includes Tier 2 capital) has also decreased.

As figure 14 shows, Eik Banki did not find it necessary to increase its share capital or raise supplemental capital in 2008. This was at least partly because, either by good fortune or good judgement, the bank had anticipated the need to strengthen its balance sheet and actually managed to get in its additional equity before the world financial crisis became apparent. In 2007, the share capital was increased by DKK 101.6 million, and immediately following this the Eik Banki group boasted a stock market value of DKK 584.3 m. This was not the only way in which management managed to strengthen the capital base well ahead of the coming crisis. In 2006 the bank added subordinated capital, and again in 2007. There is a strategy of Capital Base spreading the loan portfolio DKK m 2004 2005 2006 2007 2008

Core capital less statutory deductions 740 860 977 1,437 1,163 Subordinated debt etc. 15 - 150 448 467 Base capital less statutory deductions 755 860 1,127 1,885 1,630 Deduction in base capital - 148 131 28 - Base capital 755 712 996 1,857 1,630

Figure 14

The main cause of the lower solvency ratio in 2008 was the large P&L account deficit. This in turn was caused mainly by the large impairments and to a lesser extent by negative value adjustments of securities.

Asset Quality Being the key component in determining the creditworthiness of a bank, asset quality is a main driver of future earnings and therefore also capital generation or erosion.

The bank’s strategy in recent years has been to limit credit risk by spreading its loan portfolio geographically and through various industries.

Distribution of Loans Figure 15 shows how Eik Bank’s loans are distributed by country and figure 16 shows the distribution by sector and industry.

Being the largest bank in the Faroe Islands with a market share of 50%, Eik Banki is a major player in lending to the public, private and industrial sectors in the Islands. It is therefore inevitable that the results of the bank’s Faroese operations will on the whole follow the Faroese economy’s cycles.

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Figure 15

Retail Lending

Looking at the bank’s distribution of loans by sector and industry it is clear that retail lending is a large part of the total loans compared to other Danish midcap banks. The reason for this is two-fold. 1) In the Faroe Islands the banks usually give loans to house owners under mortgage credit conditions with first priority in private houses and apartments. 2) Skandiabanken was competing with mortgage credit institutions in Denmark. The majority of Skandiabanken’s loans were therefore under mortgage credit conditions when it was acquired by Eik Bank. The fall in house First charge loans are usually regarded as secure loans and this therefore differentiates Eik prices has been Bank Group from other banks on the Danish market, where mortgage credit usually is a challenge provided through an MCI. The bank states that 36% of total loans or almost 80% of retail loans are secured by a first charge on residential properties and other private homes, and that a majority of these are provided under mortgage credit conditions directly instead of through an MCI.

Figure 16 Eik Banki also states in its 2008 report that the average private real estate loan is DKK 538,000 (DKK 455,000 in Faroe Islands and DKK 717,000 in Denmark). By year-end 2008 2 the average house price in Tórshavn was DKK 2.1 m while a 140 m house in Copenhagen had an average price of DKK 2.9 m.

st The fall in house prices in 2008 and 1 Quarter of 2009 has been a challenge for the bank, and will continue to be in 2009. However, the problems have been nowhere as severe as they have been in the US or in parts of the UK residential lending marketplace. Eik states Hardman & Co. Leaders in Corporate Research 13 Tel: +44(0)20 7929 3399 www.hardmanandco.com

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that impairments on retail customers have been insignificant, as they still have the strength and will to pay.

There is a possibility that later in 2009 and in 2010 increasing unemployment will result in an increase in the number of house-owners who are unable to meet interest payments and capital repayments to the bank. Because of the fact that the majority of the bank’s retail lending is provided with mortgage credit conditions and mostly with a comfortable margin, this development is likely to result in a lower need for impairments on this account than its peer group in Denmark. This will especially be true for the Faroese part of the portfolio, because of the low debt-rate of Faroese households compared to mainland Denmark.

Project Finance

The group of loans provided to construction comprise project financing as well as loans to companies working within the construction industry and smaller entrepreneurial firms. The largest part of Eik Banki’s project financing is in this category.

Project financing in Eik Bank Group constitutes 7% of total loans, or about DKK 1.2 billion There could be at year end 2008. These loans have primarily been provided by Eik Bank Danmark, as a need for financing of real estate and projects have been a large part of the bank’s operations. The further annual report 2008 for Eik Bank Danmark states, that 10% of the bank’s total loans are impairments in project finance. That is equivalent to approximately DKK 970 m, or around 81% of the Project Finance Group’s total project financing. Figure 17 shows the distribution of the project financing.

We note that Eik Bank Danmark is now systematically minimising its number of large project finance commitments, in particular those related to real estate financing.

It is difficult to estimate the remaining risk of losses in this part of the Eik Bank Group’s loan portfolio. It was the real estate market that was first hit by the financial crisis, and this part of the loan portfolio has therefore counted for a large part of the loss in 2008 and the 1st quarter of 2009. We estimate that there will be need for further impairments on project financing if the crisis continues.

Project Financing Private Recreat Land Per Real Offices Retail Total ional Plots cent DKK million Estate

171 247 123 34 94 669 55,8% Denmark Faroe Islands 226 - - - 17 243 20,3% Other countries 16 - 42 215 15 288 24,0%

413 247 165 249 126 1.200 100,0% Total Percent 34.4% 20.6% 13.8% 20.8% 10.5% 100.0%

Figure 17

Other Lending

It is important to note that Eik Bank Group is not exposed to any sub-prime loans.

There appears to have been a certain amount of confusion among the less sophisticated members of the world financial community, who have been unable to differentiate between Iceland and Denmark. Even though Iceland and the Faroe Islands are close geographically it has to be stressed, that Eik Banki is a part of the Danish banking system.

One consequence of this confusion is that Eik Bank Group shares are trading at a P/E and P/B value considerably lower that those of its peers in Denmark.

It is also important to note that Eik Banki’s exposure to the Faroese fishing industry is not significant. The loans to this segment account for only 4% of the total loan portfolio.

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The Q1 Results

Eik Banki Group Q1 2009 2008

DKK m. DKK m. Interest Income 337.1 344.9 Interest Expense 204.1 185.2

Net Interest Income 133.0 159.7

Dividends etc 0.3 5.0 Fee and Commission Income 39.2 44.8

Fee and Commission Expense 5.2 4.3 Net Interest and Fee Income 157.1 149.1

Market Value Adjustments -12.3 -58.7

Other Operating Income 2.1 2.8 Profit on Financial Operations 157.1 149.1 Eik believes that the results are Staff Costs and Admin 89.0 91.3 pointing in the right direction Depreciation etc 3.6 6.2 Other Operating Expenses 18.8 0

Impairment etc 76.0 13.0

Income from Associates -6.2 0 Profit (Loss) before Taxes -36.5 38.6

Taxes -12.6 9.7

Net Profit (Loss) for Period -23.9 28.9 Earnings (Loss) per Share DKK -2.85 DKK 3.55

Figure 18

The Eik Banki Group reported a loss for Q1 2009, but the loss was considerably lower than in Q4 2008. Management stated that the results ‘point in the right direction’.

Deposits increased to DKK 14.2 bn compared to DKK 13.1 bn at end-March 2008. They also showed a very modest increase over the course of the three months – at end- December 2008 deposits were DKK 14.1 bn. Loans at the end of Q1 were DKK 15.5 bn. This compares to DKK 15.9 bn both at end-March 2008 and end-December 2008. The loans to deposits ratio therefore improved to 109% from 113% at end-December 2008 and 121% twelve months earlier. All these ratios are relatively modest compared to those run by other financial institutions. In current risk-averse markets this is regarded as a key ratio. It is both satisfactory and improving.

Liquidity was high, with an excess cover of 155% over the legal minimum. The Solvency Ratio, at 10.0% and the Core Capital Ratio, at 7.0%, were well below the levels of twelve months ago. At end-December 2008 they were 10.6% and 7.6% respectively, and if it had not been for Credit Package II we would have suggested these needed careful monitoring. However the improvements that will be generated by Credit Package II will raise solvency for the group to 13.4% and the Core Capital ratio to certainly well in excess of 10%, possibly to 12%. It should also be pointed out that the parent company, Eik Banki P/F, runs ratios substantially higher than these, and for the purpose of bonds raised on Eik Banki P/F, these higher ratios will be the relevant ones.

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The red ink shown in the Q1 2009 figures was entirely predictable, and the European investment community is unlikely to be particularly concerned by the trends that they reveal.

Interest Income for the group was marginally lower at DKK 337m (vs. DKK 345m for Q1

2008. Given the reduced level of interest rates worldwide, we find this figure surprisingly good.

Dividends from Shares and Other Holdings almost entirely disappeared, from DKK 5m to DKK 0.3m. In absolute terms, however, both figures are insignificant – even in Q1 2008 dividends were bringing in less than 2% of gross revenue. Similarly the 12% reduction in Fee and Commission Income is not a matter of major concern.

Market Value Adjustments continued to be negative, but were substantially lower than in every single quarter of 2008. The significantly lower level of market value adjustments is the primary reason why Eik Group was able to declare a Profit on Financial Operations that was 5% higher at DKK 157m.

Additional Impairments of DKK 76m were made during the quarter. These were equivalent to 0.4% of total loans and guarantees, and were one fifth the level of the draconian level of write-offs made in Q4 2008. Of course, they do not compare well with impairment levels in Q1 2008, when the world financial crisis had barely begun and the requirement for impairments on bank asset bases generally was only just starting to be recognised. Even the relatively modest impairment charge made managed to soak up 48% of the Profit on Financial Operations, however, and a modest reduction in staff costs could not compensate for this – unlike some of the major multinational financial institutions Eik Group has not made across-the-board redundancies.

The end result was a net loss before taxes of DKK 36.5m.

Management stated that it expected a profit for full year 2009 before market value adjustments, impairment and taxes but after the cost of ‘Credit Package II’ of ‘about’ DKK 300m. Its previous indicated likely profit had been DKK 350m, so to this extent management has downgraded its public estimates. This DKK 300m is equivalent to after tax earnings, assuming a 22% composite tax rate, of DKK 28.7 per share.

Forecasts Our forecasts assume a continued reduction in interest income and interest expense until Q4, when there is a possibility that European interest rates may rise slightly, but the Our estimates increase in funding costs will result in a lower NII. It also appears probable to us that Eik are lower than has already recognised the majority of the impairments needed on its loan book and the the official market value adjustments on its investments, but the future need for impairments will follow guidance the development in the economy. Expenses are likely to be slightly lower for the remaining quarters of 2009, because Eik is carefully controlling its costs.

Our forecasts assume that the economy in the Faroe Islands and Denmark will turn round in late 2009 or early 2010. The Faroe Islands imports in the 1st Quarter 2009 were approximately 30% lower than a year ago and in Denmark imports have dropped by almost 20% compared to a year ago. This development is a sign of lower activity and will put pressure on domestic businesses and employment.

Our estimates of profit from basic operations, shown in the table in Figure 19 are lower than the official guidance being given by the company management, but in our view they are still satisfactory.

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P&L accounts 31/12 Dkk m 2006 2007 2008 2009e 2010e Net interest income 275.0 376.0 512.1 508.0 545.0 Net commission income 89.0 151.2 239.1 142.0 165.0 Income from ass. and sub. undertakings 47.7 59.9 -8.0 -6.2 8.0 Dividends 16.6 69.2 26.9 3.3 5.0 Other income 15.0 19.7 25.7 14.1 20.0 Total income from basic operations 443.3 676.0 795.8 661.2 743.0 Employee costs -229.0 -340.7 -370.6 -356.1 -370.0 Other expenses -26.6 -25.2 -41.1 -55.4 -50.0 Total costs -255.7 -365.9 -411.7 -411.5 -420.0 Profit of basic operations (“Adjusted 187.6 310.1 384.1 249.7 323.0 Profit”) Market Value Adjustement 85.8 191.8 -246.0 -4.3 30.0 Profit before loan losses 273.4 501.9 138.1 245.4 353.0 Impairments 33.7 -36.6 -553.7 -176.0 -40.0 Declared Pre-tax Profit 307.2 465.3 -415.6 69.4 313.0 Figure 19

Valuation For the last five years of ‘normal’ banking market conditions Eik Banki shares had traded on a p/e ratio of approximately 10 on average. Because of the deficit in 2008 the P/E for that year obviously cannot be calculated, and of course this is true for almost every bank throughout the world. On the other hand the ratio Net Interest against the Market Value shows that Eik Banki shares had been traded at 12-15 times the value of Net Interest in 2006 and 2007. Currently the bank shares are trading at only 1-2 times Net Interest.

DKK m. 2006 2007 2008 Net Interest 275 376 512 Net Profit before tax 308 465 -416 Net Profit after tax 251 393 -314

502 520 95 Closing Share Price DKK Number Of Shares m. 7.113 8.129 8.129 Market Value DKK m. 4,288 4,690 772

P/E 13.9 10.1 - Market Value/Net Interest 15.6 12.5 1.5 Figure 20 The current share price is less than 20% of its peak, and Eik Banki Group is trading on less than 2X peak earnings, 6X the earnings consistently produced in the earlier years of the decade. The shares are also trading at only 40% of their net asset value.

The adjustments and large impairment losses in 2008 have influenced the market’s expectations of future earnings of Eik Banki. This is understandable but considering the bank’s strong basic operations and the outlook for a more normalized economic situation in the near future, it is our opinion that the bank’s shares are trading at well below their Fair Value. It also has to be stressed that costs of the Credit Packages of 90m. DKK are included in the forecast profit from basic operations.

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Conclusion Eik Banki has a strong local franchise, with its 50% Faroese market share, and has managed to expand in Denmark in a growth area – internet banking – without sacrificing the quality of its loan book and without becoming over-exposed to the troubled Danish residential property market. It has growth prospects internationally, relatively good asset quality for a bank of its size, and the Danish Government’s Credit Package II will restore its balance sheet to a position of some strength.

There are question marks, primarily concerning the risk of further impairments in the project finance area, and the problems facing the Faroese fishing industry (although as we have seen direct exposure here is very modest). Currently the shares, on our forecasts, are trading on a p/e ratio of approximately 3.4X current year earnings before impairments and market value adjustments, a p/e ratio of less than 3X 2007 actual earnings on the same basis. Unlike some banks Eik Banki’s 2007 financial results were based on reality and were not artificially inflated by unrepeatable trading book items. To this extent Eik Banki is in a rather more comfortable situation than some of the giant and much better known multinational banks.

Also we take great comfort from the asset value, which is more than twice the share price.

Eik Banki is a quality financial institution, whose biggest problem is its lack of size. However, this also presents Eik with its biggest opportunity. This is a very interesting company that deserves the attention of the investment community.

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Management Major Shareholders

Chief Managing Director: Marner Jacobsen Managing Director: Bjarni Olsen The Eik Fund (Eik Grunnurin) 52%

Key Dates Key Milestones

3 July 2007: Start of Silent Period 2006: Share Offering to the Public 2007: Assumes 40 million Euro in subordinated debt 24 July 2009: Q2 results 2007: Dual listing of Eik Bank on the OMX Nordic

Exchange in Iceland and Copenhagen 9 October 2009: Start of Silent Period 2007: Acquisition of Skandiabanken A/S' activities in 30 October 2009: Q3 results Denmark 2007: Acquisition of Privestor and Finansnyt February 2010: Q4 and full year results 2007: Divestment of SkandiaBanken A/S’ Car Finance and leasing Division March 2010: Annual Shareholder Meeting 2007: Merger of Eik Bank Danmark and SkandiaBanken 2007: Eik Banki P/F acquires certain assets of Kaupthing Bank’s operation in the Faroe Islands 2008: Eik Banki takes out a syndicated term loan facility of DKK 1 billion October 2008: Joins the Danish Government-backed Deposit Guarantee Scheme, ‘Credit Package I’. January 2009: Eik Banki P/F issues a fixed rate bond with a total nominal amount of DKK 615,000,000 February 2009: The fixed rate bond is increased by DKK 51 million nominal March 2009: Provisionally agrees to apply for the Danish Government’s scheme to boost Core Capital ratios of deserving banks, ‘Credit Package II’.

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