16 Dah Sing Banking Group Limited Annual Report 2006 Corporate Overview (Continued) The highlights of the Group s financial performance for the year a

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1 Dah Sing Banking Group Limited Annual Report Corporate Overview In 2006, we grew our business organically, fully integrated our acquisitions in Macau and Hong Kong, and embarked on the next stage of our Mainland expansion strategy through the agreement to purchase, subject to regulatory approvals, a 17% stake in Chongqing Commercial Bank, as well as starting work to analyse the benefits of expanding our Mainland banking business under a PRC subsidiary. Our business achieved a strong performance in 2006, with total loan growth for the year of 11%, against growth in the Hong Kong market of 6.7%. Commercial banking led growth in the first half of the year, continuing several years of strong growth, with a relatively weaker performance from our retail banking business. In the second half of the year, renewed efforts in the Hong Kong domestic mortgage market, coupled with continuing growth in the unsecured loan and credit card businesses resulted in an improved performance from retail banking, and by the year end, both our core commercial and retail banking businesses reported growth significantly ahead of the market. The integrations of the two acquisitions made in 2005, Pacific Finance (Hong Kong) Limited ( PF ) and Banco Comercial de Macau, S.A. ( BCM ), were smoothly completed in 2006 as planned. Both performed well during the year, were earnings enhancing and produced meaningful contributions to the Group s profit in the year. PF s loans were fully transferred to and integrated into DSB s loan portfolio by mid 2006 and PF no longer reports its business performance on a separate business entity basis starting 2006, PF, as a business portfolio, generated HK$86 million net profit in 2006, a significant growth relative to the normalized earnings (excluding exceptional interest rate hedging gain) recorded in BCM achieved a net profit of MOP117 million in 2006, up 30% relative to Its stronger performance was driven by higher loan balance and stronger income growth (both net interest income and net fee and commission income).

2 16 Dah Sing Banking Group Limited Annual Report 2006 Corporate Overview (Continued) The highlights of the Group s financial performance for the year are summarised in the table below: Variance Net interest margin 2.36% 1.98% HK$ Million Operating profit before impairment losses on loans and advances 1, % Operating profit before gains on certain investments and fixed assets 1, % Profit attributable to shareholders 1, % Advances to customers 49,909 44, % Customers deposits 67,279 58, % Certificates of deposit issued 8,768 7, % Total deposits 76,047 66, % Issued debt securities 2,300 2, % Subordinated notes 3,480 3, % Loan to deposit (including certificates of deposit) ratio 65.6% 68.0% Cost to income ratio 45.3% 48.2% Return on average total assets 1.2% 1.2% Return on average shareholders funds 13.3% 12.0% Financial Review Against the backdrop of a more benign HK$ interest rate environment and good asset quality in general, our Group posted a set of stronger results for the year. Improved net interest income, and a strong performance in net fee and commission income, led to an improved operating profit despite higher operating expenses and loan impairment charges in the year. All of our business segments achieved solid organic growth, as reflected in loans and deposits, and business segment profit when compared with Profit attributable to shareholders of the Group for the year ended 31 December 2006 was HK$1,196 million. The increase was driven mainly both by significantly higher net interest income and net fee and commission income.

3 Dah Sing Banking Group Limited Annual Report (1) (2) (3) Net interest income for the year increased by 42% to HK$1,899 million from HK$1,333 million in The strong increase was the result of (1) wider Prime-Hibor spread, (2) higher average loan balance and (3) contribution from PF and BCM portfolios. The impact of these positive factors more than outweighed the negative impact of rising funding costs to net interest income, especially from fixed-rate assets. The net interest margin of the Group was 2.36%, up from 1.98% in Relatively benign HK$ money market conditions helped contain the rise in HK$ interbank interest rates, despite steady increases in US$ short-term rates during the first six months of A wider Prime-Hibor spread was particularly favourable for loans priced on a Prime rate basis. PF and BCM made a meaningful contribution to net interest income after adjusting for the interest income foregone on the acquisition capital paid in Net fee and commission income increased by 31%, mainly due to higher loan fee and commission income from the organic growth of our Commercial and Retail banking businesses, and higher income from wealth management and investment services, in particular stronger commission income on higher unit trust sales. The consolidation of PF and BCM net fee and commission income also helped to boost the overall increase. The increase was partially offset by the drop in net trading income. Operating expenses rose 28% mainly as a result of consolidating the expenses of the subsidiaries acquired in the second half of 2005 and the amortisation costs for the intangible assets recognized in acquiring PF and BCM. Intangible amortization costs amounted to HK$35 million whilst the newly acquired subsidiaries costs (including acquisition related costs) in 2006 totaled HK$181 million. Excluding these expenses, operating expenses on an organic growth basis increased by 7.9% when compared with Cost income ratio for the year was 45.3%, lower than 48.2% in Operating profit before loan impairment charges was HK$1,426 million, up 44% relative to 2005.

4 18 Dah Sing Banking Group Limited Annual Report 2006 Higher loan impairment charges were recorded during the year, mainly resulting from bigger individual impairment allowances required on a number of Commercial Banking, transport and equipment finance customers. Collective impairment charges, despite higher average loan balances, were slightly lower than 2005 as a result of improvement in portfolio asset quality. The consolidation of the loan portfolios of PF and BCM did not lead to any material effect in our overall loan losses in the year, and overall credit quality remained strong, as demonstrated by the continuing low impaired loan ratio of 0.51%, and a total overdue and rescheduled loan ratio of 0.70% as of 31 December Operating profit after impairment charges was HK$1,265 million, 47% higher than We recorded a gain of HK$56 million relating to the revaluation of our investment properties and reversal of past impairment on bank premises, a gain of HK$88 million on disposal of securities, mainly relating to profits on investments in bonds which benefited from a tighter credit spread environment during the year, and a write-back of HK$26 million impairment charge on an investment, which was fully realized during the year. Profit before taxation for the year was HK$1,446 million, an increase of 25% over the previous year. Profit attributable to shareholders, increased by 22% to HK$1,196 million. As at 31 December 2006, the Group s total gross loans and advances amounted to HK$49.9 billion, up 11% relative to the end of Growth was recorded both in the Commercial Banking and Retail Banking sectors, and was led by trade finance, syndicated loans, property finance, unsecured personal loans, credit cards and mortgages. It was particularly encouraging to see a return to double-digit growth in our overall unsecured lending business, after a number of years of difficult market conditions in this business. Customers deposits including structured deposits totaled HK$67 billion, an increase of 15% relative to the end of Issued certificates of deposit amounted to HK$8.8 billion of which retail certificates of deposit accounted for HK$3.7 billion. Other issued debt securities totalled HK$2.3 billion. The loan to deposit ratio decreased from 68.0% as at 31 December 2005 to 65.6% as at 31 December 2006.

5 Dah Sing Banking Group Limited Annual Report Dah Sing Bank, Limited ( DSB ) exercised its call option to fully redeem its first US$125 million subordinated debt (issued in March 2001) in March To strengthen its tier 2 capital base to support business growth, DSB issued a new US$150 million 10-year subordinated debt (callable in 5 years) in June Personal Banking Our personal banking business, targeting and serving the retail banking, VIP banking and private banking segments of Hong Kong and Macau, recorded a significantly higher profit in The higher level of profitability was brought about by satisfactory growth in loans, deposits and wealth management services, stronger operating income offset to an extent by higher operating expenses and loan impairment charges. The consolidation of the full-year contribution of the PF and BCM personal banking businesses also boosted growth in income, expenses and profit of the overall personal banking business. The more favourable interest rate environment, as reflected in a wider HK$ Prime rate and HIBOR spread, was a significant factor in driving the net interest income growth of our Personal Banking businesses despite intense price competition, particularly in the residential mortgage market. Through a variety of product launches, promotions and focused marketing, we are pleased to see a satisfactory growth in our credit card and unsecured personal loan portfolios. Our drive to deliver better VIP banking and investment services, and the more favourable stock market and improved sentiment towards investment in 2006, led to a healthy increase in our wealth management fee and securities commission income. VISA Dah Sing Bank received the Golden Award in Debit Card Issuance from China UnionPay in We were very encouraged that our card promotion efforts and accomplishments were recognised by industry bodies with awards we received in 2006 including Dah Sing Bank having been recognised by China UnionPay with Golden Award in Debit Card Issuance, VISA Prepaid Card Achievement, and MasterCard Second Runner-up in Highest Growth in Merchant Purchase Volume.

6 20 Dah Sing Banking Group Limited Annual Report 2006 Personal Banking (Continued) Increases in staff, rental and business promotion costs, and the consolidation of the full-year costs of personal banking of PF and BCM portfolios in 2006 versus relatively small amount in 2005 (subsequent to their acquisitions) resulted in a significant increase in operating expenses of this business. Local economic growth in 2006 remained robust whilst a continued improvement in the unemployment rate in Hong Kong was recorded. Our personal banking division s loan asset quality remained very sound and charge-off ratios for credit card and personal loans were relatively low. The higher loan impairment charges recorded in the year was mainly caused by higher collective impairment charges, largely resulting from higher loan balances. Our private banking business achieved a set of results lower than our expectation in the year. We have taken action to strengthen the management and investment advisory capabilities of this business, and expect improvement in performance in the coming year. As of the end of 2006, our branch network includes 48 retail branches in Hong Kong under the name of Dah Sing Bank and MEVAS Bank, and 16 branches in Macau under BCM, and one subsidiary private bank in Guernsey, Channel Islands., Commercial Banking Commercial banking, which includes trade finance, commercial lending, syndicated lending, equipment finance and vehicle finance, China businesses, and consolidating those businesses originally operating under PF and similar businesses operated by BCM, reported a set of strong results in Against the background of a generally favourable export and re-export performance and demand for property finance, and with our commercial banking division s effort in growing customer base and loan assets, our commercial banking loan book, led by property related and syndicated lending, wholesale and retail trade, and import and export trade finance, achieved a very good performance and a growth rate faster than the Group s overall loan growth in Our equipment finance and vehicle finance businesses achieved solid but not rapid loan growth due to our more cautious lending in the taxi finance sector.

7 Dah Sing Banking Group Limited Annual Report Commercial Banking (Continued) A slightly higher amount of loan defaults and credit losses was experienced, mainly caused by higher individual impairment charge in Benefiting from the continued economic recovery and solid business performance in the manufacturing and trading sectors, and our ongoing vigilant credit monitoring and control, the overall asset quality of our commercial banking, equipment finance and vehicle finance businesses remained sound in the year. We continued to promote the growth of our corporate card service, and had received recognition of such a development in 2006 from MasterCard International as The Best Multinational Corporate Card Program Partner In 2006 In Hong Kong. Treasury Dah Sing Bank is recognized by MasterCard International as Our treasury division, despite the very flat and even The Best Multinational Corporate Card Program Partner In 2006 In Hong Kong. slightly inverted yield curves and rising interest rates in the year, generated a substantially higher level of profit in 2006 relative to The better results were driven by improvement in net interest income, and higher trading and fair value gains. Gains realized on securities disposal were lower than Although credits were generally favourable with steady credit spread tightening for most of our investment positions in 2006, the continued credit spread tightening over the past few years made it increasingly challenging to achieve good portfolio diversification, allocations and switches. A large part of our surplus funds investments was deployed in shorter duration bonds to reduce interest rate exposure, against the flat yield curve and challenging interest rate environment. We continued our strategy of maintaining a diversified investment portfolio to balance investment return, market risk, liquidity risk and credit risk, and continued to hold a bond portfolio comprised predominantly of investment grade debt securities, and bond investments in shorter duration or swapped to floating rate basis.

8 22 Dah Sing Banking Group Limited Annual Report Treasury (Continued) Due to an increasing amount of assets and liabilities designated at fair value through profit or loss to comply with the technical requirements of Hong Kong Accounting Standard no. 39, we note a higher degree of variability in our gains or losses associated with the fair value changes of financial instruments including derivatives recognised in our income statement. With the ongoing volatility and changes in market interest rates and credit spreads, we expect our trading and fair value income associated with trading and fair value assets and liabilities will be more volatile going forward. Development of Banking Operation in China Our Shenzhen branch in Mainland China, focussing on the commercial banking business in the Pan Pearl River Delta Area, has achieved another year of solid growth and profit making following development in the past two years since commencing business in mid After attaining two full-year operation, our Shenzhen branch submitted an application for RMB license to regulatory authority in We are making preparation to operate RMB business through our Shenzhen branch when we receive regulatory approvals, and believe this development will provide us additional opportunities to grow our business in China. We also pursued the strategy to explore investment opportunities in the banking market in China and towards the end of the year we announced that we had agreed to purchase, subject to regulatory approvals, a 17% stake in Chongqing Commercial Bank, the leading city bank in Chongqing, the largest city in Western China, and at a cost of approximately RMB694 million. We also noted the changes announced by the China Banking Regulatory Commission towards the year end allowing for the incorporation of a local subsidiary in the PRC to conduct banking business. We are actively working on the proposal and development plan to seek to procure regulatory approvals and to move forward towards the establishment of our locally incorporated subsidiary bank in China in 2007.

9 Dah Sing Banking Group Limited Annual Report Pacific Finance ( PF ) With the full integration of all of PF s businesses within DSB and with the completion of the transfer of its loan portfolio and businesses to DSB before mid 2006, PF is no longer operating as a separate business subsidiary. PF s original businesses, focusing on vehicle finance, equipment finance, mortgages and consumer lending, are businesses very complimentary to those of DSB and a smooth integration was accomplished in the first half of These businesses, on a proforma basis, achieved strong growth in terms of loan balances and profit generated. PF s pro-forma net profit of HK$86 million (before amortization of intangible costs) in 2006, driven mainly by cost saving and lower loan impairment charges, substantially increased when compared with the normalised PF net profit of HK$59 million in 2005 after excluding interest rate hedging gains booked in This acquisition was value enhancing to our Group, and contributed to expand our scale in selected lending areas which are also higher yielding. Banco Comercial de Macau ( BCM ) The acquisition of BCM is a significant strategic expansion for the Group in 2005, as this provided the Group entry into the fast growing and increasingly affluent Macau market, and allows the Group to gain significant market share in the banking business in Macau. In 2006, Macau sustained its record of rapid growth and achieved a GDP growth of over 16%, underpinned by the rapid expansion of its gaming and tourism industry, and growth in consumption and property investment and construction. BCM reported a net profit MOP117 million (approximately HK$114 million) in 2006, up 30% relative to Its stronger performance in 2006 was driven by solid loan growth, higher bancassurance sales, strong increase in net interest income and non-interest income, good expense control and lower loan impairment cost.

10 24 Dah Sing Banking Group Limited Annual Report 2006 MEVAS Bank MEVAS Bank ( MEVAS ), the separately branded banking subsidiary under the Group, recorded a net profit in 2006 of HK$20 million relative to the HK$14 million earned in The stronger performance in 2006 was the result of higher loan balances and significantly higher income (both net interest income and fee income), despite a higher collective loan impairment charge caused mainly by the much higher loan balances, and therefore a higher level of loan provisions required. In 2006, MEVAS started to participate in limited commercial banking lending via sub-participation in syndicated loans. This new business avenue provides MEVAS diversification in loan exposures and enables it to better deploy its large pool of surplus funds to earn stable returns with reasonable credit risk, drawing on expertise and support provided by DSB. Risk Management and Compliance To compete effectively in the increasingly competitive and demanding financial services market, and to meet higher standards of regulatory requirements whilst the Group continues to expand its businesses, scale and geographical operations, strengthening and upgrading risk management is an ongoing emphasis and continuing investment. These require oversight at the Board and senior management level, well defined and structured risk management framework, policies and risk control processes, clear understanding of sound risk and return balance, allocation of sufficient resources to upgrade risk management expertise and technologies to be commensurate with business expansion and increases in risk exposures.

11 Dah Sing Banking Group Limited Annual Report II Risk Management and Compliance (Continued) During 2006, we made significant effort to prepare ourselves to transition to Basel II standardized approach reporting under the new regulatory and capital regime starting January We also made efforts to evaluate different risk management IT solutions that will assist us to upgrade our asset and liability management, risk assessment and control, market risk and credit risk analysis to meet the more sophisticated requirements of Basel II internal-ratings based ( IRB ) approach. To enable us to move towards the foundation IRB target in a few years time, we had agreed to engage external consultants specialising in risk data model and statistical scoring to start developing credit modelling applications for our retail credit portfolios, and had already started data archiving for most of our loan systems to facilitate data storage and extraction for future credit analysis and system modelling. We anticipate the development process on risk management system implementation, storing and utilising data on a systematic basis to generate acceptable credit risk assessment (by way of ongoing estimate of probability of default) and more refined risk differentiation with more sophisticated capital allocation to cover different risk exposures, and upgrading our risk management policies and procedures (including analytical and modelling processes) will take a number of years, and will also require significant commitment, effort and investment. During 2006, we further strengthened our compliance function and took steps to upgrade our compliance effectiveness including increasing resources, monitoring and training covering our Hong Kong, Macau and China operations. These, together with our increased emphasis on internal control, will assist the Group its pursuit of long-term development and growth, by progressing in a sound and controlled manner.

12 26 Dah Sing Banking Group Limited Annual Report 2006 Capital and Liquidity I Banking Group (Basel I basis) Capital base of banking subsidiaries (HK$ million) Core capital 7,463 6,136 Supplementary capital and deductions 2,712 3,369 Total capital base after deductions 10,175 9,505 Capital adequacy ratio (as at year end) Tier % 10.7% Tier 1 and Tier 2 (after deductions) 16.6% 16.6% Liquidity ratio (average for the year) 58.0% 55.2% II I The Group s capital adequacy ratio remained similar to 2005 and was maintained at a healthy level. The higher Tier 1 ratio was the result of both profit retention and equity capital injection by the Company to DSB in the early part of On a Basel II standardized approach basis for reporting credit risk, the Group s capital adequacy ratio as of the end of December 2006 was broadly similar to the ratio determined on the Basel I basis as disclosed above. DSB fully repaid its first US$125 million callable subordinated debt in March 2006 as planned. To enable DSB to operate with sufficient capital buffer to undertake new business and pursue acquisition for strategic purpose, DSB issued a new 10-year (and callable after 5 years) US$150 million subordinated debt in June With our strong pool of surplus funds and diversified liquid investments funded in part by deposit growth and new term borrowing including the new subordinated debt issued by DSB, we were able to maintain our liquidity ratio at high levels despite our robust loan growth. This favourable liquidity position will support our business plan to pursue more loan and investment growth. A3A- DSB s long-term credit rating, at A3 and A- assigned by Moody s and Fitch respectively, was affirmed in 2006.

13 Dah Sing Banking Group Limited Annual Report Human Resources To improve the quality and skills of our staff, and to ensure sufficient continuing professional training of our front-line staff particularly in relation to banking services, securities and insurance businesses, we continued our training programmes to meet different needs of our staff, and to reinforce management and development programmes for middle level managers in the year. We are also pleased to note that our graduate trainees development programme over the past three years has produced good results, providing the Group with highly motivated young officers and bankers, and growth opportunities for the trainees to steadily progress and take up managerial responsibilities. We believe such an investment will produce long-term benefit to the Group. In 2006, we continued our work to improve the service excellence, teamwork, caring and trust culture throughout the organization. Senior management and most staff of the Group participated in the annual Group Conference to promote communication and sharing of our Group s vision and challenges. Our staff social club arranged a variety of programs including family, well-being and sports activities to help promote affinity, friendship and health. ( ) The Group s headcount continued to increase as a result of our business growth and increasing demand for human resources to strengthen our capabilities on sales, customer services, risk management and compliance. The total number of employees of our Group, including our staff in Macau and China, increased from 1,689 at the end of 2005 to 1,701 at the end of 2006.

14 28 Dah Sing Banking Group Limited Annual Report 2006 ; II Information Technology During 2006, our major accomplishments in the information technology area were a smooth and successful migration of our mainframe operating system to a much enhanced and robust technology platform, and the integration of a number of BCM systems with those of DSB to achieve synergy and better system support; work and preparation to implement new teller platform system, securities trading system and retail credit scoring system; and evaluation of different risk management and Basel II systems, including IT architecture and data warehouse technologies, to support the Group s risk management upgrade. Riding on the effort and development we made in 2006, we expect to roll out and implement a number of new application systems during With our operations in Macau, and our plan to achieve significant organic growth in China, we anticipate we will need to continue investing in IT application systems and infrastructure to achieve more alignment and synergy, and to upgrade our capabilities to meet both business needs and increasing regulatory requirements. We anticipate higher IT investments in the years to come, driven and guided by our growth strategy.