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1 INTERIM REPORT 8 INTERIM REPORT

2 CONTENTS Financial Results and Operation Review 2 Independent Auditor s Report 7 Consolidated Income Statement 9 Consolidated Balance Sheet 10 Consolidated Statement of Changes in Equity 11 Consolidated Cash Flow Statement 12 Notes to the Interim Financial Statements 13 Supplementary Financial Information 109 Supplementary Information 122

3 FINANCIAL RESULTS AND OPERATION REVIEW 350,230, % 513,729, % 677,177, % 218,632, ,634, ,915, ,702,0004.6% 7.9%1,230,797,000 26%440,818,000 The Directors are pleased to present the Group s Interim Report and financial statement for the six months ended 30 June The consolidated income statement, consolidated cash flow statement and consolidated statement of changes in equity of the Group for the six months ended 30 June 2008, and the consolidated balance sheet as at 30 June 2008 of the Group, all of which are audited, along with selected explanatory notes, supplementary financial information and supplementary information are set out on pages 9 to 124 of this report. The comparative figures in respect of the Group s consolidated income statement, the consolidated statement of changes in equity and the consolidated cash flow statement, and the related explanatory notes, for the six month period ended 30 June 2007 were not audited. Adversely affected by the deteriorating external economies, Hong Kong s economic growth slackened as evidenced by the slowdown in property market and falls in the stock market, however high inflationary conditions continued, causing domestic consumption to contract in the first half of The growing US sub-prime crisis has led to a significant slow down in the US economy, which, in turn, has affected the global markets particularly those with heavy reliance on exports to the US. Given the weakened US Dollar, continual macro economic controls in Mainland China and appreciation of the Renminbi, Hong Kong s business environment will remain difficult, and banking sector is likely to face more difficult challenges in the second half of the year. Financial Review Comparing the Group s operating results for the first half of 2008 with the corresponding period of 2007: Profit after taxation amounted to HK$350,230,000, representing a decrease of 59.1%, mainly attributable to the mark-to-market loss on collateralised debt obligations and impairment allowance on the investment in structured investment vehicles totalling HK$513,729,000. Net interest income was HK$677,177,000, down 7.4% versus the comparable period last year. Due to severe competition, interest rate spreads narrowed with net interest margin dropping 26 basis points below the same period last year. Insurance operating income increased by 5.9% to HK$218,632,000, however, due to increased claims reserve, insurance operations registered a net loss. During the period under review, mark-to-market loss on collateralised debt obligations was HK$228,634,000; whereas the sale of available-for-sale securities registered a profit of HK$252,915,000. Net fees and commission income and other operating income increased by 4.6% to HK$287,702,000. Total operating income decreased by 7.9% to HK$1,230,797,000. Operating expenses increased by 26% to HK$440,818,000, mainly due to higher staffing costs and advertising and promotion expenses related to the Bank s 75th Anniversary. 2

4 35.8% 9.6% 19.9%789,979,000 6,240, ,095, %195,769, %68,917,250, % 5.8% 43,823,778, % 143,756, % 0.25%60.5% 58.2% 56.1% 0.74% 1.96%5.76% 14.8% 15.7% 49.4% 3.1% 22.6% 120% 3,239,411,0001.6% The first half 2008 cost-to-income ratio at 35.8% was 9.6% higher than last year. Operating profit before impairment allowances on loans and advances decreased by 19.9% to HK$789,979,000. During the period, charge for impairment allowances on loans and advances was HK$6,240,000 and impairment allowance on structured investment vehicles was HK$285,095,000. Operating profit decreased by 75.6% to HK$195,769,000. Total customer deposits, including structured deposits, amounted to HK$68,917,250,000, up 3.2% from mid 2007 but down 3.1% compared with year-end Advances to customers went up by 5.8% from the level a year ago to HK$43,823,778,000, or up 4.5% as compared with that at year-end Impairment allowances amounted to HK$143,756,000, of which 76.2% was collective impairment allowances, representing 0.25% of the total advances to customers. The loan-to-deposit ratio was 60.5%, compared with 58.2% same time last year. At year-end 2007 the loan-to-deposit ratio was 56.1%. The return on average total assets was 0.74%, while that of mid-year 2007 was 1.96%. The return on average shareholders funds was 5.76%, compared with 14.8% at interim last year. At 30 June 2008, the consolidated capital adequacy ratio was 15.7%, and the average liquidity ratio for the first half of 2008 was 49.4%. Operation Review Deposits Total deposits, including structured deposits, decreased by 3.1% as compared with that at last year-end. Under a lower deposit interest rate environment yet with growing inflationary pressure, customers channelled their investment funds to higher-yielding investment products or to the property market, causing the Bank s deposit base to contract. However, the deposits on higher-yielding foreign currencies and Renminbi rose. The softer US Dollar has prompted some depositors to shift their funds to other higher-yielding foreign currency deposits, which together rose 22.6% as compared with that at year-end Benefiting from the continuous appreciation of the Renminbi, the Bank s Renminbi deposits surged by 120% as compared with that at 2007 year-end. As at 30 June 2008, certificates of deposit totalling HK$3,239,411,000 were issued, down 1.6% as compared with that at last year-end. An overwhelming majority of such issues are floating rate. For those fixed rate structured certificates of deposit, the interest rate risk involved is hedged by relevant derivatives. 3

5 FINANCIAL RESULTS AND OPERATION REVIEW 4.5% 6.7%10.5% 32.7% 19.1% (Wealth Builder) 0.5% Advances to customers Total loans and advances to customers grew by 4.5% as compared with that at year-end The turnover in the property market showed signs of slowing down in the first half of 2008, and the outlook for the property market for the near term remains uncertain. The Bank raised its mortgage lending rates in late June to keep abreast with market conditions. Corporate loans performed steadily and recorded an increase of 6.7% as compared with 2007 year-end, while syndicated loans achieved a 10.5% growth in the same period. In the first half of 2008, the growth of the Bank s hire-purchase and leasing subsidiary, Wing Lung Finance Limited, was affected by an increase in impairment loss on machinery financing and narrowed interest margin at large. Treasury Aggregate treasury income gained 32.7% over the level a year ago. Income from foreign exchange trading increased and income generated from money exchange business decreased. Foreign exchange options trading remained active. Widened exchange rates fluctuation has encouraged customers participation in foreign exchange options trading. It is likely that this business area would have even better performance in the second half of Wealth management Income from wealth management operation shrank by 19.1% when compared with mid-year Given the widening US sub-prime mortgage and credit crisis, investors became more pessimistic about the investment environment. In line with the substantial fall in the local stock indices and trading volume, the profit generated from wealth management business also registered a decline. A brand new wealth management product Wealth Builder focusing on retirement planning was launched in the second quarter of the year. It is a made-to-measure product which can be tailored for individual customer s needs and personal goals. It is hoped that this new service can help attract more new customers. In view of the present market atmosphere, more products on principal guaranteed funds and lower risk products will be delivered by the Wealth Management Centre. Massive promotional activities will be launched to attract potential customers and to drive sales volume. Credit card At 30 June 2008, the total number of credit cards issued rose by 0.5% as compared with that at year-end 2007 while total credit card receivables contracted. 4

6 Corporate MasterCard 10.9% 19.1% 6.9% 35 The Credit Card Centre will step up its efforts in promoting Corporate MasterCard to corporate clients, aiming at expanding customer base and income. It will intensify collaboration with other operations in cross-selling other banking products to cultivate more income sources. Securities broking As compared with the corresponding period last year, commissions earned from securities business recorded a decrease of 10.9%, while interest income from securities margin lending slipped by 19.1%. Futures commission income also recorded a decrease. The Securities Department will continue to expand its securities services and launch preferential offers to new securities accounts, aiming at drawing in potential customers as well as retaining the existing ones. Additional securities service centres have been set up in Lam Tin Sceneway Plaza Branch, Sham Shui Po Branch, Causeway Bay Branch, Hung Hom Branch and Tuen Mun Branch to better serve our customers. Insurance Wing Lung Insurance Company Limited recorded a 6.9% increase in gross premium compared to that of the corresponding period last year. As the claims for employees compensation insurance and motor vehicle insurance continued to rise in the first half of 2008, the Bank has conservatively increased the claims reserve for these insurance classes, which contributed to a loss in the insurance business. The Insurance Department recorded a decline in agency business and commission income; while net commission income from life insurance products increased as compared with the corresponding period last year. Besides adopting a more flexible pricing strategy to cope with keen competition and to maintain market share, our insurance operation will adopt a prudent approach in targeting higher quality business in order to sustain a balanced growth. Branch The Bank operates 35 local branches in total. In addition, the Bank operates Shenzhen Branch, Shanghai Branch and Nanshan Sub-Branch in China, Los Angeles Branch in the US and Cayman Islands Branch. All the branches achieved steady growth. Benefiting from the launch of Renminbi loan business and a wider interest margin, Shenzhen Branch recorded a remarkable profit growth as compared with the corresponding period last year. The Branch will be accepted to the China National Advanced Payment System (CNAPS) towards the second half of the year; and this will enable the Branch to provide, besides foreign currencies, Renminbi deposit service to foreigners and selected PRC locals, hence further improving the loan-to-deposit ratio of the Branch. In order to expand the scope of Renminbi business, application to the relevant authorities will also be made for bills acceptance business and derivative products licence. 5

7 FINANCIAL RESULTS AND OPERATION REVIEW 1,682 1, // 53.12% Shanghai Branch, which commenced operation a few months ago, runs satisfactorily with development of various types of loan business in the Yangtze River Delta. To cope with the business development needs of the Mainland branches and to enhance service quality, actions will be taken to recruit more experienced front-line staff, to strengthen staff training and development and the computer systems. Los Angeles Branch has devoted much effort in enlarging its customer base and recorded a satisfactory loan growth. Investment in information technology In the first half of 2008, the Information Technology Department continued to enhance the capacity and stability of various computer systems, including Securities Trading System, Teller Platform System, Telebanking System etc., with completion targeted within the year. Human resources At the end of June 2008, the Bank s total workforce amounted to 1,682, including 1,613 locally, 57 in China and 12 overseas. In order to upgrade the skills, knowledge and overall competitiveness of its staff for further development, the Bank s Human Resource Department has been actively organising seminars and training sessions related to banking practice, product knowledge, sales techniques and market information updates. Training sponsorships are also allotted to encourage staff in achieving further professional qualifications or pursuing higher education so as to build up a stronger talent pool. Sale and Purchase Agreements Between Major Shareholders of Wing Lung Bank Ltd and China Merchants Bank Co., Ltd. On 30 May 2008, Wu Jieh Yee Company Limited, Wu Yee Sun Company Limited and Yee Hong Company Limited, companies controlled by the Wu Family of the Bank, entered into sale and purchase agreements with China Merchants Bank Co., Ltd. to sell their combined 53.12% stake in the Bank. The transaction is still under the process of approval by the relevant regulatory authorities. By Order of the Board Maria Wan-sin FUNG Secretary Hong Kong, 27 August

8 INDEPENDENT AUDITOR S REPORT TO THE BOARD OF DIRECTORS OF WING LUNG BANK LIMITED (Incorporated in Hong Kong with limited liability) We have audited the consolidated interim financial statements of Wing Lung Bank Limited (the Bank ) and its subsidiaries (together, the Group ) set out on pages 9 to 108, which comprise the consolidated balance sheet as at 30 June 2008, and the consolidated income statement, the consolidated statement of changes in equity and the consolidated cash flow statement for the six month period then ended, and a summary of significant accounting policies and other explanatory notes. Directors responsibility for the interim financial statements The directors of the Bank are responsible for the preparation and the true and fair presentation of these consolidated interim financial statements in accordance with Hong Kong Financial Reporting Standards issued by the Hong Kong Institute of Certified Public Accountants. This responsibility includes designing, implementing and maintaining internal control relevant to the preparation and the true and fair presentation of interim financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies; and making accounting estimates that are reasonable in the circumstances. Auditor s responsibility Our responsibility is to express an opinion on these consolidated interim financial statements based on our audit, and to report our opinion solely to you, as a body, and for no other purpose. We do not assume responsibility towards or accept liability to any other person for the contents of this report. We conducted our audit in accordance with Hong Kong Standards on Auditing issued by the Hong Kong Institute of Certified Public Accountants. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance as to whether the interim financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the interim financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the interim financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and true and fair presentation of the interim financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the directors, as well as evaluating the overall presentation of the interim financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 7

9 INDEPENDENT AUDITOR S REPORT TO THE BOARD OF DIRECTORS OF WING LUNG BANK LIMITED (Incorporated in Hong Kong with limited liability) (continued) Opinion In our opinion, the consolidated interim financial statements give a true and fair view of the state of affairs of the Group as at 30 June 2008 and of its profit and cash flows for the six month period then ended in accordance with Hong Kong Financial Reporting Standards. Other matters The comparative figures in respect of the Group s consolidated income statement, the consolidated statement of changes in equity and the consolidated cash flow statement, and the related explanatory notes, for the six month period ended 30 June 2007 were not audited. PricewaterhouseCoopers Certified Public Accountants Hong Kong, 27 August

10 CONSOLIDATED INCOME STATEMENT For the six months ended 30 June 2008 Six months ended 30 June Audited Unaudited Note Interest income 4 1,735,904 2,157,171 Interest expense 5 (1,058,727) (1,425,582) Net interest income 677, ,589 Fees and commission income 226, ,485 Fees and commission expense (34,186) (29,478) Net fees and commission income 6 192, ,007 Insurance operating income 7 218, ,546 / Net trading (loss)/gain 8 (205,629) 103,849 Net gain on disposal of available-for-sale securities 252,915 19,310 Other operating income 9 95,386 81,060 Operating income 1,230,797 1,336,361 Operating expenses 10 (440,818) (349,929) Impairment charge for credit losses 11 (291,335) (11,563) Charge for insurance claims 7 (302,538) (173,819) Net loss on disposal of other properties and equipment (337) (347) Operating profit before gain on certain investments 195, ,703 Fair value adjustments on investment properties 186, ,880 Share of net (losses)/profits of / jointly controlled entities (37,800) 24,017 Share of net profits of associates 1,895 1,270 Profit before taxation 346, ,870 Income tax 13 3,690 (133,429) Profit attributable to shareholders 350, ,441 Interim dividend , ,971 HK$ HK$ Earnings per share 15 Basic Diluted The notes on pages 13 to 108 form part of these interim financial statements. 9

11 CONSOLIDATED BALANCE SHEET As at 30 June /6/ /12/2007 Audited Audited Note Assets Cash and short-term funds 16 23,296,611 26,384,235 Placements with and loans and advances to banks 17 3,274,954 3,602,908 Trading securities 18 8,052,648 2,218,841 Derivative financial instruments 19 44,643 35,813 Financial assets designated at fair value through profit or loss 20 2,740,329 2,934,803 Available-for-sale securities 21 2,002,042 3,240,308 Held-to-maturity securities 22 6,793,812 6,883,979 Advances and other accounts 23 45,980,741 44,531,182 Interests in jointly controlled entities , ,018 Interests in associates 26 6,136 6,184 Investment properties 27 2,406,600 2,254,600 Interests in leasehold land , ,345 Other properties and equipment , ,420 Tax recoverable 85,278 58,704 Deferred tax assets 34 29,085 6,799 Total assets 95,624,311 93,048,139 Liabilities Deposits and balances from banks 1,180,635 1,157,049 Trading liabilities 30 6,255, ,210 Derivative financial instruments , ,692 Financial liabilities designated at fair value through profit or loss 31 1,806,190 2,159,028 Deposits from customers 32 68,572,286 70,481,358 Certificates of deposit issued 1,778,185 1,773,194 Current taxation 43,628 40,547 Deferred tax liabilities , ,958 Other accounts and accruals 33 3,099,664 3,533,000 Total liabilities 83,778,629 80,568,036 Equity Share capital 35 1,160,951 1,160,951 Reserves 36 10,684,731 11,319,152 Total equity 11,845,682 12,480,103 Total equity and liabilities 95,624,311 93,048,139 Michael Po-ko WU Chairman Patrick Po-kong WU Vice-Chairman Philip Po-him WU Director and Chief Executive Che-shum CHUNG Director and General Manager The notes on pages 13 to 108 form part of these interim financial statements. 10

12 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY For the six months ended 30 June 2008 Six months ended 30 June Audited Unaudited Total equity as at 1 January 12,480,103 11,381,785 / Net (expense)/income recognised directly in equity: Surplus on revaluation of bank premises 780 Changes in fair value of available-for-sale securities (645,849) 131,607 Effect of deferred taxation on revaluation of bank premises 296 fair value adjustments on available-for-sale securities 13,107 (4,249) Share of associates reserves 82 (42) Share of jointly controlled entities reserves (231) Net (expense)/income for the period / recognised directly in equity (631,815) 127,316 Transfer to income statement on disposal of available-for-sale securities (252,915) (19,310) Transfer to income statement on impairment of available-for-sale securities 248,364 Net profit for the period 350, ,441 / Total net (expense)/income recognised for the period (286,136) 963,447 Dividend (348,285) (603,694) Total equity as at 30 June 11,845,682 11,741,538 The notes on pages 13 to 108 form part of these interim financial statements. 11

13 CONSOLIDATED CASH FLOW STATEMENT For the six months ended 30 June 2008 Six months ended 30 June Audited Unaudited Note / Cash (used in)/generated from operations 40(a) (2,651,118) 1,273,255 Hong Kong profits tax paid (36,254) (42,468) Overseas tax paid (6,043) (3,896) Net cash (used in)/generated from / operating activities (2,693,415) 1,226,891 Investing activities Purchase of available-for-sale securities and held-to-maturity securities (7,643,207) (4,897,854) Loans repaid from jointly controlled entities 2,109 Interest in associates (691) Dividends received from jointly controlled entities and an associate 6,155 5,105 Proceeds from sale and redemption of available-for-sale securities and held-to-maturity securities 8,346,816 4,504,631 Payment for additions of investment properties (10,866) Payment for purchase of other properties and equipment (47,974) (28,025) Proceeds from disposal of other properties and equipment Net cash generated from/(used in) / investing activities 653,040 (416,302) Financing activities Dividend paid (348,285) (603,694) Net cash used in financing activities (348,285) (603,694) Net (decrease)/increase in cash and / cash equivalents (2,388,660) 206,895 Cash and cash equivalents at 1 January 26,397,095 23,442,574 Effects of foreign exchange rate changes (159) (259) Cash and cash equivalents at 30 June 40(b) 24,008,276 23,649,210 The notes on pages 13 to 108 form part of these interim financial statements. 12

14 NOTES TO THE INTERIM FINANCIAL STATEMENTS / / / / / 1 Summary of significant accounting policies 1.1 Basis of preparation The consolidated interim financial statements have been prepared in accordance with Hong Kong Financial Reporting Standards ( HKFRSs, a collective term which includes all applicable individual Hong Kong Financial Reporting Standards, Hong Kong Accounting Standards ( HKASs ) and Interpretations) issued by the Hong Kong Institute of Certified Public Accountants ( HKICPA ), accounting principles generally accepted in Hong Kong. These consolidated interim financial statements also comply with the applicable disclosure provisions of the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited. The consolidated interim financial statements have been prepared under the historical cost convention, as modified by the revaluation of availablefor-sale financial assets, financial assets and financial liabilities held for trading, financial assets and financial liabilities (including derivative financial instruments) designated at fair value through profit or loss and investment properties. The preparation of interim financial statements in conformity with HKFRSs requires the use of certain critical accounting estimates. It also requires management to exercise its judgments in the process of applying the Group s accounting policies. The areas involving a higher degree of judgment or complexity, or areas where assumptions and estimates are significant to the consolidated interim financial statements are disclosed in note 3. The HKICPA has issued a number of new/revised HKFRSs, which are effective for accounting periods beginning on or after 1 January The Group has assessed the impact of these new/revised HKFRSs and concluded that they are not relevant to the Group s operations. Up to the date of issue of these interim financial statements, the HKICPA has also issued certain new/revised HKFRSs which are not yet effective for accounting period beginning on 1 January 2008 and have not been early adopted by the Group. The Group is in the process of making an assessment of what the impact of these new/revised HKFRSs is expected to be in the period of initial application. So far it has concluded that the adoption of the following new/revised HKFRSs which are relevant to the Group s operations is unlikely to have a significant impact on the Group s result of operations and financial position: 13 1 HK(IFRIC) Interpretation 13: Customer Loyalty Programmes, which is effective for annual periods beginning on or after 1 July 2008 HKAS 1 (Revised): Presentation of Financial Statements, which is effective for annual periods beginning on or after 1 January

15 NOTES TO THE INTERIM FINANCIAL STATEMENTS Summary of significant accounting policies (continued) 1.1 Basis of preparation (continued) 8 27 HKFRS 8: Operating Segments, which is effective for annual periods beginning on or after 1 January 2009 HKAS 27 (Revised): Consolidated and Separate Financial Statements, which is effective for annual periods beginning on or after 1 July However, HKAS 1 (Revised) and HKFRS 8 may result in new or amended disclosures in the financial statements. 1.2 Consolidation The consolidated interim financial statements include the interim financial statements of the Bank and all of its subsidiaries made up to 30 June. Subsidiaries are those entities in which the Bank, directly or indirectly, controls the composition of the Board of Directors, controls more than half of the voting power or holds more than half of the issued share capital. Subsidiaries are consolidated into the interim financial statements from the date on which control is transferred to the Group. They are de-consolidated from the date that control ceases. Inter-company transactions, balances and unrealised gains on transactions between group companies are eliminated in full in preparing the consolidated interim financial statements. Unrealised losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of subsidiaries have been changed where necessary to ensure consistency with the policies adopted by the Group. 1.3 Jointly controlled entities A jointly controlled entity is an entity which operates under a contractual arrangement whereby the Group and other parties undertake an economic activity which is subject to joint control and none of the participating parties has unilateral control over the economic activity. The consolidated income statement includes the Group s share of the results of jointly controlled entities for the period and the consolidated balance sheet includes the Group s share of the net assets of the jointly controlled entities. 14

16 %-50% Summary of significant accounting policies (continued) 1.4 Associates An associate is an entity over which the Group has significant influence but not control, generally accompanying a shareholding of between 20% and 50% of the voting rights. The consolidated income statement includes the Group s share of the results of associates for the period and the consolidated balance sheet includes the Group s share of the net assets of the associates. 1.5 Income recognition (a) (a) Interest income and expense Interest income and expense for all financial instruments are recognised in the income statement using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or a financial liability and of allocating the interest income or interest expense over the relevant period. The effective interest rate is the rate that exactly discounts estimated future cash payments or receipts through the expected life of the financial instrument or, when appropriate, a shorter period to the net carrying amount of the financial asset or financial liability. When calculating the effective interest rate, the Group estimates cash flows considering all contractual terms of the financial instrument (for example, prepayment options) but does not consider future credit losses. The calculation includes all fees and points paid or received between parties to the contract that are an integral part of the effective interest rate, transaction costs and all other premiums or discounts. Once a financial asset has been written down as a result of an impairment loss, interest income is recognised using the rate of interest used to discount the future cash flows for the purpose of measuring the impairment loss. (b) (b) Fee and commission income Fee and commission income arises on financial services provided by the Group and is recognised when the corresponding service is provided, except where the fee is charged to cover the costs of a continuing service to, or risk borne for, the customer, or is interest in nature. In these cases, the fee is recognised as income in the accounting period in which the costs or risk is incurred and is accounted for as interest income. (c) (c) Dividend income Dividend income from unlisted investments is recognised when the shareholder s right to receive payment is established. Dividend income from listed investments is recognised when the share price of the investment is quoted ex-dividend. 15

17 NOTES TO THE INTERIM FINANCIAL STATEMENTS Summary of significant accounting policies (continued) 1.6 Financial assets The Group classifies its financial assets under the following categories: loans and receivables, trading securities, financial assets designated at fair value through profit or loss, held-to-maturity securities, and available-forsale securities. The classification depends on the purpose for which the financial assets were acquired. Management determines the classification of its financial assets at initial recognition. (a) (a) Loans and receivables Loans and receivables, including cash and short term funds, placement with and loans and advances to banks, trade bills and loans and advances to customers, are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. They arise when the Group provides money, goods or services directly to a debtor with no intention of trading the receivable. Loans and receivables are carried at amortised cost using the effective interest method less impairment losses. (b) / (b) Trading securities A financial asset is classified as trading if it is acquired principally for the purpose of selling in the short term. Derivatives are also categorised as held for trading unless they are designated as hedges. Trading securities are stated at fair value. Changes in fair value are recognised as Net gain/loss from trading securities in the income statement as they arise. (c) (c) Financial assets designated at fair value through profit or loss Financial assets designated at fair value through profit or loss are not those financial assets acquired principally for the purpose of selling in the short term but designated by management as such at inception if they meet the following criteria: The designation eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an accounting mismatch ) that would otherwise arise from measuring the financial assets or recognising the gains and losses on them on different bases; A group of financial assets is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and this is the basis on which information about these assets is provided internally to the management; or 16

18 Summary of significant accounting policies (continued) 1.6 Financial assets (continued) (c) (c) Financial assets designated at fair value through profit or loss (continued) It relates to those financial instruments embedded with derivatives which significantly modify the cash flows that would otherwise be required under the contract. / (d) These financial assets are recognised initially at fair value and transaction costs taken directly to the income statement. Changes in fair value are recognised as Net gain/loss arising from financial instruments designated at fair value through profit or loss in the income statement in the period in which they arise. (d) Held-to-maturity securities Held-to-maturity securities are non-derivative financial assets with fixed or determinable payments and fixed maturities that the Group s management has the positive intention and ability to hold to maturity. If the Group were to sell other than an insignificant amount of held-tomaturity assets, the entire category would be tainted and reclassified as available-for-sale. Held-to-maturity securities are carried at amortised cost using the effective interest method less impairment losses. (e) (e) Available-for-sale securities Available-for-sale securities are non-derivatives that are either designated in this category or not classified in any of the other categories. Available-for-sale securities are those intended to be held for an indefinite period of time, which may be sold in response to needs for liquidity or changes in interest rates, exchange rates or equity prices. Available-for-sale securities are stated at fair value. Unrealised gains and losses arising from changes in the fair value are recognised directly in the investment revaluation reserve until the financial asset is derecognised or impaired at which time the cumulative gain or loss previously recognised in the investment revaluation reserve is recognised in the income statement. Purchases and sales of trading securities, financial assets designated at fair value through profit or loss, held-to-maturity and available-for-sale securities are recognised on trade-date the date on which the Group commits to purchase or sell the asset. Loans are recognised when cash is advanced to the borrowers. 17

19 NOTES TO THE INTERIM FINANCIAL STATEMENTS Summary of significant accounting policies (continued) 1.7 Impairment of financial assets (a) (a) Financial assets carried at amortised cost The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. A financial asset or a group of financial assets is impaired and impairment losses are incurred if, and only if, there is objective evidence of impairment as a result of one or more events that occurred after the initial recognition of the asset (a loss event ) and that loss event (or events) has an impact on the estimated future cash flows of the financial asset or group of financial assets that can be reliably estimated. Objective evidence that a financial asset or group of assets is impaired includes observable data that comes to the attention of the Group about the following loss events: (i) (ii) (iii) (iv) (v) (vi) (i) significant financial difficulty of the issuer or obligor; (ii) a breach of contract, such as a default or delinquency in interest or principal payments; (iii) the Group granting to the borrower, for economic or legal reasons relating to the borrower s financial difficulty, a concession that the lender would not otherwise consider; (iv) it becoming probable that the borrower will enter into bankruptcy or other financial reorganisation; (v) the disappearance of an active market for that financial asset because of financial difficulties; or (vi) observable data indicating that there is a measurable decrease in the estimated future cash flows from a group of financial assets since the initial recognition of those assets, although the decrease cannot yet be identified with the individual financial assets in the group, including: adverse changes in the payment status of borrowers in the group; or national or local economic conditions that correlate with defaults on the assets in the group. 18

20 Summary of significant accounting policies (continued) 1.7 Impairment of financial assets (continued) (a) (a) Financial assets carried at amortised cost (continued) The Group first assesses whether objective evidence of impairment exists individually for financial assets that are individually significant, and individually or collectively for financial assets that are not individually significant. If the Group determines that no objective evidence of impairment exists for an individually assessed financial asset, whether significant or not, it includes that asset in a group of financial assets with similar credit characteristics and collectively assesses them for impairment. Assets that are individually assessed for impairment and for which an impairment loss is or continues to be recognised are not included in a collective assessment of impairment. If there is objective evidence that an impairment loss on financial assets carried at amortised cost has been incurred, the amount of the loss is measured as the difference between the asset s carrying amount and the present value of estimated future cash flows (excluding future credit losses that have not been incurred) discounted at the financial asset s original effective interest rate. The carrying amount of the asset is reduced through the use of an allowance account and the amount of the loss is recognised in the income statement. If the financial asset has a variable interest rate, the discount rate for measuring any impairment loss is the current effective interest rate determined under the contract. As a practical expedient, the Group may measure impairment on the basis of an instrument s fair value using an observable market price. The calculation of the present value of the estimated future cash flows of a collateralised financial asset reflects the cash flows that may result from foreclosure less costs for obtaining and selling the collateral, whether or not foreclosure is probable. For the purposes of a collective evaluation of impairment, financial assets are grouped on the basis of similar credit risk characteristics. Those characteristics relevant to the estimation of future cash flows for groups of such assets by being indicative of the debtor s ability to pay all amounts due according to the contractual terms of the assets are considered. Future cash flows in a group of financial assets that are collectively evaluated for impairment are estimated on the basis of the contractual cash flows of the assets in the group and historical loss experience for assets with credit risk characteristics similar to those in the group. Historical loss experience is adjusted on the basis of current observable data on economic and credit environment to reflect the effects of current conditions that did not affect the period on which the historical loss experience is based and to remove the effects of conditions in the historical period that do not exist currently. 19

21 NOTES TO THE INTERIM FINANCIAL STATEMENTS Summary of significant accounting policies (continued) 1.7 Impairment of financial assets (continued) (a) (a) Financial assets carried at amortised cost (continued) Estimates of changes in future cash flows for groups of assets should reflect and be directionally consistent with changes in related observable data from period to period (for example, change in unemployment rates, property prices, payment status, or other factors indicative of changes in the probability of losses in the group and their magnitude). The methodology and assumptions used for estimating future cash flows are reviewed regularly by the Group to reduce any differences between loss estimates and actual loss experience. When a loan is uncollectible, it is written off against the related allowances for loan impairment. Such loans are written off after all the necessary procedures have been completed and the amount of the loss has been determined. Subsequent recoveries of amounts previously written off decrease the amount of the allowances for loan impairment in the income statement. If, in a subsequent period, the amount of the impairment loss decreases and the decrease can be related objectively to an event occurring after the impairment was recognised (such as an improvement in the debtor s credit rating), the previously recognised impairment loss is reversed by adjusting the allowance account. The amount of the reversal is recognised in the income statement. (b) (b) Financial assets carried at fair value The Group assesses at each balance sheet date whether there is objective evidence that a financial asset or a group of financial assets is impaired. In the case of equity investments classified as availablefor-sale, a significant or prolonged decline in the fair value of the security below its cost is considered in determining whether the assets are impaired. If any such evidence exists for available-forsale financial assets, the cumulative loss measured as the difference between the acquisition cost and the current fair value, less any impairment loss on that financial asset previously recognised in the income statement is removed from the investment revaluation reserve and recognised in the income statement. Impairment losses recognised in the income statement on equity instruments are not reversed through the income statement. If, in a subsequent period, the fair value of a debt instrument classified as available-for-sale increases and the increase can be objectively related to an event occurring after the impairment loss was recognised in the income statement, the impairment loss is reversed through the income statement. 20

22 Summary of significant accounting policies (continued) 1.8 Financial liabilities The Group classifies its financial liabilities under the following categories: trading liabilities, financial liabilities designated at fair value through profit or loss, deposits, certificates of deposit issued and other liabilities. All financial liabilities are classified at inception and recognised initially at fair value. (a) (a) Trading liabilities A financial liability is classified as held for trading if it is incurred principally for the purpose of repurchasing in the short term. It is carried at fair value and any gains and losses arising from changes in fair value are recognised in the income statement. (b) (b) Financial liabilities designated at fair value through profit or loss A financial liability is designated as fair value through profit or loss if it is so designated at inception. Financial liabilities so designated include certain certificates of deposit issued and certain deposits received from customers that are embedded with derivatives. A financial liability is typically so designated if it meets the following criteria: The designation eliminates or significantly reduces a measurement or recognition inconsistency (sometimes referred to as an accounting mismatch ) that would otherwise arise from measuring the financial liabilities or recognising the gains and losses on them on different bases; A group of financial liabilities is managed and its performance is evaluated on a fair value basis, in accordance with a documented risk management or investment strategy, and this is the basis on which information about these liabilities is provided internally to the management; or It relates to those financial instruments embedded with derivatives which significantly modify the cash flows that would otherwise be required under the contract. / Financial liabilities designated at fair value through profit or loss are carried at fair value and any gains and losses arising from changes in fair value are recognised as Net gain/loss arising from financial instruments designated at fair value through profit or loss in the income statement. (c) (c) Deposits, certificates of deposit issued and other liabilities Deposits and certificates of deposit issued, other than those classified as trading liabilities or designated at fair value through profit or loss, together with other financial liabilities are carried at amortised cost. Any difference between proceeds net of transaction costs and the redemption value is recognised in the income statement over the period of the other financial liabilities using the effective interest method. 21

23 NOTES TO THE INTERIM FINANCIAL STATEMENTS (1) (2) 1 Summary of significant accounting policies (continued) 1.9 Derivative financial instruments and hedge accounting Derivatives are initially recognised at fair value on the date on which a derivative contract is entered into and are subsequently re-measured at their fair value. Certain derivatives embedded in other financial instruments are treated as separate derivatives when their economic characteristics and risks are not closely related to those of the host contract and the host contract is not carried at fair value through profit or loss. All derivatives are carried as assets when fair value is positive and as liabilities when fair value is negative. Subsequent changes in fair value are recognised depending on the purpose of the derivatives. The method of recognising the resulting fair value gain or loss depends on whether the derivative is designated as a hedging instrument, and if so, the nature of the item being hedged. The Group designates certain derivatives as either: (1) hedges of the fair value of recognised assets or liabilities or firm commitments (fair value hedge); or, (2) hedges of highly probable future cash flows attributable to a recognised asset or liability, or a forecasted transaction (cash flow hedge). Hedge accounting is used for derivatives designated in this way provided certain criteria are met. The Group documents, at the inception of the transaction, the relationship between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. The Group also documents its assessment, both at hedge inception and on an ongoing basis, of whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. (a) (a) Fair value hedge Changes in the fair value of derivatives that are designated and qualify as fair value hedges are recorded in the income statement, together with any changes in the fair value of the hedged assets or liabilities that are attributable to the hedged risk. If the hedge no longer meets the criteria for hedge accounting, the adjustment to the carrying amount of a hedged item for which the effective interest method is used is amortised to the income statement over the period to maturity. The adjustment to the carrying amount of a hedged equity security remains in retained earnings until the disposal of the equity security. 22

24 1 1.9 (b) Summary of significant accounting policies (continued) 1.9 Derivative financial instruments and hedge accounting (continued) (b) Cash flow hedge The effective portion of changes in the fair value of derivatives that are designated and qualify as cash flow hedges are recognised in equity. The gain and loss relating to the ineffective portion is recognised immediately in the income statement. Amounts accumulated in equity are recycled to the income statement in the periods in which the hedged item will affect profit or loss. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in equity at that time remains in equity and is recognised when the forecast transaction is ultimately recognised in the income statement. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in equity is immediately transferred to the income statement. Derivative financial instruments held for trading and those that do not qualify for hedge accounting will be accounted for with changes in fair value reported through the income statement. Derivative transactions are offset and the net amount is reported in the balance sheet when there is a legally enforceable right to offset the recognised amounts and there is an intention to settle on a net basis, or realise the asset and settle the liability simultaneously Valuation of securities and derivatives The fair value of financial instruments is based on their quoted market prices at the balance sheet date without any deduction for estimated future selling costs. Financial assets are priced at current bid prices while financial liabilities are priced at current asking prices. For unlisted securities and where the market for a financial instrument is not active, the Group estimates fair value by using valuation techniques. These include the use of recent arm s length transactions, reference to other instruments that are substantially the same, discounted cash flow analysis, and option pricing models refined to reflect the issuer s specific circumstances. 23

25 NOTES TO THE INTERIM FINANCIAL STATEMENTS / Summary of significant accounting policies (continued) 1.11 Investment properties Property that is held for long-term rental yields or for capital appreciation or both, and that is not occupied by the companies in the consolidated Group, is classified as investment property. Investment property comprises land held under operating leases and buildings held under finance leases. Land held under operating leases is classified and accounted for as investment property when the rest of the definition of investment property is met. The operating lease is accounted for as if it were a finance lease. Investment property is measured initially at its cost, including related transaction costs. After initial recognition, investment property is carried at fair value. Any gain or loss arising from a change in fair value or from the retirement or disposal of an investment property is recognised in the income statement. When a property is transferred to investment property following a change in its use, any difference arising at the date of transfer between the carrying amount of the property immediately prior to the transfer and its fair value is recognised in the bank premises revaluation reserve in accordance with HKAS 16 Property, plant and equipment. However, a revaluation increase is recognised as income only to the extent that it reverses a revaluation decrease of the same asset previously recognised as an expense. Decreases are first set off against increases on previous valuations of the same asset and thereafter are debited to the income statement. Upon disposal of the property, the relevant portion of the bank premises revaluation reserve is released and transferred from the bank premises revaluation reserve to retained earnings. When an investment property becomes owner-occupied, it is reclassified as premises and its fair value at the date of reclassification becomes its cost for accounting purposes of subsequent recording Other properties and equipment (a) (a) Premises Premises represent those properties held for own use and are stated at cost less accumulated depreciation and impairment losses. Where the land and building elements of the leasehold properties held for own use can be allocated reliably at the inception of the lease, the land element is accounted for as operating lease. As such, any leasehold land premiums for acquiring the land leases, or other lease payments, are charged to the income statement on a straight line basis over the period of the lease or where there is impairment, the impairment is charged to the income statement. Any buildings which are situated on such land leases continue to be presented as part of premises. Where the land and building elements of the leasehold properties cannot be allocated reliably at the inception of the lease, the land and building elements will continue to be treated as finance lease and classified as premises. 24