KAUPTHING BANK LUXEMBOURG S.A. ANNUAL REPORT 2006

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3 TABLE OF CONTENTS Financial Summary 3 Address by the Chairman of the Board of Directors 5 Management Report 6 Auditor`s Report 10 Balance Sheet 14 Profit and Loss Account 17 Notes to the Annual Accounts 18 Organisation 34

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5 FINANCIAL SUMMARY Net revenues 120 in million EUR 100 Profit 60 in million EUR 50 Balance sheet 5000 in million EUR Assets under management and custody 5000 in million EUR 4000 Liable Capital 350 in million EUR 300 Revenue split 17% Net profit on financial operations 46% Net interest income % Net commission income 100 Return on Equity in % 100 Cost-to-income in % 150 Staff

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7 ADDRESS BY THE CHAIRMAN OF THE BOARD OF DIRECTORS 2006 will be remembered as a year of strong growth, increased profitability and improved asset quality. Considerable effort has been invested in risk management, a new compliance function has been established and a new function of operational risk management is well underway. Kaupthing Bank Luxembourg is essentially a mirror of the Group s own strategic development, having both employees and clients from all the 10 countries in which the Group operates. This international pool of employees and the diverse client base closely reflects the cosmopolitan environment of Luxembourg, where 40% of residents are of other nationalities than Luxembourgish. The workforce doubles every day as commuters cross borders from Germany, France and Belgium to work in Luxembourg. It is from this talent pool that the Bank employs 160 people of 18 different nationalities. A continuously changing business environment requires quick actions and the Bank s flat organizational structure and its disciplined and fast decision making process is a vital part of the corporate culture of the Bank and makes it competitive and responsive in the international banking market in Luxembourg. Sigurður Einarsson, Executive Chairman The Bank achieved a substantial increase in business volumes during the year and employs an intelligent approach to increase effectiveness in all business areas, with more straight through processing and streamlined processes that will ultimately reduce the risk of human errors. The Bank left its old premises in rue Guillaume Schneider and moved to new offices in Kirchberg during the year, a task that may have seemed like business as usual but was in fact the result of hard work and detailed planning according to a tight time schedule. The meticulous organization involved meant that employees were able to leave the old premises on a Friday and arrive at the new fully operational premises the following Monday. All credit for this impressive achievement should go to the Bank s IT department and to the group of dedicated employees who were directly involved in the project. Finally I would like to thank all our employees for their continuous effort and remarkable dedication to the Bank, as well as our valuable clients who I know have shared a successful 2006 with the Bank. Sigurður Einarsson 5

8 MANAGEMENT REPORT 2006 In 2006 Kaupthing Bank Luxembourg consolidated its position as one of the leading Nordic banks on the Luxembourg market. At the end of the first quarter of 2006 the Bank relocated to new premises in Kirchberg, situated on Avenue J.-F. Kennedy in the heart of the financial district. The new offices represent greatly improved working facilities, enabling the employees to take better advantage of the opportunities presented to the Bank in the future. At the same time the share capital of the Bank was increased by EUR 100 million to facilitate the fast growth of the Bank. The Bank is already reaping the benefits of the above with all business units well exceeding their stated goals for the year. Managing Directors of Kaupthing Bank, Luxembourg The diversity of the Bank s activities has proven to be of utmost importance and will mitigate its dependence on any single specific business area. The Bank s core activities are private banking and wealth management, financial markets activities including treasury and brokerage services for both internal clients and external institutional counterparts, as well as corporate banking, including participation as lead manager and arranger of syndicated credits. The Bank has also built up expertise in the administration of mutual funds and offers insurance products through its subsidiary Kaupthing Life and Pension. Magnús Gudmundsson The Bank reported an impressive 46% increase in the number of transactions in The balance sheet expanded by 82% in 2006 to approximately EUR 4.9 billion, while the capital adequacy ratio stands at 11.36%, well above the minimum capital requirement. Client deposits doubled to EUR 1.1 billion during 2006 and lending to customers increased by 83% to EUR 3.3 billion. Net revenues grew by 66% to EUR 120 million, whereas profits amounted to EUR 57 million, corresponding to an increase of 86% from the previous year. Return on equity, adjusted for a capital increase of EUR 100 million, was 25% and the cost-to-income ratio remained at a low level of 39%. All divisions of the Bank performed well. The strong results of the Financial Markets division were driven by increased business flow from institutional clients in 13 different countries in Europe, and fast growing Private Banking and Proprietary Trading units. The profitability has doubled each year since 2001 and was evenly driven by Treasury, Capital Markets and Foreign Exchange segments. Business volumes have reached new record highs in Foreign Exchange for the year 2006 of EUR 60 billion, compared with EUR 45 billion in Same goes for Capital Markets where business volumes reached EUR 15 billion compared with EUR 8.8 billion in Johnie Brøgger In 2006, the division added nine new professionals to its cosmopolitan team of 23 experts in the global Financial Markets division. The new team members have enlarged the team s network and have added scale to the business targeted for growth. The division is therefore represented in all the major European centres and centres its business on evolving lifelong partnerships based on trust and discretion with its clients. In its quest for quality and efficiency the Financial Markets division invests its time and capital in numerous projects to support risk management and straight through processing. One of the 6

9 MANAGEMENT REPORT 2006 milestones last year was becoming a CLS third party member during the last quarter of 2006, paving the way for additional growth of the Foreign Exchange business. Assets under management and custody, in the Private Banking department, grew by 25% to EUR 4 billion. The number of customers increased rapidly and numerous new bespoke products were created for the client base. The year also saw an increase in the numbers of both new and existing clients using our wealth management services, including portfolio management, tax and legal service, family and company legal issues, as well as company structures for equity and real estate holdings. Private Banking hired a marketing manager to develop Kaupthing s brand with a particular focus on brand communication to clients. Our updated client correspondence and client web access are both part of this ongoing development and information upgrade. Interactivity has increased between Private Banking and potential sources of new clients both within Luxembourg and abroad. The Bank is now seeking to promote its brand in a wider variety of venues than before. In late 2006 Private Banking expanded the representative office in Spain by appointing an additional manager, as the office is proving to be an important growth area. Private Banking now employs 50 senior account managers, assistant account managers and portfolio managers. This team has members from all of the Nordic nationalities and the UK, reflecting the Bank s strategic emphasis on targeting the markets in which Kaupthing Bank operates. The Institutional and Corporate Banking division met its targets with the successful expansion of the Bank s lending business within asset finance. The division has further strengthened its competencies in financing wind turbines, vessels and real estate. The division has increased its transaction flow significantly during the year and has taken an active part in the syndicated loan market both in the capacity as arranger and co-arranger. This conforms well to the Bank s philosophy of aiming to add value to our customers in close cooperation with partners across the financial landscape. The overall loan book has increased again during the past year, a development primarily attributable to increased lending to our growing base of Private Banking customers. Included in the range of lending products offered to our Private Banking customers is Kaupthing Mortgage, which forms part of the Bank s dedication to meeting the customer s entire need for premium financial solutions. The aggregate credit exposure towards Private Banking customers accounts for 65% of the entire loan book of the Bank. The remainder is lending to corporate customers (10%) and financial institutions (25%). Well secured loan portfolios in conjunction with ongoing efforts to maintain and enhance the Bank s risk management tools, have led to a year without losses on the loan book. The provision for loan losses stands at 0.14% of total outstanding loans as per 31 December

10 Regarding the Bank s exposure to risks, we kindly refer you to the notes 6.3 and 6.4 of the annual accounts as at 3 1 December Within the Investment Funds division, the Bank provides fund administration services for a number of investment funds encompassing both UCITS III and UCI funds. At year-end the Bank s Fund Administration administered assets of EUR 400 million. The Bank s efforts in Fund Distribution were focused on establishing a platform for the enhanced and diversified distribution of the Group s investment funds. Several funds have been streamlined for increased distribution efforts, and these initial initiatives will be leveraged upon with increased distribution efforts. The Bank s subsidiaries Kaupthing Life and Pension (KLP) and Kaupthing Asset Management Geneva have been developing positively during the year. KLP implemented new IT systems which will enable it to progress to the next level of development and actively introduce and sell its services throughout the Kaupthing network. Kaupthing Geneva is actively developing its product offering, which will pave the way for new opportunities with comprehensive financial services on top of its established Private Banking and Asset Management services. The year 2006 was marked by substantial growth and profitability in all business areas, supported by a set of business principles moulded over the years and now firmly embedded in the Bank s unique corporate culture. The Bank will continue to emphasise attracting, developing and motivating exceptional professionals, the Bank s most valuable asset. This culture is the foundation of the Bank s goals which are to provide premium financial services and to build long-term relationships with our clients by emphasizing our unique service culture, providing solid long-term investment returns and being competitive in the international markets. No significant events have occurred during the period from 31 December 2006 to date. February 15 th, 2007 Magnús Gudmundsson Managing Director Johnie Brøgger Managing Director 8

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12 AUDITOR S REPORT To the board of directors of KAUPTHING BANK LUXEMBOURG S.A. 35a, avenue J.-F. Kennedy L-1855 Luxembourg Report on the annual accounts Following our appointment by the board of directors dated February 24, 2006, we have audited the accompanying annual accounts of KAUPTHING BANK LUXEMBOURG S.A., which comprise the balance sheet as at December 31, 2006 and the profit and loss account for the year then ended, and a summary of significant accounting policies and other explanatory notes. Board of directors responsibility for the annual accounts The board of directors is responsible for the preparation and fair presentation of these annual accounts in accordance with Luxembourg legal and regulatory requirements relating to the preparation of the annual accounts. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of annual accounts 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. Responsibility of the Réviseur d Entreprises Our responsibility is to express an opinion on these annual accounts based on our audit. We conducted our audit in accordance with International Standards on Auditing as adopted by the Institut des Réviseurs d Entreprises. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the annual accounts are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the annual accounts. The procedures selected depend on the judgement of the Réviseur d Entreprises, including the assessment of the risks of material misstatement of the annual accounts, whether due to fraud or error. In making those risk assessments, the Réviseur d Entreprises considers internal control relevant to the entity s preparation and fair presentation of the annual accounts 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 board of directors, as well as evaluating the overall presentation of the annual accounts. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. 10

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14 Opinion In our opinion, the annual accounts give a true and fair view of the financial position of KAUPTHING BANK LUXEMBOURG S.A. as of December 31, 2006, and of the results of its operations for the year then ended in accordance with Luxembourg legal and regulatory requirements relating to the preparation of the annual accounts. Report on other legal and regulatory requirements The management report, which is the responsibility of the board of directors, is in accordance with the annual accounts. Luxembourg, February 15 th, 2007 KPMG Audit S.à r.l. Réviseurs d Entreprises E. Dollé 12

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16 BALANCE SHEET AS AT DECEMBER 31, 2006 Notes Assets (expressed in Euro) Cash, balances with central banks and post office banks ,164 25,824,859 Loans and advances to credit institutions 3.1, 6.1, 6.3 repayable on demand 173,781,096 63,960,831 other loans and advances 1,127,280, ,596,421 1,301,061, ,557,252 Loans and advances to customers 3.2, 6.1, 6.3 3,279,804,793 1,787,604,479 Debt securities and other fixed-income securities 3.3, 4.2, 6.1, 6.3 issued by public bodies 150,370 4,645 issued by other borrowers 229,591, ,121, ,741, ,126,362 Shares and other variable-yield securities 3.4, 6.1, ,346,015 41,520,577 Shares in affiliated undertakings 3.5, 3.8, 6.1, 6.3 7,247,726 7,247,726 Intangible assets 3.6, 3.8 1,133, ,119 Tangible assets 3.8 4,839,365 1,016,819 Other assets 1,653,673 1,613,550 Prepayments and accrued income 52,309,867 31,642,678 Total assets 4,924,585,441 2,700,998,421 Off balance sheet items Contingent liabilities 5.1, 6.1, ,014,320 30,792,021 of which: guarantees and assets pledged as collateral security 367,014,320 30,792,021 Commitments 5.2, 6.1, Fiduciary Operations 8,453,915 13,693,729 The accompanying notes form part of these annual accounts. 14

17 BALANCE SHEET AS AT DECEMBER 31, 2006 Notes Liabilities (expressed in Euro) Amounts owed to credit institutions 4.1, 6.1 repayable on demand 82,803,640 19,344,718 with agreed maturity dates or periods of notice 3,334,630,079 1,865,220,641 3,417,433,719 1,884,565,359 Amounts owed to customers other debts 4.2, 6.1 repayable on demand 638,606, ,262,643 with agreed maturity dates or periods of notice 483,222, ,138,752 1,121,829, ,401,395 Other liabilities , ,934 Accruals and deferred income 41,277,896 17,793,431 Provisions for liabilities and charges provisions for taxation 21,074,644 11,856,924 other provisions 12,752,296 7,756,763 33,826,940 19,613,687 Subordinated liabilities 4.4, Fund for general banking risks - - Subscribed capital ,000, ,000,000 Reserves 4.6 5,859,588 2,525,782 Profit brought forward 46,461,027 19,149,218 Profit for the financial year 57,001,591 30,645,615 Total Liabilities 4,924,585,441 2,700,998,421 The accompanying notes form part of these annual accounts. 15

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19 NOTES TO THE ANNUAL ACCOUNTS PROFIT AND LOSS ACCOUNT FOR THE YEAR ENDED DECEMBER 31, 2006 Notes (expressed in Euro) Interest receivable and similar income 7 197,900,909 91,463,336 of which: arising from debt securities and other fixed-income securities 6,827,066 5,479,347 Interest payable and similar charges (142,467,773) (65,210,755) Net interest income 55,433,136 26,252,581 Income from shares and other variable-yield securities 583, ,108 Commission receivable 7 59,147,201 38,638,143 Commission payable (15,094,024) (9,299,706) Net commission income 44,053,177 29,338,437 Net profit on financial operations 7 19,381,131 15,989,771 Other operating income 12, Total operating income 119,462,958 71,849,460 General administrative expenses Staff costs (30,095,449) (19,603,822) of which : - wages and salaries (25,558,937) (16,273,131) - Social security costs (1,375,283) (956,848) of which: social security costs relating to pensions (822,299) (531,363) Other administrative expenses (16,630,837) (9,466,431) (46,726,286) (29,070,253) Value adjustments in respect of tangible and intangible assets (2,262,221) (880,081) Other operating charges (400,000) - Net value adjustments in respect of loans and advances and Provisions for contingent liabilities and for commitments (394,796) (2,606,569) Income from the writing back of amounts included in the fund For general banking risks - 250,000 Profit on ordinary activities before tax 69,679,655 39,542,557 Tax on profit on ordinary activities (11,641,272) (8,857,307) Profit on ordinary activities after tax 58,038,383 30,685,250 Other taxes not shown under the preceding items (1,036,792) (39,635) Profit for the financial year 57,001,591 30,645,615 The accompanying note forms part of these annual accounts. 17

20 NOTES TO THE ANNUAL ACCOUNTS AS AT DECEMBER 31, General Kaupthing Luxembourg S.A. ( the Company ) was incorporated in the Grand-Duchy of Luxembourg on April 2, 1998 as a limited liability company ( Société Anonyme ). The Ministry of Finance granted the Company a banking licence on December 24, The Company subsequently changed its articles of incorporation on January 18, 2000 and its name to KAUPTHING BANK LUXEMBOURG S.A. (the Bank ). The Bank is thus permitted to carry out all banking activities. Its principal activities are private banking, loans to customers, interbank deposits, fund administration and holding company domiciliation. The Bank, which is a subsidiary of Kaupthing Bank hf., is included in the consolidated accounts of that company ( the parent company ). The consolidated accounts may be obtained from the registered office of the parent company at Borgatúni 19, 105 Reykjavik, Iceland. On the basis of the criteria set out by the Luxembourg law, the Bank is exempted from establishing consolidated accounts and a consolidated management report. 2 Summary of significant accounting policies The Bank s accounting policies are in accordance with regulations in force in the Grand-Duchy of Luxembourg and, in particular, the modified law of June 17, 1992, relating to the annual accounts of credit institutions. 2.1 Fixed assets Intangible assets Intangible assets are included at purchase price less accumulated amortisation. Intangible assets consist of software amortised over 4 years on a linear basis. Since January 1, 2006, formation expenses and costs in relation to capital increases are directly expensed when incurred Tangible assets Tangible assets are included at purchase price less accumulated depreciation. Tangible assets are depreciated over their expected useful life. The rates and methods of depreciation are as follows: Rates Method Office equipment, fixtures and fittings 25% linear Company cars 25% linear Fixtures and fittings costing less than EUR 867 or whose expected useful life does not exceed one year are charged directly to profit and loss account for the year. 18

21 NOTES TO THE ANNUAL ACCOUNTS Shares in affiliated undertakings Holdings are recorded at purchase price. If the valuation is lower than the purchase price, value adjustments are booked to account for the unrealised loss. 2.2 Current assets Debt securities and other fixed-income securities Holdings are recorded at purchase price. Value adjustments are made for securities in the structural portfolio for which the valuation is lower than the purchase price. The valuation is the market value on the balance sheet date or the estimated realisable value or the quotation which best represents the inherent value of the securities held Shares and other variable-yield securities Holdings are recorded at purchase price. If the valuation is lower than the purchase price, value adjustments are booked to account for the unrealised loss. Holdings hedged by derivative financial instruments are maintained at purchase price Loans and advances Loans and advances are disclosed at their nominal value. Accrued interest not received is recorded under the heading Prepayments and accrued income on the asset side of the balance sheet Value adjustments in respect of current assets The policy of the Bank is to establish specific provisions to cover the risk of loss and of the nonrecovery of debtors. Value adjustments are deducted from the relevant current assets Provision for assets at risk A tax free lump sum provision is accounted for based on the Bank s assets at risk. These assets are determined in accordance with the regulatory provisions governing the computation of the capital adequacy ratio. The lump sum provision is apportioned between the relevant assets at risk in accordance with the provisions of the Luxembourg Monetary Institute circular letter dated December 16, The portion related to the assets at risk is deducted from these assets. 2.3 Fund for general banking risks Up to December 31, 2004, the Bank had established a fund for general banking risks to cover the particular risks associated with banking activities. The remaining amount was fully reversed through the profit and loss account for the year ended December 31, Purchase price of fungible assets The Bank values fungible assets by the weighted average price method. 19

22 2.5 Valuation of foreign currency balances and transactions Foreign currency translation The share capital of the Bank is expressed in Euro ( EUR ) and the accounting records are maintained in that currency. Shares in affiliated undertakings included in fixed assets as well as intangible and tangible assets are converted at the historic rate. All other assets and liabilities denominated in a currency other than EUR are converted into EUR at the rate of exchange ruling at the balance sheet date. Income and charges in foreign currencies are converted into EUR at the rate of exchange ruling on the date of the transaction. Foreign currency differences arising from these valuation principles are taken to profit and loss account Valuation of transactions not subject to currency risk Swap transactions not linked to balance sheet items The spot result realised in cash terms is offset by the result arising from the revaluation of the forward leg. The premium/discount is spread prorata temporis. Over-the-counter closed forward transactions Future profits that are certain to arise are deducted from future losses that are certain to arise in the same currency. A provision is created for any excess losses; any excess profits are deferred. Over-the-counter closed options Options sold hedged by options bought so that no open position exists are considered to be neutral in relation to currency fluctuations. Financial futures Margin calls on financial futures traded on a recognised market are booked daily. Gains and losses on trading positions are directly booked in the profit and loss account Valuation of transactions subject to currency risk Over-the-counter speculative forward transactions Provision is made for unrealised losses on forward transactions, which do not represent the hedging of a spot position. Unrealised gains are not accounted for. 3 Detailed disclosures relating to asset headings 3.1 Loans and advances to credit institutions Loans and advances to affiliated undertakings amount to EUR 950,254,859 (2005: EUR 354,320,986). 20

23 NOTES TO THE ANNUAL ACCOUNTS 3.2 Loans and advances to customers Loans and advances to affiliated undertakings amount to EUR 4,178,628 (2005: EUR 6,086,378). 3.3 Debt securities and other fixed-income securities This heading includes debt securities, whether quoted on a recognised market or not, issued by public bodies, credit institutions or other issuers and which are not included under another balance sheet heading. Quoted and non-quoted securities are analysed as follows: EUR EUR Securities quoted on a recognised market 209,658, ,758,628 Securities not quoted on a recognised market 20,083,256 14,367, ,741, ,126,362 All the debt securities and other fixed-income securities held are included in the structural portfolio. 3.4 Shares and other variable-yield securities This heading includes shares, holdings in investment funds and other variable-yield securities whether quoted on a recognised market or not which are not included in fixed asset investments. Quoted and non-quoted shares and other variable-yield securities are analysed as follows: EUR EUR Securities quoted on a recognised market (*) 45,480,079 41,277,618 Securities not quoted on a recognised market 865, ,959 46,346,015 41,520,577 (*) of which shares and other variable-yield securities held for hedging purposes: EUR 23,198,502 (2005: EUR 14,459,638). 3.5 Shares in affiliated undertakings As at December 31, 2006, the Bank holds at least 20% of the capital of the following non-quoted undertakings : % held Capital and reserves Result for the December 31, 2006 (*) year 2006 (*) EUR EUR Kaupthing Life & Pension S.A. 100% 6,489,050 49,669 12, rue Guillaume Schneider L-2522 Luxembourg Kaupthing Asset Management S.A. 100% (94,673) (348,303) 1, rue de Rive CH-1204 Genève (*) Unaudited figures. 21

24 3.6 Intangible assets This heading consists of: EUR EUR Formation expenses - 145,968 Software 1,133, ,151 1,133, ,119 Formation expenses consist of costs in relation to capital increases. They have been fully amortized in Assets denominated in foreign currencies Assets denominated in currencies other than EUR have a total value of EUR 2,712,998,947 as at December 31, 2006 (2005: EUR 1,572,873,320). The gap between non EUR denominated assets and non EUR denominated liabilities is covered by off-balance sheet instruments. 3.8 Movements on fixed assets FIXED ASSETS Gross value Additions Reductions Gross value Cumulative Net book (in EUR) at the at the value value beginning of end of adjustments at the the financial the financial balance year year sheet date 1. Shares in affiliated undertakings 7,247, ,247,726-7,247, Intangible assets 2,617, ,929-3,414,281 (2,281,243) 1,133,038 of which: a) Formation expenses 291, ,440 (291,440) - b) Software 2,325, ,929-3,122,841 (1,989,803) 1,133, Tangible assets 3,593,260 5,594,939 (67,250) 9,120,949 (4,281,584) 4,839,365 of which: a) Office equipment fixtures and fittings 3,096,491 5,081,730-8,178,221 (3,951,403) 4,226,818 b) Company cars 496, ,209 (67,250) 942,728 (330,181) 612,547 TOTAL 13,458,338 6,391,868 (67,250) 19,782,956 (6,562,827) 13,220,129 22

25 NOTES TO THE ANNUAL ACCOUNTS 4 Detailed disclosures relating to liability headings 4.1 Amounts owed to credit institutions Amounts owed to affiliated undertakings amount to EUR 2,356,648,664 (2005: EUR 1,091,571,060). 4.2 Amounts owed to customers Amounts owed to affiliated undertakings amount to EUR 3,417,765 (2005: EUR 6,386,158). 4.3 Other liabilities This heading consists of the following: EUR EUR Short-term payables 443,645 - Preferential creditors 451, , , , Subscribed capital On March 29, 2006, an Extraordinary General Meeting of the Shareholders resolved to increase the subscribed capital of the Bank by an amount of EUR 100,000,000 by the issue of 1,000,000 new additional shares each with a nominal value of EUR 100. The capital increase has been fully subscribed and paid by a contribution in cash by the parent company. As at December 31, 2006, the subscribed and fully paid share capital of the Bank is EUR 200,000,000 made up of 2,000,000 shares with a nominal value of EUR 100 each. 4.5 Reserves Reserves are summarised as follows: EUR EUR Legal reserve 2,616,057 1,083,776 Net worth tax reserve 3,243,531 1,442,006 5,859,588 2,525,782 In accordance with article 72 of the Luxembourg company law, an amount of 5% of net profits should be allocated to a non distributable legal reserve, until this reserve reaches 10% of the subscribed capital. As a result, the 2007 Annual General Meeting of the Bank should allocate an amount of EUR 2,850,080 to the legal reserve, in respect of the 2006 financial year. In 2006 and in accordance with paragraph 8a of the net worth tax law, the Bank has deducted from its tax basis for net worth tax, the net worth tax incurred during the financial year, amounting to EUR 797,570. Such a deduction is subject to allocating an amount equal to five times the net worth tax deducted, amounting to a total of EUR 3,987,850, to a reserve, by a resolution of the 2007 Annual General Meeting of Shareholders. 23

26 4.6 Liabilities denominated in foreign currencies Liabilities denominated in currencies other than EUR have a total value of EUR 2,121,912,163 as at December 31, 2006 (2005: EUR 1,294,955,564). The gap between non EUR denominated assets and non EUR denominated liabilities is covered by off-balance sheet instruments. 5 Information relating to off-balance sheet items 5.1 Contingent liabilities Contingent liabilities consist of guarantees and other direct substitutes for loans. Contingent liabilities to affiliated undertakings amount to EUR 279,428,023 (2005: nil). 5.2 Commitments The Bank is member of the Association pour la Garantie des Dépôts, Luxembourg ( A.G.D.L. ). The A.G.D.L. has for its exclusive object the establishment of a system of mutual guarantee of deposits placed with members by private individuals and by small companies without distinction of nationality or residence. No provision has been made in respect of specific liabilities arising under this scheme. 5.3 Open forward agreements at the balance sheet date Transactions linked to exchange rates The Bank is engaged in forward foreign exchange transactions (swaps, outrights) in the normal course of its banking business. A significant portion of these transactions has been contracted to hedge the effects of fluctuations in exchange rates Transactions linked to interest rates A significant portion of these transactions has been contracted to hedge the effects of fluctuations in interest rates Transactions linked to other market rates A significant portion of these transactions has been contracted to hedge the effects of fluctuations in market prices. 5.4 Management and representative services supplied by the Bank The Bank s services to third parties consist of: Management and advice on asset management; Safekeeping and administration of marketable securities; Fund administration; Holding company domiciliation; Credit activities. 24

27 NOTES TO THE ANNUAL ACCOUNTS 6 Information relating to financial instruments 6.1 Disclosures relating to primary financial instruments in relation to non trading activities The following tables provide an analysis of the carrying amount of primary financial assets and financial liabilities of the Bank into relevant maturity groupings based on the remaining periods to repayment. As at December 31, 2006, primary financial assets and liabilities are analysed as follows (in EUR): Financial assets Less than Between three Between one More than Total three months months and year and five years one year five years Cash, balances with central banks and post office banks 448, ,164 Loans and advances to credit institutions 1,230,812,522 50,162,369 20,086,455-1,301,061,346 Loans and advances to customers 2,864,455, ,718,945 61,457, ,173,014 3,279,804,793 Debt securities and other fixed-income securities 4,413,394 55,509,723 93,751,161 76,067, ,741,454 Shares and other variable-yield securities (*) ,346,015-46,346,015 Total 4,100,129, ,391, ,641, ,240,190 4,857,401,772 (*) of which EUR 23,198,502 are held for hedging purposes. Financial liabilities Less than Between three Between one More than Total three months months and year and five years one year five years Amounts owed to credit institutions 2,911,817,922 93,147, ,809,400 22,658,938 3,417,433,719 Amounts owed to customers 1,066,650,124 55,178, ,121,829,108 Contingent liabilities 367,014, ,014,320 Total 4,345,482, ,326, ,809,400 22,658,938 4,906,277,147 25

28 6.1 Disclosures relating to primary financial instruments in relation to non trading activities (continued) As at December 31, 2005, primary financial assets and liabilities are analysed as follows (in EUR): Financial assets Less than Between three Between one More than Total three months months and year and five years one year five years Cash, balances with central banks and post office banks 25,824, ,824,859 Loans and advances to credit institutions 506,985,029 73,500,863 20,071, ,557,252 Loans and advances to customers 1,688,878,850 59,381,111 4,791,588 34,552,930 1,787,604,479 Debt securities and other fixed-income securities - 17,193, ,572,281 37,360, ,126,362 Shares and other variable-yield securities (*) ,520,577-41,520,577 Total 2,221,688, ,075, ,955,806 71,913,290 2,658,633,529 (*) of which EUR 14,459,638 are held for hedging purposes. Financial liabilities Less than Between three More than Total three months months and five years one year Amounts owed to credit institutions 1,542,548,163 69,011, ,005,453 1,884,565,359 Amounts owed to customers 606,092,552 20,308, ,401,395 Contingent liabilities 30,792, ,792,021 Total 2,179,432,736 89,320, ,005,453 2,541,758,775 26

29 NOTES TO THE ANNUAL ACCOUNTS 6.2 Disclosures relating to derivative financial instruments The following tables provide an analysis of the derivative financial assets and liabilities of the Bank into relevant maturity groupings based on the remaining periods to repayment. As at December 31, 2006, over the counter derivative financial assets and liabilities are analysed as follows (in EUR): Financial assets Less than Between three Between one Total Positive (notional amounts) three months months and year and fair value one year five years Instruments linked to exchange rates - forward currency transactions 89,989,621 33,427, ,416,815 18,620,032 - currency swap contracts 620,687, ,075, ,763,752 4,099,927 - currency option contracts 474, ,698 2,394 Instruments linked to interest rates 49,979,938 87,057,835 35,424, ,462,288 5,246,103 Instruments linked to other market rates 935,102,679 9,748, ,851, ,310 1,696,234, ,309,189 35,424,515 2,075,968,575 28,139,766 Financial liabilities Less than Between three Between one Total Negative (notional amounts) three months months and year and fair value one year five years Instruments linked to exchange rates - forward currency transactions 104,129,357 32,336, ,465,598 18,438,452 - currency swap contracts 573,550, ,199, ,749,449 8,765,941 - currency option contracts 474, ,698 2,394 Instruments linked to interest rates 89,022, ,526,413 28,608, ,157,409 5,252, ,176, ,061,734 28,608,505 1,107,847,154 32,459,032 As at December 31, 2006, the net fair value of derivative financial assets and liabilities is a loss of EUR 4,319,266 (2005: gain of EUR 150,645). 27

30 6.2 Disclosures relating to derivative financial instruments (continued) As at December 31, 2005, over the counter derivative financial assets and liabilities are analysed as follows (in EUR): Financial assets Less than Between Between More than Total Positive (notional amounts) three three one year five years fair value months months and and five one year years Instruments linked to exchange rates - forward currency transactions 212,373,471 19,917, ,291,344 21,469,394 - currency swap contracts 508,961,205 61,683, ,645,185 2,394,754 - currency option contracts 30,705, ,705, ,145 Instruments linked to interest rates - 13,315,579 20,103,927 12,186,341 45,605, ,371 Instruments linked to other market rates 431,584,948 64,965,234-3,372, ,922, ,638 1,183,624, ,882,666 20,103,927 15,559,022 1,379,170,308 24,467,302 Financial liabilities Less than Between Between More than Total Negative (notional amounts) three three one year five years fair value months months and and five Instruments linked to exchange rates one year - forward currency transactions 246,392,028 21,590, ,982,721 21,585,285 - currency swap contracts 275,623,248 29,668, ,291,284 2,345,871 - currency option contracts 30,705, ,705, ,145 Instruments linked to interest rates - 13,315,579 17,000,000 1,686,341 32,001, ,356 years 552,720,345 64,574,308 17,000,000 1,686, ,980,994 24,316, Disclosures relating to credit risk The Bank is exposed to credit risk mainly through its lending, investing and hedging activities and in cases where the Bank acts as an intermediary on behalf of customers and issues guarantees. The Bank s primary exposure to credit risk arises from its loans and advances and debt securities. The credit exposure in this regard is represented by the carrying amounts of the assets in the balance sheet. The Bank is also exposed to off balance sheet credit risk through guarantees issued and instruments linked to exchange, interest and other market rates (forward transactions, swap and option contracts). The credit exposure in respect of instruments linked to exchange, interest and other market rates are equal to the equivalent at risk according to the initial risk approach. 28

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32 6.3 Disclosures relating to credit risk (continued) The credit risk exposure as at December 31, 2006 can be analysed as follows (in EUR): Gross risk exposure Loans and advances to credit institutions 1,301,061,346 Loans and advances to customers 3,279,804,793 Secured 3,085,340,582 Unsecured 194,464,211 Debt securities and other fixed-income securities 229,741,454 Shares and other variable-yield securities 46,346,015 Contingent liabilities 367,014,320 Secured 361,442,810 Unsecured 5,571,510 Derivatives Instruments linked to exchange rates 36,754,135 Instruments linked to interest rates 1,988,098 Instruments linked to other market rates 56,691,062 5,319,401,223 The credit risk exposure as at December 31, 2005 can be analysed as follows (in EUR): Gross risk exposure Loans and advances to credit institutions 600,557,252 Loans and advances to customers 1,787,604,479 Secured 1,647,817,020 Unsecured 139,787,459 Debt securities and other fixed-income securities 203,126,362 Shares and other variable-yield securities 41,520,577 Contingent liabilities 30,792,021 Secured 29,018,229 Unsecured 1,773,792 Derivatives Instruments linked to exchange rates 27,703,878 Instruments linked to interest rates 388,039 Instruments linked to other market rates 14,039,646 2,705,732,254 30

33 NOTES TO THE ANNUAL ACCOUNTS 6.3 Disclosures relating to credit risk (continued) Loans and advances to customers are usually secured by cash, listed investments and third party guarantees. At December 31, 2006, guarantees received from affiliated undertakings amount to EUR 494,000,000 (2005: EUR 297,664,627) to secure loans and advances to customers. Credit risk concentrations on total on and off balance sheet are analysed as follows: EUR EUR Corporates 2,732,456,654 1,478,938,077 Credit institutions 1,951,639, ,008,938 Individuals 635,155, ,824,723 Public sector 150, ,516 5,319,401,223 2,705,732,254 Credit institutions, corporates and individuals are mainly from Zone A countries. 6.4 Information on the management of other risks Liquidity Risk A cash management system enables the Bank to achieve a daily automatic vostro-nostro reconciliation of its main correspondent accounts. The Bank is able to identify possible cash flow errors, to determine adjusted opening balances and generate an accurate cash flow projection to better channel short-term liquidity needs. The Managing Directors receive a daily report on the overall liquidity situation of the Bank. Interest Rate Risk The Bank monitors its interest rate risk by analysing the different maturity gaps in the balance sheet. The calculation is performed using periods from one day to twelve months. The model enables the Bank to supervise the non-synchronized interest rate positions, the impact of gaps on the net interest income, the re-evaluation of the gap compared to the actual interest rate curve, and finally the consequences on the risk limits. A value at risk calculation estimates the profit and loss impact if interest rates go up or down by 1%. Guidelines have been approved by the Board of Directors, setting out the principles for measurement of/and limitations on mismatches identified. 31

34 6.4 Information on the management of other risks (continued) Exchange Rate Risk The Bank s main exposure to foreign exchange risk arises from USD, ISK, ISV, CHF, DKK, GBP and JPY. A foreign exchange position system provides an overall view of the currency risk and related profit or loss impact as soon as the dealer has closed a deal with either a private client or a financial institution. Management controls the exchange rate risk through the daily liquidity report received from the Financial Markets department. Market Risk The Bank is subject to market risk through its portfolio of debt securities and shares and other variable yield securities. Derivative instruments are used for hedging purposes. Back to back transactions initiated by customers of the Bank do not expose the Bank to market risk. The Bank has put in place procedures in order to monitor market risk. Guidelines are reviewed and approved by the Board of Directors on a yearly basis. 7 Information on the profit and loss account Interest receivable and similar income, commission receivable and net profit on financial operations mainly originate from Central and Western Europe. 8 Other information 8.1 Personnel The average number of persons employed during the financial year was as follows: Management 2 2 Other executives 7 7 Employees

35 8.2 Administrative, managerial and supervisory bodies Remuneration paid to the various bodies of the Bank during the financial year was as follows: EUR EUR Administrative board 111,000 80,370 Managerial board 4,846,102 3,806,307 4,957,102 3,886,677 The amount of loans and advances granted to members of the Board of Directors and commitment entered into on their behalf by way of guarantees of any kind amounted to EUR 7,576,948 at December 31, 2006 (2005: EUR 4,368,837). 8.3 Fees billed by KPMG Audit S.à r.l., Luxembourg and other member firms Fees billed (excluding VAT) to the Bank by KPMG Audit S.à r. l., Luxembourg and other member firms of the KPMG network during the year are as follows: EUR EUR Audit fees 250, ,300 Audit-related fees 15,400 15,970 Tax fees 128,468 65,893 All other fees 28,343 45, , ,624 Such fees are presented under other administrative expenses in the profit and loss account. 33

36 ORGANISATION Board of Directors Sigurður Einarsson, Chairman of the Board Johnie W. Brøgger Managing Directors Magnús Gudmundsson Internal Audit Compliance Jean-Louis Frey Xavier Leydier IT Private Banking Corporate Banking Legal Olafur Hilmarsson General Manager Björn Jonsson Deputy Managing Director Peter Raun General Manager Eggert Hilmarsson General Manager Operation Anne Rassel General Manager Financial Markets Alexandre Simon Director Investment Funds Bo Matthiesen General Manager 34

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38 Meinbach Consulting & Design 2007

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40 Kaupthing Bank Luxembourg S.A. 35a, avenue J.-F. Kennedy L-1855 Luxembourg Tel Fax