MEDIUM TERM NOTE PROGRAMME AND EXTRACT OF FINANCIAL INFORMATION

Transcription

1 Hong Kong Exchanges and Clearing Limited and The Stock Exchange of Hong Kong Limited take no responsibility for the contents of this announcement, make no representation as to its accuracy or completeness and expressly disclaim any liability whatsoever for any loss howsoever arising from or in reliance upon the whole or any part of the contents of this announcement. This announcement is for information purposes only and does not constitute an invitation or offer to acquire, purchase or subscribe for securities. This announcement does not constitute an offer to sell or the solicitation of an offer to buy any securities in the United States or any other jurisdiction in which such offer, solicitation or sale would be unlawful prior to registration or qualification under the securities laws of any such jurisdiction. No securities may be offered or sold in the United States absent registration or an applicable exemption from registration requirements. Any public offering of securities to be made in the United States will be made by means of a prospectus. Such prospectus will contain detailed information about the Company making the offer and its management and financial statements. The Company does not intend to make any public offering of securities in the United States. (A joint stock company incorporated in the People s Republic of China with limited liability) (Stock code: 03968) MEDIUM TERM NOTE PROGRAMME AND EXTRACT OF FINANCIAL INFORMATION Reference is made to the formal notice of the Company dated 29 April 2015 in relation to the Medium Term Note Programme. In connection with the Programme, the Company will provide certain professional investors with recent corporate and financial information, as described in the Supplemental Offering Circular dated 30 April For purposes of transparent and timely dissemination of information to Shareholders and the broader investment community, an extract of the relevant information which relates to the management s discussion and analysis of financial condition and results of operations, as well as assets and liabilities, of the Group is attached to this announcement. As the Company may or may not proceed with the drawdown(s) under the Programme, the timing of drawdown(s) if any) is uncertain as it depends on market conditions and the corporate needs of the Company and the terms of each drawdown may vary within the parameters set out in the Programme, Shareholders and prospective investors are advised to exercise caution when dealing with the securities of the Company. 1

2 MEDIUM TERM NOTE PROGRAMME Reference is made to the formal notice of the Company dated 29 April 2015 in relation to the Medium Term Note Programme. Under the Medium Term Note Programme, the Company or such other branch of the Company (including, but not limited to, China Merchants Bank Co., Ltd. Hong Kong Branch) as specified in the applicable Pricing Supplement (each an Issuer ), subject to compliance with all relevant laws, regulations and directives, may from time to time issue Notes. The aggregate nominal amount of Notes outstanding will not at any time exceed U.S.$5,000,000,000 (or the equivalent in other currencies), subject to increases of the programme size made in accordance with the terms of the relevant dealer agreement. The Notes may be issued on a continuing basis to one or more of the dealers appointed under the Programme from time to time by the Issuer, which appointment may be for a specific issue or on an on-going basis. Application has been made to the Stock Exchange for the listing of the Programme for 12 months after 29 April 2015 by way of debt issues to professional investors only, as described in the Offering Circular dated 29 April The listing of the Programme has become effective on 30 April In connection with the Programme, the Company will provide certain professional investors with recent corporate and financial information, as described in the Supplemental Offering Circular dated 30 April For purposes of transparent and timely dissemination of information to Shareholders and the broader investment community, an extract of the relevant information which relates to the management s discussion and analysis of financial condition and results of operations, as well as assets and liabilities of the Group is attached to this announcement. GENERNAL As the Company may or may not proceed with the drawdown(s) under the Programme, the timing of drawdown(s) if any) is uncertain as it depends on market conditions and the corporate needs of the Company and the terms of each drawdown may vary within the parameters set out in the Programme, Shareholders and prospective investors are advised to exercise caution when dealing with the securities of the Company. 2

3 DEFINITIONS In this announcement, unless the context requires otherwise, the following expressions shall have the following meanings: Board Company Hong Kong Group Notes Pricing Supplement Programme or Medium Term Note Programme Regulation S Rule 144A Shareholders Stock Exchange United States or U.S. U.S. Securities Act or Securities Act the board of directors of the Company China Merchants Bank Co., Ltd. the Hong Kong Special Administrative Region of the People s Republic of China the Company and its subsidiaries notes that may from time to time be issued under the U.S.$5,000,000,000 Medium Term Note Programme the document which sets out the terms specific to each series of the Notes to be issued under the Medium Term Note Programme the medium term note programme update of up to U.S.$5,000,000,000 (or the equivalent in other currencies at the date of issue), the U.S.$5,000,000,000 medium term note programme was established on 28 May 2014 by China Merchants Bank Co., Ltd. Hong Kong Branch Regulation S under the U.S. Securities Act Rule 144A under the U.S. Securities Act shareholders of the Company The Stock Exchange of Hong Kong Limited the United States of America, its territories, its possessions and all areas subject to its jurisdiction the U.S. Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder 3

4 U.S.$ United States dollars, the lawful currency of the United States By order of the Board of Directors China Merchants Bank Co., Ltd. Li Jianhong Chairman 30 April 2015 As at the date of this announcement, the executive directors of the Company are Tian Huiyu, ZhangGuanghua and Li Hao; the non-executive directors of the Company are Li Jianhong, Ma Zehua, Li Xiaopeng, Li Yinquan, Fu Gangfeng, Sun Yueying, Su Min, Fu Junyuan and Hong Xiaoyuan; and the independent non-executive directors of the Company are Leung Kam Chung, Antony, Wong Kwai Lam, Pan Chengwei, Pan Yingli, Guo Xuemeng and Zhao Jun. 4

5 APPENDIX EXTRACT OF SUPPLEMENTAL OFFERING CIRCULAR

6 MANAGEMENT S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the Group s consolidated financial statements as at and for the years ended 31 December 2012, 2013 and 2014, together with the accompanying notes, included elsewhere in the Offering Circular. The consolidated financial statements have been prepared in accordance with IFRS. Capital adequacy ratios discussed in this section are calculated in accordance with applicable CBRC guidelines and are based on the Group s financial statements prepared in accordance with PRC GAAP. The capital adequacy ratios are not part of the consolidated financial statements and have not been audited. The selected financial information as at and for the three months ended 31 March 2014 and 2015 has been derived from the Group s unaudited condensed consolidated financial statements for the three months ended 31 March 2015 and was prepared in accordance with IFRS and should be read in conjunction with the financial statements for the year ended 31 December The following discussion and analysis contain forward-looking statements that involve risks and uncertainties. The Group s actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under Risk Factors and elsewhere in this Offering Circular. OVERVIEW Founded in 1987 with its head office in Shenzhen, China, the Bank mainly focuses on the Chinese market. The Group s PRC operations accounted for 93.0% of the Group s total assets as of 31 December The Bank s distribution network primarily covers China s more economically developed regions such as the Yangtze River Delta, Pearl River Delta and Bohai Rim, and some large and medium cities in other regions. As at 10 April 2015, the Bank had 1,943 domestic branches and overseas correspondent banks in 111 countries (including China) and regions. The growth of the Bank from a regional bank into a national commercial bank with significant asset scale and strength in China is primarily attributable to its organic growth. The Bank was listed on the Shanghai Stock Exchange in April 2002 and on the HKSE in September The Bank provides customers with various wholesale and retail banking products and services, and maintains treasury businesses for proprietary purposes and on behalf of customers. Many innovative products and services of the Bank, such as the All-in-one Card, a multi-function debit card, the All-in-one Net, a comprehensive online banking service platform, a dual-currency credit card, the Sunflower Wealth Management services and private banking services, have been widely adopted by the Bank s customers in China. As at 31 December 2012, 2013 and 2014, the Group had approximately RMB3,408.1 billion, RMB4,016.4 billion and RMB4,731.8 billion in total assets, respectively, and RMB1,863.3 billion, RMB2,148.3 billion and RMB2,448.8 billion in total loans and advances, respectively. For the years ended 31 December 2012, 2013 and 2014, the Group had an operating income of RMB113.8 billion, RMB133.0 billion and RMB166.4 billion, respectively, and a net profit of RMB45.3 billion, RMB51.7 billion and RMB56.0 billion, respectively. For the three years ended 31 December 2012, 2013 and 2014, the net interest spread of the Group was 2.87%, 2.65% and 2.33%, respectively, and the net interest margin of the Group was 3.03%, 2.82% and 2.52%, respectively. S-6

7 RECENT DEVELOPMENTS Quarterly Financial Information as at and for the Three Months Ended 31 March 2015 On 28 April 2015, the Group announced its unaudited IFRS financial results as at and for the three months ended 31 March The Group also reported additional financial and operating indicators. The following table sets forth, for the periods indicated, the Group s unaudited consolidated statement of profit or loss. For the three months ended 31 March (unaudited) (unaudited) (in millions of RMB) Interest income... 51,626 59,719 Interest expense... (24,308) (26,330) Net interest income... 27,318 33,389 Fee and commission income ,269 16,654 Fee and commission expense... (793) (1,021) Net fee and commission income... 10,476 15,633 Other net income... 3,137 1,755 Total operating income ,931 50,777 Operating expense... (13,707) (15,327) Provision for insurance claims... (83) (75) Operating profit before impairment losses... 27,141 35,375 Impairment losses on assets... (7,428) (12,744) Gains on investment in associates... 1 Gains on investment in joint ventures Profit before tax ,761 22,696 Less: income tax expense.... (4,794) (5,393) Net profit... 14,967 17,303 Attributable to: Equity shareholders of the Bank... 14,945 17,220 Non-controlling interests S-7

8 The following table sets forth, as at the dates indicated, the Group s unaudited consolidated statement of financial position. As at 31 December 2014 As at 31 March 2015 (unaudited) (in millions of RMB) ASSETS Cash... 14,793 16,319 Precious metals... 15,222 19,988 Balances with central bank , ,072 Balances with banks and other financial institutions... 55,986 53,633 Placements with banks , ,666 Financial assets purchased under agreements to resell , ,908 Loans and advances... 2,448,754 2,549,815 Interest receivables... 23,560 26,268 Financial assets at fair value through profit or loss... 40,190 40,005 Derivative financial assets... 9,315 9,403 Available-for-sale financial assets , ,190 Held-to-maturity investments , ,610 Investment receivables , ,370 Interest in joint ventures... 1,465 2,522 Interest in associates Fixed assets... 27,445 29,357 Investment properties... 1,684 1,646 Intangible assets... 3,292 3,289 Goodwill... 9,953 9,953 Deferred income tax assets... 10,291 10,423 Other assets... 14,091 16,487 Total assets... 4,731,829 4,908,944 LIABILITIES Borrowings from the central bank... 20,000 32,500 Deposits from banks and other financial institutions , ,449 Placements from banks ,603 96,370 Financial assets sold under agreements to repurchase , ,509 Deposits from customers... 3,304,438 3,332,170 Interests payable... 45,349 41,890 Financial liabilities as at fair value through profit or loss... 13,369 12,769 Derivative financial liabilities... 10,246 10,511 Bonds payable , ,569 Salaries and welfare payable... 6,068 6,514 Taxes payable... 11,656 15,327 Deferred income tax liabilities Other liabilities... 39,678 57,491 Total liabilities... 4,416,769 4,576,829 S-8

9 As at 31 December 2014 As at 31 March 2015 (unaudited) (in millions of RMB) Shareholders equity Share capital... 25,220 25,220 Capital reserve ,523 67,523 Investment revaluation reserve... 1,902 1,565 Hedging reserve... (163) (163) Surplus reserve... 28,690 28,690 Regulatory general reserve ,979 54,043 Retained profits , ,821 Proposed profit appropriations... 16,897 16,897 Exchange differences... (1,309) (1,281) Total equity attributable to equity shareholders of the Bank , ,315 Non-controlling interests Total shareholders equity , ,115 Total liabilities and shareholders equity.... 4,731,829 4,908,944 The following table sets forth, for the periods indicated, selected items from the Group s unaudited consolidated statement of cash flows. For the three months ended 31 March (unaudited) (unaudited) (in millions of RMB) Net cash inflow from (used in) operating activities... 60,242 31,161 Income tax paid... (3,593) (2,387) Net cash flow from (used in) investing activities.... (105,771) (171,771) Net cash flow from (used in) financing activities... 12,466 57,206 Effect of exchange differences on cash Net decrease in cash and cash equivalents... (36,262) (85,447) Add: balance of cash and cash equivalents at the beginning of the period , ,471 Balance of cash and cash equivalents at the end of the period , ,024 S-9

10 The following table sets forth, for the periods or as at the dates indicated, a summary of the Group s key financial and operating indicators. For the three months ended 31 March (unaudited) (unaudited) Profitability indicators Annualized return on equity attributable to shareholders of the Bank-weighted average (1)(2) % 21.33% Cost-to-income ratio (3) % 24.10% Notes: (1) Calculated on an annualised basis. (2) Calculated by dividing net profit attributable to equity shareholders of the Bank by the weighted average balance of equity attributable to equity shareholders of the Bank. (3) Calculated by dividing operating expenses (less business tax and surcharges) by operating income. As at 31 December March 2015 (unaudited) (in millions of RMB, except percentages) Asset quality indicators Non-performing loan ratio (1) % 1.24% Capital adequacy indicators (under the advanced approach under the new measurers (2) ) Net core Tier 1 capital , ,450 Net Tier 1 capital , ,456 Net capital base , ,592 Core Tier 1 capital adequacy ratio % 10.59% Tier 1 capital adequacy ratio % 10.59% Capital adequacy ratio % 12.45% Leverage ratio (3) % 5.51% Notes: (1) Calculated by dividing the non-performing loans by the total balance of loans and advances to customers. (2) The new measures refer to the Administrative Measures on the Captial of Commercial Banks (Trial) issued by CBRC on 7 June The advanced approach refer to the advanced measurement approach set out in the Administrative Measures on the Capital of Commercial Banks (Trial). In accordance with the requirements of the advanced approach, the scope of entities for calculating the capital adequacy ratio of the Group shall include the Bank and its subsidiaries. The scope of entities for calculating the capital adequacy ratio of the Company shall include all the domestic and overseas branches and sub-branches of the Bank. As at 31 March 2015, the Group s subsidiaries for calculating its capital adequacy ratio include Wing Lung Bank, CMB International Capital, CMB Financial Leasing and China Merchants Fund. (3) The leverage ratio as at 31 March 2015 was calculated based on the Measures for the Administration of the Leverage Ratio of Commercial Banks (Revised) promulgated by CBRC on 12 February However, prior to 2015, the leverage ratio was calculated based on the Measures for the Administration of the Leverage Ratio of Commercial Banks promulgated by CBRC on 1 June The leverage ratio of the Group were 4.96%, 4.66% and 4.49% respectively as at the end of 2014, the end of the third quarter and the end of the first half of S-10

11 As at 31 March 2015, total assets of the Group amounted to RMB4, billion, representing an increase of 3.74% as compared with the beginning of the year; and its total liabilities amounted to RMB4, billion, representing an increase of 3.62% as compared with the beginning of the year. Total deposits from customers amounted to RMB3, billion, representing an increase of 0.84% as compared with the beginning of the year. Total loans and advances amounted to RMB2, billion, representing an increase of 4.33% as compared with the beginning of the year. For the three months ended 31 March 2015, the Group realized a net profit attributable to shareholders of the Bank of RMB billion, representing a year-on-year increase of 15.22%, and net operating income of RMB billion, among which, net interest income amounted to RMB billion, representing a year-on-year increase of 22.22%, and accounting for 65.67% of the net operating income. Affected by the increased proportion of low-cost retail deposits on demand which was attributable to the active capital market, and the falling cost ratio of inter-bank transaction of funds which was due to the relatively adequate market liquidity, for the three months ended 31 March 2015, net interest spread and net interest margin were 2.72% and 2.90%, respectively, representing a year-on-year increase of 0.17 percentage point and 0.14 percentage point, respectively, and an increase of 0.20 percentage point and 0.18 percentage point as compared with the fourth quarter of 2014, respectively. Thanks to the great effort to expand its wealth management, mutual funds and other businesses, net fee and commission income of the Group increased rapidly by 49.23% to RMB billion from that of the corresponding period of the previous year, accounting for 30.75% of the net operating income, and representing a year-on-year increase of 5.19 percentage points. Other net income amounted to RMB1.755 billion, representing a year-on-year decrease of 44.05%, which was primarily due to a decrease in revenue from foreign exchange settlements as a result of the twodirection fluctuations in the RMB exchange rate during the reporting period. The cost-to-income ratio (excluding business tax and surcharges) of the Group was 24.10%, representing a year-on-year decrease of 3.11 percentage points. Since 2015, the Group has reclassified the income from credit card repayment by instalments from fee income to interest income and the relevant data above has been restated. As at 31 March 2015, the balance of non-performing loans of the Group amounted to RMB billion, representing an increase of RMB4.670 billion as compared with the beginning of the year; the non-performing loan ratio was 1.24%, representing an increase of 0.13 percentage point as compared with the beginning of the year; and the allowance coverage ratio of our non-performing loans was %, representing a decrease of 9.65 percentage points as compared with the beginning of the year; the allowance-to-loan ratio was 2.78%, representing an increase of 0.19 percentage point as compared with that at the beginning of the year. Employee Stock Ownership Scheme In April 2015, the Board of Directors of the Bank approved an employee stock ownership scheme based on the principles of legal compliance, voluntary participation, self-responsibility and the combination of incentives and restraints (the Scheme ). Via the Scheme, the Bank expects to further improve its legal entity governance structure, stabilize management and key personnel team, establish a sound mid and long-term incentive mechanism combining incentives and restraints and promote the long-term, sustained and healthy development of the Bank. Funds of the Scheme participating by the employees of the Bank are derived from the legitimate salary of the employees as well as funds raised through other legal means as examined and approved by the Board of the Directors of the Bank. Shares of the scheme are derived from A shares subscribed for in the bank s private placement. The total amount of funds used in the subscription of A shares in the private placement by the scheme should not exceed RMB6 billion and the number of A shares to be subscribed for in the private placement shall not exceed 434,782,608 shares. After the scheme was implemented, the total number of A shares held in all effective employee stock ownership schemes of the Bank should not exceed 10% of the total share capital of the Bank and the total number of A shares corresponding to equity interests allotted to individual holders shall not, in aggregate, exceed 1% of S-11

12 the Bank s total share capital. The subscription targets in the private placement of A shares are core personnel playing a crucial role in the Bank s overall performance and mid and long-term development, including, inter alia, directors and supervisors of the Bank (excluding independent non-executive directors and external supervisors). In principle, an employee stock ownership scheme will be launched once every year in the next two years, namely, the second phase employee stock ownership scheme and the third phase employee stock ownership scheme. The total amount of funds involved in the second phase and third phase of the employee stock ownership schemes should not exceed RMB2 billion. The Scheme will be formulated in accordance with the relevant laws, regulations, rules and normative documents of the PRC, such as the Companies Law of the PRC ( ), the Securities Law of the PRC ( ) and the Guiding Opinion on the Pilot Implementation of Employee Stock Ownership Scheme by Listed Companies ( ), as well as the articles of association of the Bank. FACTORS AFFECTING THE GROUP S RESULTS OF OPERATIONS Economic Conditions in the PRC Substantially all of the Group s operations are in the PRC. As a result, the Group s results of operations and financial condition are significantly affected by various factors relating to the operating environment in the PRC, including China s economic conditions and the economic measures undertaken by the PRC government. China has experienced rapid economic growth in recent years, achieving a compound annual growth rate ( CAGR ) for nominal GDP of approximately 13.7% from 2009 to 2013 based on data from the National Bureau of Statistics. According to the PBOC, from 31 December 2009 to 31 December 2013, total RMB-denominated loans and RMB-denominated deposits in the PRC banking industry increased at a CAGR of 15.8% and 15.0%, respectively. The PRC s economic growth has resulted in a substantial increase in corporate activities and individual wealth, which has in turn contributed to growth in the corporate and retail banking businesses of PRC commercial banks. While China s real GDP growth rate remained above 7% from 2009 to 2014, the growth rate has been decreasing during the same period and the driver of growth has changed as the PRC economy undergoes a structural change. Economic growth in the PRC is mainly driven by investment and debt financing, whereas domestic demand is still relatively weak, and certain industries face problems of overcapacity. There are uncertainties in the changing economic environment and the financial sector that could potentially affect our prospects, financial condition, business operations and the quality of the Group s assets. The PRC government has in the past implemented various monetary and other macroeconomic policies, including (i) adjusting the benchmark interest rates and the statutory deposit reserve ratio applicable to PRC commercial banks, (ii) imposing lending limits to control the growth of bank loans, and (iii) publishing industry development guidelines to promote or control the growth of specific industries in the PRC. Many of these policies have had a significant impact on lending activities and the demand for and access to bank financing, which has materially affected the business and growth prospects of PRC commercial banks, including the Bank. A number of other factors could potentially affect the Group s operating environment, such as the prospects of the banking sector in the PRC. The banking sector in which the Group operates faces many challenges brought about by the changing macroeconomic environment. These challenges include weak domestic demand, overcapacity, small (micro) and medium-sized enterprises liquidity problems, interest rate liberalisation, loans to the real estate sector, local government financing vehicles, the worsening conditions of manufacturing industries and potential risks in the financial sectors. However, there are also strategic opportunities as well, such as those brought by the urbanisation and industrialisation process and the integration of the regional economies in the PRC. S-12

13 Other factors such as the structural adjustment of the economy and the reform of financial policies, land, household registration, income distribution and the financial sector may also present new growth opportunities that may affect our operating environment in general and in turn affect our financial condition and results of operations. In addition, as the Group further expands its operations overseas, the Directors believe that economic conditions outside of China, in particular where the Group has a business presence, will also impact the Group s business, financial condition and result of operations. Interest Rates The Group s results of operations depend largely on the Group s net interest income, which has historically been the largest component of the Group s total operating income, representing 77.7%, 74.3% and 67.3% of the Group s total net operating income for the years ended 31 December 2012, 2013 and 2014, respectively. Net interest income is affected by interest rates and the average balance of the Group s interest-earning assets and interest-bearing liabilities. Interest rates applicable to us are impacted by many factors that are beyond the Group s control, such as the benchmark interest rates set by the PBOC, regulations in the banking and financial sectors in the PRC, domestic and international economic and political conditions, and competition. As part of the overall reform of the PRC s banking system during the past decade, the PBOC has gradually adopted a market-based interest rate policy to regulate the market. The PBOC has, in the past few years, made adjustments to the benchmark interest rates for deposits and loans from time to time. In March 2015, the PBOC further adjusted the benchmark interest rate for RMB-denominated deposits and loans, as a result of which the benchmark interest rates of RMB-denominated deposits and loans with a term of one year were lowered to 2.50% and 5.35%, respectively. In recent years, the PRC government has taken measures to gradually liberalize interest rates. For example, the PBOC lifted restrictions on inter-bank market interest rates, bond market interest rates and interest rates on foreign currency deposits, and removed the interest rate cap on RMB-denominated loans and the interest rate floor for RMB-denominated loans and deposits. Under current PBOC regulations, commercial banks in the PRC generally may not set interest rates for RMB-denominated deposits above 130.0% of the PBOC benchmark interest rate on deposits. The PBOC may further adjust the interest rate mechanism in the future. As the PRC government continues to carry out a market-based interest rate policy, the Directors expect that competition among banks will play an increasingly role in the setting of interest rates. Any further adjustment of benchmark rates by the PBOC in its effort to regulate the macro economy may materially affect the Group s business, financial condition and results of operations. Exchange Rate Environment The Group conducts a substantial portion of business in RMB, with certain transactions denominated in USD, HKD and, to a much lesser extent, other currencies. The Group endeavours to manage fund source and application to minimise potential mismatches in accordance with management directives. However, the Group s ability to manage foreign currency positions in relation to the RMB is limited as the RMB is not a freely convertible currency. The value of the RMB against the USD and other currencies fluctuates and is affected by many factors, such as changes in political and economic conditions in the PRC and globally. On 21 July 2005, the PRC Government introduced a managed floating exchange rate system to allow the value of RMB to fluctuate within a regulated band based on market supply and demand and by reference to a basket of currencies. In July 2008, the PRC Government announced that its exchange rate regime would change into a managed floating mechanism based on market supply and demand. Given domestic and overseas economic developments, the PBOC adjusted the RMB exchange rate regime in April 2012 to enhance the flexibility of the RMB exchange rate. The PRC Government may make further adjustments to the S-13

14 exchange rate system in the future. To the extent the Group s foreign currency-denominated assets and liabilities cannot be matched in the same currency or appropriately hedged, fluctuations in foreign currency exchange rates against RMB may adversely affect the Group s financial condition and results of operations. Regulatory Environment The PRC banking industry is highly regulated. The Group s business, financial condition and results of operations have been, and will continue to be, materially affected by changes in PRC policies, laws and regulations relating to the PRC banking industry, including the scope of business activities PRC commercial banks are permitted to engage in, interest and fees PRC commercial banks are allowed to charge and limits imposed by regulators on lending to borrowers in specific industries or in respect of specific loan products. PRC commercial banks are mainly regulated by the CBRC and the PBOC. The CBRC regulates the disclosure requirements, corporate governance, risk management, capital adequacy and internal controls of PRC commercial banks. The PBOC formulates interest rate policies, sets the statutory deposit reserve ratio, extends refinancing to commercial banks, accepts rediscounted bills from commercial banks and conducts open market operations. PRC commercial banks are also subject to supervision and regulation by other regulatory bodies, such as the MOF, the NDRC, the SAFE, the CSRC and the CIRC. The PRC banking regulatory regime is currently undergoing important changes. In recent years, the CBRC and the PBOC have gradually liberalized restrictions on fee- and commission-based banking services that a commercial bank in the PRC may provide, such as investment banking services, the sale of financial products to individual customers and other wealth management services. Any new requirements imposed by the CBRC and the PBOC as well as other governmental authorities may affect the Group s business, financial condition and results of operations. In addition, the PRC banking regulatory authorities have enhanced disclosure requirements, revised application and approval processes for banking products and services and implemented new asset quality and risk management requirements. In recent years, with the aims to minimise the risk within the financial and monetary systems in the PRC and to reinforce the risk management of loans to local government financing vehicles, the PRC State Council, the CBRC and the PBOC, along with several other PRC regulatory authorities, promulgated a series of policies and measures to direct PRC banks and other financial institutions to improve risk management of their loans to local government financing vehicles and to industries that have excessive production capacity. Certain policies increased the capital management requirements for commercial banks in the PRC. In particular, the requirement to meet higher capital adequacy ratios increases the capital PRC banks need to reserve and thus indirectly limits the growth in loan size of PRC banks. See Banking Regulation and Supervision in the PRC. We expect these regulatory reforms and governmental actions to continue to affect the PRC banking industry and our business operations. The Competitive Landscape in the PRC Banking Industry The PRC banking industry is becoming increasingly competitive. The Group faces competition from other PRC commercial banks, including national and regional commercial banks, and foreign financial institutions. Many other PRC commercial banks compete with us in substantially the same markets for loan, deposit and fee customers. In recent years, the Group has played a leading role in providing more innovative products and higher-quality services to its customers, and strived to be more adaptive to changing market conditions. Certain competitors have also implemented their strategies in providing innovative products and services as they further developed their operations. Additionally, on 1 July 2013, the General Office of the State Council of the PRC issued a guidance letter, which among others, encourages investment by private-sector capital in financial institutions and the establishment of privately owned banks, and as a result the Group may also face increased market competition. On 15 October 2013, the CBRC issued Measures for the Implementation of Administrative Licensing Matters S-14

15 Concerning Chinese-funded Commercial Banks ( ), which further relaxes the establishing conditions of Chinese-funded commercial banks and reduces the entry barriers for privately-owned banks in the PRC. The Group may therefore face increasing competition from privately-owned banks in the future. The Group also faces increasing competition from non-bank financial institutions (such as fund management companies, securities companies, insurance companies and microcredit companies) in the provision of financial services. Competition may have a material impact on the Group s financial condition and results of operations in a number of ways. For example, the Group may need to provide more competitive interest rates to attract customer deposits and to provide loans, and to increase investments in marketing activities and thus increase the Group s marketing and sales expenses. As financial market reform progresses in the PRC, the Directors expect that competition in the PRC banking industry may further intensify, which in turn will affect the Group s results of operations. Asset Quality Collateralized loans, guaranteed loans and pledged loans accounted for, in the aggregate, 75.9%, 76.5% and 75.3% of the Group s total loans and advances to customers as at 31 December 2012, 2013 and 2014, respectively. The value of collateral may fluctuate due to factors beyond the Group s control, including macroeconomic factors affecting the PRC economy or any relevant regional economy, or specific market value fluctuations of such assets. Any significant decline in the value of the collateral securing the Group s loans may result in a reduction in the amount the Group can recover from collateral realisation and an increase in the Group s impairment loss. The value of the guarantees may change along with the credit-worthiness of the guarantors from time to time. For the years ended 31 December 2012, 2013 and 2014, the Group recorded a total impairment loss of RMB5.6 billion, RMB10.2 billion and RMB31.7 billion, respectively. CRITICAL ACCOUNTING POLICIES In determining the carrying amounts of some assets and liabilities, the Group makes assumptions for the effects of uncertain future events on the Group s assets and liabilities at the end of the reporting period. These estimates involve assumptions about cash flows and the discount rates used. The Group s estimates and assumptions are based on historical experience and expectations of future events and are reviewed periodically. In addition to the assumptions and estimations of future events, judgements are also made during the process of applying the Group s accounting policies. It is possible that actual results or conditions could vary significantly from the estimates or assumptions we have described below. Impairment losses on loans and advances Loan portfolios are assessed periodically to assess whether impairment losses exist and the amounts of impairment losses if they do. Objective evidence for impairment includes observable data indicating that there is a measurable decrease in the estimated future cash flows from an individual loan. Objective evidence for impairment is described in accounting policy set out in note 2(n)(i) to the consolidated financial information as at and for the year ended 31 December Key factors which may influence impairment assessment include, among other things, significant financial difficulty of the borrower, breach of contract such as default or delinquency in payments, probability of bankruptcy or reorganisation, and significant changes in technological, market, economic or legal environment. The impairment loss for a loan that is individually evaluated for impairment is the decrease in the estimated future cash flow of that loan. When loans and advances are collectively evaluated for impairment, the estimate is based on historical loss experience for assets with credit risk characteristics similar to the loans and advances. Historical loss experience is adjusted on the basis of the relevant observable data that reflect current economic conditions. Management reviews the methodology and assumptions used in estimating future cash flows regularly to reduce any difference S-15

16 between loss estimates and actual loss experience. Management review and assessment of the amount of impairment losses requires significant judgment on whether objective evidence for impairment exists and also significant estimates when determining the present value of the expected future cash flows. Impairment of available-for-sale financial assets For available-for-sale financial assets, a significant or prolonged decline in fair value below cost or carrying cost is considered to be objective evidence of impairment. A significant level of judgment is required of management when determining whether a decline in fair value below cost or carrying cost has been significant or prolonged. In making this judgement, the Group considers historical data on market volatility and historical share price of the specific financial assets as well as other factors, such as sector performance and financial information regarding the investee, including the investee s operating and financial cash flows. Fair value of financial instruments For a number of financial instruments, no quoted prices in an active market exist. The fair value for these financial instruments is established by using valuation techniques. These techniques include using recent arm s length market transactions, reference to the current fair value of similar instruments and discounted cash flow analysis and option pricing models. The Group has established a process to ensure that valuation techniques are constructed by qualified personnel and are validated and reviewed by personnel independent of the area that constructed the valuation techniques. Valuation techniques are certified before being implemented for valuation and are calibrated to ensure that outputs reflect actual market conditions. Valuation models established by the Group make the maximum use of market inputs and rely as little as possible on the Group s specific data. However, it should be noted that some inputs, such as credit and counterparty risk and risk correlations, require management estimates. Management estimates and assumptions are reviewed periodically and are adjusted if necessary. Held-to-maturity investments Non-derivative financial assets with fixed or determinable payments and fixed maturity are classified as held-to-maturity investments if the Group has the intention and ability to hold them until maturity. In evaluating whether the requirements to classify a financial asset as held-to-maturity investments are met, management makes significant judgements with respect to the purpose of purchasing relevant assets at the beginning of such purchase. Failure in correctly assessing the Group s intention and ability to hold specific investments until maturity may result in reclassification of the whole portfolio as available-for-sale financial assets. Income taxes Determining income tax provisions involves judgement on the future tax treatment of certain transactions. The Group carefully evaluates tax implications of transactions and tax provisions are set up accordingly. The tax treatment of such transactions is reconsidered periodically to take into account all changes in tax legislations. Deferred tax assets are recognized for tax losses not yet used and temporary deductible differences. As those deferred tax assets can only be recognized to the extent that it is probable that future taxable profit will be available against which the unused tax credits can be utilised, management s judgement is required to assess the probability of future taxable profits. Management s assessment is constantly reviewed and additional deferred tax assets are recognized if it becomes probable that future taxable profits will allow the deferred tax asset to be recovered. Defined benefit plan Actuarial assumptions are made in valuing future pension obligations. There is uncertainty that these assumptions will hold true in the future. They are reviewed periodically and are updated where necessary. S-16

17 Ultimate liability arising from claims made under insurance contracts The estimation of the ultimate liability arising from claims made under insurance contracts sold to third parties is one of the Group s critical accounting estimates. Estimates and judgements are continually evaluated and based on historical experience and other factors, including expectations of loss events that have been incurred but not reported ( IBNR ) to the Group as at the end of the reporting period. The estimation of IBNR claims is generally subject to a greater degree of uncertainty than the estimation of the cost of settling claims already notified to the Group, where information about the claim events is available. IBNR claims may not be apparent to the insured until many years after the event that gives rise to the claim has happened. Estimation of the ultimate cost of certain liability claims can be a complex process. There are several sources of uncertainty that need to be considered in the estimating of the liability that the Group will ultimately pay for such claims. In particular, the claims arising from the employees compensation and other liability policies which we sold to third parties can be longer in tail, requiring coverage after the coverage policy is terminated, and difficult to estimate. The Group has appointed a third party independent actuary to estimate the claim liabilities using established actuarial methodologies. The methodologies are statistical in nature and can be affected by various factors. The more significant factors that can affect the reliability of the liability estimation include jurisprudence that can broaden the intent and scope coverage of the protections offered in the insurance contracts issued by the Group, the extent to which actual claim results differ from historical experience and the time lag between the occurrence of the event and the report of such claim to the Group. Provisions The Group uses judgement to assess whether the Group has a present legal or constructive obligation as a result of past events at each financial reporting date, and judgement is used to determine if it is probable that an outflow of resources will be required to settle the economic benefits accruing to the insured in relation to the obligation, and to determine a reliable estimate of the amount of the obligation accruing to the insured. RESULTS OF OPERATIONS The following table summarizes, for the years indicated, the Group s consolidated results of operations. Year Ended 31 December (in millions of RMB) Net interest income... 88,374 98, ,000 Net fee and commission income... 19,739 29,184 44,696 Other net income... 5,641 4,933 9,671 Operating expenses... (48,356) (54,144) (61,081) Charge for insurance claims.... (321) (331) (332) Share of profits of associates Share of profits of joint ventures Impairment losses... (5,583) (10,218) (31,681) Profit before taxation ,558 68,425 73,431 Income tax.... (14,286) (16,683) (17,382) Net profit... 45,272 51,742 56,049 Net Profit attributable to the Bank s shareholders... 45,268 51,743 55,911 S-17

18 Years Ended 31 December 2012, 2013 and 2014 Net Interest Income Net interest income has historically been the largest component of the Group s net operating income, representing 77.7%, 74.3% and 67.3% of the Group s net operating income for the years ended 31 December 2012, 2013 and 2004, respectively. The following table sets forth, for the years indicated, the Group s interest income, interest expense and net interest income. For the Year Ended 31 December (in millions of RMB) Interest income , , ,834 Interest expense... (61,727) (74,582) (110,834) Net interest income... 88,374 98, ,000 Net interest income of the Group increased by 13.2% to RMB112.0 billion in 2014 compared to RMB98.9 billion in 2013, which in turn increased by 11.9% compared to RMB88.4 billion in The table below sets forth, for the years indicated, the average balances of the Group s interest-earning assets and interest-bearing liabilities, interest income and interest expense for such assets and liabilities, and average yield or, in the case of expenses, the average cost of these interest-earning assets or interest-bearing liabilities. The average balances of interest-earning assets and interest-bearing liabilities are the average of the daily balances. For the Year Ended 31 December Average balance Interest income Average yield (%) Average balance Interest income Average yield (%) Average balance Interest income Average yield (%) (in millions of RMB, except percentages) Interest-earning assets Loan and advances (1).. 1,770, , ,092, , ,400, , Investments ,382 15, ,652 21, ,418 37, Balances with central bank ,349 6, ,535 7, ,026 8, Placements with banks and other financial institutions ,589 11, ,959 16, ,612 31, Total interest-earning assets and interest income ,921, , ,507, , ,440, , S-18

19 Average balance For the Year Ended 31 December Interest expense Average cost (%) Average balance Interest expense Average cost (%) Average balance Interest expense Average cost (%) (in millions of RMB, except percentages) Interest-bearing liabilities Deposits from customers ,214,822 42, ,583,045 48, ,056,634 64, Placements from banks and other financial institutions other financial institutions. 449,871 16, ,573 22, ,520 42, Issued debts ,843 2, ,396 3, ,385 3, Borrowings from the central bank Bank.. 4, Total interest-bearing liabilities and interest expense... 2,721,536 61, ,236,014 74, ,113, , Net interest income.. 88,374 98, ,000 Net interest spread Net interest margin Note: (1) Included in interest income on loans and advances is an amount of RMB215 million, RMB406 million and RMB655 million for the years ended 31 December 2012, 2013 and 2014, respectively, with respect to interest on impaired loans. The following table sets forth, for the years indicated, the breakdown of changes in the Group s interest income and interest expense due to changes in volume and changes in rate. Changes in volume are measured by changes in the average balances (daily average balance), while changes in interest rate are measured by changes in the average interest rates. The interest income and expense changes caused by changes in both volume and rate are counted as changes incurred by volume. For the Year Ended 31 December 2013 compared with compared with 2013 Increase/ (Decrease) Net Due to Increase/ (Decrease) (3) Increase/ (Decrease) Due to Net Increase/ (Decrease) (3) Volume (1) Rate (2) Volume (1) Rate (2) (in millions of RMB) Assets Loans and advances... 19,669 (7,965) 11,704 18,725 (628) 18,097 Investments... 4, ,677 14,283 1,845 16,128 Balances with the central bank ,306 (284) 1,590 Placements with banks and other financial institutions... 3,738 1,371 5,109 10,492 3,600 14,092 Changes in interest income ,054 (5,660) 23,394 44,806 5,101 49,339 Liabilities Deposits from customer... 6,831 (664) 6,167 9,944 5,683 15,627 Placements from banks and other financial institutions... 5, ,178 16,814 3,029 19,843 Issued debts (119) (296) 640 Borrowings from the central bank Change in interest expense... 12, ,855 27,836 8,416 36,252 Changes in net interest income... 16,406 (5,867) 10,539 16,970 (3,883) 13,087 (1) Represents the average balance for the year minus the average balance for the previous year, multiplied by the average yield/cost for the previous year. (2) Represents the average yield/cost for the year minus the average yield/cost for the previous year, multiplied by the average balance for the year. (3) Represents interest income/expense for the year minus interest income/expense for the previous year. S-19