Financial Statements for the Years Ended December 31, 2006 and 2005 and Independent Auditors’ Report
INDEPENDENT AUDITORS’ REPORT
The Board of Directors and Stockholders Cosmos Bank, Taiwan
We have audited the accompanying balance sheets of Cosmos Bank, Taiwan as of December 31, 2006 and 2005, and the related statements of income, changes in stockholders’ equity and cash flows for the years then ended. These financial statements are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
Except as stated in the next paragraph, we conducted our audits in accordance with the Rules Governing the Audit of Financial Statements of Financial Institutions by Certified Public Accountants and auditing standards generally accepted in the Republic of China. Those rules and standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
As stated in Note 15 to the financial statements, the Bank signed individual contracts with asset management companies between 2002 and 2006 to sell nonperforming loans. Based on the Law Governing Mergers of Financial Institutions, the losses on these sales were amortized using the straight-line method over 60 months. The unamortized balance was recorded as deferred loss on the sale of nonperforming loans. Had these losses not been deferred, the carrying values of the losses as of December 31, 2006 and 2005 would have decreased by NT$32,712,701 thousand and NT$18,749,041 thousand, respectively, and retained earnings would have decreased by NT$24,534,526 thousand and NT$14,061,781 thousand, respectively. In addition, the loss after tax would have increased by $10,478,372 thousand in 2006 and the income after tax would have decreased by NT$1,830,036 thousand in 2005.
In our opinion, except for the effects of the deferred loss on the sale of the nonperforming loans mentioned in the third paragraph, the financial statements referred to above present fairly in all material respects, the financial position of Cosmos Bank, Taiwan as of December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended, in conformity with the Requations Governing the Preparation of Financial Reports by Public Banks, requirements of the Business Accounting Law and Guidelines Governing Business Accounting relevant to financial accounting standards, and accounting principles generally accepted in the Republic of China.
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As stated in the third paragraph, the effect on the stockholders’ equity would have been significant had Cosmos Bank, Taiwan recognized the loss on the sale of the nonperforming loans as expense in the current year instead of deferring it. Management’s plans in regard to this matter are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
As stated in Note 3 to the financial statements, Cosmos Bank, Taiwan adopted on January 1, 2006 the newly released Statements of Financial Accounting Standards (“Statements” or SFAS) No. 34 - “Accounting for Financial Instruments” and No. 36 - “Disclosure and Presentation of Financial Instruments” and related revisions of previously released Statements. The Bank also adopted, effective January 1, 2006, the newly revised SFAS No. 25 - “Business Combinations - Accounting Treatment under the Purchase Method,” which provided that goodwill should no longer be amortized and that goodwill should be assessed for impairment periodically. Cosmos Bank, Taiwan began applying SFAS No. 35 - “Accounting for Asset Impairment” on January 1, 2005.
April 26, 2007, except for Note 1 and Note 23 on the Board of Directors’ resolution passed on April 27, 2007 to reduce capital, issue common shares and appropriate the earnings of 2006.
Notice to Readers
The accompanying financial statements are intended only to present the financial position, results of operations and cash flows in accordance with accounting principles and practices generally accepted in the Republic of China and not those of any other jurisdictions. The standards, procedures and practices to audit such financial statements are those generally accepted and applied in the Republic of China.
For the convenience of readers, the auditors’ report and the accompanying financial statements have been translated into English from the original Chinese version prepared and used in the Republic of China. If there is any conflict between the English version and the original Chinese version or any difference in the interpretation of the two versions, the Chinese-language auditors’ report and financial statements shall prevail.
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COSMOS BANK, TAIWAN
BALANCE SHEETS DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars, Except Par Value)
Percentage Percentage Increase Increase 2006 2005 (Decrease) 2006 2005 (Decrease) ASSETS Amount Amount % LIABILITIES AND STOCKHOLDERS’ EQUITY Amount Amount %
CASH AND CASH EQUIVALENTS (Note 4) $ 5,618,763 $ 4,606,577 22 DUE TO THE CENTRAL BANK AND OTHER BANKS (Note 17) $ 19,677,269 $ 21,791,642 (10 )
DUE FROM THE CENTRAL BANK AND CALL LOANS TO BANKS (Notes 5 and 29) 34,285,795 8,478,097 304 FINANCIAL LIABILITIES AT FAIR VALUE THROUGH PROFIT OR LOSS (Notes 2, 3 and 6) 31,214 49,211 (37 ) FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS, NET (Notes 2, 3, 6, 18 and 28) 4,223,017 26,991,766 (84 ) SECURITIES SOLD UNDER REPURCHASE AGREEMENTS (Notes 2, 18 and 28) 2,160,839 5,547,572 (61 )
SECURITIES PURCHASED UNDER RESELL AGREEMENTS (Notes 2, 7 and 18) - 3,050,742 (100 ) PAYABLES (Notes 2, 19 and 28) 5,711,646 4,681,081 22
RECEIVABLES, NET (Notes 2, 3, 8 and 29) 7,055,771 10,386,418 (32 ) DEPOSITS AND REMITTANCES (Notes 20 and 28) 191,104,604 202,021,675 (5 )
DISCOUNTS AND LOANS, NET (Notes 2, 9 and 28) 130,593,007 155,080,959 (16 ) BANK DEBENTURES (Notes 2, 21 and 28) 13,167,163 - -
AVAILABLE-FOR-SALE FINANCIAL ASSETS, NET (Notes 2, 3, 10, 18 and 29) 1,894,082 3,469,357 (45 ) OTHER FINANCIAL LIABILITIES (Notes 2 and 11) 194,978 97,144 101
EQUITY INVESTMENTS UNDER THE EQUITY METHOD (Notes 2, 3 and 11) 37,481 75,480 (50 ) OTHER LIABILITIES (Notes 2 and 22) 750,111 1,099,082 (32 )
OTHER FINANCIAL ASSETS, NET (Notes 2, 3 and 14) 12,278,073 10,873,623 13 Total liabilities 232,797,824 235,287,407 (1 )
FIXED ASSETS (Notes 2, 3 and 13) CAPITAL STOCK, $10.00 PAR VALUE Cost Authorized: 2,500,000 thousand shares; issued and outstanding: Land 4,553,582 4,553,582 - 2006 - 1,967,780 thousand shares; 2005 - 1,771,002 thousand shares 19,677,795 17,710,015 11 Buildings 2,848,599 2,848,599 - Machinery and equipment 1,675,701 1,561,905 7 CAPITAL SURPLUS Transportation and communications equipment 281,241 272,717 3 Paid-in capital in excess of par value 927,567 176,404 426 Miscellaneous equipment 401,254 424,999 (6 ) From treasury stock 2,245 2,245 - Total cost 9,760,377 9,661,802 1 Others 12,712 - - Accumulated depreciation (1,792,988 ) (1,442,317 ) 24 Accumulated impairment (176,728 ) (9,501 ) 1,760 942,524 178,649 428 7,790,661 8,209,984 (5 ) Construction in progress and prepayments for equipment 41,511 193,505 (79 ) RETAINED EARNINGS (ACCUMULATED DEFICIT) Legal reserve 777,389 744,058 4 Net fixed assets 7,832,172 8,403,489 (7 ) Special reserve 1,813,493 1,735,722 4 Unappropriated earnings (accumulated deficit) (11,286,541 ) 111,102 (10,259 ) INTANGIBLE ASSETS (Notes 2, 3, 13 and 28) Goodwill 409,776 416,879 (2 ) (8,695,659 ) 2,590,882 (436 ) Computer software 62,243 39,701 57 OTHERS Total intangible assets 472,019 456,580 3 Unrealized valuation losses on financial instruments (30,663 ) (82,263 ) (63 )
OTHER ASSETS, NET Total stockholders' equity 11,893,997 20,397,283 (42 ) Refundable deposits (Notes 28 and 30) 2,796,110 3,164,666 (12 ) Foreclosed collaterals, net (Notes 2, 3 and 16) 164,159 780,898 (79 ) CONTINGENCIES AND COMMITMENTS (Notes 2 and 30) Deferred loss on the sale of nonperforming loans (Notes 2 and 15) 32,712,701 18,749,041 74 Deferred income tax assets, net (Notes 2 and 26) 3,813,426 187,710 1,932 Others (Notes 2, 12, 13 and 28) 915,245 929,287 (2 )
Total other assets, net 40,401,641 23,811,602 70
TOTAL $ 244,691,821 $ 255,684,690 (4 ) TOTAL $ 244,691,821 $ 255,684,690 (4 )
The accompanying notes are an integral part of the financial statements.
(With Deloitte & Touche audit report dated April 26, 2007)
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COSMOS BANK, TAIWAN
STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars, Except Earnings (Loss) Per Share)
Percentage Increase 2006 2005 (Decrease) Amount Amount %
INTEREST REVENUE (Notes 2, 3 and 28) $ 14,555,747 $ 18,396,485 (21 )
INTEREST EXPENSE (Note 28) 4,362,795 3,721,411 17
NET INTEREST 10,192,952 14,675,074 (31 )
NET REVENUES(LOSSES) OTHER THAN INTEREST Service fee income, net (Notes 2, 28 and 31) 1,208,227 1,372,607 (12 ) Gains on the sale and valuation of on financial assets and liabilities at fair value through profit or loss (Notes 2, 3 and 6) 447,637 200,717 123 Realized gains on the sale of available-for-sale financial assets (Note 3) 461 509 (9 ) Income (losses) from equity investments under the equity method (Notes 2 and 11) 54,395 (33,080 ) 264 Foreign exchange gains, net (Notes 2 and 28) 43,610 100,919 (57 ) Loss on asset impairment (Notes 2, 3, 11, 13, 14, 16 and 28) (934,317 ) (759,488 ) 23 Amortization of loss on the sale of nonperforming loans (Notes 2 and 15) (6,911,364 ) (5,385,476 ) 28 Other provision (Note 2) (186,087 ) (685,259 ) (73 ) Other noninterest losses (Notes 2 and 11) (133,045 ) (266,050 ) (50 )
Total net losses other than interest (6,410,483 ) (5,454,601 ) 18
TOTAL NET REVENUES 3,782,469 9,220,473 (59 )
PROVISION FOR LOAN LOSSES (Notes 2 and 9) (11,707,775 ) (1,573,159 ) 644
OPERATING EXPENSES (Notes 25 and 28) Personnel (3,187,754 ) (3,372,206 ) (5 ) Depreciation and amortization (690,740 ) (653,722 ) 6 Others (3,062,290 ) (3,111,965 ) (2 )
Total operating expenses (6,940,784 ) (7,137,893 ) (3 )
(Continued)
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COSMOS BANK, TAIWAN
STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars, Except Earnings (Loss) Per Share)
Percentage Increase 2006 2005 (Decrease) Amount Amount %
INCOME (LOSS) BEFORE INCOME TAX $ (14,866,090 ) $ 509,421 (3,018 )
INCOME TAX BENEFIT (EXPENSE) (Notes 2 and 26) 3,553,884 (398,319 ) 992
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES (11,312,206 ) 111,102 (10,282 )
CUMULATIVE EFFECT OF CHANGES IN ACCOUNTING PRINCIPLES (NET OF INCOME TAX EXPENSE OF $5,346 THOUSAND) (Note 3) 25,665 - -
NET INCOME (LOSS) $ (11,286,541 ) $ 111,102 (10,259 )
2006 2005 After After Pretax Tax PretaxTax EARNINGS (LOSS) PER SHARE (Note 27) Basic earnings (loss) per share Net income (loss) $ (7.90 ) $ (6.01 ) $ 0.29 $ 0.06 Cumulative effect of changes in accounting principles 0.02 0.01 - - $ (7.88 ) $ (6.00 ) $ 0.29 $ 0.06
The accompanying notes are an integral part of the financial statements.
(With Deloitte & Touche audit report dated April 26, 2007) (Concluded)
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COSMOS BANK, TAIWAN
STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars)
Unrealized Retained Earnings (Accumulated Deficit) (Notes 2 and 23) Valuation Capital Stock Capital Surplus (Notes 2, 21, 23 and 24) Unappropriated Gains or Issued and Outstanding Paid-in Retained Losses on (Notes 2 and 23) Capital in From Earnings Financial Total Shares Excess of Par Treasury (Accumulated Instruments Treasury Stock Stockholders' (in Thousands) Amount Value Stock Options Total Legal Reserve Special Reserve Deficit) Total (Notes 2 and 3) (Notes 2 and 24) Equity
BALANCE, JANUARY 1, 2005 1,771,002 $ 17,710,015 $ 176,404 $ - $ - $ 176,404 $ 717,064 $ 1,672,737 $ 89,979 $ 2,479,780 $ (30,587 ) $ (531,390 ) $ 19,804,222
Appropriation of the 2004 earnings Legal reserve ------26,994 - (26,994 ) - - - - Special reserve ------62,985 (62,985 ) - - - -
Transferred treasury stock to employees - - - 2,245 - 2,245 - - - - - 531,390 533,635
Unrealized valuation losses on financial instruments ------(51,676 ) - (51,676 )
Net income in 2005 ------111,102 111,102 - - 111,102
BALANCE, DECEMBER 31, 2005 1,771,002 17,710,015 176,404 2,245 - 178,649 744,058 1,735,722 111,102 2,590,882 (82,263 ) - 20,397,283
Effect of accounting changes ------4,365 - 4,365
Appropriation of the 2005 earnings Legal reserve ------33,331 - (33,331 ) - - - - Special reserve ------77,771 (77,771 ) - - - -
Issuance of common stock for cash - $14.00 per share 196,778 1,967,780 751,163 - - 751,163 ------2,718,943
Issuance of convertible bank debentures - - - - 12,712 12,712 ------12,712
Unrealized valuation gains on financial instruments ------47,235 - 47,235
Net loss in 2006 ------(11,286,541 ) (11,286,541 ) - - (11,286,541 )
BALANCE, DECEMBER 31, 2006 1,967,780 $ 19,677,795 $ 927,567 $ 2,245 $ 12,712 $ 942,524 $ 777,389 $ 1,813,493 $ (11,286,541 ) $ (8,695,659 ) $ (30,663 ) $ - $ 11,893,997
The accompanying notes are an integral part of the financial statements.
(With Deloitte & Touche audit report dated April 26, 2007)
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COSMOS BANK, TAIWAN
STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars)
2006 2005
CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $ (11,286,541 ) $ 111,102 Cumulative effect of changes in accounting principles (25,665 ) - Deferred income tax (3,631,062 ) (58,282 ) Provision for loan losses 11,707,775 1,573,159 Amortization of loss on the sale of nonperforming loans 6,911,364 5,385,476 Loss on asset impairment 934,317 759,488 Recovery of loans and receivables written off in prior year 833,413 530,917 Depreciation and amortization expenses 690,740 653,722 Gains on financial assets and liabilities at fair value through profit or loss (447,637 ) (200,717 ) Amortization of discount on debt instruments with no active market (138,889 ) - Losses (gains) on sale of properties and foreclosed collaterals, net (77,992 ) 63,965 Losses (income) from equity investments under the equity method less cash dividend received (54,395 ) 39,229 Acquisition of financial assets carried at cost (9,079 ) - Amortization of the discount on convertible bank debentures 26,424 - Other provisions 186,087 685,259 Gain on disposal of financial assets carried at cost (1,706 ) - Realized gains on the sale of available for sale financial assets (461 ) (509 ) Loss on decline in value of financial assets carried at cost - 9,000 Net changes in operating assets and liabilities Financial assets at fair value through profit or loss 23,296,384 (2,461,737 ) Receivables 3,427,756 253,544 Other financial assets (2,416,257 ) (1,273,590 ) Prepaid expenses (58,302 ) 35,212 Financial liabilities at fair value through profit or loss (66,984 ) 49,211 Payables 1,030,565 726,109 Accrued pension liabilities 2,468 (12,099 ) Reserve for operations and liabilities (48,677 ) (7,347 ) Other liabilities 26,566 90,068
Net cash provided by operating activities 30,810,212 6,951,180
CASH FLOWS FROM INVESTING ACTIVITIES Decrease (increase) in due from the Central Bank and call loans to banks (25,807,698 ) 298,861 Decrease in securities purchased under resell agreements 3,050,742 4,489,120 Acquisition of available-for-sale financial assets (400,000 ) - Proceeds of the sale of available-for-sale financial assets 2,019,236 2,369,740 Increase in discounts and loans (10,136,896 ) (7,411,370 ) Proceeds of the sale of nonperforming loans 816,272 365,827 Acquisition of properties (121,135 ) (557,170 ) Proceeds of the sale of properties 37 10,695 Proceeds of the sale of financial assets carried at cost 15,361 - (Continued)
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COSMOS BANK, TAIWAN
STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars)
2006 2005
Payment of cash for repurchase of nonperforming loans $ (172 ) $ - Acquisition of debt instruments with no active market (642,688 ) (9,062,590 ) Proceeds of the sale of debt instruments with no active market 1,727,119 1,095,637 Increase in intangible assets (38,246 ) - Decrease in refundable deposits 368,556 29,719 Acquisition of foreclosed collaterals (55,573 ) - Proceeds of the sale of foreclosed collaterals 126,228 129,140 Increase in deferred charges (40,984 ) (200,811 ) Proceeds of the sale of loans to a securitization trust - 680,790
Net cash used in investing activities (29,119,841 ) (7,762,412 )
CASH FLOWS FROM FINANCING ACTIVITIES Decrease in due to the Central Bank and other banks (2,114,373 ) (257,462 ) Decrease in securities sold under repurchase agreements (3,386,733 ) (2,810,731 ) Increase (decrease) in deposits and remittances (10,917,071 ) 4,586,344 Issuance of bank debentures 13,153,451 - Increase (decrease) in other financial liabilities 157,834 (64,787 ) Decrease in other liabilities (336,664 ) (276,575 ) Issuance of common stock for cash 2,718,943 - Transfer of treasury stock - 533,635
Net cash provided by (used in) financing activities (724,613 ) 1,710,424
EFFECTS OF CHANGES IN EXCHANGE RATE 46,428 (17,272 )
INCREASE IN CASH AND CASH EQUIVALENTS 1,012,186 881,920
CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 4,606,577 3,724,657
CASH AND CASH EQUIVALENTS, END OF YEAR $ 5,618,763 $ 4,606,577
SUPPLEMENTARY DISCLOSURE OF CASH FLOW INFORMATION Interest paid $ 4,469,637 $ 3,572,078 Income tax paid $ 68,543 $ 726,913
NONCASH INVESTING ACTIVITIES Transfer of subordinated seller certificate to loans and discounts $ - $ 1,554,313 Transfer of foreclosed collaterals to fixed assets $ - $ 590,487
(Continued)
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COSMOS BANK, TAIWAN
STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars)
2006 2005
EFFECT ON CASH FLOWS BY INVESTING ACTIVITIES Carrying values of sold nonperforming loans $ 21,919,877 $ 8,470,168 Less: Deferred loss on the sale of nonperforming loans (20,782,560 ) (7,825,525 ) Transfer price 1,137,317 644,643 Less: Other receivables (321,045 ) (278,816 ) Proceeds of the sale of nonperforming loans $ 816,272 $ 365,827 Carrying values of transferred nonperforming loans $ 103,239 Shares of Yang-Kuan Asset Management Corporation acquired in exchange for nonperforming loans (3,445 ) Deferred loss on the sale of nonperforming loans (99,966 ) Payment of cash for repurchase of nonperforming loans $ (172 )
The accompanying notes are an integral part of the financial statements.
(With Deloitte & Touche audit report dated April 26, 2007) (Concluded)
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COSMOS BANK, TAIWAN
NOTES TO FINANCIAL STATEMENTS YEARS ENDED DECEMBER 31, 2006 AND 2005 (In Thousands of New Taiwan Dollars, Unless Stated Otherwise)
1. ORGANIZATION AND OPERATIONS
Cosmos Bank, Taiwan (the “Bank”) engages in banking activities permitted by the Banking Law.
As of December 31, 2006, the Bank had a main office, an offshore banking unit (OBU) and 62 domestic branches.
The business of the Bank’s Trust Department includes planning, managing and operating business of trust regulated under the Banking Law and Trust Law of the Republic of China (ROC).
The shares of the Bank have been traded on the Taiwan Stock Exchange since June 29, 1998.
As of December 31, 2006 and 2005, the Bank had 3,298 and 3,471 employees, respectively.
The Bank signed individual contracts with asset management companies between 2002 and 2006 to sell nonperforming loans. Based on the Law Governing Mergers of Financial Institutions, the losses on these sales were amortized using the straight-line method over 60 months. The unamortized amounts of $32,712,701 thousand as of December 31, 2006 was recorded as deferred loss on the sale of nonperforming loans. Had the Bank recognized the loss on the sales of the nonperforming loans as expense, retained earnings would have decreased by $24,534,526 thousand as of December 31, 2006.
On April 4, 2007, the Bank’s board of directors passed a resolution to enhance the Bank’s financial structure. The accompanying financial statements have been prepared assuming that the Bank will continue as a going concern. However, the financial statements do not include any adjustments that might result from the outcome of this uncertainty.
The Bank’s financial improvement measures were as follows:
a. Strengthen capital structure.
1) To strengthen its operations and capital structure, the Bank issued 196,778 thousand common shares for cash at NT$14.00 per share for a total of $2,754,892 thousand on June 8, 2006. The Bank also issued subordinated bank debentures amounting to $7,000,000 thousand on December 14, 2006 to improve its capital adequacy ratio.
2) On April 4, 2007, The Bank’s board of directors proposed to amend the Bank’s Articles of Incorporation to increase the total amount of capital stocks from $25,000,000 thousand to $38,500,000 thousand. Except for a portion of the new shares to be kept for convertible bank debentures, the new shares will be issued by public offer or private placement. It is anticipated that the total amount of capital will increase by $15,000,000 thousand through the new share issuance. In addition, to attract major global institutional investors to participate in the Bank’s capital raising, the Bank does not preclude the possibility of issuing preferred stocks, convertible bank debentures or global depository receipts along with the issuance of new common shares through a public offer or private placement.
3) The plan to raise capital mentioned in the preceding paragraph has two stages: (a) first stage - raise $10,000,000 thousand in the third quarter of 2007; and (b) second stage - raise $5,000,000 thousand in the fourth quarter of 2007.
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b. Improve asset quality.
After GE Asia Holdings invested in the Bank, GE Asia Holdings actively introduced to the Bank its risk management tools for analyzing the customers’ database and establish a scorecard applicable to the customers’ behavior model. Each risk management tool has been applied to the Bank’s new products, dynamic risk alert mechanism, and analysis of the behavior of borrowers with nonperforming loans to establish an optimal collection mechanism and improve the loan collection efficiency and recovery rate.
c. Implement enhanced operating strategies to improve the Bank’s financial structure.
Aside from applying the measures mentioned above, the Bank will improve its performance and profitability through a continuing striving for growth and advanced efficiency to accumulate retained earnings and increase capital. The main strategies for operational enhancement are listed below:
1) On the basis of its established advantages on consumer finance and customer resources, and combined with GE Asia Holdings’ global resources, make becoming the “leading niche bank” the Bank’s long-term vision.
2) Focus on more product and service innovation and stimulate the consumer finance market to expand.
3) Accelerate the growth of wealth management business to increase revenues other than interest.
4) Broaden small and medium enterprise financing to raise market share.
5) Develop more diverse financial services to increase operating revenues.
6) Simplify procedures, cut off costs, and improve efficiency.
To strengthen the Bank’s capital structure further, the Bank’s board of directors passed resolutions on April 27, 2007 on the following measures:
1) Reduce the Bank’s capital by 30% ($5,903,339 thousand) to offset the Bank’s accumulated deficit.
2) Amend the Articles of Incorporation to raise total authorized capital to $45,000,000 thousand.
3) Issue common stocks amounting to up to $27,300,000 thousand by private placement at one time or through a series of issuances.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The Bank’s financial statements have been prepared in conformity with the Guidelines Governing the Preparation of Financial Reports by Public Banks, Business Accounting Law, Guidelines Governing Business Accounting, and accounting principles generally accepted in the Republic of China. In preparing financial statements in conformity with these guidelines and principles, the Bank is required to make certain estimates and assumptions that could affect the amounts of allowance for possible losses, reserve for losses on guarantees, property depreciation, impairment loss on assets, the valuation of the financial instruments at fair value, pension, income tax, and accrued litigation loss. Actual results could differ from these estimates.
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Since the operating cycle in the banking industry cannot be reasonably identified, accounts included in the Bank’s financial statements are not classified as current or noncurrent. Nevertheless, these accounts are properly categorized according to the nature of each account and sequenced by liquidity. Please refer to Note 31 for the maturity analysis of assets and liabilities.
For the convenience of readers, the accompanying financial statements have been translated into English from the original Chinese version prepared and used in the ROC. If there is any conflict between the English version and the original Chinese version or any difference in the interpretation of the two versions, the Chinese-language financial statements shall prevail.
The Bank’s significant accounting policies are summarized as follows:
Basis of Preparation
The accompanying financial statements include the accounts of the Head Office, OBU, and all branches. All interoffice transactions and balances have been eliminated.
Financial Instruments at Fair Value Through Profit or Loss
Financial instruments at fair value through profit or loss are financial assets or liabilities that are classified as held for trading. These instruments are required to be initially recognized at fair value on acquisition and at fair value through profit or loss on the balance sheet date. The Bank uses trade date accounting when recording related transactions.
Financial instruments used in derivative transactions that do not qualify for hedge accounting are classified as financial assets or liabilities held for trading. If the fair value of a derivative is a positive number, the derivative is carried as an asset, and, if the fair value is a negative number, the derivative is carried as a liability.
Fair values are determined as follows: (a) short-term bills - at reference prices published by Reuters; (b) beneficiary certificates (open-end funds) - at net asset values as of the balance sheet date; (c) bonds - at year-end reference prices published by GreTai Securities Market (GTSM); and (d) listed stocks and the GTSM stocks - at closing prices as of the balance sheet date.
Securities Purchased/Sold Under Resell/Repurchase Agreements
Securities purchased under resell agreements and securities sold under repurchase agreements are generally treated as collateralized financing transactions. Interest earned on resell agreements or interest incurred on repurchase agreements is recognized as interest income or interest expense over the life of each agreement.
Overdue Loans
Under Ministry of Finance (MOF) guidelines, the Bank classifies loans and other credits (including accrued interest) overdue for at least six months as overdue loans.
Overdue loans (except other credits) are classified as discounts and loans, and other credits are classified as other financial assets.
Allowances for Possible Losses and Reserve for Losses on Guarantees
The Bank makes provisions for bad debts and losses on guarantees based on the evaluation of loans, overdue loans, bills, discounts, receivables, guarantees and acceptances for their specific or general risks.
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Debts and guarantees with specific risks are evaluated internally for their collaterals, collectibility and customers’ overall credits. Under MOF guidelines, the Bank makes full provisions for credits deemed uncollectible and makes at least 50% provisions for credits with high uncollectibility. However, under revised MOF guidelines effective July 1, 2005, the Bank makes 100%, 50%, 10% and 2% provisions for credits deemed uncollectible, highly uncollectible, substandard and special mention, respectively, as minimum provisions for possible losses.
Under MOF guidelines, credits deemed uncollectible may be written off if the write-offs are approved by the Board of Directors.
Available-for-sale Financial Assets
Available-for-sale financial assets are initially recognized at fair value plus transaction costs that are directly attributable to the financial asset acquisition. When assets are subsequently measured at fair value, the changes in fair value are excluded from earnings and reported as a separate component of stockholders’ equity. The accumulated gains or losses are recognized as earnings when the financial asset is de-recognized from the balance sheet. The Bank uses trade date accounting when recording transactions.
Cash dividends received within a year of asset acquisition are recognized as a reduction of the original investment cost and are subsequently recognized as investment income on the ex-dividend date. Any difference between the initial carrying amount of a debt security and its amount on maturity is amortized and then recognized as earnings using the effective interest method.
If an available-for-sale financial asset is determined to be impaired, a loss is recognized. If the impairment loss on equity securities decreases, this loss is reversed to the extent of the decrease and recorded as an adjustment to stockholders’ equity, and, for debt securities, the loss is recognized as earnings.
Financial Asset Securitization
Under the Regulations for Financial Asset Securitization, the Bank entrusted its George & Mary Cash Card Loan Rights to the Deutsche Bank AG, Taipei Branch for issuance of the related beneficiary certificates. Thus, the Bank had lost the rights and control on the entrustment of these loans, which were removed from the Bank’s accounts, and recognized gains on this securitization, except those on subordinated seller certificates for credit enhancement, which were reclassified as available-for-sale financial assets.
The gain on securitization of the loans is the difference between the proceeds of the securitization and carrying value of the loans. The previous carrying value was allocated in proportion to the fair market value of the entrustment loans, servicing assets and retained interests on the transfer date. The fair values of the entrustment assets, servicing assets and retained interests were evaluated at the present value of future cash flows on the basis of the assumptions of credit risk rate, repayment rate, and discount rate on the loans because the assets had no quoted market prices.
The subordinated seller certificates, shown as other long-term investments, are evaluated at the present value of future cash flows on the balance sheet date because they have no quoted market prices. The resulting losses are recorded as nonoperating losses, while the gains are written off within the range of losses recognized. Interest revenues are recognized under the accrual basis.
Servicing assets are amortized using the straight-line method over the servicing period, and the amortization is charged to operating cost. The Bank makes provision for losses on the servicing assets and writes off the provision when the value of the assets rises.
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Equity Investments under the Equity Method
Investments in shares of companies in which the Bank has significant influence over the investees are accounted for by the equity method. Any gain or loss from transactions between the Bank and an equity-method is investee considered an unrealized gain or loss and will be deferred until it is realized when the same transactions are made with a third party.
The difference between the investment cost and net equity investment is amortized over 10 years. However, under the revised Statement of Financial Accounting Standards No. 5 - “Long-term Investments in Equity Securities,” since January 1, 2006, goodwill no longer needs to be amortized.
Goodwill should be tested for impairment annually or more frequently if any situation indicates an impairment loss.
The Bank recognizes its equity in the net loss of an investee plus any advances given to an investee as zero if the loss of the investee with negative net worth is not temporary or the Bank had not guaranteed the investee’s debt. However, if (a) the Bank guarantees the obligations of an investee or commits to provide further financial support to an investee company, or (b) an investee’s losses are temporary and there is sufficient evidence showing imminent return to profitable operations, then the Bank will continue to recognize proportionally its equity in the investee’s losses. The resulting credit balance on the book value of equity-method investment will be treated as other financial liabilities in the balance sheet.
If the percentage held by the Bank declines or the Bank loses significant influence over the investee, the Bank will stop using the equity method to recognize the investment and will instead recognize the investment book value at cost, as required under Statement of Financial Accounting Standards No. 34 - “Accounting for Financial Instruments.” If the Bank significant influence over an investeee, it should change the accounting treatment for the investment from the equity method to the cost method, and any unrealized gain or loss should be regarded as realized and recognized immediately.
For equity-method investments, stock dividends received are recognized only as increases in the number of shares held, and not as income. Cost of equity investments sold is determined by the weighted-average method.
Fixed Assets
Fixed assets are carried at cost less accumulated depreciation. Major betterments, additions and renewals are capitalized, while repairs and maintenance are expensed as incurred.
Depreciation is computed using the straight-line method over service lives initially estimated as follows (plus one year to represent estimated salvage value): buildings, 42 to 60 years; machinery and equipment, 3 to 6 years; transportation and communications equipment, 2 to 15 years; and miscellaneous equipment, 2 to 10 years. Properties that have reached their residual values but are still being used are depreciated over their newly estimated service lives.
Upon sale or other disposal of properties, the related cost and accumulated depreciation are removed from the accounts, and any gain or loss is credited or charged to net nonoperating income.
Other Financial Assets
Investments in equity instruments (including unlisted stocks) with no quoted market prices in an active market and with fair values that cannot be reliably measured, are recognized at cost on acquisition. If there is objective evidence that a financial asset is impaired, an impairment loss is recognized. However, impairment loss reversal is prohibited.
Debt instruments with no active market are those with no quoted market prices in an active market and with fair values that cannot be reliably measured. These instruments are carried at amortized cost.
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Intangible Assets
Until December 31, 2005, computer software was amortized over 5 years and goodwill was amortized over 10 years. Effective January 1, 2006, under the newly revised Statement of Financial Accounting Standards No. 25. - “Business Combinations - Accounting Treatment under Purchase Method,” goodwill is no longer amortized and is assessed for impairment at least annually.
Deferred Loss on the Sale of Nonperforming Loans
In compliance with the Law Governing Mergers of Financial Institutions, loss on the sale of nonperforming loans is amortized using the straight-line method over 60 months.
Foreclosed Collaterals
Foreclosed collaterals are recorded at the lower of cost or net realizable value on the balance sheet date. If collaterals assumed are not disposed of within the statutory period, relevant regulations require that the Bank should either apply for the extension of the disposal period or increase its provision for possible losses.
Deferred Expense
Other deferred expenses, included in other assets, which are mainly for decorating leased houses, are amortized by the lower of the lease period or five years.
Asset Impairment
The Bank began applying ROC Statement of Financial Accounting Standards (SFAS) No. 35 - “Accounting for Asset Impairment” on January 1, 2005.
Under SFAS No. 35, the Bank evaluates on the balance sheet date if an asset (long-term investment under the equity method, fixed asset, goodwill and foreclosed collateral as well as a cash-generating unit) is impaired. If an asset is impaired, its recoverable amount is compared with its carrying amount. If the recoverable amount is lower than the carrying amount, the carrying amount of the asset should be reduced to its recoverable amount, and the reduction should be recognized as impairment loss. Then, the adjusted carrying amount of the asset less its residual value should be used to compute the depreciation (amortization) expense by applying a reasonable and systematic method over the remaining useful life of the asset. The accumulated impairment loss of an asset (except goodwill) recognized in prior years should be reversed if the recoverable amount increases. In addition, the asset carrying amount should be increased to its recoverable amount, but this increase should not exceed the carrying amount of the asset that would have been determined net of depreciation or amortization had no impairment loss been recognized for the asset in prior years.
Pension Costs
The Bank has two types of pension plans: Defined benefit and defined contribution.
Under the defined benefit pension plan, pension costs are recorded on the basis of actuarial calculations. Unrecognized net transition obligation is amortized over 15 years, and prior service cost and actuarial gains or losses are amortized over the employees’ remaining service years using the straight-line method. Under the defined contribution pension plan, the Bank recognizes its required monthly contributions to employees’ individual pension accounts as current expense during the employees’ service periods.
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Bank Debentures
For convertible bank debentures issued after January 1, 2006, the value of the equity component of the bank debentures has to be calculated by deducting the liability component of the bond from the par value on the issuance date. This equity component is then included in capital surplus - options.
If costs refer to more than one transaction (including issuance of common stock for cash and of bank debentures), these are allocated using a basis that is rational and consistent with similar transactions. Also, the related amount of income taxes recognized directly in equity is included in the aggregate amount of current and deferred taxes credited or charged to equity.
Treasury Stock
Capital stock acquired is carried at cost and is debited to “treasury stock,” which presented as a deduction to arrive at stockholders’ equity.
The reissuance of treasury stocks is accounted for as follows: (a) reissue price higher than the acquisition cost - the excess is credited to additional paid-in capital on treasury stock; and (b) reissue price less than the acquisition cost - initially charged to paid-in capital on treasury stock, with any remaining deficiency charged to retained earnings.
Recognition of Interest Revenue and Service Fees
Interest revenue on loans is recorded on an accrual basis. Under MOF regulations, no interest revenue is recognized on loans and other credits extended by the Bank that are classified as overdue loans. The interest revenue on those loans is recognized upon collection.
The unpaid interest on rescheduled loans should be recorded as deferred revenue (included in other liabilities), and the paid interest is recognized as interest revenue.
Service fees are recorded when a major part of the earnings process is completed and revenue is realized.
Income Tax
Provision for income tax is based on intra-period and inter-period tax allocation. The tax effects of deductible temporary differences, unused tax credits, operating loss carryforwards and credit to stockholders’ equity adjustments are recognized as deferred income tax assets, and those of taxable temporary differences and debit of stockholders’ equity adjustments are recognized as deferred income tax liabilities. Valuation allowance is provided for deferred income tax assets that are not certain to be realized.
Tax credits for personnel training and stock investments are recognized in the current period.
Income tax on interest in short-term negotiable instruments or special-purpose trust beneficiary certificates, which is levied separately, and any adjustment of income taxes of prior years are added to or deducted from the current year’s income tax expense.
Income taxes (10%) on undistributed earnings generated annually since 1998 are recorded as expenses in the year when the stockholders resolve to retain the earnings.
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Foreign-currency Transactions
The Bank records foreign-currency transactions in the respective currencies in which these are denominated. Every month-end, foreign currency income and expenses are translated into New Taiwan dollars at the month-end exchange rate. On the balance sheet date, monetary assets and liabilities denominated in foreign currencies are reporting using the month-end exchange rates, and exchange differences are recognized in the income statement.
Unrealized exchange differences on nonmonetary financial assets (investments in equity instruments) are a component of the change in their entire fair value. For nonmonetary financial assets and liabilities classified as financial instruments measured at fair value through profit or loss, unrealized exchange differences are recognized in the income statement. For nonmonetary financial instruments that are classified as available-for-sale, unrealized exchange differences are recorded directly under stockholders’ equity until the asset is sold or becomes impaired. Nonmonetary financial instruments that are classified as carried at cost are recognized at the exchange rates on the transaction dates.
Contingencies
A loss is recognized when it is probable that an asset has been impaired or a liability has been incurred and the amount of loss can be reasonably estimated. A footnote disclosure is made of the situation that might result in a possible loss but the amount of loss cannot be reasonably estimated.
Reclassifications
Certain accounts for the year ended December 31, 2005 had been reclassified to be consistent with the presentation of the financial statements for the year ended December 31, 2006.
3. ACCOUNTING CHANGES
Effective January 1, 2006, the Bank adopted the newly released Statements of Financial Accounting Standards (“Statements” or SFAS) No. 34 - “Accounting for Financial Instruments” and No. 36 - “Disclosure and Presentation of Financial Instruments” and related revisions of previously released Statements.
a. Effect of accounting changes
The Bank reclassified its financial assets and liabilities upon initial adoption of the newly released Statements. The adjustments made to the carrying amounts of the financial instruments categorized as financial assets or financial liabilities at fair value through profit or loss were included in the cumulative effect of changes in accounting principles. On the other hand, the adjustments made to the carrying amounts of those categorized as measured at amortized cost or available-for-sale financial assets were recognized as adjustments to stockholders’ equity.
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The effect of asset and liability reclassifications based on the accounting changes on January 1, 2006 is summarized as follows:
Cumulative Effect of Changes in Stockholders’ Accounting Equity Principles Adjustments (Net of Income (Net of Income Tax) Tax)
Financial assets at fair value through profit or loss $ 43,437 $ - Available-for-sale financial assets - 4,365 Financial liabilities at fair value through profit or loss (17,772 ) -
$ 25,665 $ 4,365 b. Reclassifications
Under an explanation issued by the Accounting Research and Development Foundation of the Republic of China (ARDF of the ROC), when the Bank adopted SFAS No. 34 effective January 1, 2006, the Bank had to reclassify the accounts in the comparative financial statements for the year ended December 31, 2005 instead of restating them. The Bank should state in the notes to the financial statements the different valuation methods used for the reclassified accounts and need not disclose pro forma information if the related calculation is difficult.
The Bank held many financial instruments, and the adoption of the foregoing Statements led to inconsistency in the classification and basis of valuation of financial instruments in the years ended December 31, 2006 and 2005. Thus, it was difficult to calculate the pro forma data in the year ended December 31, 2005 and the effect on net income because of the adoption of SFAS No. 34 in the year ended December 31, 2006.
Some accounting policies before the adoption of the newly released SFASs are summarized as follows:
1) Securities purchased
Securities purchased are carried at cost less allowance for the excess of total cost over total market value. Costs of securities sold are determined using the following methods: Commercial paper and bank acceptances - specific identification method; and other securities - moving-average method. If the market value falls below carrying value, the Bank recognized this loss in the income statement as “allowance for possible loss on securities purchased.” If the market value recovers, the Bank offsets the gain on this recovery against the allowance for possible losses. If the market value is lower than the cost of securities purchased, the Bank realizes a loss on decline in market value when transferring the securities purchased to long-term investments.
2) Long-term investments
Investments in shares with quoted market prices and belonging to companies in which the Bank does not exercise significant influence on their operating and financial policy decisions are stated at the lower of aggregate cost or market. The reduced market value of an investment and its write-up due to market value recovery are charged or credited to stockholders’ equity.
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3) Forward contracts
For forward contracts, which are used for trading purposes, assets and liabilities are recorded at the contracted forward rate. Gains or losses resulting from the difference between the spot rate and the contracted forward rate on the settlement date are credited or charged to current income. For contracts outstanding as of the balance sheet date, the gains or losses resulting from the difference between the contracted forward rates and the forward rates available for the remaining periods of the contracts are credited or charged to income. In addition, the receivables and payables on the forward contracts are netted out, and the resulting amount is presented as an asset or a liability.
4) Currency swap contracts
Foreign-currency spot-position assets or liabilities arising from currency swap contracts, which are entered into for trading purposes, are recorded at spot rates when the transactions occur, while the corresponding forward-position assets or liabilities are recorded at the contracted forward rates.
The related differences between spot rates and contracted forward rates are amortized and recorded as interest revenue or interest expense over the contract period on a straight-line basis. For contracts open as of the balance sheet date, the receivables and payables on the contracts are netted out, and the resulting amount is presented as an asset or a liability.
5) Cross-currency swap
Cross-currency swap contracts are recorded at their forward rates on the contract dates. The interest received or paid under the contract is recorded as interest revenue or expense.
6) Credit-linked loans
Credit-linked loans, which are used for trading purposes, are granted to foreign investment banks under agreements to buy specific companies’ defaulted swap contracts or real-estate beneficiary certificates. The Bank recognizes interest revenue at floating interest rate plus markup. If the counter-party to a contract defaults, the Bank will terminate the contract and appropriate the related bonds or certificates as stipulated in the contract.
Certain accounts in 2005 have been reclassified to conform to the newly released or revised Statements:
December 31, 2005 Before After Reclassification Reclassification Balance sheets
Securities purchased, net $ 30,126,866 $ - Long-term investments (except equity investments under the equity method) 9,646,185 - Financial assets at fair value through profit or loss - 26,991,766 Available-for-sale financial assets - 3,469,357 Receivables 233,911 - Other financial assets - 9,545,839 Financial liabilities at fair value through profit or loss (49,211 ) - Unrealized loss on long-term equity investments - (49,211 ) Unrealized gain on financial instruments 82,263 - - 82,263
$ 40,040,014 $ 40,040,014
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December 31, 2005 Before After Reclassification Reclassification Income statement
Interest revenue $ - $ 419,856 Gains on sales of securities, net 620,573 - Gains on financial assets and liabilities at fair value through profit or loss - 200,717 Revenue - other 509 - Gains on available-for-sale financial assets, net - 509
$ 621,082 $ 621,082
Effective January 1, 2006, the Bank adopted the newly revised SFAS No. 5 - “Long-term Investments in Equity Securities” and No. 25 - “Business Combinations - Accounting Treatment under the Purchase Method.” As a result, goodwill is no longer amortized and is assessed for impairment periodically. These accounting changes also resulted in a decreasing of $50,776 thousand in the net loss from operating departments in 2006 (including a decreasing of net loss $71,953 thousand in goodwill amortized and a increasing of net loss $21,177 thousand in surplus of equity investment under equity method), and a decreasing of $0.03 loss per share.
The Bank began applying Statement of Financial Accounting Standards No. 35 - “Accounting for Asset Impairment” on January 1, 2005. This accounting change resulted in an asset impairment loss of $759,488 thousand (consisting of losses of $9,501 thousand on fixed asset impairment; $17,629 thousand on goodwill impairment; and $732,358 thousand on the impairment of foreclosed collaterals).
4. CASH AND CASH EQUIVALENTS
December 31 2006 2005
Cash on hand $ 2,695,773 $ 2,620,020 Due from banks 859,658 392,134 Checks for clearing 2,063,332 1,594,423
$ 5,618,763 $ 4,606,577
5. DUE FROM THE CENTRAL BANK AND CALL LOANS TO BANKS
December 31 2006 2005
Reserves for deposits - a/c A $ 1,964,180 $ 1,504,604 Reserves for deposits - a/c B 4,828,276 4,997,595 Deposit in the Central Bank 22,210,000 - Call loans to banks 5,033,319 1,525,022 Deposits 250,020 450,876
$ 34,285,795 $ 8,478,097
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As required by law, the reserves for deposits in the Central Bank (“Central Bank”) are calculated by applying the prescribed rates to the average monthly balances of various types of deposit accounts. The use of reserves for deposits - a/c B is restricted by the Central Bank.
6. FINANCIAL INSTRUMENTS AT FAIR VALUE THROUGH PROFIT OR LOSS (FVTPL)
December 31 2006 2005 Held-for-trading financial assets
Bill investments $ 3,149,897 $ 23,272,192 Listed stocks - domestic 866,179 2,449,871 Beneficiary certificates - 784,317 Government bonds 158,534 241,475 Cross-currency swap contracts 48,407 233,911 Bank debentures - 10,000
$ 4,223,017 $ 26,991,766
Held-for-trading financial liabilities
Cross-currency swap contracts $ 31,172 $ 49,211 Forward contracts 42 -
$ 31,214 $ 49,211
The Bank engages in derivative transactions mainly to hedge its exchange rate and interest rate exposures. The Bank’s financial hedging policy is to reduce or minimize its market price or cash flow exposures.
The contract (nominal) amounts of derivative transactions as of December 31, 2006 and 2005 were as follows:
December 31 2006 2005
Cross-currency swap contracts $ 2,391,828 $ 9,495,565 Forward contracts 5,208 - Credit default swap contracts - 3,120,750 Stock price-linked instruments - 100,000 Stock price-linked contract - 100,000
The net gains on financial assets at FVTPL in 2006 and 2005 were $478,851 thousand and $249,928 thousand, respectively. The net loss on financial liabilities at FVTPL in 2006 and 2005 were $31,214 thousand and $49,211 thousand.
7. SECURITIES PURCHASED UNDER RESELL AGREEMENTS
Securities acquired for $3,050,742 thousand as of December 31, 2005, had been sold for $3,052,718 thousand by January 2006.
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8. RECEIVABLES, NET
December 31 2006 2005
Credit cards $ 5,255,428 $ 7,777,507 Accrued interest 1,133,339 1,781,100 Receivables from sales of nonperforming loans 321,045 395,516 Acceptances 123,256 64,966 Accrued income 75,389 49,429 Others 389,120 441,703 7,297,577 10,510,221 Less allowance for possible losses (241,806 ) (123,803 )
$ 7,055,771 $ 10,386,418
9. DISCOUNTS AND LOANS, NET
December 31 2006 2005
Bills negotiated $ 19,261 $ 57,689 Discounts 5,385 3,000 Overdraft 2,692 7,779 Loans Short-term 66,938,393 86,675,798 Medium-term 44,482,170 45,528,586 Long-term 25,512,043 20,322,404 Overdue loans 3,078,633 4,791,382 140,038,577 157,386,638 Less allowance for possible losses (9,445,570 ) (2,305,679 )
$ 130,593,007 $ 155,080,959
As of December 31, 2006 and 2005, the balances of loans, for which accrual of interest revenues was discontinued, were $2,996,947 thousand and $4,559,332 thousand, respectively. The unrecognized interest revenues on these loans were $262,275 thousand and $304,933 thousand in 2006 and 2005, respectively.
In 2006 and 2005, the Bank wrote off certain loans after carrying out the required legal procedures.
The details of and changes in allowance for possible losses on discounts and loans are summarized below:
December 31, 2006 Specific General Risk Risk Total
Balance, January 1, 2006 $ 2,172,940 $ 132,739 $ 2,305,679 Provisions 11,253,361 454,414 11,707,775 Recovery of written-off credits 788,228 - 788,228 Write-offs (5,355,178 ) - (5,355,178 ) Effects of exchange rate changes (934 ) - (934 )
Balance, December 31, 2006 $ 8,858,417 $ 587,153 $ 9,445,570
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December 31, 2005 Specific General Risk Risk Total
Balance, January 1, 2005 $ 1,066,727 $ 600,318 $ 1,667,045 Provisions 2,042,295 (469,136 ) 1,573,159 Recovery of written-off credits 471,961 - 471,961 Gain on asset securitization transferred to allowance 94,379 - 94,379 Write-offs (1,504,496 ) - (1,504,496 ) Effects of exchange rate changes 2,074 1,557 3,631
Balance, December 31, 2005 $ 2,172,940 $ 132,739 $ 2,305,679
10. AVAILABLE-FOR-SALE FINANCIAL ASSETS, NET
December 31 2006 2005
Government bonds $ 1,747,423 $ 1,769,011 Listed stocks - domestic 146,659 100,346 Negotiable certificates of deposits - 1,600,000
$ 1,894,082 $ 3,469,357
11. EQUITY INVESTMENTS UNDER THE EQUITY METHOD
December 31 2006 2005 % of % of Carrying Owner- Carrying Owner- Value ship Value ship Reliance Securities Investment Trust Corporation, Ltd. (RSIT) $ 37,481 20.00 $ 75,480 20.00 Investment (credit balance and included in other financial liabilities) Cosmos Construction Management Corporation (CCMC) $ - - $ (60,000 ) 33.90
In August 2006, CCMC issued common stock to increase its capital. The Bank, however, did not subscribe for these new shares; thus, it lost significant influence over CCMC and has recognized its investment in CCMC as a financial asset carried at cost since then. The Bank also reversed the investment credit balance of $60,000 thousand recognized in previous years and included the reversed amount in income from equity investments under the equity method. In addition, the Bank reversed the unrealized gain of $42,537 thousand on prior years’ transactions and included this gain in other noninterest revenue.
As of December 31, 2005, CCMC had loans, but the Bank did not guarantee for any of CCMC’s loans nor did it have any intention to support CCMC. Thus, as of December 31, 2005, the Bank had stopped recognizing its equity in CCMC’s income or loss.
The equity-method investee’s financial statements as of December 31, 2006 on which the calculation of investment carrying value and the related income was based had been audited. As of December 31, 2006 and 2005, net income on this investment was $54,395 thousand and net loss was $33,080 thousand, respectively.
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The difference between the cost of the investment in RSIT and the Bank’s equity in RSIT’s net assets resulted in goodwill. The status of this goodwill as of December 31, 2006 is shown as follows:
Beginning Ending Balance Impairment Balance
Goodwill $ 32,394 $ 32,394 $ -
12. FINANCIAL ASSET SECURITIZATION
a. In December 2003, the George & Mary Cash Card Loan with a carrying value of $11,567,438 thousand was entrusted by the Bank to the Deutsche Bank AG, Taipei Branch for issuance of beneficiary certificates of $11,390,000 thousand (US$335,000 thousand), which consisted of:
1) Investor certificates amounting to $7,820,000 thousand (US$230,000 thousand), denominated in U.S. dollars, issued by the G & M Finance Limited overseas, and with interest paid in accordance with the contract;
2) Excess Spread Rights (ESR) certificates amounting to $1,190,000 thousand (US$35,000 thousand), at a fixed rate of 2.2%;
3) Subordinated seller certificates amounting to $2,380,000 thousand (US$70,000 thousand), at a fixed rate of 2.6%; and
4) The seller interest, representing receivables that exceeded the sum of the investor interest and the subordinated seller’s interest. These receivables are being held by the Bank for future sale or securitization.
The holder of the subordinated seller certificates amounting to $2,380,000 thousand has the right on interests in excess of the fixed amount paid to the investors. If debtors fail to repay the entrusted loans, investors or the Deutsche Bank AG, Taipei Branch has no right of recourse to the Bank. The repayment of the principals for the senior investor certificates has precedence of the repayment of subordinated seller certificates and will be based on related credit risks, repayment rates, and changes in interest rates on those transferred loans. Under the securitization plan, loan repayments after a revolving period (six months after the date of issuance) will be appropriated as follows:
1) Interest payable for investor certificates; 2) The principals of investor certificates until the certificates are paid off; 3) Interest payable for ESR certificates; 4) The principals of ESR certificates until the certificates are paid off; and 5) The remainder, if any, as payments to the holders of subordinated seller certificates.
The Bank recognized an income of $926,452 thousand, included in other noninterest income, and servicing assets amounting to $87,217 thousand, included in other assets - others, which will be amortized using the straight-line method over the servicing period from 2004.
The foregoing investor certificates and ESR certificates were settled in March 2005, and the trust contract on George & Mary Card Loan was terminated in May 2005. Thus, the Bank transferred to loans the carrying value of the retained’s interest minus cash received.
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The movement of servicing assets (included in other assets - others) in 2005 was as follows:
2005
Beginning balance $ 6,570 Amortization (6,570 )
Ending balance $ -
b. Cash flows were as follows:
In 2005, the cash received and paid on securitization trusts are summarized as follows (in New Taiwan dollars):
2005
Other cash flows received on retained interests $ 26,226 Servicing fees received 71,365 Redeemed subordinated 680,790
13. FIXED ASSETS
Accumulated depreciation and impairment consisted of:
December 31 2006 2005 Accumulated depreciation Buildings $ 356,796 $ 300,220 Machinery and equipment 932,072 692,200 Transportation and communications equipment 181,475 140,696 Miscellaneous equipment 322,645 309,201
$ 1,792,988 $ 1,442,317
Accumulated impairment Land $ 88,175 $ 3,497 Buildings 72,013 3,032 Machinery and equipment 10,848 2,972 Transportation and communications equipment 3,626 - Miscellaneous equipment 2,066 -
$ 176,728 $ 9,501
In testing asset for impairment, the Bank defined each branch or operating unit as a cash-generating unit (CGU). Unamortized goodwill, with carrying value of $538,052 thousand as of January 1, 2005, was allocated to branches or operating units resulting from the acquisition of a credit cooperative. The recoverable amount of a CGU was determined at its value in use, and the key assumptions, such as estimated future cash flows, were based on each CGU’s operations or objective data on its business cycle. Under the assumption of sustainable operations, the Bank estimated each CGU’s net cash flow for the next five years The discount rates for future cash flows were 8.78% and 13.45% as of December 31, 2006 and 2005, respectively.
In 2006, the Bank recognized impairment losses of $167,227 thousand on fixed assets; $22,422 thousand on other deferred charges; and $7,103 thousand on goodwill. In 2005, the Bank recognized impairment losses of $9,501 thousand on fixed assets and $17,629 thousand on goodwill.
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14. OTHER FINANCIAL ASSETS
December 31 2006 2005
Debt instruments with no active market $ 7,781,512 $ 8,774,419 Financial assets carried at cost 770,289 771,420 Others 3,726,272 1,327,784
$ 12,278,073 $ 10,873,623
a. Debt instruments with no active market were as follows:
December 31 2006 2005
Mortgage and asset-backed securities guaranteed by U.S. government $ 4,975,238 $ 6,102,857 Zero-coupon bonds 1,764,444 1,625,547 Special-purpose trust beneficiary certificates 1,010,071 1,014,283 Leveraged spread notes 31,759 31,732
$ 7,781,512 $ 8,774,419
b. Financial assets carried at cost were as follow:
December 31 2006 2005 % of % of Carrying Owner- Carrying Owner- Value ship Value ship Unlisted common stock with no quoted market price CDIB & Partners Investment Holding Ltd. $ 500,000 4.95 $ 500,000 4.95 Taiwan Asset Management Corporation 100,000 0.57 100,000 0.57 Euroc II Venture Capital Corporation 60,000 7.50 60,000 7.50 Financial Information Service Co., Ltd. 49,120 1.23 49,120 1.23 Euroc III Venture Capital Corp. 30,000 5.00 30,000 5.00 Taiwan International Mercantile Exchange Cooperation 10,250 0.51 10,250 0.51 Master Card Incorporated Confidential 9,079 - - - Depository and Clearing Co., Taiwan (Note) 6,345 0.08 - - Yang-Kuan Asset Management Corporation 3,445 5.74 - - Lien-An Service Co. 1,250 5.00 1,250 5.00 Taipei Forex Inc. 800 0.40 800 0.40 Debt Instruments Depository and Clearing Co., Taiwan (DIDC) (Note) - - 20,000 1.00 Cosmos Construction Management Corporation - 9.39 - - Cosatech Satellite Services, Inc. - - - 3.46
$ 770,289 $ 771,420
Note: Debt Instruments Depository and Clearing Co., Taiwan (DIDC) and Taiwan Securities Central Depository Co., Ltd. merged on March 27, 2006 to establish a new company: Depository and Clearing Co., Taiwan.
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c. Other financial assets were as follow:
December 31 2006 2005
Exchange rate-linked instruments $ 3,424,487 $ - Interest rate-linked instruments 300,000 1,200,000 Stock price-linked instruments - 100,000 Others 1,785 27,784
$ 3,726,272 $ 1,327,784
Options embedded in exchange rate-linked instruments held by the Bank as of December 31, 2006 were separated from the main contracts and recognized as financial assets at fair value through profit or loss.
The Bank recognized an impairment loss of $25,869 thousand on the temporary debit for the disposal of foreclosed collaterals listed in other financial assets - others because the foreclosed collaterals are not easily disposed and the deadlines set by the authorities were over.
15. DEFERRED LOSS ON THE SALE OF NONPERFORMING LOANS
Between 2002 and 2006, the Bank signed contracts to sell the following nonperforming loans:
a. In 2002, the Bank signed contracts with China Long Sheng Assets Management Co. (CLSAMC), Taiwan Assets Management Co. (TAMC) and Long Xing Sheng Assets Management Co. (LXSAMC) to sell nonperforming loans of $6,240,239 thousand, $5,909,915 thousand and $2,753,317 thousand, respectively. These transactions, with a total selling price of $2,078,868 thousand, resulted in a loss of $12,824,603 thousand.
LXSAMC committed that if, within five years from the contract date, there are proceeds of the sale of nonperforming loans, 30% of these proceeds net of yield amount, related tax and litigation expenses and necessary administrative expenditures should be returned to the Bank.
b. In 2003, the Bank signed contracts with Taiwan Heng-Fong First Asset Management Co. (THFFAMC) to sell nonperforming loans of $3,630,562 thousand for $305,880 thousand. This sale resulted in a loss of $3,324,682 thousand.
c. In 2004, the Bank signed contracts with Chung-Cheng Asset Management Co. (CCAM) and Cosmos Marketing Consulting Co. (CMC) to sell nonperforming loans of $4,700,691 thousand and $3,753,942 thousand, respectively. These transactions, with a selling price of $495,402 thousand, resulted in a loss of $7,959,231 thousand. CCAM and CMC both commit that if, within five years from the contract date, there are proceeds of the sale of nonperforming loans, 45% of these proceeds net of yield amount, related tax and litigation expenses and necessary administrative expenditures should be returned to the Bank.
d. In 2005, the Bank signed contracts with P.I.C.K. Second Fund Co., Ltd. (P.I.C.K.), CMC, and Hui-Cheng First Asset Management Co., Ltd. to sell nonperforming loans of $820,961 thousand, $6,029,567 thousand and $1,619,640 thousand, respectively. These transactions, with a selling price of $644,643 thousand, resulted in a loss of $7,825,525 thousand. At the end of 2005, the Bank still held $395,516 thousand in receivables on the sale of nonperforming loans to CMC and P.I.C.K. The receivables were wholly settled in 2005.
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e. In 2006, the Bank signed contracts with Yang-Kuan Asset Management Co., Ltd. (YKAM), ORIX Taiwan Corporation (ORIX), and CMC to transfer and sell to these three companies nonperforming loans of $103,239 thousand, $2,454,035 thousand, and $19,465,842 thousand, respectively. For these transactions, the Bank should receive a payment of $1,140,590 thousand in cash and some YKAM stocks at face value. These sales resulted in a loss of $20,882,526 thousand.
CMC committed that if there are proceeds of the sale of nonperforming loans within five years from the contract date, 50% of these proceeds net of yield amount, related tax and litigation expenses and necessary administrative expenditures should be returned to the Bank. At the end of 2006, the Bank held $321,045 thousand in receivables on the sale of nonperforming loans to CMC. As of April 26, 2007, the date of the accompanying auditors’ report, $283,463 thousand of the receivable had been paid.
Under the Law Governing Mergers of Financial Institutions, the Bank deferred and amortized all of the losses on the sale of the above nonperforming loans by the straight-line method over 60 months. The unamortized amounts of $32,712,701 thousand and $18,749,041 thousand as of December 31, 2006 and 2005, respectively, were presented under deferred loss on the sale of nonperforming loans. The amortized amounts of $6,911,364 thousand and $5,385,476 thousand in 2006 and 2005, respectively, were recorded as amortization of loss on the sale of nonperforming loans.
16. FORECLOSED COLLATERALS, NET
December 31 2006 2005
Foreclosed collaterals $ 850,007 $ 2,565,086 Allowance for possible losses - (1,059,736 ) Accumulated impairment (685,848 ) (724,452 )
$ 164,159 $ 780,898
The Bank tested for impairment of the foreclosed collaterals at their fair value less selling costs and recognized impairment losses of $637,922 thousand and $732,358 thousand in 2006 and 2005, respectively.
17. DUE TO THE CENTRAL BANK AND OTHER BANKS
December 31 2006 2005
Due to banks $ 19,015,468 $ 20,522,338 Call loans from banks 641,548 1,250,000 Bank overdraft 6,506 6,558 Due to the Central Bank 13,747 12,746
$ 19,677,269 $ 21,791,642
18. SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
As of December 31, 2006 and 2005, securities sold for $2,160,839 thousand and $5,547,572 thousand, respectively, under repurchase agreements would be purchased for $2,162,632 thousand and $5,550,730 thousand by April 2007 and August 2006, respectively.
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As of December 31, 2006, financial assets at fair value through profit or loss and available-for-sale financial assets, which amounted to $1,049,800 thousand and $1,007,600 thousand (face value), respectively, had been sold under repurchase agreements.
As of December 31, 2005, securities purchased and securities purchased under resell agreements, which amounted to $3,633,800 thousand and $1,853,400 thousand (face value), respectively, had been sold under repurchase agreements.
19. PAYABLES
December 31 2006 2005
Checks for clearing $ 2,063,332 $ 1,594,423 Accrued interest 1,193,967 1,300,808 Accrued expenses 856,313 662,552 Payable on funds purchased 508,332 405,486 Payables on linkage bonds purchased 417,900 - Acceptances 123,356 68,502 Collections payable 122,303 115,147 Business tax payable and stamp tax payable 62,193 76,594 Income tax payable 4,846 232,302 Others 359,104 225,267
$ 5,711,646 $ 4,681,081
20. DEPOSITS AND REMITTANCES
December 31 2006 2005 Deposits: Savings $ 147,169,259 $ 158,761,809 Time 31,267,072 32,971,924 Demand 10,372,533 8,449,634 Checking 2,050,037 1,561,280 Negotiable certificates of deposit 228,300 264,500 Remittances 17,403 12,528
$ 191,104,604 $ 202,021,675
21. BANK DEBENTURES
December 31, 2006 Discount Bank Cosmos Maturity Date Rate Par Value Amount Book Value
First convertible bank debenture issued in 2006 2006.06.08-2010.09.08 3.55% semiannually $ 6,250,000 $ (82,837 ) $ 6,167,163 First subordinated bank debenture issued in 2006 A 2006.12.14-2013.12.14 3.00% annually 4,500,000 - 4,500,000 First subordinated bank debenture issued in 2006 B 2006.12.14-2016.12.14 3.20% annually 2,500,000 - 2,500,000
$ 13,250,000 $ (82,837 ) $ 13,167,163
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a. On December 15, 2005, the Board of Directors resolved to issue privately a convertible bank debenture, with the amount not to exceed $7,000,000 thousand, to strengthen the Bank’s capital structure for future growth. This private issuance was approved by the Financial Supervisory Commission (FSC) on January 6, 2006 (FSC approval document: Jin-Kuan-Yin-(2)-Zi-No. 09585000780).
On June 8, 2006, the Bank issued a $6,250,000-thousand convertible bank debenture, with a term of four years and three months. Interest is payable semiannually at a 3.55% annual rate, and the principal is fully repayable on maturity.
Based on the bank debenture conversion terms, the conversion price is $16.00 per share, which can be modified anytime using a certain formula. Advance repayment, redemption, purchase, cancellation or amendment of all or part of the bank debenture is prohibited under the contract unless the Bank receives a written consent from the bondholders. Under SFAS 36, the Bank recognized the option of convertion as capital surplus-others amounted to $12,712 thousand.
Under the subscription agreement signed on January 23, 2006, General Electric Capital Corporation would seek a bank in Taiwan to subscribe for the convertible bank debenture issued by Cosmos Bank, and subscriber bank should sign a call option agreement with General Electric Capital Corporation to enable GE Holdings to call the convertible bank debenture at any time. China Development Industrial Bank Inc. was chosen to subscribe for all of the convertible bank debenture and had signed a call option agreement with General Electric Capital Corporation. Under this option agreement, GE Holdings can call the convertible bank debenture at any time. For future bank debenture repayments, the Bank will establish a sinking trust fund account amounting to $3,125,000 thousand by January 5, 2007. However, on December 7, 2006, the Bank received information from the China Development Industrial Bank Inc. that the Bank need not establish a sinking trust fund account.
Between the thirty-first day after issuance and the third business day before maturity, holders can exercise their right to convert their bank debenture to Cosmos Bank’s common shares. As of December 31, 2006, holders didn’t exercise their right to convert their bank debenture to Cosmos Bank’s common shares.
b. On November 9, 2005, the Board of Directors resolved to issue a publicly subordinated bank debenture, with the amount not to exceed $7,000,000 thousand, to strengthen the Bank’s capital structure for future growth. This public issuance was approved by the Financial Supervisory Commission (FSC) on November 17, 2006 (FSC approval document: Jin-Kuan-Yin-(2)-Zi-No. 09500481860).
On December 14, 2006, the Bank issued one 7-year ($4,500,000 thousand) and one 10-year ($2,500,000 thousand) subordinated bank debentures, with interest payable annually at a 3% and 3.2%, respectively, and the principal each fully repayable on maturity. Grand Cathay Securities Investment Trust Co., Ltd. assumed the responsibility for the sale of these debentures. For the 10-year subordinated bank debentures, the Bank has the right to redeem the bonds on the fifth year after bond issuance.
22. PENSION PLAN
The Labor Pension Act (the “Act”), which took effect on July 1, 2005, provides for a new defined contribution pension plan. Bank employees subject to the earlier promulgated Labor Standards Law were allowed to choose between the pension mechanism under the Labor Standards Act or the mechanism under the Act. For those employees who chose to be subject to the pension mechanism under this Act, their service years before the enforcement of this Act will be retained. However, those hired on or after July 1, 2005 automatically become subject to the Act.
Based on the Act, the rate of the Bank’s required monthly contributions to the employees’ individual pension accounts is at 6% of monthly wages and salaries.
Pension expenses were $91,274 thousand and $40,538 thousand in 2006 and 2005, respectively.
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For the Bank’s employees who chose to continue to be subject to the Labor Standards Act, benefit payments are based on length of service and average monthly salary and wage of the six months before retirement.
The Bank has two funds under its defined benefit plan: One for management and the other for nonmanagement employees (“employees”). The Bank makes monthly contributions to the employees’ pension fund, which is managed by the employees’ fund committee and deposited in the committee’s name in the Central Trust of China. The pension fund for management is administered by the employees’ pension fund administrative committee and deposited under the committee’s name to an account in the Bank.
a. Net periodic pension cost
2006 2005
Service cost $ 67,388 $ 100,072 Interest cost 32,257 30,932 Expected return on plan assets (36 ) (21,334 ) Amortization (27,123 ) (6,424 )
$ 72,486 $ 103,246
b. Reconciliation of funding status and prepaid pension cost
Benefit obligation Vested benefit obligation $ 79,440 $ 42,642 Nonvested benefit obligation 705,997 673,751 Accumulated benefit obligation 785,437 716,393 Effects on employees’ future salary level 257,756 283,720 Projected benefit obligation 1,043,193 1,000,113 Fair value of plan assets (883,856 ) (860,405 ) Pension fund contribution 159,337 139,708 Unamortized balance of prior service cost 7,927 9,758 Unrecognized net transition obligation (7,709 ) (9,636 ) Unamortized pension loss (153,514 ) (136,257 )
Accrued pension liability $ 6,041 $ 3,573 c. Vested benefits $ 90,239 $ 50,702 d. Actuarial assumptions
Discount rate 2.75% 3.25% Salary increase rate 2.00% 2.25% Expected rate of return on plan assets 2.75% 3.25%
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e. Changes in the employees’ and management’s pension funds and were as follows:
2006 2005 Employees’ pension fund Beginning balance $ 506,666 $ 437,034 Contribution 47,807 76,470 Interest income 6,766 5,851 Benefits paid (46,604 ) (12,689 )
Ending balance $ 514,635 $ 506,666
Management’s pension fund Beginning balance $ 271,372 $ 239,594 Contribution 22,211 38,875 Interest income 7,033 3,644 Benefit paid - (10,741 )
Ending balance $ 300,616 $ 271,372
23. STOCKHOLDERS' EQUITY
Under related regulations, capital surplus may only be used to offset a deficit. However, capital surplus (from issuance in excess of common stock par value, from issuance of common stock for combinations and treasury stock transactions) and donation may be transferred to common stock on the basis of the percentage of shares held by the stockholders. Any capital surplus transfer should be within a certain percentage prescribed by law.
The Bank is in a period of stable growth. Thus, the Bank’s earnings appropriation policy is aligned with its goals to maintain the adequacy of capital and provide for future financial needs. Under the Bank’s Articles of Incorporation (the “Articles”), annual net income, less any losses of prior years, should be appropriated as follows:
a. 30% as legal reserve;
b. Special reserve, if needed;
c. 80% of the remainder plus prior years’ unappropriated earnings, as dividends;
d. The final remainder: 80% as bonus to stockholders, 15% as bonus to employees and 5% as remuneration to directors and supervisors.
The cash dividends should be at least 10% of the total dividends to be paid/distributed. However, if the cash dividend is less than NT$0.1 per share, the entire dividend should be paid in stock.
Under a directive of the Securities and Futures Bureau, the Bank has to appropriate a special reserve from current year’s earnings and the unappropriated earnings generated in prior years that is equal to the debit balance of any stockholders’ equity account (except deficit). The special reserve should be adjusted on the basis of the debit balance of the stockholders’ equity account as of year-end.
The Articles also provide that the stockholders may appropriate other special reserves or retain all or part of the annual net income (less legal reserve). In making this appropriation, the Bank should consider its capital adequacy ratio, long-term financial position, and stockholders’ cash needs.
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For a higher capital adequacy ratio, increased working capital for business expansion, and enhancement of the Bank’s overall financial condition and profitability, the Bank’s dividends will mainly be in the form of stock.
Under the Law Governing Mergers of Financial Institutions, loss on the sale of nonperforming loans is amortized using the straight-line method over five years, and special reserve equal to the loss should be appropriated.
The appropriation of deficit resolved by the Band of Director on April 27, 2007 is as follows,
Unappropriated earnings, beginning of 2006 $ - Net loss after tax in 2006 11,286,541 Accumulated deficit (11,286,541 ) Offset of deficit Legal reserve 777,389 Special reserve 1,813,493 Capital surplus - paid-in capital in excess of par value 927,567 Capital surplus from treasury stock 2,245
Accumulated deficit $ (7,765,847 )
Information on the appropriation of earning or deficit offsetting can be accessed through the web site of the Taiwan Stock Exchange (http://emops.tse.com.tw).
On April 19, 2006, the stockholders resolved to appropriate a legal reserve of $33,331 thousand amounted to 30% of the 2005 net income. Remaining $77,771 thousand of the 2005 net income has been resolved as a special reserve.
The stockholders also resolved to raise the registered capital stock to $19,677,795 thousand at NT$10.00 per share and authorized the Board of Directors to plan and execute the stock issuance for this capital increase.
The Bank increased its capital by $1,967,780 thousand and issued 196,778 thousand shares at NT$14.00 per share, for a total issuance amounting to $2,754,892 thousand.
GE Capital Asia Investments Holdings B.V. subscribed for all the new shares. On May 18, 2006, the Board of Directors resolved that June 8, 2006 would be the capital increase date. This issuance was approved by the Ministry of Economic Affairs on August 6, 2006.
Under the Company Law, legal reserve should be appropriated until the reserve equals the Bank’s paid-in capital. This reserve may only be used to offset deficit. When the reserve reaches 50% of the aggregate par value of the Bank’s outstanding capital stock, up to 50% thereof may be declared as stock dividends. In addition, the Banking Law provides that, before the legal reserve equals the Bank’s paid-in capital, annual cash dividends and bonuses should not exceed 15% of paid-in capital.
Under the Integrated Income Tax System, which took effect on January 1, 1998, ROC resident stockholders are allowed a tax credit for the income tax paid by the Bank on earnings generated annually since 1998. An imputation credit account (ICA) is maintained by the Bank for such income tax.
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24. TREASURY STOCK
(Shares in Thousands)
Reason for Redemption Beginning of the Year Increase Decrease End of the Year
Reissuance to employees
As of December 31, 2005 47,646 - 47,646 -
Under the Securities and Exchange Law, the Bank should not acquire treasury stock in excess of 10% of its total shares outstanding. In addition, the Bank should not spend more than the aggregate amount of the retained earnings, paid-in capital in excess of par value, and realized capital surplus arising from gains on disposal of properties and donated capital on treasury share acquisition. In addition, the Bank should not use treasury stock to secure any of its obligations and to exercise any stockholders’ rights on those stocks.
The Bank reissued 47,646 thousand treasury shares to its employees at NT$11.2 per share on June 21, 2005.
25. PERSONNEL, DEPRECIATION AND AMORTIZATION EXPENSES
2006 2005 Personnel expenses Salaries $ 2,653,851 $ 2,780,816 Insurance 175,477 170,443 Pension 163,760 143,784 Other 194,666 277,163 Depreciation expenses 430,009 370,115 Amortization expenses 260,731 283,607
26. INCOME TAX
a. Income tax expense (benefit) calculated as follows:
2006 2005
Income tax expense - current before tax credits $ 68,542 $ 468,170 Investment tax credit - (5,355 ) Net changes in deferred income tax: Amortization of goodwill 25,557 - Impairment loss on foreclosed collaterals 8,997 63,568 Reversal of allowance (provision) for loss 7,607 (2,416 ) Unrealized gain on financial instruments 1,476 - Loss on the transfer of foreclosed collaterals to fixed assets 353 (14,835 ) Allowance for serving assets - 15,994 Pension costs (617 ) 3,025 Tax credits (3,315 ) - Unrealized foreign exchange gain (loss) (13,209 ) 30,177 Impairment loss (54,686 ) (6,572 ) Loss carryforwards (1,226,435 ) - Allowance for possible losses on loans and receivables (2,376,748 ) (147,223 ) Adjustment of prior year’s tax 8,594 (6,214 )
$ (3,553,884 ) $ 398,319
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b. A reconciliation of income tax expense - current before tax credits and income tax expense on income before income tax is shown below:
2006 2005
Income tax revenue (expense) on income before income tax at statutory rate (25%) $ (3,716,523 ) $ 127,345 Permanent differences: Tax-exempt income (21,343 ) (22,779 ) Others 163,431 211,297 Temporary differences 3,642,977 124,916 Income tax (10%) on undistributed earnings - 27,391
Income tax expense - current before tax credits $ 68,542 $ 468,170
c. Net deferred income tax assets were as follows:
December 31 2006 2005 Deferred income tax assets (liabilities) Allowance for possible losses on loans and receivables $ 2,539,083 $ 162,335 Loss carryforwards 1,226,435 - Impairment loss 57,512 6,572 Loss on the transfer of foreclosed collaterals to fixed assets 14,482 14,835 Tax credits 3,315 - Pension costs 1,510 893 Provision for loss 329 7,936 Convertible bank debenture 43 - Unrealized foreign exchange gain (649 ) (13,858 ) Unrealized gain on financial instruments (6,823 ) - Amortization of goodwill (21,811 ) - Loss on market value decline of foreclosed collaterals - 8,997
Net deferred income tax assets $ 3,813,426 $ 187,710
As of the end of 2006, loss carryforwards were as follows:
Total Tax Credits Remaining Expiry Accrued Year Granted Tax Credit Year
2006 $ 1,226,435 $ 1,226,435 2011
d. Imputed tax credits are summarized as follows:
December 31 2006 2005
Balance of stockholders’ imputed tax credits $ 762,909 $ 683,078
The Bank had no earnings to be distributed in 2006 and the actual creditable tax ratio was 33.33% for 2005 earnings.
e. The accumulated deficit and unappropriated earnings as of December 31, 2006 and 2005, respectively, had no earnings generated before January 1, 1998.
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f. Income tax returns through 2003 had been examined by the tax authorities. The Taipei National Tax Administration will refund 65% of certain withholding taxes. The Bank accepted the refund at this percentage.
g The income tax returns through previous year of Cosmos Bills Finance Corporation, which merged with the Bank in 2002, had been examined by the tax authorities. The Taipei National Tax Administration determined that only 60% of some taxes withheld by the Bank would be refunded to the Bank. The Bank accepted this assessment. (However, if the authorities later allow a higher rebate for mergers, the Bank will retroactively claim rebates at the higher rebate rate.)
27. EARNINGS (LOSS) PER SHARE
Earnings (Loss) Per Share (NT Dollars) Amount (Numerator) Shares Before After Before After (Denominator) Income Income Income Tax Income Tax (Thousands) Tax Tax 2006
Basic loss per share (dollars) Net loss $ (14,866,090 ) $ (11,312,206 ) 1,882,599 $ (7.90 ) $ (6.01 ) Cumulative effect of changes in accounting principles 31,011 25,665 0.02 0.01
$ (14,835,079 ) $ (11,286,541 ) $ (7.88 ) $ (6.00 )
2005
Basic earnings per share $ 509,421 $ 111,102 1,748,680 $ 0.29 $ 0.06
28. RELATED-PARTY TRANSACTIONS
In addition to the disclosures in other footnotes, the Bank’s related parties and significant transactions between the Bank and the related parties were as follows:
a. Related parties
Related Party Relationship with the Bank
Prince Motors Corporation (PMC) Same chairman Cosmos Construction Management Corporation Same chairman; equity-method investee that (CCMC) became a cost-method investee on September 1, 2006 Reliance Securities Investment Trust Corporation, Ltd. Equity-method investee (RSIT) GE Capital Asia Investments Holdings B.V Main stockholder holding 10% of total shares (“GE Asia Holdings”) of the Bank since June 8, 2006 General Electric Capital Corporation (GECC) Affiliate of GE Asia Holdings GE Capital Taiwan Holdings Inc. (“GE Holdings”) Affiliate of GE Asia Holdings General Electric International Inc. (GEII) Affiliate of GE Asia Holdings GE Processing Services Pty Limited (“GE Australia”) Affiliate of GE Asia Holdings GE Capital Thailand Affiliate of GE Asia Holdings (Continued)
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Related Party Relationship with the Bank
GE Capital Corporation (“GE Capital”) Affiliate of GE Asia Holdings Shin Kong Life Insurance Co., Ltd. (SLIC) SLIC’s chairman is a second-degree relative of the Bank’s chairman Shin Kong Financial Holding Co., Ltd. (“SK Holdings”) The chairman of SK Holdings is a second-degree relative of the Bank’s chairman Others The Bank’s chairman, president, directors, supervisors, managers and the relatives up to the second degree of the chairman and president (Concluded)
b. Significant transactions between the Bank and related parties
1) 2006 2005 Revenue Revenue December31, 2006 Interest Rate (Expense) December31, 2005 Interest Rate (Expense) Amount % (%) Amount Amount % (%) Amount
a) Deposits $ 3,102,237 2 0.00-6.79 $ (44,263 ) $ 2,480,221 1 0.00-6.45 $ (33,256 ) b) Loans $ 5,374,986 4 2.00-18.25 $ 128,220 $ 5,022,019 3 1.79-18.25 $ 134,799 c) Guarantees and acceptances $ 344,000 19 0.50-0.75 $ 4,935 $ 1,002,550 23 0.50-0.75 $ 5,770
d) Refundable deposits - rental
PMC $ 1,617,920 58 - $ (39,356 ) $ 1,617,920 51 - $ (38,627 ) Others 135,156 5 - (31,013 ) 225,156 7 - (30,272 )
$ 1,753,076 63 $ (70,369 ) $ 1,843,076 58 $ (68,899 ) e) Financial assets at fair value through profit or loss - forward contracts
PMC $ - - - $ - - - $ 65,058
2) Purchase or sell of notes and bonds (2006)
RP Notes and Bonds Sold to Interest Rate Interest Related Parties Related Parties Range Expense
SK Holdings $ 30,883,085 1.43%-1.63% $ 5,826 SLIC 122,807,828 1.41%-1.66% 32,173
3) The Bank paid SLIC insurance expenses of $4,330 thousand in 2006 and $2,466 thousand in 2005.
4) The Bank paid CCMC property appraisal fees of $20,299 thousand in 2006 and $7,019 thousand in 2005.
5) GE Asia Holdings subscribed for the Bank’s common shares (Note 23) and GECC bought call options from China Development Industrial Bank Inc. (Note 21) under certain subscription agreements. The Bank also has support service agreements (SSAs) with GEII and GE Australia signed on June 5, 2006. Under the SSAs, GE Holdings and GE Australia will provide the Bank with management systems, data processing service, system support, and IT (information technology) services as part of intensive training and technology transfer services. The SSAs also provide for the integration of global Best Practices with Bank operations to redesign or enhance systems on business development and management operations, such as strategy planning and analysis, product design, marketing, client relationship management, employee-performance management, human resource, process upgrade, risk management, overdue loan processing, 6σ enhancement, etc. It also supports information processing for all systems, system development and maintenance, daily operations, and strategy support.
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Unless constrained by uncontrollable environment factors, GE Holdings and the Bank promise to fully cooperate with each other use global human resources and obtain best practices and key information and technology that can help the Bank enhance earnings generation. The Bank will pay GE Holdings (1) technology providing cost US$84,000 thousand as total service fee, payable at US$11,000 thousand in the six months ending December 31, 2006; US$22,000 thousand annually from 2007 to 2009; and US$7,000 thousand for the six months ending June 30, 2010; (2) consulting expenses of up to US$3,339 thousand for assigning directors, chief manager, CEO, CFO, CRO and managers of the Claims Department, etc. and costs of supporting personnel based on the assignment period. The technology provision and consulting service fees of $456,395 thousand for 2006 were included in labor expense and other agency and administrative expense under operating expense. At the end of 2006, there was a fee of $427,041 thousand still unpaid. Of this balance, $425,817 thousand had been paid as of April 26, 2007, the date of the accompanying auditors’ report.
6) GE Australia provided the Bank with Vision Plus software to integrate with the Bank’s consumer financing business. The fees and charges payable to GE Australia for the data processing services are based on the number of customer accounts processed with the help of GE Australia. As of December 31, 2006, the Bank had prepaid US$1,000 thousand for GE Australia’s services, included in other assets.
7) The Bank got from GE Capital Thailand the right to use NAOS for US$400 thousand based on a support services agreement. For this right, the Bank amortized $1,511 thousand, included in depreciation and amortization.
8) To improve its car loan operations, the Bank signed a car loan acquisition contract with GE Capital to buy car loans amounting to $1,359,280 thousand for $1,413,467 thousand. The premium rate is about 4%, estimated at the net value calculated using the cash flow model. In addition, on August 17, 2006, the Bank signed a contract on the purchase from Mega International Commercial Bank of a car loan for $1,023,770 thousand, the amount due to GECC (a related party of the Bank, as shown in Note 28) for GECC’s providing services to Mega Bank for a price of $1,064,721 thousand, with a premium rate of about 4%. The transaction price was evaluated using the future cash flow model. At the end of 2006, based on an estimate of future cash flows, the recognized impairment loss on this car loan was $41,380 thousand.
Under the Banking Law, except for consumer loans and government loans, credit extended by the Bank to any related party should be 100% secured, and the terms of credits extended to related parties should be similar to those for third parties.
The Bank signed several lease contracts with related parties for renting office buildings. Either the rentals are paid monthly, semiannually, annually or no rentals are paid but the Bank gave deposits to the lessors. The latest expiry of these contracts is in August 2015. At the end of 2006, the Bank had paid refundable deposits of $1,753,076 thousand (recorded as refundable deposits), of which the largest deposit amount went to PMC. To cover the deposit to PMC from the Bank, PMC provided real estate as a guarantee.
The rents payable to related parties for the coming five years are as follows:
Year Amount
2007 $ 63,532 2008 51,891 2009 39,447 2010 23,817 2011 13,079
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The undiscounted amount and the present value of the minimum rentals from 2012 to 2015, computed at the one-year time deposit interest rate of 2.175% of the Postal Remittances and Savings Bank, were as follows:
Rental Present Value
$24,000 $20,574
The terms of a technology service contract signed by the Bank with GEII and GE Australia on the Vision Plus and NAOS business platform systems purchased from GE Australia and GE Capital Thailand were not comparable to those in the market because of the uniqueness of the related transaction. However, the terms of all other related-party transactions were similar to those for unrelated parties.
29. PLEDGED ASSETS
a. As of December 31, 2006 and 2005, negotiable certificates of deposit (NCDs) recorded as due from the Central Bank and call loans to banks, amounting to $2,600,000 thousand and recorded as available-for-sale financial assets, net, amounting to $1,600,000 thousand, respectively, had been provided as collateral for day-term overdraft to comply with the requirement for real-time gross settlement under the Central Bank’s clearing system.
b. Government bonds with carrying value of $239,300 thousand (recorded as available-for-sale financial assets, net, amounting to $231,200 thousand, and other receivables amounting to $8,100 thousand) as of December 31, 2006 and government bonds with carrying value of $257,300 thousand (recorded as available-for-sale financial assets, net, amounting to $251,200 thousand, and other receivables amounting to $6,100 thousand) as of December 31, 2005 had been placed with the court as guarantee deposits in line with the Bank’s request for court approval to seize and sell the properties of the Bank’s debtors to satisfy the debtors’ obligations to the Bank.
c. As of December 31, 2006 and 2005, the Bank had provided the National Credit Card Center (NCCC) with government bonds (recorded as available-for-sale financial assets, net) with carrying values of $210,000 thousand, respectively, as the reserve required by the NCCC for payment of the Bank’s credit card obligations.
30. COMMITMENTS
In addition to those disclosures in Note 28 and 31, the commitments as of December 31, 2006 were as follows:
a. Leases
The Bank leases the premises occupied by its branches under operating lease agreements expiring on various dates until October 31, 2013. Refundable deposits on these leases amounted to $795,504 thousand as of December 31, 2006. The leases also require the payment of rentals monthly, semiannually or annually, or a refundable rental deposit, which generates no interest. Future minimum annual rentals on these leases as of December 31, 2006 were as follows:
Year Amount
2007 $ 331,078 2008 215,716 2009 152,539 2010 110,728 2011 48,409
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The undiscounted amount and the present value of the minimum rentals from 2012 to 2013, computed at the one-year time deposit interest rate of 2.175% of the Postal Remittances and Savings Bank, were as follows:
Rental Present Value
$11,319 $9,862
b. Significant outstanding purchase contracts
Contract Item Amount Prepayment Payable
Banking information and operating systems $ 148,666 $ 88,067 $ 60,599 Premise improvements, water and electricity, and air conditioning 13,018 10,868 2,150
31. FINANCIAL INSTRUMENTS
a. Fair value of financial instruments
December 31 2006 2005 Carrying Estimated Carrying Estimated Amount Fair Value Amount Fair Value Assets
Financial assets at fair value through profit or loss $ 4,223,017 $ 4,223,017 $ 26,991,766 $ 26,991,766 Available-for-sale financial assets 1,894,082 1,894,082 3,469,357 3,469,357 Other financial assets 11,507,784 11,507,784 10,102,203 10,102,203 Other financial assets - with fair values approximating carrying amounts 180,339,713 180,339,713 184,767,459 184,767,459
Liabilities
Financial liabilities at fair value through profit or loss 31,214 31,214 49,211 49,211 Bank debentures 13,167,163 13,167,163 - - Other financial liabilities - with fair values approximating carrying amounts 218,905,375 218,905,375 233,934,009 233,934,009
Effective January 1, 2006, the Bank adopted the Statement of Financial Accounting Standards (SFAS) No. 34 - “Accounting for Financial Instruments.” Because SFAS No. 34 was adopted only in 2006, the Bank’s derivatives were not recognized in the financial statements as of and for the year ended December 31, 2005. The amount of the cumulative effect of accounting changes and the adjustments of stockholders’ equity resulting from the adoption of SFAS No. 34 are mentioned in Note 3.
b. Methods and assumptions applied to estimate the fair value of financial instruments are summarized as follows:
1) The carrying amounts of short-term financial instruments approximate their fair values because of the short maturities of these instruments. Other short-term financial assets are cash and cash equivalents, due from the Central Bank and call loans to banks, securities purchased under resell agreements, receivables (except tax refund receivable) and refundable deposits. Other short-term financial liabilities are due to the Central Bank and other banks, payables (except tax payable), remittances, securities sold under repurchase agreements and guarantee deposits received.
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2) For financial instruments measured at fair value through profit or loss and available-for-sale financial assets, fair value is best determined on the basis of quoted market prices. However, in many instances where there are no quoted market prices for the Bank’s various financial instruments, fair values are based on estimates using other financial data and appropriate valuation methodologies.
If there are no active market prices for derivative financial instruments, fair values of forward contracts will be calculated using the discounted cash flow method, while values of options are provided by counter-parties.
The Bank estimates the fair value of each forward contract on the basis of the exchange rates quoted by Reuters on each settlement date. The fair value of a cross-currency swap contract is calculated using the prices quoted by Bloomberg.
3) Discounts and loans, deposits are interest-earning assets and interest-bearing liabilities. Thus, their carrying amounts represent fair value. The fair value of overdue loans is based on their carrying amount, net of allowance for possible losses.
4) If equity investments under the equity method and financial assets carried at cost both consist of unlisted stocks, these investments have no quoted market prices in an active market and their fair value cannot be reliably measured. Thus, the Bank does not disclose their fair value.
5) If there are trade prices or prices quoted by major market players, the latest trade prices and quoted prices are used as the basis for valuating the fair value of debt instruments with no active market and classified as other financial assets.
6) Other financial liabilities include an appropriate loan fund. They are items that can be transferred to other banks at any time depending on the business situation. Thus, the carrying amounts of these liabilities represent their fair values.
The Bank regards the book value of guarantee deposit as fair value because they have no maturity dates.
c. As of December 31, 2006, fair values of financial assets and liabilities determined at quoted market prices or market prices estimated using a valuation method were as follows:
December 31, 2006 Quoted Market Estimated Prices Market Prices Financial assets
Financial assets at fair value through profit or loss $ 4,174,610 $ 48,407 Available-for-sale financial assets 1,894,082 -
Financial liabilities
Financial liabilities at fair value through profit or loss - 31,214
d. Loss on the valuation of financial instruments at estimated market prices in 2006 was $7,967 thousand.
e. The net service fee of $1,208,227 thousand consisted of revenues of $1,453,282 thousand and charges of $245,055 thousand in 2006. The net service fee of $1,372,607 thousand consisted of revenues of $1,726,020 thousand and charges of $353,413 thousand in 2005.
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f. The Bank was exposed to fair value interest rate risk from financial assets (a) amounting to $12,805,606 thousand and $38,686,105 thousand as of December 31, 2006 and 2005, respectively; and liabilities (b) amounting to $15,328,002 thousand and $5,547,572 thousand as of December 31, 2006 and 2005, respectively. The Bank was exposed to cash flow interest rate risk from financial assets (a) amounting to $380,166 thousand and $1,565,642 thousand as of December 31, 2006 and 2005, respectively; and liabilities (b) amounting to $31,214 thousand and $49,211 thousand as of December 31, 2006 and 2005, respectively.
g. In 2006 and 2005, the interest revenues excluded on financial assets and liabilities at fair value through profit or loss were $14,076,633 thousand and $17,839,109 thousand, respectively. The interest expenses for financial assets and liabilities at fair value through profit or loss were $4,016,697 thousand and $3,481,488 thousand, respectively. In 2006, the adjustments of stockholders’ equity credited directly from the available-for-sale financial assets amounted to $50,941 thousand. In 2006, the decrease from the adjustments of stockholders’ equity to net income amounted to $659 thousand.
h. Financial risk information
1) Market risk
The Bank monitors profit or loss on investment positions by marking to market to consider investment strategies and investment positioning.
The Bank evaluated the market risk of financial instruments using daily value at risk (VaR). VaR is the potential loss in market value of financial instruments held by the Bank within a certain confidence interval for a specified period.
VaR of securities held by the Bank is shown in the table listed below. The Bank made an assumption that, if there is a 99% level of confidence, there is only a 1% chance that the Bank will incur a loss on its financial instruments within a day. In addition, based on VaR assumptions, there are only 2 out of 200 days when the Bank could face losses on its financial instruments. The average, highest and the lowest amounts of the interest rate and price risks that were calculated at the daily VaR in the year ended December 31, 2006 were as follows:
2006 Type of Market Risk Average Highest Lowest
Fair value interest rate risk $ 6,662 $ 12,417 $ 4,983 Price risk 57,603 83,017 24,524
The Bank engages in trade financing and foreign currency exchange; thus, it is exposed to exchange risks on differences between spot and forward rates. The Bank’s policy is to have a square position on its forward contracts. If the contract transactions do not square off, all Bank employees are authorized to handle the contracts in accordance with the Cosmos Bank Handling International Financing Transaction Rules. In addition, the exchange rate risks on foreign security investments or other international financing business are hedged by cross-currency swap contracts, and the gains and losses on these contracts are measured at rates quoted by Bloomberg. These gains and losses are assessed and reported to Bank management regularly.
2) Credit risk
The Bank is exposed to potential loss due to contract defaults by counter-parties or financial instrument issuers.
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The Bank evaluates the creditworthiness of credit applications case by case, taking into account the applicant’s credit history, credit rating and financial condition. Collateral, mostly in the form of cash, inventories, marketable securities and other assets, may be required depending on the evaluation result. As of December 31, 2006 and 2005, of about 44% and 38% of total loans granted, about 44% and 58%, respectively, had been secured. However, there are no collaterals for issuing credit cards. Thus, the Bank evaluates the creditworthiness of credit cardholders regularly and modifies the credit facilities if necessary. If the counter-parties or others concerned (e.g., guarantors) break a contract, the Bank will execute its right on the collaterals and decrease its credit risk. In addition, the Bank discloses its maximum credit exposure without taking collateral fair value into consideration.
The maximum credit exposure of financial assets is the carrying amounts of financial assets on the balance sheet date.
The amounts of financial contracts with off-balance-sheet credit risks as of December 31, 2006 and 2005 were as follows:
December 31 2006 2005
Credit card commitments $ 73,279,441 $ 91,279,574 Guarantees and letters of credit issued 2,376,341 4,948,213 Irrevocable loan commitments 453,843 989,595
Concentration of credit risk exists when counter-parties to financial transactions are individuals or groups engaged in similar activities or activities in the same region, which would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. It is also affected by the nature of the borrowers’ operations. The concentration of the Bank’s credit risk was as follows:
December 31 Group 2006 2005
Private enterprise $ 60,582,664 $ 65,921,051 Natural person 79,396,434 91,387,845 Nonprofit enterprise 25,969 77,742
$ 140,005,067 $ 157,386,638
December 31 Industries 2006 2005
Wholesale, retail and catering $ 18,943,677 $ 18,745,772 Manufacturing 16,140,590 16,102,840 Finance, insurance and real estate 12,421,665 15,892,512
$ 47,505,932 $ 50,741,124
3) Liquidity risk
As of December 31, 2006 and 2005, the liquidity reserve ratios were 16.66% and 12.79%, respectively. The Bank has sufficient equity capital and working capital to execute all contract obligations and has no liquidity risk.
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The management policy of the Bank is to match the contractual maturity profile to the interest rates for its assets and liabilities. Because of uncertainties, however, the maturities did not fully match the interest rates, resulting in gaps that may potentially give rise to gain or loss.
The Bank applied appropriate ways to group assets and liabilities. The maturity analysis of assets and liabilities was as follows:
December 31, 2006 Due after Due after Due after One Month Three Months One Year Due in Up to Up to Up to Due after One Month Three Months One Year Seven Years Seven Years Total Assets
Cash and cash equivalents $ 5,618,763 $ - $ - $ - $ - $ 5,618,763 Due from the Central Bank and call loans to banks 25,232,843 1,542,952 7,510,000 - - 34,285,795 Financial assets at fair value through profit or loss 923,165 200,000 2,949,422 134,522 15,908 4,223,017 Available-for-sale financial assets 2,323 - 54,852 1,690,248 146,659 1,894,082 Debt instruments with no active market 81,490 162,980 2,297,091 5,239,951 - 7,781,512 Receivables 6,617,386 367,324 214,040 94,546 4,281 7,297,577 Discounts and loans 13,681,889 15,342,501 62,800,197 41,002,112 7,211,878 140,038,577 Equity investments under the equity method - - - - 37,481 37,481 Financial assets carried at cost - - - - 770,289 770,289 Other financial assets - others 3,429,684 6,823 337,242 - - 3,773,749 Foreclosed collaterals - 102,120 747,887 - - 850,007 Refundable deposits 166,250 22,500 309,160 681,500 1,616,700 2,796,110
$ 55,753,793 $ 17,747,200 $ 77,219,891 $ 48,842,879 $ 9,803,196 $ 209,366,959
Liabilities
Due to the Central Bank and other banks $ 1,737,677 $ 2,085,904 $ 9,053,688 $ 6,800,000 $ - $ 19,677,269 Financial liabilities at fair value through profit or loss 31,214 - - - - 31,214 Payables 4,154,258 693,148 712,986 151,254 - 5,711,646 Deposits and remittances 22,993,147 34,820,905 108,766,394 16,978,102 7,546,056 191,104,604 Securities sold under repurchase agreements 2,049,189 101,650 10,000 - - 2,160,839 Bank debentures - - - 10,667,163 2,500,000 13,167,163 Other financial liabilities 18,382 102 176,494 - - 194,978
$ 30,983,867 $ 37,701,709 $ 118,719,562 $ 34,596,519 $ 10,046,056 $ 232,047,713
December 31, 2005 Due after Due after Due after One Month Three Months One Year Due in Up to Up to Up to Due after One Month Three Months One Year Seven Years Seven Years Total Assets
Cash and cash equivalents $ 4,606,577 $ - $ - $ - $ - $ 4,606,577 Due from the Central Bank and call loans to banks 8,478,097 - - - - 8,478,097 Financial assets at fair value through profit or loss 14,803,660 8,346,324 3,674,868 166,914 - 26,991,766 Available-for-sale financial assets 1,593,898 19,116 27,765 1,728,232 100,346 3,469,357 Debt instruments with no active market 164,250 328,500 2,831,622 5,418,315 31,732 8,774,419 Securities purchased under resell agreements 3,050,742 - - - - 3,050,742 Receivables 9,378,730 600,271 531,220 - - 10,510,221 Discounts and loans 15,158,414 15,555,642 84,712,290 35,984,442 5,975,850 157,386,638 Equity investments under the equity method - - - - 75,480 75,480 Financial assets carried at cost - - - - 771,420 771,420 Other financial assets - others 98,767 - 111,446 1,202,109 - 1,412,322 Foreclosed collaterals - 218,550 946,032 1,400,504 - 2,565,086 Refundable deposits 44,800 32,901 693,156 777,109 1,616,700 3,164,666
$ 57,377,935 $ 25,101,304 $ 93,528,399 $ 46,677,625 $ 8,571,528 $ 231,256,791
Liabilities
Due to the Central Bank and other banks $ 2,120,212 $ 4,302,881 $ 14,968,549 $ 400,000 $ - $ 21,791,642 Payables 2,996,794 411,582 1,179,633 93,072 - 4,681,081 Financial liabilities at fair value through profit or loss 49,211 - - - - 49,211 Deposits and remittances 24,445,848 36,881,993 123,896,656 16,797,178 - 202,021,675 Securities sold under repurchase agreements 5,441,556 46,634 59,382 - - 5,547,572 Other financial liabilities 2,164 102 7,057 27,821 60,000 97,144
$ 35,055,785 $ 41,643,192 $ 140,111,277 $ 17,318,071 $ 60,000 $ 234,188,325
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4) Fair value interest rate risk and cash flow interest rate risk
The Bank had signed cross-currency swap contracts to reduce risks from market interest rate changes. Please refer to Note 34 for the related effective interest rates.
32. RISK CONTROL AND HEDGE POLICY
The Bank documents its risk management policies, including overall operating strategies and risk control philosophy. The Board of Directors reviews the policies regularly and reviews Bank operations monthly to make sure that the Bank’s policies are executed properly.
The Bank has established a risk management committee. On the other hand, the executive director of the risk management department is in charge of enhancing risk management functions. The functions of the risk management department are as follows:
a. To develop risk management strategies;
b. To consider ways to execute the risk management strategy and all management rules as well as develop the appropriate organization framework;
c. To monitor, control, evaluate and review the Bank’s overall operating risk; and
d. To monitor the Bank’s risk management and report to the Board of Directors all risk management developments regularly or make special reports if risk management exceptions occur.
33. CAPITAL ADEQUACY RATIO
Unit: In Thousands of New Taiwan Dollars, %
December 31, December 31, Items 2006 2005 Net eligible capital $ 16,262,893 $ 19,093,874 Total risk-weighted assets 173,822,698 196,677,858 Capital adequacy ratios 9.36 9.71 Ratios of tier 1 capital to risk-weighted assets 6.60 10.16 Ratios of tier 2 capital to risk-weighted assets 3.30 0.11 Ratios of tier 3 capital to risk-weighted assets - - Ratios of common stockholders’ equity to total assets (Note 3) 4.86 7.98
Note 1: Capital adequacy ratio = Net eligible capital/Risk-weighted assets.
Note 2: Total assets refer to total amount of assets in the balance sheet.
Note 3: This ratio will be calculated every June 30 and December 31.
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34. AVERAGE AMOUNT OF AND AVERAGE INTEREST RATE ON INTEREST-EARNING ASSETS AND INTEREST-BEARING LIABILITIES
Average balance was calculated at the daily average balances of interest-earning assets and interest-bearing liabilities.
2006 Average Average Balance Rate (%) Interest-earning assets
Cash and cash equivalents - due from banks $ 751,747 1.15 Due from the Central Bank and call loans to banks 14,492,505 2.06 Financial assets at fair value through profit or loss 19,069,957 1.63 Securities purchased under resell agreements 2,222,168 1.49 Receivables of credit cards 6,423,121 11.69 Discounts and loans 149,328,000 8.29 Available-for-sale financial assets - bonds 2,447,698 1.98 Other financial assets - others 2,527,107 1.61 Debt instruments with no active market 8,508,852 4.99
Interest-bearing liabilities
Due to the Central Bank and other banks 20,962,170 2.07 Securities sold under repurchase agreements 7,623,600 1.34 Demand deposits 8,500,125 0.48 Savings - demand deposits 35,073,929 0.82 Time deposits 32,807,646 2.02 Time savings deposits 117,737,867 1.99 Bank debentures 3,889,726 3.86
2005 Average Average Balance Rate (%) Interest-earning assets
Cash and cash equivalents - due from banks $ 1,290,460 1.63 Due from the Central Bank and other banks 9,340,283 1.67 Receivables of credit cards 7,109,304 16.22 Securities purchased (except stocks and mutual funds) 29,502,519 1.45 Securities purchased under resell agreements 5,802,494 1.25 Bills, discounts and loans (except overdue loans) 153,036,409 10.55 Other long-term investments Mortgage and asset-backed securities 2,461,187 5.67 Subordinated seller certificates 859,036 2.37 Specific-purpose beneficiary certificates 422,788 2.03
Interest-bearing liabilities
Due to the Central Bank and other banks 2,500,958 1.37 Demand deposits 7,831,992 0.34 Savings - demand deposits 34,335,948 0.82 Time deposits 31,135,706 1.55 Time savings deposits 145,433,795 1.77 Securities sold under repurchase agreements 7,586,830 1.08
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35. ASSET QUALITY, CONCENTRATION OF CREDIT EXTENSIONS, INTEREST RATE SENSITIVITY, PROFITABILITY AND MATURITY ANALYSIS OF ASSETS AND LIABILITIES
a. Asset quality
(In Thousands of New Taiwan Dollars, %)
December 31, 2006 December 31, 2005 Nonperforming Nonperforming Items Loans/ Loans/ Amount Amount Outstanding Outstanding Loan Balance Loan Balance Nonperforming loans - class A $ 3,392,842 2.43 $ 4,379,273 2.78 Nonperforming loans - class B 4,942,595 3.55 931,874 0.59 Total Nonperforming loans 8,335,437 5.98 5,311,147 3.37 Outstanding loans for which repayment has been postponed through debt negotiation and thus not reported as nonperforming loans 4,156,291 - Outstanding loans for which repayment has been postponed through debt negotiation and thus not reported as nonperforming loans 395,819 -
Note 1: Nonperforming loans were the amounts of nonperforming loans reported to the authorities and disclosed to the public, as required by the “Regulations Governing the Procedures for Banking Institutions to Evaluate Assets and Deal with Nonperforming/Non-accrued Loans”.
Note 2: Nonperforming loans - Class A and Class B were the amounts of nonperforming loans reported to the Banking Bureau, as required by this Bureau in its letter dated April 19, 2005 (Ref. No. 0941000251).
Note 3: Nonperforming loan ratio = Nonperforming loans/Outstanding loan balance.
Note 4: Amounts of executed contracts on negotiated debts, which were not reported as nonperforming loans or receivables, were disclosed in accordance with the Banking Bureau’s letter dated April 25, 2006 (Ref. No. 09510001270).
b. Concentrations of credit extensions
(In Thousands of New Taiwan Dollars, %)
Items December 31, 2006 December 31, 2005 Credit to interest party $10,374,330 $11,017,244 Credit to interest party/Total credit 7.31 6.80 Credit with stocks pledged/Total credit 2.27 3.20 Type of Industry % Type of Industry % a. Wholesale, retail and 13.35 a. Wholesale, retail and 12.31 catering catering Loan concentration by industry b. Manufacturing 10.84 b. Manufacturing 9.68 c. Finance, insurance and real 9.02 c. Finance, insurance and real 9.52 estate estate
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Note 1: Total credit included loans, discounts, acceptances, guarantees and prepaid factoring accounts receivable.
Note 2: Ratio of credit extensions to interest parties: Credit to interest party ÷ Total credit.
Note 3: Ratio of credit extensions secured by pledged stocks: Credit with stocks pledged ÷ Total credit.
Note 4: Loan concentration by industry is calculated under the definition identified by the Financial Supervisory Commission, Executive Yuan. c. Interest rate sensitivity information
Interest Rate Sensitivity December 31, 2006
(In Thousands of New Taiwan Dollars, %)
181 Days to Items 1 to 90 Days 91 to 180 Days Over One Year Total One Year Interest rate-sensitive assets $ 136,218,055 $ 12,269,236 $ 8,260,143 $ 23,865,491 $ 180,612,925 Interest rate-sensitive liabilities 105,760,050 60,029,858 33,751,475 19,751,725 219,293,108 Interest rate-sensitive gap 30,458,005 (47,760,622 ) (25,491,332 ) 4,113,766 (38,680,183 ) Net worth 16,604,318 Ratio of interest rate-sensitive assets to liabilities 82.36 Ratio of interest rate sensitivity gap to net worth (232.95 )
Note 1: The above amounts included only New Taiwan dollar amounts held by the head office and branches of the Bank (i.e., excluding foreign currency).
Note 2: Interest rate-sensitive assets and liabilities are interest-earning assets and interest-bearing liabilities with revenues or costs affected by interest rate changes.
Note 3: Interest rate sensitivity gap = Interest rate-sensitive assets － Interest rate-sensitive liabilities.
Note 4: Ratio of interest rate-sensitive assets to liabilities = Interest rate-sensitive assets/Interest rate-sensitive liabilities (in New Taiwan dollars).
Interest Rate Sensitivity December 31, 2006
(In Thousands of U.S. Dollars, %)
181 Days to Items 1 to 90 Days 91 to 180 Days Over One Year Total One Year Interest rate-sensitive assets $ 37,336 $ 12,919 $ 15,000 $ 145,408 $ 210,663 Interest rate-sensitive liabilities 101,012 13,884 59,577 - 174,473 Interest rate-sensitive gap (63,676 ) (965 ) (44,577 ) 145,408 36,190 Net worth (6,367 ) Ratio of interest rate-sensitive assets to liabilities 120.74 Ratio of interest rate sensitivity gap to net worth (568.40 )
Note 1: The above amounts included only U.S. dollar amounts held by the head office, domestic branches, OBU and overseas branches of the Bank and excluded contingent assets and contingent liabilities.
Note 2: Interest rate-sensitive assets and liabilities are interest-earning assets and interest-bearing liabilities with revenues or costs affected by interest rate changes.
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Note 3: Interest rate sensitivity gap = Interest rate-sensitive assets － Interest rate-sensitive liabilities.
Note 4: Ratio of interest rate-sensitive assets to liabilities = Interest rate-sensitive assets/Interest rate-sensitive liabilities (in U.S. dollars)
Item December 31, 2005 Ratio of interest rate-sensitive assets to liabilities (%) 71.34 Ratio of interest rate sensitivity gap to net worth (%) (288.08)
Note 1: Interest rate-sensitive assets and liabilities are interest-earning assets and interest-bearing liabilities with revenues or costs affected by interest rate changes.
Note 2: Ratio of interest rate-sensitive assets to liabilities = Interest rate-sensitive assets/Interest rate-sensitive liabilities (in New Taiwan dollars and with maturities of less than one year)
Note 3: Interest rate sensitivity gap = Interest rate-sensitive assets － Interest rate-sensitive liabilities d. Profitability
(%)
Year Ended Year Ended Items December 31, December 31, 2006 2005 Before income tax (5.93) 0.20 Return on total assets After income tax (4.51) 0.04 Before income tax (91.88) 2.53 Return on equity After income tax (69.90) 0.55 Net income ratio (298.39) 1.20
Note 1: Return on total assets = Income before (after) income tax/Average total assets
Note 2: Return on equity = Income before (after) income tax/Average equity
Note 3: Net income ratio = Income after income tax/Total net revenues
Note 4: Income before (after) income tax was the income in the years ended December 31, 2006 and 2005.
Note 5: The above profitability ratios are expressed annually.
e. Maturity analysis of assets and liabilities
Maturity Analysis of Assets and Liabilities December 31, 2006 (In Thousands of New Taiwan Dollars)
Remaining Period to Maturity Total 181 Days- 1-30 Days 31-90 Days 91-180 Days Over 1 Year 1 Year Main capital inflow on maturity $ 246,298,162 $ 56,874,062 $ 18,564,241 $ 19,958,527 $ 65,380,382 $ 85,520,950 Main capital outflow on maturity 321,153,066 31,024,724 36,915,090 41,355,388 149,189,082 62,668,782 Gap (74,854,904 ) 25,849,338 (18,350,849 ) (21,396,861 ) (83,808,700 ) 22,852,168
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Maturity Analysis of Assets and Liabilities December 31, 2005 (In Thousands of New Taiwan Dollars)
Remaining Period to Maturity Total 181 Days- 1-30 Days 31-90 Days 91-180 Days Over 1 Year 1 Year Main capital inflow on maturity $ 256,096,487 $ 56,233,431 $ 25,624,076 $ 15,344,453 $ 83,727,562 $ 75,166,965 Main capital outflow on maturity 235,948,211 32,581,270 41,107,023 47,490,028 91,845,560 22,924,330 Gap 20,148,276 23,652,161 (15,482,947 ) (32,145,575 ) (8,117,998 ) 52,242,635 Accumulated Gap 20,148,276 23,652,161 8,169,214 (23,976,361 ) (32,094,359 ) 20,148,276
Note: The above amounts included only New Taiwan dollar amounts held by the head office and domestic branches of the Bank (i.e., excluding foreign currency).
Maturity Analysis of Assets and Liabilities December 31, 2006 (In Thousands of U.S. Dollars)
Remaining Period to Maturity Total 181 Days- 1-30 Days 31-90 Days 91-180 Days Over 1 Year 1 Year Main capital inflow on maturity $ 253,512 $ 28,467 $ 17,180 $ 15,817 $ 29,981 $ 162,067 Main capital outflow on maturity 253,512 98,653 21,495 15,038 70,863 47,463 Gap - (70,186 ) (4,315 ) 779 (40,882 ) 114,604
Note: The above amounts included only U.S. dollar amounts held by the head office, domestic branches and OBU of the Bank. f. Operation and legal risk
Matters Requiring Special Notation
(In Thousands of New Taiwan Dollars)
Summary and Amount Causes December 31, 2006 December 31, 2005 Within the past year, a responsible person or None None professional employee violated the law in the course of business, resulting in an indictment by a prosecutor Within the past year, a fine was levied on the Bank None None for violations of the Banking Law Within the past year, misconduct occurred, resulting None None in the Ministry of Finance’s imposing strict corrective measures on the Bank Within the past year, the individual loss or total loss None None from employee fraud, accidental and material events, or failure to abide by the “Guidelines for Maintenance of Soundness of Financial Institutions” exceeded NT$50 million Other None None
Note 1: The term “within the past year” means one year before the balance sheet date.
Note 2: The term “a fine was levied on the Bank for violations of the related laws and regulations” means a fine levied by the Banking Bureau, Securities and Futures Bureau, Insurance Bureau or Examination Bureau.
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36. BORROWERS, GUARANTORS AND COLLATERAL PROVIDERS AS INTEREST PARTIES
(In Thousands of New Taiwan Dollars)
December 31, 2006 December 31, 2005 Loan Classification Based on Loan Classification Based on Repayment Status Repayment Status Loan Type Account Account Amount Nonperformi Amount Nonperformi Volume Normal Volume Normal ng Loans ng Loans Loans Loans
Consumer loans (Note 1) 1,407 $ 206,927 $ 206,927 $ - 1,307 $ 228,894 $ 228,871 $ 23 Loan for mortgage housing 214 482,743 480,459 2,284 176 397,970 397,970 - Other loans (Note 2) 47 9,684,660 9,448,422 236,238 88 10,390,380 10,390,380 - Guarantees 197 8,578,736 8,576,452 2,284 184 9,459,583 9,459,583 - Collateral providers 436 10,242,421 10,003,899 238,522 414 10,435,236 10,435,236 -
Note 1: Consumer loans are governed by Article 32 of the Banking Law in ROC.
Note 2: Other loans, except for consumer loans and loans for employees’ mortgage housing, are those of borrowers who are interest parties.
Note 3: The interest parties mentioned above are governed by Article 33-1 of the Banking Law in ROC.
37. TRUST BUSINESS UNDER THE TRUST LAW
a. Trust-related items, as shown in the following balance sheet and trust property list
Balance Sheet of Trust Accounts December 31, 2006 and 2005
Trust Assets 2006 2005 Trust Liabilities 2006 2005
Short-term Trust capital investments Money $ 33,571,510 $ 20,770,848 Bonds $ 19,546,000 $ 8,735,606 Securities 114,878 464,890 Mutual funds 14,025,510 12,035,242 Real property 8,400 - Common stock 114,878 464,890 Superficies 1,189,000 - Real property 8,400 - Intangible assets Superficies 1,189,000 -
Trust assets $ 34,883,788 $ 21,235,738 Trust liabilities $ 34,883,788 $ 21,235,738
Trust Property List December 31, 2006 and 2005
Investment Items 2006 2005
Short-term Bonds $ 19,546,000 $ 8,735,606 Mutual funds 14,025,510 12,035,242 Common stock 114,878 464,890 Real property Others 8,400 - Intangible assets Superficies 1,189,000 -
$ 34,883,788 $ 21,235,738
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b. Nature of trust business operations under the Trust Law: Note 1.
38. ADDITIONAL DISCLOSURES
Following are the additional disclosures required by the Securities and Futures Bureau for the Bank and its investees:
a. Related information of significant transactions and investees:
1) Investments accumulated or disposed of at costs or prices of at least NT$300 million or 10% of the paid-in capital: None
2) Acquisition of individual real estates at costs of at least NT$300 million or 10% of the paid-in capital: None
3) Disposal of individual real estates at costs of at least NT$300 million or 10% of the paid-in capital: None
4) Allowance of service fees to related parties amounting to at least NT$5 million: None
5) Receivables from related parties amounting to at least NT$300 million or 10% of the paid-in capital: None
6) Sale of nonperforming loans amounting to at least NT$5 billion: Note 15
7) Financial asset securitization: Note 12
8) Other significant transactions which may affect the decisions of users of financial reports: Note 1
9) Name, locations and other information of investees on which the Bank exercises significant influence: Table 1 (attached)
b. Investment in Mainland China: None.
39. SEGMENT INFORMATION
The Bank mainly conducts banking businesses. As of December 31, 2006, the Bank had no overseas operation department.
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TABLE 1
COSMOS BANK, TAIWAN
NAMES, LOCATIONS, AND OTHER INFORMATION OF INVESTEES ON WHICH THE COMPANY EXERCISES SIGNIFICANT INFLUENCE YEAR ENDED DECEMBER 31, 2006 (In Thousands of New Taiwan Dollars)
Investment Amount Balance as of December 31, 2006 Net Income Investment Investor Company Investee Company Location Main Businesses and Products December 31, December 31, Shares Percentage of Carrying (Loss) of the Note Gain (Loss) 2006 2005 (Thousands) Ownership Amount Investee
Cosmos Bank, Taiwan Cosmos Construction Management No. 31, Baocing St., Songshan Construction projects examinations and advisory $ 50,000 $ 50,000 6,991 9.39 $ - Note 1 Note 1 Note 1 (the “Bank”) Corporation (CCMC) District, Taipei services
The Bank Reliance Securities Investment Trust 4F, No. 50, Hsinsheng S. Rd., Issuing beneficiary certificates, investment and advisory 143,723 143,723 8,785 20.00 37,481 (28,029 ) (5,605 ) Corporation, Ltd. (RSIT) Sec. 1, Taipei
Note 1: Cosmos Construction Management issued common stock for cash during August 2006. The Bank did not purchase the issuance of common stock according to the original portion and lost significant influence. Therefore, this equity investment listed as financial asset carried at cost.
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