Contents

Highlights of the year ...... 3 Financial highlights...... 6 Chairman’s statement ...... 8 Chief Executive’s review ...... 10 Shareholder information ...... 12 Review of Group operations ...... 16 Performance ...... 17 Balance sheet ...... 21 Review of business areas: Retail Banking ...... 28 Corporate Banking ...... 30 Merchant Banking ...... 32 Capital Markets ...... 34 Asset Management ...... 37 Assed-based Financing ...... 40 Insurance Division – Sjóvá-Almennar ...... 42 Awards and Recognition...... 45 Risk Management ...... 48 Credit risk ...... 48 Financial risk ...... 50 Treasury & Risk Management ...... 52 Operating risk ...... 53 Human resources ...... 54 Information technology ...... 56 Corporate social responsibility ...... 57 Annual accounts ...... 61 Signatures ...... 62 Auditors’ report...... 63 Profit and loss account ...... 64 Balance sheet ...... 66 Statement of cash flows...... 68 Accounting principles and notes ...... 70 Sjóvá-Almennar – Annual accounts ...... 94 Profit and loss account ...... 95 Balance sheet ...... 96 Corporate governance ...... 98 Highlights of the year 2003

Best performance ever for Íslandsbanki

Return on equity 30%

Total assets increased by 42%

Cost/income ratio 50% for banking activities

Earnings per share ISK 0.63

The Board of Directors moves that shareholders be paid a dividend of ISK 0.23 per share

ISB acquired Sjóvá-Almennar Insurance, which is now a subsidiary of the Bank

New branch opened in Luxembourg and the London office received a branch licence

At year-end, some 19% of outstanding loans were to customers outside of Iceland

Moody’s raised ISB’s credit rating to A1

3 1905 1935 1961 Fiskveiðasjóður Iðnlánasjóður Verzlunarbanki Íslands Fisheries Investment Fund Industrial Loan Fund Iceland Bank of Commerce The Icelandic Fisheries Investment Fund was During the Depression years 1930-1940, Commerce expanded as the established in 1905 to encourage the the Industrial Loan Fund was set up to 20th century progressed and in development of the fishing industry. It provide support for manufacturing in 1961 Icelandic merchants took provided loans for purchase of fishing Iceland. It provided loans for purchase of the initiative of establishing vessels and gear and supported a variety of machinery and equipment, as well as Verzlunarbanki Íslands, Iceland actions to further progress of the industry. operating loans. Bank of Commerce. 1904 1904 1930 1953

Útvegsbanki Íslands Iðnaðarbanki Íslands Íslandsbanki Fisheries Bank of Iceland Industrial Bank of Iceland The original Íslandsbanki opened The Fisheries Bank of Iceland was The Industrial Bank opened in in 1904, the first year of Icelandic established in April 1930, taking 1953 with the objective of Home Rule, as the first Icelandic over the assets and liabilities of promoting manufacturing and bank in the form of a limited- the original Íslandsbanki, which small-scale industry in Iceland. liability company. The bank laid had recently closed. It was to the foundation for expanding provide special support for fisheries and boosted Icelandic fisheries, manufacturing and industry and enterprise. commerce.

The first advertisement by the original Íslandsbanki in 1904: Íslands banki has opened for business. Hours of service are from 10 am to 3 pm and from 6:30 to 7:30 pm weekdays. Appointments may be requested with the Board of Directors during opening hours. Reykjavík, 7 June 1904. The Bank’s Board of Directors A Century of Financial History

1971 1998 Alþýðubanki FBA Union Bank The Icelandic Investment Bank Íslandsbanki Icelandic workers acquired their own bank in FBA, the Icelandic Investment Bank began Íslandsbanki leads the way in financial 1971 with the opening of the Union Bank, where operations in 1998, taking over the activities of the market innovation, most recently with its Icelandic trade unions were majority owners. Fisheries Investment Fund, Industrial Loan Fund acquisition of the insurance company The objectives of the bank included increasing and Industrial Development Fund. The objective Sjóvá-Almennar in order to increase employment security for wage earners and in establishing FBA was to strengthen the financial services offered to customers. promoting industrial development. market and reduce state ownership. 1970 1990 2000 2004

Iðnþróunarsjóður Industrial Development Fund Íslandsbanki Íslandsbanki FBA In 1970, governments in the The creation of the largest In 2000 Íslandsbanki merged with Nordic countries agreed to privately owned bank in Iceland FBA to form the most powerful establish an industrial in 1990 marked a turning point enterprise on the Icelandic development fund for Iceland in financial life. Íslandsbanki financial market and a leading to facilitate the country’s hf. was created through the business actor. adaptation to new market merger of Bank of Commerce, conditions after becoming an Fisheries Bank, Industrial Bank EFTA member. and Union Bank.

Íslandsbanki builds on a solid heritage, with roots extending back to 1904, when the original Íslandsbanki opened. Other banks and funds would follow, to serve the needs of households and specific industrial sectors, accelerating industrial development and bringing better living standards. Financial highlights

Amounts in millions of ISK

Profit and Loss Account 2003 2002 2001 20001) Net operating income 11,039 9,708 10,049 7,344 Other operating income 9,578 4,366 2,872 3,295 Net operating income 20,617 14,074 12,921 10,639 Salaries and related expenses 5,422 4,302 3,752 3,486 Other expenses 3,651 2,879 2,875 2,905 Depreciation 712 542 474 436 Other operating expenses 9,785 7,723 7,101 6,827 Claims, net of reinsurance -1,540 – – – Provision for losses on the loan portfolio -2,864 -2,184 -2,113 -1,227 Appraisal change on investment securities – – – -1,657 Profit before taxes 6,428 4,167 3,707 928 Taxes -593 -760 -567 -266 Profit 5,835 3,407 3,140 662

Balance Sheet Average total assets 365,395 323,764 323,287 267,452 Total assets 443,943 312,367 348,211 296,917 Equity 29,423 20,964 20,287 16,917 Share capital 10,080 9,400 9,700 9,895

Key ratios Return on equity 2) 30.1% 18.2% 24.5% 6.8% Return on equity before taxes 2) 33.1% 22.3% 28.0% 8.3% CAD ratio 11.4% 12.7% 12.2% 9.7% Tier I 8.0% 10.1% 9.0% 7.5% Solvency ratio 3.6 Cost/income – banking 50.0% 54.8% 55.0% 64.2% Cost/income – insurance 31.9% Provision for losses as % of loans and guarantees 0.9% 0.8% 0.8% 0.5% Loss ratio 82.5% Average number of employees 948 907 940 959 Employees at year-end 1,085 870 886 922

Percentages of average total assets Interest margin 3.0% 3.0% 3.1% 2.7% Other income 2.6% 1.3% 0.9% 1.2% Expenses 2.7% 2.4% 2.2% 2.6% Provision for losses on the loan portfolio 0.8% 0.7% 0.7% 0.5% Profit 1.6% 1.1% 1.0% 0.2%

1) The merger between Íslandsbanki and FBA took place in June 2000. 2) Return on shareholders’ equity adjusted for dividend and changes in shares outstanding.

6 Financial highlights

Profit Return on equity ISK m 35% 6,428 33.1 6,000 5,835 30% 30.1 28.0 5,000 25% 4,167 24.5 4,000 3,707 20% 22.3 3,407 3,140 18.2 3,000 15%

2,000 10%

928 8.3 1,000 662 5% 6.8

0 0% 2000 2001 2002 2003 2000 2001 2002 2003 Profit before taxes Net profit Return on equity before taxes Return on equity

Total assets at year-end Percentages of average total assets ISK m 3.5% 443,943 3.0% 400,000 348,211 2.5% 312,367 296,917 300,000 2.0%

200,000 1.5%

1.0% 100,000 0.5%

0 16,917 20,287 20,964 29,423 0.0% 2000 2001 2002 2003 2000 2001 2002 2003

Equity Interest margin Other income Expenses Provision for losses on the loan portfolio Profit

Capital adequacy ratio (CAD) Capital allocation 14% 12.7% 12.2% 12% 11.4% 2.6% Other 3.2% Retail Banking 10% 9.7% 17% 3.4% 24% Treasury & 2.2% 8% Risk Management 5% Insurance 9% 6% Division 7.5% 10.1% 9.0% 7% 29% 4% 8.0% Asset-based Corporate Financing 9% Banking 2% Merchant Banking 0% 2000 2001 2002 2003

Tier I Tier II

7 Chairman’s statement

In the course of only a At times like this, the principal threat to industry is that of few years, numerous misguided economic policy. Due to the approaching danger changes to the infra- of overheating in the economy, created by the construction structure of the of power plants and aluminium smelters, there is a need for Icelandic economy have restraint in public spending, both by the national govern- taken place in rapid suc- ment and local authorities. Developments of the scale now cession. The entire busi- getting underway can have a crowding-out effect, and ness environment has deprive the country of part of the advantages that flourish- undergone a major ing domestic companies competing with foreign enterprises overhaul, which has can bring the nation in the coming years. Unfortunately, the unleashed the power of economic trends of the past year reflect a certain skepticism individual innovation towards the economic management, as revealed for and initiative to the instance in the króna exchange rate development. Under benefit of the entire nation. By globalising and de-regulating such circumstances, the performance trends in various sec- society, Iceland has opened up for itself a great number of tors of industry have differed widely. While those companies new opportunities, which it has then taken advantage of for serving the domestic market have grown and expanded, further development and value creation. With open minds companies exporting abroad, or which must compete with and an entrepreneurial spirit, Icelanders have created a place imports, have had to grapple with the high exchange rate, for themselves among the nations of the world with the which has damaged their profitability and competitive highest per capita income. We can be proud of and satisfied position. This situation threatens to create an economic with this achievement. disequilibrium which may prove difficult to correct without resulting in reduced purchasing power, increased unemploy- There is little cause for anything but optimism at this point ment and, in the worst case, economic stagnation or even in time, with regard to the future of the Icelandic economy. contraction. The soaring current account deficit, unfortu- A solid framework and dependable infrastructure has nately, is an indication in this direction. enabled the economy to recover and expand anew following a temporary downturn. Productivity has increased, asset Although the past year in many respects holds out rich prices have been rising, the employment situation has promises of an approaching economic upswing, which we improved and price level stability has prevailed. Encouraged should of course welcome, we still must tread cautiously. by increasing purchasing power, lower interest rates and Opportunities arise when we create the space and environ- expectations of an economic upswing, consumer spending ment for broad-based economic growth, enabling us to and household investments have grown. Corporate opera- make the best use of our inherent advantages. tions have also expanded. Good performance Íslandsbanki’s performance this past year was exceptional, A challenge for economic policy and the best ever since the Bank’s establishment. Ahead of us is a period of major industrial projects. The Substantial growth has characterised its operations, both in investments involved will have a substantial impact on all of Iceland and abroad. ISB’s total assets as of 31 December 2003 business and industry in Iceland. These projects open up amounted to ISK 444 billion, an increase of 42% during the major opportunities, which can return a permanent eco- year. Pre-tax profits were ISK 6,428 million and ISK 5,835 nomic advantage to the nation, if put to proper advantage. million after taxes. Earnings per share were ISK 0.63, which Despite the fact that the projects have only just begun, the is an increase of 75% from the previous year. Return on equi- efficiency of the market has shifted at least part of their ty was also a record high of 30.1%. The objective which the economic impact forward in time. A sizeable share of the Bank set itself of lowering its cost/income ratio to 50% was economic growth in the past year can thus be attributed to achieved this year for the first time. Increased cost restraint consumer expectations of improved economic circum- and growth both contributed to this outcome. Both loans stances in connection with this industrial development. and deposits increased substantially during the year, while

8 Chairman’s statement

lending to parties abroad continued to grow, and comprised Iceland during the early years of the last century, when the around one-third of the total loans of Corporate Banking and mechanisation of fishing boats began and trawler fisheries Merchant Banking. Rising equity and bond prices account for commenced. All of it was the result of new foreign venture the largest share of profits, or ISK 2.7 billion. Provisions for capital, which flowed into the country with the establish- loan losses amounted to ISK 2.9 billion, and have increased ment of Íslandsbanki. This important milestone will be over the previous year. In accordance with ISB’s shareholder celebrated, because our history stretches in a continuous line policy, the Board of Directors has agreed to move at the from this point onwards, although for some time the Bank Annual General Meeting that shareholders be paid a divi- had a different name. dend of 23%, which is equivalent to 41% of profits.

The price development of the Bank’s shares was especially Awards favourable this past year. Share price at the beginning of the During the past year, as so often before, ISB has received year was 4.74, and closed at year-end at 6.40, an increase of various types of recognition. We could mention, for instance, 35% during the year. Shareholders increased in number, from that the Association of Icelandic Economists awarded the 2003 10,688 at the beginning of the year to 11,045 at year-end. As Bank the Icelandic Knowledge Award for , for exception- has been the case in recent years, trading in the company’s al corporate culture and internal marketing. The three inter- shares was the highest of any company on the Iceland Stock national financial journals which select the bank of the year Exchange, which shows clearly the marketability of ISB’s in Iceland, Euromoney, The Banker and Global Finance, chose shares. All the employees of the Bank and the insurance ISB as the country’s best bank for the second consecutive company will receive a special bonus due to its fine perform- year. Furthermore, Sjóvá-Almennar received the Icelandic 2003 ance. Quality Award for and also the award Striking the Balance, for its efforts towards facilitating a positive work- life balance for employees. Increasing activities With an eye to boosting and expanding operations, and Cornerstones increasing the services offered to customers, ISB has The Board of Directors has emphasised the need to co-ordi- acquired the insurance company Sjóvá-Almennar tryggingar. nate the efforts of the Íslandsbanki Group so that its By the end of 2003, ISB had acquired all the share capital of strength and capability can be put to best advantage. this, the largest insurance company in Iceland. It is now To that end, the following Cornerstones have been defined operated as a subsidiary of the Bank. Integration of banking upon which to build: and insurance operations is underway and, according to all the indications, the joint operation of the two companies Customers first – Proactive and dynamic should result in considerable savings. ISB opened a branch in Trust and integrity – Performance Luxembourg last spring which mainly provides services for The Board of Directors hopes that each employee will always small and medium-size commercial and savings banks in keep these Cornerstones at the forefront of his or her mind, Nordic countries. Its successful operations this year indicate and they will be reflected in the success of our efforts. good future prospects. The Bank’s office in London has been changed to a branch, providing in the main services to inter- On behalf of the Board of Directors I would like to express national seafood industry and supporting the expansion of my thanks to the CEO, Managing Directors and all of Icelandic companies abroad. Íslandsbanki’s employees for their fine efforts and enjoyable relations. I would also like to thank the customers of Celebrating a centennial of service Íslandsbanki and Sjóvá-Almennar for doing business with us during the past year, and express my hope that they will The 7th of June this coming summer marks the 100th continue to do so for many years to come. anniversary of the founding of the original Íslandsbanki. It took place only four months after Iceland was granted Home Rule in 1904. The establishment of the bank is regarded as a leading factor in the enormous advances which occurred in

9 Chief Executive’s review

Comparison with Nordic banks As far as economy of operations is concerned, ISB compares highly favourably with other financial institutions in Iceland, as it has been the most cost-efficient of the banks through the years. In 2003, we achieved our long-term goal of bring- ing the cost/income ratio of banking operations down to 50%. In recent years, ISB has looked in particular to other leading banks in the Nordic countries for comparison: Danske Bank, Svenska Handelsbanken, DnB NOR and Nordea. In terms of cost/income ratio, ISB compares favourably with these banks.

Cost/income ratio 2001–2003

Strong growth and high profitability characterised ISB’s Svenska 2001 activities in 2003. Earnings on operations grew steadily Handelsbanken 2002 Íslandsbanki 2003 throughout the year and the 30% return on equity is practi- cally unique in the Íslandsbanki’s history. The financial Danske Bank

position is strong, with growth in almost all areas of opera- Nordea tions. The acquisition of Sjóvá-Almennar is a decisive step, DnB NOR which adds new breadth to the company and offers new 0% 10% 20% 30% 40% 50% 60% 70% opportunities on the domestic market. At the same time As reported by the banks there has been considerable growth in foreign activities in a number of areas. Similarly, ISB’s profitability has been high in recent years. In comparison to other Nordic banks, ISB’s operating New environment performance is enviable. In recent years, the Icelandic financial market has undergone rapid development. Since 1998, when FBA – The Icelandic Return on equity 2001–2003 Investment Bank began operation, and later merged with 2000 Íslandsbanki in , the entire financial environment in Íslandsbanki Iceland has been transformed. The privatisation of former Svenska state banks has greatly spurred competition on the domestic Handelsbanken market, while at the same time the banks have sought new Danske Bank 2001 opportunities abroad. Nordea 2002 The increased competition has not, however, resulted in DnB NOR 2003 greatly improved efficiency in the banking system as a 0% 5%10%15%20% 25% 30% 35% whole. Increased cost efficiency was not the principal As reported by the banks objective of the privatisation of the state-owned commercial banks; ISB’s participation in the process was thus rejected. The Bank’s capital adequacy is solid; at the end of last year Nor are recent actions by the government to maintain the ISB’s capital adequacy ration was 11.4%. Of this, Tier I capital savings banks in their present form conducive to consolidat- was 8.0%. Following its acquisition of Sjóvá-Almennar, ISB ing in the banking system. Icelandic banks’ possibilities to has reviewed its objective with regard to Tier I capital. The increase the cost-efficiency of their domestic operations are group now aims at having this above 7% rather than around thus limited to internal growth and integration with other 8% as previously. The Bank’s CAD ratio is considerably higher financial institutions such as insurance companies. than that of comparable Nordic banks.

10 Chief Executive’s review

employees share a common vision and speak with one CAD ratios at year-end 2003 voice.

Íslandsbanki At the same time, ISB does its best to ensure that the inter-

Danske Bank ests of employees and shareholders go hand in hand. Svenska In accordance with the policy of the Board of Directors on Handelsbanken performance-linked salaries, all employees of the Group DnB NOR received a bonus of ISK 241,200 as a result of its 2003 oper- Nordea ating performance. In addition, the salaries of a large group

0% 2% 4% 6% 8% 10% 12% of employees are linked to the Bank’s EVA. Performance- Tier I Tier II linked salaries are intended to ensure that the interests of As reported by the banks employees, the company and its shareholders coincide as closely as possible. In parallel to ISB’s acquisition of Sjóvá- Proactive, with a strong tradition Almennar, all of the Group’s employees were offered shares in the Bank, and most of them accepted this offer. The success of ISB’s operations is rooted in its combination of strong tradition and innovation. Cost awareness and integrity towards customers are at the core of the compa- Opportunities for the Future ny’s activities, while at the same time ambition and initia- The management of ISB has always borne in mind that a tive have brought success to both our Bank and its strong infrastructure is the premise for good profitability customers. We want to preserve these important key values and future growth. This policy has proved its value in the in ISB’s activities; they have been put into words as our operating surpluses of recent years and we intend to contin- corporate values, the Cornerstones. ue along this path. ISB is extremely well prepared to meet Last year, ISB launched a special programme for the Group’s increased competition and take advantage of the opportuni- employees which has no parallel among Icelandic compa- ties ahead – to the advantage of our customers and our nies. All of ISB’s and Sjóvá-Almennar’s employees learn of shareholders. the company’s history and activities, its products and services, corporate values and future objectives. In this way we co-ordinate our efforts for the future, so that all our

11 Shareholder information

Íslandsbanki’s shares are listed on the Iceland Stock Exchange (ICEX). There are 10.5 billion listed shares with a nominal value of ISK 1.00 each. The same rights attach to all shares in ISB and each share represents one vote at shareholders’ meetings. All shares are freely transferable to both Icelandic and foreign citizens.

At the Annual General Meeting in March 2003, shareholders Price development and trading volume approved an amendment to the company’s Articles of of ISB shares in 2003 Association decreasing share capital from 10 billion to 7.0 ISK bn 9 billion shares, with the aim to maximise utilisation of Price (left axis) 6.5 25 equity. In connection with the acquisition of Sjóvá- Volume (right axis) Almennar, a shareholders’ meeting in October authorised 6.0 20 an increase in share capital of 1.5 billion shares, bringing the total number of listed shares to 10.5 billion at year-end. 5.5 15

5.0 10

Market capitalisation 4.5 5 At year-end 2003 the market capitalisation of ISB was ISK 64 5 20 4.0 0 . billion. Market capitalisation rose by ISK billion Jan Feb Mar Apr May Jun Jun Aug Sep Oct Nov Dec during the year, but this increase includes the acquisition of Sjóvá-Almennar and the increase in share capital this involved. In terms of market capitalisation, ISB was the 76 billion, which was 14% of the total turnover of listed equi- 2003 third-largest company on ICEX at year-end . ties during the year. Turnover in ISB’s shares in 2003 repre- 15 14 5 The weighting of ISB in the ICEX- Index is around . %. sents around 147% of its average outstanding share capital during the year. Price development The price of ISB’s shares rose by 35% in 2003. During this Shareholders same period the ICEX Finance and Insurance sector index At year-end 2003, ISB’s shareholders were 11,045 in number, rose by 53% and the ICEX-15 Index by 56%. as compared to 10,688 at the beginning of the year. In In 2003, shares of ISB were the most-traded shares of any November, a number of shareholders in Sjóvá-Almennar company listed on ICEX. Aggregate share turnover was ISK tryggingar hf. accepted the offer to exchange their shares for shares in ISB at a price of 5 95 Changes in ISB’s shares 2001–2003 ISK . per share. Almost all shares in ISB Outstanding Shares Share Outstanding Date before change issued/purchased price after change are owned by domestic par- 20/12/2001 9,895,000,000 -195,000,000 4.18 9,700,000,000 ties. A total of 20 sharehold- 30/04/2002 9,700,000,000 -100,000,000 4.90 9,600,000,000 ers owned over 100 million 26/07/2002 9,600,000,000 -100,000,000 4.83 9,500,000,000 29/10/2002 9,500,000,000 -100,000,000 4.80 9,400,000,000 shares, with their total 28/01/2003 9,400,000,000 -400,000,000 4.71 9,000,000,000 holding amounting to 06/10/2003 9,000,000,000 500,000,000 5.95 9,500,000,000 around 54% of the outstand- 23/10/2003 9,500,000,000 500,000,000 5.95 10,000,000,000 10/11/2003 10,000,000,000 500,000,000 5.95 10,500,000,000 ing share capital at year-end 03/12/2003 10,500,000,000 -420,000,000 6.60 10,080,000,000 2003.

On 10 March 2003, the AGM authorised a reduction of share capital from 10 billion shares to 9 billion shares. On 3 October 2003, a shareholders’ meeting authorised an increase of share capital from 9 billion shares to 10.5 billion shares.

12 Shareholder information

Distribution of shares by size of holding ISB’s International credit ratings

Number of shares owned Shareholders Shares Moody’s Investors Service number proportion number proportion Long-term rating A1 1–100,000 6,791 61.5% 235,287,448 2.2% Short-term rating P-1 100,001–1,000,000 3,686 33.4% 1,047,100,280 10.0% Financial strength B- 1,000,001–10,000,000 475 4.3% 1,238,897,790 11.8% 10,000,001–100,000,000 73 0.7% 2,284,211,134 21.8% Fitch Ratings Over 100,000,000 20 0.2% 5,694,503,348 54.2% Long-term rating A Total: 11,045 10,500,000,000 Short-term rating F1 Individual C Support 2

Dividend policy 40 ISB’s policy is to pay % of profits to shareholders in the Financial calendar for 2004 form of dividends, provided that the equity position is in line with targets. The Board of Directors has decided to move at Anticipated publication dates for ISB’s interim financial 2004 ISB’s AGM on 8 March 2004 that a dividend of ISK 0.23 per statements in are as follows: share be paid for the year 2003, or the equivalent of 41% of 1st quarter: 30 April 2004 the year’s profit. By comparison, the dividend for the year 2nd quarter: 27 July 2004 2002 amounted to ISK 0.17 per share. 3rd quarter: 26 October 2004 4th quarter: 28 January 2005 Largest shareholders at year-end 2003 ISB shares Share Lífeyrissjóður verslunarmanna (pension fund) 8.6% 2003 2002 2001 2000 Lífeyrissjóðurinn Framsýn (pension fund) 7.3% Share price at year-end 6.40 4.74 4.34 4.15 Straumur Fjárfestingarbanki hf. (investment bank) 5.8% Highest closing price Lífeyrissjóðir Bankastræti 7 (pension fund) 4.8% 6.65 5.10 4.34 5.30* Lowest closing price Kaldbakur hf. (investment company) 4.2% 4.64 4.34 3.66 4.07* Framtak Fjárfestingarbanki hf. (investment bank) 4.0% Price to earnings (P/E ratio) 11.1 13.1 13.4 62.0 Íslandsbanki 2.7% Market capitalisation at Lífeyrissjóður sjómanna (pension fund) 1.9% year end (ISK millions) 64,512 44,556 42,098 41,064 MP Fjárfestingarbanki hf. (investment bank) 1.7% Authorised shares at Hafsilfur ehf. (holding company) 1.4% year-end (millions) 10,500 10,000 10,000 10,000 Hrómundur ehf. (holding company) 1.4% Outstanding shares at Total 43.9% year-end (millions) 10,080 9,400 9,700 9,895

Key figures per share Net earnings per share (ISK) 0.63 0.36 0.32 0.07 Dividend per share (ISK) 0.23 0.17 0.13 0.05 Equity per share at year-end (ISK) 2.92 2.23 2.09 1.71 Credit rating Dividend per share/earnings per share 41% 45% 40% 75%

ISB’s is rated by two international rating agencies: Moody’s * After the merger of Íslandsbanki and FBA. Investors Service and Fitch Ratings. Moody’s upgraded ISB in April 2003, raising its long-term credit rating to A1 from A2 and the financial strength rating to B- from C+. These rat- ings are the highest of any Icelandic bank. Moody’s rates ISB’s short-term liabilities P-1. Fitch Ratings confirmed its A long-term rating and F1 short-term rating for ISB in July 2003.

13 Jón forseti RE 108 sailing into its home port, Reykjavík, for the first time in 1907. A Force for Industrial Development

From its very beginnings, Íslandsbanki has been a solid supporter of industrial development. The first trawler built for Icelanders, Jón forseti, was financed to a large extent with loan financing provided by the original Íslandsbanki. The Bank has put its knowledge of industry to work in assisting Icelandic enterprises expanding abroad, and in serving international corporations, for instance, in the seafood industry. Review of Group operations

Íslandsbanki’s operations were highly successful in 2003. Not only was the return on equity of 30.1% the highest ever, considerably exceeding the Bank’s long-term objectives, but revenue and profit growth also exceeded expectations. The equity position is very strong, and well in line with the Bank’s stated objectives. Provisions for loan losses were higher than the average aimed at by the Bank. The cost/income ratio for banking activities was 50.0% in 2003, which is in line with long-term financial goals.

In connection with its purchase of Sjóvá-Almennar Insurance employees’ interests go hand in hand. Shareholder value is Ltd., the Board of Directors of Íslandsbanki reviewed the evaluated in terms of Economic Value-added (EVA®). EVA Group’s financial objectives. They remain for the most part brings accounting methods more into line with economic unchanged, with the exception of references for the CAD reality and takes the company’s market value into considera- ratio. The goal will now be to keep Tier I capital at 7% or tion to a greater extent than do other assessments. higher, whereas the previous objective was to have Tier I Bank operations are organised into profit centres, comprised capital around 8%. As far as Sjóvá-Almennar are concerned, of profit units. Each profit unit has separate accounts, and in the aim is to maintain a solvency ratio, i.e. solvency as a calculating the profit and EVA of each their shares in the proportion of minimum solvency, above 3. According to the cost of operating support units, management costs and objectives, the cost/income ratio for insurance activities will costs of capital are included. be 17% and the aim will be to have a loss ratio of 75–80%. The aim will continue to be to pay out around 40% of the Group’s profit as a dividend, as long as its equity position is Performance in accordance with its objectives. The following discussion of the performance and financials Íslandsbanki emphasises building shareholder value through of Íslandsbanki in 2003 is based on the consolidated profitability, growth and stability. The Bank seeks to gener- financial statements of the Bank and its subsidiaries, unless ate value and keep costs down. Shareholders’ interests and otherwise stated.

Financial goals of the Íslandsbanki Group and 2003 results

Íslandsbanki Sjóvá-Almennar Íslandsbanki Group 2003 results*

Return on equity (ROE) At least non-indexed Return on equity 30.1% benchmark bonds plus 6%

Financial strength Solvency ratio above 3.0 CAD ratio above 10% CAD ratio 11.4% Tier I Capital over 7% Tier I capital 8.0% Solvency ratio 3.6%

Growth of revenue 7–15% Revenue 46.5% and profit Profit 71.3%

Cost/income Less than 50% Less than 17% Banking activities 50.0% ratio Insurance activities 31.9%

Provision for loan losses Less than 0.5% Less than 0.5% Provision for loan losses 0.8% over the cycle over the cycle

Loss ratio 75–80% on average Loss ratio 82.5%

Dividends 40% of profit, if CAD ratio Proposal for a 41% dividend accordswith the goals

* Only the fourth quarter results for Sjóvá-Almennar

16 Review of Group operations

Quarterly performance in 2003 ISK m Q1 Q2 Q3 Q4 Total

Net interest income 2,525 2,536 2,754 3,224 11,039 Other operating income 1,455 1,817 2,120 4,186 9,578 Net operating income 3,980 4,353 4,874 7,410 20,617 Other operating expenses -2,180 -2,107 -2,059 -3,439 -9,785 Claims, net of reinsurance – – – -1,540 -1,540 Provision for losses -504 -610 -805 -945 -2,864 Pre-tax profit 1,296 1,636 2,010 1,486 6,428 Taxes -234 -294 -311 246 -593 Profit 1,062 1,342 1,699 1,732 5,835

In 2003 Íslandsbanki’s net profit before taxes amounted to Return on equity ISK 6,428 million and profit after taxes was ISK 5,835 million. 35% By comparison, pre-tax profit the previous year was ISK 33.1% 4,167 million and ISK 3,407 million after taxes. After-tax 30% 30.1% profit thus grew by 71.3%. Profit was greatest in Q4, ISK 1,732 million, of which ISK 422 million was tax savings 25% resulting from the acquisition of the investment bank 20% 22.3% 1 Framtak fjárfestingarbanki. Profit was lowest in Q , 18.2% ISK 1,062 million. Earnings per share amounted to ISK 0.63 15% in 2003 as compared to ISK 0.36 the previous year. 10% Each share is ISK 1.00. Return on equity was 30.1%, as compared to 18.2% in 2002. The Bank’s EVA was ISK 3,490 5% million in 2002, as compared with ISK 76 million in 2002. 0% EVA is profit after taxes, less the cost of capital deployed 2002 2003 on operations. Cost of capital is the equity market’s required Return on equity before taxes Return on equity rate of return on shares in Íslandsbanki and was estimated in calculations 12.5% in 2003. Net interest income amounted All the Bank’s profit centres returned a pre-tax profit in to ISK 11,039 million, other operating income ISK 9,578 2003, and most of them had a positive EVA. The pre-tax million and other operating expense 9,785 million, claims profits of Retail Banking and Corporate Finance were ISK 897 net of reinsurance amounted to ISK 1,540 million, provisions million and ISK 854 million respectively. Merchant Banking for loan losses ISK 2,864 million and income tax ISK 593 returned a profit of ISK 475 million, Capital Markets’ pre-tax million. profit was ISK 1,044 million and the pre-tax profit of Asset In 2003, Íslandsbanki purchased Sjóvá-Almennar Insurance, Management was ISK 270 million. The pre-tax profit of which is now a subsidiary of the Bank. Sjóvá-Almennar is Asset-based Financing (Glitnir) amounted to ISK 346 million. part of the consolidated accounts as of 1 October 2003. Treasury and Risk Management, which now includes, for This company’s performance is thus only included in instance, the Bank’s proprietary trading, generated a pre-tax Íslandsbanki’s consolidated accounts in the 4th quarter. At profit of ISK 2,267 million. The Insurance Division (Sjóvá- the time of the purchase, shares owned by Sjóvá-Almennar Almennar) is included in the Bank’s accounts in Q4 for the were assessed at market value and in the Bank’s consolidat- first time, with a profit of ISK 188 million. In calculating the ed accounts the reappraisal value of the shares is entered to profit of individual profit centres, their operating expenses reduce goodwill resulting from the acquisition. include their share in the overheads of support units, Íslandsbanki’s share in Sjóvá-Almennar’s after-tax profit for management costs and cost of capital. All such expenses the year amounts to ISK 151 million. are fully apportioned among the profit centres.

17 Review of Group operations

Performance of business units 2003

Retail Corp. Merchant Capital Asset Asset-b. Treasury & Insurance Group Banking Banking Banking Markets Mgmt Financing Risk Mgmt Division Other Net interest income 11,039 5,555 2,159 1,251 435 25 923 479 402 -190 Other operating income 9,578 1,571 64 269 1,182 948 160 2,095 2,214 1,075 Net operating income 20,617 7,126 2,223 1,520 1,617 973 1,083 2,574 2,616 885 Other operating expenses -9,785 -4,915 -644 -607 -573 -703 -431 -282 -788 -842 Claims, net of reinsurance -1,540 0 0 0 0 0 0 0 -1,540 0 Provisions for loan losses -2,864 -1,314 -725 -438 0 0 -306 -25 -100 44 Profit before taxes 6,428 897 854 475 1,044 270 346 2,267 188 87 Economic Value-added 3,490 159 -170 382 802 202 159 1,737 -103 322

Net interest income fourth quarter, ISK 4,186 million, and lowest in the first quar- 1 455 4 Net interest income amounted to ISK 11,039 million in 2003, ter, ISK , million. High Q income is partly the result of an increase of 13.7% from the previous year, which can be the inclusion of Sjóvá-Almennar, as insurance premiums net attributed to the Bank’s balance sheet growth, while aver- of reinsurance and bonuses and rebates from reinsurers 1 906 age total assets increased by 13% over the previous year. Net amounted to ISK , million. interest income was greatest in Q4, amounting to ISK 3,224 Other operating income million. The interest rate margin, as a percentage of average ISK m 3,752 total assets for the year, was 3.0%, which is the same as for 3,500 3,480 2002. The interest rate margin decreased as the year pro- 3,000 2,905 gressed, however, dropping from 3.2% in Q1 to 2.9% in Q4. 2,500 2,000 1,906 Net operating income 1,500 ISK m 1,000 786 625 500 196 229 20,000 65 46.5% 0 2002 2003 15,000 Dividends from shares Trading, Trading gain on other and other holdings net financial activities 31.0% Sundry operating income Insurance premiums net 10,000 53.5% 69.0% 2003 5,000 Earnings on shares and other holdings in amounted to ISK 786 million, as compared to a loss of ISK 196 million the previous year. The main contributing factor here is a 0 2002 2003 share of ISK 647 million in profit made by the investment Net interest income Other operating income Earnings on shares and other holdings

ISK m 2003 2002 Other operating income Straumur Investment Bank ...... 647 153 MasterCard Iceland ...... 68 66 Other operating income was ISK 9,578 million in 2002, VISA Iceland ...... 21 33 having risen by ISK 5,212 million from the previous year. Icelandic Banks’ Data Centre ...... 21 22 Íslensk endurtrygging reinsurance ...... 20 – The major factor here is the greatly improved performance Fasteign real estate holding company ...... 12 – of trading book equities, in addition to which the inclusion Other ...... -3 -78 of Sjóvá-Almennar also has a substantial impact. On a Total 786 196 quarterly basis, other operating income was highest in the

18 Review of Group operations

bank Straumur, while ISB’s profit share in Straumur was tially. Bond trading generated a profit of ISK 242 million in ISK 153 million in 2002. 2003 as compared to a profit of ISK 401 million in 2002. Interest rates on government-guaranteed indexed bonds Income from fees and commissions, gross dropped by 0.55–0.62 percentage points in 2003, contribut- ing to higher bond prices. Exchange rate gain on exposures ISK m 2003 2002 Foreign exchange...... 713 792 of foreign-denominated assets and liabilities amounted to Loans ...... 604 708 ISK 68 million as compared to an ISK 258 million loss in Payment processing...... 1,292 1,165 2002 Asset management ...... 652 503 . Securities trading...... 781 603 Corporate advisory ...... 229 183 Yield on benchmark bonds in 2003 Other commission income ...... 401 345 Total 4,672 4,299 5.5%

5.0% Income from service charges and commissions was ISK 4,672 million, increasing by ISK 373 million from the previous year, 4.5% or 8.7%. Service expenses increased by 12.3% and amounted to ISK 920 million. Service revenues net of service expense 4.0% increased by ISK 272 million or 7.8%. The greatest increase was in income from asset management, securities brokering 3.5% and consultancy services. Jan Mar May Jul Sep Nov Jan RIKS 15 IBH 41 IBH 26 Trading, net

ISK m 2003 2002 Sundry operating income was ISK 229 million in 2003, as Trading shares ...... 2,595 -78 against ISK 625 million the previous year. That year there Trading bonds ...... 242 401 Foreign exchange ...... 68 -258 was a profit of ISK 330 million resulting from the newly Total 2,905 65 established real estate holding company.

Other operating expenses Trading gain on other financial activities amounted to ISK Other operating expenses totalled ISK 9,785 million in 2003, 2,905 million, as compared to a gain of ISK 65 million in an increase of ISK 2,062 million or 26.7% from 2002. 2002. Gain on trading securities was ISK 2,595 million in 2003, while in 2002 there was a loss of ISK 78 million on Salaries and salary-related expenses were ISK 5,422 million trading securities. The ICEX-15 Index rose by 56% during the in 2003, having risen by ISK 1,120 million from the previous year and most foreign securities indices also rose substan- year, or 26.0%. Apart from contractual wage rises during the year, this increase is due in particular to performance-linked salaries plus the inclusion of Sjóvá-Almennar in the Development of equity indices in 2002 Bank’s accounts. A special contribution made in 2003 to 180 Íslandsbanki’s employees’ pension fund was similar to that 160 of 2002. At the beginning of 2003 there were 870 full-time 140 equivalent positions, while at year-end they numbered 120 1,085. The increase is completely the result of Sjóvá- 100 Almennar’s 218 personnel who are now included in the 80 Íslandsbanki Group employees. 60 3 651 Jan Mar May Jul Sep Nov Jan Other general operating expense amounted to ISK , 26 8 ICEX-15 S&P 500 FTSE 100 NASDAQ million, increasing by . % over the previous year. The increase can be attributed to three factors in particular.

19 Review of Group operations

There is a strong culture of cost restraint among employees Other operating expenses and rationalisation work will continue, The cost/income ISK m ratio for insurance activities was 31.9%.

10,000 7.3% Claims net of reinsurance and provisions

8,000 for loan losses 7.0% 37.3% Claims net of reinsurance for the insurance division are now 6,000 37.3% included in Íslandsbanki’s Profit and Loss Accounts for the first time; they amounted to ISK 1,540 million in the fourth 4,000 quarter. 55.7% 55.4%

2,000 Provision account for loan losses 0 ISK m 2002 2003 8,931 Salaries and related expenses Other expenses Depreciation 9,000 8,000

7,000 6,470 In the first place, to a special contribution to the Depositors’ 6,000 1.8% and Investors’ Guarantee Fund early in 2003; secondly, to increased rental costs, as the Bank sold its real estate to a 5,000 1.6% separate holding company near the end of 2002; and thirdly, 4,000 due to the addition of Sjóvá-Almennar to the Bank’s 3,000 accounts. Depreciation of fixed assets and goodwill totalled ISK 712 million in 2003 as compared with ISK 542 million the 2,000 previous year. Of this amount, ISK 140 million is depreciation 1,000 0.8% 0.9%

of goodwill arising from the acquisition of Sjóvá-Almennar, 0 2002 2003 based on a 20-year lifetime. Treatment of goodwill will be reviewed with the introduction of new international report- General Specific ing standards.

The cost/income ratio for banking activities in 2003 was The provision for losses on the loan portfolio is divided into 50.0% as compared to 54.8% the previous year. The Bank’s specific and general provisions. Specific provisions are objective has been to reduce this ratio to below 50%. intended to cover lending which has received a poor risk evaluation on the accounting day. General provisions are designed to meet losses which are considered likely based Banking employees on conditions on the accounting day, apart from those 1,200 1,085 obligations for which specific provision is made. 1,000 948 The total provision in 2003 amounted to ISK 2,864 million, 907 870 as compared to ISK 2,184 million the previous year. 800 The increase of 31.1% year-on-year can be attributed to 600 substantial lending growth during the period and expected 400 loan losses due to customers’ operating difficulties. As a proportion of the total loan portfolio and guarantees 200 issued at the end of the year, the provision amounts to 0 0 9 0 8 2002 2003 . %, as compared to . % for the previous year. Average At year-end As a proportion of average total assets, the provision was 8%, while the year before it was 0.7%. After the ISK 2,864

20 Review of Group operations

Development of overdue exposures 2003 Balance sheet 5% At year-end 2003 Íslandsbanki’s total assets amounted to ISK 444 billion, after increasing by ISK 132 billion or 42.1% 4% during the year. Total assets increased by 6.6% during Q4, to Overdue a great extent as a result of the inclusion of Sjóvá-Almennar 3% tryggingar, as the company’s total assets amounted to ISK 30 billion at year-end 2003. At the same time the Bank held 2% Active overdue in custody customer assets amounting to ISK 199 billion, 1% including mutual funds with total assets amounting to ISK 64.6 billion. The increase in assets in custody from the 0% beginning to the end of the year was 35.9%. JFMAMJJASOND

Balance sheet 31 December 2003 million provision for the year, the specific provision account ISK m Domestic Foreign Total stood at ISK 6,000 million at year-end and the general Assets provision account at ISK 2,931 million, bringing the total Cash, Treasury bills and amounts due provision to ISK 8,931 million or 2.7% of the total loans and from credit institutions ...... 24,461 19,906 44,367 Loans ...... 256,956 58,210 315,166 guarantees issued. Comparable figures for 2002 were ISK Bonds and shares in other companies ...... 57,552 538 58,090 6,470 million and 2.4%. The general section of the loss Other assets ...... 25,818 502 26,320 Total assets 364,787 79,156 443,943 provision account now corresponds to 0.9% of loans, interest due and guarantees issued, the same as at year-end Liabilities and equity 2002 1 353 2002 Amounts owed to credit institutions ...... 6,044 21,732 27,776 . Final write-offs were ISK , million in , as Saving depostits ...... 87,898 19,774 107,672 against ISK 1,776 million the previous year. Borrowings ...... 21,815 210,129 231,944 Technical provisions ...... 19,413 0 19,413 Other liabilities ...... 10,027 622 10,649 Taxes Deferred income tax liability ...... 1,356 1 1,357 Subordinated loans ...... 556 15,153 15,709 The Bank and its domestic subsidiaries are jointly taxed. Equity...... 29,423 0 29,423 According to the 2003 financial statement, income tax Total liabilities and equity 176,532 267,411 443,943 expensed was ISK 593 million as compared to ISK 760 million in 2002. The tax entry is comprised of a deferred income tax liability at the beginning of the year amounting 357 Cash, Treasury bills and amounts due from to ISK million, taxes transferred to the group due to credit institutions Sjóvá-Almennar and Framtak fjárfestingarbanki amounted to ISK 1,141 million, imputed income tax was ISK 593 million, Cash, Treasury bills and amounts due from credit institu- 44 367 2003 of which income tax savings from Framtak fjárfestingar- tions totalled ISK , million at year-end , increasing 33 484 banki were ISK 422 million, income tax payable in 2004 from ISK , million one year earlier. The largest of amounts to ISK 916 million, with the result that the income these items is the amounts due from credit institutions. 34 593 tax obligation at year-end 2003 amounts to ISK 1,175 million. This totalled ISK , million and had increased by 11 011 The calculation of deferred income tax liability is based on ISK , million. the temporary difference in Balance Sheet items, i.e. mostly leasing contracts, holdings in affiliated companies and Loans fixed assets. The parent company includes its share in At year-end 2003, total loans amounted to ISK 315,166 subsidiaries’ income tax with its own income tax. million, an increase of ISK 62,170 million or 24.6% during the year. Loans to customers outside of Iceland amounted to ISK 58 billion at year-end 2003, or 18.5% of the Bank’s total loans, increasing by ISK 29 billion or 101.4%. The increase in loans to Icelandic customers was about ISK 33 billion or

21 Review of Group operations

borrower, accounting for 28.9%, followed by fisheries with Loans and leasing agreements by maturity 20 2 17 8 at year end . %, individual borrowers were . %, manufacturing and ISK bn construction accounted for 14.8%, commerce for 14.5% and other borrowers for 3.8%. 140 2002 120 2003 Market securities 100 Market securities are comprised of market bonds and mar-

80 ket equities. According to Rules on the Financial Statements of Credit Institutions, securities are then divided into invest- 60 ment securities and trading securities. Investment securities 40 are securities which an institution has formally decided to

20 hold for a longer term than one year; other securities are classified as trading securities. 0 On demand Up to Over 3 months Over 1 year and Over 5 years 3 months and up to 1 year up to 5 years At year-end 2003, market securities owned by the group totalled ISK 50,691 million, an increase of ISK 32,803 million 14.7%. Leasing contracts amounted to ISK 16,529 million of during that year. Market securities consist of market bonds 35 319 total loans and appropriated assets ISK 882 million. amounting to ISK , million, which increased by ISK 25,962 million from the previous year, and market equities The breakdown of loans to customers and leasing contracts valued at ISK 15,372 million which rose by ISK 6,841 m. by maturity at year-end 2003 was such that claims due were 2.3%, loans with a residual maturity of three months or less Bonds and other fixed rate securities were 17.8%, loans with a residual maturity of over three 12 2 ISK m months and up to one year were . %, those from one to 2003 2002 five years were 44.0% and those over five years were 23.7%. Trading bonds: Listed on the Iceland Stock Exchange ...... 34,469 9,357 Other listed shares ...... 15 0 Loans by sector Unlisted shares ...... 835 0 Total trading bonds ...... 35,319 9,357 The breakdown of loans and leasing contracts by borrower 2003 Swap contracts ...... -20,860 0 at year-end shows that services were the largest single Forward contracts...... -7,909 -3,505 Derivatives position ...... -28,769 -3,505 Loan and leasing portfolio by sectors at year-end Net position 6,550 5,852

19.3% 17.8%

The Bank’s market bonds at year-end 2003 were all trading bonds, almost all of them listed on ICEX, and amounting to 22.9% 20.2% a value of ISK 35,319 million, as previously mentioned, as compared to ISK 9,357 million at year-end 2002. At year-end 28.9% 2003, swaps and forward contracts against market bonds 25.6% were ISK 28,769 million, making the Bank’s net market bond position ISK 6,550 million at year-end 2003 as compared 11.2% 14.5% with ISK 5,852 million at year-end 2002.

15.3% 14.8% Market equities are comprised of trading equities, which 5.7% 3.8% amounted to ISK 13,832 million, and investment equities 2002 2003 amounting to ISK 1,540 million. At year-end 2003, swaps and Individuals Services Industry and contractors forward contracts against market equities were ISK 2,045 Fisheries Retail and commerce Other million, making the Bank’s net market equities position ISK

22 Review of Group operations

year or 25.5%. Of this figure, ISK 70,605 million was in the Equity shares and other variable-yield securities form of time deposits and ISK 37,067 million in demand ISK m deposits. Time deposits increased by 33.5% and demand 2003 2002 Trading shares and unit shares: deposits by 12.5%. Listed on the Iceland Stock Exchange ...... 12,279 6,749 Other listed shares ...... 585 230 Amounts owed to credit institutions amounted to ISK 27,776 Unlisted shares ...... 968 828 million at year-end, as compared to ISK 24,150 million at the 13,832 7,807 Investment shares: beginning of the year. Listed on the Iceland Stock Exchange ...... 0 305 Unlisted shares ...... 1,540 419 Borrowings 1,540 724

Total shares ...... 15,372 8,531 ISK m 2003 2002 Swaps contracts ...... -470 -4 Issued bonds ...... 217,205 144,754 Forward contracts ...... -1,575 -1,413 Loans from credit institutions ...... 11,660 16,462 Other borrowings ...... 3,079 2,861 Derivatives position ...... -2,045 -1,417 Total 231,944 164,077 Net position 13,327 7,114

Borrowing at the end of 2003 amounted to ISK 231,944 million, having increased by ISK 67,867 million. Of this, bonds 13 327 2003 7 114 , million at year-end as compared with ISK , issued totalled ISK 217,205 million, loans from credit institu- 2002 million at year-end . Sjóvá-Almennar’s assets comprised tions in the form of bonds totalled ISK 11,660 million and other 8 ISK billion of the Group’s net market equities position at borrowing ISK 3,079 million. Issued bonds increased by ISK 2003 year-end . Counterparty risk is closely monitored in 72,451 million, or 50.1%, while loans from other credit institu- regard to position of derivatives agreements and the current tions in the form of bonds decreased by ISK 4,802 million. market value of collateral, as further described in the chapter on risk management and asset quality on page 50. Time deposits by maturity at year-end ISK bn Deposits and other borrowings 40 2002 Total deposits at year-end 2003 amounted to ISK 107,672 35 2003 million, an increase of ISK 21,845 million over the previous 30 25 20 15 Deposits and other borrowings at year-end 10 ISK bn 5 350 0 Up to Over 3 months Over 1 year and Over 5 years 300 3 months and up to 1 year up to 5 years

250 63.1%

200 59.9% The share of amounts owed to other credit institutions in

150 total credit financing, which also consists of deposits and borrowing, decreased from 8.8% to 7.6%. The share of 100 19.3% 19.2% borrowings rose from 59.9% to 63.1%, while that of deposits 50 12.0% 10.1% dropped from 31.3% to 29.3%. Maturities of time deposits at 8.8% 7.6% 2003 0 the end of were as follows: the large majority are up to 2002 2003 three months, ISK 7 billion mature in from over three Amounts owed to credit institurions Demand deposits months to one year’s time, and ISK 22 billion have a residual Time deposits Borrowings maturity of one year or longer.

23 Review of Group operations

Technical provisions the Bank has a strong financial position. Tier I capital was 8 0 10 1 Technical provisions were ISK 19,413 million at year-end . %, as compared with . % the previous year. The Bank’s 7 2003. This is comprised of premium provision; non-life and goal is to keep Tier I capital above %. life insurance claims provision; equalisation provision; and bonuses and premium provision. Premium provision Inflation indexation and foreign exchange amounted to ISK 4,020 million at year-end, non-life and life balance insurance claims provision to ISK 14,351 million, equalisation Inflation-indexed assets net of indexed liabilities stood at provision to 615 million and bonuses and premium provision ISK 9,169 million at year-end 2003, as compared with 23,763 to ISK 427 million. By comparison, Sjóvá-Almennar’s techni- at the end of 2002. The Bank’s indexed assets include assets cal provisions at year-end 2002 were ISK 18,179 million. and derivatives based on indexed trading securities, which are short-term investments. Excluding these, the Bank aims Equity and equity ratio to achieve a positive balance between indexed assets and At year-end 2003 the Bank’s equity stood at ISK 29,423 liabilities. million, having increased by 40.4% during the year. Dividends of ISK 1,535 million were paid during the year. Indexation balance 10 500 The total nominal value of shares is ISK , million. Own ISK m 2003 2002 shares were ISK 420 million at year-end and share capital Indexed assets ...... 101,338 71,175 10 080 according to the balance sheet thus ISK , million. The Indexed liabilities...... 92,169 47,412 Bank’s share capital was decreased by ISK 1,000 million Indexation balance...... 9,169 23,763 during the year, as part of its policy to maximise utilisation of equity. It was later in the year increased by ISK 1,500 mil- lion in relation to the Bank’s acquisition of Sjóvá-Almennar. Foreign-denominated assets net of liabilities were ISK 5,753 2003 At year-end 2003, subordinated loans totalled ISK 15,709 million at year-end , including assets and liabilities in million and had increased by ISK 4,610 million during the the form of forward contracts and currency and interest-rate year. These are comprised of Tier I capital subordinated debt, swaps. in the amount of ISK 4,403 million, and debt in the amount of ISK 11,306 million which is classified as Tier II capital. Foreign currency balance

Based on CAD rules, the Bank’s total equity ratio was 11.4% ISK m 2003 2002 at the end of 2003, as compared with 12.7% at the same Assets in foreign contracts ...... 220,673 157,937 time the year before. The Bank aims at keeping this ratio Forward contracts ...... 85,221 66,553 Currency and interest rate swaps ...... 118,933 82,536 above 10.0%. Since the minimum stipulated by law is 8.0%, Options ...... 748 469 Total assets in foreign currencies ...... 425,574 307,495

Capital adequacy ratio (CAD) Debts in foreign currencies ...... 255,243 175,483 14% Forward contracts ...... 63,727 54,694 12.7% Currency and interest rate swaps ...... 100,851 75,917 12% 11.4% Options ...... 0 211 2.6% 10% Total debts in foreign currencies ...... 419,821 306,305 3.4% 8% Foreign currency balance ...... 5,753 1,190 6% 10.1% 4% 8.0% 2% Off-balance sheet items, obligations on 0% behalf of clients 2002 2003 Tier I Tier II Íslandsbanki has provided guarantees and overdraft facilities to customers. Guarantees issued amounted to ISK 5,871

24 Review of Group operations

million at year-end, as compared with ISK 5,174 million at Derivatives at year-end 2003 year-end 2002. Unused overdraft facilities amounted to 13 216 13 777 ISK , million at year-end as compared with ISK , ISK m Book value million at year-end 2002. Principal Assets Liabilities Foreign exchange contracts: Derivatives, comprised of cross-currency and interest-rate Forward exchange rate contracts ...... 90,545 1,546 1,665 Swaps ...... 39,957 4,155 2,522 swaps and forward securities contracts, stood at ISK 258,657 Options, purchased ...... 4,018 90 0 million at year-end 2003. The largest derivative group was Options, sold ...... 5,797 0 199 140 317 140,317 5,791 4,386 cross-currency swaps, at ISK , million, followed by Interest rate contracts 75 288 interest-rate swaps in the amount of ISK , million and Futures, sold ...... 73,426 192 1,978 forward securities contracts totalling ISK 43,052 million. Forward interest rate contracts, purchased ...... 931 0 0 The Bank’s risk due to these contracts lies in currency and Forward interest rate interest rate differential. contracts, sold ...... 931 0 0 75,288 192 1,978 At year-end, the risk was equivalent to loans granted Securities contracts 3 154 Forward, bought ...... 1,239 23 12 amounting to ISK , million when evaluating the Bank’s Forward, sold ...... 12,187 94 96 CAD ratio according to current rules. Swaps ...... 19,868 66 404 Options, bought ...... 4,302 403 0 Options, sold ...... 5,456 0 458 43,052 586 970 Total derivatives 258,657 6,569 7,334

25 A crowd collects at the opening of the Industrial Bank in 1953. Customised Service

Íslandsbanki emphasises meeting the needs of individual customers. Our personal service prioritises the specific interests of each person. Long line-ups in banks are practically a thing of the past, since changed banking practices and modern branch design meet customers' needs for prompt and accessible services. Retail Banking

Retail Banking provides individuals and households, as well as small and medium-size enterprises, with financial services via the Internet, a telephone service centre and branches throughout Iceland. The internal structure of the division is aimed at providing specialised service through its three units, for individuals, small companies and Internet business.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 5,555 1,474 1,365 1,385 1,331 Other operating income 1,571 342 404 444 381 Net operating income 7,126 1,816 1,769 1,829 1,712 Other operating expenses -4,915 -1,143 -1,212 -1,263 -1,297 Provision for losses -1,314 -357 -330 -362 -265 Pre-tax profit 897 316 227 204 150 Economic Value-added 159 -193 375 7 -30

Retail Banking serves ISB’s largest group of customers. Retail Banking deposits 1998–2003 Continuous efforts are devoted to improving the division’s ISK bn services, increasing variety and ease of access for customers. 100 90 Deposits with Retail Banking totalled ISK 100 billion at year- 80 end, increasing by 22% during 2003. Total loans made by the 82 70 division amounted to ISK 86 billion at year-end, which is an 72 60 increase of 3.6%. 60 50 53 Retail Banking returned a pre-tax profit of ISK 897 million. 40 47 Net operating income was ISK 7.1 billion, while operating 30 expenses were almost ISK 4.9 billion. Provisions for loan 20 losses amounted to ISK 1.3 billion. EVA for the year was 10 159 0 around ISK million. 1998 1999 2000 20012002 2003

New services for individuals loans. With these rebates the Bank rewards customers and At year-end 2003, ISB introduced a new option for housing encourages them to fulfil their obligations on time. Services 16 buyers, in the form of non-indexed housing mortgages at provided to the Bank’s customers younger than years of variable interest rates. A borrower is offered a mortgage age have been reviewed, and a successful marketing which is either fully or partially denominated in foreign campaign was launched aimed at older upper secondary currency, at interest rates based on interbank rates. These school and university students. new loans have made it possible to offer housing loans at lower rates than before. Special mortgage insurance from Lasting business connections Sjóvá-Almennar life insurance is offered in conjunction with ISB emphasises providing companies with personal services, these loans, reducing the interest cost and increasing the to create lasting connections with each individual company borrower’s financial security. doing business with the Bank. Through periodical visits and As in the past few years, participants in ISB’s preferred interviews, each company’s specific needs are analysed. customer services, with a record of making repayments on Services for companies on the Internet have been greatly time, have received a 5–6% rebate on interest paid on their increased with the new and improved ISB Business Online

28 Retail Banking

features in online banking. ISB’s website is reviewed contin- Retail Banking loan portfolio at year-end 2003 uously, with the aim of making the Bank’s services as acces- sible and user-friendly as possible. At the end of 2003, faster 11% and more powerful internet services for individuals, organi- 41% sations and enterprises were introduced, with an improved 17% user interface and slate of new options.

Households The improvements to ISB Business Online have resulted in a Services considerable increase in Internet transactions. Financial Industry and transactions increased by 47% in 2003 and the number of contractors individuals registered on ISB Personal Banking Online Commerce increased by 21%, evidence of the steady increase in online Other 18% banking. 13%

Growth in online financial transactions in 2003 140 1st January = 100 service. Payment service for companies is a new feature 130 intended especially for smaller companies, equalising pay- 120 ments of recurrent costs. A new corporate payment card was introduced, which can save companies considerable 110 sums in administrative costs for purchasing. 100

90 Expanding Internet services 80 Ever since it opened Iceland’s first Internet bank in 1995, ISB 70 has striven to be a leader in the eBanking business. Since 60 that time the Bank has introduced a wide variety of new Jan FebMar Apr May Jun Jul Aug Sep Oct Nov Dec

29 Corporate Banking

Corporate Banking is responsible for relations with and services to medium-size and large Icelandic corporations, as well as municipalities. It provides these parties with comprehensive financing and risk advisory services. There are four operating units within Corporate Banking: Corporate Credit, Real Estate and Project Financing, Risk Advisory and Relationship Management.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 2,159 564 518 534 543 Other operating income 64 17 16 10 21 Net operating income 2,223 581 534 544 564 Other operating expenses -644 -182 -154 -144 -164 Provision for losses -725 -139 -334 -124 -128 Pre-tax profit 854 260 46 276 272 Economic Value-added -170 -198 -103 122 9

Lending by Corporate Banking amounted to ISK 124 billion at Risk Advisory the end of 2003. Total loans by Corporate Banking and Specialists in Corporate Merchant Banking amounted to ISK 184 billion at year-end, Banking’s Risk Advisory an increase of 25% year-on-year. unit provide customised Corporate Banking returned a pre-tax profit of ISK 854 advice on currency million in 2003. Net operating income was ISK 2,223 million, composition of loans. while operating expenses were ISK 644 million. Provisions The advice is based on for loan losses amounted to ISK 725 million. In 2003 EVA was the company’s income negative by ISK 170 million. and/or expenses in foreign currencies, and ways sought to keep Relationship Management financial costs at a Corporate Banking handles relations with the Bank’s largest minimum. The special- customers. It is the task of the customer relations managers ists provide advice on using currency hedging for cash flow to assess the needs of each customer and find solutions to in foreign currencies. them by utilising the Bank’s various service units to good On ISB Business Online, customers can check on the status advantage. This arrangement encourages closer relations and of all their foreign and domestic loans and examine the better understanding of each customer’s financial needs. development of their debt portfolio. Advice is tailored to fit It also makes all handling and follow-up more effective. the needs of corporations, municipalities and pension funds. The customer relations managers are mainly responsible for building up business connections both in Iceland and abroad. Internationally, emphasis has been particularly on Real Estate and Project Financing leading fisheries and seafood companies throughout the Project financing is a frequent way of funding larger projects world. Business relations include lending, corporate advisory by spreading the risk among lenders, shareholders and other as well as risk management advice. In view of the good parties connected with the project. It offers the borrower an results, further advances in this field can be expected in opportunity to diversify risk better, enabling it to undertake the coming years. more and larger projects than would otherwise be the case.

30 Corporate Banking

US dollar and the euro against the ISK in 2003 Corporate Credit 90 Corporate Credit specialists look after, on the one hand, 88 granting operating and long-term credit and, on the other 86 hand, co-ordinating the Bank’s services to customers. USD 84 An assessment of favourable capital structure for customers EUR 82 is compiled, reflecting their current needs. The staff of 80 Corporate Credit work closely with the Bank’s other service 78 divisions in order to achieve comprehensive and cost-effec- 76 tive solutions for each individual customer. 74 72 Corporate Banking loan portfolio 70 at year-end 2003 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

9% Fisheries 2% 33% 3% Financial services It is ISB’s policy to be involved in projects of this sort abroad, 4% Holding companies as well as leading the way in supervising such projects in 5% Retail and services Iceland. This has enabled the Bank to build up knowledge Real estate and expertise, enabling it to respond to the needs of 5% Public entities Icelandic customers with the newest products offered on Transportation the global finance market for project financing. Construction 12% Manufacturing 14% This past year saw extensive growth in these activities at Other ISB, which involved the Bank in some ten projects of this 13% sort abroad.

31 Merchant Banking

Merchant Banking is responsible for ISB’s international corporate credit, loan syndication, leverage finance, mezzanine finance, principal finance and private placements, as well as advising on mergers, acquisitions and public offerings. Part of the division is based in London and focuses on cross border mergers and acquisitions, private placements and international credit.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 1,251 395 392 350 114 Other operating income 269 22 119 72 56 Net operating income 1,520 417 511 422 170 Other operating expenses -607 -190 -155 -133 -129 Provision for losses -438 -219 -121 -66 -32 Pre-tax profit 475 8 235 223 9 Economic Value-added 382 74 131 190 -13

International Fish Industry arranger for Clearwater Seafoods L.P. in raising a CAD 120 million syndicated loan facility. ISB refinanced all the long- Within Merchant Banking there is a dedicated team of pro- term debt financing for Fisheries Products International in fessionals focusing on serving the fishery, fish farming and Canada and the USA with a CAD 80 million bilateral facility. other fish related and food processing industries. ISB’s ties with the fishing industry in Iceland go back a century and the Bank has over the years built strong relationships with many Leveraged Finance of the world’s leading companies in these sectors. It now ISB arranges and participates in leveraged finance transac- provides credit and advisory services to companies all over tions arranged by other banks at senior, mezzanine and the world. principal finance levels, primarily in Northern Europe. In many instances ISB will only participate at one risk level, but International credit and loan in other instances the bank may provide a fully integrated syndication finance solution to its customers. The international credit portfolio consists of credit facilities Mezzanine Finance granted to some of Iceland’s leading international compa- 8 nies, bilateral facilities and participation in syndicated loan ISB invested in new mezzanine finance transactions in 2003 6 3 facilities to the leading players in the global fish industry, . By year-end, ISB’s mezzanine portfolio was ISK . bil- 81 13 senior leveraged buy-out facilities in Northern Europe and a lion (USD million), consisting of investments in busi- portfolio of non-relationship investment grade assets in nesses in the UK, Germany, France and Sweden, in addition 2003 order to enhance the bank’s economic and sector diversity. to its investment in ICG Mezzanine Fund , in which the At the end of 2004 the credit portfolio was equivalent to bank is one of the leading investors. 51 2 661 ISK . billion (USD million). ISB arranged and underwrote the GBP 10.3 million mezzanine ISB was a mandated lead arranger for the EUR 185 million financing for Soldier Ltd. in the successful public-to-private syndicated loan facility for Pharmaco hf., the pharmaceuti- acquisition of the world’s best-known toy store, Hamley’s plc, cals company. The syndication was most successful and in London ended up being well oversubscribed in the European market. ISB was also active in financing the Canadian fish industry. Principal Finance Among the transactions in Canada, ISB acted as a lead In order to provide its customers with a fully integrated

32 Merchant Banking

finance solutions for leveraged finance acquisitions, ISB set Non-Icelandic portfolio up a Principal Finance unit last autumn within the Merchant excluding financial institutions Banking Division. Principal Finance provides equity or quasi- equity financing for unlisted companies. Integrated finance 13% UK 24% Canada can be an attractive financing solution for smaller and 2% USA medium sized businesses when it comes to management 4% Norway buyouts, public-to-private transactions, acquisitions or busi- 4% Danmark ness expansions and other changes in business ownership. 4% France So far Principal Finance has not entered into any transaction Sweden but there are potential investments in the pipeline at the 8% Ireland beginning of 2004. 11% Germany 9% Luxembourg 11% Other 10% Corporate Finance The two Corporate Finance teams in Reykjavik and London saw an increase in merger and acquisition activities during Corporate Finance also arranged private placements of equi- the year, mostly in Iceland. The outlook for 2004 is for an ty in Iceland and internationally for some rapidly growing even further increase in deal flow in Iceland and internation- business enterprises. Among those, was the private place- ally. ment of new share capital for Landmat Inc., which brought Nokia Venture Partners into the company as one of its ISB advised and prepared public filing for Opin kerfi Group leading investors, bringing with it not only capital, but also hf. in relation to its acquisition of Virtus AB in Sweden. knowledge and business connections of considerable value The bank also assisted Opin kerfi in acquiring and delisting to Landmat. Another private placement was arranged for Skýrr hf. Another successful public acquisition and delisting Lazy Town, to finance the production of the first Lazy Town which ISB advised on was the acquisition of Framtak episodes for Nickelodeon, the Viacom children’s television Investment Bank by Straumur Investment Company, where station. In addition to the private placement the bank ISB acted for Straumur. provided Lazy Town with all of its debt financing.

33 Capital Markets

Capital Markets handles brokerage in foreign and domestic securities, foreign exchange and derivatives, as well as providing money market loans and financing securities purchases through forward contracts. Its main clients are pension funds, larger corporations, banks, investment companies and mutual funds. These include parties both in Iceland and abroad, with foreign business rapidly growing in importance.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 435 139 144 105 47 Other operating income 1,182 400 349 253 180 Net operating income 1,617 539 493 358 227 Other operating expenses -573 -152 -152 -135 -134 Pre-tax profit 1,044 387 341 223 93 Economic Value-added 802 295 266 168 73

There was substantial growth in all areas of Capital Markets’ increase, however, can be attributed to individual large activities in 2003. Income from both forex and securities transactions and delistings of companies. If only brokering increased. Capital Markets’ share of trading on on-exchange trading is considered, turnover also rose from ICEX grew considerably over the previous year, and now the previous year, increasing from ISK 65 billion to ISK 91 accounts for just over 8% of bond trading and almost 23% of billion, or by 40%. On-exchange trading thus continued to equity trading. This is not including the Bank’s trading on account for a relative low proportion of total turnover, own account. Taking this into consideration the aggregate dropping from 20% in 2002 to 16% in 2003. share of ISB in ICEX turnover in 2003 was just under 22% of There were a considerable number of delistings on ICEX bond turnover and almost 30% of share turnover. in 2003, a total of 18 companies and funds were delisted. Capital Markets’ pre-tax profit in 2003 was ISK 1,044 million. In six instances this was due to a merger with another listed Net operating income was ISK 1,617 million. Of this interest company. One new company was listed on the ICEX Main and commissions totalled ISK 1,557 million and ISK 60 List last year. million was trading rate gains on foreign equity positions. Net operating expenses were ISK 573 million. EVA for the year was ISK 802 million. ICEX Main List 2003 100 2,200 Domestic equity market 80 2,000 The year 2003 was an especially good one for the Icelandic equity market. The ICEX-15 Index rose by 56% during the 60 1,800 year, its second-largest annual rise ever. It was primarily 40 1,600 the largest ICEX companies which led the upward climb; the ICEX Main Index rose by 44% during the year. 20 1,400

0 1,200 A new record for equity turnover on ICEX was set in 2003. Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

Total turnover increased by 72% year-on-year, rising from Volume in ISK bn (left axis) ICEX Main Index (right axis) ISK 321 billion to ISK 554 billion. A major portion of this

34 Capital Markets

Domestic bond market of 20% over the previous year. The greatest increase was in issuance of housing bonds, government paper and corporate Bond market turnover was ISK 893 billion in 2003, an and municipal bonds. Issuance by credit institutions, howev- increase of 30% over the previous year. During the last five er, decreased considerably from that of the previous year. years, turnover on the bond market has grown by an average of 27% per year. Price formation on the bond Total issuance of new bonds listed on ICEX by large corpora- market has improved considerably with increased turnover. tions and municipalities increased somewhat over the The bond market makers for benchmark issues of govern- previous year. ISB’s Capital Markets led the way in manag- ment-backed bonds are the leading bond traders, together ing corporate and municipal bond offers in 2003. The activi- with both domestic and foreign institutional investors. ty on this market is determined by the financing needs of corporations and municipalities, and by investors’ demand for such bonds. ICEX Bond Trading Volume

T-bills and bank bills Forex market Housing bonds There are three market makers on the interbank currency Housing authority bonds market in Iceland: ISB, KB banki and Landsbanki. Forex Non-indexed trading on the interbank market amounted to ISK 1,186 government bonds billion in 2003, an increase of 43% over the previous year. CPI-indexed 2002 government bonds The króna rose by 1.2% during the course of the year, after 2003 Other 13 5 long-term bonds an increase of . % the previous year. 0 100 200 300 400 500 600

ISK Index and trading volume on the domestic interbank market in 2003 Bond market yields dropped substantially during Q2 and Q3, 160 130 then rose again in the closing months of the year. During 140 128 the entire course of the year, yields on housing and housing 120 126 authority bonds dropped by 55–75 basis points (bp), result- 100 124 ing in very good returns on long-term CPI-indexed bonds. 80 122 Yields on non-indexed bonds, on the other hand, rose in line 60 120 with expectations of increased inflation and increases in the 40 118 60 Central Bank’s policy rate. The increase was bp in 20 116 30 Treasury bonds with shorter maturities and bp for longer 0 114 maturities. Money-market interest rates, on the other hand, Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec remained low throughout the year, both due to the Central Volume on the interbank market in ISK billion (left axis) Bank’s foreign currency purchases and changes to the Foreign exchange versus ISK (index, right axis) reserve requirements for deposit institutions.

Pension funds’ bond purchase were directed at bonds other The Central Bank purchased foreign currency on the than government-backed instruments in 2003. Net purchas- domestic forex market throughout the year, with the aim es by pension funds of such bonds amounted to almost ISK of boosting its foreign currency reserves. The Central Bank’s 15 billion, as compared to just over ISK 6 billion the previous purchases totalled ISK 43 billion during the year, or 1.8% of year. On the other hand, pension funds’ purchases of hous- total turnover. ing and housing authority bonds fell markedly. Net purchas- ISB’s share of the interbank market was 28% in 2003, a es amounted to ISK 5–6 billion as compared to ISK 18 billion slight increase over the previous year; market makers also in 2002. decreased by one during the year. This turnover gives an Total bond issuance was ISK 120 billion in 2003, an increase indication of the Bank’s share in foreign currency brokering.

35 Capital Markets

Foreign markets Foreign equity index developments in 2003 Indices rose practically everywhere in the world, after major 130 declines in the previous three years. On a global scale, equity 120 23 2003 prices rose by % in . 115 Purchases by Icelandic investors of foreign securities have 110 never been greater than in 2003. Net purchases amounted 105 to a total of ISK 45.5 billion, an increase of 77% over the ISK 100 25.7 billion of 2002. Purchases of foreign securities are 95 MSCI Global expected to continue to be high in 2004. 90 MSCI USA 85 MSCI Europe 80 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

36 Asset Management

Asset Management looks after the management and investment of assets for individuals and insti- tutional investors. It provides counselling and investment services in domestic and international markets. Private banking services are offered to individuals with extensive financial activities. Asset Management operates bond, equity and pension funds.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 25 9 6 5 5 Other operating income 948 313 218 216 201 Net operating income 973 322 224 221 206 Other operating expenses -703 -202 -162 -175 -164 Pre-tax profit 270 120 62 46 42 Economic Value-added 202 94 45 33 30

Favourable developments on all the main securities markets in 2003 have meant good returns on funds and portfolios Development of equity indices 1996–2003 under management. Assets under management increased 400 ICEX Main List substantially, rising from ISK 146 billion at the beginning of 350 S&P 500 (in USD) 2003 to ISK 199 billion at year-end, an increase of 36%. 300 MSCI Europe (in EUR) There was a high inflow from all the main customer groups, 250 i.e. pension funds, institutional investors, private banking customers and general investors. 200 150

Assets under management 1999–2003 100

ISK bn 50 1996 1997 1998 1999 2000 2001 2002 2003

199 1 January 1996 = 100 200

146 Domestic equities surged upwards, with the ICEX Main List 150 135 120 Index rising by 44%. Foreign equities markets also began 100 94 to pick up in the spring; in the US the S&P500 index rose 26% in dollar terms during the year. The increase in ISK was 50 11%, as the US dollar fell by 12% against the króna during 2003. The global equity index rose by 15% in ISK terms. 0 Yields on the domestic bond market were also good, with 1999 2000 2001 2002 2003 the government bond index rising by 11%.

The pre-tax profit of Asset Management operations amounted to ISK 270 million. Net operating income was Good fund returns ISK 973 million, while operating expenses were ISK 703 Yields of funds managed by ISB were generally good in 2003. million. EVA for the year was around ISK 202 million. The real return on bond funds was 6–12% and on domestic equity funds 40–43%. There was a high inflow to mutual funds during the year, which together with good returns, A favourable year on the markets has meant a sizeable increase in the funds’ total assets. All the main securities classes gave good returns in 2003. Total assets of mutual funds increased by almost ISK 16

37 Asset Management

of mutual funds was completely separated from manage- Fund performance 2002 and 2003 ment of other portfolios. Management of mutual funds was 190 transferred to the management company Rekstrarfélag ÍSB 180 ISB Fund 9 – money market which is fully owned by Íslandsbanki. 170 ISB Fund 1 – domestic bonds ISB Fund 7 – housing bonds 160 ISB Fund 6 – ICEX Main List In December, the company received a licence from the 150 Financial Supervisory Authority to operate as a financial 1 January 2002 = 100 140 undertaking authorised to manage mutual funds. At year- 130 end the management company had five employees and 120 total assets under management amounted to ISK 65 billion. 110 100 Jan 02 Jul 02 Jan 03 Jul 03 Jan 04 Assets in ISB mutual funds ISK bn

70 Foreign equity funds Domestic equity funds billion during 2003, or by 32%. Total assets in bond funds 60 10 6 25 Domestic bond funds increased by ISK . billion, or %, assets in domestic 50 1 5 34 equity funds by ISK . billion, or %, and assets in foreign 40 equity funds by ISK 3.7 billion, or 167%. 30 20 Performance of ISB Life-style and reference index 10 1400 0 1300 1999 2000 2001 2002 2003 2004 ISB Life-style Index 1200 1100 1000 Service for institutional investors 900 Institutional and corporate investors have to a growing 800 extent chosen to take advantage of asset management 700 and other related services offered. This service is usually 600 tailored to the needs of each individual customer. 500 In 2003, a considerable emphasis was placed on investments Feb 01 Aug 01 Feb 02 Aug 02 Feb 03 Aug 03 in foreign equities. The core of such portfolios are usually passively managed equities, while active management is added to increase potential rate of return. Performance of sector funds The year 2003 was also favourable for foreign funds under ISB’s management. The Bank’s foreign sector funds all showed Growth of private banking services strong growth in 2003, with excellent yields exceeding their ISB’s private banking offers financial services for individuals reference indices. The króna exchange rate developments in and families with an asset portfolio exceeding ISK 100 2003, however, were not favourable to the funds’ yields, as million. There was a very extensive increase in assets the currency appreciated 12% against the USD. Despite this, under management and in transactions by this service in the funds’ nominal yields in ISK terms were 11–29%. 2003. Private banking is tailored to the needs of individual customers, who in effect are provided with their own financial manager. The service includes asset investment, Management company for taxation advice, risk management and general banking mutual funds services. A new Act on UCITS and Investment Funds came into effect in July 2003. Following its entry into force, the management

38 Asset Management

New book on asset man- Pension Fund or special pension accounts. Considerable agement emphasis is placed on courses and public education in pension matters, and good information, for instance, on In the autumn, ISB published the book individuals’ pension savings, is available on the Internet. Asset Management and Equities (Hlutabréf og eignastýring). It describes in detail leading practices Almenni Pension Fund grows in selecting investment equities and The total assets of Almenni Pension Fund as of 31 December managing assets. The book provides 2003 amounted to ISK 26 billion, an increase of 33% during comprehensible explanations on the year. Assets in the private pensions fund amounted to complicated subjects, offering entertaining instruction for ISK 21 billion and in the collective pension rights fund to ISK both private and professional investors. Asset 5 billion. The increase was proportionally greater in assets in Management’s annual autumn conference, Investments the collective pension rights fund, a rise of 49%. 2004, was held in Reykjavík and Akureyri to coincide with the book’s publication. All of Almenni’s portfolios returned good yields in 2003. For example, the real yield on Life Portfolio II was 13.6%, which is the highest return of any of the fund’s portfolios Advice on securities and pension since 1993. savings Securities transactions and pension issues are steadily grow- Yield on Life Portfolios in 2003 ing in importance in private finances. Equities trading by 20% individuals in 2003 was among the highest ever. Trading in Nominal yield ISB’s funds and in Icelandic equities is simple through the Real yield 15% Internet bank, where customers have direct access to the Icelandic Stock Exchange. Customers also have easy access to their asset positions and to detailed market information 10% and research. 5% Advice on pension issues and supplementary pension sav- ings are an important part of Asset Management’s service. Customers have a number of options to choose from con- 0% I II III IV Collective cerning their pension portfolios, either through the Almenni rights

39 Asset-based Financing

Asset-based Financing operates under the brand name Glitnir. Its services are aimed at assisting customers in leasing or acquiring equipment and commercial property. Businesses are offered assistance in financing vehicles, equipment and premises, while personal car financing schemes are available for individuals.

ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 923 223 240 206 254 Other operating income 160 39 39 40 42 Net operating income 1,083 262 279 246 296 Other operating expenses -431 -96 -108 -122 -105 Provision for losses -306 -167 -50 -14 -75 Pre-tax profit 346 -1 121 110 116 Economic Value-added 159 10 58 10 81

Operations of Asset-based Financing went well in 2003, New personal vehicle registrations despite the fact that a concentration on new financing in thou. the preceding two years slowed overall lending growth 16 during the year somewhat. The external operating environ- ment has improved substantially. Demand for vehicles and 14 industrial equipment grew once more, increasing the need 12 for their financing. Total loans made by Asset-based 10 Financing amounted to ISK 21.7 billion at year-end, which 8 is an increase of 8% during the year. 6 4 The division’s pre-tax profit amounted to ISK 346 million. 2 Net operating income was ISK 1,083 million, while operating 0 expenses were ISK 431 million. Provisions for loan losses 1995 1996 1997 1998 1999 2000 2001 2002 amounted to ISK 306 million. EVA for the year was ISK 159 million. Increased domestic demand New automobiles registered in Iceland in 2003 increased by 42 Loan portfolio by sector at year-end 2003 % from the previous year. Despite this increase, sales in 2003 were only slightly over the average for the last ten 3% 2% 1% years. Last year’s increase can be attributed to growing 9% 37% Public sector purchasing power, a stronger króna and falling interest Agriculture rates. In addition, the increased choice of financing possibili- Fisheries ties auto purchases also played a part in stimulating sales. Retail and Sales of industrial and heavy equipment have also increased, commerce especially in connection with large industrial projects. Manufacturing industry 22% 2003 Services The year marked the beginning of a period of econom- Private ic growth which in all probability will extend at least over individuals the next three years. Growth began with increasing private 27% consumption, including increased automobile buying. Later in the year, investments picked up, not only for heavy

40 Asset-based Financing

industrial projects but also general investments, e.g. in new Loan portfolio by categories af year-end 2003 housing. Sales of transport vehicles, excluding vessels and aircraft, also grew considerably. 11% 65% 4% Motor vehicles 8% Computer and Major growth in new financing office equipment 1% 9 8 Construcion Total new business at Glitnir amounted to ISK . billion in 7% equipment 2003, increasing by 57% over the previous year. Financing Ships and aircraft of automobiles, for both individuals and business opera- Industrial machinery tions, began to grow again after a drop in the past two 4% Other equipment 57 2002 years. The increase amounted to % over , or equal to Premises the increase in new financing of industrial equipment and premises, which also increased by 57%.

New loans and leases ISK bn 10 9.5 9.8 Four different options are available for financing of industri- 9 4.1 al and heavy equipment. Finance lease and hire purchase 8.0 3.2 8 are subject to different tax treatment. Operating lease is 6.8 2.5 7 6.3 6.3 6 2.8 offered to customers in partnership with the sellers. In all 2.6 2.6 5 4.9 6.3 three instances, Glitnir retains ownership of the equipment 5.5 5.7 4 2.3 during the lease period. Investment loans are offered for 3 4.0 3.7 3.7 65 2 registered equipment when the loan ratio is % or less. 2.6 1 These loans are secured with a pledge in the equipment. 0 1997 1998 1999 2000 20012002 2003 Glitnir’s business equipment financing services are offered Cars Business equipment/premises by all main equipment outfitters, but customers are also frequently consulted by Glitnir’s personnel directly on the Innovations in auto financing most economical type of financing. Relationship managers in the Bank’s branches and Corporate Banking division also Glitnir launched a new, private leasing service during the act as intermediaries for business equipment financing for first half of 2003 which has proved very popular. It involves customers. leasing automobiles to individuals, in a manner similar to that of company leasing, which is intended for business Finally, Glitnir provides hire purchase arrangements for operations. A new type of vehicle financing was also intro- business premises. Car dealers and sellers of registered duced, giving customers the option of having half the con- equipment are also offered inventory financing from Glitnir. tract amount denominated in a basket of foreign currencies. Glitnir places high priority on training and maintaining The interest on such contracts is somewhat lower than for good relations with sellers. Meetings are held with sellers’ those concluded wholly in Icelandic króna. personnel to address issues concerning co-operation, services and the market environment. Courses are also held Range of financing options for sellers’ recruits, training them in use of the Glitnir car finance management system. Private individuals are now offered vehicle financing through loans, hire purchase and private leasing. Businesses Glitnir is one of 24 member companies of the International are offered vehicle financing through loans, finance lease, Finance & Leasing Association (IFLA). As a rule, association hire purchase and operating lease. Glitnir’s car financing members are leaders in the field in their home countries. options are available from all vehicle distributors and main Customers in Iceland have access to these companies car dealers, who have an online link to its information sys- through Glitnir when they need to seek financing overseas tem. Loan pledges can also be processed at all ISB branches. and vice versa.

41 Insurance Division – Sjóvá-Almennar

In October 2003 Íslandsbanki acquired all the shares of the insurance company Sjóvá-Almennar tryggingar hf. which became a subsidiary of the bank. Following this acquisition Sjóvá-Almennar acquired all the shares in the life insurance company Samlíf and its name was subsequently changed to Sjóvá-Almennar líftryggingar hf. The companies hold a leading position on the insurance market; together they offer all classes of non-life and life insurance.

Sjóvá-Almennar, group Effect on consolidated ISK m 2003 Q4 Q3 Q2 Q1 account Net interest income 1,245 388 258 297 302 402 Other operating income 12,991 4,639 3,953 2,220 2,179 2,214 Net operating income 14,236 5,027 4,211 2,517 2,481 2,616 Other operating expenses -2,834 -916 -628 -722 -568 -788 Claims, net of reinsurance -6,201 -1,578 -1,471 -1,546 -1,606 -1,540 Provision for losses -443 -99 -215 -55 -74 -100 Pre-tax profit 4,758 2,434 1,897 194 233 188 Economic Value-added -103

The Insurance Division is included in Íslandsbanki’s accounts the acquisition. Accordingly, while profit on the operations as of 1 October 2003, with the result that only the compa- of the Insurance Division was ISK 188 million in the 4th ny’s performance in the 4th quarter is part of the consolidat- quarter, EVA was negative by ISK 103 million. ed accounts. At the time of the purchase, securities owned The following section, however, discusses Sjóvá-Almennar’s by Sjóvá-Almennar were assessed at market value and in performance for the year 2003 as a whole. the Bank’s consolidated accounts the reappraisal value of the securities is entered to reduce goodwill resulting from Sjóvá-Almennar’s performance 3 930 Performance of insurance and The Sjóvá-Almennar group’s operating profit was ISK , investment operations million in 2003, which is a substantial increase over the pre- vious year. The dominating factor here is profit from sale of ISK m 2003 2002 investments and changes in appraisal value of the compa- Premiums, net of reinsurance...... 7,353 7,090 ny’s shareholdings. Allocated investment income...... 2,288 645 Unrealised income from life insurance ...... 265 -195 Insurance operations continued to be in good balance Claims, net of reinsurance...... -6,150 -5,299 and claims in compulsory motor insurance dropped by Bonuses and premium rebates ...... -284 -172 5 Net operating expenses ...... -2,172 -1,752 about % from the previous year. The group’s accounted Change in equalisation provision ...... -51 -23 premium income increased by 5% during the year and Profit from insurance operations ...... 1,249 294 premiums net of reinsurance by 6%. Claims net of reinsur- Investment income...... 6,803 1,548 ance increased by 16% from the previous year, with much Investment expenses...... -873 -653 Investment income transferred ...... -2.288 -645 of this increase attributable to changes in the company’s Profit from investment operations ...... 3,642 250 reinsurance programmes, leading to a larger proportion of 2003 Other expenses and minority interest ...... -133 29 risks now being retained. In , the equalisation provision Taxes ...... -828 -72 was increased, according to the company’s rules. Profit...... 3,930 501 Net operating costs were 29%, a slight increase over previous year.

42 Insurance Division – Sjóvá-Almennar

Premiums net of reinsurance 1999–2003 Performance of individual portfolios in 2003 ISK bn as a proportion of premiums

7 7.4 7.1 Property insurance 6 6.1 Marine, aviation and cargo insurance 5 4.8 Compulsory motor 4 insurance 3.9 Motor hull 3 insurance Genaral liability 2 insurance 1 Accident and sickness insurance 0 Non-life 1999 2000 2001 2002 2003 insurance total

Life insurance

The overall number of polices in force increased by 2% over Total 2003 the previous year. The greatest increase was in property. 0% 5% 10% 15% 20% 25% A total of 20,210 claims were reported in 2003, as compared to 20,853 in 2002, a decrease of 3%. At year-end 2003 just 2002, when this ratio was 70%. Premiums in marine, avia- over 282,000 policies were in force. tion and cargo insurance comprised 7% of the company’s premium income. Operations of individual portfolios In property accounted premiums increased by 18%. As previ- In compulsory motor insurance total premiums dropped by 1 1 ously, this growth was mainly in home and home-owners % and the average premium also by %. At the same time, 4 policies. There was also a considerable increase in compulso- total premiums in motor hull increased by %, while the 3 ry fire insurance. The overall loss ratio was 54% as compared average premium increased by %. Claims incurred for the 2003 to 68% the previous year. Premiums in property insurance year decreased in number as compared to the previous comprised 25% of the company’s premiums. year. There was a slight increase in claims in motor hull insurance. Total premiums in motor insurance comprised Premiums in marine, aviation and cargo increased by 1%. 53% of the company’s direct premiums, a drop of 2% from The loss ratio was 33% which is considerably lower than in the previous year.

51 Claims, net of reinsurance, and loss ratio In general liability the loss ratio was % as compared with 1999–2003 66 % in 2002. Premiums increased by 3% while paid claims ISK bn 140% dropped by 21%. Premiums in general liability comprised 8% of the company’s direct premiums. 6 120% 6.0 5.8 5 100% The loss ratio in accident and sickness was 66% as 5.3 5.1 compared with 56% the previous year. Most of the differ- 4 80% 4.2 ence here is a rise in claims in the seamen’s accident portfo- 3 60% lio. Premiums increased by 5% over the previous year, while paid claims rose by 25%. Premiums in accident and sickness 2 40% insurance comprised 7% of the company’s direct premiums. 1 20% Premiums in inward reinsurance increased by 47% over last 0 0% 1999 2000 2001 2002 2003 year. The loss ratio was 56% as compared to 58% the previ- Claims (left axis) Loss ratio (right axis) ous year. The major part of these premiums came from Sjóvá-Almennar líftryggingar.

43 Insurance Division – Sjóvá-Almennar

Accounted premiums by individual portfolios Paid claims by individual portfolios

4% 11% 8% 20% 22% 7% Property Property Marine, aviation 6% Marine, aviation 7% and cargo and cargo Compulsory 4% Compulsory 6% motor motor Motor hull Motor hull Gen. liability 13% Gen. liability 13% Accident and Accident and sickness sickness 45% Life Life 34%

The profit on the operations of Sjóvá-Almennar líftryggingar Over 20,000 of Sjóvá-Almennar customers registered in amounted to ISK 101 million in 2003, as compared to a loss Stofn, the loyality scheme for preferred customers, and of ISK 120 million the previous year. who had made no claims, received a bonus check of up to 10% of their premium in February. Total rebates amount- Accounted premium income in life insurance for the year ed to over ISK 260 million. Sjóvá-Almennar is the only was ISK 1,102 million, an increase of 6% over the previous insurance company which rewards good customers in this year. Paid claims increased by 3% over the previous year. manner. Accounted premium in non-life insurance amounted to ISK 30 million, a decrease of 8% from 2002. Sjóvá-Almennar received the Icelandic Quality Award for 2003, which is presented annually by the association Sjóvá-Almennar’s activities Excellence Iceland. The objective of the Icelandic Quality Award is to recognise major administrative achievements At the end of the year, a decision was taken to lower by companies and institutions, while at the same time premiums for compulsory motor liability insurance by as encouraging them to adopt clear objectives and assess much as 10% as of 1 January 2004. By this action, Sjóvá- their achievement regularly. The company also received Almennar aims at passing on to its customers the improve- the award Striking the Balance, made in recognition of ment which has occurred in mandatory motor vehicle efforts towards finding a work-life balance in word and insurance recently. The reason for the improved situation in in deed. this class of insurance is, in particular, a drop in the number of claims, which can be attributed to better conditions, not least milder weather.

44 Awards and Recognition in 2003

The Association of Icelandic Economists awarded Íslandsbanki the Icelandic Knowledge Award for 2003, for exceptional corporate culture and internal marketing

Euromoney selected Íslandsbanki as the Best Bank in Iceland in July, for the second year in a row in its annual Awards for Excellence

The Banker honoured Íslandsbanki with the title Bank of the Year in Iceland in September, for the second consecutive year

Global Finance selected Íslandsbanki as the Best Bank in Iceland in October, for the second year in a row

Sjóvá-Almennar received the Icelandic Quality Award for 2003, which is presented annually by Stjórnvísi, the national quality management association

In November, Sjóvá-Almennar was recognised with the award known as Striking the Balance, made in recognition of efforts towards finding a work-life balance

45 The Bank of Commerce offered drive-in banking when the branch at Laugavegur opened in 1962. A Leader in Innovation

Íslandsbanki and its predecessors have been at the forefront of innovation in the financial market. The drive-in window in 1962 is an example of increasing customers’ ease of doing business. Íslandsbanki was among the first banks to offer financial service on the Internet in 1995 and has since led the way in this area. Risk management and asset quality

Risk management is integrated into Íslandsbanki’s activities in most areas. Every effort is made to ensure it is effective and dependable. Surveillance of the main risk factors in the operations is in the hands of Credit Control, which monitors risk where the loan portfolio is concerned, and Treasury & Risk Management, which supervises financial risk. The goal of risk management is to strike a balance between risk of loss and maximising income. Effective risk management is one of the key factors in Íslandsbanki’s competitiveness.

The Board of Directors sets general rules on risk manage- ment. The Board of Directors sets specific rules on the Bank’s Credit Control Treasury & Risk Management lending activities, as provided for by law and decides on Interest rate risk issues regarding its largest exposures. The Board also Market Equity risk decides on loan-loss provisions and final write-offs. risk Credit Financial Currency risk risk risk The Risk Committee is responsible for credit control and Counterparty risk works under the direction of the deputy CEO. The Liquidity Liquidity managem. risk Committee has specific limits in accordance with the finan- Refinancing cial strength of the counterparty. It decides on credit autho- risations for employees and approves credit limits for indi- vidual customers. The Risk Committee also sets detailed pro- cedural rules on evaluation of credit risk. beginning of 2007. The objective of the new rules is to encourage more effective risk management by financial The Loan Committee has more limited authorisation than institutions worldwide and to eliminate certain flaws of the the Risk Committee, but works in a similar manner. older rules, for instance, by making calculation of capital The Asset & Liability Committee works under the direction adequacy more sensitive to loan quality. The new rules also of the Managing Director of Treasury & Risk Management. take into consideration financial institutions’ operating risk It formulates funding policy for the Bank, having regard for in calculating their equity, which is not the case with the interest rate, currency, liquidity and refinancing risk. currently applicable rules. The Asset & Liability Committee also formulates policy Since Íslandsbanki intends to be well prepared for these concerning the Bank’s capital structure and the internal new rules, teams are working on several development pricing of capital. projects to further improve the bank’s credit decisions and risk management. The bank is currently working on statistical analysis of its loan portfolio and on compiling Board of Directors an historical database to analyse credit risk and evaluate probability of customer default. Risk Committee Asset and Liability Management Committee Credit Committee Credit risk In assessing credit risk, the probability of default is used as a For some time, Íslandsbanki has been preparing systemati- basis, i.e. an assessment of a customer’s ability to fulfil cally for the so-called Basel II rules on calculating risk-adjust- obligations towards the Bank. Credit risk arises in the Bank’s ed assets of credit institutions (the capital adequacy ratio). lending divisions, i.e. Retail Banking, Corporate Finance and EU Directives on financial institutions take into considera- Asset-based Financing, as well as in part of Sjóvá-Almennar’s tion the new Basel rules, which are to take effect at the activities and in the Luxembourg branch.

48 Risk management and asset quality

rating of the Bank’s loans has improved each year, indicat- Loan portfolio by sector 1999–2003 ing that the quality of the loan portfolio is improving. 35% 2003 30% 2002 25% 2001 Provisions for loan-loss account 20% 2000 Provisions for loan losses are calculated as a percentage of 1999 15% the Bank’s exposure in each risk class.

10% Provisions comprise specific provisions and general provi- 5% sions. In determining the specific provisions, an assessment 0% Fisheries Services House- Manufac- Commerce Govern- Munici- Agriculture Other is made of customers’ obligations where there is considered holds turing ment palites to be a substantial probability of default, obligations have been in default for over three months, customers are in financial difficulties and/or if re-evaluation of collateral Diversification of risk reveals that its market value is lower than the customer’s The Bank’s credit risk is well diversified between the various outstanding obligations. Finally, all exposures over a specific economic sectors, in line with the Bank’s objective of keep- minimum level are examined. ing total credit granted to an individual sector within 30% of the Bank’s loan portfolio. The Bank has also sought to diver- Such a detailed examination of the Bank’s loan portfolio is 80 90 sify credit risk between countries; currently some 18.5% of its carried out twice each year, with – % of the total port- loans are to customers outside Iceland. Concentration of folio examined. If specific provisions exceed the calculated exsp0sure to a single sector is highest in services, 29%. contribution then the general portion of the account will reflect that.

Credit rating Provisions for loan losses amounted to 0.9% of the Bank’s A credit assessment is prepared for each of the Bank’s total capital, exceeding its long-term objective of 0.5%. Last customers, varying in detail depending upon the nature and year the general provisions for loan losses were similar to scope of their business. On the basis of this assessment, those of 2002 and at year-end amounted to 0.9% of loans. customers are rated in ten risk groups. The risk assessment is based on the customer’s financial standing and probabili- Default developments ty of default. Pricing of credit also takes into account the At the end of the year 2003 defaults, calculated as of the length of the repayment period, sector risk and the collater- first day past due, amounted to 2.5% of the total loans and al for the loan. Credit risk classification also provides the guarantees issued; at year-end 2002 the comparable figure basis for calculating loan-loss provisions. The weighted risk was 3.6% and at year-end 2001 it was 4.7%. Active overdue, i.e. defaults less loans with specific provisions and foreclosed

Lending by risk class 25% Overdue exposures 2001–2003 5% 20% Overdue exposures 4% 15%

10% 3%

5% 2% Active overdue exposures

0% 1% Not 12345678910classified Dec 2002 – Weighted average risk class: 5.9 0% Dec 2003 – Weighted average risk class: 5.4 2001 2002 2003

49 Risk management and asset quality

mortgages, have also decreased and amounted to 1.2% at having the highest percentage of non-performing loans and year-end 2003. Merchant Banking the lowest.

Defaults in absolute terms have also fallen substantially from the previous year, from ISK 9.6 billion at year-end 2002 Large exposures 10 to ISK 8.1 billion at year-end 2003. The lower default ratio is Large exposures are those exceeding % of the Bank’s equi- thus not the result of increased lending but of improved ty measured on a risk-weighted asset basis. By law, such 800 repayments and customers’ performance. The Bank’s exposures may not total more than % of equity at any default ratio varies somewhat in the various profit units, time and obligations to individual customers may not 25 with defaults proportionally highest in Retail Banking and exceed % of equity. ISB’s objective is keep the concentra- 400 lowest in Merchant Banking. tion of large exposures within %. Major exposures amounted to 169% of the equity of the Defaults at financial institutions 2002–2003 Bank consolidation at year-end. The obligations of one party exceeded 25% of the Bank’s equity, but are within this limit ISK bn 6% based on the equity of the Group. This can be explained by 25 5% changes in the definitions of financially related parties. 20 4% 15 3% Financial Risk 10 2% Market Risk 5 1% Market risk refers to the impact which a possible change 0 0% in interest rates, foreign exchange rates or share prices may Dec Jun Dec Jun Dec Jun Dec 2001 2002 2003 have on the Bank’s performance. Market risk arises in partic- ÍSB Other (left axis) ÍSB Other (right axis) ular in Treasury & Risk Management, which manages proprietary securities and forex trading, and also in Capital Markets. Compared to other Icelandic financial institutions, ISB’s defaults are considerably lower than the average of its Currency risk competitors, according to data compiled quarterly by the Changes in the exchange rates for individual currencies can Financial Supervisory Authority. In December 2003, total have a major impact on the Bank’s performance if there is defaults of over 30 days standing were around 2.5% for an imbalance between assets and liabilities in individual Íslandsbanki, whereas the average of other commercial and currencies. The Bank is a market maker on the interbank savings banks was 4.0%. forex market. Since such market making cannot always operate in complete balance, it involves currency risk. Non-performing loans Limits to deviations in the currency balance are set by the The bank’s non-performing loans have decreased Risk Committee. Market making and possible positions considerably since year-end 2002, from ISK 5,261 million taken fall under Treasury & Risk Management. to ISK 4,815 million at year-end 2003. The decrease in non- performing loans occurred despite changes in the definition Counterparty risk in Capital Markets of non-performing loans. Previously, loans were considered Customers’ derivative trading with the Bank involve non-performing if six months overdue, but in 2003 loans counterparty risk, which the Bank includes under market were declared non-performing if three months overdue. risk rather than credit risk, since it derives from price Once loans are declared non-performing the Bank ceases to changes in the underlying contract items. The same applies enter interest and loan fees as income and an assessment is to counterparty risk resulting from securities and currency made of the risk of loan loss. Non-performing loans vary broking, since price changes can affect a customer’s ability between the Bank’s business units, with Retail Banking to honour its part of the contract.

50 Risk management and asset quality

Capital Markets manages such exposures by setting limits The Bank’s own trading in trading book securities takes on customers’ transactions and requiring collateral. Treasury place in Treasury & Risk Management. This trading must be & Risk management, on the other hand, defines the limits kept within limits set by the Bank’s Risk Committee, which and monitors customers’ positions and the current market defines the size of loss which may result from an value of collateral. If developments in the market value of unfavourable interest-rate change of 1%. The size of the the contract and collateral require, the Bank can request fur- bond portfolio varies greatly but at year-end, net positions ther collateral or, if this is not forthcoming, close the con- were ISK 7,073 million as compared with ISK 5,808 million tract. the previous year. The risk arising from a 1% interest rate change over the yield curve was ISK 704 million at year-end, 2 1 Equity risk or around . % of equity and subordinated loans. The size of the bond position and its performance is measured daily Equity risk arises from the impact which changes in the mar- and compared with specified targets. Trading gains (includ- ket price of shares have on the Bank’s performance. ing interest income) on the domestic bond trading book Treasury & Risk Management trade on its own account with amounted to ISK 619 million during the year, while the net domestic trading book equities, while Capital Markets man- result, after taking into consideration dividends, interest age foreign trading book equities. The Risk Committee sets expense, capital employed and operating costs, was ISK 256 limits on the total size of the equity portfolio and its distri- million. bution. Trading book equities are marked to market each day, and are monitored to ensure the portfolio is within the limits specified. Liquidity and refinancing risk It must be ensured that the Bank always has sufficient liquid The size of the share portfolio varies greatly. The net share assets to meet both foreseeable and unexpected obliga- position in the trading book gives the shareholdings, taking tions. Treasury is responsible for conducting the Bank’s into consideration shares held against derivative contracts. funding in order to minimize the liquidity and refinancing At year-end positions in domestic equities in the trading risk. book of Treasury & Risk Management amounted to ISK 3,660 million as compared with ISK 4,361 million the previ- On the domestic market the Bank may raise funds from ous year. Trading gains amounted to ISK 1,574 million during deposits or on the interbank market, the money market and the year, while the net result, after taking into consideration the bond market. Because a high proportion of the Bank’s dividends, interest expense, capital employed and operating loans are in foreign currencies, however, the majority of its costs, was ISK 1,356 million. funding takes place abroad. At year-end, the Bank’s total funding amounted to ISK 386 billion, only one-third of Interest rate risk which was domestic. The Bank bears a twofold risk of interest rate changes. On the one hand, the impact on the market value of trading Foreign long-term funding book bonds and, on the other hand, the impact on the The Bank’s EMTN (Euro Medium-Term Note) Programme is Bank’s interest rate margin resulting from a possible imbal- its most important international funding vehicle. In 2003, ance of assets and liabilities. issuance of bonds with a maturity of over one year totalled EUR 975 million, in addition to a syndicated revolving credit Maturities and duration of assets and liabilities never bal- facility amounting to EUR 160 million. This loan together ance out completely and interest rate changes thus affect with the Bank’s other revolving facilities are generally the Bank’s interest rate margin. A drop in interest rates can undrawn, and serve in particular as a back-up for other have either a positive or negative impact on the interest rate short-term and long-term funding. Undrawn facilities to margin and the role of Treasury & Risk Management is to which the Bank has access currently amount to over EUR manage this risk. Treasury serves as the internal bank for 230 million. the profit centres, which finance themselves on internal interest rates. Thus interest rate risk is for the most part To minimise re-financing risk, the Bank seeks to ensure a restricted to Treasury and Risk Management. suitable distribution of maturities and keep the timing for

51 Risk management and asset quality

The Bank’s short-term funding is intended in particular to Foreign funding – geographical distribution finance assets which are also of short-term nature, since a balance is generally sought between the borrowing term of 1% 6% assets and liabilities. Special attention is given to ensuring 28% that assets with a term of over one year are financed with 18% Germany Italy debts with a term of over one year. France UK Liquidity management Scandinavia The Central Bank of Iceland sets liquidity requirements for Other European 9% countries deposit institutions. In calculating the ratio, the cash flow of Asia 15% assets and liabilities is assessed with regard to liquidity. USA and Canada 9% Assets in Treasury bonds, for example, are weighted at 90% 14% of their value, expected cash flow of loans 80% and equities on the ICEX-15 Index at 50%. According to these calculations, the aggregate three-month liquidity ratio should be greater refinancing in mind in determining the borrowing period. than 1, i.e. weighted short-term assets must exceed weight- Emphasis is also placed on geographical distribution of ed short-term liabilities. investors: the Bank’s bonds have been issued in eight currencies and sold to investors throughout Europe and Asia. Development of liquidity ratio in 2003 Work is underway on increasing the size of the EMTN 1.6 Programme from EUR 2.5 billion to EUR 3.5 billion. 1.4 Foreign short-term funding 1.2 1.0 The Bank’s short-term funding on foreign markets is mainly obtained through issuance of short-term notes under its 0.8 Euro-Commercial Paper (ECP) Programme, as well as 0.6 Domestic Foreign through short-term money-market borrowing. The maxi- 0.4 Liquidity ratio Minimum mum amount of the ECP Programme is currently EUR 500 0.2 2003 million. During , the average amount of such short- 0.0 term notes outstanding was over EUR 380 million, plus Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec almost EUR 100 million of interbank borrowing.

Although the Central Bank’s liquidity rules cover both posi- tions in ISK and foreign currencies, Íslandsbanki has deemed Composition of foreign funding it advisable to measure domestic and foreign liquidity sepa-

4% rately. In addition, the Bank has used other references, such as having back-up possibilities for foreign short-term fund- 70% 22% ing (particularly drawing rights or highly liquid assets) always amount to at least the total cash flow of one-month foreign debt and half the cash flow of three-month debt. Deposits Notes and 4% interbank market Bank loans Bonds

52 Risk management and asset quality

Treasury & Risk Management ISK m 2003 Q4 Q3 Q2 Q1

Net interest income 479 109 156 -50 264 Other Operating Income 2,095 498 514 665 418 Net Operating Income 2,574 607 670 615 682 Other Operating Expenses -282 -114 -83 -36 -49 Provision for losses -25 -11 -14 0 0 Pre-tax Profits 2,267 482 573 579 633 Economic Value-added 1,737 369 437 439 492

Performance of Treasury & Risk Operating Risk Management Considerable emphasis has gone into keeping operating risk The equity and bond trading books have the greatest impact at a minimum. Operating risk is defined as the risk of loss on the operating performance of Treasury & Risk due to ineffective inner procedures, human error, technical Management. All types of imbalance in the Bank’s assets failure or external factors. and liabilities, e.g. due to inflation indexing, appear on the Extensive work has gone into further improving operating balance sheet of Treasury & Risk Management and thus in security in information systems in recent years. the division’s performance. In addition, the branch in The Bank has drawn up a policy concerning management Luxembourg, which provides in particular services to of information security, in accordance with international commercial and savings banks in Nordic countries, is directly standards, which a special security committee is responsible under Treasury & Risk Management. for implementing (see page 56). The Bank is also insured Treasury & Risk Management profit in 2003 amounted to against a variety of damages. Working procedures and ISK 2,267 million. Net interest income was ISK 479 million. human error, on the other hand, are aspects which each Financing of the equity trading book generally results in operating unit is responsible for. Internal Audit ensures that negative interest income, but last year’s positive net interest such operating risk is kept to a minimum. income is the result of a positive indexing balance and posi- tive interest rate differential of the bond trading book. Other income from operations amounted to ISK 2,095 mil- lion, in particular trading on equities, as well as trading gains on the bond trading book and earnings on exchange- rate linked assets and liabilities. Total proprietary trading profit was ISK 1,769 million. EVA of Treasury & Risk Management in 2003 amounted to ISK 1,737 million.

53 Human resources

The employees of Íslandsbanki Group form the core of its activities. Their expertise, talents and devotion to their work form the basis of the company’s future. The emphasis is on having a diverse group of employees who work together as a team. Íslandsbanki aims to attract exceptional employees, see to it that they enjoy their work and expand upon their knowledge and capability to find the optimal solutions for the customers.

Diverse employee profile Number of employees by age-group Employees of the Íslandsbanki Group are of various ages, with the average age around 40 years at Íslandsbanki and 15–19 45 years for Sjóvá-Almennar. Their average length of service 20–24 is 12 years, reflecting a low personnel turnover. While 25–29 employees come from a variety of educational backgrounds, 30–34 around 30% of employees have a university degree. 35–39 40–44 As part of the integration of the operations of Íslandsbanki 45–49 and Sjóvá-Almennar, their support divisions were merged. 50–54 2003 At year-end , employees in Sjóvá-Almennar’s IT and 55–60 accounting sections moved to Íslandsbanki headquarters at 61–65 Kirkjusandur, together with several employees in marketing 65–69 and human resources. In April 2004 the operations sections 0 20 40 60 80 100 120 of the companies will be merged.

In 2003, the average number of full-time equivalent posi- banki Group. The programme was organised in co-operation tions at Íslandsbanki was 893, of which 844 are banking with Reykjavík University. There employees are made positions, which is a drop of six from the previous year. The acquainted with the product line of the Íslandsbanki Group, average number of full-time equivalent positions in Sjóvá- the company’s history and its predecessors; the company’s Almennar was 200. The majority of Íslandsbanki’s employ- policy and values are discussed; and finally each employee ees are female, seven out of ten in fact, while around half of sets personal career objectives to work towards. Sjóvá-Almennar’s employees are female. A special course is held for new employees, following which Íslandsbanki received almost 2000 job applications in 2003, general instruction is continued, taking into consideration of which around 380 were applications for summer jobs. each employee’s experience and knowledge. Major empha- During the year 73 new employees were hired. sis is placed on training personnel to respond correctly when security questions arise.

Continuing educational programme In addition to the company’s own training, Íslandsbanki offers its employees the chance to apply for grants to study, The Íslandsbanki Group regards continuing education as at both upper secondary and university level, while working. of central importance in maintaining its competitive A great number of employees have taken advantage of this advantage. Goal-directed job development makes it possible to increase their education. to utilise each individual’s capabilities to best advantage. Employees are offered a wide selection of courses throughout the year and specific training in various areas. High job satisfaction 2003 In November , an integrated programme called The Íslandsbanki Group places major emphasis on job satis- Stefnumót was launched for all employees of the Íslands- faction, which reduces staff turnover, increases output and

54 Human Resources

contributes to better company performance. These factors, Employee profit sharing in turn, influence customer satisfaction and loyalty, which The Íslandsbanki Group emphasises having employees improves the company’s long-term operations. In this area, share in the company’s operating profits, thus linking Íslandsbanki and Sjóvá-Almennar have achieved good together the interests of employees, shareholders and the results and assessments of job satisfaction are high in both Company. All Íslandsbanki’s employees are thus paid an companies. Similarly, service surveys which Íslandsbanki has annual bonus of ISK 12,000 and upwards, which is paid to conducted, of both individual and corporate customers, each employee if the return on equity amounts to at least have been very positive. 11%. This bonus increases by another ISK 12,000 for each Each year, IMG-Gallup conducts a workplace analysis at percentage point of return on equity above that. In 2003 the Íslandsbanki and Sjóvá-Almennar. Employees answer a Bank’s ROE was 30.1% and all Íslandsbanki’s personnel will large number of questions on their attitude to their work, thus be paid a bonus amounting to ISK 241,200 for a full- working environment, management, etc. The results of the time position. survey taken in the autumn 2003 showed a very positive Salaries and wage-related expenses at Íslandsbanki in attitude among employees, who are generally more 2003 amounted to ISK 5.4 billion, or 55.4% of the company’s satisfied in their jobs than are those of other companies. operating expenses. In 2002 this percentage was 55.7%. The response rate in both companies was very high, 93% for Íslandsbanki and 99% for Sjóvá-Almennar.

55 Information technology

The objective of IT is to increase the efficiency of the service and facilitate the further technological advancement of banking business. ISB has always emphasised technological innovations increas- ing ease of use and information provision for customers, in addition to which extensive efforts have been devoted to ensuring maximum security of information systems.

Following a comprehensive assessment of the Bank’s IT strategy follows the IST 1 7799 security standard. status in 2002, a new strategy was adopted on IT utilisation. The Security Committee, comprised of the managing The strategy resulted in a variety of projects concerning directors of Credit Control, Treasury & Risk Management, IT, changes in emphasis, new structure, and participation of Retail Banking and the director of Internal Auditing, is other divisions in IT decisions. All of these projects were responsible for implementing the policy. An information completed in 2003 and serve as the framework for current security manager monitors and implements ISB’s security operations. policy on behalf of the Committee. The Financial Supervisory Authority carried out an extensive assessment of the Bank’s One of the most extensive structural changes was the information security situation with positive results in all establishment of the Project Management Office, which respects. serves as the forum for project management within the Bank. The Project Management Office plays a key role in the structure and operations of a large number of projects Merging of IT departments underway at the Bank. Following the acquisition of Sjóvá-Almennar, a decision was taken to locate all of the Íslandsbanki Group’s IT matters in Security issues a single section and the departments were merged at As utilisation of IT expands in scope, effective control of Kirkjusandur. The merger has clearly proceeded well and information security becomes of growing importance. work on further integration of the companies’ IT is under- ISB has adopted a clear policy in this respect, following way, aimed at providing support for a comprehensive prod- pre-determined arrangements. The implementation of this uct line in banking and insurance services in the future.

56 Corporate social responsibility

Íslandsbanki and Sjóvá-Almennar are active members of the community and, as such, their role is not limited to responsible business but includes support for humanitarian, educational and cultural issues. Through their sponsorship, the companies support worthy causes, doing their part to make Iceland a richer and more vital place to live, to the advantage of business and the nation as a whole.

Íslandsbanki’s Cultural Fund celebrated its 15th year of operation in 2003. The Fund provides grants to artistic and cultural activities, scientific and educational affairs, preven- tive efforts and humanitarian organisations. Allocations to the Fund are decided upon by the Bank’s shareholders at its Annual General Meeting each year. In deciding upon the grants, the Fund’s Board places special emphasis on innova- tive and progressive projects, as well as projects which can On the 15th anniversary of the Cultural Fund, Íslandsbanki presented spark interest among children and youths in the arts, the childrens’ hospital Barnaspítali Hringsins with a gift of 35 works culture, education and science. Grants were awarded to a of art, plus a grant to establish a culture fund for the hospital. total of 120 projects this past year.

ISB also makes a large number of other grants, in addition to those of the Cultural Fund, for instance, to educational, employment and social projects, and to sports in Iceland. The Bank awarded around 1,100 such grants during 2003.

Sjóvá-Almennar’s Culture Fund was established in 1997, to provide grants in support of projects of benefit to the Íslandsbanki’s support for Special Olympics in Iceland helped dedi- Icelandic community, for instance to culture and the arts, cated handicapped athletes to compete in the Special Olympics in sports and preventive efforts. Grants from Sjóvá-Almennar’s Dublin in June 2003. Culture Fund were awarded to 37 applicants in 2003, for a total amount of ISK seven million.

These illustrations are a few examples of projects supported in 2003.

Íslandsbanki sponsored an exhibition by world-famous visual artist Matthew Barney in the Reykjavík Living Art Museum.

57 Employees of the original Íslandsbanki in its first office on Hafnarstræti in 1905. Employees with Initiative

Íslandsbanki emphasises encouraging the initiative of its personnel. By so doing, the Bank ensures increased expertise, customer satisfaction and sound operations. When the original Íslandsbanki opened in 1904, it had only seven employees, but together they moved mountains during the early years of financial services in Iceland. 60 Annual accounts

61 Annual Report and Signatures by the Board of Directors and the CEO

The Annual Accounts include the Consolidated Annual Accounts of fjárfestingarbanki hf. will, on the other hand, merge with the Íslandsbanki hf. and its subsidiaries. The Annual Accounts are pre- Bank, effective as of 1 January 2004. pared in accordance with the Annual Accounts Act and the Rules During the year, the average number of the Bank’s employees was on the Financial Statements of Credit Institutions. The accounting 948. Total salaries during the year amounted to ISK 4,155 million principles applied in preparing Íslandsbanki hf.’s Annual Accounts and salary-related expenses amounted to ISK 1,267 million. are consistent with those of the Bank for the previous year. The Bank has granted its management stock options, the nominal Net profit from the Bank’s operations in 2003 amounted to ISK value of which amounts to a total of ISK 109 million, exercisable in 5,835 million, which corresponds to a 30.1% return on equity dur- 2004–2006. The Bank will use its own shares and purchase shares ing the year. The Board of Directors proposes to pay a dividend of on the market to fulfil its employees’ stock options. The Bank’s 23% in the year 2004, and that the remaining profit be allocated as cost arising from employee stock options in 2003 amounted to indicated in the Notes to the Annual Accounts. Equity, according ISK 254 million and is expensed in the Profit and Loss Account. to the Balance Sheet, amounted to ISK 29,423 million at the end of Furthermore, the Bank’s management have put options on shares the year, including share capital in the amount of ISK 10,080 in the Bank for a nominal value of ISK 248 million, at the exchange million. The Bank’s CAD ratio, calculated according to the Act on rate 4.7 and 5.95. The put options are exercisable in 2005 and Financial Undertakings, was 11.4%. Under Icelandic law this ratio 2006. No cost is expensed in relation to the put options, as the may not be lower than 8.0%. market price of shares in the Bank exceeds the put option rate. The Bank’s total assets amounted to ISK 443,943 million at year- At Íslandsbanki’s Annual General Meeting in March 2003 the end. Furthermore, the Bank held ISK 198,787 million in trust for its Bank’s share capital was decreased by ISK 1,000 million, as part clients, including mutual funds amounting to ISK 64,654 million. of the Bank’s policy of maximising utilisation of equity. At a share- In 2003 the Bank converted its office in London to a branch and holders’ meeting in October the Bank’s Board of Directors was furthermore opened a new branch in Luxembourg. In addition, authorized to increase the Bank’s share capital by up to ISK 1,500 the Bank purchased the insurance company Sjóvá-Almennar million to finance the Bank’s purchase of Sjóvá-Almennar tryggingar hf. and the Framtak fjárfestingabanki hf. Both these tryggingar hf. and the Board used all its authorization. The Bank’s companies are now wholly owned by Íslandsbanki hf. The compa- total share capital according to its Articles of Association thus nies’ total assets amounted to 41,991 million. Sjóvá-Almennar amounts to ISK 10,500 million at year-end. Shareholders at year- tryggingar hf. will continue to be operated as an independent end 2003 numbered 11,045 and no shareholder owned more than company but in close co-operation with the Bank. Framtak 10.0% of the shares in the Bank at year-end.

The Board of Directors and the CEO of Íslandsbanki hf. hereby confirm the Bank’s Annual Accounts for the year 2003 by means of their signatures.

Reykjavík, 27 January 2004. Board of Directors:

Chief Executive Officer:

62 Auditors’ Report

To the Board of Directors and Shareholders of Íslandsbanki hf. We have audited the accompanying Consolidated Balance Sheet includes examining, on a test basis, evidence supporting the of Íslandsbanki hf. and its subsidiaries as of December 31, 2003, amounts and disclosures in the Annual Accounts. An audit also and the related Consolidated Profit and Loss Account and includes assessing the accounting principles used and significant Consolidated Statement of Cash Flows for the year then ended. estimates made by management, as well as evaluating the overall These Annual Accounts are the responsibility of the Company’s presentation of the Annual Accounts. We believe that our audit Management. Our responsibility is to express an opinion on these provides a reasonable basis for our opinion. Annual Accounts based on our audit. In our opinion, the Annual Accounts give a true and fair view of We conducted our audit in accordance with generally accepted the financial position of Íslandsbanki hf. as of 31 December 2003, auditing standards. Those standards require that we plan and per- and the results of its operations and its cash flows for the year form the audit to obtain reasonable assurance about whether the then ended, in accordance with the law and generally accepted Annual Accounts are free of material misstatements. An audit accounting principles in Iceland.

Reykjavik, 27 January 2004.

KPMG Endurskoðun hf.

63 Consolidated Profit And Loss Account for the Year 2003

The amounts are in millions of Icelandic krónur (ISK)

Notes 2003 2002 Financial income 6,32 24,144 24,481 Financial expenses 6,33 ( 13,105) ( 14,773)

Net Interest Income 11,039 9,708

Insurance premiums, net of reinsurance 7,34 1,906 0 Income from shares and other holdings 9,59–61 786 196 Fees and commissions 8,35 4,672 4,299 Commission expenses 36 ( 920)( 819) Trading, net 37 2,905 65 Sundry operating income 38 229 625

Other Operating Income 9,578 4,366

Net Operating Income 20,617 14,074

Salaries and related expenses 39 5,422 4,302 Other operating expenses 3,651 2,879 Depreciation 63 712 542

Other Operating Expenses 9,785 7,723

Insurance claims, net of reinsurance 43 ( 1,540) 0 Provision for losses on the loan portfolio 55 ( 2,864)( 2,184)

Pre-tax Profits 6,428 4,167

Income tax 76 ( 593)( 760)

Net Profit for the Year 80 5,835 3,407

Earnings Per Share:

Earnings per share 10,44 0,63 0,36

64 Consolidated Profit And Loss Account for the Year 2003 – Banking and Insurance Operations*

The amounts are in millions of Icelandic krónur (ISK)

Banking Operations Insurance Operations Notes 2003 2002 2003 2002 Financial income 23,724 24,481 433 0 Financial expenses ( 13,086)( 14,773)( 31) 0

Net Interest Income 10,638 9,708 402 0

Insurance premiums, net of reinsurance 001,913 0 Income from shares and other holdings 766 196 20 0 Fees and commissions 4,669 4,299 3 0 Commission expenses ( 920)( 819) 00 Trading, net 2,627 65 278 0 Sundry operating income 232 625 0 0 Other Operating Income 7,374 4,366 2,214 0

Net Operating Income 18,012 14,074 2,616 0

Salaries and related expenses 5,042 4,302 380 0 Other operating expenses 3,373 2,879 289 0 Depreciation 593 542 119 0

Other Operating Expenses 9,008 7,723 788 0

Insurance claims, net of reinsurance 00( 1,540) 0 Provision for losses on the loan portfolio ( 2,764)( 2,184)( 100) 0

Pre-tax Profits 6,240 4,167 188 0

Income tax ( 556)( 760)( 37) 0

Net Profit for the Year 5,684 3,407 151 0

* Transactions between the entities are not netted in the Profit and Loss Account

65 Consolidated Balance Sheet December 31, 2003

The amounts are in millions of Icelandic krónur (ISK)

Assets Notes 2003 2002 Cash and demand deposits with the Central Bank 897 645 Treasury bills eligible for refinancing with the Central Bank 4,829 3,552 Required reserves with the Central Bank 4,048 5,705 Amounts due from other credit institutions 34,593 23,582

Cash, Treasury Bills and Amounts due from Credit Institutions 45–48 44,367 33,484

Loans to customers 297,755 239,025 Lease contracts 16,529 13,106 Mortgages foreclosed 882 865

Loans 12–14,49–55 315,166 252,996

Bonds and other fixed-income securities 35,319 9,357 Shares and other variable-income securities 15,372 8,531 Shares in affiliated companies 7,399 2,961 Shares in subsidiaries 034

Market Securities and Shares in Other Companies 15,56–61 58,090 20,883

Goodwill 16,62 12,149 270 Property and equipment 17,63 3,283 1,145 Reinsurers’ share in insurance fund 18,64 1,607 0 Sundry receivables and assets 65 9,281 3,589

Other Receivables and Assets 26,320 5,004

Total Assets 443,943 312,367 Liabilities and Equity Amounts owed to credit institutions 69,70 27,776 24,150 Savings deposits 71,72 107,672 85,827 Borrowings 73 231,944 164,077 Insurance technical provisions 74 19,413 0 Sundry liabilities 75 10,649 5,893 Deferred liabilities 19,20,76,77 1,357 357 Subordinated loans 21,78 15,709 11,099

Liabilities 414,520 291,403

Share capital 10,080 9,400 Share premium 3,629 341 Accrued cost of stock options 275 84 Retained earnings 15,439 11,139

Equity 79–82 29,423 20,964

Total Liabilities and Equity 443,943 312,367

Not included in the Balance Sheet: 24,85–89 Obligations on behalf of clients Other obligations

66 Consolidated Balance Sheet December 31, 2003 – Banking and Insurance Operations*

The amounts are in millions of Icelandic krónur (ISK)

Assets Banking Operations Insurance Operations Notes 2003 2002 2003 2002 Cash and demand deposits with the Central Bank 884 645 13 0 Treasury bills eligible for refinancing with the Central Bank 4,829 3,55200 Required reserves with the Central Bank 4,048 5,70500 Amounts due from other institutions 34,252 23,582 3,753 0

Cash, Treasury Bills and Amounts due from Credit Institutions 44,013 33,484 3,766 0

Loans to customers 291,986 239,025 5,928 0 Lease contracts 16,529 13,10600 Mortgages foreclosed 720 865 162 0

Loans 309,235 252,996 6,090 0

Bonds and other fixed-income securities 34,379 9,357 940 0 Shares and other variable-income securities 7,058 8,531 8,314 0 Shares in affiliated companies 2,878 2,961 4,521 0 Shares in related companies 8,378 34 0 0

Market Securities and Shares in Other Companies 52,693 20,883 13,775 0

Goodwill 11,169 270 980 0 Property and equipment 1,214 1,145 2,069 0 Reinsurers’ share in insurance fund 001,607 0 Sundry receivables and assets 7,348 3,589 1,947 0

Other Receivables and Assets 19,731 5,004 6,603 0

Total Assets 425,672 312,367 30,234 0 Liabilities and Equity Amounts owed to credit institutions 27,776 24,15000 Savings deposits 111,084 85,82700 Borrowings 231,516 164,077 587 0 Insurance technical provisions 0019,413 0 Sundry liabilities 9,992 5,893 671 0 Deferred liabilities 172 357 1,185 0 Subordinated loans 15,709 11,09900

Liabilities 396,249 291,403 21,856 0

Share capital 10,080 9,400 525 0 Share premium 3,629 341 131 0 Accrued cost of stock options 275 84 0 0 Retained earnings 15,439 11,139 7,722 0

Equity 29,423 20,964 8,378 0

Total Liabilities and Equity 425,672 312,367 30,234 0

* Transactions between the entities are not netted in the Balance Sheet

67 Consolidated Statement of Cash Flows for the Year 2003

The amounts are in millions of Icelandic krónur (ISK)

Notes 2003 2002 Cash Flows from Operating Activities

Net profit for the year 5,835 3,407 Difference between net profit and cash from operations: Indexation and exchange rate difference ( 1,508)( 3,998) Provision for losses on the loan portfolio 55 2,864 2,184 Deferred income tax liability, changes ( 324)( 344) Insurance technical provisions, changes ( 378) 0 Other items ( 435) 113 Changes in operating assets and liabilities 1,614 3,693

Net Cash Provided by Operating Activities 7,668 5,055

Time deposits with the Central Bank, changes 1,657 5,003 Other time deposits with credit institutions ( 6,541)( 1,640) Loans, changes ( 57,258)( 12,946) Trading bonds, changes ( 25,428) 7,924 Trading shares, changes 9,657 4,006 Investment shares, changes 0 ( 115) Investment in shares in other companies, changes ( 10,273)( 291) Investment in fixed assets ( 476)( 378) Proceeds from the sale of fixed assets 28 2,410 Other assets, changes 1,238 ( 575)

Cash Flow from Investing Activities ( 87,396) 3,398

Amounts owed to credit institutions 3,626 ( 7,954) Saving deposits, changes 21,207 8,840 Borrowings, changes 67,500 ( 13,107) Sundry liabilities 1,661 414 Subordinated loans 4,132 ( 858) Dividend paid 80 ( 1,535)( 1,247) Own stock, changes 80 ( 5,020)( 1,556)

Cash Flows from Financing Activities 91,571 ( 15,468)

Increase (Decrease) in Cash and Cash Equivalents 11,843 ( 7,015)

Cash and Cash Equivalents at the Beginning of the Year 7,554 14,569

Cash and Cash Equivalents at Year-end 23 19,397 7,554

Non-cash Investing and Financing Activities:

Capital stock exchanged in the acquisition of subsidiaries 8,925

Other Information:

Income tax paid 1,051 549 Dividends from affiliated companies 215 41

68 Consolidated Statement of Cash Flows for the Year 2003 – Banking and Insurance Operations*

The amounts are in millions of Icelandic krónur (ISK)

Banking Operations Insurance Operations Notes 2003 2002 2003 2002 Cash Flows from Operating Activities

Net profit for the year 5,684 3,407 151 0 Difference between net profit and cash from operations: 0 Indexation and exchange rate difference ( 1,509)( 3,998) 10 Provision for losses on the loan portfolio 2,810 2,184 54 0 Deferred income tax liability, changes ( 351)( 344) 27 0 Insurance technical provision, changes ( 204) 0 ( 174) 0 Other items ( 30) 113 ( 405) 0 Changes in operating assets and liabilities 944 3,693 670 0

Net Cash Provided by Operating Activities 7,344 5,055 324 0

Time deposits with the Central Bank, changes 1,657 5,00300 Other time deposits with credit institutions ( 6,541)( 1,640) 00 Loans, changes ( 57,258)( 12,946) 00 Trading bonds, changes ( 21,916) 7,924 ( 3,512) 0 Trading shares, changes 6,347 4,006 3,310 0 Investment shares, changes 0 ( 115) 00 Investment in shares in other companies, changes ( 10,952)( 291)( 3,382) 0 Investment in fixed assets ( 439)( 378)( 37) 0 Proceeds from the sale of fixed assets 28 2,41000 Other assets, changes 1,238 ( 575) 00

Cash Flow from Investing Activities ( 87,836) 3,398 ( 3,621) 0

Amounts owed to credit institutions 3,626 ( 7,954) 00 Saving deposits, changes 21,207 8,84000 Borrowings, changes 67,550 ( 13,107)( 50) 0 Sundry liabilities 1,661 414 0 0 Subordinated loans 4,132 ( 858) 00 Dividend paid ( 1,535)( 1,247) 00 Own stock, changes ( 5,020)( 1,556) 416 0

Cash Flows from Financing Activities 91,621 ( 15,468) 366 0

Increase (Decrease) in Cash and Cash Equivalents 11,129 ( 7,015)( 2,931) 0

Cash and Cash Equivalents at the Beginning of the Year 7,554 14,569 3,644 0

Cash and Cash Equivalents at Year-end 18,683 7,554 713 0

Other Information:

Income tax paid 1,051 549 0 0 Dividends from affiliated companies and subsidiaries 215 41 0 0

69 Notes

The amounts are in millions of Icelandic krónur (ISK)

Summary of Accounting Principles other financial institutions, loans and market securities. Interest expenses are calculated on amounts owed to financial institu- tions, deposits, borrowings and subordinated loans. If loans Basis of Preparation have been in default for more than three months, interest 1. The Annual Accounts of Íslandsbanki hf. contain the income is no longer calculated. Revenue and expenses which Consolidated Annual Accounts of the Bank and its subsidiaries. are regarded as equivalent to interest, such as borrowing fees, The Annual Accounts have been prepared in accordance with are included with interest income and expenses as they accrue. the Annual Accounts Act and the Rules on the Financial Statements of Credit Institutions. Those parts which concern Income and Expenses Relating to Insurance Operations insurance operations have been prepared in accordance with 7 the Regulation on the Presentation and Contents of the Annual . Premiums recognized as income in the Profit and Loss Account Accounts and Consolidated Annual Accounts of Insurance are premiums derived during the year including premiums Companies other than Life Insurance Companies. The Annual transferred from the previous year less next year’s premiums, Accounts are based on cost accounting apart from trading secu- which are entered as premium liability. rities, which are marked to market. The Annual Accounts are Expensed claims in the Profit and Loss Account are claims prepared according to the same accounting principles used for incurred during the year plus increase or decrease due to claims the previous year. The Annual Accounts have been prepared in for previous years, and considering the reinsurers’ share, cf. Icelandic currency (ISK) and amounts are presented in ISK mil- Note 43. lions unless otherwise indicated. 2. Subsidiaries are companies in which the Bank holds a control- Fees and Commission Income ling interest. The Annual Accounts of the subsidiaries are includ- 8. The Bank provides various services to its customers and derives ed in the Consolidated Annual Accounts of the Bank from the income therefrom. Fees and commissions include income from date the majority interest was acquired and until the interest is consultancy services provided to individuals and companies, no longer held. Balances between group companies, transac- asset management and corporate services. Fees and commis- tions and profits created in transactions between group compa- sions are entered into the Bank’s Profit and Loss Account when nies are netted in the Annual Accounts. they are derived. 3. Affiliated companies are companies where the Group has a sig- nificant influence over the financial and operational policies but not a controlling interest. The Consolidated Annual Accounts Income from Shares and Other Holdings contain the Group’s share in the performance of affiliated com- 9. The Bank’s share in the profit or loss of subsidiaries and affiliat- panies from the beginning of its influence until the end. Should ed companies is included in income from shares and other hold- the Group’s share in any loss be higher than the book value of ings, along with dividends from investment shares. Dividends an affiliated company, the book value is recorded as zero and from trading shares are, however, included with income from there are no further entries of losses unless the Bank has grant- trading rate gains on shares in the Profit and Loss Account. ed guarantees for the affiliated company or financed it. Earnings per Share Foreign Currency 10. Earnings per share is the ratio between profit and weighted 4. Assets and liabilities in foreign currency are converted to ISK at average capital stock during the year and shows the profit per the exchange rate of year-end 2003. Operational revenue and each ISK 1 of share capital. Diluted earnings per share are not expenses in foreign currency are converted at the exchange rate calculated, as the Bank has not taken convertible loans and the of the date of transaction. effects of stock option contracts are fully included in the Annual Accounts. Annual Accounts of Foreign Subsidiaries 5. The Group’s foreign activities are closely related to the activities Breakdown of Specific Activities of the Parent Company. Accordingly, assets and liabilities relat- 11. The Annual Accounts contain three breakdowns of activities: an ed to the foreign operations are converted into ISK at the year- overview showing the Bank’s performance with a breakdown by end exchange rate. Revenue and expenses of foreign activities individual profit centres, showing the average asset position of are converted into ISK at the average exchange rate for the year. each unit; an overview of the performance of insurance opera- Exchange rate difference resulting from the conversion into ISK tions according to insurance classes; and an overview of the is entered as exchange rate difference in the Profit and Loss Bank’s assets and liabilities according to whether they are trans- Account. actions with domestic or foreign counterparties.

Interest Income and Expenses Loans 6. Interest income and interest expenses are entered into the 12. Loans are capitalised with accrued interest, indexation and Profit and Loss Account as they accrue based on the actual inter- exchange rate difference at year-end. Indexed loans are entered est rate. Interest income is calculated on amounts due from based on indices effective at the beginning of 2004 and loans in

70 Notes

The amounts are in millions of Icelandic krónur (ISK)

foreign currency based on the exchange rate of the relevant cur- Insurance Technical Provision rencies at year-end 2003. 18. Insurance technical provision is divided into premium provision, 13. Provision for losses on the loan portfolio is made to meet the claim provision, equalization provision and performance-based risk attached to lending operations. The loss provision is based provision. Premium provision in the Balance Sheet is the portion on estimation and does not represent a final write-off. In addi- of the premium intended to cover insurance risk during the year tion to the required contribution, certain risk factors are evalu- that belongs to the next reporting year. Claim provision in the ated to determine the total contribution for this purpose. Firstly, Balance Sheet is the total amount of claims existing but not yet there are specific provisions to adjust for obligations of creditors settled plus an actuarial estimate of claims that have occurred that have received a poor risk evaluation and secondly, there is but have not been notified. Equalization provision is the a general provision to meet the general risk of lending opera- amount that is set aside to meet changes in the Bank’s claims tions. Interest on loans, the collection of which is uncertain, is experience from one year to the next and due to uncertainty not entered as income. The provision has been deducted from regarding the final claim amount, within the limits stipulated in the appropriate Balance Sheet items, less the provision for rules laid down by the Financial Supervisory Authority. issued guarantees, which is posted among sundry liabilities in Performance-based provision is the amount that is set aside and the Balance Sheet. used to pay performance-based rebates and discounts. 14. The Bank has redeemed assets on foreclosed mortgages. In some cases the foreclosure has been made through special Deferred Liabilities management companies owned by the Bank and loans to them 19. The deferred income tax liability has been calculated and are included in foreclosed mortgages. These companies, which included in the Annual Accounts. The liability is based on the are owned by the Bank’s subsidiaries, are all included in the difference between Balance Sheet items in the tax return, on Consolidated Annual Accounts. Foreclosed mortgages are the one hand, and in the Annual Accounts on the other. This dif- entered at estimated market prices in the Bank’s Annual ference is due to the fact that tax assessment is based on other Accounts. premises than the Annual Accounts. These are mostly tempo- rary difference because some expenses are expensed earlier in Market Securities and Holdings the tax return than in the Annual Accounts. 15. The Bank’s securities are presented as trading securities and 20. The subsidiary Sjóvá-Almennar hf. has a pension liability. The investment securities. Investment securities are those that will recording of the pension liability in the Annual Accounts is be held for more than one year according to a formal decision, based on actuarial calculations and using a discount rate of whereas other securities are categorised as trading securities. 3.5%. Investment shares are capitalized at cost price or market price, whichever is lower. Listed trading securities are capitalized at Subordinated Loans year-end market value. Unlisted trading bonds are capitalized 21. The Bank has borrowed funds by issuing bonds with subordi- according to the required rate of return at the time of purchase, nate terms. These bonds have the characteristics of equity in whereas unlisted trading shares are entered at the cost price or being subordinate to other liabilities of the Bank. In the calcula- estimated market price, whichever is lower. tion of the capital adequacy ratio, the bonds are included with equity, as shown in Note 78. On the one hand, there are subor- Goodwill dinated loans with no maturity date that the Bank may not 2010 16. In cases where the Bank has purchased or acquired shares in retire until and then only with the permission of the subsidiaries at a price that does not correspond to the Bank’s Financial Supervisory Authority. These loans qualify as Tier I share in the company’s equity, the difference is capitalized as capital in the calculation of the capital adequacy ratio. On the goodwill. The goodwill is expensed in the Profit and Loss other hand, there are subordinated loans with various dates of 20 Account over a period of five years. maturity over the next years. These loans are entered as lia- bilities with accrued interest, indexation and exchange rate dif- Property and Equipment ference at year-end. Indexed loans are recorded using indices effective as of 1 January 2004 and currency-linked loans using 17. Property and equipment are capitalized at cost price less depre- exchange rates of the currency in question at year-end 2003. ciation. Depreciation is calculated as a fixed annual percentage based on the estimated useful life of the property and equip- Stock Option Contracts ment until a scrap value is reached. Estimated useful life is spec- 22 ified as follows: . Stock option contracts enable the Bank’s employees to acquire shares in the Bank. The purchase price equals the market value 50 Real estate years of the shares at the grant date. The Bank’s cost is evaluated as 6 Fixtures years the difference between the stock option price and the market 5 Office equipment years value of the shares on the Balance Sheet date, taking into Vehicles 6 years account the accrued rights of the employees. The cost is posted among salaries and salary-related expenses in the Profit and Loss Account.

71 Notes

The amounts are in millions of Icelandic krónur (ISK)

Cash and Cash Equivalents and amounts owed to credit institutions. 23. Cash and cash equivalents in the Statement of Cash Flows con- The market risk attached to derivatives is created by changes in sist of cash and demand deposits with the Central Bank, treas- the price of the factors on which the contracts are based, such ury bills eligible for refinancing with the Central Bank and as interest rate or changes to prices of currency and listed secu- demand deposits with credit institutions. rities. Risk attached to borrowings reflects the loss which would be incurred by the Bank if the counterparty in a derivatives con- Derivatives tract could not fulfil its part of the contract. Forward rate agreements and futures relating to currency, 24. Derivatives are financial instruments, the contracted or notion- securities and interest rate are entered in the Bank’s Annual al amounts of which are not included in the Bank’s Balance Accounts at their year-end market value. Sheet, either because rights and obligations arise out of one and the same contract, the outcome of which is due after the Premium on options on bonds, deposits, loans and other items Balance Sheet date or because the notional amounts serve on the Bank’s Balance Sheet is redeemed during the maturity merely as variables for calculation purposes. The notional period of the contract. Options on shares are entered at their amounts of derivatives do not necessarily give any indication of market value. the size of the cash flows and the market and credit risk attached to derivatives transactions. Examples of derivatives International Accounting Standards are forward FX agreements, options, swaps, futures and for- 25 ward interest rate agreements. The underlying value may be an . According to rules on the presentation of Annual Accounts of interest rate, currency, commodity, bond or equity products. companies listed on the Iceland Stock Exchange, the Bank will change its accounting principles to conform to international The Bank’s derivatives transactions are conducted as trading standards on Consolidated Annual Accounts as of 2005. The activity, entered at their market value, and as a hedge against Bank has begun preparing for these changes. the Bank’s own interest rate and currency exposures due to issuance of securities and other borrowings. Hedge contracts Changes Within the Group are entered in the same manner as the hedged item. The Bank’s derivatives are mainly intended to reduce the price, exchange 26. In 2003 the Bank purchased two companies, Sjóvá-Almennar and interest rate risk assumed by the Bank or its customers. tryggingar hf. and Framtak fjárfestingarbanki hf. These acquisi- Derivatives performance is entered in the Profit and Loss tions were entered based on the purchase method in the Bank’s Account and in the Balance Sheet. Net assets are capitalised accounts but part of the purchase price was paid for with shares with amounts due from credit institutions and other assets in the Bank. The effect of these transactions on the Bank’s whereas net obligations are entered under sundry liabilities Consolidated Annual Accounts are as follows:

Framtak Sjóvá- fjárfestingar- Almennar banki hf. tryggingar hf. Total

Amounts due from credit institutions 5,127 3,644 8,771 Loans 2,252 6,462 8,714 Market securities and shares in other companies 3,737 12,782 16,519 Other assets 184 7,804 7,988 Total assets 11,300 30,692 41,992

Amounts owed to credit institutions 2,730 0 2,730 Borrowings 2,345 623 2,968 Insurance claimes 019,791 19,791 Other liabilities 30 1,083 1,113 Deferred income tax liability 174 968 1,142 Subordinated loans 551 0 551 Total liabilities 5,830 22,465 28,295

Net estimated value 5,470 8,227 13,697 Goodwill 011,198 11,198 Purchase price 5,470 19,425 24,895

72 Notes

The amounts are in millions of Icelandic krónur (ISK)

Quarterly Statements 27. Summary of the Group’s operating results by quarters: Q1 Q2 Q3 Q4 Total Net interest 2,525 2,536 2,754 3,224 11,039 Sundry operating income 1,455 1,817 2,120 4,186 9,578 Net operating income 3,980 4,353 4,874 7,410 20,617

Salaries and related expenses 1,191 1,192 1,190 1,849 5,422 Sundry operating expenses 989 915 869 1,590 4,363 Other operating expenses 2,180 2,107 2,059 3,439 9,785

Insurance claims, net of reinsurance 000( 1,540)( 1,540) Provision for losses on the loan portfolio ( 504)( 610)( 805)( 945)( 2,864)

Pre-tax profits 1,296 1,636 2,010 1,486 6,428

Income tax ( 234)( 294)( 311) 246 ( 593)

Net profit for the year 1,062 1,342 1,699 1,732 5,835

73 Notes

The amounts are in millions of Icelandic krónur (ISK)

Breakdown of specific activities 28. Summary of the Group’s operating results by profit centre: Retail Corporate Merchant Capital Asset 2003 Banking Banking Banking Markets Mgmt.

Net interest income 5,555 2,159 1,251 435 25 Other operating income 1,571 64 269 1,182 948 Net operating income 7,126 2,223 1,520 1,617 973

Salaries and related expenses 1,677 208 294 190 278 Other operating expenses 3,238 436 313 383 425 Other operating expenses 4,915 644 607 573 703

Insurance claims, net of reinsurance 00000 Provisions for losses on the loan portfolio ( 1,314)( 725)( 438) 00 Pre-tax profits 897 854 475 1,044 270 Income tax ( 162)( 154)( 86)( 188)( 49) Net profit for the year 735 700 389 856 221

Total assets – average 133,046 130,884 44,506 6,316 650

2002

Net interest income 6,163 4,069 0 273 5 Other operating income 1,648 47 0 409 673 Net operating income 7,811 4,116 0 682 678

Salaries and related expenses 1,727 368 0 163 226 Other operating expenses 2,925 673 0 374 360 Other operating expenses 4,652 1,041 0 537 586

Insurance claims, net of reinsurance 00000 Provisions for losses on the loan portfolio ( 1,228)( 708) 0 ( 3) 0 Pre-tax profits 1,931 2,367 0 142 92 Income tax ( 348)( 426) 0 ( 26)( 17) Net profit for the year 1,583 1,941 0 116 75

Total assets – average 122,122 161,326 0 1,995 496

74 Notes

The amounts are in millions of Icelandic krónur (ISK)

Asset- Tresury Insurance based and Risk Sjóvá- Other Financing Mgmt. Almennar operations Total

923 479 402 ( 190) 11,039 160 2,095 2,214 1,075 9,578 1,083 2,574 2,616 885 20,617

168 195 380 2,032 5,422 263 87 408 ( 1,190) 4,363 431 282 788 842 9,785

00( 1,540) 0 ( 1,540) ( 306)( 25) ( 100) 44 ( 2,864) 346 2,267 188 87 6,428 ( 62)( 408)( 37) 553 ( 593) 284 1,859 151 640 5,835

20,600 278,087 7,470 ( 256,164) 365,395

1,115 ( 601) 0 ( 1,316) 9,708 182 1,091 0 316 4,366 1,297 490 0 ( 1,000) 14,074

142 106 0 1,570 4,302 260 32 0 ( 1,203) 3,421 402 138 0 367 7,723

0000 ( 292) 0047( 2,184) 603 352 0 ( 1,320) 4,167 ( 120)( 63) 0 240 ( 760) 483 289 0 ( 1,080) 3,407

22,194 239,209 0 ( 223,578) 323,764

75 Skýringar, frh.

The amounts are in millions of Icelandic krónur (ISK)

29. Summary of the performance of insurance operations based on insurance class: General Personal Marine Motor third-party injury and Asset and cargo vehicle liability accident Life insurance insurance insurance insurance insurance insurance Total

Recorded premiums 474 21 787 78 84 273 1,717

Premiums 469 164 1,037 156 165 152 2,143 Claims ( 287)( 85)( 841)( 94)( 237)( 63)( 1,607) Rebates and discounts ( 12) 0 ( 41) 0 ( 4)( 14)( 71) Operating expenses ( 134)( 26)( 291)( 41)( 39)( 77)( 608) From (to) reinsurers ( 11)( 67)( 16)( 47) 061( 80) Change in equalization provison ( 7)( 22)( 3) 0200( 12) Investment income 124 27 981 133 114 10 1,389 Profit (loss) on insurance operations 142 ( 9) 826 107 19 69 1,154 Investment income 685 Investment expenses ( 165) Profit from investment operations 520 Investment income transferred to insurance operations ( 1,389) Other income and expenses ( 97) Pre-tax profits 188 Income tax ( 37) Net profit for the year 151

30. Summary of development of estimated claim liability for previous years: General Personal Marine Motor third-party injury and Asset and cargo vehicle liability accident Life insurance insurance insurance insurance insurance insurance Total

Claims during the period ( 356)( 119)( 1,018)( 115)( 207)( 63)( 1,878) Development of claim provision 69 34 177 21 ( 30) 0 271 Claims according to Note 29 ( 287)( 85)( 841)( 94)( 237)( 63)( 1,607)

76 Notes

The amounts are in millions of Icelandic krónur (ISK)

31. The following is a breakdown of the Group’s assets and liabilities by domestic or foreign counterparties: Domestic Foreign Total Assets:

Cash, treasury bills and amounts due from credit institutions 24,461 19,906 44,367 Loans 256,956 58,210 315,166 Market securities and shares in other companies 57,552 538 58,090 Other receivables and assets 25,818 502 26,320 Total assets 364,787 79,156 443,943

Liabilities and equity:

Amounts owed to credit institutions 6,044 21,732 27,776 Saving deposits 87,898 19,774 107,672 Borrowings 21,815 210,129 231,944 Insurance technical provision 19,413 0 19,413 Other liabilities 10,027 622 10,649 Deferred income tax liability 1,356 1 1,357 Subordinated loans 556 15,153 15,709 Equity 29,423 0 29,423 Total liabilities and equity 176,532 267,411 443,943

Financial Income 32. Financial income is specified as follows: 2003 2002

Interest on amounts due from credit institutions 1,318 2,294 Interest on loans 20,292 20,164 Interest on market securities 1,845 1,225 Other interest income 689 798 Total financial income 24,144 24,481

Financial Expenses 33. Financial expenses are specified as follows:

Interest on amounts paid to credit institutions 736 1,524 Interest on deposits 4,406 4,859 Interest on borrowings: Interest on issued securities 4,606 4,867 Interest on subordinated loans 549 708 Interest on other borrowings 258 229 Interest on subordinated loans 660 683 Other interest expenses 1,890 1,903 Total financial expenses 13,105 14,773

77 Notes

The amounts are in millions of Icelandic krónur (ISK)

Other operating income 34. The following is a breakdown of insurance premiums, net of reinsurance: 2003 2002 Premiums on casualty insurance 1,799 0 Premiums on life insurance 89 0 Commission and dividend from reinsurers 18 0 Total insurance premiums, net of reinsurance 1,906 0

35. Fees and commissions:

Asset management 652 502 Trading and consulting 1,011 786 Payment processing 1,292 1,165 Loans and guarantees 604 709 Foreign commissions 713 792 Other fees and commission income 400 345 Total fees and commissions 4,672 4,299

36. Commission expenses:

Inter-bank charges 730 599 Debit and credit card fees 19 27 Foreign banks 24 24 Securities and derivatives 129 153 Other fees and commission expenses 18 16 Total commission expenses 920 819

37. Trading, net:

Trading in shares 2,595 ( 78) Trading in bonds 242 401 Foreign currency denominated assets and liabilities 68 ( 258) Total trading net 2,905 65

38. Sundry operating income is specified as follows:

Gains from the sale of real estate 27 376 Other income 202 249 Total sundry operating income 229 625

78 Notes

The amounts are in millions of Icelandic krónur (ISK)

Other Operating Expenses 39. Salaries and related expenses are specified as follows: 2003 2002 Salaries 4,155 3,399 Salary-related expenses 1,267 903 Total salaries and related expenses 5,422 4,302

The Bank’s total number of employees is as follows:

Average number of employees 948 907 Positions at the end of the year 1,085 870

Employment Terms for the Board of Directors and the CEO 40. Salaries paid to the Board of Directors and the CEO for their work for companies within the group, their stock options and ownership in the Bank are specified as follows: Salaries and Owner- fringe Call Put ship at benefits options options year-end Bjarni Ármannsson, CEO 261) 30 35 37 Kristján Ragnarsson, Chairman of the Board 300 1 Einar Sveinsson, Vice-Chairman 182) 3 10 263 Guðmundur B. Ólafsson 2000 Guðrún Helga Lárusdóttir 00020 Helgi Magnússon 1006 Jón Snorrason 1 0 0 150 Víglundur Þorsteinsson 1000 Other Board Members (6) 4000

Eleven Managing Directors 1983) 29 203 207

254 624) 2485) 6846)

1) In addition to salaries and fringe benefits, the CEO received ISK 19 million as a settlement of a stock option contract from 1999. 2) Salaries to the Vice-Chairman include his salary and fringe benefits as the CEO of the Bank’s subsidiary Sjóvá-Almennar tryggingar hf. during the year, including ISK 2 million due to redemption of stock option contracts. 3) The salaries of the Managing Directors include ISK 37 million due to redemption of stock option contracts. 4) Stock options offered in 2002 to the CEO and Managing Directors, based on the exercise prices 4.1–4.4, are exercisable in the period 2004–2006. 5) Put option contracts with the CEO and Managing Directors were concluded in 2003. They are based on the exercise prices 4.7 and 5.95 and are exercisable in the period 2005–2006. No costs are expensed because the market price of the Bank’s stock exceeds the exercise price of the put options. 6) Included among the holdings of the aforementioned persons are holdings of their spouses, dependent children and companies owned by them, if any.

During the year Valur Valsson retired as one of the Bank’s CEOs. His total salary and fringe benefits for the year amounted to ISK 57 million, including bonus payments, redemption of stock options and settlement of pension liability.

79 Notes

The amounts are in millions of Icelandic krónur (ISK)

41. The Bank has granted the Board of Directors, CEO and Managing Directors loans amounting to ISK 1,244 million. These loans are granted under the same conditions and terms as to other customers of the bank. Part of the loans granted to the CEO and Managing Directors, in the amount of ISK 1,141, are in relation to purchases of shares in the Bank granted at 5.0% interest rates. The afore-mentioned amounts do not include loans related to business activities of Board Members.

Auditors’ Fees 42. Remuneration to the Bank’s Auditors are specified as follows: 2003 2002 Audit of Annual Accounts 13 13 Review of Interim Accounts 63 Other services 98 Total 28 24

Thereof remuneration to others than the Auditors of the Parent Company 95

Insurance Claims, Net of Reinsurance 43. Insurance Claims, net of reinsurance, are specified as follows:

Insurance claims relating to casualty insurance 1,506 0 Own benefits from life insurance 21 0 Equalization provision, changes 13 0 Total 1,540 0

Earnings per Share 44. Calculation of earnings per share is based on profit and the weighted average share capital at year-end:

Profit according to the Annual Accounts 5,835 3,407 Calculated average share capital: Share capital according to the Annual Accounts at the beginning of the year 9,400 9,700 Effect of the decrease (increase) of share capital during the year ( 117)(125) Calculated average share capital 9,283 9,575

Earnings per share 0,63 0,36

80 Notes

The amounts are in millions of Icelandic krónur (ISK)

Cash, Treasury Bills and Amounts Due from Credit Institutions 45. Cash and demand deposits with the Central Bank are specified as follows: 2003 2002 Cash 681 564 Demand deposits with the Central Bank 216 81 Total 897 645

46. Amounts due from credit institutions are specified as follows according to borrowers:

Required deposits with the Central Bank according to its rules on required deposits 48 5,705 Other fixed-term amounts due from Central Bank 4,000 0

Amounts due from other credit institutions: Affiliated companies 710 997 Other credit institutions 33,883 22,585 Total amounts due from credit institutions 38,641 29,287

47. Amounts due from credit institutions, other than required deposits at the Central Bank, with maturities as follows:

On demand 13,671 3,357 Up to 3 months 10,694 5,905 Over 3 months and up to 1 year 5,662 3,816 Over 1 year and up to 5 years 6,219 8,561 Over 5 years 2,347 1,943 Total 38,593 23,582

48. Subordinated receivables owned by the Bank are presented among amounts due from credit institutions in the Annual Accounts and are specified as follows:

Related companies 0391 Other companies 1,379 1,508 Total 1,379 1,899

Loans 49. Loans to customers specified by types of loans as follows:

Overdrafts 28,409 30,420 Bills of exchange 983 1,041 Debentures 258,601 198,650 Other loans 9,762 8,914 Total 297,755 239,025

81 Notes

The amounts are in millions of Icelandic krónur (ISK)

50. Loans to customers and lease contracts are specified by sector as follows: 2003 2002 Central government and state-owned enterprises 0.5% 1.1% Municipalities 2.6% 3.7% Business enterprises: Agriculture 0.7% 0.9% Fishing industries 20.2% 22.9% Commerce 14.5% 11.2% Industry and contractors 14.8% 15.3% Services 28.9% 25.6% Individuals 17.8% 19.3% Total 100.0% 100.0%

51. Loans to customers and lease contracts by maturity:

On demand 7,292 6,591 Up to 3 months 56,022 63,290 Over 3 months and up to 1 year 38,389 54,435 Over 1 year and up to 5 years 138,277 63,744 Over 5 years 74,304 64,071 Total 314,284 252,131

52. Lease contracts by type of assets:

Vehicles 9,322 6,774 Factory and industrial machines 1,637 1,520 Machines 1,383 1,078 Computer, electronic and office equipment 744 934 Real estate 2,501 2,044 Other assets 942 756 Total 16,529 13,106

53. Foreclosed mortgages are valued at estimated market prices and are specified as follows:

Real estate 574 660 Operating assets 237 147 Other assets 71 58 Total 882 865

82 Notes

The amounts are in millions of Icelandic krónur (ISK)

54. Non-performing loans at year-end are specified as follows: 2003 2002 Loans with a specific provision for losses 7,625 6,434 Specific provision for losses ( 5,757)(4,162) Non-performing loans less specific provision for losses 1,868 2,272 Other non-performing loans 2,947 2,989 Non-performing loans, total 4,815 5,261

55. Provision for losses has been deducted from the appropriate Balance Sheet items, less the provision for issued guarantees amounting to ISK 29 million, which is posted among sundry liabilities in the Balance Sheet. Changes in the provision are as follows: Provision for losses 2003 2002 Specific General Total Total Provision at beginning of the year 4,210 2,260 6,470 6,021 Transferred into Group 660 197 857 0 Provision for losses during the year 2,390 474 2,864 2,184 Actual losses during the year ( 1,353) 0 ( 1,353)(1,776) Payments on loans previously written-off 93 0 93 41 Provision at year-end 6,000 2,931 8,931 6,470

Provision for losses on the loan portfolio as a percentage of loans and issued guarantees 1.8% 0.9% 2.7% 2.4%

Bonds and Shares in Other Companies 56. Trading bonds are specified as follows: Market value Book value Trading bonds: Listed on the Iceland Stock Exchange 34,469 34,469 Other listed bonds 15 15 Unlisted bonds 835 Total 35,319

The Bank has entered into forward contracts and swaps amounting to ISK 28,769 million against its bonds.

57. Bonds and other fixed-rate securities are specified by issuer as follows: Bonds issued by public organisations 33,921 Bonds issued by others 1,398 Total 35,319

Of the above-mentioned amounts ISK 587 million will be paid within one year.

83 Notes

The amounts are in millions of Icelandic krónur (ISK)

58. Shares and other variable-income securities are specified as follows: Market value Book value Trading shares and unit shares: Listed on the Iceland Stock Exchange 12,279 12,279 Other listed shares 585 585 Unlisted shares 968 Total 13,832 Investment shares: Unlisted shares 1,540 Total shares and unit shares 15,372

The Bank has entered into forward contracts and swaps amounting to ISK 2,045 million against its shares.

59. Investment shares are specified as follows: Nominal Book Ownership Dividends value value Steinhólar ehf. 25.0% 0 900 900 Bílanaust hf. 18.3% 0 9 102 Ráeyri ehf. 6.5% 0078 Talenta Líftækni 1 sf. 48.3% 0 238 68 Shares in 69 other companies 18 392 Total investment shares 18 1,540

60. Shares in affiliated companies are specified as follows: Profit Nominal Book Ownership share value value Straumur Fjárfestingarbanki hf. 31.9% 647 1,305 5,065 Eignarhaldsfélagið Fasteign hf. 49.9% 12 526 574 Kreditkort hf. 35.0% 68 175 380 Eignarhaldsfélagið Stofn hf. 25.0%(6) 11 280 Reiknistofa bankanna 21.9% 21 277 277 Íslensk endurtrygging hf. 29.9% 20 106 265 Greiðslumiðlun hf. 18.5% 21 12 257 Securitas hf. 60.0%(7) 90 141 Eignarhaldsfélagið Sundabakki ehf. 33.3% 0 939 140 Farsímagreiðslur ehf. 27.0% 01919 Shares in 3 other companies ( 8)– 1 Total shares in affiliated companies 768 7,399

84 Notes

The amounts are in millions of Icelandic krónur (ISK)

61. Shares in the Bank’s subsidiaries are specified as follows: Profit Nominal Book Ownership share value value Sjóvá-Almennar tryggingar hf. 100.0% 11 525 19,435 Framtak fjárfestingabanki hf. 100.0% 423 2,541 3,121 R. Raphael & Sons PLC, England 100.0%(118) 316 848 ÍSB Eignarhaldsfélag ehf. 100.0%(27) 300 366 Rekstrarfélag ÍSB ehf. 100.0% 52532 Íslandsbanki Asset Management S.A., Luxembourg 100.0%(1) 99 Total shares in subsidiaries 293 23,811

The Bank has six subsidiaries that are included in the Consolidated Annual Accounts. These subsidiaries are Bucks Land & Building Co. Ltd., Sjóvá-Almennar Líftryggingar hf., L.B.W.F. ehf., Steinvirki ehf., FBA GP hf. and Proteus ehf

The Íslandsbanki Securities Funds hf. and Íslandsbanki Securities Home Funds hf. merged with Rekstrarfélag ÍSB hf. during the year.

Other Assets 62. Goodwill consists of premium on the purchases of shares in subsidiaries. Goodwill is specified as follows: Goodwill 1.1.2003 270 Transferred into Group 842 Additions during the year 11,312 Amortization during the year ( 275) Book value 31.12.2003 12,149

63. Property and equipment are specified as follows: Fixtures, Equipment Real estate and vehicles Total Total value 1.1.2003 174 2,611 2,785 Transferred into Group 1,859 1,353 3,212 Additions during the year 0 476 476 Disposals during the year ( 33)(947)(980) Total value 31.12.2003 2,000 3,493 5,493

Previously depreciated 61 1,579 1,640 Transferred into Group 364 714 1,078 Depreciated during the year 74 363 437 Disposals during the year ( 30)(915)(945) Total depreciation 31.12.2003 469 1,741 2,210

Book value 31.12.2003 1,531 1,752 3,283

Depreciation ratios 2–3% 15–20%

contd.:

85 Notes

The amounts are in millions of Icelandic krónur (ISK)

63. contd.: Depreciation in the Profit and Loss Account is as follows: Depreciation 437 Amortization, cf. Note 62. 275 Depreciation in the Profit and Loss Account 712

The official real estate value, fire insurance value and insurance value of property and equipment is as follows:

Official real estate value of buildings and leased land 1,427 Fire insurance value of buildings 2,241 Insurance value of fixtures, equipment and vehicles 1,713

64. Reinsurers’ share in insurance fund is as follows: 2003 2002 Premium fund 417 0 Claim fund of casualty insurance 1,174 0 Benefit fund of life insurance 16 0 Total 1,607 0

65. Sundry receivables and assets are as follows: Policy holders 1,699 0 Other receivables and assets due to primary insurance operations 136 0 Other receivables and assets due to reinsurance operations 5,022 112 Fees and commission income 245 252 Other income 915 657 Sundry prepaid expenses 501 203 Other assets 763 2,365 Total 9,281 3,589

Balances with Affiliated Companies 66. Balances with affiliated companies are as follows at the year-end 2003:

Assets: Loans to credit institutions 710 Loans to customers 864 Total assets 1,574

Liabilities: Amounts owed to credit institutions 44 Deposits 350 Total liabilities 394

86 Notes

The amounts are in millions of Icelandic krónur (ISK)

Assets and Liabilities Inflation-indexed or subject to Currency-rate Risk 67. The Group’s total CPI-linked assets amounted to ISK 101,338 million at year-end, and the total amount of indexed liabilities amounted to ISK 92,169 million at year-end.

68. The total amount of assets in foreign currencies in the Group’s Annual Accounts amounted to ISK 425,574 million at year-end and the total liabilities amounted to ISK 419,821 million at that time. Included among assets and liabilities are forward contracts, currency and interest rate swaps and options, see Note 86.

Amounts Owed to Credit Institutions 69. The following is a breakdown of amounts owed to credit institutions by creditors: 2003 2002 Liabilities payable on demand: Liabilities to the Central Bank 60 Liabilities to other credit institutions 3,689 3,010 Total liabilities payable on demand 3,695 3,010 Other liabilities owed to credit institutions: Liabilities to the Central Bank 07,755 Liabilities to other credit institutions 24,081 13,385 Other liabilities owed to credit institutions total 24,081 21,140

Total amount owed to credit institutions 27,776 24,150

70. Amounts owed to credit institutions mature as follows:

On demand 3,695 3,010 Up to 3 months 20,487 15,285 Over 3 months and up to 1 year 1,085 3,852 Over 1 year and up to 5 years 1,520 1,333 Over 5 years 989 670 Total 27,776 24,150

Saving Deposits 71. Saving deposits are specified as follows:

Demand deposits 37,067 32,947 Time deposits 70,605 52,880 Total saving deposits 107,672 85,827

87 Notes

The amounts are in millions of Icelandic krónur (ISK)

72. Time deposits mature as follows: 2003 2002 Up to 3 months 40,829 32,338 Over 3 months and up to 1 year 7,374 6,389 Over 1 year and up to 5 years 18,852 12,745 Over 5 years 3,550 1,408 Total 70,605 52,880

Borrowings 73. The Bank’s borrowings are specified as follows:

Issued bonds 217,205 144,754 Loans from credit institutions 11,660 16,462 Other borrowings 3,079 2,861 Total 231,944 164,077

Of the afore-mentioned amounts ISK 94,757 million will mature within one year.

Insurance Technical Provision 74. Insurance technical provision is specified as follows:

Premium provision 4,020 0 Claim provision of casualty insurance 14,014 0 Claim provision of life insurance 337 0 Equalization provision 615 0 Performance-based provision 427 0 Total 19,413 0

Investments in relation to life insurance that involve an investment risk on the part of the policyholder are offset against provision in rela- tion thereto. The amount is ISK 1,522 million.

Sundry Liabilities 75. Sundry liabilities are as follows:

Outstanding market transactions 2,708 201 Income tax and net worth tax 1,168 1,114 Other liabilities 4,098 2,189 Accruals 488 189 Deferred income 2,187 2,200 Total 10,649 5,893

88 Notes

The amounts are in millions of Icelandic krónur (ISK)

Deferred Income Tax Liability 76. The change in the deferred income tax liability is as follows:

Deferred income tax liability at the beginning of 2003 357 Transferred to Group 1,141 Calculated income tax for 2003 593 Income tax payable in 2004 ( 916) Deferred income tax liability at the end of 2003 1,175

The Bank’s deferred income-tax liability is specified as follows: Lease contracts 131 Shares in other companies 1,160 Property and equipment 121 Assets and liabilities in foreign currencies 211 Tax loss of subsidiary carried forward ( 302) Other items ( 146) Deferred income-tax liability at the end of 2003 1,175

The corporate income tax rate is 18% whereas the effective income tax rate in the Bank’s Profit and Loss Account is 9.2%. The difference is specified as follows: 18% income tax calculated on the profit of the year 1,160 Tax exempt dividend on shares ( 75) Deferred capital gains by reducing the purchase price of shares in related companies ( 553) Amortization of goodwill 45 Other items 16 Total Income Tax 593

77. The change in pension liability is as follows:

Transferred to Group 148 Incresase in pension liability during the period 34 Pension liability at year-end 182

89 Notes

The amounts are in millions of Icelandic krónur (ISK)

Subordinated Loans 78. The subordinated loans are as follows: Currency Interest Maturity date Book value Loans which qualify as Tier I capital: Foreign loans – unlisted EUR 3.6% none 3,388 Listed on the Iceland Stock Exchange ISK 8.9% none 1,015 4,403

Loans which qualify as Tier II capital: Listed on the Iceland Stock Exchange ISK 6.0% 2006 556 Listed on the Iceland Stock Exchange ISK 6.5% 2008 189 Listed on the Iceland Stock Exchange ISK 6.2% 2009 634 Listed on the Iceland Stock Exchange ISK 6.0% 2009 300 Listed on the Iceland Stock Exchange ISK 5.3% 2011 553 Listed on the London Stock Exchange USD 2.0% 2010 1,199 Listed on the London Stock Exchange EUR 3.1% 2011 628 Listed on the London Stock Exchange EUR 2.8% 2013 4,484 Listed on the London Stock Exchange EUR 7.5% 2015 449 Listed on the London Stock Exchange EUR 6.8% 2015 900 Listed on the London Stock Exchange EUR 6.8% 2021 1,414 11,306

Total subordinated loans 15,709

Equity 79. According to the Bank’s Articles of Association, its total share capital amounts to ISK 10,500 million. At the end of the year, own shares amounted to ISK 420 million and share capital, according to the Balance Sheet, amounted to ISK 10,080 million. During the year the Bank decreased its share capital by ISK 1,000 million as a part of the Bank’s policy to maintain Tier I capital as close to 7.0% as possible. Share cap- ital was then increased by ISK 1,500 million in order to meet the Bank’s acquisition of Sjóvá-Almennar tryggingar hf.

80. Changes in equity are as follows: Accrued cost of Share Share stock Retained capital Premium options earnings Total Equity 1.1.2003 9,400 341 84 11,139 20,964 Dividend paid ( 1,535)( 1,535) Issued new capital 1,500 7,425 8,925 Purchased and sold own shares ( 820)( 4,137)( 63)(5,020) Cost of stock options expensed 254 254 Net profit for the year 5,835 5,835 Equity 31.12.2003 10,080 3,629 275 15,439 29,423

90 Notes

The amounts are in millions of Icelandic krónur (ISK)

81. The equity of the Group at year-end amounted to ISK 29,423 million, equivalent to 6.6% of total assets according to the Balance Sheet. The capital adequacy ratio of the Group, calculated in accordance with Article 84 of the Act on Financial Undertakings, is 11.4%. This ratio may not be lower than 8.0% according to the Act. The ratio is calculated as follows: Book Weighted Risk base: value value Assets recorded in the Annual Accounts 443,943 292,281 Minimum solvency margin of the insurance company ( 1,345) Assets subtracted from equity ( 10,464) Guarantees and other items not included in the Balance Sheet 6,952 Risk base, total 287,424

Capital: Tier I capital: Recorded equity 29,423 Assets subtracted from equity ( 9,830) Subordinated loans 3,400 Tier II capital: Subordinated loans 11,880 Minimum solvency margin of the insurance company ( 1,345) Assets subtracted from equity ( 634) Total equity 32,894

Capital adequacy ratio 11.4% Thereof Tier I capital 8.0%

82. Calculated according to the Act on Insurance Activities, the minimum solvency margin of Sjóvá-Almennar tryggingar hf. amounted to ISK 1,345 million and its solvency margin to ISK 4,878 million.

Stock Options 83. The Bank has granted its employees stock options exercisable from 2004 until 2006. Some of the contracts are based upon the Bank’s per- formance during the year. The Bank will use own shares and purchase shares on the market to meet employee stock options. Total number of shares covered by employee stock options at year-end amount to ISK 109 million, and changes in options are as follows: Number Market of shares value Stock options at the beginning of the year 219 1,038 Stock options issued during the year 29 131 Stock options transferred from Sjóvá-Almennar tryggingar hf. 25 108 Stock options exercised during the year ( 88)( 455) Expired or terminated stock options during the year ( 76)( 359) Correction of strike price due to dividend payment ( 25) The Bank’s cost relating to stock options during the year, expensed 254 Stock options at year-end 109 692

Vested, unexercised stock options at year-end are specified as follows: Vested contracts, exchange rate 3.01 to 4.00, average exchange rate 3.06 9 58 Vested contracts, exchange rate 4.01 to 5.00, average exchange rate 4.13 17 109 Total 26 167

91 Notes

The amounts are in millions of Icelandic krónur (ISK)

84. The Bank’s CEO, 11 Managing Directors and the CEO of Sjóvá-Almennar tryggingar hf. have put options for a total number of shares in the Bank for ISK 248 million at the exercise price of 4.7 and 5.95. The contracts were issued in 2003 and are exercisable during 2005 and 2006. No costs are expensed because the market price of the Bank’s stock exceeds the exercise price of the put options.

Obligations 85. The Bank has granted its customers guarantees and overdraft permissions. These guarantees and overdrafts are specified as follows: 2003 2002 Guarantees granted to customers 5,871 5,174 Unused overdrafts 13,216 13,777

86. Derivatives, with a breakdown by remaining maturity period of principal and book value:

Principal Book value Over 3 Up to 3 months and months up to 1 year Over 1 year Total Assets Liabilities Foreign exchange contracts: Forward exchange rate contracts 66,428 24,117 0 90,545 1,546 1,665 Swaps 1,331 18,116 20,510 39,957 4,155 2,522 Options, purchased 898 3,120 0 4,018 90 0 Options, sold 1,220 4,488 89 5,797 0 199 Total 69,877 49,841 20,599 140,317 5,791 4,386

Interest rate contracts: Swaps 4,555 5,690 63,181 73,426 192 1,978 Options, purchased 009319310 0 Options, sold 009319310 0 Total 4,555 5,690 65,043 75,288 192 1,978

Securities contracts: Forwards, purchased 923 316 0 1,239 23 12 Forwards, sold 11,468 417 302 12,187 94 96 Swaps 15,056 4,332 480 19,868 66 404 Options, purchased 309 1,920 2,073 4,302 403 0 Options, sold 03,567 1,889 5,456 0 458 Total 27,756 10,552 4,744 43,052 586 970

Derivatives, total 102,188 66,083 90,386 258,657 6,569 7,334

The book value of derivative contracts is specified by counterparties as follows: Assets Liabilities Credit institutions 5,268 4,069 Other customers 1,301 3,265 Total 6,569 7,334

The objective of the above-mentioned agreements is to reduce the currency and interest rate risk of the Bank and its customers. The Bank’s risk due to these contracts includes interest and currency rate differential. The risk at year-end equals loans to customers amounting to ISK 3,154 million when evaluating the Bank’s capital adequacy ratio according to current regulations.

92 Notes

The amounts are in millions of Icelandic krónur (ISK)

87. The Bank has concluded lease agreements regarding the real 89. According to the Act on Deposit Guarantees and Investor- estate it uses for its operations. The real estate is owned by Eignar- Compensation Scheme, the total assets of the Fund must be at haldsfélagið Fasteign hf., of which the Bank owns 49.9% of the least 1.0% of the average insured deposits in Commercial Banks shares. The lease agreement is for a period of 29 years and the and Savings Banks for the previous year. At the end of the year Bank has first option to purchase or the right to extend the lease 2003 the Bank has no obligations towards the Fund. agreement at the end of that period. The current value of the Bank’s obligation in relation to the lease is around ISK 2,400 mil- lion. Other Items 90 1996 88. The Bank pays 6.0% of total payroll to pension funds on behalf of . During the year the Fair Trade and Competion Authority its employees, and additionally the Bank pays to the Pension started an investigation on alleged violations of the Competition Fund of Íslandsbanki hf. an amount to compensate for its Act by Sjóvá-Almennar tryggingar hf. Due to this, the employees’ pension rights. The Bank and its subsidiaries guaran- Competition Authority required various documents from the tee the pension right obligations. According to the Fund’s Articles company. The Company received the initial report of the 2002 of Association, assets and liabilities must be balanced if the dif- Competition Authority in and replied to it in great detail. ference between them exceeds 10%. According to an actuarial The Company denied all allegations of illegal consultation with computation the difference between the Fund’s assets and lia- other insurance companies. It is not clear when the final conclu- bilities is less than 10% at year-end 2003, based on an interest sion will be reached in the case. rate of 3.0% in excess of estimated increase in payroll.

93 Annual Accounts Sjóvá-Almennra tryggingar hf.

94 Profit and Loss Account for the Year 2003

The amounts are in millions of Icelandic krónur (ISK)

2003 2002 Insurance operations Gross premiums 9,631 9,189 Reinsurance premiums ceded ( 1,255)( 1,790) Change in gross unearned premiums provisions ( 137)( 160) Change in other life-insurance premiums liability ( 684)( 191) Change in gross unearned premiums provisions, reinsurers’ share ( 202) 42 Premiums, net of reinsurance 7,353 7,090 Allocated investment income 2,288 645

Unrealized income from life insurance where the insured bears the investment risk 265 ( 195) Gross claims paid ( 5,573)( 5,605) Reinsurers’ share received 650 1,053 Change in gross provisions for outstanding claims ( 964)( 1,050) Change in gross provisios for outstanding claims, reinsurers’ share ( 263) 303 Claims, net of reinsurance ( 6,150)( 5,299) Bonuses and premium rebates ( 284)( 172) Sales costs ( 1,441)( 1,315) Administrative expenses ( 906)( 793) Reinsurance commissions and profit participation 175 356 Net operating expenses insurance operations ( 2,172)( 1,752) Change in equalization provision ( 51)( 23)

Profit from insurance operations 1,249 294

Investment operations Profit share from subsidiaries and affiliated companies 112 23 Income on other holdings 286 138 Expenses from real estate ( 99)( 16) Interests and trading rate gain 1,344 943 Profit on sale of assets 4,062 460 Appraisal change on investment securities 1,098 0 Investment income 6,803 1,548 Administrative expenses ( 294)( 228) Interest expenses ( 148)( 206) Provision for losses on investments ( 431)( 219) Investment expenses ( 873)( 653) Allocated investment income transferred to insurance operations ( 2,288)( 645)

Result from investment operations 3,642 250

Other expenses ( 105)( 32) Income tax and tax on net worth ( 828)( 72) Minority interest ( 28) 61

Profit for the year 3,930 501

95 Sjóvá-Almennrar Balance Sheet

The amounts are in millions of Icelandic krónur (ISK)

Assets 2003 2002

Goodwill 980 637 Land and buildings 1,424 1,506 Shares in affiliated companies 4,521 1,399 Variable-yield securities 7,397 8,779 Bonds and fixed-income securities 1,857 1,198 Loans guaranteed by mortgages 5,609 5,805 Other loans 3,532 780 Other financial investments 18,395 16,562 Investments due to life insurance where the insured bears the investment risk 1,523 839 Reinsurance deposits 23 25 Investments 25,886 20,331

Premium provision 418 619 Claim provision for non-life insurance operations 1,174 1,343 Claim provision for life insurance operations 15 109 Technical provisions, reinsurers’ share 1,607 2,071

Amounts due from affiliated companies 60 Amounts due from policyholders 1,699 2,102 Other receivables arising out of direct insurance operations 135 24 Other receivables arising out of reinsurance operations 11 Other receivables 83 70 Receivables 1,924 2,197

Tangible assets 646 686 Cash and cash equivalents 714 1,399 Own shares 010 Other assets 1,360 2,095

Assets total 31,757 27,331

96 December 31 2003

The amounts are in millions of Icelandic krónur (ISK)

Liabilities and Equity 2003 2002

Share capital 525 585 Share premium 98 1,313 Statutory reserve 131 146 Retained earnings 7,624 3,898 Equity 8,378 5,942

Minority interest 0 119

Gross unearned premiums 4,020 3,882 Gross outstanding claims in non-life insurance operations 14,014 13,080 Gross outstanding claims in life insurance operations 337 307 Equalization provisions 615 564 Bonuses and premium provisions 427 345 Technical provisions 19,413 18,178

Life insurance claims where the insured bears the investment risk 1,523 839

Pension plan obligations 183 135 Deferred income tax liability 1,003 224 Other provisions 1,186 359

Deposits received from reinsurers 089

Creditors arising out of direct insurance operations 25 475 Creditors arising out of reinsurance operations 76 80 Bonds 587 819 Other creditors 404 325 Creditors 1,092 1,699

Accrued expenses and deferred revenue 165 106

Liabilities and equity total 31,757 27,331

97 Board of Directors and CEO

Chairman Vice-Chairman Kristján Ragnarsson Einar Sveinsson Former president of the Federation of Icelandic Fishing Vessel Owners CEO of Sjóvá-Almennar tryggingar hf. Member since 1990 Member since 1992 Shareholding: 1.342.923 Shareholding: 262.962.335 Call options: 0 Call options: 2.901.000 Put options: 0 Put options: 10.000.000

Guðmundur B. Ólafsson Guðrún H. Lárusdóttir

Attorney at Law Managing Director of Stálskip ehf. Member since 2003 Member since 2003 Shareholding : 263.641 Shareholding : 19.673.126 Call options: 0 Call options: 0 Put options: 0 Put options: 0

Helgi Magnússon Jón Snorrason

CEO of Harpa-Sjöfn hf. Managing Director of Taxus ehf. Member since 1997 Member since 2003 Shareholding : 5.807.069 Shareholding : 150.276.858 Call options: 0 Call options: 0 Put options: 0 Put options: 0

Víglundur Þorsteinsson CEO Chairman of the Board of BM Vallá hf. Bjarni Ármannsson Member since 2001 Shareholding: 0 Shareholding: 36.918.918 Call options: 0 Call options: 30.000.000 Put options: 0 Put options: 35.000.000

Deputies Friðrik Jóhannsson Halldór Björnsson Hilmar Pálsson Managing Director of Burðarás ehf. President of the Federation of General Former CEO of Brunabótafélag Íslands hf. and Special Workers Guðmundur Ásgeirsson Halldóra Þórðardóttir Vilmundur Jósefsson Managing Director of Nesskip hf. Executive Director at Kubbur ehf. Managing Director of Gæðafæði ehf.

98 Organisation and Senior Managers

Deputy CEO Björn Björnsson

Managing Directors Retail Banking Asset Management Information Technology Jón Þórisson Sigurður B. Stefánsson Haukur Oddsson Corporate Banking Assed-based Financing Marketing & Research Guðmundur Tómasson Kristján Óskarsson Hulda Dóra Styrmisdóttir Merchant Banking Finance Division Credit Control & Personnell Erlendur Magnússon Þorgils Óttar Mathiesen Björn Björnsson Capital Markets Treasury & Risk Management Finnur Reyr Stefánsson Tómas Kristjánsson

Board of Directors

Internal Auditing

Profit units CEO Support functions Deputy CEO

Retail Corporate ISB Merchant Capital Asset Asset-based Insurance Banking Finance Banking Markets Management Financing Division

Finance Division

Treasury and Risk Management

Information Technology

Marketing, PR and Research

Credit Control and Personnel

Internal Auditing Auditors Jónatan Ólafsson, Director KPMG Endurskoðun hf.

99 Íslandsbanki Sjóvá-Almennar ISB London ISB Luxembourg Kirkjusandur Kringlan 5 2 Royal Exchange Buildings 26-28, rue Edward Steichen IS-155 Reykjavík IS-103 Reykjavík London EC3V 3LF L-2540 Luxembourg Iceland Iceland UK Postal Address: 354 440 4000 354 569 2500 44 (0) 20 7621 3460 Tel.: + Tel.: + Tel.: + P.O.Box 1647 354 440 4001 354 581 3718 44 (0) 20 7621 3476 Fax: + Fax: + Fax: + L-1016 Luxembourg E-mail: [email protected] E-mail: [email protected] Tel.: +352 266 864 1 www.isb.is www.sjova.is Fax: +352 266 864 64

100 Supervision and Editorial: Íslandsbanki Layout: Íslandsbanki Design: Fíton Printing: Litróf Photographs: Lárus Karl Ingason, Vigfús Birgisson and others

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