Kaupthing Bank Annual Report 2004 Table of Contents

KAUPTHING BANK ANNUAL REPORT 2004 TABLE OF CONTENTS

Key Business Objectives of Kaupthing Bank 2 Highlights of 2004 4 Delivering Value From Growth - Address of the Executive Chairman 8 Year of Growth and Profitability - Address of the CEO 11 Shares in the Bank 14

Risk Management 22 Corporate Governance 33 Compliance 38 Credit Rating 39

Market overview in 2004 42 Kaupthing Bank’s results 46 Five-year summary 50

Operating results of profit centres 54 Asset Management and Private Banking 55 Capital Markets 58 Treasury 60 Investment Banking 62 Corporate Banking 66 Retail Banking 68 Quarterly overview 71

Employees 74 Acquisition of FIH Erhvervsbank 76 A. Sundvall ASA / PFA Pension / NBSAM 79 History of Kaupthing Bank 80 Main subsidiaries 81

Annual Accounts 2004 86 Icelandic and Swedish accounting principles 118 International Financial Reporting Standards (IFRS) 120

The Board of Directors 128 Senior Management 129

For further information please contact: Jonas Sigurgeirsson, Head of Investor Relations Tel: + 354-444-6112. e-mail: [email protected]

The annual report and further information on Kaupthing Bank can also be found on the Bank’s website at www.kaupthing.net.

All amounts are in ISK millions unless otherwise stated. I KAUPTHING BANK I ANNUAL REPORT 2004 I

KEY BUSINESS OBJECTIVES

Kaupthing Bank has a number of key business objectives that it believes are necessary stepping stones towards achieving its long-term goal of creating a leading investment bank in the Nordic region. During recent years, these objectives have been visible through Kaupthing Bank’s determined international expansion, both through organic and acquisitive means.

• Maximise the Bank’s value and long-term shareholder value • Achieve 15% long-term return on equity • Be a leading bank in Iceland and one of the prime investment banks in the Nordic region • Sustain rapid growth without compromising profitability • Develop and sustain dependable, long-term relationships with its customers • Employ motivated, well-educated and enterprising staff who are experts in their respective fields • Continue to develop the Bank’s workforce as its most valuable resource • Utilise the most up-to-date information technology in order to improve the Bank’s competitiveness

I 2 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

COMPREHENSIVE FINANCIAL SERVICES

Kaupthing Bank focuses on building our clients’ business through comprehensive financial services including private banking and asset management, pension services, brokerage, investment banking, corporate and retail banking. Kaupthing Bank aims to create long-term business relationships by fulfilling the clients’ ever-changing needs and finding new ways to support their business most effectively.

Profitable business units Kaupthing Bank seeks to build both independent and profitable business units in each geographic location, as well as to leverage each unit as a component within the group. Rapid growth calls for constant innovation from employees, and to do this we consistently seek to recruit the best people. Having built a strong ethical and professional culture, Kaupthing Bank values its people’s international, multi-cultural background and recognises these differences as a strength. Cooperation between our international offices combined with staff innovation creates a solid foundation on which each office can operate profitably.

Strong client relationships Our reputation as a trusted adviser and partner is highly dependent on the delivery of quality services. Customer-driven, Kaupthing Bank offers high quality products and services provided by creative, dedicated professionals. Management emphasises close, responsive relationships with clients, which evolve to match changing customer needs and market forces.

New business opportunities Kaupthing Bank vigorously pursue business opportunities, actively promoting and selling our products and client services. The Bank continually seeks ways to build a customer base where it can add substantial value and create mutually beneficial relationships across all service areas.

Further strengthening of the Bank’s activities In recent years Kaupthing Bank has focused on strengthening activities outside Iceland, and has placed special emphasis on its home market, the Nordic countries. We will continue to pursue growth opportunities that support the Bank’s long-term goals.

I 3 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

HIGHLIGHTS OF 2004

Results • Kaupthing Bank posted net earnings of ISK 15,760 million, compared with ISK 7,520 million combined net earnings in 2003. Return on equity was 22.6%, considerably higher than the Bank’s target on return on equity of 15%.

• Kaupthing Bank increased its equity from ISK 45.9 billion to ISK 149.4 billion during 2004 and had a strong CAD ratio, 14.2%, at year end.

• The Bank’s total assets amounted to ISK 1,534 billion at year end 2004, compared with total assets of ISK 559 billion at the beginning of the year. The acquisition of the Danish bank FIH Erhvervsbank explains the majority of this significant increase.

FIH Erhvervsbank • In June Kaupthing Bank entered into an agreement with FöreningsSparbanken (Swedbank) on the purchase of FI-Holding, the owner of the Danish corporate bank FIH Erhvervsbank. The acquisition was completed in September. It was a transforming acquisition for Kaupthing Bank, and it doubled the size of the Bank and placed it in a leading position in the Danish corporate banking sector.

• The acquisition of FIH Erhvervsbank was funded by an increase in the Bank’s share capital and by a subordinated bond issue. In a rights issue in August, shareholders representing 96.4% of share capital in the Bank exercised their pre-emptive rights. The acquisition price was DKK 7,292 million.

Upgrade • In November Moody’s Investors Service announced the upgrading of Kaupthing Bank’s credit rating. The Bank’s long term deposit and senior debt ratings were upgraded from A2 to A1. The subordinated debt rating was upgraded to A2 from A3. Moody’s affirmed the C+ in financial strength rating. The short term rating of P-1 was also affirmed, which is the highest rating given. According to Moody’s the rating upgrade reflected the Bank’s healthy financial fundamentals and the opinion that, with the addition of FIH Erhvervsbank, Kaupthing Bank should be able to gain access to the Danish small and medium-sized business market and complement its own product palette in the future.

I 4 I I HIGHLIGHTS OF 2004 I

Strengthening operations • In February 2004, Kaupthing Bank acquired the Norwegian securities company A. Sundvall ASA. The purpose of the acquisition was to strengthen the Bank’s activities in Norway. The company operates within securities brokerage, investment banking and research.

• In May 2004, Kaupthing Bank entered into a Limited Liability Partnership with eight individual partners in the United Kingdom to form a specialised credit management business called New Bond Street Asset Management. Its objective is to act as a fund manager for diversified credit asset classes using fundamental credit analysis, portfolio management theory and credit structuring techniques to maximise return to investors.

• In November Kaupthing Bank Luxembourg S.A., a subsidiary of Kaupthing Bank, acquired all shares in PFA Pension Luxembourg. The aquisition is effective from the beginning of January 2005. The purpose of the acquisition is to increase Kaupthing Bank Luxembourg’s client base in Private Banking as well as to expand the business by offering insurance products to its existing clients.

• In December the Finnish financial supervisory authority granted Kaupthing Bank’s Finnish subsidiary, Kaupthing Sofi Oyj, a banking licence. The company changed its name to Kaupthing Bank Oyj at the beginning of 2005. Kaupthing Bank and its subsidiaries now have banking licences in five countries: Iceland, Denmark, Sweden, Luxembourg and Finland.

Growing bank • At the end of 2004 Kaupthing Bank operated in ten countries. The Bank has operations in all the Nordic countries, as well as Luxembourg, New York, Geneva and London. The Bank’s increased financial strength and its more extensive network of operating centres creates numerous opportunities.

• The Bank’s share of the equities volume on the Nordic stock exchanges was 4.10% in Stockholm, 6.77% in Helsinki, 1.16% in Copenhagen, 0.93% in Oslo and 32.66% in Reykjavík. Kaupthing Bank had a combined total of 4.28% of the equities turnover in the Nordic stock exchanges.

• Kaupthing Bank and its subsidiaries are members of seven stock exchanges in Europe and the United States. Assets under management at the Bank totalled ISK 508 billion at year end 2004, and assets in custody amounted to ISK 910 billion.

I 5 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

DELIVERING VALUE FROM GROWTH

Sigurdur Einarsson, Kaupthing Bank performed strongly in 2004, and it was yet another Executive Chairman record year characterized by both organic and external growth. One of the highlights was the acquisition of Danish bank FIH Erhvervsbank, which doubled the size of the Bank. The Bank’s operating results were most satisfactory, and I believe we are well positioned to meet the chal- lenges which lie ahead.

Acquisition of FIH Erhvervsbank The acquisition of the Danish bank FIH Erhvervsbank is by far the largest takeover in which Kaupthing Bank has been involved. I believe that FIH Erhvervsbank is an exceptional company and this acquisition will be prove to be a first-rate investment. It has balanced the income distribution of the Bank and increased its geographic diversification. Having FIH Erhvervsbank on board presents a broad range of growth opportunities in Norway, Sweden and Denmark. Interest income will become an increasingly important source of revenue, whilst commission income and trading gains will gradually represent a smaller part of income generation.

Sigurdur Einarsson A fast growing bank In recent years we have grown extensively by way of mergers and acquisitions. In all major aspects these transactions have gone according to schedule and created a larger, stronger bank with formidable staff resources. These acquisitions include eight Scandinavian companies in a period of four years, among them Swedish bank JP Nordiska and FIH Erhvervsbank. In Iceland Kaupthing Bank merged successfully in 2003 with retail bank Búnadarbanki. In Sweden we are proud to have transformed JP Nordiska into a profitable and growing business after a number of years of loss making operation.

These acquisitions and mergers have increased shareholder value and reinforced the financial strength of the Bank. We will consequently continue on this track, and we have a shareholder base that is strongly supportive of our long-term growth ambitions.

Kaupthing Bank’s subsidiaries in various countries are independent entities with local identity. Management is only centralized in areas which are vital to the organization’s shared identity and mission. The managers and the staff of our subsidiaries are in principle free to pursue decided goals in the way they choose within the framework set out by the Bank’s management, but they invariably use the platform of the group and the benefits of our international network for better results.

We aim to further strengthen and increase activities in the countries where we operate, and geographic expansion in the immediate neighbouring countries to existing operations is a possibility.

I 8 I I DELIVERING VALUE FROM GROWTH I

Investment banking focus Kaupthing Bank has operations in ten countries across six business segments, or profit centres, in addition to ancillary units. It is our aim to obtain banking licences in the countries where we operate and to have similar core business offerings in all local operations. The Bank’s profit centres are Investment Banking, Capital Markets, Treasury, Retail Banking, Corporate Banking and Asset Management and Private Banking. All profit centres returned a profit in 2004 and our outlook is good for 2005.

Our Investment Banking Division has been one of the major contributors to the Bank’s success in recent years and an increasing proportion of projects are of an international nature. In the coming years the Bank will place even greater focus on cross-border projects, particularly in the Nordic countries and in the United Kingdom, using our international network and financial strength. We offer to structure, arrange and underwrite acquisition and leverage finance, including senior debt, mezzanine debt and equity related financing together with our flexibility, flat organisational structure and quick decision making. This makes Kaupthing Bank unique in the Nordic context.

One of the distinctive features of our Investment Banking activities has been to invest in unlisted companies with a clear exit strategy. At year end 2004, shares in unlisted companies represented only 0.8% of total assets. Our goal is to have closer to 3% of the Bank's total assets in unlisted shares. This policy has over the years been highly successful, and the IRR of these investment has been above 25% in the last five years.

The Bank has the ability and willingness to commit own funds to transactions and takes risks alongside its customers to enhance the value of their enterprises. These investments are, of course, selective and carefully scrutinized. They are invariably related to projects in which our Investment Banking Division has been engaged with companies, managements or investors in connection with management buy-outs, mergers and other types of restructuring. The aim is to take minority stakes in companies demonstrating good cash flow records and solid management teams with aspirations for growth. The capital invested can range from ordinary equity to more hybrid investments, e.g. convertible bonds or capital loans. We currently do not intend to participate in seed or venture capital financing.

Risk in operations One of the main management tasks ahead is to ensure that lines of communication remain clear and short, even though the Bank is constantly expanding. This is in my opinion a key issue, as it is clearly one of the Bank’s key competitive strengths. I have said before that anyone in the banking sector who claims not to take risk is deluding themselves. Risk is inherent in the business of banking. It is important not to confuse a long decision making process with an effective one. We place great emphasis on rapid, thorough and high quality decision making. It is essential that all

I 9 I I DELIVERING VALUE FROM GROWTH I

decisions are made with adequate consideration and analysis and not on the mistaken assump- tion that taking one’s time improves the quality of the decision.

Profitable operations Ever since we decided to commence activities in the United Kingdom, operations have flourished. The Bank has achieved much in a very short time and we aim to further enhance our UK operation in the near future. Strengthening the Bank’s position in London, the business capital of Northern Europe, is therefore of paramount importance.

The Bank’s Luxembourg operation has prospered well ever since it was first established. The organic growth of Kaupthing Bank Luxembourg, which is our international private banking hub, shows an underlying strength which is promising for the future. In Luxembourg we started up the operation in 1998; the Luxembourg operation accounts now for 10% of Kaupthing Bank’s total income. The Bank has grown purely organically in Luxembourg with the first acquisition takeing place at the beginning of 2005, when the Bank took over PFA Pension in Luxembourg.

Kaupthing Bank as a whole has grown significantly, both organically and through strategic acquisitions, at the same time improving earnings and profitability. There remains great potential for further expansion but growth for growth’s sake is not the object, rather profitable operations are the key issue.

At Kaupthing Bank we look forward to new opportunities and to continuing to build on recent success. We look forward with real confidence as we take advantage of opportunities in the coming years for the benefit of customers and shareholders.

Dividends At the Bank’s Annual General Meeting the Board of Directors will propose that ISK 3,304 million be paid as dividends to shareholders for 2004, which corresponds to ISK 5 per share and represents 21% of last year’s profit. This is consistent with Kaupthing Bank’s dividend policy of paying out dividends which represent 10-30% of net earnings annually.

In conclusion I would like to thank my fellow board members for their excellent work during the year. Furthermore, I wish to express my gratitude to the employees for their outstanding contribution to the Bank once again. I also wish to pay special thanks to Sólon R. Sigurdsson, former CEO, who retired at the end of 2004, for his endeavour and dedication to Kaupthing Bank. And finally I wish to extend my thanks to the Bank’s customers and shareholders for their business and trust over the past year.

Sigurdur Einarsson

I 10 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

YEAR OF GROWTH AND GOOD PROFITABILITY

2004 was an excellent year for Kaupthing Bank. The Bank doubled in Hreidar Már size following the acquisition of Danish bank FIH Erhvervsbank and Sigurdsson sustained organic growth. Furthermore, the Bank continued both to Chief Executive Officer reinforce its position on its home market, the Nordic countries, and for the first time the Bank achieved its long standing goal of generating more than 50% of earnings outside of Iceland.

Strong year Kaupthing Bank posted net earnings of ISK 15,760 million in 2004, or ISK 31.7 per share. This represents an increase of 109.6% in profit between years and a 71.3% increase in earnings per share.

The operating environment in 2004 was in general positive, as illustrated by the Bank’s results. Net operating income was ISK 48.6 billion and increased by 53% between years. The cost to income ratio was 50.2% and fell from 58.2% in 2003 and we aim to reduce it further in 2005. Return on equity after tax was 22.6% in 2004, which is well above the Bank’s long-term target of 15%.

Hreidar Már Sigurdsson The Bank had total assets at year end of ISK 1,534 billion, increasing by 174.6% during the year. This increase is largely attributable to the acquisition of FIH Erhvervsbank. Shareholders’ equity totalled ISK 149.4 billion and increased by 225% in 2004. This can be largely explained by the issue of share capital to finance the acquisition of FIH Erhvervsbank, firstly in a pre-emptive rights issue that took place in August, and secondly in a placement of new shares to institutional investors in October. The CAD ratio was 14.2%, and the Tier 1 capital was 11.5% at year end.

The Bank’s robust financial position prompted a Moody’s Investors Service rating upgrade in November. According to Moody's the rating upgrade in November reflected the Bank’s leading position in Iceland, as the country’s largest financial institution. It stated that the Bank’s sound financial fundamentals are based on sound asset quality, high efficiency and good capitalisation. It also took into account the Bank’s acquisition of FIH Erhvervsbank, and noted that Kaupthing Bank had historically managed acquisitions well. Moody’s further noted that the Bank's performance continues to gain strength not simply as a result of a strongly performing stock market in Iceland.

Acquisition of FIH Erhvervsbank The acquisition of the Danish Bank FIH Erhvervsbank was a transforming acquisition for Kaupthing Bank. In June the Bank entered into an agreement with FöreningsSparbanken (Swedbank) on the purchase of the Danish bank FIH-Erhvervsbank through its holding company FI-Holding and the acquisition was completed in September. The acquisition

I 11 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

doubled the size of Kaupthing Bank and gave us a leading position in the Danish corporate banking sector.

The acquisition of FIH Erhvervsbank was funded by an increase in the Bank’s share capital and with the issue of subordinated bonds. In the rights issue that followed in August, shareholders representing 96.38% of share capital in the Bank exercised their pre-emptive rights. The acquisition price was DKK 7,292 million.

FIH Erhvervsbank is a leading player in the Danish corporate banking market and brings transfer- able skills and a client base to Kaupthing Bank. By adding Investment Banking, Capital Markets and Private Banking to the scope of FIH Erhvervsbank, Kaupthing Bank will further reinforce its position on the Nordic market.

International growth Kaupthing Bank now operates in 10 countries. In 2004 the Bank performed particularly well in Luxembourg and in the United Kingdom, and operations in Iceland, Denmark, Faroe Islands, and Sweden were also most satisfactory.

Kaupthing Bank announced its first acquisition in Luxembourg last November. The Bank acquired all shares in PFA Pension Luxembourg and the acquisition took effect at the beginning of 2005. The purpose of the deal was to increase the Bank’s client base in Private Banking as well as to expand the business by offering insurance products to its existing clients.

In May 2004 the Bank entered into a Limited Liability Partnership with eight individual partners in the United Kingdom to form a specialised credit management business called New Bond Street Asset Management. Its objective is to act as a fund manager for diversified credit asset classes. Under an Investment Advisory Agreement, New Bond Street Asset Management has established a two billion euro portfolio of exposures to financial institutions, sovereigns, and asset backed securities for Kaupthing Bank. Further significant growth is expected in this business over the next few years.

Competition on the Icelandic housing market The Bank enjoyed a good year in Iceland, where it is a leading player in all areas of the financial market. Iceland still remains one of our key markets and we are committed to maintaining our leading role on that market.

In August the Bank began to compete with the state-owned Housing Financing Fund (HFF) by offering mortgages at highly competitive rates. There proved to be great demand for these new loans, and by the end of the year the Bank had a market share of 7% of all mortgages, an area where the HFF was previously the only player.

I 12 I I YEAR OF GROWTH AND GOOD PROFITABILITY I

Changes to financial reporting The implementation of IFRS leads to substantial changes in accounting principles and the presentation of the profit and loss account and the balance sheet. The notes in the accounts will also be more detailed. Although it results in changes in the valuation of some assets and liabilities, it has only a limited effect on shareholders’ equity, total assets, and the CAD ratio. It does not have material affects on net profit and, therefore, earnings per share.

Prospects Kaupthing Bank enjoyed a strong year in 2004 and the prospects remain good in 2005. The economic outlook in Denmark, the Bank’s largest single market, as well as in Iceland and the Bank’s other key markets is generally positive.

We aim to maintain a rapid growth rate but not at the expense of profitability. Our objective remains to grow by means of organic and external growth, only when estimated returns from such acquisitions can be expected to exceed the Bank’s return on equity targets. The Bank has enjoyed prosperous operations in recent years, and we will continue to reach our target of 15% return on equity in the near future.

I wish to conclude by thanking our shareholders for the trust they have shown us. Our goal at Kaupthing Bank is to maximise the profitability of the capital that is entrusted to us. One of our most important tasks is to retain our employees, whilst at the same time seeking to bring new skilled individuals on board. I wish to thank our outstanding team of employees for their great effort during the year. The success achieved during 2004 speaks for itself and encourages us to aim for even greater achievements in the future.

Hreidar Már Sigurdsson

I 13 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

SHARES IN THE BANK

The main objective of Kaupthing Bank is to create shareholder value. Kaupthing Bank is listed on two stock exchanges: in Reykjavík Share performance of Kaupthing Bank in 2004 compared with the ICEX 15 on and in Stockholm. the Iceland Stock Exchange 240 Dividends and dividend policy KAUP 220 ICEX 15 Kaupthing Bank’s current dividend policy is to pay dividends representing about 10- 30% 200 of profit every year. The amount of dividends declared is subject to applicable restrictions

180 on the payment of dividends under Icelandic law and other such factors, as the Board may deem relevant. The Board of Directors of Kaupthing Bank will propose that for 2004 160 dividends amounting to ISK 3,304 million, or ISK 5.00 per share, be paid to shareholders, 140 which represents 21% of profit. On the basis of the Bank’s share price on 31 December 120 2004 (ISK 442), the dividends represent 1.13% of market capitalization.

100 Jan 04 Jul 04 Dec 04 Kaupthing Bank’s share performance Kaupthing Bank’s share price was ISK 224.5 at the beginning of 2004 and had risen to ISK 442.0 by 31 December 2004, an increase of 96.9% over the year. Taking into account Share performance of Kaupthing Bank in 2004 compared with SX40 Financials dividend payments during the year, dividend reinvested, this represents a return for share- on the Stockholm Stock Exchange and holders of 98.7%. In comparison the Main List of the Iceland Stock Exchange climbed 58.9% the European Bank Index 240 in 2004, and the SX40 Financials on the Stockholm Stock Exchange rose 22.3%. KAUP 220 SX40 MSCI EUR/BANKS The total market capitalization of Kaupthing Bank at the end of 2004 was ISK 292.0 billion 200 (€3.5 billion). In terms of market capitalization it is the ninth largest bank in the Nordic

180 countries, as illustrated by the diagram.

160

140 The market capitalization of the ten largest banks in the Nordic countries at year end mEUR 120 25,000

21,749 100 Jan 04 Jul 04 Dec 04 20,000

15,158 15,000 13,294

10,023 9,624 9,442 10,000

5,728 5,000 3,758 3,497 1,883

0 Nordea Danske Bank SHB SEB DnBNor Swedbank Sampo Skandia Kaupthing Jyske Bank Bank

I 14 I I SHARES IN THE BANK I

Share capital Kaupthing Bank’s share capital as of 31 December 2004 amounted to ISK 6,606,856,400 nominal value, consisting of 660,685,640 shares. Each share entitles the holder thereof to Main group of shareholders one vote. All shares are of the same class and hold equal rights. All issued share capital in 11.4% Kaupthing Bank is listed on the Main List of the Iceland Stock Exchange and on the O-list 40.3% Financial Holding institutions companies and of the Stockholm Stock Exchange. institutional investors 1.2% Own Shareholders shares 24.2% General public At the end of 2004 Kaupthing Bank had a total of 31,978 shareholders, including 3,893 shareholders in Sweden. Ownership is well distributed, as is clearly illustrated when shareholders are categorised by size of shareholding. One shareholder owned more than 10% in Kaupthing Bank at the end of 2004: Meidur ehf. with 16.98%.

5.0% 2.4% Employees Mutual and investment funds 15.6% Pension funds

Dividend per share 6 ISK

0 Purchasing own shares 2001 2002 2003 2004 According to the authorization granted at the annual general meeting of Kaupthing Bank in March 2004, the Bank can purchase up to 10% nominal value of own share capital. During the year the Bank purchased 2,999,000 shares in order to fulfil employee stock option agreements.

I 15 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Shareholders on 31 December 2004

Number of shares % of total share capital Number of shareholders % of shareholders 1-1,000 6,746.113 1.0% 22,841 71.4% 1,001-10,000 24,500,261 3.7% 7,939 24.8% 10,001-100,000 22,599,818 3.4% 979 3.1% 100,001-1,000,000 48,696,022 7.4% 149 0.5% 1,000,001- 558,143,426 84.5% 70 0.2% Total 660,685,640 100% 31,978 100%

Increase in share capital At a shareholders’ meeting of Kaupthing Bank held on 5 July, the Bank’s Board of Directors was granted two separate authorizations to increase share capital by ISK 1,100,000,000 at nominal value in each instance, by issuing up to 110,000,000 new shares. The first authorization included shareholders’ pre-emptive rights, and the second authorization was on a non pre-emptive basis.

At a meeting of the Board of Directors of Kaupthing Bank on 5 July it was decided on the basis of authorizations granted at shareholders’ meetings to increase share capital in the Bank by up to ISK 1,101,371,280 at nominal value by issuing 110,137,128 shares. Shareholders had pre-emptive rights to the new shares.

A rights issue took place between 29 July and 6 August. Shareholders in the Bank exercised pre- emptive rights whereby each existing share entitled shareholders to 0.25 new shares at a price of ISK 360/SEK 37.30 per share. The total proceeds from these new shares amounted to ISK 39.6 billion. The increase in share capital as a result represented 20.0% of the Bank’s total share capital.

The Board of Directors of Kaupthing Bank resolved on 12 October to invite investors to submit offers to acquire between 80 million and 110 million shares in the Bank. Shares were offered for sale to institutional investors both within and outside the current group of shareholders. A total of 110 million shares were allocated to investors at the price of ISK 480 per share, a market value of ISK 52.8 billion. The total share capital of the Bank, following the increase, amounts to ISK 6,606,856,400 nominal value, divided into 660,685,640 shares. The increase as a result represented 16.6% of the Bank’s total share capital. The table below shows the change in share capital during 2004.

Change in share capital during 2004

Date Change Issued Share cap. nv. Nom. value No. of shares per share 1 Jan. Shares in Kaupthing Bank on Jan. 1 4,405,485,120 10 440,548,512 11 Aug. Share increase – rights issue 1,101,371,280 5,506,856,400 10 110,137,128 15 Oct. Share increase – share offering 1,100,000,000 6,606,856,400 10 110,000,000 31 Dec. Issued capital at year end 6,606,856,400 10 660,685,640 31 Dec. Own shares at year end 86,137,370 10 8,613,737 31 Dec. Outstanding shares at year end 6,520,719,030 10 652,071,903

I 16 I I SHARES IN THE BANK I

Earnings per share The Bank reported net earnings of ISK 15,760 million in 2004, which corresponds to ISK 31.7 per share. The Bank’s equity totalled ISK 149.4 billion at year end 2004.

Figures on Kaupthing Bank shares

2004 2003 2002* Share price at year end (ISK) 442 225 130 ** High/low (ISK) 224/506 224.5/129 133/112 ** Earnings per share Market Capitalization (ISK million) 292,023 98,903 59,145 35 ISK Dividend per share (ISK) 5.0 3.0 2.0 Shareholders’ return (dividend reinvested) 98.7% 75.0% 4.8% 30 P/E Ratio 13.9 12.1 11.03 25 Price-to-book Ratio (stated) 1.95 2.15 1.76 Outstanding shares 652,719,030 438,350,399 215,073,706 ** 20 Issued share capital (ISK) 6,606,856,400 4,405,485,120 2,150,737,060 15

5 Liquidity of Kaupthing Bank shares 0 Shares in Kaupthing Bank are highly liquid. Trading in the Bank’s shares averaged approxi- 2000 2001 2002 2003 2004 mately ISK 490 million per trading day during 2004 and the turnover rate was 63.1%. The majority of trading in the Bank’s shares takes place in Iceland, with 96.5% on the Iceland Stock Exchange, and 3.5% on the Stockholm Stock Exchange. The volume of trading in Kaupthing Bank shares on both stock exchanges totalled ISK 126.0 billion during the year. In 2004 Kaupthing Bank had the second highest volume of any company listed on the Iceland Stock Exchange, accounting for 16.9% of the total volume. The Icelandic bank Íslandsbanki is the market maker for Kaupthing Bank shares on the Iceland Stock Exchange and the Swedish securities brokerage Hagströmer & Qviberg is the market maker for the Bank’s shares on the Stockholm Stock Exchange.

Employees’ shareholdings A large number of Kaupthing Bank employees are shareholders in the Bank, and the Bank believes that employees’ equity interest in the Bank fosters commitment and personal interest in the success of the Bank as a whole. Kaupthing Bank employees currently own approximately 5% of the Bank. Prior to the merger of Kaupthing Bank and Búnadarbanki, both banks had entered into stock option agreements with their respective employees. The first agreements were made in 2000, and the number of options varied between employees, as is usual for employee stock option plans. Most option agreements were set up so that employees were allocated a fixed number of options when the agreements were entered into, and parts of the allocated options are vested in October or December each year for four or five years after the agreements were entered into. All options which remain

I 17 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

unexercised at the end of the period of the respective agreement are cancelled. However, program 4 can only be exercised on the final day of the agreement. On 31 December 2004, allocated employee stock options amounted to 12.6 million shares. Kaupthing Bank will use own shares or increase share capital in order to fulfil employee stock options.

Stock option programs

Exercisable Number of shares Exercise price (ISK) Exercisable in (thousands) Program 1 150 114.9 2005 Program 2 2,767 102.5 2005 Program 3 81 102.5 2005-2007 Program 4 1,000 122.0 2005 Program 5 240 120.0 2005-2006 Program 6 1,896 114.9 2005-2008 Program 7 6,496 303.0 2005-2008 Total 12,630

Put options On 19 November 2003 Kaupthing Bank sold a total of 11 million shares to a total of 60 key employees at market value (ISK 210 per share at the time of the transaction). Employees have an exercisable put option to sell these shares back to Kaupthing Bank at the acquisition price plus financing costs. The put options are only exercisable three years after the purchase, 19 November 2006. On 29 March 2004, the executive chairman of the board, Sigurdur Einarsson, and Hreidar Már Sigurdsson, CEO, purchased 812,000 shares each at market price in the Bank (ISK 303 per share), in accordance with an option plan that was approved at the Annual General Meeting on 27 March 2004. They are obliged to hold the shares for five years. As above, the holders have a put option to sell these shares back to Kaupthing Bank at acquisition price plus financing cost.

Compliance Strict rules govern securities trading by employees of Kaupthing Bank and the role of the Compliance Officer includes monitoring such trading. The role of the Compliance Officer is further discussed on page 38.

Investor relations Kaupthing Bank aims to ensure that market participants are provided with clear and detailed information on the activities and operations of the Bank. The Bank places great emphasis on developing investor relations, for example by means of investor meetings, capital markets days, and roadshow presentations. The Bank’s website, www.kaupthing.net, contains the Bank’s noti- fication to stock exchanges, annual reports and quarterly results, as well as other important information for market participants.

I 18 I I SHARES IN THE BANK I

Annual Report The annual report is only published in English. It is also available in PDF format on the Bank’s website, www.kaupthing.net.

The Bank’s annual report is sent to all shareholders owning more than 10,000 shares in the Bank and to anyone else specially requesting it. A copy of the annual report can be ordered on the Bank’s website www.kaupthing.net.

I 19 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

RISK MANAGEMENT

Kaupthing Bank faces various types of risks related to its business as a financial institution, which arise from its day to day operations. Management devotes a significant portion of its time to the management of these risks. The mainstays of effective risk management are the identification of significant risk, the quantification of the Bank’s risk exposure, actions to limit risk and the constant monitoring of risk. The most significant of these risks are discussed below.

Risk policy of Kaupthing Bank The assessment of risk, in particular the determination of its true price along with actions aimed at limiting the risk with sensible credit and investments in other assets, is one of the major tasks of banks and other financial institutions. Many risk factors can adversely affect Kaupthing Bank. It is the policy of the Board of Directors that the various risks that Kaupthing Bank faces in its business are to be constantly monitored and managed. For these purposes the Bank operates a centralised risk management division. In addition, Kaupthing Bank’s internal auditor oversees the operations in order to ensure that its rules are implemented in accordance with resolutions made by the board of directors.

The board of directors determines Kaupthing Bank’s goals in terms of risk by issuing a risk policy. The risk policy both defines acceptable levels of risk for day-to-day operations, as well as the willingness of Kaupthing Bank to incur risk weighed against the expected rewards. The risk policy is detailed in the Internal Control and Procedural Handbook, which is maintained by Risk Management and revised at least annually. Amendments or minor changes can be made more frequently but each change needs the approval of Kaupthing Bank’s Chief Executive Officer before it becomes effective and then needs to be approved by the Board of Directors at the earliest convenience. Significant changes and changes that affect limits are submitted to the Board for review and confirmation before they take effect.

It is incumbent upon the Risk Management division to enforce the risk policy. In order to do so Risk Management constantly monitors risk, with the aim of identifying and quantifying significant risk exposures and acting upon such exposures if deemed necessary. To ensure that the decision-making process within Kaupthing Bank is regulated and that the boundaries set by the Board of Directors and regulatory authorities are not exceeded, Risk Management regularly reports risk exposures, usage of limits and any special concerns to senior management and the Board of Directors. The Risk Management division is divided into five areas: credit control, market risk, operational risk, credit risk analysis and research and development which is responsible for developing risk models and risk analysis tools for Kaupthing Bank’s operations.

I 22 I I RISK MANAGEMENT I

Credit risk

Credit risk is the current or prospective risk to earnings and capital arising from the failure of an obligor of Kaupthing Bank to repay principal or interest at the stipulated time or otherwise to perform as agreed. This risk is enhanced if the assigned collateral only partly covers the claims made on the borrower or if its value is variable or uncertain. Credit risk arises anytime the Bank commits its funds, resulting in capital or earnings being dependent on counterparty, issuer or borrower performance. The risk comprises concentration risk, residual risk, credit risk in securiti- sation, cross border (or transfer) risk and more.

The main asset of Kaupthing Bank is its loan portfolio, and the ever growing possibilities and financial strength of the Bank means that managing and analyzing the loan portfolio becomes increasingly more important. Raised emphasis within the Bank to increase the quality of the Bank’s credit portfolio has paid off, not only by seeking business with strong parties but also by making the credit process stricter and critically inspecting problem loans. To maintain and further improve the healthy loan portfolio it is imperative to scrutinize all applications and weed out potential problem loans as early as possible, as well as constantly monitor the current loan portfolio. However, it is not the policy of the Bank to solely issue credit of very low risk but it is of utmost importance that the price of issued credit reflects both risk and costs incurred. This means that a detailed assessment of individual customers, their financial position and the collateral is a prerequisite for granted credits.

Credit risk management Credit risk is monitored within Risk Management. The Research and Development division within Risk Management is responsible for developing and maintaining credit monitoring and reporting systems. This includes collecting data from all operational systems within the Bank, data verifi- cation and unification. The unit also performs numerical analysis of the loan portfolio, e.g. estimates expected loss, concentrations within the loan portfolio and maps defaults in a systematic way. Likewise, the proprietary rating models employed within the Bank have been developed and tested by Research and Development.

In addition, two divisions within Risk Management concentrate on different aspects of the credit portfolio. Credit Control focuses on the distressed client process, e.g. monitors defaults, follows up on the legal process and oversees specific provisions and write-offs. Credit Risk Analysis is a newly created unit dedicated to, but financially independent from, the credit process, the loan application phase in particular. This unit monitors the integrity of the credit process, e.g. in regard to data collection, limit compliance, application preparation, documentation and collateral regi- stration and valuation.

I 23 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

At year-end, approximately 80% of credit facilities to corporate entities had been assigned a rating. This year, model building will continue and during the year all corporate counterparties will be rated. Similarly, all retail exposures to individuals will be classified according to credit risk profile. The Bank reviews its credit portfolio at least once a year, adjusting the internal credit rating if needed. For more doubtful exposures the Bank monitors the credit risk more frequently, often quarterly but on a daily basis if the case calls for the added attention.

Much work is done within Corporate Banking and Risk Management in order to map larger exposures and how the many different entities are intertwined. This gives the Bank a comprehensive overview of the outstanding exposure and the potential risks that can arise from interlinked ownership.

The risk assessment performed with the internal risk procedure directly affects the overall credit decision and further gives the necessary decision level needed in order to grant the credit. For all problem loans identified extensive measures are taken in order to assure the Bank’s position, along with placing the credit on a watch list where special rules and procedures may apply.

Credit application process The credit application process within Kaupthing Bank has been strengthened in recent years and both the specific tools used as well as the overall process is constantly although conservatively being ratio- nalized and developed. The Group Credit Committee is at the pinnacle of the credit process and has overruling authority in matters related to credit, the only exception being that exposures exceeding 10% of the Bank’s capital need the approval of the Board Credit Committee. Moreover, the Group Credit Committee covers all large credit tenders, limits the lending authority of personnel, and restricts exposures to different types of entities and reviews loans granted outside of committee meetings.

In order to make use of the local expertise a large part of the credit and collateral risk is maintained on a local level in the Bank’s subsidiaries. The same or similar credit rules apply in every subsidiary but, in addition, further requirements stipulated by local regulations may apply. To maintain a group-wide overview, the CEO or his deputy is a member of all local credit committees. The local committees are nonetheless supervised by the Group Credit Committee where all larger credits are approved and monitored. This gives Kaupthing Bank the possibility to utilize the much needed local expertise but maintain the risk on a global level. Local credit committees of the Bank’s subsidiaries are thus able to grant credits, but the grand total of the exposure of the applicant and financially related counterparties is limited. All applications that would lead to exposures exceeding the set limit are referred to the Board Credit Committee.

A necessary part of accurate pricing of credits is an effective and precise credit rating system. Emphasis has been placed within the Kaupthing Bank Group on improving credit risk modelling on a group wide scale. Where applicable, and together with the internal credit rating, the Bank uses the services of external credit rating agencies and collection services to strengthen the credit process even further. Recently, proprietary rating models have been developed and thoroughly tested

I 24 I I RISK MANAGEMENT I

within the Bank. The credit evaluation process is, however, not only dependant upon these quantitative numbers but on an array of qualitative factors as well. Factual information is collected on the borrower and pertinent macroeconomic data gathered, such as the sector it operates in etc. The creditworthiness of the borrower is therefore dependant upon, not only the recorded numbers, but also on the more subjective factors where the credit analyst answers predetermined questions. Here the analyst cannot rely solely on his numerical skill but must have extensive knowledge of the inner workings of the company in question and be in close contact with its management. Furthermore, a Sector division of loan mass facility rating of the collateral is performed to determine the loss parameter in the case of default. at year-end 2004

1% Transportation The general rule is that the larger the exposure the more detailed analysis is performed. For 9% Trade smaller exposures the due process is, however, fundamentally the same but requires less scrutiny 13% 6% and data. Guarantors are analyzed in the same manner. Individuals Holding companies

Credit exposure At year end 2004 the total loan portfolio, including leasing contracts, amounted to ISK 1,088 billion. The loan portfolio more than tripled in 2004, the acquisition of FIH accounting for about 170% of the increase and inner growth around 40%. Corporate loans totalled ISK 941 billion and loans to individuals totalled ISK 147 billion, up from ISK 88 billion last year, largely due to new mortgage loans introduced in Iceland during the latter half of 2004. The portfolio is well diversified but the Bank has the largest and approximately equal exposure to companies within the Industry and Service sectors, which constitute around 55% of the portfolio. Other significant sectors are Real Estate and Trade that 28% combined represent approximately one quarter of the portfolio. Analysis has revealed that risks due 15% Industry Real to underlying exposures within the 6% assigned to Holding companies are diversified. estate 27% Service Development of total loan mass in ISK billions since the beginning of 2002

1200 ISK billions

1000 Corporate Loans Individual Loans

800

600

400

200

0 12.01 03.02 06.02 09.02 12.02 03.03 06.03 09.03 12.03 03.04 06.04 09.04 12.04

Credit defaults During 2003 and continuing into 2004 significant efforts were made to increase the quality of the loan portfolio. Stricter rules and work procedures while issuing credit were introduced and certain loans that were considered doubtful were called on default.

I 25 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

An indicative measure of the quality of past credit decisions is the aggregate of payments that are more than 90 days overdue (90 day defaults). There are two ways in which 90 day defaults can be reduced: either the obligations can be met by the client or the provided collateral or, secondly the debt is written off. In order to examine the real development of 90 day defaults it is therefore necessary to add the write-offs made during the period to the active 90 day defaults, otherwise false default reductions might be observed. The accompanying figure displays the development of 90 day defaults and write-offs for the past three years.

Development of 90 Day Defaults, Write-Offs, Specific and General Loan Loss Reserve (SLLR & GLLR)

30 ISK billions 90 Day Defaults Write-Offs+SLLR 25 Write-Offs Write-Offs+SLLR+GLLR 20

0 12.01 03.02 06.02 09.02 12.02 03.03 06.03 09.03 12.03 03.04 06.04 09.04 12.04

The nature of credit risk is such that bad debt will not manifest itself in defaults until some time after the credit has been issued. The full effect of improved credit risk management will therefore only be felt over time. However, there are clear and significant signs of improvement during the year 2004 and the measures taken during the last two years have been proven effective and the trend is promising. During the latter half of 2004 defaults decreased at a faster pace than loans were written off and now amount to ISK 6,600 million compared with ISK 9,800 million at the beginning of the year. With the addition of the loan loss reserves of FIH, which are very high compared to the default rate of FIH, they are approximately three times the level of 90 day defaults.

Asset quality The main asset of Kaupthing Bank is its loan portfolio. An informative way of assessing the quality of the loan portfolio and how it has been evolving is to examine specific, general and total loan- loss reserves in relation to the linked quantities; write-offs, non-performing loans and provisions. To make the comparison meaningful over time and between different financial institutions it is most natural to display these quantities as a percentage of the total loan portfolio. In the figure below this is done for the Bank for the period 1998–2004 (combined for Kaupthing Bank and Búnadarbanki up to 2002).

I 26 I I RISK MANAGEMENT I

6% 120% General LLR % Loans Specific LLR % Loans 5% Write-offs % Loans Provisions % Loans 100% NPL % Total Loans LLR % NPL ( ->) 4% 80%

3% 60% Percentage of Total Loans

2% 40%

1% 20%

0% 0% 1998 1999 2000 2001 2002 2003 2004

The Figure shows the loan-loss reserve (LLR) as a percentage of Total Loans and how it is divided into Specific and General LLR. It also shows the percentage of total loans which are write-offs, non-performing loans (NPL) and Provisions. The dotted line and the right axis show the LLR as a percentage of NPL.

Since 2001 the ratio of non-performing loans has risen from just under 3% to just below 4% of total loans in 2003. During the last year the ratio fell to under 2%. It is noteworthy that this trend is almost identical even if the FIH part of the group is not taken into account. Similarly the loan loss reserve as a percentage of non-performing loans is steadily rising, again irrespective of FIH’s addition to the group. Provision in relation to loan mass has drastically declined, but write-offs remained high during 2004 although it is expected they will be reduced in 2005.

All these are signs of a very much improved loan portfolio and that the tactical changes made in regard to credit risk during the last two years have been fruitful and will continue to improve the asset quality in coming years.

Market risk

Market risk is the current or prospective risk to earnings and capital arising from adverse move- ments in bond prices, security and commodity prices and foreign exchange rates in the trading book. The risk arises from market making, dealing, and position taking in bonds, securities, currencies, commodities and derivatives.

Market risk management and control Each trading unit within the group adheres to the general rules set by the Board of Directors. Moreover, each trading unit has its own set of working procedures and rules that further specify their targets, limits and scope in trading.

The position limits, or any changes to them, are proposed by the Bank’s Managing Director of Capital Markets and then approved by the Bank’s Managing Director of Risk Management and reviewed by the Bank’s Chief Executive Officer who can interfere in limit decisions. Each position limit size is based on, among other things, underlying liquidity, the Bank’s risk appetite as well as legal limitations on individual positions posed by the relevant authorities.

I 27 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Measurement methods Risk measures are generated by proprietary systems that utilize the counter party, market data and trade databases generated and used by the Bank’s trade systems. Additionally, the risk management systems are augmented by various third party solutions. Models employed in evaluating these measures include position based models, volatility based models, i.e. based on the volatility of market variables and their related covariance and scenario based models, i.e. the frequency of a severe loss is estimated by repeating random scenarios with certain statistical properties that have most often been estimated from historical data.

All trades and intra-day profit or loss are reported continuously to the Managing Director of Risk Management through a position monitoring system. The Managing Director of Risk Management appoints a person and a backup person whose responsibility it is to monitor the intra-day positions in different trading units within the group and alert the Managing Director of Risk Management if any deviations or exceptions are observed.

The Bank’s Risk Management division sends a daily report on profit and loss and turnover to the Managing Director of Risk Management, Managing Director of Capital Markets, Managing Director of Finance and the Bank’s Chief Executive Officer.

The Bank’s Market Risk Management division sends a monthly risk assessment report to the Managing Director of Capital Markets, the Bank’s Chief Executive Officer, the Bank’s Board of Directors detailing volatility based and scenario based measures such as Value-at-Risk (VaR) and stress tests based on current exposure.

Market risk analysis Each month, as a part of a monthly risk assessment report, the probability and cumulative probability is calculated as a function of one-month-P&L (profit and loss), for listed equities and bonds.

14% 100%

12% 80%

10% 84,1% VaR

8% 60%

6% 40% Cumulative Prob. 4% Frequency 20% 2%

0% 0% -3.4 -2.4 -1.4 -0.4 0.6 1.6 2.6 3.6 4.6 Monthly P&L bn ISK

The data in the figure is based on a historical simulation over a period of two years. The dashed vertical line shows 84.1% VaR, which indicates that there is 15.9% probability that the loss will be more than ISK 0.99 billion during the next month.

I 28 I I RISK MANAGEMENT I

The market risk development is shown by a graph of realized daily P&L (grey dots) including funding and trading cost. For reference, the graph also shows the Expected Shortfall according to 97.7% VaR (gray line), based on historical data and calculated in the same way as in the previous graph, except for a day instead of month.

The figure shows realised daily profit and loss including funding and trading cost (dots). The black line shows the expected shortfall according to 97.7% VaR.

1.05 K 0.8 Exp. shortfall P&L bn IS .055 0.3 0.05 -0.2 -0.45 -0.7 -0.95 -1.2 Dec 03 Feb 04 Apr 04 May 04 Jul 04 Sep 04 Oct 04 Dec 04

Other simulation based models, such as Monte Carlo simulation, are also used to measure the VaR of the Bank’s security portfolio, which helps in identifying all major contributing risk factors of the Market Risk.

Furthermore, according to the Internal Control and Procedural Handbook, the Board of Directors will use Risk Weighted Assets with respect to Risk Capital - as defined in laws regarding CAD ratios - as a measure of the division of risk into different types of risk.

Market risk portion of risk weighted assets

19%

18%

17%

16%

15%

14%

13%

12%

11% Dec 03 Feb 04 Apr 04 May 04 Jul 04 Aug 04 Oct 04 Dec 04

I 29 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Quarterly values from CAD reports

Name 31.12.03 31.03.04 30.6.04 30.9.04 31.12.04

Risk weighted market risk assets 72.0 66.7 73.8 130.5 136.1 Risk weighted assets, total 402.8 409.2 440.0 1103.2 1158.7 Market Risk Ratio % 17.9 16.3 16.8 11.8 11.7

All figures are in ISK billions

Operational risk

Operational risk is the risk of loss, resulting from inadequate or failed internal processes, human and system error, or from external events that affect the Bank’s operations and can result in direct losses and/or have adverse affects on the share price. The Bank has two guiding principles towards operational risk. Firstly, processes should be of such quality that the risk of operational failures is acceptable and that such failures are detected early if they occur. Secondly, when the risk has been estimated, capital must be allocated accordingly.

Operational risk should in essence be treated in the same way as other types of risk, i.e. constantly monitored and controlled. In practice, the same methodology as employed in managing credit or market risk may not apply and specific measures must be introduced to estimate and reduce operational risk.

The evaluation of the charge on risk capital due to operational risk is in accordance with rules from the Bank for International Settlements regarding operational risk. The minimum capital requirement due to operational risk is evaluated for departments within the Bank. This estimation of required capital is in itself a procedure during which operational risk factors are both identified and, if possible, remedied or reduced. To ensure the rigor and quality of the process it is divided into five levels. These are operational process, control and risk assessment, key risk indicators, loss data collection and analysis and reporting.

In each department the directors are responsible for the operational risk, but the Risk Management division sets the course, provides guidance and gives information on the development of operational risk and is the cohesive force between departments. The Risk Management division tracks each department’s operational risk and if the risk deviates from the predefined risk boundaries the head of the relevant department is notified and/or others as deemed appropriate. Risk Management then follows through until the risk has been eliminated or reduced to acceptable levels. Additionally, in accordance with solid operational risk management practices, it is ensured that employees are trained in such a way that no single employee is irreplaceable.

Operational risk analysis The operational risk is estimated by using Basel II standardized approach and is in accordance with the third consultative document published by Bank for International Settlements in June 2004. The operational risk is estimated for six business lines, Corporate Finance, Trading and

I 30 I I RISK MANAGEMENT I

Sales, Retail Banking, Commercial Banking, Agency Services and Asset Management. The remaining two business lines, according to Basel II Standardized approach, Payment and Settlement as well as Retail Brokerage are included in the Trading and Sales business line.

The total operational risk for all the business lines is currently measured to be approximately ISK 8 billion. If the operational risk is accounted for in the CAD ratio, as is proposed by Basel II, the CAD ratio would be approximately 13.1% instead of the current level of 14.2%.

Operational Risk Estimated using Basel-II Standardized Approach ISK millions 10,000 20% Corporate Finance Commercial Banking w. OpRisk Charge Trading & Sales Asset Management CAD Ratio 8,000 Retail Banking Agency Services 15%

6,000

10%

4,000

5% 2,000

0 0% 2003 2003 2003 2003 2004 2004 2004 2004 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Operational risk for each business unit, according to Basel II Standardized approach

The Operational Risk department also acknowledges the fundamental role of the Bank’s internal auditing in controlling certain parts of operational risk.

Liquidity risk Liquidity risk arises from the inability to manage unplanned changes in funding sources. Therefore, access to liquid funds, i.e. liquidity, is essential to Kaupthing Bank’s business. The Bank’s liquidity could be impaired by an inability to access secured and/or unsecured debt markets, an inability to access funds from our subsidiaries or an inability to sell assets. This situation might arise due to circumstances beyond the control of the Bank, such as general market disruption or an operational incident that affects either third parties or us. Accordingly, Kaupthing Bank has developed a comprehensive set of liquidity and funding policies that intend to maintain significant flexibility to address both firm specific and broader industry or market liquidity events. The objective is to be able to fund the Bank and to enable our core business to continue to generate revenues, even under adverse circumstances at the market.

The Bank’s credit rating is important to its liquidity. A downgrade in credit rating would not only affect liquidity but also increase competitive cost, limit accessibility to capital markets and increase funding cost.

I 31 I I RISK MANAGEMENT I

The Central Bank of Iceland has issued rules regarding liquidity ratio (No.386/2002). The liquidity ratio refers to the ratio between liquid claims and liquid liabilities. The liquidity ratio is calculated on a monthly basis and reported to the Central Bank. In the rules it is stipulated that the three month liquidity ratio is to be above 1. According to calculations performed by the end of year 2004, the liquidity ratio for the coming three months was 1.49, which translates to excess liquidity of approximately ISK 90 billion.

The Financial Supervisory Authority of Iceland has issued guidelines (No.2/2004), which focus on sound practices in foreign currency liquidity management. The Bank’s processes conform to or exceed these guidelines and access to funds in foreign currencies is continuously monitored, both at intra-day levels as well as on a longer term basis.

Basel II The Basel Committee on Banking Supervision has developed a new framework for setting capital adequacy requirements, Basel II. The new rules are planned to come into effect on 31 December 2006. The basic idea behind the new framework is to create a clear link between capital adequacy requirements and risk. The present standardized methods of capital adequacy will be replaced by more risk sensitive methods. The new requirements will include capital requirement for operational risk in addition to credit risk and market risk, in current rules.

Kaupthing Bank has the ambition in regard to credit risk to move towards the Internal Rating Based (IRB) approach. The aim is to start with implementing the Foundation approach (FIRB) by using loss given default parameters (LGD) given in the Framework and then move on to the Advanced approach (AIRB) as soon as possible. During the last year the focus has been on the development of rating models and parameters such as probability of default (PD), in particular for corporate exposures. The Bank is currently working on data preparation for further development of internal models, rating models for retail exposures and LGD models. These will form parameters a basis for the calculation of capital adequacy requirements for credit risk exposures.

For operational risk, Kaupthing Bank intends to initially implement the Standardized approach which has partially already been implemented within the group and then move towards the Advanced Measurement Approach (AMA). Sound Practices for the Management and Supervision of Operational Risk, issued by the Basel Committee on Banking Supervision, have been used for guidance in implementing an appropriate Operational Risk Management Environment. The Bank has developed an Operational Risk Framework in which Operational Risk is defined and principles laid down on how it is to be identified, measured and controlled. For quantitative measurements the Bank has developed a corporate loss database to which all operational losses will be reported and for qualitative measurements the Bank is currently conducting a control self assessment in every business unit.

I 32 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

CORPORATE GOVERNANCE

Corporate Governance in Kaupthing Bank is defined as the framework by which the Bank is directed and controlled and the relationships between the Bank’s management, its Board, its shareholders and other stakeholders.

The aim of the Corporate Governance program in Kaupthing Bank is to ensure disclosure and transparency, to define the responsibilities of the Board and the management, to define the rights and role of shareholders and stakeholders, to ensure the equitable treatment of shareholders and to avoid conflicts of interests.

It is the objective of the management and the Board to have transparent and effective internal control within Kaupthing Bank. An Internal Control and Procedural Handbook (ICP) reflects the most recent rules and procedures in effect at Kaupthing Bank. The ICP handbook is to be reviewed annually by the Board of Directors and all changes and updates are presented specially to the Board of Directors for review and approval.

In 2004, the Iceland Chamber of Commerce, the Iceland Stock Exchange and the Confederation of Icelandic Employers issued Guidelines on Corporate Governance. According to an external legal opinion, Kaupthing Bank is in full compliance with the Guidelines.

Statutory bodies

Shareholders’ Meetings The supreme authority in the affairs of Kaupthing Bank, within the limits established by the Articles of Association and statutory law, is in the hands of legitimate shareholders’ meetings. Shareholders’ meetings may be attended by shareholders, their proxies and advisors. The CEO furthermore has full rights to speak and submit motions at shareholders’ meetings. Shareholders’ meetings are open to representatives of the press and the Iceland Stock Exchange.

The Annual General Meeting of Kaupthing Bank is held before the end of April each year.

At shareholders’ meetings each share carries one vote. Decisions at shareholders’ meetings are taken by majority vote unless otherwise provided in the Articles of Association or statutory law.

The Board of Directors The Board of Directors of Kaupthing Bank is the supreme authority in the affairs of the Bank between shareholders’ meetings. It handles the affairs of the Bank and ensures that its organization and operation are at all times in correct and appropriate order. The Board ensures adequate supervision of the accounts and disposal of the Bank’s property. The Board of Directors may not involve itself in decisions on individual dealings, unless their scope is substantial in relation to the size of the Bank. Individual Board members must not involve themselves in decisions on individual dealings.

I 33 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

The Board of Directors of the Company is composed of nine members, to be elected at the Annual General Meeting for a term of one year. Nine substitute members are also elected. The Board elects a Chairman of the Board from among its members, and allocates tasks in other respects as required. The Board is authorized to entrust the Chairman of the Board with special activities on behalf of the company. The Chairman of the Board (the Executive Chairman) is the public rep- resentative of the Board of Directors, unless otherwise decided by the Board of Directors.

The Board of Directors appoints the CEO of the Bank and decides on the terms of his employment.

The Board of Directors has established Working Procedures setting out further details of the performance of its duties. These Procedures discuss in particular the authorization of the Board to take decisions on individual dealings, the eligibility of Board members, the handling of information on individual customers by the Board and the participation of the Board members in the Boards of Directors of subsidiaries and associated companies.

The Board has established a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of the Executive Chairman and the Chief Executive Officer. No Director is involved in deciding his or her own remuneration. The Annual General Meeting in 2004 furthermore adopted a proposal on options to employees and management.

The role of the Executive Chairman is to coordinate the activities of the Bank’s subsidiaries, pursue opportunities to increase efficiency by merging with other companies or to seek out potential acquisitions in Iceland and abroad. The Chairman shall ensure that agendas of meetings of the Board of Directors include items which are important to the operations of the Company and are prerequisites for the supervisory duties of the Company’s Board of Directors. The Chairman shall ensure that all directors are properly briefed on issues arising at board meetings.

Queries by the Board of Directors or individual Board Members shall generally be raised at meetings of the Board of Directors and shall be addressed to the CEO or others present at the meeting. Otherwise, queries shall be sent to the Chairman of the Board. It is not permitted to request information or direct queries directly to other employees of the Bank between meetings of the Board of Directors. This does not, however, apply to the Executive Chairman.

The Bank plans to assess the activity, work practices and work procedures of the Board annually along with the progress of the Bank, with the assistance of outside parties as applicable. The Working Procedures of the Board of Directors state that Board Members should familiarise themselves with the provisions of law, the Articles of Association of the Bank, general regulations of the securities market, special regulations of the Bank on the handling of inside information and insider trading and other rules.

The majority of the members of the Board is independent of the Bank.

I 34 I I CORPORATE GOVERNANCE I

If, prior to an Annual General Meeting, the Bank is informed by the Board or by shareholders of a proposal for the election of the Board which is supported by shareholders with holdings corresponding to at least 10% of the votes for all shares in the Bank, the Bank makes public the proposal in good time prior to the Annual General Meeting.

The Board of Directors has furthermore proposed an amendment to the Articles of Association of the Bank, stating that those who wish to be considered for the Board of Directors must announce this no later than seven days before the Annual General Meeting.

Management The CEO of Kaupthing Bank and the Board of Directors are jointly responsible for the management of the Company. The CEO is responsible for the day-to-day operations of the Bank, and in this respect he observes the policy and directions of the Board of Directors. The day-to-day operations do not include measures which are unusual or extraordinary. Such measures are only taken by the CEO pursuant to special authorization from the Board of Directors of the Bank unless it is impos- sible to wait for decisions of the Board of Directors without seriously disadvantaging the operation of the Bank. In such cases the Board of Directors is promptly notified of the measures.

The CEO ensures that the accounts and finances of Kaupthing Bank conform to law and accepted standards and that the disposal of the Bank’s assets is secure.

Accounts and auditing A state authorised public accountant or accounting firm is elected auditor at each Annual General Meeting of Kaupthing Bank for a term of one year. The Auditor examines the Bank’s accounts and all relevant account documents for each year of operation, and has access to all the Bank’s books and documents for this purpose.

Auditors are not elected from among the Members of the Board of the Bank or employees. The qualifications and eligibility of the Auditor at elections are in other respects governed by law.

Board Committees and Internal Auditor

The Board has established an Audit Committee, Compensation Committee and Credit Committee, and furthermore the Internal Auditor is responsible to the Board of Directors. In addition, the Board exercises its control governance through a number of policies and instructions.

Audit Committee The Audit Committee keeps regular contact with both external and internal auditors and ensures that complaints and observations from the auditors are acted upon. Furthermore, the Audit Committee discusses accounting principles and any changes in them. The Audit Committee con-

I 35 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

sults and advises the Board of the scope of internal audit. The Committee shall keep under review the scope and results of the audit and its cost effectiveness and the independence and objectiv- ity of the auditors. Where the auditors also supply a substantial volume of non-audit services to the Bank, the Committee should keep the nature and extent of such services under review.

The Executive Chairman and employees are not allowed to be members of the Committee. Members of the Audit Committee are Hjörleifur Jakobsson, Chairman, Bjarnfredur Ólafsson and Brynja Halldórsdóttir.

Compensation Committee The Compensation Committee discharges the Board’s responsibility in matters relating to executive compensation and administration of the Bank’s incentive compensation and equity-based plans, in accordance with applicable rules and regulations. The principal responsibility in compen- sating executives is to coordinate the incentives of the executives with actions that will enhance long-term shareholder value. Members of the Compensation Committee are: Ásgeir Thoroddsen, Chairman, Finnur Ingólfsson and Tommy Persson.

The Compensation Committee also outlines the policy of the Bank regarding employee stock- options. The stock-option policy is submitted to the Annual General Meeting for approval.

Credit Committee The Board’s Credit Committee makes decisions on lending regarding parties whose obligations towards the Bank exceed 10% of the Bank’s equity base.

Members of the Credit Committe are: Sigurdur Einarsson, Chairman, Bjarnfredur Ólafsson, Board Member, Gunnar Páll Pálsson, Board Member, and Hreidar Már Sigurdsson, CEO. The Managing Director of Risk Management is also present at the meetings.

Internal Auditor The Internal Auditor is directly subordinated to the Board of Directors and ensures that the evaluation of the internal control is satisfactory and efficient and that the activities of the Bank are in accordance with the Board’s policies and instructions.

Internal Committees

Executive Committee The CEO of the Bank consults the Executive Committee on matters of special importance to the Bank.

I 36 I I CORPORATE GOVERNANCE I

Credit Committee The Credit Committee is the second highest credit granting body of the Bank. The CEO chairs the Committee, and among others present at the meetings are the Managing Directors of Corporate Banking and Risk Management.

IT Committee The CEO consults the IT Committee on IT related issues and IT strategy.

ALCO Committee The ALCO Committee maintains oversight over the Bank’s balance sheet, proposes policies con- cerning the structure of assets and liabilities, co-ordination on risk, capital, funding and liquidity matters.

I 37 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

COMPLIANCE

A special Compliance Officer is employed within the Bank. The Compliance Officer is directly responsible to the Chief Executive Officer and is independent in his duties. The Compliance Officer monitors the implementation of working procedures within the Bank, including rules regarding trading by employees and primary insiders. The Compliance Officer has initative in interpreting the rules, and takes decisions based on the rules. The Compliance Officer makes proposals for improved working procedures for various positions within the Bank, and helps develop and maintain the monitoring system.

In accordance with legislation and recommendations of the Icelandic Financial Supervisory Authority (FME) the Bank has established the following working procedures which have been confirmed by the FME: Rules on proprietary securities trading, employees’ securities trading, the separation of operating units, rules on permission for employees to participate in business activities and rules on the handling of inside information and insider trading.

The Compliance Officer ensures that employees and management are aware of existing laws and regulations. In-company presentations and re-training with respect to the working procedures are also the responsibility of the Compliance Officer. In addition to the Compliance Officer, the Internal Auditor, lawyers and Risk Management supervise the implementation of these regulations.

I 38 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

CREDIT RATING

In November 2004 Moody's Investors Service upgraded its credit rating of Kaupthing Bank. The Bank's long term deposit and senior debt ratings were upgraded from A2 to A1. The subordinated debt rating was upgraded to A2 from A3. Moody’s affirmed C+ in financial strength rating. The short term rating of P-1 was also affirmed, which is the highest rating given.

According to Moody's the rating upgrade reflects the Bank’s leading position in its domestic market in Iceland, the fact that it is one of the country’s largest institutions, and its healthy financial fundamentals. The Bank’s sound financial fundamentals are based on sound asset quality, high efficiency and good capitalisation. Moody’s also believes that with the addition of FIH Erhvervsbank Kaupthing Bank should be able to gain access to the Danish small and medium- sized business market and complement its own product palette in the future. Moody’s notes that Kaupthing Bank has historically managed acquisitions well. Moody’s further notes that the Bank's performance continues to gain strength and this is not simply the result of the strongly performing stock market in Iceland.

Moody's credit ratings often play a key role in determining the terms of loans to financial institutions and companies and are a decisive factor in pricing securities on the major financial markets.

Moody’s historic credit rating for Kaupthing Bank

Date Long-term debt Subord debt Financial strength Short-term Nov 04 A1 A2 C+ P-1 Dec 03 A2 A3 C+ P-1 May 03 A3 Baa1 C P-1

I 39 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

MARKET OVERVIEW

The economic conditions at the beginning of 2004 were such that growth in 2004 and 2005 was forecast to be over 4%. The global economy fared remarkably well, despite surging oil prices threatening The Euro strengthening path against USD economic growth, and investors’ fears that policy mismanagement in

1.4 China could precipitate the world into recession. The moderation in US activity indicators called for a long run steady-state low inflation. 1.3 Given the absence of central banks’ intervention, the depreciation of the US dollar has put strains on the growth dynamics of the US’ trad- 1.2 ing partners, such as the eurozone. Despite these factors, the world

1.1 economy grew at an above-trend rate in 2004.

1 The financial markets’ reaction to the mitigated economic backdrop could have been more sanguine, especially as far as the equities markets are concerned. Equities in the developed

0.9 markets remained sluggish for most of the year while emerging markets and equity markets Jan 03 Jul 03 Jan 04 Jul 04 Jan 05 in the Nordic countries soared. The Icelandic ICEX 15 witnessed the largest increase, rising 59% in 2004 followed by the OBX index in Oslo gaining 31%. The OMX in Stockholm was up by 17%, the Copenhagen �s KFX index by 17% as well and the HEX in Finland rose by 3%. EMU Annual GDP

5% Equity indexes in 2004 4% Iceland Norway 3% Eastern Europe 2% Latin America Denmark 1% Asia ex Japan Sweden 0% UK Euro zone -1% Japan USA -2% Finland

0% 10% 20% 30% 40% 50% 60% 70% -3% Mar 92 Mar 96 Mar 00 Mar 04 Mar 94 Mar 98 Mar 02 USA The US economy grew by 4.4% last year, at its fastest pace in five years, up from 3.0% in 2003 and 1.9% in 2002. Consumer and corporate spending boosted growth as corporate expenditures increased by 10.3% and consumer spending by 3.8%. Business spending grew at a pace similar to that of the late 1990s. In the fourth quarter, however, growth was dragged down by a record trade deficit and came in well below expectations at 3.1%. The sheer size of the trade deficit translated into a loss of approximately 1.7 percentage points of growth.

I 42 I I MARKET OVERVIEW I

Stock Indexes in USA and Europe 120

100

MSCI WORLD 20 Europe (BE500) USA (S&P 500)

0 Dec 99 Jun 00 Dec 00 Jun 01 Dec 01 Jun 02 Dec 02 Jun 03 Dec 03 Jun 04 Dec 04

Eurozone The year 2004 did not provide much encouraging evidence of the strength of the eurozone economy and of its ability to step up from recession. Economic growth probably stood at around 1.8% in 2004 and the German economy expanded by 0.6%, compared with 1.2% average growth between 1993-2003. Last year the economy was mainly driven by external growth, which still provided little impetus to spur employment. High unemployment rates and concerns about job losses have indeed constrained consumers, preventing household expenditure growth from flourishing as in other economies. The eurozone is especially vulnerable to exports as they account for one- fifth of its economy, twice as much as the US. The strengthening of the euro last year did impair the economy’s export price competitiveness but recent developments on the currency and energy price fronts do not hint at any collapse in activity in the near term.

United Kingdom The UK economy, which experienced a mere economic downturn during the last global recession, has led this latest economic cycle. The extremely lively pace of consumer expenditure, supported by a booming housing market has enabled a superior pace of overall activity. The Bank of England was the first major central bank to embark on a tightening policy, starting to raise rates in November 2003. After what historically appears to have been a brief tightening course (both in terms of extent and duration), the market is already expecting that this monetary cycle has peaked.

The Nordic countries All of the Nordic countries, Sweden, Norway, Denmark, Finland and Iceland have benefited from the global economic rebound, but to a varying extent. GDP growth is likely to have exceeded 3% in 2004 for Sweden, Norway and Finland, with Denmark weighing in at 1.9%. Iceland is forecast to have registered 5.4% GDP growth in 2004, the highest of the Nordic countries. Thus, all of these economies are growing faster than the eurozone average.

I 43 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Iceland The Central Bank of Iceland has forecast 5.4% economic growth in Iceland in 2004, the highest growth rate in the Nordic region. Such a high growth rate is largely explained by large-scale construction projects in the aluminium industry, investments in property and private consumption, which increased sharply last year. As a result inflation rose and measured 4.0% during the year, and the Central Bank raised policy rates by 300 basis points to combat overheating.

2004 was also characterised by rising asset prices, such as real estate, shares and bonds. Higher asset prices and lower long-term interest rates were the main driving forces in the real economy last year, whether in terms of increasing private consumption or construction of new housing.

2004 was an excellent year for bonds owners, as it was the third year in succession during which returns on the bond market were exceptional. There was upheaval on the domestic bond market as the Housing Financing Fund (HFF) exchanged housing bonds for the new HFF bonds. Kaupthing Bank’s decision to offer indexed property loans at better rates than the HFF also had an impact on the market.

Sweden GDP growth in Sweden was rapid last year and amounted to 3.6%, the fastest pace in the last 30 years as interest rates were historically low. The economy benefited from a robust trend in exports, compounding with an industrial structure evolving around sectors highly exposed to the global economic rebound. Despite the sustained level of economic activity, inflation declined from the previous year with the CPI levelling off to 0.5% and the UND1X inflation standing at 0.8%, well below the Riksbank’s 1-3% target interval. Indeed, the Riksbank cut interest rates twice in early 2004 by a total of 75 basis points to 2.0%. Imported inflation was especially low at the end of the year, a trend that can partly be explained by a stronger currency. In addition, even though economic growth has been strong through the year, continued weakness in the labour market has meant that there has been no indication of wage-induced inflation pressures. The continuing strength in economic activity is nevertheless expected to lead to a decrease in the unemployment rate which was 5.5% in 2004.

Denmark The Danish economy was the weakest in the Nordic countries with 1.9% GDP growth in 2004. Private consumption was the primary source of economic growth, as it reached its highest level since 1998. Disposable income increased significantly thanks to a domestic reduction in taxes and duties, interest rates at historical low levels, a decrease in inflation and the development of new kinds of loans in the Danish mortgage market. These four factors were the foremost important reasons why private consumption increased by 3.5% in 2004, the highest increase in 10 years, and is expected to remain strong in 2005. A continued rebound in investment is also expected to support growth in 2005.

I 44 I I MARKET OVERVIEW I

Finland GDP growth in Finland picked up in 2004 and will probably exceed 3% for the whole year. In Finland, net exports made an important contribution to GDP growth as they expanded both in volume and value terms. The Finnish trade performance was, however, weak considering developments in world trade. This can partly be explained by the appreciation of the euro, negatively impacting exporters’ competitiveness. Furthermore, a substantial part of Finnish exports go to non-euro area countries. Inflation was low during 2004 which can be explained by changes in indirect taxes and increased competition.

Norway The Norwegian economy is as always affected by oil market developments. Domestic demand has contributed strongly to the Norwegian recovery, not least because of booming investments in the oil sector. In spite of a continued recovery in 2005, inflation pressures remain moderate and we do not expect monetary tightening during the first half of the year.

On balance, all of the Nordic economies are likely to be supported by domestic demand in 2005. In this, they differ favourably from core European countries, especially Germany, where domestic demand growth has been sluggish and where the strong currency now threatens export growth as well. Even though a weak European economy in 2005 could harm the Nordics, growth is still likely to remain stronger in this area. And with subdued inflation, the risk of overheating and need for sharp monetary tightening is limited.

I 45 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

KAUPTHING BANK’S RESULTS

Kaupthing Bank posted a pre-tax profit of ISK 20,348 million in

Income distribution in 2004 2004, compared with ISK 9,393 million the previous year. Net earn-

39% ings amounted to ISK 15,760 million in 2004, compared with ISK Net interest income 7,520 million in 2003. This represents an increase of 109.6%. 10% Other income Kaupthing Bank posted a pre-tax profit of ISK 5,242 million during the fourth quarter of 2004, compared with ISK 3,229 million during the same period in 2003. Net earnings amounted to ISK 4,055 million during the fourth quarter of 2004, compared with ISK 2,441 million during the same period in 2003, an increase of 66.1% between periods.

Earnings per share amounted to ISK 31.7 in 2004, compared with ISK 18.5 in 2003.

Income

23% Net operating income in 2004 amounted to ISK 48,569 million, compared with ISK 31,780 Trading gains 27% million in 2003, an increase of 52.8% between years. Net commission income Net interest income in 2004 amounted to ISK 18,900 million, compared with ISK 10,124 million in 2003, representing an increase of 86.7% between years. This increase is largely a result Income distribution by quarter of FIH’s joining the group in 2004. The interest margin, i.e. interest income minus interest 16,000 ISK millions expenses as a ratio of average total assets, was 1.8% in 2004, compared with 2.0% in 2003.

14,000 The lower interest margin is primarily the result of changes in the composition of the Bank’s loan portfolio after the acquisition of FIH. 12,000

10,000 Net commission income totalled ISK 13,297 million during the year, compared with ISK 9,683 8,000 million in 2003. Net commission income therefore increased by 37.3% between years.

6,000 Trading gains in 2004 totalled ISK 11,290 million, compared with ISK 10,044 million in 4,000 2003, an increase of 12.4%. Of this total, ISK 7,735 million represents trading gains from 2,000 equities, ISK 2,948 million from bonds and ISK 607 million from foreign exchange. 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004 Other income totalled ISK 5,082 million in 2004, compared with ISK 1,929 million in 2003. This 163.5% increase between years is largely due to dividend payments to Kaupthing Bank Other income Net trading income during the second quarter from the Bank’s holding in Singer & Friedlander Group Plc. and Net commission income profit from the sale of the Bank’s subsidiary in Denmark, Kaupthing Bank A/S. Net interest income

Expenses

Other operating expenses totalled ISK 24,402 million in 2004, compared with ISK 18,493 million in 2003, an increase of 32.0% between years. The cost to income ratio in 2004 was 50.2% and decreased from 58.2% in 2003.

I 46 I I KAUPTHING BANK’S RESULTS I

Income specified by location of its markets and customers

Net Net Net Net Interest Commission Trading Other Operating income income income income income

Iceland 7,928 42% 7,172 54% 3,949 35% 969 19% 20,019 41% Scandinavia 7,628 40% 3,344 25% 1,612 14% 2,365 47% 14,949 31% UK 1,142 6% 1,197 9% 4,209 37% 1,733 34% 8,280 17% Luxembourg 1,749 9% 1,411 11% 1,519 13% 12 0% 4,691 10% Other countries 453 2% 172 1% 1 0% 3 0% 629 1% Group 18,900 100% 13,296 100% 11,290 100% 5,082 100% 48,569 100%

The Bank’s salaries and related expenses totalled ISK 12,652 million in 2004 and increased by Income and expenses 25.1% from 2003. At the end of 2004 the total number of full-time equivalent positions at the 16,000 ISK millions Bank and its subsidiaries was 1,606, compared with 1,237 at the beginning of the year. Other administrative expenses totalled ISK 9,108 million in 2004, increasing by 29.6% from 2003. 14,000 12,000

Amortisation of goodwill and depreciation of fixed assets amounted to ISK 2,642 million in 10,000 2004, compared with ISK 1,355 million in 2003. This rise is attributable to an increase in 8,000 amortisation of goodwill in connection with the acquisition of FIH. 6,000

Provision for losses totalled ISK 3,819 million in 2004, compared with ISK 3,894 million in 4,000

2003. Provision for losses decreased despite the fact that FIH is now consolidated in the 2,000 Bank’s accounts. 0 Q4 Q1 Q2 Q3 Q4 2003 2004 2004 2004 2004 Income tax in 2004 totalled ISK 4,040 million, which represents an increase of 172% from Net operating income the previous year. Total other operating expenses

Balance sheet Credit reserves 14,000 Assets ISK millions

The Bank’s total assets on 31 December 2004 amounted to ISK 1,534 billion and increased 12,000 by ISK 975 billion or 174.6% during the year. General 10,000 Specific

8,000 The Bank’s loans to customers on 31 December 2004 amounted to ISK 1,088 billion, and increased by ISK 737 billion since the end of 2003, or 210%. The increase is mainly due 6,000 to the acquisition of FIH. Loans to customers represented 71% of the Bank’s total assets 4,000 on 31 December 2004, compared with 63% of total assets at the end of 2003. The Bank’s 2,000 total provision for losses on 31 December 2004 was ISK 16,492 million, which represents 1.4% of loans and guarantees compared to 2.1% at the end of 2003. The decrease is 0 2001 2002 2003 2004 mainly due to the acquisition of FIH.

I 47 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Asset distribution

ISK billions 1088.3 31 Dec.03 31 Dec.04

351

169.7 113.5 50.5 80.8 65.7 75.5 33.7 16.6 13 2.9 8.3 22.9

Amounts due Loans to Bonds Listed Unlisted Subsidiaries Other Assets from Credit Customers Shares Shares Institutions Loans to customers Holdings in bonds and other fixed income securities were valued at ISK 170 billion at the end of 1% Transportation 2004, an increase of ISK 89 billion from the end of 2003. This increase is largely attributable to 9% Trade FIH’s holdings in bonds. Taking derivatives into account, the Bank is exposed to market risk of

13% 6% ISK 72 billion. Inflation-indexed assets net of indexed liabilities stood at ISK 36 billion at year-end Individuals Holding companies 2004, as assets were 170 billion and liabilities were 134 billion.

The Bank’s holdings in shares and other variable yield securities amounted to ISK 79 billion at the end of 2004, and increased by 56% during the year. The Bank has entered derivatives agreements against these assets to a total of ISK 13 billion. The Bank is not exposed to market risk of ISK 11.0 billion due to minority interests in the Bank’s subsidiary, Norvestia, in Finland. The Bank is therefore exposed to market risk of approximately ISK 55 billion. Listed shares amounted to ISK 65.7 billion, or 4.3% of the Bank’s total assets. Unlisted shares amounted to ISK 13.0 billion, or 0.8% of the Bank’s total assets. The Bank’s four largest positions in unlisted shares, see

28% table below, represented approximately 91% of the Bank’s total assets in unlisted shares. All the 15% Industry Real Bank’s securities are entered at market value, with the exception of unlisted securities, which are estate entered at purchase value or estimated market value, whichever is lower. 27% Service

Kaupthing Bank´s main assets in unlisted shares 31 December 2004

A feature of the Bank’s activities is to invest in unlisted companies with the aim of selling the holding within a certain time of acquiring it, for example at the same time as a company becomes listed on a stock market. In connection with these investments Kaupthing Bank has been able to provide companies with professional advice and has been involved in financial restructur-

I 48 I I KAUPTHING BANK’S RESULTS I

ing, mergers and acquisitions in order to facilitate stock market listing for companies. Examples of such cooperation in recent years include Össur, Bakkavör Group, Karen Millen and Oasis. Kaupthing Bank thereby plays an active role in developing the companies which engage Kaupthing Bank Investment Banking and it clearly illustrates that the prosperity of the Bank is closely linked with that of its customers.

Other assets increased by 229% during the year, from ISK 22,944 million to ISK 75,513 Cost / Income ratio million. A large part of the increase is because of goodwill from the acquisition of FIH. 70%

60%

Liabilities and equity 50%

Amounts owed to credit institutions totalled ISK 147.5 billion. The Bank’s savings deposits 40% totalled ISK 202 billion at the end of the year, which represents an increase of ISK 19.5 30% billion or 10.7% during the year. Deposits represented 13.2% of the Bank’s total financing on 31 December 2004, compared with 32.7% on 31 December 2003. 20%

10% Liabilities and Equity 0% Q2 Q3 Q4 Q1 Q2 Q3 Q4 ISK billions 884 2003 2004 31 Dec.03 31 Dec.04

CAD ratio 16%

211 14% 148 183 202 149 79 93 58 46 12% 30 11 10% Amounts owed Deposits Borrowings Other Liabilities Subordinated Equity to Credit Inst. Loans 8%

The Bank’s equity totalled ISK 149.4 billion on 31 December 2004, compared with ISK 45.9 6% billion at the end of 2003, which represents an increase of 225% during the year. This 4% increase is largely explained by the issue of share capital to finance the acquisition of FIH, 2% firstly in a pre-emptive rights issue in August, and secondly in a placement of new shares 0% to institutional investors in October. The sales value of the new shares totalled ISK 92.4 2001 2002 2003 2004 billion. The Bank’s equity base was ISK 168.8 billion on 31 December 2004. The CAD ratio was 14.2%, the same as at the end of 2003. Tier 1 capital was 11.5% on 31 December 2004, compared with 12.1% at the end of 2003.

On 31 December 2004 the Bank’s total share capital was 660,685,640 shares, each with a nominal value of ISK 10. The total number of shareholders at the end of 2004 was 31,978. One shareholder owned more than 10% of share capital, and this was Meidur ehf., which owned 17.0%. Kaupthing Bank owned 19.2% in Meidur ehf. on 31 December 2004.

I 49 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

FIVE YEAR SUMMARY

(ISK millions) 2004 2003 2002* 2001* 2000* Profit and Loss Net interest income 18,900 10,124 6,998 5,811 4,089 Other operating income 29,669 21,656 14,414 8,039 5,112

Net operating income 48,569 31,780 21,412 13,850 9,201

Other operating expenses -24,402 -18,493 -12,455 -10,565 -7,030 Provision for losses at year end -3,819 -3,894 -2,794 -1,691 -815 Taxes -4,040 -1,486 -764 321 -343 Minority interest -548 -387 -36 --

Net earnings 15,760 7,520 5,363 1,915 1,013

Balance Sheet Assets Amounts due from credit institutions 113,543 50,546 38,519 17,696 19,553 Loans 1,088,346 350,994 269,333 204,552 126,823 Bonds and other fixed income securities 169,666 80,832 69,298 44,264 28,575 Shares and other variable yield securities 78,686 50,327 32,882 35,343 19,115 Subsidiaries 8,266 2,926 3,528 1,997 2,646 Goodwill 34,208 5,948 3,002 365 0 Fixed assets 6,467 5,441 5,279 4,930 4,300 Other assets 34,838 11,555 10,571 8,416 6,609 Total assets 1,534,020 558,569 432,412 317,563 207,621

Liabilities and equity Amounts owed to credit institutions 147,455 79,267 109,865 88,166 47,731 Deposits 202,038 182,497 164,570 83,473 67,369 Borrowings 884,219 210,645 102,029 109,750 66,828 Other liabilities 74,767 17,279 10,034 5,116 5,495 Deferred income tax liability 9,165 1,646 411 317 1,337 Minority interest 9,306 10,603 1,114 223 58 Subordinate loans 57,627 10,704 11,010 8,364 6,187 Equity 149,443 45,928 33,379 22,154 12,616

Total liabilities and equity 1,534,020 558,569 432,412 317,563 207,620

* Pro forma

I 50 I I FIVE YEAR SUMMARY I

2004 2003 2002* 2001* 2000* Key Ratios Cost/income ratio 50.2% 58.2% 58.2% 76.3% 76.4% Return on equity 22.6% 23.0% 18.7% -- Provisions for losses during the year 0.4% 1.1% 1.0% 0.8% 0.6% Provision for losses 1.4% 2.4% 2.1% 2.0% 1.7% Earnings per share, ISK 31.7 18.5 14.8 6.1 4.2 Earnings per share diluted, ISK 31.2 18.4 14.7 6.1 4.2 P/E ratio 13.9 12.1 8.8 20.5 37.1 Average no. of shares outstanding, million 497.4 406.3 361.8 313.5 239.1 Avg. no. of shares outstanding diluted, million 505 410.6 364 315.1 239.1 No. of shares at end of period, million 652.1 438.4 409.2 356.1 239.1 No. of shares at end of period diluted, million 659.7 442.7 411.4 357.7 239

* Pro forma

Definitions: Cost/income ratio: Other operating expenses as a percentage of net operating income. Return on equity: Net profit as a percentage of average shareholders’ equity. Provisions for losses during the year: Provisions for losses during the year as a percentage of average total assets. Provisions for losses at year-end: Provisions for losses at year-end as a percentage of loans and guarantees at year-end. Earnings per share: Net earnings for the year divided by the average number of shares. Earnings per share diluted: Net earnings for the year divided by the average number of shares, diluted. P/E ratio: Share price divided by earnings per share for the last 12 months.

I 51 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

OPERATING RESULTS OF KAUPTHING BANK’S PROFIT CENTRES

Kaupthing Bank divides its operations into six profit centres, in addition Net operating income distribution by division to ancillary units. The Bank’s profit centres are: Asset Management and 6% Asset Management Private Banking, Capital Markets, Corporate Banking, Investment Banking and Private Banking (previously Corporate Finance), Retail Banking and Treasury. 7% Retail Banking

19% All profit centres returned a profit in 2004. The largest gross profit was posted by Corporate Capital Markets Banking, or ISK 10,574 million. Corporate Banking provides services such as advice and assistance in financing to medium-sized and large companies particularly in Iceland and Denmark. Investment Banking posted a gross profit of ISK 9,273 million. It is responsible for assisting companies with stock offerings and provides advice on mergers and acquisitions and also invests in unlisted companies. Treasury is responsible for inter-bank trading, derivatives and FX trading and the funding of the Bank. Treasury returned a gross profit of ISK 3,098 million during the year. Retail Banking provides financial services to individuals, families and smaller companies. Retail Banking posted a profit of ISK 1,717 million during the year. Asset Management and Private Banking returned a gross profit of ISK 1,239 million during the year. It is responsible for managing and investing assets for individuals and institutional investors and operates a number of mutual

29% and pension funds. Capital Markets returned a gross profit of ISK 6,388 million. Capital Markets is Investment Banking responsible for securities brokerage for institutional investors and proprietary trading. 10% Treasury

33% The gross profit of each profit centre is displayed in the table below. Corporate Banking

Gross profit of Kaupthing Bank´s profit centres in 2004

ISK millions Capital Investment Corporate Asset Mgmt & Retail Markets Banking Treasury Banking Private Banking Banking Total

Net interest income -182 -802 2,040 11,225 -188 6,671 18,764 Net commission income 2,808 2,743 1,353 1,531 2,954 1,352 12,741 Trading gains 6,245 8,449 651 72 0 4 15,421 Other income 0 33 0 0 0 61 94 Net operating income 8,871 10,423 4,044 12,828 2,766 8,088 47,020 Expenses 2,483 1,150 922 961 1,527 3,869 10,912 Provision for losses 0 0 24 1,293 0 2,502 3,819 Total expenses 2,483 1,150 946 2,254 1,527 6,371 14,731 Gross profit 6,388 9,273 3,098 10,574 1,239 1,717 32,289

I 54 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

ASSET MANAGEMENT AND PRIVATE BANKING

• Excellent year for Asset Management and Private Banking • 25.4% increase in assets under management in 2004 • 86% increase in gross profit between years

Assets under management Asset Management and Private Banking posted a gross profit of ISK 1,240 million in 2004, compared with ISK 665 million the previous year, which represents a rise of 86%. The increase 31% Non Icelandic was due to higher commission income, which was in particular driven by growth in assets under Insitiutional management, strong results in performance-based commission and the successful launch of 33% Icelandic new products. Furthermore, operations are increasingly benefiting from economies of scale, and Institutional favourable conditions on the financial markets in 2004 also contributed to the results.

Asset Management and Private Banking

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income -188 47 25 -88 -39 -86 Net commission income 2,955 2,029 775 665 689 826 Trading gains 0 0 0 0 0 0 Other income 0 6 0 0 0 0 22% Net operating income 2,767 2,082 800 577 650 740 Icelandic other Expenses 1,527 1,417 422 395 340 370 clients

Provision for losses 0 0 0 0 0 0 14% Total expenses 1,527 1,417 422 395 340 370 Non Icelandic clients Gross profit 1,240 665 378 182 310 370

Assets under management Kaupthing Bank Asset Management and Private Banking manages financial assets for institutional, corporate and private clients. Asset Management is organised into three units: Alternative and Mutual Fund Management, Asset Management for Institutional Investors and Services for Institutional Investors. Private Banking consist of two units: Customer Relations and Portfolio Management.

Assets under management In 2004 there was growth on all markets in which Kaupthing Bank operates its Asset Management and Private Banking services. There was a large increase in assets under management and in custody during the year, and the number of clients rose sharply. 55% Icelandic

45% There was a considerable inflow of capital from institutional investors, customers in private bank- Non Icelandic ing and private pension savings. Assets under management increased from ISK 405 billion in 2003 to ISK 508 billion at the end of 2004. Assets in custody amounted to ISK 910 billion, providing a total of ISK 1,418 billion under management and in custody, compared with ISK 1,012 billion

I 55 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Assets under management

600 ISK billions

500

400

300

200

100

0 1998 1999 2000 2001 2002 2003 2004

the previous year. Asset Management and Private Banking services are offered in seven different countries within the Kaupthing Group: the Faroe Islands, Finland, Luxembourg, Norway, Sweden, Switzerland and Iceland. The Bank’s asset management operation in Asset Management - Gross profit Denmark was sold during the fourth quarter of 2004 following the acquisition of the Danish 400 ISK millions corporate bank FIH Erhvervsbank. 350

300 Asset Management 250 The Asset Management division offers a comprehensive range of Icelandic, Swedish and 200 international mutual funds, as well as alternative investment vehicles. Furthermore, the 150 Asset Management division offers customized asset allocation strategies and managed

100 accounts, designed to meet the diverse needs of corporate, institutional and private cli-

50 ents. Special emphasis is placed on asset and liability management of pension funds and professional services in identifying client needs, structuring portfolios accordingly, manag- 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 ing risk and monitoring processes. 2003 2004

The Asset Management division employs its market experience and proprietary tools in asset allocation, security selection, portfolio risk management and related services. In an international, competitive environment, Kaupthing Bank has placed its focus on compe- tent staff, efficient IT processes and highly effective teamwork between Kaupthing Bank’s international asset managers, researchers and analysts. This emphasis is aimed at obtain- ing the best possible results for clients and ensuring that they are offered comparable services and return on investments.

The Bank expanded its range of pension products during the year. The Bank operates private pension divisions for several pension funds and participates in the Swedish private pension fund system.

I 56 I I ASSET MANAGEMENT AND PRIVATE BANKING I

Kaupthing Bank has signed numerous mandates with a wide range of institutional clients, located mainly in Finland, Sweden and Iceland. This includes mandates for local bonds, equities and balanced mandates, but also a wide range of global and specialised mandates.

At the end of 2004 assets under management by Asset Management at Kaupthing Bank Group amounted to ISK 406 billion.

Private Banking Kaupthing Bank’s Private Banking division provides its individual clients with a range of investments and portfolios to match their requirements. Account managers focus on customer relations with the aim of maintaining high quality service and financial advice to clients. Account managers also play a role in managing their clients’ assets through cooperation with the Asset Management team. Each client has his or her own dedicated account manager who is selected to match the individual client’s needs and service expectations. The services range from the custody of shares or deposits to complex and tailor-made investments, as well as tax and legal set-ups for high net worth individuals. Kaupthing Bank offers private banking services from its offices in Iceland, Sweden, Luxembourg, Switzerland, the Faroe Islands and Finland. The offices co-operate closely in the development of new products and services to match the demanding and changing requirements of the clientele. At the end of 2004 assets under management by Private Banking at Kaupthing Bank Group amounted to ISK 102 billion.

I 57 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

CAPITAL MARKETS

• Record profits in Capital Markets • Strong position in the stock exchanges in Iceland, Sweden and Finland • Record turnover Market capitalization in equities on the Nordic stock exchanges at the end of 2004 Capital Markets posted a gross profit of ISK 6,390 million in 2004, compared with ISK 5,529 mil- 16% Copenhagen lion in 2003, representing an increase of 16%. Capital Markets’ improved results are largely due to 16% a higher turnover which resulted in a substantial increase in commission, as well as record trading Oslo 2% Iceland gains in Proprietary Trading. Capital Markets reported trading gains of ISK 6,245 million in 2004, compared with ISK 6,093 million in 2003.

Capital Markets

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income -182 -760 -44 -229 119 -28 Net commission income 2,809 2,061 1,159 481 418 751 Trading gains 6,245 6,093 300 3,791 630 1,524 Other income 0 215 0 0 0 0

23% Net operating income 8,872 7,609 1,415 4,043 1,167 2,247 Helsinki Expenses 2,482 2,080 769 567 547 599 43% Stockholm Provision for losses 0 0 0 0 0 0 Total expenses 2,482 2,080 769 567 547 599 Gross profit 6,390 5,529 646 3,476 620 1,648 Turnover in equities on the Nordic stock exchanges in 2004

11% In Capital Markets activities are broadly divided into two parts: Institutional Sales and Proprietary Copenhagen Trading. Institutional Sales executes orders for institutional clients as well as placing equity and 14% Oslo bond offerings. Proprietary Trading trades for the Bank’s own account in bonds and equities on 1% Reykjavik the international securities markets, and is also an active market maker. The Bank’s Research department, an independent operating unit, cooperates closely with Capital Markets. The Bank offers its clients first-class service in securities trading on international securities markets, with local know-how and expertise maximised with Group strengths.

Kaupthing Bank is a true Nordic bank with membership agreements with all the Nordic exchanges in 2004. These exchanges are all parties to the NOREX alliance and use the same trading system and harmonised rules. The Bank also has membership of the Tallinn Stock Exchange through its Helsinki office and is a member of the National Association of Securities Dealers (NASD) in the

24% USA, enabling the Bank to trade directly on the Nasdaq. Kaupthing Bank is also a listing agent Helsinki authorised by the Luxembourg Stock Exchange to list securities, such as bonds, shares and other 50% Stockholm instruments.

The Bank has a substantial market share in the Nordic area with 4.3% of the equities turnover on the Nordic stock exchanges in 2004. In Stockholm and Helsinki, the two largest Nordic markets, the Bank’s market share was respectively around 4% and slightly less than 7% respectively. On the Iceland Stock

I 58 I I CAPITAL MARKETS I

Market share in equities trading of individual stock market members on Nordic stock exchanges in 2004 Kaupthing Bank had the seventh highest equities turnover.

7% Reykjavik Helsinki Stockholm Copenhagen Oslo

0% Enskilda Carnegie Fischer SHB Morgan Nordea Kaupthing Alfred Deutsche Danske Partners Stanley Bank Berg Bank Bank

Exchange the Bank maintained its strong position with a market share of approximately 33% in equities trading and around 29% in bonds. Capital Markets - Gross profit 3500 ISK millions Proprietary trading and market making 3000

The Bank engages in proprietary trading and market making in many instruments and 2500 markets. This involves managing positions for the Bank’s own account. Some positions are 2000 strategic, medium-term whilst other are short-term positions aimed at taking advantage of price discrepancies or spreads in different markets, within a clearly defined risk framework 1500 based on various factors such as liquidity, legal framework and the Bank’s risk policy. The 1000 proprietary trading units within the group have complimentary focus on different instru- 500 ments and markets. The different units also vary in terms of strategy and timeframe. 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Market making involves the Bank committing itself to buying and selling certain classes 2003 2004 of securities in accordance with pre-determined rules. Kaupthing Bank’s market making includes trading with numerous companies and institutions, especially in Iceland.

Research The Bank’s Research department, an independent operating unit, cooperates closely with Capital Markets. It provides equity and fixed income research as well as macroeconomic research. The equity research analysts are locally based and provide in-depth research, including sector and company reports, overall recommendations and strategic guidance. In 2004 Research focused on strengthening its resources by adding several new highly experienced specialists to the team. At the end of 2004, Research employed 40 people.

I 59 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

TREASURY

• Record profits in Treasury • Three large public bond transactions closed in 2004, a total of €1.5 billion • Strong position in derivatives and foreign exchange trading

Treasury posted a gross profit of ISK 3,101 million before overhead costs in 2004, compared with ISK 2,653 million in 2003, representing an increase of 17%. Treasury’s strong results are explained by the Bank’s robust position in derivatives and foreign exchange trading and own position taking in foreign exchange. Total expenses remained virtually unchanged between years, rising slightly from ISK 939 million to ISK 945 million.

Treasury

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income 2,040 2,018 984 427 207 422 Net commission income 1,354 597 340 218 219 577 Trading gains 652 900 114 175 199 164 Other income 0 77 0 0 0 0 Net operating income 4,046 3,592 1,438 820 625 1,163 Expenses 921 821 245 270 194 212 Provision for losses 24 118 5 0 19 0 Total expenses 945 939 250 270 213 212 Gross profit 3,101 2,653 1,188 550 412 951

Kaupthing Bank Treasury is divided into inter-bank trading desk, funding desk, derivatives desk, and FX and derivatives sales. Treasury functions are mainly administrated from Reykjavík but it also has operations in Luxembourg, Denmark, Sweden and Finland.

Inter-bank trading The inter-bank trading desk manages the Bank’s currency exposure and liquidity, including all the Bank’s trading with other banks on the Icelandic and international money and currency markets. Kaupthing Bank is one of three banks in Iceland to act as a market maker on the Icelandic currency and money markets and is a leading player on these markets.

FX and derivatives sales Foreign exchange and derivatives sales offers companies and institutional investors foreign exchange and a range of interest rate and currency derivatives for position taking and risk management. Our greatest strength is being innovative in customizing these services to the client’s needs. We help them manage their risks and offer a comprehensive array of derivative products. Kaupthing Bank Treasury also provides monitoring and advisory services on currrency and interest rate risk management, for its customers.

I 60 I I TREASURY I

Treasury - Gross profit Derivatives 1200 ISK millions The derivatives desk is responsible for trading all derivatives. A large and growing part of 1000 our business is in the area of structured products, where we offer customized solutions to a wide variety of investors. Kaupthing Bank is a leading market maker for equity-, interest 800 rate- and foreign exchange derivatives related to the Icelandic króna. 600

Funding 400

Treasury is responsible for the overall funding of Kaupthing Bank and internally between 200 business units, divisions and subsidiaries. Funding is based on deposits and borrowings in 0 the Icelandic and international market, which includes the issuance of commercial paper, Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 bonds and syndicated loans. Funding operations have increased steadily in line with the 2003 2004 Bank’s growth and international expansion, and with the acquisition of the Danish corpo- Funding structure rate bank, FIH Erhvervsbank, market funding of the group doubled in size. To support this sudden increase of borrowing in the international market by the Group it was decided that 4% Subordinated FIH Erhvervsbank would continue to issue notes under its own operating EMTN program in 7% 1% 10% Icelandic Repo Money close co-ordination with headquarters. Bond & Market Note Market 4% ECP The growing financial strength of the Bank and improved credit rating from Moody’s Investors Service have reinforced the Bank’s position on the international finance markets and resulted in improved access to international financing and lower cost of capital. By decreasing its total cost of capital, the Bank can offer its customers even better terms, thus strengthening its competitive position.

In May 2004, Kaupthing Bank completed a €600 million bond issue within the EMTN program, which is the largest bond issue an Icelandic company has ever issued and was voted deal of the year out of Iceland in 2004 by the Banker magazine. Among Kaupthing Bank’s 3% most recent issue is a two tranche subordinated issue, the largest of its kind issued by an 55% International EMTN Loan Market

Icelandic company in the international market. The Tier 1 and Tier 2 tranches amounted to 16% €150 million and €300 million respectively. Deposits

Favourable trend in EMTN spread Kaupthing Bank has placed great importance on increasing the diversification of its market 35 funding. An increasing proportion of funding is from southern Europe and the UK, whereas Basis points 2 yrs funding has traditionally been chiefly from Germany and the Benelux countries. Kaupthing 30 3 yrs 5 yrs

Bank has also made efforts to diversify the Bank’s sources of funding with the issuance 25 of fixed rate and structured notes. Flexibility in issuance of notes provides access to new investors and increases the variety of the Bank’s overall funding. 20

0 Jul 03 Oct 03 Jan 04 Apr 04 Jul 04 Oct 04

I 61 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

INVESTMENT BANKING

• Record profits in Investment Banking • Rapid growth in M&A assignments, particularly in Iceland and the United Kingdom • Major development of Investment Banking activities during year

Investment Banking made a gross profit of ISK 9,273 million before overhead costs in 2004, compared with ISK 4,495 million in 2003, representing an increase of 106%. Investment Banking’s excellent results are attributable to the 167% year-on-year increase in trading gains. Net commission income was ISK 2,742 million, of which more than half was generated in the last quarter of the year, during which Investment Banking completed several major M&A projects.

Investment Banking

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income -801 -684 -274 -272 -122 -133 Net commission income 2,742 2,854 1,511 372 493 366 Trading gains 8,449 3,168 1,071 2,690 3,776 912 Other income 33 97 17 0 12 4 Net operating income 10,423 5,435 2,325 2,790 4,159 1,149 Expenses 1,150 940 395 281 230 244 Provision for losses 0 0 0 0 0 0 Total expenses 1,150 940 395 281 230 244 Gross profit 9,273 4,495 1,930 2,509 3,929 905

Investment Banking (previously Corporate Finance) operates in most of the Bank’s international offices and is centrally managed from the Bank's London office. Investment Banking provides various services to corporate clients through its four main product areas: M&A advisory, capital market transactions, acquisition and leverage finance and principal investments. One of the fundamental drivers of the division's success has been combining advisory with the Bank's financing capabilities, creating a integrated solution for clients. This has been done in close co-operation with other divisions of the Bank, in particular Capital Markets and Corporate Banking. Investment Banking has been a leading player in Iceland in recent years both in terms of the number and size of managed offerings, arrangements of financing and advisory roles. With the Bank placing greater focus on international projects, an increasing proportion of Investment Banking transactions originates from outside Iceland, particularly from the Nordic countries and the UK.

M&A advisory The year 2004 turned out to be another record year in transaction volume. The total volume of M&A advisory provided by Investment Banking during 2004, including advisory for Kaupthing Bank itself, amounted to approximately ISK 225 billion. Cross-border acquisitions by Icelandic companies have been on the increase in recent years and reached record levels during 2004.

I 62 I I INVESTMENT BANKING I

Acquisitions during the year amounted to approximately ISK 190 billion, which is four times the total for 2003. Kaupthing Bank advised on the majority of these deals.

The key M&A deals for the Bank included the €330 million acquisition of the French food producer Labeyrie Group by SÍF and the Bank´s own €1,300 million acquisition of FIH Erhvervsbank in Denmark. In the UK Investment Banking advised the Finnish refrigeration company Huurre Group on its acquisition of WR Refrigeration, Bakkavör Group on its acquisition of 20% stake in food producer Geest, an investor group in acquiring a strategic stake in shoe retailer Studio Group and facilitated the acquisition of fashion retailer Karen Investment Banking - Gross profit 4000 Millen by Oasis. Other deals included advising Medcare Flaga on its acquisition of the US ISK millions sleep diagnostics company Sleep Tech, Investor Growth Capital and Priveq Partners on 3500 their acquisition of Swedish Orphan International and the Faroese investment fund Notio 3000 on its acquisition of Tórshavnar Skipasmidja. 2500

2000

Capital markets transactions 1500

Kaupthing Bank managed a number of capital markets transactions during 2004, primarily 1000 in Iceland and Sweden. Investment Banking was involved in a number of equity offerings 500 for clients in co-operation with Capital Markets as volumes in Iceland skyrocketed after a 0 period of very little activity in recent years. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004

Measured by market value, Kaupthing Bank arranged approximately 70% of share issues of listed companies on ICEX and approximately 80% of share offerings raising new capital. A total of ISK 117.5 billion was raised in equity offerings arranged by Kaupthing Bank in Iceland. Investment Banking managed offerings for SÍF to fund the acquisition of Labeyrie Group, Medcare Flaga to fund the acquisition of Sleep Tech, Icelandair to fund their growth strategy and the division also managed Kaupthing Bank’s rights issue and non pre-emptive rights issue to fund the acquisition of FIH Erhversbank and to strenghten the capital base of the Bank. In Sweden Kaupthing Bank arranged an IPO for Tethys Oil and nine other share issues in 2004, with a total of ISK 4 billion in market value.

Acquisition and leverage finance Investment Banking, in co-operation with Corporate Banking, successfully grew the Bank’s acquisition and leverage finance business, particularly in the UK. Acquisition and leverage finance is positioned within the Bank as an Investment Banking product, supported by the Corporate Banking infrastructure. Fees and interest income are booked under Corporate Banking.

Transactions in 2004 originated by Investment Banking included the €282 million senior financing for the SÍF/Labeyrie Group deal that was co-underwritten by Kaupthing Bank and Halifax Bank of Scotland, the £50 million senior and subordinated financing for R20´s

I 63 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

acquisition of Laurel Pub Company solely underwritten by the Bank, the £43 million subordinated facility for Huurre Group to fund their acquisition of WR refrigeration and £80 million senior and subordinated facilities for Oasis´s acquisition of Karen Millen.

Principal investments A feature of Investment Banking’s activities has been to invest in unlisted and listed companies with the aim of selling the holdings within a certain time period from the acquisition. The investments are with few exceptions related to advisory work in connection with management buy-outs, mergers, restructurings and acquisitions where clients have shown interest in having the Bank co-invest with them. Kaupthing Bank’s aim is to take minority stakes in companies it invests in. The capital invested can range from ordinary equity to more hybrid investments e.g. convertible bonds or capital loans. Examples of investments in recent years include Össur, Bakkavör Group, Karen Millen, Studio Group, Laurel pub Company, Oasis Group, Huurre Group, Baugur Group and SÍF. Kaupthing Bank thereby plays an active role in developing the companies which Investment Banking works for, and it clearly illustrates that the prosperity of the Bank is closely linked with that of its customers.

In 2004 Kaupthing Bank acquired holdings in companies such as the food producer SÍF, the shoe retailer Studio Group and Laurel Pub Company, besides increasing its holding in the fashion retailer Mosaic Fashion (Oasis Group). The Bank successfully sold its holdings in the oil distributor Skeljungur, the fashion retailer Karen Millen, the Coca Cola bottler Vífilfell and approximately half of its holding in the investment company Baugur Group.

The table below shows Kaupthing Bank’s unlisted holdings exceeding ISK 1,000 million. At the end of 2004 Kaupthing Bank’s total holdings in unlisted companies amounted to ISK 13.0 billion, or 0.8% of the Bank’s total assets.

Kaupthing Bank’s main assets in unlisted shares 31 December 2004

Company Sector Share Vátryggingafélag Íslands hf. Insurance company 30% Meidur ehf. Investment company 19% Mosaic Fashions Ltd. Fashion retailer 11% Baugur Group hf. Investment company 9%

Vátryggingafélag Íslands is an Icelandic insurance company that was delisted from the ICEX Alternative Market in December 2004. Meidur is an investment company in which Bakkabrædur Holding S.à r.l. has a 59.1% holding. Kaupthing Bank has a 19.2% share in Meidur, whilst SPRON, Sparisjódurinn í Keflavík, Sparisjódabanki Íslands hf., Sparisjódur Mýrarsýslu, Sparisjódur Húnathings og Stranda, Sparisjódur Siglufjardar, Sparisjódur Svarfdæla and Sparisjódur Vestfirdinga have a combined holding of 21.7%. Mosaic Fashions is a British company that owns the fashion retailers Oasis, Coast, Karen Millen and Whistles. Baugur Group is a substantial minority shareholder in Mosaic Fashions. Baugur Group is an investment company which owns and invests in companies in Iceland and northern Europe with the aim of maximising their profitability. The focus has chiefly been in the UK in recent years, particularly the retail sector.

I 64 I I INVESTMENT BANKING I

EXAMPLES OF TRANSACTIONS COMPLETED BY INVESTMENT BANKING

Acquisition of IPO Rights issue SEK 75,000,000 SEK 61,000,000 Amount undisclosed March 2004 March 2004 March 2004

Acquired Acquired Acquisition of a strategic stake Amount undisclosed £120,000,000 Amount undisclosed April 2004 June 2004 June 2004

Acquisition of Acquisition of Senior and subordinated debt facilities

€1,300,000,000 €330,000,000 £50,000,000 September 2004 December 2004 December 2004

Acquisition of Acquisition of Private Placement

Amount undisclosed US$25,000,000 €44,000,000 April 2004 July 2004 December 2004

I 65 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

CORPORATE BANKING

• Record profits in Corporate Banking • The acquisition of FIH Erhvervsbank had profound effects on this division • Significant decrease in provision for losses between years Loans to customers

6% Holding Corporate Banking posted a gross profit of ISK 10,573 million, compared with ISK 1,639 million Companies 1% the previous year, representing an increase of 645%. This huge rise is largely attributable to the Transportation 13% financial results of FIH Erhvervsbank, which were included in Corporate Banking’s results from Individuals 28% Industry 1 July 2004 onwards. Net commission income increased substantially from the previous year, 9% Trade and predominantly derived from the Bank’s Investment Banking activities in the United Kingdom. Provisions for loan losses decreased from ISK 2,414 million to ISK 1,293 million. Loan losses were in general lower than in the previous year, most significantly in the case of FIH Erhvervsbank, where provisions for losses were negative for 2004.

Corporate Banking

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income 11,225 4,055 4,065 3,993 1,409 1,758 Net commission income 1,531 307 996 135 317 83 Trading gains 72 63 72 0 0 0 15% Real Estate 27% Other income 0 72 0 0 0 0 Service Net operating income 12,828 4,497 5,133 4,128 1,726 1,841 Expenses 962 444 356 291 161 154 Provision for losses 1,293 2,414 496 -39 306 530 Total expenses 2,255 2,858 852 252 467 684 Gross profit 10,573 1,639 4,281 3,876 1,259 1,157

Corporate Banking offers companies a range of services including advice and assistance in connection with financing. Companies are provided with short-term or long-term loans, as well as revolving credit facilities and the emphasis is on tailoring the loans to suit the customers’ needs. The majority of the division’s assets are vested within FIH Erhvervsbank in Denmark and the parent company in Iceland, but the aim is to develop and grow the Bank’s Corporate Banking activities in other countries.

In September 2004 Kaupthing Bank completed the acquisition of FI-Holding A/S, which holds all shares in the Danish corporate bank FIH Erhvervsbank. The company was sold by FöreningsSparebanken of Sweden. FIH Erhvervsbank has total assets of DKK 65,909,797, of which DKK 54,148,899 are loans to corporates. The loan portfolio of Corporate Banking has more than trebled in size since the acquisition, which is accounted for in Kaupthing Bank’s profit and loss account from 1 July 2004. The acquisition of FIH Erhvervsbank has greatly benefited the Corporate Banking operation and has opened up numerous stimulating opportunities.

Aside from FIH Erhvervsbank, Corporate Banking has significantly increased the number of financing projects outside Iceland, and the Bank intends to step up these activities further.

I 66 I I CORPORATE BANKING I

The Bank is involved in a number of large financing projects, often in collaboration with other financial institutions. Projects completed by Corporate Banking in 2004 included the refinancing of Nordural Aluminium, €60 million refinancing and financing of the enlarge- ment and alteration of Leifur Eiríksson Air Terminal in Keflavík, €20 million financing of Corporate Banking - Gross profit a factory ship for Iceland’s largest fishing company, HB Grandi, as well as financing the 4500 ISK millions acquisition of Pickenpack Hussmann & Hahn GmbH, the refinancing of ÍAV, Iceland’s largest 4000 contractor, refinancing and financing of new facilities for the Blue Lagoon and the refinanc- 3500 ing of Iceland Seafood International. The Bank also participated in various syndicated loans, 3000 mainly in the UK leveraged market. 2500

2000

Corporate Banking also played a role in the financing of merger and acquisition projects 1500 arranged by Investment Banking, including the acquisition of Karen Millen by Oasis and 1000

R20’s acquisition of Laurel Pub Company. Further involvement included the acquisition 500 facility for Huurre Group in its acquisition of WR Refrigeration in March 2004, and an acqui- 0 sition facility for SIF in its acquisition of Labeyrie in December 2004. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004

The client group of Corporate Banking is highly varied and represents virtually all sectors of the market. The Bank seeks to provide the best possible solutions for each company Corporate Banking - Provisions which calls for close co-operation between Corporate Banking and the clients. Corporate for loan losses 1,000 Banking has also provided investment financing activities. These activities entail lending ISK millions to investment funds and holding companies with liquid investments (such as listed equi- 800 ties and bonds) as collateral. Loans are made on the basis of certain specified collateral coverage criteria, and for each loan collateral coverage is monitored against the market 600 value of the collateral. 400

Corporate Banking has similar operations in the Bank’s subsidiaries in Luxembourg and 200 Sweden and is, after having obtained a banking license at the beginning of 2005, developing its activities in Finland. Corporate Banking is also actively involved in acquisition financing 0 and the financing of other projects undertaken by the Bank’s London subsidiary. -100 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004

I 67 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

RETAIL BANKING

• 22% increase in net interest income in 2004 • Robust market position in Iceland where division’s activities almost exclusively take place • Major breakthrough achieved in Iceland with new mortgage loans competing directly with state-owned Housing Financing Fund

Retail Banking made a gross profit of ISK 1,713 million in 2004, compared with ISK 2,246 million the previous year, which represents a decrease of 24%. The reduction in gross profit is due to an increase in provision for losses which amounted to ISK 2,502 million in 2004, compared with ISK 1,362 million in 2003. Net interest income increased to ISK 6,670 million from ISK 5,448 million despite lower margins. This is attributable to the increased volume in lending, especially in mortgage financing.

Retail Banking

ISK millions 2004 2003 Q4 2004 Q3 2004 Q2 2004 Q1 2004

Net interest income 6,670 5,448 1,931 1,612 1,579 1,548 Net commission income 1,351 1,516 370 300 352 329 Trading gains 4 55 -6 4 5 1 Other income 60 63 27 5 16 12 Net operating income 8,085 7,082 2,322 1,921 1,952 1,890 Expenses 3,870 3,474 1,035 888 1,072 875 Provision for losses 2,502 1,362 474 621 787 620 Total expenses 6,372 4,836 1,509 1,509 1,859 1,495 Gross profit 1,713 2,246 813 412 93 395

Provisions for loan losses increased from ISK 1,362 million to ISK 2,502 million, representing an 84% increase. This reflects the higher volume of loans to customers. During 2003 and 2004 significant efforts were made to improve the quality of the loan portfolio. Stricter rules and working procedures while issuing credit were introduced and certain loans that were considered doubtful were called in. This resulted in a higher provision for loan losses in 2004 which peaked in the second quarter.

Kaupthing Bank has retail banking operations in two countries, Iceland and Sweden, with the majority of activity taking place in Iceland. The division is responsible for traditional retail banking activities, with a focus on individual customers and smaller businesses. Larger businesses, such as medium-sized and large companies, are customers of Corporate Banking. Retail Banking offers comprehensive banking services such as loans, deposits, credit card issuing and clearing. On 31 December 2004, Kaupthing Bank operated 35 branches and service points in Iceland, including 14 branches in the Reykjavík area.

I 68 I I RETAIL BANKING I

Diversified loan portfolio The Bank’s loan portfolio is diverse in Iceland, the Bank’s key retail banking market. Total loans to customers on 31 December 2004 amounted to ISK 1,088 billion and increased by ISK 737.4 billion during the year. The increase is largely due to the acquisition of the Danish corporate bank FIH Erhvervsbank which was completed in September 2004. Loans to customers represented 64.6% of the Bank’s total assets on 31 December 2004, and the inter- Reatail Banking - Gross profit est differential decreased from 2.0% in 2003 to 1.8% in 2004. Loans to companies in indus- 900 ISK millions try comprise the largest proportion of the Bank’s loans to customers, totalling 28.1%. Loans 800 to individual customers represented 25.2%. The number of customers in the Bank totalled 700 more than 80,000 at the end of 2004 and deposits increased by 10.7% during 2004. 600

500

Mortgage lending – major change in 2004 400 The majority of housing in Iceland has traditionally been financed through the state spon- 300 sored Housing Financing Fund (HFF) which finances its mortgage lending through the 200 issuance of securities, known as Housing Financing Fund bonds. The HFF bonds form the 100 benchmark curve in the largely inflation-indexed bond market in Iceland. Kaupthing Bank 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 has traditionally been the largest underwriter and trader of HFF bonds, but had partici- 2003 2004 pated little in the financing of private homes. Competition in the retail banking sector has increased sharply in recent years in Iceland and that trend was underlined in 2004 when Kaupthing Bank became the first Icelandic bank to substantially lower interest rates on its mortgage loans from 5.30% to 4.40%, undercutting the rates offered by the HFF. The Retail Banking - Provisions for maximum amount of individual mortgage loans was also increased. The competing banks loan losses 900 subsequently followed by matching Kaupthing Bank’s rates and products. Following this new ISK millions offering, pricing in the Icelandic real estate market, has increased substantially, and consid- 800 erable surplus demand currently characterises the market as consumers are able to obtain 700 higher mortgages at lower rates than before and therefore more expensive properties. 600

500

Changing role 400 The Bank’s retail banking activities have undergone considerable changes, transforming 300 from being a traditional lending institution into a modern bank which provides compre- 200 hensive financial solutions for its customers. Kaupthing Bank places great importance on 100 continuous product development and innovation. Services at the Bank’s branches have 0 been revolutionised during the last ten years, with the latest new product offering, mort- Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 2003 2004 gages, transforming the role of branches. The role played by financial advisers has grown significantly, whilst traditional clearing is less important nowadays as automation and self service on the Internet are replacing traditional teller services to some degree. The Bank also has increased its range of services by selling and advising on personal insurance and pension products. The objective of Retail Banking is to advise its customers on comprehensive financial services which are tailored to the customers’ exact requirements.

I 69 I I RETAIL BANKING I

Insurance Retail Banking cooperates closely with Kaupthing Bank’s subsidiary, Althjóda líftryggingarfélagid hf. (Alíf), in offering a range of personal insurance products in Iceland. Alíf’s life insurance and health insurance products are far more comprehensive than anything previously available on the Icelandic market and has the largest market share in Iceland in comparable products. Alíf only operates in personal insurance. To meet increasing competition Kaupthing Bank is in cooperation with a leading non-life insurance company, Vátryggingafélag Íslands (e. The Icelandic Insurance Company), and now offers a collaborative service named Vöxtur (e. Growth), whereby mutual customers receive better terms by purchasing certain products from both companies.

Net Bank Kaupthing Net Bank is one of the leading on-line banks in Iceland and has been operating since 1997. The Net Bank provides a detailed overview of a customer’s personal finances and allows users to perform a range of tasks, such as paying most types of bills. The number of customers using the Net Bank is steadily increasing, and at the end of 2004 more than 33,000 customers were active users of the Net Bank.

I 70 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

QUARTERLY OVERVIEW OF KAUPTHING BANK

ISK millions Q4 2004 Q3 2004 Q2 2004 Q1 2004 Q4 2003 Q3 2003 Q2 2003 Q1 2003

Net Interest Income 6,711 5,523 3,165 3,501 3,018 2,505 2,203 2,398

Other operating revenue: Income from shares and other holdings 578 194 2,520 924 96 189 554 262 Commission, income and expenses 5,212 2,289 2,584 3,212 3,086 2,338 2,250 2,009 Trading gains 955 6,327 2,146 1,862 3,097 3,038 1,879 2,030 Other operating revenues 699 8 87 72 184 39 518 87 7,444 8,818 7,337 6,070 6,463 5,604 5,201 4,388

Net Operating Income 14,155 14,341 10,502 9,571 9,481 8,109 7,404 6,786

Other operating expenses: Salaries and salary related expenses -4,064 -3,120 -2,846 -2,622 -2,795 -2,367 -2,612 -2,336 Other operating expenses -3,018 -2,133 -1,910 -2,047 -1,890 -1,637 -1,789 1,712 Depreciation -856 -919 -465 -402 -395 -332 -290 338 -7,938 -6,172 -5,221 -5,071 -5,080 -4,336 -4,691 -4,386

Provision for losses -975 -582 -1,112 -1,150 -1,172 -1,344 -751 -627

Pre-tax profit 5,242 7,587 4,169 3,350 3,229 2,429 1,962 1,773 Income tax -1,013 -1,965 -504 -558 -401 -415 -273 -397

Profit before minority interest 4,229 5,622 3,665 2,792 2,828 2,014 1,689 1,376 Minority interest -174 -75 -157 -142 -387 -- -

Net profit 4,055 5,547 3,508 2,650 2,441 2,014 1,689 1,376

I 71 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

EMPLOYEES

Kaupthing Bank believes that one of its principal strengths is the quality and dedication of its employees and their shared sense of Full time equivalent positions at year-end being part of a team. Kaupthing Bank strives to maintain a work

1,800 environment that fosters high ethical standards, mutual respect,

1,600 honesty, professionalism, creativity and teamwork.

1,200

1,000 Number of employees

800 The number of employees at Kaupthing Bank and its subsidiaries totalled 1,606 at the end

600 of 2004, increasing by 26.4% during the year from 1,271 on 1 January 2004. The average age of employees at the Bank is 39.7 and 55.3% of employees are women. 400

200 At the end of 2004 62% of the Bank’s employees were located in Iceland. The number 0 2000 2001 2002 2003 2004 of employees by country was as follows at the end of 2005: Iceland 993, Sweden 227, Luxembourg 76, Finland 71, Denmark 164, United Kingdom 19, USA 7, Faroe Islands 9, * 2000-2002 proforma Kaupthing Bank Switzerland 3 and Norway 37. and Búnadarbanki

Corporate culture Number of employees - by division The management of Kaupthing Bank firmly believes that ensuring employee satisfaction

103 results in better customer service. The Bank’s management therefore strives to develop a Asset Management & Private Banking united and progressive team of employees. The year 2004 was a year of rapid change and

48 increased competition. In order to adapt to this constantly shifting environment, the man- Investment Banking agement believes it is important that employees are given the opportunity to show initia- 128 Corporate tive and be flexible in their work. As the Bank operates in an international environment it is 131 Banking Capital Markets only natural that the Bank sets its sights on the highest standards of service, productivity and other critical factors in the Bank’s operations.

Human resources One of Kaupthing Bank’s most important conditions for its continued growth is its ability to retain key employees and attract new staff. Kaupthing Bank makes attracting, hiring, educating and retaining personnel a high priority. Kaupthing Bank’s recruitment strategy is based on attracting highly qualified candidates through employee networks, selective head-hunting, advertisements and a high profile presence at universities. 640 Ancillary units & management 41 Headquarters Treasury At the beginning of 2004 the Bank moved into new headquarters at Borgartún 19 in 514 Retail Banking Reykjavík. These headquarters house the Bank’s management and core activities. At the same time several departments, such as IT, Middle Office and Back Office, moved into the former headquarters of Kaupthing Bank at Ármúli 13, Reykjavík. In 2004 it was decided to expand the Bank’s headquarters. The Bank has bought a building adjacent to the head

I 74 I I EMPLOYEES I

offices, and this will be fully converted and connected as an annex to the main building. This will provide an additional 6,000 m2 of floor space at the headquarters. The renovations are expected Number of employees - by to be completed in early 2006. country

19 Profit sharing United Kingdom

7 In order to motivate and reward its employees, Kaupthing Bank has a system of paying bonuses. USA 71 Finland Bonuses are paid with regard to Kaupthing Bank’s operating profit and upon reaching certain tar- 9 gets on return on equity. Furthermore, Kaupthing Bank pays its employees performance related Faroe Islands 164 3 bonuses as a percentage of growth of assets under management. The CEO and managing direc- Denmark Switzerland 37 tors of each division determine these bonus payments. Bonus payments for the CEOs are propor- Norway tionate to the profits of Kaupthing Bank. In 2004, bonus payments for Kaupthing Bank totalled ISK 2,290 million as shown in the consolidated financial statements.

Conditions for employee stock options A large number of Kaupthing Bank employees are also shareholders in the Bank, and the Bank believes that employees’ equity interest in the Bank fosters commitment and personal interest in the success of the Bank as a whole. Kaupthing Bank employees currently own approximately 5% of the Bank. Prior to the merger of Kaupthing Bank and Búnadarbanki, both banks had entered into stock option agreements with their respective employees. The first agreements were made 227 993 Sweden Iceland in 2000, and the number of options varied between employees, as is usual for employee stock 76 option plans. Most option agreements were set up so that employees were allocated a fixed num- Luxembourg ber of options when the agreements were entered into, and parts of the allocated options are vested in October or December each year for four or five years after the agreements were entered into. All options which remain unexercised at the end of the period of the respective agreement Employees - by gender are cancelled. However, program 4 can only be exercised on the final day of the agreement. On 31 December 2004, allocated employee stock options amounted to 12.6 million shares. Kaupthing Bank will use own shares or increase share capital in order to fulfil employee stock options.

Stock option programs

Exercisable Number of shares Exercise price (ISK) Exercisable in (thousands) Program 1 150 114.9 2005 Program 2 2,767 102.5 2005 Program 3 81 102.5 2005-2007 44.7% Men Program 4 1,000 122.0 2005 55.3% Program 5 240 120.0 2005-2006 Women Program 6 1,896 114.9 2005-2008 Program 7 6,496 303.0 2005-2008 Total 12,630

I 75 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

THE ACQUISITION OF FIH ERHVERVSBANK A/S

In June Kaupthing Bank entered into an agreement with Förenings Sparbanken (Swedbank) on the purchase of the entire share capital of FI- Holding, which owned the Danish corporate bank FIH Erhvervsbank (FIH). The acquisition was completed in September (effective from July 1) and the acquisition price was DKK 7,292 million. The acquisition of FI-Holding (here after FIH) was funded by an increase the Bank’s share capital and with an issue of subordinated bonds. In the rights issue that followed in August, shareholders representing 96.38% of share capital in the Bank exercised their pre-emptive rights.

The acquisition of FIH was a continuation of Kaupthing Bank’s strategy to grow its corporate banking capabilities and expand its presence in the Nordic region. The acquisition doubled the size of Kaupthing Bank’s balance sheet and gave the Bank a leading position in the Danish corporate banking sector. The management team of FIH remained unchanged and there was no need for a reorganisation of the FIH business.

FIH Erhvervsbank

FIH, Kaupthing Bank’s largest subsidiary, is one of the leading commercial banks in Denmark specialis- ing in corporate lending, with 165 employees supplying Danish companies with medium and long-term financing. The product portfolio consists of a broad range of financing services including long and short-term loans, acquisition and leveraged finance, private equity funds and equity capital raising. FIH offers corporate finance services including mergers and acquisition advisory services and makes principal investments in unlisted Danish companies and in Scandinavian private equity funds.

FIH has successfully built a business with a client base of 4,500 companies, ranging from multina- tional corporations to small and medium-sized companies in a wide range of industries. Through the strength and experience of its management team, FIH has built up a 17% market share of the Danish corporate lending segment. FIH also has a strong capital structure and a proven track record in minimizing losses in its credit portfolio.

FIH Erhvervsbank was founded in 1958 under the Danish name Finansieringsinstituttet for Industri og Håndværk (Finance for Danish Industry). In 1958, Danish companies’ medium-term financing requirements were at the heart of FIH’s activities. FIH started by providing loans on machinery to enhance industry’s growth potential. Today, FIH’s name, along with its product portfolio, has changed and FIH reaches far wider than it initially did. However, the point of departure – that FIH caters to healthy, well run companies, their decision-makers and advisers – remains unchanged.

The majority of FIH’s employees works from the head office in Copenhagen, but there are also regional sales offices in Fredericia, Aarhus, Aalborg and Herning.

I 76 I I THE ACQUISITION OF FIH ERHVERVSBANK A/S I

FIH’s results in 2004

2004 was a good year for FIH. At DKK 620 million, profit after tax was up DKK 53 million on the previous year, representing a 9% increase. The year saw a continued increase in lending to medium-sized companies, while lending to large companies showed a decline on account of liquidity improvements for the largest of these companies. Further information on FIH’s annual results can be found on its homepage www.fih.dk

FIH – Client activities

FIH provides some 4,500 of the top Danish companies with a wide range of financial products. The largest companies are served by FIH Corporate Customers, at the head office in Copenhagen, while medium-sized companies are served by FIH’s five Core Customer units.

Corporate Customers The business area comprises Corporate Banking, Structured Finance and Private Equity. The aim is for Corporate Customers to work closely on offering financial solutions designed to provide all types of capital to the largest and most attractive companies in Denmark, Sweden and Norway. At the end of 2004, the business area's total loans to customers were DKK 28.5 billion and total invested capital in unlisted shares (private equities) amounted to DKK 594.3 million.

- Corporate Banking The business area provides financial solutions to the 250 top companies in Denmark, as well as the largest companies in Sweden and Norway.

- FIH Structured Finance The business area provides financing for various types of ownership changes, including company acquisitions by private equity funds, management buy-outs, management buy-ins and delisting transactions.

The financing solutions are structured individually to match the characteristics of the individual transaction, meaning that the pricing matches the risk and term of the financing. The business area cooperates with all leading Private Equity Investment Funds.

- FIH Private Equity Private Equity makes minority investments in unlisted shares (private equities). The strategy is to obtain balanced exposure to FIH's traditional business focus. Investments are made in three main categories through the wholly-owned subsidiary FIH KapitalPartner A/S. FIH invests:

• directly in small and medium-sized companies in the role of active investor. • directly in large Danish companies in the role of passive investor. • indirectly in large companies through private equity funds, mainly with a Danish/ Scandinavian focus.

I 77 I I THE ACQUISITION OF FIH ERHVERVSBANK A/S I

Core Customers The original FIH business is today represented by the FIH Core Customers segment. The division is responsible for and is in charge of servicing small and medium-sized companies. Core Customers is organised in five offices, located in Copenhagen, Fredericia, Aarhus, Herning and Aalborg. Core Customers employs 65 staff, servicing more than 4,200 companies. Loans to customers total DKK 27 billion, or roughly 50 per cent of FIH's total loans to customers.

The acquisition rationale

The acquisition of FIH was a continuation of Kaupthing Bank’s strategy to expand its presence in the Nordic region and it approximately doubled the size of Kaupthing Bank, in terms of total assets, and gave the Bank a strong position in the Danish corporate banking sector. The acquisition significantly increased the Bank’s net interest exposure, its exposure to the Danish economy as well as its exposure to corporate banking.

The Board of Directors of Kaupthing Bank believes that the acquisition of FIH will create shareholder value by further broadening the offering of high quality professional services that contrib- ute to the success of the Bank’s clients. It also believes that Kaupthing Bank with FIH will provide a platform for growth in corporate finance, acquisition finance and private equity investments. The cross-selling opportunities arising from this acquisition will enable FIH’s wide range of clients to benefit from Kaupthing Bank’s broader product portfolio.

As competition within the banking sector is continually increasing, the acquisition of FIH was a logical continuation of the series of mergers and transformations that has occurred on the Nordic and international financial markets. The growth and globalisation of companies require increasingly large and powerful banks to provide specialised services and comprehensive solutions with increasing financial efficiency. The acquisition of FIH represented a further step by Kaupthing Bank towards meeting these requirements.

Kaupthing Bank, with FIH, will achieve greater efficiency in operations and related investments, benefiting from a reduced cost of capital and the ability to effectively service larger clients. Kaupthing Bank will have greater resources at its disposal, enabling larger corporate and acquisition and leveraged finance loans to be underwritten and arranged for clients.

Kaupthing Bank has the ability to offer a wider variety of services to FIH’s clients, generating poten- tially significant revenue synergies, whilst increased scale is expected to enable Kaupthing Bank to seize an increasing proportion of mergers and acquisitions transactions, allowing the Bank to lead larger and more complex assignments for its clients. Kaupthing Bank, with FIH, is better placed to grow not only through the acquisition of a significant client base in Denmark, but more importantly through the enhanced ability to service a broader and larger client base that will enable Kaupthing Bank to compete more effectively in key growth areas such as acquisition and leveraged finance.

I 78 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

A. SUNDVALL ASA

In February 2004 Kaupthing Bank acquired the Norwegian securities company A. Sundvall ASA. The company is one of the smaller but also oldest securities companies in Oslo.

A. Sundvall ASA operates in the fields of securities brokerage, investment banking and research and employs 25 people. Net operating income in 2003 amounted to NOK 30 million, and the company reported a pre-tax profit of NOK 4 million. Equity at the end of 2003 totalled NOK 25 million. Prior to this acquisition Kaupthing Bank had activities in Norway via its subsidiary Kaupthing Norge AS (previously Tyren Holding AS), which specialises in asset management. The purpose of the acquisition was to reinforce the Bank’s Norwegian operation and to bring the Bank closer to its objective of becoming one of the leading investment banks in the Nordic region.

PFA Pension Luxembourg Kaupthing Bank Luxembourg S.A., a subsidiary of Kaupthing Bank hf., acquired all shares in PFA Pension Luxembourg in November 2004. The seller was the leading Danish pension company PFA Pension. PFA Pension Luxembourg supplies, amongst other services, unit linked policies to both corporate and private individuals. The acquisition is effective from the beginning of 2005.

The purpose of the acquisition is to increase Kaupthing Bank Luxembourg’s client base in Private Banking, as well as to expand the business by offering insurance products to its existing clients.

New Bond Street Asset Management (NBSAM) In May 2004 Kaupthing Bank entered into a Limited Liability Partnership under UK law with eight individual partners to form a specialised credit management business called New Bond Street Asset Management (NBSAM). The objective of NBSAM is to act as a fund manager for diversified credit asset classes using fundamental credit analysis, portfolio management theory and credit structuring techniques to maximise return to investors. Under an Investment Advisory Agreement, NBSAM has established a €2 billion portfolio of exposures to financial institutions, sovereigns, and asset backed securities for Kaupthing Bank. A significant proportion of the portfolio comprises credit derivatives. NBSAM also manages a €1.8 billion synthetic corporate CDO in which Kaupthing Bank has risk exposure. The average credit quality of the portfolio is A1. Kaupthing Bank provides a range of services to NBSAM such as IT, legal, HR, internal and external audit, accounting, and compliance. Further significant growth is expected in this business over the next few years.

I 79 I I 79 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

HISTORY OF KAUPTHING BANK

Kaupthing Bank dates back to 1929 when the Icelandic parliament, the Althingi, passed a law on the establishment of Búnadarbanki Islands. Búnadarbanki was wholly owned by the state and formally commenced operations on 1 July 1930.

During the following decades Búnadarbanki grew rapidly in step with increasing prosperity in Iceland. Major changes occurred in the 1960s when Búnadarbanki began to open branches across the country. Over the next few years a number of restrictions on the financial market were lifted, and Búnadarbanki was one of the companies to benefit from this. In 1982 the Ministry of Commerce granted Búnadarbanki the long- awaited license to conduct currency trading. In 1986 new legislation on the Central Bank of Iceland gave commercial banks almost complete freedom to set their own interest rates. A new era began in 1992, when restrictions on trading in foreign currencies for import and export as well as other financial transfers were lifted, and at the beginning of 1995, the government’s supervision of the movement of capital to and from Iceland came to an end. At the beginning of 1998 Búnadarbanki became a limited liability company, and at the same time work began to privatise the bank, a process which took place in stages and was completed with the merger with Kaupthing Bank at the beginning of 2003. Búnadarbanki was listed on the Main List of the Iceland Stock Exchange on 17 December 1998.

Kaupthing Bank (then Kaupthing) was established in 1982, at the start of the free capital market in Iceland. In 1986 the founding members sold 49% of their shares to a group of Icelandic savings banks. The same year the Iceland Stock Exchange began operations with Kaupthing Bank as one of the five founding partners. Four years later, in 1990, Búnadarbanki acquired 50% of the shares in Kaupthing Bank and thereby had an equal holding to the savings banks, who at the same time increased their holdings by 1%. In 1996 the Icelandic savings banks acquired the remaining shares in Kaupthing Bank from Búnadarbanki. The ownership of Kaupthing Bank remained virtually unchanged until October 2000 when Kaupthing Bank was listed on the Main List of the Iceland Stock Exchange. Following the listing, the Icelandic savings banks reduced their holdings, whilst individuals and institutional investors became shareholders.

Since 1995, Kaupthing Bank has shown rapid growth, and has been a leading player in the Icelandic investment banking market. The Bank established the first global mutual fund in Iceland and was the first Icelandic financial institution to open a financial company abroad (in Luxembourg). Kaupthing Bank obtained a license to operate as an investment bank in 1997 and was granted a commercial banking licence in January 2002 (when the word “Bank” was added to its name). In recent years Kaupthing Bank has strengthened its position abroad by acquiring financial companies and establishing subsidiaries, most importantly the acquisition of the Danish corporate bank FIH Erhvervsbank in 2004 and the acquisition of the Swedish Bank JP Nordiska AB in 2002 (now Kaupthing Sverige AB), which have transformed Kaupthing Bank’s position in the Nordic countries, the area which the Bank defines as its home market.

Kaupthing Bank is a leading player in nearly all areas of the Icelandic financial sector. Kaupthing Bank is one of the ten largest banks in the Nordic countries and operates in ten countries: Iceland, Sweden, Finland, the United Kingdom, Luxembourg, the United States, Norway, Switzerland, Denmark and the Faroe Islands.

I 80 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

MAIN SUBSIDIARIES

Kaupthing Bank operates in ten countries. The following is a short descrip- tion of the Bank’s main subsidiaries. Please note that FIH Erhvervsbank is discussed on page 76.

Kaupthing Bank Luxembourg S.A. In early 1998 Kaupthing Bank set up a securities brokerage office in Luxembourg, Kaupthing Luxembourg S.A. At the beginning of 2000 its name was changed to Kaupthing Bank Luxembourg S.A. after it had been granted a commercial banking license. The range of services has increased significantly since it was established. The main activities of Kaupthing Bank Luxembourg S.A. are private banking and specialised corporate services. In addition to providing general deposit accounts and loans to customers, the private banking services of Kaupthing Bank Luxembourg S.A. include asset management, securities brokerage, and establishing holding companies. Kaupthing Bank Luxembourg S.A. also specialises in debt-syndication. Kaupthing Bank Luxembourg S.A. has 76 employees.

Kaupthing Limited Kaupthing Limited is a financial company in London authorised by the Financial Services Authority to provide investment banking advisory services. The Bank’s Investment Banking operation is directed from London. The company has 19 employees. In May 2004 Kaupthing Bank entered into a Limited Liability Partnership under UK law with eight individual partners to form a specialised credit management business called 'New Bond Street Asset Management' ('NBSAM'). The objective of NBSAM is to act as a fund manager for diversified credit asset classes using fundamental credit analysis, portfolio management theory and credit structuring techniques to maximise return to investors.

Kaupthing Bank Sverige AB Kaupthing Bank Sverige AB, operates in three Swedish cities, Stockholm, Gothenburg and Malmö. Kaupthing Bank Sverige AB has 227 employees. It provides a wide range of financial services with special emphasis on securities brokerage, advisory services and asset management. Corporate banking and mortgage lending to households also form part of activities. Services are aimed at institutions as well as individuals. Kaupthing Bank Sverige AB is among the largest players on the Stockholm Stock Exchange. During the first half of 2004 the Bank’s market share was 4.1 % on the Stockholm Stock Exchange.

Kaupthing Bank Oyj Kaupthing Bank Oyj is a Finnish securities company located in Helsinki. It specialises in asset management and securities brokerage for companies, institutional investors and high net-worth individuals. Kaupthing Bank acquired Sofi Oyj in 2001 and thereby established a position in Finland as a part of Kaupthing Bank’s growth as a Nordic bank. In December 2004, this subsidiary

I 81 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Main subsidiaries of Kaupthing Bank Subsidiaries outside of Iceland Subsidiaries in Iceland

FIH Erhvervsbank A/S (Denmark) Arion Custody Services hf. Kaupthing Føroyar Virdisbrævameklarafelag L‡sing hf. P/F (Faroe Islands) Althjoda liftryggingarfelagid hf. Kaupthing Bank Oyj (Finland) Kaupthing Bank Asset Management Norvestia Oyj (Finland) Company hf.

Kaupthing Bank Luxembourg S.A. (Luxembourg) Kaupthing Norge AS (Norway) Kaupthing Bank Sverige AB (Sweden)

Kaupthing Ltd. (UK) Kaupthing New York Inc. (USA) Kaupthing Securities Inc. (USA)

The list is not exhaustive. was granted a banking licence. Kaupthing Bank Oyj is one of the owners of the Helsinki Stock Exchange. Its market share in the Finnish stock market has increased at a steady pace in recent years to its current share of 6.8% on the Helsinki Stock Exchange. Kaupthing Bank Oyj has 64 employees.

Kaupthing Føroyar Virdisbrævameklarafelag P/F Kaupthing Føroyar Virdisbrævameklarafelag P/F is a leader in asset management for institutional and private investors in the Faroe Islands and operates two securities funds. It was the first securities firm in the Faroe Islands, established in 2000, and Kaupthing Bank intends to participate in the establishment and development of a Faroese stock exchange. Kaupthing Føroyar Virdisbrævameklarafelag P/F offers traditional banking services as well as investment services. Kaupthing Føroyar Virdisbrævameklarafelag P/F has nine employees.

Kaupthing New York Inc. In 2000 Kaupthing Bank began operations in the USA under the name Kaupthing New York Inc. Operations are divided into three categories: securities brokerage, asset management and investment banking. Brokerage of shares and bonds takes place through the subsidiary Kaupthing Securities Inc. (a member of NASD – the National Association of Securities Dealers), which obtained a brokerage license in April 2001. The company has direct access to the New York Stock Exchange and the NASDAQ Stock Exchange. Kaupthing New York’s Investment Banking operation has been engaged in various assignments for US as well as Nordic companies. Kaupthing New York Inc. has seven employees.

I 82 I I MAIN SUBSIDIARIES I

Norvestia Oyj. At the end of 2003 Kaupthing Bank acquired a majority holding in Norvestia Oyj, a Finnish investment company based in Helsinki, whose Series B shares are listed on the main list of the Helsinki Stock Exchange. Norvestia’s objective is to make long-term investments in listed Nordic equities and funds. Norvestia has seven employees. Kaupthing Bank acquired 300,000 unlisted A-shares and 1,249,617 listed B-shares, representing 54.4 % of voting rights and 30.4 % of the nominal value of total share capital in Norvestia Oyj. Norvestia Oyj is fully consolidated with Kaupthing Bank with the shares not owned by the Bank reported as a minority interest.

Kaupthing Norge AS In 2003 Kaupthing Bank acquired Tyren Holding AS, a small Norwegian asset management company that specialises in alternative fund management. The name of the company has subsequently been changed to Kaupthing Norge AS. By acquiring Tyren Holding AS, Kaupthing Bank obtained the required license to operate an asset management company in Norway. The demand for asset management services is growing in Norway and the Bank intends to participate in such developments. Furthermore, the Bank aims to establish a leading position in alternative fund management in Norway. Early in 2004 the Bank further strengthened its Norwegian operations by acquiring the securities company A. Sundvall ASA, which specialises in equities and bond brokerage, investment banking and analysis. Kaupthing Norge AS has 37 employees.

Lýsing hf. Lýsing hf. specialises in financing business equipment and commercial premises in Iceland through leasing agreements and loans. Lýsing hf. has been a key player in the market for leasing business equipment to companies and individuals and now offers car lease agreements for individuals. Kaupthing Bank sold Lýsing hf. in February 2005 for ISK 6.1 billion.

Kaupthing Bank Asset Management Company hf. This subsidiary was founded in September 1996 and manages a large selection of Icelandic mutual funds that meet the needs and requirements of both private and institutional investors. The funds and their investment strategies differ according to their focus on institutional or private investors. This subsidiary has 24 employees.

I 83 I

ANNUAL ACCOUNTS 31 DECEMBER 2004 Icelandic kronas

CONTENTS

Endorsement and Signatures of the Board of Directors and the CEO 87

Auditors’ Report 88

Profit and Loss Account 89

Balance Sheet 90

Statement of Cash Flows 92

Notes to the Annual Accounts 93

Five-Year Summary 117

ENDORSEMENT AND SIGNATURES OF THE BOARD OF DIRECTORS AND THE CEO

The Annual Accounts include the Consolidated Annual Accounts of Kaupthing Bank hf. and its subsidiaries. The Annual Accounts have been prepared in accordance with the Annual Accounts Act and the Rules on the Financial Statements of Credit Institutions. The accounting principles applied in preparing the Annual Accounts of Kaupthing Bank hf. are consistent with those of the Bank for the previous year.

The year 2004 is the first full operating year after the merger between Kaupthing Bank hf. and Bunadarbanki Islands hf.

Net earnings, according to the Profit and Loss Account, amounted to ISK 15,760 million for the year 2004 and net operating income for the Group amounted to ISK 48,569 million at the same time. The Board of Directors proposes a payment of dividend, ISK 5 per share, which equals 21% of the net earnings for the year. Furthermore, the Board proposes that the remaining profit be allocated as stated in the notes to the Annual Accounts. Equity, according to the Balance Sheet, amounted to ISK 149,443 million at year-end, including share capital amounting to ISK 6,521 million. The capital ratio of the Bank, calculated according to the Act on Financial Undertakings, was 14.2% for the Group. This ratio may not be lower than 8.0%.

The Group’s total assets amounted to ISK 1,534,020 million at year-end. Furthermore, the Bank held an amount of ISK 1,417,749 million in custody for its customers, including mutual funds which comprised assets of ISK 116,680 million.

During the year the average number of the Group’s employees was 1,501, whereof 938 were employed by the Parent Company. Total salaries during the year amounted to ISK 10,102 million.

At year-end 2004 stock options of permanent employees amounted to 12.6 million shares. Stock options are exercisable over the next four years. The Bank will use own shares and increase its share capital to fulfil the stock option agreements. In addition the Bank has sold shares in the Bank to some employees at market value. Employees hold put options for the shares at pre-determined terms. The cost attached to the agreements is entered in accordance with an evaluation of comparable agreements on the market during the term of the agreements.

Kaupthing Bank hf.’s share capital amounted to ISK 6,521 million at year-end. Share capital was increased by ISK 2,137 million during the year 2004. Registered shareholders at year-end 2004 numbered 31,978. At the end of the year, one shareholder held more than 10.0% of the shares in the Bank, Meidur ehf. which owned 17.0% of the shares. Kaupthing Bank hf. holds 19.2% of the shares in Meidur ehf.

In June Kaupthing Bank hf. concluded an agreement with Swedbank on the purchase of all issued shares in FI-Holding A/S, which owned the Danish bank FIH Erhvervsbank A/S. The purchase price was ISK 84 billion. FI-Holding A/S forms a part of Kaupthing Bank hf.’s Group as of 1 July 2004.

In order to fund the acquisition of FI-Holding A/S a total of 110,137,128 shares at a price of ISK 360 per share were sold in a pre-emptive right issue. The total sales value of the share capital increase was ISK 39.6 billion.

In October Kaupthing Bank hf. increased the Bank’s share capital by a nominal value of ISK 1,100,000,000 at a price of ISK 480 per share in a private placement. At 13 October 2004 a total of 110,000,000 shares were sold. The total sales value of the share capital increase was ISK 52.8 billion.

Various aspects of the operations of the Bank, such as risk management, treasury, corporate services and corporate governance are discussed in detail in the Annual Report.

The Board of Directors and the CEO of Kaupthing Bank hf. hereby confirm the Bank’s Annual Accounts for the year 2004.

Reykjavik, 25 January 2005

Board of Directors:

Sigurdur Einarsson Chairman Asgeir Thoroddsen Bjarnfredur Olafsson Brynja Halldorsdottir Finnur Ingolfsson Gunnar Pall Palsson Hjorleifur Thor Jakobsson Peter Gatti Tommy Christer Persson CEO: Hreidar Mar Sigurdsson

I 8 7 I I ANNUAL ACCOUNTS OF KAUPTHING BANK 200 4 I

AUDITORS’ REPORT

To the Board of Directors and Shareholders of Kaupthing Bank hf.

We have audited the accompanying Balance Sheet and Consolidated Balance Sheet of Kaupthing Bank hf. as of 31 December 2004 and the related Profit and Loss Account, Statement of Cash Flows for the year then ended and a five-year summary. These Annual Accounts are the responsibility of the Bank’s management. Our responsibility is to express an opinion on these Annual Accounts based on our audit.

We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the Annual Accounts are free of material misstatements. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the Annual Accounts. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the Annual Accounts. We believe that our audit provides a reasonable basis for our opinion.

In our opinion the Annual Accounts give a true and fair view of the financial position of Kaupthing Bank hf. as of 31 December 2004, and the results of its operations and its cash flows for the year then ended, in accordance with the law and generally accepted accounting principles in Iceland.

Reykjavik, 25 January 2005

Sigurdur Jonsson

KPMG Endurskodun hf.

I 8 8 I PROFIT AND LOSS ACCOUNT FOR THE YEAR 2004

Group Parent Notes. 2004 2003 2004 2003

Financial Income: Interest from credit institutions 1,804 2,173 2,473 1,650 Interest on loans 44,076 22,245 21,997 17,466 Interest on bonds 3,832 1,861 1,789 1,716 Other interest income 3,605 3,369 3,450 3,172 7 53,317 29,648 29,709 24,004

Financial Expenses: Interest to credit institutions 3,119 5,724 1,991 5,838 Interest on deposits 8,374 7,221 6,596 5,438 Interest on borrowings 28 20,158 5,435 8,713 4,567 Interest on subordinated loans 2,419 938 2,139 917 Other interest expenses 347 206 285 137 7 34,417 19,524 19,724 16,897

Net interest income 18,900 10,124 9,985 7,107

Other Operating Income: Dividends from shares and other holdings 8 4,216 1,101 5,333 2,358 Fees, commissions and other service charges 9 15,645 11,125 7,121 6,223 Fees, commissions and other service charges, paid ( 2,348 ) ( 1,442 ) ( 1,444 ) ( 1,207 ) Trading gains 5,6,29 11,290 10,044 11,911 7,367 Other operating income 30 866 828 555 651 29,669 21,656 23,476 15,392

Net operating income 48,569 31,780 33,461 22,499

Other Operating Expenses: Salaries and salary-related expenses 31-35 12,652 10,110 5,798 5,099 Other administrative expenses 9,108 7,028 5,972 4,596 Depreciation and amortization 17,54 2,642 1,355 709 528 24,402 18,493 12,479 10,223

Provision for losses 13,47 ( 3,819 ) ( 3,894 ) ( 3,586 ) ( 3,631 )

Pre-tax profit 20,348 9,393 17,396 8,645 Income tax 18,65 ( 4,040 ) ( 1,486 ) ( 1,636 ) ( 1,125 )

Profit before minority interest 16,308 7,907 15,760 7,520 Minority interest 2 ( 548 ) ( 387 )

Net Earnings 68 15,760 7,520 15,760 7,520

Earnings Per Share: 10,37 Earnings per share 31.7 18.5 Diluted earnings per share 31.2 18.4

AMOUNTS ARE IN ISK MILLIONS I 8 9 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

BALANCE SHEET 31 DECEMBER 2004

Assets Group Parent Notes 2004 2003 2004 2003

Cash and Amounts due from Credit Institutions: Cash and demand deposits with the Central Bank 4,101 771 1,522 608 Amounts due from credit institutions: Required deposits with the Central Bank 12,604 2,717 0 2,100 Amounts due from other credit institutions 96,838 47,057 152,396 59,770 21,38-40,58 113,543 50,545 153,918 62,478

Loans: Loans to customers 991,093 327,019 328,064 247,923 Lease contracts 94,851 22,014 0 0 Mortgages foreclosed 2,402 1,962 888 1,623 12-14,41-47 1,088,346 350,995 328,952 249,546

Bonds and Shares in Other Companies: Bonds and other fixed-income securities 15,48-49 169,666 80,832 88,978 74,904 Shares and other variable-yield securities 15,50-51 78,686 50,327 50,181 36,485 Shares in associated companies 4,52 7,066 2,070 1,215 922 Shares in subsidiaries 2,3 1,200 856 113,280 23,263 256,618 134,085 253,654 135,574

Other Assets: Goodwill 16,53 34,208 5,948 168 226 Fixed assets 17,54 6,467 5,441 5,123 4,162 Other assets 55 14,614 8,638 4,366 5,069 Prepaid expenses and accrued income 56 19,185 2,086 10,271 769 Deferred tax assets 18,65 1,039 831 0 0 75,513 22,944 19,928 10,226

Total Assets 1,534,020 558,569 756,452 457,824

I 9 0 I AMOUNTS ARE IN ISK MILLIONS Liabilities and Equity Group Parent Notes 2004 2003 2004 2002

Amounts owed to Credit Institutions 60-61 147,455 79,267 79,753 69,553

Savings Deposits: Demand deposits 79,929 103,432 65,354 77,620 Time deposits 62 122,109 79,065 47,586 41,567 202,038 182,497 112,940 119,187

Borrowings 63 884,219 210,645 349,956 206,580

Other Liabilities: Sundry liabilities 64 20,546 13,701 3,326 3,016 Accrued expenses 54,221 3,577 11,251 2,062 74,767 17,278 14,577 5,078

Provision for Deferred Income-Tax Liability 65 9,165 1,646 1,265 979

Total liabilities 1,317,644 491,333 558,491 401,377

Subordinated Loans 19,66 57,627 10,704 48,518 10,518

Minority Interest in Subsidiaries’ Equity 2 9,306 10,603 0 0

Equity: 67-69

Share capital 6,521 4,384 6,521 4,384 Share premium 110,402 23,304 110,402 23,304 Accrued stock options 157 316 157 316 Retained earnings 32,363 17,925 32,363 17,925 Equity 149,443 45,929 149,443 45,929

Total Liabilities and Equity 1,534,020 558,569 756,452 457,824

Off Balance Sheet Items: Obligations 72-75

AMOUNTS ARE IN ISK MILLIONS I 9 1 I I ANNUAL ACCOUNTS OF KAUPTHING BANK 200 4 I

STATEMENT OF CASH FLOWS FOR THE YEAR 2004

Group Parent Notes 2004 2003 2004 2003

Cash Flows from Operations: Net earnings 68 15,760 7,520 15,760 7,520 Difference between net earnings and cash from operations: Indexation and exchange rate difference 2,442 ( 338 ) 868 ( 365 ) Net earnings of subsidiaries and associated companies ( 786 ) ( 616 ) ( 2,578 ) ( 1,629 ) Provision for losses 47 3,819 3,894 3,586 3,631 Income tax 18,65 1,945 915 286 530 Other items 2,096 1,541 240 408 Minority interest ( 1,297 ) 387

Changes in assets and liabilities 425 1,634 ( 313 ) 1,738 Net cash provided by operating activities 24,404 14,937 17,849 11,833

Cash Flows from Investing Activities: Time deposits with the Central Bank, changes ( 9,887 ) 6,502 2,100 2,891 Other time deposits with credit institutions, changes 23,769 ( 32,177 ) ( 125,129 ) 8,820 Loans to customers, changes ( 98,832 ) ( 101,983 ) ( 83,416 ) ( 70,631 ) Trading securities, changes ( 35,021 ) ( 21,909 ) ( 19,235 ) ( 19,809 ) Investment bonds, changes ( 8,536 ) 2,274 ( 8,536 ) 1,460 Investment securities, changes ( 1,520 ) 41 52 Subsidiaries and associated companies, changes 223 605 ( 88,628 ) ( 27 ) Cash flows from new companies within the group ( 87,899 ) Investment in fixed assets ( 2,852 ) ( 1,042 ) ( 2,469 ) ( 822 ) Proceeds from the sale of fixed assets 1,466 838 12 Other assets, changes ( 3,513 ) ( 3,470 ) 702 ( 1,458 ) Net cash used in investing activities ( 222,602 ) ( 151,159 ) ( 323,773 ) ( 79,512 )

Cash Flows from Financing Activities: Amounts owed to credit institutions, changes ( 10,433 ) ( 6,430 ) 10,200 ( 53,695 ) Deposits, changes 12,255 22,842 ( 5,609 ) 22,068 Borrowings, changes 90,972 108,848 143,408 112,458 Other liabilities, changes 9,697 7,735 309 1,345 Subordinate loans, changes 19,242 ( 116 ) 37,999 ( 359 ) Treasury stock, bought 67,68 ( 3,208 ) ( 65 ) ( 3,208 ) ( 65 ) Paid-in capital 67,68 92,443 92,443 Dividend paid 68 ( 1,322 ) ( 1,244 ) ( 1,322 ) ( 1,244 ) Net cash provided by financing activities 209,646 131,570 274,220 80,508

Increase (Decrease) in Cash 11,448 ( 4,652 ) ( 31,704 ) 12,829

Cash and Cash Equiv. at Beginning of Year 15,537 20,189 39,065 26,236

Cash and Cash Equivalents at Year-End 21 26,985 15,537 7,361 39,065

Other Information: Income tax paid 481 127 368 127 Dividend from subsidiaries and associated companies 268 178 225 175 Investment in other companies, non-cash transactions, paid with treasury stock 0 6,152 0 6,152

I 9 2 I AMOUNTS ARE IN ISK MILLIONS NOTES TO THE ANNUAL ACCOUNTS

Summary of Accounting Principles

Basis of Preparation 1. The Annual Accounts of Kaupthing Bank hf. contain the Consolidated Annual Accounts of the Bank and its subsidiaries. The Annual Accounts have been prepared in accordance with the Annual Accounts Act and the Rules on the Financial Statements of Credit Institutions. They are based on cost accounting with the exception of trading securities that are entered at market price. The Annual Accounts are prepared according to the same accounting principles as for the previous year, they are prepared in Icelandic currency and amounts are presented in millions of Icelandic kronas.

2. Subsidiaries are companies in which the Bank holds controlling interest. Controlling interest exists when the Bank has significant influence, direct or indirect, to control a subsidiary’s financial and operational policies. The Annual Accounts of the subsidiaries are included in the Consolidated Annual Accounts of the Bank from the acquisition of majority interest and until the interest is no longer held. Balances between group companies, transactions and profits created in intra-group transactions, are eliminated in the Annual Accounts. Minority interest in the performance of subsidiaries and in their shareholders’ equity is specifically entered in the Profit and Loss Account and in the Balance Sheet. One subsidiary, Althjoda liftryggingarfelagid hf., is not included in the Bank’s Consolidated Annual Accounts as the operations of this subsidiary are different from the operations of the others. This subsidiary is accounted for in accordance with the equity method in the Annual Accounts.

3. Shares in subsidiaries are specified as follows: Ownership

FI Holding A/S, Denmark 100.0% BI Management Company S.A., Luxembourg 100.0% Gen hf., Iceland 100.0% Global Arbitrage & Trading S.A., Switzerland 100.0% Kaupthing Asset Management Sàrl, Switzerland 100.0% K Invest Holding S.A., Luxembourg 100.0% Kaupthing Bank Luxembourg S.A., Luxembourg 100.0% Kaupthing Foroyar Virdisbraevameklarafelag P/F, Faeroe Islands 100.0% Kaupthing Ltd., England 100.0% Kaupthing New York Inc., USA 100.0% Kaupthing Norge AS, Norway 100.0% Kaupthing Services S.A., Switzerland 100.0% Kaupthing Bank Oyj, Finland 100.0% Kirna ehf., Iceland 100.0% Lysing hf., Iceland 100.0% Radgjof Kaupthings ehf., Iceland 100.0% Rekstrarfelag Kaupthings Bunadarbanka hf., Iceland 100.0% Sjavarutvegssjodurinn ehf., Iceland 100.0% Urdur ehf., Iceland 100.0% Arion verdbrefavarsla hf., Iceland 99.9% Sparisjodur Kaupthings hf., Iceland 99.9% Kaupthing Advisory Company S.A., Luxembourg 99.3% Alpha Venture Capital Fund Management S.A., Luxembourg 99.0% Kaupthing Bank Sverige AB, Sweden 93.5% Althjoda liftryggingarfelagid hf., Iceland 58.0% Norvestia Oyj, Finland 30.4%

I 9 3 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

The Bank wields 54.4% of the votes in Norvestia Oyj and the company is thus considered to be a subsidiary of the Group.

4. Associated companies are companies where Kaupthing Bank hf. has significant influence over the financial and operational policies but not controlling interest. The Annual Accounts contain Kaupthing Bank hf.’s share in the performance of associated companies from the beginning of influence until the influence no longer exists. Should Kaupthing Bank hf.’s part of an assocated company’s loss exceed the book value of an associated company the book value is recorded as zero and further entries of loss are ceased unless the Bank has granted guarantees to the associated company or financed it. If the Group has purchased shares for a price that does not correspond to its share in the shareholders’ equity of the company in question the difference is expensed over a period of five to twenty years.

Foreign Currency 5. Assets and liabilities in foreign currencies are converted to Icelandic currency at the year-end 2004 exchange rate. Operational revenue and expenses in foreign currencies are converted at the exchange rate of the date of transaction.

Annual Accounts of Foreign Subsidiaries 6. The Group’s foreign activities are closely related to the activities of the Parent Company. Accordingly assets and liabilities related to the foreign operations are converted into Icelandic kronas at the year-end 2004 exchange rate. Revenue and expenses of the foreign activities are converted into Icelandic kronas at the average exchange rate for the year. Exchange rate difference thus created due to the conversion into Icelandic kronas is entered as exchange rate difference in the Profit and Loss Account.

Financial Income and Expenses 7. Interest income and interest expenses are entered into the Profit and Loss Account as they accrue based on the actual interest rate. Interest income is calculated on amounts due from other financial institutions, loans, market securities and derivatives. Interest expenses are calculated on amounts owed to financial institutions, deposits, borrowings and subordinated loans. If loans have been in default for more than three months interest income is no longer recognized. Revenue and expenses equivalent to interest, such as borrowing charges, are included with interest income and interest expenses as they accrue.

Income from Shares and Other Holdings 8. The Bank’s share in the profit or loss of associated companies and subsidiaries is included in income from shares and other holdings, along with dividends on shares.

Fees and Commission Income 9. The Bank provides various services to its clients and derives income therefrom. Commission income includes income from investment banking, corporate banking, securities brokerage, asset management and lending activities. Commission income is entered into the Bank’s Profit and Loss Account when it is derived.

Earnings per Share 10. Earnings per share is the ratio between profit and weighted average number of outstanding shares during the period and shows the profit per share. The profit for the year amounted to ISK 15,760 million and the weighted

I 9 4 I I NOTES I

average number of shares was 497.4 million. The nominal value of each share is 10 Icelandic kronas. In calculating diluted earnings per share it is taken into account that the market value of shares in the Bank exceeds the expected sales price according to stock option agreements.

Functional Summary 11. The functional summary shows the division of operating income and operating expenses by functions on the one hand and by location on the other.

Loans 12. Loans are capitalized with accrued interest, indexation and exchange rate difference at year-end. Indexed loans are entered based on indices effective at the beginning of January 2005 and loans in foreign currency based on the exchange rate of the relevant currencies at year-end 2004.

13. Provision for losses on the loan portfolio is made to meet the risk attached to lending operations. The loss provision is based on estimation and does not represent a final write-off. In addition to the required contribution, certain risk factors are evaluated to determine the total contribution for this purpose. Firstly, there are specific provisions to adjust for obligations of creditors that have received a poor risk evaluation, and secondly there is a general provision to meet the general risk of lending operations. Interest on loans, the collection of which is uncertain, is not entered as income. The provision has been deducted from the appropriate Balance Sheet items, less the provision for issued guarantees that is posted among sundry liabilities in the Balance Sheet.

14. The Bank has redeemed assets on foreclosed mortgages. In some cases the foreclosing has been made through special managing companies owned by the Bank and loans to them are included in foreclosed mortgages. These companies are all included in the Consolidated Annual Accounts. Foreclosed mortgages are entered at estimated market price or cost price whichever is lower.

Securities 15. The Bank’s securities are partly presented as trading securities and partly as investment securities. Investment securities are those that by a formal decision are expected to be held for more than one year whereas other securities are categorised as trading securities.

Investment bonds are valued at the yield of purchase. Investment shares are valued at the cost price or market price, whichever is lower. Listed trading securities are valued at the year-end market value. Unlisted trading bonds are valued according to the required rate of return at the time of purchase and unlisted trading shares are valued at the lower of cost or market.

Goodwill 16. In cases where the Bank has purchased or acquired shares in subsidiaries at a price that does not correspond to the Bank’s share in the company’s equity the difference is capitalized as goodwill. Goodwill is expensed in the Profit and Loss Account over a period of five to twenty years.

Property and Equipment 17. Property and equipment are capitalized at cost price less depreciation. Depreciation is calculated as a fixed annual percentage based on the estimated useful life of the property and equipment until a scrap value is reached. Estimated useful life is specified as follows:

I 9 5 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Buildings 25 - 50 years Fixtures 5 years Machinery and equipment 3 - 5 years Vehicles 6 years

Deferred Income-Tax Liability / Asset 18. The deferred income-tax liability / asset has been calculated and entered in the Balance Sheet. The calculation is based on the difference between Balance Sheet items as presented in the tax return on the one hand, and in the Annual Accounts on the other, taken into consideration a carry-forward tax loss. This difference is due to the fact that tax assessments are based on premises that differ from those governing the Annual Accounts, mostly because expenses, especially depreciation, are entered earlier in the tax return than in the Annual Accounts. A calculated tax asset is only offset against income-tax liability if they are due to tax assessment from the same tax authorities.

Subordinated Loans 19. The Bank has borrowed funds by issuing bonds on subordinate terms. The bonds have the characteristics of equity in being subordinate to other liabilities of the Bank. In the calculation of the capital ratio, the bonds are included with equity, as shown in note 66. On the one hand, there are subordinated loans with no maturity date that the Bank may not retire until 2011 and 2014 and then only with the permission of the Financial Supervisory Authority. These loans qualify as Tier I capital in the calculation of the capital ratio. On the other hand, there are subordinated loans with various dates of maturity over the next 10 years. The loans are entered as liabilities with accrued interest and indexation at year-end 2004.

Stock Option Contracts 20. Stock option contracts enable the Bank’s employees to acquire shares in the Bank. The purchase price equals the market value of the shares at the grant date. The Bank’s cost is evaluated as the time of conclusion according to the Black-Scholes method of evaluating stock option agreements. The cost thus evaluated is expensed during the term of the agreement. It is expensed in the Profit and Loss Account and posted as a special item among equity. Upon the implementation of international accounting standards the cost in relation to stock option agreements is expected to be evaluated in a manner similar to the present practice.

The Bank has sold shares in the Bank to some employees at market value. Employees hold put options on the shares at pre-determined terms. The cost attached to the agreements is evaluated in accordance with the evaluation of comparable agreements on the market during the term of the agreements.

Cash and Cash Equivalents 21. Cash and cash equivalents in the Statement of Cash Flows consist of cash, demand deposits with the Central Bank and demand deposits with other credit institutions.

Derivatives 22. Derivatives are financial instruments, the contracted or nominal amounts of which are not included in the Bank’s Balance Sheet, either because rights and obligations arise out of one and the same contract, the contracts perform after the Balance Sheet date or because the nominal amounts serve merely as variables for calculating purposes. The nominal amounts of derivatives do not necessarily give any indication of the size of the cash flows and the market and credit risk attached to derivatives transactions. Examples of derivatives are forward exchange contracts, forward rate agreements, futures, options and swaps. The underlying value may involve interest rate, currency, commodity, bond or equity products.

I 9 6 I I NOTES I

The Bank’s derivatives transactions are conducted as trading activity, entered at their market value, and as a hedge against the Bank’s own interest rate and currency exposure. Hedge contracts are entered in the same manner as the hedged item. The Bank’s derivatives are mainly intended to reduce the price, exchange and interest rate risk assumed by the Bank. Derivatives performance is entered in the Profit and Loss Account and in the Balance Sheet. Net assets are capitalised among amounts due from credit institutions and other assets whereas net obligations are entered among sundry liabilities and amounts owed to credit institutions.

The market risk attached to derivatives is created by changes in the price of the factors on which the contracts are based, such as interest rate changes or exchange rate changes in currency and listed securities. Risk attached to borrowings reflects the loss incurred by the Bank if the counter party in a derivative contract could not fulfil its part of the contract.

Forward rate agreements, futures and options relating to currency, securities and interest rate are entered in the Bank’s Annual Accounts at their year-end market value.

International Financial Reporting Standards 23. According to an EC Directive, companies listed on European Stock Exchanges must prepare Consolidated Annual Accounts in accordance with international financial reporting standards (IFRS) as of the year 2005. The Bank plans to present its report for the first quarter of 2005 in accordance with IFRS. The main changes in the Bank’s Annual Accounts will be in relation to the evaluation of goodwill, unlisted securities and derivatives. Furthermore, the presentation of the Profit and Loss Account as well as the Balance Sheet will be altered and Notes to the Annual Account will be more detailed.

Changes in the Group

24. In June Kaupthing Bank hf. concluded an agreement with Swedbank on the purchase of all issued shares in FI-Holding A/S, which owned the Danish bank FIH Erhvervsbank A/S. The purchase price was ISK 84 billion. FI-Holding A/S forms a part of the Group’s Annual Accounts as of 1 July 2004.

At 31 December 2004 Kaupthing Bank Denmark was sold to Foroya Sparikassi. The sales price was ISK 1,448 million and proceeds from the sale amounted to ISK 350 million.

At 31 December 2004 the Bank acquired all outstanding shares in Kaupthing Foroyar Virdisbraevameklarafelag P/F. The purchase price was ISK 167 million.

I 9 7 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Quarterly Statements 25. Summary of the Group’s operating results by quarters:

Q1 Q2 Q3 Q4 Total

Net interest income 3,501 3,165 5,523 6,711 18,900

Other operating income: Income from shares and other holdings 924 2,520 194 578 4,216 Commissions, income and expenses 3,212 2,584 2,289 5,212 13,297 Trading gains 1,862 2,146 6,327 955 11,290 Other operating income 72 87 8 699 866 6,070 7,337 8,818 7,444 29,669

Net operating income 9,571 10,502 14,341 14,155 48,569

Other operating expenses: Salaries and salary-related expenses 2,622 2,846 3,120 4,064 12,652 Other administrative expenses 2,047 1,910 2,133 3,018 9,108 Depreciation 402 465 919 856 2,642 5,071 5,221 6,172 7,938 24,402

Provision for losses ( 1,150 ) ( 1,112 ) ( 582 ) ( 975 ) ( 3,819 )

Pre-tax profit 3,350 4,169 7,587 5,242 20,348 Income tax ( 558 ) ( 504 ) ( 1,965 ) ( 1,013 ) ( 4,040 )

Profit before minority interest 2,792 3,665 5,622 4,229 16,308 Minority interest ( 142 ) ( 157 ) ( 75 ) ( 174 ) ( 548 )

Net earnings 2,650 3,508 5,547 4,055 15,760

Functional Summary 26. Summary of the Groups operations by functions:

Asset Management Capital Investment Corporate and Private Retail Markets Banking Treasury Banking Banking Banking Total

Net interest income ( 182 ) ( 802 ) 2,040 11,225 ( 188 ) 6,671 18,764 Net commission income 2,808 2,743 1,353 1,531 2,954 1,352 12,741 Trading gains 6,245 8,449 651 72 0 4 15,421 Other operating income 0 33 0 0 0 61 94 Total income 8,871 10,423 4,044 12,828 2,766 8,088 47,020

Operating expenses 2,483 1,150 922 961 1,527 3,869 10,912 Provision for losses 0 0 24 1,293 0 2,502 3,819 Total expenses 2,483 1,150 946 2,254 1,527 6,371 14,731

Gross margin 6,388 9,273 3,098 10,574 1,239 1,717 32,289

I 9 8 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

27. Income specified by location of its markets and customers:

Net Net interest commission Trading Other income income gains income Total

Iceland 7,928 7,173 3,950 969 20,020 Scandinavia 7,628 3,344 1,612 2,365 14,949 United Kingdom 1,142 1,197 4,208 1,733 8,280 Luxembourg 1,749 1,411 1,519 12 4,691 Other countries 453 172 1 3 629

Total 18,900 13,297 11,290 5,082 48,569

Interest Expenses 28. Interest on borrowings is specified as follows: Group Parent 2004 2003 2004 2003

Bonds issued 14,532 4,035 3,089 3,258 Loan contracts 5,626 1,400 5,624 1,309

Total 20,158 5,435 8,713 4,567

Other Operating Income 29. Trading gains are specified as follows:

Trading shares 7,735 4,626 4,856 2,747 Trading bonds 2,948 4,784 3,219 4,837 Assets and liabilities in foreign currency 607 634 3,836 ( 217)

Total 11,290 10,044 11,911 7,367

30. Other operating income is specified as follows:

Capital gains on the sale of subsidiaries 350 356 350 356 Other income 516 472 205 295

Total 866 828 555 651

Personnel 31. The total number of employees is as follows:

Average number of employees during the year measured as full time equivalent positions 1,501 1,328 938 850 Full time equivalent positions at year-end 1,606 1,237 922 832

AMOUNTS ARE IN ISK MILLIONS I 9 9 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

32. Salaries and salary-related expenses are specified as follows:

Group Parent 2004 2003 2004 2003

Salaries 10,102 7,670 4,771 4,053 Salary-related expenses 2,550 2,440 1,027 1,046

Total 12,652 10,110 5,798 5,099

Executive Employment Terms 33. Salaries to the executives of the Bank, their stock options and shares, owned at year-end, are specified as follows (thousand shares): Salaries Stock Put Shares at and bonuses options options year-end CEOs: Hreidar Mar Sigurdsson, CEO 97.2 3,642 812 2,007 Solon R. Sigurdsson, CEO 67.9 555 24 Directors: Sigurdur Einarsson, Chairman 108.7 4,080 812 2,526 Asgeir Thoroddsen 2.3 1 Bjarnfredur Olafsson 2.3 0 Brynja Halldorsdottir 1.8 9 Finnur Ingolfsson 2.3 78 Gudmundur Hjaltason 2.3 0 Gunnar Pall Palsson 2.3 6 Hjorleifur Thor Jakobsson 2.3 22 Peter Gatti 2.3 0 Tommy Christer Persson 2.3 0 Former Director: Jon Helgi Gudmundsson 0.5 0 14 managers of the Bank 439.5 (1) 1,155 4,500 12,246

Total 734.0 9,432 (2) 6,124 (3) 16,919 (4)

Should the Chairman of the Board resign he shall receive salary payments for 12 months onwards, but otherwise his salary payments shall continue for 48 months from the date of the termination of employment. The CEO’s term of notice is 12 months, but should his employment terminate due to other reasons his salary payments shall continue for 48 months. At year-end there are no pension liabilities due to the directors and the CEO. At year-end Solon R. Sigurdsson retired and he will receive ISK 60 million over the next two years as retirement benefits.

1) The managers have realized an amount of ISK 21 million on their stock options during the year. This amount is included in their total salaries for the year.

2) Stock option agreements with the CEO, the Chairman and the Managing Directors, that are based on the exercice prices 102.5 – 303.0, were concluded in 2000 – 2004 and are exercisable in the period 2005 – 2008.

3) Put option contracts with the CEO, Chairman and the Managing Directors were concluded in 2003 and in 2004. They are based on the exercise prices 210.0 and 303.0 and are exerciseable in the years 2006 and 2008.

4) Included among the holdings of the aforementioned persons are holdings of their spouses, minor children and companies controlled by them, if appropriate. I 1 0 0 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

34. The Bank has granted the Bank’s Directors, the CEO and the Managing Directors loans amounting to a total of ISK 1,944 million at year-end on terms similar to those on which loans are granted to other customers of the Bank. Loans granted are in relation to purchases of shares in the Bank and in relation to purchases of shares in the Bank with put options. The aforementioned amounts do not include loans related to the business activities of the Directors.

35. In order to motivate and reward its employees Kaupthing Bank hf. has a system of paying bonuses. Bonuses to key managers are paid with regard to Kaupthing Group’s operating profit and upon reaching certain targets on return on equity. Furthermore, Kaupthing Bank hf. pays its employees performance-related bonuses on projects increasing the number of customers in asset management and as a percentage of growth of assets under management. The CEO and the managing directors of each division determine these bonus payments. Bonus payments for the CEO are proportionate to the profits of the Kaupthing Group. In 2004 bonus payments totalled ISK 2,290 million.

Auditors’ Fee 36. Fee to the Bank’s auditors is specified as follows: Group Parent

Audit of the Annual Accounts 101 10 Other related audit services 53 18 Review of the Interim Accounts 31 12 Other services 50 11

Total 235 51

Fee to others than the Parent Company’s auditors, included in the above total 184

Earnings per Share 37. Earnings per share is the ratio between profit and weighted share capital at year-end:

Net earnings 15,760

Weighted average share capital: Weighted average of outstanding shares for the last 12 months 497.4 Effects of stock options 7.6 Weighted average of outstanding shares for the last 12 months taking into consideration employee stock options 505.0

Earnings per share 31.7

Diluted earnings per share 31.2

AMOUNTS ARE IN ISK MILLIONS I 1 0 1 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Cash and Amounts due from Credit Institutions 38. Cash and demand deposits with the Central Bank are specified as follows:

Group Parent 2004 2003 2004 2003

Cash 764 763 744 600 Demand deposits with the Central Bank 3,337 8 778 8

Total 4,101 771 1,522 608

39. Amounts due from credit institutions:

Required deposits with the Central Bank according to regulation 12,604 2,717 0 2,100

Amounts due from other credit institutions:

Subsidiaries 0 0 124,179 43,227 Other 96,838 47,057 28,217 16,543

Total 96,838 47,057 152,396 59,770

40. Amounts due from other credit institutions mature as follows:

On demand 22,884 14,767 5,839 8,271 Up to 3 months 65,172 31,611 96,806 30,285 Over 3 months and up to a year 3,863 621 7,268 11,308 Over 1 year and up to 5 years 2,919 58 28,858 9,806 Over 5 years 2,000 0 13,625 100

Total 96,838 47,057 152,39 59,770

Loans 41. Loans to customers and lease contracts specified by types of loans:

Overdrafts 39,623 34,319 23,049 26,634 Bonds 142,714 170,708 142,712 167,175 Loan contracts 808,756 121,992 162,303 54,114

Total 991,093 327,019 328,064 247,923

I 1 0 2 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

42. Loans to customers specified by sectors: Group Parent 2004 2003 2004 2003

Government 0.0% 0.6% 0.1% 0.1% Municipalities 4.3% 0.7% 0.7% 0.9% Industries: Agriculture 0.6% 1.0% 1.2% 1.2% Fishing industry 1.0% 2.6% 3.1% 3.3% Commerce 7.5% 13.0% 11.4% 16.5% Industry 31.1% 13.2% 13.5% 14.7% Service 43.3% 43.7% 45.7% 44.0% Individuals 12.2% 25.2% 24.3% 19.3%

Total 100.0% 100.0% 100.0% 100.0%

43. Loans to customers and lease contracts specified by maturity:

On demand 39,611 21,177 13,749 14,422 Up to 3 months 141,288 122,160 50,321 72,286 Over 3 months and up to a year 124,813 58,196 39,513 46,309 Over 1 year and up to 5 years 402,552 117,105 137,174 90,211 Over 5 years 377,680 30,395 87,307 24,695

Total 1,085,944 349,033 328,064 247,923

44. Lease contracts are specified as follows:

Buildings 69,014 3,487 0 0 Current assets 25,837 18,527 0 0

Total 94,851 22,014 0 0

45. Mortgages foreclosed are specified as follows:

Buildings 1,545 1,841 886 1,313 Current assets 84 121 2 10 Loans and shares in foreclosing and management companies 773 0 0 300

Total 2,402 1,962 888 1,623

46. Non-performing loans are specified as follows:

Loans with a specific provision for losses 16,561 7,149 6,602 6,708 Specific provision for losses ( 12,521 ) ( 5,465 ) ( 4,057 ) ( 5,014 ) Other non-performing loans 2,973 4,900 2,587 4,751

Non-performing loans, total 7,013 6,584 5,132 6,445

AMOUNTS ARE IN ISK MILLIONS I 1 0 3 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

47. Changes in the provision for losses are specified as follows:

Provision for losses 2004 2003 Specific General Total Total Group Balance at the beginning of the year 5,465 2,836 8,301 5,764 Provision for losses during the year 2,989 830 3,819 3,894 Exchange rate difference on the translation of foreign subsidiaries ( 378 ) ( 65 ) ( 443 ) 25 Actual losses during the period ( 5,566 ) ( 35 ) ( 5,601 ) ( 1,402 ) Paid in, previously written off 21 0 21 20 Taken over at acquisitions 9,990 405 10,395 0

Balance at year-end 12,521 3,971 16,492 8,301

Provision for losses on the loan portfolio as a percentage of loans and issued guarantees 1.1% 0.3% 1.4% 2.4%

Parent Balance at the beginning of the year 5,015 2,317 7,332 4,950 Provision for losses during the year 3,268 318 3,586 3,631 Actual losses during the year ( 4,282 ) 0 ( 4,282 ) ( 1,266 ) Paid in, previously written off 56 0 56 17

Balance at year-end 4,057 2,635 6,692 7,332

Provision for losses on the loan portfolio as a percentage of loans and issued guarantees 1.1% 0.7% 1.8% 2.7%

Bonds and Shares in Other Companies 48. Bonds and other fixed-income securities are specified as follows:

Group Parent Market value Book value Market value Book value

Trading bonds: Listed on the Iceland Stock Exchange 67,052 67,052 67,052 67,052 Listed on foreign stock exchange 75,702 75,702 663 663 Bonds, unlisted 17,002 11,369 159,756 79,084 Investing bonds: Listed on the Iceland Stock Exchange 9,854 9,854 9,838 9,838 Bonds, unlisted 56 56 9,910 9,894

Bonds and other fixed-income securities, total 169,666 88,978

The Bank’s market risk on bonds, derivatives included, amounts to ISK 72,456 million.

I 1 0 4 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

49. Bonds and other fixed-income securities specified by issuers: Group Parent

Bonds issued by public bodies 72,317 72,315 Bonds issued by other borrowers 97,349 16,663

Total 169,666 88,978

Bonds that mature within a year amount to ISK 17,406 / 4,420 million for the Group / Parent Company.

50. Shares and other variable-yield securities are specified as follows:

Group Parent Market value Book value Market value Book value Trading shares:

Listed on the Iceland Stock Exchange 29,826 29,826 28,948 28,948 Listed on foreign stock exchange 35,825 35,825 12,021 12,021 Shares, unlisted 11,376 9,156 77,027 50,125 Investing shares: Shares, unlisted 1,659 56

Shares and other variable-yield securities, total 78,686 50,181

Kaupthing Bank hf. has entered into derivatives amounting to ISK 12,925 million against its shares. Derivatives on listed shares amount to ISK 10,921 million and derivatives on unlisted shares amount to ISK 2,004 million. The agreements are entered at market value.

AMOUNTS ARE IN ISK MILLIONS I 1 0 5 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

51. Investment shares are specified as follows: Ownership Dividend Nominal value Book value Shares held by the Parent:

Audkenni hf., Iceland 17.8% 0 18 20 Eignarhaldsfelagid Verdbrefathing hf., Iceland 20.0% 1 14 18 Shares in four other companies 0 8 18

Total shares held by the Parent 1 56

Shares held by subsidiaries: Puhelinosuuskunta KPY Finland 13.7% 1 0 891 PolystarInstruments AB Sweden 12.6% 1 0 143 Tetra Island ehf., Iceland 25.6% 0 57 115 Shares in 17 other companies 4 0 454

Total shares held by subsidiaries 6 1,603

Total investing shares 7 1,659

52. Shares in associated companies are specified as follows:

Ownership Profit share Nominal value Book value Shares held by the Parent: Greidslumidlun hf., Iceland 21.0% 32 84 296 DSK A/S, Denmark 42.5% 27 143 220 Kreditkort hf., Iceland 20.0% 40 9 218 Reiknistofa bankanna, Iceland 17.1% ( 8 ) 207 Shares in three other companies 24 169 274

Total held by the Parent 115 1,215

Shares held by the subsidiaries: Axcel Industri Investor Invest A/S, Denmark 50.0% 35 253 1,235 Drake Management LLC., USA 20.0% 67 612 1,156 KIFU – AX II, Denmark 25.0% 50 169 751 Netdesign Invest A/S, Denmark 25.4% 212 33 741 KFU – AX II, Denmark 33.3% 45 150 708 Mezzanin Kapital A/S, Denmark 22.7% 3 140 454 FA A/S, Denmark 50.0% 91 3 345 Shares in 11 other companies 18 334 461

Total shares held by the subsidiaries 521 5,851

Total shares in associated companies 636 7,066

I 1 0 6 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

Other Assets 53. Goodwill is specified as follow: Group Parent

Balance 1.1.2004 5,948 226 Additions during the year 31,145 Disposals during the year ( 34 ) Currency exchange rate difference ( 1,292 ) Amortized during the year ( 1,559 ) ( 58)

Book value 31.12.2004 34,208 168

Machinery 54. Fixed assets and depreciation are as follows: and Real estate equipment Total Group Total value 1.1.2004 4,161 5,410 9,571 Taken over / Sold ( 45 ) 11 ( 34 ) Additions during the year 1,977 1,164 3,141 Disposals during the year ( 1,095 ) ( 414 ) ( 1,509 )

Total value 31.12.2004 4,998 6,171 11,169

Previously depreciated 1,325 2,805 4,130 Taken over / Sold 3 113 116 Depreciation during the year 102 981 1,083 Disposals during the year ( 263 ) ( 364 ) ( 627 ) Total depreciation 31.12.2004 1,167 3,535 4,702

Book value 31.12.2004 3,831 2,636 6,467

Annual depreciation ratios 2-4% 15-33%

Parent Company Total value 1.1.2004 3,760 3,290 7,050 Addition during the year 1,728 741 2,469 Disposals during the year ( 1,016 ) ( 327 ) ( 1,343 ) Total value 31.12.2004 4,472 3,704 8,176

Previously depreciated 1,260 1,627 2,887 Depreciation during the year 69 582 651 Disposals during the year ( 223 ) ( 262 ) ( 485 ) Total depreciation 31.12.2004 1,106 1,947 3,053

Book value 31.12.2004 3,366 1,757 5,123

Annual depreciation ratios 2-4% 15-33%

AMOUNTS ARE IN ISK MILLIONS I 1 0 7 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Depreciation in the Profit and Loss Account is specified as follows: Group Parent

Depreciation 1,083 651 Amortization, see note 53 1,559 58

Depreciation in the Profit and Loss Account 2,642 709

The official assessment value and fire insurance value of fixed assets are specified as follows:

The official assessment value of buildings and leased land 2,674 2,452 The fire insurance value of buildings 4,111 3,814 The insurance value of machinery and equipment 551 0

55. Other assets are specified as follows: Group Parent 2004 2003 2004 2003

Unsettled securities trading 4,001 5,916 2,465 2,700 Amounts due from subsidiaries 0 0 1,587 1,070 Sundry assets 10,613 2,722 314 1,299

Total 14,614 8,638 4,366 5,069

The above item “Unsettled securities trading” was settled in less than three days from the accounting date.

56. Prepaid expenses and accrued income is specified as follows:

Prepaid expenses 5,421 380 5,043 119 Accrued income 13,764 1,706 5,228 650

Total 19,185 2,086 10,271 769

Balances with Associated Companies and Subsidiaries 57. Specification of balances with associated companies and subsidiaries: Group Parent Associated Associated companies Subsidiaries companies Subsidiaries Assets: Amounts due from credit institutions 0 0 0 124,179 Loans to customers 0 2,394 0 3,980 Other assets 0 376 0 1,031

Total 0 2,770 0 129,190

Liabilities: Amounts owed to credit institutions 0 0 0 20,576 Deposits 0 0 0 594

Total 0 0 0 21,170

I 1 0 8 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

Subordinated Loans 58. Specification of subordinated loans: Subsidiaries Other companies

Amounts due from credit institutions 14,147 0 Loans to customers 0 6,890 Bonds and other fixed-income securities 0 1,971

Total 14,147 8,861

Assets and Liabilities in Foreign Currency 59. The total amount of assets denominated in foreign currencies in the Group’s / Parent’s Annual Accounts amounted to ISK 630,341 / 1,507,243 million, respectively, at year-end, and the total amount of liabilities amounted to ISK 629,877 / 1,505,673 million at the same time. Included in assets and liabilities are forward contracts and currency and interest rate swaps, see note 73.

Amounts owed to Credit Institutions 60. Liabilities owed to credit institutions are specified as follows:

Group Parent 2004 2003 2004 2003

Liabilities to the Central Bank 18,017 24,026 18,017 24,026 Liabilities to other credit institutions 129,438 55,241 61,736 45,527

Total 147,455 79,267 79,753 69,553

61. Liabilities owed to credit institutions mature as follows:

On demand 9,270 3,249 5,419 1,588 Up to 3 months 93,705 71,151 72,771 63,307 Over 3 months and up to a year 1,826 2,444 183 2,235 Over 1 year and up to 5 years 9,763 1,944 1,088 1,944 Over 5 years 32,891 479 292 479

Total 147,455 79,267 79,753 69,553

Savings Deposits 62. Time deposits mature as follows:

Up to 3 months 82,980 36,274 14,208 14,414 Over 3 months and up to a year 8,773 20,999 3,565 6,818 Over 1 year and up to 5 years 23,922 16,797 23,378 15,539 Over 5 years 6,434 4,995 6,435 4,796

Total 122,109 79,065 47,586 41,567

AMOUNTS ARE IN ISK MILLIONS I 1 0 9 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Borrowings 63. Borrowings are specified as follows: Group Parent 2004 2003 2004 2003

Bonds issued 850,159 150,424 315,896 147,474 Loans 34,060 60,221 34,060 59,106

Total 884,219 210,645 349,956 206,580

Borrowings that mature within a year amount to ISK 307,941 / 87,583 million for the Group / Parent.

Sundry Liabilities 64. Sundry liabilities are specified as follows:

Unsettled securities trading 7,967 5,455 464 169 Income tax and net worth tax 1,729 127 1,676 279 Loans on mortgages foreclosed 75 1,026 75 903 Provision for losses on guarantees 240 147 156 147 Other liabilities 10,535 6,946 955 1,518

Total 20,546 13,701 3,326 3,016

The above item “Unsettled securities trading” was settled within three days from the Balance Sheet date.

Deferred Tax asset / Deferred Income-tax Liability 65. Deferred Tax asset / liability is specified as follows: Group Parent Asset Liability Liability

Deferred tax asset / income-tax liability at the beginning of 2004 ( 831 ) 1,646 979 Taken over at acquisitions ( 303 ) 5,364 0 Exchange rate difference on the translation of foreign subsidiaries 71 ( 406 ) Joint taxation effects 0 0 ( 1 ) Calculated income tax for 2004 115 3,925 1,636 Income tax because of 2004 operations to be paid in the year 2005 ( 91 ) ( 1,364 ) ( 1,349 )

Deferred tax asset / income-tax liability at year-end ( 1,039 ) 9,165 1,265

Deferred tax asset / income-tax liability is specified as follows:

Shares in other companies ( 3 ) 1,478 606 Currency-linked assets and liabilities 0 346 346 Loans 0 4,670 0 Derivatives 0 2,726 0 Other items 0 65 0 Fixed assets ( 1 ) 357 313 ( 4 ) 9,642 1,265

Carry-forward tax loss ( 1,035 ) ( 477 ) 0 Deferred tax asset / income-tax liability at year-end ( 1,039 ) 9,165 1,265 I 1 1 0 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

Subordinated Loans 66. Subordinated loans are specified as follows:

Original Interest Interest Maturity Book interest change after change date value

Loans that qualify as Tier I capital:

Issued in 2001 ISK 8.7% 2011 No maturity date 1,190

3 mth. Euribor+ Issued in 2004 EUR 5.9% 2014 245 bps. No maturity date 12,758 13,948

Loans that qualify as Tier II capital: Issued in 2000 ISK 6.0% 2005 7.5% 2010 1,470 Issued in 2000 ISK 7.0% 2007 9.0% 2012 2,128 Issued in 2001 ISK 6.0% 2006 7.5% 2011 122 Issued in 2001 ISK 8.0% 2006 10.0% 2011 1,421 Issued in 2002 ISK 6.0% 2007 7.5% 2012 904 Issued in 2002 ISK 7.5% 2009 10.0% 2014 1,279 Issued in 2004 ISK 5.4% 2009 7.4% 2014 1,917 Issued in 2002 EUR 3.3% 2007 5.8% 2012 418

3 mth. Euribor+ Issued in 2004 EUR 3.3% 2009 165 bps. 2014 24,911

34,570

Parent company’s total subordinated loans 48,518

Subsidiaries’ subordinated loans: Issued in 1999, Tier II EUR 6.4% 2009 2,505 Issued in 1996, Tier II DKK 0.0% 2007 684 Issued in 1999, Tier II JPY 4.8% 2032 5,920 Subsidiaries’ total subordinated loans 9,109

Total 57,627

Equity 67. According to the Parent Company’s Articles of Association, total share capital amounts to ISK 6,607 million. At year- end 2004 own shares amounted to ISK 86 million and share capital, according to the Balance Sheet, thus amounted to ISK 6,521 million. One share amounts to a nominal value of ISK 10. One vote is attached to each share. Increase of share capital during the year is specified as follows: Share capital Market value

Issued new share capital due to the acquisition of FIH 1,101 39,649 Issued new share capital 1,100 52,794 Own shares bought and sold ( 64 ) ( 2,949 )

Total 2,137 89,494

AMOUNTS ARE IN ISK MILLIONS I 1 1 1 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

68. Changes in equity are specified as follows:

Share Share Accrued stock Retained capital premium options earnings Total

Equity 1.1.2004 4,384 23,304 316 17,925 45,929 Dividend paid ( 1,322 ) ( 1,322 ) Treasury stock, sold 2,201 90,242 92,443 Own shares, bought and sold ( 64 ) ( 3,144 ) ( 159 ) ( 3,367 ) Net earnings 15,760 15,760 Equity 31.12.2004 6,521 110,402 157 32,363 149,443

Share premium is specified as follows:

Share premium account 110,036 Statutory reserve 366 Share premium, total 110,402

69. Equity at year-end amounts to ISK 149,443 million. The capital ratio, calculated in accordance to Article 84 of the Act on Financial Undertakings, was 14.2%. According to the law the ratio is not allowed to fall below 8.0%. The ratio is calculated as follows: Group Book value Weighted value Risk base: Assets recorded in the Annual Accounts 1,534,020 1,166,377 Assets deducted from capital ( 50,335 ) Guarantees and other items not included in the Balance Sheet 73,129 Risk base, total 1,189,171

Capital: Tier I capital: Recorded equity 149,443 Minority interest 9,306 Goodwill ( 34,208 ) Other assets ( 1,232 ) Subordinated loans 13,947

Tier II capital: Subordinated loans 43,108

Investment in credit institutions ( 11,598 ) Total equity base 168,766

Capital ratio 14.2% Thereof Tier I capital 11.5%

I 1 1 2 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

Stock Options 70. The Bank has granted its employees stock options exercisable from 2005 until 2008. The Bank will use own shares and increase share capital to meet employee stock options. Employee stock options at year-end are 12.6 million shares. Changes in stock options are specified as follows

Shares (in thous.)

Stock options at the beginning of the year 7,654 Stock options issued during the year 8,120 Stock options exercised during the year ( 2,999 ) Expired or terminated stock options during the year ( 145 )

Stock options at year-end 2004 12,630

Stock options are specified as follows at year-end:

Exercisable in: Price Shares (in thous.)

2005 114.9 150 2005 102.5 2,767 2005 – 2007 102.5 81 2005 122.0 1,000 2005 – 2006 120.0 240 2005 – 2008 114.9 1,896 2005 – 2008 303.0 6,496

12,630

71. The Bank has sold shares to 64 of its employees at market value. These shares hold put options on 12.7 million shares at the strike price of 210 - 457 exercisable in 2006 - 2008. At year-end the Bank has no obligations with respect to these put options.

Obligations 72. The Bank has granted its customers guarantees and overdraft permissions. These guarantees and overdrafts are specified as follows:

Group Parent 2004 2003 2004 2003

Guarantees 116,160 16,139 38,865 15,505 Unused overdrafts 14,787 13,404 13,439 12,638 Loan commitments 144,688 13,769 85,939 13,769

AMOUNTS ARE IN ISK MILLIONS I 1 1 3 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

73. Derivatives, remaining maturity date of principal and book value, are specified as follows:

Principal Book value Over 3 Up to months and Over 3 months up to a year 1 year Total Assets Liabilities

Group Currency and interest rate derivatives Agreements unlisted: Forward exchange rate agreements 279,196 17,507 306 297,009 4,170 3,427 Interest rate and exchange rate agreements 109,933 199,415 728,588 1,037,936 8,675 45,167 Options, purchased 12,530 2,989 2,357 17,876 293 0 Options, sold 8,848 5,094 22,819 36,761 0 188

Total 410,507 225,005 754,070 1,389,582 13,138 48,782

Equity derivatives Agreements unlisted: Swaps 6,015 5,106 2,581 13,702 879 528 Options, purchased 0 2,089 2,000 4,089 31 Options, sold 0 721 2,000 2,721 96 Agreements: Futures 0 5,029 0 5,029 0 6

Total 6,015 12,945 6,581 25,541 910 630

Bond derivatives Agreements unlisted: Swaps 45,546 1,335 0 46,881 181 2,941

Derivatives total 462,068 239,285 760,651 1,462,004 14,229 52,353

I 1 1 4 I AMOUNTS ARE IN ISK MILLIONS I NOTES I

73. Contd.:

Principal Book value Over 3 Up to months and Over 3 months up to a year 1 year Total Assets Liabilities

Parent Currency and interest rate derivatives Agreements unlisted: Forward exchange rate agreements 175,914 12,678 213 188,805 2,694 2,834 Interest rate and exchange rate agreements 2,989 26,287 170,790 200,066 5,388 4,810 Options, purchased 12,530 2,708 0 15,238 293 0 Options, sold 8,848 3,971 0 12,819 0 188

Total 200,281 45,644 171,003 416,928 8,375 7,832

Equity derivatives Agreements unlisted: Swaps 6,015 5,106 77 11,198 879 528 Options, purchased 0 0 2,000 2,000 0 0 Options, sold 0 0 2,000 2,000 0 36

Total 6,015 5,106 4,077 15,198 879 564

Bond derivatives Agreements unlisted: Swaps 45,546 1,335 0 46,881 181 2,941

Derivatives total 251,842 52,085 175,080 479,007 9,435 11,337

The objective of the above-mentioned agreements is to control the currency and interest rate risk of the Group. The credit risk is valued at ISK 25,583 / 14,251 million when calculating the capital ratio of the Group / Parent Company.

74. The lease agreements in force at year-end are for a period of up to 20 years and the Bank has a priority right to purchase the leased real estate or right to extend the lease agreement at the end of that period. The net present value of the Bank’s obligations in relation to the lease is approximately ISK 1,110 million. The Bank has concluded lease agreements regarding the real estate it uses for its operations in Iceland.

75. According to the Act on Deposit Guarantees and Investor Compensation Scheme, the total assets of the Depositors’ and Investors’ Guarantee Fund shall be a minimum of 1.0% of the average insured deposits in Commercial Banks and Savings Banks for the previous year. At year-end 2004 the Bank has no obligation in relation to its participation in the Fund.

AMOUNTS ARE IN ISK MILLIONS I 1 1 5 I I ANNUAL ACCOUNTS OF Kaupthing Bank 200 4 I

Other Items 76. Reconciliation of net earnings according to the Annual Accounts and the Swedish GAAP:

Group Parent 2004 2003 2004 2003

Annual Accounts, net earnings 15,760 7,520 15,760 7,520 Amortization of goodwill ( 168 ) ( 168 ) ( 168 ) ( 168 ) Net earnings in accordance with Swedish GAAP 15,592 7,352 15,592 7,352

Had the Swedish GAAP been used, equity in the Annual Accounts as of 31 December 2004 would have been ISK 1,073 million higher, corresponding to the goodwill item that arose upon the acquisition of Sofi Financial Services Group.

77. The Board of Directors of Kaupthing Bank hf. laid down detailed rules regarding its work procedures, i.a. for the purpose of operating in accordance with exemplary corporate management practices. Furthermore, the Board has appointed two committees, the audit committee and the compensation committee. The majority of the Directors and committee members are independent of the Bank. The Bank’s Board of Directors will continue to ensure that the Bank conducts its operations in accordance with exemplary corporate management practices.

I 1 1 6 I AMOUNTS ARE IN ISK MILLIONS FIVE-YEAR SUMMARY

2004 2003 2002 2001 2000

Profit and Loss Net interest income 18,900 10,124 6,998 5,811 4,089 Other operating income 29,669 21,656 14,414 8,039 5,112 Net operating income 48,569 31,780 21,412 13,850 9,201

Operating expenses ( 24,402 ) ( 18,493 ) ( 12,455 ) ( 10,565 ) ( 7,030 ) Provision for losses ( 3,819 ) ( 3,894 ) ( 2,794 ) ( 1,691 ) ( 815 ) Income tax ( 4,040 ) ( 1,486 ) ( 764 ) 321 ( 343 ) Minority interest ( 548 ) ( 387 ) ( 36 ) 0 0

Net earnings 15,760 7,520 5,363 1,915 1,013

Assets Amounts due from credit institutions 113,543 50,546 38,519 17,696 19,553 Loan 1,088,346 350,994 269,333 204,552 126,823 Bonds and other fixed-income securities 169,666 80,832 69,298 44,264 28,575 Shares and other variable-yield securities 86,952 53,253 36,410 37,340 21,761 Goodwill 34,208 5,948 3,002 365 0 Fixed assets 6,467 5,441 5,377 4,930 4,300 Other assets 34,838 11,555 10,473 8,416 6,609

Total assets 1,534,020 558,569 432,412 317,563 207,621

Liabilities and Equity Amounts owed to credit institutions 147,455 79,267 109,865 88,166 47,731 Deposits 202,038 182,497 164,570 83,473 67,369 Borrowings 884,219 210,645 102,029 109,750 66,828 Other liabilities 74,767 17,278 10,034 5,116 5,495 Deferred income-tax liability 9,165 1,646 411 317 1,337 Subordinate loans 57,627 10,704 11,010 8,364 6,187 Minority interest 9,306 10,603 1,114 223 58 Equity 149,443 45,929 33,379 22,154 12,616

Total liabilities and equity 1,534,020 558,569 432,412 317,563 207,621

Key Ratios Return on equity 22.6% 23.0% 18.7% – – Capital ratio (CAD) 14.2% 14.2% 14.7% 11.6% – Provision for losses during the year 0.4% 1.1% 1.0% 0.8% 0.6% Provision for losses at year-end 1.4% 2.4% 2.1% 2.0% 1.7% Expenses to net operating income ratio 50.2% 58.2% 58.2% 76.3% 76.4%

Trading between Kaupthing Bank hf. and Bunadarbanki Islands hf. formed an insignificant part of the banks’ trading in 1999 to 2002 and should therefore not have a significant impact when the operations of the merged bank are compared. I KAUPTHING BANK I ANNUAL REPORT 2004 I

DIFFERENCES BETWEEN ICELANDIC AND SWEDISH ACCOUNTING PRINCIPLES

Generally accepted accounting principles (GAAP) in Group consolidation of Swedish financial companies is Iceland are based on The Annual Accounts Act of prepared in accordance with the Act (1995:1559) on 1994 and rules on the financials statements of credit Annual Accounts for Credit Institutions and Securities institutions that reflect EU Directives and standards Companies (ÅRKL) and regulations and general guide- issued by the Icelandic Accounting Standards Board. lines issued by the Swedish Financial Supervisory Authority (FFFS 2002:22). A slight difference can be Generally accepted accounting principles in Sweden are detected between the form of the accounts and the based on the Act (1995:1559) on Annual Accounts for information disclosed in Kaupthing Bank’s Accounts. Credit Institutions and Securities Companies incorpo- rating EU Directives, Finansinspektionen´s Regulations Inflation adjustments were included in income up and General Guidelines on Annual Accounts of until January 2002, although Iceland had not had a Credit Institutions and Securities Companies and on hyperinflationary economy since 1990. The following accounting standards issued by the Swedish Financial areas have been identified where Kaupthing Bank’s Accounting Standards Council. accounting principles differ significantly from Swedish companies with similar operations using Swedish An EU regulation requires all listed companies to apply GAAP as of 1 January 2002 international accounting standards (IAS) in their consolidated statements as of year 2005. As a member of Consolidated Accounts the European Economic Area, Iceland will be required Kaupthing Bank: to apply the regulations as well. See page 120 for an Two methods were applied in Kaupthing Bank’s con- overview of how Kaupthing Bank’s financial report- solidated statements for investments in subsidiaries, ing will be affected by the implementation of the the purchase method and pooling of interests method International Financial Reporting Standards (IFRS). of accounting.

As a step in the adoption of IAS, The Swedish Financial The Bank has not adopted in full the IAS recommenda- Accounting Standards Council has issued several new tions No. 22 on business combinations and No. 27 on recommendations that comply with IAS in all major consolidated financial statements and accounting for respects. The corresponding process has not yet investments in subsidiaries. A deviation in Kaupthing occurred in Iceland. In Iceland amendments have been Bank’s consolidated statements is thus created by made on the Annual Accounts Act as a step in the assuming that the aforementioned standards were adoption of IAS. applied, as in two instances in 2001 the pooling of interests method of accounting was used instead of Today there are some differences between Icelandic the purchase method according to IAS. and Swedish GAAP, although not all are applicable to financial sector companies. Swedish GAAP: Under Swedish GAAP the same investment transac- As a financial sector company, Kaupthing Bank’s tions ought to have applied the purchase method accounting principles are in accordance with laws and instead of the pooling of interests method. regulations on Annual Accounts and directions issued by the Icelandic Financial Supervisory Authority on the financial statements of credit institutions. Impairment of assets Kaupthing Bank: Kaupthing Bank’s Annual Report consists of two docu- Fixed assets and goodwill are written down in propor- ments, which complement each other, while a Swedish tion to their lifetime. Kaupthing Bank has not adopted Annual Report is one single document. IAS recommendation No. 36 on impairment of assets.

I 118 I I DIFFERENCES BETWEEN ICELANDIC AND SWEDISH ACCOUNTING PRINCIPLES I

Swedish GAAP: acquisition cost and fair value. Financial instruments Swedish GAAP are based on the Swedish Financial denominated in foreign currency are translated by Accounting Standards Council recommendation No. closing rate. Unrealised and realised gains and losses 17 on impairment of assets and follows in all mate- are reported in the income statement for the period rial aspects IAS recommendation No. 36 on the same and are included in unrestricted shareholders’ equity. subject. Financial fixed assets are reported at acquisition cost. If the acquisitions above had been posted according Investments in fixed income securities are reported at to the purchase method, the goodwill would have been amortised cost if there is a positive intent to hold the written down over a period of years and an impairment investments for at least one year. of assets test performed. Swedish GAAP: Changes in accounting principles Under Swedish GAAP, financial instruments in the Kaupthing Bank: trading book are reported at either fair value or the In accordance with Icelandic GAAP, Kaupthing Bank lower of acquisition cost and fair value. When finan- decides upon the necessary changes in accounting cial instruments are reported at fair value and when principles on a case-to-case basis. In 2002, Kaupthing unrealized gains are included in reported net income Bank abandoned its inflation adjustment accounting for the period, an amount equivalent to the reported because of changes made in national laws and regula- unrealised gains, net of tax, are transferred from tions to the effect. unrestricted shareholders’ equity to restricted shareholders’ equity. Swedish GAAP: Under Swedish GAAP, it is possible to report invest- In Sweden changes in accounting principles are ments in fixed income securities at amortised cost accounted for in accordance with recommendation when an enterprise has the positive intent and ability No. 5 issued by the Swedish Financial Accounting to hold to maturity irrespective of how long that period Standards Council. The recommendation follows in is. Reconciliation of net results according to Annual all material aspects the corresponding sections in Financial Statements against Swedish GAAP Note 76 recommendation No. 8 issued by the International in the Annual Accounts specifies a variation in profit, Accounting Standards Board on net profit or loss equity and goodwill from the Swedish GAAP. for the period, fundamental errors and changes in accounting policies. Stock Options Financial instruments Kaupthing Bank: Accounting principles applied by Kaupthing Bank As stated in the annual accounts for the Bank stock and Swedish companies with similar activities differ option contracts have been issued to the employees. slightly in terms of diverse financial instruments. The The cost related to the options has been valued either effects on reported net income and shareholders’ at market value or with mathematical models and is equity are therefore not quantified. expensed in the Profit and Loss account.

Kaupthing Bank: Swedish GAAP: Investments in equities and fixed income securities in Under Swedish GAAP cost related to stock option con- the trading book, as well as all equity, interest rate and tracts is not expensed but posted on equity. currency related derivative financial instruments, are reported at fair value (market value) or the lower of

I 119 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

IMPLEMENTATION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS)

On 1 January 2005 new legislation came into effect in the European Economic Area whereby all companies listed on European Stock Exchanges are obliged to present their annual accounts in accordance with the International Financial Reporting Standards, IFRS. The changes in the Bank’s shareholders’ equity as of 1 January 2005 as a result of the implementation of IFRS were announced in a press release from the Bank on 16 February 2005.

Changes in shareholders’ equity Shareholders’ ISK millions equity

Shareholders’ Equity according to previous GAAP 31 December 2004 149,443

Adjustments at the beginning of 2004: Impairment of Goodwill IFRS 3 -311 Value changes in Loans because of Embedded Derivative, upfront fee etc IAS 39 -388 Other adjustments -20 Recalculation of Tax liabilities IAS 39 85

Total transition to IFRS 1/1 2004 -634

Adjustments at the beginning of 2005: Value changes because of Hedge Accounting IAS 39 -1,353 Changes in Impairment of Loans IAS 39 4,538 Value changes in Loans because of Embedded Derivative, upfront fee etc IAS 39 -1,234 Trading Liabilities measured at fair value IAS 39 -1,654 Value changes in Financial Assets designated at fair value through P/L IAS 39 1,446 Value changes in Borrowings because of embedded derivative etc IAS 39 -600 Investment in associates IAS 28 -461 Impairment of Goodwill and reversal of amortisation IFRS 3 348 Other adjustments 8 Recalculation of Tax liabilities IAS 12 -477 Total transition to IFRS 1/1 2005 561

Shareholders’ Equity 1 January 2005 149,370

Changes from previous GAAP -73

The total effect on shareholders’ equity of the transition to IFRS is as seen above ISK -73 million, i.e. a minor reduction from the previous GAAP. The following describes the effects of these new accounting principles on the Bank’s balance sheet and how these changes will appear in the annual accounts.

Origination fees / upfront fees The main changes to interest income from the implementation of IFRS are as follows: origination fees will be accrued over the term of the loan instead of being recognised as income at the time of disbursement. As a result the Bank’s interest income will decrease in the short term but the long- term effects will be insignificant.

I 120 I I IMPLEMENTATION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) I

In the opening balance sheet the effective rate of interest on loans has been recalculated in accordance with IAS 39. As a result shareholders’ equity on 1 January 2005 decreased by ISK 1,622 million.

Impairment of loans In accordance with IAS 39 the Bank has performed the impairment of loans. As a result the Bank’s shareholders’ equity increased by ISK 4,538 million.

According to IAS 39 the Bank is obliged to review all loans to ascertain whether there is objective evidence of impairment. If the objective indication of impairment affects the size of expected cash flows from the loan, the loan will be written down to the present value of expected future cash flows.

Loans which are not specifially written down become part of the portfolio, and the portfolio will be assessed for impairment. Assessment of a portfolio assumes that loans have similar risk characteristics. Objective evidence of impairment of a group of loans exists if objective data indicates a decrease in expected future cash flows from a portfolio of loans and the decrease can be measured reliably but cannot be identified with the individual loans in the portfolio.

The implementation of IAS 39 regarding impairment means that calculated interest income related to impaired loans will be recognised as interest income, calculated at original effective interest rate, while the value of a loan at the time of impairment will be calculated based on net present value of future cash flows.

The 2004 policy of not recognising interest income if loans have been in default for more than three months will be ceased from 1 January 2005 as it is not consistent with IAS 39.

Goodwill In accordance with IFRS goodwill will no longer be amortised. Instead the value of goodwill will be tested for impairment. Shareholders’ equity on 1 January 2004 decreased by ISK 311 million because goodwill was amortised owing to the fact that it was not possible to perform an impairment test in accordance with IAS 36. The amortisation of goodwill for 2004 was reversed. In addition the goodwill from the acquisition of FI-Holding in July 2004 was recalculated in accordance with IFRS 3, business combinations. As a result shareholders’ equity on 1 January 2005 increased by ISK 300 million before tax. Kaupthing Bank will not restate business combinations that occurred before the transition date of 1 January 2004.

Foreign currency translation Under the 2004 accounting standards, income and expenses in foreign currency were translated into Icelandic króna using the exchange rates current at the time of recognition.

The income and expenses of Kaupthing Bank’s non-Icelandic branches and subsidiaries were translated at average exchange rates, while balance-sheet items were translated at the rates current at the end of the year. All exchange rate differences were included in the profit and loss account under Trading income.

I 121 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Under IAS 21, the Effects of Changes in Foreign Exchange Rates, all translation differences must be recognised directly in shareholders’ equity as a separate reserve. Assets and liabilities in non-Icelandic branches and subsidiaries are translated into Icelandic króna at the exchange rates current on the balance sheet date. Income and expenses are translated at the exchange rates current at the time of the transaction. Exchange rate gains and losses on outstandings with non-Icelandic units that are considered part of the total net investment in the non-Icelandic units are recognised directly against shareholders’ equity. Exchange rate adjustments of liabilities and derivatives used to hedge net investments are also recognised directly against shareholders’ equity.

New companies consolidated Due to the implementation of IFRS the Bank will treat two companies that previously were allocated as associated companies as subsidiaries, Althjóda Líftryggingarfélagid and Eik fasteignafélag. Legal entities which are mortgages foreclosed are consolidated as non-current assets and disposal groups classified as held for sale in the balance sheet.

Unlisted assets entered at market value The Bank will now enter all its shares in unlisted companies at estimated fair value instead of purchase price or mark-to-market, if this was estimated to be lower than purchase price. This change results in trading gains which are mostly entered in the profit and loss account. Upon the implementation of IFRS shareholders’ equity on 1 January 2005 increased by ISK 1,446 million due to the increase in unlisted assets to fair value. When calculating the fair value of Meidur ehf., the company’s share in Kaupthing Bank is valued at cost.

The Danish mortgage loans In the EU carve out version of IAS 39 it is not permitted to measure liabilities at fair value. Nevertheless in the case of the subsidiary of FI-holding, FIH Realkredit, mortgage loans and closely related issued mortgage bonds are measured at fair value. These items will not affect equity in the opening balance sheet of 1 January 2005. Uncertainty remains with respect to whether the annual accounts for 2005 can reflect the fair value measurement of issued bonds.

Minority interests Under the 2004 accounting policies, minority interests were presented as a separate item outside shareholders’ equity. According to IAS 27, Consolidated and Separate Financial Statements, minority interest shall be presented within equity, separately from the parent shareholders’ equity.

Hedge accounting The implementation of IAS 39 on hedge accounting will affect the opening balance as of 1 January 2005. The Group will use hedge accounting for financial assets and liabilities where relevant. All derivatives will be measured at fair value. The net effect of the conversion to hedge accounting applied under IFRS on the equity in the opening balance sheet of 1 January 2005 is approximately ISK -1,353 million. The effect is a result of applying fair value to certain assets and related derivatives, as opposed to previously applying deferral hedge accounting (amortised cost principle).

I 122 I I IMPLEMENTATION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) I

In addition, initial recognition of income related to derivatives is reflected by an opening balance effect of approximately ISK - 600 million.

From previous GAAP to IFRS The table below provides an overview of the effect of the transition to IFRS broken down by valuation and presentation.

Balance sheet January 1, 2005 Change Change in ISK millions in valuation presentation

Previous GAAP 31/12 2004 IFRS 1/1 2005 Cash and amounts due from credit institutions 113,543 0 -107,253 6,290 Cash and cash balances with central bank Loans, lease contracts 1,088,346 11,704 54,366 1,154,416 Loans and receivables - 630 31,124 31,754 Mortgage loans 1) Bonds, shares and other securities 248,352 30 -43,196 205,186 Financial assets held for trading 2) - 1,445 62,249 63,694 Financial assets designated at fair value through P/L 3) - -28 1,535 1,507 Financial assets available-for-sale 4) - 3,246 574 3,820 Derivatives used for hedging 5) Shares in associated companies 8,266 -461 -4,156 3,649 Investment in associates and joint ventures Goodwill 34,208 -11 34,197 Intangible assets - 377 18,778 19,155 Investment property 6) Fixed assets 6,467 12 514 6,993 Property, plant and equipment Deferred tax assets 1,039 0 53 1,092 Tax assets - -61 3,692 3,631 Non-current assets and disposal groups classified as held for sale 7) - 0 107 107 Reinsurers´ share in insurance fund Other assets 33,799 109 -14,946 18,962 Other assets Total assets 1,534,020 16,992 3,441 1,554,453 Total assets

Amounts owed to credit institutions 147,455 0 -114,967 32,488 Deposits from credit institutions and central bank Savings deposits 202,038 0 155 202,193 Other deposits Borrowings 884,219 2,861 81,432 968,512 Borrowings Subordinated loans 57,627 0 -4 57,623 Subordinated loans - 696 34,180 34,876 Mortgage funding 1) - 0 1,345 1,345 Insurance liabilities - 1,654 12,262 13,916 Trading liabilities 8) - 11,125 8,094 19,219 Derivatives used for hedging 5) Provision for deferred income-tax liability 9,165 392 -1,824 7,733 Tax liabilities - 0 1,402 1,402 Liabilities included in disposal groups classified as held for sale 7) Other liabilities 74,767 337 -18,867 56,237 Other liabilities Equity 149,443 -73 0 149,370 Shareholders' equity Minority interest in subsidiaries' equity 9,306 0 233 9,539 Minority interest Total liabilities and equity 1,534,020 16,992 3,441 1,554,453 Total liabilities and equity

1) Mortgage loans / Mortgage funding: Danish mortgage loans (Real kredit) and bonds issued are measured at fair value 2) Financial assets held for trading: Securities and derivatives measured at fair value. Securities measured at fair value (short term gain), OTC derivatives etc. measured at fair value 3) Financial assets designated at fair value though P/L: Other securities measured at fair value with changes through P/L 4) Financial assets available-for-sale: Securities measured at fair value with changes in equity 5) Derivatives used for hedging: Derivatives used for interest risk hedging, measured at fair value 6) Investment properties: Among investment properties are operating lease properties 7) Non-Current assets and disposal groups classified as held for sale: Includes mortgage foreclosed and disposal entities 8) Trading liabilities: Derivatives at fair value and short positions in trading securities

I 123 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

The new balance sheet According to IFRS the new balance sheet appears as below:

Opening balance sheet from January 1, 2005

ISK millions

Assets Cash and cash balances with central banks 6,290 Loans and receivables 1,154,416 Mortgage loans measured at fair value 31,754 Financial assets held for trading 205,186 Financial assets designated at fair value through P/L 63,694 Financial assets available-for-sale 1,507 Derivatives used for hedging 3,820 Investment in associates and joint ventures 3,649 Intangible assets 34,197 Investment property 19,155 Property, plant and equipment 6,993 Tax assets 1,092 Non-Current assets and disposal groups classified as held for sale 3,631 Reinsurers share in insurance fund 107 Other assets 18,962

Total assets 1,554,453

Liabilities and equity Deposits from credit institutions and central bank 32,488 Other deposits 202,193 Borrowings 968,512 Subordinated loans 57,623 Mortgage funding measured at fair value 34,876 Insurance liabilities 1,345 Trading liabilities 13,916 Derivatives used for hedging 19,219 Tax liabilities 7,733 Liabilities included in disposal groups classified as held for sale 1,402 Other liabilities 56,237 Shareholders’ equity 149,370 Minority interest 9,539

Total liabilities and equity 1,554,453

Different balance sheet The main difference from previous GAAP on the balance sheet are: Assets • Bonds, shares and other securities on one line according to previous GAAP are now divided into four lines;

I 124 I I IMPLEMENTATION OF INTERNATIONAL FINANCIAL REPORTING STANDARDS (IFRS) I

- Financial assets held for trading - Financial assets designated at fair value through P/L - Financal assets avaliable-for-sale - Derivatives used for hedging (also on the liability side)

• Investment property - Properties for renting purpose, measured at fair value - Underlying assets of operating lease, measured at fair value

• Reinsurers’ share in insurance fund and insurance liabilities - New in the balance sheet from Althjoda Liftryggingafelagid, as explained above

• Non-current assets and disposal groups classified as held for sale. - Assets of legal entities which are mortgages foreclosed, "one line consolidation" - Other mortgages forecosed

Liabilities • Insurance liabilities - New in the balance sheet from Althjoda Liftryggingafelagid, as explained above

• Trading liabilities - Liabilities in connection to Trading assets like negative position of OTC derivatives etc.

• Liabilities included in disposal groups classified as held for sale - Liabilities of legal entities which are mortgages foreclosed, "one line consolidation" - Liabilities on other mortgages forecosed

I 125 I

I KAUPTHING BANK I ANNUAL REPORT 2004 I

THE BOARD OF DIRECTORS OF KAUPTHING BANK

Sigurdur Einarsson Hjörleifur Thór Jakobsson Ásgeir Thoroddsen Bjarnfredur H. Ólafsson Brynja Halldórsdóttir

BOARD OF DIRECTORS

Sigurdur Einarsson Finnur Ingólfsson Born 1960 • Elected 2003 • Executive Chairman of Born 1954 • Elected 2003 • CEO of Vátryggingafélag Kaupthing Bank • Cand. polit. from the University Íslands hf. • Holdings in Kaupthing Bank: 0 shares, of Copenhagen • Joined Kaupthing Bank in 1994 0 call options, 0 put options. Holdings of financially • Holdings in Kaupthing Bank: 2,511,979 shares, related parties: 30,202,920 shares. 4,080,444 call options, 812,000 put options. Holdings of financially related parties: 14,111 shares. Gunnar Páll Pálsson Born 1961• Elected 2001 • CEO of Commercial Hjörleifur Thór Jakobsson Workers’ Union of Reykjavík (VR) • Holdings in Born 1957 • Elected 2003 • Vice Chairman of the Kaupthing Bank: 1,710 shares, 0 call options, 0 put Board • CEO of Olíufélagid ehf. • Holdings in Kaupthing options. Holdings of financially related parties: 4,722 Bank: 12,788 shares, 0 call options, 0 put options. shares. Holdings of financially related parties: 8,827 shares. Peter Gatti Ásgeir Thoroddsen Born 1947 • Elected 2003 • Managing director of Born 1942 • Elected 2003 • Attorney to the Supreme Hauck & Aufhäuser Privatbankiers KGaA • Holdings Court of Iceland • Holdings in Kaupthing Bank: 718 in Kaupthing Bank: 0 shares, 0 call options, 0 put shares, 0 call options, 0 put options. Holdings of options. Holdings of financially related parties: 0 financially related parties: 316 shares. shares.

Bjarnfredur H. Ólafsson Tommy Persson Born 1967 • Elected 2003 • Attorney to the District Born 1948 • Elected 2002 • CEO of Länsforsäkringar Court of Iceland • Holdings in Kaupthing Bank: 176 AB • Other directorships: Chairman of the Swedish shares, 0 call options, 0 put options. Holdings of Insurance Federation and the Swedish Insurance financially related parties: 352 shares. Employers’ Association. • Chairman of EurAPCO AG.• Board member of Eureko BV • Holdings in Kaupthing Brynja Halldórsdóttir Bank: 0 shares, 0 call options, 0 put options. Holdings Born 1957 • Elected 2004 • CEO Norvik hf. • Holdings of financially related parties: 0 shares. in Kaupthing Bank: 9,206 shares, 0 call options, 0 put options. Holdings of financially related parties: 1,084,327 shares.

I 128 I I THE BOARD OF DIRECTORS OF KAUPTHING BANK I

Finnur Ingólfsson Gunnar Páll Pálsson Peter Gatti Tommy Persson

SENIOR MANAGEMENT

Chief Executive Officer Ingólfur Helgason Born 1967 • Managing director of Capital Markets Hreidar Már Sigurdsson • Graduated in Business Administration from the Born 1970 • CEO • Graduated in Business University of Iceland 1993 • Joined Kaupthing Bank Administration from the University of Iceland 1994 in 1993 • Holdings in Kaupthing Bank: 1,879,335 • Joined Kaupthing Bank in 1994 • Holdings in shares, 126,592 call options, 750,000 put options. Kaupthing Bank: 2,005,091 shares, 3,642,148 call Holdings of financially related parties: 0 shares. options, 812,000 put options. Holdings of financially related parties: 148,617 shares. Related parties’ rights pursuant to swap agreement: 205,078 shares. Kristín Pétursdóttir Born 1965 • Managing director of Treasury • MSc Managing directors of profit centres in International Business from Handelshøyskolen in Bergen • Joined Kaupthing Bank in 1997 • Holdings Ármann Thorvaldsson in Kaupthing Bank: 1,108,718 shares, 66,148 call Born 1968 • Managing director of Investment Banking options, 375,000 put options. Holdings of financially • MBA from Boston University • Joined Kaupthing Bank related parties: 0 shares. in 1994 • Holdings in Kaupthing Bank: 1,776,102 shares, 84,148 call options, 750,000 put options. Kristján Arason Holdings of financially related parties: 509 shares. Born 1961 • Managing director of Private Banking • Graduated in Business Administration from the Bjarki Diego University of Iceland • Joined Kaupthing Bank in Born 1968 • Managing director of Corporate Banking • 2001• Holdings in Kaupthing Bank: 680,971 shares, Graduated in Law from the University of Iceland in 1993, 240,000 call options, 150,000 put options. Holdings LL.M from University of London in 1999 • Joined Kaupthing of financially related parties: 0 shares. Bank in 2000 • Holdings in Kaupthing Bank: 1,133,709 shares, 6,000 call options, 375,000 put options. Holdings Thórarinn Sveinsson of financially related parties: 874 shares. Born 1967 • Managing director of Asset Management • MSc in Engineering from MIT • Joined Kaupthing Fridrik S. Halldórsson Bank in 1998 • Holdings in Kaupthing Bank: 502,680 Born 1959 • Managing director of Retail Banking • shares, 308,000 call options, 150,000 put options. Graduated in Business Administration from the University Holdings of financially related parties: 0 shares. Rights of Iceland in 1985 • Joined Búnadarbanki Íslands hf. in pursuant to swap agreement: 252,249 shares. 1993 • Holdings in Kaupthing Bank: 441,518 shares, 184,932 call options, 150,000 put options. Holdings of financially related parties: 0 shares. I 129 I I KAUPTHING BANK I ANNUAL REPORT 2004 I

Organisation chart

Board of Directors

Internal Auditor

CEO

Risk Management

Investment Finance & Retail Banking Banking Accounting

Capital Corporate Asset Man. & Treasury Markets Banking Private Banking

Managing directors of finance and risk Internal Auditor management Gudjón Jóhannesson Gudný Arna Sveinsdóttir Born 1969 • Internal Auditor • Graduated in Business Born 1966 • Managing director of Finance and Administration from the University of Iceland in Accounting • MSc in Finance and Accounting from 1995 • State authorised public accountant since the University of Uppsala in 1996 • Joined Kaupthing 2000 • Chairman of the Internal Auditing Association Bank in 2001 • Holdings in Kaupthing Bank: 742,550 of Iceland (IIA) since 2003 • Joined Búnadarbanki shares, 1,200 call options, 375,000 put options. Íslands hf. in 1999 • Holdings in Kaupthing Bank: Holdings of financially related parties: 0 shares. 17,891 shares, 0 call options, 0 put options. Holdings of financially related parties: 0 shares. Dr. Steingrímur P. Kárason Born 1968 • Managing director of Risk Management State Authorised Public Accountants • Ph.D. in Mechanical Engineering from MIT in 1997 The state authorised public accountants of Kaup- • Joined Kaupthing Bank in 1997 • Holdings in Kaup- thing Bank are KPMG Endurskodun hf., and on their thing Bank: 1,842,133 shares, 120,000 call options, behalf, Sigurdur Jónsson. 750,000 put options. Holdings of financially related parties: 33,179 shares. Sigurdur Jónsson Born 1956 • State Authorised Public Accountant • Accountant of Kaupthing Bank from 1991.

I 130 I I THE BOARD OF DIRECTORS OF KAUPTHING BANK I

Managing directors of main subsidiaries

Christer Villard Johnie Brøgger Born 1949 • CEO of Kaupthing Bank Sverige • Graduated Born 1958 • Managing director of Kaupthing Bank in Law from the University of Stockholm • Joined Luxembourg S.A.• MBA from Copenhagen School Kaupthing Bank in 2002 (Aragon 1997) • Holdings in of Economics and Business and MSc in Accounting Kaupthing Bank: 0 shares, 0 call options, 0 put options. • Joined Kaupthing Bank in 1999 • Holdings in Holdings of financially related parties: 0 shares. Kaupthing Bank: 1,275,319 shares, 100,000 call options, 750,000 put options. Holdings of financially Heikki Niemelä related parties: 0 shares. Born 1976 • Managing director of Kaupthing Bank Oyj • MBA in Finance from Helsinki School of Economics Lars Johansen and Business Administration / Indiana University, USA Born 1945. Managing Director and CEO of FIH Erhvervs- 1999 • Joined Kaupthing Bank in 2002 • Holdings bank A/S, Copenhagen. Master Degree in Economics in Kaupthing Bank: 400,000 shares, 0 call options, from the University of Copenhagen (1970). Joined 150,000 put options. Holdings of financially related Kaupthing Bank in 2004 (FIH Erhvervsbank A/S 1998). parties: 0 shares. Holdings in Kaupthing Bank: 0 shares, 0 call options, 0 put options. Holdings of financially related parties: Helgi Bergs 0 shares. Born 1966 • Managing director of Kaupthing Ltd. • Graduated in Engineering from the University of Magnús Gudmundsson Iceland in 1990 • Joined Kaupthing Bank in 1997 • Born 1970 • Managing director of Kaupthing Holdings in Kaupthing Bank: 975,200 shares, 40,000 Bank Luxembourg S.A.• Graduated in Business call options, 425,000 put options. Holdings of finan- Administration from the University of Iceland • Joined cially related parties: 0 shares. Kaupthing Bank in 1994 • Holdings in Kaupthing Bank: 1,709,870 shares, 150,000 call options, Henrik Sjøgren 750,000 put options. Holdings of financially related Born 1964, Managing Director of FIH Erhvervsbank A/S, parties: 0 shares. Copenhagen. Bachelor of Commerce (Financial and Economy) from Copenhagen Business School (1990). Peter Holm Joined Kaupthing Bank in 2004 (FIH Erhvervsbank Born 1968 • Managing director of Kaupthing Føroyar 1992). Holdings in Kaupthing Bank: 0 shares, 0 call • Cand. Merc. from Copenhagen Business School • options, 0 put options. Holdings of financially related Joined Kaupthing Bank in 2000 • Holdings in Kaupthing parties: 0 shares. Bank: 32,000 shares, 8,000 call options, 0 put options. Holdings of financially related parties: 0 shares. John E. Skajem Born 1963 • Managing director of Kaupthing Norge Robert Gibbons • MBA from the University of Chicago GSB 1992 Born 1969 • CEO of Kaupthing New York Inc. • MBA • Joined Kaupthing Bank in 2003 • Holdings in from Stern NYU • Joined Kaupthing Bank in 2001 • Kaupthing Bank: 53,413 shares, 0 call options, 0 put Holdings in Kaupthing Bank: 0 shares, 81,000 call options. Holdings of financially related parties: 12,475 options, 0 put options. Holdings of financially related shares. parties: 0 shares.

I 131 I

Kaupthing Bank Kaupthing Bank Oyj Kaupthing Norge AS Borgartún 19 Pohjoisesplanadi 37A, 6th floor Grev Wedels Plass 9 105 Reykjavik FIN-00100 Helsinki Post box 657 Sentrum Iceland Finland 0151 Oslo Tel: +354 444 6000 Tel: +358 9 478 4000 Norway Fax: +354 444 6119 Fax: +358 9 478 40111 Tel: +47 24 14 74 00 [email protected] [email protected] Fax: +47 24 14 74 01 www.kaupthing.net www.kaupthing.fi [email protected] www.kaupthing.no FIH-Erhvervsbank Kaupthing Føroyar 43, Langelinie Allé Virdisbrævameklarafelag P/F Kaupthing Asset Management S.à.r.l. DK-2100 Copenhagen Ø Tinghúsvegur 14, Postboks 3090 1 Rue de Rive Denmark FO-110 Torshavn CH-1204 Geneva Tel: +45 7222 5000 Faroe Islands Switzerland Fax: +45 7222 5001 Tel +298 351500 Tel: +41 22 310 1915 www.fih.dk Fax: +298 351501 Fax: +41 22 591 2942 [email protected] [email protected] Kaupthing New York Inc. www.kaupthing.fo www.kaupthing.ch 230 Park Avenue, Suite 1528 Kaupthing Bank Luxembourg S.A. Kaupthing Bank Sverige AB New York NY 10169 12, Rue Guillaume Schneider Stureplan 19 USA L-2522 Luxembourg 107 81 Stockholm Tel: +1 212 457 8700 Luxembourg Sweden Fax: +1 212 457 8725 Tel: +352 46 31 31 Tel: +46 8 791 48 00 [email protected] Fax: +352 46 31 32 Fax: +46 8 611 26 90 www.kaupthing.us [email protected] [email protected] www.kaupthing.lu www.kaupthing.se Kaupthing Ltd. 89 New Bond Street, 5th Floor London W1S 1DA United Kingdom Tel: +44 207 529 5222 Fax: +44 207 529 5223 [email protected] www.kaupthing.co.uk