Consolidated Financial Statements. Butterfield Bank (Cayman) Limited

Transcription

1 Consolidated Financial Statements Butterfield Bank (Cayman) Limited For the years ended 31 December 2010 and 2009

2 Contents Report of Independent Auditors 1 Consolidated Balance Sheets 2 Consolidated Statements of Income 3 Consolidated Statements of Changes in Shareholder s Equity 4 Consolidated Statements of Comprehensive Income 4 Consolidated Statements of Cash Flows

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4 Consolidated Balance Sheets As at 31 December (Expressed in United States Dollars) Assets Cash and demand deposits with banks 126,825, ,750,508 Term deposits with banks 678,491,060 1,060,944,050 Total cash and deposits with banks (note 3 and note 8) 805,316,700 1,383,694,558 Investments Available for sale 540,486, ,963,735 Held to maturity - 76,795,658 Total investments (note 4 and 12) 540,486, ,759,393 Loans, net of allowance for credit losses (note 5, 6 and 8) 616,125, ,757,494 Premises, equipment and computer software (note 7) 61,224,349 57,526,071 Accrued interest (note 8) 2,077,198 2,397,189 Intangible assets (note 9) 700, ,973 Other assets (note 8 and 15) 6,842,303 14,079,613 Total assets 2,032,772,859 2,604,995,291 Liabilities Deposits Non-interest bearing 260,049, ,364,165 Interest bearing Customers 1,520,739,346 2,058,090,492 Banks 36,663,020 76,292,697 Total deposits (note 8 and 10) 1,817,451,536 2,411,747,354 Accrued interest 451, ,461 Other liabilities (note 8 and 15) 60,106,779 34,138,469 Total other liabilities 60,558,052 34,635,930 Total liabilities 1,878,009,588 2,446,383,284 Shareholder s equity Share capital ($1.00 par: Authorised shares 16,450,000 (2009:16,450,000)) 16,450,000 16,450,000 Retained earnings 147,331, ,116,393 Accumlated other comprehensive loss (9,017,844) (10,954,386) Total shareholder's equity 154,763, ,612,007 Total liabilities and shareholder's equity 2,032,772,859 2,604,995,291 Signed on behalf of the Board by: Conor J. O Dea Managing Director James E. O Neill Director The accompanying notes on pages 6 to 29 form an integral part of these consolidated financial statements. Page 2

5 Consolidated Statements of Income For the years ended 31 December (Expressed in United States Dollars) Non-interest income Asset management (note 8) 4,481,156 4,721,507 Banking services 9,694,540 9,005,558 Foreign exchange revenue 11,438,592 11,385,384 Trust and corporate services 5,263,271 5,174,775 Other non-interest income 180, ,876 Total non-interest income 31,058,165 30,932,100 Interest income Loans (note 8 and 13) 24,142,036 23,870,926 Investments 3,289,640 7,445,780 Deposits with banks (note 8) 3,827,787 9,528,750 Total interest income 31,259,463 40,845,456 Interest expense (note 8) (2,550,316) (6,209,265) Net interest income before allowance for credit losses 28,709,147 34,636,191 Allowance for credit losses (note 5) (3,808,338) (7,786,858) Net interest income after allowance for credit losses 24,900,809 26,849,333 Total revenue 55,958,974 57,781,433 Non-interest expense Salaries and other employee benefits 27,414,283 26,254,777 Technology and communications 11,165,013 9,777,606 Professional and outside services 716, ,471 Property 5,058,698 5,681,357 Non-income taxes 1,605, ,803 Amortisation of intangible assets (note 9) 80,784 80,784 Marketing 808,624 1,009,922 Other expenses (note 8 and 14) 3,287,618 5,000,361 Total non-interest expense 50,137,773 49,414,081 Net income before investment losses and gains 5,821,201 8,367,352 Net realised losses on available for sale investments (note 4) (11,606,479) - Net realised gains on held to maturity investments (note 4) - 261,300 Net (loss)/income (5,785,278) 8,628,652 The accompanying notes on pages 6 to 29 form an integral part of these consolidated financial statements. Page 3

6 Consolidated Statements of Changes in Shareholder's Equity For the years ended 31 December (Expressed in United States Dollars) Share capital Authorised, issued and fully paid: 16,450,000 shares of $1.00 each 16,450,000 16,450,000 Retained earnings Appropriated - general reserve 35,000,000 35,000,000 Unappropriated at beginning of year 118,116, ,487,741 Net (loss)/income (5,785,278) 8,628, ,331, ,116,393 Dividends - (19,000,000) Unappropriated at end of year 112,331, ,116,393 Retained earnings - balance at end of year 147,331, ,116,393 Accumulated other comprehensive income Balance at beginning of year (10,954,386) - Unrecognised gains and losses on available for sale securities 1,936,542 (10,954,386) Balance at end of year (9,017,844) (10,954,386) Total shareholder s equity 154,763, ,612,007 Consolidated Statements of Comprehensive Income For the year ended 31 December (Expressed in United States Dollars) Comprehensive income Net (loss)/income (5,785,278) 8,628,652 Other comprehensive income/(loss) 1,936,542 (10,954,386) Total comprehensive loss (3,848,736) (2,325,734) The accompanying notes on pages 6 to 29 form an integral part of these consolidated financial statements. Page 4

7 Consolidated Statements of Cash Flows For the years ended 31 December (Expressed in United States Dollars) Cash flows from operating activities Net (loss)/income (5,785,278) 8,628,652 Adjustments to reconcile net income to cash provided by operating activities Depreciation and amortisation 3,960,966 4,154,207 Allowance for credit losses 3,808,338 7,786,858 Net realised losses on sale of available for sale investments 11,606,479-13,590,505 20,569,717 Net change in other assets and liabilities 33,479,423 10,739,616 Cash provided by operating activities 47,069,928 31,309,333 Cash flows from investing activities Net decrease in term deposits with banks 382,452, ,698,720 Net additions to premises, equipment and computer software (6,907,583) (5,795,846) Net increase in loans (55,176,533) (64,925,004) Available for sale securities: proceeds from sales and maturities 303,942, ,123,219 Available for sale securities: purchases and transfers (340,541,877) (441,500,000) Held to maturity securities: proceeds from sales, maturities and transfers 67,532, ,233,627 Held to maturity securities: purchases - (14,992,500) Cash provided by investing activities 351,301, ,842,216) Cash flows from financing activities Net decrease in customer deposits (594,295,818) (705,056,032) Cash dividends paid - (19,000,000) Cash used in financing activities (594,295,818) (724,056,032) Net decrease in cash and demand deposits (195,924,868) (64,904,483) Cash and demand deposits at beginning of year 322,750, ,654,991 Cash and demand deposits at end of year 126,825, ,750,508 Supplemental disclosure of cash flow information Cash interest paid in the year 2,596,504 7,849,447 The accompanying notes on pages 6 to 29 form an integral part of these consolidated financial statements. Page 5

8 Note 1: Nature of Business Butterfield Bank (Cayman) Limited (the Bank ) is a full service community bank and a provider of specialised international financial services. The Bank offers a full range of community banking services in the Cayman Islands, encompassing retail and corporate banking and treasury activities. In the wealth management area, the Bank provides private banking, asset management and personal trust services. The Bank also provides services to corporate and institutional customers, which include asset management and corporate trust services. The Bank was incorporated on 22 November 1967 under the laws of the Cayman Islands and is a wholly-owned subsidiary of The Bank of N.T. Butterfield & Son Limited ("Butterfield"), a company incorporated in Bermuda. Butterfield is a publicly traded corporation with shares listed on the Bermuda and Cayman Islands stock exchanges. The Butterfield Group is regulated by the Bermuda Monetary Authority (BMA), while the Bank is regulated by the Cayman Islands Monetary Authority (CIMA). Both regulators operate in accordance with Basel principles. The Bank holds a category 'A' banking licence and a trust licence under the Banks and Trust Companies Law of the Cayman Islands. In addition, the Bank is licenced under the Securities and Investment Business Law. The Bank has the following subsidiaries: Butterfield Asset Management (Cayman) Ltd. Field Nominees (Cayman) Limited Field Directors (Cayman) Limited Field Secretaries (Cayman) Limited Butterfield Asset Management (Cayman) Ltd. was formed to offer investment services to customers of the Bank. It has not yet commenced trading. All other subsidiaries are used for nominee purposes. The Bank has structured its operations in order that it will not be deemed to be engaged in trade or business within the U.S. for purposes of U.S. federal tax laws, or subject to taxation in any jurisdiction. Note 2: Significant Accounting Policies (a) Basis of Presentation and Use of Estimates and Assumptions The accounting and financial reporting policies of the Bank and its subsidiaries conform to Generally Accepted Accounting Principles in the United States of America ( GAAP ). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period, and actual results could differ from those estimates. Critical accounting estimates are those that require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on our future financial condition and results of operations. We believe that our most critical accounting policies upon which our financial condition depends, and which involves the most complex or subjective decisions or assessments, are as follows: (b) Basis of Consolidation i. Allowance for credit losses ii. Investments iii. Impairment of long-lived assets iv. Impairment of intangible assets v. Fair value of financial instruments vi. Concentrations of credit risk & customers vii. Commitments and contingencies viii. Going Concern The Consolidated Financial Statements include the accounts of the Bank and its majority-owned subsidiaries, and those variable interest entities (VIEs) where the Company is the primary beneficiary. The Bank has no interest in any VIEs which are required to be consolidated under ASC 810. Intercompany accounts and transactions have been eliminated. The Bank consolidates subsidiaries where it holds, directly or indirectly, more than 50% of the voting rights or where it exercises control. Entities where the Bank holds 20% to 50% of the voting rights and/or has the ability to exercise significant influence, are accounted for under the equity method, and the pro rata share of their income (loss) is included in other non-interest income. (c) Foreign Currency Translation Assets and liabilities arising from other foreign currency transactions are translated into United States dollars at the rates of exchange prevailing at the balance sheet date while associated revenues and expenses are translated to United States dollars at the average rates of exchange prevailing throughout the period. The resulting gains or losses are included in foreign exchange revenue in the Consolidated Statements of Income. Page 6

9 (d) Assets Held in Trust or Custody Securities and properties (other than cash and deposits held with the Bank) held in a trust, agency or fiduciary capacity for customers are not included in the Consolidated Balance Sheets since the Bank is not the beneficiary of these assets. (e) Investments Investments are classified as available for sale (AFS) or held to maturity (HTM). Investments are classified primarily as AFS when used to manage the Bank s exposure to interest rate and liquidity movements, as well as to make strategic longer-term investments. AFS investments are carried at fair value in the Consolidated Balance Sheet with unrealised gains and losses reported as net increases or decrease to Accumulated other comprehensive income (loss). Investments that the Bank has the positive intent and ability to hold to maturity are classified as HTM and are carried at amortised cost in the Consolidated Balance Sheet. Unrecognised gains and losses on HTM securities are disclosed in the notes to the financial statements. The specific identification method is used to determine realised gains and losses on AFS and HTM investments, which are included in Net realised gains and losses on AFS and HTM investments respectively in the Consolidated Statement of Income. Interest income, including amortisation of premiums and discounts, on securities for which cash flows are not considered uncertain are included in interest income in the Consolidated Statement of Income. For securities with uncertain cash flows, the investments are accounted for under the cost recovery method, whereby all principal and coupon payments received are applied as a reduction of the amortised cost and carrying amount. Accrual of income is suspended in respect of debt securities that are in default, or from which it is unlikely that future interest payments will be received as scheduled. Recognition of other-than-temporary impairments In April 2009, the FASB amended the other-than-temporary impairment (OTTI) model for debt securities. Under the new guidance, OTTI loss must be recognised in net income if it is more likely than not that the investor will sell the debt security before recovery of its amortised cost basis. However, even if an investor does not expect to sell a debt security, it must evaluate expected cash flows to be received and determine if it expects to recover the security's entire amortised costs basis (the recoverable value) and whether a credit loss exists. In situations where there is no credit loss, the unrealised loss on HTM investments is not recognised. In situations where there is a credit loss, only the amount of impairment relating to credit losses on AFS and HTM investments is recognised in net income and the decrease in fair value relating to factors other than credit losses are recognised in Other Comprehensive Income (loss) (OCI). The Bank adopted the new guidance effective for the period ending 30 June The Bank did not record a transition adjustment for securities held at 30 June 2009, which were previously considered other-than-temporarily impaired, as Management s analysis showed OTTI on securities which it had previously recognised other-than-temporary impairments to be entirely credit related. Determining whether the entire amortised cost basis is recoverable depends on market conditions and assumptions that are subject to change over time. The Bank expects that market conditions will continue to evolve, and that the recoverable value of the Bank's positions may frequently change. The degree of judgment involved in determining the recoverable value of an investment security is dependent upon the availability of observable market prices or observable market parameters. When observable market prices and parameters do not exist, judgment is necessary to estimate recoverable value which gives rise to added uncertainty in the valuation process. The valuation process takes into consideration factors such as interest rate changes, movements in credit spreads, default rate assumptions, prepayment assumptions, type and quality of collateral, and market sentiment. Management's valuations may include inputs and assumptions that are less observable or require greater estimation, thereby resulting in values which may be greater or lower than the actual value at which the investments may be ultimately sold or the ultimate cash flows that may be recovered. If the assumptions on which Management based its valuations change, the Bank may experience additional OTTI or realised losses or gains, and the period-to-period changes in value could vary significantly. Investments in unrealised loss positions are analysed as part of Management s ongoing assessment of OTTI. When Management intends to sell securities, it recognises an impairment loss equal to the full difference between the amortised cost basis and the fair value of those securities. When Management does not intend to sell debt securities in an unrealised loss position, potential OTTI is considered using a variety of factors, including the length of time and extent to which the fair value has been less than cost; adverse conditions specifically related to the industry, geographic area or financial condition of the issuer or underlying collateral of a security; payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and changes in fair value of the security after the balance sheet date. For debt securities, Management estimates cash flows over the remaining lives of the underlying collateral to assess whether credit losses exist and to determine if any adverse changes in cash flows have occurred. Management s cash flow estimates take into account expectations of relevant market and economic data as of the end of the reporting period including, for example, underlying loan-level data, and structural features of securitisation, such as subordination, excess spread, over collateralisation or other forms of credit enhancement. Management compares the losses projected for the underlying collateral ( pool losses ) against the level of credit enhancement in the securitisation structure to determine whether these features are sufficient to absorb the pool losses, or whether a credit loss on the debt security exists. As at 31 December 2010, Management s cash flow forecasts were created in conjunction with third-party analytical cash flow modeling specialists. Management also performs other analyses to support its cash flow projections. For debt securities, management considers a decline in fair value to be other-than-temporary when it does not expect to recover the entire amortised cost basis of the security. Fair value of investments is determined in accordance with note 2 (n). Page 7

10 (f) Loans Loans are reported at the principal amount outstanding, net of allowance for credit losses, unearned income and net deferred loan fees. Interest income is recognised over the term of the loan using the interest method, or on a basis approximating a level rate of return over the term of the loan, except for loans classified as non-accrual. Impaired loans A loan is considered to be impaired when, based on current information and events, the Bank determines that it will not be able to collect all amounts due according to the loan contract, including scheduled interest payments. The Bank accounts for and discloses non-accrual loans as impaired loans. When a loan is identified as impaired, the impairment is measured based on the present value of expected future cash flows, discounted at the loan s effective interest rate, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral. In these cases the current fair value of the collateral, less selling costs is used instead of discounted cash flows. If we determine that the value of the impaired loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), impairment is recognized through an allowance estimate or a charge-off to the allowance. Non accrual All Commercial, Commercial residential and Consumer loans are placed on non-accrual status immediately if: a. in the opinion of Management, full payment of principal or interest is in doubt; or b. when principal or interest is 90 days past due. Residential loans are placed on non-accrual status immediately if: a. in the opinion of Management, full payment of principal or interest is in doubt; or b. when principal or interest is 90 days past due, unless the loan is well secured and any collection efforts are reasonably expected to result in repayment of all amounts due under the contractual terms of the loan. Cash received on non accrual loans where there is no doubt regarding full repayment (no impairment recognised) is applied as repayment of the principal amount of the loan and only after the entire loan principal is recovered, is interest income recognised. Where there is doubt regarding the ultimate full repayment of the non accrual loan (impairment recognised), all cash received is applied to reduce the principal amount of the loan. Interest income on these loans is recognised only after the entire balance receivable is recovered and interest is actually received. Interest income on non-accrual loans is recognised only to the extent it is received in cash. Interest income on these loans is recognised only after the entire balance receivable is recovered and interest is actually received. Loans are restored to accrual status only when interest and principal payments are brought current and future payments are reasonably assured. Delinquencies The entire balance of an account is contractually delinquent if the minimum payment of principal or interest is not received by the specified due date. Delinquency is reported on loans that are 30 days or more past due. Charge offs Commercial loans are either fully or partially charged down to fair value of collateral securing the loans when: management judges the asset to be uncollectible; repayment is deemed to be protracted beyond reasonable time frames; the asset has been classified as a loss by either our internal loan review process or external examiners; or the customer has filed bankruptcy and the loss becomes evident owing to a lack of assets. The outstanding balance of Commercial real estate-secured loans that is in excess of the estimated property value, less cost to sell, is charged off no later than the end of the month in which the account becomes 180 days past due. Credit card consumer loans that are contractually 180 days past due and other consumer loans with an outstanding balance under $100,000 that are contractually 180 days past due are written off and reported as charge-offs. Unsecured consumer loans are charged off no later than the end of the month in which the account becomes 180 days past due. Residential loans are fully or partially charge down to the net realizable value no later than the end of the month in which the account becomes 180 days past due. Page 8

11 (g) Allowance for Credit Losses The Bank maintains an allowance for credit losses, which in Management s opinion is adequate to absorb all incurred credit related losses in its lending and off-balance sheet credit related arrangements portfolios at the balance sheet date. The allowance for credit losses consists of specific allowances and a general allowance as follows: Specific Allowances Specific allowances are determined on an exposure by exposure basis and reflect the associated estimated credit loss. The specific allowance for credit loss is computed as the difference between the recorded investment in the loan and present value of expected future cash flows from the loan. The effective rate of return on the loan is used for discounting the cash flows. However, when foreclosure of a collateral-dependent loan is probable, the Bank measures impairment based on the fair value of the collateral. The Bank considers estimated costs to sell, on a discounted basis, in the measurement of impairment if those costs are expected to reduce the cash flows available to repay or otherwise satisfy the loan. If the measurement of an impaired loan is less than the recorded investment in the loan, then the Bank recognises impairment by creating an allowance with a corresponding charge to provision for credit losses. General Allowances The allowance for credit losses attributed to the remaining portfolio is established through a process that estimates the incurred loss at the balance sheet date inherent in the lending and off-balance sheet credit related arrangements portfolios based upon various analyses. These analyses consider historical default rates and loss severities, internal risk ratings, and geographic, industry, and other environmental factors. Management also considers overall portfolio indicators including trends in internally risk rated exposures, cash-basis loans, historical and forecasted write-offs, and a review of industry, geographic and portfolio concentrations, including current developments within those segments. In addition, management considers the current business strategy and credit process, including limit setting and compliance, credit approvals, loan underwriting criteria and loan workout procedures. Each portfolio of smaller balance, homogeneous loans, including consumer mortgage, installment, revolving credit, and most other consumer loans, is collectively evaluated for impairment. The allowance for credit losses attributed to these loans is established via a process that estimates the probable losses inherent and incurred in the portfolio, based upon various analyses. Management considers overall portfolio indicators including historical credit losses; delinquent (defined as loans with payments contractually over 30 days past due), non-performing, and classified loans; trends in volumes and terms of loans; an evaluation of overall credit quality; the credit process, including lending policies and procedures; and economic, geographical, product, and other environmental factors. (h) Intangible Assets Intangible assets (customer relationships) are accounted for using the purchase method. Acquired intangible assets with finite lives are amortised on a straight line basis over their estimated useful lives, not exceeding 15 years. Intangible assets estimated useful lives are re-evaluated annually and an annual impairment test is carried out to determine if certain indicators of impairment exist. (i) Premises, Equipment and Computer Software Land, buildings, equipment and computer software, including leasehold improvements, are carried at cost less accumulated depreciation. The Bank generally computes depreciation using the straight-line method over the estimated useful life of an asset, which are 50 years for buildings, and 3 to 10 years for other equipment. For leasehold improvements the Bank uses the straight-line method over the lesser of the remaining term of the leased facility or the estimated economic life of the improvement. The Bank capitalises certain costs, including interest cost incurred during the development phase, associated with the acquisition or development of internal use software. Once the software is ready for its intended use, these costs are amortised on a straight-line basis over the software's expected useful life, which is between 5 and 10 years. Management reviews at least annually the recoverability of the carrying amount of premises, equipment and computer software and an impairment charge is recorded when the carrying amount of the reviewed asset is deemed not recoverable by future expected cash flows to be derived from the use and disposition of the asset. (j) Derivatives All derivatives are recognised on the Consolidated Balance Sheet at their fair value. On the date that the Bank enters into a derivative contract, it designates the derivative as either: a hedge of the fair value of a recognised asset or liability (a fair value hedge); a hedge of a forecasted transaction or the variability of cash flows that are to be received or paid in connection with a recognised asset or liability (a cash flow hedge), or an instrument that is held for trading or non-hedging purposes (a trading or non-hedging instrument). Changes in the fair value of a derivative that is highly effective, and that is designated and qualifies as a fair value hedge, along with changes in the fair value of the hedged asset or liability that are attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a cash flow hedge, to the extent that the hedge is effective, are recorded in other comprehensive income, until earnings are affected by the variability of cash flows of the hedged transaction. Any hedge ineffectiveness is recorded in current period earnings. Changes in the fair value of a derivative that is highly effective and that is designated and qualifies as a foreign currency hedge is recorded in either current period earnings or other comprehensive income, depending on whether the hedging relationship satisfies the criteria for a fair value or cash flow hedge. If, however, a derivative is used as a hedge of a net investment in a foreign operation, the changes in the derivative s fair value, to the extent that the derivative is effective as a hedge, are recorded in the cumulative translation adjustment account within other comprehensive income. Changes in the fair value of derivative trading and non-hedging instruments are reported in current period earnings. Page 9

12 The Bank formally documents all relationships between hedging instruments and hedged items, as well as its risk management objective and strategy for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair value, cash flow, or foreign currency hedges to specific assets and liabilities on the consolidated balance sheet or specific firm commitments or forecasted transactions. The Bank also formally assesses whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives may be expected to remain highly effective in future periods. When it is determined that a derivative has ceased to be highly effective as a hedge, the Bank discontinues hedge accounting prospectively. For those hedge relationships that are terminated, hedge designations that are removed, or forecasted transactions that are no longer expected to occur, the hedge accounting treatment described in the paragraphs above is no longer applied and the end-user derivative is terminated or transferred to the trading account. For fair value hedges, any changes to the hedged item remain as part of the basis of the asset or liability and are ultimately reflected as an element of the yield. For cash flow hedges, any changes in fair value of the end-user derivative remain in other comprehensive income and are included in retained earnings of future periods when earnings are also affected by the variability of the hedged cash flows. If the forecasted transaction is no longer likely to occur, any changes in fair value of the end-user derivatives are recognised in net income. (k) Employee Future Benefits The Bank maintains a trusteed defined contribution pension plan for substantially all employees. The Bank provides a monthly contribution to the trust based on each participating employee's pensionable earnings. The Bank also contributes to The Bank of N. T. Butterfield & Son Limited's (the Bank's parent company, herein after the "Parent Bank") non-contributory defined benefits pension plan for one (2009: three) eligible long serving employees. No unfunded liabilities are recorded in these financial statements as all relevant amounts are recorded and borne by the Parent Bank. Amounts paid are expensed in the year. (l) Share Based Compensation The Parent Bank engages in equity settled share-based payment transactions in respect of services received from eligible employees. The fair value of the services received is measured by reference to the fair value of the shares or share options granted on the date of the grant. The cost of the employee services received in respect of the shares or share options granted is recognised in Salaries and other employee benefits in the Consolidated Statements of Income over the shorter of the vesting or service period. The fair value of the options granted is determined using option pricing models, which take into account the exercise price of the option, the current share price, the risk free interest rate, the expected volatility of the share price over the life of the option and other relevant factors. Time vesting conditions, conditions are taken into account by adjusting the number of shares or share options included in the measurement of the cost of employee services so that ultimately, the amount recognised in the Consolidated Statements of Income reflects the number of vested shares or share options. The Bank recognizes compensation cost for awards with performance conditions if and when the Bank concludes that it is probable that the performance condition will be achieved, net of an estimate of pre-vesting forfeitures (e.g., due to termination of employment prior to vesting). (m) Revenue Recognition Banking services fees primarily include fees for certain loan origination, letters of credit, other financial guarantees, compensating balances and other financial services related products. Certain loan origination fees are primarily overdraft and other revolving lines of credit fees. These fees are recognised as revenue over the period of the underlying facilities. Letters of credit fees are recognised as revenue over the period in which the related service is provided. All other fees are recognised as revenue in the period in which the service is provided. Asset management fees include fees for investment management, investment advice, custody and brokerage services. Investment management and custody fees are recognised over the period in which the related service is provided, on a net asset value basis. Investment advice and brokerage services fees are recognised in the period in which the related service is provided. Trust and corporate services fees include fees for private and institutional trust, executorship, corporate and managed bank accounts. Fees are recognised as revenue over the period of the relationship or when the Bank has rendered all services to the clients and is entitled to collect the fee from the client, as long as there are no contingencies associated with the fee. Loan interest income includes the amortisation of non-refundable loan origination and commitment fees. These fees are deferred (except for certain retrospectively determined fees meeting specified criteria) and recognised as an adjustment of yield over the life of the related loan. These loan origination and commitment fees are offset by their related direct cost and only the net amounts are deferred and amortised into interest income. Interest income on all securities, including amortisation of premiums and discounts on debt securities held for investment, are included in investment income in the Consolidated Statements of Income. Loans placed on non-accrual status and investments with uncertain cash flows are accounted for under the cost recovery method, whereby all principal, interest and coupon payments received are applied as a reduction of the amortised cost and carrying amount. Page 10

13 (n) Fair Value of Financial Instruments Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Bank determines the fair values of assets and liabilities based on the fair value hierarchy which requires an entity to maximise the use of observable inputs and minimise the use of unobservable inputs when measuring fair value. The fair value standard describes three levels of inputs that may be used to measure fair value. Investments classified as trading and available for sale, and derivative assets and liabilities are recognised in the Consolidated Balance Sheet at fair value. The aggregate of the estimated fair value of amounts presented does not represent Management s estimate of the underlying value of the Bank. Level 1, 2 and 3 valuation inputs Management classifies items that are recognised at fair value on a recurring basis used on the Level of inputs used in their respective fair value determination as described below. Fair value inputs are considered Level 1 when based on unadjusted quoted prices in active markets for identical assets. Fair value inputs are considered Level 2 when based on internally developed models or based on prices published by independent pricing services using proprietary models. To qualify for Level 2, all significant inputs used in these models must be observable in the market place or can be corroborated by observable market data for substantially the full term of the investment and includes, among others: interest yield curves, credit spreads, prices for similar assets and foreign exchange rates. Level 2 also includes financial instruments that are valued using quoted price for identical assets but for which the market is not considered active due to low trading volumes. Fair value inputs are considered Level 3 when based on internally developed models using significant unobservable assumptions involving management s estimations or nonbinding bid quotes from brokers. The following methods and assumptions were used in the determination of the fair value of financial instruments: Cash and deposits with banks The fair value of cash and deposits with banks, being short term in nature, is deemed to equate to the carrying value. Investments The fair values of investments are determined based on the quoted market price or independent pricing services when available. If unavailable, observable inputs from similar items in active markets or identical / similar items with inactive markets are used. In the absence of observable quoted prices unobservable inputs are used. Loans The majority of loans are variable rate and re-price in response to changes in market rates and hence the fair value has been estimated as the carrying value. For fixed rate loans, the fair value is based on management s best estimates. Accrued interest The carrying values of accrued interest receivable and payable are assumed to approximate their fair values given their short-term nature. Deposits The fair value of fixed rate deposits, being short term in nature, is deemed to equate to the carrying value. The fair value of deposits with no stated maturity date is deemed to equate to the carrying value. Derivatives Fair value of exchange traded derivatives is based on quoted market prices. Fair value of over-the-counter derivatives is calculated as the net present value of contractual cash flows using prevailing market rates. (o) Credit Related Arrangements In the normal course of business, the Bank enters into various commitments to meet the credit requirements of its customers. Such commitments, which are not included in the Consolidated Balance Sheets include: Page 11

14 i) Commitments to extend credit which represent undertakings to make credit available in the form of loans or other financing for specific amounts and maturities, subject to certain conditions. ii) Standby letters of credit, which represent irrevocable obligations to make payments to third parties in the event that the customer is unable to meet its financial obligations. iii) Documentary and commercial letters of credit, primarily related to the import of goods into the Cayman Islands by customers, which represent agreements to honor drafts presented by third parties upon completion of specific activities. These credit arrangements are subject to the Bank's normal credit standards and collateral is obtained where appropriate. The contractual amounts for these commitments set out in the table in Note 12 represent the maximum payments the Bank would have to make should the contracts be fully drawn, the counterparty default, and any collateral held prove to be of no value. As many of these arrangements will expire or terminate without being drawn upon or are fully collateralised, the contractual amounts do not necessarily represent future cash requirements. The Bank does not carry any liability for these obligations. (p) Consolidated Statement of Cash Flows For the purposes of the Consolidated Statement of Cash Flows, cash and demand deposits with banks include cash and demand deposits; vault cash and cash in transit where the Bank holds the related assets. (q) Impairment or Disposal of Long-Lived Assets Impairment losses are recognised when the carrying amount of a long-lived asset exceeds the sum of the undiscounted cash flows expected from its use and disposal. The impairment recognised is measured as the amount by which the carrying amount of the asset exceeds its fair value. Long-lived assets that are to be disposed of other than by sale are classified and accounted for as held for use until the date of disposal or abandonment. Assets that meet certain criteria are classified as held for sale and are measured at the lower of their carrying amounts or fair value, less costs of sale. Note 3: Cash and Deposits with Banks 31 December Unrestricted Non-interest earning Cash deposits 13,678,480 12,005,550 Interest earning Deposits maturing within three months and on demand 791,638,220 1,061,689,008 Deposits maturing between three to six months - 260,000,000 Deposits maturing between six to twelve months - 50,000,000 Sub-total Interest earning 791,638,220 1,371,689,008 Total unrestricted cash and deposits 805,316,700 1,383,694,558 Total by currency US Dollars 622,796,602 1,012,388,246 Other currencies 182,520, ,306,312 Total unrestricted cash and deposits 805,316,700 1,383,694,558 The effective yield on interest earning deposits at 31 December 2010 was 0.25% (2009: 0.21%). Note 4: Investments Losses and gains on investments Investments in unrealised loss positions are analysed as part of management s ongoing assessment of OTTI. When management intends to sell securities, it recognises an impairment loss equal to the full difference between the amortised cost basis and the fair value of those securities. When management does not intend to sell debt securities in an unrealised loss position, potential OTTI is considered using a variety of factors, including the length of time and extent to which the fair value has been less than cost; adverse conditions specifically related to the industry, geographic area or financial condition of the issuer or underlying collateral of a security; payment structure of the security; changes to the rating of the security by a rating agency; the volatility of the fair value changes; and changes in fair value of the security after the balance sheet date. For debt securities, management estimates cash flows over the remaining lives of the underlying collateral to assess whether credit losses exist and to determine if any adverse changes in cash flows have occurred. Management s cash flow estimates take into account expectations of relevant market and economic data as of the end of the reporting period including, for example, underlying loan-level data, and structural features of securitisation, such as subordination, excess spread, over collateralisation or other forms of credit enhancement. Management compares the losses projected for the underlying collateral ( pool losses ) against the level of credit enhancement in the securitisation structure Page 12

15 to determine whether these features are sufficient to absorb the pool losses, or whether a credit loss on the debt security exists. As at 31 December 2010, management s cash flow forecasts were created in conjunction with well-known third-party corporations specialising in analytical cash flow modelling. Management also performs other analyses to support its cash flow projections. For debt securities, management considers a decline in fair value to be other-than-temporary when it does not expect to recover the entire amortised cost basis of the security. The following table presents the gains and losses on investments: Available Held to Available Held to Year ended 31 December for sale maturity Total for sale maturity Total (Losses)/gains recognised in net income (11,606,479) - (11,606,479) - 261, ,300 OTTI impairments recognised in net income (11,606,479) - (11,606,479) - 261, ,300 Net (losses)/gains recognised in net income (11,606,479) - (11,606,479) - 261, ,300 Net decrease/(increase) in non-credit related impairments recognised in other comprehensive income ( OCI ) 1,936,542-1,936,542 (10,954,386) - (10,954,386) Net change in losses recognised in accumulated other comprehensive income ( AOCI ) 1,936,542-1,936,542 (10,954,386) - (10,954,386) Total recognised (losses)/gains (9,669,937) - (9,669,937) (10,954,386) 261,300 (10,693,086) Transfer of investments from the Held To Maturity ( HTM") to the Available For Sale ( AFS ) portfolio The entire HTM portfolio as at 31 December 2009 was transferred to the AFS portfolio in March 2010 as the Bank along with the Parent Bank no longer had the intent to hold these securities to maturity. The net carrying amount of the transferred securities was $76.8 million at the time of the transfer. Subsequent to the transfer, a net unrealised noncredit loss of $11.6 million was recognised in OCI. Amortised cost, carrying amount and estimated fair value Unrealised gains and losses that are not reflected in the carrying amount of investments are reported as unrecognised gains and losses on HTM investments. The amortised cost, carrying amounts and fair values, are as follows: Gross Gross Carrying Amortised Unrealised Unrealised Amount/ 31 December 2010 Cost Gains Losses Fair Value Available for sale Certificates of deposit 43,650, ,772-43,780,772 US government and federal agencies 287,624, ,703 (2,750,979) 284,976,286 Debt securities issued by non-us governments 10,000, ,000,000 Corporate debt securities 94,987, (1,526,113) 93,462,620 Asset-backed securities - Student loans 113,241,872 - (4,975,119) 108,266,753 Total available for sale 549,504, ,367 (9,252,211) 540,486,431 Gross Gross Carrying Amortised Unrealised Unrealised Amount/ 31 December 2009 Cost Gains Losses Fair Value Available for sale Certificates of deposit 102,500, , ,141,500 Corporate debt securities 258,547,584 10,592 (5,368,022) 253,190,154 Mortgage-backed securities - Subprime and Alt-A 654,642 26,552 (11,270) 669,924 Asset-backed securities - Student loans 114,681,068 - (4,503,929) 110,177,139 Asset-backed securities - Automobile loans 20,021,064 - (299,346) 19,721,718 Collateralised debt and loan obligations 19,513,763 - (1,450,463) 18,063,300 Total available for sale 515,918, ,644 (11,633,030) 504,963,735 Page 13

16 OTTI Gross Gross Amortised Recognised Carrying Unrecognised Recognised Fair 31 December 2009 Cost in AOCI Value Gains Losses Value Held to maturity Debt securities issued by non-us governments 11,333,333-11,333, ,333,333 Mortgage-backed securities - Prime 2,310,141-2,310,141 - (405,045) 1,905,096 Mortgage-backed securities - Subprime and Alt-A 41,120,346-41,120,346 - (9,208,551) 31,911,795 Collateralised debt and loan obligations 22,031,838-22,031,838 - (2,684,978) 19,346,860 Total held to maturity securities with unrealised losses 76,795,658-76,795,658 - (12,298,574) 64,497,084 Investments in the above table with gross unrecognised losses as at 31 December 2010 were considered temporarily impaired on that date. The impairments recognised in AOCI represent the total loss that would have been recognised in net income if the investment securities had been sold at their estimated fair value on 31 December The impairments recognised in AOCI are the result of various factors other than deterioration in the creditworthiness of the issuer. As at 31 December 2010, management did not intend to sell these securities and believed it is not likely that the Bank would be required to sell these securities prior to recovery of their amortised cost basis. Overall, unrecognised losses have decreased since 31 December 2009 due primarily to the disposal of securities resulting in a realised loss of $ million and increased fair values across asset classes resulting from improved market spread and market liquidity. Unrealised loss positions The following tables show the fair value and gross unrealised losses of the Bank's investments with unrealised losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealised loss position. Debt securities are categorised as being in a continuous loss position for "Less than 12 months" or "12 months or more" based on the point in time that the fair value declined below the cost basis. Less than 12 months 12 months or more Gross Gross Total Total Gross Number of Fair Unrealised Fair Unrealised Fair Unrealised 31 December 2010 Securities Value Losses Value Losses Value Losses Available for sale US government and federal agencies ,874,934 (2,750,979) ,874,934 (2,750,979) Corporate debt securities ,462,830 (1,526,113) 88,462,830 (1,526,113) Asset-backed securities - Student loans ,266,753 (4,975,119) 108,266,753 (4,975,119) Total available for sale securities with unrealised losses ,874,934 (2,750,979) 196,729,583 (6,501,232) 451,604,517 (9,252,211) Total securities with unrealised losses ,874,934 (2,750,979) 196,729,583 (6,501,232) 451,604,517 (9,252,211) Less than 12 months 12 months or more Gross Gross Total Total Gross Number of Fair Unrealised Fair Unrealised Fair Unrealised 31 December 2009 Securities Value Losses Value Losses Value Losses Available for sale Corporate debt securities ,678,072 (5,368,022) 229,678,072 (5,368,022) Mortgage-backed securities - Subprime and Alt-A ,372 (11,270) 643,372 (11,270) Asset-backed securities - Student loans ,177,139 (4,503,929) 110,177,139 (4,503,929) Asset-backed securities - Automobile loans ,721,718 (299,346) 19,721,718 (299,346) Collateralised debt and loan obligations ,063,300 (1,450,463) 18,063,300 (1,450,463) Total available for sale securities with unrealised losses ,283,601 (11,633,030) 378,283,601 (11,633,030) Held to maturity Mortgage-backed securities - Prime ,905,096 (405,045) 1,905,096 (405,045) Mortgage-backed securities - Subprime and Alt-A ,911,795 (9,208,551) 31,911,795 (9,208,551) Collateralised debt and loan obligations ,346,860 (2,684,978) 19,346,860 (2,684,978) Total held to maturity securities with unrealised losses ,163,751 (12,298,574) 53,163,751 (12,298,574) Total securities with unrealised losses ,447,352 (23,931,604) 431,447,352 (23,931,604) The following is a description of the Bank s main investment categories and the key assumptions used in estimating the present value of cash flows most likely to be collected from these investments. Page 14

17 Certificates of deposit As of 31 December 2010, there were no gross unrealised losses on the Bank s holdings of certificates of deposit (CDs). Management assesses the credit quality of the issuers, which includes assessments of credit ratings (the Bank only purchases CDs that are rated investment grade) and credit worthiness of the issuer and concluded that the CDs do not have any credit losses. US government and federal agencies As of 31 December 2010, gross unrealised losses on securities related to United States (US) government and federal agencies were $2.751 million, none of which related to investments that were in an unrealised loss position for longer than 12 months. Overall, management believes that all the securities in this class do not have any credit losses, given the explicit and implicit guarantees provided by the US federal government. Debt securities issued by non-us governments As of 31 December 2010, there were no gross unrealised losses on debt securities issued by non-us governments. All securities in this category were issued by governments of Caribbean jurisdictions. These securities do not have any credit losses. Corporate debt securities As of 31 December 2010, gross unrealised losses related to corporate debt securities were $1.526 million, all of which related to investments that were in an unrealised loss position for longer than 12 months. The unrealised losses were due to widened credit spreads caused by illiquidity. Asset-backed securities - Student loans As of 31 December 2010, gross unrealised losses on student-loan asset backed securities were $4.975 million, all of which related to securities that have been in an unrealised loss position for longer than 12 months. All of these securities are "AAA" rated and management believes these securities do not have any credit losses. There are explicit and implicit guarantees provided by the US government. The unrealised losses were due to widened credit spreads caused by illiquidity. The following table presents securities by remaining contractual or expected maturity: Remaining term to maturity 0 to 3 3 to 12 1 to 5 Over Carrying 31 December 2010 months months years 5 years Value Available for sale Certificates of deposit 36,155,334 7,625, ,780,772 US government and federal agencies ,550,506 52,425, ,976,286 Debt securities issued by non-us governments - 1,333,333 5,333,333 3,333,334 10,000,000 Corporate debt securities 9,973,180 4,999,790 78,489,650-93,462,620 Asset-backed securities - Student loans - - 3,044, ,222, ,266,753 Total available for sale 46,128,514 13,958, ,417, ,981, ,486,431 Total by currency US Dollars 46,128,514 13,958, ,417, ,981, ,486,431 Total investments 46,128,514 13,958, ,417, ,981, ,486,431 Page 15

18 Remaining term to maturity 0 to 3 3 to 12 1 to 5 Over Carrying 31 December 2009 months months years 5 years Value Available for sale Certificates of deposit - 95,557,500 7,584, ,141,500 Corporate debt securities 4,997,770 18,507, ,684, ,190,154 Mortgage-backed securities - Subprime and Alt-A 643, , ,924 Asset-backed securities - Student loans - - 4,307, ,869, ,177,139 Asset-backed securities - Automobile loans - 19,721, ,721,718 Collateralised debt and loan obligations ,063,300 18,063,300 Total available for sale 5,641, ,786, ,576, ,959, ,963,735 Held to maturity Debt securities issued by non-us governments - 1,333,333 5,333,333 4,666,667 11,333,333 Mortgage-backed securities - Prime ,310,141 2,310,141 Mortgage-backed securities - Subprime and Alt-A ,377,994 24,742,352 41,120,346 Collateralised debt and loan obligations ,031,912 9,999,926 22,031,838 Total held to maturity - 1,333,333 33,743,239 41,719,086 76,795,658 Total investments 5,641, ,119, ,319, ,678, ,759,393 Total by currency US Dollars 5,641, ,119, ,319, ,678, ,759,393 Total investments 5,641, ,119, ,319, ,678, ,759,393 Investments at carrying value includes $ million (2009: $ million) of floating-rate instruments and $ million (2009: $ million) of fixed-rate instruments. The approximate yield on floating-rate securities at 31 December 2010 was 0.41% (2009: 0.42%), while the approximate yield on fixed-rate securities was 2.66% (2009: 1.94%). The average yield is based on amortised cost balances at year-end. Average yield is derived by dividing interest income (including the effect of amortisation of premiums and accretion of discounts) by the amortised cost. The estimated duration, which reflects anticipated future prepayments is approximately 3.71 years (2009: 2.47 years). Note 5: Loans The composition of the loan portfolio at each of the indicated dates was as follows: 31 December Commercial loans: Commercial and industrial 200,603, ,181,132 Commercial real estate 49,188,484 49,513,966 Overdrafts 10,204,790 5,620,345 Total commercial loans 259,996, ,315,443 Less allowance for credit losses on commercial loans (3,262,625) (8,972,173) Total commercial loans after allowance for credit losses 256,733, ,343,270 Consumer loans: Automobile financing 6,052,737 6,075,824 Credit card 13,671,116 12,415,909 Mortgages 325,061, ,952,825 Overdrafts 1,315,294 3,026,339 Other consumer 16,040,504 17,668,158 Total consumer loans 362,140, ,139,055 Less allowance for credit losses on consumer loans (2,748,926) (2,724,831) Total commercial loans after allowance for credit losses 359,391, ,414,224 Total loans 622,137, ,454,498 Less allowance for credit losses (6,011,551) (11,697,004) Net loans 616,125, ,757,494 Page 16

19 Commercial 31 December 2010 Commercial Real Estate Consumer Residential Total Total loans individually evaluated for impairment 2,150,956 1,396,891 41,386 6,391,462 9,980,695 Total loans collectively evaluated for impairment 208,656,945 47,791,593 37,038, ,669, ,156,545 Total loans 210,807,901 49,188,484 37,079, ,061, ,137,240 Commercial 31 December 2009 Commercial Real Estate Consumer Residential Total Total loans individually evaluated for impairment 5,419,494 19,091,852-1,949,918 26,461,264 Total loans collectively evaluated for impairment 179,381,983 30,422,114 39,186, ,002, ,993,234 Total loans 184,801,477 49,513,966 39,186, ,952, ,454,498 The principal means of securing residential mortgages, personal, credit card and business loans are charges over assets and guarantees. Mortgage loans are generally repayable over periods of up to thirty years and personal, credit card, business and government loans are generally repayable over terms not exceeding five years. The effective yield on total loans as at 31 December 2010 is 4.00% (2009: 4.01%). The table below summarises the changes in the allowance for credit losses: Commercial 31 December 2010 Commercial Real Estate Consumer Residential Total General Allowances Allowance for general losses at beginning of year 1,454, , ,499 2,263,332 4,647,004 Provision this year 362,622 68, ,456 34, ,338 Recoveries 22, , ,447 Charge-offs (113,663) - (520,575) - (634,238) Allowance for general losses at end of year 1,726, , ,864 2,298,062 5,011,551 Commercial 31 December 2010 Commercial Real Estate Consumer Residential Total Specific Allowances Allowance for specific losses at beginning of year 750,000 6,300, ,050,000 Provision this year 1,000,000 2,000,000-10,000 3,010,000 Recoveries Charge-offs (750,000) (8,300,000) - (10,000) (9,060,000) Allowance for specific losses at end of year 1,000, ,000,000 Commercial 31 December 2009 Commercial Real Estate Consumer Residential Total General Allowances Allowance for general losses at beginning of year 1,042, , ,658 1,886,644 3,832,131 Provision this year 408,165 3, , ,688 1,036,858 Recoveries 10, , ,457 Charge-offs (6,216) - (523,226) - (529,442) Allowance for general losses at end of year 1,454, , ,499 2,263,332 4,647,004 Commercial 31 December 2009 Commercial Real Estate Consumer Residential Total Specific Allowances Allowance for specific losses at beginning of year , ,000 Provision this year 750,000 6,300,000 - (300,000) 6,750,000 Recoveries Charge-offs Allowance for specific losses at end of year 750, ,050,000 Page 17

20 For the year ended 31 December 2010, the amount of gross interest income that would have been recorded had impaired loans been current was $710,028 (2009: $543,749). For the year ended 31 December 2010 the Bank recovered overdue interest of $89,027 (2009: $94,866) on impaired loans that were repaid in the year. The average balance of impaired loans during the year ended 31 December 2010 was $20,089,583 (2009: $10,135,208). The table below sets forth information about the Bank s impaired loans: Non accrual Loans Unpaid Average Interest principal Gross Specific recorded income 31 December 2010 balance loan allowance Total investment recognised Commercial loans Commercial and Industrial Loans 2,150,956 2,150,956 (1,000,000) 1,150,956 3,159, ,438 Total commercial loans 2,150,956 2,150,956 (1,000,000) 1,150,956 3,159, ,438 Commercial real estate loans Mortgage ,331,493 - Construction 1,396,891 1,396,891-1,396, ,080 - Total commercial real estate loans 1,396,891 1,396,891-1,396,891 10,011,573 - Consumer loans 41,386 41,386-41,386 35,440 - Residential loans 6,391,462 6,391,462-6,391, ,317 - Total 9,980,695 9,980,695 (1,000,000) 8,980,695 17,219, ,438 Non accrual Loans Unpaid Average Interest principal Gross Specific recorded income 31 December 2009 balance loan allowance Total investment recognised Commercial loans Commercial and Industrial Loans 5,419,494 5,419,494 (750,000) 4,669,494 4,865,955 - Total commercial loans 5,419,494 5,419,494 (750,000) 4,669,494 4,865,955 - Commercial real estate loans Mortgage 18,662,560 18,662,560 (6,300,000) 12,362,560 4,746,747 - Construction 429, , , ,056 - Total commercial real estate loans 19,091,852 19,091,852 (6,300,000) 12,791,852 5,183,803 - Residential loans 1,949,918 1,949,918-1,949,918 3,172,042 - Total 26,461,264 26,461,264 (7,050,000) 19,411,264 13,221,800 - Page 18