Economic and Financial Environment

Despite persistent weakness in the construction-related sector, the local economy showed signs of improvement, as evidenced by an apparent bottoming out of consumer spending and a recovery in tourism. Department store sales were sluggish in the second half of the fiscal year, but supermarket sales, foods in particular, remained strong. Electric appliances were weak overall, while new car sales were generally strong, thanks to firm sales of sub-compact cars and minicars. In construction, housing starts were supported at a high level thanks to strong construction of rental units. However, this had a limited impact on sales of construction materials because of a decline in the construction of owner-occupied houses. Public construction, due to a sharp decline in the first half of the fiscal year, finished the term slightly below the previous year’s level. Tourism, having declined immediately after the terrorist attacks in the United States in the previous fiscal year, has since shown a strong recovery thanks to campaigns to attract tourists to the region as well as nationwide support for tours.

Review of Operations

◆ Deposits steady increase in balance

Liquid deposits and time deposits both increased during the fiscal year under review to a combined term-end balance of 1,265.3 billion (US$10,526 million), up ¥45.2 billion, on a consolidated basis, and ¥1,267.3 billion (US$10,544 million), up ¥45.3 billion, on a non-consolidated basis. Partly owning to a shift to the banking account against the backdrop of the continued low-interest environment, the balance of money in trust (non-designated) declined ¥27.0 billion to ¥80.1 billion (US$667 million). The aggregate of banking and trust accounts rose ¥18.2 billion, to ¥1,345.4 billion (US$11,193 million) on a consolidated basis, and ¥18.3 billion to ¥1,347.5 billion (US$11,211 million) on a non-consolidated basis.

Due to the sluggish economic conditions, corporate deposits declined, but individuals’deposits, which account for approximately 70% of the whole, showed steady growth, rising by ¥18.3 billion during the term.

◆ Loans to Individuals – increased as projected

We have been aggressively promoting loans to individuals, with the aim of establishing an image of Bank of the Ryukyus as the “Loan Experts.” Among our leading mortgage loans, we launched a mortgage loan coupled with life insurance featuring a cancer clause in June 2002, extending borrowing periods for loans, and allowing the spouses to apply for the loan as joint debtors. As a result, the term-end balance of loans rose ¥39.5 billion on a non-consolidated basis.

Regarding loan products for individuals, in addition to our general-purpose loans using wage remittance accounts, we have added a Post Loan, a type of “card loan.” The distinctive feature of the Post Loan is that application for this loan can be made just by mailing in an completed application, precluding the need to visit a bank teller. In this way, we are working to expand our product lineup.

◆ Securities and Foreign Exchange – little change in securities balance

The term-end balance for securities declined ¥0.5 billion, to ¥198.7 billion (US$1,653 million) on a consolidated basis, and dropped ¥2.1 billion, to ¥203.2 billion (US$1,691 million) on a non-consolidated basis. The value of foreign exchange transactions decreased US$5.652 billion from the previous year to US$5.032 billion on a non-consolidated basis due to a decline in foreign-currency denominated deposits and other non-trade transactions.

◆ Net business profit and business profit on core banking operations

-- the highest figures ever posted

Net business profit is the most prominent profit indicator for banks in Japan. It represents the total sum of profits on ordinary banking operations including deposits, loans and foreign exchange, as well as securities operations. In the banking industry, this indicator is commonly used as a profit indicator where other industries employ operating income. For the reporting term, the Bank posted a net business profit of ¥13.7 billion, up ¥0.8 billion, on a non-consolidated basis. This is attributable to a larger interest margin, an increase in interest on securities and a reduction in general and administrative expenses. Net business profit, however, may substantially fluctuate year by year, as it includes profit/loss account on securities, which has a similar nature to extraordinary profit/loss accounts, and credit cost(provision to general reserve for possible loan losses plus write-off expenses). Recently, business profit on core banking operations* has attracted more attention, as these one-time factors are eliminated from the indicator. The Bank's business profit on core banking operations reached the historically high figure of ¥14.2 billion, up ¥0.6 billion, on a non-consolidated basis.

Note: Business profit on core banking operations is equivalent to the amount of net business profit deducting amortization under trust account and net gain on securities, and adding an amount equivalent to the provision to the general reserve for possible loan losses.

◆ Income before income taxes and net income　-- Third highest net income

Income before income taxes increased ¥2.4 billion to ¥7.1 billion on a consolidated basis, thanks to a wider interest margin and an increase in interest on bonds and a decline in general and administrative expenses.

Net income declined ¥1.5 billion to ¥4.4 billion (US$37million) on a consolidated basis, and by ¥7.4 billion to ¥4.1 billion(US$34 million) on a non-consolidated basis, due to a decrease in deferred tax assets preparatory to the introduction of revenue-based taxation on enterprise tax. Despite this, the Bank posted the third-highest net income in its history.

For the current term ending March 31, 2004, we forecast net income of ¥6.1 billion on a consolidated basis, and ¥5.8 billion on a non-consolidated basis, on the premises of more efficient operations and more successful meeting of customer requirements. Annual dividends will be ¥40 per ordinary share.

◆ Disclosure of problem assets under the Financial Reconstruction Law

　--The ratio of problem assets to total claims improved

Problem assets (claims subject to mandatory disclosure under the Financial Reconstruction Law) decreased ¥21.5 billion during the reporting term to ¥131.9 billion (US$1,097million) on a non-consolidated basis under strict asset self-assessment. As problem assets disposal will remain the Bank's most urgent issue, we will make more effort to reduce the level of problem assets.

◆ Enhanced Business Efficiency (Non-consolidated)

Personnel expenses declined ¥7 million from the previous term to ¥9.9 billion (US$82 million). Increased operational efficiency and downsizing by 56 employees (year-on-year) more than offset higher retirement benefit-related expenses resulting from a cut in the discount rate applied to retirement plan assets. Non-personnel expenses decreased by ¥158 million to ¥9.1 billion (US$76 million), due to a reduction in depreciation costs and rental fees. Total operating expenses including taxes were dropped ¥186 million to ¥20.0 billion (US$166 million).

Thanks to this reduction in expenses, the Bank’s OHR¹, an indicator of business efficiency, which was 58.4% for the six-month period ended September 2002 on a non-consolidated basis, became 59.2% for the year ended March 2003. This is a favorable 67.6% of the average for regional banks of comparable scale (for the six-month period ended September 2002) and a favorable 62.7% for the regional bank average for the same period ended September 31, 2002². We are also working to enhance our business efficiency by supporting new investments, which has led to the continued strengthening of our competitiveness, and by attempting to achieve a balance between raising profits and curbing expenses.

Notes:

1.

Overhead ratio (OHR) is calculated by dividing operating expenses by gross business profit, and is used to indicate the amount of profit per unit of expense. The smaller the figure, the greater the business efficiency.

2.

The average volume of funds under management-in accordance with stipulations by the Regional Bank and other regional banks of comparable scales.

3.

The figures in the graphs have been rounded down.

◆ Capital Ratio (At 10.19%, twice the domestic standard)

Capital ratio is one of the chief indicators designed to show the security and soundness of the asset portfolio of a bank. Standards considered necessary for this ratio are 8% for banks having overseas business offices and 4% (domestic standard) for banks operating domestically, as in the case of the Bank of the Ryukyus. As of March 31, 2003, the Bank had secured a capital ratio of 10.20% on a consolidated basis, and 10.19% on a non-consolidated basis according to the domestic standard, which is over twice the minimum requirement.

◆ Credit Rating –acquired A- rating

Credit ratings are conducted by a credit rating agency, as an impartial third party, on the occasion of the issuance of bonds and other investment instruments, to determine the likelihood of repayment of principal and interest. Following the agency’s review, a rating is assigned.

Bank of the Ryukyus was ranked seventh out of the top 20 by the Japan Credit Rating Agency, Japan’s leading credit rating agency and given an “A-“ rating (a single A minus), which is a favorable rating. In the future, we will continue working to enhance profitability and improve our capital ratio, to raise our rating.

Note: Credit ratings are divided into 10 ratings, ranging from AAA to D. Regarding the ratings from AA to B, within the same ranking a relative position is indicated using a plus sign or a minus sign. If this sign is taken into account, the number of rankings increase to 20.

Increasing Soundness of Asset Portfolio

The Bank is vigorously working to improve its loan portfolio and enhance customer support

The Bank has recognized that the improvement of its loan portfolio is its most urgent management task, and is focusing on early disposal of non-performing loans and reduction in the level of assets subject to mandatory disclosure under the Financial Reconstruction Law.

Regarding loans to legally or effectively bankrupt borrowers (under the borrower categories used for asset self-assessment in accordance with the Law), the Bank will promptly take measures for final disposal. Regarding loans to borrowers threatened with bankruptcy and to borrowers requiring caution, we will take a more cautious stance for final disposal. The vast majority of these borrowers are still engaging in business operations and have the potential to be reclassified as "normal" borrowers on condition that their performance recovers and loans overdue are eliminated. The Bank is making utmost effort to help these borrowers to improve their financial position. The Bank has established a designated support office where certified business consultants provide the borrowers with customized balance sheet rehabilitation plans. We believe that continuous borrower support will contribute to upgrading borrower categories, and consequently revitalize small and medium-sized companies of the region. In this way, our loan portfolio will also improve. As a regional bank, we are determined to realize our corporate mission of contributing to the prosperity of regional society.

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Definition of borrower categories used for asset self-assessment and their relation to claims subject to mandatory disclosure under the Financial Reconstruction Law

Our policy on reserve for possible loan losses and the concept of coverage ratio

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Claims on legally or effectively bankrupt borrowers

Write-downs of or making provision for the amount equivalent to the portion not covered by collateral or guarantees

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Claims on borrowers threatened with bankruptcy

Making provision for specific reserve for possible loan losses in the estimated loan loss for individual borrowers based on the historical default rates

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Claims on other borrowers mentioned above

Making non-specific provision for possible loan losses in the estimated loan loss amounts--for 3 years for claims on borrowers requiting supervision, and 1 year for claims on other borrowers requiring caution and normal borrowers-- based on historical default rates.

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Coverage ratio

Representing the ratio of amounts covered by collateral, guarantees and reserves to the total amount of claims subject to mandatory disclosure

Definitions of borrower categories under asset self-assessment and their relation to claims subject to mandatory disclosure under the Financial Reconstruction Law

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Self-assessment borrower category: Claims on legally or effectively bankrupt borrowers = Financial Reconstruction Law claim category: Claims on legally or effectively bankrupt borrowers

This claim category refers to claims on borrowers who are legally or effectively bankrupt, under liquidation procedures or in comparable circumstances

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Borrower category: Claims on borrowers threatened with bankruptcy = Claim category: Claims on potentially bankrupt borrowers

This category refers to claims on borrowers who will probably fall into business failure, judging from the fact that payment of interest was overdue due to effective insolvency of borrowers caused by continuous loss-making operations.

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Borrower category: Claims on borrowers requiring supervision > Claim category: Substandard loans

Claims on borrowers requiring supervision refers to claims on borrowers who have restructured loan balance or loans overdue 3 months or more

Substandard loans refers to loans overdue 3 months or more or loans with renegotiated terms and conditions

Claims on borrowers requiring supervision are determined based on borrower category, while substandard loans are determined based on individual assessment of claims. Therefore, amounts classified under claims to borrowers requiring supervision are larger than those classified under substandard loans. For example, a borrower has two loan obligations, for one of which repayments are being made in accordance with the initial loan conditions, while for another the loan conditions have been changed. These loans are classified as claims on borrowers requiring supervision, while only the latter is classified as a subordinated loan.

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Borrower category: Other claims to borrowers requiring caution

refers to borrowers of such loans as loans without appropriate loan conditions, or loans overdue shorter than 3 months, and borrowers without appropriate financial position.