Board of Directors’ report

Bahrain’s Best Retail Bank
for the fifth successive year

Global Banking and Finance Review

The adoption of IFRS 9 was one of several priorities advanced during the 2016 phase of the Bank’s three-year strategic cycle.

Capital adequacy

20.0%

Capital adequacy rose from 18.5 percent in 2016 to 20.0 percent in 2017.

Our focus on technology has two aspects: enhancing the services we provide to customers, and increased vigilance to the ever-growing threats to cyber security.

Cash dividend

35fils

The Board has recommended a cash dividend of 35 fils per share.

Corporate business will remain important, but in the current environment it carries more risk, as was evident in the provisioning made for 2017.

Earnings per share

48fils

Earnings per share for 2017 stood at 48 fils.


The Board of Directors is pleased to present the 46th annual report and consolidated financial statements of BBK and its subsidiaries (the Group) for the year ended 31 December 2017.

Operating environment

There have been some signs of improvement in our operating environment, not least the rise in the oil price that is so influential in our regional economies. Nevertheless, regional political issues – and to an extent, economic issues – combined to maintain the challenging market conditions of recent times, perhaps even more so in the past year.

Towards the end of 2017, oil prices stabilised at a higher level, which would have been thought improbable not so long ago. From $36 per barrel this time last year, we are now in the $55-60 range, a major improvement.

However, this should not be taken as an indicator that our region can relax and slow down the structural economic reforms that were prompted by the decline in oil revenues. Restructuring continues to be of vital importance, particularly for Bahrain. A good example is the gradual removal ofsubsidies on a range of items from food to fuel, which reduces government costs while increasing revenues.

Similarly, the introduction of value added tax (VAT) will mark a significant change in the tax landscape of the GCC and assist in boosting government revenues. Businesses in Saudi Arabia and the United Arab Emirates will be required to comply with the VAT regime from January 2018. Bahrain and other GCC states are getting ready to implement VAT during 2018-19 pending official issuance of specific VAT rules and guidelines. Government revenues across the GCC region will also benefit from special taxes on tobacco products, soft drinks, and energy drinks effective from 1 January 2018.

Expected GDP growth of 2.5 to 2.8 percent in 2017 is lower than forecast and lower than the previous year, attributed by a World Bank report to weak aggregate demand and accumulated fiscal deficits. Despite austerity measures, the World Bank notes that Bahrain remains exposed to financing risks due to its limited savings, high debt levels, and low oil and bauxite prices.

Economic policy

As expected, Bahrain’s government has resorted to borrowing as it goes through a period of restructuring, drawing on domestic, regional, and international sources of funding. Although the Kingdom no longer holds a national investment-grade rating, all issues have been over-subscribed, a very positive outcome for the government and the Bahrain economy.

The issues did not have to carry a premium rate to attract investors. As interest rates have gradually risen in the USA, the differential with issues by Bahrain has not been significant.

Bahrain is also now issuing treasury bills and Sukuk direct to the public, competing with banks for deposit-taking. Banks act as intermediaries for such transactions, which carry a minimum investment of about BD 10,000 and are listed on the Bahrain Bourse for ease of trading. So far, the Bank’s deposit-taking has been unaffected by public issues, with BBK’s figures for the year exceeding those for 2016.

The response to institutional and public issues has helped the government in restructuring and economic management, although a large balance-of-payment deficit is still in place.

Strategic initiatives

The Board of Directors has completed a detailed analysis of the Bank’s entire strategic planning procedure to ensure continued relevance to the changing market environment. As a result, strategy reviews now take place every six months instead of yearly.

The adoption of International Financial Reporting Standard 9 (IFRS 9) was one of several priorities advanced during the 2016 phase of the Bank’s three-year strategic cycle. Among our key business achievements were the development of our representative office in Turkey, which opened in December 2016; opening Aegila Capital Management, our joint-venture investment and advisory firm in London; relocating and opening new branches in Bahrain; completion of preparations for launching BBK Lite, our tailored offering for expatriate workers; and investing further in technology.

Our review of IT requirements was particularly relevant: a major initiative that matches our systems and services to the best available technology. Next year is the third and final of the current three-year strategic cycle, and technology will be an important priority. Most of global technology development has taken place in the past five years, so staying ahead is imperative for established leaders such as BBK.

Our focus on technology has two aspects: enhancing the services we provide to customers, and increased vigilance to the ever-growing threats to cyber security. The former is evident in deposit machines and our new interactive teller machines; the latter in the cyber-attacks that are becoming increasingly frequent around the world. Although BBK has not been affected, we are alert to the threat it poses for the banking industry and always ensure that we have the best protection in place.

The Bank’s operation in India has recorded improved performance, expected to continue while attention is given to improve the performance of the Kuwait branch. Our representative office in Turkey is still at an early stage, but indications are good that the expected contributions to revenue will be achieved. Our well-established Dubai representative office continues to perform well.

CrediMax, our wholly owned specialist in bank card business, continues to perform very well, generating consistent demand because of the high quality of its services. External issues have stalled plans for cross-border expansion into Kurdistan and Saudi Arabia, but we still see potential there and are keeping our options open.

Invita, our wholly owned subsidiary specialising in call centre services, embedded its recently established Kuwait subsidiary and continued its diversification into serving the training and insurance sectors.

Financial highlights

In another year of excellent results, BBK achieved a net profit of BD 58.7 million for 2017, up by 4.0 percent on the previous year’s BD 56.4 million, and equivalent to 48 fils earnings per share. Net interest income rose by BD 5.1 million, an increase of 5.9 percent on the BD 85.8 million reported in 2016. Total shareholders’ equity rose by 5.6 percent to BD 500.8 million.

The Bank again demonstrated consistent performance in its core business, underlining the soundness of its strategy and management team. The total balance sheet strengthened to BD 3,763.1 million, an increase of 1.6 percent.

At 20.0 percent, capital adequacy is at an unprecedented level, up from 18.48 percent a year earlier. This is substantially above the minimum regulatory requirement, boosted by the successful BD 86 million perpetual bond issue in 2016. The ratio of liquid assets to total assets has strengthened to 34.69 percent, from 32.61 percent. The Board has recommended a cash dividend of 35 fils per share.

Regulatory compliance

BBK has been one of the few banks regionally to fully implement the new International Financial Reporting Standard 9 well ahead of 1 January 2018, when its requirements become formally effective. In fact, the Bank is among global leaders in early adoption of the standard, which specifies how an entity should classify and measure financial assets, financial liabilities, and some contracts to buy or sell non-financial items.

IFRS 9 is regarded as the most significant accounting development for banks today because it requires significant changes to a bank’s operational and risk management processes. Recognising the importance of IFRS 9, BBK began planning and implementation two years before the effective date – a decision that has proved very valuable.

In moving from making general provision for estimated credit loss, the entire portfolio is now assessed for signs of weakness, and investment or political factors are taken into account when assessing the need for provisions. This has resulted in increased provisioning, as was expected globally, but the Bank has been able to cope with this – and absorb the cost of implementing IFRS 9 – while still achieving higher profitability.

BBK is also well prepared to capture and report tax-residency status, to satisfy the Common Reporting Standards (CRS) as well as the USA’s Foreign Account Tax Compliance Act (FATCA). Value added tax is another challenging project that the Bank aims to complete ahead of the expected implementation date in the Kingdom of Bahrain.

Appropriations

The Board of Directors recommends the following appropriations of the Bank’s net profit for approval by shareholders:

BD’000
Retained earnings as at 1 January 2017 122,830
Profit for the year 2017 58,685
Proposed appropriation for donations (1,400)
Distribution on Perpetual Tier 1 Convertible Capital Securities (7,103)
Other negative changes in retained earnings (619)

Retained earnings as at 31 December 2017 available for distribution (before proposed dividend)

172,393

Proposed cash dividends (35% of paid-up capital, net of treasury stock) 37,761

Retained earnings as at 31 December 2017 (after proposed dividend)

134,632

Supporting society

As detailed in the CSR section of this annual report, BBK continues to invest in a range of community initiatives, demonstrating our commitment to supporting Bahrain and its people.

Forward view

In the coming year, IFRS 9 will remain a focus, enabling BBK to draw maximum benefit from our investment in early adoption. We are in a position to better identify potential weaknesses and problems in our total portfolio.

Corporate business will remain important, but in the current environment it carries more risk, as was evident in the provisioning made for 2017. Our experience is not unique – it is typical of the regional banking sector and we will work with corporate customers that need help to overcome their challenges.

Global events such as the US presidential elections and the British referendum to leave the European Union have so far had little or no impact in Bahrain and we do not expect this to change in the coming year. On the positive side, the US economy is strong, with gradual upward movement in interest rates. More significantly, our region’s challenges take precedence as political change and economic restructuring gather pace.

We can expect only moderate GDP growth in the coming year, but we are confident that Bahrain will come through. There is a commitment to economic reform, and the sustained over-subscription of bond issues confirms the positive nature of investor sentiment.

Appointment of auditors

At the Annual General Meeting held on 29 March 2017, Ernst & Young were re-appointed as external auditors to BBK for the financial year ending 31 December 2017.

Fitch

Rating
Long-term issuer default
rating
BB+
Short-term issuer default
rating
B
Viability rating bb+
Support rating 3
Support rating floor BB+
Outlook Negative

Report issue date: 2 November 2017

Fitch

Long-Term Issuer Default Rating

BB+

Moody’s

Rating
Bank deposits B2/NP
Baseline credit assessment b1
Adjusted baseline credit assessment b1
Counterparty risk assessment Ba3(cr)/
NP(cr)
Senior unsecured B1
Subordinate (P)B2
Outlook Negative

Report issue date: 7 August 2017

Moody’s

Long-Term Bank Deposits

B2

Ratings

In November 2017, Fitch affirmed BBK’s long-term issuer default rating at BB+ with a ‘Negative’ outlook, the same as Bahrain’s sovereign rating. The agency says the rating indicates BBK’s standalone strength and resilient financial performance, as reflected in the Bank’s viability ratings, support ratings, and support rating floors.

BBK has maintained solid margins and consistent profitability through its well-entrenched banking franchise in Bahrain. Funding and liquidity remain satisfactory and are important rating influencers. Asset quality metrics are sound, supported by an adequate level of provisioning. Fitch does not expect a further sharp increase in impaired loans. However, it notes that the operating environment in Bahrain remains challenging and could impose additional pressure on the Bank’s asset quality metrics.

Moody’s reported in August 2017 that its B2 (Negative)/Not-Prime ratings of BBK’s local currency deposit and senior unsecured debt illustrate BBK’s standalone credit strength, as reflected in a baseline credit assessment (BCA) of b1, the same level as Bahrain’s B2 (Negative) sovereign rating.

The b1 BCA indicates BBK’s strong domestic franchise, which with recent efficiency improvements supports profitability, solid liquidity buffers, a resilient funding profile, and sound capital levels. BBK’s long-term foreign currency deposit rating of B2 is constrained by Bahrain’s B2 country ceiling for such deposits, which takes account of foreign currency transfer and convertibility risks.

Appreciation

The Board thanks BBK shareholders for their continued confidence; our clients for their loyalty and patronage; and BBK’s management and employees for the hard work and commitment that underpin another year of excellent results.

On behalf of the Board of Directors

Murad Ali Murad

Chairman