Board of Directors’ report

Prudent

Our name is synonymous with fiscal prudence, as evidenced by our strong liquidity and capital base, stable deposits, and quality assets.

19.6%

Capital adequacy

Capital adequacy declined slightly, from 20.0 percent in 2017 to 19.6 percent in 2018.

40fils

Cash dividend

The Board has recommended a cash dividend of 40 fils per share.

2018 40%
2017 35%
56fils

Earnings per share

Earnings per share for 2018 stood at 56 fils, up from 48 fils in 2017

The Board of Directors is honoured to present the 47th annual report and consolidated financial statements of BBK and its subsidiaries (the Group) for the year ended 31 December 2018.

Operating environment

Throughout the difficult economic times that have prevailed since 2014, the fact that Bahrain has not experienced negative growth is testament to the Kingdom’s sound fundamentals and the economic policies pursued.

Unemployment, always a primary indicator of economic downturn, has remained consistent, with no marked increase. Similarly, interest rates – another key indicator of economic health – have been reasonable, influenced mainly by the external environment and global movements.

These factors are very positive for a country with economic challenges. Bahrain has achieved moderate growth, with GDP rising by 3.9 percent in real terms in 2017, despite a contraction in the hydrocarbon sector.

Bahrain’s headline real growth rate increased sharply in the second quarter of 2018 to an annualised 2.4 percent, according to the Bahrain Economic Development Board (EDB), which noted a broad-based recovery across the economy and a near-term outlook of relatively stable growth, around the 3 percent mark.

In particular, the EDB highlighted the expansion of Bahrain’s non-oil GDP in the regional context. The oil industry now accounts for less than one-fifth of Bahrain’s GDP, with growth dynamics critically linked to non-oil drivers.

Tourism was an important factor in Bahrain’s non-oil growth, with visitor numbers up 5.8 percent year-on-year. Construction, up 6.7 percent, and manufacturing, up 4.5 percent, were also important contributors.

The World Bank forecast that full-2018 growth in Bahrain’s economy would reach 3.2 percent, although it suggests a slight GDP decline in 2019. However, higher oil production – the result of a major refinery expansion – and a host of megaprojects in the pipeline give cause for optimism.

The discovery earlier in 2018 of at least 80 billion barrels of shale oil in Bahraini waters also boosts the Kingdom’s prospects. The offshore field also contains an estimated 10-20 trillion cubic feet of deep gas reserves.

Economic policy

Support from our Gulf neighbours significantly reduced the risk of a debt crisis in Bahrain through a $10 billion aid package tied to fiscal reforms, while the Kingdom strengthened its reputation for economic management. The aid extended will support Bahrain’s funding requirements in the form of phased long-term and interest-free loans.

At the same time, Bahrain has released a detailed programme to reduce debt and abolish its budget deficit by 2022. This is by far the most comprehensive plan to put Bahrain on a sustainable financial footing since oil prices plunged in 2014.

The reforms, focused mainly on taxation and subsidies, are spread over several years. They will enable Bahrain to retain borrowing powers in international markets, a facility in doubt earlier in the year when plans to sell US dollar bonds were dropped because of the high yields demanded.

Excluding the aid package, Bahrain had estimated its borrowing needs at $20 billion over five years. It now plans to use the aid to reduce that by $10 billion, while reforms aim to balance the budget and shrink the deficit from the current 9.9 percent of gross domestic product to 0.1 percent in 2022. Bahrain’s public debt as a ratio of GDP is projected to fall to 82 percent in 2022 instead of the previously forecast 104 percent.

Bahrain will create new bodies to oversee government spending and borrowing, including a new debt management office. The plan promises to cut public spending with six task forces, introduce voluntary retirement for state employees, and mount an efficiency drive. Further changes include the introduction of value-added tax and changing the pensions system.

Strategic cycle

The goals for our 2016-18 strategic cycle have been largely achieved, highlights being the opening of our representative office in Turkey, introduction of our BBK Lite branches for migrant workers, the roll-out of our private banking and wealth management offering, BBK Privé, and launching new technology platforms within the Bank and its subsidiaries. These and other achievements are fully detailed in the Chief Executive’s review.

In terms of strategic objectives, and in the context of the prevailing market conditions, BBK’s results are commendable. In such challenging times, many of our clients have been struggling, prompting requests for restructuring. This has led us to take more proactive measures and set aside the required provisioning to cater for any unexpected market downturns.

The Bank is witnessing a compound profit growth of 6-7 percent annually, but the application of the IFRS 9 requirements to make higher provisions for expected credit losses (rather than losses actually incurred) has affected BBK and the entire banking sector. With a market share of 15-20 percent, we continue to be one of the most important banks in Bahrain, with very strong corporate and government segments. We have also grown substantially in consumer and retail business and will be concentrating on further mobilising this sector in the upcoming cycle.

Our new three-year strategic plan has now been finalised, following an internal process supported by a leading worldwide management consulting firm.

The dominant theme of our 2019-21 strategic cycle is fintech. BBK has long been a technology leader, but others are catching up and we need to move to the next level of digital innovation. The Central Bank of Bahrain (CBB) is committed to the modernisation of the financial sector and we will be reviewing our platforms to introduce new channels and further enhance our security measures. BBK has done well in this area, but we must respond to the rapidly-changing digital environment and stay ahead of the market.

Financial highlights

BBK achieved a net profit of BD 67.1 million for 2018, 14.4 percent higher than the previous year’s BD 58.7 million, equating to 56 fils earnings per share. Net interest income rose by 20.9 percent to BD 110 million, while total shareholders’ equity marginally decreased by 0.1 percent to BD 500.4 million.

The profit increase is mainly attributable to the growth in the loans and investment portfolio, as well as improved margins resulting from higher global interest rates, all supported by highly effective management of assets and liabilities.

Other income also increased, mainly due to improved performance of the Bank’s investment portfolio. On the other side, and as part of the prudent risk management practice, the Bank has taken higher net provisioning charges of BD 35.4 million in 2018 (2017: 29.0 million).

Operating costs increased by 6.9 percent to BD 57.7 million (2017: BD 54.0 million), the result of continuous investment in human capital, technology, and infrastructure. Nevertheless, our cost-to-income ratio improved to 35.8 percent (2017: 37.8 percent), reflecting BBK’s ability to grow revenue streams and carefully control costs.

The Board has recommended a cash dividend of 40 fils per share.

Regulatory compliance

Ever more stringent regulatory requirements necessitate the increasing investment of time and money, but the benefits outweigh the costs and proved their value during the past year. By achieving compliance with new international financial reporting standards (IFRS 9) two years ahead of the January 2018 deadline, BBK was well-positioned to identify risk factors early and take remedial action where necessary.

The CBB has been helpful in detailing the risks specified in the Basel III regulatory framework for banks, such as capital adequacy ratios as they apply to specific areas of operation. We are very comfortable with our compliance and continued ability to do so, even if the CBB introduces additional risk factors or raises capital adequacy requirements.

In some areas we have been ahead of CBB requirements, such as the recent ruling that Board members receive a minimum of 15 hours’ training each year. BBK has long provided directors – and executive managers – with training in corporate governance and allied matters.

The CBB is exercising ever closer scrutiny of commercial banks, with more frequent inspections and heightened focus on issues such as fee structures, credit card interest rates, and foreign exchange charges. We welcome these measures as added consumer protection and an incentive for banks to reduce costs by making better use of technology.

Supporting society

As detailed in the Corporate Social Responsibility (CSR) section of this annual report, BBK continues to invest in a range of social initiatives, demonstrating our commitment to supporting the local communities we serve.

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 2018 134,632
Profit for the year 2018 67,118
Proposed appropriation for donations (1,600)
Distribution on Perpetual Tier 1 Convertible Capital Securities (7,103)
Other negative changes in retained earnings (1,063)

Retained earnings as at 31 December 2018 available for distribution (before proposed dividend)

191,984

Proposed cash dividends (40% of paid-up capital, net of treasury stock) (43,017)

Retained earnings as at 31 December 2018 (after proposed dividend)

148,967

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 Stable

Report issue date: 18 October 2018

 

Fitch

Long-Term Issuer Default Rating

BB-

Moody’s

Rating
Bank deposits B2/NP
Baseline credit assessment b2
Adjusted baseline credit
assessment
b2
Counterparty risk assessment B1
Senior unsecured (P)B2/B2
Subordinate (P)B3
Outlook Stable

Report issue date: 19 December 2018

Moody’s

Long-term debt

B2

CEO award

The Board takes great pleasure in congratulating BBK’s Chief Executive, Reyadh Yousif Sater, on receiving the ‘Top CEO’ award that recognises the best performing leaders of companies listed on Gulf stock markets.

The honour was conferred at the Top CEO Awards and Conference 2018 event, where the organisers described Mr Sater’s distinction as a transparent and stringent selection based on comprehensive evaluation by Trends Media and INSEAD Business School, making this award the region’s most reputable leadership award and a benchmark for businessmen and their companies.

Appointment of auditors

At the Annual General Meeting held on 20 March 2018, Ernst & Young were re-appointed as external auditors to BBK for the financial year ending 31 December 2018.

Ratings

In October 2018, Fitch Rating Agency affirmed BBK’s Long-Term Issuer Default Rating (IDR) at ‘BB-’ with a Stable Outlook, the same as Bahrain’s sovereign ratings. It also affirmed the Viability Rating (VR) at ‘bb-’ and the Support Rating (SR) at ‘3’. Fitch says that BBK’s IDRs are driven by its standalone creditworthiness, as reflected by its ‘bb-’ VR. The IDRs are also underpinned by potential sovereign support, as reflected by the Bank’s Support Rating Floor (SRF) of ‘BB-’.

BBK’s VR is capped by the operating environment in Bahrain and, more specifically, by the Bahraini sovereign rating of ‘BB-’. This reflects the fact that BBK is predominantly a domestic bank with significant exposure to the sovereign and the domestic operating environment. The VR also considers the Bank’s impaired loans ratio, concentration risk and the adequate capital ratios, but also its wellentrenched domestic franchise, adequate margins, and consistent profitability.

In December 2018, Moody’s Investors Service affirmed the long-term deposit and issuer ratings of BBK, along with three other retail banks it rates in Bahrain. Moody’s also affirmed the Baseline Credit Assessments (BCA), adjusted BCAs, Counterparty Risk Assessments (CRAs) and Counterparty Risk Ratings (CRRs) of these banks. The outlook on BBK was changed to stable, from negative.

Moody’s assigned B2 stable/Not-Prime long-term and short-term local-currency deposit ratings to BBK. The ratings capture the Bank’s standalone credit strength, reflected in its Baseline Credit Assessment (BCA) of b2, which is at the same level as the Government of Bahrain’s (B2 stable) rating.

BBK’s b2 BCA captures its (1) strong domestic franchise, which supports its sound profitability, (2) solid liquidity buffers and resilient funding, and (3) adequate capital. These strengths are moderated by the Bank’s high deposit and credit concentrations, and a difficult operating environment, which increases asset risks. BBK’s long-term foreign-currency deposit rating of B3 is constrained by Bahrain’s B3 country ceiling for such deposits, which captures foreign-currency transfer and convertibility risks.

Forward view

We look to the future with optimism, with Bahrain having made excellent progress to overcome its economic challenges during the year. As a bank, we will benefit in our domestic market and build on our operational achievements. With interest rates rising, our cost of funding will increase, as will our returns on new loans and assets. Nevertheless, reducing costs will remain a primary focus, as it has over the last strategic cycle.

Provisioning will remain a crucial area – understanding why we need to make such high provisions and identifying better ways to manage the challenge. We also need a strategy to counter new competitors entering BBK’s traditional markets. We are considering a number of concepts as we look towards further diversification of our activities.

Appreciation

On behalf of the Board, I acknowledge the contributions of the ex-Deputy Chairman, Mr. Aref Saleh Khamis, and ex-Board Member Dr. Zakareya Sultan AlAbbasi, for their invaluable contributions to the Board and the success of the Bank throughout the years. They have been Directors since 2003 and 2012 respectively and have left the Board in December 2018.

In conclusion, we extend our thanks and appreciation to shareholders for their support, to clients for their trust, and to all Group employees for their dedication and efforts throughout the year.

On behalf of the Board of Directors

Murad Ali Murad

Chairman