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ANNUAL REPORT 2015

MANAGEMENT DISCUSSION & ANALYSIS

4.0. 2015 ACTIVITY AND PERFORMANCE ANALYSIS

4.1. BUSINESS OVERVIEW IN 2015

Despite the tough operating conditions both domestically and regionally throughout 2015, Bank Audi achieved relatively good performances in most of its entities within continued control on risk and costs as a precautionary measure against persisting regional uncertainties and volatility. The Group registered a growth in its consolidated net earnings after provisions and taxes by 15.1%, reaching USD 403 million, as compared to USD 350 million in 2014. This performance stemmed in particular from the reinforcement of the earnings generation capacity in main development pillars of the Group, mainly in Lebanon, Turkey, Egypt, and Private Banking entities. It encompasses the allocation of USD 133 million of net loan loss provision charges, strengthening the Bank’s asset quality. In parallel, consolidated assets of Bank Audi increased to USD 42.3 billion.

At the business level, both the number of customers and the total number of accounts continued to increase, with 155,371 new customers and 311,303 new accounts in 2015. At end-December 2015, the Bank’s franchise counted 994,643 customers and 1,907,918 accounts.

Although this consolidated performance continued to be hampered by the depreciation of the exchange rates in main countries of presence versus the US Dollar, in particular the Turkish Lira, the Egyptian Pound and the Euro by respectively 25.6%, 9.5% and 11.4% over the year, it nonetheless confirms the Group’s resilience, driven by diversified sources of assets and earnings which enable it to maintain its financial standing, to reinforce its leading positioning among top regional banking groups in a persisting challenging environment, and to add value to all stakeholders .

4.2. CONSOLIDATED BALANCE SHEET MANAGEMENT

As in previous years, the management of the balance sheet at Bank Audi continues to favour placements in asset classes that have the highest impact on profitability while taking into consideration an optimum diversification of risks and a conservative approach to asset quality. Balance sheet allocation is, as such, determined by specific limits set internally and based on Management’s risk appetite and underlying volumes. These limits are applied by all entities over and above the abidance to local regulations requirements, and are monitored on a day-to-day basis by the Group Risk department. Changes to those limits relative to business or market conditions are proposed by Management for the approval of the Board of Directors which, as per the Group’s Corporate Governance guidelines (Article 2.8.), review them annually.

Consolidated assets recorded a nominal increase of USD 310 million in 2015 (representing a growth of 0.7%), reaching a total of USD 42.3 billion at end-December 2015 (from USD 42.0 billion at end-December 2014) and USD 52.1 billion when accounting for fiduciary deposits, security accounts and assets under management. When adjusting to the depreciation of the exchange rates of both the Turkish Lira and the Egyptian Pound relative to the US Dollar, consolidated assets of Bank Audi would have increased by USD 2.1 billion to USD 44.1 billion (corresponding to a growth of 5.1%), driven by an increase in assets in Turkey and Egypt by USD 1.3 billion and USD 0.8 billion respectively, with assets of entities operating in Lebanon increasing slightly by USD 242 million (excluding consolidation adjustments). Based on the above, the contribution of entities outside Lebanon to consolidated assets moved from 48.1% as at end-December 2014 to 48.6% as at end-December 2015, while the share of assets booked in investment grade countries reached 33.3%.

SUMMARISED BALANCE SHEET (USD MILLION)

consolidated balance sheet

ASSETS, DEPOSITS AND LOANS BREAKDOWN BY GEOGRAPHY AND RATING

consolidated balance sheet

At end-December 2015, Bank Audi continued to report a highly liquid balance sheet with primary liquidity reaching USD 16.4 billion (including Central Bank CDs) and representing 46.1% of customers’ deposits, a high level when compared to regional and global averages. In parallel, Bank Audi boosted its loan to deposits ratio by 2.4% to stand at 50.3% at end-December 2015. In parallel, portfolio securities as a percentage of deposits moved from 28.2% as at end-December 2014 to 28.5% as at end-December 2015, whereby the net exposure to Lebanese sovereign Eurobonds as a percentage of net customers’ deposits contracted by 3.5% to stand at 1.5%, the lowest level among Lebanese banks’ portfolios.

consolidated balance sheet

The following discussion covers an analysis of the evolution of funding sources and their uses in 2015 at a consolidated level.

FUNDING SOURCES

At end-December 2015, consolidated deposits represented 84% of total funding sources, down by 1% relative to the corresponding period of last year, while banks’ deposits, subordinated debt and other liabilities had similar shares in total funding, reaching 5%, 1% and 2% respectively. Shareholders’ equity represented, at the same date, 8% of the funding sources.

consolidated balance sheet

Consolidated Customers’ Deposits

Consolidated customers’ deposits recorded in 2015 a nominal decrease of USD 212 million (representing a contraction by 0.6%), moving from USD 35.8 billion at end-December 2014 to USD 35.6 billion at end-December 2015. When adjusting to the devaluation of the Turkish Lira and the Egyptian Pound against the US Dollar of 25.6% and 9.5% respectively, consolidated deposits would have increased by USD 1.1 billion, equivalent to 3.0% growth, deemed a good performance given the weak 1.5% deposits growth in the region in 2015 following the sharp deterioration of oil prices. At end-December 2015, 45.1% of customers’ deposits were sourced from foreign entities, and 30.2% were booked in investment grade countries.

Customers’ Deposits by Business Segment

Corporate deposits increased by USD 929 million from USD 7.8 billion at end-December 2014 to USD 8.7 billion at end-December 2015, increasing its share in total deposits from 21.8% to 24.6%. Similarly, retail deposits increased by USD 539 million to reach USD 10.5 billion at end-December 2015, accounting for 29.5% of consolidated deposits as compared to 27.8% the previous year. On the other hand, SME, personal and public deposits decreased by USD 1.1 billion, USD 488 million and USD 48 million respectively, totally offsetting the increase in corporate and retail deposits.

BREAKDOWN OF CUSTOMERS' DEPOSITS BY BUSINESS SEGMENT (USD MILLION)

consolidated balance sheet

Customers’ Deposits by Type

The breakdown of consolidated customers’ deposits by type somehow remained unchanged and skewed toward time deposits which, although decreasing by USD 388 million to USD 23.7 billion at end-December 2015, still accounted for 66.7% of customers’ deposits. In parallel, sight deposits made up for the 0.7% share lost by time deposits, increasing by USD 217 million from USD 5.2 billion at end-December 2014 to USD 5.4 billion at end-December 2015. Saving deposits, certificates of deposits, margin deposits and other deposits represented 14.2%, 2.6%, 1.0% and 0.4% of total deposits respectively at end-December 2015, almost the same level as at end-December 2014.

BREAKDOWN OF CUSTOMERS' DEPOSITS BY TYPE (USD MILLION)

consolidated balance sheet

Subordinated Debt

At end-December 2015, Bank Audi had 4 unsecured subordinated loans with a nominal value of USD 638 million, representing 1.81% of consolidated customers’ deposits, up from 1.42% at end-December 2014. The subordinated loans bear an average interest rate of 6.85% with an average maturity of 8.1 years.

SUBORDINATED DEBT INFORMATION

consolidated balance sheet

On 31 October 2014, Bank Audi extended a subordinated loan to Odea Bank, its wholly owned subsidiary in Turkey, amounting to USD 150 million, bearing an interest of 6.5% and maturing on 30 September 30 2024. As per the applicable capital regulation of the BRSA, the Bank Regulation and Supervision Agency in Turkey, this loan was considered as part of the Tier 2 capital of Odea Bank. It was nonetheless eliminated on consolidated level, along with other intra group adjustments.

In the first half of 2015, Bank Audi sal carried on a securitisation of this loan, with third parties qualified investors subscribing to USD 138 million, while the remaining USD 8 million and USD 4 million were subscribed respectively by Bank Audi Egypt and Audi Capital (KSA). Subsequently, the USD 138 million subscribed by third parties became accounted for in the consolidated Tier 2 capital, as per applicable regulation.

Moreover, on 27 March 2014, Bank Audi closed the issuance of USD 150 million of subordinated loans with the IFC, a member of the World Bank Group, and the IFC Capitalisation Fund, which are expected to be repaid on 11 April 2024, unless previously redeemed by the Bank or accelerated with such early redemption or acceleration being subject to the approval of the Central Bank of Lebanon. The loans bear an interest rate spread of 6.55% over 6-month LIBOR and applicable fees per annum payable on a semi-annual basis, subject to the availability of free profits in accordance with Central Bank’s Basic Circular No. 6830, as applicable at the time of the issuance.

This issuance comes over and above the issuance by the Bank in September 2013 of USD 350 million of subordinated unsecured bonds which are expected to be repaid on 16 October 2023, unless previously accelerated or redeemed by the Bank. Those bonds carry an annual interest rate of 6.75% payable on a quarterly basis and subject to t he same conditions as mentioned above.

The above two issuances are also accounted for as regulatory Tier 2 capital. Please refer to Note 37 in the Consolidated Financial Statements for further details.

Shareholders’ Equity

At end-December 2015, consolidated shareholders’ equity reached USD 3,287 million, down from USD 3,348 million at end-December 2014. The USD 60 million decrease was mainly driven by USD 190 million of dividends payment for the 2014 exercise, the redemption of the USD 125 million series “E” preferred shares, and a negative change in foreign currency translation reserves by USD 134 million, as well as USD 14 million of other changes which totally offset the USD 403 million of net profits generated during the year.

consolidated balance sheet

Differences in the foreign currency translation reserves over the period arouse as a result of translating the investment of the holding bank in its subsidiaries from their respective functional currency into Lebanese Pounds (or USD) using the exchange rate at end-December 2015, which differed from the rate in effect at end-December 2014. In fact, the Turkish Lira, Egyptian Pound and Syrian Pound, devalued against the US Dollar over the period by 25.6%, 9.5% and 70.1% respectively, driving the USD 134 million of negative change in foreign currency translation reserves, split over USD 61 million from Odea Bank, USD 40 million from Bank Audi Egypt and USD 26 million for Bank Audi Syria. Foreign currency translation reserves could be reversed following a potential appreciation of the respective currencies of Bank Audi’s markets of presence versus the US Dollar.

Meanwhile, in January 2014, the Bank opted to hedge a large part of the capital invested in Odea Bank, which has been converted into Turkish Lira, to protect itself against the depreciation of the currency against the US Dollar. The hedging strategies that were entered into are a combination of capped calls and rolling collars which would provide adequate levels of protection while minimising the impact of their cost on the net income of the Bank. As a result, the Bank bore an annual cost of hedge of USD 15 million in 2015, as compared to USD 17.6 million in 2014.

In parallel, regulatory equity moved from USD 3,176 million at end-December 2014 to USD 3,347 million at end-December 2015, translating into a capital adequacy ratio of 13.4% as per Basel III, as compared to an 12% regulatory minimum requirement (including the capital conservation buffer). Please refer to section 4.6. for a detailed analysis of the evolution of capitalisation ratios in 2015.

ASSET ALLOCATION

In what follows, we analyse the evolution of the various asset classes and their respective key indicators at end-December 2015 relative to end-December 2014.

Consolidated Loan Portfolio

Bank Audi’s loan portfolio consists of direct lending such as term loans, residential and commercial mortgages, and overdrafts. The Bank offers a wide range of traditional banking products and services to large corporate clients, namely working capital finance by way of credit lines, overdraft facilities and short-term loans (with terms of less than one year) and trade finance, while also being active in syndications.

In addition, the Bank continuously provides support and financing to small and medium enterprises (SMEs), and aims to increase their share in the total loan portfolio across main entities. To that end, the Bank has mandated the IFC to conduct an in-depth assessment of its SME proposition in Lebanon and Egypt, and develop an enhanced program allowing this segment to become a value driver. At the retail level, the Bank adopted a new customer-centric focused model across entities which boosted the contribution of retail lending in the total portfolio.

In 2015, Bank Audi continued to build its consolidated loan portfolio, registering a nominal growth of 4.4% (equivalent to a nominal increase of USD 758 million), reaching 10.4% in real terms on the basis of constant exchange rates for the Turkish Lira and Egyptian Pound as at end-December 2014, corresponding to a real increase of USD 1.8 billion, mainly attributed to entities in Lebanon, Turkey and Egypt. At end-December 2015, consolidated net loans reached USD 17.9 billion of which 65.2% accounted for by entities outside Lebanon (while 49.2% were booked in investment grade countries).

The following covers the analysis of net exposures by development pillars, as well as the breakdown of net loans by customer type, economic sector, maturity, currency and collaterals.

Net Loans Breakdown by Net Exposure to Development Pillars

At end-December 2015, the largest share of net funded exposure was still accounted for by Turkey, an investment grade country, with a share of 41%, witnessing to the overall quality of the portfolio. In second comes the net lending exposure to Lebanon sustained at 30%, followed by 14% net exposure to Egypt, rising from 11% last year. This evolution underscores the availability of growth lending opportunities across markets of presence, in line with the Bank’s risk appetite and its standing objective to reach an optimal risk diversification level impacting positively on revenue generation.

consolidated balance sheet

Net Loans Breakdown by Customer Type

At the same date, corporate clients continue to contribute most to the consolidated loan portfolio, accounting for 64% of the total (62% at end-December 2014), followed by consumer loans with 18% (17% in 2014), loans to SMEs with 11% (11% at end-December 2014), and finally loans to individuals and Private Banking with 7% (9% at end-December 2014).

This remains in line with the Group’s strategy to strengthen its presence within the corporate business line in all three main markets of the Group, namely Turkey, Egypt and Lebanon.

consolidated balance sheet

Net Loans Breakdown by Economic Sector

Loan portfolio concentration by economic sector remains within the Board of Directors’ approved concentration limits relative to each of the loan portfolio and consolidated equity. At end-December 2015, the largest concentrations by sector were consumer loans (18%), real estate services and developers (17%), manufacturing (16%), other loans (14%), and financial intermediaries (12%).

consolidated balance sheet

Net Loans Breakdown by Maturity

The maturity profile of the consolidated loan portfolio continues to be skewed to the advantage of long-term facilities, accounting for 45% of the total at end-December 2015, up by 41% at end-December 2014, followed by short-term loans and facilities with maturities below 1 year, representing 37% of the total, while medium-term facilities shares in total loans decreased by 4%, reaching 17% of the consolidated loan portfolio at end-December 2015.

consolidated balance sheet

Net Loans Breakdown by Currency

By currency, the consolidated loan portfolio remains highly skewed towards the US Dollar which accounted for 48% of the loan portfolio, rising to USD 8.6 billion at end-December 2015. In parallel, the share of the Turkish Lira decreased by 4% to 18% at end-December 2015, as a result mainly of the devaluation of Turkish Lira against the US Dollar.

On the other hand, despite a devaluation of the Egyptian Pound versus the US Dollar by 9.5% in 2015, the share of loans denominated in Egyptian Pounds increased by 2%, reaching 10% at end-December 2015, underscoring a growth momentum outpacing the devaluation impact. On this backdrop, the contribution of loans denominated in Lebanese Pounds was sustained at the same 8% level as at end-December 2014.

consolidated balance sheet

Net Loans Breakdown by Collateral

Notwithstanding the fact that lending decisions rely primarily on the availability and sustainability of cash flows as a first source of repayment, Bank Audi also relies on the availability and enforceability of collaterals. As at end-December 2015, Bank Audi’s loan portfolio remains adequately collateralised, as secured loans represented more than 43% of the total loan portfolio of which real estate mortgages (26%) and cash and bank guarantees (13%). Loans covered by personal guarantees represented 26% of the portfolio as compared to 24% at end-December 2014.

consolidated balance sheet

Loan Quality

ASSET QUALITY (USD MILLION)

consolidated balance sheet

1 Including interest in suspense on doubtful loans.


On the asset quality level, a detailed analysis of doubtful loans movement in 2015 underscores the tight credit risk management adopted in light of the challenging operating environment. Additions of new doubtful loans reached USD 179 million in 2015, and were met by USD 110 million of loans written off amid USD 66 million of FX effect. Subsequently, gross doubtful loans increased in net terms by USD 2.5 million to USD 542 million at end-December 2015.

consolidated balance sheet

With gross loans growing at a faster pace than gross doubtful loans, the ratio of gross doubtful loans to gross loans ratio improved from 3.05% at end-December 2014 to 2.94% at end-December 2015, a low level when compared to the industry averages in Lebanon (3.5%), the MENA region (3.9%), the emerging markets (6.9%) and the world (7.5%).

In parallel, specific loan loss reserves, including interest in suspense, decreased from USD 387 million at end-December 2014 to USD 371 million at end-December 2015, representing a contraction by USD 15.8 million. This contraction is mainly driven by the USD 110 million of write-offs mentioned, in addition to a USD 24 million negative differences in foreign currency translation and transfers totally offsetting the USD 145 million of net specific loan loss reserves taken during the year. Subsequently, the coverage ratio of doubtful loans by specific provisions reached 68.4% at end-December 2015. The below chart highlights the movement of specific provisions on doubtful loans.

consolidated balance sheet

Total collective provisions increased in 2015 by USD 23 million, from USD 139 million at end-December 2014 to USD 162.2 million at end-December 2015, growing by 16.8%, outpacing the growth of the loan portfolio, in support of Management’s commitment to gradually increase the ratio of collective provisions to 1% over the medium term. Collective provisions represented 0.90% of net loans at end-December 2015, as compared to 0.86% at end-December 2014. When accounting collective provisions and real guarantees, the coverage of gross doubtful loans would reach 118%.

The table below highlights the evolution of loan quality indicators in main development pillars: Lebanon, Egypt, Turkey and Private Banking entities.

ASSET QUALITY BY DEVELOPMENT PILLARS (USD MILLION)

consolidated balance sheet

1 A level deemed adequate in view of the solid collaterals throu gh first degree mortgages and other securities having satisfacto ry LTVs.


Changes in Primary Liquidity

Consolidated primary liquidity, comprised principally of balances held at the Central Bank (excluding Central Bank certificates of deposits) and placements with banks, continued to stand at at USD 12.6 billion at end-December 2015, representing 35.5% of customers’ deposits. Nonetheless, primary liquidity funded the increase in consolidated net loans, decreasing from USD 13.1 billion as at end-December 2014, corresponding to 36.6% of customers’ deposits. Including BDL certificates of deposits, consolidated primary liquidity reached USD 16.4 billion at end-December 2015, representing 46.1% of customers’ deposits, one of the highest levels in the region.

By currency, primary liquidity in Lebanese Pounds is essentially composed of cash and deposits with the Central Bank. The ratio of Lebanese Pound-denominated liquid assets to Lebanese Pound-denominated customers’ deposits increased to 20.1% as at end-December 2015 from 13.5% as at end-December 2014, underscoring Management’s decision to favour the Central Bank’s risk over sovereign exposure.

In foreign currencies, primary liquidity consists of cash and short-term deposits placed at central banks, excluding certificates of deposits, and placements at prime banks (rated A3 and above) in OECD countries. Primary liquidity in foreign currencies decreased from USD 12.5 billion as at end-December 2014 to USD 11.8 billion as at end-December 2015, representing 37.6% of consolidated deposits in foreign currencies, as compared to 40% as at end-December 2014.

LIQUIDITY BREAKDOWN (USD MILLION)

consolidated balance sheet

Primary liquidity remains mainly concentrated on central banks’ placements, with their share in the total increasing from 67.0% as at end-December 2014 to 72.2% as at end-December 2015. Bank placements, composed of money market deposits and short-term loan participations and reverse repo balances, accounted for the remaining 27.8%.

Total money markets placements and nostros with banks reached USD 1.8 billion at end-December 2015, as compared to USD 2.4 billion as at end-December 2014. These are mainly based in low risk OECD and GCC countries that show high levels of solvency and financial and monetary stability. Over 70% of the placements denominated in hard currency are held in banks rated A- or better.

Exposures to banks are continuously monitored by the Risk Management department in close coordination with the Group Financial Institutions and Correspondent Banking department (Group FI). Regular portfolio reviews are conducted throughout the year to assess the banks’ risk profiles and ensure that related positions remain within the overall risk appetite of the Group. During these reviews, specific attention is paid to concentration risk levels to ensure that these remain well under control.

The charts below show the breakdown of money markets placements held with banks as at end-December 2015 by ratings and geographic location. These continue to show a well balanced split, concentrated in regions of low risk countries and high rating categories.

consolidated balance sheet

Changes in Portfolio Securities

Consolidated portfolio securities increased by USD 57 million in Consolidated portfolio securities increased by USD 57 million in 2015, moving from USD 10,100 million at end-December 2014 to USD 10,158 million as at end-December 2015, corresponding to a growth of 0.6%. As a percentage of total assets, the Bank’s securities portfolio represented 24.0% as at end-December 2015, as compared to 24.1% as at end-December 2014.

The following table shows the distribution of the Bank’s securities portfolio by type and currency of security as at end-December 2015.

PORTFOLIO SECURITIES BREAKDOWN (USD MILLION)

consolidated balance sheet

Lebanese Bond Portfolio

The composition of the Lebanese portfolio securities in foreign currencies changed in 2015 to the advantage of Central Bank CDs in foreign currencies, increasing by USD 1,102 million at the detriment of the Group’s net exposure on Lebanese sovereign Eurobonds, decreasing by USD 559 million (including risk-ceded government Eurobonds) over the same period. Management’s preference to place BDL Certificates of Deposits is justified by the lower capital consumption tied with those instruments (50% of risk weights on placements at the BDL) relative to Lebanese Eurobonds carrying 100% risk weights with equivalent yields. At end-December 2015, Bank Audi’s exposure to Lebanese sovereign Eurobonds in foreign currency stood at USD 1,997 million (as compared to USD 2,557 million as at end-December 2014), of which USD 1,547 million of bonds whose risk has been ceded to customers (as compared to USD 1,489 million as at end-December 2014). Subsequently, the net exposure to sovereign Eurobonds reached, at the same date, USD 450 million, representing 4.4% of the Bank’s total portfolio securities and 1.5% of foreign currency denominated customers’ deposits (as compared to respectively 10.6% and 3.6% as at end-December 2014), accounting for the lowest level among Lebanese banks.

Non-Lebanese Sovereign Securities

In parallel, the Bank also bears a significant exposure to non-Lebanese sovereign risk, particularly that of Turkey and Egypt in consideration to the Group’s sizeable operations in those markets. As at end-December 2015, the non-Lebanese sovereign bonds portfolio reached USD 2,540 million, down from USD 2,662 million as at end-December 2014 and underscoring a year-on-year decrease by USD 122 million. The Bank’s exposure to the sovereign risk of Egypt reached USD 1,543 million at end-December 2015, while its exposure to the sovereign risk of Turkey amounted to USD 177 million. In relative terms, the portfolio of non-Lebanese sovereign bonds represented 25.0% of the total securities portfolio and 8.1% of foreign currency denominated customers’ deposits (as compared to 26.4% and 8.5%, respectively, as at end-December 2014).

Other International Fixed Income Securities

Well diversified across sectors, placements in other international fixed income securities contracted by 27.3% in 2015, moving from USD 600 million at end-December 2014 to USD 436 million at end-December 2015. These placements continue to favour highly rated financial institutions which accounted for 74.5% of the total international bond portfolio at end-December 2015 (as compared to 69% as end-December 2014), while corporate issuers accounted for 25.5% (31.0% in the previous year). This portfolio is spread across sectors. Corporate issuers accounted for 19% and sovereign names for 6% of the total. The relatively high concentration on banks is mitigated by good issuer diversification and relatively short tenor bond maturities (under 2 years), making these investments somewhat similar to ordinary placements with banks in terms of implied risk profile and market risk exposure.

In terms of geographical allocation, exposure is allocated as follows: 47% in GCC markets, 22% in Europe, 13% in the Far East, 10% in Australia and 7% in the USA, showing very little change from the previous year.

In term of ratings, the international bond portfolio enjoys a high average rating, with the major part of the total exposure being invested in bond issues rated A+ or better. The portfolio is also characterised by a good level of diversification, with the highest single issuer position representing 10% of the total portfolio and the second largest representing 6.6%.

4.3. RESULTS OF OPERATIONS

In 2015, Bank Audi’s performance remains broad-based, supported by the reinforcement of the earnings generation capacity in main development pillars of the Group, mainly in Lebanon, Turkey, Egypt, and Private Banking entities. Bank Audi’s net earnings after provisions and taxes grew by 15.1% in 2015, reaching USD 403 million, as compared to USD 350 million in 2014. This follows the allocation of USD 133 million of net loan loss provision charges, strengthening the Bank’s asset quality and USD 15 million of expenses tied to the hedge of the Group’s investment in Turkey.

Entities outside Lebanon contributed up to 50.5% of the consolidated net earnings’ growth, driving an increase in the share of these entities in consolidated net earnings from 41.6% in 2014 to 42.8% in 2015.

NET PROFITS BREAKDOWN BY DEVELOPMENT PILLARS (USD MILLION)

results of operations

The increase in net profits primarily stems from a USD 87.3 million increase in total revenues, corresponding to a growth of 6.6% exceeding the 5.3% growth in consolidated general operating expenses, equivalent to USD 38.8 million, translating into an improvement in overall efficiency. The table below presents an overview of Bank Audi’s consolidated financial results in 2015 as compared to 2014:

INCOME STATEMENT (USD MILLION)

results of operations

The increase in total revenues from USD 1.3 billion in 2014 to USD 1.4 billion in 2015 was predominantly driven by an improved spread by 5 basis points amid an increase in recurrent fee income totally offsetting the decrease in net profits from financial instruments. By development pillars, the share of Lebanese entities in total revenues declined to 44.2% (versus 48.9% in 2014) as a result of lower revenues from financial investment in the absence of market opportunities totally offsetting the widening interest income. In parallel, the share of Private Banking entities in total revenues also declined to 9.3% from 9.9% in 2014, an evolution triggered by stronger revenues growth in other entities. In fact, entities in Turkey, Egypt and other jurisdictions made up for the decrease generating revenues representing respectively 22.6%, 14.6% and 9.3% of total revenues in 2015, as compared to 20.2%, 12.2% and 8.8% in 2014.

EVOLUTION OF INTEREST INCOME

While the Bank believes that it has the ability to increase net interest income over time, it can be significantly affected by variety of factors such as the mix and overall size of earning assets portfolio, cost of funding and foreign currency exchange rates as well as the evolution of international reference rates. In 2015, net interest income growth continues to be challenged by the persisting low international interest rate environment, as well as by the volatile macroeconomic conditions in some countries of presence.

Net interest income accounted for 63.8% of the consolidated total operating income rising from 61.6% in 2014. In fact, net interest income grew by 10.4% during the year, from USD 815.2 million in 2014 to USD 900.3 million, driven by an improvement in consolidated spread by 5 basis points from 2.10% to 2.15%. Entities in Lebanon, Turkey and Egypt accounted for respectively 42.8%, 27.6% and 15.6% of the total net interest income in 2015.

The below table showcases the contribution of main entities to the improvement in consolidated net spread based on the evolution of their relative weights in total average assets:

CONTRIBUTION TO CHANGE IN CONSOLIDATED SPREAD BY DEVELOPMENT PILLARS IN 2015

results of operations

Lebanese entities: net interest income of Lebanese entities increased from USD 357.2 million in 2014 to USD 385.0 million in 2015, corresponding to a growth of 7.8%. The USD 27.9 million increase was generated by a quantity effect with average assets growing by 4.5% over the period reaching USD 16.1 million, coupled with a price effect of USD 11.7 million, highlighting an improvement in the spread by 6 basis points from 1.80% in 2014 to 1.86% in 2015. Lebanese entities contributed to 32.7% of the total increase in the consolidated interest margin.

Turkey: the political crisis before the parliamentary election early November 2015, as well as the exacerbating regional uncertainties, weighed on the financial markets conditions in Turkey during 2015, dictating a tight follow-up on a daily basis of asset and liability management at Odea Bank to ensure, at any given time and on a best effort basis, the most optimal yield on assets at the lowest cost of deposits. This increased volatility translated in a steep hike in the cost of deposits in Turkish Lira from 10% at year-end 2014 to close to 12% at year-end 2015, corresponding to a 2% increase.

This increase was met by a corollary increase in yields on loans in Turkish Lira, albeit on a lower magnitude moving from 13.86% at year-end 2014 to 14.53%, corresponding to a 0.7% increase. This evolution primarily impacted Odea Bank’s spread on assets which moved from 2.78% in the month of December 2014 (as per IFRS) to reach 2.34% in the month of December 2015, after reaching a low of 1.80% in the month of October. On average, net spread of Odea Bank increased by 5 basis points from 2.29% in 2014 to 2.34% in 2015. On the backdrop of an increase in assets in Turkish Lira by 25.3%, this translated in a corollary increase in interest income in functional currencies by 45% during the year.

Egypt: the contribution of Bank Audi Egypt to the consolidated interest income increased by USD 24.6 million from USD 115.7 million in 2014 to USD 140.3 million in 2015, accounting for 15.6% of the total. This increase is mainly attributable to a quantity effect with average assets growing by 26.2%, offsetting a negative price effect with net spread of Bank Audi Egypt contracting by 12 basis points from 3.13% in 2014 to 3.01% in 2015.

EVOLUTION OF NON-INTEREST INCOME

In 2015, consolidated non-interest income increased by a mere USD 2.2 million, corresponding to a growth by 0.4%. In details, this increase was mainly driven by a USD 22 million increase in recurrent net fees and commission income and a USD 24.8 million in net profits on foreign exchange, both increases making up for the lower net profits on financial instruments by USD 42.9 million r elative to 2014. The increase in net fees and commissions is principally accounted for by corporate finance, credit-related fees, and electronic cards increasing in the aggregate by USD 10 million, USD 5.1 million and USD 3.4 million respectively. The increase in foreign exchange was mainly driven by the revaluation of structural capital position of Bank Audi Egypt and Bank Audi Syria, by respectively USD 6.4 million and USD 13.4 million. Subsequently, non-interest income reached USD 510.1 million in 2015, representing 36.2% of total income as compared to 38.4% in 2014.

In spite of the depreciation of mainly the Turkish Lira and Egyptian Pounds versus the US Dollar, all development pillars reported increases in their contribution to consolidated non-interest income, except for Lebanese entities whose contribution decreased by 18.1% from USD 290.3 million to USD 237.9 million mainly due to lower net profits on financial instruments by USD 41.1 million in the absence of market opportunities. Consequently, the share of Lebanese entities in the consolidated non-interest income fell by 10.6% in 2015 to 46.6%.

In parallel, the contribution of Odea Bank increased by 27.9%, reaching USD 70.1 million, representing 13.8% of the total in 2015, up from 10.8% in 2014, while the contribution of Bank Audi Egypt moved from USD 45.9 million in 2014 to USD 65.2 million in 2015, with its share in total rising from 9% to 12.8%. Notwithstanding, Private Banking entities continued to post the 2nd highest contribution to consolidated non-interest income, reaching USD 79.1 million in 2015 corresponding to a 15.5% share.

The table below presents a breakdown of non-interest income by main development pillars:

NON-INTEREST INCOME BREAKDOWN BY DEVELOPMENT PILLARS (USD MILLION)

results of operations

EVOLUTION OF GENERAL OPERATING EXPENSES

In 2015, consolidated general operating expenses reported a moderate growth of 5.3%, moving from USD 728.8 million in 2014 to USD 767.6 million in 2015. In details, the USD 38.8 million increase is broken down over a decrease of USD 1.6 million of staff expenses and increase of USD 11.5 million of depreciation and amortisation charges, and USD 28.9 million of other operating expenses. The increase in consolidated general operating expenses is mainly driven by Odea Bank (USD 11.8 million) and Bank Audi Egypt (USD 13.8 million), hiring respectively 150 and 212 employees, while rolling out 7 and 3 branches. Meanwhile, general operating expenses of Lebanese entities increased by USD 4.9 million, driven by higher rent charges with the new IT head office and higher depreciation costs amid a decrease in staff expenses.

On the backdrop of a faster growth in total revenues than in general operating expenses, the cost to income ratio improved by 66 basis points, from 55.1% in 2014 to 54.4% in 2015.

EVOLUTION OF LOAN LOSS PROVISION CHARGES

Net loan loss provisions decreased by USD 6.6 million, from USD 139.6 million in 2014 to USD 133.0 million in 2015, accounting for 9.4% of total income in 2015 against 10.6% in 2014. By development pillars, the allocation of net loan loss provisions in 2015 is broken down over USD 17.0 million in Lebanese entities, USD 94.1 million in Turkey, USD 13.9 million in Egypt, and USD 8.9 million in other entities, while in Private Banking entities recoveries exceeded the allocated loan loss provisions. The increase in provisions at Odea Bank is partly explained by the seasoning of the portfolio and an increase in provisioning on the retail portfolio within the context of an increasing allocation of collective provisions in order to gradually book collective reserves representing a targeted 1% of the net loan portfolio over the medium term.

The USD 133.0 million of net loan loss provision in 2015 is broken down over USD 122.1 million of specific provisions, USD 36.6 million of collective provision, and negative contribution of write-off and other recoveries by USD 12.2 million and USD 13.5 million respectively.

results of operations

Subsequently, the consolidated cost of risk ratio reached 0.74%, in line with the global and MENA averages of 0.7%. By development pillars, the cost of risk ratio reached 0.28% in Lebanese entities (1.09% in 2014), 1.26% in Odea Bank (0.81% in 2014), 0.59% in Bank Audi Egypt (0.36% in 2014), and 0.95% in other entities (0.99% in 2014), within a slight negative ratio in Private Banking entities.

EVOLUTION OF INCOME TAX

Consolidated income tax (including deferred and other taxes) grew by 2.0%, moving from USD 104.8 million in 2014 to USD 106.9 million in 2015. Relative to net profits before tax, the income tax increased at a slower pace, allowing for a lower effective tax rate reaching 21.0% in 2015 versus 23.0% in 2014. Bank Audi Egypt drove the increase in income tax, reporting an increase of USD 10.5 million, while the income tax of Lebanese entities decreased by USD 10.7 million coming for a higher base in 2014, grossed up by one-time taxes on capital repatriation. As a result, Bank Audi Egypt registered an effective tax rate of 37.3%, as compared to a statutory tax rate of 22.5%, with the difference justified by the a tax on portfolio securities excised at the source.

KEY PERFORMANCE METRICS

The evolution of activity and results in 2015 relative to 2014 turned the following key performance metrics:

KEY PERFORMANCE INDICATORS

results of operations

In sum, the return on average assets ratio increased from 0.90% to 0.96%, driven by 15.1% growth in net earnings, outpacing the 8% growth in average assets. Notwithstanding, the return on average common equity ratio maintained the same level of 13.63%, as in 2014, as a result of the full impact of the USD 300 million common equity increase at end-September 2014. Adjusting to the latter, the Group’s return on average common equity ratio would have reached 15.3%, exceeding the weighted average cost of equity of the Group. Management target remains to achieve a sustainable ROE across entities, in excess of 20% of the cost of equity of each entity.

The chart below details the contribution of the various components to the evolution of the return on average common equity ratio during 2015:

results of operations

INVESTMENT CONSIDERATIONS

Earnings per Share

Basic earnings per share is calculated based on the weighted number of common shares actually issued and net profits after tax. On this basis, Bank Audi’s basic common earnings per share reached USD 0.92 in 2015, as compared to USD 0.86 in 2014, corresponding to an increase of 7.1%.

The table below represents the evolution of Bank Audi’s common earnings per share, including net profits from discontinued operations over the past 5 years:

results of operations

COMMON BOOK PER SHARE

Common equity represents total equity less minority shares and preferred shares. Common equity per share is based on the outstanding number of common shares net of Treasury stocks at the end of the period. The table below presents the evolution of common equity per share between end-December 2014 and end-December 2015:

EQUITY METRICS (USD THOUSANDS)

results of operations

Common equity per share of Bank Audi increased from USD 6.95 at end-December 2014 to exceed the USD 7 mark reaching USD 7.13 at end-December 2015. On the basis of a closing price of USD 6.05 at end-December 2015 for ordinary shares, the common share is traded at 0.85 times the common book value, reflecting very low multiples with respect to regional peers, trading at an average of 1.3 times book value.

4.4. ANALYSIS BY GEOGRAPHY AND MAIN DEVELOPMENT PILLARS

The Group’s activity and earnings growth in 2015 were driven by its main development pillars, in particular Turkey, but also Lebanon, Egypt and the Private Banking entities.

What follows is a brief discussion of the overall growth trends across those pillars:

LEBANESE ENTITIES (EXCLUDING AUDI PRIVATE BANK)

analysis by geopgraphy and main development pillars

1Return on required regulatory capital.


The Lebanese banking sector reported, on the overall, a modest activity growth steered by a slumped economic scene as a result of the persisting domestic uncertainties and broad regional conflicts. Within this context, assets of Lebanese entities incr eased in 2015 by USD 270 million. With deposits stabilising across the same period, the increase in assets was primarily funded by a USD 129 million increase in dues to banks and subsidiaries, and a USD 36 million increase in equity. Deposits in foreign currency, representing the main source of funding, increased by USD 76 million, while Lebanese Pounds deposits decreased by USD 72 million.

Notwithstanding, loans to customers increased by USD 600 million, driven primarily by loans in foreign currencies rising by USD 489 million, while Lebanese Pounds loans increased by USD 111 million, mainly in the form of subsidised mortgage loans. Amid a slight increase in gross doubtful loans, this increase drove an improvement in the gross doubtful loans to gross loans ratio by 37 basis points to 4.25%, while coverage of those loans increased to 80.4%, with collective provisions representing 1.1% of net loans.

Based on those performances, Bank Audi in Lebanon continues to benefit from a strong leadership positioning across business line, ensuring an 11.7% market share in assets, 11.2% in loans, and 12.7% in customers’ deposits.

In 2015, Lebanese entities reported USD 209.6 million of net profits, rising by USD 25.1 million relative to 2014. Amid a decrease in total revenues by USD 24.2 million triggered by lower revenues from financial investment in the absence of market opportunities totally offsetting the widening interest income, the increase in net profits is mainly driven by USD 43.9 million of lower loan loss provision charges, justified by stable credit risk profile in spite of the tough environment. At the cost level, general operating expenses increased by USD 5.3 million over the same period, mainly driven by USD 7.6 million of depreciation and amortisation charges, the USD 6.9 million rent of new premises amid a USD 9.2 million contraction in staff expenses.

ODEA BANK - TURKEY

analysis by geopgraphy and main development pillars

In Turkey, macro-economic conditions remained stable despite the volatility, within a slight improvement in prospects following the results of the parliamentary elections last October. The Turkish economy recorded a real growth of more than 3% during 2015, driving a double-digit growth in the banking sector’s activity with assets, deposits and loans growing respectively by 18.2%, 18.3% and 19.7% in 2015.

Over the same period, the contribution of Odea Bank to consolidated assets’ increase was flat, justified by the impact of the 25.6% depreciation of the Turkish Lira which totally shielded the real growth actually registered by Odea Bank. In fact, assets, deposits and loans of Odea Bank expressed in Turkish Lira grew by respectively 25.2%%, 19.1% and 20.9%, outpacing the sector’s performance over the period.

Subsequently, Odea Bank’s assets market share reinforced by 8 basis points to 1.36%, while those for deposits and loans were reached respectively 2% and 1.46%. Those performances continue to confirm the established challenger bank profile of Odea Bank, which allows it to rank, in less than 3 years of activity, 9th by assets and loans among non-state conventional banks in the competitive Turkish market and 8th by deposits.

Gross doubtful loans of Odea Bank increased by TRY 224 million, principally from retail loans as the portfolio seasons. Accordingly, the ratio of gross doubtful loans to gross loans moved from 1.46% at end-December 2014 to 2.22% at end-December 2015. Coverage ratio of those loans by specific provisions reached 38.62%. Collective provisions represented, at end-December 2015, 0.46% of performing loans, as compared to 0.33% at end-December 2014, on the back of a 20.5% growth in performing loans over the year.

At the profitability level, despite the impact of the FX fluctuations, Odea Bank’s contribution to consolidated net pr ofits increased from USD 15.8 million in 2014 to USD 23.2 million in 2015, while taking into account the allocation of USD 31.1 million of additional net loan loss provision charges. Operating profits before taxes and provisions, witnessing to the earnings capacity of Odea Bank, rose by 79.2% to TRY 332.5 million. Management’s target is to sustain the positive jaws to quickly improve efficiency and profitability.

BANK AUDI EGYPT

analysis by geopgraphy and main development pillars

The Egyptian economy has considerably recovered after four years of slow activity, with growth estimated at 4.2% over the past year, matched with a 27.6% growth in banking assets, 20.6% in deposits and 24.7% in loans in the first 11 months of the year. Within this context, Bank Audi Egypt reported a nominal increase in assets by USD 464 million in 2015, driven by an increase in deposits by USD 293 million and USD 590 million in loans. Adjusting to the impact of the 9.5% depreciation of the EGP versus the US Dollar over the year, assets, deposits and loans of Bank Audi Egypt increased in real terms by USD 818 million, USD 616 million and USD 754 million respectively, largely exceeding the set targets, underscoring a solid performance.

Based on a faster assets and deposits growth in the sector, Bank Audi Egypt’s assets and deposits market share decreased by 13 basis points and 8 basis points respectively in the 11 months of the year, to reach 1.45% and 1.68% at end-November. On the other hand, Bank Audi Egypt achieved a 35.3% growth in net loan, exceeding that of the sector, and driving an increase in loans market share from 2.02% as at end-December 2014 to 2.19% as at end-November 2015.

In parallel, the ratio of gross doubtful loans to gross loans improved significantly from 2.58% as at end-December 2014 to 1.38% as at end-December 2015, justified in part by the increase in gross loans and by a contraction in doubtful loans by USD 13.9 million, following the write-off of a number of corporate and retail loans.

On the profitability level, Bank Audi Egypt registered net profits of USD 69.5 million in 2015, rising by 20.7% relative to 2014 and outperforming the set target. Based on the above, Bank Audi Egypt continued to report solid profitability ratios, with an ROAA of 1.5% and ROAE of 19.8%.

PRIVATE BANKING ENTITIES

analysis by geopgraphy and main development pillars

Assets under management of Private Banking entities (including fiduciary deposits and custody accounts) increased from USD 5.6 billion at end-December 2014 to USD 6.2 billion at end-December 2015, representing an increase by USD 621 million, of which USD 797 million of new money (USD 393 million in Banque Audi (Suisse), USD 262 million in Audi Capital (KSA), and USD 142 million in Audi Private Bank) offset by an estimated USD 250 million of FX and market effects and USD 74 million of consolidation adjustments. Within this context, Private Banking entities generated, in 2015 , net revenues of USD 131.7 million, growing by 0.7% relative to 2014, translating in net earnings of USD 46.9 million, in line with the set budget for the year, and growing by 7.2% relative to 2014.

4.5. ANALYSIS BY BUSINESS SEGMENTS

Bank Audi is managed on the basis of a cross-sectional organisation matrix of business lines and markets, reflecting the following four major business segments: Corporate and Commercial Banking, Retail and Individual Banking, Private Banking, and Treasury and Capital Markets Activities. Those business segments are determined based on the products and services provided or the type of customers served, and constitute the basis for Management’s evaluation of financial results. Results of each business segment are intended to reflect the performance of each business line, namely in terms of total assets and total revenues. Senior Management sets the business segment reporting methodology, which is approved by the Group Executive Committee. A detailed description of the business segment reporting methodology is provided in Note 4 of the consolidated financial statements.

The performance of the four principal business segments of Bank Audi in 2015 is discussed and analysed in what follows:

CORPORATE AND COMMERCIAL BANKING

Bank Audi provides integrated Corporate and Commercial Banking solutions, with a coverage span entailing the Middle East, GCC, Africa and Europe through its established headquarters in Lebanon and its entities operating in Turkey, Egypt, Jordan, Saudi Arabia, Qatar, France and Switzerland. Despite the continuing challenging economic and political conditions prevailing in several key markets that triggered a slow down in new lending in some markets and a decrease in exposure in other markets, Bank Audi still managed to consolidate its regional Corporate and Commercial Banking franchise.

Total assets generated by the corporate and commercial segment at group level reached USD 13,365 million at end-December 2015, almost the same level as at end-December 2014 (USD 13,409 million).

In Turkey, Bank Audi (via its subsidiary Odea Bank) further initiated and developed relationships with top tier corporate and commercial clients in a wide range of sectors including healthcare and education, construction and real estate, textile and other manufacturing industries, oil and gas, energy, retail and commercial development, tourism, as well as transportation and logistics. The corporate and commercial loan portfolio of Odea Bank stood at USD 6,755 million as at end-December 2015.

Egypt remains a key focus for growth at the corporate and commercial levels. Bank Audi Egypt’s lending activity covers a wide range of corporations in the fields of infrastructure, power generation, higher education, fertilizer production, oil and gas, real estate development, steel manufacturing, pharmaceuticals, and airlines. The corporate and commercial loan portfolio of Bank Audi Egypt stood at USD 1,537 million as at end-December 2015, up 14.2% from the level achieved as at end-December 2014 (USD 1,346 million).

In Lebanon, Bank Audi continued supporting the growth of many local businesses by building a strong relationship with the existing customers and increasing penetration to large corporates. Bank Audi continues to be the largest commercial and corporate lender in the Lebanese sector, with a corporate and commercial loan portfolio standing at USD 4.6 billion at end-December 2015, up 12.2% from the level achieved as at end-December 2014 (USD 4.1 billion).

Based on the above, the corporate and commercial business generated total revenues of USD 521.4 million in 2015, as compared to USD 493.6 million in 2014, corresponding to a growth of 5.6%. The USD 27.7 million increase in total revenues is mainly attributed to a USD 22.9 million increase in non-interest income.

During 2015, Bank Audi continued, at group level, the implementation of its updated Environmental and Social Management System (ESMS) to actively manage environmental and social risks and to promote environmental business opportunities.

RETAIL AND INDIVIDUAL BANKING

We believe that growing portfolio and rising market shares represent the most telling indicators for customer endorsement and customer satisfaction, underscoring daily votes by customers at branch level. In fact, consolidated retail loans reached USD 3.2 billion at end-December 2015, achieving a year-on-year growth of 13.8%. This growth reflects an 8.7% growth in housing loans, a 16.1% growth in personal loans, an 18.7% growth in credit cards, and a 19.6% growth in car loans. The growth of the consolidated retail portfolio was not achieved at the detriment of its quality, with gross doubtful retail loans to retail loans reaching 3.5% at end-December 2015, a level still below the Group’s risk limit, with coverage of those loans by specific provisions of 60.2%, while collective provisions represented 0.9% of retail loans.

The retail business line continues to position Bank Audi as a retail bank of choice through the constant efforts accompanying the strategy of transforming the business to become a truly customer-centric organisation. The Bank offers more than 150 retail products and services to more than 1.2 million retail clients across the region. The product ranges include conventional checking and savings accounts, fixed-term deposits, loans and residential mortgages, credit cards, bank insurance products, as well as a host of innovative retail products developed in association with leading partners across the region. Customers are being served through an omni-channel network of more than 400 advanced self-service machines (ITM, ATM and Novo), digital channels (online and mobile), and more than 180 branches.

In Lebanon,the Bank’s main objective was to focus on customer centricity to improve customers’ retention and enhance customers’ experience and profitability. To do so, new customer-centric services are being implemented, which focus on convenience and transparency. At the level of behavioural segmentation, many products offered and promoted in 2015 aimed at satisfying increasingly differentiated client demands. Those include “Aman Al Madkhoul”, a personal accident insurance program for salaried employees, the “Wedding Account” new online platform for couples and guests, and the USD 5 offer on mobile phones for our “Spring Account” customers between 18 and 24 years old.

Moreover, new service models are emerging to satisfy new client demands. Bank Audi Lebanon initiated a transformation program tackling the increase of functionalities on Alternative Delivery Channels (ADC) and improving both accessibility and customer experience. Customer transactions over ADCs have exceeded transactions over the counter as a result of last year’s introduction of new features in the online banking platform (such as the internal/external transfer options), combined with the Novo e-branch which opens 7/7 from 10am till 10pm, the ITM (Interactive Teller Machine) and the extensive ATM network across the nation.

The e-Payments and Card Solutions (EPCS) activity continued to be focused on building the foundation for a cashless society, the objective being to implement pioneering payment landscapes and business solutions evolving with customers’ needs and international market trends.

The launch of the highly innovative “Tap2Pay NFC series of contactless payment” payment devices won Bank Audi two distinctive awards at the Smart Card and Payment Awards Middle East 2015. Bank Audi was the only Lebanese bank that was granted both the “Best Payment Initiative Middle East” and “Best Contactless Solution 2015” prizes. The Bank was also recognised for its Gift Card Vending Machine which won the “Best Use of Technology” award at the annual MasterCard Innovation Forum 2015.

Bank Audi Egypt maintained its efforts to implement the new branch operating model by believing in the strength and integrity of relationship management and service excellence, and by launching new products and innovative alternative channels for the first time in Egypt (“Novo by Bank Audi”).

In Turkey, Odea Bank continues to operate with the “Not Everyone’s Bank but Yours” vision in mind. Odea Bank has acquired more than 50,000 time deposit and investment customers, nearly TRY 14.5 billion of retail account balances and TRY 44 billion of retail investment volume.

PRIVATE BANKING AND WEALTH MANAGEMENT

Bank Audi Group enjoys strong expertise and know-how in Private Banking and wealth management. Audi Private Bank offers a full and diversified range of services to high net-worth clients, with full access to major markets worldwide and global investment products, including discretionary portfolio management, investment advisory, trade execution in all asset classes, Lombard credit, and other Private Banking services such as estate planning, fiduciary deposits, safe custody and credit cards. Deeply-rooted in the MENA region, it operates through four main booking centres based in Switzerland (2nd largest Arab private bank in Switzerland with an established footprint since the 70s), Lebanon (accounting for by far the largest Private Banking entity), Saudi Arabia and Qatar, with additional representative offices in Monaco, Jordan and the United Arab Emirates. Audi Private Bank also covers Sub-Saharan Africa and Latin America through dedicated relationship managers.

As mentioned earlier, and despite erratic market conditions worldwide, assets under management of Private Banking entities (including fiduciary deposits and custody accounts) increased from USD 5.6 billion at end-December 2014 to USD 6.2 billion at end-December 2015, representing an increase of USD 621 million, of which USD 797 million of new money (USD 393 million in Banque Audi (Suisse), USD 262 million in Audi Capital (KSA) and USD 142 million in Audi Private Bank) offset by an estimated USD 250 million of FX and market effects and USD 74 million of consolidation adjustments. Within this context, Private Banking entities generated, in 2015, net revenues of USD 131.7 million, growing by 0.7% relative to 2014, translating in net earnings of USD 46.9 million, in line with the set budget for the year, and growing by 7.2% relative to 2014.

TREASURY AND CAPITAL MARKETS

Bank Audi’s financial services include Capital Markets, Investment Banking, asset management and securities services. The Bank is leveraging its regional presence to further develop its securities services and brokerage platform, consolidating the business towards increased intra-group synergies.

In Lebanon, Bank Audi remains the leading international market maker in Lebanese securities, namely in the Republic of Lebanon Eurobonds and Lebanese Treasury notes, with a turnover of USD 5.3 billion in 2015. Bank Audi has maintained its existing institutional coverage of Lebanese securities to international non-bank financial institutions, despite regional uncertainties emanating from the ongoing wars. Funds outflows from emerging markets fixed income managers have also negatively affected our business. Nevertheless, Lebanon has continued to outperform its emerging markets peers in regards to Eurobond prices, and continues to trade at yields a few notches above its credit ratings. As for equities, Bank Audi’s market share on the Beirut Stock Exchange represented 17.75% of traded value in 2015. Those activities, in Lebanon and the MENA region, are supported by an extensive research coverage business.

In Capital Markets activities, Bank Audi issued, in February 2015, certificates of participation in a subordinated loan that it had granted to Odea Bank in October 2014. The certificates constitute undivided beneficial interests in all amounts of principal, interest, and certain other amounts (if any) paid by Odea Bank to the Bank. The issued amount was USD 150 million, with a 6.50% interest payable quarterly, maturing in October 2024. USD 138 million worth of those certificates were sold to qualified investors through the Bank’s branch network in Lebanon, and have since been accepted in the consolidated regulatory Tier 2 equity.

In line with the consolidated position, assets of the Treasury and Capital Market activities increased by 2.7% in 2015, reaching USD 20.7 billion at end-December 2015. In parallel, total revenues of this business segment increased by 7.4% year-on-year, moving from USD 419.5 million in 2014 to USD 450.8 million in 2015.

4.6. CAPITAL MANAGEMENT

Bank Audi adopts a holistic view on capital focusing on: i) ensuring that capital sufficiently covers all material risks generated by the Bank’s activities; ii) protecting depositors in case of stress events; iii) factoring in the requirements of various stakeholders including regulators, rating agencies, depositors and shareholders; and iv) optimising the capital usage while providing support for the expansion of business segments and entities. Changes in shareholders’ equity, net earnings of the year and dividend policies are inter-linked with the preservation of capital strength.

EVOLUTION OF SHAREHOLDERS’ EQUITY

At end-December 2015, consolidated shareholders’ equity reached USD 3,287 million, down from USD 3,348 million at end-December 2014. The USD 60 million decrease was mainly driven by USD 190 million of dividends payment for the 2014 exercise, the redemption of the USD 125 million series “E” preferred shares, and a negative change in foreign currency translation reserves by USD 134 million, as well as USD 14 million of other changes which totally offset the USD 403 million of net profits generated during the year.

In parallel, regulatory equity moved from USD 3,176 million at end-December 2014 to USD 3,347 million at end-December 2015, corresponding to an increase by USD 171 million, broken down over an increase of USD 43 million in core Tier 1 capital and USD 254 million of Tier 2 capital, mainly driven by the USD 138 million subordinated loans issuance in Odea Bank sold to third parties. In parallel, regulatory Tier 2 equity also increased by USD 113 million, following the approval of the Central Bank of Lebanon, granted in October 2015, to include 50% of the revaluation variance of fixed assets. The latter totally weighed out the decrease of USD 125 million, in additional Tier 1 capital (due to redemption of the series “E” preferred shares).

REGULATORY REQUIREMENTS – CENTRAL BANK OF LEBANON CIRCULAR NO. 44

31 December 2015 marked the end of the transitional arrangements set by the Central Bank of Lebanon in its amendments to Basic Circular No. 44 for minimum capital requirements. The minimum capital adequacy ratios as at 31 December 2015 stand at 8% for common equity Tier 1, 10% for Tier 1 capital, and 12% for total capital (Pillar I), including a capital conservation buffer of 2.5% which must be met with common equity Tier 1 (CETI).

Bank Audi’s common equity Tier 1, Tier 2 and total capital adequacy ratios at a consolidated level moved from respectively 8.8%, 2.2% and 13.0% as at end-December 2014 (post-adjustment to the revaluation of real estate assets) to 8.7%, 3.1% and 13.4% respectively, which are above the above mentioned minimum BDL required ratios.

Whilst the increase in T ier 2 capital offset the decrease in additional Tier 1, the slight change in total capital adequacy ratio is mainly attributed to a limited increase in risk-weighted assets, from USD 24.4 billion at end-December 2014 to USD 25.0 billion at end-December 2015.

CAPITAL ADEQUACY RATIO AS PER BDL CIRCULAR 358 (USD MILLION)

capital management

REGULATORY REQUIREMENTS – BANKING CONTROL COMMISSION MEMORANDUM 283 ON ICAAP

In October 2015, the Banking Control Commission issued a memorandum requiring banks to conduct an Internal Capital Adequacy Assessment Process (ICAAP) on a yearly basis starting end-December 2015. The Bank views the ICAAP as an important internal initiative rather than just a regulatory one, by consistently calculating both regulatory and economic capital. This is reflected by how the ICAAP has become an integral part of Bank Audi’s decision-making process and an essential tool used by Management and the Board for capital planning. The Internal Capital Adequacy Assessment Process report is prepared annually and is submitted to Senior Management, the Board Group Risk Committee, and the Board of Directors.

ICAAP also acts as an important exercise that drives the Bank to develop and better use risk measurement techniques. Bank Audi continues to build on the approaches used in previous ICAAP submissions to further develop and refine various risk methodologies and include more sensitive risk measures able to capture risk more adequately. In preparation for moving towards more advanced methods in the Basel framework, the Bank adopted the Foundation-IRB approach within the internal credit risk capital charges calculations for certain asset classes in order to better capture the quality and riskiness of the portfolios. Bank Audi also continued to improve the stress tests and scenario analyses prepared in the ICAAP and covering a variety of plausible scenarios of different severity levels.

The ICAAP is conducted for the Group on a consolidated basis and on an individual basis for material entities to ensure that standalone capital remains adequate.