ANNUAL REPORT 2016

FINANCIAL STATEMENTS

3.0. NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1.0. CORPORATE INFORMATION

Bank Audi sal (the Bank) is a Lebanese joint stock company registered since 1962 in Lebanon under No. 11347 at the Register of Commerce and under No. 56 on the Banks’ list at the Bank of Lebanon (“BDL”). The Bank’s head office is located in Bank Audi Plaza, Omar Daouk Street, Beirut, Lebanon. The Bank’s shares are listed on the Beirut Stock Exchange and London SEAQ. The Bank, together with its subsidiaries (collectively “the Group”), provides a full range of Retail, Commercial, Investment and Private Banking activities through its headquarters, as well as its branches in Lebanon and its presence in Europe, the Middle East and North Africa.

The consolidated financial statements were authorised for issue in accordance with the Board of Directors’ resolution on 20 March 2017.

2.0. ACCOUNTING POLICIES

3.0. BUSINESS COMBINATIONS

During September 2015, Bank Audi sal acquired additional 33% of Capital B. Solutions (CBS) Ltd (“CBS”) with a total percentage of 70.5% for LBP 10,944 million. CBS (previously “Capital Outsourcing Limited”) is a company limited by shares in accordance with Companies Law pursuant to DIFC Law No. 2 of 2009. The registered office of CBS is situated in the Dubai International Financial Centre (DIFC). CBS is engaged in providing all information technology enabled services and data processing services, sale, exploitation and lease of all kind of information technology materials, telecommunications’ equipment, as well as electrical and electronic supplies. The fair value of the identifiable assets and liabilities acquired and goodwill arising as at the date of acquisition was:

BUSINESS COMBINATIONS

From the date of acquisition till year-end 2015, CBS contributed to a gain of LBP 97 million to the net profit of the Group. If the contribution had taken place at the beginning of the year 2015, the total net operating income for the year ended 2015 would have increased by LBP 579 million.

Goodwill resulting from the above acquisition of LBP 28,084 million was impaired upon testing on 31 December 2016 (Note 32).

4.0. SEGMENT REPORTING

Management monitors the operating results of its business units separately for the purpose of making decisions about resource allocation and performance assessment. Segments are evaluated based on information relating to net operating income and financial position. Income taxes and depreciation are managed on a group basis and are not allocated to operating segments.

Interest income is reported net, since Management monitors net interest income and not the gross income and expense amounts. Net interest income is allocated to the business segment based on the assumption that all positions are funded or invested via a central funding unit. An internal Funds Transfer Pricing (FTP) mechanism was implemented between operating segments.

The assets and liabilities that are reported in the segments are net from inter-segments’ assets and liabilities since they constitute the basis of Management’s measures of the segments’ assets and liabilities and the basis of the allocation of resources between segments.

BUSINESS SEGMENTS

The Group operates in four main business segments which are Corporate and Commercial Banking, Retail and Personal Banking, Treasury and Capital Markets, and Group Functions and Head Office.

Corporate and Commercial Banking: provides diverse products and services to the corporate and commercial customers including loans, deposits, Trade Finance, exchange of foreign currencies, as well as all regular Corporate and Commercial Banking activities.

Retail and Personal Banking: provides individual customers’ deposits and consumer loans, overdrafts, credit cards, and funds transfer facilities, as well as all regular Retail and Private Banking activities.

Treasury and Capital Markets: provides Treasury services including transactions in money and capital markets for the Group’s customers, manages investment and trading transactions (locally and internationally), and manages liquidity and market risks. This segment also offers investment banking and brokerage services, and manages the Group’s own portfolio of stocks, bonds, and other financial instruments.

Group Functions and Head Office: consists of capital and strategic investments, exceptional profits and losses, as well as operating results of subsidiaries which offer non-banking services.

Transfer prices between operating segments are on an arm’s length basis in a manner similar to transactions with third parties.

The following tables present net operating income information and financial position information.

NET OPERATING INCOME INFORMATION

NET OPERATING INCOME INFORMATION

NET OPERATING INCOME INFORMATION

FINANCIAL POSITION INFORMATION

FINANCIAL POSITION INFORMATION

Capital expenditures amounting to LBP 171,857 million for the year 2016 (2015: LBP 174,850 million) are allocated to the Group Functions and Head Office business segment.

GEOGRAPHICAL SEGMENTS

The Group operates in three geographical segments: Lebanon, Middle East and North Africa and Turkey, (MENAT) and Europe, and as such, is subject to different risks and returns. The following tables show the distribution of the Groups’ net external operating income, assets and liabilities allocated based on the location of the subsidiaries reporting the results or advancing the funds. Transactions between segments are carried at market prices and within pure trading conditions.

NET OPERATING INCOME INFORMATION

NET OPERATING INCOME INFORMATION

FINANCIAL POSITION INFORMATION

FINANCIAL POSITION INFORMATION

5.0. INTEREST AND SIMILAR INCOME

INTEREST AND SIMILAR INCOME

The components of interest and similar income from loans and advances to customers at amortised cost are detailed as follows:

INTEREST AND SIMILAR INCOME

The components of interest and similar income from financial assets classified at amortised cost are detailed as follows:

INTEREST AND SIMILAR INCOME

6.0. INTEREST AND SIMILAR EXPENSE

INTEREST AND SIMILAR EXPENSE

The components of interest and similar expense from deposits from customers are detailed as follows:

INTEREST AND SIMILAR EXPENSE

7.0. FEE AND COMMISSION INCOME

FEE AND COMMISSION INCOME

The increase in commissions from brokerage and custody activities resulted mainly from LBP 927,997 million in fees net of associated costs, which were earned for the execution of trades of financial instruments with the Central Bank of Lebanon on behalf of customers in relation to the Central Bank of Lebanon’s initiative to raise foreign currency reserves.

8.0. FEE AND COMMISSION EXPENSE

FEE AND COMMISSION EXPENSE

9.0. NET GAIN ON FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

NET GAIN ON FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

Trading gain on financial assets at fair value through profit or loss includes the results of trading in the above classes of securities, as well as the result of the change in their fair values.

Currency derivatives includes gains and losses from spot transactions, forward and swap currency contracts, amortisation of time value of options designated for hedging purposes.

Foreign exchange includes the result of the revaluation of the daily open foreign currency positions. Gains during 2016 resulted mainly from the Group’s subsidiary in Egypt pursuant to the significant decrease in the exchange rate of the Egyptian Pound.

For the year ended 31 December 2016, derivatives include a gain of LBP 9,046 million (2015: gain of LBP 120 million) representing the change in fair value of the credit default swaps related to the Lebanese sovereign risk and embedded in some of the Group’s deposits, as discussed in Note 35 to these consolidated financial statements.

During 2016, the Group entered into certain financial transactions with the Central Bank of Lebanon relating to Treasury bills and certificates of deposits denominated in Lebanese Pounds. These transactions were available to banks provided that they are able to reinvest an amount equivalent to the nominal value of the sold instruments in Eurobonds issued by the Lebanese Republic or certificates of deposits issued by the Central Bank of Lebanon denominated in US Dollars and purchased at their fair values. The net gains from such trades on financial instruments amounted to LBP 669,993 million of which LBP 307,063 million was not realised in the Consolidated Income Statement (Note 38).

10.0. NET GAIN ON SALE OF FINANCIAL ASSETS AT AMORTISED COST

The Group derecognises some debt instruments classified at amortised cost due to the following reasons:
  • Deterioration of the credit rating below the ceiling allowed in the Group’s investment policy;
  • Liquidity gap and yield management;
  • Exchange of certificates of deposits by the Central Bank of Lebanon;
  • Currency risk management as a result of change in the currency base of deposits; or
  • Liquidity for capital expenditures.

The schedule below details the gains and losses arising from the derecognition of these financial assets:

NET GAIN ON SALE OF FINANCIAL ASSETS AT AMORTISED COST

Refer to Note 9 for the effect on unrealised gains on certain financial transactions carried out with the Central Bank of Lebanon.

11.0. OTHER OPERATING INCOME

OTHER OPERATING INCOME

(A) Revenue from non-banking activities represents software license and IT services revenue earned by Capital Banking Solutions Ltd, a subsidiary.

(B) Pursuant to the acquisition of additional 33.00% equity in Capital Banking Solutions Ltd during 2015 (Note 3), the Group re-measured its non-controlling investment immediately before obtaining control which resulted in a gain of LBP 7,161 million.

12.0. NET CREDIT LOSSES

NET CREDIT LOSSES

13.0. PERSONNEL EXPENSES

PERSONNEL EXPENSES

14.0. OTHER OPERATING EXPENSES

OTHER OPERATING EXPENSES

15.0. INCOME TAX

The components of income tax expense for the year ended 31 December are detailed as follows:

INCOME TAX

The tax rates applicable to the parent and subsidiaries vary from 7.25% to 35.00% in accordance with the income tax laws of the countries where the Group operates. For the purpose of determining the taxable results of the subsidiaries for the year, the accounting results have been adjusted for tax purposes. Such adjustments include items relating to both income and expense, and are based on the current understanding of the existing tax laws and regulations and tax practices.

The components of operating profit before tax, and the differences between income tax expense reflected in the financial statements and the calculated amounts are shown in the table below:

INCOME TAX

The movement of current tax liabilities during the year is as follows:

INCOME TAX

Deferred taxes recorded in the Consolidated Statement of Financial Position result from the following items:

INCOME TAX

The movement of net deferred tax during the year is as follows:

INCOME TAX

16.0. (LOSS) PROFIT FROM DISCONTINUED OPERATIONS

Bank Audi Syria sa (“BASY”), which is 47.00% owned by the Group, is engaged in Commercial Banking activities, mainly deposits taking and loan granting in Syria, which used to be captioned under the Corporate and Commercial Banking and the Treasury and Capital Markets business segments, as well as the MENAT geographical segment. In prior years, BASY was consolidated in the Group accounts due to de facto control.

Since March 2011, Syria has witnessed extremely violent and crippling war in different parts of the country. The war has turned into a humanitarian disaster resulting in Syria being ranked number one on the list of the most dangerous countries in the world. The intensity of the acts of war have led several international bodies and countries (e.g. EU and USA) to set and implement sanctions and restrictions on dealing with Syria. In addition, the business environment of the country has been burdened by heavy state intervention, and Syria was ranked one of the eight most unfree economies in the world by The Heritage Foundation.

The Syrian pound has significantly deteriorated against the US Dollar, since 2011. The Syrian government has maintained currency controls and has created exchange mechanisms which rendered the market extremely illiquid over time, resulting in an other-than-temporary lack of exchangeability between the Syrian Pound and the US Dollar. The supply of foreign currencies in the market remains structurally well below demand and there are no obvious limits as to how low the Syrian currency can fall.

The above circumstances, combined, have significantly affected Syria’s financial system. Banks are largely isolated from the international banking market, being shut-off from the international payment and settlement systems, as well as from credit markets. There was a major flight of deposits as Syrians have reallocated to safer assets. Syria’s economy has contracted considerably in real terms since 2011, which has significantly affected the demand for credit facilities and the investment opportunities available for banks inside Syria. Banks are unable to repatriate funds outside the country and end up placing their funds in non-income generating assets, with the Central Bank of Syria and other local commercial or state-owned banks. The negative evolution of the macroeconomic situation limited the Group’s ability to effectively manage the subsidiary. In addition, restrictions relating to the regulatory environment, foreign exchange, import authorisation, interest rates, granting and Board attendance , have added to the limitations already existing on the significant activities of banks, further preventing the Group from developing and implementing decisions on key operational and financial aspects regarding Syrian operations.

As a result of these factors which are expected to continue for the foreseeable future, effective 31 August 2016 the Group has a) determined that the recoverable value of its net investment in BASY to be insignificant based on the lack of market prospects and expectations of no dividend payments in future periods, and has accordingly written off the net assets of BASY in its consolidated financial statements, and b) concluded that the requisite conditions of IFRS 10 have not been met in order for an accounting control to be carried out on the subsidiary and, accordingly, three Board members representing the Group resigned from the Board of Directors of BASY.

The deconsolidation of BASY resulted in the recognition of losses of LBP 155,594 million, which include: a) the negative impact of LBP 109,258 million resulting from losses from the translation into Lebanese Pounds of the financial statements of BASY, previously recognised under foreign currency translation reserve in equity and reclassified to the Income Statement upon loss of control; and b) a negative impact of LBP 46,336 million due to the full write-off of the net investment.

The fully impaired investment in BASY was classified as an investment at fair value through other comprehensive income as of 31 December 2016. The Group will reassess its position in case there are significant future changes in the circumstances calling for deconsolidation.

National Bank of Sudan, which was 76.56% owned by the Group, is a separate legal entity offering Islamic Banking activities to its customers, which used to be reported under the Treasury and Capital Markets business segment and the MENAT geographical segment. During 2016, the Group sold its investment in National Bank of Sudan due to the limited market prospects in Sudan and in order to better manage the Group’s risk profile. The sale took effect during December 2016 for a total consideration of LBP 22,612 million. Arabeya Online for Securities Brokerage, which was fully owned by the Group, is a separate legal entity offering brokerage services to its customers, which used to be reported under the Treasury and Capital Markets business segment and MENAT geographical segment. During August 2016, the Group decided to cease the activities of the subsidiary sold it for a total consideration of LBP 7,538 million.

The results of Bank Audi Syria, National Bank of Sudan and Arabeya Online Brokerage are as follows: 2016

(LOSS) PROFIT FROM DISCONTINUED OPERATIONS

(LOSS) PROFIT FROM DISCONTINUED OPERATIONS

17.0. EARNINGS PER SHARE

Basic earnings per share is calculated by dividing the profit for the year attributable to ordinary equity holders of the Bank by the weighted average number of ordinary shares outstanding during the year. The Bank does not have arrangements that might result in dilutive shares. As such, diluted earnings per share was not separately calculated.

The following table shows the income and share data used to calculate earnings per share:

EARNINGS PER SHARE

There were no transactions involving common shares or potential common shares between the reporting date and the date of the completion of these consolidated financial statements which would require the restatement of earnings per share.

18.0. CASH AND BALANCES WITH CENTRAL BANKS

CASH AND BALANCES WITH CENTRAL BANKS

OBLIGATORY RESERVES

  • In accordance with the regulations of the Central Bank of Lebanon, banks operating in Lebanon are required to deposit with the Central Bank of Lebanon an obligatory reserve calculated on the basis of 25.00% of sight commitments and 15.00% of term commitments denominated in Lebanese Pounds. This is not applicable for investment banks which are exempted from obligatory reserve requirements on commitments denominated in Lebanese Pounds. Additionally, all banks operating in Lebanon are required to deposit with the Central Bank of Lebanon interest-bearing placements representing 15.00% of total deposits in foreign currencies regardless of nature.
  • Subsidiary banks operating in foreign countries are also subject to obligatory reserve requirements determined based on the banking regulations of the countries in which they operate.

The following table summarises the Group’s placements in central banks available against the obligatory reserves as of 31 December:

CASH AND BALANCES WITH CENTRAL BANKS

19.0. DUE FROM BANKS AND FINANCIAL INSTITUTIONS

DUE FROM BANKS AND FINANCIAL INSTITUTIONS

The movement of the impairment allowance was as follows:

DUE FROM BANKS AND FINANCIAL INSTITUTIONS

20.0. LOANS TO BANKS AND FINANCIAL INSTITUTIONS AND REVERSE REPURCHASE AGREEMENTS

LOANS TO BANKS AND FINANCIAL INSTITUTIONS AND REVERSE REPURCHASE AGREEMENTS

Reverse repurchase agreements held by the Group as of 31 December 2016 comprise the following:

LOANS TO BANKS AND FINANCIAL INSTITUTIONS AND REVERSE REPURCHASE AGREEMENTS

Reverse repurchase agreements held by the Group as of 31 December 2015 comprise the following:

LOANS TO BANKS AND FINANCIAL INSTITUTIONS AND REVERSE REPURCHASE AGREEMENTS

21.0. DERIVATIVE FINANCIAL INSTRUMENTS

The tables below show the positive and negative fair values of derivative financial instruments, together with the notional amounts analysed by the term to maturity. The notional amount is the amount of a derivative’s underlying asset, reference rate or index and is the basis upon which changes in the value of derivatives are measured. The notional amounts indicate the volume of transactions outstanding at year-end and are indicative of neither the market risk nor the credit risk.

Credit risk in respect of derivative financial instruments arises from the potential for a counterparty to default on its contractual obligations and is limited to the positive market value of instruments that are favorable to the Group.

FORWARDS AND FUTURES

Forwards and futures contracts are contractual agreements to buy or sell a specified financial instrument at a specific price and date in the future. Forwards are customised contracts transacted in the over-the-counter market. Futures contracts are transacted in standardised amounts on regulated exchanges and are subject to daily cash margin requirements.

OPTIONS

Options are contractual agreements that convey the right, but not the obligation, for the purchaser either to buy or to sell a specific amount of a financial instrument at a fixed price, either at a fixed future date or at any time within a specified period.

SWAPS

Swaps are contractual agreements between two parties to exchange movements in interest or foreign currency rates, as well as the contracted upon amounts for currency swaps.

In a currency swap, the Group pays a specified amount in one currency and receives a specified amount in another currency. Currency swaps are mostly gross-settled.

A credit default swap (CDS) is a credit derivative between two counterparties, whereby they isolate the credit risk of at least one third party and trade it. Under the agreement, one party makes periodic payments to the other and receives the promise of a payoff if the third party defaults. The former party receives credit protection and is said to be the “buyer”, while the other party provides credit protection and is said to be the “seller”. The third party is known as the “reference entity”.

The notional amount of credit default swaps represents the carrying value of certain time deposits held by the Group as of 31 December 2016 and 2015. The Group has positions in the following types of derivatives:

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS HELD FOR TRADING PURPOSES

Most of the Group’s derivative trading activities relate to deals with customers which are normally offset by transactions with other counterparties. Also included under this heading are any derivatives entered into for risk management purposes which do not meet the IFRS 9 hedge accounting criteria.

DERIVATIVE FINANCIAL INSTRUMENTS HELD FOR HEDGING PURPOSES



The Group uses derivatives for hedging purposes in order to reduce its exposure to credit and market risks. This is achieved by hedging specific financial instruments, portfolios of fixed rate financial instruments and forecast transaction, as well as strategic hedging against overall financial position exposures.

During 2016, the Group had USD 400 million of its net investment in Odea Bank A.Ş. hedged through currency option contracts (capped calls) with a notional amount of USD 400 million (LBP 603,000 million) as of December 2016. During 2015, the notional amount of these contracts amounted to USD 700 million (LBP 1,055,250 million) and was comprised of USD 400 million hedged through capped calls and USD 300 million hedged through currency collars. The collars matured on 30 December 2016. At 31 December 2016, the positive fair value of the capped call contracts amounted to USD 91 million (LBP 137,644 million). The Bank designated only the intrinsic value of these options as the hedging instrument.

During 2016, the Group renewed its currency swap contracts designated to hedge the net investment in its subsidiaries in Cyprus, France, Kingdom of Saudi Arabia and Qatar. The notional amount of these contracts amounted to LBP 220,836 million as of 31 December 2016 (2015: LBP 222,913 million). The positive fair value of these contracts amounted to LBP 8,753 million while the negative fair value contracts reached LBP 1,315 million (2015: positive fair value of LBP 5,072 million while the negative fair value LBP 131 million) and was transferred to “Foreign currency translation reserve” in equity to offset results of translation of the net investment in those subsidiaries.

No ineffectiveness from hedges of net investments in foreign operations was recognised in profit or loss during the year.

Information pertaining to the effect of applying hedge accounting for hedged items and hedging instruments is summarised as follows:

DERIVATIVE FINANCIAL INSTRUMENTS

DERIVATIVE FINANCIAL INSTRUMENTS

22.0. FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

The classification of the above instruments according to the type of interest is as follows:

FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

23.0. LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

The breakdown and movement of the impairment allowance during the year are as follows:

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

The movement of unrealised interest during the year is as follows:

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

Bad loans and related provisions and unrealised interest which fulfil certain requirements have been transferred to off-balance sheet accounts. The gross balance of these loans transferred during 2016 amounted to LBP 183,991 million (2015: LBP 34,327 million). Besides, amounts recovered from off-balance sheet accounts during 2016 amounted to LBP 23,119 million (2015: LBP 18,323 million) (Note 12).

During November 2016, the Central Bank of Lebanon issued Intermediate Circular No. 439 which required banks operating in Lebanon to constitute additional collective provisions. As such, the collective impairment allowances as at 31 December 2016 include an amount of LBP 384,039 million in excess of the provisioning requirements of IAS 39 (2015: nil).

24.0. LOANS AND ADVANCES TO RELATED PARTIES AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

The breakdown and movement of the impairment allowance during the year are as follows:

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

The movement of unrealised interest during the year is as follows:

LOANS AND ADVANCES TO CUSTOMERS AT AMORTISED COST

Bad loans and related provisions and unrealised interest which fulfil certain requirements have been transferred to off-balance sheet accounts. The gross balance of these loans transferred during 2016 amounted to LBP 183,991 million (2015: LBP 34,327 million). Besides, amounts recovered from off-balance sheet accounts during 2016 amounted to LBP 23,119 million (2015: LBP 18,323 million) (Note 12).

During November 2016, the Central Bank of Lebanon issued Intermediate Circular No. 439 which required banks operating in Lebanon to constitute additional collective provisions. As such, the collective impairment allowances as at 31 December 2016 include an amount of LBP 384,039 million in excess of the provisioning requirements of IAS 39 (2015: nil).

25.0. FINANCIAL ASSETS AT AMORTISED COST

FINANCIAL ASSETS AT AMORTISED COST

The classification of the above instruments according to the type of interest is as follows:

FINANCIAL ASSETS AT AMORTISED COST

26.0. FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

The Group classified the following instruments in private sector securities at fair value through other comprehensive income as it holds them for strategic reasons.

The tables below list those equity instruments and dividends received, as well as the changes in fair value net of applicable taxes:

FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

FINANCIAL ASSETS AT FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

27.0. INVESTMENTS IN ASSOCIATES

INVESTMENTS IN ASSOCIATES

The Group’s investments accounted for under the equity method are not listed on public exchanges. The following table illustrates the summarised financial information of these investments:

ASSOCIATES’ STATEMENT OF FINANCIAL POSITION

INVESTMENTS IN ASSOCIATES

INVESTMENTS IN ASSOCIATES

ASSOCIATES’ OPERATING RESULTS

INVESTMENTS IN ASSOCIATES

Assurex SAL has contingent liabilities of LBP 3,175 million of which LBP 3,100 million relate to guarantees issued in accordance with regulatory requirements.

28.0. PROPERTY AND EQUIPMENT

INVESTMENTS IN ASSOCIATES

The Group’s investments accounted for under the equity method are not listed on public exchanges. The following table illustrates the summarised financial information of these investments:

ASSOCIATES’ STATEMENT OF FINANCIAL POSITION

INVESTMENTS IN ASSOCIATES

INVESTMENTS IN ASSOCIATES

ASSOCIATES’ OPERATING RESULTS

INVESTMENTS IN ASSOCIATES

Assurex SAL has contingent liabilities of LBP 3,175 million of which LBP 3,100 million relate to guarantees issued in accordance with regulatory requirements.

29.0. INTANGIBLE FIXED ASSETS

INTANGIBLE FIXED ASSETS

INTANGIBLE FIXED ASSETS

30.0. NON-CURRENT ASSETS HELD FOR SALE

The Group occasionally takes possession of properties in settlement of loans and advances. The Group is in the process of selling these properties and are as such included in non-current assets held for sale. Gains or losses on disposal are recognised in the Consolidated Income Statement for the year.

NON-CURRENT ASSETS HELD FOR SALE

31.0. OTHER ASSETS

The Group occasionally takes possession of properties in settlement of loans and advances. The Group is in the process of selling these properties and are as such included in non-current assets held for sale. Gains or losses on disposal are recognised in the Consolidated Income Statement for the year.

NON-CURRENT ASSETS HELD FOR SALE

32.0. GOODWILL

GOODWILL

For the purpose of impairment testing, goodwill is allocated to the Cashgenerating Units (CGUs) which represent the lowest level within the Group at which the goodwill is monitored for internal management purposes. The following CGUs include in their carrying value goodwill that is a significant proportion of total goodwill reported by the Group. These CGUs do not carry on their statement of financial position any intangible assets with indefinite lives, other than goodwill.

The following schedule shows the discount and terminal growth rates used for CGUs subject to impairment testing.

GOODWILL

The key assumptions described above may change in response to changes in economic and market conditions. The Group estimates that reasonably possible changes in these assumptions are not expected to cause the recoverable amount of either unit to decline below the carrying amount.

The Commercial Banking CGU in Egypt is a separate legal entity performing Commercial Banking activities to its customers and is reported under mainly the Corporate and Commercial Banking business segment and the MENAT geographical segment. The recoverable amount of this CGU, of LBP 363,271 million as at 31 December 2016, has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decrease in the level of activity due to the prevailing economic conditions in Egypt. The discount rate applied to cash flow projections is 19.00% (2015:17.00%). As a result, an impairment loss on goodwill of LBP 65,639 million was recognised for the year ended 31 December 2016 (2015: none).

The private banking CGU in Lebanon is a separate legal entity performing Private Banking activities to its customers and is reported mainly under Retail and Personal Banking business segment and the Lebanon geographical segment. The recoverable amount of this CGU, of LBP 267,131 million as at 31 December 2016, has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 17.00% (2015: 16.00%) and cash flows beyond the five-year period are extrapolated using a 2% growth rate. As a result, an impairment loss on goodwill amounting to LBP 54,716 million was recognised for the year ended 31 December 2016 (2015: none).

The Banking IT Support CGU in UAE is a separate legal entity performing outsourcing activities to its customers and is reported under Group Functions and Head Office business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 2,582 million as at 31 December 2016, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 12.00%. As a result, an impairment loss on goodwill of LBP 28,084 million was recognised for the year ended 31 December 2016 (2015: none).

The online brokerage CGU in Egypt is a separate legal entity performing brokerage activities to its customers and is reported under the Treasury and Capital Markets business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 19,640 million as at 31 December 2015, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 17.00%. As a result, an impairment loss on goodwill amounting to LBP 5,276 million was recognised during the year ended 31 December 2015.

The Commercial Banking CGU in Sudan is a separate legal entity performing Islamic Banking activities to its customers and is reported under the Treasury and Capital Markets business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 77,058 million as at 31 December 2015, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 22.00% and cash flows beyond the five-year period are extrapolated using a 2.00% growth rate. As a result, an impairment loss on goodwill amounting to LBP 181 million was recognised during the year ended 31 December 2015.

The Online Brokerage CGU in Egypt and the Commercial Banking CGU in Sudan were deconsolidated during 2016 pursuant to their sale, as disclosed under Note 16 to the consolidated financial statements.

GOODWILL SENSITIVITY

The cost of equity assigned to an individual CGU and used to discount its future cash flows can have a significant effect on its valuation. The cost of equity percentage is generally derived from an appropriate capital asset pricing model, which itself depends on inputs reflecting a number of financial and economic variables including the risk rate in the country concerned and a premium to reflect the inherent risk of the business being evaluated. Projected terminal growth rates used are in line with, and do not exceed, the projected growth rates in GDP and inflation rate forecasts for the jurisdictional area where the operations reside.

Management performed a sensitivity analysis to assess the changes to key assumptions that could cause the carrying value of the units to exceed their recoverable amount. These are summarised in the following table, which shows the details of the sensitivity of the above measures on the Bank’s CGU’s value in use (VIU):

GOODWILL

The following table presents the sensitivity of each input by showing the change required to individual current assumptions to reduce headroom to nil (breakeven) for the Private Banking CGU in Switzerland:

GOODWILL

33.0. DUE TO CENTRAL BANKS

GOODWILL

For the purpose of impairment testing, goodwill is allocated to the Cashgenerating Units (CGUs) which represent the lowest level within the Group at which the goodwill is monitored for internal management purposes. The following CGUs include in their carrying value goodwill that is a significant proportion of total goodwill reported by the Group. These CGUs do not carry on their statement of financial position any intangible assets with indefinite lives, other than goodwill.

The following schedule shows the discount and terminal growth rates used for CGUs subject to impairment testing.

GOODWILL

The key assumptions described above may change in response to changes in economic and market conditions. The Group estimates that reasonably possible changes in these assumptions are not expected to cause the recoverable amount of either unit to decline below the carrying amount.

The Commercial Banking CGU in Egypt is a separate legal entity performing Commercial Banking activities to its customers and is reported under mainly the Corporate and Commercial Banking business segment and the MENAT geographical segment. The recoverable amount of this CGU, of LBP 363,271 million as at 31 December 2016, has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decrease in the level of activity due to the prevailing economic conditions in Egypt. The discount rate applied to cash flow projections is 19.00% (2015:17.00%). As a result, an impairment loss on goodwill of LBP 65,639 million was recognised for the year ended 31 December 2016 (2015: none).

The private banking CGU in Lebanon is a separate legal entity performing Private Banking activities to its customers and is reported mainly under Retail and Personal Banking business segment and the Lebanon geographical segment. The recoverable amount of this CGU, of LBP 267,131 million as at 31 December 2016, has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 17.00% (2015: 16.00%) and cash flows beyond the five-year period are extrapolated using a 2% growth rate. As a result, an impairment loss on goodwill amounting to LBP 54,716 million was recognised for the year ended 31 December 2016 (2015: none).

The Banking IT Support CGU in UAE is a separate legal entity performing outsourcing activities to its customers and is reported under Group Functions and Head Office business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 2,582 million as at 31 December 2016, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 12.00%. As a result, an impairment loss on goodwill of LBP 28,084 million was recognised for the year ended 31 December 2016 (2015: none).

The online brokerage CGU in Egypt is a separate legal entity performing brokerage activities to its customers and is reported under the Treasury and Capital Markets business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 19,640 million as at 31 December 2015, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 17.00%. As a result, an impairment loss on goodwill amounting to LBP 5,276 million was recognised during the year ended 31 December 2015.

The Commercial Banking CGU in Sudan is a separate legal entity performing Islamic Banking activities to its customers and is reported under the Treasury and Capital Markets business segment and the MENAT geographical segment. The recoverable amount of this CGU amounted to LBP 77,058 million as at 31 December 2015, and has been determined based on a value in use calculation using cash flow projections from financial budgets approved by Senior Management covering a five-year period. The projected cash flows have been updated to reflect the decreased level of activity. The discount rate applied to cash flow projections is 22.00% and cash flows beyond the five-year period are extrapolated using a 2.00% growth rate. As a result, an impairment loss on goodwill amounting to LBP 181 million was recognised during the year ended 31 December 2015.

The Online Brokerage CGU in Egypt and the Commercial Banking CGU in Sudan were deconsolidated during 2016 pursuant to their sale, as disclosed under Note 16 to the consolidated financial statements.

GOODWILL SENSITIVITY

The cost of equity assigned to an individual CGU and used to discount its future cash flows can have a significant effect on its valuation. The cost of equity percentage is generally derived from an appropriate capital asset pricing model, which itself depends on inputs reflecting a number of financial and economic variables including the risk rate in the country concerned and a premium to reflect the inherent risk of the business being evaluated. Projected terminal growth rates used are in line with, and do not exceed, the projected growth rates in GDP and inflation rate forecasts for the jurisdictional area where the operations reside.

Management performed a sensitivity analysis to assess the changes to key assumptions that could cause the carrying value of the units to exceed their recoverable amount. These are summarised in the following table, which shows the details of the sensitivity of the above measures on the Bank’s CGU’s value in use (VIU):

GOODWILL

The following table presents the sensitivity of each input by showing the change required to individual current assumptions to reduce headroom to nil (breakeven) for the Private Banking CGU in Switzerland:

GOODWILL

34.0. DUE TO BANKS AND FINANCIAL INSTITUTIONS

DUE TO BANKS AND FINANCIAL INSTITUTIONS

Included in term loans above, is an amount of LBP 627,551 million (2015: LBP 438,051 million) representing loans granted from various supranational entities for the purpose of financing small and medium-sized enterprises in the private sector with annual interest rates ranging from 2.24% to 5.68%. The commitments arising from bank facilities received are disclosed in Note 51 to these consolidated financial statements.

35.0. CUSTOMERS’ DEPOSITS

DUE TO BANKS AND FINANCIAL INSTITUTIONS

Included in term loans above, is an amount of LBP 627,551 million (2015: LBP 438,051 million) representing loans granted from various supranational entities for the purpose of financing small and medium-sized enterprises in the private sector with annual interest rates ranging from 2.24% to 5.68%. The commitments arising from bank facilities received are disclosed in Note 51 to these consolidated financial statements.

36.0. DEPOSITS FROM RELATED PARTIES

DEPOSITS FROM RELATED PARTIES

37.0. DEBT ISSUED AND OTHER BORROWED FUNDS

DEBT ISSUED AND OTHER BORROWED FUNDS

The principal of the loans is to be repaid at maturity. Any principal amount of the loans prepaid may not be re-borrowed. Prepayment on the loans is applicable as follows:

Loan 1: the Group, at its sole discretion and after obtaining approval of the Central Bank of Lebanon, has the right to prepay all outstanding amounts (entirely and not partially) according to the following:
  • First time, after five years from issuance and upon payment of interest thereafter.
  • Without regard to the dates set above and according to the following:
    • At any time after one year from the date of issuance, in the event of amendments to local and international laws and regulations, the subordinated bonds cannot be computed within the private funds of the Group (Tier II);
    • At any time after one year from the date of issuance for reasons related to the amendment of Lebanese taxation laws.

Loans 2 and 3: the Group shall, on any interest payment date or not less than 30 days’ prior written notice, have the right to prepay the entire outstanding principal amount of the loan, in whole but not in part, together with accrued but unpaid interest thereon, and all other amounts payable, and subject to the approval of the Central Bank of Lebanon:
  • In the event of a change in Lebanese law or regulation resulting in an increase in the withholding tax rate applicable to payments of interest on the loans to more than 5.00% above the rate in effect on the date of the disbursement. No penalty or premium shall be payable in connection with any prepayment following changes in taxation; or
  • Subject to the payment of a premium of 2.00% of the outstanding principal amount of the loans to be prepaid, at the option of the Group, on any interest payment date at any time after the fifth anniversary of the date on which the loan is disbursed.

Loan 4: o n 2 1 O ctober 2 014, B ank A udi s al g ranted O dea B ank a subordinated loan in the amount of USD 150 million. This loan matures on 30 September 2024 and pays quarterly interest of 6.50%. During 2015, the Bank offered and sold certificates of participation relating to the USD 150 million subordinated loan, of which USD 138 million were sold to third parties. The certificates constitute pass-through obligations of Bank Audi sal. Odea Bank shall repay the loan at maturity and may repay the loan in whole, but not in part (1) within one month from the fifth anniversary of the subordinated debt issuance date, or (2) due to changes in BRSA regulation if the loan ceases to be treated as Tier 2 capital under the applicable BRSA regulation.

Besides, during 2015, the Group had issued bills denominated in Turkish Lira to domestic investors in the amount of LBP 77,100 million. These bills matured on 28 February 2016 and paid semi-annual interest of 9.75%.

38.0. OTHER LIABILITIES

OTHER LIABILITIES

(A) During 2016, the Central Bank of Lebanon issued Intermediate Circular No. 446 dated 30 December 2016 and relating to the gain realised by banks from certain financial transactions with the Central Bank of Lebanon, consisting of the sale of financial instruments denominated in Lebanese Pounds and the purchase of financial instruments denominated in US Dollars. In accordance with the provisions of this circular, banks should recognise in the Income Statement, only part of the gain net of tax, caped to the extent of the losses recorded to comply with recent regulatory provisioning requirements (refer to Note 23), the impairment losses on goodwill recorded in accordance with IAS 36, and the shortage needed to comply with the capital adequacy requirements. Lebanese banks may further recognise up to 70.00% of the remaining balance of the gain realised net of tax in the Income Statement as non-distributable profits to be appropriated to reserves for capital increase, qualifying for inclusion within regulatory Common Equity Tier 1.

The Bank did not recognise in its Consolidated Income Statement LBP 307,063 million in gains realised from certain financial transactions with the Central Bank of Lebanon, but rather elected to recognise LBP 182,702 million representing 70.00% of the gains, net of taxes, directly in other comprehensive income (refer to Note 43). The remaining 30.00%, equivalent to LBP 78,300 million, was booked as deferred income. The related taxes amounting to LBP 46,061 million were recorded directly in current tax liability (refer to Note 15). The amount recorded as deferred income qualifies for inclusion within regulatory Tier 2 capital, in accordance with the provisions of the circular.

39.0. PROVISIONS FOR RISKS AND CHARGES

PROVISIONS FOR RISKS AND CHARGES

A) PROVISIONS FOR RISKS AND CHARGES

PROVISIONS FOR RISKS AND CHARGES

The movement of provision for risks and charges is as follows:

PROVISIONS FOR RISKS AND CHARGES

B) END OF SERVICE BENEFITS

Banking entities operating in Lebanon have two defined benefit plans covering all their employees. The first requires contributions to be made to the National Social Security Fund whereby the entitlement to and level of these benefits depend on the employees’ length of service, the employees’ salaries and contributions paid to the fund among other requirements. Under the second plan, no contributions are required to be made, however a fixed end of service lump sum amount should be paid for long service employees. The entitlement to and level of these end of service benefits provided depends on the employees’ length of service, the employees’ salaries, and other requirements outlined in the Workers’ Collective Agreement. The first plan described above also applies to non-banking entities operating in Lebanon. Defined benefit plans for employees at foreign subsidiaries and branches are set in line with the laws and regulations of the respective countries in which these subsidiaries are located. The movement of provision for staff retirement benefit obligation is as follows:

PROVISIONS FOR RISKS AND CHARGES

The charge for the year is broken down as follows:

PROVISIONS FOR RISKS AND CHARGES

Defined benefit plans in Lebanon constitute more than 75% of the Group’s required obligation. The key assumptions used in the calculation of Lebanese retirement benefit obligation are as follows:

PROVISIONS FOR RISKS AND CHARGES

A quantitative sensitivity analysis for significant assumptions is shown as below:

PROVISIONS FOR RISKS AND CHARGES

40.0. SHARE CAPITAL AND WARRANTS ISSUED ON SUBSIDIARY CAPITAL

SHARE CAPITAL

The share capital of Bank Audi sal as at 31 December is as follows:

SHARE CAPITAL AND WARRANTS ISSUED ON SUBSIDIARY CAPITAL

1. The Extraordinary General Assembly of shareholders held on 26 August 2014 decided to increase the Bank’s capital by LBP 64,950 million through the issuance of 50,000,000 ordinary shares with a nominal value of LBP 1,299 per share. This capital increase was divided into two issuances the first (40,000,000 shares) of which was reserved for the Bank’s shareholders of ordinary shares, while the second (10,000,000 shares) was reserved for the Bank’s shareholders and new investors. The issuance had the following terms:

  • Number of shares: 50,000,000 (of which 11,018,762 were converted to GDRs)
  • Share’s issue price: USD 6
  • Share’s nominal value: LBP 1,299 (later became LBP 1,656 upon increasing the nominal value).
  • Issue premium : Calculated in USD as the difference between USD 6 and the counter value of the par value per share based on the exchange rate at the underwriting dates.
  • Benefits: Annual dividends starting from the year 2014 results inclusive.
  • Warrants right: 3 warrants per newly issued share exercisable in one month during the first semester of the year 2019. The warrant holder has the right to exchange it against 1 share in Odea Bank A.Ş. by paying USD 0.95 per share.

The Extraordinary General Assembly of shareholders held on 23 September 2014 validated and ratified the capital increases according to the aforementioned terms.

2. The Extraordinary General Assembly of shareholders held on 23 September 2014 decided to increase the Bank’s capital by LBP 142,067 million through the increase of nominal value per share from LBP 1,299 to LBP 1,650 by transferring the amount of LBP 140,312 million from the Issue Premium – common shares and LBP 1,755 million from the Issue Premium – preferred shares. The Extraordinary General Assembly of shareholders held on 4 December 2014 validated and ratified the capital increases according to the aforementioned terms.

3. The Bank issued preferred shares series “F” under the following terms:

Preferred Shares Series ”F”

  • Number of shares: 1,500,000
  • Share’s issue price: USD 100
  • Share’s nominal value: LBP 1,254 (later became LBP 1,656 upon increasing the nominal value).
  • Issue premium: Calculated in USD as the difference between USD 100 and the counter value of the par value per share based on the exchange rate at the underwriting dates.
  • Benefits: Annual non-cumulative dividends of USD 4 per share for the year 2012, and USD 6 for each subsequent year.
  • Repurchase right: The Bank has the right to repurchase the shares in 5 years after issuance, as well as to call them off by that date.

The Extraordinary General Assembly of shareholders held on 22 June 2012 validated and ratified the capital increases according to the aforementioned terms.

4. Pursuant to the resolution of the Extraordinary General Assembly of shareholders held on 15 April 2013, the Bank issued series “G” and “H” preferred shares under the following terms:

Preferred Shares Series ”G”

  • Number of shares: 1,500,000
  • Share’s issue price: USD 100
  • Share’s nominal value: LBP 1,299 (later became LBP 1,656 upon increasing the nominal value).
  • Issue premium: Calculated in USD as the difference between USD 100 and the counter value of the par value per share based on the exchange rate at the underwriting dates.
  • Benefits: Annual non-cumulative dividends of USD 4 per share for the year 2013, and USD 6 for each subsequent year.
  • Repurchase right: The Bank has the right to repurchase the shares in 5 years after issuance, as well as to call them off by that date.

Preferred Shares Series ”H”

  • Number of shares: 750,000
  • Share’s issue price: USD 100
  • Share’s nominal value: LBP 1,299 (later became LBP 1,656 upon increasing the nominal value)
  • Issue premium: Calculated in USD as the difference between USD 100 and the counter value of the par value per share based on the exchange rate at the underwriting dates.
  • Benefits: Annual non-cumulative dividends of USD 4.5 per share for the year 2013, and USD 6.5 for each subsequent year.
  • Repurchase right: The Bank has the right to repurchase the shares in 7 years after issuance, as well as to call them off by that date.

The Extraordinary General Assembly of shareholders held on 21 June 2013 validated and ratified the capital increases according to the aforementioned terms for preferred shares series “G” and “H”.

5. Pursuant to the resolution of the Extraordinary General Assembly of shareholders held on 29 November 2016, the Bank issued preferred shares series “I” under the following terms:

Preferred Shares Series ”I”

  • Number of shares: 2,500,000
  • Share’s issue price: USD 100
  • Share’s nominal value: LBP 1,656
  • Issue premium: Calculated in USD as the difference between USD 100 and the counter value of the par value per share based on the exchange rate at the underwriting dates.
  • Benefits: Annual non-cumulative dividends of USD 3 per share for the year 2016, and USD 7 for each subsequent year.
  • Repurchase right: The Bank has the right to repurchase the shares in 5 years after issuance, as well as to call them off by that date.
  • Conversion: Mandatorily convertible into 15 common shares in case 1) Common Equity Tier 1 to risk-weighted assets falls below 66.25% of minimum required by the Central Bank of Lebanon or 2) the Bank is deemed non-viable by the Central Bank of Lebanon without such a conversion.

The Extraordinary General Assembly of shareholders held on 21 December 2016 validated and ratified the capital increase according to the aforementioned terms.

WARRANTS ISSUED ON SUBSIDIARY SHARES

As mentioned above, during 2014, and in conjunction with the capital increase held during that year, the Bank issued 172.5 million warrants entitling the holders, during the exercise period, to purchase Odea Bank shares at an exercise price of USD 0.95 per share. The exercise period is expected to be the 30-day period commencing on 15 May 2019. The warrants are in registered form, detachable and freely tradable.

A warrant holder may exercise any or all of the warrants held during the exercise period. The shares to be made available for delivery by the Bank pursuant to the exercise of the warrants shall be fully paid and shall rank pari passu with shares of the same class in issue on the exercise date, including the right to participate in full in all dividends payable on or after the exercise date.

SHARE CAPITAL AND WARRANTS ISSUED ON SUBSIDIARY CAPITAL

PAID DIVIDENDS

In accordance with the resolution of the General Assembly of shareholders held on 8 April 2016, dividends were distributed as follows:

SHARE CAPITAL AND WARRANTS ISSUED ON SUBSIDIARY CAPITAL

In accordance with the resolution of the General Assembly of shareholders held on 7 April 2015, dividends were distributed as follows:

SHARE CAPITAL AND WARRANTS ISSUED ON SUBSIDIARY CAPITAL

41.0. ISSUE PREMIUMS

ISSUE PREMIUMS

42.0. CASH CONTRIBUTION TO CAPITAL

In previous years, agreements were entered between the Bank and its shareholders whereby the shareholders granted cash contributions to the Bank amounting to USD 48,150,000 (equivalent to LBP 72,586 million) subject to the following conditions:
  • These contributions will remain placed as a fixed deposit as long as the Bank performs banking activities;
  • If the Bank incurs losses and has to reconstitute its capital, these contributions may be used to cover the losses if needed;
  • The shareholders have the right to use these contributions to settle their share in any increase of capital;
  • No interest is due on the above contributions;
  • The above cash contributions are considered as part of Tier 1 capital for the purpose of determining the Bank’s capital adequacy ratio; and
  • The right to these cash contributions is for the present and future shareholders of the Bank.

43.0. NON-DISTRIBUTABLE RESERVES

NON-DISTRIBUTABLE RESERVES

LEGAL RESERVE

The Lebanese Commercial Law and the Bank’s articles of association stipulate that 10% of the net annual profits be transferred to legal reserve. In addition, subsidiaries and branches are also subject to legal reserve requirements based on the rules and regulations of the countries in which they operate. This reserve is not available for dividend distribution.

The Bank and different subsidiaries transferred to legal reserve an amount of LBP 67,646 million (2015: LBP 48,748 million) as required by the laws applicable in the countries in which they operate.

RESERVES APPROPRIATED FOR CAPITAL INCREASE

During 2016, the Bank recognised directly in reserves appropriated for capital increase an amount of LBP 182,702 million equivalent to 70.00% of net gains realised from trading sovereign financial instruments with the Central Bank of Lebanon (Note 38).

The Group transferred LBP 2,041 million from 2015 profits (2015: LBP 4,580 million from 2014 profits) to reserves appropriated for capital increase. This amount represents the net gain on the disposal of fixed assets acquired in settlement of debt, in addition to reserves on recovered provisions for doubtful loans and debts previously written off, whenever recoveries exceed booked allowances.

GAIN ON SALE OF TREASURY SHARES

These gains arise from the Global Depository Receipts (GDRs) owned by the Group. Based on the applicable regulations, the Group does not have the right to distribute these gains.

RESERVES FOR GENERAL BANKING RISKS

According to the Bank of Lebanon’s regulations, banks are required to appropriate from their annual net profit a minimum of 0.20% and a maximum of 0.3 percent of total risk-weighted assets and off-balance sheet accounts based on rates specified by the Central Bank of Lebanon to cover general banking risks. The consolidated ratio should not be less than 2.00% by the year 2017. This reserve is part of the Group’s equity and is not available for distribution.

RESERVE FOR UNREALISED REVALUATION GAINS ON FINANCIAL ASSETS AT FAIR VALUE THROUGH PROFIT OR LOSS

As per the Banking Control Commission’s Circular No. 270 dated 19 September 2011, banks operating in Lebanon are required to appropriate in a special reserve from their annual net profits the value of gross unrealised profits on financial assets at fair value through profit or loss. This reserve is not available for dividend distribution until such profits are realised and released to general reserves.

RESERVE FOR FORECLOSED ASSETS

The reserve for foreclosed assets represents appropriation against assets acquired in settlement of debt in accordance with the circulars of the Lebanese Banking Control Commission. Appropriations against assets acquired in settlement of debt shall be transferred to unrestricted reserves upon the disposal of the related assets.

OTHER RESERVES

In accordance with decision 362 of the Council of Money and Credit of Syria, unrealised accumulated foreign exchange profits from the revaluation of the structural position in foreign currency maintained by the subsidiary bank in Syria should be appropriated in non-distributable reserve.

Pursuant to the deconsolidation of the Syrian subsidiary in 2016, the balance represents regulatory reserves against retail credit portfolios in Lebanon.

44.0. DISTRIBUTABLE RESERVES

DISTRIBUTABLE RESERVES

45.0. PROPOSED DIVIDENDS

In its meeting held on 20 March 2017, the Board of Directors of the Bank resolved to propose to the annual Ordinary General Assembly the distribution of dividends of LBP 753.75 per common share and GDR. Proposed dividends related to preferred shares amounted to LBP 45,791 million. These dividends are subject to the General Assembly’s approval.

46.0. TREASURY SHARES

DISTRIBUTABLE RESERVES

47.0. OTHER COMPONENTS OF EQUITY

OTHER COMPONENTS OF EQUITY

REAL ESTATE REVALUATION RESERVE

Effective 31 December 2014, the Group made a voluntary change in its accounting policy for subsequent measurement of two classes of property and equipment being i) Land and ii) Building and building improvements from cost to revaluation model. The revaluation surplus amounted to LBP 383,096 and was booked net of deferred taxes of LBP 49,332 million. During 2015, the Group reversed LBP 4,691 million out of the previously deferred taxes due to the change in applicable tax rates in Egypt.

CUMULATIVE CHANGES IN FAIR VALUE

The cumulative changes as at 31 December represent the fair value differences from the revaluation of financial assets measured at fair value through other comprehensive income. The movement during the year can be summarised as follows:

OTHER COMPONENTS OF EQUITY

Change in the Fair Value of Time Value of Hedging Instruments IFRS 9 (2013) stipulates that the Group may separate the intrinsic value and the time value of a purchased option contract and designate only the change in the intrinsic value as the hedging instrument. The Group exercised this option with a view to enhance hedge effectiveness. The decrease in fair value of the time value of these options, to the extent that it relates to the hedged item, amounted to LBP 27,861 million for the year ended 31 December 2016 (2015: LBP 75,458 million) and was recognised in other comprehensive income and accumulated in this reserve account. Amortisation of the time value at the date of designation, in addition to other costs of hedging amounted to LBP 23,300 million for the year ended 31 December 2016 (2015: LBP 21,958 million).

48.0. GROUP SUBSIDIARIES

A. LIST OF SIGNIFICANT SUBSIDIARIES

The following table shows information related to the significant subsidiaries of the Bank:

GROUP SUBSIDIARIES

B. SIGNIFICANT RESTRICTIONS

The Group does not have significant restrictions on its ability to access or use its assets and settle its liabilities other than those resulting from the supervisory frameworks within which banking subsidiaries operate. The supervisory frameworks require banking subsidiaries to keep certain levels of regulatory capital and liquid assets, limit their exposure to other parts of the Group, and comply with other ratios.

C. NON-CONTROLLING INTERESTS

GROUP SUBSIDIARIES

During 2016, the Group disposed of 23.58% of the ownership interests of Odea Bank A.Ş. pursuant to the capital increase of the latter which was mostly subscribed to with supranational investors. Following the partial disposal, the Group still controls Odea Bank A.Ş. and retains 76.42% of the ownership interests.

The transaction has been accounted for as an equity transaction with non-controlling interests, resulting in the following:

GROUP SUBSIDIARIES

MATERIAL PARTIALLY OWNED SUBSIDIARIES

GROUP SUBSIDIARIES

SUMMARISED STATEMENT OF PROFIT OR LOSS

GROUP SUBSIDIARIES

SUMMARISED STATEMENT OF FINANCIAL POSITION

GROUP SUBSIDIARIES

The tables below summarises the financial position of the deconsolidated entities as at deconsolidation date:

GROUP SUBSIDIARIES

GROUP SUBSIDIARIES

SUMMARISED CASH FLOW INFORMATION

GROUP SUBSIDIARIES

49.0. CASH AND CASH EQUIVALENTS

CASH AND CASH EQUIVALENTS

50.0. FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair values in this note are stated at a specific date and may be different from the amounts which will actually be paid on the maturity or settlement dates of the instrument. In many cases, it would not be possible to realise immediately the estimated fair values given the size of the portfolios measured. Accordingly, these fair values do not represent the value of these instruments to the Group as a going concern. Financial assets and liabilities are classified according to a hierarchy that reflects the significance of observable market inputs. The three levels of the fair value hierarchy are defined below.

QUOTED MARKET PRICES – LEVEL 1

Financial instruments are classified as Level 1 if their value is observable in an active market. Such instruments are valued by reference to unadjusted quoted prices for identical assets or liabilities in active markets where the quoted price is readily available, and the price represents actual and regularly occurring market transactions on an arm’s length basis. An active market is one in which transactions occur with sufficient volume and frequency to provide pricing information on an ongoing basis.

VALUATION TECHNIQUE USING OBSERVABLE INPUTS – LEVEL 2

Financial instruments classified as Level 2 have been valued using models whose most significant inputs are observable in an active market. Such valuation techniques and models incorporate assumptions about factors observable in an active market that other market participants would use in their valuations, including interest rate yield curve, exchange rates, volatilities, and prepayment and defaults rates.

VALUATION TECHNIQUE USING SIGNIFICANT UNOBSERVABLE INPUTS – LEVEL 3

Financial instruments are classified as Level 3 if their valuation incorporates significant inputs that are not based on observable market data (unobservable inputs). A valuation input is considered observable if it can be directly observed from transactions in an active market, or if there is compelling external evidence demonstrating an executable exit price. Unobservable input levels are generally determined based on observable inputs of a similar nature, historical observations or other analytical techniques.

Fair value measurement hierarchy of the Group’s financial assets and liabilities carried at fair value:

FAIR VALUE OF FINANCIAL INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

The movement of items recurrently measured at fair value categorised within Level 3 during the year is as follows:

FAIR VALUE OF FINANCIAL INSTRUMENTS

ASSETS AND LIABILITIES CARRIED AT FAIR VALUE USING A VALUATION TECHNIQUE WITH SIGNIFICANT OBSERVABLE INPUTS (LEVEL 2)

Derivatives

Derivative products are valued using a valuation technique with market observable inputs. The most frequently applied valuation techniques include for ward pricing and swap models, using present value calculations. The models incorporate various inputs including the credit quality of counterparties, foreign exchange spot and forward rates and interest rate curves.

Government Bonds, Certificates of Deposits and Other Debt Instruments

The Group values these unquoted debt securities using discounted cash flow valuation models where the lowest level input that is significant to the entire measurement is observable in an active market. These inputs include assumptions regarding current rates of interest, commodity prices, implied volatilities, and credit spreads.

ASSETS AND LIABILITIES CARRIED AT FAIR VALUE USING A VALUATION TECHNIQUE WITH SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3)

Equity Shares of Non-listed Entities

The Group’s strategic investments are generally classified at fair value through other comprehensive income and are not traded in active markets. These are investments in private companies, for which there is no or only limited sufficient recent information to determine fair value. The Group determined that cost adjusted to reflect the investee’s financial position and results since initial recognition represents the best estimate of fair value.

Derivatives

Collars held by the Group for hedging purposes are valued using a valuation technique with significant unobservable inputs. The applied valuation technique uses a Monte Carlo simulation which requires inputs that cannot be pinned down with precision, given the lack of sufficient liquidity in the USD/TRY options markets and the Turkish Lira yield curve, particularly beyond the shortest maturities. In addition, the valuation need to reflect the substantial volatility skew that exists between USD puts and USD calls with comparable deltas, and specifically the fact that the implied volatility of USD calls is substantially greater than that of USD puts, even when their deltas and tenures are equal.

COMPARISON OF CARRYING AND FAIR VALUES FOR FINANCIAL ASSETS AND LIABILITIES NOT HELD AT FAIR VALUE

The fair values included in the table below were calculated for disclosure purposes only. The fair valuation techniques and assumptions described below relate only to the fair value of the Group’s financial instruments not measured at fair value. Other institutions may use different methods and assumptions for their fair value estimations, and therefore such fair value disclosures cannot necessarily be compared from one institution to another.

Fair value measurement hierarchy of the group’s financial assets and liabilities for which fair value is disclosed:

FAIR VALUE OF FINANCIAL INSTRUMENTS

FAIR VALUE OF FINANCIAL INSTRUMENTS

ASSETS AND LIABILITIES FOR WHICH FAIR VALUE IS DISCLOSED USING A VALUATION TECHNIQUE WITH SIGNIFICANT OBSERVABLE INPUTS (LEVEL 2) AND/OR SIGNIFICANT UNOBSERVABLE INPUTS (LEVEL 3)

For financial assets and financial liabilities that are liquid or have a short-term maturity (less than three months), the Group assumed that the carrying values approximate the fair values. This assumption is also applied to demand deposits which have no specific maturity and financial instruments with variable rates.

Deposits with Banks and Loans and Advances to Banks

For the purpose of this disclosure there is minimal difference between fair value and carrying amount of these financial assets as they are short-term in nature or have interest rates that re-price frequently. The fair value of deposits with longer maturities is estimated using discounted cash flows applying market rates for counterparties with similar credit quality.

Government Bonds, Certificates of Deposits and Other Debt Securities

The Group values these unquoted debt securities using discounted cash flow valuation models where the lowest level input that is significant to the entire measurement is observable in an active market. These inputs include assumptions regarding current rates of interest and credit spreads.

Loans and Advances to Customers

For the purpose of this disclosure, fair value of loans and advances to customers is estimated using discounted cash flows by applying current rates for new loans with similar remaining maturities and to counterparties with similar credit quality.

Deposits from Banks and Customers

In many cases, the fair value disclosed approximates carrying value because these financial liabilities are short-term in nature or have interest rates that re-price frequently. The fair value for deposits with long-term maturities, such as time deposits, are estimated using discounted cash flows, applying either market rates or current rates for deposits of similar remaining maturities.

Debt Issued and Other Borrowed Funds

Fair values are determined using discounted cash flows valuation models where the inputs used are estimated by comparison with quoted prices in an active market for similar instruments.

51.0. CONTINGENT LIABILITIES, COMMITMENTS AND LEASING ARRANGEMENTS

CREDIT-RELATED COMMITMENTS AND CONTINGENT LIABILITIES

To meet the financial needs of customers, the Group enters into various commitments, guarantees and other contingent liabilities which are mainly credit-related instruments including both financial and non-financial guarantees and commitments to extend credit. Even though these obligations may not be recognised on the Statement of Financial Position, they do contain credit risk and are therefore part of the overall risk of the Group. The table below discloses the nominal principal amounts of credit-related commitments and contingent liabilities. Nominal principal amounts represent the amount at risk should the contracts be fully drawn upon and clients default. As a significant portion of guarantees and commitments is expected to expire without being withdrawn, the total of the nominal principal amount is not indicative of future liquidity requirements.

CREDIT-RELATED COMMITMENTS AND CONTINGENT LIABILITIES

GUARANTEES

Guarantees are given as security to support the performance of a customer to third parties. The main types of guarantees provided are:
  • Financial guarantees given to banks and financial institutions on behalf of customers to secure loans, overdrafts, and other banking facilities; and
  • Other guarantees are contracts that have similar factures to the financial guarantee contracts but fail to meet the strict definition of a financial guarantee contract under IFRS. These include mainly performance and tender guarantees.

DOCUMENTARY CREDITS

Documentary credits commit the Group to make payments to third parties, on production of documents, which are usually reimbursed immediately by customers.

LOAN COMMITMENTS

Loan commitments are defined amounts (unutilised credit lines or undrawn portions of credit lines) against which clients can borrow money under defined terms and conditions.

Revocable loan commitments are those commitments that can be unconditionally cancelled at any time subject to notice requirements according to their general terms and conditions. Irrevocable loan commitments result from arrangements where the Group has no right to withdraw the loan commitment once communicated to the beneficiary.

In addition to the above, the Group has issued letters of intent in the amount of LBP 14,962,625 million as of 31 December 2016 (2015: LBP 15,704,228 million). These letters of intent do not represent loan commitments on behalf of the Group.

INVESTMENT COMMITMENTS

The Group invested in funds pursuant to the provisions of Decision No. 6116 dated 7 March 1996 of the Central Bank of Lebanon. In accordance with this resolution, the Group can benefit from facilities granted by the Central Bank of Lebanon to be invested in startup companies, incubators and accelerators whose objects are restricted to supporting the development, success and growth of startup companies in Lebanon or companies whose objects are restricted to investing venture capital in startup companies in Lebanon. These investments have resulted in future commitments on the Group of LBP 30,164 million as of 31 December 2016 (2015: LBP 27,211 million).

LEGAL CLAIMS

Litigation is a common occurrence in the banking industry due to the nature of the business. The Group has an established protocol for dealing with such legal claims. Once professional advice has been obtained and the amount of damages reasonably estimated, the Group makes adjustments to account for any adverse effects which the claims may have on its financial standing. At year-end, the Group had several unresolved legal claims. Based on advice from legal counsel, Management believes that legal claims will not result in any material financial loss to the Group.

OPERATING LEASE AND CAPITAL EXPENDITURE COMMITMENTS

CREDIT-RELATED COMMITMENTS AND CONTINGENT LIABILITIES

COMMITMENTS RESULTING FROM CREDIT FACILITIES RECEIVED

The Group has the following commitments resulting from the credit facilities received from non-resident financial institutions:
  • The net past due loans (after the deduction of provisions) should not exceed 5 percent of the net credit facilities granted;
  • The provision for past due loans which includes specific and collective provisions and unrealised interest should not fall below 70 percent of the past due loans;
  • The net doubtful loans should not exceed 20 percent of the Tier 1 capital.
  • Sustaining a liquidity ratio exceeding 115 percent;
  • Sustaining a capital adequacy exceeding the minimum ratio as per the regulations applied by the Central Bank of Lebanon and the requirements of the Basel agreements to the extent that it is applied by the Central Bank of Lebanon.

OTHER COMMITMENTS AND CONTINGENCIES

Financial assets at amortised cost include Lebanese government Treasury bills amounting to LBP 805,013 million (2015: LBP 31,519 million) pledged to the Central Bank of Lebanon against credit facilities. They also include Turkish Treasury bills amounting to LBP 1,055 million (2015: LBP 97,960 million) pledged against repurchase agreements (Note 33).

The Bank’s books in Lebanon remain subject to the review of the tax authorities for the period from 1 January 2012 to 31 December 2016 and the review of the National Social Security Fund (NSSF) for the period from 30 September 2011 to 31 December 2016. In addition, the subsidiaries’ books and records are subject to review by the tax and social security authorities in the countries in which they operate. Management believes that adequate provisions were recorded against possible review results to the extent that they can be reliably estimated.

52.0. ASSETS UNDER MANAGEMENT

Assets under management include client assets managed or deposited with the Group. For the most part, the clients decide how these assets are to be invested.

ASSETS UNDER MANAGEMENT

53.0. RELATED PARTY TRANSACTIONS

RELATED PARTY TRANSACTIONS

Parties are considered to be related if one party has the ability to control the other party or exercise significant influence over the other party in making financial or operational decisions, or one other party controls both. The definition includes subsidiaries, associates, key Management personnel and their close family members, as well as entities controlled or jointly controlled by them.

Key Management personnel are defined as those persons having authority and responsibility for planning, directing and controlling the activities of the Group, directly or indirectly. At the level of the Group, key Management personnel include the members of the Bank’s Board of Directors and Group Executive Committee.

Loans to related parties (a) were made in the ordinary course of business, (b) were made on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with others, and (c) did not involve more than a normal risk of collectability or present other unfavourable features.

Related party balances included in the Group’s Statement of Financial Position are as follows as of 31 December:

RELATED PARTY TRANSACTIONS

Related party balances included in the Group’s Income Statement are as follows for the year ended 31 December:

RELATED PARTY TRANSACTIONS

SUBSIDIARIES

Transactions between the Bank and its subsidiaries meet the definition of related party transactions. However, where these are eliminated on consolidation, they are not disclosed in the Group’s financial statements.

ASSOCIATES

The Group provides banking services to its associates and to entities under common directorships. As such, loans, overdrafts, interest and non-interest bearing deposits and current accounts are provided to these entities, as well as other services. These transactions are conducted on the same terms as third-party transactions. Summarised financial information for the Group’s associates is set out in Note 27 to these financial statements.

KEY MANAGEMENT PERSONNEL

Key Management personnel are those individuals who have the authority and responsibility for planning and exercising power to directly or indirectly control the activities of the Bank and its employees. The Bank considers the members of the Board of Directors (and its sub-committees) and Executive Committee to be the key Management personnel.

RELATED PARTY TRANSACTIONS

Short-term benefits comprise of salaries, bonuses, attendance fees and other benefits.

Provision for end of service benefits of key Management personnel amounted to LBP 29,944 million as of 31 December 2016 (2015: LBP 23,485 million).

During 2016, the Group sold National Bank of Sudan, a subsidiary, to Fondal Limited, a related party, for a total consideration of LBP 22,612 million (Note 16).

54.0. RISK MANAGEMENT

The Group is exposed to various types of risks, some of which are:
  • Credit risk: the risk of default or deterioration in the ability of a borrower to repay a loan;
  • Market risk: the risk of loss in balance sheet and off-balance sheet positions arising from movements in market prices. Movements in market prices include changes in interest rates (including credit spreads), exchange rates and equity prices;
  • Liquidity risk: the risk that the Group cannot meet its financial obligations when they come due in a timely manner and at reasonable cost;
  • Operational risk: the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events;
  • Other risks faced by the Group include concentration risk, reputation risk, legal risk and business/strategic risk.

Risks are managed through a process of ongoing identification, measurement, monitoring, mitigation and control, and reporting to relevant stakeholders. The Group ensures that risk and rewards are properly balanced and in line with the risk appetite that is approved by the Board of Directors.

BOARD OF DIRECTORS

The Board of Directors (the Board) is ultimately responsible for setting the level of acceptable risks to which the Group is exposed, and as such, defines the risk appetite for the Group. In addition, the Board approves risk policies and procedures. Periodic reporting is made to the Board on existing and emerging risks in the Group. A number of Management committees and departments are also responsible for various levels of risk management, as set out below.

BOARD GROUP RISK COMMITTEE

The role of the Board’s Group Risk Committee (BGRC) is to oversee the risk management framework and assess its effectiveness, review and recommend to the Board the group risk policies and risk appetite, monitor the group risk profile, review stress tests scenarios and results, and provide access for the Group Chief Risk Officer (CRO) to the Board. The BGRC meets at least every quarter in the presence of the Group CRO.

EXECUTIVE COMMITTEE

The mandate of the Group Executive Committee is to support the Board in the implementation of its strategy, to support the Group CEO in the day-to-day management of the Group, and to develop and implement business policies for the Group and issue guidance for the Group within the strategy approved by the Board. The Executive Committee is involved in reviewing and submitting to the Board the risk policies and risk appetite.

ASSET LIABILITY COMMITTEE

The Asset Liability Committee (ALCO) is a Management committee responsible in part for managing market risk exposures, liquidity, funding needs and contingencies. It is the responsibility of this committee to set up strategies for managing market risk and liquidity exposures and ensuring that Treasury implements those strategies so that exposures are managed in a manner consistent with the risk policy and limits approved by the Board.

INTERNAL AUDIT

All risk management processes are independently audited by the Internal Audit department at least annually. This includes the examination of both the adequacy and effectiveness of risk control procedures. Internal Audit discusses the results of its assessments with Management and reports its findings and recommendations to the Audit Committee of the Board.

RISK MANAGEMENT

Risk Management is a function independent from business lines and headed by the Chief Risk Officer. The function has the responsibility to ensure that risks are properly identified, measured, monitored, controlled, and reported to heads of business lines, Senior Management, ALCO, the Board Risk Committee and the Board. In addition, the function works closely with Senior Management to ensure that proper controls and mitigants are in place. The Risk function at the Group level has the responsibility of drafting risk policies and principles for adoption at the entity level. In addition, it is in charge of cascading risk appetite to entities and business lines, and monitoring and aggregating risks across the Group.

RISK APPETITE

The Risk appetite reflects the business strategy and market environment of the Group, as well as the level of risks that the Group is willing to accept. Risk appetite is formalised in a document which is reviewed by the Executive Committee and the Board Group Risk Committee and approved by the Board. This document comprises qualitative and quantitative statements of risk appetite that includes indicators for asset quality and concentration.

Information independently compiled from all business lines and risk-taking units is examined and processed in order to identify and measure the risk profile. The results are reported and presented on a regular basis to Management and to the Board.

55.0. CREDIT RISK

Credit risk is the risk that the Group will incur a loss because its customers or counterparties fail to discharge their contractual obligations. Credit risk appetite and limits are set at the Group level by the Board and are cascaded to the entities, which, in turn, formulate their own limits in line with the Group’s risk appetite.

CREDIT LIMITS

The Group controls credit risk by setting limits on the amount of risk it is willing to accept for individual counterparties and for geographical and industry concentration, and by monitoring exposures in relation to such limits. These limits include the following:

FINANCIAL INSTITUTIONS

Percentage floors and absolute limits are set on the Group’s placements with highly rated financial institutions.

SOVEREIGN EXPOSURE AND OTHER FINANCIAL INSTRUMENTS

Limits are placed on sovereign exposures and other financial instruments according to their ratings.

LOANS AND ADVANCES TO CUSTOMERS

The Group sets risk appetite per country, economic sector, tenure of the loan, rating, and group of obligors, among others, in order to limit undue risk concentrations.

CREDIT GRANTING AND MONITORING PROCESSES

The Group has set clearly established processes related to loan origination, documentation and maintenance of extensions of credits.

INITIATION

Initiation of the credit facilities is done by the business originating function which is shared between branches and the Corporate and Commercial Departments.

ANALYSIS

Credit analysis is performed within the business originating function and is reviewed independently by the Credit Review Department, which, in turn, prepares a written independent credit opinion about the facilities and submits it to the respective approval authority.

APPROVAL

Credit officers and credit committees are responsible for the approval of facilities up to the limit assigned to them, which depends on the size of the exposure and the obligor’s creditworthiness as measured by his internal rating. Once approved, facilities are disbursed when all the requirements set by the respective approval authority are met and documents intended as security are obtained and verified by the Credit Administration function.

MONITORING

The Group maintains continuous monitoring of the quality of its portfolio. Regular reports are sent to the Executive Committee and to the Board, detailing the credit risk profile including follow-up accounts, large exposures, risk ratings and concentration by industry, geography and group of obligors.

RECOVERY AND RESTRUCTURING

The Group assesses impaired loans by assessing the expected loss on a case by case basis for non-retail loans and on a collective basis for retail products. They are directly managed by the Recovery and Restructuring Department which is responsible for formulating a workout strategy, in coordination with the Legal and Compliance Department.

PROVISIONING POLICY

As part of the conservative approach to sustain the quality of the Group’s loan portfolio, an evaluation of loan loss provisions is made on a regular basis. As such, all adversely classified accounts are reviewed and the Recovery and Restructuring Department makes recommendation for specific provisions against the accounts. These recommendations are submitted to the appropriate approval authority before they are implemented. In this regard, specific approval from the regulatory authority might be necessary depending on the regulatory environment of the concerned entity.

Besides, impairment is assessed on a collective basis for loans that are not individually impaired. The Group is in process of preparing for the adoption of IFRS 9, starting 1 January 2018, at a consolidated level, as required by the Central Bank of Lebanon.

In the normal course of business, some loans may become unrecoverable. Such loans would then be required to be partially or fully written off with proper approval when:
  • All efforts to recover the bad debt have failed;
  • The borrower’s bankruptcy or inability to repay is established;
  • Legal remedies have proved to be futile and/or cost prohibitive.

Requests for write-offs are to be submitted to the appropriate authority for approval. Approved write-offs are notified to the Executive Committee and then to the Board.

DERIVATIVE FINANCIAL INSTRUMENTS

Credit risk arising from derivative financial instruments is, at any time, limited to those with positive fair values, as recorded in the Statement of Financial Position. In the case of credit derivatives, the Group is also exposed to the risk of default of the derivative’s counterparty.

MANAGEMENT OF RISK CONCENTRATION

Credit concentrations arise when a number of counterparties are engaged in similar business activities in the same geographic region or have similar economic features that would cause their ability to meet contractual obligations to be similarly affected by changes in economic, political and other conditions.

In order to limit undue credit concentration risk and maintain a diversified portfolio base, the Group has set specific limits by certain asset class and type in the Risk Appetite document.

CREDIT-RELATED COMMITMENTS RISKS

The Group makes available to its customers guarantees which may require payments on their behalf. Such guarantees expose the Group to risks similar to balance sheet exposure and they are mitigated by the same control processes and policies.

ANALYSIS TO MAXIMUM EXPOSURE TO CREDIT RISK AND COLLATERAL AND OTHER CREDIT ENHANCEMENTS

The following table shows the maximum exposure to credit risk by class of financial asset. It further shows the total fair value of collateral, capped to the maximum exposure to which it relates and the net exposure to credit risk.

CREDIT RISK

The surplus of collateral mentioned above is presented before offsetting additional credit commitments given to customers amounting to LBP 4,799,560 million as at 31 December 2016.

CREDIT RISK

The surplus of collateral mentioned above is presented before offsetting additional credit commitments given to customers amounting to LBP 5,222,426 million as at 31 December 2015.

ANALYSIS TO MAXIMUM EXPOSURE TO CREDIT RISK AND COLLATERAL AND OTHER CREDIT ENHANCEMENTS

COLLATERAL AND OTHER CREDIT ENHANCEMENTS

The amount and type of collateral required depends on an assessment of the credit risk of the counterparty. Guidelines are implemented regarding the acceptability of types of collateral and valuation parameters.

Management monitors the market value of collateral on a regular basis and requests additional collateral in accordance with the underlying agreement when deemed necessary.

The main types of collateral obtained are as follows:

Securities: the balances shown above represent the fair value of the securities.

Letters of Credit/Guarantees: the Group holds in some cases guarantees, letters of credit and similar instruments from banks and financial institutions which enable it to claim settlement in the event of default on the part of the counterparty. The balances shown represent the notional amount of these types of guarantees held by the Group.

Real Estate (Commercial and Residential): the Group holds in some cases a first degree mortgage over residential property (for housing loans) and commercial property (for commercial loans). The value shown above reflects the fair value of the property limited to the related mortgaged amount.

Netting Agreements: the Group makes use of netting agreements where there is a legally enforceable right to offset in the event of counterparty default and where as a result there is a net exposure for credit risk. However, there is no intention to settle these balances on a net basis under normal circumstances, and they do not qualify for offset. The amounts above represent available netting agreements in the event of default of the counterparty.

This includes netting agreements for loans and advances to customers and financial assets at amortised cost. In addition, derivatives may also be settled net when there is a netting agreement in place providing for this in the event of default, reducing the Group’s exposure to counterparties on derivative asset positions. The reduction in risk is the amount of liability held.

In addition to the above, the Group also obtains guarantees from parent companies for loans to their subsidiaries, personal guarantees for loans to companies owned by individuals, second degree mortgages, and assignments of insurance or bills proceeds and revenues, which are not reflected in the above table.

RESTRUCTURED LOANS

Restructuring activity aims to manage customer relationships, maximise collection opportunities and, if possible, avoid foreclosure or repossession. Such activities include extended payment arrangements, deferring foreclosure, modification, loan rewrites and/or deferral of payments pending a change in circumstances.

Restructuring policies and practices are based on indicators or criteria which, in the judgment of local Management, indicate that repayment will probably continue. The application of these policies varies according to the nature of the market and the type of the facility.

CREDIT RISK

CREDIT RATING SYSTEM

The Group assesses the quality of its credit portfolio using the following credit rating methodologies:
  • External ratings from approved credit rating agencies for financial institutions and financial assets.
  • Internal rating models that take into account both financial as well as non-financial information such as Management quality, operating environment and company standing. These internal rating models include a Corporate model, SME models, a Project Finance model and an Individual models. The Group uses the Facility Risk Rating (FRR) model to rate facilities based on the Obligator Risk Rating and collaterals.
  • Internally developed scorecards to assess the creditworthiness of retail borrowers in an objective manner and streamline the decision making process.
  • Supervisory ratings comprising six main categories: (a) Regular includes borrowers demonstrating good to excellent financial condition, risk factors, and capacity to repay. These loans demonstrate regular and timely payment of dues, adequacy of cash flows, timely presentation of financial statements, and sufficient collateral/guarantee when required. (b) Follow-up represents a lack of documentation related to a borrower’s activity, an inconsistency between facilities’ type and related conditions. (c) Follow-up and regularisation includes credit worthy borrowers requiring close monitoring without being impaired. These loans might be showing weaknesses; insufficient or inadequate cash flows; highly leveraged; deterioration in economic sector or country where the facility is used; loan rescheduling more than once since initiation; or excess utilisation above limit. (d) Substandard loans include borrowers with incapacity to repay from identified cash flows. Also included under this category are those with recurrent late payments and financial difficulties. (e) Doubtful loans where full repayment is questioned even after liquidation of collateral. It also includes loans stagnating for over 6 months and debtors who are unable to repay restructured loans. Finally, (f) Bad loans with no or little expected inflows from business or assets. This category also includes borrowers with significant delays and deemed insolvent.

CREDIT QUALITY

The table below shows the credit quality by asset class for all financial assets with credit risk, based on the past-due status and impaired/non-impaired classification. The amounts presented are gross of impairment allowances.

CREDIT RISK

CREDIT RISK

The aging analysis of past due but not impaired loans and advances to customers at amortised cost as at 31 December is as follows:

CREDIT RISK

The classification of loans and advances to customers and related parties at amortised cost as per supervisory ratings is as follows:

CREDIT RISK

CREDIT RISK

EXTERNAL RATING ANALYSIS

The classification of the Group financial instruments and balances due from banks and financial institutions as per external ratings is as follows:

CREDIT RISK

GEOGRAPHIC ANALYSIS

The Group controls credit risk by maintaining close monitoring credit of its assets exposures by geographic location. The distribution of financial assets by geographic region as of 31 December is as follows:

CREDIT RISK

INDUSTRIAL ANALYSIS

The distribution of financial assets by industry as of 31 December is as follows:

CREDIT RISK

56.0. MARKET RISK

Market risk is defined as the potential loss in both on balance sheet and off-balance sheet positions resulting from movements in market risk factors such as foreign exchange rates, interest rates and equity prices.

The Market Risk Unit’s responsibilities are to identify, measure, report, and monitor all potential and actual market risks to which the Group is exposed. The purpose is to introduce transparency around the Treasury, investment portfolio, and asset and liability risk profile through consistent and comprehensive risk measurements, aggregation, management and analysis. Policies are set and limits monitored in order to ensure the avoidance of large, unexpected losses and the consequent impact on the Group’s safety and soundness.

Tools developed in-house by a centralised unit of specialists offer a holistic view of risk exposures and are customised to meet the requirements of all end users (Group Risk, Senior Management, business lines and Legal Compliance). Stress scenarios include the various manifestations of the credit crisis that are relevant to the Group’s exposures, as well as scenarios related to the Group’s environment.

A. CURRENCY RISK

Foreign exchange (or currency) risk is the risk that the value of a portfolio will fall as a result of changes in foreign exchange rates. The major sources of this type of market risk are imperfect correlations in the movements of currency prices and fluctuations in interest rates. Therefore, exchange rates and relevant interest rates are acknowledged as distinct risk factors.

In addition to regulatory limits, the Board has set limits on positions by currency. These positions are monitored to ensure they are maintained within established limits.

The following tables present the breakdown of assets and liabilities by currency:

MARKET RISK

MARKET RISK

THE GROUP’S EXPOSURE TO CURRENCY RISK

The Group is subject to currency risk on financial assets and liabilities that are listed in currencies other than the Lebanese Pounds. Most of these financial assets and liabilities are listed in US Dollars, Euros and Turkish Liras.

The table below shows the currencies to which the Group had significant exposure at 31 December on its non-trading monetary assets and liabilities and its forecast cash flows. The numbers represent the effect of a reasonably possible movement of the currency rate against the Lebanese Pound, with all other variables held constant, first on the income statement (due to the potential change in fair value of currency sensitive non-trading monetary assets and liabilities) and equity (due to the impact of currency translation gains/losses of consolidated subsidiaries and the change in fair value of currency swaps used to hedge net investment in foreign subsidiaries). A negative amount reflects a potential net reduction in income or equity, while a positive amount reflects a net potential increase.

MARKET RISK

HEDGING NET INVESTMENTS

A foreign currency exposure arises from net investments in subsidiaries that have a different functional currency from that of the Bank. The risk arises from the fluctuation in spot exchange rates between the functional currency of the subsidiaries and branches and the Bank’s functional and presentation currency which causes the amount of the net investment to vary. Such a risk may have a significant impact on the Group’s financial statements. In order to mitigate this risk, the Group has entered into foreign currency derivative contracts to enhance its risk profile and manage the effect of foreign currency translation.

Hedge of Net Investment in Odea Bank A.Ş.
The Hedged Item
During January 2014, the Bank decided to hedge USD 600 million component of its net investment in Odea Bank A.Ş. through currency option contracts, which was increased to USD 700 million in January 2015.

The Hedging Instruments and Hedged Risk
During January 2014, the Group entered in a series of capped calls deals with prime rated financial institutions for a total notional amount of USD 400 million. Each capped call deal comprises a combination of a long plain vanilla call option on USD/TRY and a short plain vanilla call option, both legs having different strike prices. On average, and for all the deals, this strategy is translated in a protection against the upside of the USD against TRY triggered when USD/TRY hits 2.26 and continues until it touches 3.23. The term of the hedging instruments ends during April 2018.

For this strategy, the hedged risk is the change in the USD/TRY spot exchange rate within the range of prices falling between strike price of the long call option and that of the short call. The risk is hedged from January 2014 to April 2018 where the deals mature and settle.

The remaining USD 300 million were hedged through zero-cost collars each comprising a combination of a long call option and a short put option maturing in one month, and the strategy is automatically rolled-over for 36 months ending in December 2016. The roll-over strike prices of the calls and puts depend on whether the spot rate has been trending up or down in the past month. The strikes of each collar may be set at either a “wide” range if the USD has been weakening, or a “narrow” range if the USD has been strengthening.

This strategy hedges the changes in the USD/TRY spot exchange rate beyond the narrow range delimited by the strike price of the bought call option and the strike price of the sold put option. As such, it protects against significant variations of the TRY during the month but not against limited variations. The Group forgoes any profit on the net investment should the TRY price appreciate beyond the strike price of the written put. In return, however, maximum downside protection is assured. The risk was hedged from January 2014 to December 2016.

The Group designated only the change in the intrinsic value as the hedging instrument in both of the above strategies.

Sources of Ineffectiveness
For the capped calls, since the hedge is effective over a range, ineffectiveness arises if the Turkish Lira exchange rate goes below the strike of the bought call option (where changes in foreign exchange position will not be offset by the hedge), or above the strike price of the sold call option (where part of the depreciation will not be captured). As for the collars, ineffectiveness exists when the USD/TRY exchange rate ranges between the strike price of the bought call option and the strike price of the sold put option.

Hedge of Net Investment in Other Subsidiaries
During 2016, the Group renewed its currency swap contracts designated to hedge the net investment in its subsidiaries in Cyprus, France, Kingdom of Saudi Arabia and Qatar. The hedged risk is the risk of weakening EUR, SAR, and QAR exchange rate versus the USD that will result in changes in the value of the Group’s net investment in its subsidiaries. The swaps are renewed on annual basis for a period of one year.

MARKET RISK

ASSESSMENT OF HEDGE EFFECTIVENESS CRITERIA

The Group establishes that an economic relationship exists between the hedged item and the hedging instruments since the hedging instruments have fair value changes that offset the changes in the value of the net investment resulting from the hedged risk. The effect of credit risk does not dominate the value changes that result from that economic relationship. The analysis of the possible behaviour of the hedging relationship during its term indicates that it is expected to meet the risk management objective.

The hedge ratio is being designated based on actual amounts of the hedged item and hedging instrument. The notional amounts of the options and forward described above are on a par with the components of net investment hedged. Hence, the hedge ratio is 100%.

B. INTEREST RATE RISK

Interest rate risk arises from the possibility that changes in interest rates will affect future profitability or the fair value of financial instruments. The Group is exposed to interest rate risk as a result of mismatches of interest rate repricing of assets and liabilities. Positions are monitored on a daily basis by Management and, whenever possible, hedging strategies are used to ensure positions are maintained within established limits.

INTEREST RATE SENSITIVITY

The table below shows the sensitivity of interest income and shareholders’ equity to reasonably possible parallel changes in interest rates, all other variables being held constant.

The impact of interest rate changes on net interest income is due to assumed changes in interest paid and received on floating rate financial assets and liabilities, and to the reinvestment or refunding of fixed rated financial assets and liabilities at the assumed rates. The result includes the effect of hedging instruments and assets and liabilities held at 31 December 2016 and 2015. The change in interest income is calculated over a 1-year period. The impact also incorporates the fact that some monetary items do not immediately respond to changes in interest rates and are not passed through in full, reflecting sticky interest rate behaviour. The pass-through rate and lag in response time are estimated based on historical statistical analysis and are reflected in the outcome.

There is no direct effect for the change in interest rates on equity pursuant to the early adoption of IFRS9 (2013) in 2014 whereby no debt instruments can be classified at fair value through other comprehensive income. Besides, the effect on equity resulting from the discount rate applied to defined benefit plan obligations is disclosed in Note 39 to these financial statements. The effect of any future associated hedges made by the Group is not accounted for. The sensitivity of equity was calculated for an increase in basis points whereby a similar decrease has an equal and offsetting effect.

MARKET RISK

The Group’s interest sensitivity position based on contractual repricing arrangements is shown in the table below. The expected repricing and maturity dates may differ significantly from the contractual dates particularly with regard to the maturity of customer demand deposits.

MARKET RISK

MARKET RISK

C. PREPAYMENT RISK

Prepayment risk is the risk that the Group will incur a financial loss because its customers and counterparties repay or request repayment earlier than expected, such as fixed rate mortgages when interest rates fall.

Market risks that lead to prepayments are not material with respect to the markets where the Group operates. Accordingly, the Group considers prepayment risk on net profits as not material after considering any penalties arising from prepayments.

D. EQUITY PRICE RISK

Equity price risk is the risk that the value of a portfolio will fall as a result of a change in stock prices. Risk factors underlying this type of market risk are a whole range of various equity (and index) prices corresponding to different markets (and currencies/maturities) in which the Group holds equity-related positions.

The Group sets tight limits on equity exposures and the types of equity instruments that traders are allowed to take positions in. Nevertheless, depending on the complexity of financial instruments, equity risk is measured in first cash terms, such as the market value of a stock/index position, and also in price sensitivities, such as sensitivity of the value of a portfolio to changes in the underlying asset price. These measures are applied to an individual position and/or to a portfolio of equities.

57.0. LIQUIDITY RISK

Liquidity risk is defined as the risk that the Group will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. Liquidity risk arises because of the possibility that the Group might be unable to meet its payment obligations when they fall due under both normal and stress circumstances. To limit this risk, Management has arranged diversified funding sources, in addition to its core deposit base, and adopted a policy of managing assets with liquidity in mind and of monitoring future cash flows and liquidity on a daily basis. The Group has developed internal control processes and contingency plans for managing liquidity risk. This incorporates an assessment of expected cash flows and the availability of high grade collateral which could be used to secure additional funding if required.

The Group maintains a portfolio of marketable and diverse assets that can be liquidated in the event of an unforeseen interruption of cash flow. As per applicable regulations, the Group must retain obligatory reserves with the central banks where the Group entities operate.

The liquidity position is assessed and managed under a variety of scenarios, giving due consideration to stress factors relating to both the market in general, and specifically to the Group. The Group maintains a solid ratio of highly liquid net assets in foreign currencies to deposits and commitments in foreign currencies taking market conditions into consideration.

The Group stresses the importance of customers’ deposits as source of funds to finance its lending activities. This is monitored by using the advances to deposits ratio, which compares loans and advances to customers as a percentage of clients’ deposits.

LIQUIDITY RISK

ANALYSIS OF FINANCIAL ASSETS AND LIABILITIES BY REMAINING CONTRACTUAL MATURITIES

The table below summarises the maturity profile of the Group’s financial assets and liabilities as of 31 December based on contractual undiscounted cash flows. The contractual maturities have been determined based on the period remaining to reach maturity as per the Statement of Financial Position actual commitments. Repayments which are subject to notice are treated as if notice were to be given immediately. Concerning deposits, the Group expects that many customers will not request repayment on the earliest date the Group could be required to pay.

The table does not reflect the expected cash flows indicated by the Group’s deposit retention history.

LIQUIDITY RISK

LIQUIDITY RISK

The table below shows the contractual expiry by maturity of the Group’s contingent liabilities and commitments. Each undrawn loan commitment is included in the time band containing the earliest date it can be drawn down. For issued financial guarantee contracts, the maximum amount of the guarantee is allocated to the earliest period in which the guarantee could be called.

LIQUIDITY RISK

MATURITY ANALYSIS OF ASSETS AND LIABILITIES

The table below summarises the maturity profile of the Group’s assets and liabilities. The contractual maturities of assets and liabilities have been determined on the basis of the remaining period at the Statement of Financial Position date to the contractual maturity date and do not take account of the effective maturities as indicated by the Group’s deposit retention history and the availability of liquid funds. The maturity profile is monitored by Management to ensure adequate liquidity is maintained.

The maturity profile of the assets and liabilities at 31 December 2016 is as follows:

LIQUIDITY RISK

The maturity profile of the assets and liabilities at 31 December 2015 is as follows:

LIQUIDITY RISK

58.0. OPERATIONAL RISK

Operational risk is the risk of loss or damage resulting from inadequate or failed internal processes, people, systems or external events. The failure of operational risk controls may result in reputational damage, business disruptions, business loss, or non-compliance with laws and regulations that can lead to significant financial losses.

The operational risk management framework is implemented by an independent operational Risk Management team that operates in coordination with other support functions such as: Corporate Information Security and Business Continuity, Compliance, and Internal Control. The Internal Audit provides an independent assurance on the effectiveness of this framework through annual reviews.

Operational risks are controlled based on a set of principles detailed in the Board-approved operational risk management framework. These principles include: redundancy of mission-critical systems, segregation of duties, four-eyes principle, independency of employees performing controls, reconciliations, mandatory vacations, awareness, training and rotation of employees of specific functions. Controls are also embedded within the applications modules and process workflows. In addition, specific processes are controlled through client identity checks, end-of-day reports and dual validations.

Incidents are captured and analysed to identify their root causes. Corrective and preventive measures are recommended to prevent their reoccurrence. Risk and Control Assessments (RCAs) are conducted on an ongoing basis to identify risks and control vulnerabilities associated to changes pertaining to products, processes, activities and systems. Key Risk Indicators are also developed continuously to detect breaches and alarming trends. Recommendations to improve the control environment are communicated to concerned parties and escalated to Management as deemed necessary.

Major incidents, RCA findings and operational losses are reported to the Board of Directors and Risk Committees on a quarterly basis.

Insurance coverage is used as an additional layer of mitigation and is commensurate with the Group business activities, in terms of volume and nature.

59.0. CAPITAL MANAGEMENT

By maintaining an actively managed capital base, the Group’s objectives are to cover risks inherent in the business, to retain sufficient financial strength and flexibility to support new business growth, and to meet national and international regulatory capital requirements at all times. The adequacy of the Group’s capital is monitored using, among other measures, the rules and ratios established by the Central Bank of Lebanon according to the provisions of Basic Circular No. 44. These ratios measure capital adequacy by comparing the Group’s eligible capital to regulatory required capital derived by assigning standard risk weights to on and off-balance sheet exposures depending on their relative risk.

During 2016, the Central Bank of Lebanon issued Intermediary Circular No. 436 by which it amended Basic Circular No. 44 related to the minimum Capital Adequacy Ratios (CAR). These ratios are set to increase gradually between December 2016 and December 2018, to reach 10.00%, 13.00% and 15.00% for CET1, Tier 1 and Total CAR respectively in 2018, including a capital conservation buffer of 4.50% in 2018. The following table shows the applicable regulatory capital ratios from end of 2015 to end of 2018:

CAPITAL MANAGEMENT

The regulatory capital including net income for the year less proposed dividends as of 31 December is as follows:

CAPITAL MANAGEMENT

The capital adequacy ratio including net income for the year less proposed dividends as of 31 December is as follows:

CAPITAL MANAGEMENT

The Group manages its capital structure and makes adjustments to it in light of changes in economic conditions, its business model and risk profile. In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends payment to shareholders, return capital to shareholders or issue capital securities.