Aviation Finance Treading cautiously

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1 26 Group Business & Risk Review (Contd.) The past year has been one of overcoming market challenges, leveraging change, maintaining prudent momentum towards more expansion and greater prof itability. Looking at the coming year, we are inspired by our success and the opportunities that lie ahead. 59, , , Net Profit Aviation Finance Treading cautiously As the market continued its struggle to reverse the downward trend spurred by the fateful events of September 11, the Aviation Finance department, through its systematic plan of action, regained its momentum and generated net revenue for the bank. In an environment that has not yet proven conducive to the aviation industry the department focused on carrying ahead the consolidation initiate in 2001 to surpass anticipated challenges. In 2002 this initiative was continued through thoughtful restructuring and business revivals. This year witnesses the Aviation Finance department s amalgamation into a new department called Specialised Finance. The broader based Specialised Finance team will benefit from the specialist skills developed within the aviation sector and extend it to other transport and lease based industries. Most analysts agree that the aviation industry will not recover much before 2004 at earliest. AUB s agenda for 2003 is to maintain asset quality and to continue a very cautious and selective approach to new lending if any.

2 Group Business & Risk Review (Contd.) 27 Well tested and successfully functioning at top banks worldwide, Equation, Opics and Swift are solutions that meet the present and anticipated future needs of the bank. Finance, Risk, IT, Operations & Strategic Development Information Technology Efficiency and strategic cost hedge During 2002, the Information Technology department was active in identifying and implementing solutions based on the established strategy for centralisation and consolidation of processes and management systems. The perceived and actualised benefits from a single processing platform in Bahrain are key downside mitigants for challenges of capturing the goals of cross border mergers has largely been a year of decision-making and gaining of momentum in implementation towards complete integration of the Bank s processes. This year saw all group projects of the department rapidly progress towards completion. These include implementation of Equation as the centralized real-time solution at the core of the Bank s operations, Swift for automated message management and Opics as the group s comprehensive, integrated treasury and capital markets solution. Significant advancement in the deployment of the new centralized ATM controller and integration of system are other highlights of the year s activities. Understanding that the IT industry evolves rapidly, the department leverages its investment in technology by ensuring that its hardware, software and support infrastructure lend themselves to evolutionary changes in technology. This is accomplished through the adoption of widely accepted industry standards, and by utilising technologies offered and supported by market leaders within the industry. Coming from the world leader and successfully functioning at top banks worldwide, Equation, Opics and Swift are solutions that meet the present and anticipated future needs of the Bank. The department also provided IT support to various divisions through effective utilisation of existing and new information technology. For instance, for retail banking, the department implemented applications to increase service to customers and enhance staff productivity. AUB s IT strategy is based on securing best quality not option solutions to its requirements. The problems of extensive proprietary development of existing systems has been the development from a cost and timing perspective of many institutions IT initiatives. AUB consciously seeks to avoid this pitfall by selecting tested systems with proven and suitable support infrastructures. Proprietary development is kept to a minimum. Our approach is not a compromise on quality of systems and associated development. It is a recognition that IT systems are areas to support revenue enhancement and cost reduction within established tier frameworks for completion and delivery. Objectives for 2003 are focused on building the structure of Information Technology for the group. The department has major infrastructure projects to develop a centralised IT infrastructure that supports enterprise technology solutions, facilities interoperability and connectivity, achieves consistently high service level and supports the bank s growth in size and earnings. To achieve these objectives the IT resource structure will be changed into a group entity rather than an entity with just one ACP. Software and hardware recovery will be centralised with AUB, the parent bank, to benefit from economies of scale as well as the lower operating cost base of a GCC based platform. Separate department for strategic system implementations will be formulated comprising local systems implementation in Bahrain alongside operational systems abroad to handle all day-to-day maintenance.

3 28 Group Business & Risk Review (Contd.) Human Resources Friendly and business aligned As AUB continued its rapid growth through 2002, the Human Resources department s performance was highlighted by the successful induction of managers into the key required positions across the group, providing effective and structured training initiatives for human resource development, efficient handling of slimmer budgets, review of short and medium term compensation policies and optimisation of human capital within set financial parameters. Over the past several years, the department faced a challenging human resources budget in the UK as business shifted to Bahrain, the efficient handling of this process has helped set a benchmark for the coming years. The department also filled key roles within the expanding company framework. In line with its endeavour to effectively recruit, hire, train and retain quality employees, it has placed emphasis on quality training as a valuable tool for competitive advantage, with a strong commitment to develop younger staff in Bahrain and London to assume greater responsibilities. The year 2002 saw the inception of a more selective and evaluative approach to proprietary training. Significant bespoke training programs were determined and actualised, which included the successful completion of a specialised workshop on Credit Training and Customer Service, correlated in Bahrain for group staff. The department concentrated on aligning corporate training needs with personal and department objectives. The process generated the dual benefits of improved staff skills and more effective cost management. In the coming year, the department aspires to intensify its effort to gain recognition as the employer of choice with a focus on attracting and retaining top class talent and supporting AUB s meritocratic approach to all staff dealings. Further, efforts will be stepped up towards the integration and infusion of an organisation-wide approach to reinforce the existing commitment to customer satisfaction and loyalty. Entrenchment of strategies forged during 2002, support of cross business initiatives and planning integrative solution and training programmes to best manage the expanding business are the guidelines for the next year.

4 The most valuable assets of a bank are its staff. Aligned with a clear vision and a meritocratic system, signif icant upward momentum is achieved.

5 30 Group Business & Risk Review (Contd.) Risk Management The Risk Management Group enables AUB to identify risks as opportunities and to quickly manage the downside while maximising the upside to extract the best returns from allocated capital. This involves the identification, assessment and ongoing control of any material risk that could have a potential negative impact on the Group s reputation. The function, therefore, does not fully eliminate those risks which are embedded in any banking business, but aims at consciously managing them with the objective of earning competitive returns sufficient to compensate the degree of assumed risk. Risk is financially evaluated in terms of potential impact on income and asset values, taking into consideration the changes in political, economic and market conditions, and the creditworthiness of the Bank s clients. In doing so, the Group relies on the competence, experience and dedication of its professional staff, sound analytical skills and techniques and ongoing investment in technology. The Bank also supports and places considerable emphasis on the risk management recommendations of the Basel Committee on Banking Supervision and the initiatives undertaken by the Bahrain Monetary Agency (BMA) as well as the Financial Services Authority (FSA). In addition, a Risk Management culture is actively and consistently promoted, relying on the appropriate processes that effectively identify, measure, monitor and control risk exposures that are also presented to the Senior Management and Board of Directors to ensure the necessary periodic oversight and guidance. These processes get subjected to additional scrutiny by the regular review of internal and external auditors and regulators, which help the Group to further strengthen its risk management practices on an ongoing basis. The risk management control process is based on detailed credit policies and procedures that emanate from: (a) business lines accountability for risk taken where each business center becomes responsible for developing its plan that includes risk/return as well as risk acceptance criteria and relevant policies appropriate for this particular activity; (b) credit function that understands, monitors and independently controls each credit relationship ensuring that the approval authorities are obtained and a uniform risk management standard including risk ratings have been correctly assigned to each and every credit relationship;

6 Group Business & Risk Review (Contd.) 31 We meet our risk challenges by careful analysis, calculated risk assumptions and rigorous compliance to regulatory requirements. It is our commitment to thoroughly understand the critical change drivers in our selected business areas that let us stay ahead. (c) approved policies for a product or business, which are clearly understood, monitored and are in agreement with the overall credit policy and the Board approved Risk Framework for the Group (d) the ongoing assessment of portfolio credit risk and approval of new products and new risks that then get reported to Senior Management by credit officers; and (e) an integrated limits structure as an essential component that permits management to control exposures and to monitor the assumption of risk against predetermined approved tolerance with global limits established for each major type of risk that gets sub-allocated to individual business units. The major risks associated with AUB s business are: credit, market, liquidity and operational risks. These are detailed in the following sections: Credit Risk Credit risk is the risk for potential financial loss that may arise from a counterparty failing to perform according to agreed terms. It arises from traditional lending activity, from settling payments between financial institutions, from products that create replacement risk (when counterparty commitments to the Bank are determined by reference to the changing values of contractual commitments, for example: foreign exchange forward contracts), derivatives and securities transactions, contingent obligations, and all other lending activities undertaken by the Bank. The credit process is consistent for all forms of credit risk for a single obligor. The overall exposure is evaluated on an ongoing basis to ensure a broad diversification of credit risk. Potential concentrations by country, product, industry, risk grade are regularly reviewed to avoid excessive exposure and ensure diversification. Credit risk within the Group is actively managed by a rigorous process from initiation, to approval to disbursement and day-to-day management in accordance with well-defined Credit Policies and Procedures (CP&P) that details all requirements, and is also designed to identify, at an early stage, exposures which require more detailed review and closer monitoring. If an asset is considered uncollectable, a mandatory write-off takes place. This is conducted by a risk management process which is completely independent in reporting terms from the asset generation departments. The CP&P include a robust risk rating system that stratifies the credit portfolio by level of risk to monitor the credit quality and to be able to assess the pricing and aid in the prompt identification of problem exposures. Management of material problem exposures are vested with Special Exposures Groups in Bahrain and U.K., which all report into the Risk Management area. All problem exposures are subject to quarterly and in certain cases monthly reviews. In addition to the role played by the Risk Management Group, the credit risk is managed within the Group by the Group Credit Committee (GCC) which is vested with the overall day-to-day responsibility for all matters relating to Group Credit Risk including the implementation of the Credit policy. Specifically, it undertakes the following: Act as credit approval body approving credits within its own delegated authority. Recommend to Executive Committee all policy issue changes related to credit risk as well as credits falling outside its discretion. Determine appropriate pricing or security guidelines for all risk asset products. Monitor the ongoing risk profile of the Group as a whole and by individual business sectors and countries. Ensure the adequacy of general and specific provisions and make appropriate recommendation, to the Executive Committee.

7 32 Group Business & Risk Review (Contd.) Market Risk Market risk is the risk of a potential financial loss that may arise from adverse changes in the value of a financial instrument or a portfolio of financial instruments including interest, foreign exchange rates, equity and commodity prices and derivatives. This risk arises from timing differences in the maturity of assets and liabilities, changes that occur in the yield curve and changes in volatilities/ implied volatilities in the market value of derivatives. Given the group s low risk strategy, aggregate market risk levels are very low. Besides the usual techniques of managing the asset and liability mix, either directly or through derivatives that act as hedges, the Group utilises value-at-risk (VaR) models to assist in estimating potential losses that may arise from adverse market movements. The Group calculates VaR on a historical simulation basis using one-day movements in market rates and prices, a three standard deviation confidence level (99.6%) which takes into account the actual correlations observed historically between different markets and rates. The one day movement in market prices is calculated by reference to market data from the last 1,000 trading days. Daily backtesting is done to ensure compliance with Basel Committee requirements and for internal purposes. In 2002, average daily VaR on the Trading book was US$336,000 ( US$661,000). Maximum and minimum VaR were US$726,000 and US$125,000 ( US$1,544,000 and US$187,000). The reduced range during 2002 reflected the reduction in risks taken as considered appropriate given changing market conditions. VaR limits are delegated by the Board to the Group Asset and Liability Committee (GALCO) and sub delegated to Treasury. Liquidity Risk Liquidity risk is the risk of being unable to meet all financial commitments, at all times, without having to raise funds at unreasonable prices or sell assets on a forced basis. It is measured by estimating the Group s potential liquidity and funding requirements under different stress scenarios. The effective approach to liquidity management would be to make certain that funds are available under all circumstances to meet the funding requirements of the Group not only under adverse conditions, but preferably at sufficient levels to also capitalise on opportunities for business expansion. A prudent mix of liquidity controls based on expected economic and Group-specific events substantially ensures access to liquidity without the need to increase costs. It also provides for the maintenance of a stock of liquidity and marketable assets and also as adequately diversified deposit base in terms of maturity and number of counterparties. Group Treasury continuously monitors liquidity risk and actively manages the balance sheet to control this risk. At the subsidiary level, the respective Treasury function manages this risk under the jurisdiction of its Assets & Liabilities Committee (ALCO). At the Group level, the liquidity risk is managed by the Group Assets & Liability Committee (GALCO) which is vested with the overall day-to-day responsibility for all matters relating to Group liquidity. Specifically, it undertakes the following: Managing the Group liquidity at the parent level. Delegating limits to subsidiary ALCO s and monitoring compliance to guidelines relating to Liquidity Policy. Receiving and following up on the monthly liquidity reports from the subsidiary ALCO s. Approving all proposals relating to the Group Liquidity Policy. Approving and ratifying corrective actions in the event of liquidity breaches.

8 Group Business & Risk Review (Contd.) 33 Operational Risk AUB views operational risk as the risk of potential financial loss or damage to its reputation as a result of breakdown in communications, information or legal/compliance issues, internal systems or procedural failure, human error, natural disaster, criminal activity, business interruption, management failure or inadequate staffing. No material losses have occurred in However, due to the nature of the risk, there can be no assurance that this risk will be completely eliminated. The risk is mitigated, however, by the establishment of effective infrastructure and controls, key elements of which are qualified well trained personnel whose duties are duly segregated: clear authorisation levels, reliable technology, communication of risk tolerance, financial management and reporting. Furthermore, the independent audit function regularly tests and evaluates the actual functioning of all these issues and advises Senior Management and the Board of any possible problem. Additionally, the Group maintains adequate insurance coverage and contingency plans for systems failure including back-up systems with off-site data storage. AUB conf idently looks forward to pursue its growth strategies through product and service innovation and providing investors with competitive f inancial and investment products, especially at the retail level.

9 34 Group CEO and Managing Director CEO Ahli United Bank (Bahrain) CEO Ahli United Bank (UK) Deputy Group CEO Private Banking and Wealth Management Deputy Group CEO Risk Finance and Strategic Development Deputy Group CEO Commercial Banking and Treasury Regulatory and Support Group Private Banking Risk Management Treasury Audit and Compliance Asset Management Finance, IT and Operations Corporate and Trade Finance Corporate Secretary and Legal Real Estate Fund Management Strategic Development and Institutional Coverage Proprietary Investments and Trading Human Resources The strong f inancial performance of 2002 has made it an important year in our progress towards a signif icant regional presence and towards making the prospects better for our customers, employees, shareholders and the community at large.

10 Group Senior Management Ahli United Bank B.S.C. Adel A. El-Labban Group Chief Executive Officer & Managing Director, Member of the Executive Committee Director and former Chief Executive Officer, Ahli United Bank (UK) plc; Director, AUB (Bahrain); Director Bank of Kuwait & the Middle East, Kuwait; Former Managing Director, Commercial International Bank of Egypt; Chairman, Commercial International Investment Company; Vice President, Corporate Finance, Morgan Stanley; Manager Loans and Syndications, Arab Banking Corporation; General Manager Corporate Banking Group, Chase National Bank, Egypt. Sherif Hassan Abdallah Deputy Group Chief Executive Risk, Finance and Strategic Development Director and Chairman of the Audit Committee and member of the Executive Committee, AUB (Bahrain); Former First Vice President and Group Head of Credit, Arab Banking Corporation; Director and Chairman of the Audit Committee, ABC Islamic Bank; Director ABC Clearing Company; Director and member of the Audit and Executive Committees of ABC Egypt. Previously Industry Account Officer, Chase National Bank, Egypt; Investment Officer, Misr Iran Development Bank; Economic lecturer at the American University in Cairo. Michael Collis Deputy Group Chief Executive Commercial Banking and Treasury Director and member of the Executive Committee, Ahli United Bank (UK) plc; Former Deputy Chief Executive Officer, Ahli United Bank (UK) plc in London; Previously with Lloyds Bank and Bankers Trust Company in London; Head of UK Corporate Finance, Dai-ichi Kangyo; and Executive Director, Head of Corporate Finance, Nikko Bank. Bruno Martorano Deputy Group Chief Executive Private Banking and Wealth Management Director and member of the Audit And Executive Committees, AUB (Bahrain); Former Deputy Chief Executive Officer, Ahli United Bank (UK) plc in London; Previously Head of Private Banking, Banque Nationale de Paris (Hong Kong); Regional Private Banking Manager, Middle East and Africa; BNP (Paris); Vice President, Securities Desk, BNP (New York); Chemical Bank, Correspondent Banking, Europe. Ahli United Bank (Bahrain) B.S.C.(c) Sabah K. Al Moayyed Chief Executive Officer (Acting) Former Deputy Chief Executive Officer, Ahli United Bank (Bahrain); Assistant General Manager, Corporate Banking & Trade Finance, National Bank of Bahrain; Vice President, Head of Syndication and Trade Finance, United Gulf Bank, Bahrain; Head of Risk Management, Citibank, Bahrain. Abdulla Al Raeesi Deputy Chief Executive Officer Head of Delivery Channels, Commercial Bank of Qatar; Head of Systems Development/Support, BBK; Head of Executive Information Centre, ABC; Head of Business and Technology, Arthur Andersen; General Manager, ECC International. Ahli United Bank (UK) plc Philip Young Chief Executive Officer (Acting) Deputy Chief Executive Officer Finance Operations & Risk, Ahli United Bank (UK) plc; Chief Administrative Officer, Daiwa Europe Limited; Managing Director, UK & European Equity Derivatives, NatWest Markets, London; Senior Manager, Deloittes Management Consultancy; Audit Senior, Peat Marwick Mitchell. John Crocker Deputy Chief Executive Officer Commercial Banking and Treasury Deputy General Manager and Head of Corporate Finance, Credit Anstalt Ag/Bank Austria, London; Executive Director and Member of Executive Board, Secondment to Bank Austria Creditanstaltd, Slovenia; Deputy Head, Corporate Finance, London; Head, Asia & Australasia Group; Credit Analyst, Johnson Matthey Banks Limited; Graduate Trainee, National Westminster Bank.

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