Burgan Bank S.A.K. Financial Statements 31 December 2006
Income Statement Year ended 31 December 2006 2006 2005 Notes Interest income 129,862 91,446 Interest expense (76,468) (48,269) Net interest income 53,394 43,177 Net gains from foreign currencies 2,024 1,459 Net gains from investment securities 2,569 5,728 Dividend income 4,229 4,693 Fees and commissions 19,988 13,287 Other income 7 5,382 1,291 Operating income 87,586 69,635 Staff expenses (11,870) (8,716) Other expenses (11,849) (11,908) Operating profit before provisions 63,867 49,011 Provision for impairment of loans and advances 6 (6,124) (4,076) Provision for impairment of investment securities (5) (1,113) Operating profit 57,738 43,822 Contribution to the Kuwait Foundation for the Advancement of Sciences (KFAS) (520) (394) Board of Directors remuneration 12 (70) (70) National labour support tax (NLST) (1,420) (974) Profit for the Year 55,728 42,384 Fils Fils Basic earnings per share 13 69.9 51.9 Fils Fils Diluted earnings per share 13 69.8 51.9 The attached notes 1 to 22 form an integral part of these financial statements 4
Statement of Changes in Equity Year ended 31 December 2006 Share capital Share premium Treasury shares Statutory reserve Voluntary reserve Treasury shares reserve Investment revaluation reserve Share based compensatio n reserve Retained earnings Total At 1 January 2005 86,060 64,759 (10,115) 17,346 17,724 1,599 18,750-24,957 221,080 Available-for-sale investments: - Net fair valuation gains - - - - - - 14,604 - - 14,604 - Net transfer to income statement - - - - - - (1,496) - - (1,496) Net income recognised directly in equity - - - - - - 13,108 - - 13,108 Profit for the year - - - - - - - 42,384 42,384 Total recognised income for the year - - - - - - 13,108-42,384 55,492 Transfer to reservers - - - 4,382 4,382 - - - (8,764) - Dividends paid - - - - - - - - (20,830) (20,830) Purchase of treasury shares - - (8,442) - - - - - - (8,442) Balance at 31 December 2005 86,060 64,759 (18,557) 21,728 22,106 1,599 31,858 37,747 247,300 At 1 January 2006 86,060 64,759 (18,557) 21,728 22,106 1,599 31,858-37,747 247,300 Available-for-sale investments: - Net transfer to income statement - - - - - - (2,655) - - (2,655) - Net fair valuation gains - - - - - - 2,150 - - 2,150 Gain on sale of treasury shares - - - - - 271 - - - 271 Share based compensation expense (Note 18) - - - - - - 36-36 Net income (expense) recognised directly in equity - - - - - 271 (505) 36 - (198) Profit for the year - - - - - - - - 55,728 55,728 Total recognised income (expense) for the year - - - - - 271 (505) 36 55,728 55,530 Transfer to reservers - - - 5,774 5,774 - - - (11,548) - Dividends paid (Note 12) - - - - - - - - (32,194) (32,194) Purchase of treasury shares - - (11,200) - - - - - - (11,200) Sale of treasury shares - - 718 - - - - - - 718 Balance at 31 December 2006 86,060 64,759 (29,039) 27,502 27,880 1,870 31,353 36 49,733 260,154 The attached notes 1 to 22 form an integral part of these financial statements 5
Statement of Cash Flows Year ended 31 December 2006 2006 2005 Note Operating activities Profit for the year 55,728 42,384 Adjustments: Net gains from investment securities (2,569) (5,728) Dividend income (4,229) (4,693) Depreciation 2,261 2,472 Provision for impairment of loans and advances 6,124 4,076 Impairment of investment securities 5 1,113 Provision for share based compensation 36 - Operating profit before changes in operating assets and liabilities 57,356 39,624 Changes in operating assets and liabilities: Treasury bills and bonds (106,703) 26,828 Due from banks and other financial institutions (188,444) (60,864) Loans and advances to customers (123,540) (53,717) Government debt bonds 48,558 50,636 Other assets (12,463) (5,598) Due to banks 48,236 38,913 Due to other financial institutions 142,000 1,580 Certificates of deposit 38,000 (86) Deposits from customers 70,737 118,342 Other liabilities 9,126 (3,110) Net cash (used in) from operating activities (17,137) 152,548 Investing activities Purchase of investment securities (82,429) (24,903) Sale of investment securities 70,568 33,318 Net additions to property and equipment (1,721) (687) Dividends received 4,229 4,693 Net cash (used in) from investing activities (9,353) 12,421 Financing activities Other borrowed funds (450) (29,895) Purchase of treasury shares (11,200) (8,442) Sale of treasury shares 989 - Cash dividend paid (32,194) (20,830) Net cash used in financing activities (42,855) (59,167) Net (decrease) increase in cash and cash equivalents (69,345) 105,802 Cash and cash equivalents at the beginning of the year 371,389 265,587 Cash and cash equivalents at the end of the year 3 302,044 371,389 The attached notes 1 to 22 form an integral part of these financial statements 6
1. INCORPORATION AND PRINCIPAL ACTIVITIES Burgan Bank S.A.K. (the Bank ) is a public shareholding company incorporated in the State of Kuwait by Amiri Decree dated 27 December 1975 and is listed on the Kuwait Stock Exchange. It is registered as a Bank with the Central Bank of Kuwait. The Bank s address is P.O. Box 5389, Safat 12170, State of Kuwait. It is engaged in all banking activities. These financial statements have been approved for issue by the Board of Directors on 11 January 2007 and are issued subject to approval of the ordinary general assembly of the shareholders. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of preparation The financial statements have been prepared in accordance with the regulations of the State of Kuwait for financial services institutions regulated by the Central Bank of Kuwait. These regulations require adoption of all International Financial Reporting Standards (IFRS) except for the International Accounting Standard (IAS) 39 requirement for collective provision, which has been replaced by the Central Bank of Kuwait s requirement for a minimum general provision as described under the accounting policy for impairment of assets. These financial statements have been presented in Kuwaiti Dinars rounded off to the nearest thousand. The accounting policies used in the preparation of the financial statements are consistent with those used in previous year. Measurement Basis The financial statements are prepared under the historical cost measurement basis, as modified for the revaluation at fair value of financial assets at fair value through income statement, available for sale financial assets and derivative financial instruments. International Accounting Standards Board (IASB) Standards and International Financial Reporting Interpretations Committee Interpretation (IFRIC) Interpretations issued but not adopted The following IASB Standards and Interpretations have been issued but are not yet mandatory, and have not yet been adopted by the Bank: IFRS 7 Financial Instruments: Disclosures IFRIC Interpretation 8 Scope of IFRS 2 IFRIC Interpretation 9 Reassessment of Embedded Derivatives IFRIC Interpretation 10 Interim Financial Reporting and Impairment IFRIC Interpretation 11 IFRS 2 - Group and Treasury Share Transactions The application of IFRS 7, which will be effective for the year ending 31 December 2007 will result in amended and additional disclosures relating to financial instruments and associated risks. The application of IFRIC 8, 9, 10 and 11, which will be effective for the year ending 31 December 2007, not expected to have material impact on the financial statements of the Bank. Cash and cash equivalents Cash and cash equivalents comprise cash in hand and on current account with banks and other financial institutions (OFI s) and balances with Central Bank and due from banks and OFI s with maturities of less than 30 days. Financial assets and liabilities The Bank classifies its financial assets and liabilities as investments at fair value through income statement, available for sale, loans and receivables and financial liabilities. The Bank recognises financial assets and financial liabilities on the date it becomes a party to the contractual provisions of the instruments. Financial liabilities are not recognised unless one of the parties has performed or the contract is a derivative contract. 7
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Financial assets and liabilities (continued) Financial assets and liabilities are measured initially at fair value (transaction price) plus, in case of a financial asset or financial liability not at fair value through income statement, directly attributable transaction costs. Transaction costs on financial assets and financial liabilities at fair value through income statement are expensed immediately. Investments at fair value through income statement The Bank upon initial recognition classifies investments as investments at fair value through income statement if they are acquired principally for the purpose of selling in the short term or if they are managed and their performance is evaluated on reliable fair value basis in accordance with documented investment strategy. After initial recognition investments at fair value through income statement are remeasured at fair value with all changes in fair value recognised in the income statement. Investments available for sale Investments available for sale are those non-derivative financial assets that are designated as available for sale or are not classified as investments at fair value through income statement, or loans and receivables. After initial recognition, investments available for sale are measured at fair value with gains and losses being recognised as a separate component of equity until the investment is derecognised or until the investment is determined to be impaired at which time the cumulative gain and loss previously reported in equity as Investment revaluation reserve is recognised in the income statement. Investments whose fair value cannot be reliably measured are carried at cost less impairment losses, if any. Loans and receivables Debt instruments which have fixed or determinable payments but are not quoted in an active market are classified as loans and receivables. Loans and receivables are carried at amortised cost using the effective interest method. Financial liabilities Financial liabilities are stated at amortised cost using the effective interest method. Due to banks, Due to other financial institutions, Certificates of deposit, Deposits from customers and Other borrowed funds are classified as financial liabilities. Settlement date accounting A regular way purchase and sale of financial assets are recognised using settlement date accounting. Changes in fair value between the trade date and settlement date are recognised in income statement or in equity as investment revaluation reserve in accordance with the policy applicable to the related instrument. Regular way purchases or sales are purchases or sales of financial assets that require delivery of assets within the time frame generally established by regulations or conventions in the market place. Fair value The fair value of investments traded in recognised financial markets is their quoted market price, based on the current bid price. For investments where there is no quoted market price, a reasonable estimate of fair value is determined by reference to the current market value of another instrument that is substantially the same or is derived from recent arm s length transactions, discounted cash flow analysis or other valuation techniques commonly used by market participants. The fair value of financial assets carried at amortized cost is estimated by discounting the future contractual cash flows at the current rates for similar financial assets. The fair value of derivative is the equivalent of the unrealised gain or loss from marking to market the derivative using prevalent market rates or internal pricing models. 8
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Financial assets and liabilities (continued) Derecognition A financial asset (in whole or in part) is derecognised either when: the rights to receive the cash flows from the asset have expired; the Bank has transferred its right to receive cash flows from the assets or has assumed an obligation to pay them in full without material delay to a third party under a pass through arrangement; or Bank has transferred its rights to receive cash flows from the asset and either (a) has transferred substantially all the risks and rewards of the asset, or (b) has neither transferred nor retained substantially all the risks and rewards of the asset, but has transferred control of the asset. Where the Bank has transferred its right to receive cash flows from an asset and has neither transferred not retained substantially all the risks and rewards of the asset nor transferred control of the asset, the asset is recognised to the extent of the Bank s continuing involvement in the asset. A financial liability is derecognised when the obligation specified in the contract is discharged, cancelled or expired. Offsetting Financial assets and liabilities are offset when the Bank has a legally enforceable right to offset and intends to settle either on a net basis or to realise the asset and settle the liability simultaneously. Impairment of assets A financial asset is impaired if its carrying amount is greater than its estimated recoverable amount. An assessment is made at each balance sheet date to determine whether there is objective evidence that a specific financial asset, or a group of similar assets, may be impaired. If such evidence exists, the estimated recoverable amount of a debt instrument is determined based on the net present value of future cash flows, discounted at original interest rates, and of an equity instrument is determined with reference to market rates or appropriate valuation models. Any impairment loss is recognised in the income statement. Reversal, of impairment losses recongised in prior years is recorded when there is an indication that the impairment losses recongised for the asset no longer exist or have decreased. The reversal of impairment losses are recognised in the income statement except for available for sale equity investments which are recognised in the investment revaluation reserve. Loans and advances by the Bank are subject to credit risk provisions for impairment if there is objective evidence that the Bank will not be able to collect all amounts due. The amount of provision is the difference between the carrying amount and the recoverable amount, being the present value of expected future cash flows (excluding future credit losses that have not been incurred), including amounts recoverable from guarantees and collateral, discounted based on the original effective interest rate. Loans and advances are written off against the provision when there is no realistic prospect of recovery. In addition, in accordance with Central Bank of Kuwait instructions, a minimum general provision of 2% on all credit facilities net of certain restricted categories of collateral, and not subject to specific provision, is made. Derivative financial instruments and hedging Derivatives are initially recognised at fair value on the date a derivative contract is entered into and are subsequently re-measured at their fair value. Where derivative contracts are entered into by specifically designating such contracts as a fair value hedge or a cash flow hedge of a recognised asset or liability or a forecast future transaction, the Bank accounts for them using hedge accounting principles, provided certain criteria are met. In relation to fair value hedges, which meet the condition for hedge accounting, any gain or loss from remeasuring the hedging instrument is recognised immediately in the income statement, along with the corresponding change in fair value of the hedged asset or liability that is attributable to that specific hedged risk. In relation to cash flow hedges, which meet the conditions for hedge accounting, the portion of the gain or loss on the hedging instrument that is determined to be an effective hedge is recognised directly in equity and the ineffective portion is recognised in the income statement. For cash flow hedges affecting future transactions subsequently results in the recognition of a financial asset or a financial liability, the associated gains or losses which are recognised in equity are re-classified to the income statement in the same period or periods during which the financial asset or financial liability affects income statement. 9
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Derivative financial instruments and hedging (continued) Hedge accounting is discontinued when the hedging instrument expires or is sold, terminated or exercised, or it no longer qualifies for hedge accounting or the forecast transaction is no longer expected to occur or the designation is revoked. At that point in time, any cumulative gain or loss on the hedging instrument recognised in equity is kept there until the forecast transaction occurs. In cases where the forecast transaction is no longer expected to occur or the designation is revoked, the net cumulative gain or loss recognised in equity is transferred to the income statement. In the case of fair value hedges of interest-bearing financial instruments, any adjustment to its carrying value relating to the hedge is amortised over the remaining term of maturity. If such derivative transactions, while providing effective economic hedges under the Bank s risk management policies do not qualify for hedge accounting under IAS 39, they are treated as derivatives held for trading. Derivatives with positive fair values (unrealised gains) are included in other assets and derivatives with negative fair values (unrealised losses) are included in other liabilities in the balance sheet. The resultant gains and losses are included in income statement. Treasury shares The Bank s holding in its own shares is stated at acquisition cost and is recognised in equity. These shares are not entitled to any cash dividend that the Bank may propose. Gains or losses arising on sale of treasury shares are separately disclosed under equity and in accordance with Central Bank of Kuwait instructions, these amounts are not available for distribution. Share based payments The cost of share based payment transactions with employees is measured by reference to the fair value at the date on which they are granted. The fair value of the employee stock options is determined using the Black- Scholes option pricing model. The fair value of these options is recognised as an expense over the vesting period with corresponding effect to equity. The proceeds received net of any directly attributable transaction costs are credited to share capital (nominal value) and share premium when the options are exercised. Revenue recognition Interest income and expense are recognised in the income statement for all interest bearing instruments on effective interest basis. If a financial instrument categorised, as loans and receivables is impaired, interest income is thereafter recognised based on the rate of interest that was used to discount the future cash flows to their net present value. Fees and commissions earned for the provision of services over a period of time are accrued over that period. These fees include credit related fees and other management fees. Loan commitment fees and originating fees that are an integral part of the effective interest rate of a loan are recognised (together with any incremental cost) as an adjustment to the effective interest rate on loan. Dividend income is recognised when the right to receive such income is established. Foreign currency Foreign currency transactions are recorded in Kuwaiti Dinars at the rates of exchange prevailing at the date of the transactions. Monetary assets and liabilities in foreign currencies are converted into Kuwaiti Dinars at the rates of exchange prevailing at the balance sheet date. The resulting exchange gains and losses are taken to the income statement. Non-monetary assets and liabilities in foreign currencies that are stated at fair value are translated to Kuwaiti Dinars at the foreign exchange rates ruling at the dates that the values were determined. In case of non-monetary assets whose change in fair values are recognised directly in equity, foreign exchange differences are recognised directly in equity and for non-monetary assets whose change in fair value are recognised directly in the income statement are recognised in the income statement. 10
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Fiduciary assets Assets held in trust or in a fiduciary capacity are not treated as assets of the Bank and accordingly are not included in these financial statements. Repurchase and resale agreements Assets sold with a simultaneous commitment to repurchase at a specified future date at an agreed price (repos) are not derecognised in the balance sheet. Amounts received under these agreements are treated as liabilities and the difference between the sale and repurchase price treated as interest expense using the effective yield method. Assets purchased with a corresponding commitment to resell at a specified future date at an agreed price (reverse repos) are not recognised in the balance sheet. Amounts paid under these agreements are treated as assets and the difference between the purchase and resale price treated as interest income using the effective interest method. Contingencies Contingent assets are not recognised in the financial statements, but are disclosed when an inflow of economic benefit is probable. Contingent liabilities are not recognised in the financial statements, but are disclosed unless the possibility of an outflow of resources embodying economic benefit is remote. Significant accounting judgements and estimates Judgements In the process of applying the Bank s accounting policies, management has made the following judgements, apart from those involving estimations, which have the most significant effect on the amounts recognised in the financial statements: Classification of financial assets and liabilities On acquisition of financial assets management decides whether it should be classified as Investments carried at fair value through income statement or available for sale. Financial assets upon initial recognition are classified as Investments at fair value through income statement if they are managed and their performance is evaluated on reliable fair value basis in accordance with documented investment strategy. All other investments are classified as available for sale. Impairment of investments The Bank treats available for sale equity investments as impaired when there has been a significant or prolonged decline in the fair value below its cost or where other objective evidence of impairment exists. The determination of what is significant or prolonged requires considerable judgement. Fair value of financial assets The Bank determines fair value of financial assets by using valuation techniques. The Bank uses its judgement to select a variety of methods and make assumptions that are mainly based on market conditions existing at each balance sheet date. Estimation uncertainty The key assumptions concerning the future and other key sources of estimation uncertainty at the balance sheet date, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year are discussed below: Impairment losses on loans and advances The Bank reviews its problem loans and advances on a quarterly basis to assess whether a provision for impairment should be recorded in the income statement. In particular, considerable judgement by management is required in the estimation of the amount and timing of future cash flows when determining the level of provisions required. Such estimates are necessarily based on assumptions about several factors involving varying degrees of judgment and uncertainty, and actual results may differ resulting in future changes to such provisions. 11
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Estimation uncertainty (continued) Valuation of unquoted equity investments and derivatives Fair valuation of unquoted equity investments and derivatives is normally based on one of the following: recent arm s length market transactions; current fair value of another instrument that is substantially the same; the expected cash flows discounted at current rates applicable for items with similar terms and risk characteristics; or other valuation models. The determination of the cash flows and discount factors for unquoted equity investments and derivatives requires significant estimation. 3. CASH AND CASH EQUIVALENTS 2006 2005 Cash in hand and on current account with banks and OFI s 29,378 27,768 Balances with the Central Bank of Kuwait 886 175 Due from banks and OFI s maturing within 30 days 271,780 343,446 4. TREASURY BILLS AND BONDS 302,044 371,389 Treasury bills and bonds are issued by the Central Bank of Kuwait on behalf of the Ministry of Finance and are classified as loans and receivables. 5. DUE FROM BANKS AND OTHER FINANCIAL INSTITUTIONS 2006 2005 Due from banks and OFI s 169,567 86,544 Loans and advances to banks and OFI s 257,614 152,193 427,181 238,737 Due from banks and OFI s are classified as loans and receivables. 6. LOANS AND ADVANCES TO CUSTOMERS Loans and advances to customers are classified as loans and receivables. a) Balances Kuwait Other Middle East 12 Europe Rest of World Total 31 December 2006 Trade and commerce 55,298 620 - - 55,918 Real estate 331,479 - - - 331,479 Personal 404,490 - - - 404,490 Manufacturing 5,550 - - - 5,550 Construction 42,215 - - - 42,215 Others 117,860-1,936 1,582 121,378 956,892 620 1,936 1,582 961,030 Less: Provision for impairment (43,809) 917,221
6. LOANS AND ADVANCES TO CUSTOMERS (continued) Kuwait Other Middle East Europe Rest of World Total 31 December 2005 Trade and commerce 52,432 1,877-375 54,684 Real estate 246,998 - - - 246,998 Personal 392,886 - - - 392,886 Manufacturing 5,407 - - - 5,407 Construction 46,379 - - - 46,379 Others 88,586-2,514 1,664 92,764 832,688 1,877 2,514 2,039 839,118 Less: Provision for impairment (39,313) 799,805 b) Provisions Cash Facilities Non Cash Facilities Total Specific General Specific General At 1 January 2006 25,830 18,582 683 5,211 50,306 Exchange adjustments (32) - - - (32) Ceded to the Central Bank of Kuwait (58) - - - (58) Amounts written off (689) - - (689) Charge to income statement 2,412 2,629 (254) 2,189 6,976 27,463 21,211 429 7,400 56,503 Provision for impairment of loans and advances in the income statement is net of recovery of previously written off loan of KD 852 thousand (2005: KD Nil). Specific provisions for cash facilities is inclusive of an amount of KD 4,865 thousand (2005: KD 5,099 thousand) being provision for cash facilities due from Banks and other financial institutions. Cash Facilities Non Cash Facilities Total Specific General Specific General At 1 January 2005 24,663 15,940 845 6,044 47,492 Exchange adjustments (56) - - - (56) Ceded to the Central Bank of Kuwait (130) - - - (130) Amounts written off (1,076) - - - (1,076) Charge to income statement 2,429 2,642 (162) (833) 4,076 At 31 December 2005 25,830 18,582 683 5,211 50,306 Provisions summarised above relate to loans and advances to Banks, OFI s and customers. Provision against cash facilities are deducted from loan balances and provision against non-cash facilities are included in other liabilities. The analysis of specific and general provisions set out above is based on the requirements of the Central Bank of Kuwait. According to the Central Bank of Kuwait instructions, a minimum general provision of 2% on all credit facilities net of certain restricted categories of collateral which are not subject to specific provision has been made. 13
6. LOANS AND ADVANCES TO CUSTOMERS (continued) c) Non-performing loans Non-performing loans and advances, which either do not accrue interest or where interest is suspended, are as follows: Collateral held against nonperforming Loans and advances Provisions loans Granted prior to the invasion of Kuwait in 1990 5,111 5,111 - Granted after liberation of Kuwait in 1991 29,234 17,487 10,101 34,345 22,598 10,101 At 31 December 2005 Granted prior to the invasion of Kuwait in 1990 5,169 5,169 - Granted after liberation of Kuwait in 1991 28,825 14,360 12,183 33,994 19,529 12,183 7. GOVERNMENT DEBT BONDS The Central Bank of Kuwait on behalf of the Government of the State of Kuwait, purchased the debts of Kuwaiti and Gulf Cooperation Council customers as at 1 August 1990, together with related interest up to 31 December 1991 in accordance with Decree No. 32 of 1992 relating to the banking and financial sector and Law No. 41 of 1993 as amended by Law No. 80 of 1995 regarding the State s purchase of debts and the means of its collection. The purchase value of these loans were determined in accordance with the above Decree and Laws, and was settled by issuing bonds with a value date of 31 December 1991, maturing within a period not exceeding 20 years. Interest on these bonds is paid semi-annually in arrears at a rate fixed semi-annually by the Central Bank of Kuwait. The interest rate was set at 3.77 % per annum for the six months to 30 June 2006 and 4.39 % per annum for the six months to 31 December 2006 (2005: 2.38% and 2.9% respectively). During 2006 the Central Bank of Kuwait redeemed bonds amounting to KD 48,558,000 (31 December 2005: KD 50,636,000). Government debt bonds are classified as loans and receivables. The Bank is required to manage the purchased debts without remuneration in accordance with Decree No. 32 of 1992 and Law No. 41 of 1993, as amended. During the financial year ended 31 December 2006, the Bank has been awarded a favourable verdict by the Supreme Court of Kuwait requiring the Central Bank of Kuwait (CBK) to revoke its previous decision of not purchasing certain pre-invasion customers' debts amounting to KD 2,534,540. a total of KD 4,171,534 as other income (i.e. KD 2,534,540 and interest income of KD 1,636,994 at the respective applicable interest rates for Government Debt Bonds (GDB) as declared by the CBK for the period 1 January 1992 to 31 December 2006) and is included in other assets. The Bank is in the process of executing the court verdict. This will result in an increase amounting to KD 2,534,540 in the value of government bonds of the bank with a corresponding decrease in other assets. 14
8. INVESTMENT SECURITIES Available for sale 2006 2005 - Unquoted debt securities 8,084 8,340 Equity securities - Quoted 54,325 50,195 - Unquoted 40,364 30,749 Total available for sale 102,773 89,284 Investments at fair value through income statement - Quoted securities 4,899 4,468 107,672 93,752 Investments available for sale include an investment in Burgan International Holding S.A.with a carrying value of KD 673,465 (31 December 2005: KD 686,000), a wholly owned subsidiary incorporated in Luxembourg on 10 September 2001 which is not consolidated as it is immaterial to the Bank s financial statements. 9. OTHER ASSETS 2006 2005 Accrued interest receivable 24,726 18,498 Others 11,337 5,102 36,063 23,600 Other assets are classified as loans and receivables. 10. OTHER BORROWED FUNDS Interest rate 2006 2005 Medium term USD borrowing due 2009 LIBOR + 0.375% 45,540 45,990 Fixed rate KD bond due 2007 5.875% 30,000 30,000 75,540 75,990 On 5 October 2004, the Bank borrowed syndicated term loans amounting to USD 157.5 million maturing in 5 years, paying interest semi-annually in arrears for USD 100 million and paying interest quarterly in arrears for USD 57.5 million. The Bank has the option to redeem the whole or any part of the facility without any penalty. On 17 April 2002, the Bank issued KD 30 million of fixed rate bonds, which pay interest semi-annually in arrears. The bonds mature in 5 years from the issue date. 15
11. OTHER LIABILITIES 2006 2005 Accrued interest payable 24,149 17,363 Staff benefits 3,750 3,153 Provision for non-cash credit facilities 7,829 5,894 Other balances 11,898 12,090 47,626 38,500 12. EQUITY AND RESERVES a) The authorised issued and fully paid share capital comprises 860,603,940 shares (31 December 2005: 860,603,940) of 100 fils each. b) The share premium and treasury shares reserve are not available for distribution. c) As required by the Commercial Companies Law and the Bank s articles of association, 10% of the profit for the year before KFAS, Board of Directors remuneration and NLST has been transferred to statutory reserve. The Bank may resolve to discontinue such annual transfers when the reserve equals 50% of paid up share capital. Distribution of statutory reserve is limited to the amount required to enable the payment of dividend of 5% of share capital in years when accumulated profits are not sufficient for the payment of a dividend of that amount. d) The articles of association of the Bank require that an amount of not less than 10% of the profit for the year before KFAS, Board of Directors remuneration and NLST be transferred annually to the voluntary reserve. There is no restriction on distribution of this reserve. e) Treasury shares 2006 2005 Number of shares held 67,879,348 49,471,450 Percentage of shares held 7.89% 5.75% Cost 29,039 18,557 Market value 48,873 26,715 Reserves equivalent to the cost of the treasury shares held are not available for distribution. f) Proposed dividend and Directors remuneration The Board of Directors has recommended distribution of a cash dividend of -- fils per share (2005: 40 fils) on outstanding shares excluding treasury shares amounting to KD (2005: KD 32,194,057). Such dividend if approved shall be payable to the shareholders registered in the Bank s records as of the date of the annual general assembly meeting. 2005 dividend was approved at the general meeting of the shareholders held on 28 March 2006 and paid during the year. Directors' remuneration for 2006 is subject to the approval of the shareholders at the annual general shareholders meeting. Directors' remuneration for 2005 was approved at the general shareholders meeting held on 28 March 2006 and paid during the year. 16
13. EARNINGS PER SHARE Basic earnings per share is calculated by dividing the profit for the period by the weighted average number of shares outstanding during the period. Diluted earnings per share is calculated by dividing the profit for the period by the weighted average number of ordinary shares outstanding during the period plus the weighted average number of ordinary shares that would be issued on the conversion of all the dilutive potential ordinary shares into ordinary shares. The information necessary to calculate earnings per share based on weighted average number of shares outstanding during the period, less treasury shares, is as follows: 2006 2005 KD KD Profit for the year 55,728,000 42,384,000 Shares Shares Weighted average number of bank s issued and fully paid up shares 860,603,940 860,603,940 Less: Weighted average number of treasury shares (63,465,012) (43,246,245) Weighted average number of shares, less treasury shares, outstanding 797,138,928 817,357,695 during the year Effect of dilution due to employee share option plan 664,264 - Effect of dilution due to discounted share purchase plan 58,748 Weighted average number of shares, less treasury shares, outstanding during 797,861,940 817,357,695 the year adjusted for the effect of dilution Basic earnings per share (Fils) 69.9 51.9 Diluted earnings per share (Fils) 69.8 51.9 17
14. SEGMENTAL INFORMATION a) Primary segment information. The Bank is organised into three main business segments: Retail: incorporating private customer current accounts, savings, deposits, investment products, credit and debit cards, consumer and housing loans. Commercial: incorporating business current accounts, deposits, overdrafts, loans and other credit facilities. Treasury: incorporating money market, foreign exchange, treasury bills and bonds, investments and fund management. Segment results include revenue and expenses directly attributable to a segment and an allocation of cost of funds based on the daily weighted average balance of segment assets. Year ended 31 December 2006 Retail Commercial Treasury Total Operating income 30,850 28,850 27,886 87,586 Segment result 18,544 23,935 27,252 69,731 Unallocated costs (11,993) Operating profit 57,738 Assets 597,109 389,324 1,223,782 2,210,215 Liabilities 656,475 358,652 934,934 1,950,061 Retail Commercial Treasury Total Year ended 31 December 2005 Operating income 24,069 21,929 23,637 69,635 Segment result 13,676 19,547 20,669 53,892 Unallocated costs (10,070) Operating profit 43,822 Assets 515,721 527,077 846,914 1,889,712 Liabilities 363,852 460,646 817,914 1,642,412 b) Secondary segment information. Although the management of the Bank is based primarily on business segments, the Bank earns revenue and has assets in two geographic markets; Kuwait which is designated as domestic, and the remainder is designated as international. The following table shown the distribution of the Bank s operating income, assets and liabilities by geographical segment: Domestic International Total 31 December 31 December 31 December 2006 2005 2006 2005 2006 2005 Operating income 83,103 65,756 4,483 3,879 87,586 69,635 Assets 1,830,495 1,578,322 379,720 311,390 2,210,215 1,889,712 Liabilities 1,584,811 1,411,290 365,250 231,122 1,950,061 1,642,412 18
15. COMMITMENTS AND CONTINGENT LIABILITIES a) Capital commitments There is a capital commitment on the Bank in respect of an investment in a private equity partnership at 31 December 2006 amounts to USD 400,000 equivalent to KD 116,000 (31 December 2005: KD 511,000). b) Contingent liability There is a lawsuit against the Bank demanding it to pay an amount of KD 20 million plus interest. The Bank has launched a counter lawsuit requesting the appointment of an expert. The case is still in court. The Bank has recently entered into an irrevocable settlement agreement with the counterparty according to which both parties have agreed to suspend the legal proceedings for three months and consequently legal cases shall be dropped upon the fulfilment of a certain specified terms in the agreement. 16. TRANSACTIONS WITH RELATED PARTIES These represent transactions with certain related parties (major shareholders, directors and key management personnel of the Bank and entities controlled, jointly controlled or significantly influenced by such parties) who were customers of the Bank during the year. The terms of these transactions are approved by the Bank s management. The balances included in the financial statements are as follows: 2006 2005 Related parties Due from banks and other financial institutions 55,267 48,521 Loans and advances 38,931 23,582 Investment securities managed by a related party 4,899 4,468 Due to banks 230 757 Due to other financial institutions 8,252 6,149 Deposits from customers 11,049 14,955 Commitments and contingencies 8,714 6,458 No. of Board members or executive staff No. of parties related to Board or executive staff 2006 2005 Board members Loans and advances 3-552 205 Deposits from customers 6 1 1,069 977 Executive staff Loans and advances 5-118 221 Deposits from customers 6-281 166 Commitments and contingencies 4-4 5 19
16. TRANSACTIONS WITH RELATED PARTIES (continued) Key management compensation Remuneration paid or accrued in relation to key management (deemed for this purpose to comprise Directors in relation to their committee service, the Chief Executive Officer and other Senior Officers) was as follows: 2006 2005 Short term employee benefits including salary & bonus 1,015 828 Accrual for end of service indemnity 82 38 Accrual for cost of long term incentive rights 99 133 Accrual for share based compensation 36 - Total compensation paid to key management 1,232 999 17. USE OF FINANCIAL INSTRUMENTS A. Strategy in using financial instruments By its nature the Bank s activities are principally related to the use of financial instruments including derivatives. The Bank accepts deposits from customers at both fixed and floating rates and for various periods and seeks to earn above average interest margins by investing the funds in high quality assets. The Bank seeks to increase these margins by consolidating short term funds and lending for longer periods at higher rates whilst maintaining sufficient liquidity to meet all claims that might fall due. The Bank also seeks to raise its interest margins by obtaining above average margins, net of provisions, through lending to corporate and retail borrowers with a range of credit standings. Such exposures involve not just on balance sheet loans and advances but the Bank also enters into guarantees and other commitments such as letters of credit, letters of guarantees and acceptances. The Board places limits on the level of exposure that can be taken in relation to both overnight and intra-day positions. B. Credit risk The Bank takes on exposure to credit risk, which is the risk that a counterparty will be unable to pay amounts in full when due. The Bank structures the levels of credit risk it undertakes by placing limits on the amount of risk accepted in relation to one borrower, or groups of borrowers, and to geographical and industry segments. Such risks are monitored on a regular basis and are subject to regular review. Limits on the level of credit risk by product, industry sector and by country are approved by the Board. The exposure to any one borrower, including Banks and OFI s is further restricted by sub limits covering on and off balance sheet exposures and daily delivery risk limits in relation to trading items such as forward foreign exchange contracts. Actual exposures against limits are monitored daily. Exposure to credit risk is managed through regular analysis of the ability of borrowers and potential borrowers to meet interest and capital repayment obligations and by changing these lending limits where appropriate. Exposure to credit risk is also managed in part by obtaining collateral and corporate and personal guarantees. Credit related commitments The primary purpose of these instruments is to ensure that funds are available to customers as required. Guarantees, acceptances and standby letters of credit, which represent irrevocable assurances that the Bank will make payments in the event that the customer cannot meets its obligations to third parties, carry the same credit risk as loans. Documentary and commercial letters of credit, which are written undertakings by the Bank on behalf of the customer authorising a third party to draw drafts on the Bank up to a stipulated amount under specific terms and conditions, are collateralised by the underlying shipments of goods to which they relate and therefore carry less risk than a direct borrowing. 20
17. USE OF FINANCIAL INSTRUMENTS (continued) Commitments to extend credit represent unused portions of authorisations to extend cash credit. With respect to credit risk on commitments to extend credit, the Bank is potentially exposed to loss in an amount equal to the total unused commitments. However, the likely amount of loss is less than the total unused commitments since most of these commitments will expire or terminate without being funded. The economic sector risk and geographical concentration within loans and advances, which form the significant portion of assets subject to credit risk, is given in note 6. Financial instruments with contractual amounts representing credit risk: 2006 2005 Acceptances 70,500 33,900 Letters of credit 85,830 48,477 Letters of guarantee 281,481 235,366 437,811 317,743 Commitments to extend credit 152,203 92,078 Geographical concentration of assets, liabilities and off balance sheet items: 2006 Assets 2005 Assets 2006 Liabilities 2005 Liabilities 2006 Off balance sheet items 2005 Off balance sheet items Kuwait 1,830,495 1,578,322 1,584,811 1,411,290 489,824 332,058 Other Middle East 203,872 188,183 263,987 142,801 43,805 30,570 Europe 143,813 99,758 91,474 65,351 55,310 34,261 Rest of World 32,035 23,449 9,789 22,970 2,792 1,210 2,210,215 1,889,712 1,950,061 1,642,412 591,731 398,099 C. Currency Risk Currency risk is the risk that the value of a financial instrument will fluctuate due to changes in foreign exchange rates. The Bank takes on exposure to effects of fluctuations in the prevailing currency exchange rates on its financial position and cash flows. The Board of Directors sets limits on the level of exposure by currency and in total for both overnight and intra-day positions, which are monitored daily. The Bank had the following significant net exposures denominated in foreign currencies as of 31 December: 2006 2005 Long/(short) Long/(short) US Dollar (10,780) 12,697 Euro 289 130 Japenese Yen 222 29 Saudi Riyal 211 66 Others 400 191 21
17. USE OF FINANCIAL INSTRUMENTS (continued) D. Liquidity Risk Liquidity risk is the risk that the Bank will be unable to meet its net funding requirements. The Bank is exposed to daily calls on its available cash resources from overnight deposits, current accounts, maturing deposits, loan draw downs, guarantees and from margin and other calls on cash settled derivatives. The Bank does not maintain cash resources to meet all of these needs as experience shows that a minimum level of reinvestment of maturing funds can be expected. The table below summarises the maturity of assets and liabilities: Up to 3 months 3 6 months 6 12 months More than 12 months Total : Assets Cash and cash equivalents 302,044 - - - 302,044 Treasury bills and bonds 56,906 129,580 147,298 55,125 388,909 Due from banks and other financial 130,888 119,743 38,585 137,965 427,181 institutions Loans and advances to customers 242,481 57,435 105,655 511,650 917,221 Government debt bonds 13,063 13,063 Investment securities 59,224 - - 48,448 107,672 Other assets 18,292 2,779 4,542 10,450 36,063 Property and equipment - - - 18,062 18,062 Total assets 809,835 309,537 296,080 794,763 2,210,215 Liabilities and Equity Due to banks 266,490 25,031 - - 291,521 Due to other financial institutions 204,805 30,187 - - 234,992 Certificates of deposit 43,000 20,000 - - 63,000 Deposits from customers 1,030,558 132,386 73,822 616 1,237,382 Other borrowed funds 30,000-45,540 75,540 Other liabilities 44,740 1,613 865 408 47,626 Equity - - - 260,154 260,154 1,589,593 239,217 74,687 306,718 2,210,215 Net liquidity gap (779,758) 70,320 221,393 488,045-22
17. USE OF FINANCIAL INSTRUMENTS (continued) Up to 3 months 3 6 months 6 12 months More than 12 months Total At 31 December 2005: Assets Cash and cash equivalents 371,389 - - - 371,389 Treasury bills and bonds 79,890 120,454 81,862-282,206 Due from banks and other financial institutions 113,077 26,793 27,308 71,559 238,737 Loans and advances to customers 221,852 56,031 87,314 434,608 799,805 Government debt bonds - - - 61,621 61,621 Investment securities 54,663 - - 39,089 93,752 Other assets 10,849 1,447 2,853 8,451 23,600 Property and equipment - - - 18,602 18,602 Total assets 851,720 204,725 199,337 633,930 1,889,712 Liabilities and Equity Due to banks 236,016 7,269 - - 243,285 Due to other financial institutions 91,531-1,461-92,992 Certificates of deposit 25,000 - - - 25,000 Deposits from customers 997,628 96,981 69,846 2,190 1,166,645 Other borrowed funds - - - 75,990 75,990 Other liabilities 34,362 1,613 1,588 937 38,500 Equity - - - 247,300 247,300 1,384,537 105,863 72,895 326,417 1,889,712 Net liquidity gap (532,817) 98,862 126,442 307,513 - Maturities of assets and liabilities have been determined on the basis of the remaining period at the balance sheet date to the contractual maturity date. The actual maturities may differ from the maturities shown above since borrowers may have the right to prepay obligations with or without prepayment penalties. 23
E. Interest Rate Risk Interest rate risk arises from the possibility that changes in interest rates will affect the fair value or cash flows of the financial instruments. The Bank takes on exposure to the effects of fluctuations in the prevailing levels of market interest rates on its financial position and cash flows. This arises as a result of mismatches or gaps in the amounts of assets and liabilities and off balance sheet instruments that mature or reprice in a given period. The Bank manages this risk by matching the repricing of assets and liabilities through risk management strategies. The table below summarises the Banks exposure to interest rate risk: Up to 3 months 3 12 months More than 12 months Non interest bearing Total Effective interest rate % : Assets Cash and cash equivalents 271,780 - - 30,264 302,044 3.620-8.750 Treasury bills and bonds 191,951 196,958 - - 388,909 5.125-6.375 Due from banks and other 3.600-10.250 financial institutions 130,888 296,293 - - 427,181 Loans and advances to 2.550-10.250 customers 316,461 597,680-3,080 917,221 Government debt bonds - 13,063 - - 13,063 3.77-4.39 Investment securities - 10,974-96,698 107,672 0.750-7.1734 Other assets - - - 36,063 36,063 Property and equipment - - - 18,062 18,062 911,080 1,114,968-184,167 2,210,215 Liabilities and Equity Due to banks 265,691 25,031-799 291,521 0.480-5.938 Due to other financial 0.813-6.875 institutions 205,234 23,750-6,008 234,992 Certificates of deposit 43,000 20,000 - - 63,000 5.500-5.875 Deposits from customers 811,018 212,645 616 213,103 1,237,382 0.813-6.750 Other borrowed funds - 75,540 - - 75,540 5.743-5.875 Other liabilities - - - 47,626 47,626 - Equity - - - 260,154 260,154-1,324,943 356,966 616 527,690 2,210,215 Net interest rate gap (413,863) 758,002 (616) (343,523) - 24
17. USE OF FINANCIAL INSTRUMENTS (continued) Up to 3 3 12 months months More than 12 months Non interest bearing Total Effective interest rate % At 31 December 2005: Assets Cash and cash equivalents 348,448 - - 22,941 371,389 2.450 8.500 Treasury bills and bonds 79,890 202,316 - - 282,206 3.500 4.625 Due from banks and other financial institutions 113,077 125,660 - - 238,737 6.320 9.500 Loans and advances to customers 225,237 571,605-2,963 799,805 2.500 10.000 Government debt bonds - 61,621 - - 61,621 2.380 2.900 Investment securities 2,500 2,920-88,332 93,752 0.750 6.250 Other assets - - - 23,600 23,600 - Property and equipment - - - 18,602 18,602-769,152 964,122-156,438 1,889,712 Liabilities and Equity Due to banks 235,157 7,269-859 243,285 0.045 5.750 Due to other financial institutions 80,373 1,461-11,158 92,992 0.625 6.260 Certificates of deposit 25,000 - - - 25,000 3.125 4.750 Deposits from customers 732,263 166,827 2,190 265,365 1,166,645 0.450 6.260 Other borrowed funds - 75,990 - - 75,990 4.642 5.875 Other liabilities - - - 38,500 38,500 - Equity - - - 247,300 247,300-1,072,793 251,547 2,190 563,182 1,889,712 Net interest rate gap (303,641) 712,575 (2,190) (406,744) - F. Operational Risk Operational risk is the risk of loss caused by failures in operational process, people and system that supports operational processes. The Bank has a set of policies and procedures, which are approved by the Board of Directors and are applied to identify, assess and supervise operational risk in addition to other types of risks relating to the banking and financial activities of the Bank. Operational risk is managed by Risk Management. Risk Management ensures compliance with policies and procedures to identify, assess, supervise and monitor operational risk as part of overall Global Risk Management. The Operational Risk Management function of the Bank is in line with the CBK instructions dated 14 November 1996, concerning the general guidelines for internal controls and the instructions dated 13 October 2003, regarding the sound practices for managing and supervising operational risks in banks. G. Equity Price Risk Equity price risk arises from the change in fair values of equity investments. The Bank manages this risk through diversification of investments in terms of geographical distribution and industry concentration. The majority of the Bank s quoted investments are quoted on the regional Stock Exchanges. 18. SHARE BASED COMPENSATION The Bank operates two share based compensation plans for its employees, namely a discounted share purchase plan (DSPP) and an employee share option scheme (ESOP). The DSPP scheme is available for all Bank employees who have completed a minimum of one year employment with the Bank and subject to meeting a certain performance condition. Eligible employees under the DSPP can purchase Bank shares at a predetermined discount with a lock-in period of 5 years. The ESOP scheme is available only for employees who hold certain specified posts within the Bank. Eligible employees are granted the option to purchase a predetermined number of Bank shares at a specified exercise price, the exercise of the option is subject to meeting certain performance conditions, the option is valid for 10 years with the first year being the fiscal year ending 31 December 2006. The total number of shares allowed to be granted under both schemes is not to exceed 5,000,000 shares in total and not to exceed 10% of total share capital. 25