BAC BAHAMAS BANK LIMITED Financial Statements

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2 BAC BAHAMAS BANK LIMITED Financial Statements Page Independent Auditors Report 1-2 Statement of Financial Position 3 Statement of Comprehensive Income 4 Statement of Changes in Equity 5 Statement of Cash Flows 6 Notes to Financial Statements 7-42

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9 Notes to Financial Statements 1. Reporting entity BAC Bahamas Bank Limited ( the Bank ) was incorporated under the laws of The Commonwealth of The Bahamas on August 13, 1992 and was granted a banking license on March 16, 1992 by The Central Bank of The Bahamas. The Bank s registered office is located at Norfolk House, Frederick Streets, Nassau, Bahamas. The Bank is a wholly owned subsidiary of BAC International Bank, Inc. (the Parent Company), a bank incorporated in the Republic of Panama. The Parent Company is ultimately owned by Grupo Aval Acciones y Valores S.A., a company incorporated in Colombia. The Bank is primarily involved in corporate and investment banking. A substantial portion of the Bank s business is with the related parties. A significant amount of the Bank s cash and cash equivalents are held with related parties and the Bank s revenue is primarily from the interest income on such cash and cash equivalents (see note 6). Accordingly, the Bank is economically dependent on these related parties and is exposed to a significant credit risk in respect of the related parties balances at the reporting date. 2. Basis of preparation (a) Statement of compliance The financial statements have been prepared in accordance with International Financial Reporting Standards (IFRSs) issued by the International Accounting Standards Board (IASB). (b) Basis of measurement The financial statements have been prepared on the historical cost basis. The Bank initially recognizes loans, accounts receivable and deposits on the date on which they are originated. All other financial instruments are recognized on the trade date, which is the date on which the Bank becomes a party to the contractual provisions of the instrument. (c) Functional and presentation currency These financial statements are presented in United States dollars ($), which is also the Bank s functional currency. (d) Use of estimates and judgments Preparation of financial statements requires the Bank s management to make judgments, estimates and assumptions affecting the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Final results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized prospectively. 7

10 2. Basis of preparation, continued (d) Use of estimates and judgments, continued Information about significant areas of estimation, uncertainty and critical judgments in applying accounting policies that have the most significant effect on the amounts recognized in the financial statements are disclosed in the following notes: Fair value measurement (note 3(d)(iv) and 14) Impairment (note 3(d)(vii), 3(h) and 5) Allowance for loan losses (note 3(f) and 5) 3. Significant accounting policies The accounting policies explained below have been applied consistently to all periods presented in these financial statements. (a) Foreign currency Assets and liabilities in foreign currencies are translated at prevailing exchange rates at the reporting date. Transactions in foreign currencies during the year are translated at exchange rates in effect on the date of the transaction. Differences arising from such translations are presented as other operating income or other expenses in the statement of comprehensive income. (b) Interest Interest income and expense are recognized as part of profit or loss in the statement of comprehensive income using the effective interest rate method. This method uses a rate that discounts the estimated future cash receipts and payments through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. The effective interest rate is established on initial recognition of the financial asset and liability and is not revised subsequently. The calculation of the effective interest rate includes all fees paid or received, transaction costs and discounts or premiums. Transaction costs are incremental costs that are directly attributable to the acquisition, issue or disposal of a financial asset or liability. Interest income and expense presented in the statement of comprehensive income include interest on financial assets and liabilities at amortized cost on an effective interest rate method. (c) Fees and commission Fees and commission income that are integral to the effective interest rate of a financial asset or liability are included in the measurement of the effective interest rate. Other fees and commission income, including service commissions are recognized as the related services are provided. Deferred loan fees, if any, are amortized over the period of the loan using the effective interest rate method. 8

11 3. Significant accounting policies, continued (d) Financial instruments (i) (ii) Classification Financial instruments include financial assets and financial liabilities. In classifying financial assets in each of the categories described below, the Bank has determined that it meets the description or criteria set out in the accounting policies. The Bank has not designated any financial instruments as fair value through profit or loss. Loans and receivables are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market. The Bank has classified loans to customers, accrued interest receivable and other receivables as loans and receivables. The Bank considers due from banks with original maturities of three months or less that are subject to insignificant risks of changes in their fair value and are used by the Bank in the management of its short-term commitments, to be cash and cash equivalents. Financial liabilities include demand and time deposits from customers, accrued interest payable and other liabilities. Recognition The Bank initially recognizes loans to customers and demand and time deposits from customers, on the date that they are originated. All other financial assets and liabilities are initially recognized on the trade date which is when the Bank becomes a party to the contractual provisions of the instrument. (iii) Measurement Financial instruments are measured initially at fair value plus, in the case of financial assets or financial liabilities not at fair value through profit or loss, transaction costs that are directly attributable to the acquisition or issue of the financial asset or financial liability. Transaction costs on financial assets and financial liabilities at fair value through profit or loss and available-for-sale investments are expensed immediately, while on other financial instruments they are amortized. 9

12 3. Significant accounting policies, continued (d) Financial instruments, continued (iii) Measurement, continued (iv) Subsequent to initial recognition, financial assets classified as loans and receivables are carried at amortized cost using the effective interest rate method, less impairment losses, if any. Financial liabilities are carried at amortized cost. Fair value measurement Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date in the principal, or in its absence, the most advantageous market to which the Bank has access at that date. The fair value of a liability reflects its nonperformance risk. When applicable, the Bank measures the fair value of an instrument using the quoted price in an active market for that instrument. A market is regarded as active if transactions for the asset or liability take place with sufficient frequency and volume to provide pricing information on an ongoing basis. When there is no quoted price in an active market, the Bank uses valuation techniques that maximize the use of relevant observable inputs and minimize the use of unobservable inputs. The chosen valuation technique incorporates all the factors that market participants would take into account in pricing a transaction. The best evidence of the fair value of a financial instrument at initial recognition is normally the transaction price i.e. the fair value of the consideration given or received. If the Bank determines that the fair value at initial recognition differs from the transaction price and the fair value is evidenced neither by a quoted price in an active market for an identical asset or liability nor based on a valuation technique that uses only data from observable markets, the financial instrument is initially measured at fair value, adjusted to defer the difference between the fair value at initial recognition and the transaction price. Subsequently, that difference is recognized in profit or loss on an appropriate basis over the life of the instrument but no later than when the valuation is supported wholly by observable market data or transaction is closed out. 10

13 3. Significant accounting policies, continued (d) Financial instruments, continued (v) (vi) Derecognition The Bank derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows from the financial asset in a transaction in which substantially all the risks and rewards of ownership of the financial asset are transferred. Any interest in transferred financial assets that is created or retained by the Bank is recognized as a separate asset or liability. The Bank derecognizes a financial liability when its contractual obligations are discharged or cancelled or expire. Transactions whereby the Bank transfers assets recognized on its statement of financial position, but retains either significantly all risks and rewards of the transferred assets or a portion of them are not derecognized from the statement of financial position. The Bank also derecognizes certain assets when it charges off balances pertaining to the assets deemed to be uncollectible. Offsetting Financial assets and liabilities are set off and the net amount is presented in the statement of financial position when, and only when, the Bank has a legal right to set off the amounts and intends either to settle on a net basis or to realize the asset and settle the liability simultaneously. Income and expenses are presented on a net basis only when permitted by IFRS or for gains and losses arising from similar transactions. (vii) Identification and measurement of impairment At each reporting date, the Bank assesses whether there is objective evidence that financial assets are impaired. Financial assets are impaired when objective evidence demonstrates that a loss event has occurred after the initial recognition of the asset, and that the loss event has an impact on the future cash flows on the asset that can be estimated reliably. Objective evidence that financial assets (including equity securities) are impaired can include default or delinquency by a borrower, restructuring of a loan or advance by the Bank on terms that the Bank would not otherwise consider, indications that a borrower or issuer will enter bankruptcy, the absence of an active market for a security, or other observable data relating to a group of assets such as adverse changes in the payment status of borrowers or issuers, or economic conditions that correlate with defaults in the Bank. 11

14 3. Significant accounting policies, continued (d) Financial instruments, continued (vii) Identification and measurement of impairment, continued The Bank considers evidence of impairment at both a specific asset and collective level. All individually significant financial assets are assessed for specific impairment. All significant assets found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. Assets that are not individually significant are then collectively assessed for impairment by grouping together financial assets (carried at amortized cost) with similar risk characteristics. Impairment losses on assets carried at amortized cost are measured as the difference between the carrying amount of the financial assets and the present value of estimated cash flows discounted at the assets original effective interest rates. Impairment losses are recognized in the statement of comprehensive income and reflected in an allowance account against loans to customers. Interest on the impaired asset continues to be recognized through the unwinding of the discount. When a subsequent event causes the amount on an impairment loss to decrease, the impairment loss is reversed through the statement of comprehensive income. (e) Cash and cash equivalents Cash and cash equivalents include notes and coins on hand, unrestricted balances with banks and highly liquid financial assets, which are subject to insignificant risk of changes in their fair value, and used by the Bank in the management of its short-term commitments. Cash and cash equivalents are carried at amortized cost in the statement of financial position. (f) Loans receivable As described in note 3(d)(i), loans receivable are non-derivative financial assets with fixed or determinable payments that are not quoted in an active marked and that the Bank does not intend to sell immediately or in the near term. Loans receivable are stated at their outstanding unpaid principal balances adjusted for unearned income, when applicable, and are presented net of specific and general allowances for collectability. Carrying amount of loans that are identified as being impaired are reviewed on a regular basis to reduce these loans to their recoverable amounts. General allowances are maintained to reduce the carrying amount of portfolios of similar loans to their estimated recoverable amounts at the reporting date. The expected cash flows for portfolios of similar assets are estimated based on a previous experience and considering the credit rating of the underlying customers and late payments of interest or penalties. Increases in the allowance account are recognized in the statement of comprehensive income. Once a loan is determined to be uncollectible, all necessary legal procedures have been completed, and the final loss has been quantified, the loan is written off. 12

15 3. Significant accounting policies, continued (g) Furniture and equipment Furniture and equipment are stated at cost less accumulated depreciation and impairment losses, if any. Depreciation is recognized in the statement of comprehensive income on a straight-line basis over the estimated useful lives of each part of an item of furniture and equipment. The estimated useful lives for the current and corresponding periods are as follows: Equipment 3-5 years Fixtures and fittings 5-10 years Depreciation methods and useful lives are reassessed at the reporting date. Expenditure for maintenance and repairs are charged against income. At the time of disposal or retirement of assets, the cost and related accumulated depreciation are eliminated, and any resulting profit or loss is reflected in the statement of comprehensive income. (h) Impairment of non-financial assets The carrying amounts of the Bank s non-financial assets are reviewed at each reporting date to determine whether there is any indication of impairment. If any such indication exists then the asset s recoverable amount is estimated. The recoverable amount of an asset is the greater of its value in use and its fair value less costs to sell. In assessing value in use, the estimated future cash flows are discounted to their present value using a discount rate that reflects current market assessments of the time value of money and the risks specific to the asset. An impairment loss is recognized if the carrying amount of an asset exceeds its estimated recoverable amount. Impairment losses are recognized in the statement of comprehensive income. An impairment loss is reversed if there has been a change in the estimates used to determine the recoverable amount. An impairment loss is reversed only to the extent that the asset s carrying amount does not exceed the carrying amount that would have been determined, net of depreciation or amortization, if no impairment loss had been recognized. (i) Related parties (a) A person or a close member of that person s family is related to the Bank if that person: (i) (ii) has control or joint control over the Bank; has significant influence over the Bank; or (iii) is a member of the key management personal of the Bank or of a parent of the Bank. 13

16 3. Significant accounting policies, continued (i) Related parties, continued (b) An entity is related to the Bank if any of the following conditions applies: (i) (ii) The entity and the Bank are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others). One entity is an associate or joint venture of the other entity (or associate or joint venture of a member of a group of which the other entity is a member) (iii) Both entities are joint ventures of the same third party. (iv) One entity is a joint venture of a third entity and the other entity is associate of the third entity. (v) The entity is a post-employment benefit plan for the benefit of employees of either the Bank or an entity related to the Bank. (vi) The entity is controlled or jointly controlled by a person identified in (i)(a). (vii) A person identified in (a)(i) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity). (c) A related party transaction is a transfer of resources, services or obligations between the Bank and related party, regardless of whether a price is charged. (j) New standards and interpretations not yet adopted There are a number of standards and interpretations which were not effective as of the reporting date and have not been adopted in preparing of these financial statements. The most significant ones which may impact the Bank s financial statements are described below: (i) IFRS 9 Financial Instruments In July 2014, the International Accounting Standards Board (IASB) issued the final version of International Financial Reporting Standards 9 (IFRS 9) Financial Instruments that must be applied for fiscal years starting on or as of January 1, This standard replaces International Accounting Standard 39 (IAS 39). Based on evaluations as of December 31, 2017, the total estimated adjustment for adoption of IFRS 9 on January 1, 2018 in the opening equity of the Bank is an approximate decrease of $37,000 related to the impairment of financial assets. The foregoing evaluation is preliminary because not all transition work has been completed. The current impact of adopting IFRS 9 may change because: IFRS 9 requires that the Bank revises its internal accounting processes and controls and these revisions have not been completed yet; 14

17 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Although parallel testing has been done on the systems during the second semester of 2017, changes to the systems and associated controls implemented have not been operational for a longer period of time; The Bank has not completed the assessment and testing of controls for new technology systems and changes in their control environment; The Bank is fine-tuning and completing its models to calculate provisions for the impairment model for expected losses; and, New accounting policies, assumptions and opinions are subject to change until the Bank prepares its first interim financial statements as of March 31, 2018, that includes the initial application adjustments. Implementation strategy The Bank s IFRS 9 implementation process was overseen by a committee established by the Parent Company, that includes representatives from the areas of risk, finance, operations and information technology (IT) functions. This committee met frequently during the year 2017, to evaluate the key assumptions, made decisions and monitored the progress of implementation at all levels of the Bank, including the assessment of the need for resources. The Bank has completed a preliminary impact assessment and accounting analysis; and has completed the work on the design and development of models, systems, processes and controls. Classification and Measurement - Financial Assets IFRS 9 contains a new approach to classification and measurement of financial assets that reflects the business model in which the assets are managed and their cash flow features. IFRS 9 includes three main classification categories for financial assets: measured at amortized cost (AC), at fair value through other comprehensive income (FVOCI) and at fair value through profit or loss (FVPL). A financial asset is measured at amortized cost and not at fair value through profit or loss, if it meets both of the following conditions: 1. The asset is kept within a business model to collect contractual cash flows; and, 2. The contractual terms of the financial asset establish specific dates for cash flows that represent solely payments of principal and interest on the outstanding balance. A debt instrument is measured at FVOCI only if it meets both of the following conditions and has not been designated as FVPL: 15

18 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued 1. The asset is kept within a business model whose objective is achieved by collecting contractual cash flows and sell these financial assets; and, 2. The contractual terms of the financial asset establish specific dates for cash flows that represent solely payments of principal and interest on the current outstanding balance. All assets not classified as measured at amortized cost or at fair value through OCI as described above, are measured at fair value through profit or loss. In addition, in the initial recognition, the Bank may irrevocably designate a financial asset that meets the measurement requirements at AC or FVOCI to be measured at FVPL, if doing so eliminates or significantly reduces an accounting mismatch that may occur if not done. Presently, the Bank does not anticipate using this option. A financial asset is classified in one of the referenced categories at the time of its initial recognition. Business Model Assessment The Bank will assess the objectives of the business models that hold the financial instruments in a portfolio to better represent how the business is managed and how the management information is reported. The information considered will include: The policies and objectives for each portfolio of financial instruments and the operations of these policies in practice. These include, whether management s strategy is to collect cash flows from contractual interest and principal repayments or from the sale of financial assets; How they are evaluated or reported to key management personnel of the Bank on portfolio performance; The risks that affect the performance of the business models (and the financial assets held within) and the way those risks are managed; How managers of the business are compensated (for example, whether compensation is based on the fair value of the assets managed or the contractual cash flows collected); and, The frequency, value and timing of sales in prior fiscal years, the reasons for those sales and exceptions about future sales activity. However, the information on sales activity cannot be considered in isolation, but rather as part of an evaluation of how the Bank s objectives established for managing financial assets is achieved and how cash flows are realized. Financial assets held or managed for trading and where their performance is evaluated on a fair value basis, are measured at FVPL because these are not held to cover contractual cash flows or to obtain contractual cash flows and to sell these financial assets. 16

19 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Assessment if contractual cash flows are solely payments of principal and interest For purposes of this assessment, principal is defined as the fair value of the financial asset at initial recognition. Interest is defined as compensation for the time value of money, credit risk associated with holding the current principal for a period of time or for other risks from loan agreements and other associated costs (e.g. liquidity risk and administrative costs), as well as the profit margin. When evaluating whether contractual cash flows are solely payments of principal and interest, the Bank considers the contractual terms of the instrument. This includes an assessment to determine whether the financial asset contains a contractual term that could change the timing or amount of the contractual cash flows in such a way that it does not meet this condition. In making this assessment the Bank considers: Contingent events that change the amount and timing of cash flows; Hedging conditions; Prepayment and extension terms; Terms that limit the Bank in achieving cash flows for specific assets (e.g. unfunded asset agreements); and, Terms that change the considerations on the value of money over time, for example periodic revision of interest rates. Interest rates on certain consumer and business loans are based on variable interest rates established at the discretion of the Bank. Variable interest rates are generally established in accordance with the practices of the market where the Bank operates, plus certain additional discretionary basis points. In these cases, the Bank will assess whether the discretionary feature is consistent with the solely principal and interest criteria considering a number of factors that include whether: Debtors can prepay the loans without significant penalties; Competitive market factors indicate that interest rates are consistent between banks; and, Any regulatory protection standard in favor of customers requiring banks to treat customers reasonably. All fixed rate consumer and corporate loans contain a prepayment condition. A prepayment feature is consistent with the solely principal and interest criteria, if the prepayment amount substantially represents unpaid amounts of principal and interest on the amount of outstanding principal, which may include fair compensation for early termination of the contract. 17

20 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued In addition, a prepayment feature is consistent with these criteria, if a financial asset is acquired or originates from a premium or discount to the contractual par amount and the prepayment amount substantially represents the contractual par amount, plus accrued, but unpaid, contractual interest (which may include fair compensation for early termination) and the fair value of the prepayment feature is insignificant in the initial recognition. Assessment of the impact of the preliminary classification of financial assets Based on a high level preliminary assessment of possible changes in classification and measurement of financial assets held as of December 31, 2017, the Bank has estimated that by the adoption of IFRS 9 on January 1, 2018, there is no impact to equity as loans and accounts receivable currently classified as loans and measured at amortized cost under IAS 39, will continue to measurement at amortized cost under IFRS 9. Impairment of Financial Assets IFRS 9 replaces the incurred loss model of IAS 39, replacing it with an expected credit losses model (ECL). This new model requires the application of considerable judgment regarding how changes in economic factors impact on ECL, which is determined on a weighted average basis. The new impairment model will be applicable to the following financial assets that are not measured at FVPL. Debt instruments; Other accounts receivable; Loans portfolio; Issued financially secured contracts; and Commitments for issued loans. IFRS 9 requires a provision for impairment of financial assets at AC and FVOCI in an amount equal to the expected impairment losses in a period of twelve months after the end date of financial statements or during the remaining life of the loan. Expected losses during the remaining life of the loan are the losses expected from all possible impairment events during the expected life of the financial instrument, while expected losses in a twelve-month period are the portion of expected losses arising from impairment events that are possible during the twelve months following the date of the report. 18

21 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Under IFRS 9, reserves for losses are recognized in an amount equal to the ECL during the life of the asset, except in the following cases, in which the amount recognized is equal to ECL for the 12 months following the measurement date: Investments in debt instruments determined to represent low credit risk at the reporting date; and Other financial instruments (different from short term accounts receivable) on which the credit risk has not increased significantly since initial recognition. Impairment requirements under IFRS 9 are complex and require estimated judgments and significant assumptions by management, particularly in the following areas: Assess whether the credit risk has increased significant from initial recognition; and, Incorporate prospective information in the measurement of expected impairment losses. Measuring ECL ECL is the estimated weighted probability of credit losses measured as follows: Financial assets with no credit impairment at the reporting date: the present value of all contractual cash payments in arrears (for example the difference between Bank cash flow debt in accordance with the contract and cash flows that the Bank expects to receive); Impaired financial assets to the reporting date: the difference between the book value and the present value of estimated future cash flows; Outstanding loan commitments: the present value of the difference between contractual cash flows owed to the Bank in the event it enforces the commitment and cash flows that the Bank expects to receive; and, Financially secured contracts: expected payments to reimburse the holder minus any amount the Bank expects to recover. Impaired financial assets are defined by IFRS 9 in a manner similar to impaired financial assets under IAS 39. Definition of Impairment Under IFRS 9, the Bank will consider a financial asset to be impaired when: There is little probability that the debtor will fully pay its credit obligations to the Bank, without recourse for the Bank to take such actions as enforcing the guarantees (if any); or 19

22 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued The debtor is more than 90-days past-due on any material credit obligation. If the debtor is impaired when it s evaluated, the Bank will consider indicators such as: Qualitative (e.g. noncompliance with contractual clauses); Quantitative (e.g. arrears or non-payment of another obligation from the same issuer to the Bank); and, Based on data developed internally and obtained from external sources. Inputs used in the assessment of whether financial instruments are impaired and their importance may vary over time to reflect changes in circumstances. Significant Increase in Credit Risk Under IFRS 9, when determining whether the credit risk of a financial instrument has increased significantly since initial recognition, the Bank will consider relevant fair, sustainable information available at no cost or disproportionate effort, including information and quantitative and qualitative analyses based on historical experience and expert evaluation of Bank s credit department, including information with future projections. The Bank expects to identify whether there is a significant increase in the credit risk exposure by comparing: The probability of default (PD) during the remaining life of a financial instrument at the reporting date; with The PD during the remaining life, which was estimated at initial recognition of the financial instrument. The assessment of whether the credit risk has increased significantly from initial recognition of a financial asset requires identification of the initial recognition date of the instrument. For purposes of rotating credit (credit cards, among others), the date when the credit was first delivered may be a long time ago. Changes in the contractual terms of a financial asset may also impact this assessment, as discussed below. 20

23 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Grading by Credit Risk Categories The Bank will assign a credit risk grade to each exposure based on a variety of data that are determined to predict the PD and applying the judgment of a credit expert. The Bank expects to use these grades to identify significant increases in credit risk under IFRS 9. Credit risk grading is defined using qualitative and quantitative factors indicative of the risk of losses. These factors may vary depending on the type of exposure and the type of borrower. Credit risk grading is defined and calibrated so that the risk of losses increases exponentially as the credit risk is impaired and so that, for example, the difference in the risk of losses between grades 1 and 2 is less than the difference between the credit risk between grades 2 and 3. Each exposure will be given a credit risk grade upon initial recognition based on information available on the debtor. Exposures will be subject to continuous monitoring, that may result in movement of an exposure to a different credit risk grade. Generating the Structure of the PD term It is expected that the credit risk grading is the main input to determine the structure of the PD term for the different exposures. The Bank has the intention of obtaining performance and loss information on the credit risk exposures analyzed by jurisdiction or region, type of product and debtor, as well as by credit risk grade. For some portfolios, information purchased from external credit reference agencies may also be used. The Bank will use statistical models to analyze the data compiled and generate estimates of the probability of impairment during the remaining life of the exposures and how these probabilities of impairment change over time. This analyses includes identification and calibration of relationships between changes in impairment rates and key macroeconomic factors, as well as in-depth analysis of certain impairment risk factors (for example loans charge-offs). For the majority of loans, key economic factors will probably include growth in gross domestic product, changes in interest rates on the market and unemployment. For exposures in specific industries and/or regions, the analysis may be extended to products impacted by real estate prices. The approach used by the Bank to prepare prospective economic information within its assessment is indicated below. 21

24 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Determine if the credit risk has increased significantly The Bank has established a general framework that incorporates quantitative and qualitative information to determine if the credit risk of a financial asset has significantly increased since its initial recognition. The initial framework is aligned with the internal process of the Bank for credit risk management. The criteria to determine whether the credit risk has increased significantly will vary by portfolio and will include limits based on noncompliance. The Bank will evaluate whether the credit risk of a particular exposure has increased significantly since initial recognition if, based on the Bank s qualitative modeling, the expected probability of impairment during the remaining life will increase significantly from initial recognition. In determining the credit risk increase, the expected impairment losses in the remaining life is adjusted by changes in expiration dates. Under certain circumstances, using the judgment of credit experts, and based on relevant historical information, the Bank may determine that an exposure has had a significant increase in credit risk, if particular qualitative factors indicate this and those factors may not be completely captured by periodic quantitative analyses. The Bank will assume that a significant credit risk occurs no later than when the asset is in arrears for more than 30 days. The Bank will monitor the effectiveness of the criteria used to identify significant increases in credit risk based on regular reviews to confirm that: The criteria can identify significant increases in credit risk before an exposure becomes impaired; The criteria are inconsistent with the time when the asset is more than 30 days past the due date; The average time to identify a significant increase in credit risk and noncompliance appear to be reasonable; Exposures are not generally transferred directly from the ECL in the twelve months following the impairment of a group of loans; There is no unjustified volatility in the provision for impairment of transfers between groups with the probability of expected losses in the twelve months following the reporting date and the probability of expected losses in the remaining life of the loans. 22

25 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Modified Financial Assets The contractual terms of the loans may be modified for a number of reasons, including changes in market conditions, client retention and other factors unrelated to an actual or potential impairment of the client s loan. When the terms of a financial asset are modified under IFRS 9 and the modification does not result in the removal of the asset from the balance sheet, the determination of whether the credit risk has significantly increased reflects comparisons of: The PD during the remaining life on the date of the reporting date based on the terms modified, with The PD on the estimated remaining life based on the date of initial recognition and the original contractual terms. The Bank renegotiates loans to customers in financial difficulties to maximize the opportunities to collect and to minimize the risk of noncompliance. Under the Bank s renegotiation policies, customers in financial difficulties are given concessions that generally involve a reduction in interest rate, extension of the payment term, reductions in the balances due or a combination of these. For financial assets modified as part of the Bank s renegotiation policies, the estimation of the PD will reflect whether the modifications have improved or restored the ability of the Bank to collect principal and interest and the prior experience of the Bank in similar actions. As part of the process, the Bank will evaluate the debtor s payment compliance as compared to the modified terms of the debt and will consider several performance indicators for the group of debtors modified. Generally, restructuring indicators are a relevant factor on increased credit risk. Therefore, a restructured debtor must demonstrate a consistent payment behavior over a period of time before no longer being considered as an impaired loan or that the PD has decreased in such a way that the provision may be reversed and the loan measured for impairment over a term of twelve months after the closing date of the report. Inputs in Measuring ECL Key inputs in measuring ECL are usually the structure of the terms of the following variables: Probability of default (PD) Losses given default (LGD) Exposure at default (EAD) 23

26 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued The foregoing parameters will be derived from internal statistical models and other historical information. These models will be adjusted to reflect prospective information as described below: Estimated PDs at a certain date, which will be calculated based on statistical classification and evaluation models using grading tools adjusted to the different counterpart categories and exposures. These statistical models will be based on data compiled internally comprising both qualitative and quantitative factors. If a counterpart or exposure migrates between different grades, then this will result in a change in the estimated PD. PDs will be estimated considering contractual terms on expiration of exposures and estimated prepayment rates. LGD is the magnitude of probable losses in the event of noncompliance. The Bank will estimate the parameters of the LGD based on historical loss recovery rates against the noncomplying parties. LGD models will consider the structure, collateral and the priority of the lost debt, the industry of the counterpart and the recovery costs of any collateral integrated into the financial asset. For loans secured by real property, indices related to the value of the security as compared to the loan (Loan to value, LTV ), will probably be parameters used in the determination of the LGD. LGD estimates will be calibrated using different economic scenarios and for loans secured by real estate, variations in price indices for these assets. These loans will be calculated on the bases of discounted cash flows using the effective interest rate of the loan. EAD represents expected exposure in the event of noncompliance. The Bank will derive the EAD from the current exposure of the counterpart and potential changes in the current amount permitted under the terms of the contract, including amortization and prepayments. The EAD of a financial asset will be the gross value at the time of noncompliance. For loan commitments and financial security, the EAD considers the amount removed, as well as potential future amounts that may be removed or collected under the contract, which are estimated based on historical issues and projected prospective information. For some financial assets, the Bank will determine the EAD by modeling a range of possible results of exposures as several points over time using scenarios and statistical techniques. As described above and subject to using a maximum PD of twelve months for which credit risk has increased significantly, the Bank will measure the EAD considering the risk of noncompliance during the maximum contractual period (including options to extend the customer's debt) on which there is an exposure to credit risk, even if, for purposes of risk management, the Bank considers a longer period of time. The maximum contractual period is extended to the date on which the Bank has the right to require payment of a loan or terminate a loan commitment or security given. 24

27 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued For consumer credit card balances and certain corporate revolving credit that includes both a loan and a component of the customer s commission not to withdraw the loan, the Bank will measure EADs over a longer period than the maximum contractual period, if the contractual ability of the Bank to demand payments and pay off the commitment not withdrawn does not limit the Bank s exposure to credit losses for the contractual period of the contract. These facilities do not have a fixed term or a collection structure and are managed on a collective basis. The Bank may cancel them effective immediately, but this contractual right is forced in the normal management of the Bank s day to day manager, rather only when the Bank finds that there has been increased credit risk for each loan. This longer period of time will be estimated taking into account the actions for the management of credit risk that the Bank expects to take and that mitigate the EAD. These measures include a reduction in limits and cancellation of loan contracts. Where parameter modeling is performed on a collective basis, the financial instruments will be pooled on the basis of shared risk characteristics that include: Type of instrument; Credit risk rating; Guarantees; Date of initial recognition; Remaining expiration term; Industry; and Geographical location of the debtor. The above pooling will be subject to regular review to ensure that the exposure of a particular group remains appropriately uniform. Projection of Future Conditions Under IFRS 9, the Bank will incorporate information with projection of future conditions in both, the evaluation of whether the credit risk of an instrument has increased significantly from initial recognition and a measurement of ECL. Based on the recommendations of the Bank s Credit Risk Committee, use of economic experts and consideration of a variety of current and projected external information, the Bank will formulate a base case for the projection of relevant economic variables as well as a range representative of other possible projected scenarios. This process involves the development of two more additional economic scenarios and considers the relative probabilities of each outcome. 25

28 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued The external information may include economic data and publication of projections by government committees, monetary authorities, supranational organizations (such as The Organisation for Economic Co-operation and Development and the International Monetary Fund), academic projections, private sector, and credit risk rating agencies. The base case is expected to represent the most probable outcome consistent with the information used by the Bank for other purposes and strategical planning and the budget. Other scenarios will represent a more optimistic or pessimistic outcome. In addition, the Bank will plan periodic stress testing to calibrate the determination of these other representative scenarios. The Bank is in the process of identifying and documenting key guidelines for credit risk and credit losses for each portfolio of financial instruments, using an analysis of historical data to estimate the relationship between macro-economic variables, credit risk and credit losses. Preliminary Assessment of the Impact of the Change in the loss provisions model due to Impairment of Financial Instruments The most significant impact to the Bank from the implementation of IFRS 9 is expected to result in new impairment requirements. Impairment losses will increase and become more volatile for financial assets within the scope of IFRS 9 impairment models. The Bank has estimated that as a result of adopting IFRS 9 as of January 1, 2018, the increase in impairment allowances for financial assets will be approximately $37,000. New impairment requirements will have a greater impact on impairment provisions for unsecured loan products with longer expected life, such as credit cards. As mentioned earlier, the expected impact is based on an initial management assessment and may change upon completion of the final assessment Disclosures IFRS 9 contains extensive new disclosure requirements, particularity for credit risk and allowances for expected credit losses. The Bank is in the process of performing an analysis to identify data gaps in current processes and plans to implement the changes in the system and the controls it believes will be necessary to capture the required data, before the issuance of the first financial statement where IFRS 9 is adopted. Impact on capital planning The main impact on regulatory capital of the Bank arises from the new requirements for the impairment of IFRS 9, which is affected through retained earnings. 26

29 3. Significant accounting policies, continued (j) New standards and interpretations not yet adopted, continued (i) IFRS 9 Financial Instruments, continued Transition Changes in accounting policies resulting from the adoption of IFRS 9, are generally applied retroactively, except as described below. The Bank will not re-state comparative information in preceding periods with respect to changes in classification and measurement (including impairment). The differences in the amounts of financial assets resulting from the adoption of IFRS 9 will be recognized in retained earnings in equity as of January 1, (ii) IFRS 15 Revenue from Regular Activities from Contracts with Customers In July 2014, IASB issued IFRS 15 Revenue from Regular Activities from Contracts with Customers, which replaces several earlier standards, but particularly IAS 11 Construction Contracts and IAS 18 Revenue from Regular Activities. This new standard with mandatory application as of January 1, 2018, requires that revenue from regular activities with customers other than those originating from financial instruments and financial lease agreements will be recognized with specific reporting standard. IFRS 15 establishes that revenue be recognized in such a way that it reflects the transfer of control of goods and services pledged to customers in exchange for an amount that expresses the compensation to which the Bank expects to have a right. Under this new premise, the Bank recognizes income from regular activities, other than financial yield such as: fees for bank services, sale of goods and services for other reasons through the application of the following stages: 1. Identification of the contract with the customer. 2. Identification of performance obligations of the contract. 3. Determination of the transaction price. 4. Assignment of the transaction price with the performance obligations. 5. Recognition of income to the extent that the Bank satisfies its performance obligations to each customer. In accordance with the above, the main changes that apply to the Bank in determining other income different from financial yield and income from lease contracts, correspond to the reassessment made of the assignment of the transaction price based on fair value of the different services or on costs plus profit margin, instead of using a residual value method. The preliminary high-level assessment made by the Bank indicates that the implementation of IFRS 15 will have no material impact on the Bank s income corresponding to the above referenced operations. 27