BANCO DE BOGOTA (NASSAU) LIMITED Financial Statements

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2 Financial Statements Page Independent Auditors Report 1 Statement of Financial Position 3 Statement of Comprehensive Income 4 Statement of Changes in Equity 5 Statement of Cash Flows

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5 Statement of Financial Position December 31, 2017, with corresponding figures for 2016 Notes ASSETS Cash and cash equivalents 4, 6 & 7 $ 16,284,771 24,452,477 Securities available-for-sale 4, 5, 6 & 9 39,028,164 39,958,504 Loans to customers 4, 5 & 8 69,279,109 85,815,023 Accrued interest receivable and other assets 4, 6 & 10 1,316,799 1,169,029 Furniture, equipment and improvements 6,881 8,595 Total assets $ 125,915, ,403,628 LIABILITIES AND EQUITY Liabilities: Deposits from customers 4, 6 & 11 $ 70,631,855 95,984,523 Accrued interest payable 4 250, ,591 Other liabilities 208, ,438 Total liabilities 71,091,211 96,565,552 Equity: Share capital 4 & 12 50,558,400 50,558,400 Fair value reserve 9 (83,659) 176,904 Reserve for losses on loans to customers 8 1,415,362 1,415,362 Retained earnings 2,934,410 2,687,410 Total equity 54,824,513 54,838,076 Commitments and contingencies 16 Total liabilities and equity $ 125,915, ,403,628 See accompanying notes to financial statements. These financial statements were approved on behalf of the Board of Directors on March15, 2018 by the following: 3

6 Statement of Comprehensive Income, with corresponding figures for 2016 Notes Interest income Interest on bank deposits $ 257, ,263 Interest on securities 898,651 1,210,665 Interest on loans to customers 3,739,598 3,795,294 Total interest income 4,895,261 5,162,222 Interest expense Interest on time deposits (1,339,948) (1,611,067) Interest on borrowings - (3,354) Interest on current and other accounts (60,339) (52,799) Total interest expense (1,400,287) (1,667,220) Net interest income 3,494,974 3,495,002 Other operating income/(expenses) Dividend income 6 140,194 15,255 Fees and commissions 6 67,202 97,304 Commission expense (41,084) (46,867) Net realized gain on securities available-for-sale 9 191, ,546 Other income 1, Total other operating income 359, ,938 General and administrative expenses Salaries and other employee benefits 6 (150,845) (151,660) Bank license fees (69,061) (70,290) Rent 6 (66,196) (67,057) Professional services and directors' fees 6 (414,644) (442,232) Depreciation (1,714) (1,715) Amortization of intangibles 10 (58,059) (52,573) Other expenses 6 & 13 (159,298) (150,835) Total general and administrative expenses (919,817) (936,362) Net income for the year $ 2,934,410 2,821,578 Other comprehensive (loss)/income Items that are or may be reclassified to profit or loss Fair value reserve (available-for-sale financial asset) Net change in fair value $ (69,290) 1,407,641 Net amount transferred to profit or loss (191,273) (196,546) Other comprehensive (loss)/income (260,563) 1,211,095 Total comprehensive income for the year $ 2,673,847 4,032,673 See accompanying notes to financial statements. 4

7 Statement of Changes in Equity, with corresponding figures for 2016 Balance at December 31, 2015 $ Share capital Fair value reserve Reserve for losses on loans Retained earnings Total 50,558,400 (1,034,191) 1,281,194 1,594,433 52,399,836 Net income ,821,578 2,821,578 Other comprehensive income Net change in fair value - 1,407, ,407,641 Net amount transferred to profit or loss - (196,546) - - (196,546) Reserve for loan losses ,168 (134,168) - Total other comprehensive income - 1,211, ,168 (134,168) 1,211,095 Total comprehensive income for the year - 1,211, ,168 2,687,410 4,032,673 Transactions with owners of the Bank Dividends paid (1,594,433) (1,594,433) Total transactions with owners of the Bank (1,594,433) (1,594,433) Balance at December 31, 2016 $ 50,558, ,904 1,415,362 2,687,410 54,838,076 Net income ,934,410 2,934,410 Other comprehensive loss Net change in fair value - (69,290) - - (69,290) Net amount transferred to profit or loss - (191,273) - - (191,273) Total other comprehensive loss - (260,563) - - (260,563) Total comprehensive income for the year - (260,563) - 2,934,410 2,673,847 Transactions with owners of the Bank Dividends paid (2,687,410) (2,687,410) Total transactions with owners of the Bank (2,687,410) (2,687,410) Balance at December 31, 2017 $ 50,558,400 (83,659) 1,415,362 2,934,410 54,824,513 See accompanying notes to financial statements. 5

8 Statement of Cash Flows, with corresponding figures for 2016 Notes Cash flows from operating activities: Net income for the year $ 2,934,410 2,821,578 Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization 59,773 54,288 Net realized gain on securities availablefor-sale (191,273) (196,546) Interest income (4,895,261) (5,162,222) Interest expense 1,400,287 1,667,220 Net cash used in operations before changes in working capital (692,064) (815,682) Changes in: Loans to customers 16,535,914 (586,595) Other assets (69,488) (56,048) Deposits from customers (25,352,668) (11,843,764) Other liabilities 39,559 22,540 Interest received 4,758,920 5,375,810 Interest paid (1,561,519) (1,712,575) Net cash used in operating activities (6,341,346) (9,616,314) Cash flows from investing activities: Disposal of furniture, equipment and improvements - 10 Purchase of securities available-for-sale (37,444,544) (13,223,500) Proceeds from redemptions and sale of securities available-for-sale 38,305,594 25,183,267 Net cash provided by investing activities 861,050 11,959,777 Cash flows from financing activities: Dividends paid (2,687,410) (1,594,433) Repayment of borrowings - (7,500,000) Net cash used in financing activities (2,687,410) (9,094,433) Decrease in cash and cash equivalents (8,167,706) (6,750,970) Cash and cash equivalents at beginning of the year 24,452,477 31,203,447 Cash and cash equivalents at end of the year 7 $ 16,284,771 24,452,477 See accompanying notes to financial statements. 6

9 1. Reporting entity Banco de Bogota (Nassau) Limited ( the Bank ) was incorporated under the Laws of the Commonwealth of The Bahamas on June 9, 1978 and is a wholly owned subsidiary of Banco de Bogota (Panama), S.A. ( the Parent Company ) a company incorporated in the Republic of Panama, which is in turn wholly-owned by Banco de Bogota, S.A. ( the Ultimate Parent Company ), a company incorporated in the Republic of Colombia. The Bank operates under a banking license granted under the Bank and Trust Act, 2000, and is principally engaged in providing offshore banking facilities. The Bank enters into transactions with its Parent Company and affiliates, most of which are conducted under the Parent Company s instructions. The Bank s registered office is located at 2 nd Floor, Norfolk House, Frederick Street, Nassau, The Bahamas. 2. Basis of preparation (a) Statement of compliance The financial statements have been prepared in accordance with International Financial Reporting Standards ( IFRS ). (b) Basis of measurement The financial statements have been prepared on the historical cost basis except for available-for-sale investments which are measured at fair value, and for equity securities that are carried at cost. (c) Functional and presentation currency These financial statements are presented in United States dollars ( US$ or $ ), which is the Bank s functional currency. (d) Use of estimates and judgments The preparation of financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income, and expenses. Actual results may differ from these estimates. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. 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: (d) Use of estimates and judgments (continued) Fair value measurement (note 3(d) (iv), 5 and 15) Impairment (note 3(d) (vii), 5) Allowance for loan losses (note 3(g), 5) 7

10 3. Significant accounting policies The Bank has consistently applied the following accounting policies to all periods presented in these financial statements. (a) Foreign currency The Bank s functional currency is the US$. Assets and liabilities in foreign currencies are translated at prevailing exchange rates at the reporting date. Transactions in foreign currencies during the period are translated at exchange rates in effect on the date of the transaction. Differences arising from such translations are presented as other operating income/(expenses) in the statement of comprehensive income. The Bank is not exposed to any foreign currency risk as all the assets and liabilities are denominated in functional and presentational currency. (b) Interest income and expense Interest income and expense are recognized in profit or loss 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. (c) The calculation of the effective interest rate includes all fees paid or received, transaction costs, and discounts or premiums. Transaction costs include 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; and interest income on available-for-sale investments. Interest income on loans to customers and investments represents the main source of revenue and is recognized on an accrual basis. Deferred loan fees, if any, are amortized over the period of the loan using the effective interest rate method. 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. Other fees and commission expense relate mainly to transaction and service fees, which are expensed as the services are received. 8

11 3. Significant accounting policies (continued) (d) Financial instruments (i) 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. These are investments at fair value, with fair value changes recognized immediately in 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 cash and cash equivalents, loans to customers, accrued interest receivable and other receivables as loans and receivables. Available-for-sale investments are those non-derivative financial assets that have not been classified as loans and receivables, held-to-maturity assets or financial assets at fair value through profit or loss. Financial liabilities include deposits from customers, borrowings, accrued interest payable and other liabilities. (ii) Recognition The Bank recognizes financial assets and financial liabilities on the day the Bank becomes a party to the contractual provisions of the instruments. It initially recognizes loans and deposits due from customers on the date that they are originated. All other financial assets and liabilities are recognized initially on the settlement date, which is the date that the financial instrument is delivered to or by the Bank. (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 are expensed immediately. Subsequent to initial recognition, loans and receivables and financial assets and financial liabilities that are not at fair value through profit or loss are carried at amortized cost less impairment losses where applicable, using the effective interest rate method. The amortized cost of a financial asset or liability is the amount at which the financial asset or liability is measured at initial recognition, minus principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between the initial amount recognized and the maturity amount, minus any reduction for impairment. 9

12 3. Significant accounting policies (continued) (d) Financial instruments (continued) (iii) Measurement, continued Subsequent to initial recognition, available-for-sale investments whose fair value can be reliably measured are carried at fair value. Unrealized gains and losses arising from changes in the fair value are recognized in the statement of changes in equity as other comprehensive income, until an asset is considered to be impaired, at which time the loss is recognized in profit or loss in the statement of comprehensive income. When the available-for-sale securities are sold, collected, or otherwise disposed of, the cumulative gain or loss recognized in the statement of changes in equity is recorded in profit or loss in the statement of comprehensive income. (iv) 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 non-performance 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 the transaction is closed out. The Bank recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period during which the change has occurred. 10

13 3. Significant accounting policies (continued) (d) Financial instruments (continued) (v) Derecognition The Bank derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or when 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. (vi) Offsetting Financial assets and liabilities are offset 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 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 are impaired can include default or delinquency by a borrower, restructuring of an amount due to the Bank on terms that the Bank would not consider otherwise, 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. The Bank considers evidence of impairment for both specific assets and at a 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. 11

14 3. Significant accounting policies (continued) (d) Financial instruments (continued) Impairment losses on financial 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. (viii) Identification and measurement of impairment Impairment losses on available-for-sale investment securities are recognized by transferring the cumulative loss that has been recognized in other comprehensive income to profit or loss as a reclassification adjustment. The cumulative loss that is reclassified from other comprehensive income to profit or loss is the difference between the acquisition cost, net of any principal repayment and amortization, and the current fair value, less any impairment loss previously recognized in profit or loss. Changes in impairment provisions attributable to time value are reflected as a component of interest income. If, in a subsequent period, the fair value of an impaired available-for-sale debt security increases and the increase can be objectively related to an event occurring after the impairment loss was recognized in profit or loss, then the impairment loss is reversed, with the amount of the reversal recognized in profit or loss. However, any subsequent recovery in the fair value of an impaired available-for-sale equity security is recognized in other comprehensive income. The Bank writes off certain loans to customers and advances and investment securities when they are determined to be uncollectible. (e) Cash and cash equivalents Cash and cash equivalents consist of highly liquid financial assets with original maturities of three months or less, 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) Securities available-for-sale Available-for-sale investment securities are non-derivative investments that are designated as available-for-sale or not classified as another category of financial assets. Unquoted investments whose fair value cannot be reliably measured are carried at cost. All other available-for-sale investments including transactions with related parties are carried at fair value. 12

15 3. Significant accounting policies (continued) (g) Loans to customers Loans to customers are non-derivative financial assets with fixed or determinable payments that are not quoted in an active market and that the Bank does not intend to sell immediately or in the near term. Loans to customers are stated at their outstanding unpaid principal balances adjusted for unearned income, when applicable, and are presented net of specific and general allowances for bad debts, if any. Specific allowances are made against the carrying amount of loans to customers that are identified as being impaired based on regular reviews of outstanding balances to reduce these loans to customers 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 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. Subsequent recoveries of loans to customers previously written off as uncollectible are credited to the allowance account. (h) Furniture, equipment and improvements Furniture, equipment and improvements 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 life of each item. The estimated useful lives for the current and comparative periods are as follows: Furniture and equipment Improvements 3-15 years 10 years Depreciation methods and useful life 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. (i) Dividends Dividends proposed or declared after the reporting dates are not recognized in the financial statements. 13

16 3. Significant accounting policies (continued) (j) Related parties A related party is a person or entity that is related to the entity that is preparing its financial statements ( reporting entity ). a) A person or a close member of that person s family is related to a reporting entity if that person: i) has control or joint control over the reporting entity; ii) has significant influence over the reporting entity; or iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting entity. b) An entity is related to a reporting entity if any of the following conditions apply: i) The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others). ii) One entity is an associate or joint venture of the other entity (or an 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 an associate of the third entity. v) The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity. vi) The entity is controlled, or jointly controlled by a person identified in (j 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). (k) Uniformity in the presentation of financial statements The accounting policies previously detailed have been applied consistently in the periods presented in the financial statements. 14

17 3. Significant accounting policies (continued) (l) New standards and interpretations not yet adopted At the date of the statement of financial position there are standards, amendments and interpretations which are not effective for the year ended December 31, 2017, therefore, have not been applied in preparing the financial statements. The most significant are the following: IFRS 9 Financial Instruments In July 2014, the IASB issued the final version of IFRS 9 Financial Instruments. IFRS 9 is effective for annual periods beginning on or after January 1, 2018, with early adoption permitted. It replaces IAS 39 Financial Instruments: Recognition and Measurement. Based on assessments undertaken to date, the total estimated adjustment of the adoption of IFRS 9 on the opening balance of the Bank s equity at January 1, 2018 is approximately USD900 thousands referred to the deterioration of financial assets. The Bank does not estimate effect related to the changes in classification and measurement of the financial assets different from deterioration. The above assessment is preliminary because not all transition work has been finalized. The actual impact of adopting IFRS 9 on January 1, 2018 may change because: IFRS 9 will require the Bank to revise its accounting processes and internal controls and these changes are not yet complete; Although parallel runs were carried out in the second half of 2017, the new systems and associated controls in place have not been operational for a more extended period; The Bank has not finalized the testing and assessment of controls over its new IT systems and changes to its governance framework; The Bank is refining and finalizing its models for ECL calculations; and The new accounting policies, assumptions, judgments and estimation techniques employed are subject to change until the Bank finalizes its first financial statements that include the date of initial application. I. Classification Financial assets IFRS 9 contains a new classification and measurement approach for financial assets that reflects the business model in which assets are managed and their cash flow characteristics. IFRS 9 includes three principal classification categories for financial assets: measured at amortized cost, Fair Value through Other Comprehensive Income (FVOCI) and Fair Value through Profit or Loss (FVPL). It eliminates the existing IAS 39 categories of held to maturity, loans and receivables and available for sale. 15

18 3. Significant accounting policies (continued) I. Classification Financial assets (continued) A financial asset is measured at amortized cost if it meets both of the following conditions and is not designated as at FVPL: It is held within a business model whose objective is to hold assets to collect contractual cash flows; and Its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding. A financial asset is measured at FVOCI only if it meets both of the following conditions and is not designated as at FVPL: It is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets; and Its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding. On initial recognition of an equity investment that is not held for trading, the Bank may irrevocably elect to present subsequent changes in fair value in OCI. This election is made on an investment-by investment basis. All financial assets not classified as measured at amortized cost or FVOCI as described above are measured at FVPL. In addition, on initial recognition the Bank may irrevocably designate a financial asset that otherwise meets the requirements to be measured at amortized cost or at FVOCI as at FVPL if doing so eliminates or significantly reduces an accounting mismatch that would otherwise arise. A financial asset is classified into one of these categories on initial recognition. Under IFRS 9, derivatives embedded in contracts where the host is a financial asset in the scope of IFRS 9 are not separated. Instead, the hybrid financial instrument as a whole is assessed for classification. Business model assessment The Bank will make an assessment of the objective of the business model in which a financial asset is held at a portfolio level because this best reflects the way the business is managed and information is provided to management. The information that will be considered includes: The stated policies and objectives for the portfolio and the operation of those policies in practice, including whether management s strategy focuses on earning contractual interest revenue, maintaining a particular interest rate profile, matching the duration of the financial assets to the duration of the liabilities that are funding those assets or realizing cash flows through the sale of assets; How the performance of the portfolio is evaluated and reported to the Bank s management; 16

19 3. Significant accounting policies (continued) Business model assessment (continued) The risks that affect the performance of the business model (and the financial assets held within that business model) and how those risks are managed; How managers of the business are compensated e.g. whether compensation is based on the fair value of the assets managed or the contractual cash flows collected; and The frequency, volume and timing of sales in prior periods, the reasons for such sales and expectations about future sales activity. However, information about sales activity is not considered in isolation, but as part of an overall assessment of how the Bank s stated objective for managing the financial assets is achieved and how cash flows are realized. Financial assets that are held for trading and those that are managed and whose performance is evaluated on a fair value basis will be measured at FVPL because they are neither held to collect contractual cash flows nor held both to collect contractual cash flows and to sell financial assets. Assessments whether contractual cash flows are solely payments of principal and interest For the purposes of this assessment, principal is defined as the fair value of the financial asset on initial recognition. Interest is defined as consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g. liquidity risk and administrative costs), as well as a profit margin. In assessing whether the contractual cash flows are solely payments of principal and interest, the Bank will consider the contractual terms of the instrument. This will include assessing whether the financial asset contains a contractual term that could change the timing or amount of contractual cash flows such that it would not meet this condition. In making the assessment, the Bank will consider: Contingent events that would change the amount and timing of cash flows; Leverage features; Prepayment and extension terms; Terms that limit the Bank s claim to cash flows from specified assets e.g. nonrecourse asset arrangements; and Characteristics that modify the considerations for the value of the money in the time, e.g. periodic review of interest rates. 17

20 3. Significant accounting policies (continued) Assessments whether contractual cash flows are solely payments of principal and interest (continued) Interest rates on certain retail loans made by the Bank are based on standard variable rates (SVRs) that are set at the discretion of the Bank. SVRs are generally based on the LIBOR rate and also include a discretionary spread. In these cases, the Bank will assess whether the discretionary feature is consistent with the SPPI criterion by considering a number of factors, including whether: The borrowers are able to prepay the loans without significant penalties; The market competition ensures that interest rates are consistent between banks; and Any regulatory or customer protection framework is in place that requires banks to treat customers fairly. All of the Bank s retail loans and certain fixed-rate corporate loans contain prepayment features. A prepayment feature is consistent with the SPPI criterion if the prepayment amount substantially represents unpaid amounts of principal and interest on the principal amount outstanding, which may include reasonable compensation for early termination of the contract. In addition, a prepayment feature is treated as consistent with this criterion if a financial asset is acquired or originated at a premium or discount to its contractual par amount, the prepayment amount substantially represents the contractual par amount plus accrued (but unpaid) contractual interest (which may also include reasonable compensation for early termination), and the fair value of the prepayment feature is insignificant on initial recognition. Impact assessment Based on the preliminary high-level evaluation on the possible changes in classification and measurement of financial assets held as at December 31, 2017, the results were as follows: Investment securities that are classified as available-for-sale under IAS 39 may, under IFRS 9, be measured at FVOCI. Loans and advances to banks and to customers that are classified as loans and receivables and measured at amortized cost under IAS 39 will in general also be measured at amortized cost under IFRS 9. II. Impairment Financial assets IFRS 9 replaces the incurred loss model in IAS 39 with a forward-looking expected credit loss model. This will require considerable judgment over how changes in economic factors affect ECLs, which will be determined on a probability-weighted basis. 18

21 3. Significant accounting policies (continued) II. Impairment Financial assets (continued) The new impairment model applies to the following financial instruments that are not measured at FVPL: Financial assets that are debt instruments; Other accounts receivables; Credit portfolio; and Loan commitments issued. Under IFRS 9, no impairment loss is recognized on equity investments. IFRS 9 requires a loss allowance to be recognized at an amount equal to either 12- month ECLs or lifetime ECLs. Lifetime ECLs are the ECLs that result from all possible default events over the expected life of a financial instrument, whereas 12-month ECLs are the portion of ECLs that result from default events that are possible within the 12 months after the reporting date. The Bank will recognize loss allowances at an amount equal to lifetime ECLs, except in the following cases, for which the amount recognized, will be 12-month ECLs: Debt investment securities that are determined to have low credit risk at the reporting date; and Other financial instruments (other than short term accounts receivables) for which credit risk has not increased significantly since initial recognition. The impairment requirements of IFRS 9 are complex and require management judgments, estimates and assumptions, particularly in the following areas, which are discussed in detail below: Assessing whether the credit risk of an instrument has increased significantly since initial recognition; and Incorporating forward-looking information into the measurement of ECLs. Measurement of ECLs ECLs are a probability-weighted estimate of credit losses and will be measured as follows: Financial assets that are not credit-impaired at the reporting date: the present value of all cash shortfalls i.e. the difference between the cash flows due to the entity in accordance with the contract and the cash flows that the Bank expects to receive; Financial assets that are credit-impaired at the reporting date: the difference between the gross carrying amount and the present value of estimated future cash flows; Undrawn loan commitments: the present value of the difference between the contractual cash flows that are due to the Bank if the commitment is drawn down and the cash flows that the Bank expects to receive; and Financial guarantee contracts: the present value of the expected payments to reimburse the holder less any amounts that the Bank expects to recover. 19

22 3. Significant accounting policies (continued) Measurement of ECLs (continued) Financial assets that are credit-impaired are defined by IFRS 9 in a similar way to financial assets that are impaired under IAS 39. Definition of default Under IFRS 9, the Bank will consider a financial asset to be in default when: The borrower is unlikely to pay its credit obligations to the Bank in full, without recourse by the Bank to actions such as realizing security (if any is held); or The borrower is more than 90 days past due on any material credit obligation to the Bank. Overdrafts are considered past due once the customer has breached an advised limit or been advised of a limit that is smaller than the current amount outstanding. In assessing whether a borrower is in default, the Bank will consider indicators that are: Qualitative: e.g. breaches of covenant; Quantitative: e.g. overdue status and non-payment of another obligation of the same issuer to the Bank; and Based on data developed internally and obtained from external sources. Inputs into the assessment of whether a financial instrument is in default and their significance may vary over time to reflect changes in circumstances. Significant increase in credit risk Under IFRS 9, when determining whether the credit risk (i.e. risk of default) on a financial instrument has increased significantly since initial recognition, the Bank will consider reasonable and supportable information that is relevant and available without undue cost or effort, including both quantitative and qualitative information and analysis based on the Bank s historical experience, expert credit assessment and forward-looking information. The Bank will primarily identify whether a significant increase in credit risk has occurred for an exposure by comparing: The remaining lifetime probability of default (PD) as at the reporting date; with The remaining lifetime PD for this point in time that was estimated on initial recognition of the exposure. Also qualitative aspects will be considered as well as the backstop of the norm (30 days). Assessing whether credit risk has increased significantly since initial recognition of a financial instrument requires identifying the date of initial recognition of the instrument. For certain revolving facilities (e.g. credit cards and overdrafts), the date when the facility was first entered into could be a long time ago. Modifying the contractual terms of a financial instrument may also affect this assessment, which is discussed below. 20

23 3. Significant accounting policies (continued) Credit risk grades The Bank will allocate each exposure to a credit risk grade based on a variety of data that is determined to be predictive of the risk of default and applying experienced credit judgment. The Bank will use these grades in identifying significant increases in credit risk under IFRS 9. Credit risk grades are defined using qualitative and quantitative factors that are indicative of the risk of default. These factors may vary depending on the nature of the exposure and the type of borrower. Credit risk grades are defined and calibrated such that the risk of default occurring increases exponentially as the credit risk deteriorates e.g. the difference in the risk of default between credit risk grades 1 and 2 is smaller than the difference between credit risk grades 2 and 3. Each exposure will be allocated to a credit risk grade on initial recognition based on available information about the borrower. Exposures will be subject to ongoing monitoring, which may result in an exposure being moved to a different credit risk grade. Generating the term structure of PD Credit risk grades will be a primary input into the determination of the term structure of PD for exposures. The Bank will collect performance and default information about its credit risk exposures analyzed by jurisdiction, by type of product and borrower and by credit risk grading. For some portfolios, information purchased from external credit reference agencies may also be used. The Bank will employ statistical models to analyze the data collected and generate estimates of the remaining lifetime PD of exposures and how these are expected to change as a result of the passage of time. This analysis will include the identification and calibration of relationships between changes in default rates and changes in key macro-economic factors, as well as indepth analysis of the impact of certain other factors (e.g. forbearance experience) on the risk of default. For most exposures, key macroeconomic indicators are likely to include GDP growth, benchmark interest rates and unemployment. For exposures to specific industries and/or regions, the analysis may extend to relevant commodity and/ or real estate prices. The Bank s approach to incorporating forward-looking information into this assessment is discussed below. Determining whether credit risk has increased significantly The Bank has established a framework that incorporates both quantitative and qualitative information to determine whether the credit risk on a particular financial instrument has increased significantly since initial recognition. The framework aligns with the Bank s internal credit risk management process. 21

24 3. Significant accounting policies (continued) The criteria for determining whether credit risk has increased significantly will vary by portfolio and will include a backstop based on delinquency. The Bank will deem the credit risk of a particular exposure to have increased significantly since initial recognition if, based on the Bank s quantitative modeling, the remaining lifetime PD is determined to have an gross increase between 15% and 43.2% (according to the credit segment) since initial recognition. In measuring increases in credit risk, remaining lifetime ECLs is adjusted for changes in maturity. In certain instances, using its expert credit judgment and, where possible, relevant historical experience, the Bank may determine that an exposure has undergone a significant increase in credit risk if particular qualitative factors indicate so and those indicators may not be fully captured by its quantitative analysis on a timely basis. As a backstop, and as required by IFRS 9, the Bank will presumptively consider that a significant increase in credit risk occurs no later than when an asset is more than 30 days past due. The Bank will determine days past due by counting the number of days since the earliest elapsed due date in respect of which full payment has not been received. The Bank will monitor the effectiveness of the criteria used to identify significant increases in credit risk by regular reviews to confirm that: The criteria are capable of identifying significant increases in credit risk before an exposure is in default; The criteria do not align with the point in time when an asset becomes 30 days past due; The average time between the identification of a significant increase in credit risk and default appears reasonable; Exposures are not generally transferred directly from 12-month ECL measurement to credit-impaired; and There is no unwarranted volatility in loss allowance from transfers between 12- month ECL and lifetime ECL measurements. Modified financial assets The contractual terms of a loan may be modified for a number of reasons, including changing market conditions, customer retention and other factors not related to a current or potential credit deterioration of the customer. An existing loan whose terms have been modified may be derecognized and the renegotiated loan recognized as a new loan at fair value. Under IFRS 9, when the terms of a financial asset are modified and the modification does not result in derecognition, the determination of whether the asset s credit risk has increased significantly reflects comparison of: The remaining lifetime PD at the reporting date based on the modified terms; with The remaining lifetime PD estimated based on data on initial recognition and the original contractual terms. 22

25 3. Significant accounting policies (continued) Modified financial assets (continued) For financial assets modified as part of the Bank s renegotiation policy, the estimate of PD will reflect whether the modification has improved or restored the Bank s ability to collect interest and principal and the Bank s previous experience of similar renegotiation action. As part of this process, the Bank will evaluate the borrower s payment performance against the modified contractual terms and consider various behavioral indicators. Generally, renegotiation is a qualitative indicator of default and credit impairment and expectations of renegotiation are relevant to assessing whether there is a significant increase in credit risk. Following renegotiation, a customer needs to demonstrate consistently good payment behavior over a period of time before the exposure is no longer considered to be in default/credit-impaired or the PD is considered to have decreased such that the loss allowance reverts to being measured at an amount equal to 12-month ECLs. Inputs into measurement of ECLs The key inputs into the measurement of ECLs are likely to be the term structures of the following variables: Probability of default (PD); Loss given default (LGD); and Exposure at default (EAD). These parameters will be derived from internally developed statistical models and other historical data that leverage regulatory models. They will be adjusted to reflect forward-looking information as described below. PD are estimates at a certain date, which will be calculated based on statistical rating models and assessed using rating tools tailored to the various categories of counterparties and exposures. These statistical models will be based on internally compiled data comprising both quantitative and qualitative factors. Where it is available, market data may also be used to derive the PD for large corporate counterparties. If a counterparty or exposure migrates between ratings classes, then this will lead to a change in the estimate of the associated PD. PDs will be estimated considering the contractual maturities of exposures and estimated prepayment rates. 23

26 3. Significant accounting policies (continued) Inputs into measurement of ECLs (continued) LGD is the magnitude of the likely loss if there is a default. The Bank will estimate LGD parameters based on the history of recovery rates of claims against defaulted counterparties. The LGD models will consider the structure, collateral, seniority of the claim, counterparty industry and recovery costs of any collateral that is integral to the financial asset. For loans secured by retail property, loan-to-value (LTV) ratios are likely to be a key parameter in determining LGD. LGD estimates will be calibrated for different economic scenarios and, for real estate lending, to reflect possible changes in property prices. They will be calculated on a discounted cash flow basis using the effective interest rate as the discounting factor. EAD represents the expected exposure in the event of a default. The Bank will derive the EAD from the current exposure to the counterparty and potential changes to the current amount allowed under the contract, including amortization, and prepayments. The EAD of a financial asset will be the gross carrying amount at default. For lending commitments and financial guarantees, the EAD will consider the amount drawn, as well as potential future amounts that may be drawn or repaid under the contract, which will be estimated based on historical observations and forward-looking forecasts. For some financial assets, the Bank will determine EAD by modelling the range of possible exposure outcomes at various points in time using scenario and statistical techniques. As described above, and subject to using a maximum of a 12-month PD for financial assets for which credit risk has not significantly increased, the Bank will measure ECLs considering the risk of default over the maximum contractual period (including any borrower s extension options) over which it is exposed to credit risk, even if, for risk management purposes, the Bank considers a longer period. The maximum contractual period extends to the date at which the Bank has the right to require repayment of an advance or terminate a loan commitment or guarantee. Where modeling of a parameter is carried out on a collective basis, the financial instruments will be grouped on the basis of shared risk characteristics that include: Instrument type; Credit risk gradings; Collateral type; Date of initial recognition; Remaining term to maturity; Industry; and Geographic location of the borrower. The groups will be subject to regular review to ensure that exposures within a particular Bank remain appropriately homogeneous. 24