Mercantil Servicios Financieros, C.A. and its Subsidiaries

Transcription

1 - Infor maci ón altamente confidencial Mercantil Servicios Financieros, C.A. and its Subsidiaries Report of Independent Accountants and Consolidated Financial Statements

2 - Infor maci ón altamente confidencial Index to the consolidated financial statements Pages I Report of independent accountants 1-2 II Consolidated financial statements 1-5 III 1 Reporting entity and regulatory environment Basis of preparation Cash and due from banks 16 4 Investment portfolio Loan portfolio Interest and commissions receivable 23 7 Long-term investments 23 8 Available-for-sale assets 24 9 Property and equipment Other assets Deposits Debt authorized by the SNV Financial liabilities Other liabilities Subordinated debt Taxes Employee benefits and employee benefit plans Other income Other operating expenses Equity Income per share Financial assets and liabilities in foreign currency Memorandum accounts Credit-related commitments Maturity of financial assets and liabilities Fair value of financial instruments Geographic segment information Financial information by subsidiary Risk management Regulatory capital requirements Contingencies Financial statements of Mercantil Servicios Financieros, C.A. (Holding) Supplementary information - Consolidated financial statements adjusted for the effects of inflation

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5 Consolidated balance sheet Assets Cash and due from banks (Note 3) Cash 24,816,727 8,541,437 Central Bank of Venezuela 523,287, ,641,397 Venezuelan banks and other financial institutions 4,647, ,861 Foreign banks and other financial institutions 2,684,915 1,663,855 Pending cash items 19,953,194 7,525, ,389, ,660,516 Investment portfolio (Note 4) Investments in trading securities 552,122 6,554 Investments in available-for-sale securities 76,664,631 38,773,837 Investments in held-to-maturity securities 72,043,579 47,804,801 Share trading portfolio 1,013, ,732 Investments in time deposits and placements 26,749,129 7,396,830 Restricted investments and repurchase agreements 3,187,552 1,651, ,210,406 96,020,224 Loan portfolio (Note 5) Current 672,166, ,346,672 Rescheduled 1,034, ,653 Overdue 2,581, ,495 In litigation 103,252 50, ,885, ,685,460 Allowance for losses on loan portfolio (20,523,470) (10,544,876) 655,362, ,140,584 Interest and commissions receivable (Note 6) 8,464,501 5,053,051 Long-term investments (Note 7) 4,841,675 1,613,928 Available-for-sale assets (Note 8) 1,979, ,827 Property and equipment (Note 9) 8,481,814 5,348,577 Other assets (Note 10) 50,001,247 26,109,903 Total assets 1,484,731, ,324,610 Memorandum accounts (Note 23) 1,608,628, ,149,850 The accompanying notes are an integral part of the consolidated financial statements 1

6 Consolidated balance sheet Liabilities and Equity Liabilities Deposits (Note 11) Non-interest bearing checking accounts 765,770, ,706,706 Interest-bearing checking accounts 190,561, ,429,396 Savings deposits 303,597, ,482,821 Time deposits 21,717,580 11,284,243 1,281,646, ,903,166 Debt authorized by the SNV (Note 12) Publicly traded debt securities issued by MERCANTIL 701, ,621 Financial liabilities (Note 13) Liabilities to Venezuelan banks and savings and loan institutions, up to one year 4,439,100 3,357,500 Liabilities to foreign banks and savings and loan institutions, up to one year 4,538,625 2,490,114 Liabilities to foreign banks and savings and loan institutions, more than one year 4,748,100 2,048,649 Liabilities under repurchase agreements 498, ,894 Other liabilities, up to one year 14,951 42,042 14,239,526 8,378,199 Interest and commissions payable 114, ,268 Other liabilities (Note 14) 111,461,809 44,737,862 Subordinated debt (Note 15) 1,127, ,169 Total liabilities 1,409,291, ,767,285 Minority interests in consolidated subsidiaries 35,780 23,722 Equity (Note 20) Capital stock 680, ,397 Capital inflation adjustment 191, ,709 Share premium 12,713,451 - Capital reserves 166, ,715 Translation adjustment of net assets of subsidiaries abroad 6,377,026 2,983,244 Retained earnings 56,038,556 39,914,413 Repurchased shares held by subsidiaries (615,633) (234,638) Employee benefit plan remeasurement (Note 2-m) (1,877,630) (504,556) Unrealized gain from adjustment of investments to market value 1,729,251 1,352,319 Total equity 75,404,391 44,533,603 Total liabilities and equity 1,484,731, ,324,610 The accompanying notes are an integral part of the consolidated financial statements 2

7 Consolidated income statement Years ended (Thousands of bolivars, except net income per share) Interest income (Note 2) Income from cash and due from banks 1,371, ,712 Income from investment portfolio (Note 4) 8,891,293 5,417,729 Income from loan portfolio (Note 5) 108,102,085 52,962,731 Total interest income 118,365,299 58,844,172 Interest expense (Note 2) Interest on demand and savings deposits (27,362,124) (16,453,734) Interest on time deposits (259,689) (145,524) Interest on securities issued by MERCANTIL (119,838) (54,939) Interest on other financial liabilities (1,268,027) (532,248) Total interest expense (29,009,678) (17,186,445) Gross financial margin 89,355,621 41,657,727 Allowance for losses on loan portfolio and provision for commissions receivable (Notes 2, 5 and 6) (12,671,036) (4,924,512) Net financial margin 76,684,585 36,733,215 Commissions and other income Trust fund operations 514, ,036 Foreign currency operations (Note 22) 99,332 30,594 Customer account transactions 10,702,207 3,347,452 Commissions on letters of credit and guarantees granted 22,358 24,309 Equity in long-term investments (Note 7) 616, ,040 Exchange gain (Note 22) 112, ,899 Gain on sale of investment securities (Note 4) 632, ,886 Other income (Note 18) 25,188,886 10,253,797 Total commissions and other income 37,888,170 15,424,013 Insurance premiums, net of claims (Notes 1 and 2) Premiums 63,344,695 27,856,851 Claims (51,316,251) (23,368,580) Total insurance premiums, net of claims 12,028,444 4,488,271 Income from financial operations 126,601,199 56,645,499 Operating expenses Salaries and employee benefits (24,691,335) (10,052,560) Depreciation, property and equipment expenses, amortization of intangibles and other (Notes 8, 9 and 10) (13,895,142) (4,715,174) Fees paid to regulatory agencies (11,417,688) (5,842,759) Other operating expenses (Note 19) (46,780,133) (14,939,935) Total operating expenses (96,784,298) (35,550,428) Operating income before tax and minority interests 29,816,901 21,095,071 Income tax (Note 16) Current (9,135,398) (7,437,214) Deferred (2,634,841) 441,521 Total tax (11,770,239) (6,995,693) Net income before minority interests 18,046,662 14,099,378 Minority interests (10,922) (7,615) Net income 18,035,740 14,091,763 Net income per share (Note 21) Basic Diluted Weighted average of outstanding common shares 101,285,190 99,416,137 Weighted average of outstanding diluted common shares 101,285,190 99,416,137 The accompanying notes are an integral part of the consolidated financial statements 3

8 Consolidated statement of changes in equity Years ended Unrealized Translation gain (loss) adjustment from of net Repurchased Employee adjustment of Capital assets of shares benefit investments inflation subsidiaries held by plan to market Capital adjustment Share Capital abroad Retained subsidiaries remeasurement value Total stock (Note 2-1) premium reserves (Note 2) earnings (Note 20) (Note 2-m) (Note 4) equity Balances at December 31, , , ,715 2,982,241 27,054,686 (91,626) (93,223) 1,679,066 32,553,965 Net income ,091, ,091,763 Shares repurchased by subsidiaries (143,012) - - (143,012) Dividends declared, net of cash dividends paid to subsidiaries (Note 20) (1,643,369) (1,643,369) Unrealized loss on investments (326,747) (326,747) Employee benefit plan remeasurement (Note 2) ,333 - (411,333) - - Translation adjustment of net assets of subsidiaries abroad (Note 22) , ,003 Balances at December 31, , , ,715 2,983,244 39,914,413 (234,638) (504,556) 1,352,319 44,533,603 Net income ,035, ,035,740 Capital increase (Note 20) 16,549-12,713, ,730,000 Shares repurchased by subsidiaries (380,995) - - (380,995) Dividends declared, net of cash dividends paid, to subsidiaries (Note 20) (1,911,597) (1,911,597) Unrealized gain on investments , ,932 Employee benefit plan remeasurement (Note 2) (1,373,074) - (1,373,074) Translation adjustment of net assets of subsidiaries abroad (Note 22) ,393, ,393,782 Balances at December 31, , ,709 12,713, ,715 6,377,026 56,038,556 (615,633) (1,877,630) 1,729,251 75,404,391 The accompanying notes are an integral part of the consolidated financial statements 4

9 Consolidated cash flow statement Years ended Cash flows from operating activities Net income 18,035,740 14,091,763 Adjustments to reconcile net income to net cash provided by operating activities Allowance for losses on loan portfolio (Note 5) 12,665,057 4,923,022 Exchange gain, net (859,959) - Depreciation and amortization (Notes 9 and 10) 2,790,377 1,057,244 Employee benefit plan remeasurement (1,373,074) Amortization of available-for-sale assets (Note 8) 6, Provision for interest receivable and other assets 596, ,888 Gain on equity in long-term investments, net (616,262) (329,040) Deferred income tax 2,634,841 (441,521) Minority interest expenses 10,922 7,615 Accrual for length-of-service benefits 2,865,977 1,945,835 Payment of length-of-service benefits (3,155,263) (1,511,822) Net change in operating accounts Interest and commissions receivable (3,281,823) (2,571,937) Interest and commissions payable (58,259) 60,764 Available-for-sale and other assets (29,339,665) (19,221,707) Other liabilities 66,680,225 22,722,912 Net cash provided by operating activities 67,602,421 21,005,368 Cash flows from investing activities Net change in investment portfolio (54,931,619) (24,896,258) Net change in long-term investments (2,629,629) (945,088) Loans granted (698,153,068) (297,674,378) Loans collected 395,937, ,993,059 Net additions to property and equipment (4,392,994) (3,953,314) Net cash used in investing activities (364,169,954) (181,475,979) Cash flows from financing activities Net change in Deposits 720,857, ,228,496 Short-term financial liabilities 1,998,209 2,966,963 Debt securities issued by MERCANTIL (186,584) 268,114 Subordinated debt - 9,831 Long-term financial liabilities obtained 902, ,572 Long-term financial liabilities repaid Cash dividends (1,900,482) (1,635,468) Capital increase 16,549 - Share premium 12,713,451 - Repurchased shares (380,995) (143,012) Net cash provided by financing activities 734,021, ,812,753 Cash and cash equivalents Net increase for the year 437,454,080 81,342,142 Income from effect of exchange differences on cash 1,486,981 - At the beginning of the year 163,056,718 81,714,576 At the end of the year 601,997, ,056,718 Supplementary information Taxes paid 7,628, ,152 Interest paid 27,781,015 16,593,430 Translation adjustment of net assets of subsidiaries abroad 3,393,782 1,003 Unrealized gain (loss) from adjustment of investments to market value 376,932 (326,747) The accompanying notes are an integral part of the consolidated financial statements 5

10 1. Reporting entity and regulatory environment Mercantil Servicios Financieros, C.A. (MERCANTIL) was incorporated in the Bolivarian Republic of Venezuela in 1997 and its shares are listed on Bolsa de Valores de Caracas, C.A. (Caracas Stock Exchange). In addition, MERCANTIL has an American Depository Receipts (ADR) program, Level 1, which is listed on the Over the Counter (OTC) market in the United States of America with Classes A and B shares as underlying assets. MERCANTIL is regulated by the Venezuelan Stock Market Law and the Venezuelan Securities Superintendency (SNV) and, therefore, must present its legal and statutory financial statements in accordance with the rules for the preparation of financial statements of entities regulated by the SNV. MERCANTIL and its subsidiaries provide financial and general banking services to corporate, middle market and retail customers. Third-party asset management and securities brokerage services are provided in Venezuela and other jurisdictions, as well as insurance services in Venezuela and Panama. The main subsidiaries of MERCANTIL are: Company name Mercantil, C.A. Banco Universal Mercantil Bank, N.A. (formerly Mercantil Commercebank, N.A.) Mercantil Seguros, C.A. Mercantil Bank (Panamá), S.A. Mercantil Seguros Panamá, S.A. Mercantil Bank (Schweiz) AG Mercantil Bank & Trust Limited (Cayman) Mercantil Bank Curacao, N.V. Mercantil Capital Markets (Panamá), S.A. Mercantil Merinvest, C.A. Location Venezuela United States of America Venezuela Panama Panama Switzerland Cayman Islands Curacao Panama Venezuela MERCANTIL, seeking to consolidate its trademark and the corporate culture, has decided to change the name of the subsidiaries Mercantil Commercebank, N.A., Mercantil Commercebank Investment Services and Mercantil Commercebank Trust Company to the following names: Mercantil Bank, N.A., Mercantil Investment Services and Mercantil Trust Company. Likewise, other subsidiaries located in Panama, Curacao, Cayman Islands and Switzerland have planned to change their business name, which is awaiting approval from the relevant authorities. Other entities controlled by MERCANTIL or of which MERCANTIL is considered the final beneficial owner or the main beneficiary are included in the consolidated financial statements. MERCANTIL s statutory consolidated financial statements at were approved by the Board of Directors on January 12, 2017 and 2016, respectively, and approved for issue by the Audit Committee on February 14, 2017 and February 16, 2016, respectively. Regulatory environment Law of the National Financial System This Law aims to supervise and coordinate the National Financial System, which is formed by the group of public, private and communal financial institutions and any other form of organization operating in the banking sector, the insurance sector, the stock market and any other sector or group of financial institutions that the policy-making body deems should form part of the system in order to ensure that financial resources are used and invested for the public interest and for economic and social development. This Law prohibits institutions belonging to the National Financial System from forming financial groups with each other or with companies from other sectors of the national economy or to associate with international financial groups for purposes other than those defined in the Law. 6

11 Stock Market Law The new Stock Market Law was published in December This Law eliminates authorized securities dealers and replaces them with securities brokers and brokerage firms; establishes a new classification for brokerage firms as limited and universal; states that brokerage firms must have at least three shareholders and no less than 25% of their capital stock must be owned by a securities broker. Likewise, it introduces the definition of obligations and asset-backed securities and the figure of securitization companies; expressly establishes public accountant firms authorized by the SNV as taxpayers, and specifies that the SNV must expressly authorize the sale or transfer of shares, the change of business objective and the transformation or merge. In addition, it includes the definitions of Risk Management System, System for the Prevention and Control of Money Laundering and Terrorism Financing, and Proliferation of Weapons of Mass Destruction, which will be governed by SNV rules. Income Tax Law Venezuelan Income Tax Law requires, among other things, a 40% proportional income tax for institutions engaged in banking, financial, insurance and reinsurance activities; these institutions and special taxpayers are excluded from the inflation adjustment for tax purposes set forth in this Law. The Law establishes that net operating losses may be carried forward for three years and offset up to a maximum of 25% of annual income (Note 16). Law on Tax on Large Financial Transactions In December 2015 the Venezuelan government enacted the Decree Law on Tax on Large Financial Transactions applicable to incorporated and unincorporated entities qualified by the Tax Administration as special taxpayers. The tax rate is equivalent to 0.75% applicable to debits made from bank accounts and operations without the mediation of financial institutions. This Decree became effective as from February 1, Sports and Physical Education Law Companies subject to this Law must contribute 1% of their net income to the activities contemplated therein. This Law seeks to regulate physical education and the sponsorship, organization and management of sporting activities as public services. New Labor Law (LOTTT) The new Labor Law extends job security, establishes the retrospective accrual of length-of-service benefits, and improves the indemnity for termination of employment. Based on actuarial studies, the impact of these changes has been estimated and recorded (Note 17). In addition, the LOTTT regulates certain legal benefits such as working hours, rest days, holidays, vacation, profit sharing, absences and leave. The collective labor agreement of MERCANTIL s subsidiaries in Venezuela also establishes the legal benefits that match or exceed benefits established in the Law. Laws applicable to the main subsidiaries a) Mercantil, C.A. Banco Universal Mercantil, C.A. Banco Universal (the Bank) is incorporated and domiciled in Venezuela and its activities are regulated by the Law on Banking Sector Institutions and the rules and instructions of the Superintendency of Banking Sector Institutions (SUDEBAN), the Central Bank of Venezuela (BCV) and the Social Bank Deposit Protection Fund (FOGADE). b) Mercantil Bank, N.A. This subsidiary, incorporated, domiciled and regulated in accordance with the laws of the United States of America, is supervised and regulated by the Office of the Comptroller of the Currency (OCC). 7

12 c) Mercantil Seguros, C.A. This company, incorporated in Venezuela, is regulated by the Insurance Activity Law and its regulations, and by the accounting rules and instructions of the Insurance Superintendency. d) Mercantil Bank (Panamá), S.A. This bank, incorporated and domiciled in accordance with the laws of Panama, is supervised by the Superintendency of Banks of Panama. e) Mercantil Seguros Panamá, S.A. This company, incorporated and domiciled in accordance with the laws of Panama, is supervised by the Insurance and Reinsurance Superintendency of Panama. f) Mercantil Bank (Schweiz) AG This bank, incorporated and domiciled in Switzerland, is regulated by the laws of Switzerland and supervised by the Swiss Federal Banking Commission and the Swiss National Bank. g) Mercantil Bank & Trust Limited (Cayman) This bank, incorporated and domiciled in accordance with the laws of Cayman Islands, is supervised by the Cayman Islands Monetary Authority (CIMA). h) Mercantil Bank Curacao, N.V. This bank, incorporated and domiciled in accordance with the laws of Curacao, is supervised by the Central Bank of Curacao (De Centrale Bank van Curacao en Sint Maarten). i) Mercantil Capital Markets (Panamá), S.A. This company, incorporated and domiciled in accordance with the laws of Panama, is supervised by the Stock Market Superintendency of Panama. j) Mercantil Merinvest, C.A. This subsidiary is a holding company for subsidiaries in Venezuela and Panama engaged in securities brokerage and mutual fund management. The subsidiaries are regulated by the SNV, the Stock Market Law in Venezuela and the Stock Market Superintendency in Panama. Mercantil Holding Financiero Internacional was incorporated in 2015 and began operations in October 2016; subsequently, was made up of the subsidiaries: Mercantil Bank (Panamá), S.A., Mercantil Bank & Trust Limited (Cayman) and Mercantil Bank Curacao, N.V. As from 2016, this holding is supervised by the Superintendency of Banks of Panama. 2. Basis of preparation The Venezuelan Federation of Public Accountants (FCCPV) approved the adoption of accounting principles generally accepted in Venezuela (VEN NIF) as the accounting principles of mandatory application in Venezuela as from January These standards are mainly based on International Financial Reporting Standards (IFRS) and their interpretations issued by the International Accounting Standards Board (IASB), except for certain criteria concerning adjustments for inflation and the valuation of foreign currency transactions and balances, among others. In January 2009, the SNV established that, as from 2011, publicly traded companies must present their financial statements in accordance with International Accounting Standards (IAS) and IFRS. However, MERCANTIL, as an entity regulated by the SNV, for being an issuer of commercial paper, debenture bonds and publicly traded shares must continue to present its financial information in conformity with the SNV s Accounting Manual and Plan of Accounts. 8

13 The accompanying consolidated financial statements have been prepared following the rules and instructions of the SNV, which differ in certain respects from VEN NIF. When SNV rules contain no specific guidance, MERCANTIL follows VEN NIF. The main differences that affect MERCANTIL are the following: 1) Consolidated financial statements adjusted for the effects of inflation VEN NIF require that the effects of inflation on the consolidated financial statements be recognized, provided that inflation for the year exceeds one digit. In accordance with SNV instructions, as from 1999 MERCANTIL has not recognized the effects of inflation on its consolidated financial statements. The SNV has ruled that the methodology to be followed by MERCANTIL for preparing and presenting its nominal consolidated financial statements is that set out in IAS 29 Financial reporting in hyperinflationary economies for an economy that is no longer hyperinflationary. According to this standard, when an entity ceases to prepare and present inflation-adjusted consolidated financial statements, it should use the amounts expressed in terms of purchasing power at the end of the previous reporting period as the basis for presenting consolidated financial statements expressed in nominal bolivars. Therefore, MERCANTIL considered the amounts expressed in terms of purchasing power at December 31, 1999 as the basis for presenting its consolidated financial statements expressed in nominal bolivars for subsequent periods. The SNV established that inflation-adjusted consolidated financial statements using the last rate published by the BCV should be included as supplementary information. 2) Foreign currency Foreign currency transactions, mainly in U.S. dollars, are recorded at the official exchange rate in effect at the transaction date and adjusted to the official rate prevailing at year end (Note 22). Net exchange gains and losses are included in the results for the year, except for those resulting from investments in available-for-sale debt securities and investments in publicly traded shares denominated in foreign currency, which are recorded in equity. The assets and liabilities of subsidiaries abroad are translated at the year-end official exchange rate, equity accounts at the historic official exchange rate, and income accounts at the average official exchange rate for the year (Note 22). Translation adjustments are recorded in equity. VEN NIF establish two options for measuring foreign currency transactions and balances: a) at the official exchange rates established in the exchange agreements issued by the BCV or b) on the basis of best estimates of future cash flows in bolivars expected to be obtained using the exchange or settlement mechanisms permitted under Venezuelan law. In addition, VEN NIF establish that exchange gains and losses on available-for-sale or held-to-maturity securities must be included in the income statement. 3) Investments in trading and available-for-sale securities Trading and available-for-sale securities may remain in these categories for a maximum and minimum of 90 days as from the date they were classified in these categories. Under VEN NIF, they may remain in these categories indefinitely. 4) Transfer between investment portfolios According to VEN NIF, when held-to-maturity securities for significant amounts are reclassified to available-for-sale securities and such transfer is due to a change in their original intended use not qualified as an isolated, external, nonrecurring or unusual event affecting MERCANTIL, all investments remaining in this category should be reclassified to available-for-sale securities. According to SNV rules, reclassifications of held-to-maturity securities to any other category must be approved by the SNV. 5) Permanent losses on investment securities When permanent losses resulting from a fair value impairment of investment securities are recorded, any subsequent recovery in fair value does not affect the new cost basis. VEN NIF allow any recovery of impairment losses on debt securities previously expensed to be recorded as income. 9

14 6) Rescheduled loans For the subsidiary Mercantil, C.A. Banco Universal, the Accounting Manual for Banking Institutions issued by SUDEBAN establishes that loans whose original repayment schedule, term or other conditions have been modified by the creditor at the request of the debtor must be reclassified within rescheduled loans. VEN NIF provide no specific guidance; however, they do state that impairment losses on financial assets carried at amortized cost shall be recognized in the results for the year in which they are incurred. 7) Overdue and in-litigation loans Loans classified as overdue must be written off within 24 months after inclusion in this category. Loans in litigation must be fully provided for after 24 months in the in-litigation category. In addition, overdue monthly loan installments that have been repaid must be reclassified to the category to which they pertained before being classified as overdue. Likewise, when an individual repays pending loan installments of a loan in litigation, thereby terminating the lawsuit, MERCANTIL must reclassify the loan to the category to which it pertained before being classified as in litigation or overdue. In-litigation loans are those in the legal collection process. Under VEN NIF, these loans are recorded based on collectibility. 8) Allowance for losses on loan portfolio Allowances for losses on the loan portfolio are determined based on a collectability assessment for individual loans and, in the case of the subsidiary Mercantil, C.A., Banco Universal, on a global risk percentage for loans not assessed individually and a general allowance of 1% over loan balances at month end, except for microcredits, which are subject to a general 2% allowance. In addition to minimum general and specific allowances for losses on loan portfolio, SUDEBAN established a general countercyclical allowance equivalent to 0.75% of the gross loan portfolio. VEN NIF require the allowance for losses on the loan portfolio to be determined based on asset recoverability, considering the fair value of guarantees, and do not provide for a general allowance. 9) Assets received as payment and idle assets Assets received as payment are recorded at the lower of assigned value, book value, market value or appraisal value not older than one year. In accordance with VEN NIF, assets received as payment are recorded at the lower of cost and market value and are classified as property and equipment or availablefor-sale assets depending on their use. 10) Property and equipment SNV rules establish that property and equipment is initially recorded at acquisition or construction cost, as applicable. Until 1999, property and equipment was recorded at restated cost, net of accumulated depreciation. From 2000 new additions are recorded at cost. VEN NIF allow the revaluation of property and equipment, and any increase in value is recognized in equity within revaluation surplus. MERCANTIL assesses possible impairment in the value of its long-lived assets when events or changes in circumstances indicate that their carrying amount may not be recoverable. An impairment loss is recognized in the results for the year for the amount by which the asset s carrying amount exceeds fair value. According to VEN NIF, the recoverable amount of an asset or group of assets to be held and used is the higher of fair value less costs to sell and value in use (value in use is the present value of estimated future cash flows to be obtained from an asset or cash generating unit (CGU)). The CGU represents the lowest level within the entity that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets. 10

15 11) Goodwill MERCANTIL amortizes goodwill using the straight-line method over 20 years (Note 10). According to VEN NIF, goodwill is not amortized but tested for impairment annually or whenever events or circumstances indicate that the value of the respective reporting unit may be impaired. Impairment is determined comparing the book value to the recoverable amount of the CGU, and if the carrying amount exceeds the recoverable amount, an impairment loss is recognized in the consolidated income statement. 12) Deferred tax MERCANTIL computes a deferred tax asset or liability in respect of temporary differences between income and expenses arising in different years for accounting and tax purposes, provided that there is a reasonable expectation of realization or recovery over time. In addition, the amount by which the deferred tax asset exceeds tax expense for the year is not recognized. In accordance with VEN NIF, a deferred tax asset or liability is calculated in respect of all temporary differences between the tax balance sheet and the accounting balance sheet. Deferred tax asset is recognized provided that there is reasonable expectation of recovery and deferred tax liability must always be recognized. 13) Commissions charged Commissions charged on loans granted are recorded as income when collected, whereas under VEN NIF they should be deferred and recorded as income over the loan term. 14) Transactions with derivative instruments Contracted amounts in transactions with derivative instruments, mainly for futures trading, are shown under memorandum accounts instead of in the consolidated balance sheet as required by VEN NIF (Note 23). Below is a summary of the SNV accounting principles that do not differ from VEN NIF: a) Consolidation The consolidated financial statements include the accounts of MERCANTIL and its more than 50%-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. MERCANTIL s accounting year end is December 31, except for certain non-banking subsidiaries whose accounting year ends on November 30. Subsidiaries whose accounting year ends on November 30 are consolidated with the financial statements of MERCANTIL at December 31. The accounting policies applied by subsidiaries have been amended to ensure consistency with the accounting policies adopted by MERCANTIL, when necessary. Special purpose entities controlled by MERCANTIL or of which MERCANTIL is considered the final beneficial owner or the main beneficiary are included in the consolidated financial statements. b) Cash equivalents For purposes of the consolidated cash flow statement, MERCANTIL considers cash and due from banks as cash equivalents and the portion of investments in time deposits and placements maturing within 90 days. c) Investment portfolio Investments are classified upon acquisition, based on their nature and intended use, into one of the following categories: Trading securities These investments are recorded at fair value and comprise investments in debt securities acquired for short-term trading. Unrealized gains or losses resulting from fair value changes are included in the results for the year. 11

16 Available-for-sale securities Available-for-sale debt securities are recorded at fair value. Unrealized gains or losses arising from differences in market values are included in equity as an unrealized gain or loss on adjustment of investments to market value until they are sold or reclassified to investments in trading securities. If these investments are reclassified to the held-to-maturity category, the unrealized gain or loss on available-for-sale securities will be maintained separately in equity and will be amortized during the investment s remaining life as an adjustment to yield. The fair value of investments in trading or available-for-sale debt securities not listed on stock exchanges is determined according to the present value of future cash flows of the securities, trading operations on the secondary market, or specific market prices of financial instruments with similar characteristics. Held-to-maturity securities These are investments in debt securities that MERCANTIL has the firm intention and ability to hold until maturity. They are recorded at cost, adjusted for amortization of premiums or discounts. Discounts or premiums on acquisition are recorded in the consolidated income statement over the term of the security. Impairment testing MERCANTIL assesses at each balance sheet date, or sooner if circumstances require it, whether there is objective evidence that a financial asset is impaired. An impairment in the fair value of held-to-maturity and available-for-sale securities is charged to the results for the year when management considers that it is other than temporary. Indicators of impairment are: 1) a prolonged period where fair value remains substantially below cost, 2) the financial condition and liquidity of the issuer, 3) a fall in the issuer s credit rating, 4) the disappearance of an active market for the security, and 5) MERCANTIL s inability to hold the investment long enough to allow for recovery of fair value, among others. For the years ended, MERCANTIL has identified no other-than-temporary impairments in the value of its investments. Share trading portfolio This portfolio includes investments in shares to be publicly traded. These investments are presented at fair value, except for investments in shares not publicly traded, issued by companies regulated by the Law on Banking Sector Institutions and the Stock Market Law and similar institutions abroad, which must be presented at cost. Time deposits and placements These investments are funds deposited with banks and are recorded at cost, which is equivalent to nominal value. Restricted investments and repurchase agreements Restricted investments include repurchase operations and other investments whose ownership rights are restricted or pledged as loan guarantees. They are valued using the same criteria as for the investments from which they are derived. Long-term investments Investments in 20% to 50%-owned affiliates are recorded under the equity method (Note 7). d) Investment securities acquired under resale agreements Investment securities acquired under resale agreements are recorded as restricted investments for the amount of funds transacted. The difference with respect to the resale price is recorded within interest income on the accrual basis (Note 4). e) Loan portfolio Rescheduled loans are those whose original repayment schedule, term or other conditions have been modified at the request of the debtor or according to certain other conditions. 12

17 Loans are classified as overdue 30 days after maturity. Individual loan installments are shown as overdue if repayment is more than 30 days past due. When any installment is more than 90 days past due, the entire loan balance is classified as overdue. Loans for minor amounts and of similar nature are assessed as a whole to determine applicable allowances. f) Property and equipment Property and equipment is shown net of accumulated depreciation. Property and equipment is depreciated using the straight-line method over the estimated useful lives of the assets. Gains or losses on the sale of personal and real property are shown in income accounts. g) Available-for-sale assets Available-for-sale assets other than personal and real property received as payment are recorded at the lower of cost and market value. Gains or losses from the realization of available-for-sale assets are included in income accounts. MERCANTIL assesses the collectability of items within other assets using the same criteria, where applicable, as for the loan portfolio. Provisions are set aside for items that require them due to their nature or aging. h) Deferred and systems development expenses Deferred expenses are mainly in respect of office setup, office improvement and software. These expenses, as well as those incurred for systems development, are recorded at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over 4 years. i) Use of estimates in the preparation of consolidated financial statements The preparation of consolidated financial statements and their notes requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the amounts of gains and losses recorded during the year, and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements. The areas involving a higher degree of judgment or complexity, or areas where management s assumptions or estimates are significant to the consolidated financial statements are the allowance for losses on the loan portfolio (Note 5), the income tax provision (Note 16), reserves for insurance operations, and the determination of fair values (Note 26). Provision for legal and tax claims MERCANTIL sets aside a provision for legal and tax contingencies considered probable and reasonably quantifiable based on the opinion of its legal advisors and facts known at the assessment date (Note 31). j) Liabilities under repurchase agreements Repurchase agreements are treated as financing operations and recorded as liabilities for the amount of the funds obtained from these transactions. The difference with respect to the repurchase price is recorded as interest expense over the term of the liability. k) Income from premiums and reserves for insurance operations Reserves for insurance claims include the estimated cost of claims reported and related expenses in addition to the estimated provisions for claims incurred but not yet reported. Since reserves are based on estimates, the actual amounts may be greater or smaller than those reserves. The effects of changes in estimated reserves are included in the results for the year in which they occur. Reserves for insurance operations are shown within other liabilities (Note 14). 13

18 Insurance premiums collected are recorded as income when earned. Insurance managed by MERCANTIL, including equity, accident and health insurance policies, qualify as short-term insurance agreements. l) Income tax Income tax is calculated based on the legal rate applicable to the related fiscal jurisdiction and is recognized as an expense for the year. The tax provision is based on management s projection of tax results. MERCANTIL records a deferred tax asset when, in the opinion of management, there is reasonable expectation that future tax results will allow its realization. Deferred tax asset (liability) must always be recognized (Note 16). m) Employee benefits Accrual for length-of-service benefits Based on the provisions of the LOTTT and the collective labor agreement of MERCANTIL s subsidiaries in Venezuela, length-of-service benefits are a vested right of employees. Under the LOTTT, MERCANTIL transfers guaranteed length-of-service benefits quarterly and annually to a trust fund on behalf of each employee. In addition, the LOTTT establishes that length-of-service benefits will be calculated retrospectively upon termination of employment considering the last salary earned by the employee and length of service. The LOTTT requires the payment to employees at employment termination of the higher of retrospective length-of-service benefits and total amounts accrued in the employee s trust fund. Due to the uncertainty involved in estimating an employee s last salary, termination date and total amounts to be accrued in the employee s trust fund at year end, the Company uses actuarial methods to measure and record its additional obligation for length-of-service benefits based on assumptions that include discount rates, salary increase rates and employee turnover rates. These assumptions are reviewed annually and changes may affect the amount of the obligation. Indemnity Under the LOTTT, if an employee protected by the dismissal ban is terminated for reasons other than justified dismissal, the employee will be entitled to receive an additional indemnity equal to his or her accrued length-of-service benefits. This amount is recorded within salaries and employee benefits upon termination of employment. Profit-sharing bonus and vacation leave As established in its collective labor agreement, MERCANTIL grants profit-sharing bonuses and vacation leave to its employees that match or exceed the legal minimums, and accrues the related liabilities as incurred. Retirement pension plan MERCANTIL has a long-term defined benefit plan covering all eligible employees which is managed by Fundación BMA. Fundación BMA has assets and liabilities representing this benefit. Related costs and liabilities are calculated using actuarial methods and are recorded in the results for the year. The net costs of the pension plan are based on actuarial assumptions that are revised annually, such as the discount rate of the obligation, the inflation rate and salary increases, and include service costs, interest expense and returns on plan assets. Changes in assumptions may affect the amount of future contributions. MERCANTIL uses the projected unit credit method to calculate the present value of the Defined Benefit Obligation (DBO). MERCANTIL makes biannual or annual contributions to the plan, except when the DBO is already covered by plan assets. Plan assets are carried at fair value. 14

19 Post-retirement benefits The Supplementary Retirement Pension Plan and the Supplementary Savings Plan include certain additional post-retirement benefits for personnel of MERCANTIL and its Venezuelan subsidiaries meeting certain conditions in respect of age and length of service, mainly medical insurance. The related costs and liabilities are determined based on actuarial methods. Past service costs of the pension plan are recorded in the consolidated income statement in the year in which the change occurs. Defined contribution scheme MERCANTIL maintains a defined contribution scheme called the Mercantil Supplementary Savings Plan. Contributions to the plan are recorded in the results for the year in which they are made. This Plan is a voluntary programmed savings scheme in the form of individual capitalization accounts that is managed by the Savings and Loan Fund of MERCANTIL employees. Under the Supplementary Savings Plan, employees contribute between 1% and 5% of their basic monthly salary and MERCANTIL doubles the employee s contribution up to a maximum of 10% of said salary. In addition, Mercantil Bank, N.A. has a 401K benefit plan to which MERCANTIL contributes a fixed percentage of participating employees salaries. During the years ended, Mercantil Bank, N.A. contributed Bs 33,849,000 and Bs 20,506,000, respectively, to the plan. Life insurance The subsidiary Mercantil Bank, N.A. has a life insurance for certain employees in which the subsidiary is the beneficiary, which is recorded at the cash surrender value at the consolidated balance sheet date within other assets. Changes are recorded as other income in the consolidated income statement. n) MERCANTIL stock option plan MERCANTIL has a long-term stock option plan for certain key officers. Stock options are recorded as equity. MERCANTIL determines the fair value of these options and amortizes the related expense over the vesting period. The fair value of each option is determined at the option grant date using the Black- Scholes-Merton valuation model and does not take into consideration cash dividends that will not be received by the participants. o) Recognition of revenue, costs and expenses Income, costs and expenses are recorded as earned or incurred. Interest collected in advance is included as deferred income within other liabilities and is recorded as income when earned (Note 14). Interest on customer deposits, liabilities and borrowings is recorded as interest expense when incurred. Income from financial leases and amortization costs of leased property are shown as net interest income. p) Fair value of financial instruments MERCANTIL recognizes transactions with financial instruments at their transaction date. Financial instruments are recorded in the consolidated balance sheet as either assets or liabilities at their respective fair values. The carrying amount of cash and due from banks, the investment portfolio and interest and commissions receivable approximates their fair value due to the short-term maturities of these instruments. Since most of MERCANTIL s loans, commercial paper and other financial liabilities bear interest at variable market rates, management considers their carrying amounts to approximate fair value (Note 26). q) Memorandum accounts MERCANTIL records under memorandum accounts assets received in trust, commercial paper and debenture bonds that have been authorized for issue by the SNV but have not been placed at year closing, lines of credit and special trust services (Note 23). 15

20 r) Assets received in trust MERCANTIL acts as custodian, administrator and manager of third-party investments. MERCANTIL values assets received in trust, shown under memorandum accounts, using the same parameters as for its own assets, except investment securities that are recorded at cost, which should not differ significantly from fair value at purchase. Discounts or premiums are amortized over the term of the securities as a credit or debit to interest income, resulting in a lower or greater effective yield on investments. Debt securities in foreign currency are adjusted to the prevailing official exchange rate. Investments in equity securities in bolivars and foreign currency are recorded at cost. In accordance with certain trust agreements, investments in debt or equity securities included in these trusts are maintained at cost or market values. s) Dividends Cash dividends are recorded as liabilities when approved at a Shareholders Meeting (Notes 14 and 20-c). t) Net income per share Basic net income per share is determined by dividing net income for the year by the weighted average of outstanding common shares, excluding repurchased shares (Notes 20-b and 21). 3. Cash and due from banks The main banking subsidiaries must maintain minimum balances of cash and due from banks in local and foreign currencies as required by regulatory agencies. These balances are determined based on deposits and other borrowings by subsidiaries. Below are the balances at December 31 with the BCV included in cash and due from banks: Legal reserve 238,770, ,169,364 Demand deposits 284,517,117 24,472, ,287, ,641,397 At December 31, 2015 and 2014, the legal reserve is 18.5% of all deposits. The legal reserve for marginal increases in deposits is 28% as from March Legal reserve funds do not earn interest for MERCANTIL and are not available for use. Demand deposits with the BCV relate to internal liquidity risk limits, and earn no interest. At December 31, 2016, this balance includes the effect of recent high liquidity levels of the Venezuelan financial system. Pending cash items relate mainly to clearinghouse operations. 16

21 4. Investment portfolio The investment portfolio at December 31 comprises the following: Book value Book value (equivalent (equivalent to market to market Cost value) Cost value) a) Investments in trading securities Investment securities issued by Venezuelan entities Securities issued or guaranteed by the Bolivarian Republic of Venezuela In foreign currency 367, ,863 6,488 6,488 Securities issued by the National Treasury of the United States of America 112, , Investment securities issued by entities in other countries Other investments 71,596 71, , ,122 6,554 6,554 Book value Book value (equivalent (equivalent Unrealized Unrealized to market Unrealized Unrealized to market Cost gain loss value) Cost gain loss value) b) Investments in available-for-sale securities Investment securities issued by Venezuelan entities Securities issued or guaranteed by the Bolivarian Republic of Venezuela In local currency (1) 20,308,173 1,844,797 (64,368) 22,088,602 21,737,722 2,275,721 (510,897) 23,502,546 In foreign currency 527,660 2,205 (100,395) 429,470 1,544,620 39,667 (418,133) 1,166,154 20,835,833 1,847,002 (164,763) 22,518,072 23,282,342 2,315,388 (929,030) 24,668,700 Other investments In local currency 459,820 1,588 (5,890) 455, , (8,973) 211,884 In foreign currency (133) 10 24,554 - (12,195) 12, ,955 1,596 (6,023) 455, , (21,168) 224,243 Investment securities issued by public companies and decentralized entities In foreign currency 31,019, ,019, (170) ,315,178 1,848,598 (170,786) 53,992,990 23,527,404 2,316,051 (950,368) 24,893,087 Investment securities issued by entities in the United States of America Securities issued or guaranteed by the government of the United States of America (2) 5,564,053 26,320 (66,820) 5,523,553 4,809,775 37,053 (46,016) 4,800,812 Debt in companies sponsored and supervised by the government of the United States of America (3) 9,703,093 47,876 (163,422) 9,587,547 3,136,778 33,681 (27,442) 3,143,017 Securities issued by the National Treasury of the United States of America 6,115, ,249 (84,991) 6,165, , (1,266) 167,500 Other investments 122, (67) 122,311 4,985,684 45,320 (86,593) 4,944,411 21,505, ,541 (315,300) 21,398,601 13,100, ,136 (161,317) 13,055,740 Investments in other countries 1,265,913 13,250 (6,123) 1,273, ,268 7,097 (12,355) 825,010 75,086,451 2,070,389 (492,209) 76,664,631 37,458,593 2,439,284 (1,124,040) 38,773,837 (1) These investments include Principal and Interest Covered Bonds (TICC) with a reference par value of US$116,394,000 at December 31, 2016 (US$122,384,000 at December 31, 2015), payable in bolivars at the official exchange rate (Note 22). In addition, at December 31, 2016, they include Agriculture Bonds issued by Petróleos de Venezuela, S.A. for Bs 189,144,000 (Bs 373,060,000 at December 31, 2015) (Note 4-g). (2) These investments include securities of the Government National Mortgage Association and the Small Business Administration. (3) These investments include shares of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation. 17