Mercantil Servicios Financieros, C.A. and its Subsidiaries

Transcription

1 Mercantil Servicios Financieros, C.A. and its Subsidiaries Report of Independent Accountants and Consolidated Financial Statements

2 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 17 4 Investment portfolio Loan portfolio Interest and commissions receivable 23 7 Long-term investments 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) 50

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5 Consolidated balance sheet June 30, December 31, Assets Cash and due from banks (Note 3) Cash 8,522,979 8,541,437 Central Bank of Venezuela 174,296, ,641,397 Venezuelan banks and other financial institutions 344, ,861 Foreign banks and other financial institutions 3,271,021 1,663,855 Pending cash items 13,998,482 7,525, ,433, ,660,516 Investment portfolio (Note 4) Investments in trading securities 285,568 6,554 Investments in available-for-sale securities 52,259,664 38,773,837 Investments in held-to-maturity securities 49,487,491 47,804,801 Share trading portfolio 487, ,732 Investments in time deposits and placements 20,162,053 7,396,830 Restricted investments and repurchase agreements 3,291,082 1,651, ,973,076 96,020,224 Loan portfolio (Note 5) Current 459,334, ,346,672 Rescheduled 430, ,653 Overdue 1,436, ,495 In litigation 32,857 50, ,235, ,685,460 Allowance for losses on loan portfolio (13,816,864) (10,544,876) 447,418, ,140,584 Interest and commissions receivable (Note 6) 6,352,737 5,053,051 Long-term investments (Note 7) 4,105,502 1,613,928 Available-for-sale assets (Note 8) 871, ,827 Property and equipment (Note 9) 6,900,603 5,348,577 Other assets (Note 10) 37,778,222 26,109,903 Total assets 829,833, ,324,610 Memorandum accounts (Note 23) 1,101,878, ,149,850 The accompanying notes are an integral part of the consolidated financial statements 1

6 Consolidated balance sheet June 30, December 31, Liabilities and Equity Liabilities Deposits (Note 11) Non-interest bearing checking accounts 262,320, ,706,706 Interest-bearing checking accounts 227,866, ,429,396 Savings deposits 175,742, ,482,821 Time deposits 20,257,668 11,284, ,186, ,903,166 Debt authorized by the SNV (Note 12) Publicly traded debt securities issued by MERCANTIL 878, ,621 Financial liabilities (Note 13) Liabilities to Venezuelan banks and savings and loan institutions, up to one year 2,870,818 3,357,500 Liabilities to foreign banks and savings and loan institutions, up to one year 4,241,869 2,490,114 Liabilities to foreign banks and savings and loan institutions, more than one year 4,349,100 2,048,649 Liabilities under repurchase agreements 698, ,894 Other liabilities, up to one year 8,116 42,042 12,168,153 8,378,199 Interest and commissions payable 216, ,268 Other liabilities (Note 14) 64,025,984 44,737,862 Subordinated debt (Note 15) 1,127, ,169 Total liabilities 764,602, ,767,285 Minority interests in consolidated subsidiaries 29,019 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 6,396,559 2,983,244 Retained earnings 44,756,752 39,914,413 Repurchased shares held by subsidiaries (600,633) (234,638) Pension plan remeasurement (Note 2-n) (504,556) (504,556) Unrealized gain from adjustment of investments to market value 1,400,554 1,352,319 Total equity 65,201,497 44,533,603 Total liabilities and equity 829,833, ,324,610 The accompanying notes are an integral part of the consolidated financial statements 2

7 Consolidated income statement Six-month periods ended The accompanying notes are an integral part of the consolidated financial statements 3 June 30, December 31, (Thousands of bolivars, except net income per share) Interest income (Note 2) Income from cash and due from banks 674, ,769 Income from investment portfolio (Note 4) 3,635,361 2,944,593 Income from loan portfolio (Note 5) 42,981,699 32,071,802 Total interest income 47,291,304 35,364,164 Interest expense (Note 2) Interest on demand and savings deposits (12,529,533) (10,112,307) Interest on time deposits (118,446) (71,190) Interest on securities issued by MERCANTIL (63,290) (28,458) Interest on other financial liabilities (633,575) (429,096) Total interest expense (13,344,844) (10,641,051) Gross financial margin 33,946,460 24,723,113 Allowance for losses on loan portfolio and provision for commissions receivable (Notes 2, 5 and 6) (3,800,812) (3,264,872) Net financial margin 30,145,648 21,458,241 Commissions and other income Commissions on trust fund operations 198, ,251 Commissions on foreign currency operations (Note 22) 14,097 33,134 Commissions on customer account transactions 3,095,782 2,240,251 Commissions on letters of credit and guarantees granted 13,402 11,744 Equity in long-term investments (Note 7) 61, ,692 Exchange gain (loss) (Note 22) 859,959 (1,480) Gain on sale of investment securities (Note 4) 673, ,872 Other income (Note 18) 9,971,646 6,237,742 Total commissions and other income 14,888,097 9,474,206 Insurance premiums, net of claims (Note 2) Premiums 25,142,841 16,864,906 Claims (21,174,294) (14,053,190) Total insurance premiums, net of claims 3,968,547 2,811,716 Income from financial operations 49,002,292 33,744,163 Operating expenses Salaries and employee benefits (10,106,429) (5,551,487) Depreciation, property and equipment expenses, amortization of intangibles and other (Notes 8, 9 and 10) (4,767,470) (3,281,473) Fees paid to regulatory agencies (4,992,482) (3,385,344) Other operating expenses (Note 19) (17,810,507) (9,802,339) Total operating expenses (37,676,888) (22,020,643) Operating income before tax and minority interests 11,325,404 11,723,520 Income tax (Note 16) Current (4,585,986) (4,764,354) Deferred 27, ,543 Total tax (4,558,322) (4,589,811) Net income before minority interests 6,767,082 7,133,709 Minority interests (5,188) (3,738) Net income 6,761,894 7,129,971 Net income per share (Note 21) Basic Diluted Weighted average of outstanding common shares 100,461,654 99,636,532 Weighted average of outstanding diluted common shares 110,461,654 99,636,532

8 Consolidated statement of changes in equity Six-month periods ended Translation Unrealized adjustment gain (loss) from of net Repurchased adjustment of Capital assets of shares investments inflation subsidiaries held by Pension 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-n) (Note 4) equity Balances at June 30, , , ,715 2,998,777 32,366,773 (144,753) (93,223) 1,680,413 37,830,808 Net income ,129, ,129,971 Cash dividends paid to subsidiaries , ,336 Shares repurchased by subsidiaries (89,885) - - (89,885) Unrealized loss on investments (328,094) (328,094) Pension plan remeasurement (Note 2) ,333 - (411,333) - - Translation adjustment of net assets of subsidiaries abroad (Note 22) (15,533) (15,533) Balances at December 31, , , ,715 2,983,244 39,914,413 (234,638) (504,556) 1,352,319 44,533,603 Net income ,761, ,761,894 Capital increase (Note 20) 16,549-12,713, ,730,000 Dividends declared, net of cash dividends paid to subsidiaries (1,919,555) (1,919,555) Shares repurchased by subsidiaries (365,995) - - (365,995) Unrealized gain on investments ,235 48,235 Translation adjustment of net assets of subsidiaries abroad (Note 22) ,413, ,413,315 Balances at June 30, , ,709 12,713, ,715 6,396,559 44,756,752 (600,633) (504,556) 1,400,554 65,201,497 The accompanying notes are an integral part of the consolidated financial statements 4

9 Consolidated cash flow statement Six-month periods ended The accompanying notes are an integral part of the consolidated financial statements 5 June 30, December 31, Cash flows from operating activities Net income 6,761,894 7,129,971 Adjustments to reconcile net income to net cash provided by operating activities Allowance for losses on loan portfolio (Note 5) 3,800,686 3,263,497 Exchange gain, net (859,959) - Depreciation and amortization (Notes 9 and 10) 1,160, ,421 Amortization of available-for-sale assets (Note 8) Provision for interest receivable and other assets 526, ,457 Gain on equity in long-term investments, net (61,527) (216,692) Deferred income tax (27,664) (174,543) Minority interest expenses 5,188 3,738 Accrual for length-of-service benefits 1,773, ,080 Payment of length-of-service benefits (1,348,515) (811,601) Net change in operating accounts Interest and commissions receivable (1,170,059) (2,072,465) Interest and commissions payable 43,451 27,844 Available-for-sale and other assets (12,320,855) (12,321,921) Other liabilities 18,216,711 11,847,998 Net cash provided by operating activities 16,500,006 8,623,913 Cash flows from investing activities Net change in investment portfolio (7,470,952) (15,664,107) Net change in long-term investments (2,428,658) (1,176,941) Loans granted (212,791,566) (194,584,166) Loans collected 127,384,084 98,580,563 Net additions to property and equipment (2,130,513) (1,487,217) Net cash used in investing activities (97,437,605) (114,331,868) Cash flows from financing activities Net change in Deposits 125,397, ,863,071 Short-term financial liabilities (23,289) 198,449 Debt securities issued by MERCANTIL (9,576) 499,626 Subordinated debt - 9,755 Long-term financial liabilities obtained 851, ,075 Long-term financial liabilities repaid 2,394 (246) Cash dividends (1,595,901) (197,065) Capital increase 16,549 - Share premium 12,713,451 - Repurchased shares (365,995) (89,885) Net cash provided by financing activities 136,986, ,401,780 Cash and cash equivalents Net increase for the period 56,049,135 50,693,825 Income from effect of exchange differences on cash 1,486,981 - At the beginning of the period 163,056, ,362,893 At the end of the period 220,592, ,056,718 X Supplementary information Taxes paid 7,385,978 35,025 Interest paid 12,648,922 10,184,111 Translation adjustment of net assets of subsidiaries abroad 3,413,315 (15,533) Unrealized gain (loss) from adjustment of investments to market value 48,235 (328,094)

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 Mercantil, C.A. Banco Universal in Venezuela (99.94% owned); Mercantil Commercebank Holding Corporation (wholly owned), which is the final beneficial owner of Mercantil Commercebank, N.A., a U.S.-based commercial bank; the Venezuela-based insurance company Mercantil Seguros, C.A., wholly owned through Auyantepuy Holding Limited and; Mercantil Merinvest, C.A. and its subsidiaries, all wholly owned. Other consolidated financial subsidiaries wholly owned by MERCANTIL through several subholdings include Mercantil Bank Curacao, N.V. (an off-shore bank domiciled in Curacao); Mercantil Bank (Panamá), S.A.; Mercantil Seguros Panamá, S.A.; Mercantil Bank (Schweiz) AG (domiciled in Switzerland) and its subsidiary Mercantil Bank & Trust Limited (Cayman Islands) (domiciled in Grand Cayman, B.W.I.) and; Mercantil Inversiones y Valores, C.A. MERCANTIL s statutory financial statements at were approved by the Board of Directors on July 12 and January 12, 2016, respectively, and approved for issue by the Audit Committee on August 16 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. The 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. 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 6

11 Proliferation of Weapons of Mass Destruction, which will be governed by SNV rules. The Law grants 90 continuous days as from its publication to submit an Adjustment Plan to the new provisions. In March 2016, the subsidiary Mercantil Merinvest Casa de Bolsa, C.A. submitted to the SNV the Adjustment Plan set out in this Law, which established actions to be taken for capital stock adequacy and authorization to act as Investment Portfolio Manager on behalf of third parties. Subject to this approval, the cancellation of the authorization to act as Portfolio Manager of Mercantil Servicios de Inversión, C.A. will be requested. At June 30, 2016, the SBV s reply to the aforementioned Plan is still pending. MERCANTIL required no submission of an Adjustment Plan. Law on Banking Sector Institutions This Law, among other things, considers banking as a public service; defines financial intermediation as fundraising for investment in loan portfolios and securities issued or guaranteed by the Venezuelan government or government agencies; limits the bank s assets and transactions with a single debtor and defines debtor in relation to this limitation; regulates the formation and functions of the Board of Directors; establishes disqualification instances to act as directors; defines financial groups; establishes a social contribution to finance projects developed by communal councils and establishes prohibitions. Insurance Activity Law In December 2015 the Venezuelan government published a Reform of the Insurance Activity Law. The scope of this Law extends to other sectors of the Venezuelan economy, e.g., risk management companies and insurance brokers, among others. This Reform establishes new obligations regarding minimum operating capital, the creation of a guarantee to the Nation, new provisions for the investment of technical reserves and the provision of services related to managed funds. In addition, it establishes a special contribution for the social development of between 1% and 3% of premiums of health insurance policies or any other insurance policy established by the People s Power Ministry for Finance, a contribution for the research and development of the insurance activity of no more than 5% of income for the year and an increase in administrative penalties. Regulated entities are required to present a plan to adjust to the new regulatory framework within 60 working days to be executed within 6 months following approval. During the first six-month period of 2016, the subsidiary Mercantil Seguros, C.A. submitted to the Insurance Superintendency the Adjustment Plan set out in the Law, which established adjustments to bylaws, mainly due to the increase in minimum operating capital, which should reach at least 250,000 tax units. In addition, the deadlines for adjusting technical reserves, as well as the guarantee to the Nation, were established. This Plan is for 180 days upon approval. During the six-month period ended June 30, 2016, the Insurance Superintendency has not yet responded to the aforementioned Plan. Income Tax Law The Reform of the Income Tax Law published in November 2014 establishes, among other things, that net operating losses may be carried forward for three years and offset up to a maximum of 25% of annual income, whereas net uncompensated losses arising from the annual inflation adjustment may not be carried forward to future years. In addition, the Law requires institutions engaged in banking, financial, insurance and reinsurance activities to be excluded from the inflation adjustment for tax purposes. Subsequently, in December 2015 a new Partial Reform of the Income Tax Law was published establishing a 40% proportional tax for net income derived from banking, financial, insurance or reinsurance activities. In addition, taxpayers qualified by the Tax Administration as special taxpayers are excluded from the inflation adjustment for tax purposes. 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 7

12 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). Regulations require the subsidiary Mercantil, C.A. Banco Universal to earmark a minimum nominal percentage of 29.50% of its gross loan portfolio at June 30, 2016 to finance loans for agriculture, tourism and small businesses (62.25% at December 31, 2015 for agriculture, tourism, mortgages, manufacturing, and small businesses). At, directed loan portfolios amount to Bs 120,602,538,000 and Bs 95,373,129,000, respectively. Deposit and lending rates are regulated by the BCV. The BCV sets maximum and minimum interest rates for deposits and credit operations based on reference rates. In this regard, at June 30, 2016 and December 31, 2015, the annual interest rate for lending operations may not exceed 24% and 29% for credit card transactions. Financial institutions may only charge an additional 3% per annum on amounts overdue from clients. The maximum interest rates for directed loan portfolios are: June 30, 2016 December 31, 2015 Agriculture 13% 13% Microcredits 24% 24% Tourism 7.73% or 12.07% 7.82% or 10.82% Mortgages 4.66% to 10.66% 4.66% to 10.66% Manufacturing i) 18% as the maximum interest rate for credit operations for this sector; and ii) an annual interest rate not greater than 16.20% of the previous rate for loans earmarked for small and medium industries, state-owned industries, community industries, as well as joint ventures for manufacturing. i) 18% as the maximum interest rate for credit operations for this sector; and ii) an annual interest rate not greater than 16.20% of the previous rate for loans earmarked for small and medium industries, state-owned industries, community industries, as well as joint ventures for manufacturing. 8

13 The annual interest rates on savings deposits may not fall below 16% calculated on daily balances up to Bs 20,000 and 12.50% on daily balances greater than Bs 20,000. Annual interest rates on time deposits may not fall below 14.50%. At, the BCV set at 29.50% the annual interest rate to be charged on discount, rediscount and advance operations, except as regards operations conducted under special regimes. The BCV has regulated service fees charged by banks to customers in respect of savings and current accounts, and leasing, international, and credit and debit card transactions. b) Mercantil Commercebank, 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). c) 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. d) Mercantil Bank (Panama), 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, 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. f) 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. 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. 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 financial statements be recognized, provided that inflation for the year exceeds one digit. In accordance with SNV instructions, as from 1999 MERCANTIL 9

14 has not recognized the effects of inflation on its financial statements. The SNV has ruled that the methodology to be followed by MERCANTIL for preparing and presenting its nominal 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 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 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 financial statements expressed in nominal bolivars for subsequent periods. The SNV established that inflation-adjusted financial statements should be included as supplementary information. At June 30, 2016, the inflation rates for the first six-month period of 2016 are not available. As from August 2015, the SNV deferred the presentation of this information. In July 2016, the SNV instructed the referral of the audited supplementary inflation-adjusted financial statements for 2015 and as from January 2016 the presentation of audited supplementary financial statements and their notes based on inflation-adjusted amounts considering the last inflation rate published by the BCV. At the issue date of this report, the extension to submit the aforementioned reports was requested. 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 period end (Note 22). Net exchange gains and losses are included in the results for the period, 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 period-end official exchange rate, equity accounts at the historic official exchange rate, and income accounts at the average official exchange rate for the period (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. 6) Rescheduled loans For the subsidiary Mercantil, C.A. Banco Universal, the Accounting Manual for Banks, Other Financial Institutions and Savings and Loan 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, 10

15 they do state that impairment losses on financial assets carried at amortized cost shall be recognized in the results for the period 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 period 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. 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. 11

16 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 period 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). 15) Pension plan remeasurement and other post-retirement benefits Pension plan remeasurement and other post-retirement benefits are recorded in the consolidated income statement and are subsequently reclassified in equity, whereas under VEN NIF the effect due to experience and changes in actuarial assumptions of the retirement and post-retirement benefit plans must be recorded directly in equity. 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 period. 12

17 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 period 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 six-month periods 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). 13

18 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. 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 and other 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 period, 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. 14

19 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 period in which they occur. Reserves for insurance operations are shown within other liabilities (Note 14). 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 period. 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 period end, the Company uses actuarial methods to measure and record its 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. n) Employee benefit plans 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 period. 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 15

20 expense and returns on plan assets. contributions. Changes in assumptions may affect the amount of future 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. 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 period 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 period 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 Commercebank, N.A. has a 401K benefit plan to which MERCANTIL contributes a fixed percentage of participating employees salaries. During the six-month periods ended June 30, 2016 and December 31, 2015, Mercantil Commercebank, N.A. contributed Bs 15,712,000 and Bs 11,780,000, respectively, to the plan. Life insurance The subsidiary Mercantil Commercebank, 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. o) 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. p) 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. q) 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 16