Mercantil, C.A. Banco Universal and its Subsidiaries (Subsidiary of Mercantil Servicios Financieros, C.A.)

Transcription

1 Mercantil, C.A. Banco Universal and its Subsidiaries (Subsidiary of Mercantil Servicios Financieros, C.A.) 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 Operations and regulatory environment Basis of preparation Cash and due from banks Investment securities Loan portfolio Investments in affiliates Available-for-sale assets Property and equipment Other assets Deposits Deposits and liabilities with Banco Nacional de Vivienda y Hábitat (BANAVIH) Borrowings Other liabilities from financial intermediation Accruals and other liabilities Taxes Employee benefits and employee benefit plans General and administrative expenses Other operating income Other operating expenses Extraordinary expenses Equity Net income per share Financial assets and liabilities in foreign currency Memorandum accounts Credit-related commitments Balances and transactions with related companies Fundación Mercantil Maturity of financial assets and liabilities Fair value of financial instruments Risk management Liabilities and contingencies Money laundering prevention 44-45

3 Report of Independent Accountants To the Shareholders and Board of Directors of Mercantil, C.A. Banco Universal Report on the consolidated financial statements We have audited the accompanying consolidated financial statements of Mercantil, C.A., Banco Universal (the Bank), which comprise the consolidated balance sheet at, and the related consolidated statements of income, changes in equity and cash flows for the years then ended, and a summary of significant accounting policies and other explanatory notes. Management s responsibility for the consolidated financial statements Management is responsible for the preparation and fair presentation of consolidated financial statements in accordance with the accounting rules and instructions of the Superintendency of Banking Sector Institutions (SUDEBAN), which are of mandatory use for the Venezuelan banking system. As described in Note 2, these rules differ in certain significant respects from accounting principles generally accepted in Venezuela. This responsibility includes: designing, implementing and maintaining internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error; selecting and applying appropriate accounting policies and; making accounting estimates that are reasonable in the circumstances. Auditor s responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in Venezuela. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation of consolidated financial statements that give a true and fair view in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Espiñeira, Pacheco y Asociados (PricewaterhouseCoopers) Contadores Públicos. Av. Principal de Chuao, Edificio PwC Apartado Caracas 1010-A, Venezuela Teléfono: (0212) Fax: (0212) Espiñeira, Pacheco y Asociados (PricewaterhouseCoopers). Todos los derechos reservados. "PwC" se refiere a la firma venezolana Espiñeira, Pacheco y Asociados (PricewaterhouseCoopers), o según el contexto, a la red de firmas miembro de PricewaterhouseCoopers International Limited, cada una de las cuales es una entidad legal separada e independiente R.I.F: J

4 Opinion In our opinion, the accompanying consolidated financial statements present fairly, in all material respects, the financial position of Mercantil, C.A., Banco Universal at, and the results of its operations and its cash flows for the years then ended, in conformity with the accounting rules and instructions of the Superintendency of Banking Sector Institutions (SUDEBAN). Espiñeira, Pacheco y Asociados (PricewaterhouseCoopers) Pedro Pacheco Rodríguez CPC CP 431 CNV P-810 Caracas, Venezuela February 22, de 2

5 (Subsidiary of Mercantil Servicios Financieros, C.A.) Consolidated balance sheet Assets Cash and due from banks (Note 3) 154,144,732 74,866,697 Cash 8,491,608 4,323,074 Central Bank of Venezuela 137,641,397 66,235,157 Venezuelan banks and other financial institutions Foreign and correspondent banks 507, ,069 Pending cash items 7,504,090 3,705,104 Investment securities (Note 4) 69,286,892 44,523,248 Deposits with the Central Bank of Venezuela and overnight deposits 2,100,000 1,188,775 Investments in available-for-sale securities 18,982,404 17,081,145 Investments in held-to-maturity securities 12,291,413 5,755,357 Restricted investments 659, ,558 Investments in other securities 35,253,978 20,208,413 Loan portfolio (Note 5) 307,411, ,619,332 Current 316,170, ,580,574 Rescheduled 510, ,986 Overdue 627, ,910 In litigation 50, (Allowance for losses on loan portfolio) (9,947,308) (5,898,194) Interest and commissions receivable 3,990,894 2,174,876 Interest receivable on cash and due from banks - 2 Interest receivable on investment securities 1,013, ,519 Interest receivable on loan portfolio 2,894,615 1,495,187 Commissions receivable 121,604 88,417 Interest and commissions receivable on other accounts receivable 3 31 (Provision for interest receivable and other) (38,684) (24,280) Investments in affiliates (Note 6) 1,296, ,098 Available-for-sale assets (Note 7) ,636 Property and equipment (Note 8) 2,968, ,305 Other assets (Note 9) 11,955,324 2,566,782 Total assets 551,055, ,892,974 Memorandum accounts (Note 24) Contingent debtor accounts 2,573,472 2,619,615 Assets received in trust 28,110,445 20,688,549 Other special trust services 7,707 12,527 Other debtor memorandum accounts 759,338, ,295,678 Other debtor control accounts 7,704 9, ,038, ,626,201 The accompanying notes are an integral part of the consolidated financial statements 1

6 (Subsidiary of Mercantil Servicios Financieros, C.A.) Consolidated balance sheet Liabilities and Equity Deposits (Note 10) 497,091, ,083,275 Demand deposits 349,420, ,734,430 Non-interest-bearing checking accounts 181,422,138 83,655,412 Interest-bearing checking accounts 126,057,606 77,386,303 Checking accounts under Exchange Agreement No , ,562 Demand deposits and certificates 41,874,285 13,465,153 Other demand deposits 4,215,562 4,432,223 Savings deposits 142,548,766 78,120,226 Time deposits 530, ,884 Restricted deposits 376, ,512 Deposits and liabilities with Banco Nacional de Vivienda y Hábitat (Note 11) 1, Borrowings (Note 12) 69, ,164 Venezuelan financial institutions, up to one year 43, ,741 Foreign financial institutions, up to one year 26, ,423 Other liabilities from financial intermediation (Note 13) 4,137 4,061 Interest and commissions payable 104,454 63,195 Expenses payable on deposits 104,410 62,813 Expenses payable on borrowings Accruals and other liabilities (Note 14) 16,444,993 5,218,099 Total liabilities 513,716, ,637,169 Equity (Note 21) Capital stock 268, ,060 Contributions pending capitalization 2,890, Capital reserves 281, ,782 Equity adjustments (1,426) (1,036) Retained earnings 33,017,542 22,869,098 Unrealized gain on investments (Note 4) 883, ,865 Total equity 37,339,030 24,255,805 Total liabilities and equity 551,055, ,892,974 The accompanying notes are an integral part of the consolidated financial statements 2

7 Consolidated income statement Years ended Interest income (Note 2) 56,151,013 28,191,405 Income from cash and due from banks Income from investment securities 4,153,422 3,751,552 Income from loan portfolio (Note 5) 51,872,534 24,302,434 Income from other accounts receivable (Note 25) 42,852 43,436 Other interest income 81,604 92,984 Interest expense (Note 2) (16,622,690) (9,057,578) Expenses from deposits (16,479,934) (8,889,692) Expenses from borrowings (1,036) (2,267) Expenses from other liabilities from financial intermediation (Note 25) (136,335) (158,951) Other interest expense (5,385) (6,668) Gross financial margin 39,528,323 19,133,827 Income from financial assets recovered (Note 5) 518, ,461 Expenses from uncollectible accounts and write-down of financial assets (Notes 2 and 5) (4,836,208) (2,796,003) Uncollectible loans and other accounts receivable (4,836,208) (2,796,003) Net financial margin 35,210,960 16,635,285 Other operating income (Note 18) 12,208,251 6,598,506 Other operating expenses (Note 19) (5,152,807) (2,541,281) Financial intermediation margin 42,266,404 20,692,510 Operating expenses (22,039,775) (10,549,964) Salaries and employee benefits (7,185,532) (4,127,807) General and administrative expenses (Note 17) (10,050,280) (3,562,357) Fees paid to the Social Bank Deposit Protection Fund (4,331,536) (2,640,937) Fees paid to the Superintendency of Banking Sector Institutions (472,427) (218,863) Gross operating margin 20,226,629 10,142,546 Income from available-for-sale assets (Note 7) 232,946 89,762 Sundry operating income 279, ,292 Expenses from available-for-sale assets (Note 7) (260) (3,685) Sundry operating expenses (Notes 9 and 14) (2,081,915) (1,027,212) Net operating margin 18,657,182 9,501,703 Extraordinary expenses (Note 20) (114,977) (70,229) Gross income before tax 18,542,205 9,431,474 Income tax (Note 15) (6,380,627) (814) Net income 12,161,578 9,430,660 Appropriation of net income Retained earnings 12,161,578 9,430,660 Provision for the Antidrug Law (Notes 14 and 32) 188,443 96,482 Supplementary information Net income per common share (in bolivars) (Note 22) 45,36 35,18 Dividends paid 2,010,453 1,099,047 The accompanying notes are an integral part of the consolidated financial statements 3

8 Consolidated statement of changes in equity Years ended Retained earnings Capital reserves Unappropriated surplus Contributions Other Pension plan Unrealized Capital pending mandatory Equity Restricted Unappropriated remeasurement gain on Total stock capitalization Capital reserves adjustments surplus earnings (Note 2-l) investments equity Balances at December 31, , ,060 8,042 (774) 8,219,671 6,320,494-1,473,460 16,557,049 Net income ,430, ,430,660 Cash dividends (Note 21) (1,099,047) - - (1,099,047) Reserve for the Social Contingency Fund , (2,681) Adjustment from exchange differences, net (Note 23) (262) (262) Adjustment of investments to market value (Note 4) (632,595) (632,595) Restricted surplus from participation in the results of subsidiaries and equity in affiliates (Note 21) ,456 (36,456) Pension plan remeasurement (Note 16) ,367 (91,367) - - Reclassification of 50% of net income to restricted surplus (Note 21) ,715,330 (4,715,330) Balances at December 31, , ,060 10,723 (1,036) 12,971,457 9,989,007 (91,367) 840,865 24,255,805 Net income ,161, ,161,578 Contributions pending capitalization (Note 21) - 2,890, ,890,185 Cash dividends (Note 21) (2,010,453) - - (2,010,453) Reserve for the Social Contingency Fund , (2,680) Adjustment from exchange differences, net (Note 23) (390) (390) Adjustment of investments to market value (Note 4) ,305 42,305 Restricted surplus from participation in the results of subsidiaries and equity in affiliates (Note 21) ,961 (70,961) Pension plan remeasurement (Note 16) ,612 (407,612) - - Reclassification of 50% of net income to restricted surplus (Note 21) ,080,789 (6,080,789) Balances at December 31, ,060 2,890, ,060 13,403 (1,426) 19,123,207 14,393,314 (498,979) 883,170 37,339,030 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 12,161,578 9,430,660 Adjustments to reconcile net income to net cash provided by operating activities Equity in affiliates 62,447 (17,725) Allowance for losses on loan portfolio 4,803,366 2,779,329 Provision for interest receivable 32,609 12,565 Provision for contingent loans - 3,893 Write-offs of uncollectible accounts and decrease in branch provision for doubtful accounts (770,178) (502,106) Income tax provision 6,934, Deferred income tax (553,978) - Provision for other assets 4,324 3,843 Release of provision for other assets (1,858) (1,079) Write-offs against the provision for other assets (3,326) (2,259) Other provisions 751, ,718 Depreciation of property and equipment 395, ,669 Amortization of deferred expenses and goodwill 385, ,655 Amortization of available-for-sale assets 260 3,685 Accrual for length-of-service benefits 1,621,521 1,022,553 Payment of length-of-service benefits (1,182,283) (650,391) Net change in Deposits with the Central Bank of Venezuela and overnight deposits (911,225) 8,564,910 Interest and commissions receivable (1,832,700) (749,313) Other assets (9,218,894) (1,282,597) Interest and commissions payable 41,259 39,927 Accruals and other liabilities 3,101, ,756 Net cash provided by operating activities 15,821,186 20,387,507 Cash flows from financing activities Net change in Deposits 239,008,393 95,326,351 Deposits and liabilities with Banco Nacional de Vivienda y Hábitat Borrowings (198,322) 96,583 Other liabilities from financial intermediation 76 (15,865) Contributions pending capitalization 2,890,185 - Dividends paid (2,010,453) (1,099,047) Net cash provided by financing activities 239,690,816 94,308,375 Cash flows from investing activities Loans granted during the year (410,674,926) (216,853,870) Loans collected during the year 261,833, ,756,007 Net change in Available-for-sale investments (1,858,954) 1,167,217 Held-to-maturity investments (6,536,056) 11,314 Restricted investments (369,539) (242,898) Investments in other securities (15,045,565) (9,588,885) Investments in subsidiaries and affiliates (1,160,006) (2,111) Available-for-sale assets 21,779 (25,624) Property and equipment (2,443,907) (594,255) Net cash used in investing activities (176,233,967) (84,373,105) Cash and due from banks Net change 79,278,035 30,322,777 At the beginning of the year 74,866,697 44,543,920 At the end of the year 154,144,732 74,866,697 Supplementary information on non-cash activities Adjustment of available-for-sale investments to market value 42,305 (632,595) Equity adjustments from exchange differences (Note 23) (390) (262) Taxes paid 2,842 - Interest paid 16,581,430 9,017,652 Reclassification of Interest and commissions receivable to allowance for losses on loan portfolio (Note 5) 15,926 (10,587) The accompanying notes are an integral part of the consolidated financial statements 5

10 1. Operations and regulatory environment Reporting entity Mercantil, C.A. Banco Universal (the Bank), founded in 1925 in the Bolivarian Republic of Venezuela, and its subsidiaries operate in the financial services sector in Venezuela and abroad. The Bank s primary activities consist in providing financial intermediation services to individuals and corporations through its main office in Caracas, agencies throughout the country, its agency in the United States of America (Coral Gables, FL), and its branch in Curacao. Most of the Bank s assets are located in Venezuela. At December 31, 2015, the Bank, its agency, branch and subsidiaries have 7,229 employees. The Bank s consolidated financial statements at were approved for issue by the Board of Directors on January 12, 2016 and January 12, 2015, 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. 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; establishes disqualification instances to act as directors; establishes a social contribution to finance projects developed by communal councils and establishes prohibitions. The Law on Banking Sector Institutions was published in December 2014, which repealed the previous Law. This Law introduces changes regarding the formation of the Board of Directors and its functions; regulates the formation of financial groups and increases the maximum limit of contributions to the Superintendency of Banking Sector Institutions (SUDEBAN). In January 2015, management submitted to SUDEBAN the Adjustment Plan set out in this Law, which establishes actions to be taken to form the Board of Directors; as well as the new connecting assumptions and indicated for consideration the structure of the Banks s investments in shares. During the year ended December 31, 2015, SUDEBAN approved the Adjustment Plan. Income Tax Law The Income Tax Law issued in November 2014 establishes 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 as from the 2015 tax year (Note 15). 6

11 In December 2015 a new Partial Reform of the Income Tax Law was published establishing a 40% proportional tax (previously 34%) for net income derived from banking, financial, insurance or reinsurance activities as from the 2016 tax year. In addition, taxpayers qualified by the Tax Administration as special taxpayers as from the 2016 tax year 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 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 or accounting profit 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 16). In addition, the LOTTT regulates certain legal benefits such as working hours, rest days, holidays, vacation, profit sharing, absences and leave. The Bank s collective labor agreement also establishes the legal benefits that match or exceed benefits established in the Law. Branch and agency The Bank s branch and agency abroad, which have not been incorporated separately from the Bank, are subject to specific requirements of regulatory agencies in the countries where they operate regarding prior consultation for certain transactions, quality of assets, and capital and liquidity levels, as explained below: Mercantil, C.A. Banco Universal - Curacao Branch This branch operates in Curacao. It is supervised and controlled by the Central Bank of Curacao and Saint Marteen and SUDEBAN in Venezuela. Mercantil, C.A. Banco Universal - Coral Gables, FL agency (United States of America) This agency is subject to banking regulations in the State of Florida. In addition, it is supervised and regulated by the Federal Reserve Bank and SUDEBAN in Venezuela. Central Bank of Venezuela (BCV) 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 December 31, 2015 and 2014, 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. 7

12 The maximum interest rates for directed loan portfolios at December 31 are as follows: Agriculture 13% 13% Microcredits 24% 24% Tourism 7.73% or 10.73% 6.84% or 10.84% 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. 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%. The annual interest rate to be charged by the BCV on discount, rediscount and advance operations, except as regards those conducted under special regimes, was set at 29.50%. 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. 2. Basis of preparation The accompanying consolidated financial statements include the accounts of the Bank and its subsidiaries and have been prepared based on the Accounting Manual for Banks, Other Financial Institutions and Savings and Loan Entities (Accounting Manual) and the accounting rules and instructions of SUDEBAN, which differ in certain significant respects from accounting principles generally accepted in Venezuela (VEN NIF). The Venezuelan Federation of Public Accountants (FCCPV) approved the adoption of VEN NIF as the accounting principles of mandatory application in Venezuela as from January 1, 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, among others. The main differences with VEN NIF applicable to the Bank are: 1) Consolidation The accompanying consolidated financial statements show investments in over 50%-owned subsidiaries under the equity method. In accordance with VEN NIF, these subsidiaries controlled by the Bank or of which the Bank is considered the main beneficiary of their income must be consolidated. 2) Inflation-adjusted consolidated financial statements VEN NIF require that the effects of inflation on the financial statements be recognized provided that inflation for the year exceeds one digit. SUDEBAN has stipulated that inflation-adjusted financial statements must be provided as supplementary information. At December 31, 2015, the inflation rates for that month end are not available. SUDEBAN deferred the presentation of this information in December and June At December 31, 2014, the Bank has prepared inflation-adjusted 8

13 consolidated financial statements using the National Consumer Price Index (NCPI) published by the BCV, based on the methodology established in VEN NIF. 3) 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. The assets, liabilities and equity of the branch and agency abroad are translated at the prevailing official exchange rate. Income accounts are translated at the average official exchange rate for the year. VEN NIF establish two options to measure transactions and balances in foreign currency: 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. VEN NIF establish that exchange gains and losses on available-for-sale or held-tomaturity securities must be included in the income statement. 4) Investments in trading and available-for-sale securities According to SUDEBAN rules, investments in trading securities may remain in this category for only 90 days from the date they were classified as held for trading and investments in available-for-sale securities may not remain in this category for more than one year as from the date they were classified as available for sale, except for securities issued and guaranteed by the Venezuelan government and investments in shares of mutual guarantee companies. Under VEN NIF, they may remain in these categories indefinitely. 5) Discounts or premiums on held-to-maturity investments Discounts or premiums on held-to-maturity investments are amortized over the term of the security with a debit or credit to gain or loss on investment securities under other operating income or other operating expenses, respectively. Under VEN NIF, they are accounted for as part of the security s yield and, therefore, must be recognized under interest income. 6) Permanent losses on investment securities When permanent losses arising from impairment in the fair value of investment securities are recorded, any subsequent recovery in fair value does not affect the new cost basis. Under VEN NIF, any recovery of previously expensed impairment losses on debt securities may be recognized as income. 7) Valuation of reclassified securities a) Reclassification of held-to-maturity securities to available-for-sale securities 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 the Bank and its subsidiaries, all investments remaining in this category must be reclassified to available-for-sale securities. According to SUDEBAN rules, reclassifications of held-to-maturity securities must be approved by SUDEBAN. b) Reclassification of available-for-sale securities to held-to-maturity securities SUDEBAN rules establish that available-for-sale investments reclassified to the held-to-maturity category must be recorded at their fair value at the reclassification date. Unrealized gains or losses are maintained separately in equity and are amortized over the investment s remaining life as an adjustment to yield. Under VEN NIF, the fair value of the investment at the reclassification date becomes the new amortized cost basis, and any gain or loss previously recognized in equity is accounted for as follows: a) gains or losses on fixed maturity investments, as well as any difference between the new amortized cost and value at maturity, are taken to profit and loss and amortized over the investment s remaining life and; b) gains or losses on non-maturity investments will remain in equity until the asset is sold or otherwise disposed of, when they shall be recognized in profit or loss. 9

14 8) Investments in other securities Investments in other securities include investment trusts, as well as investments not classified under any of the other categories defined by the Accounting Manual. According to VEN NIF, investments in other securities are recorded under three categories: at fair value through profit or loss, available for sale and held to maturity. 9) Rescheduled loans The Accounting Manual establishes that loans whose original payment schedule, term or other conditions have been modified 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 charged to the results for the year in which they are incurred. 10) Overdue and in-litigation loans Loans classified as overdue must be written off within 24 months after inclusion in this category. In-litigation loans are those in the legal collection process. 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 a debtor repays pending loan installments of a loan in litigation, thereby terminating the lawsuit, the Bank and its subsidiaries must reclassify the loan to the category to which it pertained before being classified as in litigation. Under VEN NIF, they are recorded based on collectibility. 11) Allowance for losses on loan portfolio Allowances for losses on the loan portfolio are determined based on a collectibility assessment for individual loans, a global risk assessment 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 the minimum general and specific allowances required for the loan portfolio, SUDEBAN established a general countercyclical allowance equivalent to 0.75% of the gross loan portfolio balance. 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 provision, which would have to be accounted for as a reduction of retained earnings in the statement of changes in equity. 12) Assets received as payment and idle assets Assets received as payment must be recorded at the lower of assigned value, book value, market value or appraisal value not older than one year, and are amortized using the straight-line method over 1 to 3 years. Assets idle for more than 24 months are written out of asset accounts. 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 non-current assets held for sale depending on their use. 13) Property and equipment The Accounting Manual establishes that these assets shall be initially recorded at acquisition or construction cost, as applicable. VEN NIF allow revaluation of property and equipment, and any increase in value is credited to equity under revaluation surplus. The Bank 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 14) Leasehold improvements Significant leasehold improvements are recorded as amortizable expenses and included under other assets. According to VEN NIF, leasehold improvements are recorded within property and equipment. 15) Goodwill Goodwill relates to the excess of cost over book value of shares at the date of acquisition and is being amortized using the straight-line method over 20 years (Note 9). As from 2008, goodwill must be amortized over no more than 5 years. According to VEN NIF, goodwill should not be amortized but tested for impairment annually or sooner 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. 16) Provisions The Accounting Manual establishes timeframes to record provisions for bank reconciling items, pending items and accounts receivable forming part of other assets, interest receivable and disposal of certain assets, among others. According to VEN NIF, provisions are recorded based on the probability of collection or recovery. No timeframes are established for creating provisions for these items. 17) Deferred tax The Bank recognizes a deferred tax asset or liability in respect of temporary differences between the tax and the book balance sheets, except for provisions for losses on other than unrecoverable loans. A deferred tax asset is not recognized for any amount exceeding future taxable income. 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 (Note 15). 18) Employee stock option plan The Bank has a long-term stock option plan allowing certain key officers to purchase shares of Mercantil Servicios Financieros, C.A. (MERCANTIL) (Note 16). The Bank makes contributions to Fundación BMA for share purchases and records them in the results for the year in which they are made. According to VEN NIF, the related expense is recorded at the fair value of options granted to employees and amortized over the vesting period. The effect of shares purchased for the stock option plan on the financial statements is also recognized. 19) 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 24). 20) Commissions collected Commissions collected on loans granted are shown as income when collected, whereas under VEN NIF, they are deferred and shown as income over the term of the loan. 21) Interest income Interest on loans, investments and accounts receivable is recorded as income when earned, except: a) interest receivable on loans more than 30 days overdue; b) interest on overdue or in-litigation loans, or other loans classified as real risk, high risk or unrecoverable; c) interest on current and rescheduled loans expected to be collected in 6 months or more and; d) overdue interest, which is recorded as income when collected. According to VEN NIF, interest is recorded as income when earned using the effective interest method. 11

16 In addition, interest accrued but not collected in respect of overdue loans is fully provided for. Interest on loan installments is fully provided for if repayment is more than 30 days past due. According to VEN NIF, interest is provided for based on collectibility. 22) Cash flows For purposes of the consolidated cash flow statement, the Bank considers cash and due from banks as cash equivalents. Under VEN NIF, investments and deposits maturing within 90 days are considered cash equivalents. 23) 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 SUDEBAN rules and instructions that do not differ from VEN NIF: a) Consolidation The consolidated financial statements include the accounts of the Bank, its Curacao branch and the agency in Coral Gables, FL, as well as the wholly owned subsidiary Inversiones y Valores Mercantil V, C.A. and its subsidiaries, domiciled in Venezuela. The Bank s agency, branch and subsidiaries are regulated by different accounting rules. The agency is regulated by accounting principles generally accepted in the United States of America and the branch by IFRS. They also follow bank practices generally used in the countries where they operate. Subsidiaries are mainly regulated by accounting principles generally accepted in Venezuela. However, necessary adjustments and groupings have been made to present the consolidated financial statements in accordance with the rules and instructions of SUDEBAN. b) Investment securities Investment securities are classified upon acquisition, based on their nature and intended use, as deposits with the BCV and overnight deposits, investments in trading securities, investments in available-for-sale securities, investments in held-to-maturity securities, investments in other securities and restricted investments. They are accounted for as described below: Deposits with the Central Bank of Venezuela (BCV) and overnight deposits Excess liquidity deposited at the BCV, overnight deposits and debt securities issued by Venezuelan financial institutions are included in this category. These investments are recorded at realizable value, representing cost or par value. In addition, this category includes securities acquired under repurchase agreements, which are recorded at the agreed value. Investments in available-for-sale securities Investments in available-for-sale debt and equity securities are recorded at fair value. Unrealized gains or losses, net of tax, resulting from differences in fair values are included in equity under unrealized gain (loss) on investments until they are sold. Investments in available-for-sale debt securities not listed on stock exchanges are recorded at fair value based principally on the present value of future cash flows of the securities. Investments in held-to-maturity securities Investments in debt securities that the Bank has the firm intention and ability to hold until maturity are recorded at cost, which should not differ significantly from fair value at purchase, and are subsequently adjusted for amortization of discounts or premiums. Discounts or premiums are amortized over the term of the securities as a credit or debit to income from investment securities. 12

17 The Bank assesses at each balance sheet date, or sooner if circumstances require it, whether there is objective evidence that financial assets are 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. Certain factors identified as indicators of impairment are, among others: 1) a prolonged period where fair value remains substantially below cost, 2) the financial difficulty 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) the Bank s inability to hold the investment long enough to allow for recovery of fair value. For the years ended, the Bank has identified no other-than-temporary impairments in the value of its investments. Restricted investments Restricted investments originating from other investment categories are measured using the same criteria used to record those investments from which they are derived. c) Investments in subsidiaries and affiliates Investments in shares of 20% to 50%-owned affiliates are shown using the equity method and are recorded in investments in affiliates (Note 6). Investments in companies less than 20% owned that the Bank has the intention of holding, and over whose administration it has significant influence, are recorded under the equity method or at cost. d) Investment securities acquired under resale agreements Securities acquired under resale agreements are recorded as deposits with the BCV and overnight deposits for the amount of funds transacted. The difference with respect to the resale price is recorded within interest income on an accrual basis (Note 4). e) Loan portfolio As required by SUDEBAN, commercial loans and term, mortgage and credit card loan installments are classified as overdue if repayment is more than 30 days past due. Advances on negotiated letters of credit are classified as overdue if not repaid within 270 days after their due date. Furthermore, the entire principal balance of term, mortgage or credit card loans is classified as overdue if repayment of any installment is more than 90 days late. In addition, the entire balance of loans granted to small businesses is considered past due if repayment of at least one monthly installment is 60 days overdue or one weekly installment is 14 days overdue. f) 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 sale of available-for-sale assets are included in income accounts. g) Property and equipment Property and equipment is shown net of accumulated depreciation. Depreciation is calculated 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. h) Deferred expenses Deferred expenses are mainly in respect of office setup, office improvement and software expenses. These expenses are recorded at cost, net of accumulated amortization. Amortization is calculated using the straight-line method over 4 years. 13

18 i) Use of estimates in the preparation of consolidated financial statements The preparation of consolidated financial statements and their notes requires management to make reasonable estimates 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 15) and the determination of fair values (Note 29). Below is a summary of the main bases used in the preparation of the consolidated financial statements: Contingent loans The provision for contingent loans is determined based on a collectibility assessment aimed at quantifying the specific allowance for possible losses on each loan considering, among other things, economic conditions, client credit risk, credit history and the fair value of guarantees received. The Bank performs its review on a quarterly basis in accordance with SUDEBAN rules. Loans of a similar nature are assessed as a whole to determine any applicable allowances. Other assets The Bank assesses the collectibility of items recorded under other assets using the same criteria, where applicable, as those applied to the loan portfolio. Furthermore, the Bank sets aside provisions for those items that require them due to their nature or aging, or following SUDEBAN requirements. Provision for legal and tax claims The Bank 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 (Notes 14 and 31). j) Income tax The tax provision is based on management s projection of tax results. The Bank records a deferred tax asset (liability) 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 15). k) Employee benefits Accrual for length-of-service benefits Based on the provisions of the LOTTT and the Bank s collective labor agreement, length-of-service benefits are a vested right of employees. Under the LOTTT, the Bank transfers guaranteed length-ofservice 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-ofservice 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 Bank 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. 14

19 Indemnity Under the LOTTT, if an employee 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, the Bank grants profit-sharing bonuses and vacation leave to its employees that match or exceed the legal minimums, and accrues the related liabilities as incurred (Note 14). l) Employee benefit plans Retirement pension plan The Bank 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 consolidated results for the year. The net costs of the retirement 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. Important changes in assumptions may affect the amount of future contributions. The Bank uses the projected unit credit method to calculate the present value of the Defined Benefit Obligation (DBO). The Bank makes annual contributions to the plan, except when the DBO is already covered by plan assets. Plan assets are recorded at fair value. Post-retirement benefits The Supplementary Defined Benefit Plan and the Supplementary Savings Plan include certain additional post-retirement benefits for the Bank s employees 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 The Bank maintains a defined contribution scheme called MERCANTIL Supplementary Savings Plan (Plan de Ahorro Previsional Complementario MERCANTIL) to replace the Supplementary Defined Benefit Plan (Plan Complementario de Pensiones de Jubilación). Contributions to the plan are recorded in the results for the year in which they are incurred. 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 employees of Mercantil Servicios Financieros, C.A. Under this Plan, employees contribute between 1% and 5% of their basic monthly salary and the Bank doubles the employee s contribution up to a maximum of 10% of said salary. m) Stock option plan The Bank has a long-term stock option plan of MERCANTIL shares for certain key officers. Stock options are recorded as equity. The Bank 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. n) Recognition of revenue, costs and expenses Income, costs and expenses are recorded as earned or incurred. Interest collected in advance is included within accruals and other liabilities as deferred income and recorded as income when earned (Note 14). 15