BANK OF CHILE | CIK:0001161125 |

(h)   Loans to customers:

 

(i)   Loan classification

 

Loans to customers include originated and purchased non-derivative financial assets with fixed or determinable payments that are not quoted on an active market and which the Bank does not intend to sell immediately or in the short-term.

 

Individual classified loans

 

An individual analysis of debtors is applied to individuals and companies that are of such significance with respect to size, complexity or level of exposure to the Bank that they must be analyzed in detail.

 

For purposes of establishing the appropriate allowances, the Bank classifies the debtors and their operations related to loans into one of three categories of loan portfolio: Normal, Substandard and Non-complying Loans.

 

(i.1)   Normal Loans:

 

Normal loans correspond to borrowers who are up to date on their payment obligations and show no sign of deterioration in their credit quality.

 

(i.2)   Substandard Loans:

 

Substandard loans include all borrowers with insufficient payment capacity or significant deterioration of payment capacity that it may be reasonably expected that they will not comply with all principal and interest payments obligations set forth in the credit agreement.

 

This category also includes all loans that have been non-performing for more than 30 days.

 

(i.3)   Non-complying Loans:

 

The non-complying loans correspond to borrowers whose payment capacity is seriously at risk and who have a high likelihood of filing for bankruptcy or are renegotiating credit terms to avoid bankruptcy.  This category comprises all loans outstanding from debtors that have at least one installment payment of interest or principal overdue for 90 days or more.

 

Group classified loans

 

The group analysis is used to analyze a large number of loans whose individual amounts are not significant.  For this analysis, the Bank uses models based on attributes of the debtors and their loans, and on the behavior of a group of loans.

 

Loans to customers include originated and purchased non-derivative financial assets with fixed or determinable payments that are not quoted on an active market and which the Bank does not intend to sell immediately or in the short-term.

 

(ii)   Valuation method

 

Loans are initially measured at cost plus incremental transaction costs, and subsequently measured at amortized cost using the effective interest rate method, except that when the Bank has defined certain loans as hedged items, which are measured at fair value, changes are recorded in the Consolidated Statement of Income.

 

(iii)   Lease contracts

 

Accounts receivable relating to leasing contracts, included under the caption “Loans to customers”, correspond to periodic rent installments of contracts, which meet the definition to be classified as financial leases and are presented at their nominal value net of unearned interest as of each year-end.

 

(iv)   Factoring transactions

 

This corresponds to invoices and other commercial instruments representative of credit, with or without recourse, received in factoring operations and which are registered to book value plus interest and adjustments until maturity.

 

In those cases where the transfer of these instruments was made without responsibility of the grantor, the Bank assumes the default risk.

 

(v)   Impairment of loans

 

At each year ended date, Banco de Chile and its subsidiaries assess whether there is objective evidence that a loan asset or a group of loans is impaired.  A loan asset or a group of loans is considered impaired, and impairment losses are incurred if:

 

(a)   there is objective evidence of impairment as a result of a loss event that occurred after the initial recognition of the asset and up to the balance sheet date (“a loss event”);

 

(b)   the loss event had an impact on the estimated future cash flows of the financial asset or the group of financial assets; and,

 

(c)   a reliable estimate of the loss amount can be made.

 

Banco de Chile and its subsidiaries first assess whether objective evidence of impairment exists for loans that are individually significant.  It then assesses collectively for loans that are not individually significant and loans which are significant but for which no objective evidence of impairment was observed as a result of the individual assessment.

 

(i)   Allowances for individual evaluations:

 

An individual analysis of debtors is applied to individuals and companies that are of such significance with respect to size, complexity or level of exposure to the Bank, that they must be analyzed in detail.  All corporate customers are evaluated individually and for commercial customers the cut-off amount for the individual evaluation is MCh$536.

 

To allow management to determine whether a loss event has occurred on an individual basis, all significant counterparty relationships are reviewed periodically.  This evaluation considers current information and events related to the counterparty, such as whether the counterparty is experiencing significant financial difficulty or in breach of contract as, for example, default or delinquency in interest or principal payments.

 

The individual evaluation requires assigning a risk category to each debtor and its respective loans.  This risk category should consider the following factors: industry or sector, group considerations and management, financial situation, payment behavior and payment capacity.

 

If there is evidence of impairment leading to an impairment loss for an individual counterparty relationship, then the amount of the loss is determined as the difference between the carrying amount of the loan(s), including accrued interest, and the present value of expected future cash flows discounted at the loan’s original effective interest rate or the effective interest rate established upon reclassification to loans, including cash flows that may result from foreclosure less costs for obtaining and selling the collateral.  The carrying amount of the loans is reduced by the use of an allowance account and the amount of the loss is recognized in the income statement as a component of the provision for credit losses.

 

(ii)   Allowances for group evaluations:

 

The collective assessment of impairment is used primarily to establish an allowance amount relating to loans that are either individually significant but for which there is no objective evidence of impairment, or are not individually significant but for which there is, on a portfolio basis, a loss amount that is probable of having occurred and is reasonably estimable.  The loss amount has two components.

 

The first component is an allowance amount representing the incurred losses on the portfolio of smaller balance homogeneous loans, which are loans to individuals and small business customers of the private and retail business.  The loans are grouped according to similar credit risk characteristics and the allowance for each group is determined using statistical models based on historical experience.  The second component represents an estimate of incurred losses inherent in the group of loans that have not yet been individually identified or measured as part of the smaller-balance homogeneous loans.  Loans that were found not to be impaired when evaluated on an individual basis are included in the scope of this component of the allowance.

 

Once a loan is identified as impaired, although the accrual of interest in accordance with the contractual terms of the loan is discontinued, the accretion of the net present value of the written down amount of the loan due to the passage of time is recognized as interest income based on the original effective interest rate of the loan.

 

At each balance sheet date, all impaired loans are reviewed for changes to the present value of expected future cash flows discounted at the loan’s original effective interest rate.  Any change to the previously recognized impairment loss is recognized as a change to the allowance account and recorded in the income statement as a component of the provision for credit losses.

 

Loans are written-off when collection efforts have been exhausted, but not later than the following maximum periods:

 

 

The term represents the time elapsed for a loan from the date on which the unpaid collection or portion is in default.

 

Cash recoveries on written-off loans are recorded directly in income, through the provision for credit losses in the Consolidated Statement of Comprehensive Income.

 

If in a subsequent period the amount of a previously recognized impairment loss decreases and the decrease is due to an event occurring after the impairment was recognized, the impairment loss is reversed by reducing the allowance account accordingly.  Such reversal is recognized in profit or loss through a direct impact to the provision for credit losses.

 

(vi)  Renegotiated loans:

 

The Bank attempts to restructure loans rather than to take possession of collateral.  This may involve extending the payment arrangements and the agreement of new loan conditions.  After having renegotiated the terms, any impairment is measured using the original effective interest rate as calculated before the modification of terms and the loan is no longer considered past due.  Renegotiated loans are continuously reviewed by management to ensure that all criteria are met and that future payments are likely to occur.  The loans continue to be subject to an individual or collective impairment assessment, calculated using the loan’s original effective interest rate.

 

(vii) Collateral valuation:

 

The Bank seeks to use collateral, where possible, to mitigate its risks on financial assets. The collateral comes in various forms such as mortgages, pledges, securities, other non-financial assets and credit enhancements.  The fair value of collateral is generally assessed, at a minimum, at inception through a certified appraiser.  Later, a model updates the collateral value considering factors such as location, collateral type, and observable market value, among others.  However, some types of collateral, such as securities, are valued daily.  To the extent possible, the Bank uses active market data for valuing financial assets held as collateral. (See Note 42 for further analysis of collateral).