United States
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 20-F
OR
For the fiscal year ended: June 30, 2008
Date of event requiring this shell company report
For the transition period from to
Commission file number: 1-13542
IRSA INVERSIONES Y REPRESENTACIONES SOCIEDAD ANÓNIMA
(Exact name of Registrant as specified in its charter)
IRSA INVESTMENTS AND REPRESENTATIONS INC.
(Translation of Registrant’s name into English)
Republic of Argentina
(Jurisdiction of incorporation or organization)
Bolívar 108
(C1066AAB) Buenos Aires, Argentina
(Address of principal executive offices)
Gabriel Blasi
Chief Financial Officer
Tel +(5411) 4323-7449 – finanzas@irsa.com.ar
Moreno 877 22nd Floor
(C1091AAQ) Buenos Aires, Argentina
(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
Securities registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Global Depositary Shares, each representing
ten shares of Common Stock
Securities registered or to be registered pursuant to Section 12(g) of the Act: None
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act: None
The number of outstanding shares of the issuer’s common stock as of June 30, 2008 was 578,676,460.
Indicate by check mark if the registrant is a well known seasoned issuer, as defined in Rule 405 of the Securities Act:
¨ Yes x No
If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934.
x Yes ¨ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:
If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.
¨ Item 17 x Item 18
If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Table of Contents
Disclosure Regarding Forward-Looking Information
Certain Measurements and Terms
Presentation of Financial and Certain Other Information
Market Data
Item 1
Item 2
Item 3
Item 4
Item 4 A
Item 5
Item 6
2
Item 7
Item 8
Item 9
Item 10
Item 11
Item 12
Item 13
Item 14
Item 15
3
Item 16
Part III
Item 17
Item 18
Item 19
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DISCLOSURE REGARDING FORWARD-LOOKING INFORMATION
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward looking statements.
This annual report includes forward-looking statements, principally under the captions “Summary,” “Risk Factors,” “Operating and Financial Review and Prospects” and “Business Overview.” We have based these forward-looking statements largely on our current beliefs, expectations and projections about future events and financial trends affecting our business. Many important factors, in addition to those discussed elsewhere in this annual report, could cause our actual results to differ substantially from those anticipated in our forward-looking statements, including, among other things:
changes in general economic, business, political or other conditions in Argentina or changes in general economic or business conditions in Latin America;
changes in capital markets in general that may affect policies or attitudes toward lending to or investing in Argentina or Argentine companies;
changes in exchange rates or regulations applicable to currency exchanges or transfer;
unexpected developments in pending litigation;
increased costs;
unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms; and
the risk factors discussed under “Risk Factors”.
The words “believe,” “may,” “will,” “aim,” “estimate,” “continue,” “anticipate,” “intend,” “expect,” “forecast” and similar words are intended to identify forward-looking statements. Forward-looking statements include information concerning our possible or assumed future results of operations, business strategies, financing plans, competitive position, industry environment, potential growth opportunities, the effects of future regulation and the effects of competition. Forward-looking statements speak only as of the date they were made, and we undertake no obligation to update publicly or to revise any forward-looking statements after we distribute this annual report because of new information, future events or other factors. In light of the risks and uncertainties described above, the forward-looking events and circumstances discussed in this annual report might not occur and are not guarantees of future performance.
CERTAIN MEASUREMENTS AND TERMS
As used throughout this annual report, the terms “IRSA,” the “Company,” “we,” “us,” and “our” refer to IRSA Inversiones y Representaciones Sociedad Anónima, together with our consolidated subsidiaries, except where we make clear that such terms refer only to the parent company.
In Argentina the standard measure of area in the real estate market is the square meter (m2), while in the United States and certain other jurisdictions, the standard measure of area is the square foot (sq. ft.). All units of area shown in this annual report (e.g., gross leasable area of buildings and size of undeveloped land) are expressed in terms of square meters. One square meter is equal to approximately 10.764 square feet. One hectare is equal to approximately 10,000 square meters and approximately 2.47 acres.
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PRESENTATION OF FINANCIAL AND CERTAIN OTHER INFORMATION
In this annual report where we refer to “Peso,” “Pesos,” or “Ps.” we mean Argentine pesos, the lawful currency in Argentina; when we refer to “U.S. dollars,” or “US$” we mean United States dollars, the lawful currency of the United States of America; and when we refer to “Central Bank” we mean the Argentine Central Bank.
This annual report contains our audited consolidated financial statements as of June 30, 2008 and 2007 and for the fiscal years ended June 30, 2008, 2007 and 2006 (our audited consolidated financial statements), which have been audited by Price Waterhouse & Co. S.R.L., Buenos Aires, Argentina, a member firm of PricewaterhouseCoopers, an independent registered public accounting firm, whose report is included herein.
We prepare our consolidated financial statements as of June 30, 2008 and 2007 in thousands of Pesos and in accordance with generally accepted accounting principles in Argentina, as set forth by the Federación Argentina de Consejos Profesionales de Ciencias Económicas (“FACPCE”) and as implemented, adapted, amended, revised and/or supplemented by the Consejo Profesional de Ciencias Económicas de la Ciudad Autónoma de Buenos Aires (“CPCECABA”) (collectively, “Argentine GAAP”) and the regulations of theComisión Nacional de Valores, which differ in certain significant respects from accepted accounting principles in the United States of America (“U.S. GAAP”). Such differences involve methods of measuring the amounts shown in the consolidated financial statements as well as additional disclosures required by U.S. GAAP and Regulation S-X of the U.S. Securities and Exchange Commission (“SEC”). See Note 28 to our consolidated financial statements for a description of the principal differences between Argentine GAAP and U.S. GAAP, as they relate to us, and reconciliation to U.S. GAAP of net income and shareholders’ equity.
In order to comply with regulations of the Comisión Nacional de Valores, we recognized deferred income taxes on an undiscounted basis. This accounting practice represented a departure from Argentine GAAP for the years ended June 30, 2006. However, such departure has not had a material effect on our consolidated financial statements. As further discussed below, the CPCECABA issued revised accounting standards, one of which required companies to account for deferred income taxes on an undiscounted basis, thus aligning its accounting practices with that of the Comisión Nacional de Valores. Since the Comisión Nacional de Valores adopted the CPCECABA standards effective for our fiscal year ended June 30, 2007, there was no longer a difference on this subject between Argentine GAAP and the Comisión Nacional de Valores regulations.
In order to comply with the regulations of the Comisión Nacional de Valores, we discontinued inflation accounting as of February 28, 2003. Since Argentine GAAP required companies to discontinue inflation adjustments only as from October 1, 2003, the application of Comisión Nacional de Valores resolution represented a departure from Argentine GAAP. However, due to low inflation rates during the period from March to September 2003, such a departure has not had a material effect on the consolidated financial statements.
In compliance with Rule 3-09 of Regulation S-X, also contained in this annual report are the consolidated financial statements of Banco Hipotecario S.A. (“Banco Hipotecario”) as of June 30, 2008 and 2007 and for the twelve months ended June 30, 2008, 2007 and 2006, which also have been audited by Price Waterhouse & Co. S.R.L., Buenos Aires, Argentina, a member firm of PricewaterhouseCoopers, an independent registered public accounting firm, whose report is included herein.
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The Comisión Nacional de Valores issued General Resolutions 485 and 487 on December 29, 2005 and January 26, 2006, respectively, adopting with certain modifications, the new accounting standards previously issued by the CPCECABA through its Resolution CD 93/2005. These standards were effective for our fiscal year ended June 30, 2007. The most significant changes included in the accounting standards adopted by the Comisión Nacional de Valores related to (i) changes in the impairment test of long-lived assets and (ii) changes to deferred income tax accounting. Under the new standards, the carrying value of a long-lived asset is considered impaired by a company when its value in use or its net realizable value, whichever is greater, is less than its carrying value. Value in use is determined by the expected cash flows from the assets discounted at a rate commensurate with the risk involved. Net realizable value is determined by the selling price of the assets less costs to sell. The new standards also provided for the accounting treatment of differences between the tax basis and book basis of non-monetary items for deferred income tax calculation purposes when companies prepare price-level restated financial statements. The new accounting standard mandated companies to treat these differences as temporary but allowed a one-time accommodation to continue treating those differences as permanent at the time of adoption of the standard. As a result, we elected to continue treating differences as permanent.
Certain amounts which appear in this annual report (including percentage amounts) may not sum due to rounding. Solely for the convenience of the reader, we have translated certain Peso amounts into U.S. dollars at the exchange rate quoted by the Central Bank for June 30, 2008, which was Ps.3.025 = US$1.00. We make no representation that the Peso or U.S. dollar amounts actually represent or could have been or could be converted into U.S. dollars at the rates indicated, at any particular rate or at all.
References to fiscal years 2004, 2005, 2006, 2007 and 2008 are to the fiscal years ended June 30 of each such year.
MARKET DATA
Market data used throughout this annual report were derived from reports prepared by unaffiliated third-party sources. Such reports generally state that the information contained therein has been obtained from sources believed by such sources to be reliable.
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PART I
This item is not applicable.
A. Selected Financial Data
The following selected consolidated financial data has been derived from our audited consolidated financial statements as of the dates and for each of the periods indicated below. This information should be read in conjunction with and is qualified in its entirety by reference to our consolidated financial statements and the discussion in Operating and Financial Review and Prospects included elsewhere in this annual report. The selected consolidated statement of income data for the years ended June 30, 2008, 2007, and 2006 and the selected consolidated balance sheet data as of June 30, 2008 and 2007 have been derived from our consolidated financial statements which have been audited by Price Waterhouse & Co. S.R.L., Buenos Aires, Argentina, a member firm of PricewaterhouseCoopers, an independent registered public accounting firm.
The selected consolidated income statement data for the years June 30, 2005 and 2004 and the selected consolidated balance sheet data as of June 30, 2006 and 2005 have been derived from our audited consolidated financial statements as of June 30, 2006 and 2005 and for the three years in the period ended June 30, 2006 which are not included herein. Certain reclassifications have been made to financial data derived from the audited consolidated financial statements as of June 30, 2006 and 2005 and for the three years in the period ended June 30, 2006 to conform to the presentation of our fiscal year ended June 30, 2008. The reclassifications had no impact on previously reported net income, net income per share, shareholders equity or cash flows.
The selected consolidated balance sheet data as of June 30, 2004 have been derived from our audited consolidated financial statements as of June 30, 2005 and 2004 and for each of the three years in the period ended June 30, 2005, which are not included herein. Certain reclassifications have been made to financial data derived from the audited consolidated financial statements as of June 30, 2005 and 2004 and for the three years in the period ended June 30, 2005 to conform to the presentation of our fiscal year ended June 30, 2008. The reclassifications had no impact on previously reported net income, net income per share, shareholders equity or cash flows.
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Summary Consolidated Financial and Other Information for IRSA
STATEMENT OF INCOME DATA
Argentine GAAP
Revenues:
Development and sale of properties
Office and other non-shopping center rental properties
Shopping centers
Consumer financing
Hotel operations
Financial operations and others
Total revenues
Costs
Gross profit (loss):
Total gross profit
Gain from recognition of inventories at net realizable value
Selling expenses
Administrative expenses
Net (loss) income from retained interest in securitized receivables
Gain from operations and holdings of real estate assets, net
Operating income (loss):
Total operating income
Amortization of negative goodwill, net
(Loss) gain on equity investees
Financial results, net
Other expenses, net
Income before taxes and minority interest
Income tax and MPIT
Minority interest
Net income
Basic net income per share(3)
Basic net income per GDS(3)
Diluted net income per share(4)
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Diluted net income per GDS(4)
Weighted - average number of shares outstanding
Adjusted weighted - average number of shares(4)
Capital Stock
U.S. GAAP
Revenues
Gross profit
Gain on purchasers’ rescissions of sales
Operating (loss) income
Other incomes (expenses), net
Basic net income (loss) per share(3)
Basic net income (loss) per GDS(3)
Basic net income (loss) before extraordinary items and accounting changes per share(3)
Diluted net income (loss) per share(4)
Diluted net income (loss) per GDS(4)
Diluted net income (loss) before extraordinary items and accounting changes per share(4)
BALANCE SHEET DATA
Cash and banks and current investments
Inventories
Accounts receivable, net
Non-current investments(5)
Fixed assets, net
Total current assets
Total assets
Short-term debt(6)
Total current liabilities
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Long-term debt(7)
Total non-current liabilities
Shareholders’ equity
Other receivables and prepaid expenses
Intangible assets, net
Trade accounts payable
Other liabilities
CASH FLOW DATA
Net cash provided by operating activities
Net cash used in investing activities
Net cash provided by (used in) financing activities
U.S. GAAP(8)
Effect of exchange rate changes on cash and cash equivalents
OTHER FINANCIAL DATA
Capital expenditures(9)
Depreciation and amortization(10)
Ratio of current assets to current liabilities
Ratio of shareholders’ equity to total liabilities
Ratio of non-current assets to total assets
Working capital(11)
Solely for the convenience of the reader, we have translated Peso amounts into U.S. dollars at the exchange rate quoted by Banco de la Nación Argentina for June 30, 2008 which was Ps.3.025 per US$1.00. We make no representation that the Peso or U.S. dollar amounts actually represent,
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could have been or could be converted into dollars at the rates indicated, at any particular rate or at all. See “Exchange Rates and Exchange Controls.” Sums may not total due to rounding.
Exchange Rates
In April 1991, Argentine law established a fixed exchange rate according to which the Central Bank was statutorily obliged to sell U.S. dollars to any individual at a fixed exchange rate of Ps.1.00 per US$1.00. On January 7, 2002, the Argentine congress enacted the Public Emergency Law, abandoning over ten years of fixed Peso-U.S. dollar parity at Ps.1.00 per US$1.00. After devaluing the Peso and setting the official exchange rate at Ps.1.40 per US$1.00, on February 11, 2002, the government allowed the Peso to float. The shortage of U.S. dollars and their heightened demand caused the Peso to further devalue significantly in the first half of 2002. Since June 30, 2002, the Peso has appreciated versus the U.S. dollar from an exchange rate of Ps.3.80 =US$1.00 to an exchange rate of Ps.3.4060=US$1.00 at December 17, 2008 as quoted by Banco de la Nación Argentina at the U.S. dollar selling rate. During the fiscal year 2008, the Central Bank has indirectly affected the exchange rate market, through active participation, in order to counteract external shocks.
The following table presents the high, low, average and period closing exchange rate for the purchase of U.S. dollars stated in nominal Pesos per U.S. dollar.
Fiscal year ended June 30, 2003
Fiscal year ended June 30, 2004
Fiscal year ended June 30, 2005
Fiscal year ended June 30, 2006
Fiscal year ended June 30, 2007
Fiscal year ended June 30, 2008
June 2008
July 2008
August 2008
September 2008
October 2008
November 2008
December 2008
Source: Banco de la Nación Argentina
Fluctuations in the Peso-dollar exchange rate may affect the equivalent in dollars of the price in Pesos of our shares on the Buenos Aires Stock Exchange. Increases in Argentine inflation or devaluation of the Argentine currency could have a material adverse effect on our operating results.
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B. Capitalization and Indebtedness
C. Reasons for the Offer and Use of Proceeds
D. Risk Factors
You should carefully consider the risks described below, in addition to the other information contained in this annual report. We may face additional risks and uncertainties that are not presently known to us, or that we currently deem immaterial, which may also impair our business. In general, you take more risk when you invest in the securities of issuers in emerging markets such as Argentina than when you invest in the securities of issuers in the United States. You should understand that an investment in our common shares and GDSs involves a high degree of risk, including the possibility of loss of your entire investment.
Risks Related to Argentina
Argentina’s recent growth may not be sustainable.
The Argentine economy has experienced significant volatility in recent decades, characterized by periods of low or negative growth, high inflation and currency devaluation. During 2001 and 2002, Argentina experienced a period of severe political, economic and social crisis, which caused a significant economic contraction and led to radical changes in government policies. Although the economy has recovered significantly since then, uncertainty remains as to whether the recent growth is sustainable, since it has depended, to a significant extent, on favorable exchange rates, high commodity prices and excess capacity. The recovery, however, has resulted in inflation and has intensified the country’s need for capital investment, with many sectors, in particular the energy sector, operating near full capacity. Additionally, the current global financial crisis and economic downturn has begun to have a significant adverse impact on the country’s performance and could worsen in the foreseeable future. Commodities prices, particularly those related to Argentine exports such as soybean, have declined significantly recently. Access to international financing, already limited as a result of the sovereign default in 2002, is currently virtually unavailable. Moreover, the country’s relative stability since 2002 has been affected recently, by increased political tension and government intervention in the economy.
Our business depends to a significant extent on macroeconomic and political conditions in Argentina. We cannot assure you that Argentina’s recent growth will continue. A deterioration in the country’s economy would likely have a significant adverse effect on our business, financial condition and results of operations.
Continuing inflation may have an adverse effect on the economy.
The devaluation of the Peso in January 2002 created pressures on the domestic price system that generated high inflation throughout 2002, before inflation substantially stabilizing in 2003. However, inflationary pressures have since reemerged with consumer prices increasing by 12.3% in 2005. In 2006 and in 2007, inflation was 9.8% and 8.5%, respectively, in part due to actions implemented by the Argentine government to control inflation, which included limitations on exports and price arrangements agreed to with private sector companies. However, in spite of this decline in inflation, uncertainty surrounding future inflation may impact the country’s growth.
As of November 30, 2008, according to the argentine statistics and census agency, or INDEC, consumer prices increased by 7.9% on an annualized basis.
In the past, inflation has undermined the Argentine economy and the government’s ability to create conditions conducive to growth. A return to a high inflation environment would impact in the long term credit
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market and real estate market and may also affect Argentina’s foreign competitiveness by diluting the effects of the Peso devaluation and negatively impacting the level of economic activity and employment. If inflation remains high or continues to rise, Argentina’s economy may be negatively impacted and our business could be adversely affected
There are concerns about the accuracy of Argentina’s official inflation statistics.
In January 2007, INDEC modified its methodology used to calculate the consumer price index, which is calculated as the monthly average of a weighted basket of consumer goods and services that reflects the pattern of consumption of Argentine households. Several economists as well as the international and Argentine press have suggested that this change in methodology was related to the Argentine government’s policy aimed at curbing inflation. At the time that INDEC adopted this change in methodology, the Argentine government also replaced several key personnel at INDEC, prompting complaints of governmental interference from the technical staff at INDEC . In addition, the International Monetary Fund, or IMF, has requested that the government clarify its inflation rates. More recently, in June 2008, INDEC published a new consumer price index that eliminates nearly half of the items included in previous surveys and introduces adjustable weightings for fruit, vegetables and clothing, which have seasonal cost variations. INDEC has indicated that it based its evaluation of spending habits on a study of a national household consumption survey from 2004 to 2005 in addition to other sources; however, the new index has been criticized by economists and investors after its debut report found prices rising well below expectations. These events have affected the credibility of the consumer price index published by INDEC, as well as other indexes published by INDEC which require the consumer price index for their own calculation, including the poverty index, the unemployment index and real gross domestic product. Argentina’s inflation rate may be significantly higher than the rates indicated by official reports,. In addition, if it is determined that it is necessary to correct the consumer price index and the other INDEC indexes derived from the consumer price index, there could be a significant decrease in confidence in the Argentine economy, which could, in turn, have a materially adverse effect on our ability to access international credit markets at market rates to finance our operations.
Argentina’s ability to obtain financing from international markets is limited which may affect its ability to implement reforms and foster economic growth.
In the first half of 2005, Argentina restructured part of its sovereign debt that had been in default since the end of 2001. The Argentine government announced that as a result of the restructuring, it had approximately US$126.6 billion in total outstanding debt remaining. Of this amount, approximately US$19.5 billion are defaulted bonds owned by creditors who did not participate in the restructuring of the external financial debt. As of June 30, 2008, the total outstanding debt was approximately US$ 149.8 billion.
Some bondholders in the United States, Italy and Germany have filed legal actions against Argentina, and holdout creditors may initiate new suits in the future. Additionally, foreign shareholders of certain Argentine companies have filed claims in excess of US$17 billion before the International Centre for the Settlement of Investment Disputes, or ICSID, alleging that certain government measures are inconsistent with the fair and equitable treatment standards set forth in various bilateral treaties to which Argentina is a party. As of the date of this annual report, the ICSID has rendered decisions in eight cases, requiring the Argentine government to pay approximately US$ 1.0 billion plus interest in claims.
Argentina has recently reinitiated discussions with holdout creditors and certain multilateral institutions. However, Argentina’s past default and its failure to restructure completely its remaining sovereign debt and fully negotiate with the holdout creditors may prevent Argentina from reentering the international capital markets. Litigation initiated by holdout creditors as well as ICSID claims may result in material judgments against the Argentine government and could result in attachments of, or injunctions relating to, assets of Argentina that the government intended for other uses. As a result, the government may not have the financial resources necessary to implement reforms and foster growth which could have a material adverse effect on the country’s economy and, consequently, our business. In addition, the difficulties Argentina faces to access financing in the international markets could have an adverse effect on our capacity to obtain financing in the international markets in order to finance our operations and growth.
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Significant devaluation of the Peso against the U.S. dollar may adversely affect the Argentine economy as well as our financial performance.
Despite the positive effects of the real depreciation of the Peso in 2002 on the competitiveness of certain sectors of the Argentine economy, it has also had a far-reaching negative impact on the Argentine economy and on businesses and individuals’ financial condition. The devaluation of the Peso has had a negative impact on the ability of Argentine businesses to honor their foreign currency-denominated debt, initially led to very high inflation, significantly reduced real wages, had a negative impact on businesses whose success is dependent on domestic market demand, such as utilities and the financial industry, and adversely affected the government’s ability to honor its foreign debt obligations.
If the Peso devalues significantly, all of the negative effects on the Argentine economy related to such devaluation could recur, with adverse consequences to our business. Moreover, it would likely result in a decline in the value of our common shares and the ADSs as measured in U.S. dollars.
Significant appreciation of the Peso against the U.S. dollar may adversely affect the Argentine economy.
A substantial increase in the value of the Peso against the U.S. dollar also presents risks for the Argentine economy. The appreciation of the Peso against the U.S. dollar negatively impacts the financial condition of entities whose foreign currency-denominated assets exceed their foreign currency-denominated liabilities, such as us. In addition, in the short term, a significant real appreciation of the Peso would adversely affect exports. This could have a negative effect on GDP growth and employment as well as reduce the Argentine public sector’s revenues by reducing tax collection in real terms, given its current heavy reliance on taxes on exports. The appreciation of the Peso against the U.S. dollar could have an adverse effect on the Argentine economy and our business.
Government measures to preempt or respond to social unrest may adversely affect the Argentine economy.
The Argentine government has historically exercised significant influence over the country’s economy. Additionally, the country’s legal and regulatory frameworks have at times suffered radical changes, undue political influence and significant uncertainties. Moreover, during its crisis in 2001 and 2002, Argentina experienced significant social and political turmoil, including civil unrest, riots, looting, nationwide protests, strikes and street demonstrations. Despite Argentina’s economic recovery and relative stabilization, social and political tension and high levels of poverty and unemployment continue. In 2008, Argentina faced nationwide strikes and protests from farmers due to increased export taxes on agricultural products, which disrupted economic activity and have heightened political tension. Future government policies to preempt, or in response to, social unrest may include expropriation, nationalization, forced renegotiation or modification of existing contracts, suspension of the enforcement of creditors’ rights, new taxation policies, including royalty and tax increases and retroactive tax claims, and changes in laws and policies affecting foreign trade and investment. Such policies could destabilize the country and adversely and materially affect the economy, and thereby our business.
The nationalization of Argentina’s pension funds will adversely affect local capital markets.
In December 2008, the Argentina government transferred the approximately Ps. 94.4 billion (US$29.3 billion) in assets held by the country’s ten private Administradoras de Fondos de Jubilaciones y Pensiones (pension fund management companies, or “AFJPs”) to the government-run social security agency (ANSES).
AFJPs were the largest participants in the country’s local capital market. With the nationalization of their assets, the local capital market is expected to diminish in size and be substantially concentrated in the hands of the government. In addition, the government will become a significant shareholder in many of the country’s private companies. As a result, access to liquidity may be further limited, funding costs may rise and the government may have greater influence over the operations of private companies.
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The nationalization of the AFJPs has adversely affected investor confidence in Argentina. In addition, we cannot assure you that the government will not take similar measures in the future that interfere with private sector businesses and adversely affect the economy.
Exchange controls and restrictions on transfers abroad and capital inflow restrictions have limited, and can be expected to continue to limit, the availability of international credit.
In 2001 and 2002, Argentina imposed exchange controls and transfer restrictions substantially limiting the ability of companies to retain foreign currency or make payments abroad. Many of these restrictions were substantially eased after the crisis. However, in June 2005, the government issued decree No. 616/2005, that established additional controls on capital inflows, including the requirement that, subject to limit exemptions, 30% of funds remitted to Argentina remain deposited in a domestic financial institution for one year without earning any interest. This measure increases the cost of obtaining foreign funds and limits access to these funds.
The Argentine government may impose additional controls on the foreign exchange market and on capital flows from and into Argentina, in the future, for example in response to capital flight or depreciation of the peso. These restrictions may have a negative effect on the economy and our business if imposed in an economic environment where access to local capital is substantially constrained.
Payment of dividends to non-residents has been limited in the past and may be limited again.
Beginning in February 2002, the payment of dividends, irrespective of amount, outside Argentina required prior authorization from the Central Bank. On January 7, 2003, the Central Bank issued communication “A” 3859 eliminating the limitation on companies´ ability to purchase foreign currency and transfer it outside Argentina to pay dividends. However similar restrictions may be enacted by the Argentine government or the Central Bank again and, if this were to occur, it could have an adverse effect on the value of our common shares and the ADSs. Moreover, in such event, restrictions on the transfers of funds abroad may impede your ability to receive dividend payments as a holder of ADSs.
The stability of the Argentine banking system is uncertain.
During 2001 and the first half of 2002, a significant amount of deposits were withdrawn from Argentine financial institutions. This massive withdrawal of deposits was largely due to the loss of confidence of depositors in the Argentine government’s ability to repay its debts, including its debts within the financial system, and to maintain peso-dollar parity in the context of its solvency crisis. To prevent a run on the U.S. dollar reserves of local banks, the government restricted the amount of money that account holders could withdraw from banks and introduced exchange controls restricting capital outflows. While the condition of the financial system has improved, adverse economic developments, even if not related to or attributable to the financial system, could result in deposits flowing out of the banks and into the foreign exchange market, as depositors seek to shield their financial assets from a new crisis. Any run on deposits could create liquidity or even solvency problems for financial institutions, resulting in a contraction of available credit.
In the event of a future shock, such as the failure of one or more banks or a crisis in depositor confidence, the Argentine government could impose further exchange controls or transfer restrictions and take other measures that could lead to renewed political and social tensions and undermine the Argentine government’s public finances, which could adversely affect Argentina’s economy and prospects for economic growth.
The Argentine economy could be adversely affected by economic developments in other global markets, in particular the current global financial crisis and economic downturn.
Financial and securities markets in Argentina are influenced, to varying degrees, by economic and market conditions in other global markets. Although economic conditions vary from country to country, investors’ perception of the events occurring in one country may substantially affect capital flows into other countries, including Argentina and the availability of funds for issuers in such countries. Lower capital inflows and declining securities prices negatively affect the real economy of a country through higher interest rates or currency volatility.
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The Argentine economy was adversely impacted by the political and economic events that occurred in several emerging economies in the 1990s, including Mexico in 1994, the collapse of several Asian economies between 1997 and 1998, the economic crisis in Russia in 1998 and the Brazilian devaluation in January 1999.
In addition, Argentina may also be affected by the economic conditions of major trade partners, such as Brazil, or countries such as the United States, that are significant trade partners and/or have influence over world economic cycles. If interest rates rise significantly in developed economies, including the United States, Argentina and other emerging market economies could find it more difficult and expensive to borrow capital and refinance existing debt, which would negatively affect their economic growth. In addition, if these countries, which are also Argentina’s trade partners, fall into a recession the Argentine economy would be impacted by a decrease in exports. All of these factors would have a negative impact on us, our business, operations, financial condition and prospects.
In 2008, particularly in recent months, the global financial system has been experiencing unprecedented volatility and disruption. The current financial turmoil has led to a significant tightening of credit, low levels of liquidity, extreme volatility in fixed income, credit, currency and equity markets and capital outflows away from emerging markets, including Argentina. This financial crisis has also begun to significantly and adversely impact global economic conditions. Countries around the world are currently experiencing a significant deterioration in economic conditions, including the United States which is currently in a pronounced recession. These conditions have had a negative impact on the Argentine economy, and could continue to adversely affect the conditions in the country in the foreseeable future. Although the extent of the impact is difficult to predict at this time, current global financial and economic conditions are expected to have a material adverse effect on Argentina’s economy, and consequently on our business.
If the decline in international prices for Argentina’s main commodity exports continues it could have an adverse effect on Argentina’s economic growth and on our business
Argentina’s economy has historically relied on the export of commodities, the prices of which have been volatile in the past and largely outside its control.
Argentina’s recovery from the crisis at 2001 and 2002 has depended to a significant extent on the rise in commodity the prices, particularly prices of its main commodity exports, such as soybean. High commodity prices have contributed significantly to government revenues from taxes on exports. In recent months, the prices of the commodities that Argentina exports have decline significantly. If commodity prices continue to decline, the growth of the Argentine economy, could be adversely affected. Such occurrence would have a negative impact on the levels of government revenues and the government’s ability to service its debt.
Restrictions on the supply of energy could negatively affect Argentina’s economy.
As a result of several years of recession, and the forced conversion into Pesos and subsequent freeze of gas and electricity tariffs, there has been a lack of investment in gas and electricity supply and transport capacity in Argentina in recent years. At the same time, demand for natural gas and electricity has increased substantially, driven by a recovery in economic conditions and price constraints. The federal government has been taking a number of measures to alleviate the short-term impact of energy shortages on residential and industrial users. If these measures prove to be insufficient, or if the investment that is required to increase natural gas production and transportation capacity and energy generation and transportation capacity over the medium-and long-term fails to materialize on a timely basis, economic activity in Argentina could be curtailed.
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Risks Relating to our Business
Our performance is subject to risks associated with our properties and with the real estate industry.
Our economic performance and the value of our real estate assets, and consequently the value of the securities issued by us, are subject to the risk that if our properties do not generate sufficient revenues to meet its operating expenses, including debt service and capital expenditures, our cash flow and ability to pay distributions to our shareholders will be adversely affected. Events or conditions beyond our control that may adversely affect our operations or the value of our properties include:
downturns in the national, regional and local economic climate;
volatility and decline in discretionary spending;
competition from other office, industrial and commercial buildings;
local real estate market conditions, such as oversupply or reduction in demand for office, or other commercial or industrial space;
changes in interest rates and availability of financing;
the exercise by our tenants of their legal right to early termination of their leases;
vacancies, changes in market rental rates and the need to periodically repair, renovate and re-lease space;
increased operating costs, including insurance expense, utilities, real estate taxes, state and local taxes and heightened security costs;
civil disturbances, earthquakes and other natural disasters, or terrorist acts or acts of war which may result in uninsured or underinsured losses;
significant expenditures associated with each investment, such as debt service payments, real estate taxes, insurance and maintenance costs which are generally not reduced when circumstances cause a reduction in revenues from a property;
declines in the financial condition of our tenants and our ability to collect rents from them;
changes in our ability or our tenants’ ability to provide for adequate maintenance and insurance, possibly decreasing the useful life of and revenue from property; and
law reforms and governmental regulations (such as those governing usage, zoning and real property taxes).
If any one or more of the foregoing conditions were to affect our business, it could have a material adverse effect on our financial condition and results of operations.
Our investment in property development or redevelopment may be less profitable than we anticipate.
We are engaged in the development and construction of office space, retail and residential properties, frequently through third-party contractors. Risks associated with our development, re-development and construction activities include the following, among others:
abandonment of development opportunities and renovation proposals;
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construction costs of a project may exceed its original estimates for reasons including raises in interest rates or increases in the costs of materials and labor, making a project unprofitable;
occupancy rates and rents at newly completed properties may fluctuate depending on a number of factors, including market and economic conditions, resulting in lower than projected rental rates and a corresponding lower return on our investment;
pre-construction buyers may default on their purchase contracts or units in new buildings may remain unsold upon completion of construction;
the unavailability of favorable financing alternatives in the private and public debt markets;
sale prices for residential units may be insufficient to cover development costs;
construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs; and
we may be unable to obtain, or may face delays in obtaining, necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations, or we may be affected by building moratoria and anti-growth legislation.
The real estate industry in Argentina is increasingly competitive.
Our real estate and construction activities are highly concentrated in the Buenos Aires metropolitan area, where the real estate market is highly competitive due to a scarcity of properties in sought-after locations and the increasing number of local and international competitors.
Furthermore, the Argentine real estate industry is generally highly competitive and fragmented and does not have high-entry barriers restricting new competitors from entering the market. The main competitive factors in the real estate development business include availability and location of land, price, funding, design, quality, reputation and partnerships with developers. A number of residential and commercial developers and real estate services companies compete with us in seeking land for acquisition, financial resources for development and prospective purchasers and tenants. Other companies, including joint ventures of foreign and local companies, have become increasingly active in the real estate business in Argentina, further increasing this competition. To the extent that one or more of our competitors are able to acquire and develop desirable properties, as a result of greater financial resources or otherwise, our business could be materially and adversely affected. If we are not able to respond to such pressures as promptly as our competitors, or the level of competition increases, our financial condition and results of our operations could be adversely affected.
In addition, many of our shopping centers are located in close proximity to other shopping centers, numerous retail stores and residential properties. The number of comparable properties located in the vicinity of our properties could have a material adverse effect on our ability to lease retail space in our shopping centers or sell units in our residential complexes and on the rent price or the sale price that we are able to charge. We cannot assure you that other shopping center operators, including international shopping center operators, will not invest in Argentina in the near future. As additional companies become active in the Argentine shopping center market, such increased competition could have a material adverse effect on our results of operations.
We face risks associated with property acquisitions.
We have in the past acquired, and intend to acquire in the future, properties, including large properties (such as the acquisition of Abasto de Buenos Aires or Alto Palermo Shopping) that would increase our size and potentially alter our capital structure. Although we believe that the acquisitions that we have completed in the past and that we expect to undertake in the future, have, and will, enhance our future financial performance, the success of such transactions is subject to a number of uncertainties, including the risk that:
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we may not be able to obtain financing for acquisitions on favorable terms;
acquired properties may fail to perform as expected;
the actual costs of repositioning or redeveloping acquired properties may be higher than we estimate;
acquired properties may be located in new markets where we may have limited knowledge and understanding of the local economy, absence of business relationships in the area or unfamiliarity with local governmental and permitting procedures; and
we may not be able to efficiently integrate acquired properties, particularly portfolios of properties, into our organization and to manage new properties in a way that allows us to realize cost savings and synergies.
Some of the land we have purchased is not zoned for development purposes, and we may be unable to obtain, or may face delays in obtaining the necessary zoning permits and other authorizations.
We own several plots of land which are not zoned for development purposes or for the type of developments we intend to propose, including Santa María del Plata (through Solares de Santa María S.A.) and Puerto Retiro (through Puerto Retiro S.A.C.I. y N (“Puerto Retiro”)). In addition, we do not yet have the required land-use, building, occupancy and other required governmental permits and authorizations. We cannot assure you that we will continue to be successful in our attempts to rezone land and to obtain all necessary permits and authorizations, or that rezoning efforts and permit requests will not be unreasonably delayed. Moreover, we may be affected by building moratoria and anti-growth legislation. If we are unable to obtain all of the governmental permits and authorizations we need to develop our present and future projects as planned, we may be forced to make unwanted modifications to such projects or abandon them altogether.
Acquired properties may subject us to unknown liabilities.
Properties that we acquire may be subject to unknown liabilities for which we would have no recourse, or only limited recourse, to the former owners of such properties. As a result, if a liability were asserted against us based upon ownership of an acquired property, we might be required to pay significant sums to settle it, which could adversely affect our financial results and cash flow. Unknown liabilities relating to acquired properties could include:
liabilities for clean-up of undisclosed environmental contamination;
law reforms and governmental regulations (such as those governing usage, zoning and real property taxes); and
liabilities incurred in the ordinary course of business.
Some potential losses are not covered by insurance, and certain kinds of insurance coverage may become prohibitively expensive.
We currently carry liability and fire insurance policies that cover potential risks such as property damage, negligence liability, fire, falls, collapse, lightning and gas explosion, electrical and water damages, theft and business interruption on all of our properties. Although we believe the policy specifications and insured limits of these policies are generally customary, there are certain types of losses, such as lease and other contract claims and terrorism and acts of war that generally are not insured. Should an uninsured loss or a loss in excess of insured limits occur, we could lose all or a portion of the capital we have invested in a property, as well as the anticipated future revenue from the property. In such an event, we might nevertheless remain obligated for any mortgage debt or other financial obligations related to the property. We cannot assure you that material losses in excess of insurance proceeds will not occur in the future. If any of our properties were to experience a catastrophic loss, it could seriously disrupt our operations, delay revenue and result in large expenses to repair or rebuild the property.
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In addition, we cannot assure you that we will be able to renew our insurance coverage in an adequate amount or at reasonable prices. Insurance companies may no longer offer coverage against certain types of losses, such as losses due to terrorist acts and mold, or, if offered, these types of insurance may be prohibitively expensive.
Demand for our premium properties which target the high-income demographic may be insufficient.
We have focused on development projects intended to cater to affluent individuals and have entered into property swap agreements pursuant to which we contribute our undeveloped properties to ventures with developers who will deliver to us units in full-service apartments in premium locations. At the time the developers return these properties to us, demand for premium apartments could be significantly lower than we currently project. In such case, we would be unable to sell these apartments at the prices or in the time frame we estimated, which could have a material adverse effect on our financial condition and results of operations.
It may be difficult to buy and sell real estate quickly and transfer restrictions apply to some of our properties.
Real estate investments are relatively illiquid and this tends to limit our ability to vary its portfolio promptly in response to changes in economic or other conditions. In addition, significant expenditures associated with each equity investment, such as mortgage payments, real estate taxes and maintenance costs, are generally not reduced when circumstances cause a reduction in income from the investment. If income from a property declines while the related expenses do not decline, our business would be adversely affected. A significant portion of our properties are mortgaged to secure payment of indebtedness, and if we are unable to meet its mortgage payments, we could lose money as a result of foreclosure on the properties by the various mortgagees. In addition, if it becomes necessary or desirable for us to dispose of one or more of the mortgaged properties, it might not be able to obtain a release of the lien on the mortgaged property without payment of the associated debt. The foreclosure of a mortgage on a property or inability to sell a property could adversely affect our business. In transactions of this kind, we may also agree, subject to certain exceptions, not to sell the acquired properties for significant periods of time.
We may be negatively affected by the financial crisis in the U.S. and global and capital markets.
We must maintain liquidity to fund our working capital, service our outstanding indebtedness and finance investment opportunities. Without sufficient liquidity, we could be forced to curtail our operations or we may not be able to pursue new business opportunities.
The capital and credit markets have been experiencing extreme volatility and disruption during the last months. If our current resources do not satisfy our liquidity requirements, we may have to seek additional financing. The availability of financing will depend on a variety of factors, such as economic and market conditions, the availability of credit and our credit ratings, as well as the possibility that lenders could develop a negative perception of the prospects of our company or the industry generally. We may not be able to successfully obtain any necessary additional financing on favorable terms, or at all.
The current economic environment for real estate companies and credit crisis may adversely impact our results of operations and business prospects significantly.
The success of our business and profitability of our operations are dependent on continued investment in the real estate markets and access to capital and debt financing. A long term crisis of confidence in real estate investments and lack of available credit for acquisitions would be likely to constrain our business growth. As part of our business goals, we intend to increase our properties portfolio with strategic acquisitions of core properties at advantageous prices, and value added properties where we believe we can bring the necessary expertise to enhance property values. In order to pursue acquisitions, we need access to equity capital and also debt financing.
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Current disruptions in the financial markets, including the bankruptcy and restructuring of major financial institutions, may adversely impact our ability to refinance existing debt and the availability and cost of credit in the near future. Presently, access to capital and debt financing options are severely restricted and it is uncertain how long current economic circumstances may last. Any consideration of sales of existing properties or portfolio interests may be tempered by current decreasing property values. Our ability to make scheduled payments or to refinance our indebtedness´ obligations depends on our operating and financial performance, which in turn is subject to prevailing economic conditions. There can be no assurances that government responses to the disruptions in the financial markets will restore investor confidence, stabilize the markets or increase liquidity and the availability of credit.
Our level of debt may adversely affect our operations and our ability to pay our debt as it becomes due.
We have had, and expect to continue to have, substantial liquidity and capital resource requirements to finance our business. As of June 30, 2008, our consolidated financial debt was Ps.1,311.4 million (including accrued and unpaid interest and deferred financing costs). Although we are generating sufficient funds from operating cash flows to satisfy our debt service requirements and our capacity to obtain new financing is adequate, given the current availability of credit lines with banks, we cannot assure you that we will maintain such cash flow and adequate financial structure in the future. The fact that we are leveraged may affect our ability to refinance existing debt or borrow additional funds to finance working capital, acquisitions and capital expenditures. In addition, current disruptions in the financial markets, including the bankruptcy and restructuring of major financial institutions, may adversely impact our ability to refinance existing debt and the availability and cost of credit in the near future. Presently, access to capital and debt financing options are severely restricted and it is uncertain how long current economic circumstances may last. This would require us to allocate a substantial portion of cash flow to repay principal and interest, thereby reducing the amount of money available to invest in operations, including acquisitions and capital expenditures. Our leverage could place us at a disadvantage compared to our competitors who are less leveraged and limit our ability to react to changes in market conditions such as the current international crisis, changes in the real estate industry and economic downturns. Although we have successfully restructured our debt, we cannot assure you that we will not relapse and become unable to pay our obligations.
We may not be able to generate sufficient cash flows from operations to satisfy our debt service requirements or to obtain future financing. If we cannot satisfy our debt service requirements or if we default on any financial or other covenants in our debt arrangements, the holders of our debt will be able to accelerate the maturity of such debt or cause defaults under the other debt arrangements. Our ability to service debt obligations or to refinance them will depend upon our future financial and operating performance, which will, in part, be subject to factors beyond our control such as macroeconomic conditions and regulatory changes in Argentina. Also, the illiquidity of the international capital markets and the illiquidity of the local capital market, due to the nationalization of the Argentine private pension funds, may create us additional difficulties to obtain future financing. If we cannot obtain future financing, we may have to delay or abandon some or all of our planned capital expenditures, which could adversely affect our ability to generate cash flows and repay our obligations.
The current credit crisis could have a negative impact on our major customers which in turn could materially adversely affect our results of operations and liquidity.
The current credit crisis is having a significant negative impact on businesses around the world. Although we believe that our cash provided by operations and available borrowing capacity under the current conditions will provide us with sufficient liquidity through the current credit crisis, the impact of the crisis on our major customers cannot be predicted and may be quite severe. A disruption in the ability of our significant customers to access liquidity could cause serious disruptions or an overall deterioration of their businesses which could lead to a significant reduction in the demand for leasable spaces and the inability or failure on their part to meet their payment obligations to us, any of which could have a material adverse effect on our results of operations and liquidity.
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We are subject to risks inherent to the operation of shopping centers that may affect our profitability.
Shopping centers are subject to various factors that affect their development, administration and profitability. These factors include:
the accessibility and the attractiveness of the area where the shopping center is located;
the intrinsic attractiveness of the shopping center;
the flow of people and the level of sales of each shopping center rental unit;
increasing competition from internet sales;
the amount of rent collected from each shopping center rental unit; and
the fluctuations in occupancy levels in the shopping centers.
An increase in operating costs, caused by inflation or other factors, could have a material adverse effect on us if our tenants are unable to pay higher rent due to the increase in expenses. Moreover, the shopping center business is closely related to consumer spending and to the economy in which customers are located. All of our shopping centers are in Argentina, and, as a consequence, their business could be seriously affected by potential recession in Argentina. For example, during the economic crisis in Argentina, spending decreased significantly, unemployment, political instability and inflation significantly reduced consumer spending in Argentina, lowering tenants’ sales and forcing some tenants to leave our shopping centers. If the international financial crisis has a substantial impact on economic activity in Argentina, it will likely have a material adverse effect on the revenues from the shopping center activity.
The loss of significant tenants could adversely affect both the operating revenues and value of our shopping center and other rental properties.
If certain of our most important tenants were to experience financial difficulties, including bankruptcy, insolvency or a general downturn of business, or if we simply failed to retain their patronage, our business could be adversely affected. Our shopping centers and, to a lesser extent, our office buildings are typically anchored by significant tenants, such as well known department stores who generate shopping traffic at the mall. A decision by such significant tenants to cease operations at our shopping centers or office buildings could have a material adverse effect on the revenues and profitability of the affected segment and, by extension, on our financial condition and results of operations. The closing of one or more significant tenants may induce other tenants at an affected property to terminate their leases, to seek rent relief and/or cease operating their stores or otherwise adversely affect occupancy at the property. If we are not able to successfully lease the affected space again, the bankruptcy and/or closure of significant tenants, could have an adverse effect on both the operating revenues and underlying value of the properties involved.
We are subject to payment default risks due to our investments in consumer financing through our subsidiary Alto Palermo.
Through our subsidiary Alto Palermo we own as of November 30, 2008 a 93.4% interest in Tarshop S.A., or Tarshop, a company dedicated to the consumer financing business that originates credit cards accounts and personal loans to promote sales from Alto Palermo’s tenants and other selected retailers. For the fiscal year ended June 30, 2008, Tarshop had net revenues of Ps 291.0 million, representing 45.5 % of Alto Palermo’s consolidated revenues and 26.8% of our consolidated revenues for such fiscal period and incurred a net loss of Ps 18.6 million. For the three months ended September 30, 2008, Tarshop had net revenues of Ps. 48.8 million, representing for such period 33.9 % of Alto Palermo’s consolidated revenues and 22.3% of our consolidated revenues for such fiscal period, and incurred a net loss of Ps. 57.1 million.
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Consumer financing businesses such as Tarshop are adversely affected by defaults or late payments by borrowers and card holders on credit card accounts, difficulties enforcing collection of payments, fraudulent accounts and the writing off of past due receivables. Alto Palermo may face higher liquidity risks due to the nationalization of the AFJPs. Tarshop provides an allowance for uncollectible accounts based on impaired accounts, historical charge-off patterns and management judgment. Due to the current credit crisis and other conditions, some customers experienced delays in payments and delinquency rates increased during the year ended June 30, 2008. Moreover, delinquency rates further increased as of September 30, 2008 and thereafter. Tarshop has increased the level of the allowance for doubtful accounts which amounts to Ps. 66.5 million as of June 30, 2008. The allowance for doubtful accounts was increased to Ps. 83.7 million as of September 30, 2008. Tarshop is closely monitoring the delays, delinquency and uncollectibility rates.
The present rates of delinquency, collection proceedings and loss of receivables may vary and be affected by numerous factors beyond our control, which, among others, include:
adverse changes in the Argentine economy;
adverse changes in the regional economies;
political instability;
changes in regulations;
increases in unemployment; and
erosion of real and/or nominal salaries.
Recent months have witnessed an unprecedented, and largely unpredicted, turmoil in financial markets in the US and in global economies. This contraction and the factors described above may have an adverse effect on rates of delinquency, collections and receivables, any one or more of which could have a material adverse effect on the results of operations of Tarshop’s consumer financing business.
In addition, if our consumer financing business is adversely affected by one or more of the above factors, the quality of Alto Palermo’s securitized receivables is also likely to be adversely affected. Therefore, Alto Palermo could be adversely affected to the extent that Alto Palermo holds an interest in any such securitized receivables.
Tarshop’s accounts receivables, which consist of cash flows from consumer financing and personal loans, are placed into a number of trust accounts that securitize those receivables. Tarshop sells beneficial interests in these trust accounts through the sale of debt certificates, but remains a beneficiary of these trust accounts by holding Ps.156.8 million in equity certificates as of June 30, 2008.
The securitization market is still open and Tarshop completed securitization programs during the recent months with no disruptions. As of June 30, 2008, Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps.156.8 million and Ps.19.4 escrow reserves for losses. As of September 30, 2008, Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps.161.2 million and Ps.17.9 million escrow reserves for loses. Due to the factors mentioned above, as of June 30, 2008, Tarshop recorded an other-than-temporary impairment charge of Ps. 12.0 million to the retained interests to reflect current fair value. For the three months ended September 30, 2008 no additional impairment charge of related to the retained interests in securitized receivables was necessary.
Alto Palermo cannot assure you that collection of payments from credit card accounts and personal loans will be sufficient to distribute earnings to holders of participation certificates, which would reduce Tarshop’s earnings. In addition, local authorities might increase credit card or trust account regulations, negatively affecting Tarshop’s revenues and results of operation. The Company may also face higher liquidity risks on financial trusts.
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Our subordinated interest in Tarshop’s securitized assets may have no value.
Tarshop S.A., an Alto Palermo subsidiary, is a consumer financing company that originates credit card accounts and personal loans to promote sales from Alto Palermo’s tenants and other selected retailers. Tarshop operates in the issuance, processing and marketing of its own non-banking credit card called Tarjeta Shopping and grants loans and personal credits.Tarshop’s accounts receivables, which consist of cash flows from consumer financing and personal loans, are placed into a number of trust accounts that securitize those receivables. Tarshop sells beneficial interests in these trust accounts through the sale of debt certificates, but remains a beneficiary of these trust accounts by holding Ps.156.8 million in participation certificates as of June 30, 2008. As of June 30, 2008, the Company has recorded an other-than-temporary impairment charge of Ps. 12.0 million to the retained interests in securitized receivables to reflect current fair value of the participation certificates.
We cannot assure you that collection of payments from credit card accounts and personal loans will be sufficient to distribute earnings to holders of participation certificates, which would reduce Tarshop’s earnings. In addition, local authorities might increase credit card or trust account regulations, negatively affecting Tarshop’s revenues and results of operation. In addition, as the nationalization of the AFJPs may cause cost an increase in funding costs, we may also face higher liquidity risks on financial trusts.
We are subject to risks affecting the hotel industry.
The full-service segment of the lodging industry in which our hotels operate is highly competitive. The operational success of our hotels is highly dependant on our ability to compete in areas such as access, location, quality of accommodations, rates, quality food and beverage facilities and other services and amenities. Our hotels may face additional competition if other companies decide to build new hotels or improve their existing hotels to increase their attractiveness.
In addition, the profitability of our hotels depends on:
our ability to form successful relationships with international and local operators to run our hotels;
changes in tourism and travel patterns, including seasonal changes;
affluence of tourists, which can be affected by a slowdown in global economy; and
taxes and governmental regulations affecting wages, prices, interest rates, construction procedures and costs.
Our business is subject to extensive regulation and additional regulations may be imposed in the future.
Our activities are subject to federal, state and municipal laws, and to regulations, authorizations and licenses required with respect to construction, zoning, use of the soil, environmental protection and historical patrimony, consumer protection, antitrust and other requirements, all of which affect our ability to acquire land, buildings and shoppings, develop and build projects and negotiate with customers. In addition, companies in this industry are subject to increasing tax rates, the creation of new taxes and changes in the taxation regime. We are required to obtain licenses and authorizations with different governmental authorities in order to carry out our projects. Maintaining our licenses and authorizations can be a costly provision. In the case of non-compliance with such laws, regulations, licenses and authorizations, we may face fines, project shutdowns, cancellation of licenses, and revocation of authorizations. In addition, public authorities may issue new and stricter standards, or enforce or interpret existing laws and regulations in a more restrictive manner, which may force us to make expenditures to comply with such new rules. Development activities are also subject to risks relating to potential delays or an inability to obtain all necessary zoning, environmental, land-use, development, building, occupancy and other required governmental permits and authorizations. Any such delays or failures to obtain such government approvals may have an adverse effect on our business.
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In the past, the Argentine government imposed strict and burdensome regulations regarding leases in response to housing shortages, high rates of inflation and difficulties in accessing credit. Such regulations limited or prohibited increases on rental prices and prohibited eviction of tenants, even for failure to pay rent. Most of our leases provide that the tenants pay all costs and taxes related to their respective leased areas. In the event of a significant increase in the amount of such costs and taxes, the Argentine government may respond to political pressure to intervene by regulating this practice, thereby negatively affecting our rental income. We cannot assure you that the Argentine government will not impose similar or other regulations in the future. Changes in existing laws or the enactment of new laws governing the ownership, operation or leasing of properties in Argentina could negatively affect the Argentine real estate market and the rental market and materially and adversely affect our operations and profitability.
Lease Law No. 23,091 imposes restrictions that limit our flexibility.
Argentine laws governing leases impose certain restrictions, including the following:
lease agreements may not contain inflation adjustment clauses based on consumer price indexes or wholesale price indexes. Although many of our lease agreements contain readjustment clauses, these are not based on an official index nor do they reflect the inflation index. In the event of litigation it may be impossible for us to adjust the amounts owed to us under our lease agreements;
residential leases must comply with a mandatory minimum term of two years and retail leases must comply with a mandatory minimum term of three years except in the case of stands and/or spaces for special exhibitions;
lease terms may not exceed ten years, except for leases regulated by Law No. 25,248 (which provides that leases containing a purchase option are not subject to term limitations); and
tenants may rescind commercial lease agreements after the initial six-month period.
As a result of the foregoing, we are exposed to the risk of increases of inflation under our leases and the exercise of rescission rights by our tenants could materially and adversely affect our business and we cannot assure you that our tenants will not exercise such right, especially if rent values stabilize or decline in the future.
Eviction proceedings in Argentina are difficult and time consuming.
Although Argentine law permits a summary proceeding to collect unpaid rent and a special proceeding to evict tenants, eviction proceedings in Argentina are difficult and time-consuming. Historically, the heavy workloads of the courts and the numerous procedural steps required have generally delayed landlords’ efforts to evict tenants. Eviction proceedings generally take between six months and two years from the date of filing of the suit to the time of actual eviction.
We have usually attempted to negotiate the termination of lease agreements with defaulting tenants after the first few months of non-payment in order to avoid legal proceedings. Delinquency may increase significantly in the future, and such negotiations with tenants may not be as successful as they have been in the past. Moreover, new Argentine laws and regulations may forbid or restrict eviction proceedings, and in such case, they would likely have a material and adverse effect on our financial condition and results of operation.
Our assets are concentrated in the Buenos Aires area.
Our principal properties are located in the City of Buenos Aires and the Province of Buenos Aires and a substantial portion of our revenues are derived from such properties. For the fiscal year ended June 30, 2008, more than 88% of our consolidated revenues were derived from properties in the Buenos Aires metropolitan area including the City of Buenos Aires. Although we own properties and may acquire or develop additional properties outside Buenos Aires, we expect to continue to depend to a large extent on economic conditions affecting those
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areas, and therefore, an economic downturn in those areas could have a material adverse effect on our financial condition and results of operations.
We face risks associated with potential expansion to other Latin American markets.
From 1994 to 2002, we had substantial investments outside of Argentina, including Brazil Realty, which was sold in 2002, and Fondo de Valores Inmobiliarios in Venezuela, which was sold in 2001. We continue to believe that Brazil and other Latin American countries offer attractive opportunities for growth in the real estate sector. We will continue to consider investment opportunities outside of Argentina as they arise.
Investments in Brazil and other Latin American countries are subject to significant risks including sovereign risks and risks affecting these countries’ real estate sectors. These risks include competition by well-established as well as new developers, unavailability of financing or financing on terms that are not acceptable to us, exchange rate fluctuations, lack of liquidity in the market, rising construction costs and inflation, extensive and potentially increasing regulation and bureaucratic procedures to obtain permits and authorizations, political and economic instability that may result in sharp shifts in demand for properties, risks of default in payment and difficulty evicting defaulting tenants.
If the bankruptcy of Inversora Dársena Norte is extended to our subsidiary Puerto Retiro, we will likely lose a significant investment in a unique waterfront land reserve in the City of Buenos Aires.
On November 18, 1997, in connection with the acquisition of our subsidiary Inversora Bolívar S.A., or “Inversora Bolívar,” we indirectly acquired 35.2% of the capital stock of Puerto Retiro. Inversora Bolívar had purchased such shares of Puerto Retiro from Redona Investments Ltd. N.V. in 1996. In 1999, through Inversora Bolívar, we increased our interest in Puerto Retiro to 50.0% of its capital stock.
On April 18, 2000, Puerto Retiro received notice of a complaint filed by the Argentine government, through the Ministry of Defense, seeking to extend the bankruptcy of Inversora Dársena Norte S.A. (“Indarsa”). Upon filing of the complaint, the bankruptcy court issued an order restraining the ability of Puerto Retiro to dispose of, in any manner, the real property it had purchased in 1993 from Tandanor S.A. (“Tandanor”). Puerto Retiro appealed the restraining order which was confirmed by the court on December 14, 2000.
In 1991, Indarsa had purchased 90% of Tandanor, a formerly government owned company, which owned a large piece of land near Puerto Madero of approximately 8 hectares, divided into two spaces: Planta 1 and 2. After the purchase of Tandanor by Indarsa, in June 1993 Tandanor sold “Planta 1” to Puerto Retiro, for a sum of US$18 million pursuant to a valuation performed by J.L. Ramos, a well-known real estate brokerage firm in Argentina.
Indarsa failed to pay to the Argentine government the outstanding price for its purchase of the stock of Tandanor. As a result the Ministry of Defense requested the bankruptcy of Indarsa. Since the only asset of Indarsa was its holding in Tandanor, the Argentine government is seeking to extend the bankruptcy to the companies or individuals which, according to its view, acted as a single economic group. In particular, the Argentine government has requested the extension of the bankruptcy to Puerto Retiro which acquired Planta 1 from Tandanor.
The time for producing evidence in relation to these legal proceeding has expired. The parties have submitted their closing arguments and are awaiting a final judgment. However, the judge has delayed his decision until a final judgment in the criminal proceedings against the former Defense Minister and former directors of Indarsa has been delivered. We cannot give you any assurance that we will prevail in this proceeding, and if the plaintiff’s claim is upheld by the courts, all of the assets of Puerto Retiro would likely be used to pay Indarsa’s debts and our investment in Puerto Retiro, valued at Ps.54.5 million, as of June 30, 2008, would be lost. As of June 30, 2008, we had not established any reserve in respect of this contingency.
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Property ownership through joint ventures may limit our ability to act exclusively in our interest.
We develop and acquire properties in joint ventures with other persons or entities when we believe circumstances warrant the use of such structures. For example, in the Shopping Center segment, we own 63.3% of Alto Palermo, while Parque Arauco S.A. owns 29.6%. We own 80% of Panamerican Mall S.A., while 20% is owned by Centro Comercial Panamericana S.A. In the Development and Sale segment, we have a majority ownership interests in various properties, including 100% ownership of Pereiraola S.A. We also have ownership of 50% in Puerto Retiro and Cyrsa. In addition we have a 90% stake in Solares de Santa María S.A., while Sutton Group owns the remaining 10%. In the Hotel operations segment, we own 50% of the Llao Llao Hotel, while another 50% is owned by the Sutton Group. We own 80% of the Hotel Libertador, while 20% is owned by Hoteles Sheraton de Argentina S.A. In the financial services sector, we own 11.8% of Banco Hipotecario, while the Argentine government has a controlling interest in it. Finally, after the end of fiscal year ended June 30, 2008 we acquired a 30% interest in Metropolitan 885 Third Avenue LLC.
We could become engaged in a dispute with one or more of our joint venture partners that might affect our ability to operate a jointly-owned property. Moreover, our joint venture partners may, at any time, have business, economic or other objectives that are inconsistent with our objectives, including objectives that relate to the timing and terms of any sale or refinancing of a property. For example, the approval of certain of the other investors is required with respect to operating budgets and refinancing, encumbering, expanding or selling any of these properties. In some instances, our joint venture partners may have competing interests in our markets that could create conflicts of interest. If the objectives of our joint venture partners are inconsistent with our own objectives, we will not be able to act exclusively in our interests.
If one or more of the investors in any of our jointly owned properties were to experience financial difficulties, including bankruptcy, insolvency or a general downturn of business, there could be an adverse effect on the relevant property or properties and in turn, on our financial performance. Should a joint venture partner be declared bankrupt, we could become liable for our partner’s share of joint venture liabilities.
We may not be able to recover the mortgage loans we have provided to purchasers of units in our residential development properties.
In recent years, we have provided mortgage financing to purchasers of units in our residential development properties. Before January 2002, our mortgage loans were U.S. dollar-denominated and accrued interest at a fixed interest rate generally ranging from 10% to 15% per year and for terms generally ranging from one to fifteen years. However, on March 13, 2002, the Central Bank converted all U.S. dollar denominated debts into Peso denominated debts at the exchange rate of Ps.1.00 = US$1.00. In addition, the Central Bank imposed maximum interest rates of 3% for residential mortgage loans to individuals and 6% for mortgage loans to businesses. These regulations adversely affected the U.S. dollar value of our outstanding mortgages.
Beside risks normally associated with providing mortgage financing, including the risk of default on principal and interest, other regulatory risks such as suspension of foreclosure enforcement proceedings could adversely affect our cash flow. Argentine law imposes significant restrictions on our ability to foreclose and auction properties. Thus, when there is a default under a mortgage, we do not have the right to foreclose on the unit. Instead, in accordance with Law No. 24,441, in order to reacquire a property we are required to purchase it at a court ordered public auction, or at an out-of-court auction. However, the Public Emergency Law temporarily suspended all judicial and non-judicial mortgage and pledge enforcement actions. Several laws and decrees extended this mortgage foreclosure suspension period. On June 14, 2006, a new suspension period was approved, which established a 180-day suspension period for mortgage foreclosure proceedings affecting debtors’ only dwellings and where the original loan was no higher than Ps.100,000.
On November 6, 2003 Law No. 25,798 was enacted. It established a system to restructure debts resulting from unpaid mortgage loans, by creating a trust by means of which the Executive Branch will refinance the mortgage debts and reschedule the maturity date. Financial institutions were given up to 60 business days from the enactment of the law to accept said terms. This law was partially modified by Law No. 25,908 (enacted on
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July 13, 2004), which included various conditions referring to the incorporation into this system of the mortgage loans that were in judicial or private execution proceedings. The parties to secured loan agreements were given a term to express their adhesion to such system. The term for financial institutions to accept the system was extended in several occasions by Decree No. 352/2004, Law No. 26,062, Law No. 26,084 and Law No. 26,103.
On November 8, 2006, Law No. 26,167 was enacted. It established a special proceeding to replace ordinary trials for the enforcement of some mortgage loans. Such special proceedings give creditors ten days to inform the debtor the amounts owed to them and thereafter agree with the debtor on the amount and terms of payment. In case of failure by the parties to reach an agreement, payment conditions are to be determined by the judge. Also, this law established the suspension of the execution of judicial judgments, judicial and extrajudicial auctions, evictions and other proceedings related to the mortgage loans contemplated in such law.
We cannot assure you that laws and regulations relating to foreclosure on real estate will not continue to change in the future or that any changes will not adversely affect our business, financial condition or result of operations.
Dividend restrictions in our subsidiaries’ debt agreements may adversely affect us.
We have subsidiaries and hence an important source of funds for us is cash dividends and other permitted payments from our subsidiaries. The debt agreements of our subsidiaries contain covenants restricting their ability to pay dividends or make other distributions. If our subsidiaries are unable to make payments to us, or are able to pay only limited amounts, we may be unable to pay dividends or make payments on our indebtedness.
We are dependent on our chairman Eduardo Elsztain and certain other senior managers.
Our success depends on the continued employment of Eduardo S. Elsztain, our chief executive officer, president and chairman of the board of directors, who has significant expertise and knowledge of our business and industry. The loss of or interruption in his services for any reason could have a material adverse effect on our business. Our future success also depends in part upon our ability to attract and retain other highly qualified personnel. We cannot assure you that we will be successful in hiring or retaining qualified personnel. A failure to hire or retain qualified personnel may have a material adverse effect on our financial condition and results of operations.
We may face potential conflicts of interest relating to our principal shareholders.
Our largest beneficial owner is Mr. Eduardo S. Elsztain, through his indirect shareholding through Cresud. As of November 30, 2008, such beneficial ownership consisted of: (i) 290,654,653 shares held by Cresud, (ii) 1,503,602 shares held by IFISA, (iii) 661,000 shares held by Consultores Assets Management S.A., (iv) 4,425,439 held by Dolphin Fund PLC, a limited liability company organized under the laws of Isle of Man, (v) 21,874,790 shares held by Agrology S.A., a subsidiary of Cresud, and (vi) 342,197 shares held directly by Mr. Elsztain.
Conflicts of interest between our management, us and our affiliates may arise in the performance of our respective business activities. As of November 30, 2008, Mr. Elsztain also beneficially owned (i) approximately 33.4% of Cresud’s common shares and (ii) approximately63.3% of the common shares of our subsidiary Alto Palermo. We cannot assure you that our principal shareholders and their affiliates will not limit or cause us to forego business opportunities that their affiliates may pursue or that the pursuit of other opportunities will be in our interest.
Due to the currency mismatches between our assets and liabilities, we have significant currency exposure.
As of June 30, 2008, the majority of our liabilities, such as our 8.5% notes due 2017, Alto Palermo’s Series I Notes, the mortgage loan to our subsidiary Hoteles Argentinos S.A. and Alto Palermo’s convertible notes are denominated in U.S. dollars while our revenues and most of our assets as of June 30, 2008 are denominated in
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Pesos. This currency gap exposes us to a risk of exchange rate volatility, which would negatively affect our financial results if the dollar were to appreciate against the Peso. Any further depreciation of the Peso against the U.S. dollar will correspondingly increase the amount of our debt in Pesos, with further adverse effects on our results of operation and financial condition and may increase the collection risk of our leases and other receivables from our tenants and mortgage debtors, most of whom have Peso-denominated revenues.
The shift of consumers to purchasing goods over the Internet may negatively affect sales in our shopping centers.
During the last years, retail sales by means of the Internet have grown significantly in Argentina, even though the market share of Internet sales related to retail sales is still not significant. The Internet enables manufacturers and retailers to sell directly to consumers, diminishing the importance of traditional distribution channels such as retail stores and shopping centers. We believe that our target consumers are increasingly using the Internet, from home, work or elsewhere, to shop electronically for retail goods, and this trend is likely to continue. If e-commerce and retail sales through the Internet continue to grow, consumers’ reliance on traditional distribution channels such as our shopping centers could be materially diminished, having a material adverse effect on our financial condition, results of operations and business prospects.
Risks Relating to our Investment in Banco Hipotecario
Our investment in Banco Hipotecario is subject to risks affecting Argentina’s financial system.
As of June 30, 2008, IRSA owned 11.8% of Banco Hipotecario which represented 6.5% of our consolidated assets at such date. Banco Hipotecario recorded losses of Ps. 91.0 million for the year ended June 30, 2008. Moreover, for the three months ended September 30, 2008, Banco Hipotecario recorded losses of Ps. 239.6 million and might record new losses for the rest of the fiscal year. Substantially all of Banco Hipotecario’s operations, properties and customers are located in Argentina. Accordingly, the quality of its loan portfolio, its financial condition and results of operations depend to a significant extent on economic and political conditions prevailing in Argentina. The political and economic crisis in Argentina during 2002 and 2003 and the Argentine government’s actions to address it have had and may continue to have a material adverse effect on Banco Hipotecario’s business, financial condition and results of operations.
Financial institutions are subject to significant regulation relating to functions that historically have been mandated by the Central Bank and other regulatory authorities. Measures adopted by the Central Bank have had, and future regulations may have, a material adverse effect on Banco Hipotecario’s financial condition and results of operations.
Laws and decrees implemented during the economic crisis in 2001 and 2002 have substantially altered contractual obligations affecting Argentina’s financial sector. Recently, the Argentine Congress has considered various initiatives intended to reduce or eliminate a portion of the mortgage loan portfolio on the debt owed to Banco Hipotecario. Also, there have been certain initiatives intended to review the terms pursuant to which Banco Hipotecario was privatized. As a result, we cannot assure you that the Argentine legislature will not enact new laws that will have a significant adverse effect on Banco Hipotecario’s shareholders’ equity or that the Argentine government would compensate Banco Hipotecario for the resulting loss. These uncertainties could have a material adverse effect on the value of our investment in Banco Hipotecario.
Over the past few months, the financial markets in the most important countries in the world have been affected by volatility, lack of liquidity and credit, which entailed a significant drop in international stock indexes, and an economic slow-down started to become evident worldwide. Despite the actions taken by central countries, the international markets’ future is still uncertain.
As regards Argentina, and after June 30, 2008, stock markets reflected significant drops in the prices of government and corporate securities, as well as an increase in interest rates, country risk and exchange rates, a situation that is still ongoing as of the date of issuance of this report. Banco Hipotecario considers that these situations did not exist as of June 30, 2008, but arose subsequent to that date.
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As a result of the situation described above, the market value of the BODEN 2012, BOGAR and Discount bonds as of December 15, 2008, decreased approximately by Ps.806,451 compared to its market value as of June 30, 2008. The decrease in the prices of government securities plus the increase in the Argentine credit risk originated the necessity to increase the guarantees deposited for swap and repo transactions.
In addition, as a consequence of the financial situation described above, the decrease in the quotation of Banco Hipotecario’s shares have caused a decrease in the fair value of the Total Return Swap approximately by Ps.37,328 as of December 15, 2008 compared to its fair value as of June 30, 2008.
The net position of the derivative financial instruments have experienced a decline of Ps.114,388 as of September 30, 2008, compared to June 30, 2008, as a consequence of the financial crisis described above. Subsequently, and as of the date of issuance of this report, the main variables that determine fair value (EURO/US Dollar/BADLAR/LIBOR/Country Risk), continue being affected by the market volatility mentioned before.
Banco Hipotecario’s management is monitoring the effects derived from the above situation described in order to implement the necessary measures to mitigate its effect. This document must be analyzed taking into consideration the scenario described above.
Banco Hipotecario relies heavily on mortgage lending and the value of our investment in it depends in part on its ability to implement successfully its new business diversification strategy.
Historically, Banco Hipotecario has been engaged exclusively in mortgage lending and related activities. As a result, factors having an adverse effect on the mortgage market have a greater adverse impact on Banco Hipotecario than on its more diversified competitors. Due to its historic concentration in this recession-sensitive sector, Banco Hipotecario is particularly vulnerable to adverse changes in economic and market conditions in Argentina due to their adverse effect on (i) demand for new mortgage loans and (ii) the asset quality of outstanding mortgage loans. The last economic crisis had a material adverse effect on its liquidity, financial conditions and results of operations. In addition, a number of governmental measures that apply to the financial sector have had a material adverse effect particularly on Banco Hipotecario, impairing its financial condition.
In light of the economic conditions in Argentina for the foreseeable future, Banco Hipotecario cannot rely exclusively on mortgage lending and related services. Accordingly, Banco Hipotecario has adapted its business strategy to confront the challenges of these new market conditions. Banco Hipotecario’s ability to diversify its operation will depend on how successfully it diversifies its product offerings and transforms itself into a financial institution that no longer relies solely on mortgage lending.
In the past years Banco Hipotecario has made several investments that are designed to enable it to develop retail banking activities. Banco Hipotecario must overcome significant challenges to achieve this goal including, among others, its lack of experience and client relationships outside the mortgage sector, the existence of large, well-positioned competitors and significant political, regulatory and economic uncertainties in Argentina. As a result, we cannot give you any assurance that Banco Hipotecario will be successful in developing significant retail banking activities in the foreseeable future, if at all. If Banco Hipotecario is unable to diversify its operations by developing its retail banking activities and other non-mortgage banking activities, the value of our substantial investment in Banco Hipotecario would likely be materially and adversely affected.
Banco Hipotecario’s mortgage loan portfolio is not adequately indexed for inflation and any significant increase in inflation could have a material adverse effect on its financial condition.
In accordance with Emergency Decree No. 214/02 and its implementing regulations, pesified assets and liabilities were adjusted for inflation as of February 3, 2002 by application of the Coeficiente de Estabilización de Referencia, or CER, a consumer price inflation coefficient. On May 6, 2002, the Executive Branch issued a decree providing that mortgages originally denominated in U.S. dollars and converted into Pesos pursuant to Decree No. 214/2002 and mortgages on property constituting a borrower’s sole family residence may be adjusted for
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inflation only pursuant to a coefficient based on salary variation, the CVS, which during 2002 was significantly less than inflation as measured by the wholesale price index, or WPI. Through December 31, 2002, the WPI and the CVS posted cumulative increases of 118.2% and 0.2%, respectively, and the CER increased 41.4%. During 2003, inflation rose by 4.3% as measured by the WPI, 3.7% as measured by the CER and 15.8% as measured by the CVS. As a result, only 10% of Banco Hipotecario’s mortgage loans are adjusted for inflation in accordance with the CER, 30% are adjusted in accordance with the CVS and 60% remain entirely unindexed. Additionally, pursuant to Law No. 25,796, Section 1, repealed effective April 1, 2004, the CVS as an indexation mechanism applied to the relevant portion of Banco Hipotecario’s mortgages loans. The CVS increased until it was repealed by 5.3%, whereas the increase in CER was 5.5% as of December 31, 2004 and the WPI increased by 7.9%. During 2005, the CER was 11.75% and the WPI 10.7%, while in 2006 the CER and WPI increased by 10.3% and 7.1%, respectively. In 2007, CER and WPI increased by 8.5% and 14.4% respectively. For the six months period ended June 30, 2008, the CER increased 6%.
Argentina’s history prior to the adoption of the Convertibility Law, which set the exchange rate of the Argentine Peso to the U.S. dollar at Ps.1.00 = US$1.00, raises serious doubts as to the ability of the Argentine government to maintain a strict monetary policy and control inflation. As a result of the high inflation in Argentina from 2002 onwards, Banco Hipotecario’s mortgage loan portfolio experienced a significant decrease in value and if inflation continues increasing, it might continue to undergo a major decrease in value. Accordingly, an increase in Banco Hipotecario’s funding and other costs due to inflation might not be offset by indexation, which could adversely affect its liquidity and results of operations.
Legislation limiting Banco Hipotecario’s ability to foreclose on mortgaged collateral may have an adverse effect on it.
Like other mortgage lenders, the ability to foreclose on mortgaged collateral to recover on delinquent mortgage loans impacts the conduct of Banco Hipotecario’s business. In February 2002, the Argentine government amended Argentina’s Bankruptcy Law, suspending bankruptcies and foreclosures on real estate that constitutes the debtor’s primary residence, initially for a six-month period and subsequently extended until November 14, 2002. Since 2003, the Argentine government has approved various laws that have suspended, in some cases, foreclosures for a period of time in accordance with Law No. 25,972 enacted on December 18, 2004, and, in some cases, temporarily suspended all judicial and non-judicial mortgage and pledge enforcement actions. Several laws and decrees extended this mortgage foreclosure suspension period. Most recently, on June 14, 2006, Argentine Law 26,103 was enacted which established a 180-day suspension period for mortgage foreclosure proceedings affecting debtors where the subject mortgage related to the debtor’s sole residence and where the original loan was not greater than Ps.100,000.
Law No. 25,798, enacted November 5, 2003, and implemented by Decrees No. 1284/2003 and No. 352/2004, among others, sets forth a system to restructure delinquent mortgage payments to prevent foreclosures on a debtor’s sole residence (the “Mortgage Refinancing System”). The Mortgage Refinancing System establishes a trust composed of assets contributed by the Argentine government and income from restructured mortgage loans. Banco de la Nación Argentina, in its capacity as trustee of said trust, enters into debt restructuring agreements with delinquent mortgage debtors establishing the following terms: (i) a grace period on the mortgage loan of one year and (ii) monthly installment payments on the mortgage loan not to exceed 30% of the aggregate income of the family living in the mortgaged property. Banco de la Nación Argentina then subrogates the mortgagee’s rights against the debtor, by issuing notes delivered to the mortgagee to settle the amounts outstanding on the mortgage loan. The sum restructured under the Mortgage Refinancing System may not exceed the appraisal value of the property securing the mortgage after deducting any debts for taxes and maintenance. The Mortgage Refinancing System was established for a limited period of time, during which parties to mortgage loan agreements could opt to participate and was subsequently extended by a number of decrees and laws.
Law No. 26,167, enacted on November 29, 2006, suspended foreclosures and also established a special proceeding for the enforcement of certain mortgage loans. Such special proceedings give creditors a 10-day period to inform the court of the amounts owed under the mortgage loan. Soon thereafter, the judge will call the parties for a hearing in order to reach an agreement on the amount and terms of payment thereunder. In case of
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failure by the parties to reach such agreement, they will have a 30-day negotiation period, and if the negotiations do not result in an agreement, then, payment and conditions will be determined by the courts.
On November 29, 2006, Law No. 26,177 created the Unidad de Reestructuración, a government agency responsible for the revision of each of the mortgage loans granted by the state-owned Banco Hipotecario Nacional, the predecessor of Banco Hipotecario, before the enactment of the Convertibility Law in 1991. The Unidad de Reestructuración also makes non-binding recommendations to facilitate the restructuring of such mortgage loans. If no agreement is reached, the Unidad de Reestructuración will submit a proposal to the National Congress, which may recommend forgiveness or other write-off of such loans, extensions of their scheduled maturities or other subsidies that adversely affect Banco Hipotecario’s ability to foreclose on such mortgage loans.
On December 7, 2007 Law No. 26,313 was enacted, establishing a mandatory restructuring of certain mortgage loans that were granted by the former Banco Hipotecario Nacional prior to April 1, 1991, for the purchase, improvement, construction and/or expansion of single family residences, or for the repayment of loans that were used for any of such purposes. On December 19, 2008, through Decree 2107/08, the government issued regulations explaining its scope of application. This law applies only to non-performing mortgage loans granted before April 1, 1991, and requires a new balance calculation for loans affected. Banco Hipotecario S.A., as legal successor to the former Banco Hipotecario Nacional, has estimated that it has enough loan allowances to face possible negative economic effects that could arise from this situation.
We cannot assure you that the Argentine government will not enact further new laws restricting Banco Hipotecario’s ability to enforce its rights as creditors. Any such limitation on its ability to successfully implement foreclosures could have a material adverse effect on its financial condition and results of operations.
Banco Hipotecario’s non-mortgage loan portfolio has grown rapidly and is concentrated in the low- and middle-income segments.
As a result of Banco Hipotecario’s strategy to diversify its banking operations and develop retail and other non-mortgage banking activities, in recent years its portfolio of non-mortgage loans has grown rapidly. During the period between June 30, 2005 and June 30, 2008, Banco Hipotecario’s portfolio of non-mortgage loans grew 150.9% from Ps.911.0 million to Ps.2,361.4 million. A substantial portion of its portfolio of non-mortgage loans consists of loans to low- and middle-income individuals and, to a lesser extent, middle-market companies. These individuals and companies are likely to be more seriously affected by adverse developments in the Argentine economy than high income individuals and large corporations. Consequently, in the future Banco Hipotecario may experience higher levels of past due non-mortgage loans that would likely result in increased provisions for loan losses. In addition, large-scale lending to low- and middle-income individuals and middle-market companies is a new business activity for Banco Hipotecario, and as a result its experience and loan-loss data for such loans are necessarily limited. Therefore, we cannot assure you that the levels of past due non-mortgage loans and resulting charge-offs will not increase materially in the future.
Given the current valuation criteria of the Central Bank for the recording of BODEN and other public securities on Banco Hipotecario’s balance sheets, its most recent financial statements may not be indicative of its current financial condition.
Banco Hipotecario prepares its financial statements in accordance with Central Bank accounting rules which differ in certain material respects from Argentine GAAP. During 2002, Central Bank accounting rules were modified in several respects that materially increased certain discrepancies between Central Bank accounting rules and Argentine GAAP. In accordance with Central Bank accounting rules, Banco Hipotecario’s consolidated balance sheet as of June 30, 2008 includes US$684.7 million of BODEN issued by the Argentine government as compensation for pesification, as well as an US$84.4 million asset representing its right to acquire additional BODEN. Banco Hipotecario’s consolidated balance sheet as of June 30, 2008 also includes Ps.239.1 million representing Central Bank borrowings which Banco Hipotecario incurred to finance its acquisition of the additional BODEN. Since September 30, 2005 Banco Hipotecario has subscribed additional BODEN 2012 in the
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amount of US$773.5 million and reduced Central Bank borrowings in the amount of Ps.1,844.0 million. Additionally, its most recent consolidated annual income statements include the accrual of interest income to be received on BODEN not yet received and interest to be paid adjusted by CER on Central Bank borrowings.
In accordance with Central Bank accounting rules, the BODEN reflected on Banco Hipotecario’s consolidated balance sheet as of June 30, 2008 have been recorded at 100% of face value. The fair value of the Boden 2012 as of June 30, 2008, decreases the shareholder’s equity in Ps.212.6 million.
Due to interest rate and currency mismatches of its assets and liabilities, Banco Hipotecario has significant currency exposure.
As of June 30, 2008, Banco Hipotecario’s foreign currency-denominated liabilities exceeded its foreign currency-denominated assets by approximately US$238.3 million. Substantially all of Banco Hipotecario’s foreign currency assets consist of dollar-denominated BODEN, but Banco Hipotecario’s liabilities in foreign currencies are denominated in both U.S. Dollars and Euros. This currency gap exposes Banco Hipotecario to risk of exchange rate volatility which would negatively affect Banco Hipotecario’s financial results if the U.S. Dollar were to depreciate against the Peso and/or the Euro. We cannot assure you that the U.S. Dollar will not appreciate against the Peso, or that we will not be adversely affected by Banco Hipotecario’s exposure to risks of exchange rate fluctuations.
Because of its large holdings of BODEN and other government securities, Banco Hipotecario has significant exposure to the Argentine public sector.
On December 23, 2001, the Argentine government declared the suspension of payments on most of its sovereign debt, which as of December 31, 2001, totaled approximately US$144.5 billion, a substantial portion of which was restructured by the issuance of new bonds in the middle of 2005. Banco Hipotecario has a significant exposure to the Argentine government’s solvency. As of June 30, 2008, the net exposure of Banco Hipotecario to the Argentine public sector, without considering liquid assets in accounts opened at the BCRA, amounts to Ps. 2,526,723. The market value of Boden and other government securities as of December 15, 2008, decreased by approximately Ps.877.1 million compared to its market value as of June 30, 2008. Further, defaults by the Argentine government on its debt obligations, including Boden and other government securities held by Banco Hipotecario, would materially and adversely affects its financial condition which would in turn affect our investment.
The market value of lower-case and other government securities as of October 31, 2008, decreased by approximately Ps.1.029 million compared to its market value as of June 30, 2008.
Banco Hipotecario operates in a highly regulated environment, and its operations are subject to regulations adopted, and measures taken, by the Central Bank, the Comisión Nacional de Valores and other regulatory agencies.
Similarly, theComisión Nacional de Valores, which authorizes Banco Hipotecario’s offerings of securities and regulates the public markets in Argentina, has the authority to impose sanctions on Banco Hipotecario and its board of directors for breaches of corporate governance. Under applicable law, the Comisión Nacional de Valores has the authority to impose penalties that range from minor regulatory enforcement sanctions to significant monetary fines, to disqualification of directors from performing board functions for a period of time, and (in an extreme case) prohibiting issuers from making public offerings, if they were to determine that there was wrongdoing or material violation of law. Although Banco Hipotecario is not currently party to any proceeding
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before the Comisión Nacional de Valores, we cannot assure you that the Comisión Nacional de Valores will not initiate new proceedings against Banco Hipotecario, its shareholder or directors or impose further sanctions.
Commencing in early 2002, laws and decrees have been implemented that have substantially altered the prevailing legal regime and obligations established in contract. In the recent past, various initiatives have been presented to Congress intended to reduce or eliminate the debt owed to Banco Hipotecario on a portion of its mortgage loan portfolio and there were initiatives intended to review the terms pursuant to which Banco Hipotecario Nacional was privatized. As a result, we cannot assure you that the legislative branch will not enact new laws that will have a significant adverse impact on Banco Hipotecario’s shareholders’ equity or that, if this were to occur, the Argentine government would compensate us for the resulting loss.
The Argentine government may prevail in all matters to be decided at a Banco Hipotecario’s general shareholders meeting.
According to the Privatization Law and Banco Hipotecario’s by-laws, holders of Class A and Class D Shares have special voting rights relating to certain corporate decisions. Whenever such special rights do not apply (with respect to the Class A Shares and the Class D Shares) and in all cases (with respect to the Class B Shares and the Class C Shares), each share of common shares entitles the holder to one vote. Pursuant to Argentine regulations, Banco Hipotecario may not issue new shares with multiple votes.
The holders of Class D Shares have the right to elect nine of Banco Hipotecario’s board members and their respective alternates. In addition, for so long as Class A Shares represent more than 42.0% of Banco Hipotecario’s capital, the Class D Shares shall be entitled to three votes per share, provided that holders of Class D Shares will be entitled to only one vote per share in the case of a vote on:
a fundamental change in Banco Hipotecario’s corporate purpose;
a change in Banco Hipotecario’s domicile outside of Argentina;
dissolution prior to the expiration of Banco Hipotecario’s corporate existence;
a merger or spin-off after which Banco Hipotecario would not be the surviving corporation;
a total or partial recapitalization following a mandatory reduction of capital; and
approval of voluntary reserves, other than legally mandated reserves, when their amount exceeds Banco Hipotecario’s capital stock and its legally mandated reserves.
In addition, irrespective of what percentage of Banco Hipotecario’s outstanding capital stock is represented by Class A Shares, the affirmative vote of the holders of Class A Shares is required to adopt certain decisions. Class D Shares will not be converted into Class A Shares, Class B Shares or Class C Shares by virtue of their reacquisition by the Argentine government, PPP, or Programa de Propiedad Participada (or the Shared Property Program), participants or companies engaged in housing development or real estate activities.
According to the Privatization Law, there are no restrictions on the ability of the Argentine government to dispose of its Class A shares, and all but one of such shares could be sold to third parties in a public offering. If the Class A shares represent less than 42% of Banco Hipotecario’s total voting stock as a result of the issuance of new shares other than Class A shares or otherwise, the Class D shares we hold will automatically lose their triple voting rights. If this were to occur, we would likely lose its current ability, together with our affiliates that also hold Class D shares of Banco Hipotecario, to exercise substantial influence over decisions submitted to the vote of Banco Hipotecario’s shareholders.
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Banco Hipotecario will continue to consider acquisition opportunities which may not be successful.
From time to time in recent years, Banco Hipotecario has considered certain possible acquisitions or business combinations, and Banco Hipotecario expects to continue considering acquisitions that it believes offer attractive opportunities and are consistent with its business strategy. We cannot assure you, however, that Banco Hipotecario will be able to identify suitable acquisition candidates or that Banco Hipotecario will be able to acquire promising target financial institutions on favorable terms. Additionally, its ability to obtain the desired effects of such acquisitions will depend in part on its ability to successfully complete the integration of those businesses. The integration of acquired businesses entails significant risks, including:
unforeseen difficulties in integrating operations and systems;
problems assimilating or retaining the employees of acquired businesses;
challenges retaining customers of acquired businesses;
unexpected liabilities or contingencies relating to the acquired businesses; and
the possibility that management may be distracted from day-to-day business concerns by integration activities and related problem solving.
Risks Related to the Global Depositary Shares and the Shares
Shares eligible for sale could adversely affect the price of our common shares and Global Depositary Shares.
The market prices of our common shares and GDS could decline as a result of sales by our existing shareholders of common shares or GDSs in the market, or the perception that these sales could occur. These sales also might make it difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
The GDSs are freely transferable under US securities laws, including shares sold to our affiliates. Cresud, which as of November 30, 2008, owned approximately 54.0% of our common shares (or approximately 312,529,443 common shares which may be exchanged for an aggregate of 31,252,944 GDSs), is free to dispose of any or all of its common shares or GDSs at any time in its discretion. Sales of a large number of our common shares and/or GDSs would likely have an adverse effect on the market price of our common shares and the GDS.
We are subject to certain different corporate disclosure requirements and accounting standards than domestic issuers of listed securities in the United States.
There is less publicly available information about the issuers of securities listed on theBolsa de Comercio de Buenos Aires than information publicly available about domestic issuers of listed securities in the United States and certain other countries. In addition, all listed Argentine companies must prepare their financial statements in accordance with Argentine GAAP and the regulations of the Comisión Nacional de Valores which differ in certain significant respects from U.S. GAAP. For this and other reasons, the presentation of Argentine financial statements and reported earnings may differ from that of companies in other countries in this and other respects.
We are exempted from the rules under the Exchange Act prescribing the furnishing and content of proxy statements, and our officers, directors and principal shareholders are exempted from the reporting and short-swing profit recovery provisions contained in Section 16 of the Exchange Act.
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Investors may not be able to effect service of process within the U.S. limiting their recovery of any foreign judgment.
We are a publicly held corporation (sociedad anónima) organized under the laws of Argentina. Most of our directors and our senior managers, and most of our assets are located in Argentina. As a result, it may not be possible for investors to effect service of process within the United States upon us or such persons or to enforce against us or them, in United States courts, judgments obtained in such courts predicated upon the civil liability provisions of the United States federal securities laws. We have been advised by our Argentine counsel, Zang, Bergel & Viñes, that there is doubt as to whether the Argentine courts will enforce to the same extent and in as timely a manner as a US or foreign court, an action predicated solely upon the civil liability provisions of the United States federal securities laws or other foreign regulations brought against such persons or against us.
If we are considered to be a passive foreign investment company for United States federal income tax purposes, U.S. holders of our equity securities would suffer negative consequences.
Based on the current and projected composition of our income and the valuation of our assets, including goodwill, we do not believe we were a passive foreign investment company (“PFIC”) for United States federal income tax purposes for the taxable year ending June 30, 2008, and we do not currently expect to become a PFIC, although there can be no assurance in this regard. The determination of whether we are a PFIC is made annually. Accordingly, it is possible that we may be a PFIC in the current or any future taxable year due to changes in our asset or income composition or if our projections are not accurate. The volatility and instability of Argentina’s economic and financial system may substantially affect the composition of our income and assets and the accuracy of our projections. If we become a PFIC, U.S. holders of our equity securities will be subject to certain United States federal income tax rules that have negative consequences for U.S. holders such as additional tax and an interest charge upon certain distributions by us or upon a sale or other disposition of our equity securities at a gain, as well as additional reporting requirements. See “Taxation – Certain United States Federal Income Tax Consequences – Passive Foreign Investment Company” for a more detailed discussion of the consequences if we are deemed a PFIC. You should consult your own tax advisors regarding the application of the PFIC rules to your particular circumstances.
Under Argentine law, shareholder rights may be fewer or less well defined than in other jurisdictions.
Our corporate affairs are governed by our by-laws and by Argentine corporate law, which differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States, such as the States of Delaware or New York, or in other jurisdictions outside Argentina. In addition, your rights or the rights of holders of our common shares to protect your or their interests in connection with actions by our board of directors may be fewer and less well defined under Argentine corporate law than under the laws of those other jurisdictions. Although insider trading and price manipulation are illegal under Argentine law, the Argentine securities markets are not as highly regulated or supervised as the US securities markets or markets in some other jurisdictions. In addition, rules and policies against self dealing and regarding the preservation of shareholder interests may be less well defined and enforced in Argentina than in the United States, putting holders of our common shares and GDSs at a potential disadvantage.
The protections afforded to minority shareholders in Argentina are different from and more limited than those in the United States and may be more difficult to enforce.
Under Argentine law, the protections afforded to minority shareholders are different from, and much more limited than, those in the United States and some other Latin American countries. For example, the legal framework with respect to shareholder disputes, such as derivative lawsuits and class actions, is less developed under Argentine law than under U.S. law as a result of Argentina’s short history with these types of claims and few successful cases. In addition, there are different procedural requirements for bringing these types of shareholder lawsuits. As a result, it may be more difficult for our minority shareholders to enforce their rights against us or our directors or controlling shareholder than it would be for shareholders of a US company.
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Holders of common shares may determine to not pay any dividends.
In accordance with Argentine corporate law we may pay dividends to shareholders out of net and realized profits, if any, as set forth in our audited financial statements prepared in accordance with Argentine GAAP. The approval, amount and payment of dividends are subject to the approval by our shareholders at our annual ordinary shareholders meeting. The approval of dividends requires the affirmative vote of a majority of the shareholders entitled to vote at the meeting. As a result, we cannot assure you that we will be able to generate enough net and realized profits so as to pay dividends or that our shareholders will decide that dividends will be paid.
Our ability to pay dividends is limited by law, by our by-laws and by certain restrictive covenants in our debt instruments.
In accordance with Argentine corporate law, we may pay dividends in Pesos only out of retained earnings, if any, to the extent set forth in our audited financial statements prepared in accordance with Argentine GAAP. In addition, our ability to pay dividends on our common shares is limited by certain restrictive covenants in our debt instruments.
On February 2, 2007, we issued our 8.5% notes due 2017 in an aggregate principal amount of US$150.0 million. These bonds contain a covenant limiting our ability to pay dividends which may not exceed the sum of:
50% of our cumulative consolidated net income; or
75% of our cumulative consolidated net income if our consolidated interest coverage ratio for our most recent four consecutive fiscal quarters is at least 3.0 to 1; or
100% of cumulative consolidated net income if our consolidated interest coverage ratio for our most recent four consecutive fiscal quarters is at least 4.0 to 1; or
100% of the aggregate net cash proceeds (with certain exceptions) and the fair market value of property other than cash received by us or by our restricted subsidiaries from (a) any contribution to our equity capital or to the capital stock of our restricted subsidiaries or issuance and sale of our qualified capital stock or the qualified capital stock of our restricted subsidiaries subsequent to the issue of our notes due 2017, or (b) any issuance and sale subsequent to the issuance of our notes due 2017, of our indebtedness, or of the indebtedness of our restricted subsidiaries that has been converted into or exchanged for our qualified capital stock.
As a result, we cannot give you any assurance that in the future we will pay any dividends in respect of our common shares.
A. History and Development of the Company
General Information
Our legal and commercial name is IRSA Inversiones y Representaciones Sociedad Anónima. We were incorporated and organized on April 30, 1943 under Argentine law as a sociedad anónima (stock corporation), and we were registered with the Public Registry of Commerce of the City of Buenos Aires (Inspección General de Justicia or “IGJ”) on June 23, 1943 under number 284, on page 291, book 46 of volume A. Pursuant to our bylaws, our term of duration expires on April 5, 2043. Our shares are listed and traded on the Bolsa de Comercio de Buenos Aires and Global Depositary Shares representing our shares are listed on the New York Stock Exchange. Our principal executive offices are located at Bolívar 108 1st floor, Buenos Aires (C1066AAD), Argentina. Our headquarters are located at Moreno 877, (C1091AAQ), Buenos Aires, Argentina. Our telephone is
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+54 (11) 4323-7400, and our website is www.irsa.com.ar. Information contained in or accessible through our website is not a part of this annual report. All references in this annual report to this or other internet sites are inactive textual references to these URLs, or “uniform resource locators” and are for your information reference only. We assume no responsibility for the information contained on these sites. Our Depositary Agent for the Global Depositary Shares in the United States is The Bank of New York whose address is P.O. Box 11258 Church Street Station, New York, New York 10286, and whose telephone is +1-610-312-5315.
History
Since 1991, when our current management and certain international investors acquired substantially all of our capital stock, we have been actively engaged in diverse real estate activities in Argentina. Following our global public offering in December 1994, we developed our real estate activities in the office rental market by acquiring three office towers located in prime office zones of Buenos Aires: Libertador 498, Maipú 1300 and Madero 1020.
Since 1996, we have, through our subsidiary APSA, expanded our real estate activities into the shopping center segment by acquiring controlling interests in ten shopping centers: Paseo Alcorta, Alto Palermo Shopping, Buenos Aires Design, Alto Avellaneda, Alto Noa, Abasto Shopping, Patio Bullrich, Mendoza Plaza Shopping, Alto Rosario and Córdoba Shopping Villa Cabrera. Since 1996, we also entered into the residential real estate market through the development and construction of multi-tower apartment complexes in the City of Buenos Aires and through the development of private residential communities in greater Buenos Aires.
In 1997, we entered the hotel market through the acquisition of a 50% interest in the Llao Llao Hotel near Bariloche and the Inter-Continental Hotel in the City of Buenos Aires. In 1998, we also acquired the Libertador Hotel in the City of Buenos Aires and subsequently sold a 20% interest to an affiliate of Sheraton Hotels.
In 2002, we issued US$100.0 million of convertible notes due November 2007, accruing a 8% per annum interest rate, payable on a semi-annual basis. A warrant is attached to each convertible note and grants its holder an option to acquire additional shares. As of today, there are no outstanding convertible notes and warrants. As a result of the conversions and exercises our outstanding capital stock increased to 578,676,460.
During the 2004 fiscal year we increased our ownership interest in Banco Hipotecario, reflecting the intention to maintain the participation in Banco Hipotecario as a long-term investment.
During the 2005 fiscal year we increased our ownership interest in Mendoza Plaza Shopping S.A. from 68.8% to 85.4% through our subsidiary Alto Palermo. We also opened Alto Rosario Shopping.
The excellent prospects of the offices business had pushed us to make an important investment in this segment by acquiring Bouchard 710 building on fiscal year 2005, covering 15,014 square meters of rentable premium surface.
In the 2007 fiscal year, we consolidated our cash generating rental businesses, consummating various significant acquisitions in the shopping center and office building business segments.
We purchased Edificio Bouchard Plaza, also known as Edificio La Nación, a 23-floor AAA office building with a total leaseable area of 33,324 sqm., located in downtown Buenos Aires. We also purchased Edificio Dock del Plata which has a gross leaseable area of 7,921 sqm located in the exclusive area of Puerto Madero. With these new purchases, we increased our premium office leaseable area by 70%, our share in this market segment raised close to 20%. We also launched the development of an office building at Dock IV of Puerto Madero, which will have approximately 11,000 sqm. of leasable surface.
In December 2006, we started to operate our tenth shopping center. Located in the neighborhood of Villa Cabrera in the city of Cordoba, Cordoba Shopping has a 35,000 sqm. total area, 104 stores, 12 cinema screens and a parking lot for 1,500 vehicles. Moreover, through our subsidiaries, we have started the construction of one of
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our most important projects; The Panamerican Mall, placed in the neighborhood of Saavedra, City of Buenos Aires, in the intersection of the Panamericana Highway and General Paz Avenue. The project includes the construction of a shopping center, a hypermarket, a cinema complex and an office building and/or a residential building.
In order to finance the investments and developments detailed above, in February 2007 we issued 8.5% US$150 million ten-year notes. Bids were received for up to 350% of the offer price, showing the investor community’s strong support for our business plan. In addition, in May 2007 APSA issued 7.875% US$120 million ten year notes and 11% Ps.154 million five year notes.
On August 27, 2007, we acquired a 50% ownership interest in an office building including in place leases of 31,670 square meters of gross leaseable area, known as the BankBoston Tower for the total consideration of US$54 million including in place leases. This modern property is located at 265 Carlos María Della Paolera in the City of Buenos Aires, and was designed by the recognized Architect Cesar Pelli.
On December 28, 2007, Alto Palermo entered into an agreement with INCSA, an unrelated party, for the acquisition of the Soleil Factory shopping center business, for US$ 20.7 million, of which US$ 8.1 million were paid and recorded as supplier advances. The transaction is subject to certain conditions. Upon fulfillment of the conditions and transfer of the business, the remaining balance of the purchase price amounting to US$ 12.6 million will begin to accrue fixed interest at 5% per year. This balance will be paid in seven annual installments starting one year after the signing of the contract. As part of the same agreement, Alto Palermo entered into an offer to acquire, construct and operate a shopping center on land belonging to INCSA located in San Miguel de Tucuman, Province of Tucuman, in the northwest of Argentina. This transaction is also subject to the completion of the “Soleil Factory” transaction, among other suspensive conditions. The parties determined the value of this transaction to be US$ 1.3 million.
In April 2008, we acquired a building known as “República Building”, a property located in the City of Buenos Aires. This property, designed by the renowned architect César Pelli (who also designed the World Financial Center in New York and the Petronas Towers in Kuala Lumpur) is a unique premium office building in downtown Buenos Aires and adds approximately 19,533 gross leaseable square meters to our portfolio. We paid US$ 70.2 million partially financed by a mortgage loan from Banco Macro for an amount of US$ 33.6 million accruing interest at a fixed rate of 12% per annum and payable in five equal, annual and consecutive installments as from April 2009. On May 6, 2008, we filed with the Antitrust Authority a request for its opinion as to the need to notify the Comisión Nacional de Defensa de la Competencia (or Antitrust Authority) the acquisition of Edificio República. The Antitrust Authority advised us that we were in fact required to so notify it. We challenged this opinion in the local courts.
On June 27, 2008, Alto Palermo acquired a plot of land situated at Beruti 3351/3359, between Bulnes and Avenida Coronel Díaz in Palermo, a neighborhood in the City of Buenos Aires quite close to our Shopping Center known as “Shopping Alto Palermo”. The transaction was executed for a total price of US$17.8 million.
On July 2, 2008, we acquired a 30% interest in Metropolitan 885 Third Avenue LLC (“Metropolitan”), a limited liability company organized under the laws of Delaware, United States of America. The main asset of Metropolitan is a 34 story building known as the Lipstick Building located at third avenue between 53rd and 54th streets in Manhattan, New York City. In addition to this asset, the acquired company also includes the debt related to this building. The purchase price paid was US$ 22.6 million. The property has approximately 59,000 square meters of leasable space. Also, we acquired the right ( “put right”) to sell the 50% of our stake in a period starting 6 months after this transaction until the third year anniversary of this transaction. Additionally, we acquired the right of first offer for 60% of the 5% currently held by of one of the shareholders of Metropolitan.
Capital Expenditures
Five months period-Fiscal Year 2009. For the five months of fiscal year 2009 we invested Ps. 116.9 million in capital expenditures of which mainly (i) Ps. 70.9 million were related to the construction of Panamerican Mall; (ii) Ps.
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19.4 million in improvements in Dique IV, (iii) Ps. 10.2 million were related to the improvements of our shopping center properties and (iv) Ps. 7.4 million in the Hotel segment, of which Ps. 4.2 million were invested in Sheraton Libertador Hotel. Regarding the capital expenditures for the rest of fiscal year 2009, they could vary according to the potential events described in our risk factors section.
2008 Fiscal Year. For the fiscal year ended June 30, 2008, we invested Ps.768.7 million of which Ps.419.0 million were related to the acquisition of business and assets, mainly the purchase of two buildings (including their in place leases) known as “Edificio República” and “Torre Bank Boston” for Ps.228.3 million and Ps.173.9 million, respectively. We also made investments in fixed assets of Ps. 332.5 million of which, Ps.257.7 million were invested million through Alto Palermo primarily in the partial construction of the Panamerican Mall for Ps.114.4 million, improvements of shopping centers for Ps.50.0 million, in the initial payment for the transfer of Soleil Factory shopping center for Ps.25.6 million, and Ps.40.0 million in the Hotel segment of which Ps. 30.7 million were invested in Hotel Llao Llao. We also invested Ps. 23.1 million relating to Patio Olmos Building and Ps. 16.1 were related to advance payment for a plot of land located at Beruti 3571.We also invested Ps.17.2 million in undeveloped parcels of land.
2007 Fiscal Year. For the fiscal year ended June 30, 2007, we invested Ps.419.4 million of which Ps.410.1 million, were related to the acquisition of Bouchard 551 for Ps.243.2 million, Ps.96.4 million through Alto Palermo primarily for the improvement of shopping centers and Ps.57.1 million in the Hotel segment, of which Ps.49.4 million were invested in Hotel Llao Llao. We also invested Ps.9.3 million in undeveloped parcels of land.
2006 Fiscal Year. For the fiscal year ended June 30, 2006, we invested Ps.116.2 million of which Ps.54.1 million were related to our shopping centers totaling Ps.33.6 million, and in the Hotel segment of Ps.20.1 million.
We believe that our two principal developments projects, the construction of Panamerican Mall through our subsidiary Alto Palermo and our residential project Horizons through CYRSA, will be finished in the first half of 2009 and in early 2011, respectively. However, in view of the current market conditions, construction might suffer some delays. In addition, during the construction period we may need additional financing, which will be dependent the prevailing market conditions at the moment we need the funds.
Recent Developments
Impact of recent credit crisis. During recent months, the world’s principal financial markets have suffered the impact of volatility, lack of liquidity, and uncertainty. Consequently, stock market indexes showed a significant decline worldwide as a result of an evident economic slowdown. Although many countries took immediate action, the future of the international markets is uncertain. We do not yet know direct effects of the crisis on the market value of major financial assets, particularly equity and debt instruments.
In Argentina, stock markets also showed a pronounced downward trend in the price of equity and debt instruments. We also saw increases in interest rates, country risk and foreign exchange rates. As of the date of this annual report, these effects persist. Management is closely evaluating and monitoring the effects of the current liquidity crisis and will take all corrective actions that are necessary.
In addition, we and our subsidiaries have experienced declines in our respective stock prices during the three months ended September 30, 2008 as compared to the prior quarter. Management believes that this decline is reflective of the current macro-economic conditions and is not related to our operating performance. The stability of our tenants (measured by the levels of occupancy in our properties as well as the delinquency or uncollectibility rates) as well as the market value of our properties has not been significantly affected by the current credit crisis as of the date of this annual report. We believe that the stock prices have declined due to reasons unrelated to our business fundamentals. As of the date of these annual report , management believes that the declines in stock prices are temporary.
Furthermore, we have a 11.8 % equity interest in Banco Hipotecario as of June 30, 2008 and carried this investment under the equity method of accounting. Banco Hipotecario recorded losses of Ps. 91.0 million for the
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year ended June 30, 2008. Moreover, for the three months ended September 30, 2008, Banco Hipotecario recorded losses of Ps. 239.6 million and could record losses for the rest of the fiscal year. Such losses are primarily due to the decline in the market value of the Argentine government bonds Banco Hipotecario received as compensation and held in its portfolio. In spite of these losses, Banco Hipotecario remains well-capitalized in compliance with regulatory guidelines as of June 30, 2008 and thereafter.
Banco Hipotecario also experienced a significant decline in its stock price during the year ended June 30, 2008 and the three months ended September 30, 2008. Management believes that this decline is not reflective of the current operating performance of Banco Hipotecario.
We considered several factors including, but not limited to, the following (1) the reasons for the decline in value (whether it is credit event, interest or market related); (2) our ability and intent to hold the equity investment for a sufficient period of time to allow for recovery of value; (3) whether the decline is substantial for us; (4) the historical and anticipated duration of the events causing the decline in value and (5) the major fundamentals underlying our business. The evaluation of other-than-temporary impairments is a quantitative and qualitative process, which is subject to various risks and uncertainties. As of the date of these annual report, management believes that these declines are temporary and will continue to monitor market conditions and determine if any impairment to the carrying value of the investment is necessary.
In addition, the other business segment affected by the current credit crisis is Consumer financing. This segment includes the origination of consumer loans and credit card receivables and securitization through the indirect subsidiary Tarshop activities.
Consumer loan and credit card receivables arise primarily under open-end revolving credit accounts used to finance purchases of goods and services offered by our shopping centers, hypermarkets and street stores, and financing and lending activities. These accounts have various billing and payment structures, including varying minimum payment levels and finance charge rates. We provide an allowance for uncollectible accounts based on impaired accounts, historical charge-off patterns and management’s judgment.
Due to the current credit crisis and other conditions, some customers experienced delays in payments and delinquency rates increased during the year ended June 30, 2008. Moreover, delinquency rates further increased as of September 30, 2008 and thereafter. Tarshop has increased the level of the allowance for doubtful accounts which amounts to Ps. 66.5 million as of June 30, 2008. The allowance for doubtful accounts was increased to Ps. 83.7million as of September 30, 2008. We are closely monitoring the delays, delinquency and uncollectibility rates.
Tarshop´s generated a net loss of Ps. 18.6 million for the year ended June 30, 2008. For the three months ended September 30, 2008, Tarshop generated an additional net loss of Ps. 57.1 million. After year-end, we contributed an additional Ps. 60.0 million and increased its interest from 80% to 93.4% as of November 30, 2008. We have committed to support Tarshop financially under a credit line up to a maximum amount of Ps. 120.0 million, including the Ps. 86 million already contributed. At present we are evaluating the suitability of capitalizing these loans. We have taken several actions to enhance Tarshop’s capital base from streamlining operations to closing redundant stores to revising and making credit criteria more stringent. The securitization market is still open and Tarshop completed securitization programs during the recent months with no disruptions. As of June 30, 2008 Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps. 156.8 million and Ps. 19.4 million escrow reserves for losses, respectively. As of September 30, 2008, Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps.161.2 million and Ps.17.9 escrow reserves for losses. Due to the factors mentioned above, as of June 30, 2008, Tarshop has recorded an other-than-temporary impairment charge of Ps. 12.0 million to the retained interests to reflect current fair value. For the three months ended September 30, 2008 no additional impairment charge of related to the retained interests in securitized receivables was necessary.
Acquisition of ownership interest. On July 2, 2008, we acquired a 30% interest in Metropolitan 885 Third Avenue LLC (“Metropolitan”), a limited liability company organized under the laws of Delaware, United States
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of America. The main asset of Metropolitan is a 34 story building known as the Lipstick Building located at third avenue between 53rd and 54th streets in Manhattan, New York City. In addition to this asset, the acquired company also includes the debt related to this building. The purchase price paid was US$ 22.6 million. The property has approximately 59,000 square meters of leasable space. Also, we acquired the right ( “put right”) to sell the 50% of our stake in a period starting 6 months after this transaction until the third year anniversary of this transaction. Additionally, we acquired the right of first offer for 60% of the 5% currently held by of one of the shareholders of Metropolitan.
Coto Air Space – Barter commitment between Alto Palermo and CYRSA. In July, 2008 Alto Palermo entered into a barter agreement with CYRSA pursuant to which Alto Palermo, subject to certain closing conditions, would surrender to CYRSA its right to construct a tower over a preexisting structure (owned by a third party) in exchange for a small cash payment (US$0.09 million) and 25% of the housing units in the future buildings. The total fair value of the transaction is US$ 5.9 million.
Dique IV, Puerto Madero. Our current portfolio of projects includes the addition of 11,000 square meters of leasable area in Dique IV in Puerto Madero, currently under construction and entailing a total projected investment of approximately Ps.50.5 million. Completion is scheduled for the beginning of calendar year 2009.
Torres Renoir, Dock III. On November 24, 2008, the Decree of Co-Ownership and Administration of the Renoir building developed on plot 1.c. was granted. The first lien mortgages established by DYPSA on plot 1.c. and on plot 1.e were cancelled, and a new first lien mortgage was established on the functional units to be delivered to IRSA and on an additional functional unit. On the same date, DYPSA began the process of registration of deeds of the units to be delivered to IRSA as consideration in kind for the sale of the plot. The deeds will be granted to IRSA or its assignees within 45 days.
Acquisition of ours shares and consolidation of financial statements. In the first quarter of fiscal year 2009, Cresud purchased 32,539,475 of our shares. As a result of this acquisition, Cresud’s investment in our common shares increased from 42.13% as of June 30, 2008 to 47.76% as of September 30, 2008.
From July 1, 2008 to December 17, 2008 Cresud acquired an additional 68,712,005 of our shares on the open market for US$ 47,423,279. Thus, Cresud’s direct and indirect interest in us through Cresud’s affiliates amounts to 54.01%. Therefore Cresud consolidates us as from that date.
Cresud´s purchase of our Notes. As of November 25, 2008, Cresud had acquired nominal value US$25.21 million of our 8.500% Series No. 1 Notes due 2017, for an average weighted price of US$ 0.4844952 per Note, totaling US$ 12,214,124.
Tarshop. As a result of the current international financial scenario, a high volatility has been observed in interest rates and systemic delinquency has increased, affecting the performance and financing of the consumer finance business. The higher delinquency levels have led to an increase in the subordination of financial trusts which, added to the changes in their tax treatment, the higher interest rates resulting from higher risk and a slight deceleration in private consumption, have resulted in the need to review the general economic and the business specific prospects.
In order to face the growing volatility in the international financial markets and to provide Tarshop S.A. with a suitable capital base taking into account the current market conditions, in September 2008 Alto Palermo decided to take part in Tarshop S.A.’s capital increase for up to Ps.60 million, and increased its equity interest in Tarshop S.A. from 80% to 93.4%.
In addition, Alto Palermo implemented several actions aimed at improving Tarshop S.A.’s performance, including the revision of the point of sale structure, a 17% headcount reduction, the closing of 13 points of sale and a 10% reduction in leased centralized areas.
In line with the commercial actions, various other measures have been implemented, including:
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In addition, the recent changes introduced in the tax treatment of financial trusts and other reforms made by the National Executive Branch result in the need to monitor Tarshop S.A. and fine-tune its positioning strategy to gear with the changing conditions.
On October 2008 in the light of the difficult market conditions and in compliance with the strategic plan devised and implemented by Alto Palermo, subordinated loans were granted to Tarshop S.A. for a total amount of Ps. 51 million to improve its financial position given the particular moment by which the financial trust segment is going through, that is a source in Tarshop’s financing.
On November 25, 2008, Alto Palermo completed a disbursement of Ps. 35 million to Tarshop S.A. This disbursement was subject to the revision and verification of the debt portfolio of Tarshop S.A. by Alto Palermo’s Management and the Board of Directors. The amount was part of a credit line of up to Ps. 120 million, Alto Palermo granted to Tarshop S.A. to strengthen it financially, to fund its operating costs and to reposition Tarshop S.A. given the complex situation existing temporarily in the Financial Trusts markets. Out of the credit line approved, as of November 25, 2008, Ps. 86 million were disbursed. At present, Alto Palermo is evaluating the suitability of capitalizing these loans.
Repurchase of Alto Palermo’s Notes. On September 12, 2008 Alto Palermo announced the repurchase of its Serie II Notes for a face value of US$ 3.0 million. As a result, the amount of Alto Palermo’s Notes in its portfolio had a face value of US$ 4.8 million. On November 25, 2008, Alto Palermo announced the repurchase of its Fixed Rate Notes due 2017, Serie I for a face value of US$ 5.00 million.
Cresud’s Purchase of Alto Palermo´s Notes. As of November 25, 2008, Cresud had acquired nominal value US$5.00 million of Alto Palermo’s Series I Notes due 2017, for an average weighted price of US$ 0.4185 per Note, totaling US$ 2.1 million.
Purchase of Alto Palermo´s Notes. On November 25, 2008, we announced the acquisition of nominal value US$8.03 million of Alto Palermo’s Series I Notes due 2017, for an average weighted price of US$0.39820 per Note and for a total amount of US$ 3.2 million
Torres Rosario Project. On November 27, 2008, Alto Palermo executed the deed of barter transfer, resulting from the execution of the option granted to Condominios del Alto S.A. to purchase parcel 2-h. This parcel represents 11,686 square meters. As consideration for its acquisition Condominios del Alto S.A. agreed to deliver forty two housing units, with a total constructed surface area of 3,182 square meters, representing 22% of the apartment area of the building and 47 parking spaces, representing 22% of the parking area of the building.
Luján. In May 2008, we entered into a preliminary purchase contract with transfer of possession with Birafriends S.A. (an unrelated party) for the acquisition of a plot of land in Luján, Province of Buenos Aires, for a total purchase price of US$ 3.0 million. We paid US$ 1.2 million and the remaining balance will be paid at the time of the signing of the deed. On December 2008, we assigned the preliminary purchase contract to Cresud. Cresud will pay the remaining balance at the time of the signing of the deed, and will also refund us the amount we paid at the time of the signing of the preliminary purchase.
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B. Business Overview
Operations and principal activities
We are one of Argentina’s leading real estate companies in terms of total assets. We are engaged, directly and indirectly through subsidiaries and joint ventures, in a range of diversified real estate related activities in Argentina, including:
the acquisition, development and operation of shopping centers,
the origination of consumer loans and the securitization of corresponding receivables,
the acquisition and development of residential properties and undeveloped land reserves for future development and sale,
the acquisition, development and operation of office and other non-shopping center properties primarily for rental purposes, and
the acquisition and operation of luxury hotels.
As of June 30, 2008, we had total assets of Ps.4,472.0 million and shareholders’ equity of Ps.1,924.2 million. Our net income for the fiscal years ended June 30, 2006, 2007, and 2008 was Ps.96.6 million, Ps.107.1 million, Ps.54.9 million, respectively. We are the only Argentine real estate company whose shares are listed on the Buenos Aires Stock Exchange and whose GDSs are listed on the New York Stock Exchange.
Consolidated Revenues by Geographic Area
Offices and other non-shopping center leased properties:
City of Buenos Aires
Buenos Aires Province
Shopping Centers and Consumer Financing Operations:
Salta Province
Santa Fe Province
Mendoza Province
Córdoba Province
Sales and Developments:
Hotels:
The City of Buenos Aires
Rio Negro Province
Total The City of Buenos Aires
Total Buenos Aires Province
Total Rio Negro Province
Total Santa Fe Province
Total Salta Province
Total Córdoba Province
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Total Mendoza Province
Total
Shopping Centers. We are engaged in purchasing, developing and managing shopping centers through our subsidiary Alto Palermo. Alto Palermo operates and owns majority interests in ten shopping centers, six of which are located in the Buenos Aires metropolitan area, and the other four of which are located in the Provinces of Mendoza, Rosario, Córdoba and Salta. Our Shopping Center segment had assets of Ps.1,705.0 million as of June 30, 2008, representing 38.1% of our consolidated assets at such date, and generated operating income of Ps.182.3 million during our 2008 fiscal year, representing 71.5% of our consolidated operating income for such year.
Consumer Financing. We operate a consumer financing business through our majority-owned subsidiary, Tarshop S.A. Tarshop originates consumer loans and credit card accounts and generally securitizes a portion of its portfolio of receivables. Tarshop’s consumer financing operations consist primarily of lending and servicing activities relating to the credit card products we offer to consumers at shopping centers, hypermarkets and street stores. We finance a substantial majority of our credit card activities through securitization of the receivables underlying the accounts we originate. Our revenues from credit card operations are derived from interest income generated by financing and lending activities, merchants’ fees, insurance charges for life and disability insurance, and fees for data processing and other services. Our consumer financing segment had assets of Ps. 134.1 million as of June 30, 2008, representing 3.0% of our consolidated assets and generated an operating loss of Ps. 17.7 million during our fiscal year ended June 30, 2008 representing (6.9%) of our consolidated operating income.
Residential Properties. The acquisition and development of residential apartment complexes and residential communities for sale is another of our core activities. Our development of residential apartment complexes consists of the construction of high-rise towers or the conversion and renovation of existing structures, such as factories and warehouses. In residential communities, we acquire vacant land, develop infrastructure such as roads, utilities and common areas, and sell plots of land for construction of single-family homes. Our Development and Sale of Properties segment had assets of Ps.462.9 million as of June 30, 2008, representing 10.4% of our consolidated assets at such date, and generated operating income of Ps.19.3 million during our 2008 fiscal year ended June 30, 2008, representing 7.6% of our consolidated operating income for such year.
Office Buildings. In December 1994, we launched our office rental business by acquiring three prime office towers in Buenos Aires: Libertador 498, Maipú 1300 and Madero 1020. As of June 30, 2008, we, directly and indirectly, owned interests in 28 office buildings and other non-shopping center rental properties in Argentina that in the aggregate represented 260,866 square meters of gross leasable area. Our Offices and Other Non-Shopping Center Rental Properties segment had assets of Ps.1.056,5 million as of June 30, 2008, representing 23.6% of our consolidated assets at such date, and generated operating income of Ps.52,3 million during our 2008 fiscal year, representing 20.5% of our consolidated operating income for such year.
Hotels. In 1997, we acquired the Hotel Llao Llao and an indirect controlling interest in the Hotel Intercontinental in Buenos Aires. In March 1998, we acquired the Hotel Sheraton Libertador in Buenos Aires. During fiscal year 1999, we sold a 20% interest in the Hotel Libertador to Hoteles Sheraton de Argentina S.A., and during the fiscal year 2000, we sold 50% of our interest in the Hotel Llao Llao to the Sutton Group. Our Hotels segment, which consists of these three hotels, had assets of Ps. 252.0 million as of June 30, 2008, representing 5.6% of our consolidated assets at such date, and generated income of Ps.18.0 million during our 2008 fiscal year, representing 7.1% of our consolidated operating income for such year.
Banco Hipotecario. We currently own 11.8% of Banco Hipotecario, Argentina’s leading mortgage lender in terms of outstanding mortgage loans. We acquired 2.9% of Banco Hipotecario for Ps.30.2 million when it was
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privatized in 1999. During 2003 and 2004, we increased our investment in Banco Hipotecario to 11.8% by acquiring additional shares, and by acquiring and exercising warrants, for an aggregate purchase price of Ps.33.4 million. In May 2004, we sold Class D shares representing 1.9% of Banco Hipotecario to IFISA, one of our controlling shareholders, for Ps.6.0 million, generating a loss of Ps.1.6 million. Our 11.8% investment in Banco Hipotecario is held in the form of Class D shares, which are currently entitled to three votes per share, affording us the right to vote approximately 18.36% of the total votes that can be cast at Banco Hipotecario’s shareholders’ meetings. As of June 30, 2008, our investment in Banco Hipotecario represented 6.5% of our consolidated assets, and during our fiscal years ended June 30, 2006, 2007 and 2008, this investment generated gains of Ps.47.0 million and Ps.41.4 million and a loss of Ps.12.4 million, respectively.
Business Strategy
We seek to take advantage of our position as a leading company in Argentina dedicated to owning, developing and managing real estate. Our business strategy seeks to (i) generate stable cash flows through the operation of our real estate rental assets (shopping centers, office buildings, hotels), (ii) achieve long-term appreciation of our asset portfolio by selectively acquiring strategically located properties by taking advantage of development opportunities, and (iii) enhance the margins of our sales and developments segment through timely transformation of our land reserves into developed residential and commercial properties.
Shopping centers. In recent years, the Argentine shopping center industry has benefited from improved macroeconomic conditions and a significant expansion in consumer credit. We believe that the Argentine shopping center sector offers attractive prospects for long-term growth due to, among other factors, (i) a continuing evolution of consumer preferences in favor of shopping malls (away from small neighborhood shops) and (ii) a level of shopping center penetration that we consider low compared to many developed countries. We seek to improve our leading position in the shopping center industry in Argentina by taking advantage of economies of scale to improve the operating margins of our diversified portfolio of existing shopping centers and by developing new properties at strategic locations in Buenos Aires and other important urban areas, including in Argentine provinces and elsewhere in Latin America. The shopping center business is at present the strongest source of cash generation of our business segments.
Consumer financing. We operate a consumer financing business through Tarshop S.A., our controlled subsidiary. Tarshop’s operations consist primarily of lending and servicing activities relating to the consumer financing products we offer to consumers at shopping centers, hypermarkets and street stores. We seek to consolidate the operations of our consumer financing business and intend to maintain low levels of credit exposure through the securitization of our credit card loans. From time to time we consider strategic alternatives to maximize the value of our investment in Tarshop including its possible merger with, or sale to, another financial institution actively engaged in the Argentine credit card industry. Although we are actively considering a range of such strategic alternatives, we cannot give you any assurance if or when any of them will be in fact be implemented.
Residential properties. During the economic crisis in Argentina in 2001 and 2002, a scarcity of mortgage financing restrained growth in middle class home purchases. As a result, in recent years, we focused on projects for affluent individuals who did not need to finance their home purchases, by concentrating on the development of residential properties for medium- and high-income individuals. In urban areas, we seek to purchase undeveloped properties in densely-populated areas and build apartment complexes offering “greenspace” for recreational activities. In suburban areas, we seek to develop residential communities by acquiring undeveloped properties with convenient access to Buenos Aires, developing roads and other basic infrastructure such as power and water, and then selling lots for the construction of residential units. During fiscal year 2008, we entered into a partnership with Cyrela Brazil Realty S.A. Empreendimentos e Participações, a leading Brazilian residential real estate developer, to penetrate new market segments. IRSA-CYRELA will develop residential real estate projects in Argentina and increase its presence in this business by offering financing to its customers.
Office buildings. During the Argentine economic crisis in 2001 and 2002, little new investment was made in high-quality office buildings in Buenos Aires and, as a result, we believe there is currently substantial demand
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for desirable office space in Buenos Aires. We seek to purchase, develop and operate premium office buildings in strategically-located business districts in the City of Buenos Aires and other locations that we believe offer potential for rental income and long-term capital gain. We expect to continue our focus on attracting premium corporate tenants to our office buildings and will consider opportunities to acquire existing properties or construct new buildings depending on the location and circumstances.
Hotel operations. We believe our portfolio of three luxury hotels is positioned to take advantage of future growth in tourism and business travel in Argentina. Our strategy has been investing in high-quality properties which are operated by leading international hotel companies to capitalize on our operating experience and international reputation. We are currently remodeling the Hotel Sheraton Libertador and the Hotel Intercontinental. In December, 2007, we inaugurated 43 new suites in the Hotel Llao Llao in Bariloche, Argentina.
Banco Hipotecario. Banco Hipotecario is a full-service commercial bank offering a wide variety of banking activities and related financial services to individuals, small and medium sized companies and large corporations. Banco Hipotecario is a leader in this segment in Argentina. Since 1999, Banco Hipotecario’s shares have been listed on the Buenos Aires Stock Exchange, and since 2006 it has participated in the Level 1 ADR program of the Bank of New York. We believe that our 11.8% investment in Banco Hipotecario has attractive prospects for long-term appreciation. Unlike certain other countries in Latin America, Argentina has a low level of mortgages outstanding, particularly if measured in terms of GDP; accordingly, a significant potential growth is expected for this sector in the future. Finally, we believe that the mortgage origination business and our real estate development business (which we expect to be bolstered through our recent partnership with Cyrela mentioned above) may potentially benefit from synergies that enhacing operational efficiencies and cross selling opportunities that may promote the development of our projects.
Land reserves. We continuously seek to acquire undeveloped land at locations we consider attractive inside and outside Buenos Aires. In all cases, our intention is to purchase land with significant development or appreciation potential for subsequent sale. We believe that holding a portfolio of desirable undeveloped parcels of land enhances our ability to make strategic long-term investments and affords us a valuable “pipeline” of new development projects for upcoming years.
International. In the past, we have made significant real estate investments outside of Argentina, including investments in Brazil Realty S.A. in Brazil and Fondo de Valores Inmobiliarios in Venezuela which we disposed of in 2002 and 2001, respectively. Although we cannot assure you that we will make further investments outside of Argentina, we believe that Brazil and certain other Latin American countries offer certain interesting real estate opportunities. We expect to continue to evaluate actively such regional opportunities as they arise.
Shopping Centers
Overview
We are engaged in the ownership, acquisition, development, leasing, management and operation of shopping centers through our subsidiary Alto Palermo, and is one of the largest owners and managers of shopping centers in Argentina in terms of gross leasable area and number of shopping centers. As of June 30, 2008, Alto Palermo owned a majority interest in, and operated, a portfolio of ten shopping centers in Argentina, of which five are located in the City of Buenos Aires (Abasto, Paseo Alcorta, Alto Palermo, Patio Bullrich and Buenos Aires Design), one is located in the greater Buenos Aires area (Alto Avellaneda), and the rest are located in different provinces (Alto Noa in the City of Salta, Alto Rosario in the City of Rosario, Mendoza Plaza in the City of Mendoza and Córdoba Shopping Villa Cabrera in the City of Córdoba).
As of June 30, 2008, we owned approximately 63.3% of Alto Palermo, and Parque Arauco S.A. (“Parque Arauco”) owned 29.6%. The remaining shares are held by the public and traded on the Bolsa de Comercio de Buenos Aires and on the Nasdaq National Market (USA) under the symbol “APSA.” In addition, as of June 30, 2008, we owned US$31.7 million of Alto Palermo’s convertible notes due 2014. If we and all other holders of
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such convertible Notes were to exercise our option to convert the convertible notes into shares of Alto Palermo’s common stock, our shareholding in Alto Palermo would increase to 65.9% of its fully diluted capital.
Alto Palermo’s shopping centers comprise a total of 232,659 square meters of gross leasable area (excluding certain space occupied by hypermarkets which are not Alto Palermo’s tenants and the surface area of our subsidiary Panamerican Mall that includes several projects one of which is the construction of a shopping center). Total tenant sales in Alto Palermo’s shopping centers, excluding Córdoba Shopping, as reported by retailers, were approximately Ps. 3,581.5 million for the fiscal year ended June 30, 2008 and Ps. 2,825.8 million for the fiscal year ended June 30, 2007 (with Córdoba Shopping Villa Cabrera, the total sales to June 30, 2008 were of Ps. 3,702.3 millions). Tenant sales at Alto Palermo’s shopping centers are relevant to its revenues and profitability because they are one of the factors that determine the amount of rent that Alto Palermo charge its tenants. They also affect the tenants’ overall occupancy costs as a percentage of the tenant’s sales.
During the fiscal year ended June 30, 2008, the income from Alto Palermo’s largest tenants who are the biggest tenants of each shopping center, was 4.8% of consolidated sales from revenues and services.
As of June 30, 2008, Alto Palermo owned and/or operated the following ten shopping centers in Argentina:
Shopping Center
Location
Paseo Alcorta
Patio Bullrich
Abasto
Alto Palermo(1)
Buenos Aires Design(2)
Alto Avellaneda
Alto Noa
Alto Rosario
Mendoza Plaza
Córdoba Shopping Villa Cabrera(3)
Tenant Retail Sales
The following table sets forth the total approximate tenant retail sales in Pesos at the shopping centers in which Alto Palermo had an interest for the fiscal years ended June 30, 2006, 2007 and 2008:
Alto Palermo
Buenos Aires Design
Córdoba Shopping—Villa Cabrera
Total sales (2)
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The following table shows certain information on shopping centers in which Alto Palermo held an interest as of June 30, 2008:
Abasto (4)
Alto Palermo (5)
Alto Avellaneda (6)
PatioBullrich
Alto Noa (7)
Buenos Aires Design (8)
Mendoza Plaza (9)
Alto Rosario (10)
Córdoba Shopping – Villa Cabrera - (11) (12)
Occupancy Rate
The following table sets forth the occupancy rate expressed as a percentage of the gross leasable area for the fiscal years ended June 30, 2006, 2007 and 2008:
Córdoba Shopping Villa Cabrera
Overall Average
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Rental Price
The following table shows the annual average rental price per square meter for the fiscal years ended June 30, 2006, 2007 and 2008:
Alto Avellaneda(2)
Córdoba Shopping – Villa Cabrera
(2)
Alto Avellaneda´s revenue fall per square meter in fiscal year 2008, is due to the inclusion of 11.600 m2 belonging to Falabella.
Lease Expirations
The following table sets forth the schedule of estimated lease expirations for Alto Palermo’s shopping centers for leases in effect as of June 30, 2008, assuming that none of the tenants exercise renewal options or terminate their leases early:
Lease Expiration as of June 30,(3)
2009
2010
2011
2012 and subsequent years
Totall(2)
Depreciation
The net book value of the properties has been determined using the straight-line method of depreciation calculated over the useful life of the property. For more information, see Alto Palermo’s consolidated financial statements.
Detailed Information About Each of Alto Palermo’s Shopping Centers
Set forth below is information regarding Alto Palermo’s shopping center portfolio, including tables with the names of the five largest tenants of each shopping center and certain lease provisions agreed with such tenants.
Abasto, City of Buenos Aires.
Abasto is a 171-store shopping center property located in the center of the City of Buenos Aires with direct access from the Carlos Gardel subway station, six blocks from the Once railway terminal and near the highway to Ezeiza International Airport. Abasto opened on November 10, 1998. Alto Palermo invested approximately
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US$111.6 million in Abasto. The main building is a landmark building that, between 1889 and 1984 was the primary fresh produce market for Buenos Aires. Alto Palermo converted the property into an 116,646 square meter shopping center with approximately 39,642 square meters of gross leasable area. Abasto is the fourth largest shopping center in Argentina in terms of gross leasable area. This shopping center is close to Torres de Abasto, Alto Palermo’s developed residential apartment complex, and to Coto supermarket.
Abasto includes a food court with 24 restaurants, a multiplex cinema with 12 movie theaters and seating for approximately 3,100 people covering an area of 9,890 square meters, entertainment facilities and a 3,800 square meter children’s museum that is not included in the gross leasable area. The shopping center is spread out over five levels and has a 1,200-car parking lot consisting of 40,169 square meters (excluding the supermarket).
Abasto’s target clientele consists of middle-income individuals between the ages of 25 and 45 which Alto Palermo believes represent a significant portion of the population in this area of Buenos Aires.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales of approximately Ps. 720,4 million, representing sales per square meter of approximately Ps. 18,172.6. Revenues from leases increased from approximately Ps. 56,4 million for the fiscal year 2007 to Ps. 70.3 million for the fiscal year 2008 which represent monthly revenues per gross leasable square meter of Ps. 118.4 in 2007 and Ps. 147.8 in 2008. As of June 30, 2008, the occupancy rate in Abasto was 99.6%.
Abasto’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 11.8% of Abasto’s gross leasable area as of June 30, 2008 and approximately 8.7% of the annual base rent for the fiscal year ended on such date.
Alto Palermo, City of Buenos Aires
Alto Palermo is a 143-store shopping center which opened in 1990 in a well-known middle class and densely populated neighborhood named Palermo in the City of Buenos Aires. Alto Palermo is located at the intersection of Santa Fe and Coronel Díaz avenues, only a few minutes from downtown Buenos Aires with nearby access from the Bulnes subway station. Alto Palermo has a total constructed area of 65,029 square meters that consists of 18,551 square meters of gross leasable area. The shopping center has an entertainment center and a food court with 19 restaurants. Alto Palermo is spread out over four levels and has a 654-car pay parking lot of 32,405 square meters. In 1992 Alto Palermo was awarded a prize from the International Council of Shopping Centers for its overall design and appearance. Alto Palermo’s targeted clientele consists of middle-income individuals between the ages of 28 and 40. In January 2007 Alto Palermo started a substantial renovation of this shopping center that was partially finished in May, 2008. This renovation includes the modification of Coronel Díaz’s front, the low bridge of this street Arenales, the access on Santa Fe, the food court, and general renovations inside the mall.
During fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales of approximately Ps. 631,8 million, which represented sales per square meter of approximately Ps. 34,058.6. Revenues from leases increased from approximately Ps.57.7 million for the fiscal year 2007 to Ps.70.3 million for the fiscal year 2008, which represented monthly revenues per gross leasable square meter of Ps. 264.2 in 2007 and Ps.315.9 in 2008. As of June 30, 2008, the occupancy rate in Alto Palermo was 100%.
Alto Palermo’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 17.4% of its gross leasable area at June 30, 2008 and approximately 9.2% of its annual base rent for the fiscal year ended on such date.
Alto Avellaneda, greater Buenos Aires area
Alto Avellaneda is a 142-store suburban shopping center that opened in October 1995 and is located in the City of Avellaneda, which is on the southern border of the City of Buenos Aires. This shopping center is next to a railway terminal and is close to downtown Buenos Aires. Alto Avellaneda has a total constructed area of
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108,598.8 square meters which consists of 37,030 square meters of gross leasable area and common areas covering 23,712 square meters. The shopping center has a multiplex cinema with six movie theatres, the first Wal-Mart superstore in Argentina, a bowling center, an entertainment center, a food court with 17 restaurants and an anchor store, Falabella, that opened April 28, 2008. Wal-Mart (not included in gross leasable area) purchased the space it occupies, but it pays for its pro rata share of the common expenses of Alto Avellaneda. The shopping center is contained mostly on one floor, with the cinema located on the second floor, and has a 2,700-car free parking lot consisting of 47,856 square meters. Alto Avellaneda Shopping’s targeted clientele consists of middle-income individuals between the ages of 16 and 30.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales of approximately Ps.560.7 million which represents sales per square meter of approximately Ps.15, 141.6. Revenues from leases increased from approximately Ps.31.2 million for the fiscal year 2007 to Ps.40.5 million for the fiscal year 2008 which represent monthly revenues per gross leasable square meter of Ps.95.3 in 2007 and Ps.91.2 in 2008. As of June 30, 2008, the occupancy rate in Alto Avellaneda was 99.8%.
Alto Avellaneda’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 34.7% of its gross leasable area as of June 30, 2008 and approximately 12.2% of its annual base rent for the fiscal year ended on such date.
Buenos Aires Design, City of Buenos Aires
Buenos Aires Design is a shopping center with 63 stores specialized in interior and home decoration stores which opened in 1993. Alto Palermo owns a 54% interest in Emprendimiento Recoleta S.A. (“ERSA”), the company which has the concession to operate Buenos Aires Design. The other shareholder of ERSA is o Grupo Bapro S.A.with a 44% interest.
As a result of a public auction, in February 1991, the City of Buenos Aires granted to ERSA a 20-year concession to use a plot of land in the Centro Cultural Recoleta. There can be no assurance that the City of Buenos Aires will extend the term of this concession upon its expiration. The concession agreement provides for ERSA to pay the City of Buenos Aires a monthly amount of Ps. 20,168. It establishes that the concession may be terminated for any of the following reasons, among others:
material breach of the obligations of the parties, which with regard to ERSA include: (i) breach of applicable law, (ii) change of the purpose of the area under concession; (iii) non payment of the monthly fee for two consecutive periods;
destruction or abandonment of the area under concession;
bankruptcy or liquidation;
restitution of the plot of land under concession, which shall only take place for public interest reasons.
In June 1991, Alto Palermo entered into an agreement with the shareholders of ERSA providing Alto Palermo’s administration of Buenos Aires Design for a monthly administration fee of approximately Ps. 12,000 plus VAT.
Buenos Aires Design is in a high-income neighborhood named Recoleta in the City of Buenos Aires, near Libertador Avenue and downtown Buenos Aires. Buenos Aires Design is located in one of Buenos Aires’ most popular tourist attraction areas. Many exclusive hotels and restaurants are located in this area, and the shopping center is close to the National Museum of Fine Arts, the Museum of Modern Art and other popular cultural institutions.
Buenos Aires Design has a total constructed area of 26,131.5 square meters that consists of 14,069 gross meters of leasable area. The shopping center has five restaurants anchored by the Hard Rock Café and a terrace that covers 3,700 square meters. The shopping center is divided into two floors and has a 174-car pay parking lot. Buenos Aires Design’s targeted clientele consists of upper-middle income individuals between the ages of 25 and 45.
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During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales in nominal value of approximately Ps. 132.9 million which represents sales per square meter of approximately Ps. 9,450. Revenues from leases increased from approximately Ps. 10.4 million for the fiscal year 2007 to Ps. 12 million for the fiscal year 2008 which represent monthly revenues per gross leasable square meter of Ps. 61.7 in 2007 and Ps. 71.2 in 2008. As of June 30, 2008, the occupancy rate in Buenos Aires Design was 100%.
Buenos Aires Design’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 22.9% of Buenos Aires Design’s gross leasable area on June 30, 2008 and approximately 20.1% of its annual base rent for the fiscal year ended on such date.
Paseo Alcorta, City of Buenos Aires
Paseo Alcorta is a 111-store shopping center which opened in 1992, located in the residential area of Palermo Chico, one of the most exclusive areas in the City of Buenos Aires, and a short drive from downtown Buenos Aires, has a total constructed area of approximately 87,553.8 square meters that consists of 14,465 square meters of gross leasable area. Paseo Alcorta has a food court with 17 restaurants and a Carrefour hypermarket on the ground floor. Carrefour purchased the space it occupies but pays for its pro rata share of the common expenses of the shopping center. Paseo Alcorta is spread out over three shopping center levels and has a parking lot for approximately 1,300 cars. Paseo Alcorta’s targeted clientele consists of high-income individuals between the ages of 34 and 54.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales in nominal value of approximately Ps.385.5 million which represents sales per square meter of approximately Ps.26,652. Revenues from leases increased from approximately Ps 31.2 million for the fiscal year 2007 to Ps.37.4 million for the fiscal year 2008, which represent monthly revenues per gross leasable square meter of Ps.180.8 in 2007 and Ps.215.5 in 2008 As of June 30, 2008, the occupancy rate in Paseo Alcorta was 99.5%.
Paseo Alcorta’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 14.2% of Paseo Alcorta’s gross leasable area at June 30, 2008 and approximately 9.2% of its annual base rent for the fiscal year ended on such date.
Patio Bullrich, City of Buenos Aires
Patio Bullrich is an 80-store shopping center which opened in 1988 and the first shopping center to start operations in the City of Buenos Aires. Alto Palermo acquired Patio Bullrich on October 1, 1998 for US$ 72.3 million.
Patio Bullrich is in the neighborhood of Recoleta, one of the most prosperous areas of the City of Buenos Aires. This district is a residential, cultural and tourist center that includes distinguished private homes, historical sites, museums, theatres and embassies. The shopping center is located within walking distance of prestigious hotels and the subway, bus and train systems. Additionally, the shopping center is only 10 minutes by car from the downtown area of the City of Buenos Aires.
Patio Bullrich has a total constructed area of 29,982 square meters that consist of 11,685 square meters of gross leasable area and common areas covering 12,472 square meters. The shopping center has a multiplex cinema with four- movie theatres complex with 1,381 seats, an entertainment area of 3,066 square meters and a food court of 14 restaurants. The center is spread out over four levels and has a pay parking lot for 215 cars in an area consisting of 4,825 square meters.
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Patio Bullrich is one of the most successful shopping centers in Argentina in terms of sales per square meter. Its targeted clientele consists of high-income individuals aged 45 and above.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales of approximately Ps. 271.4 million that represent sales per square meter of approximately Ps. 23,227. Revenues from leases increased from approximately Ps. 25.4 million for the fiscal year 2007 to Ps. 28.9 million for the fiscal year 2008, which represent monthly revenues per gross leasable square meter of Ps. 192.6 in 2007 and Ps. 205.9 in 2008. As of June 30, 2008, the occupancy rate in Patio Bullrich was 100%.
Patio Bullrich’s five largest tenants (in terms of sales in the shopping center) accounted for approximately 18.3% of Patio Bullrich’s gross leasable area at June 30, 2008 and approximately 12.7% of its annual base rent for the fiscal year ended on such date.
Alto Noa, City of Salta
Alto Noa is an 89-store shopping center that opened in 1994. Alto Noa is located in the City of Salta, the capital of the Province of Salta, in the northwestern region of Argentina. The province of Salta has a population of approximately 1.2 million inhabitants with approximately 0.6 million inhabitants in the City of Salta. The shopping center has a total constructed area of approximately 30,876 square meters which consists of 18,851 square meters of gross leasable area. Alto Noa has a food court with 14 restaurants, a large entertainment center, a supermarket and a multiplex cinema with eight movie theatres. The shopping center is contained on one floor and has a free parking lot for 551 cars. Alto Noa’s targeted clientele consists of middle-income individuals between the ages of 28 and 40.
On May 29, 1998, Alto Palermo entered into a lending facility agreement with Hoyts which established the terms of the construction and for the lease of space to operate a cinema complex in Alto Noa. Pursuant to this agreement, Hoyts agreed to finance up to US$ 4.0 million of the cost of the construction of the part of the building where the cinema complex would be located. Construction was completed in August 2000, at which time Hoyts started leasing the space for a period of ten years with options for Hoyts to renew the lease for two additional consecutive ten-year periods. As of October 2000, borrowings under the facility totaled US$ 4.0 million. These borrowings accrue interest at the six-month LIBOR plus 2.25%. Under the agreement, borrowings are being repaid by offsetting against the rent payable by Hoyts Cinema. The amount outstanding under this loan as of June 30, 2008 was Ps 3.7 million. If after 30 years of lease, the loan has not been repaid in its entirety, the remaining balance shall become due. Pursuant to Decree No. 214/02, the loan and the lease agreements, which were originally denominated in U.S. Dollars, were mandatorily converted into Pesos.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales in nominal value of approximately Ps. 173.9 million, which represents sales per square meter of approximately Ps. 9,230. Revenues from leases increased from approximately Ps. 6.6 million for the fiscal year 2007 to Ps. 9.6 million for the fiscal year 2008 which represent monthly revenues per gross leasable square meter of Ps. 29.4 in 2007 and Ps. 42.5 in 2008. As of June 30, 2008, the occupancy rate in Alto Noa was 100%.
Alto Noa’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 33% of Alto Noa’s gross leasable area at June 30, 2008 and approximately 16.4% of its annual base rent for the fiscal year ended on such date.
Mendoza Plaza, City of Mendoza
Mendoza Plaza is a 152-store shopping center which opened in 1992 and is in the City of Mendoza, the capital of the Province of Mendoza. As of June 30, 2008 Alto Palermo owns a 100% interest in Mendoza Plaza Shopping S.A.. The city of Mendoza has a population of approximately 1.0 million inhabitants, making it the fourth largest city in Argentina. Mendoza Plaza consists of 39,688 square meters of gross leasable area. Mendoza Plaza has a multiplex cinema covering an area of approximately 3,659 square meters with ten movie theatres, the Chilean department store Falabella, a food court with 20 restaurants, an entertainment center and a supermarket which is also a tenant. The shopping center has two levels and has a free parking lot for 2,600 cars. Mendoza Plaza’s targeted clientele consists of middle-income individuals between the ages of 28 and 40.
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During the fiscal year ended June 30, 2008, shopping center visitors generated total retail sales in nominal value of approximately Ps.433.4 million, which represents sales per square meter of approximately Ps.10,920. Revenues from leases increased from approximately Ps. 18.8 million for the fiscal year 2007 to Ps.24.2 million for the fiscal year 2008 which represent monthly revenues per gross leasable square meter of Ps.39.7 in 2007 and Ps.50.9 in 2008. As of June 30, 2008, the occupancy rate in Mendoza Plaza Shopping was approximately 97.7%.
Mendoza Plaza’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 33.5% of Mendoza Plaza’s gross leasable area at June 30, 2008 and approximately 21% of its annual base rent for the fiscal year ended on such date.
Alto Rosario, City of Rosario
Alto Rosario is a 145-store shopping center located in the city of Rosario, the third largest city in Argentina in terms of population. It has a total constructed area of approximately 100,750 square meters, which consists of 28,561 square meters of gross leasable area. Alto Rosario has a food court with 15 restaurants, a large entertainment center, a supermarket and a Showcase cinema with 14 state-of-the-art movie theatres. The shopping center occupies on one floor and has a free parking lot for 1,736 cars. Alto Rosarios’s targeted clientele consists of middle-income individuals between the ages of 28 and 40.
During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales in nominal value of approximately Ps. 271.3 million, which represents sales per square meter of approximately Ps. 9,500. Revenues from leases increased from approximately Ps. 15.5 million for the fiscal year 2007 to Ps. 20.0 million for the fiscal year 2008, which represent monthly revenues per gross leasable square meter of Ps. 42.6 in 2007 and Ps. 58.5 in 2008. As of June 30, 2008, the occupancy rate in Alto Rosario was 99.2%.
Alto Rosario’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 37.4% of Alto Rosario’s gross leasable area at June 30, 2008 and approximately 10.3% of its annual base rent for the fiscal year ended on such date.
Córdoba Shopping Villa Cabrera.
On July 7, 2006, Alto Palermo executed a share purchase agreement jointly with Alto Palermo’s subsidiary Shopping Alto Palermo S.A. for the acquisition of all the shares held by Empalme S.A.I.C.F.A. y G., owner of Córdoba Shopping Villa Cabrera. The price agreed upon for such transaction was set at a gross amount of US$12.0 million plus a variable amount (originally established in the contract), that was determined at Ps.4 million. The Company’s incorporation was effective on December 31, 2006. To date, Alto Palermo’s and its subsidiary Shopping Alto Palermo S.A. paid over US$10 million and the amount related to the “year-end adjustment”. As of June 30, 2008, one US$2.0 million installments is pending payment; such installment will become due and payable semi-annually as from December 2008, accruing interest at 6.0% p.a. To secure the unpaid payment price, Alto Palermo has pledged in favor of the sellers 100% of Alto Palermo’s equity interests in Empalme. Upon repaying each of the remaining installments, the encumbrance will be partially lifted.
As of December 16, 2008 the fourth installment was cancelled and the encumbrance was lifted.
Córdoba Shopping Villa Cabrera is a shopping center covering 35,000 square meters of surface area, which consists of 10,117 square meters of gross leasable area. Córdoba Shopping has 104 commercial stores, 12 cinemas and parking lot for 1,500 vehicles, located in Villa Cabrera, City of Córdoba. This investment represents for us a growing opportunity in the commercial centers segment in line with the expansion strategy and presence in the principal markets inside the country.
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During the fiscal year ended June 30, 2008, visitors to the shopping center generated total retail sales in nominal value of approximately Ps. 120.8 million, which represents sales per square meter of approximately Ps. 11,943. Revenues from leases for the fiscal year 2008 were Ps. 10.6 million, which represent monthly revenues per gross leasable square meter of Ps. 87.1. As of June 30, 2008, the occupancy rate was 97.2%.
Córdoba Shopping’s five largest tenants (in terms of sales in this shopping center) accounted for approximately 13.7% of Córdoba Shopping’s gross leasable area at June 30, 2008 and approximately 7.6% of its annual base rent for the fiscal year ended on such date.
New Projects and Undeveloped Properties.
Renovation works at existing shopping centers.
During the fiscal year ended June 30, 2008, Alto Palermo completed several renovation projects in its shopping centers. Alto Palermo continued the construction of parking spaces in Paseo Alcorta shopping center which is expected to open shortly. The anchor store, Falabella was opened in Alto Avellaneda shopping center.
In Patio Bullrich, Alto Palermo finished the Yenny store during the first days after the closing of the quarter, and made progress in the construction of the buildings adjacent to the Shopping center. Alto Palermo also renovated the Coronel Díaz avenue facade, the Santa Fe avenue access, and the food court of the Alto Palermo shopping center and as of June 30, 2008, Alto Palermo was close to finishing the under-bridge in Arenales Street and improvements to the shopping centers’ interiors. Alto Palermo Shopping Center’s re-launching was accompanied by the addition of new tenants, which has generated a higher number of customers and, enhanced the sales of the other tenants.
Panamerican Mall Project, Buenos Aires City.
In December 2006, Alto Palermo entered into several agreements for the construction, commercialization, and administration of a new shopping center to be developed in the Saavedra neighborhood, in the City of Buenos Aires, by Panamerican Mall S.A. This project includes the construction of a shopping center, a hypermarket, cinemas, and an office building and/or a residential building. The completed project will cover an area of over 50,000 m2 of gross leasable area. This is one of the most important project in Alto Palermo’s pipeline. In the first half of March 2007, Alto Palermo started the construction of the shopping center, and Alto Palermo believes that it will be open in the first half of 2009.
Barter transaction agreement.
In October 2007, Alto Palermo entered into a barter agreement with Condominios del Alto S.A. pursuant to which Alto Palermo bartered a plot of land located in Rosario, Province of Santa Fe for 15 apartments and 15 parking spaces of the total units to be constructed on the land. Under this agreement, Alto Palermo will have a 14.85% and 15% of the total square meters covered by the apartments and garages, respectively. The total value of the transaction is US$ 1.1 million. Upon signing the agreement, Condominios del Alto S.A. paid Alto Palermo US$ 15,300 and assumed certain obligations. Condominios del Alto S.A. (i) guaranteed the transaction by mortgaging the land in favor of Alto Palermo for US$ 1.1 million; (ii) established a security insurance of US$ 1.6 million in Alto Palermo’s favor; and (iii) made the shareholders of Condominios del Alto S.A. guarantors of its obligations up to the amount of US$ 0.8 million.
Alto Palermo also, entered into another barter agreement with Condominios del Alto S.A. pursuant to which Alto Palermo bartered another plot of land for 42 apartments and 47 parking spaces of the total units to be constructed on the land. Under this agreement, Alto Palermo will have 22% of the total square meters covered by the apartments and garages, respectively. The total value of the transaction is US$ 2.3 million.
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Torres Rosario, City of Rosario.
Alto Palermo owns a plot of land of about 50,000 m2 in theCity of Rosario , in the same place where Alto Palermo’s shopping center Alto Rosario Shopping . On October 11, 2007, entered into a barter agreement with Condominios del Alto S.A. whereby Alto Palermo exchanged a fraction of lot 2-g, with a total area of 7,901.30 m2, for 15 units to be built with an area of 1,504.45 m2 and 15 parking spaces. During the fiscal year ended, there has been work progress in the site, its completion being estimated for the first months of the calendar year 2009.
Acquisition of Patio Olmos.
In November 2006, Alto Palermo acquired from the Provincial Government of Cordoba a property known as “Edificio Ex Escuela Gobernador Vicente de Olmos” (“Olmos”) located in Cordoba, Argentina for an aggregate purchase price of Ps. 32.5 million, of which Alto Palermo made a down payment of Ps. 9.7 million as of that date. The property, which is located in the City of Cordoba, is a 5,147 square meter four-story building. The property is leased to an unrelated party who exploits the building as a shopping center. Alto Palermo did not acquire any rights to the shopping center business. The transaction was pending certain approvals which were obtained in September 2007 when the deed was signed and the remaining balance paid.
Caballito Project.
Alto Palermos is the owners of a plot of land with an area of approximately 25,539 m2 in the City of Buenos Aires, in the Caballito neighborhood. This land could be allocated to the construction of a shopping center. Alto Palermo has not yet obtained the authorization from the Government of the City of Buenos Aires to develop the shopping center in this site, and Alto Palermo cannot assure you that Alto Palermo will obtain it.
Exercise of option.
In August 2007, Alto Palermo exercised the option to purchase a 75% interest in a company engaged in the development of a cultural, recreational and entertainment complex in the Palermo neighborhood in Buenos Aires. Alto Palermo paid US$ 0.6 million for the option which is accounted for under non current investments. The purchase is subject to certain approvals by the regulatory authorities which have not been obtained as of the date of this annual report. Should the approvals be obtained, Alto Palermo has committed to invest approximately US$ 24.4 million.
Coto Residential Project.
Alto Palermo is the owners of an air space of about 24,000 m2 above Coto Hypermarket, close to Alto Palermo’s Abasto Shopping Center, in downtown Buenos Aires. Alto Palermo S.A and Coto Centro Integral de Comercialización S.A. (Coto) executed a public deed on September 24, 1997, whereby Alto Palermo acquired the rights to receive parking units and the rights to construct above the building located between Agüero, Lavalle, Guardia Vieja and Gallo Streets, in the Abasto neighborhood of Buenos Aires.
In July, 2008 Alto Palermo entered into a barter agreement with CYRSA pursuant to which Alto Palermo is subject to certain closing conditions, would surrender to CYRSA its right to construct a tower over a preexisting structure (owned by a third party) in exchange for deminimis cash (US$ 0.9 million) and 25% of the housing units in the future buildings. The total fair value of the transaction is US$ 5.9 million.
Acquisition of Soleil Factory, Province of Buenos Aires.
On December 28, 2007, Alto Palermo entered into an agreement with INCSA, an unrelated party, for the acquisition of the Soleil Factory shopping center for an aggregate purchase price of US$ 20.7 million, of which US$ 8.1 million were paid and recorded as supplier advances. The transaction is subject to certain conditions. Upon fulfilment of the conditions and transfer of the business, the remaining balance of the purchase price amounting to US$ 12.6 million will accrue fixed interest at 5% per year. This balance will be paid in seven annual and consecutive installments starting on the first anniversary of the signing of the contract. As part of the same agreement, Alto Palermo entered into an offer to acquire, construct and operate a shopping center on land
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belonging to INCSA located in San Miguel de Tucuman, Province of Tucuman, in the northwest of Argentina. This transaction is also subject to the completion of the “Soleil Factory” transaction among other conditions. The parties determined the value of this transaction to be US$ 1.3 million.
Acquisition of Beruti Plot of Land.
In fiscal year 2008, Alto Palermo S.A. acquired a plot of land located at Beruti 3351/9, in the Palermo neighborhood, of the City of Buenos Aires. The property is 3,207 m2and was acquired for US$ 17.8 million. The significance of this acquisition lies on the strategic location of the property, close to Alto Palermo, its main shopping center.
Neuquén Project.
The main asset of Shopping Neuquén S.A. is a 50,000 m2 undeveloped parcel of land located in Neuquén, Argentina, where Alto Palermo intends to develop a commercial project including the construction of a shopping center, and a hypermarket.
On December 13, 2006, Shopping Neuquén S.A. entered into an agreement with the Municipality of Neuquén and with the Province of Neuquén which rescheduled the terms of the commercial and residential venture and authorized Shopping Neuquén S.A. to transfer to third parties the title to the plots of land, provided that it is not the one on which the Shopping Center will be built. This agreement was conditional on the ratification of the agreement by means of an ordinance of the legislative body of the Municipality of Neuquén, and on the approval of the architectonic project and the extension of the environmental impact research study by the Municipality.
After registering the blueprints for the project, Shopping Neuquén S.A. has to start the works within a term of 90 days. The first stage of the work (a minimum of 21,000 square meters of the Shopping Center and 10,000 square meters of the hypermarket) should be concluded in a maximum of 22 months from the construction starting date. In case of default in any of the covenants established in the agreement, the Municipality of Neuquén is entitled to terminate the agreement.
This agreement put an end to the lawsuit “Shopping Neuquén S.A. against Municipalidad de Neuquén on Administrative Action”before the High Court of Neuquén.
Principal Terms of Alto Palermo’s Leases
Under Argentine Law, terms of commercial leases must be between three to ten years, with most leases in the shopping center business having terms of no more than five years. Alto Palermo’s lease agreements are generally denominated in Pesos.
Decree No. 214/2002 and Decree No. 762/2002, which modify Public Emergency Law No. 25,561, determine that duties to turn over sums of money which are denominated in U.S. dollars and which are not related to the financial system as of January 7, 2002 are subject to the following:
obligations will have to be paid in Pesos at a rate of Ps.1.00 = US$1.00. Additionally, these obligations are subject to inflation adjustment through the CER index;
if, as a consequence of this adjustment, the agreement is unfair to any of the parties, as long as the party that has the obligation to pay is not overdue and the adjustment is applicable, either may ask the other for a fairness adjustment. If they do not reach an agreement, a court will make the decision in order to preserve the continuity of the contract relation in a fair way; and
new lease agreements may be freely entered into between parties, even U.S. dollar denominated lease agreements.
Leasable space in Alto Palermo’s shopping centers is marketed through an exclusive arrangement with Alto Palermo’s real estate brokers Fibesa S.A. and Comercializadora Los Altos S.A.. Alto Palermo has a standard lease
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agreement, the terms and conditions of which are described below, which Alto Palermo uses for most tenants. However, Alto Palermo’s largest tenants generally negotiate better terms for their respective leases. No assurance can be given that lease terms will be as set forth in the standard lease agreement.
Alto Palermo charges its tenants a rent which consists of the higher of (i) a monthly base rent (the “Base Rent”) and (ii) a specified percentage of the tenant’s monthly gross sales in the store (the “Percentage Rent”) (which generally ranges between 4% and 10% of tenant’s gross sales). Furthermore, pursuant to the rent escalation clause in most leases, a tenant’s Base Rent generally increases between 4% and 12% each year during the term of the lease. Although many of Alto Palermo’s lease agreements contain readjustment clauses, these are not based on an official index nor do they reflect the inflation index. In the event of litigation, there can be no assurance that Alto Palermo may be able to enforce such clauses contained in Alto Palermo’s lease agreements.
In addition to rent, Alto Palermo charges most of its tenants an admission right, which is required to be paid upon entering into a lease agreement and upon a lease agreement renewal. The admission right is normally paid in one lump sum or in a small number of monthly installments. If the tenant pays this fee in installments, it is the tenant’s responsibility to pay for the balance of any such amount unpaid in the event the tenant terminates its lease prior to its expiration. In the event of unilateral termination and/or resolution for breach of duties by the tenant, a tenant will not be refunded its admission right without Alto Palermo’s consent.
Alto Palermo is responsible for supplying each shopping center with the electrical power connection and provision, a main telephone switchboard, central air conditioning connection and a connection to a general fire detection system. Each rental unit is connected to these systems. Alto Palermo also provides the food court tenants with sanitation and with gas systems connections. Each tenant is responsible for completing all the necessary installations within its own rental unit, in addition to the direct expenses generated by these items within each rental unit. These direct expenses generally include: electricity, water, gas, telephone and air conditioning. Tenants must also pay for a percentage of total charges and general taxes related to the maintenance of the common areas. Alto Palermo determines this percentage based on the tenant’s gross leasable area and the location of its store. The common area expenses include, among others, administration, security, operations, maintenance, cleaning and taxes.
Alto Palermo carries out promotional and marketing activities to increase attendance to Alto Palermo’s shopping centers. These activities are paid for with the tenants´ contributions to the Common Promotional Fund (“CPF”), which is administered by us. Every month tenants contribute to the CPF an amount equal to approximately 15% of their rent (Base Rent plus Percentage Rent), in addition to rent and expense payments. Alto Palermo may increase the percentage that tenants must contribute to the CPF, but the increase cannot exceed 25% of the original amount set forth in the corresponding lease agreement for the contributions to the CPF. Alto Palermo may also require tenants to make extraordinary contributions to the CPF to fund special promotional and marketing campaigns or to cover the costs of special promotional events that benefit all tenants. Alto Palermo may require tenants to make these extraordinary contributions up to four times a year provided that each such extraordinary contribution may not exceed 25% of the preceding monthly rental payment of the tenant.
Each tenant leases its rental unit as a shell without any fixtures. Each tenant is responsible for the interior design of its rental unit. Any modifications and additions to the rental units must be pre-approved by us. Alto Palermo has the option to decide tenants’ responsibility for all costs incurred in remodeling the rental units and for removing any additions made to the rental unit when the lease expires. Furthermore, tenants are responsible for obtaining adequate insurance for their rental units, which must include, among other things, coverage for fire, glass breakage, theft, flood, civil liability and workers’ compensation.
Control Systems
Alto Palermo has computer systems to monitor tenants’ sales in all of its shopping centers. Alto Palermo also conducts regular manual audits of its tenants accounting sales records in all of our shopping centers. Almost every store in those shopping centers has a computerized cash register that is linked to a main computer server in the administrative office of such shopping center. Alto Palermo uses the information generated from the computer
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monitoring system for auditing the Percentage Rent to be charged to each tenant and use the statistics regarding total sales, average sales, peak sale hours, etc., for marketing purposes. The lease contracts for tenants in Alto Avellaneda, Alto Palermo, Paseo Alcorta, Patio Bullrich, Buenos Aires Design (only with respect to agreements signed after its acquisition), Abasto, Alto Rosario Shopping, Alto Noa, Empalme and Mendoza Plaza Shopping contain a clause requiring tenants to be linked to the computer monitoring system.
Related Business
Consumer Financing Segment
Alto Palermo participates in the consumer financing business through its subsidiary Tarshop, in which its holds a 93.4% interest as of November 30, 2008. Tarshop is a non-regulated entity, operating in the issue, processing and marketing of its own non-banking credit card called Tarjeta Shopping, and grants loans and personal credits.
Tarshop competes in the two key businesses of the consumer financing market: purchase and credit cards and personal loans. In addition, Tarshop competes in the personal loans segment on the basis of two clearly differentiated product lines: cash loans and direct financing at stores.
As a result of a new commercial strategy implemented by Tarshop based on its positioning as one of the leading companies in the consumer financing market, and in view of the progress in personal loans reflected in the total sales of Tarshop, Alto Palermo has decided to change the name of its Credit Card segment to Consumer financing, to more accurately reflect Tarshop’s business.
As of June 30, 2008, Tarshop had 894,000 customer accounts of which 640,000 had unpaid balances, an average indebtedness of Ps. 1,630 per account. The total loan portfolio amounted to Ps. 1,044.6 million, 78% of which was securitized through the Tarjeta Shopping Financial Trusts Program.
Alto Palermo derives major sales from the credit card line, which in the fiscal year ended on June 30, 2008, accounted for 74% of total sales, amounting to Ps. 1,413.8 million (an average monthly amount of Ps. 117.8 million). As of this filing Tarshop has issued 958,000 cards including main holders and additional holders, and since 2005, it has issued, an average of over 11,000 cards for main holders each year.
During the same period, the personal loans business line generated 26% of the average monthly sales. In recent years, personal loans granted have increased, amounting Ps. 502 million for the fiscal year ended on June 30, 2008.
As of June 30, 2008, Tarshop had a commercial network that, comprised 29 points of sale, spread in the City of Buenos Aires, Greater Buenos Aires, Córdoba, Tucumán, Salta, and Jujuy. As at June 30, 2008, there were over 45,000 stores accepting its credit cards, 46% of which regularly made transactions and generated over 7.5 million transactions during the year.
Tarshop also owns 50% of the capital stock of Metroshop S.A.; the remaining 50% is owned by Metronec S.A., a subsidiary of Roggio S.A. This company is engaged in marketing credit cards by the addition of a chip that grants automatic access to the main means of transport by marking and personal loans through an independent distribution network. Tarshop processes the products marketed by Metroshop.
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The table below contains information about Alto Palermo’s consumer financing business for the relevant fiscal years:
Revenue:
Interest collected
Commissions to merchants
Other fees and commissions
Interest, default interest, and other interest
Charges for account maintenance
Charges for life and disability insurance
Income of metroshop
Other services
Reissued credit cards
Total credits (1)
Issued credit cards
Branches (2)
Adhered stores (2)
The table below contains information about Alto Palermo’s consumer financing business for fiscal year ended on June 30, 2008, according to income statement of Tarshop:
Tariffs to stores and loans
Income from services
Interest
Other income from services
Account statements
Income from Metroshop services
Less: Revenues discounts
Total Revenues
Purchase and credit card
Tarshop operates in this business not only as an issuing and financing company as processor of its own card trademark, and as payer to the network of stores accepting the product. These characteristics are typical of a closed purchase and credit card system.
Tarjeta Shopping is accepted in over 45,000 affiliated stores, as of June 30, 2008, including the main supermarket, household appliances chains, and shopping centers.
Tarshop provides a wide variety of benefits, such as exclusive discounts and promotions, financing plans in installments, cash advances through Banelco and Link networks all over the country, balance financing through minimum payments, payment through automatic teller machine networks “Banelco” and “Link;” through the Internet using the “Pago mis cuentas” service; or through direct debit payment, and, through Alto Palermo owns network of branches.
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A differentiating element of Tarshop’s competitive strategy is its ability to establish the eligibility of customers, and grant them their credit card immediately, which allows the customers to have immediately use of the product.
The main channels for attracting customers are Alto Palermo’s branch offices, and by stands and points of sale in its shopping centers and retail stores.
Cash loans and consumer financing at stores
Tarshop’s loans business operates through two distinct modalities:
Personal loans granting cash amounts without a fixed use, called “Préstamos Tarshop.”
Consumer financing at stores, granting loans to individuals intending to purchase a specific good, for a fixed amount in a store, called “Créditos Tarshop.”
Cash loans are granted in fixed installments in pesos and the terms offered vary according to market conditions.
Credit is granted immediately, upon the customer’s submittal of the relevant documents. The store submits this documentation to its processing center where, after the relevant analysis of the documents, Alto Palermo decides whether the credit is granted. Alto Palermo is developing a now software tool which will allow affiliated stores to determine eligibility at once in its centralized databases.
“Crédito Tarshop” is a powerful product since it turns each affiliated store into a small branch office to attract more customers.
Distribution Network
As of June 30, 2008, Tarshop had 29 branches, including Alto Palermo’s shopping centers Alto Avellaneda, Alto Palermo and Abasto, as well as storefronts in major commercial centers located in the District of Avellaneda, downtown Buenos Aires and in the cities of Lomas de Zamora, Morón, Quilmes, Liniers, Florencio Varela, San Justo, Moreno, Merlo, among others.It also has branches in the Provinces of Córdoba, Tucumán, Catamarca, Salta and San Salvador de Jujuy.
Alto Palermo has promotion stands, and account representatives at Wal-Mart Avellaneda, Supermercados Coto in the cities of Lanús, Sarandi, Temperley and Supermercado Hyper Libertar located in the city of Salta. Alto Palermo has strategic alliances with certain major household appliances and motorcycle stores, where credit can be granted on the spot.
Each branch is organized as an independent business unit, responsible for achieving its commercial goals, such as invoicing and account opening. Tarshop also has its own ATM structure in branches that allow for the collection of payables and for granting of cash loans to customers.
Assessment
Applications for issue of credit products are subject to a credit assessment process. The steps followed for assessment are classified per activity as follows: verification and control of documents submitted, confirmation through an automated and sequential software that consults credit information supplied to the company by different providers, and finally, and whenever required, the data reported by the customer is validated via telephone verification. Upon completion of all data verification, and analysis a determination of the account credit limit ais made.
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Credit Limit Allocation
The allocation of a credit limit consists, as of June 30, 2008, in the assessment of the amount to be granted according to the level of indebtedness, income and risk score. Calculation of income may take into account income of one or more members of the applicant’s family group, who are required to submit evidence of the documents as a guarantee. The limit under the current credit policy shall not exceed the sum of Ps 30,000. Any credit exceeding this amount must be duly authorized. Based on the information submitted by the applicant, and the verifications performed, the corresponding credit limit is allocated. The credit limit allocated to an account is established by using a limit simulator, a program that calculates credit limits according to predefined variables per area, channel and product.
Tarshop assess aplications based on the applicant’s seniority and payment history. Tarshop regularly updates the credit limit of an account, according to the analysis performed by the Portfolio Analysis and Maintenance Group.
Invoicing Cycle
Tarshop handles an invoicing cycle which ends on the 20th day of each month and fixes a first maturity date between the 7th and the 11th day of the month to be closed. The statement fixes a second maturity date accruing interest on the 20th day each month. Amounts due appearing on account statements may be paid in any branch or in any payment outlet belonging to the mass collection agents contracted by Tarshop for that purpose. On the 20th day of the month, unpaid amounts are considered in default and accounts are blocked for use until the customer makes a payment.
Collection Process
Tarshop’s collection process is carried out according to the strategy defined by its Risk Management group. It is divided into different tranches of default and, preventive action is taken through a system of automatic calls to accounts deemed by the Company as prospectively risky. The internal management process starts on the 23rd day each month through a telephone call by the Collection Group Call Center, which is simultaneously supplemented by letters and automatic messages. This process is enhanced as account default moves forward. When internal management is unsuccessful, collection management is referred in a pre-litigation instance to external law firms hired for that purpose. Upon expiration of the term for external pre-litigation Alto Palermo perform, a portfolio analysis and the accounts that may be subject to judicial proceedings are grouped together. Any accounts not fulfilling the requirements to bring legal action are referred to Collection Agents who visit the defaulting customers personally at their home address. Throughout the process the use of mitigation tools is assessed, ranging from, refinancing to payment reduction settlements.
The policies for allowances for bad debts as of June 30, 2008, are similar to those established by the Banco Central de la República Argentina (Central Bank of the Republic of Argentina)1.
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Allowance for bad debts was estimated based on credit classification performed according to criteria related to debtors’ obligation default levels, and according to this classification the minimum allowance criteria arising from Communication “A” 2729 and amendments of the Banco Central de la República Argentina have been applied.
Further, the Company verifies coverage capabilities of the allowance resulting from the application of the procedure indicated in the previous paragraph, by evaluating the default risk portfolio according to its behavior.
Even if the Company uses the information available to carry out assessments, some future adjustments to allowance may be necessary if economic conditions substantially differ from the hypotheses used to perform the assessments. The Company has considered all the facts and/or operations subject to reasonable and normal assessment methods, which are reflected in the basic financial statements.
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The table below shows the percentages of allowance calculated by Tarshop, as of June 30, 2008, based on the rules issued by the Banco Central:
Delay
Regular Compliance
Inadequate Compliance
Deficient Compliance
Difficult Recovery
Unrecoverable
The table below provides information about Alto Palermo’s credit card loans (including securitized fraction):
Portfolio Condition
Regular Compliance (2)
Matured:
31-89 days
90-180 days
181-365 days
Over 365 days and under legal proceedings (3)
Allowance for Bad Debts of Portfolio Effective as Percentage of Defaulting Portfolio
Allowance for Bad Debts of Portfolio Effective as Percentage of Effective Portfolio
Funding and Securitization Activities
Tarshop’s main liquidity needs and capital uses include: payment of sales made by retail stores, working capital needs, investment in new technology, the opening and improvement of branches and holding of cash to take advantage of investment opportunities that may arise. Tarshop has significantly expanded its business by securitizing its credit card receivables pursuant to the Tarjeta Shopping Trust Program. By resorting to this innovative financial tool, Tarjeta Shopping has led one of the largest issues in the market and successfully placed 48 series for more than Ps.2.0 billion.Tarjeta Shopping was assigned the highest rating by Standard & Poor’s.
Tarshop has historically incurred liabilities mainly in local currency and to a lesser extent in foreign currency, and has leveraged twice the coverage for its commitments incurred in foreign currency.
Receivables Portfolio Securitization
Tarshop has its own Ps.900 million Trust Securitization Program. As of June 30, 2008, 43 series have been issued aggregating Ps.1,670 million in bonds and certificates of participation. During the first semester of 2008, 6 series were issued for Ps. 386 million, while in the same period in 2007, 4 series were issued for Ps.261 million. Total terms under each issue range from 20 to 30 months. The applicable nominal interest rates for Class A and B Bonds are approximately 15.3% and 21.7%, respectively. Interest rates were higher as compared to the previous year as a result of the prevailing local financial market conditions. The interest accrued on both Bonds is subject to floor and ceiling rates. Class A Bonds in both the revolving and non-revolving structures have an AAA rating granted by S&P. Due to the current financial crisis and the increase in delinquency rates, ratings agencies have increased the financial trust’s requirements of subordination, resulting in an increase of the percentage of certificates respect to Class A and B Bonds, such increase was lower than 10%.
Regarding the receivables transferred in connection with Tarshop’s Trust Securitization Program that qualified for sale treatment, neither Tarshop nor the trustee have responsibility over any shortfall or failure in collecting the receivables which are the source of cash payment for the bond holders. Due to the legal
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structure of securitization process set forth by Law No. 24,441 the agreements related to the securitization stipulate that the rights of beneficiaries (TDF holders) will not be affected by any financial or liquidity failure of either the trustee or Tarshop. The agreements also state that the transfer qualifies as a non-recourse transfer of receivables since if receivables are not collected in full, neither Tarshop or the trustee is obliged to use their own cash flows to cover any potential shortfall or collection failure.
Liquidity Policy
Tarshop’s policy is to maintain cash and bank account balances for an average of approximately Ps.2.0 million. All balances and reserves are stated in local currency.
Technology
Information systems are an essential element for credit card companies, as the processing of a large number of transactions and the management of unusual transaction volumes in certain key sales dates is required. This has prompted Tarjeta Shopping to procure state-of-the art technology, and for this reason the current data and transaction processing systems maintain all branches linked through its local intranet, allowing expediency and confidentiality in the handling and transmission of data. In addition, the participating stores may carry out transactions on-line 24 hours a day via POS networks operating in Argentina.
The expansion of the call center, Alto Palermo’s credit department and number of branches required a significant investment in technology and communications, resulting in an aggressive growth in the number of transactions and inquiries answered, granting of accounts and increases in transaction processing speed.
The technology group´s resources are divided into four sectors: Systems Development, Technology, Server Management and IT Security. Business growth has enabled us to incorporate highly trained professionals, training programs and, better practice methods.
Tarjeta Shopping operates with proprietary information systems, developed and suited to the company’s business. Its main systems are developed in 4GL language and Java with Informix 10 Data Base Engine, migrating to a new system developed on visual technologies under Oracle 10G Data Base. The main system platform is composed of SUN Spark servers, with Solaris 10 operating systems.
All business processes, from origination to account opening, issue of cards, transaction validation, loan management, customer management, generation and printing of bills, payments, collections, delinquency management and processing, are supported by these systems.
The systems allows the on-line capturing and validation of on-line purchases, receiving transactions through POS networks (mainly Posnet and LaPos), as well as cash withdrawal transactions through Banelco and Link ATMs.
Tarjeta Shopping’s equipment and IT systems are comparable to those used by large-scale credit card companies, which will allow it to mantain its current cost structure while maintaining the growth of accounts it has been showing so far.
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Summary Financial and Other Data
The following table sets forth certain balance sheet and other data for Tarshop as of June 30, 2006, 2007 and 2008:
Income Statement Data
Operating income
Other income (expenses), net
Income tax expense
Balance Sheet Data
Current assets:
Cash and banks
Investments
Accounts receivable
Other receivables
Inventory
Non-current assets:
Property, plant and equipment
Intangible Assets net
Total non-current assets
Current liabilities:
Accounts payable
Customer advances
Short-term debt
Related parties
Salaries and social security payable
Taxes payable
Non-current liabilities:
Long-term debt
Total liabilities
Total liabilities and shareholders’ equity
Other Financial Data
Return on assets
Return on shareholders’ equity
Net interest margin
Non-performing loans as a percentage of total loans
Reserve for loan losses as a percentage of total loans
Reserve for loan losses as a percentage of non-performing loans
Development and Sale of Properties
The acquisition and development of residential apartment complexes and residential communities for sale is one of our core activities. Our development of residential apartment complexes consists of the new construction of high-rise towers or the conversion and renovation of existing structures such as factories and warehouses. In connection with our development of residential communities, we frequently acquire vacant land, develop infrastructure such as roads, utilities and common areas, and sell plots of land for construction of single-family homes. We may also develop or sell portions of land for others to develop complementary facilities such as shopping areas within residential developments.
In our fiscal year ended June 30, 2008, revenues from our Development and Sale of Properties segment were Ps.196.8 million, compared to Ps.75.8 million in fiscal year 2007. The local currency remained stable
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throughout the 2007 fiscal year; the real estate market was promoted by the increase in the demand for all types of properties, whether office buildings, housings, retail premises or other. Likewise, the current framework provides incentives for the development of projects linked to our real estate activity. Therefore, during the 2009 fiscal year we expect to complete the projects under development, as well as to analyze new undertakings.
Construction and renovation works on our residential development properties is currently performed, under our supervision, by independent Argentine construction companies that are selected through a bidding process. We enter into turnkey contracts with the selected company for the construction of residential development properties pursuant to which the selected company agrees to build and deliver the development for a fixed price and at a fixed date. We are generally not responsible for any additional costs based upon the turnkey contract. All other aspects of the construction including architectural design are performed by third parties.
Another modality for the development of residential undertakings is the exchange of land for constructed square meters. In this way, we deliver undeveloped pieces of land and another firm is in charge of building the project. Eventually, we receive finished square meters for commercialization, without taking part in the construction works.
In the first quarter of the fiscal year ended June 30, 2008, in order to strengthen our presence in the development properties segment, we, together with CYRELA, a Brazilian developer, created a venture that operates under the name IRSA-CYRELA (CYRSA) to develop high end residential units in Argentina.
IRSA-CYRELA’s first project, located on two adjacent blocks in the Vicente López neighborhood, was launched in March under the name “Horizons”. This development will entail a new concept in residential complexes given its emphasis on the use of common spaces. This project includes two complexes with a total of six buildings, totaling 59,000 sqm of construction distributed in 467 units. Horizons has 32 amenities, including a meeting room; a work zone; indoor swimming pools; club house and spa, sauna, gym, children room, teen room; theme-park areas and an aerobic trail. As of June 30, 2008, we had executed preliminary sales agreements for 96% of the available units, and the clients have made advance payments. We expect that the units will be completed and delivered in early 2011. We consolidate the results of this venture in our financial statements, with revenues accruing as work is completed.
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The following table shows certain information and gives an overview regarding our sales and development properties:
Sales and Development Properties
Residential Apartment
Torres Jardín
Torres de Abasto (8)
Edificios Cruceros
Barrio Chico
Minetti D
Alto Palermo Park (9)
Torres Renoir (15)
Torres Renoir II (15)
Torres de Rosario (8)
Terrenos de Caballito (16)
Credit for barter transaction Terreno Caballito (Cyrsa) (15)
Credit for barter transaction Terreno Caballito (KOAD) (15)
Libertador 1703 y 1755 (16)
Other residential apartments (10)
Subtotal Residential Apartments
Residential Communities
Abril/Baldovinos (11)
Benavidez (15)
Villa Celina I, II y III
Subtotal Residential Communities
Land Reserves
Puerto Retiro (9)
Santa María del Plata
Pereiraola (11)
Terrenos Alcorta (8)
Terreno Rosario (8)
Caballito Mz 35
Canteras Natal Crespo
Luján
Terreno Beruti (8)
Pilar
Padilla 902
Air Space Coto (8)
Torres Jardín IV
Terreno Caballito (8)
Patio Olmos
Other land reserves (12)
Subtotal Land Reserves
Other
Alsina 934
Bouchard 551
Madero 1020
Dique III
Other Properties (13)
Subtotal Other
Total (14)
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Notes:
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Residential Apartments
In the apartment building market, we acquire undeveloped properties strategically located in densely populated areas of the City of Buenos Aires, particularly properties located next to shopping centers and hypermarkets or those to be constructed. We then develop multi-building high-rise complexes targeting the middle-income market. These are equipped with modern comforts and services, such as open “green areas,” swimming pools, sports and recreation facilities and 24-hour security. In the loft buildings market, our strategy is to acquire old buildings no longer in use located in areas with a significant middle and upper-income population. The properties are then renovated into unfinished lofts allowing buyers the opportunity to design and decorate them according to their preferences.
Apartment Projects Under Development
Torre Caballito, City of Buenos Aires. This undeveloped 2.1 hectare property is situated in the northern area of Caballito’s residential neighborhood in the City of Buenos Aires. On May 4, 2006, we and Koad S.A. (“Koad”), an Argentine developer, entered into an asset exchange agreement valued at US$7.5 million pursuant to which we sold to Koad plot number 36 of “Terrenos de Caballito” in exchange for Koad’s agreement to construct, at its sole expense, a residential complex to be named “Caballito Nuevo”. Koad has agreed to develop a residential complex consisting of two 34-story towers containing 220 apartments each, consisting of one, two and three bedroom residential units with surface areas ranging from 40 to 85 square meters. The proposed apartment complex is currently expected to offer a wide variety of amenities and services. The total area of this apartment complex that will be for sale is estimated to be approximately 28,000 square meters. On August 2009, we will be entitled to ownership of 26.7% of the total square meters and 25% of the parking lots of the entire complex, representing 118 apartments and 55 parking lots located in Tower 1. As a result of an incentive scheme agreed to with Koad, the number of square meters we will receive could vary according to the project’s date of completion. As a result of this transaction, Koad granted to us a first lien mortgage on the property to secure up to US$7.4 million of its obligations to us and posted a surety bond in our favor supporting an additional US$2.0 million of Koad’s obligations to us.
Torres Renoir, Dock III. In September 2004, we and Desarrollos y Proyectos Sociedad Anónima (“DYPSA”) signed a barter contract whereby we delivered DYPSA plot 1c) of Dique III in exchange for receiving, within a maximum term of 36 months, housing units, parking lots and parking spaces, representing in the aggregate 28.50% of the square meters built in the building constructed by DYPSA. The transaction amounted to US$ 8.0million. As a security for the transaction, DYPSA set up a first degree mortgage for US$ 8.0 million in our favor. During the fiscal year ended June 30, 2008 DYPSA transferred us the possession of all of the individual storage spaces and parking lots totaling US$ 0.5 million. We signed preliminary sales agreements for certain units to be received which where valued at their net realizable value. The increase for this method of valuation amounted to Ps. 21.0 million; of which Ps. 2.6 million and Ps. 18.4 million were recorded as of June 30, 2008 and 2007, respectively.
In June 2006, we signed a barter contract with DYPSA whereby we delivered DYPSA plot 1e) of Dique III in exchange for receiving, within a maximum term of 36 months, house units, parking and storages spaces representing in the aggregate 31.50% of the square meters built in the building to be constructed by DYPSA. The value of the transaction amounts to US$ 13.5 million. In November 2007, we and DYPSA resolved the substitution of the mentioned barter exchange for a payment of US$ 18.3 million, which was fully collected as of June 30, 2008. The gain on the substitution was Ps. 14.8 million.
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Vicente López, Olivos, Provincia de Buenos Aires. On January 16, 2007, we acquired the total shares of Rummaala S.A. (“Rummaala”), the main asset of which is a plot of land located in Vicente Lopez, Province of Buenos Aires. The purchase price was US$21.17 million, payable as follows: (i) US$4.25 million in cash and (ii) by delivering certain units of the building to be constructed in the land owned by Rummaala in the amount of US$16.92 million, within a 4-year term as from the approval date of the plans by the related authorities or when the facilities be vacated, whichever occurs last. As security for compliance with the construction of the building and transfer of the future units, the shares acquired were pledged.
Simultaneously with the above mentioned transaction, Rummaala acquired a plot of land adjacent to its own property for a total consideration of US$15.00 million, payable as follows: (i) US$0.50 million in cash; (ii) by delivering certain units of buildings Cruceros I and II in the amount of US$1.25 million and (iii) by delivering certain units of the building to be constructed in the land acquired for a total consideration of US$13.25 million, within a 40-month term starting from the approval date of the plans by the related authorities or when the facilities be vacated, whichever occurs last. As security for compliance with the construction of the building and transfer of the units, the property located at Suipacha 652 was mortgaged.
In April 2007, we constituted CYRSA S.A. in order to develop high-end residential units in Argentina. To that end, we contributed 100% of the capital stock in Rummaala S.A. and the debt in kind associated to the acquisition of the land to CYRSA for a net amount of $21.5 million, whereas CYRELA contributed $21.5 million (an amount equivalent to the value of the shares that we contributed).
We also entered into an agreement with Cyrela Brazil Realty S.A. Empreendimentos e Partiçipacões for the development of residential projects in Argentina through CYRSA S.A., which will operate under the name of IRSA - CYRELA.
Cyrsa is presently developing this plot of land. As of June 30, 2008 we had executed preliminary sales agreements representing 96% of the units to be sold.
The sale prices set forth in these preliminary sales contracts consist of a fixed part and a variable part to be determined in line with future construction expenses.
The client can choose from these purchase plans:
The price determined will be paid on installments and be fully paid at the time of transfer / signature of deeds.
Partial payment in installments payable up to the time of transfer / signatures of deeds and, the remaining balance is financed for 90 months, with the units mortgaged in our favor as guarantees.
We are committed to transfer the functional units by February 2011.
Torres Rosario Project, City of Rosario, Province of Santa Fe. IRSA’s subsidiary Alto Palermo owns a plot of land of approximately 42,620 (without parcel 7 already permuted) square meters in the city of Rosario, near the Alto Rosario Shopping Center. On October 11, 2007, we entered into a barter agreement with Condominios del Alto S.A. pursuant to which our subsidiary Alto Palermo S.A. bartered a fraction of parcel 2-g representing a total of 7,901.30 square meters for the construction of a residential complex. As consideration for this parcel, Condominios de
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Alto S.A. will deliver fifteen housing units, with a total constructed surface area of 1,504.45 square meters and fifteen parking spaces. In addition, APSA granted to Condominios an option to purchase through barter parcel 2-h.
Terreno Caballito, CYRSA. In June 2008 we entered into a barter agreement with CYRSA (the 50-50 joint venture with Cyrela) in which we bartered a 9,784 square meter property in the Caballito neighborhood in the city of Buenos Aires.
CYRSA agreed to develop a residential project comprised of a first stage of two towers and a third tower to be developed in a second stage at the option of CYRSA. In exchange for the transfer of the property, CYRSA paid to IRSA US$0.12 million and agreed to transfer to IRSA certain home units in the buildings to be built which will represent 25% of the area constructed. Furthermore, as security for the performance of its obligations, CYRSA has created a security interest over the property by mortgaging it in favor of IRSA in the amount of US$12.6 million. If CYRSA does not construct the third building by June 2010, then IRSA will receive the functional units and have the right to construct the third building in the future.
Completed Apartment Projects
Torres Jardín, City of Buenos Aires. Torres Jardín is a high-rise residential complex located in the Buenos Aires neighborhood of Villa Crespo, approximately five minutes from Abasto Shopping. Torres Jardín I, II and III have been completed and consist of 490 one, two and three-bedroom residential apartments. The complex also includes 295 spaces of underground parking. As of June 30, 2008 there are 20 parking spaces pending sale. The project originally included four 23-story towers targeting the middle-income market, but we decided not to construct Torres Jardín IV and may consider a barter transaction with a third party for its construction.
Torres de Abasto, City of Buenos Aires. In May 1999, we completed the construction of “Torres de Abasto,” a 545-apartment high-rise residential complex located one block from Abasto in the center of the City of Buenos Aires. The complex had a construction cost of US$34.3 million and consists of three 28-story buildings and one 10-story building, all of which target the middle-income market. The complex has a swimming pool, a terrace, 24-hour security, approximately 310 underground parking spaces and four retail stores on the ground floor of one of the buildings. As of June 30, 2008, 100% of the units in the complex had been sold.
Edificios Cruceros, City of Buenos Aires. “Edificios Cruceros” is a project located in the Puerto Madero area. This building covers 6,400 square meters of surface area of which 3,633 belong to us, and it is close to the “Edificios Costeros” office building. This project targets the high-income segment of the population and all its common areas have views of the river. This development was partially financed through the advance sale of its apartments. As of June 30, 2008, the project was completed and 100% of the units had been sold.
Barrio Chico, City of Buenos Aires. In March 2003 we purchased a plot of land on San Martin de Tours Street in the district of Barrio Parque, an exclusive residential zone in the City of Buenos Aires. At the time the sales contract was signed, US$0.08 million were prepaid. In June 2003 at the time the deed of title was transferred, US$0.23 million were paid. At that time, the property was mortgaged to Providence for US$0.75 million, to guarantee 25% of the housing units we were obligated to deliver upon the building’s completion. We financed the construction of this luxury residential complex designed for high-income customers with its own working capital. This is a unique Project located in Barrio Parque, an exclusive residential zone in the City of Buenos Aires. During May 2006 the successful marketing of this project was launched. As of June 30, 2008 the project was completed and only 2 units and 8 parking spaces remain to be sold.
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Palacio Alcorta, City of Buenos Aires. Palacio Alcorta is a 191-loft units residential property that we converted from a former Chrysler factory in the residential neighborhood of Palermo Chico, one of the most exclusive areas of the City of Buenos Aires, located just a ten-minute drive from downtown Buenos Aires. The loft units range from 60 to 271 square meters. This development project targets the upper-income market. Palacio Alcorta also has seven retail units and 165 parking spaces. As of June 30, 2008, all of the loft units in the complex had been sold.
Minetti D., City of Buenos Aires. Minetti D. is a 70-loft residential property located in the north-central area of the City of Buenos Aires. Each loft unit has a salable area of 86 square meters and a parking space. Lofts in this building are targeted towards the middle-income market. As of June 30, 2008, 98.9% of the units had been sold.
Alto Palermo Park and Plaza, City of Buenos Aires. Alto Palermo Park is one of two 34-story apartment buildings located two blocks from Alto Palermo Shopping in the exclusive neighborhood of Palermo. Apartments in this building are targeted primarily towards the upper-income market. Alto Palermo Park is located next to Alto Palermo Plaza. Both buildings are comprised of three- and four-bedroom apartments with an average area of 158 square meters in the case of Alto Palermo Park and of 294.5 square meters, in the case of Alto Palermo Plaza. Each unit includes an average of 18 and 29 square meter parking/storage space, respectively. These buildings were included in the assets we acquired in November 1997 from Pérez Companc S.A. As of June 30, 2008, all of the units in Alto Palermo Plaza were sold and there was only one unit to be sold in the Alto Palermo Park.
In the residential communities market, we acquire undeveloped properties located in suburban areas or neighborhoods near the large cities to develop private neighborhoods and country clubs in which to sell vacant lots for the construction of single family homes. In these properties we build streets and roads and arrange for the provision of basic municipal services and amenities such as open spaces, sports facilities and security. We seek to capitalize on improvements in transportation and communication around the City of Buenos Aires, the growing suburbanization of the region and the shift of the population moving to countryside-type residential communities.
An important factor in the trend towards living in suburban areas has been the improvements and additions to the Autopista Panamericana, Avenida General Paz and Acceso Oeste highways, which significantly reduce traveling time, encouraging a significant number of families to move to the new residential neighborhoods. Furthermore, improvements in public train, subway and bus transportation since their privatization have also influenced the trend to adopt this lifestyle.
Abril, Hudson, Greater Buenos Aires. Abril is a 312-hectare private residential community located near Hudson City, approximately 34 kilometers south of the City of Buenos Aires. We have developed this property into a private residential community for the construction of single family homes targeting the upper-middle income market. The project includes 20 neighborhoods subdivided into 1,273 lots of approximately 1,107 square meters each. Abril also includes an 18-hole golf course, 130 hectares of woodlands, a 4,000 square meter mansion and
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entertainment facilities. A bilingual school, horse stables and sports centers and the construction of the shopping center were concluded in 1999. The neighborhoods have been completed, and as of June 30, 2008, 95.9% of the property had been sold for an aggregate of Ps.222.1 million, with 53,628 square meters left to be sold.
El Encuentro, Benavidez, Tigre. In the district of Benavidez, Municipality of Tigre, 35 km north from downtown Buenos Aires, we are developing a 99.8 hectare gated residential complex known as “El Encuentro”, which will have a privileged front access to Highway No. 9, allowing an easy way to and from the city. On May 21, 2004 an exchange deed was signed whereby DEESA agreed to pay US$3.98 million to Inversora Bolívar, of which US$0.98 million were paid and the balance of US$3.0 million will be paid through the exchange of 110 residential plots already chosen and identified in the option contract signed on December 3, 2003. Furthermore, through the same act, DEESA set up a first mortgage in favor of Inversora Bolívar on real property amounting to US$3.0 million in guarantee of compliance with the operation. As of June 30, 2008, the neighborhood was equipped with all the utilities: power supply, water, sewage, effluent treatment plant, public lighting, finished driveways and accesses, buildings, sports facilities, etc. However, the underground tunnel and the Bancalari-Benavidez road are still pending completion. In mid-fiscal year 2008, the preliminary marketing of the complex started.
Villa Celina, Greater Buenos Aires. Villa Celina is a 400-plot residential community for the construction of single family homes located in the residential neighborhood of Villa Celina on the southwestern edge of the City of Buenos Aires. We have been developing this property in several stages since 1994. The first three stages involved 219 lots, each measuring on average 347 square meters and the last two stages involve 181 lots. As of June 30, 2008, only one plot had not been sold.
We have acquired large undeveloped properties as land reserves located in strategic areas for the future development of office and apartment buildings, shopping centers and single family housing. We have acquired what we believe to be two of the largest and most important undeveloped river front plots in Buenos Aires, Puerto Retiro and Santa María del Plata, for the future development of residential and office spaces. In addition, we have benefited from the improvement of land values during periods of economic growth, As of June 30, 2008, our land reserves totaled 27 properties consisting of approximately 2,195 hectares (including Rosario, Terreno Beruti, Caballito, and Coto C.I.C.S.A. (“Coto”) air space owned by Alto Palermo).
Land Reserves in the City of Buenos Aires
Solares de Santa María, City of Buenos Aires, (formerly Santa María del Plata). Solares de Santa María is a 70-hectare property facing the Río de la Plata in the south of Puerto Madero, 10 minutes from downtown Buenos Aires. This is an urbanization project developed through our subsidiary Solares de Santa María S.A. (“Solares de Santa María”). This project is currently expected to have residential complexes as well as offices, stores, hotels, sports, water areas, services areas with schools, supermarkets and parking lots.
As part of the project, we sold 10% of the capital stock of Solares de Santa María capital stock for US$10.6 million to Mr. Israel Sutton Dabbah, who is part of the Sutton Group. An initial payment of US$1.5 million was made and the balance of US$9.1 million is payable on December 23, 2009.
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Background
A rule passed by the Legislative Branch of the City of Buenos Aires in 1992 (Ordinance 45,665/92), provided general urban standards for the site, and call for a proposal to be submitted for approval of the Environmental Urban Plan Council (Consejo de Planificación Urbana—COPUA). In 1997 we acquired the site which the National Executive Branch had assigned to be the athlete residence of the Olympic Games (Olympic Village) in case Buenos Aires was chosen as host city to hold the Olympic Games (former Boca Juniors Football Club sports town). This property is currently owned by our subsidiary Solares de Santa María S.A. From that date forward, we have sought the approval of a mixed-use development project to be built on the site before the governmental authorities of the City of Buenos Aires.
Evolution of Approval Instances
In 2000, we filed a master plan for the Santa María del Plata site, which was assessed by COPUA and submitted to the City Treasurer’s Office, for approval.
In 2002, by Decree 405/02, the Government called for a public hearing to be held in June 2002, which was attended by professional and private entities and assessed by all competent agencies.
In July 2006, the COPUA made its recommendations about the project. On December 13, 2006, we filed an amendment to the project to adjust it to the recommendations made by COPUA, that included the following:
The project met the Guidelines of the Environmental Urban Plan.
The project was included in the proposals for the strategic development of the City’s Southern Area.
A pedestrian lane was designed along the permiter of the entire site on the Río de la Plata bank.
Integration with the city was prioritized respecting the surrounding urban landscape, designing a waterfront along the Río de la Plata bank, and providing vehicular integration with the avenues surrounding the site.
We proposed the donation of 50% of the site to the City of Buenos Aires which is the maximum amount set forth in the Planning Code.
The specific ruling within the scope of Ordinance Nº 45,665/92, Law 23,738/89 and Decree 5783/92 was proposed.
On March 29, 2007, COPUAM (formerly COPUA) passed the 145-COPUAM-07 REPORT which stated that it had no objections to the company’s proposal and requested that the General Attorney render a decision concerning the ruling proposed.
In May 2007, the Traffic Bureau requested a new traffic study for the area. This new study was carried out and the report and traffic simultarion were discussed with the authorities.
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Prior to its execution, the Decree was approved by the Minister of Planning and Public Works, the Traffic and Transport Bureau, the General Attorney and the General Technical Administrative and Legal Bureau of the Ministry of Planning and Public Works. On November 9, 2007, 11 years after the dossier was opened and 15 years after the general ruling on the site was issued by the City Council, the Government chief of the City of Buenos Aires executed Decree No. 1584/07. On December 1, 2007 Decree No. 1584 was published in the City Official Gazette No. 2815. The assignment of space for public use and convenience is the maximum provided for in the Planning Code: 50% of the site will be donated for public use (357,975 sqm).
Notwithstanding this approval, several operational and legal issues remain in the implementation of this project. The Decree has been challenged by an appeal for legal protection (acción de amparo) and as a result, we cannot give you any assurances as to when we will be able to kick off this project.
As of October 30, 2008, our internal team completed the Urban Development project draft for Solares de Santa María. Feasibility studies have been filed with the service companies and we have held multiple informative meetings with several governmental agencies aimed at defining the development of the draft project.
Puerto Retiro. Puerto Retiro is an 8.3 hectare undeveloped riverside property bounded by the Catalinas and Puerto Madero office zones to the west, the transportation hub Retiro to the north and the Río de la Plata to the south and east. One of the only two significant privately owned waterfront properties in The City of Buenos Aires, Puerto Retiro may currently be utilized only for port activities. We have initiated negotiations with municipal authorities in order to rezone the area. Our plan is to develop a 360,000 square meter financial center. The launching date has not been settled and consequently, the estimated cost and financing method are not decided. We own a 50% interest in Puerto Retiro through our wholly-owned subsidiary Inversora Bolívar S.A. (“Inversora Bolívar”). See “–Legal Proceedings –Puerto Retiro.”
Caballito, Ferro Project. This is a property of approximately 23,389 square meters in the City of Buenos Aires, neighborhood of Caballito, one of the most densely populated of the city, purchased by Alto Palermo in November, 1997. This plot would allow developing a shopping center having 30,000 square meters, a hypermarket, a cinema complex, and several recreation and entertainment activity areas. We are currently working to define the commercial project. The authorization of the government of the City of Buenos Aires for the development of a shopping center, an office building and a private hospital in this plot has not been granted yet, and we cannot give assurance that it will be granted.
Terreno Figueroa Alcorta. On December 22, 2005, our subsidiary Alto Palermo s sold the plot of land denominated Alcorta Plaza for a total price of US$7.7 million to RAGHSA S.A.. The agreed terms and conditions of payment were determined in four installments of US$ 1.9 million and 7.5% annual interest on the balance. The four installments had been collected as of the fiscal year ended June 30, 2008.
Terreno Beruti. On June 24, 2008, Alto Palermo acquired a plot of land situated at Beruti 3351/3359, in Palermo, a neighborhood in the City of Buenos Aires quite close to our Shopping Center “Shopping Alto Palermo”. The transaction involved a surface area of 3,238 square meters for a price of US$ 17.8 million. This is a significant acquisition because of the strategic location of the property, in the immediate vicinity of our main shopping center.
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Coto Air Space. Alto Palermo is the owners of an air space of about 19,755 m2 above Coto Hypermarket, close to its Abasto Shopping Center, in downtown Buenos Aires. Alto Palermo S.A and Coto Centro Integral de Comercialización S.A. (Coto) executed a public deed on September 24, 1997, whereby Alto Palermo acquired the rights to receive parking units and the rights to construct above the building located between Agüero, Lavalle, Guardia Vieja and Gallo Streets, in the Abasto neighborhood of Buenos Aires.
In July, 2008 Alto Palermo entered into a barter agreement with CYRSA pursuant to which Alto Palermo, subject to certain closing conditions, would surrender to CYRSA its right to construct a tower over a preexisting structure (owned by a third party) in exchange for deminimis cash (US$ 0.9 million) and 25% of the housing units in the future buildings. The total fair value of the transaction is US$ 5.9 million.
Land Reserves in the Province of Buenos Aires
Pereiraola, Hudson. Through Inversora Bolivar, we own a 100.0% interest in Pereiraola S.A., a company whose principal asset is a 130 hectare undeveloped property adjacent to our Abril community. We intend to use this property to develop a private community for the construction of single family homes targeted at the middle-income market. We have not yet established the costs and financing method for this proposed project, but we have already obtained the necessary municipal permits. The plot’s book value is estimated to be Ps.21.7 million as of June 30, 2008.
Pilar. Pilar is a 74 hectare undeveloped land reserve property located close to Pilar City, 55 kilometers northwest of the City of Buenos Aires. The property is easily accessible due to its proximity to the Autopista del Norte. The Pilar area is one of the most rapidly developing areas of the country. We are considering several alternatives for this property including the development of a residential community or the sale of this property as it is and, therefore, we do not have a cost estimate or a financing plan. The plot’s book value is estimated to be Ps. 3.4 million as of June 30, 2008.
Other Undeveloped Parcels in the City and Province of Buenos Aires.Our land reserve portfolio also includes nine land reserve properties located in Buenos Aires and its surrounding areas. These properties are projected for future developments of offices, shopping centers, apartment buildings and residential communities. The main properties under this category include Merlo, Mariano Acosta and Pontevedra. We also own a property in the outskirts of the City of Santa Fe called Isla Sirgadero.
Land Reserves in Other Provinces
Ex Escuela Gobernador Vicente de Olmos, Córdoba, Province of Córdoba. In November, 2006 we participated in a public bidding process called by Corporación Inmobiliaria Córdoba S.A. for the sale of the building known as Ex Escuela Gobernador Vicente de Olmos, located in
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the City of Córdoba. The building has 5,147 square meters of surface area. The building contains a portion of the Patio Olmos shopping center, which operates in four commercial plants and has two underground parking lots. This shopping center also includes two neighboring buildings with cinemas and a commercial annex, legally related through easement contracts. The building is under a concession contract effective for a 40-year term, expiring in February 2032, in which we act as grantor. This contract establishes a monthly rent payment and increases of Ps.2,513 every 47 months. On September 25, 2007, Alto Palermo signed with the Government of the Province of Córdoba the title deed of the property where the Patio Olmos Shopping Center is currently operating and the concession agreement was also transferred. The agreed purchase price balance of Ps.22.7 million was paid. As of June 30, 2008, the concession is in its 196th month with a monthly payment of Ps.12,565.
Canteras Natal Crespo, Province of Córdoba. The initail guidelines for the development of this project are in process on the basis of the master plan of the Chilean architect firm URBE. Preliminary presentations have been submitted to the Municipality of La Calera and to the Provincial Government of Córdoba.
This project consists of a mix of residential and commercial buildings and will be located in an attractive natural setting in the mountains of Córdoba. Canteras Natal Crespo S.A. is a company located in the Province of Córdoba that will have as its main activity the development of this project
Office and Other Non-shopping Center Rental Properties
We are engaged in the acquisition, development and management of offices and other non-shopping center rental properties in Argentina. As of June 30, 2008, we directly and indirectly, owned interests in 28 office and other rental properties in Argentina which comprised 260,866 square meters of gross leaseable area. Of these properties, 19 were office properties which comprised 163,724 square meters of gross leaseable area. For the fiscal year ended June 30, 2008, we had revenues from office and non shopping center rental properties of Ps.101,0 million.
All of our office rental property in Argentina is located in the City of Buenos Aires. All of these properties are rented to various different premium tenants. For the year ended June 30, 2008 the average occupancy rate for all IRSA’s properties in the Offices and Other Rental Property segment was approximately 93.55%. Nine different tenants accounted for approximately 27.0% of our total revenues for the fiscal year ended June 30, 2008. IRSA’s seven main office rental tenants are: Grupo Total Austral, Price Waterhouse, Apache Energía, Exxon Mobile Business Center, Sibille S.C. (KPMG), Microsoft de Argentina S.A., and Unilever Argentina.
Management. We generally act as the managing agent of the office properties in which we own an interest. These interests consist primarily of the ownership of entire buildings or a substantial number of floors in a building. The buildings in which we own floors are generally managed pursuant to the terms of a condominium agreement that typically provides for control by a simple majority of the interests (based on the area owned) in the building. As the managing agent of operations, we are responsible for handling services, such as security, maintenance and housekeeping. These services are generally contracted to third party providers. The cost of the services are passed-through and paid for by the tenants, except in the case of our units that are not rented, in which case we absorb the cost. Our leasable space is marketed through commissioned brokers, the media, and directly by us.
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Leases. We lease our offices and other properties pursuant to contracts with an average term of three years, with the exception of a few contracts with terms of five years. These contracts are renewable for two or three additional years at the tenant’s option. Contracts for the rental of property not located in shopping malls are generally stated in U.S. dollars, and in accordance with Argentine law they are not subject to inflation adjustment. Rental rates for renewed periods are negotiated at market value.
Properties
The following table sets forth certain information regarding our direct and indirect ownership interest in offices and other non-shopping center leased properties.
Offices
Intercontinental Plaza(6)
Dock Del Plata
Libertador 498
Maipú 1300
Laminar Plaza
Reconquista 823/41
Suipacha 652/64
Edificios Costeros
Costeros Dique IV
Bouchard 710
Della Paolera 265
Edificio República
Other Offices(7)
Subtotal Offices
Other rental properties
Other rental properties(8)
Works in Progress Dique IV(11)
Museo Renault
Thames(6)
Santa María del Plata S.A.
Other Properties(9)
Subtotal
Related fees(12)
Total offices and other(10)
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The following table shows a schedule of the lease expirations of IRSA’s office and other properties for leases outstanding as of June 30, 2008, assuming that none of the tenants exercise renewal options or terminate their lease early. Most tenants have renewal clauses in their leases.
Fiscalyear ofleaseexpiration
The following table shows our office occupancy percentage during fiscal years ended June 30, 2006, 2007 and 2008:
Intercontinental Plaza
Bouchard 557
Dock del Plata
Maipu 1300
Costeros Dock IV
Others(2)
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The following table sets forth the annual average income per square meter for our offices during fiscal years ended June 30, 2006, 2007 and 2008:
Bouchard 557(2)
Della Paolera 265(3)
Edificio República(4)
Others(4)
Set forth below you will find information regarding our principal currently owned office properties, including the names of the tenants occupying 5% or more of the gross leasable area of each property.
Intercontinental Plaza, City of Buenos Aires. Intercontinental Plaza is a modern 24-story building located next to the Intercontinental Hotel in the historic neighborhood of Monserrat in downtown City of Buenos Aires. We own the entire building which has floors averaging 900 square meters with 324 parking spaces. The principal tenants currently include Total Austral S.A., Danone Argentina S.A., IRSA, Alto Palermo and Cresud.
Bouchard 710, City of Buenos Aires. Bouchard 710 is an office building acquired by us in June 2005, located in the Retiro area. The building is a 12-story tower, with an average area per floor of 1,251 square meters, with 180 units for car parking. Tenants are Unilever de Argentina S.A., Finterbusch Pickenhayn Sibille S.C. (KPMG), and Microsoft de Argentina S.A.
Bouchard 551, City of Buenos Aires. Bouchard 551 is a Class A office building we acquired in March 2007, for a total price of US$84.1 million, located in the Retiro area close to the intersection of the Leandro N. Alem and Córdoba avenues and the Plaza Roma. The building is a 23-story tower covering a surface area of 2,900 square meters in the low floors that becomes smaller as it goes higher up to 900 square meters approximately, and parking for 177 units. On January 9, 2008, we sold a 29.9% stake in the building, which represented an attractive opportunity for us to realize the appreciation of our portfolio assets. The transaction included a surface area of 9,946 sqm plus 133 parking spaces and amounted to US$ 34.4 million. Principal lessees include La Nación S.A. and Price Waterhouse & Co. and AS. EM. S.R.L.
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Dock del Plata, City of Buenos Aires. Dock del Plata is a Class A office building we acquired in November 2006, for a total purchase price of US$8.8 million, located in the Puerto Madero area at Alicia Moreau de Justo 400. The building is 4-story high, with an average surface per plant of 1,500 square meters and parking lot for 309 units. The principal lessees are Veco S.A., Davila 380 S.A., Farmacity S.A., Rosso Alba, Francia y Ruiz Romero, Converse Argentina S.A., AT & T Communications Serv. S.R.L., MCO LEX S.R.L., Garfin Agropecuaria S.A., CA Argentina S.A. and Dell América Latina Corp.
Della Paolera 265, BankBoston Tower. In August 2007, we acquired a 50% interest in the “Bank Boston Tower”, a 31,670 square meter property located in Buenos Aires, for a total consideration of US$54 million. As of June 30, 2008, the occupancy rate of the BankBoston Tower was 100%. The principal tenants include Standard Bank, Exxon Mobile, Kimberly Clark de Argentina, Hope, Duggan & Silva S.C. and Apache Energía.
Libertador 498, City of Buenos Aires. Libertador 498 is a 27-story office tower located at the intersection of three of the most important fares thorough of the City of Buenos Aires, making it accessible from the north, west and south of the city. We own 17 floors with an average area per floor of 620 square meters and 281 parking spaces. The building has a singular cylindrical design and a highly visible circular neon billboard that makes it a landmark in the Buenos Aires skyline. The principal tenants in this building currently include MTV Networks Argentina S.R.L., Epson Argentina S.A., Yara Argentina S.A., Alfaro Abogados S.C., Julius Baer Financial Consultancy S.A., LG Electronics Argentina S.A., Allergan Productos Farmaceuticos S.A. and our subsidiary CYRSA S.A.
Maipú 1300, City of Buenos Aires. Maipú 1300 is a 23-story office tower located on the San Martín Plaza, a prime office zone. The building is also located within walking distance of the Retiro commuter train station, Buenos Aires’ most important public transportation hub, connecting rail, subway and bus transit. We own the entire building which has an average area per floor of 440 square meters. The building’s principal tenants currently include Allende & Brea, Carlson Wagonlint Travel Argentina S.A. and PPD Argentina S.A.
Laminar Plaza, City of Buenos Aires. Laminar Plaza is a 20-story office building located in Catalinas, the City of Buenos Aires’ most exclusive office district. Each floor has an average area of 1,453 square meters, including common areas. We own 5 floors and 66 parking spaces. The main tenants, among others, are as follows: Cisco Systems, Telefónica Moviles de Argentina S.A., Chubb Argentina de Seguros S.A., Hewitt Associates S.A., Apache Petrolera Argentina S.A., Natural Energy S.A. and Fertiva Latinoamérica S.A.
Suipacha 652/64, City of Buenos Aires. Suipacha 652/64 is a 7-story office building located in the office district of the City of Buenos Aires. We own the entire building and 70 parking spaces. The building has unusually large floor, most measuring 1,580 square meters. This property underwent substantial renovations shortly after we acquired the deed in 1991 to prepare the building for rental. The building’s principal tenants currently include Gameloft Argentina S.A., Monitor de Medios Publicitarios S.A, Organización de Servicios Director Empresarios (OSDE) and Alto Palermo’s subsidiary, Tarshop S.A.
Reconquista 823/41, City of Buenos Aires. Reconquista 823/41 is a 15-story office tower located in the Catalinasarea. We own the entire building which is made up of three basements,
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space for 52 cars in the car parks, the ground floor and 15 floors of office space. The building has floors with an average area of 540 square meters. As of June 30, 2008, we have an occupancy rate of 100.0%. The building’s principal tenants include Marval & O’Farrel and Tracker S.R.L.
Edificios Costeros, Dique II, City of Buenos Aires. Costeros A and B are two four-story buildings developed by us and located in the Puerto Madero area. We own the two buildings which have a gross leasable area of 6,319 square meters. In September 1999 we completed their construction and in April 2000 began to market the office spaces and 147 parking spaces. The main tenants of these properties are as follows: Leo Burnett Worldwide Invest. Inc., Reckitt Benchiser Argentina S.A., Martina Di Trento S.A., Italcred S.A., Minera Agua Rica L.L.C. and Somos Tres S.R.L.
Edificios Costeros, Dique IV, City of Buenos Aires. On August 29, 2001, we signed the deed of purchase of “Section C” of the office complex known as Puerto del Centro that includes buildings “5” and “6.” The property is located in the Puerto Madero area and has approximately 5,500 square meters of gross leasable area and 50 parking spaces. The building’s principal tenants currently include Nextel Argentina S.A., Consultora de Estudios Bonaerense S.R.L., London Supply S.A.C.I.F.I., Techint Cía. Técnica Internacional S.A.C.I. and Trafigura Argentina S.A.
Edificio República. In April 2008, we acquired and paid US$70.2 million for the property. The acquisition was partially financed by a mortgage loan from Banco Macro of US$33.6 million accruing interest at a fixed rate of 12% per annum and payable in five installments beginning in April 2009. This property, which was designed by the renowned architect César Pelli (who also designed the World Financial Center in New York and the Petronas Towers in Kuala Lumpur) is a unique premium office building in downtown Buenos Aires and adds 19,533 gross leaseable square meters to our portfolio. The building has 20 floors, 16 of which were vacated at the time of acquisition. As of June 30, 2008, we executed agreements for 9,000 sqm with several important tenants, including Apache Energía, Deutsche Bank, Estudio Beccar Varela and Banco Itaú, at values of US$37 and US$39 per square meter.
Dock IV, City of Buenos Aires. This luxury office building has a total surface area of approximately 20,668 square meters, and will offer 11,000 square meters of large and versatile office space for lease. The building’s layout welcomes both companies requiring smaller office space, averaging 200 square meters, and corporations in need of an entire floor. The total projected investment amounts to approximately Ps.50.5 million. As of October 31, 2008, approximately 82% of the project had been completed.
Other office properties. We also have interests in three smaller office properties, all of which are located in the City of Buenos Aires. These properties are either entire buildings or portions of buildings, none of which contributed more than Ps.1.4 million in annual rental income for fiscal year 2008. Among these properties are Madero 942, Libertador 602, Av. de Mayo 595, Rivadavia 2768 and Sarmiento 517.
Retail and other properties. Our portfolio of non-shopping center leased properties includes ten non-shopping center leased properties that are leased as street retail, a warehouse, two leased undeveloped parcels of land and various other uses. Most of these properties are located in the City of Buenos Aires, although some are located in other cities in Argentina. These properties include Constitución 1111, Museo Renault, Edificio Crucero I, Thames and Santa María del Plata.
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Hotels
At the end of the 1997 fiscal year, we acquired the Hotel Llao Llao, our first luxury hotel. Some months later, as part of the acquisition from Pérez Companc of the Old Alto Palermo, we acquired an indirect 50% interest in the Hotel Intercontinental in Buenos Aires which we own through our subsidiary Inversora Bolívar. In March 1998, we acquired the Hotel Libertador. During fiscal year 1999, we sold a 20% interest in the Hotel Libertador to Hoteles Sheraton de Argentina S.A., (“Hoteles Sheraton de Argentina”) and during the fiscal year 2000, we sold 50% of our interest in the Hotel Llao Llao to the Sutton Group. During fiscal year 2007 we increased our share in Inversora Bolivar by 100% and obtained an indirect share in the Hotel Intercontinental of 76.34%.
The following chart shows certain information regarding our hotels:
Hotel
Intercontinental(3)
Sheraton Libertador(4)
Llao Llao(5)
Plots in Bariloche(5)
Hotel Llao Llao, San Carlos de Bariloche, Province of Rio Negro. In June 1997 we acquired the Hotel Llao Llao from Llao Llao Holding S.A. The Sutton Group currently owns a 50% stake in the hotel. The Hotel Llao Llao is located on the Llao Llao península, 25 kilometers from San Carlos de Bariloche and is one of the most important tourist hotels in Argentina. Surrounded by mountains and lakes, this hotel was designed and built by the famous architect Bustillo in a traditional alpine style and first opened in 1938. The hotel was renovated between 1990 and 1993 and has a total constructed surface area of 15,000 square meters and 158 rooms. The hotel-resort also includes an 18-hole golf course, tennis courts, health club, spa, game room and swimming pool. The hotel is a member of The Leading Hotels of the World, Ltd., a prestigious luxury hospitality organization representing 430 of the world’s finest hotels, resorts and spas. The Hotel Llao Llao is currently being managed by Compañía de Servicios Hoteleros S.A. which manages the Alvear Palace Hotel, a luxury hotel located in the Recoleta neighborhood of Buenos Aires.
During 2007, the hotel was expanded at a cost of approximately US$12.7 million. The number of suites in the hotel increased to 201 rooms, improvements were made in the kitchen and laundry room, and a high technology water purifying plant was constructed. As of June 30, 2008, the works were completed and 43 additional rooms were being offered to the public.
Hotel Intercontinental, City of Buenos Aires. In November 1997, we acquired 51% of the Hotel Intercontinental from Pérez Companc S.A. The Hotel Intercontinental is located in the
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downtown City of Buenos Aires neighborhood of Monserrat, adjacent to the Intercontinental Plaza office building. Intercontinental Hotels Corporation, a United States corporation, currently owns 25% of the Hotel Intercontinental. The hotel’s meeting facilities include eight meeting rooms, a convention center and a divisible 588 square meter ballroom. Other amenities include a restaurant, a business center, a spa and a fitness facility with swimming pool. The hotel was completed in December 1994 and has 309 rooms. The hotel is managed by the Intercontinental Hotels Corporation.
During the fiscal year ended June 30, 2008, we invested US$1.5 million in improvements to the rooms (standard and junior suites), corridors and floors of the “Club Continental” sector. These improvements were aimed at providing greater comfort for hotel guests, according to the standards of Intercontinental Hotels worldwide.
Hotel Sheraton Libertador, City of Buenos Aires. In March 1998 we acquired 100% of the Hotel Sheraton Libertador from Citicorp Equity Investment for an aggregate purchase price of US$23 million. This hotel is located in downtown Buenos Aires. The hotel contains 193 rooms and 7 suites, eight meeting rooms, a restaurant, a business center, a spa and fitness facilities with a swimming pool. In March 1999, we sold 20% of our interest in the Sheraton Libertador Hotel for US$4.7 million to Hoteles Sheraton de Argentina. The hotel is currently managed by Sheraton Overseas Management Corporation, a United States corporation.
Terreno Bariloche, “El Rancho,” San Carlos de Bariloche, Province of Río Negro. On December 14, 2006, through our hotel operator subsidiary, Llao Llao Resorts S.A., we acquired a land covering 129,533 square meters of surface area in the City of San Carlos de Bariloche in the Province of Río Negro. The total price of the transaction was US$7.0 million, of which US$4.2 million were paid cash and the balance of US$2.8 million was financed by means of a mortgage to be paid in 36 monthly, equal and consecutive installments of US$0.086 million each. The land is in the border of the Lago Gutiérrez, close to the Hotel Llao Llao in an outstanding natural setting and has a large cottage covering 1,000 square meters of surface area designed by the architect Ezequiel Bustillo.
Our Investment in Banco Hipotecario
We have a significant investment in Banco Hipotecario which represented 6.5% of our consolidated assets as of June 30, 2008. Established in 1886 by the Argentine government and privatized in 1999, Banco Hipotecario has historically been Argentina’s leading mortgage lender, provider of mortgage-related insurance and mortgage loan services. All of its operations and customers are located in Argentina where it operates a nationwide network of 41 branches and 50 sales offices.
Banco Hipotecario is a full-service commercial bank offering a wide variety of banking activities and related financial services to individuals, small- and medium-sized companies and large corporations. As of June 30, 2008, Banco Hipotecario ranked third in the Argentine financial system in terms of shareholders’ equity and tenth in terms of total assets. As of June 30, 2008, Banco Hipotecario’s shareholders’ equity was Ps.2,651.7 million, its assets were Ps.10,572.3 million, and its net income for the first six months of 2008 was Ps.9.5 million. Since 1999, Banco Hipotecario’s shares have been listed on the Buenos Aires Stock Exchange in Argentina, and since 2006 it has had a Level I GDR program.
Banco Hipotecario’s business strategy is focused on leveraging its financial position and developing a diversified banking business built on its existing mortgage franchise. Since its debt
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restructuring in 2004, it began to make progress in this diversification strategy, growing its lending business and developing new business lines, implementing integrated technological solutions to enable its entry into retail banking, extending its marketing network and creating back-office services to support its new operations.
In 2004, as part of its business diversification strategy, Banco Hipotecario expanded its product offerings and began offering personal loans, resumed mortgage lending and launched asset-backed loans. It expanded its corporate loan product offerings and implemented certain customer loyalty strategies. In response to demand for retail and wholesale time deposits and savings accounts, Banco Hipotecario started offering personal checking accounts and launched the Visa Banco Hipotecario credit card which has steadily grown in terms of market penetration and transaction size. Banco Hipotecario also continued its strategy of expanding the offering of non-mortgage related insurance products it offers, including combined family, life, unemployment, health, personal accident and ATM theft insurance.
As of June 2008, it continued expanding these business lines, as non-financial private sector loans increased to Ps.669.6 million, principally as a result of retail and consumer loan originations, which represent a 70.5% increase over the amount at June 2007. Commercial loans to the private sector decreased 17.5% during the same period.
Banco Hipotecario seeks to achieve a balanced portfolio of mortgage loans, consumer financing and corporate credit lines, while maintaining an adequate risk management policy. As of June 30, 2008, its portfolio of non-mortgage loans increased to 51.7% of its total loan portfolio compared to 51.2% as of June 30, 2007
During 2007 and the six-month period ended June 30, 2008, Banco Hipotecario also experienced continued growth in deposits, including savings accounts and time deposits.
The following table sets forth Banco Hipotecario’s sources of funding as of the dates indicated.
Checking accounts
Saving accounts
Time deposits
Other deposit accounts
Accrued interest payable
Seasonality
Our “shopping centers” business unit is subject to strong seasonality. During the summer holiday season (January and February) our tenants experience their minimum sales levels, compared to the winter holiday season (July) and December (Christmas) when our tenants tend to reach their peak sales figures. Clothing and footwear tenants tend to change their collections in the spring and fall. This has a positive effect on the sales of stores. Discount sales at the end of each season also have a major impact on our business.
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Competition
We compete in the shopping center sector through our subsidiary Alto Palermo. Because most of our shopping centers are located in developed and highly populated areas, there are competing shopping centers within, or in close proximity to, our targeted areas. The number of shopping centers in a particular area could have a material effect on our ability to lease space in our shopping centers and on the amount of rent that we are able to charge. We believe that due to the limited availability of large plots of land and zoning restrictions in the City of Buenos Aires, it will be difficult for other companies to compete with us in areas through the development of new shopping center properties. Our principal competitor is Cencosud S.A. which owns and operates Unicenter shopping center and the Jumbo hypermarket chain, among others.
The following chart shows certain information relating to the most important owners and operators of shopping centers in Argentina:
Company
Location(1)
Alto Avellaneda(4)
Abasto de Buenos Aires
Mendoza Plaza Shopping(4)
Paseo Alcorta(4)
Alto Palermo Shopping
Buenos Airess Design(3)
Alto Noa(4)
Córdoba Shopping(4)
Alto Rosario (4)
Cencosud
Unicenter Shopping(4)
Plaza Oeste Shopping(4)
Quilmes Factory(4)
Portal Lomas(4)
San Martín Factory(4)
Parque Brown Factory(4)
Las Palmas del Pilar Shopping(4)
Portal de Palermo(4)
Portal de la Patagonia(4)
Portal de Escobar(4)
Portal de los Andes(4)
Portal de Madryn
Portal de Tucumán(4)
Portal de Rosario(4)
Other Operators
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Source: Argentine Chamber of Shopping Centers.
Consumer Financing
The credit card market in Argentina is highly competitive due to (i) the active participation in this market of significantly all international and domestic banks conducting business in Argentina, most of which have significantly greater financial resources than we do and (ii) the strong market position of both Visa and Mastercard in Argentina. Our principal competitors in various segments of the credit card market include:
International and domestic Cards: Visa, Master, AMEX, Cabal and Diners.
Regional cards: Naranja, Provencred, Efectivo Sí and Credilogros.
Zonal cards: Italcred, Carta Sur, Crédito Actual and Credial.
Closed cards: Falabella, Garbarino, Frávega, Musimundo, Carrefour and Johnson’s.
Banks: Columbia, Itaú, Comafi, Privado, Hipotecario, Macro, StandardBank
International financial companies: GE Money, Cetelem and AIG (Efectivo Sí).
A large number of companies are currently competing with us in the development and sale of properties in Argentina. This segment is highly fragmented, and an increasing number of companies have been taking advantage of low construction costs and attractive property values, making this segment highly competitive. In addition, there is a large supply of comparable properties in the vicinity of our developed properties. This may adversely affect our ability to sell our developed properties at prices that generate a positive return on our investment.
Office and Other Non-Shopping Center Rental Properties
Substantially all of our office and other non-shopping center rentals are located in developed urban areas. There are many office buildings, shopping malls, retail and residential premises in the areas where our properties are located. This is a highly fragmented market, and the abundance of comparable properties in our vicinity may adversely affect our ability to rent or sell office space and other real estate and may affect the sale and lease price of our premises.
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In the future, both national and foreign companies may participate in Argentina’s real estate development market, competing with us for business opportunities. Moreover, in the future we may participate in the development of real estate in foreign markets, potentially encountering well established competitors.
We own three luxury hotels in Argentina which are managed through strategic alliances by international operators including Sheraton Overseas Management Corporation, Intercontinental Hotels Corporation and the local operator Compañía de Servicios Hoteleros S.A. which manages the Hotel Alvear. The Hotel Llao Llao is unique for its landscape and beauty, and our other two hotels, Hotel Intercontinental and Hotel Sheraton Libertador, are located in the City of Buenos Aires. We compete with many other leading luxury hotels in the City of Buenos Aires including, among others: Abasto Plaza, Alvear Palace, Caesar Park, Claridge, Emperador, Feir’s Park, Four Seasons, Hilton, Loi Suites, Marriot Plaza, Meliá, NH City, Panamericano, Sheraton, Sofitel, Madero, MayFlower, Etoile, Faena, and Regal Pacific.
Regulation and Government Supervision
The laws and regulations governing the acquisition and transfer of real estate, as well as municipal zoning ordinances, are applicable to the development and operation of our properties.
Currently, Argentine law does not specifically regulate shopping center lease agreements. Since our shopping center leases generally differ from ordinary commercial leases, we have created standard provisions that govern the relationship with our shopping center tenants.
Leases
Argentine law imposes certain restrictions on landlords, including:
a prohibition to include price adjustment clauses based on inflation increases in lease agreements; and
the imposition of a three-year minimum lease term for retail property, except in the case of stands and/or spaces in markets and fairs.
Although our lease agreements were U.S. dollar-denominated, Decree No. 214/2002, Decree No. 762/2002 and Law N° 25,820 that amended the Public Emergency Law, provided that monetary obligations in force as of January 7, 2002 arising from agreements governed by private law and which provided for payments in U.S. dollars were subject to the following rules:
financial obligations were to be paid in Pesos at the exchange rate of Ps.1.00 = US$1.00 plus the CER for commercial leases;
from October 1, 2002 and until March 31, 2004 for residential leases, the obligations where the tenant is an individual and the dwelling is used as the family residence of permanent use were to be paid in Pesos at the exchange rate of Ps.1.00 = US$1.00 plus the CVS;
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if because of the application of these provisions, the amount of the installment were higher or lower than the amount at the moment of the payment, any of the parties could require an equitable adjustment of the price. If the parties did not reach an agreement, the judicial courts could decide about the difference in each particular case; and
pursuant to Decree No. 117/2004 and Law No. 25,796 that amends Law No. 25,713, the CVS became unenforceable since April 1, 2004.
Under the Argentine Civil Code and the Lease Law No. 23,091, lease terms may not exceed ten years, except for leases regulated by Law No. 25,248 (which provides that real estate leases containing purchase options –leasing inmobiliario- are not subject to term limitations). Generally, terms in our lease agreements go from 3 to 10 years. Despite this restriction, in November 2007, the judicial courts authorized Alto Palermo to enter into a lease agreement with Wal Mart Argentina SRL for a term of 30 years. This exception was authorized taking into consideration the size of the investment required and the amount of time that was necessary to recoup this investment. In June 2008, Alto Palermo requested the judicial courts a new authorization to enter into a lease agreement with Falabella for a term of 30 years. In August 2008, the judicial courts rejected the request and in November 2008 Alto Palermo appealed this decision. As of the date of this filing, the court’s decision is still pending.
Lease Law No. 23,091, as amended by Law No. 24,808 provides that tenants may rescind commercial lease agreements after the first six months by sending a written notice at least 60 days before the termination of the contract. Such rescission is subject to penalties which range from one to one and a half months of rent. If the tenant rescinds during the first year of the lease the penalty is one and a half month’s rent and if the rescission occurs after the first year of lease the penalty is one month’s rent.
While current argentine government policy discourages government regulation of lease agreements, there can be no assurance that additional regulations will not be imposed in the future by the Argentine Congress, including regulations similar to those previously in place. Furthermore, most of our leases provide that the tenants pay all costs and taxes related to the property in proportion to their respective leasable areas. In the event of a significant increase in the amount of such costs and taxes, the argentine government may respond to political pressure to intervene by regulating this practice, thereby negatively affecting our rental income. On August 16, 2006, former economy minister Felisa Miceli announced a loosening of requirements on mortgage loans up to Ps.300,000. Banks were enabled to finance 100 percent of house purchases on property valued at up to Ps.200,000 and 90 percent of purchases of property worth up to Ps.300,000. The duration of these loans will be up to 30 years. These measures were taken in response to the escalating cost of leases and the difficulties in accessing the mortgage loan market. These measures became effective in September, 2006.
The Argentine Civil and Commercial Procedure Code enables the lessor to pursue what is known as an “executory proceeding” where lessees fail to pay rent. In executory proceedings debtors have fewer defenses available to prevent foreclosure, making these proceedings substantially shorter than ordinary ones. In executory proceedings the origin of the debt is not under discussion; the trial focuses on the instrument of the debt itself. The aforementioned code also permits special eviction proceedings, which are carried out in the same way as ordinary proceedings. The Argentine Civil Code enables judges to summon tenants who fall two months in arrears to vacate the property they are renting within 10 days of having received notice to such effect. However, historically, large court dockets and numerous procedural hurdles have resulted in significant delays to evictions proceedings, which generally last from six months to two years from the date of filing of the suit to the time of actual eviction.
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On February 4, 2003, the Argentine government enacted Decree No. 204/2003 establishing a mediation procedure for a limited period of 90 days. On May 2003, the Argentine Congress enacted Law No. 25,737 which suspended foreclosures for an additional period of 90 days, which ended in May 2003. On September 2003, several financial institutions voluntarily agreed not to foreclose on their mortgage loans. On November 2005, the Argentine congress enacted Law No. 26,062 that extended the foreclosures suspension for an additional 120 days period, which was extended for 90 days more by Law No. 26,084 and for 180 days more by Law No. 26,103. Pursuant to these successive extensions, foreclosure on mortgaged property was suspended until December 2006.
On November 6, 2003 Law No. 25,798 was enacted. It established a mechanism to reschedule debts resulting from unpaid mortgages, by creating a trust by means of which the Executive Branch will refinance the mortgage debts and reschedule the maturity date. Financial institutions were given until a period of 60 business days from the enactment of the law to accept said terms. This law was partially modified by Law No. 25,908 (enacted on July 13, 2004) which included various conditions referring to the incorporation into this system of the mortgage loans that were in judicial or private execution proceedings. The parties to secured loan agreements were given a term to express their adhesion System. The term for financial institutions to accept the mechanism was extended in several occasions by Decree No. 352/2004, Law No. 26,062, Law No. 26,084 and Law No. 26,103.
On November 8, 2006, Law No. 26,167 was enacted. It established a special proceeding to replace ordinary trials for the enforcement of some mortgage loans. Such special proceedings give creditors ten days to inform the debtor of the amounts owed to them and thereafter agree with the debtor on the amount and terms of payment. In case of failure by the parties to reach an agreement, payment conditions are to be determined by the judge. Also, this law established the suspension of the execution of judicial judgments, judicial and extrajudicial auctions, evictions and other proceedings related to the mortgage loans contemplated in this law.
Development and Land Use
Buenos Aires Urban Planning Code. Our real estate activities are subject to several municipal zoning, building and environmental regulations. In the city of Buenos Aires, where the vast majority of our real estate properties are located, the Buenos Aires Urban Planning Code (Código de Planeamiento Urbano de la Ciudad de Buenos Aires) generally restricts the density and use of property and controls physical features of improvements on property, such as height, design, set-back and overhang, consistent with the city’s urban landscape policy. The administrative agency in charge of the Urban Planning Code is the Secretary of Urban Planning of the City of Buenos Aires.
Buenos Aires Building Code. The Buenos Aires Building Code (Código de la Edificación de la Ciudad de Buenos Aires) complements the Buenos Aires Urban Planning Code and regulates the structural use and development of property in the city of Buenos Aires. The Buenos Aires Building Code requires builders and developers to file applications for building permits, including the submission to the Secretary of Work and Public Services (Secretaría de Obras y Servicios Públicos) of architectural plans for review, to assure compliance therewith.
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We believe that all of our real estate properties are in material compliance with all relevant laws, ordinances and regulations.
Sales and Ownership
Real Estate Installment Sales Law. The Real Estate Installment Sales Law No. 14,005, as amended by Law No. 23,266 and Decree No. 2015/1985, imposes a series of requirements on contracts for the sale of subdivided plots of land regarding, for example, the sale price which is paid in installments and the deed, which is not conveyed until final payment. The provisions of this law require, among other things:
the registration of the intention to sell the property in subdivided plots in the Real Estate Registry (Registro de la Propiedad Inmueble) corresponding to the jurisdiction of the property. Registration will only be possible with regards to unencumbered property. Mortgaged property may only be registered where creditors agree to divide the debt in accordance with the subdivided plots. However, creditors may be judicially compelled to agree to the division;
the preliminary registration with the Real Estate Registry of the purchase instrument within 30 days of execution of the agreements.
Once the property is registered, the installment sale may not occur in a manner inconsistent with the Real Estate Installment Sales Act, unless seller registers his decision to desist from the sale in installments with the Real Estate Registry. In the event of a dispute over the title between the purchaser and third-party creditors of the seller, the installment purchaser who has duly registered the purchase instrument will obtain the deed to the plot. Further, the purchaser can demand conveyance of title after at least 25% of the purchase price has been paid, although the seller may demand a mortgage to secure payment of the balance of the purchase price.
After payment of 25% of the purchase price or the construction of improvements on the property equal to at least 50% of the property value, the Real Estate Installment Sales Act prohibits the rescission of the sales contract for failure by the purchaser to pay the balance of the purchase price. However, in such event the seller may take action under any mortgage on the property.
Consumer Protection Law. Consumer Protection Law No. 24,240, as amended, regulates several issues concerning the protection of consumers in the arrangement and execution of contracts. The Consumer Protection Law purports to prevent potential abuses deriving from the strong bargaining position of sellers of goods and services in a mass-market economy where standard form contracts are widespread. As a result, the Consumer Protection Law deems void and unenforceable certain contractual provisions in consumer contracts, including those which:
warranty and liability disclaimers;
waiver of consumer rights;
extension of seller rights; and
shifting of the burden of proof against consumers.
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In addition, the Consumer Protection Law imposes penalties ranging from fines to closing down of establishments in order to induce compliance from sellers.
The Consumer Protection Law defines consumers or users, as the individuals or legal entities that acquire or use goods or services free of charge or for a price for final use for of their own benefit or that of their family or social group. It also includes the acquisition of rights on a time-share leasing, country club, private cemetery, among others.
In addition, the Consumer Protection Law defines the suppliers of goods and services as the individuals or legal entities, either public or private that in a professional way, even occasionally, produce, import, distribute or commercialize goods or supply services to consumers or users.
The Consumer Protection Law excludes the services supplied by professionals that require a college degree and registration in officially recognized professional organizations or by a governmental authority. However, this law regulates the advertisements that promotes the services of such professionals.
The Consumer Protection Law determines that the information contained in the offer addressed to undetermined prospective consumers, binds the offeror during the period in which the offer takes place and until its public revocation. Further, it determines that specifications included in advertisements, announcements, prospectuses, circulars or other media bind the offeror and are considered part of the contract entered into by the consumer. On June 2005, Resolution No. 104/05, which complements the Consumer Protection Law, adopted MERCOSUR’s Resolution on which requires that those who engage in commerce over the Internet (E-Business) to disclose in a precise and clear manner the characteristics of the products and/or services offered and the sale terms.
Buildings Law. Buildings Law No. 19,724, as amended, sets forth a regime for the construction of buildings for later subdivision into condominium (Propiedad Horizontal). Under this law, developers must inform potential purchasers of their intention to sell the building as a condominium, as well as of all sale conditions, and the size of each unit in relation to the whole building. The sale of these units is subject to subdivision approval and in order to be included in Buildings Law regime must be registered with the Real Estate Registry (Registro de la Propiedad Inmueble). This law also states that, in the event that construction is not completed, all amounts already deposited must be repaid to the purchasers.
Mortgage Regulation. The Argentine Civil Code regulates mortgages both as a contract and as a right over property. There are no special provisions in the Civil Code aimed at protecting mortgagors. Any agreement entered into by a mortgagor and a mortgagee at time of execution of the mortgage or prior to the default of the mortgagor allowing the mortgagee to recover the property without a public auction of the property will not be enforced by the courts as contrary to Argentine public policy.
Until the enactment of Trust Law No. 24,441, the only procedure available to collect unpaid amounts secured by a mortgage was a proceeding regulated by the Civil and Commercial Procedure Code. The heavy caseload on the courts that hear such matters usually delays the proceeding, which currently takes 1 to 2 years to complete.
Chapter V of Trust Law No. 24,441 institutes a new procedure which may expedite collection of unpaid amounts secured by a mortgage. To be applicable, the new rules, which allow an out-of-court auction, need to be expressly agreed to by the parties in the mortgage contract.
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Currently, we include in our mortgages a clause enabling the enforcement of Law No. 24,441. However, there can be no assurance that such collection provisions will accelerate the recovery of unpaid amounts under mortgage guarantees.
The Argentine Government has tried to avoid the massive foreclosure of mortgages since the 2001 crisis. The Public Emergency Law, as amended, established the suspension for the term of 270 days from the enactment of that law, of all the judicial or non-judicial enforcement procedures, including the enforcement of mortgages and pledges, regardless of their origin. On February 14, 2002, Law No. 25,563 amending the Bankruptcy Law (the “New Bankruptcy Law”) was enacted. Under the New Bankruptcy Law, certain bankruptcies and foreclosures (including foreclosures on mortgage loans) were suspended for a period of 180 days from the law’s effective date. Such period was extended for 90 days more by Law No. 25,640 dated September 2002, expiring on February, 2003.
On February 4, 2003, the Executive Branch enacted Decree No. 204/2003 creating a mediation proceeding, for a limited period of 90 days, to be conducted through the Legal Emergency Units (Unidades de Emergencias Legales) depending from the Ministry of Labor, Employment and Social Security and the Ministry of Production.
On May 2003, the Argentine Congress enacted Law No. 25,737 which suspended foreclosures for an additional period of 90 days, which ended in May 2003. On September 2003, several financial institutions voluntarily agreed not to foreclose on their mortgage loans. On November 2005, the Argentine congress enacted Law No. 26,062 that extended the foreclosures suspension for an additional 120 days period, which was extended for 90 days more by Law No. 26,084 and for 180 days more by Law No. 26,103. Pursuant to these successive extensions, foreclosure on mortgaged property was suspended until December 2006.
On November 8, 2006, Law No. 26,167 was enacted. It established a special proceeding to replace ordinary trials for the enforcement of some mortgage loans. These special proceedings give creditors ten days to inform the debtor of the amounts owed to them and agree with the debtor on the amount and terms of payment. In case the parties fail to reach an agreement, payment conditions are to be determined by the judge. Also, this law established the suspension of the execution of judicial judgments, judicial and extrajudicial auctions, evictions and other proceedings related to the mortgage loans contemplated in this law.
Most mortgages executed by us provide that we are empowered to declare the anticipated expiration of the loan upon non-payment of an installment. This enables us to recover the unpaid amounts through the sale of the relevant property pursuant to the Civil and Commercial Procedure Code and Law No. 24,441.
Pursuant to Argentine law, fees and expenses related to collection procedures must be borne by the debtor, and the proceeds from any auction of the property may be used for the settlement of such obligation.
Although our mortgages are U.S. dollar-denominated, Decree No. 214/2002 and Decree No. 762/2002 that amend the Public Emergency Law provide that monetary obligations in force as of January 7, 2002, resulting from agreements governed by private law and which provide for payments in U.S. dollars are subject to the following rules:
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Protection for the Disabled Law. The Protection for the Disabled Law No. 22,431, enacted on March 20, 1981, as amended, provides that in connection with the construction and renovation of buildings, obstructions to access must be eliminated in order to enable access by handicapped individuals. In the construction of public buildings, entrances, transit pathways and adequate facilities for mobility impaired individuals must be provided.
Buildings constructed before the enforcement of the Protection for the Disabled Law must be adapted to provide accesses, transit pathways and adequate facilities for mobility-impaired individuals. Those pre-existing buildings, which due to their architectural design may not be adapted to the use by mobility-impaired individuals, are exempted from the fulfillment of these requirements. The Protection for the Disabled Law provides that residential buildings must ensure access by mobility impaired individuals to elevators and aisles.
Credit Cards Law. Law No. 25,065, amended by Law No. 26,010 and Law No. 26,361, regulates different aspects of the business known as “credit card system.” The regulations impose minimum contractual contents and the approval thereof by the Industry, Commerce and Mining Secretary (Secretaría de Industria, Comercio y Minería de la Nación), as well as the limitations on the interest to be collected by users and the commissions to the stores adhering to the system. The Credit Card Law applies to banking and non-banking cards, such as “Tarjeta Shopping,” issued by Tarshop S.A.
Antitrust Law. Law No. 25,156, as amended, prevents trust practices and requires administrative authorization for transactions that according to the Antitrust Law constitute an economic concentration. According to this law, mergers, transfers of goodwill, acquisitions of property or rights over shares, capital or other convertible securities, or similar operations by which the acquirer controls or substantially influences a company, are considered as an economic concentration. Whenever an economic concentration involves a company or companies which exceed the accumulated sales volume by approximately Ps.200.0 million in Argentina; then the respective concentration should be submitted for approval to the Comisión Nacional de Defensa de la Competencia, or Antitrust Authority. The request for approval may be filed, either prior to the transaction or within a week after its completion.
When a request for approval is filed, the Antitrust Authority may (i) authorize the transaction, (ii) subordinate the transaction to the accomplishment of certain conditions, or (iii) reject the authorization.
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The Antitrust Law provides that economic concentrations in which the transaction amount and the value of the assets absorbed, acquired, transferred or controlled in Argentina, do not exceed Ps.20.0 million are exempted from the administrative authorization. Notwithstanding the foregoing, when the transactions effected during the prior 12-month period exceed in total Ps.20.0 million or Ps.60.0 million in the last 36 months, these transactions must be notified to the Antitrust Authority.
As the consolidated annual sales volume of Alto Palermo and IRSA exceed Ps.200.0 million, IRSA should give notice to the Antitrust Authority of any concentration provided for by the Antitrust Law.
After our acquisition of Bouchard 557, we asked the Argentine Antitrust Authority whether it was necessary to notify it of such acquisition. The Antitrust Authority advised us that we were in fact required to notify it, and the pertinent court ratified such decision. Consequently, on April 22, 2008, the notice of the operation was filed with the Antitrust Authority. As of the date of this annual report, this matter is still to be resolved.
After we sold the 29.85% interest in Bouchard 557, to Techint Compañía Técnica Internacional Sociedad Anónima Comercial e Industrial, we asked the Antitrust Authority if it was necessary to notify this operation. On July 4, 2008, the Antitrust Authority informed us that it was not necessary to report this sale.
We filed a new request for the Antitrust Authority’s opinion regarding our acquisition of Bank Boston Tower on August 30, 2007. The Antitrust Authority advised us that we were in fact required to so notify it, and we challenged this opinion in the local courts.
On May 6, 2008, we filed with the Antitrust Authority a request for its opinion as to the need to notify the Antitrust Authority the acquisition of Edificio República. The Antitrust Authority advised us that we were in fact required to so notify it. We challenged this opinion in the local courts.
On January 15, 2007 we were notified of two claims filed against us before the Antitrust Authority, one by a private individual and the other one by the licensee of the shopping center, both opposing the acquisition from the province of Córdoba of a property known as Ex-Escuela Gobernador Vicente de Olmos. On February 1, 2007 we responded the claims. On June 26, 2007, the Antitrust Authority notified us that it has initiated a summary proceeding to determine whether the completion of the transaction breaches the Antitrust Law. As of the date of this filing the result of this proceeding has not been determined.
On January 22, 2008, Alto Palermo requested the Antitrust Authority’s clearance for the transfer of the Soleil Factory shopping center. As of the date of this filing, the Antitrust Authority has not reached a decision.
For more information see Item 3 “Risk Factors—Risk related to our Business—Our business is subject to extensive regulation and additional regulations may be imposed in the future.”
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C. Organizational Structure
The following is our organizational chart showing our principal subsidiaries, as of June 30, 2008:
The following table presents information relating to our ownership interest and the percentage of our consolidated total net revenues represented by our subsidiaries as of June 30, 2008.
Subsidiary
Activity
Ritelco S.A.
Patagonian Investment S.A.
Palermo Invest S.A.
Solares de Santa María S.A.
CYRSA S.A.(4)
Pereiraola S.A.I.C.I.F.y A.
Inversora Bolivar S.A.(3)
Hoteles Argentinos S.A.
Llao Llao Resorts S.A.
Rummaala S.A.
Alto Palermo S.A.(2)
Quality Invest S.A.
E-Commerce Latina S.A.
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Financel Communications S.A.
Canteras Natal Crespo S.A.(2)
We have a significant interest in Banco Hipotecario, an Argentine company organized under Argentine Law engaged in banking activity. As of June 30, 2008, we owned 11.8% of Banco Hipotecario, and 6.76% of such ownership was through our subsidiaries Inversora Bolívar S.A. and Ritelco S.A. Also, as of June 30, 2008, the voting power held by IRSA, Inversora Bolívar S.A. and Ritelco S.A. in Banco Hipotecario was 18.36%.
D. Property, Plants and Equipment
Property
As of June 30, 2008, all of our property (consisting of rental properties in the office and retail real estate sectors, development properties primarily in the residential real estate sector, and shopping centers) was located in Argentina. We lease our headquarters, located at Bolívar 108, C1066AAD and Moreno 877, piso 22, C1091AAQ Buenos Aires, Argentina, pursuant to two lease agreements that expire on February 28, 2014 and November 30, 2008, respectively. We do not currently lease any material properties other than our headquarters.
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The following table sets forth certain information about our properties:
Property(10)
Intercontinental Plaza(3)
Works in progress Dique IV
Madero 942
Av. De Mayo 595/99
Av. Libertador 602
Rivadavia 2768
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Sarmiento 517
Constitución 1111
Local comercial Cruceros
Thames(3)
Constitución 1159
Other Properties(8)
Alto Palermo Shopping(4)
Abasto(4)
Patio Bullrich(4)
Buenos Aires Design(4)
Alto Rosario(4)
Mendoza Plaza(4)
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Panamerican Mall(4)
Neuquén(4)
Puerto Retiro(3)
Pereiraola(5)
Terreno Torres de Rosario (4)
Terreno Beruti (4)
Patio Olmos (4)
Others Reserves of Land(6)
Residential apartments, communities and others(9)
Hotel Llao Llao
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Hotel Intercontinental (3)
Hotel Libertador
Terrenos Bariloche
Rate
7%
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On October 29, 2007 we paid US$ 24.3 million of principal and US$ 0.35 million of accrued interest of our secured floating rate notes due November 2009 and US$ 14.95 million of principal and US$ 0.21 million of accrued interest of our unsecured loan agreement. The payment of such debt produced the cancellation of the mortgages that we had in connection with the issuance of the collateralized notes (13 functional units at Libertador 498, 71 complementary units in Laminar Plaza and 19 complementary units in Dique IV).
Insurance.
We carry insurance policies with insurance companies that we consider to be financially sound.
In our Development and Sale of Properties segment, we only maintain insurance when we retain ownership of the land under development or when we develop the property ourselves.
Our liability and fire insurance policies cover potential risks such as property damage, negligence liability, fire, falls, collapse, lightning and gas explosion, electrical and water damages, theft, and business interruption. Such insurance policies have specifications, limits and deductibles which we believe are customary.
We maintain insurance policies for our properties after the end of construction only if we retain ownership, primarily in the Offices and Other Non-Shopping Center Rental Properties segment.
We carry directors and officer’s insurance covering management’s civil liability, as well as legally mandated insurance, including employee personal injury.
We also provide life or disability insurance for our employees as benefits.
We believe our insurance policies are adequate to protect us against the risks for which we are covered. Nevertheless, some potential losses are not covered by insurance and certain kinds of insurance coverage may become prohibitively expensive. See “Risk Factors—Risks Related to our Business—Some potential losses are not covered by insurance, and certain kinds of insurance coverage may become prohibitively expensive.”
None.
A. Operating Results
The following Operating and Financial Review and Prospects should be read in conjunction with Item 3: “Key Information-Selected Financial Data” and our audited consolidated financial statements and related notes appearing elsewhere in this annual report. This “Operating and Financial Review and Prospects” discussion contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include, among others, those statements including the words “will,” “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many risk factors, including those set forth elsewhere in this
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annual report. See Item 3 “Risk Factors” for a more complete discussion of the economic and industry-wide factors relevant to us and the opportunities and challenges as a result of the global economic crisis, and risks on which we are focused.
For purposes of the following discussion, unless otherwise specified, references to fiscal years 2008, 2007 and 2006 relate to our fiscal years ended June 30, 2008, 2007 and 2006, respectively.
We maintain our financial books and records in Pesos. We prepare our consolidated financial statements in conformity with Argentine GAAP and the regulations of the Comisión Nacional de Valores which differ in significant respects from U.S. GAAP. These differences involve methods of measuring the amounts shown in the financial statements as well as additional disclosures required by U.S. GAAP and Regulation S-X of the SEC. See Note 28 to our audited consolidated financial statements included elsewhere in this annual report herein for a description of the principal differences between Argentine GAAP and U.S. GAAP, as they relate to us, and a reconciliation to U.S. GAAP of our net income and shareholders’ equity.
Our Results of Operations
Effects of the economic crisis since 2001 Our historical financial results have been, and are expected to continue to be, materially affected by the general level of economic activity and growth of per capita disposable income in Argentina, where all of our assets are located and our operations are performed. From December 2001 through most of 2002, Argentina experienced a crisis that virtually paralyzed its economy and led to radical changes in government policies. Argentina’s trade and fiscal deficits and the rigidity of its fixed exchange rate system (known as the convertibility regime), combined with the country’s excessive reliance on foreign capital and with its mounting external debt, resulted in a deep contraction of the economy and in banking and fiscal crises when capital started to leave the country.
In response to the political and economic crisis, the Argentine government undertook a number of far-reaching initiatives that significantly changed the monetary and foreign exchange regime and the regulatory framework for conducting business in Argentina. Between December 2001 and January 2002, Argentina abolished the fixed parity between the Peso and the U.S. dollar, rescheduled bank deposits, converted dollar denominated debts into pesos, and suspended payment on a significant portion of its public debt.
Most sectors of the Argentine economy were severely affected by the crisis and regulatory changes. In April 2002, the economy started its path to stabilization and realized a clear improvement of economic variables during the second half of the year, mainly as a result of expanding exports and decreasing imports. While the devaluation of the Peso had significant adverse consequences, it resulted in a positive balance for Argentina’s current account, which fostered a reactivation of domestic production. The sharp decline in the Peso’s value against foreign currencies, together with a decline in production costs in U.S. dollar terms, made Argentine products relatively inexpensive in the export markets. At the same time, the costs of imported goods increased significantly due to the devaluation of the Peso, forcing Argentine consumers to substitute their purchase of foreign goods with domestic products, substantially boosting domestic demand for domestic products.
During the second half of 2002, Argentina’s Gross Domestic Product (GDP) increased 4.4%, and the consumer price index inflation was 8.0% for the six-month period ended
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December 31, 2002, compared to 30.5% for the six-month period ended June 30, 2002. The improving economic conditions, particularly the reduction of capital outflows from the Argentine economy and the banking system, allowed the government to begin lifting restrictions on bank withdrawals in November 2002.
Despite the improvement in economic conditions during the second half of 2002, Argentina’s overall GDP contracted 10.9% for the full year, receding to 1993 values, investment collapsed (with, for example, negative growth of 43% in the second quarter compared to the second quarter of 2001), and inflation increased sharply. The main impact of the crisis was the tremendous social hardship. Unemployment rose from 12.9% to 19.7% between 1998 and 2002, real wages declined 24% in 2002, and the poverty index increased from 29% of the population in 2000 to 52% in 2002.
In May 2003, Argentina’s political environment was reorganized when Néstor Kirchner took office as president. The economy continued to show indications of recovery, as GDP grew 8.8% in 2003. A combination of sound fiscal and monetary policies kept consumer price inflation under control at 3.5% in 2003. During 2003, Argentina moved towards normalizing its relationship with the IMF, withdrew all the national and provincial governments’ quasi-money securities from circulation (amounting to Ps.7.8 billion), and eliminated all deposit restrictions. The trade balance experienced a sustained surplus, aided by the rise in commodity prices and export volumes. Social indicators also improved. The unemployment rate decreased to 17.3% in 2003 and real wages began to recover.
During 2004 and 2005, the Argentine economy continued to grow. GDP grew 9.0% in 2004 and 9.0% in 2005 according to the Central Bank’s survey of independent forecasting firms. Inflation remained relatively low in 2004 although it almost doubled to 6.1% from 2003, and it increased to 12.3% during 2005, 9.8% during 2006, 8,5% during 2007 and 4,7% as of the first semester of 2008.
In June 2005, the Argentine government completed a restructuring of a substantial portion of the federal government’s public debt, which had been in default since December 2001. Argentina reduced the outstanding principal amount of its public debt from US$191.3 billion to US$126.6 billion and negotiated lower interest rates and extended payment terms. Approximately US$19.5 billion of defaulted bonds held by creditors who did not participate in the exchange offer remain outstanding.
During 2008, the international scenario has shown signs of deterioration, as a consequence of the subprime mortgages collapse. Thus, from the standpoint of economics and finance, uncertainty has grown and global growth expectations have been revised down, not only with respect to the developed countries, but also to the emerging ones.
Therefore, Argentina faces a global economic slow-down that may significantly impair economic growth. However, Argentina can continue to generate positive export balances through the export of primary commodities and industrial manufactures.
Although the Argentine economy has recovered significantly from the crisis occurred un 2002, the effects of the global economic slow down on Argentina cannot be predicted. See “Risk Factors—Risks Related to Argentina.”
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Effects of inflation
From 1997 until the end of year 2001, the Argentine government’s policies substantially reduced the level of inflation. Therefore, during that period inflation did not significantly affect our financial condition and results of operations. The following are annual inflation rates’ since 2002 published by the Argentine Ministry of Economy and Production:
Year ended June 30,
Consumer Price Index
Wholesale Price Index
2002
2003
2004
2005
2006
2007
2008(1)
The increase in inflationary risk may erode our present macroeconomic stability, causing a negative impact on our operations.
During 2006 and 2007 retail prices increased significantly, making inflation one of the main economic issues. In order to hold back inflation, the government signed trade agreements, primarily within the food and textile sectors. In this regard, the Wholesale Price Index (“IPIM”) increased by 9.1% in the first eleven months of 2008. This shows that inflation is one of the most important problems facing Argentina today.
Effects of interest rate fluctuations
Most of our U.S. dollar denominated debt accrues interest at a fixed rate. An increase in interest rates will not necessary result in a significant increase in our financial costs and may not materially affect our financial condition and our results of operations.
Effects of foreign currency fluctuations
A significant portion of our financial debt is denominated in U.S. dollars. Therefore, a devaluation of the Argentine Peso against the U.S. dollar would increase our indebtedness measured in Pesos and materially affect our results of operations. Foreign currency exchange rate fluctuations significantly increase the risk of default on our mortgages and lease receivables. Due to the fact that many of our customers have their cash flows in Pesos, a fluctuation of exchange rate may increase their U.S. dollar-denominated liabilities. Foreign currency exchange restrictions that may be imposed by the Argentine Government could prevent or restrict our access to U.S. dollars, affecting our ability to service our U.S. dollar denominated liabilities.
Evolution of our Business Segments
The profitability of our shopping center business is highly sensitive to consumer spending, overall GDP growth in Argentina and availability of financing. The contraction in consumer spending and the greater reliance on informal and low quality products that characterized the Argentine economy during the crisis has been significantly lessened along with an increase in GDP growth. This economic reactivation has significantly increased the revenues of Alto Palermo, our subsidiary engaged in shopping center ownership and operation. During the fiscal years ended June 30, 2006, 2007 and 2008, our shopping center revenues were Ps.215.0 million, Ps.270.3 million and Ps.345.4 million respectively.
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Consumer Financing operations.
Tarshop S.A. is a subsidiary of Alto Palermo through which we have rolled out a consumer financing business. Economic reactivation and the consequent increase in consumer spending have been fueling the growth in this business as in the case of the shopping center segment. Conceived originally as a marketing tool intended to stimulate sales at our shopping centers, Tarshop’s credit card business has extended beyond our shopping centers, becoming one of the fastest growing consumer financing businesses in the consumer financing industry in Argentina. As of June 30, 2008, Tarshop had 894,000 customer accounts of which 640,000 had unpaid balances, an average indebtedness of Ps. 1,630 per account. Total portfolio amounted to Ps. 1,044.6 million, 78% of which was securitized through the Tarjeta Shopping Financial Trusts Program. During the fiscal years ended June 30, 2006, 2007 and 2008, the revenues of our credit card operations were Ps.123.0 million, Ps.213.0 million and Ps.291.0 million, respectively.
As a result of the current international financial scenario, we have observed a high volatility in interest rates and increases in systemic delinquency, affecting the performance and financing of the consumer finance business. The higher delinquency levels have led to an increase in the subordination of financial trusts which, added to the changes in their tax treatment, the higher interest rates resulting from higher risk and a slight deceleration in private consumption, have forced us to review the general economic and the business prospects of Tarshop S.A. We are focused on improving Tarshop’s capital base and operating performance in order to consolidate its position in the industry. For more information about our consumer financing Segment, please see “Recent Developments” section.
Demand for new residential units is influenced by a number of factors, including employment rates, short-term and long-term interest rates, availability of government-sponsored and private mortgage financing programs and products, consumer confidence, governmental policies, demographic factors and, to a lesser extent, changes in property taxes, energy costs and federal income tax rates. In addition, the feasibility of developing and marketing new residential units depends on a number of factors such as the inventory of existing units, zoning restrictions, government policies, cost and availability of land, construction and sales costs and the availability of financing on reasonable terms, among other factors. At the time of the crisis, residential sales came to a virtual standstill and real estate prices fell sharply. During the last four years, the market has begun to recover, making gradual progress. This continuing market stabilization accounts for much of the revenue increase in our Development and Sale of Properties segment. During the fiscal years ended June 30, 2006, 2007 and 2008, our Development and sale of properties segment had revenues of Ps.104.0 million, Ps.75.8 million and Ps. 196.8 million, respectively.
The profitability of offices and other non-shopping center rental properties segment is similarly affected by the macroeconomic factors described above. Favorable market conditions and the incidence of bankruptcy are also closely related to levels of vacancy and to the price at which we can lease our premises which in turn adversely affect our revenues in this segment. During the 2001 Argentine economic crisis and its aftermath, few development projects were built in Argentina. However, demand for office space and rental properties has increased substantially during the last four years, significantly raising prices. During the fiscal years ended June 30, 2006, 2007 and 2008, our offices and other non-shopping center rental properties segment had revenues of Ps.30.6 million, Ps.55.7 million and Ps.101.0 million, respectively.
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The revenues from our hotel business are also highly sensitive to market conditions. For example, the devaluation of the Peso following the repeal of the Convertibility Law made Argentina a less expensive, and therefore a more attractive, tourist destination, significantly increasing the influx of foreign tourists. The appreciation of foreign currency also rendered domestic travel destinations more appealing to the Argentines, many of whom replaced foreign travel with local travel. During fiscal years ended June 30, 2006, 2007 and 2008, our Hotel operations segment had revenues of Ps.103.8 million, Ps.122.7 million and Ps.148.8 million, respectively.
Factors Affecting Comparability of Results of Operations
Described below are certain considerations that will facilitate an understanding of our overall operating results. These factors are based upon the information which is currently available to us and do not represent all of the factors that are relevant to an understanding of our current and future results of operations.
Recent results on equity investees
We currently own 11.8% of Banco Hipotecario, Argentina’s leading mortgage lender in terms of mortgage loans granted and provider of mortgage-related insurance and mortgage loan services. For fiscal years ended June 30, 2007 and 2008, our investment in Banco Hipotecario generated a gain of Ps.41.4 million and a loss of Ps.12.4 million respectively. The results we recorded in our 2007 and 2008 fiscal years represented 38.6% and (22.5)%, respectively, of our consolidated net income for such years.
Variability of results due to substantial property acquisitions and dispositions
The development and sale of large residential and other properties does not yield a stable, recurring stream of revenue. On the contrary, large acquisitions and sales significantly affect revenues for a reporting period, making it difficult to compare our year-to-year results. For example, the Ps.108.4 million sale of Bouchard 551 and the Ps.56.6 million sale of plot Y of Dique III have significantly impacted our results for our 2008 fiscal year. Our historical revenues have varied from period to period depending upon the timing of sales of properties, and our future period-on-period results of operations are likely to continue to vary, perhaps significantly, as a result of periodic acquisitions and dispositions of properties.
Critical Accounting Policies and Estimates
In connection with the preparation of our consolidated financial statements included in this annual report, we have relied on variables and assumptions derived from historical experience and various other factors that we deemed reasonable and relevant. Although we review these estimates and assumptions in the ordinary course of business, the portrayal of our financial condition and results of operation often requires our management to make judgments regarding the effects of matters that are inherently uncertain on the carrying value of our assets and liabilities. Actual results may differ from those estimated under different variables, assumptions or conditions. In order to provide an understanding about how management forms our judgments about future events, including the variables and assumptions underlying the estimates, and the sensitivity of those judgments to different variables and conditions, we have included comments related to each critical accounting policy described as follows:
revenue recognition;
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business combinations;
useful lives of real estate assets;
provision for allowances and contingencies;
impairment of long-lived assets;
debt restructuring;
deferred income tax;
minimum presumed income tax; and
negative goodwill, net
Revenue recognition
We primarily derive our revenues from domestic office space and shopping center leases and services operations, from the development and sale of properties, from consumer financing operations and from hotel operations.
Accounting for real estate barter transactions. During the years ended June 30, 2008 and 2006 we entered into certain non-monetary transactions with third parties pursuant to which we sold plots of land in the ordinary course of business in exchange for cash and/or other real estate properties. Under Argentine GAAP, these transactions were recorded based on the fair value of the assets involved and, as a result, a gain or loss was recognized at the time of the exchange. We believe that this accounting policy is a “critical accounting policy” because the impact of accounting for real estate barter transactions under this method could have a material effect on our consolidated balance sheet as well as on our results of operations.
Recognition of inventories at net realizable value. Inventories, on which we received payments in advance that establish the sales price and the terms and conditions of the contract assuring the closing of the transaction and the realization of the gain, are valued at net realizable value. At June 30, 2008, payments for Ps.2.8 million were valued according to these criteria, which were principally applied to the following developments: Torre Renoir Dock III for Ps.2.6 million and “Torres Rosario” for Ps.0.2 million. We believe that the accounting policy related to recognition of inventories at net realizable value is a “critical accounting policy” because the impact of accounting under this method could have a material effect on our consolidated balance sheet as well as on our results of operations. The performance of a sensitivity analysis, which reduced the fair market value of the properties by 5%, would have resulted in a smaller “Gain from recognition of inventories at net realizable value” by Ps.2.1 million for our fiscal year ended June 30, 2008.
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Leases and services from shopping center operations. We account for our leases with tenants as operating leases. We generally charge tenants a rent which consists of the higher of (i) a monthly base rent (the “Base Rent”) and (ii) a specified percentage of the tenant’s monthly gross retail sales (the “Percentage Rent”) (which generally ranges between 4% and 10% of tenant’s gross sales). Furthermore, pursuant to the rent escalation clause in most leases, the tenant’s Base Rent generally increases between 7% and 12% each year during the term of the lease. Certain of our lease agreements contain provisions which provide for rents based on a percentage of sales or based on a percentage of sales volume above a specified threshold. We determine the compliance with specific targets and calculate the additional rent on a monthly basis as provided for in the contracts. Thus, we do not recognize contingent rents until the required thresholds are exceeded.
Our lease agreements vary from 36 to 120 months. Law No. 24,808 provides that tenants may rescind commercial lease agreements after the initial six months, upon not less than 60 days’ written notice, subject to penalties of one and a half months rent if the tenant rescinds during the first year of its lease, and one month of rent if the tenant rescinds after the first year of its lease.
We also charge our tenants a monthly administration fee, prorated among the tenants according to their leases, which varies from shopping center to shopping center, relating to the administration and maintenance of the common area and the administration of contributions made by tenants to finance promotional efforts for the overall shopping centers operations. We recognize administration fees monthly when earned. In addition to rent, we generally charge tenants admission rights. Admission rights are non-refundable admission fees that tenants may be required to pay upon entering into a lease or upon lease renewal. An admission right is normally paid in one lump sum or in a small number of monthly installments. We recognize admission rights using the straight-line method over the life of the respective lease agreements. Furthermore, the lease agreements generally provide for the reimbursement of real estate taxes, insurance, advertising and certain common area maintenance costs. These additional rents and tenant reimbursements are accounted for on the accrual basis.
We also derive revenues for parking lot fees charged to visitors. We recognize parking revenues as services are performed.
Leases and services from office and other non-shopping center rental properties. We account for our leases with tenants as operating leases. We charge tenants a base rent on a monthly basis. We recognize rental income on a straight-line basis over the term of the leases.
Development and sale of properties. We record revenue from the sale of properties when all of the following criteria are met: (a) the sale has been consummated (a sale is not considered consummated until (i) the parties are bound by the terms of a contract, (ii) all consideration has been exchanged, (iii) any permanent financing for which the seller is responsible has been arranged and (iv) all conditions precedent to the closing have been performed); (b) we determine that the buyer’s initial and continuing investments are adequate to demonstrate a commitment to pay for the property (the adequacy of a buyer’s initial investment is measured by (i) its composition and (ii) its size compared with the sales value of the property); (c) our receivable is not subject to future subordination (our receivable will not be placed in or occupy a lower rank, class or position with respect to other obligations of the buyer); and (d) we have transferred to the buyer the risk and rewards of ownership and does not have a continuing involvement in the property.
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We generally enter into purchase and sale agreements with purchasers of units in our residential development properties prior to the commencement of construction. Pursuant to this practice, we initiate our marketing and sales efforts on the basis of already-commissioned architectural designs and model units. As a general rule, purchasers pay a booking charge for the units and subsequently enter into fixed price purchase and sale agreements. The balance of the purchase price is due upon delivery of the constructed and completed unit.
Construction of such residential development properties is done pursuant to “turn-key” contracts with major Argentine and South American construction companies that provide for construction to be completed within a prescribed period and budget, subject to customary exceptions.
We use the percentage-of-completion method of accounting with respect to sales of development properties under construction effected under fixed-priced contracts. Under this method, revenue is recognized based on the ratio of costs incurred to total estimated costs applied to the total contract price. We do not commence revenue and cost recognition until such time as the decision to proceed with the project is made and construction activities have begun.
The percentage-of-completion method of accounting requires management to prepare budgeted costs (i.e., the estimated costs of completion) in connection with sales of properties and/or units. All changes to estimated costs of completion are incorporated into revised estimates during the contract period.
Under this method of accounting, revenues for work completed may be recognized in the statement of income prior to the period in which actual cash proceeds from the sale are received. In this situation, a deferred asset is recorded. Alternatively, and as is more common for us, where property and/or unit purchasers pay us an advance down-payment and monthly cash installments prior to the commencement of construction, a liability is recorded. This is recorded as a customer advance in the financial statements.
Consumer financing. We derive revenues from origination of consumer loans and consumer financing transactions and securitization of corresponding receivables. Revenues from credit card transaction are primarily comprised of (i) merchant discount fees which are recognized when transactional information is received and processed by the Company; (ii) data processing services which consist of processing and printing cardholders account statements, and which are recognized as services are provided; (iii) life and disability insurance charges to cardholders which are recognized on an upfront basis, and (iv) interest income generating by financing and lending activities. Revenue from financing and lending activities are comprised of interest income generating by financing and lending activities. Revenue from financing and lending activities are comprised of interest income which is recognized on an accrual basis.
Hotel operations. We recognize revenues from occupation of rooms, catering, and restaurant services as earned at the close of each business day.
Business combinations
Acquisitions are accounted for under the purchase method of accounting. Under the purchase method of accounting, we allocate the purchase price of properties to tangible and identified intangible assets acquired based on their fair values in accordance with the provisions of Technical Resolution No. 18. In making estimates of fair values for the purpose of allocating purchase price, our management uses a number of sources. We also consider information about each property obtained as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of tangible and intangible assets acquired. We allocate a portion of the purchase price to tangible assets including the fair value of the building on an as-if-vacant
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basis and to land determined either by real estate tax assessments, third-party appraisals or other relevant data. Generally, we determine the as-if-vacant value by using a replacement cost method. Also, a portion of the purchase price is allocated to above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining noncancelable term of the lease. The capitalized above-market and below-market lease values are amortized as a reduction of or an addition to rental income over the remaining noncancelable terms of the respective leases. Should a tenant terminate its lease, the unamortized portion of the lease intangibles would be charged or credited to income. A portion of the purchase price is also allocated to the value of leases acquired and management uses independent sources or management’s determination of the relative fair values of the respective in-place lease values. Our estimates of value are made using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods, considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. We also estimate costs to execute similar leases including leasing commissions, legal expenses and other related costs. Other intangible assets acquired may include tenant relationships which are valued based on management’s evaluation of the specific characteristics of each tenant’s lease and our overall relationship with the respective tenant. We have not identified any lessee with whom we have developed a type of relationship allowing the recognition of an intangible asset.
Useful lives of real estate assets
We are required to make subjective assessments as to the useful lives of our properties for purposes of determining the amount of depreciation to reflect on an annual basis with respect to those properties. These assessments have a direct impact on our net income. If we would lengthen or shorten the expected useful life of a particular asset, it would be depreciated over more or less years and result in less or more depreciation expense and higher or lower net income.
Provisions for allowances and contingencies
We provide for losses relating to mortgage, lease and other accounts receivable. The allowance for losses is recognized when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the terms of our agreements. Allowances are determined on a case-by-case basis, where applicable, by considering the present value of expected future cash flow or the fair market value of collateral if the loan is securitized. Determinations that an allowance should be recognized are dependent on information available at the time of the determination. As a result, future adjustments to the allowance may be necessary if future economic conditions differ substantially from the assumptions used at the time of the determination. We have considered all events and/or transactions subject to reasonable and standard estimation procedures. The consolidated financial statements reflect these considerations.
We have certain contingent liabilities with respect to existing or potential claims, lawsuits and other proceedings, including those involving labor and other matters. We accrue liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, our estimate of the outcomes of these matters
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and our lawyers’ experience in contesting, litigating and settling other matters. As the scope of the liabilities becomes better defined, there may be changes in the estimates of future costs, which could have material effect on our future results of operations and financial condition or liquidity.
Impairment of long-lived assets
We periodically evaluate the carrying value of our long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We consider the carrying value of a long-lived asset to be impaired when its value in use or its net realizable value, whichever is greater, is less than its carrying value. Value in use is determined by the expected cash flows from the assets discounted at a rate commensurate with the risk involved. Net realizable value is determined by the selling price of the assets less costs to sell.
Under Argentine GAAP a previously recognized impairment loss is reversed when there is a subsequent change in estimates used to compute the fair market value of the asset. In that event, the new carrying value of the asset is the lower of its fair market value or the net carrying value the asset would have had if no impairment had been recognized. Both the impairment charge and the impairment reversal are recognized in earnings. U.S. GAAP prohibits the reversal of a previously recognized impairment charge.
We believe that the accounting estimate related to asset impairment is a “critical accounting estimate” because:
it is highly susceptible to change from period to period because it requires company management and/or independent appraisers to make assumptions such as, future sales and cost of sale, future vacancy rates and future prices, which requires significant adjustments because actual prices and vacancy rates have fluctuated in the past and are expected to continue to do so; and
the impact that recognizing an impairment would have on assets reported on our balance sheet as well as on the results of our operations could be material.
During the years ended June 30, 2002, 2003, and 2005 we recognized impairment losses. As permitted by Argentine GAAP, due to increases in fair market values, these impairment charges were subsequently reversed during the years ended June 30, 2004 through the current fiscal year. Impairment charges and subsequent reversals are included in the line item “Gain from operations and holdings of real estate assets, net” in the income statement.
The fair market value of our office and rental properties was determined following the rent value method, taking into consideration each property’s future cash flow, its comparability with other properties in the market and its historic vacancy rates. The price per square meter of our properties varies according to the category and type of building, and to each property’s idiosyncratic traits. Vacancy rates are the lowest in history with rates below 1%. Moreover, we currently believe that a significant amount of new office space, comparable to our existing buildings, is not likely to become available in the City of Buenos Aires during our next two or three fiscal years. We applied an assumed 5% vacancy rate in preparing our cash flow analyses. For buildings we consider to be Class A (those having the best location and condition) the average price per square meter used was between Ps.80 and Ps.120 per square meter per month, while for buildings we consider to be Class A/B (having very good location and/or condition) the average price was between Ps.52 and Ps.69 per square meter per month, and for buildings we
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consider Class B/C (those having good location and/or condition) it was Ps.36 per square meter per month. The performance of a sensitivity analysis, which would have reduced the fair market value of these properties by 5%, would have resulted in a smaller reversal of impairment losses of Ps.0.2 million, as of June 30, 2008.
With respect to our Hotel Operations segment, the discounted cash flows methodology was applied by taking the forecasts of each hotel in a 10-year flow and discounting such estimated amounts at rates according to risk, location and other relevant factors. The cash flows to be discounted considered revenues per room, per guest, per additional charge as well as the fixed and variable expenditures related to the transaction. Rate increases and occupancy variations were estimated based on the information supplied by each hotel’s management and comparing them to industry-specific data in the local market. We believe that tourism activities and related industries in Argentina have increased by 8% to 12% over the last 12 months, above worldwide figures, according to inbound traveling and spending statistics provided by the National Tourism Agency.
Shopping centers were valued according to the rent value method. We calculated discount rates considering each property’s location, its comparability with other properties in the market, its historic rental income, vacancy rates and cash flow. The average discount rates we used ranged between 14.5% and 16.5%, the average price per leasable square meter was Ps.7,043 and the average vacancy rate was calculated taking into consideration a permanent vacancy rate of 5%.
We used the open market method for determining the fair market value of our land reserves and inventories. We estimated the value of each site by taking into consideration the value of the property according to its surface area and location, as well as the availability of inventory. The performance of a sensitivity analysis, which would have reduced the fair market value of these properties by 5% would have resulted in a smaller reversal of impairment losses of Ps.0.02 million, and an increased recognition of impairment losses of Ps. 0.02 million, as of June 30, 2008.
Debt restructuring
Extension of the Alto Palermo’s Convertible Notes’ maturity date. On August 20, 2002, Alto Palermo issued an aggregate amount of US$50.0 million of uncollateralized convertible notes (the “Convertible Notes”) in exchange for cash and the settlement of certain liabilities. The Convertible Notes accrue interest at a fixed annual interest rate of 10% (payable semiannually), are convertible at any time at the option of the holder into common shares of Ps. 0.10 par value per share and originally matured on July 19, 2006. On May 2, 2006 a Meeting of Noteholders resolved to extend the maturity date of the Convertible Notes through July 19, 2014, leaving the remaining terms and conditions unchanged.
Argentine GAAP requires that an exchange of debt instruments with substantially different terms be considered a debt extinguishment. Argentine GAAP clarifies that from a debtor’s perspective, an exchange of debt instruments between, or a modification of a debt instrument by, a debtor and a creditor shall be deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10% different from the present value of the remaining cash flows under the terms of the original instrument. The new debt instrument should be initially recorded at fair value, and that amount should be used to determine the extinguishment gain or loss to be recognized.
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Fair value should be determined by the present value of the future cash flows to be paid under the terms of the new debt instrument discounted at a rate commensurate with the risks of the debt instrument and time value of money. If it is determined that the original and new debt instrument are not substantially different, then a new effective interest rate is to be determined based on the carrying amount of the original debt instrument and the revised cash flows. Based on the analysis performed, we concluded that the instruments were not substantially different and accordingly the original Convertible Notes were not considered to have been extinguished.
We believe that the accounting policy related to the extension of Alto Palermo’s Convertible Notes’ maturity date is a “critical accounting policy” because it required us to make an estimate of the present value of the future cash flows, using an estimated discount rate which is highly susceptible to changes from period to period, and as a result the impact on the fair market value of our debt instruments could be material.
Deferred income tax
We recognize income tax using the liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Technical Resolution No. 17 requires companies to record a valuation allowance for that component of net deferred tax assets which is not recoverable.
We believe that the accounting estimate related to deferred income tax is a “critical accounting estimate” because:
it is highly susceptible to change from period to period because it requires company management to make assumptions, such as future revenues and expenses, exchange rates and inflation among others; and
the impact that calculating income tax using this method would have on assets or liabilities reported on our consolidated balance sheet as well as on the income tax result reported in our consolidated statement of income could be material.
Minimum presumed income tax (“MPIT”)
We calculate the minimum presumed income tax provision by applying the current 1% rate on computable assets at the end of the year. This tax complements the income tax. Our tax obligation each year will coincide with the highest amount due under either of these two taxes. However, if the minimum presumed income tax provision exceeds income tax in a given year, the amount in excess of income tax can be offset against income tax arising in any of the following ten years.
We have recognized the minimum presumed income tax provision paid in previous years as a credit as we estimate that it will offset future years’ income tax.
We believe that the accounting policy relating to the minimum presumed income tax provision is a “critical accounting policy” because it requires management to make estimates and
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assumptions with respect to our future results that are highly susceptible to change from period to period, and as such the impact on our financial position and results of operations could be material.
Negative Goodwill, net
Negative goodwill
When the sum of the individual fair values of the identifiable tangible and intangible assets exceeds the purchase price paid, negative goodwill exists. Under Argentine GAAP, when negative goodwill exists after an acquiring entity initially assigns values to all assets acquired and liabilities assumed, RT No. 18 states that the entity must first reassess whether all acquired assets and assumed liabilities have been identified and properly valued. If an amount of negative goodwill still results after this reassessment, intangible assets acquired (including above and below market leases, in-place leases and tenant relationships, as applicable), are subject to reduction. If after all of these intangible assets are reduced to zero and an amount of negative goodwill still remains, the remaining unallocated negative goodwill is amortized under the straight-line method over the weighted average useful life of the main tangible assets acquired.
Goodwill
Goodwill represents the excess of cost over the fair value of net identifiable assets and is amortized under the straight-line method over the weighted average useful life of the main tangible assets acquired.
The carrying amount does not exceed its respective estimated recoverable value at the end of this year.
Business Segment Reporting
We have determined that our reportable segments are those based on our method of internal reporting. Accordingly, we have six reportable segments. These segments are “Shopping centers,” “Consumer financing,” “Development and sale of properties,” “Offices and other non-shopping center rental properties,” “Hotel operations” and “Financial operations and others.”
A general description of each segment follows:
Shopping centers. This segment includes the operating results of our shopping centers principally consisting of lease and service revenues from tenants.
Consumer financing. We operate a consumer financing business through Alto Palermo’s majority-owned subsidiary Tarshop. Consumer financing operations consist primarily of lending and servicing activities relating to the credit card and personal loans products we offer to consumers at shopping centers, hypermarkets and street stores. We finance a substantial majority of our credit card and personal loans consumer financing activities through securitization of the receivables underlying the accounts we originate. Our revenues from consumer financing transactions are derived from interest income generated by financing and lending activities, merchants’ fees, insurance charges for life and disability insurance and fees for data processing and printing cardholders’ account statement.
Development and sale of properties. This segment includes the operating results of our construction and/or sale of residential buildings business.
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Offices and other non-shopping center rental properties. This segment includes the operating results from our lease and service revenues for office space and other non-retail building properties.
Hotel operations. This segment includes the operating results of our hotels principally comprised of room, catering and restaurant revenues.
Financial operations and others. This segment primarily includes revenues and associated costs generated from the sale of equity securities, other securities-related transactions and other non-core activities.
We measure our reportable segments based on net income. Inter-segment transactions, if any, are accounted for at current market prices. We evaluate performance and allocate our resources to each segment based on operating income. The company is not dependent on any single customer.
Allocation of expenses and other income to business segments
Allocation of selling expenses to business segments
Selling expenses directly attributable to the Shopping centers, Consumer financing and Hotel operations segments are directly allocated to these segments. These expenses are individually incurred by each segment. All other selling expenses are allocated to the remaining segments based on the expenses incurred by each segment.
Allocation of administrative expenses to business segments
Administrative expenses directly attributable to the Shopping centers, Consumer financing, and Hotel operations segments are directly allocated to these segments. These expenses are incurred individually by these segments. All other administrative expenses are prorated among the Development and sale of properties and the Offices and other non-shopping center rental properties segments based on the percentage of the operating assets and revenues generated by each segment. Accordingly, 45.8% and 54.2% of administrative expenses (excluding expenses directly attributable to the Shopping centers, Consumer financing, and Hotel operations segments) are allocated to the Development and sale of properties and the Offices and other non-shopping center rental properties segments, respectively.
Allocation of results from retained interest in securitized receivables to business segments
Alto Palermo’s results from its interest in Tarjeta Shopping trusts are allocated to our Consumer financing segment.
Allocation of results from operations and holding of real estate assets, net
These results are allocated to the segment that generates them.
Allocation of the amortization of goodwill
Includes, principally, the amortization of goodwill generated from (i) the acquisition of Alto Palermo, (ii) the acquisition of Alto Palermo’s subsidiaries, (iii) the purchase of Alto Palermo’s Convertible Notes and (iv) the acquisition of 33% interest in Palermo Invest. The amortization is allocated to the segment that generates the corresponding goodwill.
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Allocation of financial results to business segments
Includes interest income, interest on discounting assets and liabilities, gain (loss) on financial operations, financial expenses, exchange gain (loss), and other financial results allocated to each segment, as described below.
Gain (loss) on financial operations
The gains (losses) on financial operations related to the Shopping centers, Consumer financing, and Hotel operations segments are directly allocated to these segments as each of them manages their financial results separately. The remaining financial gains or losses are shown in the Financial operations and others segment since they are not specifically generated by any other separate segment.
Interest income, interest on discounting assets and liabilities and financial expenses
Only the results generated by Alto Palermo, Tarjeta Shopping, and our hotels are recorded in the Shopping centers, Consumer financing and Hotel operations segments, respectively. The remaining results are prorated among Development and sale of properties, Offices and other non-shopping center rental properties, Shopping centers, Consumer financing, Hotel operations, and Financial operations and others in proportion to the corresponding assets to each segment.
Exchange gain (loss) and other financial results
In the case of Shopping centers, Consumer financing, and Hotel operations, exchange gains (losses) and other financial results are attributed to the segments that give rise to them. The remaining items are recorded in Financial operations and others as they are not directly related to any segment.
Allocation of (Loss) gain on equity investees
(Loss) gain on equity investees is allocated to the corresponding segments. (Loss) gain on equity investees carrying out activities not falling under any of our segments of activity are recorded under Financial operations and others.
Allocation of other (income) expenses, net
The Shopping centers, Consumer financing, and Hotel operations segments each manage their expenses individually. The results generated by such operations are directly allocated to these segments. The remaining expenses are shown in the Financial operations and others segment since they are not specifically generated by any other separate segment.
Allocation of minority interest
Minority interests are allocated among our respective segments that generate them.
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Allocation of income tax and MPIT
The corresponding taxes are allocated to the segment that generates them, with the exception of our taxes that are prorated among the Development and sale of properties, the Offices and other non-shopping center rental properties and the Financial operations and others segments.
The following tables show certain operating data by business activity:
As of and for year ended June 30, 2008
Statement of Income Data
Net loss from retained interest in securitized receivables
Gain from operations and holding of real estate assets, net
Operating income (loss)
Amortization of goodwill
Loss on equity investees
Income (loss) before taxes and minority interest
Net income (loss)
Gross margin (b)
Operating margin (c)
Net margin (d)
Depreciation and amortization (e)
Operating assets
Non operating assets
Operating liabilities
Non operating liabilities
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As of and for year ended June 30, 2007
Net income from retained interest in securitized receivables
(Loss) gain from operations and holding of real estate assets, net
(Loss) Income before taxes and minority interest
Income tax and minimum presumed income tax
Net (loss) income
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As of and for year ended June 30, 2006
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Results of Operations for the Fiscal Years ended June 30, 2007 and 2008.
Revenues from sales, leases and services rose 46.8%, from Ps. 738.8 million for fiscal year 2007 to Ps. 1,084.2 million in fiscal year 2008, due mainly to an increase in revenues from our Development and sale of properties, Consumer financing, Shopping centers, Offices and other non-shopping center rental properties, and Hotel operations segments.
The revenues of our Development and sale of properties segment rose 159.8% from Ps. 75.8 million for fiscal year 2007 to Ps. 196.8 million in fiscal year 2008. Revenues associated with this segment commonly sustain significant period-on-period variations arising from: (i) the number of properties sold and their prices, (ii) the properties in construction and the degree of progress of such projects.
This increase in revenues was primarily due to the revenues generated during fiscal year 2008 by (i) the sale of 29.9% of the Bouchard Plaza building, commonly known as “Edificio La Nación”, for Ps. 108.4 million; (ii) the sale of Parcel Y at Dock III for Ps. 56.6 million; (iii) a barter agreement through which a plot of land in the project known as “Terreno Caballito” was exchanged for home units and parking lots appraised at Ps. 19.2 million and (iv) a barter agreement through which a plot of land in the project known as “Terreno Rosario” was exchanged for home units and parking lots appraised at Ps. 3.4 million.
Offices and Other Non-Shopping Center Rental Properties
The revenues of our Offices and other non-shopping center rental properties segment increased 81.4%, from Ps. 55.7 million for fiscal year 2007 to Ps. 101.0 million in fiscal year 2008. This increase was mainly due to Ps. 45.0 million increase in revenues from office rentals which rose from Ps. 52.9 million in fiscal year 2007 to Ps. 97.9 million in fiscal year 2008. This Ps. 45 million increase in revenues was mainly attributable to: (i) Ps. 28.3 million in revenues from rentals in the following recently acquired Class A office buildings: Della Paolera 265, purchased in August 2007 generated revenues of Ps. 15.7 million, Bouchard 551, acquired in March 2007, generated revenues of Ps. 8.8 million, and Dock del Plata, acquired in November 2006, generated revenues of Ps. 3.8 million; and (ii) Ps. 16.1 million in revenues from rentals due to the increase in prices charged per square meter and similar increases in occupancy rates (which increased from 94% during fiscal year 2007 to 93.6% during fiscal year 2008).
The revenues of our Shopping centers segment rose by 27.8% from Ps. 270.3 million for fiscal year 2007 to Ps. 345.4 million in fiscal year 2008. This increase was due mainly due to a Ps. 62.6 million increase in revenues from rentals and admission rights. This increase was due in turn to a 31.0% increase in the total sales of our tenants which went up from Ps. 2,825.8 million in fiscal year 2007 to Ps. 3,702.3 million in fiscal year 2008. The average occupancy rate at our shopping centers rose from 99.1% in fiscal year 2007 to 99.3% during fiscal year 2008.
Hotel Operations
The revenues of the Hotel operations segment rose by 21.3% from Ps. 122.7 million in fiscal year 2007 to Ps. 148.8 million in fiscal year 2008, mainly due to (i) an 18.8% increase in the average price per room at the hotels (from Ps. 469.0 per night in fiscal year 2007 to Ps. 557.0
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per night in fiscal year 2008), (ii) an increase in the average occupancy rate from 74% in fiscal year 2007 to 76% in fiscal year 2008, and (iii) a 27.2% increase in the number of rooms available at Hotel Llao Llao, which were added during fiscal year 2008.
The revenues of the Consumer financing segment rose by 36.7%, up from Ps. 213.0 million during fiscal year 2007 to Ps. 291.0 million during fiscal year 2008. This was mainly due to (i) the favorable macroeconomic conditions prevailing in Argentina in 2008 and the consequent rise in consumption, (ii) the continuous enhancement in the services rendered to Tarshop customers, (iii) an increase in the fees charged for the issuance of credit card statements and for the issuance of credit cards.
Financial Operations and Others
The revenues of the Financial operations and others segment decreased by Ps. 0.2 million, from Ps. 1.4 million during fiscal year 2007 to Ps. 1.2 million during fiscal year 2008.
Costs increased by 57.1%, from Ps. 311.6 million for fiscal year 2007 to Ps. 489,7 million in fiscal year 2008, due to an increase in the costs of the following segments: Development and sale of properties, Consumer financing, Hotel operations, Offices and other non-shopping center rental properties, and Shopping centers. When measured as a percentage of IRSA’s revenues, costs went up from 42.2% during fiscal year 2007 to 45.2% during fiscal year 2008.
The costs of the Development and sale of properties segment increased by 161.0%, from Ps. 57.8 million for fiscal year 2007 to Ps. 150.9 million in fiscal year 2008. The costs associated with this segment commonly sustain major period-on-period variations according to: (i) the number of properties sold and their prices and (ii) the properties in construction and the degree of progress of such projects.
The increase in costs in fiscal year 2008 was mainly due to: (i) the sale of a 29.9% stake in the Bouchard Plaza building, commonly known as “Edificio La Nación”, for Ps. 89.4 million, (ii) the sale of Parcel Y at Dock III for Ps. 41.8 million, (iii) a barter agreement through which a plot of land in the project known as “Terreno Caballito” was exchanged for home units and parking lots for Ps. 10,1 million, and (iv) Ps. 3.6 million cost of a barter agreement through which a plot of land in the project known as “Terreno Rosario” was exchanged for home units and parking lots. When measured as a percentage of IRSA’s revenues, the costs associated with the Development and sale of properties segment rose from 76.3% during fiscal year 2007 to 76.7% during fiscal year 2008.
The costs of the Offices and other non-shopping center rental properties segment rose by 54.6%, from Ps. 16.7 million for fiscal year 2007 to Ps. 25.8 million in fiscal year 2008. Depreciation accounts for the most significant portion of the costs associated with this segment.
The increase in the costs for fiscal year 2008 when compared to fiscal year 2007 was mainly due to increased depreciation expenses which amounted to Ps. 4.8 million, as a consequence of the addition to IRSA’s portfolio of three new buildings to be allocated to our
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rentals business, namely, Edificio República, Della Paolera 265 and Museo Renault. When measured as a percentage of the segment’s revenues, the costs associated with the Offices and other non-shopping center rental properties segment dropped from 30.0% during fiscal year 2007 to 25.6% during fiscal year 2008.
The costs of the Shopping centers segment rose by 8.8% from Ps. 91.1 million for fiscal year 2007 to Ps. 99.2 million in fiscal year 2008, primarily due to: (i) a Ps. 6.2 million increase in depreciation and amortization, (ii) higher costs resulting from lawsuit-related contingencies in the amount of Ps. 1.6 million, (iii) an increase in parking-lot related expenses in the amount of Ps. 1.4 million, and (iv) an increase in costs associated with unrecoverable expenses in the amount of Ps. 1.1 million, offset in part by (v) a decrease in the costs related to refurbishments and changes in leasable areas in the amount of Ps. 2.2 million. When measured as a percentage of the segment’s revenues, the costs associated with the Shopping centers segment dropped from 33.7% during fiscal year 2007 to 28.7% during fiscal year 2008.
The costs of the Hotel operations segment rose by 22.1%, from Ps. 69.0 million for fiscal year 2007 to Ps. 84.2 million in fiscal year 2008, mainly due to salary increases and increased social security contributions, increases in the costs of food and beverages, repairs and maintenance, public utilities, and fees and commissions paid. When measured as a percentage of IRSA’s revenues, the costs associated with the Hotel operations segment rose from 56.2% in fiscal year 2007 to 56.6% in fiscal year 2008.
The costs of the Consumer financing segment rose by 69.2% from Ps. 76.3 million during fiscal year 2007 to Ps. 129.0 million during fiscal year 2008 mainly as a result of: (i) an increase in the expenses related to interest and fees originating in the outsourcing of collection and other related services; (ii) an increase in expenses related to salaries and social security contributions; (iii) an increase in the fees for services; and (iv) an increase in taxes, charges, contributions and tax-related services.
When measured as a percentage of the segment revenues, the costs associated with the Consumer financing segment went up from 35.8% during fiscal year 2007 to 44.3% during fiscal year 2008.
The costs of the Financial operations and others segment decreased by Ps. 0.3 million, from Ps. 0.8 million for fiscal year 2007 down to Ps. 0.5 million in fiscal year 2008.
As a result of the above, gross profit rose by 39.2%, from Ps. 427.1 million for fiscal year 2007 to Ps. 594.6 million in fiscal year 2008, mainly due to the increase in gross profit from the Shopping centers, Offices and other non-shopping center rental properties, Development and sale of properties, Consumer financing, and Hotel operations segments. When measured as a percentage of the segment’s revenues, gross profit dropped from 57.8% for fiscal year 2007 to 54.8% for fiscal year 2008.
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During fiscal year 2008, IRSA recorded a Ps. 2.8 million gain from recognition of inventories at net realizable value, primarily in connection with “Torre Renoir” for Ps. 2.6 million, compared to a Ps. 20.7 million gain during fiscal year 2007, primarily related to “Dock III – Parcel X” for Ps. 18.7 million and to “San Martín de Tours” for Ps. 1.5 million.
Selling expenses rose by 44.2%, from Ps. 113.7 million for fiscal year 2007 to Ps. 164.0 million in fiscal year 2008, mainly due to an increase in the selling expenses of Consumer financing operations segment and to a lesser extent, to increases in the Hotel operations and Shopping centers segments, which were offset in part by the decreases in the Development and sale of properties, and Offices and other non-shopping center rental properties segments. When measured as a percentage of revenues, Selling expenses decreased from 15.4% for fiscal year 2007 to 15.1% in fiscal year 2008.
The selling expenses associated with the Development and sale of properties segment include a turnover tax, commissions and expenses derived from sales, advertising and promotion and the allowance for doubtful accounts. Selling expenses dropped by 40.1%, from Ps. 12.8 million during fiscal year 2007 to Ps. 7.7 million during fiscal year 2008, primarily as a result of a Ps. 7.2 million decrease in turnover tax, offset in part by a Ps. 2.1 million increase in advertising and promotion expenses. When measured as a percentage of the segment’s revenues, the Selling expenses related to the Development and sale of properties segment fell from 17.0% during fiscal year 2007 to 3.9% during fiscal year 2008.
The selling expenses of the Offices and other non-shopping center rental properties segment decreased by Ps. 0.9 million from Ps. 4.4 million for fiscal year 2007 to Ps. 3.5 million in fiscal year 2008 mainly due to the reduction in the allowance for doubtful accounts and to the decrease in advertising and promotion expenses; which were offset in part by an increase in turnover tax. When measured as a percentage of the segment’s revenues, the Selling expenses associated with the Offices and other non-shopping center rental properties segment fell from 7.9% during fiscal year 2007 to 3.4% during fiscal year 2008.
The selling expenses of the Shopping centers segment rose by 11.0% from Ps. 22.3 million for fiscal year 2007 to Ps. 24.8 million in fiscal year 2008 as a result of: (i) a Ps. 2.1 million increase in salaries and social security contributions; (ii) a Ps. 0.9 million increase in exhibitions and events; and (iii) a Ps. 0.7 million increase in turnover tax; (iv) offset in part by a Ps. 1.2 million decrease in the allowance for doubtful accounts. When measured as a percentage of the segment’s revenues, the selling expenses associated with the Shopping centers segment decreased from 8.3% during fiscal year 2007 to 7.2% during fiscal year 2008.
The selling expenses of the Hotel operations segment rose by 36.4% from Ps. 12.2 million for fiscal year 2007 to Ps. 16.6 million for fiscal year 2008. This increase was primarily due to (i) an increase in the commissions of travel agents and credit cards in the amount of Ps. 2.1 million,
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indicative of the increase in the level of activities; and (ii) a Ps. 0.9 million increase in advertising. When measured as a percentage of the segment’s revenues, the Selling expenses associated with the Hotel operations segment went up from 9.9% during fiscal year 2007 to 11.2% during fiscal year 2008.
Selling expenses from the Consumer Financing segment increased 79.8%, from Ps.62.0 million during fiscal year ended June 30, 2007 to Ps.111,4 million during fiscal year ended June 30, 2008, mainly due to: (i) an increase in allowance for doubtful accounts of Ps. 38.5 million. In this case it is important to note that as of June 30, 2008 a higher bad debt chargeoff of Ps. 21.8 million resulted from an increase in overdue accounts; (ii) a Ps. 5.5 million increase in advertising expenses and rewards; and (iii) a Ps. 4.7 million increase in turnover tax expenses. When measured as a percentage of the segment’s revenues, the Selling expenses associated with Consumer financing operations increased from 29.1% during fiscal year 2007 to 38.3% during fiscal year 2008.
Administrative expenses rose by 27.3%, from Ps. 141.4 million for fiscal year 2007 to Ps. 180.0 million in fiscal year 2008, mainly due to the increase in the activities of the Consumer financing operations segment, and to a lesser extent, to the increases sustained by each one of the remaining segments. The main components of administrative expenses are salaries and social security contributions for administrative personnel, fees and payments for services, directors’ fees, banking expenses, fixed asset depreciation, and taxes (except for turnover tax). When measured as a percentage of revenues, Administrative expenses went down from 19.1% in fiscal year 2007 to 16.6% in fiscal year 2008.
The administrative expenses of the Development and sale of properties segment rose by 11.3%, from Ps. 19.6 million for fiscal year 2007 to Ps. 21.8 million in fiscal year 2008, mainly due to a Ps. 1.6 million increase in fees and compensation for services. When measured as a percentage of the segment’s revenues, the administrative expenses associated with the Development and sale of properties segment dropped from 25.9% for fiscal year 2007 to 11.1% in fiscal year 2008.
The administrative expenses related to the Offices and other non-shopping center rental properties segment rose by 30.9%, from Ps. 16.8 million for fiscal year 2007 to Ps. 22.0 million in fiscal year 2008. The increase was mainly due to (i) a Ps. 2.5 million increase in fees and compensation for services, and (ii) a Ps. 0.7 million increase in salaries and social security contributions. When measured as a percentage of the segment’s revenues, the administrative expenses associated with the Offices and other non-shopping center rental properties segment dropped from 30.2% for fiscal year 2007 to 21.8% in fiscal year 2008.
The administrative expenses related to the Shopping centers segment rose by 19.7%, from Ps. 32.7 million for fiscal year 2007 to Ps. 39.2 million in fiscal year 2008 mainly due to (i) a Ps. 3.3 million increase in salaries and social security contributions, (ii) a Ps. 1.7 million increase in taxes, mainly related to the tax on bank debits and credits, and (iii) a Ps. 1.3 million increase in
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directors’ fees. When measured as a percentage of the segment’s revenues, the Administrative expenses associated with the Shopping centers segment, decreased from 12.1% during fiscal year 2007 to 11.3% during fiscal year 2008 as a result of the current financial crisis and the increase in delinquency rates.
The administrative expenses related to the Hotel operations segment rose by 11.5%, from Ps. 26.9 million for fiscal year 2007 to Ps. 30.0 million in fiscal year 2008, mainly as a result of (i) a Ps. 1.9 million increase in salaries and social security contributions, and (ii) a Ps. 1.6 million increase in fees and compensation for services; offset in part by (iii) a Ps. 1.3 million decrease in commissions. When measured as a percentage of the segment’s revenues, the administrative expenses associated with the Hotel operations segment decreased from 21.9% for fiscal year 2007 to 20.1% for fiscal year 2008.
The administrative expenses related to the Consumer financing segment rose by 47.7%, jumping from Ps. 45.4 million during fiscal year 2007 to Ps. 67.0 million during fiscal year 2008. This increase was mainly due to (i) a Ps. 9.1 million increase in salaries and social security contributions; (ii) a Ps. 7.5 million increase in fees and compensation for services; and (iii) increased expenses associated with property rentals and taxes of Ps. 4.2 million. When measured as a percentage of the segment’s revenues, the administrative expenses associated with the Consumer financing segment rose from 21.3% during fiscal year 2007 to 23.0% during fiscal year 2008.
Income/loss from retained interest in securitized receivables dropped by Ps. 4.5 million, from income of Ps. 3.3 million for the fiscal year ended June 30, 2007 to a Ps. 1.3 million loss for fiscal year ended June 30, 2008 due to the outcome of the placement of new issuances related to credit card trusts and the appraisal of our interest therein. A loss at the time of placement of new issuances is recognized when, as a consequence of prevailing market conditions, there is an increase in interest rates payable to Tarshop Trust Bond holders resulting in a tightening of the spreads at which receivables underlying such issues are financed. As of June 30, 2008, we increased an allowance for impairment by Ps. 12.0 million, to adjust the book amount of our certificates of interest to their estimated recoverable value.
This item reflects the income and loss resulting from impairment and the reversal of charges for impairment recognized in the past. Results from operation and holding of real estate assets rose by 4.0% from Ps. 2.6 million income for fiscal year 2007 to Ps. 2.7 million income in fiscal year 2008 recognized mainly in relation to the building located at Constitución 1159 for Ps. 2.1 million. During fiscal year 2007, income for Ps. 2.6 million had been attributed mainly as follows: Neuquén Project: Ps. 2.2 million, Suipacha 652: Ps. 0.9 million, and Av. de Mayo 589 for Ps. 0.7 million, offset in part by a loss of Ps. 1.5 million in connection with Torres Rosario.
Operating income rose by 28.4% from Ps. 198.5 million for fiscal year 2007 to Ps. 254.8 million in fiscal year 2008, mainly due to an increase in the Shopping centers, Offices and other
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non-shopping center rental properties, Development and sale of properties, and Hotel operations segments, offset in part by a decrease in the Operating income of the Consumer financing segment. When measured as a percentage of revenues, operating income decreased from 26.9% in fiscal year 2007 to 23.5% for fiscal year 2008.
Operating income in the Development and sale of properties segment rose by Ps. 13.1 million up from Ps. 6.2 million for fiscal year 2007 to Ps. 19.3 million for fiscal year 2008, due to increases in revenues and a decrease in selling expenses, partially offset by (i) increased costs, (ii) a reduction in income from the recognition of inventories at net realizable value and (iii) an increase in administrative expenses. When measured as a percentage of revenues for the segment, Operating income in the Development and sale of properties segment rose from 8.2% during fiscal year 2007 to 9.8% during fiscal year 2008.
Operating income in the Offices and other non-shopping center rental properties segment rose by 166.4%, from Ps. 19.6 million for fiscal year 2007 to Ps. 52.3 million in fiscal year 2008, due to an increase in revenues and a decrease in selling expenses, partially offset by increased costs and an increase in Administrative expenses. When measured as a percentage of revenues for the segment, operating income for the Offices and other non-shopping center rental properties segment, rose from 35.2% during fiscal year 2007 to 51.8% during fiscal year 2008.
Operating income in the Shopping centers segment rose by 46.0%, from Ps. 124.8 million for fiscal year 2007 to Ps. 182.3 million in fiscal year 2008, due to an increase in revenues, partially offset by an increase in costs, an increase in administrative expenses and an increase in selling expenses. When measured as a percentage of revenues for the segment, Operating income for the Shopping centers segment, increased from 46.2% during fiscal year 2007 to 52.8% during fiscal year 2008.
Operating income in the Hotel operations segment rose by 23.1% from Ps. 14.7 million for fiscal year 2007 to Ps. 18.0 million in fiscal year 2008, due to an increase in revenues, partially offset by an increase in costs, an increase in administrative expenses and an increase in selling expenses. When measured as a percentage of revenues for the segment, operating income for the Hotel operations segment increased from 11.9% during fiscal year 2007 to 12.1% during fiscal year 2008.
Operating income in the Consumer financing segment decreased by 154.1% from Ps. 32.6 million income for fiscal year 2007 to a Ps. 17.7 million loss in fiscal year 2008, due to increases in costs, in selling expenses and in administrative expenses and to a reduction in income from retained interest in securitized receivables concerning Tarjeta Shopping trusts, partially offset by an increase in revenues. When measured as a percentage of revenues for the segment, operating income for the Consumer financing segment decreased from 15.3% for fiscal year 2007 to (6.1)% during fiscal year 2008.
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Operating income in the Financial operations and others segment remained at Ps. 0.6 million for the fiscal years 2007 and 2008. When measured as a percentage of revenues operating income for the Financial operations and others segment increased from 43.1% for fiscal year 2007 to 54.8% for fiscal year 2008.
Amortization of goodwill includes: (i) the amortization of goodwill corresponding to the following Alto Palermo subsidiaries: Shopping Alto Palermo S.A., Fibesa S.A, Tarshop Sociedad Anónima, Emprendimiento Recoleta S.A. and Empalme S.A.I.C.F.A y G as well as (ii) the amortization of IRSA’s negative goodwill resulting from the acquisition of shares in Alto Palermo S.A. and Palermo Invest S.A. Amortization of goodwill rose by Ps. 3.1 million, from a Ps. 1.5 million loss for fiscal year 2007 to Ps. 1.6 million income in fiscal year 2008.
Results from related companies dropped by Ps. 53.2 million, from Ps. 40.0 million income for fiscal year 2007 to a Ps. 13.2 million loss in fiscal year 2008. This decrease was mainly due to a Ps. 53.7 million reduction in Banco Hipotecario’s profit from Ps. 41.4 million in fiscal year 2007 to a Ps. 12.4 million loss in fiscal year 2008.
This loss is primarily due to the decline in the market value of the Argentine government bonds Banco Hipotecario received as compensation and held in its portfolio. In spite of these losses, Banco Hipotecario remains well-capitalized in regards to regulatory guidelines as of June 30, 2008 and thereafter.
Banco Hipotecario also experienced a significant decline in its stock price during the year ended June 30, 2008 and the three months ended September 30, 2008. Management believes that this decline is not reflective of the current operating performance of Banco Hipotecario. For more information please see “Recent Developments”.
Financial results, net decreased by Ps. 80.8 million, from Ps. 4.1 million income for fiscal year 2007 to a Ps. 76.7 million loss in fiscal year 2008. This loss was mainly due to: (i) a Ps. 88.1 million decrease in results from financial operations, primarily due to a Ps. 85.2 million decrease in the fair value of our holdings of mutual funds; (ii) Ps. 33.5 million increase resulting from higher financing expenses, primarily due to the increase in interest charges paid as a consequence of the issuance of notes by IRSA and Alto Palermo during this fiscal year, partially offset by (iii) a decrease in the interest paid due to the redemption in October 2007 of IRSA’s floating rate secured notes in the amount of US$ 37.4 million, (iv) and the repayment of an unsecured loan for US$ 51 million. These reductions were partially offset by (i) foreign exchange gains in the amount of Ps. 26.3 million compared to fiscal year 2007, as a consequence of a variation in the US Dollar selling exchange rate during the fiscal year (from 3.093 Argentine Pesos per U.S. dollar as of June 30, 2007 to 3.025 Argentine Pesos per U.S. dollar as of June 30, 2008), in contrast to the previous year when the Argentine Peso/US Dollar exchange rate had increased significantly (from 3.086 Argentine Pesos per U.S. dollar as of June 30, 2006 to 3.093 Argentine Pesos per U.S. dollar as of June 30, 2007), and (ii) a Ps. 20.0 million increase due to the interest earned during fiscal year 2008 compared to fiscal year 2007, as a consequence of investments and other interest earned by Alto Palermo.
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Other income (expenses), net, decreased by 60.0% from net expenses of Ps. 14.1 million in fiscal year 2007 to net expenses of Ps. 5.6 million in fiscal year 2008, primarily due to (i) the reversal of a provision for contingencies in the amount of Ps. 5.6 million, and (ii) a decrease in charges for personal property tax of Ps. 1.2 million which, according to Argentine regulations, we must realize on behalf of our shareholders.
Income before taxes and minority interest dropped by Ps. 66.2 million, from Ps. 227.1 million for fiscal year 2007, to income of Ps. 160.9 million in fiscal year 2008.
Income tax and minimum presumed income tax dropped by 10.8% from Ps. 87.5 million for fiscal year 2007 to Ps. 78.1 million in fiscal year 2008. We applied the deferred tax method in calculating our income tax for the fiscal years 2007 and 2008, thus recognizing the temporary differences in our tax assets and liabilities.
This item includes our proportional equity interest in the subsidiaries in which we own a minority interest. The loss resulting from third-party interests in these subsidiaries dropped by 14%, from a Ps. 32.4 million loss for fiscal year 2007 to a Ps. 27.9 million loss for fiscal year 2008, mainly due to the increase in the income statement accounts of the companies in which we have a minority interest and to the acquisition of the remaining 33.33% stake in Palermo Invest S.A., which eliminated the effect of the minority interest in this company during fiscal year 2008.
Therefore, net income decreased by Ps. 52.2 million from Ps. 107.1 million for fiscal year 2007 to Ps. 54.9 million in fiscal year 2008.
Results of Operations for the Fiscal Years ended June 30, 2006 and 2007.
Revenues increased 27.9% from Ps.577.7 million in fiscal year 2006 to Ps.738.8 million in fiscal year 2007, primarily due to increases in the revenues of each of our Consumer financing, Shopping centers, Offices and other non-shopping center rental properties and Hotel operations segments, partially offset by a decrease in the revenues of our Development and sale of properties segment.
Revenues from our shopping centers segment increased 25.7% from Ps.215.0 million in fiscal year 2006 to Ps.270.3 million in fiscal year 2007. This increase was principally due to a Ps.55.3 million increase in revenues from rentals and admission rights as a consequence of (i) a 22.1% increase in the average rental price per square meter and (ii) a 24.3% increase in the total sales of our lessees, from Ps.2,273.3 million during fiscal year 2006 to Ps.2,825.8 million during fiscal year 2007, resulting in a Ps.552.5 million increase in revenues from variable rental
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payments. The average occupancy rate of our shopping centers decreased from 99.1% in fiscal year 2006 to 97.0% in fiscal year 2007.
Revenues from our Consumer Financing segment increased 73.2% from Ps.123.0 million during fiscal year 2006 to Ps.213.0 million during fiscal year 2007. This increase resulted from:
favorable macroeconomic conditions in fiscal year 2007, which showed a general increase in consumption;
an increase of 201,114 in the number of newly issued credit cards;
the opening of four new branches;
a 90.5% increase in sales made with our shopping card and a 47.1% increase in the number of stores accepting our card; and
an increase of income from financial operations and others.
Revenues from our Financial Operations and Others segment remained stable with respect to fiscal year 2006. Revenues included in this segment represent fees for services unrelated to our Others segments.
Revenues from our development and sale of properties segment decreased 27.1% from Ps.104.0 million in fiscal year 2006 to Ps.75.8 million in fiscal year 2007. This business segment generally does not show consistently recurring revenues due to the nature of our business. As a result, period-on-period comparisons may vary significantly depending on the projects that we are developing and their degree of completion. The decrease of the revenues of this segment in fiscal year 2006 was principally due to the absence in fiscal year 2007 of Ps.104.0 million of revenues which were recognized during fiscal year 2006 principally arising from the following operations:
Ps.41.8 million from the sale of parcel Y, Dock III;
Ps.23.0 million from the sale by our subsidiary Alto Palermo of a parcel of land near its Paseo Alcorta shopping center;
Ps.22.8 million from the sale of block 36 of the parcel called “Terrenos de Caballito;” and
Ps.10.0 million from the sale of Edificios Cruceros units.
The absence in fiscal year 2007 of the Ps.104.0 million of revenues mentioned above was partially offset by the following revenues recognized during fiscal year 2007:
Ps.31.0 million from the sale to third parties of 10% of our Santa María del Plata land reserve;
Ps.26.2 million from the sale of plot “Z,” Dock III;
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Ps.8.6 million from the sale of units in San Martín de Tours and
Ps.8.4 million from the sale of Edificios Cruceros units.
Revenues from our Offices and Other Non-Shopping Center Rental Properties increased 82.2% from Ps.30.6 million in fiscal year 2006 to Ps.55.7 million in fiscal year 2007. This increase was primarily due to a Ps.25.5 million increase in the revenues from office rentals, from Ps.27.4 million in fiscal year 2006 to Ps.52.9 million in fiscal year 2007. This increase in revenues from office rentals was due to:
an increase, from 94.0% in fiscal year 2006 to 99.1% in fiscal year 2007, in our average occupancy rates in offices for lease due to our inclusion in fiscal year 2007 of Dock del Plata and Bouchard 551 and Reconquista 823 (which were 100.0% occupied);
a 93.3% increase in annual rentals from offices for lease arising principally from (i) price increases in the following buildings which increased our total leasable area of Class A buildings by 53% from 78.115 to 119.360 square meters: Intercontinental Plaza resulting in higher rents of Ps.5.5 million, Bouchard 710 resulting in higher rents of Ps.3.1 million, Maipú 1300 resulting in higher rents of Ps.2.5 million and Libertador 498 resulting in higher rents of Ps.2.4 million (ii) the acquisition of two new premium buildings: Bouchard 551 (acquired in March 2007) which generated rental revenues in fiscal year 2007 of Ps.3.9 million and Dock del Plata (acquired in November 2006) which generated rental revenues in fiscal year 2007of Ps.3.1 million; and
the occupancy rate of the offices and other non-shopping center rental properties segment increased from 96.9% in fiscal year 2006 to 97.4% during fiscal year 2007.
Revenues from our hotel operations increased 18.2% from Ps.103.8 million in fiscal year 2006 to Ps.122.7 million in fiscal year 2007, principally due a 23.7% increase in the average price per room in our hotels, from Ps.379.0 in fiscal year 2006 to Ps.469.0 in fiscal year 2007. In fiscal year 2007, revenues from the Hotel Llao Llao increased Ps.8.9 million, revenues from the Hotel Intercontinental increased Ps.6.0 million and revenues from the Hotel Sheraton Libertador increased Ps.4.0 million, in each case compared to fiscal year 2006. These improvements in fiscal year 2007 were partially offset by a decrease in average occupancy rates from 78.7% in fiscal year 2006 to 74.0% during fiscal year 2007.
Our costs increased 27.8% from Ps.243.8 million in fiscal year 2006 to Ps.311.6 million in fiscal year 2007 as a result of an increase in costs of each of our business segments during fiscal year 2007 other than Financial Operations and Others. Our total costs as a percentage of our revenues remained flat at 42.2% for each of fiscal year 2006 and 2007.
Costs of the Consumer financing segment increased 73.6%, from Ps.43.9 million during fiscal year ended June 30, 2006 to Ps.76.3 million during fiscal year ended June 30, 2007. This
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increase, which reflected the expansion of our Consumer financing segment in fiscal year 2007, was primarily due to:
a Ps.11.0 million increase in the cost of salaries and social security charges;
a Ps.9.8 million increase in expenses for interest and commissions;
a Ps.5.7 million increase in charges for taxes, rates, contributions and services; and
a Ps.2.8 million increase in fees and services payable to third parties.
The cost of Consumer financing as percentage of revenues from such segment remained flat at 35.8% in each of fiscal years 2006 and 2007.
The cost of the Financial Operations and Others segment decreased Ps.0.6 million, from Ps.1.4 million in fiscal year 2006 to Ps.0.8 million in fiscal year 2007. Costs included in this line represent expenses unrelated to our other segments.
Costs of the Shopping Centers segment increased 17.7%, from Ps.77.4 million in fiscal year 2006 to Ps.91.1 million in fiscal year 2007. This increase was primarily due to:
a Ps.6.6 million increase in costs related to renovation of shopping centers’ common areas;
a Ps.4.7 million increase in depreciation and amortization charges due to the depreciation of fixed assets; and
a Ps.2.3 million increase in costs for unrecovered expenses.
The cost of the Shopping Centers segment as percentage of the revenues from such segment decreased from 36.0% in fiscal year 2006 to 33.7% during fiscal year 2007.
Costs related to Development and Sale of Properties increased 6.7%, from Ps.54.2 million in fiscal year 2006 to Ps.57.8 million in fiscal year 2007. This business segment generally does not show consistently recurring costs due to the nature of our business. As a result, period-on-period comparisons may vary significantly depending on the projects that we are developing and their degree of completion. The increase in costs of this segment was principally due to the following costs incurred in fiscal year 2007:
Ps.26.2 million related to the sale of plot “Z” of Dock III;
Ps.12.9 million related to the sale of 10% of the Santa María del Plata land reserve;
Ps.8.2 million related to the sale of San Martín de Tours units; and
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Ps.3.2 million related to the sale of Edificio Cruceros units.
The foregoing cost increases in fiscal year 2007 were partially offset by the non-recurrence in fiscal year 2007 of the following costs which were incurred in fiscal year 2006:
Ps.18.4 million in costs related to the sale of Alcorta Plaza (through Alto Palermo);
Ps.11.3 million of costs related to the sale of block 36 of the plot called “Terrenos de Caballito”;
Ps.9.7 million of costs related to the sale of plot “Y,” Dock III; and
Ps.8.8 million of costs related to the sale of Edificios Cruceros units.
Costs included in this segment as percentage of revenues from such segment increased from 52.1% in fiscal year 2006 to 76.3% in fiscal year 2007.
Costs of the Offices and Other Non-Shopping Center Rental Properties segment increased 85.5%, from Ps.9.0 million in fiscal year 2006 to Ps.16.7 million in fiscal year 2007. The principal cost component in this office segment is the depreciation of buildings rented, and the increase in fiscal year 2007 was principally due to (i) Ps.3.4 million higher depreciation in fiscal year 2007 as a result of the addition of two new rental properties, Dock del Plata and Bouchard 551 and (ii) Ps.5.9 million higher depreciation as a result of a change in the determination of remaining useful life of our rental buildings, which decreased from an average of 496 months in fiscal year 2006 to an average of 253 months in fiscal year 2007.
Costs of Hotel Operations increased 19.0%, from Ps.58.0 million in fiscal year 2006 to Ps.69.0 million in fiscal year 2007 principally due to increases in depreciation of assets, fees for commissions and services, food and beverages and salaries and social security charges in each case related to increasing revenues from such segment. Costs of Hotel Llao Llao increased Ps.6.0 million, those of Hotel Intercontinental increased Ps.2.6 million and those of Hotel Sheraton Libertador increased Ps.2.4 million. Costs of hotel operations as percentage of revenues of such segment increased from 55.9% in fiscal year 2006 to 56.2% in fiscal year 2007.
As a result of the above, gross profit increased 27.9% from Ps.333.8 million in fiscal year 2006 to Ps.427.1 million in fiscal year 2007. Our gross margin, calculated as our gross profit divided by our revenues, remained at 57.8% in fiscal years 2006 and 2007 primarily as a result of improvements in the gross margin of our Shopping Centers and Financial Operations and Others segments, partially offset by a decrease in the gross margin of our Development and Sale of Properties, Offices and Other Non-Shopping Center Rental Properties, Hotel Operations and Consumer financing segments.
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This line reflects the valuation at net realization value of inventories in respect of which we received prepayments of rentals pursuant to contractual terms which establish the consummation of the sales and the resulting profits. This business segment generally does not show consistently recurring gains, and as a result, period-on-period comparisons may vary significantly depending on the projects that we are developing and their degree of completion. During fiscal year 2007, we recognized Ps.20.7 million gain which was principally applied to the following developments:
“Dock III - Plot X” in an amount equal to Ps.18.4 million; and
“San Martín de Tours” in an amount equal to Ps.1.5 million.
During fiscal year 2006, we recognized a gain of Ps.9.1 million primarily in respect of: “Edificios Cruceros” in an amount equal to Ps.4.6 million, “Torres Rosario” in an amount equal to Ps.3.5 million, “Dock III – Plot Z” in an amount equal to Ps.1.6 million and “San Martín de Tours” in an amount equal to Ps.(0.6) million.
Selling expenses increased 89.2% from Ps.60.1 million in fiscal year 2006 to Ps.113.7 million in fiscal year 2007 principally due to an increase in the selling expenses of the Consumer financing and Shopping Centers segments of Ps.31.1 million and Ps.6.6 million, respectively. Selling expenses as a percentage of revenues increased from 10.4% in fiscal year 2006 to 15.4% in fiscal year 2007.
Selling expenses for the Shopping Centers segment increased 42.3%, from Ps.15.7 million in fiscal year 2006 to Ps.22.3 million in fiscal year 2007 due to: (i) a Ps.2.0 million increase in the costs of salaries and social security charges; (ii) a Ps.1.4 million increase in the charge for turnover tax; and (iii) a Ps.1.2 million increase in the charge for bad debts. Selling expenses related to Shopping Centers as a percentage of revenues from such segment increased from 7.3% in fiscal year 2006 to 8.3% in fiscal year 2007.
Selling expenses for the Consumer financing segment increased 100.5%, from Ps.30.9 million in the fiscal year ended June 30, 2006 to Ps.62.0 million in the fiscal year ended June 30, 2007 principally due to:
a Ps.11.7 million increase in advertising expenses;
a Ps.11.8 million increase in the charge for bad debts; and
a Ps.5.8 million increase in the charge for turnover tax.
Selling expenses of Consumer financing as a percentage of the revenues from such segment increased from 25.1% in the fiscal year 2006 to 29.1% in fiscal year 2007.
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Selling expenses for this segment consist of commissions and expenses derived from sales, stamp tax and on gross sales (gross revenues). Selling expenses for Development and Sale of Properties increased Ps.11.0 million in fiscal year 2007 principally due to a higher turnover tax charge during such fiscal year as a result of our sale of Solares de Santa María.
Selling expenses for the Offices and Other Non-Shopping Center Rental Properties segment increased Ps.3.4 million, from Ps.1.0 million in fiscal year 2006 to Ps.4.4 million in fiscal year 2007 due to a Ps.1.9 million higher charge for bad debtors by our subsidiary Inversora Bolívar, and higher charges for turnover tax and real estate commissions.
Selling expenses for the Hotel segment increased 13.9% from Ps.10.7 million in fiscal year 2006 to Ps.12.2 million in fiscal year 2007 principally due to increases in turnover tax, salaries and social security charges and commissions for tourism agencies, in each case reflecting an increase in the revenues of the segment in line with higher activity.
Administrative expenses increased 46.0% from Ps.96.9 million in fiscal year 2006 to Ps.141.4 million in fiscal year 2007 primarily due to an increase in administrative expenses in the Consumer financing segment and, to a lesser extent, increases in each of the remaining segments. Principal components of administrative expenses are salaries and social security charges, directors’ fees, fees and remunerations for services and depreciation of fixed assets. Administrative expenses as a percentage of revenues increased from 16.8% in fiscal year 2006 to 19.1% in fiscal year 2007.
Administrative expenses of the Shopping Centers segment increased 26.6%, from Ps.25.8 million in fiscal year 2006 to Ps.32.7 million in fiscal year 2007 principally due to (i) a Ps.3.7 million increase in expenses for fees and third parties’ services; (ii) a Ps.2.0 million increase in the charge for directors’ fees and (iii) a Ps.1.3 million increase in expenses for taxes, rates and contributions mostly due to the tax on bank debits and credits. Administrative expenses of the Shopping Centers segment as a percentage of the revenues from such segment remained essentially flat, increasing from 12.0% in fiscal year 2006 to 12.1% in fiscal year 2007.
Administrative expenses of the Consumer financing segment increased 75.0%, from Ps.25.9 million in fiscal year 2006 to Ps.45.4 million in fiscal year 2007. This increase was primarily due to:
a Ps.11.4 million increase in expenses for salaries, compensation, social security charges and personnel;
a Ps.2.4 million increase in expenses for rentals, taxes, rates and contributions; and
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a Ps.3.0 million increase in expenses for fees and third parties services.
Administrative expenses of Consumer financing as a percentage of revenues from such segment increased from 21.1% in fiscal year ended 2006 to 21.3% during fiscal year 2007 as a result of a higher proportional average of these expenses in respect of the revenues increase of this segment.
Administrative expenses of the Development and Sale of Properties segment increased 53.2%, from Ps.12.8 million in fiscal year 2006 to Ps.19.6 million in fiscal year 2007 due to: (i) a Ps.4.5 million increase for salaries, bonds and social security charges and directors’ fees and (ii) a Ps.2.1 million increase in bank expenses. Administrative expenses of Development and Sale of Properties as a percentage of revenues from this segment increased from 12.3% in fiscal year 2006 to 25.9% in fiscal year 2007.
Administrative expenses of the Offices and Other Non-Shopping Center Rental Properties segment increased 48.7% from Ps.11.3 million in fiscal year 2006 to Ps.16.8 million in fiscal year 2007. The increase is principally due to an increase of Ps.4.0 million in salaries, bonds and social security charges and fees to directors and to a Ps.1.8 million increase in bank expenses. Administrative expenses of Offices and Other Non-Shopping Center Rental Properties as a percentage of revenues from such segment decreased from 37.0% in fiscal year 2006 to 30.2% in fiscal year 2007.
Administrative expenses of the Hotel segment increased 28.1% from Ps.21.0 million in fiscal year 2006 to Ps.26.9 million in fiscal year 2007, principally due to: (i) a Ps.1.7 million increase in administrative expenses of Hotel Intercontinental mostly due to an increase in salaries and social security charges, commissions and depreciation of fixed assets, (ii) a Ps.1.4 million increase in administrative expenses of Hotel Sheraton Libertador principally due to an increase in fees for services and in salaries and social security charges and (iii) a Ps.2.8 million increase in administrative expenses of Hotel Llao Llao principally due to increases in salaries and social security charges, fees for services due to higher sales and taxes, rates and contributions. Administrative expenses of Hotel Operations as a percentage of revenues from such segment increased from 20.2% in fiscal year 2006 to 21.9% in fiscal year 2007.
This gain reflects the result generated by Alto Palermo’s participation in the Tarjeta Shopping credit card trusts. This gain increased 24.0% , from Ps.2.6 million in fiscal year 2006 to Ps.3.3 million in fiscal year 2007, primarily due to the creation in fiscal year 2007 of new credit card trusts in connection with new securitizations in such year.
Gain from the operations and holdings of real estate assets, net
This line reflects the impairment losses and gains associated with the reversal of previously recognized impairment charges. Results from the operation and holding of real estate assets decreased 79.6%, from a gain of Ps.12.6 million in fiscal year 2006 to a gain of Ps.2.6 million in
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fiscal year 2007, principally recorded in Neuquén Project for Ps.2.2. million, Suipacha 652 for Ps.0.9 million, Avenida de Mayo 589 for Ps.0.7 million and Torres de Abasto for Ps.0.1 million, partially offset by a loss of Ps.1.5 million corresponding to Torres Rosario. During fiscal year 2006 the gain of Ps.12.6 million had been attributable to Caballito for Ps.6.5 million, Alto Rosario for Ps.3.5 million, Espacio Aereo Coto for Ps.1.4 million, Torre Constitución for Ps.0.7 million and Reconquista 823 for Ps.0.6 million.
Operating income decreased 1.3% million from Ps.201.2 million in fiscal year 2006 to Ps.198.5 million in fiscal year 2007 mainly due to a decrease in the operating income of the Development and Sale of Properties segment that was partially offset by increases in operating income of each of our other segments. Our operating margin, calculated as our operating income divided by our revenues, decreased from 34.8% for fiscal year 2006 to 26.9% for fiscal year 2007 primarily as a result of decreases in the operating margins of our Development and Sale of Properties, Offices and other non-Shopping Center Rental Properties, Shopping Centers, and Consumer Financing segments, partially offset by an increase in the operating margin of our Financial Operations and Others segment.
Operating income of Shopping Centers increased 18.2%, from Ps.105.6 million in fiscal year 2006 to Ps.124.8 million in fiscal year 2007 mostly due to a 25.7% increase in the revenues from this segment that was partially offset by increases of 17.7% in costs, 42.3% in selling expenses and 26.6% in administrative expenses. The operating income of this segment as a percentage of revenues from such segment decreased from 49.1% during fiscal year 2006 to 46.2% during fiscal year 2007 primarily as a result of a decrease during fiscal year 2007 in the gain generated by the reversal of previously recognized impairment charges which was only Ps.0.7 million in fiscal year 2007 compared to Ps.9.5 million in fiscal year 2006.
Operating income of the Consumer Financing segment increased 31.4%, from Ps.24.8 million in fiscal year 2006 to Ps.32.6 million in fiscal year 2007 primarily due to a 73.2% increase in revenues from this segment that were partially offset by increases of 73.6% in costs, 100.5% in selling expenses and 75.0% in administrative expenses. The operating income of this segment as a percentage of the revenues from such segment decreased from 20.2% during fiscal year 2006 to 15.3% during fiscal year 2007 primarily as a result of the increase in selling expenses of almost 101% while the revenues from this segment increased 73.2%. Our selling expenses in this segment increased at a greater rate than our revenues from this segment as a result of a Ps.11.9 million increase in the charge for bad debts.
Operating income from the Development and Sale of Properties segment decreased 86.0% from Ps.44.3 million in fiscal year 2006 to Ps.6.2 million in fiscal year 2007 primarily due to a decrease in the revenues from this segment and increases in selling and administrative expenses, partially offset by higher gain from recognition of inventories at their net realizable value during fiscal year 2007. The operating income of this segment as a percentage of the revenues from such segment decreased from 42.6% during fiscal year 2006 to 8.2% during fiscal year 2007.
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Operating income from the Offices and Other Non-Shopping Center Rental Properties segment increased 65.5%, from Ps.11.9 million in fiscal year 2006 to Ps.19.6 million in fiscal year 2007 primarily due to an 82.2% increase in the revenues from this segment. The operating income of this segment as a percentage of the revenues from such segment decreased from 38.8% during fiscal year 2006 to 35.2% during the fiscal year 2007 primarily as a result of the effect during fiscal year 2007 of the adjustment in the remaining useful life of our rental buildings which generated a loss of Ps.5.9 million reflected in the cost of this segment. Without considering this effect our operating income as a percentage of our revenues would have been 45.8% instead of 35.2%.
Operating income of Hotel Operations increased from Ps.14.6 million in fiscal year 2006 to Ps.14.7 million in fiscal year 2007 mostly due to an increase in revenues from this segment that was partially offset by increases in costs and expenses. The operating income of this segment as a percentage of the revenues from such segment decreased from 14.0% during fiscal year 2006 to 11.9% during fiscal year 2007, primarily as a Ps.2.4 million increase in depreciation due to a change in the determination of the remaining useful life of our three hotels, which decreased from an average of 408 months in fiscal year 2006 to an average of 207 months in fiscal year 2007.
Operating income of the Financial Operations and other operations segment increased Ps.0.5 million from Ps.0.1 million in fiscal year 2006 to Ps.0.6 million in fiscal year 2007. Operating revenues of this segment as a percentage of the revenues from such segment increased from 4.0% in fiscal year 2006 to 43.1% in fiscal year 2007 primarily as a result of a 40.9% decrease in the costs of this segment.
The amortization of the goodwill includes: (i) amortization of the goodwill of the following subsidiaries of Alto Palermo: Shopping Alto Palermo S.A., FIBESA, Tarshop, ERSA and Empalme and (ii) of our own negative goodwill generated by our purchase of Alto Palermo and Palermo Invest S.A. shares. Amortization of goodwill increased (Ps.0.4 million), from a charge of Ps.1.1 million in fiscal year 2006 to a charge of Ps.1.5 million in fiscal year 2007.
Financial results, net increased Ps.45.0 million, from a net loss of Ps.40.9 million in fiscal year 2006 to a net gain of Ps.4.1 million in fiscal year 2007. The principal causes for this variation were:
the increase of Ps.40.4 million in results of financial operations mainly due to an increase of Ps.46.9 million in the fair market value of our investment in the mutual investment fund, Dolphin Fund Plc.;
a Ps.12.1 million positive exchange difference compared to fiscal year 2006 due to a lower depreciation during fiscal year 2007 of the Peso versus the US dollar; and
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Ps.9.9 million due to higher interest income in fiscal year 2007 of which Ps.7.6 million resulted from financial investments.
These improvements were partially offset by a Ps.16.5 million increase in financial expenses in fiscal year 2007, principally due to higher interest expense resulting from the issuance of bonds by us and Alto Palermo during fiscal year 2007.
Gain on equity investees
Gain from related companies decreased 3.9% from a gain of Ps.41.7 million in fiscal year 2006 to a gain of Ps.40.0 million in fiscal year 2007. This decrease principally resulted from a Ps.5.7 million decrease in the gain of Banco Hipotecario, from Ps.47.0 million in fiscal year 2006 to Ps.41.4 million in fiscal year 2007. This decrease was partially offset by the absence in fiscal year 2007 of the Ps.4.0 million loss incurred in fiscal year 2006 from our investment in Abril S.A.
Other income (expenses), net, decreased 22.8%, from a net expense of Ps.18.3 million in fiscal year 2006 to a net expense of Ps.14.1 million in fiscal year 2007 principally due to: (i) a Ps.7.5 million decrease in the allowance for uncollectible loans and (ii) a Ps.3.1 million increase for the recovery of allowances, which were partially offset in fiscal year 2007 by: (i) a Ps.4.5 million increase in charges for donations and (ii) a Ps.2.7 million increase in contingencies for lawsuits.
As a result of the above mentioned issue, income before taxes and minority interest increased 24.4% passing for an income of Ps.182.6 million in fiscal year 2006 to an income of Ps.227.1 million in fiscal year 2007.
Income tax and minimum presumed income tax increased 48.9%, from Ps.58.8 million in fiscal year 2006 to Ps.87.5 million in fiscal year 2007. We applied the deferred tax method to calculate our income tax for the two fiscal years, recognizing the temporary differences in the accounting and in tax assets and liabilities. Our effective tax rate in the fiscal year 2007 was 38.5% compared to 32.2% in fiscal year 2006.
The Ps.28.7 million variation was principally caused by the net impact of:
Ps.23.6 million increase in the expense for income tax for our company, from Ps.4.0 million during fiscal year 2006 to Ps.27.6 million during fiscal year 2007 due to the charge during fiscal year 2007 for Ps.11.6 million of deferred tax mostly caused by the sale of Santa María del Plata;
a Ps.12.9 million allowance for income tax in fiscal year 2007 mostly caused by the sale of shares in Banco Hipotecario and ownership units in Dolphin Fund Plc.;
a of Ps.7.8 million increase in the expense for income tax of Alto Palermo, from Ps.48.5 million in fiscal year 2006 to Ps.56.3 million in fiscal year 2007; and
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a Ps.0.5 million increase in the expense for income tax of Nuevas Fronteras S.A.
The negative result caused by third parties’ participation in subsidiaries increased 19.3% from a charge of Ps.27.2 million in fiscal year 2006 to a charge of Ps.32.4 million in fiscal year 2007 as a consequence of an increase in the income accounts of related companies in which we have a minority interest (principally in the Shopping Centers and Consumer financing segments).
Due to the above-mentioned issues, net income increased 10.9% from Ps.96.6 million in fiscal year 2006 to Ps.107.1 million in fiscal year 2007.
Banco Hipotecario SA ‘s Results of Operations
We do not consolidate the consolidated financial statements of our investee Banco Hipotecario. However, according to Rule 3-09 of Regulation S-X, we are required to file separate financial statements of significant investees. This Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read together with Banco Hipotecario’s consolidated financial statements contained elsewhere in this annual report. This discussion contains forward-looking statements that involve risks, uncertainties and assumptions. These forward-looking statements include, among others, those statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. The actual results may differ materially and adversely from those anticipated in these forward-looking statements as a result of many factors, including those set forth elsewhere in this annual report.
Banco Hipotecario maintains its financial books and records in Pesos and prepares its financial statements in conformity with the polices of the Argentine Central Bank which prescribes the reporting and disclosure requirements for banks and financial institutions in Argentina (“Central Bank accounting rules”). These rules differ in certain respects from generally accepted accounting principles in Argentina (“Argentine GAAP”). A description of significant differences between Central Bank accounting rules and Argentine GAAP are set forth in Note 6 to Banco Hipotecario’s consolidated financial statements. Central Bank accounting rules and Argentine GAAP also differ in certain significant respects from U.S. GAAP. Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by U.S. GAAP and regulations of the SEC. See Note 38 to the consolidated financial statements of Banco Hipotecario included elsewhere in this annual report for a description of the principal differences between Central Bank accounting rules and U.S. GAAP, as they relate to Banco Hipotecario, and a reconciliation to U.S. GAAP of Banco Hipotecario’s net income (loss) and shareholders’ equity.
Events in Argentina and Their Adverse Impact on Banco Hipotecario
Banco Hipotecario’s business and results of operations are dependent on, and significantly impacted by, the macroeconomic situation prevailing in Argentina. As such, its business and results of operations were materially and adversely affected by the Argentine economic crisis which began in 2001 and prevailed throughout most of 2002. Since 2003, the Argentine economy has shown signs of recovery compared to 2001 and 2002 and GDP has grown
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in each of 2003, 2004, 2005, 2006 and 2007. In addition, interest rates have fallen and the foreign exchange market has stabilized. The financial system has gradually recovered its liquidity levels, recording a significant increase in deposits and the level of loan originations began to grow, especially in 2005 and 2006. Based on current data, the Argentine economy during 2004, 2005, 2006 and 2007, GDP increased by 9.0%, 9.0%, 8.5% and 8.7% according to INDEC estimates. Based on INDEC estimates, in US dollar terms GDP increased from US$69.8 billion in 2002 to US$257.8 billion in 2007, and unemployment decreased to 7.5% as of the fourth quarter of 2007. As of December 31, 2007, approximately 20% of the population was below the poverty line according to INDEC. In 2004, 2005, 2006 and 2007 Argentina posted a fiscal surplus of approximately Ps.11,657.8 million and 19,661.0 million, Ps.23,158.0 million and Ps.25,718 million respectively. After the settlement of its exchange offer, Argentina’s sovereign debt outstanding amounted to US$149,847.4 million, representing approximately 57.8% of the GDP estimated for the year ending December 31, 2007.
During 2006 and 2007 inflation was 7.1% and 14.6% as measured by the WPI, and 9.8%, and 8.5% as measured by the CPI. The preceding information is based on data published by the Ministry of Economy and the Central Bank.
Over the past few months, the global financial markets have been affected by volatility, lack of liquidity and credit, which entailed a significant drop in international stock indexes, and a marked economic slow-down. Despite the actions taken by the US and other G7 countries, the future of the international markets is still uncertain.
In Argentina, stock markets have shown significant drops in the prices of government and corporate securities, as well as an increase in interest rates, country risk premiums and exchange rates. This situation is still ongoing as of the date of issue of these financial statements.
Banco Hipotecario’s management is permanently monitoring the effects derived from the above situation in order to implement the necessary measures to mitigate its effects. These uncertainties could have a material adverse effect on the value or IRSA’s investment in Banco Hipotecario.
Critical Accounting Policies
Banco Hipotecario believes that the following are the critical accounting policies under Argentine Banking GAAP and US GAAP, as they are important to the portrayal of its financial condition and results of operations and require its most difficult, subjective and complex judgment and the need to make estimates about the effect of matters that are inherently uncertain.
Reserve for loan losses
Banco Hipotecario reserves for loan losses are maintained in accordance with Argentine Banking GAAP. Under such regulations, a minimum reserve for loan losses is calculated primarily based upon the classification of Banco Hipotecario’s commercial loan borrowers and the past due status of Banco Hipotecario’s individual loan borrowers. Although Banco Hipotecario are required to follow the methodology and guidelines for determining its reserve for loan loss as set forth by the Central Bank, they are allowed to provide additional allowances for loan loss reserves.
Banco Hipotecario classifies individual loans based on their past due status consistent with the requirements of the Central Bank. Minimum loss percentages required by the Central Bank are also applied to the totals of each loan classification. Balances of loans and reserves are
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charged-off and reflected on its balance sheets three months from the date on which the loans were fully covered by its loan loss reserves.
For commercial loans, Banco Hipotecario is required to classify all of Banco Hipotecario’s commercial loan borrowers. In order to perform the classification, Banco Hipotecario must consider the management and operating history of the borrower, the present and projected financial situation of the borrower, the borrower’s payment history and ability to service the debt, the capability of the borrower’s internal information and control systems and the risk in the sector in which the borrower operates. Banco Hipotecario applies the minimum loss percentages required by the Central Bank to Banco Hipotecario’s commercial loan borrowers based on the loan classification and the nature of the collateral, or guarantees, of the loan. In addition, based on the overall risk of the portfolio, Banco Hipotecario considers whether or not additional loan loss reserves in excess of the minimum required are warranted.
Under US GAAP, reserve for loan losses represents the estimate of probable losses in the loan portfolio. Determining the reserve for loan losses requires significant management judgments and estimates including, among others, identifying impaired loans, determining customers’ ability to pay and estimating the fair value of underlying collateral or the expected future cash flows to be received. Actual events are likely to differ from the estimates and assumptions used in determining the allowance for loan losses. Additional provisions for loan losses could be required in the future.
Fair Value Estimates
Banco Hipotecario prepares its financial statements in accordance with the rules of the Central Bank related thereto, which differ from US GAAP in valuing financial instruments.
US GAAP requires financial instruments to be valued at fair value. Banco Hipotecario estimated the fair value as the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and such value was best evidenced by a quoted market price, if one existed. In cases where quoted market prices were not available, fair value estimation was based on the quoted market price of a financial instrument with similar characteristics, the present value of expected future cash flows, or other valuation techniques, all of which were significantly affected by the assumptions used.
For a detailed description of the applicable accounting principles, please see Note 5. To the Consolidated Financial Statements.
Government securities – BODEN
The compensatory and hedge ( additional Boden 2012 subscribed) bonds Banco Hipotecario S.A. receives are classified as “Investing securities” at par value based on Central Bank accounting rules, notwithstanding that the estimated market value of such bonds is lower than such par value. The right to receive BODEN that are issued in hedge transactions is classified as “Other receivables from financial transactions” and is recognized at par value of the BODEN to be issued, notwithstanding that the estimated market value of the BODEN linked to such right is significantly below such carrying value. The fair value of the Boden 2012 as of June 30, 2008 decreases the shareholder’s equity in $ 212,577.
Under US GAAP compensatory and hedge bonds are valued at fair value. See “Fair Value Estimates” above.
Other Receivables from Financial Transactions and Miscellaneous Receivables,
Banco Hipotecario carries other receivables from financial transactions and miscellaneous receivables net of allowances for uncollectible amounts. Its judgment regarding the ultimate collectibility is performed on an account-by-account basis considering its assessment of the
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borrower’s ability to pay based on factors such as the borrower’s financial condition, past payment history, guarantees and past-due status.
Minimum Presumed Income Tax
Banco Hipotecario has recognized the minimum presumed income tax accrued as of June 30, 2008 and paid in prior years as an asset as of June 30, 2008, that expects to be able to compute it as a payment of account of income in future years because Banco Hipotecario started to generate taxable income. Recognition of this asset arises from the ability to generate sufficient taxable income in future years to absorb the asset before it expires. Management’s determination of the likelihood that deferred tax assets can be realized is subjective, and involves estimates and assumptions about matters that are inherently uncertain. The realization of deferred tax assets arises from levels of future taxable income and the achievement of tax planning strategies.
Underlying estimates and assumptions can change over time, influencing its overall tax positions, as a result of unanticipated events or circumstances.
Argentine Banking GAAP requires income taxes to be recognized on the basis of amounts due in accordance with Argentine tax regulations. Temporary differences between the financial reporting and income tax bases of accounting are therefore not considered in recognizing income taxes.
In accordance with Statement of Financial Accounting Standards, or SFAS, N° 109, Accounting For Income Taxes, under US GAAP income taxes are recognized on the liability method whereby deferred tax assets and liabilities are established for temporary differences between the financial reporting and tax bases of our assets and liabilities. Deferred tax assets are also recognized for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized for that component of net deferred tax assets when it is more likely than not that it will not be recoverable.
As of June 30, 2007, and based on the analysis performed on the realizability of the tax loss carryforwards, Banco Hipotecario believes it will recover only a portion of the net operating tax loss carryforwards and all the temporary differences, with future taxable income. Therefore, the remaining portion of the net operating tax loss carryforward is more likely than not to be recovered in the carryforwards periods, and hence, a valuation allowance was provided against it.
As of June 30, 2008, and based on the analysis performed on the realizability of the tax loss carryforwards, Banco Hipotecario believes it will recover only the temporary differences, with future taxable income. Therefore, the net operating tax loss carryforward is more likely than not to be recovered in the carryforwards periods, and hence, a valuation allowance was provided against it.
Financial Accounting Standards Board (FASB) Interpretation No. 48 “Accounting for Uncertainty in Income Taxes”, (FIN 48) was issued in July 2006 and interprets FASB Statement of Financial Accounting Standards (SFAS) No. 109. FIN 48 became effective for the Group on January 1, 2007 and prescribes a comprehensive model for the recognition, measurement, financial statement presentation and disclosure of uncertain tax positions taken or expected to be taken in a tax return. FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
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Banco Hipotecario classifies income tax-related interest and penalties as income taxes in the financial statements. The adoption of this pronouncement had no effect on Banco Hipotecario’s overall financial position or results of operations.
Twelve month periods ended June 30, 2008 and 2007
General
The following table sets forth the principal components of its net income for the periods ended June 30, 2008 and 2007.
Financial income
Financial expenses
Net financial income
Provision for losses on loans
Net contribution from insurance (1)
Other expenses on services
Net income from financial operations
Miscellaneous income, net (2)
Income tax
Net Income
Banco Hipotecario S.A.’s net loss for the period ended June 30, 2008 of Ps. (59.6) million was lower than the Ps 357.9 net income for the period ended June 30, 2007, principally due to:
Lower financial income as a result of lower income from government and private securities and hedging transactions partially off set by the increase of financial income from new consumer products.
Higher financial expenditures as a result of higher interest liabilities resulting from increased average balances on time deposits and the increase of interest rates on bonds and similar obligations.
Higher administrative expenses mainly related to social security contributions, and fees related to actions adopted by Banco Hipotecario in developing its retail banking business.
Higher expenses on services mainly related to commissions related to Visa Credit Cards, scoring and origination of personal loans and higher structuring and underwriting expenses.
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Higher loan loss provisions resulting from increased balance on mortgage and other loans.
These factors were partially offset by:
Higher net contributions from insurance as a result of an increase in new loan origination and an expansion on insurance products offered.
Higher income from services as a result of higher bank activity.
Financial Income
The following table sets forth the principal components of its financial income for the periods ended June 30, 2008 and 2007.
Mortgage loans and other financial transactions
Government guaranteed loans
Government and Private Securities
Compensatory and other BODEN
Buyback of restructured debt
Hedges
Mortgage-backed securities
Other loans
Credit Cards loans
Personal loans
Advance loans
Effects of changes in exchange rates
Cash and due from banks
Interbank Loans
Others
Banco Hipotecario S.A.’s financial income decreased 21% to Ps. 696.6 million for the period ended June 30, 2008 as compared to Ps.882.2 million for the period ended June 30, 2007 primarily as a result of:
Lower income from government and private securities as a result of lower market prices.
Losses from derivate operations resulting from hedging transactions including its total return swap.
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Higher income from credit cards, personal loans and new consumer products as a result of a significant increase in the volume of such loans granted during the year.
Higher income from the repurchase of restructured financial debts at market prices.
Higher income from changes in exchange rates as a result of higher exchange rates.
Financial Expenses
The following table sets forth information regarding its financial expenses for the periods ended June 30, 2008 and 2007.
Bonds and similar obligations
Borrowings from Central Bank
Borrowings from banks
Other(1)
Contributions and taxes on financial income
Banco Hipotecario S.A.’s financial expenses for the period ended June 30, 2008 increased 47.0% to Ps.550.7 million from Ps. 374.7 million for the period ended June 30, 2007 primarily as a result of:
Higher interest liabilities resulting from increased average balances on time deposits, related to the growth of the private sector.
Higher interest liabilities as a result of the increase in interest on bonds and similar obligations.
This effect was partially offset by:
Lower financial expenditures as a result of the reduction of other bank borrowings.
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Provision for Losses on Loans
The following table sets forth its provision for loan losses for the periods ended June 30, 2008 and 2007.
Provision for loan losses
Charge-offs
Banco Hipotecario S.A.’s provision for loan losses for the period ended June 30, 2008 increased to Ps. 149.9 million from Ps. 43.7 million in the period ended on June 30, 2007 in connection with the significant increase in the volume of the loans granted during 2007.
The Risk and Credit Committee decided to maintain a maximum 100% coverage of the loan loss reserve, relative to the total amount of those loans classified as non-performing. Reserves and funds created by Risk and Credit Committee dated June 2, 2008, ( Ex - Section 13 of Law 24,143) and the Special fund created by a resolution of the board of Directors of Banco Hipotecario dated December 12, 2001, shall not be included in the total amount used for calculating such coverage.
Net Contribution from Insurance
The following table sets forth the principal components of its net contribution from insurance for the periods ended June 30, 2008 and 2007.
Insurance premiums earned:
Life
Property damage
Unemployment
Total premiums earned
Insurance claims paid:
Total claims paid
Net contribution from insurance
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Banco Hipotecario S.A.’s net contribution from insurance activities of Ps. 87.2 million during the period ended June 30, 2008 increased 24.9 % from Ps.69.8 million, compared to the period ended June 30, 2007. This increased was primarily a consequence of higher premiums resulted from an increase in new loan origination and an expansion of insurance products offered.
Other Income from Services
The following table includes the principal components of its other income from services for the periods ended June 30, 2008 and 2007.
Loan servicing fees from third parties
FONAVI commissions
Other Commissions
Credit Card Commissions
Saving accounts commissions
Current accounts commissions
BHN Inversión commissions
Total commissions
Recovery of loan expenses
Banco Hipotecario S.A.’s income from services increased to Ps. 194.4 million for the period ended June 30, 2008 from Ps 83.4 million in the same period of 2007, as a result of higher commissions derived from credit cards, origination of mortgage loans and new consumer products, and the commissions derived from the insurance activities developed since July 2008 by BHSA subsidiary BHN Inversión.
Other Expenses on Services
The following table includes the principal components of its other expenses on services for the periods ended June 30, 2008 and 2007:
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Structuring and underwriting fees
Banking services
Commissions on third party originations
Collections
Commissions on Visa
Commissions on saving accounts
Commissions on scoring
Commissions paid to real estate agents
Contributions and taxes on income from services
Banco Hipotecario S.A.’s other expenses on services increased 35.7 % to Ps. 92.1 million for the period ended June 30, 2008 from Ps. 67.8 million in the period ended June 30, 2007. This increase was mainly due to commissions recorded in other expenditures on services related to the VISA credit card and scoring, in connection with the higher number of credit cards managed.
Administrative Expenses
The following table sets forth the principal components of its administrative expenses for the periods ended June 30, 2008 and 2007.
Salaries and social security contributions
Fees and external administrative services
Maintenance and repair
Advertising and publicity
Nonrecoverable VAT and other taxes
Electricity and communications
Depreciation of bank premises and equipment
Amortization of organizational expenses
Corporate personnel benefits
Rent
Administrative expenses for the period ended June 30, 2008 increased 43.4 % to Ps. 388.5 million from Ps. 270.8 million for the period ended June 30, 2007. The main reasons for this increase were higher salaries and social security contributions required under applicable regulations in Argentina, and an increase in other fees related to the actions adopted by Banco Hipotecario in developing its retail banking business.
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Miscellaneous Income
The following table sets forth its miscellaneous income for the periods ended June 30, 2008 and 2007.
Penalty interest
Loan loss recoveries
Reversal of provision for lawsuit
Reversal of provision for STAR
Reversal of provision for contingencies
Banco Hipotecario S.A.’s miscellaneous income decreased 20.6 % to Ps. 184.1 million for the period ended June 30, 2008 from Ps.231.8 million for the year ended June 30, 2007 primarily as a result of the two sales of a portion of non performing portfolio recorded in memorandum accounts for approximately Ps. 120 million during the period ended June 30, 2007.
Miscellaneous Expenses
The following table sets forth the principal components of its miscellaneous expenses for the periods ended June 30, 2008 and 2007:
Provision for lawsuit contingencies
Provision StAR granted creditors under guaranteed debt
Provision SAR
Provision for insurance contingences
Provision for administrative organization
Other taxes
Contingency related to the sale of non-performing mortgage portfolio
Banco Hipotecario S.A.’s miscellaneous expenses decreased 79.1 % to Ps. 31.4 million for the period ended June 30, 2008 from Ps. 150.4 million for 2007 primarily as a result of lower provisions for the appreciation in the trading price of its Class D shares, designed to account for the higher value attributable to the stock appreciation rights issued with and attached to its Medium Term Guaranteed Debt due 2010 and its management compensation plan, and for Stock
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Appreciation Compensation plan, Lawsuits contingences, administrative organization and for the sale of a portion of its non-performing portfolio.
Twelve month periods ended June 30, 2007 and 2006
The following table sets forth the principal components of its net income for the periods ended June 30, 2007 and 2006.
Banco Hipotecario S.A.’s net income for the period ended June 30, 2007 of Ps. 357.9 million was higher than Ps 309.1 for the period ended June 30, 2006, principally due to:
Higher financial income principally as a result of higher income from government and private securities, hedging transactions and the increase of new consumer products.
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Higher expenses on services mainly to commissions related to Visa Credit Cards, scoring and origination of personal loans and higher structuring and underwriting expenses.
The following table sets forth the principal components of its financial income for the periods ended June 30, 2007 and 2006.
Banco Hipotecario S.A.’s financial income increase 20.2 % to Ps. 882.2 million for the period ended June 30, 2007 as compared to Ps.733.8 million for the period ended June 30, 2006 primarily as a result of:
Higher income from some government and private securities as a result of higher market prices.
Higher income from the increase of LIBO rate accrued during this period on the stock of BODEN US$ 2012 recorded in investment account.
Higher income from credit cards, personal loans and new consumer products as a result of a significant increase in the volume of such loans granted during 2007.
Higher income from derivate operations resulting from hedging transactions including its total return swap.
Lower income from hedge bond, as a result of the subscription made.
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Lower income from the repurchase of restructured financial debts at market prices.
Lower income from Secured loans as a consequence of the reduction of the stock.
The following table sets forth information regarding its financial expenses for the periods ended June 30, 2007 and 2006.
Banco Hipotecario S.A.’s financial expenses for the period ended June 30, 2007 decreased 9.1% to Ps.374.7 million from Ps. 412.2 million for the period ended June 30, 2006 primarily as a result of:
Lower financial expenditures principally as result of the substantial reduction of Central Bank and others Banks borrowings.
Higher interest liabilities resulting from increased average balances on savings accounts and time deposits, related to the growth of private sector.
The following table sets forth its provision for loan losses for the periods ended June 30, 2007 and 2006.
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Banco Hipotecario S.A.’s provision for loan losses for the period ended June 30, 2007 increased to Ps. 43.7 million from Ps. 10.5 million in the period ended on June 30, 2006 in connection with the significant increase in the volume of the loans granted during 2007.
The Risk and Credit Committee decided to maintain a maximum 100% coverage of the loan loss reserve, relative to the total amount of those loans classified as non-performing, consequently a recovery of Ps. 100 million was recorded. Reserves and funds created in connection with the special reserve envisaged by Section 13 of Law 24,143 and the Special fund created by a resolution of the board of Directors of Banco Hipotecario dated December 12, 2001, shall not be included in the total amount used for calculating such coverage.
The following table sets forth the principal components of its net contribution from insurance for the periods ended June 30, 2007 and 2006.
Banco Hipotecario S.A.’s net contribution from insurance activities of Ps. 69.8 million during the period ended June 30, 2007 increased 55.6 % from Ps.44.9 million, compared to the period ended June 30, 2006. This increased was primarily a consequence of higher premiums resulted from an increase in new loan origination and an expansion of insurance products offered.
The following table includes the principal components of its other income from services for the periods ended June 30, 2007 and 2006.
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Commissions for technological services (MSI)
Banco Hipotecario S.A.’s income from services increased to Ps. 83.4 million for the period ended June 30, 2007 from Ps 47.6 million in the same period of 2006, as a result of higher commissions derived from credit cards, origination of mortgage loans and new consumer products. This higher income was attributable not only to the greater number of credit cards, but also to the greater average purchases made with such cards recorded during the period.
The following table includes the principal components of its other expenses on services for the periods ended June 30, 2007 and 2006:
Banco Hipotecario S.A.’s other expenses on services increased 121.6 % to Ps. 67.8 million for the period ended June 30, 2007 from Ps. 30.6 million in the period ended June 30, 2006. This increase was mainly to commissions recorded in other expenditures on services related to the VISA credit card and scoring, in connection with the higher number of credit cards managed.
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The following table sets forth the principal components of its administrative expenses for the periods ended June 30, 2007 and 2006.
Administrative expenses for the period ended June 30, 2007 increased 46.2 % to Ps. 270.8 million from Ps. 185.2 million for the period ended June 30, 2006. The main reasons for this increase were higher salaries and social security contributions required under applicable regulations in Argentina, higher advertising expenses related to the launch of its new products and an increase in other fees related to the actions adopted by Banco Hipotecario in developing its retail banking business.
The following table sets forth its miscellaneous income for the periods ended June 30, 2007 and 2006.
Capitalization of presumed income tax
Reversal of reserve for loan losses
Banco Hipotecario S.A.’s miscellaneous income increased 33.5 % to Ps. 231.8 million for the period ended June 30, 2007 from Ps.173.7 million for the year ended June 30, 2006 primarily as a result of a reversal of reserve for loan losses of the restructured loans and for the result of the
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two sales of a portion of non performing portfolio recorded in memorandum accounts for approximately Ps. 120 million,.
The following table sets forth the principal components of its miscellaneous expenses for the periods ended June 30, 2007 and 2006:
Provision for miscellaneous receivables and others
Bogar and Guarantee loans adjustment
Banco Hipotecario S.A.’s miscellaneous expenses increased 205.8 % to Ps. 150.4 million for the period ended June 30, 2007 from Ps. 49.2 million for 2006 primarily as a result of:
Higher provisions related to the appreciation in the trading price of its Class D shares, which is designed to account for the higher value attributable to the stock appreciation rights issued with and attached to its Medium Term Guaranteed Debt due 2010 and its management compensation plan.
Higher provision for: Stock Appreciation Compensation plan, Lawsuits contingences, administrative organization and for the sale of a portion of its non performing portfolio.
This effect was partially offset by an extraordinaire adjust on changes in the valuation of public sector assets given as collateral for central Bank borrowings (BOGAR and Secured loans).
Exchange Rate Sensitivity
Exchange-rate sensitivity is the relationship between the fluctuations of exchange rates and Banco Hipotecario’s net financial income resulting from the revaluation of Banco Hipotecario’s assets and liabilities denominated in foreign currency. The impact of variations in the exchange rate on Banco Hipotecario’s net financial income depends on whether Banco Hipotecario has a net asset foreign currency position (the amount by which foreign currency denominated assets exceed foreign currency denominated liabilities) or a short foreign currency position (the amount by which foreign currency denominated liabilities exceed foreign currency denominated assets).
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In the first case an increase/decrease in the exchange rate derives in a gain/loss, respectively. In the second case, an increase/decrease derives in a loss/gain, respectively.
At June 30, 2008 and June 30, 2007 its total foreign currency-denominated liabilities were Ps. 5,068 million and 4.850 million, respectively, all of which were US dollar-and Euro-denominated obligations. At June 30, 2008, its US dollar-denominated assets (including BODEN) were Ps. 3,197 million, and its Euro-denominated assets were Ps. 1,131 million, while its US dollar-denominated liabilities were Ps.4,129 million, and its Euro-denominated liabilities were Ps.938 million.
Liquidity
Its general Banco Hipotecario’s policy has been to maintain adequate liquidity to meet its operational needs and financial obligations. At June 30, 2008, its liquid assets consisted of:
Ps.248.8 million of cash and receivables from banks;
Ps.111.8 million of Argentine government debt classified as held for trading, and
Ps.516.7 million of Argentine Central Bank Bills.
At June 30, 2007, its liquid assets consisted of:
Ps.206.1 million of cash and receivables from banks;
Ps.167.1 million of Argentine government debt classified as held for trading; and
Ps. 525.5 million of Argentine Central Bank Bills.
Cash Flows from Operating Activities. The changes in cash flows from operating activities were principally due to the change in:
Provision for losses on loans and for contingencies and miscellaneous receivables, net of reversals,
Net (gain) loss on government securities,
Net indexing of loans, deposits and other debt, and
Net change in other assets and liabilities.
Cash Flows from Investing Activities. The changes in cash flow from investing activities were due to subscription of Argentine Government Hedge BODENs.
Cash Flows from Financing Activities. The changes in cash flows from financing activities were principally due to the issuance of notes Series IV partially offset by payments on Central Bank debt, Bonds, Notes and Long Term debts, as a result of the changes from its restructuring of its financial debt in 2004 and 2003.
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Funding
Historically, Banco Hipotecario S.A. financed its lending operations mainly through:
the issuance of fixed and floating rate securities in the international capital markets,
other financing arrangements with international and domestic financial institutions,
securitizations of mortgage loans,
cash flow from existing loans,
deposits, and
Central Bank long term loans.
At June 30, 2008 and 2007, Banco Hipotecario S.A. had four principal funding sources: bonds, Central Bank, other liabilities from financial institutions, and deposits. The table below sets forth its liabilities outstanding with respect to each of its sources of funding as of the dates indicated.
Bonds (1)
Borrowings from banks and international entities
Deposits
Bonds
The principal amounts of the different series of notes that Banco Hipotecario S.A. has issued and are outstanding are as follows:
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Date of issue
Maturity Date
Bonds issued prior to restructuring(1)
GMTN (US$1,200,000,000)
Notes Issued in Restructuring:
Guaranteed bonds (US$107,941,000)
Long term bonds (US$449,880,000)
Long term bonds (Euro 278,367,000)
Series 4-9.75% Notes due 2010 (US$150,000,000)
Series 5 (US$250.000 miles)
Series 6
During January, 2008, out of court settlements were reached with holders of negotiable obligations that were in default and had not accepted Banco Hipotecario’s exchange offer in January 2004. The current settlements reached a face value of US$ 290 thousand.
On January 29, 2008, Banco Hipotecario launched an offer to purchase in cash up to US$ 56,000 of the total Negotiable Obligations in US dollars due in 2013 and the equivalent to a principal amount of up to US$ 56,000 in Euro-denominated negotiable obligations due in 2013. The purchase offer expired on February 27, 2008. As a result of the transaction, securities were bought back for US$ 16,536 and US$ 44,517 for the series in US dollars and Euros, respectively.
Borrowings from Banks and International Entities
We incurred the following indebtedness, which have been fully paid with the proceeds obtained from other financings:
Banco Hipotecario S.A. obtained Interbank loans in pesos in an aggregate principal amount of Ps.18.7 million.
Banco Hipotecario S.A. obtained a loan from Warehousing Credit Line Agreement with IFC in an aggregate principal amount of Ps. 42.4 million.
Borrowings from the Central Bank
On November 11 and December 1, 2004, Banco Hipotecario S.A. pre-paid the financial assistance loans granted by the Central Bank in amounts totaling Ps.10.0 million and Ps.30.0 million, respectively, in order to settle in advance restructured foreign debt. On January 20, 2005
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and February 25, 2005, Banco Hipotecario S.A. took part in the tender offer established by the Central Bank in accordance with the guidelines of Communications “A” 4268 and 4282, the amount of Ps.63.8 million and Ps.16.9 million, respectively, having been accepted in settlement of the previously refinanced debt. On May 3, 2005 Banco Hipotecario S.A. fully prepaid all outstanding balances due on this indebtedness of approximately Ps.233.5 million. As of June 30, 2008, Banco Hipotecario S.A. recorded in its financial statements borrowings from the Central Bank totaling Ps.239.1 million, respectively, in respect to advances Banco Hipotecario S.A. expects to incur in the future for its right to subscribe additional BODEN.
Loan Securitization Program
Banco Hipotecario has executed various financial trust agreements under which, as trustor, it has transferred the fiduciary ownership of mortgage and consumer loans of the loan portfolio to different financial institutions as trustee. Once the mortgage loans have been transferred to the trust fund, it proceeds to issue the corresponding debt securities and participation certificates and to use the proceeds of the placement thereof for setting the amount of the loans ceded by Banco Hipotecario.
The trustee is responsible for the management of the trust funds previously set up in accordance with the specifications contained in the trust agreement.
As of June 30, 2008 Banco Hipotecario recorded Ps 70.4 million in respect of mortgage loans and Ps 9.9 million in respect of accrued interest and adjustment from application of the CER receivable.
In 2004, Banco Hipotecario created a Global Trust Program “Cedulas Hipotecarias Argentinas” Under this program eight series of Argentine Mortgage Bonds Financial Funds (CHA) were created for the face value of Ps 50.0 million, Ps. 49.9 million, Ps 62.5 million, Ps 64.6 million, Ps 65.0 million, Ps. 69.1 million, Ps 71.4 million and Ps 74.5 million corresponding to Series I, II, III, IV, V, VI, VII and VIII respectively.
Under BACS’s Global Trust Securities Program dated April 3, 2008, Series I of the Cédulas Personales Financial Trust was issued for an amount of Ps. 59.4 million.
Banco Hipotecario S.A. did not rely historically on deposits as a principal source of funding. Banco Hipotecario S.A. engaged in limited deposit taking activities. Its other deposits consist of checking accounts maintained by different provincial housing funds and agencies representing Argentine government contributions from the collection of federal taxes which have been set aside for use by the provinces for special purposes and transferred to these accounts.
In December 2001 Banco Hipotecario S.A. received authorization from the Central Bank to accept time deposits for individuals as well as institutions and amended its bylaws accordingly, with the approval of a majority of its shareholders as required by Argentine Corporate Law. At June 30, 2008 and 2007 its total deposits consisted of the following:
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Other deposits accounts
Its current strategy is to increase deposits significantly over time in order to achieve significant liquidity to maintain and further develop its financing activities.
Contractual Obligations
In connection with our operating activities, we enter into certain contractual obligations. The following table shows the principal amounts plus accrued interests of our contractual obligations and their contractual interest rates as of June 30, 2008:
Annual
Interest Rate
Defaulted bonds US$ (1)
Defaulted bonds EURO (1)
Serie 4
Serie 5
Serie 6
Long term bond US$
Long term bond EURO
Loans
Repurchase Agreement, Deutsche Bank
Repurchase Agreement, Credit Suisse
Repurchase Agreement, Merrill Lynch
Repurchase Agreement, Barclays
Agreement Barclays
Repurchase Agreement DEPFA Bank
Repurchase Agreement Barclays
Repurchase Agreement Deutsche Bank
Repurchase Agreement Macquire Bank
Argentine Central Bank
Acquisition of the Hedge Bond
TOTAL
B. Liquidity and Capital Resources
Our principal sources of liquidity have historically been:
cash generated by operations;
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cash generated by the issuance of debt securities;
cash from borrowings and financings arrangements; and
cash proceeds from the sale of real estate.
Our principal cash requirements or uses (other than in connection with our operating activities) have historically been:
capital expenditures for property, plant and equipment;
interest payments and repayments of short-term and long-term debt;
acquisition of shares in companies;
payments of dividends; and
acquisitions or purchases of real estate.
Our liquidity and capital resources include our cash and cash equivalents, proceeds from bank borrowings and long-term debt, capital financing and sales of real estate investments.
As of June 30, 2008, we had a working capital of Ps.151.6 million and cash equivalents totaling Ps.389.0 million, a decrease of 45.1% from the Ps.708.5 million of cash and cash equivalents held as of June 30, 2007.
As of June 30, 2007, we had a working capital of Ps.523.7 million. At the same date, we had cash and cash equivalents totaling Ps.708.5 million, an increase of 332.2% from the Ps.163.9 million of cash and cash equivalents held as of June 30, 2006.
As of June 30, 2006, we had a working capital of Ps.62.6 million. At the same date, we had cash and cash equivalents totaling Ps.163.9 million, an increase of 15.0% from the Ps.142.6 million of cash and cash equivalents held as of June 30, 2005.
The current credit market turmoil may affect our ability to obtain additional capital; however, as of the date of this annual report, we have been able to complete some transactions and do not believe this may severely impact the execution of our business plan. If market conditions continue to deteriorate, we may have the ability to delay the funding of certain new development outlays. Also, we may need to raise additional funds in order to support more rapid expansion, develop or acquire new properties, respond to competitive pressures, or take advantage of unanticipated opportunities.
We believe our working capital (calculated by subtracting current liabilities from current assets) and our cash from operating activities are adequate for our present and future requirements. In the event that cash generated from our operations is at any time insufficient to finance our working capital, we would seek to finance such working capital needs through debt or
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equity financing or selective assets sales. For more information about liquidity please see “Risk Factors” section.
Cash Flow Information
Operating Activities
2008 Fiscal Year. Our operating activities resulted in net cash inflows of Ps.319.9 million for fiscal year 2008, primarily as a result of operating gains of Ps.368.7 million, a decrease in inventories of Ps. 129.7 million and an increase in trade accounts payable of Ps.40.8 million. These were partially offset by an increase in accounts receivable, net of Ps.121.1 million, an increase in other receivables and prepaid expenses, net of Ps.51.1 million, a decrease in customer advances, salaries and social security payable and taxes payable of Ps.30.4 million and an increase in current investments of Ps.22.7 million.
2007 Fiscal Year. Our operating activities resulted in net cash inflows of Ps.163.1 million for fiscal year 2007 primarily as a result of operating gains of Ps.276.0 million, an increase in trade accounts payable of Ps.65.1 million, a decrease in inventories of Ps.29.0 million, and an increase in accrued interest of Ps.21.5 million partially offset by an increase in accounts receivables, net of Ps.79.7 million, and increase in other receivables and prepaid expenses, net of Ps.79.6 million, an increase in non-current investments of Ps.35.6 million and an increase in current investments of Ps.29.8 million.
2006 Fiscal Year. Our operating activities resulted in net cash inflows of Ps.194.7 million for fiscal year 2006 primarily as a result of operating gains of Ps.218.5 million, an increase in trade accounts payable of Ps.56.0 million, a decrease in inventories of Ps.25.1 million, an increase in accrued interest of Ps.14.0 million and a decrease in current investments of Ps.10.3 million partially offset by an increase in account receivable, net of Ps.80.3 million, a decrease in customer advances, salaries and social security payable and taxes payable of Ps.28.4 million and an increase in non-current investments of Ps.26.4 million.
Investment Activities
2008 Fiscal Year. Our investing activities resulted in net cash outflows of Ps.788.6 million for fiscal year 2008, of which Ps.419.0 million were related to the acquisition of business and assets, mainly to the purchase of two buildings (including their in place leases) known as “Edificio República” and “Torre Bank Boston” for Ps.228.3 million and Ps.173.9 million, respectively. We also made investments in fixed assets of Ps. 332.5 million of which, Ps.257.7 million were invested through Alto Palermo primarily in the partial construction of the Panamerican Mall for Ps.114.4 million, improvements of shopping centers for Ps.50.0 million, in the initial payment for the transfer of Soleil Factory shopping center for Ps.25.6 million, and Ps.40.0 million in the Hotel segment of which Ps. 30.7 million were invested in Hotel Llao Llao. We also invested Ps. 23.1 million relating to Patio Olmos Building and Ps. 16.1 were related to advance payment for a plot of land located at Beruti 3571. We also invested Ps.17.2 million in undeveloped parcels of land.
2007 Fiscal Year. Our investing activities resulted in net cash outflows of Ps.510.8 million for fiscal year 2007, primarily as a result of investments in fixed assets of Ps.410.1 million due to (i) the acquisition of Bouchard 551 for Ps.243.2 million, (ii) Ps.96.4 million thorough Alto Palermo primarily for improvements made in shopping centers (iii) improvements in the Hotel Operations segment for Ps.57.1 million, principally in Llao Llao for Ps.49.4 million, and as a
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result of a decrease in minority interest of Ps.41.0 million principally due to the increase in our ownership in Palermo Invest and in Alto Palermo for Ps.27.5 million and Ps.7.2 million, respectively.
On December 12, 2006 we purchased from different holders 34,710 shares of Canteras Natal Crespo for a total amount of Ps.1.8 million. After this transaction, our interest on Canteras (jointly with our partner ECIPSA) increased up to 98.45%.
2006 Fiscal Year. Our investing activities resulted in net cash outflows of Ps.136.6 million for fiscal year 2006, primarily as a result of investments in fixed assets of Ps.54.1 million due to (i) improvements made in shopping centers amounting to Ps.33.6 million and (ii) improvements in the Hotel Operations segment for Ps.20.1 million. We also invested Ps.62.1 million in undeveloped parcels of land primarily through our subsidiary Alto Palermo. We also made investments of Ps.4.3 million to increase our ownership interest in Alto Palermo, and Ps.4.2 million in the acquisition of 43.2% of Canteras Natal Crespo S.A. Additionally, we posted a guaranty deposit for Ps.8.6 million at Deustche Bank guaranteeing our obligations to Argentimo S.A. relating to an agreement entered into between Alto Palermo, Argentimo S.A. and Constructora San José Argentina S.A. for the acquisition of land for the development of a shopping center and a dwelling and/or office building.
Financing Activities
2008 Fiscal Year. Our financing activities resulted in net cash inflows of Ps.149.1 million. Our net cash provided by financing activities for fiscal year 2008 was primarily related to (i) an increase in short-term and long-term debt of Ps.183.5 million, mainly due to the takeover of the Macro bank loan for the acquisition of Edificio República, (ii) our issuance of common shares as a result of the exercise of warrants for Ps.163.4 million, (iii) a capital contribution by minority owners in related parties of Ps.32.5 million. This was partially offset by (i) the repurchase of debt of Ps.138.6 million (ii) the payment of dividends by subsidiaries to minority shareholders of Ps.24.3 million, and (iii) the partial repayment of Ps.18.4 million of a mortgage obligation.
2007 Fiscal Year. Our financing activities resulted in net cash inflows of Ps.892.2 million. Our net cash provided by financing activities for fiscal year 2007 was primarily related to (i) the proceeds from short-term and long-term debt for Ps.1,199.7 million, primarily due to the issuance of our notes and Alto Palermo notes (ii) our issuance of common shares as a result of the exercise of warrants for Ps.26.0 million, partially offset by (i) the payment of short-term and long-term debt for Ps.292.2 million, (ii) the payment of dividends to minority shareholders for Ps.23.2 million and (iii) a the partial repayment of Ps.18.0 million of a mortgage payable.
2006 Fiscal Year. Our financing activities resulted in net cash outflows of Ps.36.8 million. Our net cash spent on financing activities for fiscal year 2006 was primarily related to the payment of short-term and long-term debt for Ps.82.5 million, the payment of dividends by our subsidiaries to minority shareholders totaling Ps.12.7 million, the repayment of debt owed to minority shareholders for Ps.5.2 million and a partial repayment of Ps.25.6 million of a mortgage payable, partially offset by our issuance of common shares as a result of the exercise of warrants for Ps.43.6 million and proceeds from issuance of short-term and long-term debt totaling Ps.45.1 million.
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Indebtedness
The following table sets forth the scheduled maturities of our outstanding debt as of June 30, 2008:
Maturity Schedule
Bank and other debt
Bank loans
Hoteles Argentinos secured loan
Alto Palermo 10% convertible notes due 2014
Alto Palermo 11% Series II notes(4)
Alto Palermo 7.875% Series I notes due 2017(4)
IRSA 8.5% notes due 2017(4)
Debt related to purchase of subsidiaries
Total bank and other debt
Mortgages payable
Mortgage payable Terrenos Bariloche
Total mortgages payable
Total debt
Prepayment of our Outstanding Indebtedness
On October 21, 2007, we notified the holders of our secured notes due November 2009 and the creditors under our US$51 million syndicated bank loan agreement dated November 21, 2002 of our intention to redeem all outstanding notes and repay such loans in full, plus interest accrued until the redemption and repayment date, as applicable. On October 29, 2007, we prepaid US$ 24.3 million of principal and US$0.3 million of interest accrued on the notes, and US$14.9 million of principal and US$0.2 million of interest accrued on the loans.
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On March 23, 2005, Credit Suisse First Boston International acquired the US$11.1 million indebtedness incurred by Hoteles Argentinos which had been in default since January 2002. On April 21, 2006, Hoteles Argentinos reduced the outstanding principal amount to US$6.0 million with a prepayment, and the unpaid balance was restructured to mature in March 2010 with scheduled amortization payments as described below:
Date
March 15, 2008
September 15, 2008
March 15, 2009
September 15, 2009
March 15, 2010
Interest accrues on the unpaid principal of this loan at six-month LIBOR plus 7.0%.
In addition, we entered into a credit default swap agreement with Credit Suisse International which, among other provisions, secures the payment of Hoteles Argentinos’ indebtedness and provides that in the event of default we should acquire the loan. Simultaneously with the amendment to Hoteles Argentinos’ loan agreement, we amended the credit default swap agreement with Credit Suisse International. Thus, we would only assume 80.0% of Hoteles Argentinos’ indebtedness in the event of default. The remaining 20.0% was assumed by Starwood Hotels and Resorts Worldwide Inc. (Starwood), an indirect minority shareholder of Hoteles Argentinos, which has also been instrumented through a credit default swap agreement. To secure performance of our obligations under the agreement with Credit Suisse International, we made an escrow deposit of US$1.2 million.
The loan agreement of Hoteles Argentinos provides that it may not declare or pay any dividends or make any distribution on capital stock, or purchase, redeem, retire, defease or otherwise acquire any of its own shares, or make any distribution of assets, capital stock, warrants, rights, options, obligations or securities to shareholders, except in an amount not to exceed the lesser of (x) Hoteles Argentinos’ excess cash flow for the preceding fiscal year, or (y) the consolidated retained earnings and consolidated profits earned; and then only if, after giving pro forma effect to such action, no default or event of default would occur as a consequence thereof.
On March 15, 2008 we repaid an installment of principal of US$ 0.2 million.
On August 20, 2002, Alto Palermo issued US$ 50.0 million unsecured Convertible Notes in exchange for cash and the settlement of certain liabilities owed to its shareholders. These convertible notes mature on July 19, 2014, according to the maturity date extension approved at the meeting of holders of such convertible notes on May 2, 2006. The convertible notes accrue interest (payable semi-annually) at a 10.0% fixed annual interest rate and are convertible at any time at the holder’s option into shares of common stock of Ps. 0.10 par value each. The conversion rate per U.S. dollar is the lower between (i) 30.8642 and (ii) the result from dividing the exchange rate prevailing on the conversion date by Alto Palermo’s common shares’ par value. As of June 30, 2008, as a result of the conversions made, the aggregate outstanding amount of Alto Palermo’s convertible notes was US$47.2 million. If all the noteholders exercise their conversion rights, Alto Palermo’s common shares would increase from 782.0 million (Ps. 224.0 million par value) to 2,239.7 million (Ps. 224.0 million par value). As of June 30, 2008, we hold US$31.7 million of Alto Palermo’s convertible notes.
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Our 8% convertible notes due 2007
On November 21, 2002, we issued US$100.0 million of convertible notes due November 2007. The convertible notes accrue interest at 8% per annum, payable on a semi-annual basis. The conversion price is US$0.545 per common share, which means that each US$1.00 principal amount of such convertible note may be exchanged for 1.8347 common shares. Additionally, each convertible note contains a warrant attached that grants its holder an option to acquire 1.8347 shares at a price of US$0.6541 each.
From the date of issuance through June 30, 2007, the holders of our convertible notes exercised their conversion rights for a total of 81.1 million units with a face value of US$1.0 each, issuing 148.8 million common shares with a face value of Ps. 1.0 each. In addition, from the date of issuance through June 30, 2007, the warrants issued by us were exercised for a total amount of US$56.8 million, and 104.2 million shares were issued in exchange thereof. We received funds aggregating US$68.1 million. As of September 30, 2007 the outstanding amount of convertible notes and warrants amounted to 0.9 million and 14.0 million respectively, and the amount of outstanding shares was 551,779,869.
The exercise period of the outstanding warrants and the conversion period of the convertible notes, issued on November 21, 2002, expired on November 14, 2007. During the exercise and conversion periods, the holders of warrants and convertible notes exercised a total of 99,896,806 warrants and converted a total of 99,942,343 convertible notes, increasing our capital stock to 578,676,460 common shares. As of December 31, 2007, there were no warrants or convertible notes remaining.
Alto Palermo series I and series II notes
On May 11, 2007, Alto Palermo issued two new series of notes in an aggregate principal amount of US$170 million. Series I consists of US$120 million of notes due on May 11, 2017, which accrue interest at a fixed rate of 7.875% payable semi-annually on May 11 and November 11 of each year, commencing on November 11, 2007. The Series I notes mature in a single installment on May 11, 2017.
Series II consists of Ps.154 million (equivalent to US$50 million) of notes which mature in seven, equal and consecutive semi-annual installments commencing on June 11, 2009, and which accrue interest at 11% per annum, payable on June 11 and December 11 of each year commencing on December 11, 2007.
Our 8.5% notes due 2017
On February 2, 2007, we issued our 2017 fixed rate notes for a total amount of US$150.0 million, which accrue interest at an annual interest rate of 8.5% payable semi-annually and which mature in a single installment on February 2, 2017.
These notes also contain a covenant limiting our ability to pay dividends which may not exceed the sum of:
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100% of the aggregate net cash proceeds (with certain exceptions) and the fair market value of property other than cash received by us or by our restricted subsidiaries from (a) any contribution to our capital stock or the capital stock of our restricted subsidiaries or issuance and sale of our qualified capital stock or the qualified capital stock of our restricted subsidiaries subsequent to the issue of our notes due 2017, or (b) issuance and sale subsequent to the issuance of our notes due 2017 or our indebtedness or the indebtedness of our restricted subsidiaries that has been converted into or exchanged for our qualified capital stock.
Debt for the acquisition of Edificio República
On April 28, 2008 we executed a loan agreement secured by a mortgage with Banco Macro S.A. pursuant to which Banco Macro S.A. lent us US$33.6 million which we applied to the repayment of the outstanding balance relating to the acquisition of Edificio República for a total term of 5 years. The principal must be repaid in five annual, equal and consecutive installments maturing on April 28 each year and accruing interest at an annual nominal rate of 12%. Interest must be repaid in semi-annual installments, maturing on April and October 28, of each year. The “Edificio República” has been mortgaged as security for the amount of the loan.
Five months period-Fiscal Year 2009. For the five months of fiscal year 2009 we invested Ps. 116.9 million in capital expenditures of which mainly (i) Ps. 70.9 million were related to the construction of Panamerican Mall; (ii) Ps. 19.4 million in improvements in Dique IV, (iii) Ps. 10.2 million were related to the improvements of our shopping center properties and (iv) Ps. 7.4 million in the Hotel segment, of which Ps. 4.2 million were invested in Sheraton Libertador Hotel. Regarding the capital expenditures for the rest of fiscal year 2009, they could vary according to the potential events described in our risk factors section.
2008 Fiscal Year. For the fiscal year ended June 30, 2008, we invested Ps.768.7 million of which Ps.419.0 million were related to the acquisition of business and assets, mainly the purchase of two buildings (including their in place leases) known as “Edificio República” and “Torre Bank Boston” for Ps.228.3 million and Ps.173.9 million, respectively. We also made investments in fixed assets of Ps. 332.5 million of which, Ps.257.7 million were invested million through Alto Palermo primarily in the partial construction of the Panamerican Mall for Ps.114.4 million, improvements of shopping centers for Ps.50.0 million, in the initial payment for the transfer of Soleil Factory shopping center for Ps.25.6 million, and Ps.40.0 million in the Hotel segment of which Ps. 30.7 million were invested in Hotel Llao Llao. We also invested Ps. 23.1 million relating to Patio Olmos Building and Ps. 16.1 were related to advance payment for a plot of land located at Beruti 3571. We also invested Ps.17.2 million in undeveloped parcels of land.
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Principal differences between Argentine GAAP and U.S. GAAP
The principal differences, other than inflation accounting, between Argentine GAAP and U.S. GAAP are related to the following:
the impact of certain U.S. GAAP adjustments on equity investees;
the accounting for marketable securities;
the application of different useful lives for depreciation purposes;
the deferral of certain preoperating and organization expenses under Argentine GAAP which are expensed as incurred under U.S. GAAP;
the accounting for a mortgage payable with no stated interest;
the accounting for securitization programs;
the application of certain U.S. GAAP adjustments to the estimation of the fair value of net assets acquired;
the present-value accounting;
the restoration of previously recognized impairment losses accounting;
the accounting for convertible notes;
the accounting for troubled debt restructuring;
the accounting for real estate barter transactions;
the accounting for the appraisal revaluation of fixed assets;
the revenue recognition of deferred brokerage commissions over the term of the respective leases;
the escalation rental revenue under straight-line method over the term of the leases;
the deferral of certain revenues from life and disability insurance and origination fees;
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the amortization of fees related to the Senior Notes;
the accounting for software obtained for internal use;
the accounting for increasing rate debt;
the differences between the price-level restated amounts of assets and liabilities and their historical basis, that under Argentine GAAP, are treated as permanent differences in accounting for deferred income tax calculation purposes while under U.S. GAAP are treated as temporary differences;
the effect of the reversal of gain from recognition of financial receivables at net realizable value.
the effect of the reversal of capitalized exchange differences.
the effects on deferred income tax of the foregoing taxes of the above-mentioned reconciling items, as appropriate;
the effect on minority interest of the above-mentioned reconciling items, as appropriate; and
In addition, certain other disclosures required under U.S. GAAP have been included in the U.S. GAAP reconciliation. See Note 28 to our audited consolidated financial statements included elsewhere in this annual report.
Net income under Argentine GAAP for the years ended June 30, 2006, 2007 and 2008 was approximately Ps. 96.6 million, Ps.107.1 million and Ps. 54.9 million, respectively, compared to approximately Ps. 89.9 million, Ps.103.2 million and Ps.122.1 million, respectively, under U.S. GAAP. Shareholders’ equity under Argentine GAAP as of June 30, 2007 and 2008, was Ps.1,646.7 million and Ps.1,924.2 million, respectively, compared to Ps.1,358.7 million and Ps.1,640.9 million, respectively, under U.S. GAAP.
C. Research and Development, Patents and Licenses, etc.
We do not have any research, development, patents or licenses that are material for the conduct of our business.
D. Trend Information
We believe the deteriorating international economic conditions may lead to reduced liquidity in the global economy, which in turn may lower global economic growth. This may have a negative impact on the level of economic activity in Argentina and hence on the level of financing of the public budget and foreign trade balances which during the past years have been showing signs of strength. Within this context, we believe our business lines are well positioned to face a scenario of reduced economic growth thanks to our levels of cash flow generation and long term debt maturity profiles.
According to official data for September 2008, the Monthly Estimate of Economic Activities (Estimador Mensual de la Actividad Económica, EMAE) pointed to 7.4% growth
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compared to the first nine months of the year 2007. Therefore, although some signs of a slow-down in economic growth have started to be perceived, the data available as of the month of September 2008 showed the sixty-ninth consecutive month of economic expansion since December 2002. For more information see Item 3 “Risk Factors—Risk related to Argentina—There are concerns about the accuracy of Argentina’s official inflation statistics.”
Argentina’s public finances, fiscal accounts, foreign trade current account balances, and the reserves held by the Central Bank of Argentina (Banco Central de la República Argentina, BCRA) have performed well this year. During the first ten months of calendar year 2008, Argentina’s primary fiscal surplus showed a year-on-year 20.3% increase driven by high tax revenues. Argentina’s external accounts posted a US$ 11.362 million surplus in the first ten months of calendar 2008. As a result, the Central Bank strengthened its position in reserves and accumulated as of November 30, 2008 US$46,072 million, which allows the Central Bank to manage the increased volatility in the inflows and outflows of capital caused by the current environment in financial markets.
The construction industry continues to expand, though at a more moderate pace compared to previous periods. According to the data shown by the Summary Indicator of Construction Activities (Indicador Sintético de la Actividad de la Construcción, ISAC) prepared by the National Institute of Statistics and Censuses (Instituto Nacional de Estadísiticas y Censos, INDEC), for the first nine months of calendar 2008 this index has shown a 7.6% increase compared to the same period of the previous year. Compared to the same month of the previous year, during the month of September, the index has shown a positive 5.7% change without accounting for seasonality and a 9.4% change in the series that accounts for seasonality.
As regards the demand for homes in the residential real estate market, on one hand it may be influenced by the impact of a cooler economy and on the other hand, it may be pushed by the impact of local investors’ preference for channeling their savings to the real estate sector in times of volatility in financial markets. What seems to be more apparent, is that our market should not expect to see a crisis in sub-prime mortgage loans affecting the value of homes as has been the case in other economies basically because home mortgage loans in the Argentine market remain at hardly 2% of the country’s GDP.
According to the Argentine Chamber of Medium Sized Companies (Cámara Argentina de la Mediana Empresa, CAME) in October 2008 retail sales dropped by 14.3% compared to the same month of 2007 as a result of the uncertain global and local economic conditions. In contrast, our Shopping Center segment continued to perform favorably over the first quarter of fiscal year 2009 and showed a year-on-year increase in sales. We believe the leading position of our shopping centers and our strong cash flow generation compared to the long-term profile of our debt maturities put our business in a favorable position to face a more adverse economic context.
Regarding the consumer finance market, as a result of the current international financial scenario, a high volatility has been observed in interest rates and increasing loan delinquencies have materially and adversely affected the performance and financing of consumer finance companies including Tarshop. The higher delinquency levels have led to an increase in the subordination of financial trusts which, added to the changes in their tax treatment, the higher interest rates resulting from higher risk and a slight deceleration in private consumption, have resulted in less favorable general economic and business prospects for Tarshop S.A. In this sense, we will continue to seek stabilization of Tarshop’s operating performance towards reversing its operating losses and consolidating its position in the industry.
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The Office Rental market in Buenos Aires: up to now, the local market had benefited from the absence of available office space which in turn led to a stepwise increase in prices. In our premium locations, rentals had even largely exceeded the amounts charged in Argentina in the years when the Convertibility Law was in force. Recently, certain caution has been noticed among lessees regarding the decision to lease larger areas. However, this circumstance has not yet had an impact on prices or available space. According to Richard Ellis, the rental prices for AAA class offices in the areas of Plaza San Martín, Catalinas and Plaza Roma are on average above US$35/square meter/month, and the rentals charged in the Plaza Roma area have reached approximately US$40/square meter/month.
The Hotel market, and particularly the five-star hotel sector, has been favored over the past five years by the increase in the number of tourists with high purchasing power and by a nominal exchange rate that has favored industry competitiveness. According to official sources, the receptive tourism between January and September 2008 rose by 3.7% compared to the same period in 2007.
Regarding the financial market, as a result of the current international and local scenario, stock markets reflected significant drops in the prices of government and corporate securities, liquidity restrictions, as well as an increase in interest rates, country risk and exchange rates. In addition, the market is showing a deceleration in private consumption, restriction in loans originations and increasing loan delinquencies. This situation could affect adversely the performance of financial system including Banco Hipotecario.
Nevertheless, the local market should not expect to see a crisis in sub-prime mortgage loan affecting the value of properties as has been the case of other economies. At the date of issuance of this document, the situation is still ongoing and the market’s future is still uncertain. Banco Hipotecario’s management is permanently evaluating and monitoring the effects derived from the above situation in order to implement the necessary measures to mitigate its effect.
At the date of issuance of this document, the situation is still ongoing and the market’s future is still uncertain. Banco Hipotecario’s management is permanently evaluating and monitoring the effects derived from the above situation in order to implement the necessary measures to mitigate its effect.
We believe our business segments continue to show a strong position in the current macroeconomic conditions, and that given our healthy cash flows and our long-term financing, we will be capable of sustaining our leading market position.
In our fiscal year ended June 30, 2008, revenues from our Sales and Development segment were Ps.196.8 million, compared to Ps. 75.8 million in fiscal year 2007.
Torre Caballito, City of Buenos Aires. This undeveloped 2.1 hectare property is situated in the northern area of Caballito’s residential neighborhood in the City of Buenos Aires. On May 4, 2006, we and Koad S.A. (“Koad”), an Argentine developer, entered into an asset exchange agreement valued at US$7.5 million pursuant to which we sold to Koad plot number 36 of “Terrenos de Caballito” in exchange for Koad’s agreement to construct, at its sole expense, a residential complex to be named “Caballito Nuevo”. Koad has agreed to develop a residential
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complex consisting of two 34-story towers containing 220 apartments each, consisting of one, two and three bedroom residential units with surface areas ranging from 40 to 85 square meters. The proposed apartment complex is currently expected to offer a wide variety of amenities and services. The total area of this apartment complex that will be for sale is estimated to be approximately 28,000 square meters. On August 2009, we will be entitled to ownership of 26.7% of the total square meters and 25% of the parking lots of the entire complex, representing 118 apartments and 55 parking lots located in Tower 1. As a result of an incentive scheme agreed to with Koad, the number of square meters we will receive could vary according to the project’s date of completion. As a result of this transaction, Koad granted to us a first lien mortgage on the property to secure up to US$7.4 million of its obligations to us and posted a surety bond in our favor supporting an additional US$2.0 million of Koad’s obligations to us.
Torres Renoir, Dock III. In September 2004, we and Desarrollos y Proyectos Sociedad Anónima (“DYPSA”) signed a barter contract whereby we delivered DYPSA plot 1c) of Dique III in exchange for receiving, within a maximum term of 36 months, housing units, parking lots and parking spaces, representing in the aggregate 28.50% of the square meters built in the building constructed by DYPSA. The transaction amounted to US$ 8.0 million. As a security for the transaction, DYPSA set up a first degree mortgage for US$ 8.0 million in our favor. During the fiscal year ended June 30, 2008 DYPSA transferred us the possession of all of the individual storage spaces and parking lots totaling US$ 0.5 million. We signed preliminary sales agreements for certain units to be received which where valued at their net realizable value. The increase for this method of valuation amounted to Ps. 21.0 million; of which Ps. 2.6 million and Ps. 18.4 million were recorded as of June 30, 2008 and 2007, respectively.
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In April 2007, we constituted CYRSA S.A. in order to develop high-end residential units in Argentina. To that end, we contributed 100% of the capital stock in Rummaala S.A. and the debt in kind associated to the acquisition of the land to CYRSA for a net amount of $ 21.5 million, whereas CYRELA contributed $ 21.5 million (an amount equivalent to the value of the shares that we contributed).
We also entered into an agreement with Cyrela Brazil Realty S.A. Empreendimentos e Partiçipacões for the development of residential projects in Argentina through CYRSA S.A., which will operate under the name of IRSA—CYRELA.
The price determined will be paid on installments and be fully paid atto the time of transfer / signature of deeds.
Torres Rosario Project, City of Rosario, Province of Santa Fe. IRSA’s subsidiary Alto Palermo owns a plot of land of approximately 42,620 square meters (without parcel 7 already permuted) in the city of Rosario, near the Alto Rosario Shopping Center. On October 11, 2007, we entered into a barter agreement with Condominios del Alto S.A. pursuant to which our subsidiary Alto Palermo S.A. bartered a fraction of parcel 2-g representing a total of 7,901.30 square meters for the construction of a residential complex. As consideration for this parcel, Condominios de Alto S.A. will deliver fifteen housing units, with a total constructed surface area of 1,504.45 square meters and fifteen parking spaces. In addition, APSA granted to Condominios an option to purchase through barter parcel 2-h.
CYRSA agreed to develop a residential project comprised of a first stage of two towers and a third tower to be developed in a second stage at the option of CYRSA. In exchange for the transfer of the property, CYRSA paid to IRSA US$ 0.12 million and agreed to transfer to IRSA certain home units in the buildings to be built which will represent 25% of the area constructed. Furthermore, as security for the performance of its obligations, CYRSA has created a security interest over the property by mortgaging it in favor of IRSA in the amount of US$ 12.6 million. If CYRSA does not construct the third building by June 2010, then IRSA will receive the functional units and have the right to construct the third building in the future.
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An important factor in the trend towards living in suburban areas has been the improvements and additions to the Autopista Panamericana, Avenida General Paz and Acceso Oeste highways, which significantly reduce traveling time, encouraging a significant number of families to move to the new residential neighborhoods. Furthermore, improvements in public train, subway and bus transportation since their privatization has also influenced the trend to adopt this lifestyle.
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We have acquired large undeveloped properties as land reserves located in strategic areas for the future development of office and apartment buildings, shopping centers and single family housing. We have acquired what we believe to be two of the largest and most important undeveloped river front plots in Buenos Aires, Puerto Retiro and Santa María del Plata, for the future development of residential and office spaces. In addition, we have benefited from the improvement of land values during periods of economic growth, As of June 30, 2008, our land reserves totaled 27 properties consisting of approximately 2,195 hectares (including Rosario, Terreno Beruti, Caballito and Coto C.I.C.S.A. (“Coto”) air space owned by Alto Palermo).
A rule passed by the Legislative Branch of the City of Buenos Aires in 1992 (Ordinance 45,665/92), provided general urban standards for the site, and call for a proposal to be submitted for approval of the Environmental Urban Plan Council (Consejo de Planificación Urbana - COPUA). In 1997 we acquired the site which the National Executive Branch had assigned to be the athlete residence of the Olympic Games (Olympic Village) in case Buenos Aires was chosen as host city to hold the Olympic Games (former Boca Juniors Football Club sports town). This property is currently owned by our subsidiary Solares de Santa María S.A. From that date forward, we have sought the approval of a mixed-use development project to be built on the site before the governmental authorities of the City of Buenos Aires.
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Puerto Retiro. Puerto Retiro is an 8.3 hectare undeveloped riverside property bounded by the Catalinas and Puerto Madero office zones to the west, the transportation hub Retiro to the north and the Río de la Plata to the south and east. One of the only two significant privately owned waterfront properties in The City of Buenos Aires, Puerto Retiro may currently be utilized only for port activities. We have initiated negotiations with municipal authorities in order to rezone the area. Our plan is to develop a 360,000 square meter financial center. The launching date has not been settled and consequently, the estimated cost and financing method are not decided. We own a 50% interest in Puerto Retiro through our wholly-owned subsidiary Inversora Bolívar S.A. (“Inversora Bolívar”).
Terreno Figueroa Alcorta. On December 22, 2005, our subsidiary Alto Palermo s sold the plot of land denominated Alcorta Plaza for a total price of US$7.7 million to RAGHSA S.A. The agreed terms and conditions of payment were determined in four installments of US$ 1.9 million and 7.5% annual interest on the balance. The four installments had been collected as of the fiscal year ended June 30, 2008.
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Luján. In May 2008, we entered into a preliminary purchase contract with Birafriends S.A. (an unrelated party) for the acquisition of a plot of land in Luján, Province of Buenos Aires, for a total purchase price of US$ 3.0 million we were granted the possession of the plot of land at the time of the signature of the preliminary purchase contract. IRSA paid US$ 1.2 million and the remaining balance will be paid at the time of the signing of the deed.
Other Undeveloped Parcels in the City and Province of Buenos Aires. Our land reserve portfolio also includes nine land reserve properties located in Buenos Aires and its surrounding areas. These properties are projected for future developments of offices, shopping centers, apartment buildings and residential communities. The main properties under this category include Merlo, Mariano Acosta and Pontevedra. We also own a property in the outskirts of the City of Santa Fe called Isla Sirgadero.
Ex Escuela Gobernador Vicente de Olmos, Córdoba, Province of Córdoba.In November, 2006 we participated in a public bidding process called by Corporación Inmobiliaria Córdoba S.A. for the sale of the building known as Ex Escuela Gobernador Vicente de Olmos, located in the City of Córdoba. The building has 5,147 square meters of surface area. The building contains a portion of the Patio Olmos shopping center, which operates in four commercial plants and has two underground parking lots. This shopping center also includes two neighboring buildings with cinemas and a commercial annex, legally related through easement contracts. The building is under a concession contract effective for a 40-year term, expiring in February 2032, in which we act as grantor. This contract establishes a monthly rent payment and increases of Ps.2,513 every 47 months. On September 25, 2007, Alto Palermo signed with the Government of the Province of Córdoba the title deed of the property where the Patio Olmos Shopping Center is currently operating and the concession agreement was also transferred. The agreed purchase price balance of Ps.22.7 million was paid. As of June 30, 2008, the concession is in its 196th month with a monthly payment of Ps.12,565.
Canteras Natal Crespo, Province of Córdoba. The initial guidelines for the development of this project are in process on the basis of the master plan of the Chilean architect firm URBE. Preliminary presentations have been submitted to the Municipality of La Calera and to the Provincial Government of Córdoba.
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Offices and other non-shopping center rental properties
We are engaged in the acquisition, development and management of offices and other non-shopping center rental properties in Argentina. As of June 30, 2008, we directly and indirectly, owned interests in 28 office and other rental properties in Argentina which comprised 260,866 square meters of gross leaseable area. Of these properties, 19 were office properties which comprised 163,724 square meters of gross leaseable area. For fiscal year 2008, we had revenues from office and non- shopping center rental properties of Ps.101.0 million.
All our office rental property in Argentina is located in the City Buenos Aires. All of these properties are rented to various different premium tenants. For the year ended June 30, 2008 the average occupancy rate for all IRSA’s properties in the Offices and other rental property segment was approximately 93.55%. Nine different tenants accounted for approximately 27.0% of IRSA’s total revenues for fiscal year 2008. IRSA’s seven main office rental tenants are: Grupo Total Austral, Apache Energía, Exxon Mobile Business Center, Sibille S.C. (KPMG), Microsoft Argentina S.A. and Unilever Argentina.
Revenues from our Consumer Financing segment increased 36.7% from Ps.213.0 million in fiscal year 2007 to Ps.291.0 million in fiscal year 2008. This was a result of the favorable macroeconomic conditions, the increase in general consumption levels, and the continuing expansion of our services, as reflected by (i) an increase in sales at stores and supermarkets, and (ii) an increase in the bills/statements of accounts issued.
However, the net income results of the segment were affected by an increased delinquency rate due to a lower real salary of the portfolio customers, coupled with a rise of financing and company infrastructure costs amidst the difficult global economic conditions. We believe that, despite the decrease in margins, it is still possible for us to improve the performance of this business segment so that Tarshop can maintain its position in the market.
We are engaged in purchasing, developing and managing shopping centers through our subsidiary Alto Palermo. As of June 30, 2008, Alto Palermo operated and owned majority interests in ten shopping centers, five of which are located in the City of Buenos Aires, one of which is located in the greater Buenos Aires metropolitan area and the remaining are located in the interior Argentine cities of Salta, Rosario, Mendoza and Córdoba.
At June 30, 2008, Alto Palermo’s shopping centers comprised a total of 232,659 square meters of gross leasable area (excluding certain space occupied by hypermarkets which are not Alto Palermo’s tenants and the surface area of the Panamerican Mall that includes several projects one of which is the construction of a shopping center). For the year ended June 30, 2008, the average occupancy rate of Alto Palermo’s shopping center portfolio was approximately 99.3%.
As a result of our acquisition of several shopping centers and the corporate reorganization of Alto Palermo, we recently centralized management of our shopping centers owned by our subsidiary Alto Palermo.
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Hotels operations
At the end of the 1997 fiscal year, we acquired the Hotel Llao Llao in Bariloche, Argentina, our first luxury hotel. Some months later, as part of the acquisition of the Old Alto Palermo from Pérez Companc, we acquired an indirect 50% interest in the Hotel Intercontinental in the City of Buenos Aires which we own through our subsidiary Inversora Bolívar. In March 1998, we acquired the Hotel Libertador. During fiscal year 1999, we sold a 20% interest in the Hotel Libertador to Hoteles Sheraton de Argentina S.A., (“Hoteles Sheraton de Argentina”) and during the fiscal year 2000, we sold 50% of our interest in the Hotel Llao Llao to the Sutton Group. During fiscal year 2007 we increased our share in Inversora Bolivar by 100% and obtained an indirect share in the Hotel Intercontinental of 76.34%.
E. Off-Balance Sheet Arrangements
At June 30, 2008, we did not have any off-balance sheet transactions, arrangements or obligations with unconsolidated entities or others that are reasonably likely to have a material effect on our financial condition, results of operations or liquidity.
F. Tabular Disclosure of Contractual Obligations
The following table sets forth our contractual obligations as of June 30, 2008:
Long-Term Debt Obligations
Purchase Obligations
Other Long-Term Obligations
Total(1)
G. Safe Harbor
See the discussion at the beginning of this Item 5 and “Forward Looking Statements” in the introduction of this annual report for the forward looking safe harbor provisions.
A. Directors and Senior Management
Composition of the Board of Directors
We are managed by a board of directors. Our by-laws provide that our board of directors will consist of a minimum of eight and a maximum of fourteen full directors and an equal or minor number of alternate directors. Currently our board of directors is composed of fourteen directors and five alternate directors. Our directors and alternate directors are elected for three-year terms by a majority vote of our shareholders at a general ordinary shareholders’ meeting. Our directors and alternate directors may be reelected indefinitely.
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Alternate directors will be summoned to exercise their functions in case of absence, vacancy of death of a full director up to a new director were designated.
The table below shows information about our directors and alternate directors:
Name
Eduardo S. Elsztain
Saúl Zang
Alejandro G. Elsztain
Oscar P. Bergotto
Fernando A. Elsztain
Carlos Ricardo Esteves
Cedric D. Bridger
Marcos Fischman
Fernando Rubín
Gary S. Gladstein
Mario Blejer
Mauricio Wior
Gabriel A. G. Reznik
Ricardo Liberman
Juan C. Quintana Terán
Emilio Cárdenas
Salvador D. Bergel
Enrique Antonini
Daniel Ricardo Elsztain
Carlos Ricardo Esteves, Cedric Bridger, Mario Blejer, Mauricio Wior, Emilio Cárdenas, Ricardo H. Liberman and Enrique Antonini are independent directors, pursuant to Comisión Nacional de Valores’ Resolution No. 400/2002. The following is a brief biographical description of each member of our board of directors:
Eduardo S. Elsztain. Mr. Elsztain studied economic sciences at the Universidad de Buenos Aires. He has been engaged in the real estate business for more than twenty years. He is the chairman of the board of directors of Alto Palermo, Shopping Alto Palermo S.A., Cresud, Consultores Asset Management and BACS Banco de Crédito & Securitización among others. He is also vice-chairman of Banco Hipotecario, E-Commerce Latina S.A. and Director of BrasilAgro, among other companies. He is Fernando A. Elsztain’s cousin and Alejandro G. Elsztain’s brother.
Saúl Zang. Mr. Zang obtained a law degree from the Universidad de Buenos Aires. He is a member of the International Bar Association and the Interamerican Federation of Lawyers. He is a founding partner of Zang, Bergel & Viñes law firm. He is also vice-chairman of Alto Palermo, the first vice-chairman of Shopping Alto Palermo S.A. and Cresud and vice-chairman of Puerto Retiro, Alto Palermo and Fibesa, and a director of Banco Hipotecario, Nuevas Fronteras S.A., Tarshop, Palermo Invest S.A. and BrasilAgro.
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Alejandro G. Elsztain. Mr. Elsztain obtained a degree in agricultural engineering from the Universidad de Buenos Aires. Currently he is chairman of BrasilAgro, second vice-chairman of Cresud and executive vice-chairman of Alto Palermo and SAPSA. He is also vice-chairman of Nuevas Fronteras and Hoteles Argentinos and director of IBOSA. He is the brother of Chairman Eduardo S. Elsztain and a cousin of Director Fernando A. Elsztain.
Oscar P. Bergotto.Mr. Bergotto has been our Chief Treasury Officer since 1991. He has also worked in various other real estate companies. He is director of Alto Palermo.
Fernando A. Elsztain. Mr. Elsztain studied architecture at the Universidad de Buenos Aires. He has been engaged in the real estate business as a consultant and as managing officer of a family-owned real estate company. He is chairman of the board of directors of Llao Llao Resorts S.A., Palermo Invest S.A. and Nuevas Fronteras S.A. He is also a director of Alto Palermo, SAPSA, Hoteles Argentinos and Tarshop and an alternate director of Banco Hipotecario and Puerto Retiro, among others. He is Alejandro Elsztain’s and Eduardo S. Elsztain’s cousin.
Carlos Ricardo Esteves. He has a degree in Political Science from the Universidad El Salvador. He was a member of the Boards of Directors of Banco Francés del Río de la Plata, Bunge & Born Holding, Armstrong Laboratories, Banco Velox and Supermercados Disco. He was one of the founders of CEAL (Consejo Empresario de América Latina) and is a member of the board of directors of Encuentro de Empresarios de América Latina (padres e hijos) and is co-President of Foro Iberoamericano.
Cedric D. Bridger. Mr. Bridger is qualified as a certified public accountant in the United Kingdom. From 1992 through 1998, he served as chief financial officer of YPF S.A. Mr. Bridger was also financial director of Hughes Tool Argentina, chief executive officer of Hughes Tool in Brazil and Hughes’ corporate vice-president for South American operations. He is also a director of Banco Hipotecario.
Marcos Fischman. Mr. Fischman studied at the Hebrew University of Jerusalem. He is a pioneer in individual and corporate coaching in Argentina. He provides consulting services to businessmen, scholars and artists. Since 1993, he has provided us with consulting services in organizational communication and development.
Fernando Rubín. Mr. Rubin has a degree in psychology from the Universidad de Buenos Aires and attended a post-graduate course in Human Resources and Organizational Analysis at E.P.S.O. Since July 2001, he has been the manager of organizational development at Banco Hipotecario. He served as corporate manager of human resources for IRSA, director of human resources for Moet Hennessy Louis Vuitton (“LVMH”) in Argentina and Bodegas Chandon in Argentina and Brazil. He also served as manager of the human resources division for the international consulting firm Roland Berger & Partners-International Management Consultants.
Gary S. Gladstein. Mr. Gladstein has a degree in economics from the University of Connecticut and a master’s degree in business administration from Columbia University. He was operations manager in Soros Fund Management LLC and is currently a senior consultant of Soros Fund Management LLC.
Mario Blejer. Dr. Blejer obtained a degree from Hebrew University and a Ph.D. from the University of Chicago. He lectured courses at Hebrew University, Boston University and New York University. He has published several articles on macroeconomic and financial stability subjects. He served for twenty years in different departments of the IMF. In 2002, he was appointed chairman of the Central Bank and during 2003 was appointed director of the Center for Studies of Central Banks of the Bank of England.
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Mauricio Wior. Mr. Wior obtained a masters degree in finance, as well as a bachelors degree in economics and accounting from Tel Aviv University in Israel. Mr. Wior is currently a director of Ertach S.A. and Banco Hipotecario. He has held positions at Bellsouth were he was Vice President for Latin America from 1995 to 2004. Mr. Wior was also CEO of Movicom Bellsouth from 1991 to 2004. In addition, he led the operations of various cellular phone companies in Uruguay, Chile, Peru, Ecuador and Venezuela. He was president of the Asociación Latinoamericana de Celulares (ALCACEL); U.S. Chamber of Commerce in Argentina and the Israeli-Argentine Chamber of Commerce. He was a director of Insituto para el Desarrollo Empresarial de la Argentina (IDEA), Fundación de Investigaciones Económicas Latinoamericanas (FIEL) and Tzedaka.
Gabriel A. G. Reznik. Mr. Reznik obtained a degree in Civil Engineering from University of Buenos Aires (Universidad deBuenos Aires). He worked for IRSA from 1992 until May 2005 when he resigned. He has also worked for an independent construction company in Argentina. He is an alternate director of Puerto Retiro S.A., Tarshop S.A. and Fibesa, as well as member of the board of Banco Hipotecario, and a number of other companies.
Ricardo Liberman. Mr. Liberman obtained a degree in accounting from the Universidad de Buenos Aires. He is an independent consultant, specialized in the areas of auditing and taxes.
Juan C. Quintana Terán. Mr. Quintana Terán obtained a law degree from the Universidad of de Buenos Aires. He is a consultant at Zang, Bergel & Viñes law firm. He has been chairman and Judge of the National Commercial Court of Appeals of the City of Buenos Aires (Cámara Nacional de Apelaciones en lo Comercial). He is an alternate director of Cresud, Alto Palermo and Nuevas Fronteras S.A.
Emilio J. Cárdenas. Mr. Cárdenas obtained a law degree from the Universidad de Buenos Aires and a Ph.D. from University of Michigan. He has been a member of our board of directors since 1996. He was chairman of ABRA, founding partner of Cárdenas, Cassagne & Asociados law firm, Argentina’s Permanent Representative to the United Nations, member of United Nations Security Council and is currently a member of the board of directors of HSBC Bank S.A (Bank Roberts).
Salvador D. Bergel. Mr. Bergel obtained a law degree and a PhD from the Universidad del Litoral. He is a founding partner of Zang, Bergel & Viñes law firm and a consultant at Repsol YPF S.A. He is also an alternate director of Cresud.
Enrique Antonini. Mr. Antonini holds a degree in law from the University of Buenos Aires. He is currently a member of the board of directors of Banco Mariva S.A. (since 1992), Mariva Bursátil S.A. (since 1997). He also served as a director of Inversiones y Representaciones S.A. from 1993 to 2002. He is a member of the Banking Lawyers Committee and the International Bar Association.
Daniel R. Elsztain. Mr. Elsztain graduated with a major in Economic Sciences from the Torcuato Di Tella University and has a Master in Business Administration. He has been our Commercial Director since 1998. Mr. Elsztain is the brother of both the Chairman of the Board of Directors, Mr. Eduardo S. Elzstain, and of the Vice-Chairman, Mr. Alejandro G. Elzstain and cousin of the Director Fernando A. Elzstain.
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Executive Committee
Pursuant to our by-laws, our day-to-day business is managed by an executive committee consisting of a minimum of five and a maximum of nine directors, among which there should be the chairman, first vice-chairman and second vice-chairman of the board of directors. The current members of the Executive Committee are Messrs. Eduardo S. Elsztain, Saúl Zang, Alejandro Elsztain and Fernando Elsztain as members, and Mr. Oscar P. Bergotto as alternative member. The executive committee meets as needed by our business, or at the request of one or more of its members.
The executive committee is responsible for the management of the day to day business delegated by the Board of Directors in accordance with applicable law and our by-laws. Our by-laws authorize the executive committee to:
designate the managers and establish the duties and compensation of such managers;
grant and revoke powers of attorney on behalf of us;
hire, discipline and fire personnel and determine wages, salaries and compensation of personnel;
enter into contracts related to our business;
manage our assets;
enter into loan agreements for our business and set up liens to secure our obligations; and
perform any other acts necessary to manage our day-to-day business.
Supervisory Committee
Our supervisory committee (Comisión Fiscalizadora) is responsible for reviewing and supervising our administration and affairs and verifying compliance with our by-laws and resolutions adopted at the shareholders’ meetings. The members of the supervisory committee are appointed at our annual general ordinary shareholders’ meeting for a one-year term. The supervisory committee is composed of three members and three alternate members and pursuant to Section 294 of the Argentine Corporations Law No. 19,550, as amended, must meet at least every three months.
The following table shows information about the members of our supervisory committee, who were elected at the ordinary and extraordinary shareholders’ meeting, held on October 31, 2008:
José D. Abelovich
Marcelo H. Fuxman
Roberto Murmis
Silvia De Feo
Sergio Leonardo Kolaczyk
Alicia Graciela Rigueira
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Set forth below is a brief biographical description of each member of our supervisory committee:
José D. Abelovich. Mr. Abelovich obtained a degree in accounting from the Universidad de Buenos Aires. He is a founding member and partner of Abelovich, Polano & Asociados S.R.L. / Nexia International, a public accounting firm in Argentina. Formerly, he had been a manager of Harteneck, López y Cía/Coopers & Lybrand and has served as a senior advisor in Argentina for the United Nations and the World Bank. He is a member of the supervisory committees of Alto Palermo, Cresud, SAPSA, Hoteles Argentinos, Inversora Bolívar and Banco Hipotecario S.A., among other companies.
Marcelo H. Fuxman. Mr. Fuxman obtained a degree in accounting from the Universidad de Buenos Aires. He is a partner of Abelovich, Polano & Asociados S.R.L. / Nexia International, a public accounting firm in Argentina. He is also a member of the supervisory committee of Alto Palermo, Cresud, SAPSA, Inversora Bolívar and Banco Hipotecario S.A.
Roberto Murmis. Mr. Murmis holds a degree in accounting from the Universidad de Buenos Aires. Mr. Murmis is a partner at Abelovich, Polano & Asociados S.R.L. / Nexia International. Mr. Murmis worked as an advisor to the Secretaría de Ingresos Públicos. Furthermore, he is a member of the supervisory committee of SAPSA, Cresud, Futuros y Opciones S.A. and Llao Llao Resorts S.A.
Silvia De Feo. Mrs. De Feo obtained a degree in accounting from the University of Belgrano. She is a manager at Abelovich, Polano & Asociados S.R.L. / Nexia International, an accounting firm in Argentina and former manager at Harteneck, Lopez & Cía./Coopers & Lybrand. She is also a member of the supervisory committees of SAPSA, Cresud, Inversora Bolivar S.A. and Baldovinos S.A.
Sergio Leonardo Kolaczyk. Mr. Kolaczyk obtained a degree in accounting from the Universidad de Buenos Aires. He is a professional of Abelovich, Polano & Asociados S.R.L. / Nexia International. He is also an alternate member of the supervisory committee of Alto Palermo and Cresud.
Alicia Graciela Rigueira. Mrs. Rigueira holds a degree in accounting from the Universidad de Buenos Aires. Since 1998 she has been a manager at Estudio Abelovich, Polano & Asociados S.R.L./ Nexia International. From 1974 to 1998, Mrs. Rigueira performed several functions in Harteneck, Lopez y Cia affiliated with Coopers & Lybrand. Mrs. Rigueira lectured at the Facultad de Ciencias Económicas de la Universidad de Lomas de Zamora.
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Senior Management
The Board of Directors appoints and removes senior management. Senior management performs its duties in accordance with the instructions of the Board of Directors. The following table shows information about our current senior management:
Position
Jorge Cruces
Daniel R. Elsztain
David A. Perednik
The following is a description of each of our senior managers who are not directors:
Gabriel Blasi. Mr. Blasi obtained a degree in business administration and carried out post graduate studies in Finance at CEMA University (Universidad del CEMA—Centro de Estudios Macroeconómicos Argentinos) and in the IAE (Universidad Austral). He formerly worked as a senior securities trader in Citibank. He also held several management positions related to investment banking and capital markets at Banco Río (BSCH) and was financial director of the Argentine Carrefour Group and Goyaique SACIFIA (Grupo Perez Companc). Currently, he also serves as chief financial officer of Alto Palermo and Cresud.
Jorge Cruces. Mr. Jorge Cruces obtained the degree of Architect and a Master in Business Administration, Finance Mention and Strategic Management Mention, at the University of Belgrano. Before becoming part of the group, he worked as Business Development – Real Estate Manager in Diveo Diginet and as Real Estate Projects Manager of Giménez Zapiola Binswagner. At present he serves as Chief Real Estate Officer of IRSA and APSA. He is also Academic coordinator and Professor of the Cluster Portfolio and Asset Management of the Executive program of Real Estate Management at the Torcuato Di Tella University.
David A. Perednik. Mr. Perednik obtained a degree in accounting from the Universidad de Buenos Aires. He has worked for several companies such as Marifran Internacional S.A., a subsidiary of Louis Dreyfus Amateurs where he worked as financial manager from 1986 to 1997. He also worked as a senior consultant in the administration and systems department of Deloitte & Touche. He also serves as chief administrative officer of Alto Palermo and Cresud.
B. Compensation
Directors
Under Argentine law, if the compensation of the members of the board of directors is not established in the by-laws of the company, it should be determined by the shareholders’ meeting. The maximum amount of total compensation to the members of the board of directors, including compensation for technical or administrative permanent activities, cannot exceed 25% of the earnings of the company. That amount should be limited to 5% when there is no distribution of dividends to shareholders and will be increased proportionally to the distribution.
When one or more directors perform special commissions or technical or administrative activities, and there are no earnings to distribute, or they are reduced, the shareholders meeting may approve compensation in excess of the above mentioned limits. The compensation of our directors for each fiscal year is determined pursuant to Argentine Law and taking into consideration whether the directors performed technical or administrative activities and our fiscal year’s results. Once the amount is determined, they are considered at the shareholders’ meeting.
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At our shareholders meeting held on October 31, 2008, the shareholders approved an aggregate compensation of Ps.4.2 million for all of our directors for the fiscal year ended June 30, 2008.
We do not have written contracts with our directors. However, Mr. Eduardo Elsztain, Saúl Zang, Alejandro Elsztain, Fernando Elsztain, Oscar Bergoto, Marcos Fischman and Fernando Rubín are employed by us under the Labor Contract Law No. 20.744. This law governs certain conditions of the labor relationship, including remuneration, protection of wages, hours of work, holidays, paid leave, maternity protection, minimum age requirements, protection of young workers and suspension and termination of the contract.
We pay our senior management a fixed amount, established by taking into consideration their background, capacity and experience, and an annual bonus which varies according to their individual performance and our overall results. The total and aggregate cash compensation of our senior management for the fiscal year ended June 30, 2008 was Ps.3.91 million.
During this period our contributions to compensation plan for our senior management amounted to Ps.0.48 million.
The shareholders meeting held on October 31, 2008, approved by majority vote the decision not to pay any compensation to our Supervisory Committee.
Compensation plan for executive management
We have a defined contribution plan covering its key managers in Argentina. The Plan was effective from 01/01/2006. Employees may begin participation voluntarily on monthly enrollment dates. Participants may make pre-tax contributions to the Plan of up to 2.5% of their monthly salary (Base Contributions) and pre-tax contributions of up to 15% of their annual bonuses (Extraordinary Contributions). Under the Plan, we match employee contributions to the plan at a rate of 200% for Base Contributions and 300% for Extraordinary Contributions. Contribution expense was Ps.0.4 million and Ps 0.2 million for the years ended June 30, 2008 and June 30, 2007, respectively. Participant contributions are held in trust as required by law. Individual participants may direct the trustee to invest their accounts in authorized investment alternatives. Our contributions are also held in trust. Participants or their assignees, as the case may be, may have access to the 100% of our contributions under the following circumstances:
ordinary retirement in accordance with applicable labor regulations;
total or permanent incapacity or disability; and
death.
In case of resignation or termination without good cause, the manager may redeem the amounts contributed by us only if he or she has participated in the Plan for at least 5 years.
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C. Board Practices
Audit Committee
Pursuant to the System governing the Transparency of Public Offers established through Decree No. 677/2001, the rules of the Comisión Nacional de Valores, its Resolution No. 400 and 402, the board of directors established that the Audit Committee shall be a committee of the board of directors. The main function of the Audit Committee is to assist the board of directors in performing its duty of exercising due care, diligence and competence in issues relating to us, specifically in the enforcement of the accounting policy and in the issue of accounting and financial information, the management of business risk and of internal control systems, the conduct and ethical soundness of the company’s business, the supervision of the integrity of our financial statements, the compliance by our company with the legal provisions, the independence and capability of the independent auditor and the performance of the internal audit function of our company and of the external auditors. Also, the audit committee may be requested by the board of directors to report if the conditions of a related party transaction may be reasonably considered adequate according to normal market conditions.
On November 3, 2008, our board of directors appointed Ricardo Liberman as member of the audit committee. As of the date of this annual report, the members of the audit committee are Cedric Bridger, Ricardo Liberman and Mario Blejer, all of them independent members. Cedric Bridger is the financial expert in accordance with the relevant SEC rules. We have a fully independent audit committee as per the standard provided in Rule 10(A)-3(b)(1).
Compensation of Audit Committee
The members of our Audit Committee do not receive compensation in addition to that received for their service as members of our board of directors.
D. Employees
As of June 30, 2008, IRSA had 3,349 employees. IRSA’s employees corresponding to Argentine real estate are represented by the Commerce Union (approximately 15%) -SEC: Sindicato de Empleados de Comercio- by Horizontal Property Union -SUTERH- (approximately 3% of workers) and the Administrative Construction Union –UECARA- (approximately 5% ). Shopping Centers and Consumer financing employees are also represented by the Commerce Union; approximately 66% of total workers are under commerce collective labor agreements. Hotel workers are represented by the Unión de Trabajadores del Turismo, Hoteleros y Gastronómicos de la República Argentina (UTHGRA).
The following table sets forth the number of employees in our various businesses at the dates indicated:
As of June 30, 2004
As of June 30, 2005
As of June 30, 2006
As of June 30, 2007
As of June 30, 2008
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E. Share Ownership
Share ownership of directors, members of the supervisory committee, members of the executive committee and senior management as of November 30, 2008.
The following table sets forth the amount and percentage of our shares beneficially owned by our directors, members of the executive committee, supervisory committee and senior management as of November 30, 2008:
Eduardo S. Elsztain(1)
Gabriel Adolfo Gregorio Reznik
Silvia C. De Feo
Sergio Kolaczyk
Alicia Rigueira
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A. Major Shareholders
Information about Major Shareholders
Share Ownership
The following table sets forth information regarding ownership of our capital stock by each person known to us to own beneficially at least 5% of our common shares and all our directors and officers as a group.
Shareholder
Cresud(1)
IFISA(2)
D.E. Shaw & Co. Inc.
Directors and officers including Eduardo Elsztain(3)
Argentine pension funds in the aggregate(4)
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Cresud is a leading Argentine producer of basic agricultural products. Cresud’s shares began trading on the Bolsa de Comercio de Buenos Aires on December 12, 1960, under the trading symbol “CRES” and on March 1997 its ADSs began trading on the Nasdaq Stock Market under the trading symbol “CRESY.”
Between June 30, 2007 and November 30, 2007, Cresud converted all of our 8% convertible notes that it owned and exercised all of its warrants entitling it to purchase additional common shares. As a result of these conversions and exercises, Cresud’s shareholding in us increased from 25.0% at June 30, 2007 to 34.4%.
As of November 30, 2008 Cresud´s shareholding in us increased to 50.2% through purchases in the market.
As of November 30, 2007, IFISA had exercised all of its warrants and owned 1.4% of our shares. As of November 30, 2008, IFISA´s shareholding in us decreased to 0.3%.
Parque Arauco is a significant shareholder in our subsidiary Alto Palermo. Parque Arauco is a Chilean commercial real estate developer engaged in the acquisition, development and operation of shopping centers, and its shares are listed and traded on the Santiago Stock Exchange.
Changes in Share Ownership
IFISA(2)(3)
Directors and officers(4)
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Except as set forth above, we are not aware of the existence of other shareholders owning more than 5% of our capital stock. The voting rights of our principal shareholders are not different from those of the remaining shareholders.
Differences in Voting Rights
Our major shareholders do not have different voting rights.
Arrangements for change in control
There are no arrangements that may at a subsequent date result in a change in control.
Securities held in the host country
As of November 30, 2008, the Company’s total issued outstanding capital stock outstanding consisted of 578.676.460 common shares. As of November 30, 2008, there were approximately 35,466,359 Global Depositary Shares (representing 354,663,590 of our common shares, or 63.0% of all or our outstanding shares) held in the United States by approximately 86 registered holders of Global Depositary Shares.
As of November 30, 2008 our directors and senior officers controlled, directly or indirectly, approximately 55.9% of our common shares. As a result, these shareholders have, and will continue to have, significant influence on the election of our directors and the outcome of any action requiring shareholder approval.
B. Related Party Transactions
We increased our investment in Banco Hipotecario in fiscal year 2004
Several of our directors are also directors of Banco Hipotecario.
On December 30, 2003, we purchased 4,116,267 shares of Banco Hipotecario at US$2.3868 per share and 37,537 warrants at US$33.86 each with the right to purchase 3,753,700 additional shares. We paid US$11.1 million for these securities. On February 2, 2004, we exercised a substantial portion of the warrants acquired. As a result, we acquired 4,774,000 shares of Banco Hipotecario for a total consideration of Ps.33.4 million. During the last quarter of fiscal year 2004, we sold 2,487,571 shares of Banco Hipotecario to IFIS (indirect shareholders) for a total consideration of US$6.1 million (market value equivalent to Ps.7.0 per share). We recognized a loss in connection with the sale amounting to Ps.1.6 million. See Note 3.c. to our consolidated financial statements for details on the accounting for this investment.
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As of June 30, 2008, we owned directly and indirectly Class D shares representing an 11.8% state in Banco Hipotecario, which give us the right to cast 18.36% of the total votes that may be cast at a shareholders’ meeting of Banco Hipotecario.
As of June 30, 2008, other companies affiliated with our chairman, Eduardo Elsztain (including IFIS, of which IFISA is a wholly owned subsidiary), owned Class D shares representing 9.77% of Banco Hipotecario and currently affording such holders the right to cast 15.25% of the total votes that may be cast at a shareholders’ meeting of Banco Hipotecario. As a result, as of June 30, 2008, we and other affiliated companies owned in the aggregate Class D shares representing 21.53% of Banco Hipotecario’s shares, currently affording us and such other affiliated companies the right to cast, in the aggregate, 33.61% of the total votes that may be cast at a shareholders meeting and to nominate 6 of Banco Hipotecario’s 12 directors.
Space for Fundación IRSA and Fundación Museo de los Niños at No Cost
On October 31, 1997, our subsidiary Alto Palermo approved the execution of an agreement granting Fundación IRSA the free right to use 3,800 square meters of constructed area in the Abasto Shopping Center for a 30-year period.
On November 29, 2005, Alto Palermo approved the execution of an agreement granting Fundación Museo de los Niños, the free right to use approximately 2,670.11 square meters of constructed area in the Shopping Rosario for a 30-year period.
Fundación IRSA is a charitable, non-profit organization whose Chairman is Eduardo S. Elsztain and whose Secretary, is Mariana Carmona de Elsztain, Mr. Elsztain’s wife. Fundación IRSA has used the available area to house a museum called “Museo de los Niños, Abasto,” an interactive learning center for children and adults, which opened to the public in April 1999. On September 27, 1999, Fundación IRSA assigned and transferred at no cost, the entirety of Museo de los Niños, as well as Abasto’s rights and obligations to Fundación Museo de los Niños.
Fundación Museo de los Niños is a charitable non-profit organization established by the same founders of Fundación IRSA and run by the same members of the administration committee as Fundación IRSA. Fundación Museo de los Niños acts as special vehicle for the development of Museo de los Niños, Abasto and Museo de los Niños, Rosario. On October 29, 1999, Alto Palermo approved the assignment of Museo de los Niños, Abasto’s agreement to Fundación Museo de los Niños. In addition, on December 12, 2005, an agreement granting the right to use of the space designated for Museo de los Niños, Rosario, at no cost, was signed.
Donations for Fundación IRSA and Fundacion Museo de los Ninos
During the fiscal years ended June 30, 2006, 2007 and 2008, we made donations to Fundación IRSA and Fundación Museo de los Niños for a total amount of Ps.4.3 million, Ps.2.5 million and Ps.4.8 million, respectively. Eduardo S. Elsztain is the chairman of Fundación IRSA and Fundación Museo de los Niños.
Our Shares
As of November 30, 2007, IFISA converted all of its convertible notes and warrants. After this exercise of warrants and conversion of convertible notes, IFISA had no outstanding warrants or convertible notes of our Company. As a result, IFISA owned as of November, 2007 8.0 million of our common shares, representing 1.4% of our total outstanding common shares.
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Between November 30, 2007 and November 30, 2008, IFISA decreased its ownership in us to 0.3 %, by selling in the market around 6,494,920 of our shares.
Eduardo S. Elsztain and Saúl Zang are, respectively, Chairman and Vice Chairman of our board of directors and are also shareholders of our company. They are also, respectively, chairman and vice-chairman of the board of directors of Cresud and are also shareholders of Cresud.
During November and December 2002, Cresud purchased US$49.7 million of our 8% convertible notes due 2007 and during July and November 2003, Cresud purchased an additional US$0.25 million of such convertible notes.
Our convertible notes, which were offered on October 15, 2002 for 100 million units consisting of US$100.0 million of 8% convertible notes due 2007, are convertible at any time, at the option of the holder, into a fixed number of common shares. Once converted, the holder has the right to acquire an additional equal number of shares at the exercise price of the warrant.
In May 2004, Cresud decided to exercise its option to convert 5.0 million aggregate principal amount of our Convertible Notes as part of our long term strategy, in order to revert the reduction of Cresud’s ownership percentage, which was diluted by the conversion of notes and the exercise of warrants by third parties. As a result of this conversion, Cresud received 9.2 million of our common shares.
In July 2004, Cresud converted 0.35 million convertible notes issued by us for US$0.5 million. On September 30, 2004, Cresud exercised 5.0 million Warrants for 9.2 million ordinary shares at a total cost of US$6 million. In February 2006, Cresud converted 5.0 million convertible notes issued by us for 9.2 million ordinary shares. In April 2006, Cresud converted 16.0 million of convertible notes issued by us for 29.3 million ordinary shares.
Between June 2007 and November 2007, 12.0 million convertible notes were converted and 33.0 million warrants were exercised. After this exercise of warrants and conversion of convertible notes, Cresud had no outstanding warrants or convertible notes of our Company. As of November 30, 2007 Cresud owned 34.4% of our common shares.
As of June 30, 2008 Cresud increased its participation in our Company to 38.4 % of our common shares by acquisitions in the open market.
As of November 30, 2008 Cresud´s ownership of our Company was 54.01%.
Lease of our Headquarters
Our headquarters are located at Bolívar 108, 1st floor, City of Buenos Aires. We lease this property from Elsztain e Hijos S.C.A., a company controlled by relatives of Eduardo S. Elsztain, and from Hamonet S.A., a company controlled by Fernando A. Elsztain, one of our directors, and several of his relatives. A lease agreement was signed among us, Alto Palermo, Cresud and Isaac Elsztain e Hijos S.C.A., in March 2004. This lease establishes a term of 120 months and monthly rental payments of Ps.8.5 million. We, Alto Palermo, and Cresud each pay one-third, or Ps.2.8 million, of such rent.
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Office Space Lease
In December 2003, Alto Palermo, Fibesa S.A. (a wholly owned subsidiary of Alto Palermo) and Cresud leased their administrative headquarters in the Intercontinental Plaza tower, located at Moreno 877, City of Buenos Aires, from our subsidiary Inversora Bolívar S.A. The lease agreements’ initial term is 60 months subject to an optional extension of 36 months. Alto Palermo, Fibesa S.A. and Cresud pay a monthly rent of US$0.045 million, US$0.003 million and US$0.003 million, respectively, to Inversora Bolivar S.A. In addition, IRSA, Cresud and Alto Palermo split between them the rent for the twenty-fourth floor of the above mentioned building, which amounts to US$0.003 million per month.
Legal Services
During the fiscal years ended June 30, 2006, 2007 and 2008 we paid the law firm Zang, Bergel & Viñes an aggregate amount of approximately Ps.1.9 million, Ps.3.3 million and Ps.3.8 million, respectively, as payments for legal services. Our director, Saúl Zang, and our alternate director, Salvador D. Bergel, are partners of this law firm. Juan C. Quintana Terán, our alternate director, is of counsel of this law firm. Ernesto Manuel Viñes, a partner of the firm, is a member of the board of directors of our equity investee Banco Hipotecario.
Dolphin Fund
Since 1996, we have invested in Dolphin Fund Plc, an open-ended investment fund which is related to our director and principal shareholder Eduardo Elsztain. These investments are carried at market value as of year-end. Unrealized gains and losses relating to investment funds are included in financial results, net, in the consolidated statements of income. The amounts relating to our net (loss) gain on holding Dolphin Fund Plc. for the years ended June 30, 2006, 2007 and 2008 were Ps.(0.0) million, Ps.46.8 million and Ps.(37.8) million, respectively.
Loan agreements with members of the Senior Management of Banco Hipotecario
As of June 30, 2008, several members of the senior management of Banco Hipotecario had loans from Banco Hipotecario for a total amount of approximately Ps.4.1 million with an average interest rate of 10%. We believe that each of these loans was made by Banco Hipotecario in the ordinary course of its consumer credit business, is of a type generally made available by Banco Hipotecario to the public, and was made on market terms.
Agreement for Shared Corporate Services with Cresud and Alto Palermo
In order to reduce administrative expenses and to achieve a more efficient allocation of corporate resources, we entered into an Agreement for Shared Corporate Services with Cresud and Alto Palermo, on June 30, 2004, and amended it on August 23, 2007. This agreement has a term of two years, which may be renewed for an equal term unless any of the parties decide to terminate it. Pursuant to this agreement tasks are performed by one or more of the companies for the benefit of one or more of other companies in exchange for a fee to be paid primarily through the provision of services in other areas. Through this agreement, each company continues to maintain its strategic and commercial independence while increasing operating efficiency. This agreement will not affect the independence of each company’s record and accounting systems or adversely affect internal control systems or external audit tasks. Each company will continue to maintain separate assets and liabilities.
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On August 15, 2008, we signed the Second Amendment for Shared Corporate Services (Segundo Convenio de Instrumentación de Modificciones al Contrato de Servicios Compartidos) with Cresud and Alto Palermo. Alejandro Gustavo Elsztain is the General Coordinator of the program, which is operated and implemented by Cedric Bridger for us, Gabriel Adolfo Gregorio Reznik for Cresud and Abraham Perelman for Alto Palermo, all of whom are directors and members of the Audit Committees of their respective companies. The main duties for implementation of the project are (a) monitoring the project’s implementation in accordance with the agreement; (b) reviewing the billing report on a monthly basis to analyze and check it against the provisions of the agreement, and, in the event of’ discrepancies or deviations, preparing a report to submit for the consideration of the General Coordinator, and by each company’s boards of directors and (c) assessing, on a permanent basis, the results derived from the project’s implementation and proposing to the General Coordinator changes in the event of a conflict with the agreement or, if appropriate, the possibility of establishing cost or benefit allocation mechanisms or criteria more consistent with the goals of the agreement.
Currently, the areas involved are: Human Resources, Finance, Institutional Relations, Administration and Control, Systems and Technology, Insurance, Purchases and Procurement, Messenger Services, Contracts, Technical, Infrastructure and Services, Internal Audit, Planning and Development, Development of Works, Real Estate, Hotels and Tourism and Risks and Processes.
In the future and in order to continue our policy of achieving a more efficient allocation of corporate resources, we may extend the areas in which we share corporate services with Cresud and Alto Palermo. Our chairman is also chairman of Cresud and Alto Palermo and our vice-chairman is also vice-chairman of Cresud and Alto Palermo. We believe that the terms and conditions of these transactions are consistent in all material respects with those prevailing in the market at the relevant time for agreements between unaffiliated parties.
The Share Services Agreement was filed with the SEC in a report on Form 6-K dated July 1, 2004. Amendments to this agreement were filed in reports on Form 6-K dated September 19, 2007 and the Second Agreement for Shared Corporate Services was filed on form 6K on August 19, 2008. See Exhibit 4.3 and Note 8 to our audited consolidated financial statements contained elsewhere in this annual report.
Convertible Notes of Alto Palermo
At a noteholders’ meeting held on May 2, 2006, the holders of Alto Palermo’s Series I convertible notes unanimously approved an extension of the maturity date to July 19, 2014, which had initially been scheduled to mature in July 2006.
On November 30, 2008, the outstanding principal amount of such convertible notes was US$47.2 million, and we owned US$31.7 million principal amount of such convertible notes on such date. If all the holders of Alto Palermo’s convertible notes were to exercise their conversion rights, the amount of Alto Palermo’s shares outstanding would be increased from 782.1 million to 2,210.7 million.
C. Interests of Experts and Counsel
This section is not applicable
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A. Consolidated Statements and Other Financial Information
See Item 18 for our consolidated financial statements.
Legal or Arbitration Proceedings
Legal Proceedings
Set forth below is a description of certain material legal proceedings to which we are a party. We are not engaged in any other material litigation or arbitration and no other material litigation or claim is known to us to be pending or threatened against us or our subsidiaries. Nevertheless, we may be involved in other litigation from time to time in the ordinary course of business.
Puerto Retiro
On November 18, 1997, in connection with our acquisition of our subsidiary Inversora Bolívar S.A. (“Inversora Bolívar”), we indirectly acquired 35.2% of the capital stock of Puerto Retiro. Inversora Bolívar had purchased such shares of Puerto Retiro from Redona Investments Ltd. N.V. in 1996. In 1999, we, through Inversora Bolívar, increased our interest in Puerto Retiro to 50.0% of its capital stock. On April 18, 2000, Puerto Retiro received notice of a complaint filed by the Argentine Government, through the Ministry of Defense, seeking to extend the bankruptcy of Inversora Dársena Norte S.A. (“Indarsa”). Upon filing of the complaint, the bankruptcy court issued an order restraining the ability of Puerto Retiro to dispose of, in any manner, the real property it had purchased in 1993 from Tandanor S.A. (“Tandanor”). Puerto Retiro appealed the restraining order which was confirmed by the Court on December 14, 2000.
In 1991, Indarsa had purchased 90% of Tandanor, a former government-owned company, which owned a piece of land near Puerto Madero of approximately 8 hectares, divided into two parcels: Planta 1 and 2. After the purchase of Tandanor by Indarsa, in June 1993, Tandanor sold “Planta 1” to Puerto Retiro, for a sum of US$18 million pursuant to a valuation performed by J.L. Ramos, a well-known real estate brokerage firm in Argentina. Indarsa failed to pay to the Argentine government the price for its purchase of the stock of Tandanor, and as a result the Ministry of Defense requested the bankruptcy of Indarsa. Since the only asset of Indarsa was its holding in Tandanor, the Argentine government is seeking to extend Indarsa’s bankruptcy to other companies or individuals which, according to its view, acted as a single economic group. In particular, the Argentine government has requested the extension of Indarsa’s bankruptcy to Puerto Retiro which acquired Planta 1 from Tandanor.
The deadline for producing evidence in relation to these legal proceedings has expired. The parties have submitted their closing arguments and are awaiting a final judgment. However, the judge has delayed his decision until a final judgment in the criminal proceedings against the former Defense Minister and former directors of Indarsa has been delivered. We cannot give you any assurance that we will prevail in this proceeding, and if the plaintiff’s claim is upheld by the courts, all of the assets of Puerto Retiro would likely be used to pay Indarsa’s debts and our investment in Puerto Retiro, valued at Ps.54.5 million, as of June 30, 2008, would be lost. As of June 30, 2008, we had not established any reserve with respect of this contingency.
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Llao Llao Holding
Llao Llao Holding S.A. purchased Hotel Llao Llao in November, 1997, from the Argentine National Parks Administration. Llao Llao Holding S.A., the predecessor of Llao Llao Resorts S.A., was sued in 1997 by the National Parks Administration to collect the unpaid balance of the purchase price in Argentine sovereign debt securities amounting to US$2.9 million. The trial court ruled in favor of the plaintiff. The ruling was appealed, and the court of appeals confirmed the judgment ordering the payment of US$2.9 million in Argentine sovereign debt securities available at the date of the ruling, plus compensatory and punitive interest and attorneys’ fees. On March 2, 2004, Llao Llao Resorts S.A. deposited a payment of Ps.7.2 million with Banco de la Ciudad de Buenos Aires in favor of the National Parks Administration and deposited Argentine sovereign debt securities class FRB – FRB L+13/16 2005 having a total principal amount of US$4.1 million. The aggregate amount deposited on that date was Ps.9.2 million.
On June 30, 2004, the plaintiff filed a brief rejecting Llao Llao Resorts S. A. payment on the grounds that it was a partial payment and requesting the court to determine the term for the deposit of funds amounting to final payment of the total debt. The trial court pesified the outstanding amount of plaintiff’s ruling against Llao Llao Resorts S.A., as well as the unpaid fee of the plaintiff’s attorneys. The plaintiff appealed this decision. The court of appeals ruled in favor of the plaintiff maintaining the unpaid amounts were payable in U.S. dollars. Llao Llao Resorts S.A. filed an appeal, which was rejected. Llao Llao Resorts S.A. subsequently filed with the National Supreme Court an additional appeal in response to the refusal to allow the appeal and this action is still pending.
The plaintiff filed a petition requesting that the above mentioned deposit amount be transferred to a savings account. Llao Llao Resorts S.A. did not oppose this petition maintaining that its obligations would be cancelled upon such payment. Notwithstanding the appeal the complaint filed by Llao Llao Resorts S.A., the plaintiff has continued the procedure for the collection of the outstanding amount.
The plaintiff requested the court of original jurisdiction to initiate an incidental proceeding for the execution of the judgment. Llao Llao Resorts S.A. contested this settlement and requested the plaintiff to provide additional information in order to evaluate the amount of the settlement. Also, Llao Llao Resorts S.A. requested that the execution be suspended until there is a final judgment in the appeal filed with the National Supreme Court.
Llao Llao Resorts S.A.’s request was denied and on July 14, 2008, the court of appeals announced by means of a decree dated June 18, 2008, that it had confirmed the settlement approved by the court of original jurisdiction. In accordance with the information provided by the attorneys in respect of this lawsuit, the amount to be recovered by virtue of the Court sentence amounts to Ps. 10.2 million as of September 30, 2008, such amount being recorded in Other current liabilities.
Legal issues with the City Hall of Neuquén
In June 2001, Shopping Neuquén requested that the City Hall of Neuquén allow it to transfer certain parcels of land to third parties so that each participant in the commercial development to be constructed would be able to build on its own land. The City Hall Executive Branch previously rejected this request under Decree No. 1437/2002 which also established the expiration of the rights arising from Ordinance 5178, including the loss of any improvement and expenses incurred. As a result, Shopping Neuquén had no right to claim indemnity charges and annulled its buy-sell land contracts.
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Shopping Neuquén submitted a written appeal to this decision on January 21, 2003. It also sought permission to submit a revised schedule of time terms, taking account of the current situation and including reasonable short and medium term projections. The City Hall Executive Branch rejected this request in Decree 585/2003. Consequently, on June 25, 2003, Shopping Neuquén filed an “Administrative Procedural Action” with the High Court of Neuquén requesting, among other things, the annulment of Decrees 1,437/2002 and 585/2003 issued by the City Hall Executive Branch. On December 21, 2004, the High Court of Neuquén communicated its decision that the administrative procedural action that Shopping Neuquén had filed against the City Hall of Neuquén had expired. Shopping Neuquén filed an extraordinary appeal for the case to be sent to the Argentine Supreme Court.
On December 13, 2006, Shopping Neuquén signed an agreement with both the City Hall and the Province of Neuquén stipulating a new timetable for construction of the commercial and housing enterprises (the “Agreement”). Also, Shopping Neuquén was permitted to transfer certain parcels to third parties so that each participant in the commercial development to be constructed would be able to build on its own land, with the exception of the land in which the shopping center will be constructed. The Legislative Council of the City Hall of Neuquén duly ratified the Agreement. The City Hall Executive Branch promulgated the ordinance issued on February 12, 2007.
The Agreement also provides that Shopping Neuquén will submit, within 120 days after the Agreement is signed, a new urban project draft with an adjustment of the environmental impact survey, together with a map of the property subdivision, which the City Hall of Neuquén will approve or disapprove within 30 days after its presentation. If the project is approved, Shopping Neuquén will submit the final maps of the works to the City Hall within 150 days of this decision and construction must commence within a maximum period of 90 days thereafter. The first stage of construction (including minimum construction of 21,000 square meters of the shopping center and 10,000 square meters of the hypermarket) is expected to be completed within a maximum period of 22 months. The Agreement is conditional upon the City Hall declaring the feasibility of the draft project submitted, and upon the terms and conditions of this decision being accepted by Shopping Neuquén S.A. The City Hall of Neuquén reserves its right to rescind the Agreement and file the legal actions it deems pertinent if its conditions are contravened.
On March 28, 2007, Shopping Neuquén submitted the new project draft and revised environmental impact survey to the City Hall of Neuquén. On May 10, 2007, the City Hall of Neuquén, requested certain explanations and made recommendations for our consideration before issuing an opinion on the feasibility of the draft project. On July 17, 2007, Shopping Neuquén answered the City Hall’s requests and on September 20, 2007, the City Hall approved the feasibility of the project.
Shopping Neuquén submitted the final maps of the project to City Hall. Once these maps are registered, Shopping Neuquén S.A. will have to start the works within 90 days’.
The agreement referred to above put an end to the legal proceeding between Shopping Neuquén and the City Hall of Neuquén before the High Court of Neuquén.
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Other Litigation
As of July 5, 2006, the Administración Federal de Ingresos Públicos or AFIP filed a preliminary injunction with the Federal Court for Administrative Proceedings against Alto Palermo for an aggregate amount of Ps.3,689,485.5, plus an added amount, provisionally estimated, of Ps.900,000 for legal fees and interest. The main dispute is about the income tax due for admission rights. In the first instance, AFIP pleaded for a general restraining order. On November 29, 2006, the Federal Court issued an order substituting such restraining order for an attachment on the parcel of land located in Caballito neighborhood, City of Buenos Aires, where Alto Palermo is planning to develop a shopping center.
After our acquisition of Bouchard 557 we asked the Argentine Antitrust Authority whether it was necessary to notify it of such acquisition. The Antitrust Authority advised us that we were in fact required to notify it, and the pertinent court ratified such decision. Consequently, on April 22, 2008, the notice of the operation was filed with the Antitrust Authority. As of the date of this annual report, such matter is still to be resolved.
After we sold the 29.85% interest of Bouchard 557 to Techint Compañía Técnica Internacional Sociedad Anónima Comercial e Industrial, we asked the Antitrust Authority if it was necessary to notify such operation. On July 4, 2008, the Antitrust Authority informed us that it was not necessary to report such sale.
On January 15, 2007 Alto Palermo and we were notified of two claims filed against Alto Palermo and us before the Antitrust Authority, one by a private individual and the other one by the licensee of the shopping center, both opposing Alto Palermo’s acquisition from the province of Córdoba of a property known as Ex-Escuela Gobernador Vicente de Olmos. On February 1, 2007 Alto Palermo and we responded the claims. On June 26, 2007, the Antitrust Authority notified Alto Palermo and us that it has initiated a summary proceeding to determine whether the completion of the transaction breaches the Antitrust Law. As of the date of this filing the result of this proceeding has not been determined.
On January 22, 2008, Alto Palermo requested the Antitrust Authority’s clearance of the transfer of the Soleil Factory shopping center. As of the date of this filing, the Antitrust Authority has not reached a decision.
We are involved in other litigation which derives from the ordinary course of our business. We accrue liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, our estimates of the outcomes of these matters and the lawyers’ experience in contesting, litigating and settling similar matters. As the scope of the liabilities becomes better defined, there will be changes in the estimates of future costs, which could have a material effect on our future results of operations and financial condition or liquidity.
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For more information see Item 4 “Regulation and Government Supervision” and Item 3 “Risk Factors—Risk related to our Business—Our business is subject to extensive regulation and additional regulations may be imposed in the future.
Dividend Policy
Pursuant to Argentine law, the distribution and payment of dividends to shareholders is allowed only if they result from realized and net earnings of the company pursuant to annual financial statements approved by the shareholders. The approval, amount and payment of dividends are subject to the approval by our shareholders at our annual ordinary shareholders meeting. The approval of dividends requires the affirmative vote of a majority of the shares entitled to vote at the meeting.
In accordance with Argentine law and our by-laws, net and realized profits for each fiscal year are allocated as follows:
5% of such net profits is allocated to our legal reserve, until such reserve amounts to 20% of our capital stock;
a certain amount determined at a shareholders’ meeting is allocated to compensation of our directors and the members of our Supervisory Committee; and
additional amounts may be allocated for the payment of dividends or to optional reserve funds, or to establish reserves or for whatever other purpose our shareholders determine.
According to rules issued by the Comisión Nacional de Valores, cash dividends must be paid to shareholders within 30 days of the resolution approving their distribution. In the case of stock dividends, the shares must be delivered to shareholders within three months of the annual ordinary shareholders’ meeting that approved them.
On February 2, 2007 we issued our 2017 fixed rate notes for a total amount of US$150.0 million at an annual interest rate of 8.5% payable semi-annual and mature on February 2, 2017. This bond limits our ability to pay dividends which may not exceed the sum of:
75% of our cumulative consolidated net income if the consolidated interest coverage ratio is at least 3.0 to 1; or
100% of our cumulative consolidated net income if the consolidated interest coverage ratio is at least 4.0 to 1; or
100% of the aggregate net cash proceeds (with certain exceptions) and the fair market value of property other than cash received by us or by its restricted subsidiaries from (a) any contribution to our equity capital or to the capital stock of its restricted subsidiaries or issuance and sale of our qualified capital stock or the qualified capital stock of its restricted subsidiaries subsequent to the issue of our notes due 2017, or (b) issuance and sale subsequent to the issuance of our notes due 2017 of our indebtedness or of the indebtedness of its restricted subsidiaries that has been converted into or exchanged for its qualified capital stock.
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The table below presents the dividend payment ratio and the total amount of dividends paid for, each paid entirely in common shares, for the mentioned years. Amounts in Pesos are stated in historical Pesos of their respective payment date. See “Exchange Rates and Exchange Controls.”
Year declared
1996
1997
1998
1999
2000
2001
2008
B. Significant Changes.
In addition, we and our subsidiaries have experienced declines in our respective stock prices during the three months ended September 30, 2008 as compared to the prior quarter. Management believes that this decline is reflective of the current macro-economic conditions and is not related to our operating performance. The stability of our tenants (measured by the levels of occupancy in our properties as well as the delinquency or uncollectibility rates) as well as the market value of our properties has not been significantly affected by the current credit crisis as of the date of this annual report. We believe that the stock prices have declined due to reasons unrelated to our business fundamentals. As of the date of these annual report, management believes that the declines in stock prices are temporary.
Furthermore, we have a 11.8 % equity interest in Banco Hipotecario as of June 30, 2008 and carried this investment under the equity method of accounting. Banco Hipotecario recorded losses of Ps. 91.0 million for the year ended June 30, 2008. Moreover, for the three months ended September 30, 2008, Banco Hipotecario recorded losses of Ps. 239.6 million and could record
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losses for the rest of the fiscal year. Such losses are primarily due to the decline in the market value of the Argentine government bonds Banco Hipotecario received as compensation and held in its portfolio. In spite of these losses, Banco Hipotecario remains well-capitalized in compliance with regulatory guidelines as of June 30, 2008 and thereafter.
In addition, the other business segment affected by the current credit crisis is Consumer financing. This segment includes the origination of consumer loans and credit card receivables and securitization activities through our indirect subsidiary Tarshop.
Due to the current credit crisis and other conditions, some customers experienced delays in payments and delinquency rates increased during the year ended June 30, 2008. Moreover, delinquency rates further increased as of September 30, 2008 and thereafter. Tarshop has increased the level of the allowance for doubtful accounts which amounts to Ps. 66.5 million as of June 30, 2008. The allowance for doubtful accounts was increased to Ps. 83.7 million as of September 30, 2008. We are closely monitoring the delays, delinquency and uncollectibility rates.
Tarshop´s generated a net loss of Ps. 18.6 million for the year ended June 30, 2008. For the three months ended September 30, 2008, Tarshop generated an additional net loss of Ps. 57.1 million. After year-end, we contributed an additional Ps. 60.0 million and increased its interest from 80% to 93.4% as of November 30, 2008. We have committed to support Tarshop financially under a credit line up to a maximum amount of Ps. 120.0 million, including the Ps. 86 million already contributed. At present we are evaluating the suitability of capitalizing these loans. We have taken several actions to enhance Tarshop’s capital base from streamlining operations to closing redundant stores to revising and making credit criteria more stringent. The securitization market is still open and Tarshop completed securitization programs during the recent months with no disruptions. As of June 30, 2008 Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps. 156.8 million and Ps. 19.4 million escrow reserves for losses, respectively. As of September 30, 2008, Tarshop credit risk exposure is contractually limited to the subordinated retained interests representing Ps.161.2 million and Ps.17.9 escrow reserves for losses. Due to the factors mentioned above, as of June 30, 2008,
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Tarshop has recorded an other-than-temporary impairment charge of Ps. 12.0 million to the retained interests to reflect current fair value. For the three months ended September 30, 2008 no additional impairment charge of related to the retained interests in securitized receivables was necessary.
Acquisition of ownership interest. On July 2, 2008, we acquired a 30% interest in Metropolitan 885 Third Avenue LLC (“Metropolitan”), a limited liability company organized under the laws of Delaware, United States of America. The main asset of Metropolitan is a 34 story building known as the Lipstick Building located at third avenue between 53rd and 54th streets in Manhattan, New York City. In addition to this asset, the acquired company also includes the debt related to this building. The purchase price paid was US$ 22.6 million. The property has approximately 59,000 square meters of leasable space. Also, we acquired the right ( “put right”) to sell the 50% of our stake in a period starting 6 months after this transaction until the third year anniversary of this transaction. Additionally, we acquired the right of first offer for 60% of the 5% currently held by of one of the shareholders of Metropolitan.
Coto Air Space – Barter commitment between Alto Palermo and CYRSA. In July, 2008 Alto Palermo entered into a barter agreement with CYRSA pursuant to which Alto Palermo, subject to certain closing conditions, would surrender to CYRSA its right to construct a tower over a preexisting structure (owned by a third party) in exchange for deminimis cash (US$0.09 million) and 25% of the housing units in the future buildings. The total fair value of the transaction is US$ 5.9 million.
Acquisition of ours shares and consolidation of financial statements.In the first quarter of fiscal year 2009, Cresud purchased 32,539,475 of our shares. As a result of this acquisition, Cresud’s investment in our common shares increased from 42.13% as of June 30, 2008 to 47.76% as of September 30, 2008.
From July 1, 2008 to December 17, 2008 Cresud acquired 68,712,005 additional shares of us on the open market for US$ 47,423,279. Thus, Cresud’s direct and indirect interest in us through Cresud’s affiliates amounts to 54.01%. Therefore Cresud consolidates us as from that date.
Cresud´s purchase of our Notes. As of November 25, 2008, Cresud had acquired nominal value US$25,210,000 of our 8.500% Series No. 1 Notes due 2017, for an average weighted price of US$ 0.4844952 per Note, totaling US$ 12,214,124.
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Repurchase of Alto Palermo’s Notes. On September 12, 2008 Alto Palermo announced the repurchase of its Serie II Notes for a face value of US$ 4.8 millions. As a result, the amount of Alto Palermo’s Notes in its portfolio had a face value of US$ 4.8 millions. On November 25, 2008, Alto Palermo announced the repurchase of its Fixed Rate Notes due 2017, Serie I for a face value of US$ 5 million.
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Cresud’s Purchase of Alto Palermo´s Notes. As of November 25, 2008, Cresud had acquired nominal value US$5 million of Alto Palermo’s Series I Notes due 2017, for an average weighted price of US$ 0.4185 per Note, totaling US$ 2.1 million.
Purchase of Alto Palermo´s Notes. As of November 25, 2008, we acquired nominal value 8.00 million of Alto Palermo’sSeries I Notes due 2017, for an average weighted price of US$ 0.39820 per Note and for a total amount of US$ 3.2 million
Torres Rosario Project. On November 27, 2008, Alto Palermo executed the deed of barter transfer, resulting from the execution of the option granted to Condominios del Alto S.A. to purchase parcel 2-h. This parcel represents 11,686 square meters. As consideration for its acquisition Condominios del Alto S.A. agreed to deliver forty two housing units, with a total constructed surface area of 3,182 square meters, representing 22% of the apartment of the building and 47 parking spaces, representing 22% of the parking of the building.
A. Offer and Listing Details
The following summary provides information concerning our share capital.
Stock Exchanges in which our securities are listed
Our common shares are listed on the Buenos Aires Stock Exchange and our Global Depositary Shares on the NYSE.
The following description of the material terms of our capital stock is subject to our certificate of incorporation and bylaws, which are included as exhibits to this Form 20-F , and the provisions of applicable Argentine Law.
Price history of our stock on the Bolsa de Comercio de Buenos Aires and NYSE
Our common shares are traded in Argentina on the Buenos Aires Stock Exchange, under the trading symbol “IRSA.” Since 1994, our GDSs, each presenting 10 common shares, have been listed on the NYSE under the trading symbol “IRS.” The Bank of New York is the depositary with respect to the GDSs.
The table below shows the high and low daily closing prices of our common shares in Pesos and the quarterly trading volume of our common shares on the Buenos Aires Stock Exchange for the first quarter of 2002 through December 17, 2008. The table also shows the high and low daily closing prices of our GDSs in U.S. dollars and the quarterly trading volume of our GDSs on the NYSE for the first quarter of 2002 through December 17, 2008. Each GDS represents ten common shares.
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1st Quarter
2nd Quarter
3rd Quarter
4th Quarter
December 2008 (through December 17, 2008)
Source: Bloomberg
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B. Plan of Distribution
C. Markets
Argentine Securities Markets
The Comisión Nacional de Valores is a separate governmental entity with jurisdiction covering the territory of Argentina. Its main purpose is to ensure transparency of Argentina’s securities markets, to watch over the market price formation process and to protect investors. The Comisión Nacional de Valores supervises corporations authorized to issue securities to the public, the secondary markets where these securities are traded, and all persons and corporations involved in any capacity in the public offering and trading of these securities. The Argentine markets are governed generally by Law No. 17,811, as amended, which created the Comisión Nacional de Valores and regulates stock exchanges, stockbrokers, market operations and the public offerings of securities. There is a relatively low level of regulation of the market for Argentine securities and of investors’ activities in this market, and enforcement of existing regulatory provisions has been extremely limited. Furthermore, there may be less publicly available information about Argentine companies than is regularly published by or about companies in the United States and certain other countries. However, the Argentine government and the Comisión Nacional de Valores, taking into consideration the deeper global awareness of the importance of having adequate corporate governance practices and a legal framework to enforce principles such as “full information,” and “transparency,” have issued decree No. 677/2001. This decree has the objective of determining the rights of the “financial consumer,” increasing market transparency and an adequate legal framework to increase the investor’s protection within the capital market. Most of its reforms are in line with world trends pertaining to corporate governance practices that have already been adopted by many emerging markets.
In order to offer securities to the public in Argentina, an issuer must meet certain requirements of the Comisión Nacional de Valores regarding assets, operating history, management and other matters, and only securities for which an application for a public offering has been approved by the Comisión Nacional de Valores may be listed on the Buenos Aires Stock Exchange. This approval does not imply any kind of certification or assurance related to the merits or the quality of the securities, or the issuer’s solvency. Issuers of listed securities are required to file unaudited quarterly financial statements and audited annual financial statements, as well as various other periodic reports, with the Comisión Nacional de Valores and the Buenos Aires Stock Exchange.
Securities Exchanges in Argentina
There are 10 securities exchanges in Argentina, of which the principal exchange for the Argentine securities market is the Buenos Aires Stock Exchange, which handles approximately 99% of all equity trading in the country.
Buenos Aires Stock Exchange
The Buenos Aires Stock Exchange is a complex, non-profit, and self-regulated organization. The various markets require different self-organizations of brokers within the Buenos Aires Stock Exchange, which is one of its particular characteristics. The most important and traditional of these markets is Mercado de Valores S.A. (“MERVAL”).
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The securities that may be listed on the Buenos Aires Stock Exchange are: Stocks, Corporate Bonds, Convertible Corporate Bonds, Close-ended Investment Funds, Financial Trust, Indexes, Derivatives and Public Bonds. The Buenos Aires Stock Exchange is legally qualified for admission, suspension, and delisting of securities according to its own rules approved by the Comisión Nacional de Valores. Furthermore, the Buenos Aires Stock Exchange works very closely with the Comisión Nacional de Valores in surveillance activities. Also under a special agreement, registration and listing applications are directly filed with the Buenos Aires Stock Exchange for simultaneous processing.
MERVAL
The MERVAL is a corporation whose 134 shareholder members are the only individuals and entities authorized to trade, either as principal or as agent, in the securities listed on the Buenos Aires Stock Exchange. Trading on the Buenos Aires Stock Exchange is conducted by continuous open outcry, or the traditional auction system, from 11:00 a.m. to 5:00 p.m. each business trading day of the year. Trading on the Buenos Aires Stock Exchange is also conducted through the automated trading platform, Sistema Integrado de Negociación Asistida por Computación (“SINAC”). SINAC is a computer trading system that permits trading in debt securities and equity securities. SINAC is accessed by brokers directly from workstations located at their offices. Currently, all transactions relating to listed notes and listed government securities can be effected through SINAC.
Over the Counter Market
The Electronic Open Market (Mercado Abierto Electrónico or “MAE”) is an exchange organized under the laws of Argentina, which operates as a self-regulatory organization under the supervision of theComisión Nacional de Valores.
The MAE works as an electronic environment to process Over The Counter transactions. It is an electronic exchange where both government securities and corporate bonds are traded through spot and forward contracts.
The MAE has 90 brokers/dealers members, which include national banks, provincial banks, municipal banks, private national banks, foreign banks, cooperative banks, financial institutions, foreign exchange entities and pure brokers/dealers (exclusively engaged in brokerage activities). Both Argentine or foreign capital banks and financial institutions may be the MAE’s brokers/dealers.
Securities to be traded must be registered with the pertinent supervising authorities and may be traded in the Mercado Abierto Electrónico, in other exchanges or in both of them concurrently.
Securities Central Depositary
Caja de Valores S.A. is a corporation organized under the laws of Argentina, totally private, which acts as central depositary of public bonds and private securities. It was established in 1974 by Act 20,643, and it is supervised by the Comisión Nacional de Valores.
Those authorized to make deposits of securities with the Caja de Valores are stockbrokers, banking financial institutions, and mutual funds.
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The majority shareholders of the Caja de Valores S.A. are the Buenos Aires Stock Exchange and the MERVAL (49.98% each).
Information regarding the Buenos Aires Stock Exchange
Market capitalization (Ps. billion)
Average daily trading volume (Ps. million)
Number of listed companies
Although companies may list all of their capital stock on the Buenos Aires Stock Exchange, in many cases a controlling block is retained by the principal shareholders resulting in only a relatively small percentage of many companies’ stock being available for active trading by the public on the Buenos Aires Stock Exchange.
As of June 30, 2008, approximately 111 companies had equity securities listed on the Buenos Aires Stock Exchange. As of June 30, 2008, approximately 6.75% of the total market capitalization of the Buenos Aires Stock Exchange was represented by the securities of the ten largest national companies.
The Argentine securities markets are substantially more volatile than the securities markets in the United States and certain other developed countries. The MERVAL experienced a 13% increase in 1995, a 25% increase in 1996, a 6% increase in 1997, a 37% decrease in 1998, a 28% increase in 1999, a 24% decrease in 2000, a 29% decrease in 2001, a 77% increase in 2002, a 104% increase in 2003, a 28% increase in 2004, a 13% increase in 2005, a 34% increase in 2006, a 2.93% increase in 2007 and a 2.04% decrease for the six month period ended June 30, 2008. In order to control price volatility, the MERVAL operates a system pursuant to which the negotiation of a particular stock or debt security is suspended for a 15- minute period when the price of the security registers a variation on its price between 10% and 15% and between 15% and 20%. Any additional 5% variation on the price of the security after that results in additional 10 – minute successive suspension periods.
The New York Stock Exchange
Our Global Depositary Shares are listed on the New York Stock Exchange under the trading symbol “IRS”.
D. Selling Shareholders
E. Dilution
F. Expenses of the Issue
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A. Share Capital
B. Memorandum and Articles of Association
Our corporate purpose
Our legal name is IRSA Inversiones y Representaciones Sociedad Anónima. We were incorporated under the laws of Argentina on April 30, 1943 as a sociedad anónima (stock corporation) and were registered with the Public Registry of Commerce of the City of Buenos Aires (Inspección General de Justicia or “IGJ”) on June 23, 1943 under number 284, on page 291, book 46 of volume A. Pursuant to our by-laws, our term of duration expires on April 5, 2043.
Pursuant to article 4 of our by-laws our purpose is to perform the following activities:
Invest, develop and operate real estate developments;
Invest, develop and operate personal property, including securities;
Construct and operate works, services and public property;
Manage real or personal property, whether owned by us or by third parties;
Build, recycle, or repair real property whether owned by us or by third parties;
Advise third parties with respect to the aforementioned activities;
Finance projects, undertakings, works and/or real estate transactions of third parties;
Finance, create, develop and operate projects related to Internet.
Board of Directors
Voting on proposals in which directors have material interest
Decree No. 677/01 establishes in Section 8 that the directors, administrators and members of the supervisory committee of companies whose securities are publicly offered, shall act in a loyal and diligent manner when exercising their functions. In that sense, they must:
place the corporate interests of the company and the common interest of the shareholders above any other interest, including the controlling shareholder’s interests;
refrain from obtaining a personal benefit from the issuer other than the compensation paid for their functions;
organize and implement preventive systems and mechanisms to protect corporate interests, reducing the risk of conflicts of interests, either permanent or temporary, in
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their personal relationships with the company or with persons related to the company. This duty specifically refers to competition with the company, the use or imposition of a lien on corporate assets, the determination of compensation or proposals related thereto, the use of non public information, the use of business opportunities for their own benefit or for the benefit of third parties and, in general, any situation that may generate a conflict of interests affecting the issuer;
make the necessary arrangements to perform the company’s activities and implement the necessary internal control to ensure a careful management and avoid breaches of the duties established by the applicable regulations; and
act with due diligence when preparing and disclosing the information to the market, and maintain the independence of external auditors.
The Argentine Corporations Law No. 19,550 establishes in Section 271 that directors may contract with the company when the contract is related to the regular activities of the company and its terms and conditions are established on market terms. All other contracts with directors should be approved by the shareholders.
Further, Section 73 of Decree No. 677/01 establishes a specific procedure for transactions of a company whose securities are publicly offered, entered into with its directors, members of the supervisory committee, or senior managers and which involve a relevant amount. The transaction is considered to have a relevant amount when it exceeds: (i) one percent (1%) of the corporate capital, measured pursuant to the last approved financial statements, and (ii) the equivalent of three hundred thousand Pesos (Ps. 300,000).
The related person with an interest in the transaction should submit all the relevant documentation to the approval of the board of directors. The directors shall request a report of the audit committee stating if the conditions of the operation may be reasonably considered adequate according to normal market conditions and additionally, they may request a report of two independent evaluating firms that shall have informed about the same matter and about the other operation conditions. Immediately after being approved by the board of directors the transaction has to be informed to the Comisión Nacional de Valores.
Notwithstanding that, Section 272 of the Corporations Law No.19,550 provides that when a director has an opposite interest to the one of the company, he or she should notify that situation to the board of directors and the supervisory committee and abstain to vote in that respect. The violation of this provision results in the director being jointly and severally unlimitedly liable.
In the event that the results of the reports are not favorable to the transaction, its approval should be considered by the shareholders’ meeting.
Approval of compensation of the members of the Board of Directors, Senior Management and Supervisory Committee
Our bylaws do not establish the compensation to be paid to members of the board of directors and the supervisory committee, and therefore pursuant to Section 261 of the Corporations Law No.19,550, it should be approved by the shareholders. The maximum amount that may be paid as compensation to members of the board of directors and the supervisory committee should not exceed 25% of the realized and net earnings of the company and 5% when there is no distribution of dividends. If the company does not distribute the total earnings, the
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amount of the compensation should be proportional to that distribution and within the mentioned limits. These limits may only be surpassed by express approval of the shareholders.
The total and aggregate cash compensation of our senior management for the fiscal year ended June 30, 2008 was Ps.4.05 million.
Powers of directors
Our bylaws establish, in Section 18, that the board of directors has full and broad powers to organize, manage and direct us to fulfilling the corporate purpose.
Retirement of directors
Our bylaws do not establish any requirements or provisions regarding age limits for director’s retirement, nor do they require a number of shares a director must own to qualify for the position.
Rights, preferences and restrictions attaching to the common shares
Dividend rights
The Argentine Corporation Law No. 19,550 establishes that the distribution and payment of dividends to shareholders is valid only if they result from realized and net earnings of the company pursuant to an annual balance sheet approved by the shareholders. Our board of directors submits our financial statements for the previous financial year, together with the reports of our Supervisory Committee, to the Annual Ordinary Shareholders’ Meeting. This meeting must be held by October 30 of each year to approve the financial statements and decide on the allocation of our net income for the year under review. The distribution, amount and payment of dividends, if any, must be approved by the affirmative vote of the majority of the present votes with right to vote at the meeting.
The shareholders’ meeting may authorize payment of dividends on a quarterly basis provided no applicable regulations are violated. In that case, all and each of the members of the board of directors and the supervisory committee will be jointly and severally unlimitedly liable for the refund of those dividends if, as of the end of the respective fiscal year, the realized and net earnings of the Company are not sufficient to allow the payment of dividends.
When we declare and pay dividends on the common shares, the holders of our GDRs, each representing the right to receive ten ordinary shares, outstanding on the corresponding registration date, are entitled to receive the dividends due on the common shares underlying the GDRs, subject to the terms of the Deposit Agreement dated as of May 24, 1994, as amended and restated as of December 12, 1994, as further amended and restated as of November 15, 2000, executed by and between us, The Bank of New York, as depositary and the eventual holders of GDRs. The cash dividends are to be paid in Pesos and, except under certain circumstances, are to be converted by the Depositary into U.S. dollars at the exchange rate prevailing at the conversion
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date and are to be paid to the holders of the GDRs net of any applicable fee on the dividend distribution, costs and conversion expenses, taxes and public charges. Since January 2002 and due to the devaluation of the Peso, the exchange rate for the dividends will occur at a floating market rate, which, as of the date of this annual report is Ps.3.406 for each U.S. dollar.
Our dividend policy is proposed from time to time by our board of directors and is subject to shareholders’ approval at an ordinary shareholders’ meeting. Declarations of dividends are based upon our results of operations, financial condition, cash requirements and future prospects, as well as restrictions under debt obligations and other factors deemed relevant by our board of directors and our shareholders.
Dividends may be lawfully paid only out of our retained earnings determined by reference to the financial statements prepared in accordance with Argentine GAAP. In accordance with the Argentine Companies Law, net income is allocated in the following order: (i) 5% is retained in a legal reserve until the amount of such reserve equals 20% of the Company’s outstanding capital; (ii) dividends on preferred stock or common shares or other amounts may be retained as a voluntary reserve, contingency reserve or new account, or (iii) for any other purpose as determined by the Company’s shareholders at an ordinary shareholders’ meeting.
Our legal reserve is not available for distribution. Under the applicable regulations of the Comisión Nacional de Valores, dividends are distributed pro rata in accordance with the number of shares held by each holder within 30 days of being declared by the shareholders for cash dividends and within 90 days of approval in the case of dividends distributed as shares. The right to receive payment of dividends expires three years after the date on which they were made available to shareholders. The shareholders’ meeting may authorize payment of dividends on a quarterly basis provided no applicable regulations are violated. In such case, all and each of the members of the board of directors and the supervisory committee will be jointly and severally liable for the refund of those dividends if, at the end of the respective fiscal year, the realized and net earnings of the Company are not sufficient to allow for the payment of dividends.
Voting rights and staggered elections
Our stock capital is composed by book-entry common shares with face value of Ps. 1 per share and entitled to one vote each.
All directors and alternate directors are elected for a three-year term.
Our by laws do not consider staggered elections.
Rights to share in IRSA’s profits
The holders of our common shares have the right to participate in our net and realized profits on a pro rata basis of their respective interests.
Pursuant to the Corporations Law and Section 29 of our bylaws, liquidated and realized profits of each fiscal year shall be distributed as follows:
allocate 5% of such net profits to legal reserve, until the amount of such reserve equals 20% of our capital stock;
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the sum established by the shareholders’ meeting as remuneration of the board of Directors and the supervisory committee; and
dividends, additional dividends to preferred shares if any, or to optional reserve funds or contingency reserves or to a new account, or for whatever purpose the shareholders determine at the shareholders’ meeting.
Rights to share in any surplus in the event of liquidation
In the event of liquidation, dissolution or winding-up of our company, our assets are:
to be applied to satisfy our liabilities; and
to be proportionally distributed among holders of preferred stock in accordance with the terms of the preferred stock. If any surplus remains, our shareholders are entitled to receive and share proportionally in all net assets available for distribution to our shareholders, subject to the order of preference established by our by-laws.
Provisions related to a shareholder’s ownership of certain amount of shares
Section 9 of our by-laws provides that the acquisition by any person or group, directly or indirectly of our shares, convertible securities, rights to receive any of those securities that may grant that person the control of our company or 35% or more of our capital stock may only be done by complying with certain tender offer rules for all of our shares, except for:
acquisitions by persons holding or controlling shares or convertible securities in accordance to Decree No. 677/2001, notwithstanding the provisions of theComisión Nacional de Valores; and
holdings of more than 35%, which derive from the distribution of shares or dividends paid in shares approved by the shareholders, or the issuance of shares as a result of a merger approved by the shareholders; in both cases, the excess holding shall be disposed of within 180 days of its registration in the relevant shareholder’s account, or prior to the holding of our shareholders meeting, whatever occurs first.
Our shareholders modified the first of the above exceptions in their shareholder meeting on October 10, 2007, to include the control concept under Decree No. 677/2001, which provides for the effective control regularly held in addition to the legal control.
Directors, senior managers, executive officers, members of the supervisory committee, and controlling shareholders of an Argentine company whose securities are publicly listed, should notify the Comisión Nacional de Valores on a monthly basis, of their beneficial ownership of shares, debt securities, and call and put options related to securities of such companies and their controlling, controlled or affiliated companies.
In addition, the Comisión Nacional de Valores must be immediately notified of transactions which cause a person’s holdings of capital stock of an Argentine company whose securities are publicly listed to hold 5% or more of the voting power and of every change in the holdings of such person that represents a multiple of 5% of the voting power. Holders of more than 50% of the common shares of a company or who otherwise have voting control of a company, as well as directors, officers and members of the supervisory committee, must provide
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the Comisión Nacional de Valores with annual reports setting forth their holdings in the capital stock of such companies and monthly reports of any change in their holdings.
Procedure to change the rights of stockholders
The rights of holders of stock are established in the Corporations Law and in the bylaws. The rights of shareholders provided for by the Corporations Law may not be diminished by the bylaws. Section 235 of the Corporations Law establishes that the amendment of the bylaws should be approved by the absolute majority of our shareholders at an extraordinary shareholders meeting.
On October 31, 2003 in the ordinary and extraordinary annual shareholders meeting, shareholders decided not to adhere to the “Régimen Estatutario Optativo de Oferta Pública de Adquisición Obligatoria” (Optional Statutory Body of Public Offering of Compulsory Acquisition) provided under Decree No. 677/2001, consequently, shareholders decided to incorporate that provision under Section 1 of the by-laws.
Ordinary and extraordinary shareholders’ meetings
Our by-laws provide that shareholders’ meetings may be called by our board of directors or by our Supervisory Committee or at the request of the holders of shares representing no less than 5% of the common shares. Any meetings called at the request of shareholders must be held within 30 days after the request is made. Any shareholder may appoint any person as its duly authorized representative at a shareholders meeting, by granting a proxy. Co-owners of shares must have single representation.
In general, the following matters can be considered only at a special shareholders’ meeting (asamblea extraordinaria):
matters that may not be approved at an ordinary shareholders’ meeting;
the amendment of our by-laws;
reductions in our share capital;
redemption, reimbursement and amortization of our shares;
mergers, and other corporate changes, including dissolution and winding-up;
limitations or suspensions to preemptive rights to the subscription of the new shares; and
issuance of debentures, convertible negotiable obligations and bonds that not qualify as notes (obligaciones negociables).
In addition, pursuant to Decree 677/2001, at an ordinary shareholders’ meeting, our shareholders must consider (i) the disposition of, or creation of any lien over, our assets as long as such decision has not been performed under the ordinary course of business; (ii) the execution of administration or management agreements; and (iii) whether to approve the payment of any agreement providing assets or services to us as long as such payment is material when measured against the volume of the ordinary course of business and our shareholders’ equity.
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In accordance with our by-laws, ordinary and special shareholders’ meetings (asamblea extraordinaria) are subject to a first and second quorum call, the second to occur upon the failure of the first. The first and second notice of ordinary shareholders’ meetings may be made simultaneously. In the event that both are made on the same day, the second must occur at least one hour after the first. If simultaneous notice was not given, the second notice must be given within 30 days after the failure to reach quorum at the first. Such notices must be given in compliance with applicable regulations.
A quorum for an ordinary shareholders’ meeting on the first call requires the presence of a number of shareholders holding a majority of the shares entitled to vote and, on the second call, the quorum consists of the number of shareholders present, whatever that number. Decisions at ordinary shareholders’ meetings must be approved by a majority of the votes validly exercised by the shareholders.
A quorum for a special shareholders’ meeting (asamblea extraordinaria) on the first call requires the presence of persons holding 60% of the shares entitled to vote and, on the second call, the quorum consists of the number of shareholders present, whatever that number. Decisions at special shareholders’ meeting (asamblea extraordinaria) generally must be approved by a majority of the votes validly exercised.
However, pursuant to the Argentine Corporations Law No. 19,550, all shareholders’ meetings, whether convened on a first or second quorum call, require the affirmative vote of the majority of shares with right to vote in order to approve the following decisions:
advanced winding-up of the company;
transfer of the domicile of the company outside of Argentina;
fundamental change in the purpose of the company;
total or partial mandatory repayment by the shareholders of the paid-in capital; and
a merger or a spin-off, when our company will not be the surviving company.
Holders of common shares are entitled to one vote per share. Owners of common shares represented by GDRs exercise their voting rights through the GDR Depositary, who acts upon instructions received from such shareholders and, in the absence of instructions, votes in accordance with the instructions given to the GDR Depositary by the board of directors as set forth in a written notice delivered to the GDR Depositary prior to the meeting.
The holders of preferred stock are not entitled to voting rights. However, in the event that no dividends are paid to such holders for their preferred stock, the holders of preferred stock are entitled to voting rights. Holders of preferred stock are also entitled to vote on certain special matters, such as a transformation of the corporate type, early dissolution, change to a foreign domicile, fundamental change in the corporate purposes, total or partial replacement of capital losses, mergers in which our company is not the surviving entity, and spin-offs. The same exemption will apply in the event the preferred stock is traded on any stock exchange and such trading is suspended or canceled.
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Limitations to own securities by non-resident or foreign shareholders
There are no legal limitations on ownership of securities or exercise of voting rights, by non-resident or foreign shareholders. However, foreign shareholders must fulfill certain requirements with the IGJ (“Inspección General de Justicia”) in order to assure that they will be able to properly exercise their voting rights. General Resolution No. 7 passed in September 2003 by the IGJ, and other related regulations set forth certain requirements for foreign entities registered with the IGJ. It provides, among other requirements, disclosure of information related to their proprietary interests in assets located outside Argentina to be at least equivalent in value to those located inside Argentina. The entities must comply with these requirements in order to (1) perform activities on a regular basis through their Argentine branches (Section 118 Argentine Corporate Law), or (2) exercise their ownership rights in Argentine Companies (Section 123 Argentine Corporate Law). In cases where the IGJ has concluded that the entities (a) do not have assets outside Argentina; or (b) have non-current assets that are not materially significant compared to those non-current assets which are owned by them and located in Argentina; or (c) the entity’s address in Argentina becomes the place where this entity makes a majority of its decisions, corporate or otherwise, the entities may be required to amend and register their by-laws to comply with Argentine law, thereby becoming an Argentine entity subject to Argentine law according to Section 124 of Argentine Corporate Law. In addition, Argentine companies with shareholders consisting of such entities that fail to comply with these requirements may be subject to the following sanctions: (1) the IGJ may not register corporate decisions adopted by the Argentine Company when its off-shore shareholder votes as a shareholder and when that vote is essential in attaining a majority. Any decisions made pursuant to such vote related to the approval of its annual balance sheet may be declared null and void for administrative purposes; (2) whether or not the vote of the off-shore entity is necessary for purposes of determining quorum or majority, the IGJ may register the decision without considering that vote; and (3) the directors of the Argentine Company may be held personally liable for actions taken by the Argentine Company.
Ownership threshold above which ownership should be disclosed
In addition, theComisión Nacional de Valores must be immediately notified of transactions which cause a person’s holdings of capital stock of an Argentine company whose securities are publicly listed to hold 5% or more of the voting power and of every change in the holdings of such person that represents a multiple of 5% of the voting power. Holders of more than 50% of the common shares of a company or who otherwise have voting control of a company, as well as directors, officers and members of the supervisory committee, must provide the Comisión Nacional de Valores with annual reports setting forth their holdings in the capital stock of such companies and monthly reports of any change in their holdings.
Amendments to our by-laws
On the shareholders’ meeting held on October 10, 2007, our shareholders decided to amend the following sections of the by-laws: (i) Section Thirteen in order to adapt the performance bonds granted by directors to current rules and regulations, and (ii) Section Sixteen in order to incorporate the possibility of holding remote board meetings pursuant the provisions of section 65 of Decree 677/01.
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Compliance with NYSE listing standards on corporate governance
New York Stock Exchange and Argentine Corporate Governance Requirements
Our corporate governance practices are governed by the applicable Argentine law; particularly, the Corporations Law, Decree N 677/01 and the Standards of the Comisión Nacional de Valores, as well as by our corporate by-laws. We have securities that are registered with the Securities and Exchange Commission and are listed on the New York Stock Exchange (the “NYSE”), and is therefore subject to corporate governance requirements applicable to NYSE-listed non-US companies (a “NYSE-listed” company).
NYSE-listed non-US companies that are categorized as “Foreign Private Issuers” may, in general, follow their home country corporate governance practices in lieu of most of the new NYSE corporate governance requirements (the “NYSE Sections”) codified in Section 303A of the NYSE’s Listed Company Manual. However, Foreign Private Issuers must comply with NYSE Sections 303A.06, 303A.11 and 303A.12(b) and 303A.12(c). Foreign Private Issuers must comply with Section 303A.06 prior to July 31, 2005 and with Sections 303A.11 and 303A.12(b) prior to the first annual meeting of shareholders held after January 15, 2004, or by October 31, 2004.
NYSE Section 303A.11 requires that Foreign Private Issuers disclose any significant ways in which their corporate governance practices differ from US companies under NYSE standards. A Foreign Private Issuer is simply required to provide a brief, general summary of such significant differences to its US investors either 1) on the company’s website (in English) or 2) in Form 20-F as distributed to their U.S. investors. In order to comply with Section 303A.11, we have prepared and have updated the comparison in the table below.
The most relevant differences between our corporate governance practices and NYSE standards for listed companies are as follows:
NYSE Standards for US companies Listed Companies Manual Section 303.A
IRSA’s Corporate Practices
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Neither Argentine law nor IRSA’s by-laws require that any such meetings be held.
IRSA’s board of directors as a whole is responsible for monitoring the company’s affairs. In addition, under Argentine law, the Board of Directors may approve the delegation of specific responsibilities to designated directors or non-director managers of the Company. Also, it is mandatory for public companies to form a supervisory committee (composed of syndics) which is responsible for monitoring legal compliance by the Company under Argentine law and compliance with its by-laws.
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C. Material Contracts
We do not have any material contract entered into outside the ordinary course of business other than some of the operations previously described under the sections Related Party Transactions, Recent Developments, and Our Indebtedness.
D. Exchange Controls
Currency Exchange Regulation
All foreign currency exchange transactions must be carried out in the free exchange market, in which the Argentine Central Bank participates by purchasing and selling foreign currency.
Import and Export of Capital
Import of Capital
Currently, there are no laws, executive orders or regulations nor any exchange controls in force in Argentina which limits the import of capital.
Pursuant to the Argentine Foreign Investment Law No. 21,382, and Decree No. 1,853/93, enacted in 1993, the purchase by foreign investors (any natural or legal person domiciled out of Argentina or an Argentine company of “foreign capital”) of capital participation in a company existing in Argentina (according to the Foreign Investment Act) shall constitute a foreign investment.
At present there are no restrictions on foreign investments in industries other than public broadcasting media, and no prior authorization is required to make foreign investments.
Therefore, no prior authorization is required in order to purchase our securities.
See Item 3: “Key Information – Exchange Rates”
Export of Capital, including the availability of cash or cash equivalents
From 1989 to December 3, 2001, there were no exchange controls restricting the peso-U.S. Dollar translation or the remittance of U.S. Dollars abroad. In compliance with the economic measures set forth by the Government by means of Decree No. 1570/01 dated December 3, 2001 and subsequent amendments thereto, aimed at protecting the integrity of the Argentine financial system, money could not be transferred abroad, unless expressly authorized by the Argentine Central Bank.
For purposes of accessing the funds deposited with financial institutions, clients were allowed to make electronic transfers between accounts of the same institution or others and in favor of the same holder or other persons; pay expenses by means of debit cards, checks, automatic debits and credit cards. Additionally, the Decree declared that new foreign currency deposits can only be received as time deposits, and no demand accounts denominated in foreign currency may be opened. Such restrictions were later relaxed and deposits of foreign currency in savings accounts (“cajas de ahorro”) by residents were allowed. Law No. 25,561 declared a public emergency in social, economic, administrative, financial and foreign exchange market matters, delegating to the Argentine executive branch until December 10, 2003, the powers to
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reorganize the financial, banking and foreign exchange system, reactivate the performance of the economy and improve the employment level and distribution of income, focusing on a program for the development of regional economies, creating the conditions for a sustainable economic growth, consistent with the public debt restructuring, and restructuring outstanding obligations affected by the new foreign exchange system. Such period was extended until December 31, 2006 by Law No. 26,077. Among other provisions, this law put an end to the convertibility system that had been in effect since April 1991, whereby pesos were convertible to U.S. Dollars at a rate of Ps. 1.0 per U.S Dollar.
As a consequence of the enactment of Decree 260/02, as of February 8, 2002 a single and free exchange market was implemented, through which all foreign currency exchange transactions are made. Exchange transactions are freely entered into by parties, but subject to the regulations and requirements set forth by the Central Bank. The Central Bank issued Communication “A” 3471, as amended, establishing restrictions or special requirements for exchange transactions. Lack of compliance with requirements and conditions shall result in the application of sanctions established by the Criminal Law Exchange Regime.
Such regulation has been modified several times and, therefore, only the most important provisions currently in force are mentioned below:
Argentine individuals and companies are authorized to buy up to US$ 2,000,000 per month;
the sale of foreign currency to non-residents, with the exception of international organizations, in an aggregate monthly amount exceeding US$ 5,000 shall also be previously authorized by the Central Bank, except when it is evidenced that the amounts used to purchase foreign currency (i) come from the payment of a resident to the non-resident which orders the transfer; and (ii) the payment is performed in relation to import, services, revenues or other commercial transfers for which the resident should have accessed to the exchange market in accordance to the exchange rules that regulated payments abroad to commercial account;
foreign currency exchange or arbitrage transactions with financial institutions located abroad must be previously authorized by the Central Bank, except where such financial institutions are located in countries which are members of the Basel Committee and have an international credit rating not lower than “A” granted by international rating agencies registered with the Central Bank, or where such transactions are entered into with branches of Argentine official banks located abroad;
future operations in regulated markets, options or forwards transactions and any other type of derivatives entered into and cancelled in Argentina and settled in local currency are not subject to any restriction, provided, however, that: (i) such operations do not contemplate any payment or transfer obligation of a resident to a foreign country; (ii) any inflow of foreign currency into the local exchange market for the purposes of such an operation by a non resident who is party to such a transaction is subject to a non-transferable deposit denominated in U.S. Dollars for an amount equal to 30% of the relevant transaction for a period of 365 days in accordance to such further conditions as indicated bellow (the “Non- Transferable Deposit”); and (iii) transfer of foreign currency abroad by a non resident derived from such transactions involving an aggregate monthly amount exceeding US$ 5,000 shall also be previously authorized by the Central Bank.
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Communication “A” 4285 dated January 17, 2005, relaxed restrictions on foreign currency transactions by abrogating the requirement of prior approval of the Central Bank for the execution of certain future and forward operations and for the access to the foreign exchange market for their cancellation. These operations include: (i) transactions executed by the financial system for the acquisition of certain time deposits having variable retribution; (ii) agreements for the coverage of foreign currencies and interest rates, (iii) agreements executed by exporters or importers for the coverage of commodity prices, as long as they are related to argentine foreign trade transactions; and (iv) the execution of external transactions in the form of Repos provided that they are executed for a term of at least 180 days. With the exception of inflows related to the external transactions in the form of Repos mentioned in (iv), any other inflow of foreign currency devoted to future or forward operations mentioned in (i) to (iii) is exempted from the obligation to constitute the Non- Transferable Deposit.
financial institutions must obtain prior authorization of the Central Bank in order to purchase any kind of asset, where the payment for such a transaction is made against delivery of foreign currency or any other kind of foreign denominated asset that is part of the General Exchange Position (Posición General de Cambios) (the “GEP”) of these financial institutions;
new imports of goods may be fully paid in advance, without consideration of the kind of good, as well as debts for imports with any maturity date;
access to the free and sole exchange market is allowed for payment of expired capital services originated in financial debts, except for financial entities subject to advance refinancings and rediscounts granted by the Central Bank and restructuring of its foreign debt (Decree No. 739/03 and Communication “A” 3940);
non-residents may have access to the exchange market for purposes of transferring funds in foreign currency collected in Argentina, originated from the amortization installments from national public bonds issued in foreign currency, to accounts in foreign banks;
there are no restrictions to make payments abroad for services rendered by non-residents on any basis (freight, insurance, royalties, technical advise, fees, etc.);
transfers abroad for the payment of indebtedness of private entities (comprising both financial and non-financial institutions) and government owned entities; provided that they fulfill certain regulatory requirements among others such as (i) a sworn statement affirming the fulfillment of Communication “A” 3602 informative requirements; (ii) the possession of documents which evidence the genuineness of the operation being cancelled, i.e., the entry into the country of the finance proceed and/or its use to cancel the financial or commercial debt, etc.; (iii) the amounts to be transferred have been adjusted, as the case may be, in accordance to Decree 214/02 as amended; and (iv) the fact that the inflows have remained in the county for the legal minimum term (180 days until May 26, 2005 or 365 for funds entered into after that date) has been verified;
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effective as of January 8, 2003, Argentine companies may freely transfer corporate profits and dividends corresponding to audited financial statements of local companies without prior Central Bank approval and transfers of funds abroad in order to pay reinsurance premiums will be subject only to the issuance of a statement from the regulatory authority on insurance matters Superintendencia de Seguros de la Nación (“Superintendent of Insurance Board”), with respect to the reason and amount to be transferred;
there is an obligation to enter the funds received as payment for the export of goods and services into the exchange market and to convert them into local currency within a time limit established by the Ministry of Economy and Production;
foreign currency obtained from the collection of exports corresponding to bills of lading shall be sold at the reference exchange rate when the foreign currency so obtained was not clear at the exchange market within the applicable legal terms, in accordance with applicable regulation.
before September 2005, inflows of foreign currency which would be applied to export advances and prefinancing were allowed into the local exchange market avoiding the non-transferable deposit requirement established by Decree No. 616/05, issued on June 10, 2005 by providing a sworn statement stating that foreign funds would be used for a specific purchase transaction entered into with the buyer. Subsequently, the BCRA by means of the Communication “A” 4415 substituted the sworn statement requirement with the exhibition of the shipping contract involved in said transaction. Later, on November 22, 2005 BCRA’s Communication “A”4443 relaxed this requirement exempting exporters from providing such documentary evidence if they proved that the inflow of funds would not exceed more than 25% of the amount they received during the last year for similar transactions.
The Government, through the Central Bank, holds control over capital inflows and outflows, enacting the applicable rules in this regard. Decree No. 616/05, issued on June 10, 2005, established that inflows and outflows of foreign currency into the local exchange market, and indebtedness transactions incurred by local residents that may result in a foreign currency-denominated payment to non-residents, need to be registered with the Central Bank. Furthermore, as from May 26, 2005, the following situations will be subject to certain requirements and conditions: (a) inflows of funds derived from foreign borrowing by the private financial and non financial sector, and (b) inflows of foreign currency by non-residents for the purpose of (i) holding a position in local currency, (ii) purchasing financial debt or assets and (iii) investing in government bonds in the secondary market. In these situations, the following requirements must be met: (i) inflows must remain in Argentina for 365 days to be computed as from the day they were negotiated in the local exchange market; (ii) the funds involved in the transactions covered by this decree must be deposited in a local bank account; (iii) a non-transferable deposit denominated in U.S. Dollars for an amount equal to 30% of the relevant transaction has to be made with the resulting proceeds. This deposit will only be reimbursed after the expiration of a 365 term, cannot bear interest (nor yield any other type of profit) and may not be used as collateral in any credit transaction. Such requirements do not apply to: (a) foreign direct investment, (b) primary placement of publicly traded debt or equity securities listed in one or more exchange markets, and (c) foreign trade and export finance debt related transactions.
Subsequently, Resolution No. 365/2005 from the Ministry of Economy and Production established that non-resident capital inflows destined for the primary subscription of Argentine Central Bank notes and income derived from the sale by residents of foreign assets for an amount greater than US$ 2 million per month, will also be subject to the aforementioned requirements.
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Moreover, said resolution provided certain exemptions to the requirement of making the non-transferable deposit requirement such as: (i) inflows derived from borrowings extended by multilateral and bilateral financial institutions and official credit agencies, and (ii) inflows derived from financial borrowings extended by foreign creditors, so long as they are devoted to investments in non-financial assets and the borrowed amounts are repaid at least 24 months after they were granted.
In that sense, non-financial assets include:
(i) investments recorded in the category “PP&E” of the financial statements (Notice 42303);
(ii) “intangible assets related to mine cost” and/or “research, prospection and exploration expenses” (Notice 42884);
(iii) “acquisition of rights to use” that had been recorded for accounting purposes in the category “intangible assets” of the company’s financial statements ( Notice 44670); and
(iv) investments in assets that are comparable to intellectual property rights, which are commercialized through the assignment of rights to use and should be recorded for accounting purposes in the category “intangible assets” of the company’s financial statements (Notice 46394).
This exemption automatically expires when the reported use is modified. In that case, the deposit established in item 6 of Communication “A” 4359 must be made within 10 business days of such event.
Communications “A” 4554 and “A” 4711, both dated September 24, 2007, established certain requirements and terms to file the documentation evidencing the correct classification of the transaction under the above mentioned exemption.
By contrast, according to Communication “C” 43075 dated September 26, 2005, inflows of foreign currency caused by a non-resident and devoted to the cancellation of payment obligations under a purchase agreement (including installment payments thereof) concerning a real estate property under construction may be registered as foreign direct investments provided that certain conditions are met.
Finally, Resolution No. 637/2005 from the Ministry of Economy and Production dated November 16, 2005 established that any inflow of foreign currency to the local exchange market devoted to the primary subscription of notes, bonds or participation certificates issued by the trustee of a trust, regardless of the channels in which they are traded (public or private offerings, or listings in self-regulated markets) is subject to the non-transferable deposit requirement established by Decree 616/05 if such requirement would be deemed applicable to the acquisition of the underlying assets of the trust.
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Reporting requirements on Direct Investments
On March 4, 2005 the Argentine Central Bank issued Communication “A” 4305 that regulates the reporting system of direct investments and real estate investments carried out by non-residents in Argentina and by Argentine residents abroad, which had been implemented through Communication “A” 4237 dated November 10, 2004.
Direct investments in Argentina of non-Argentine residents
Non-Argentine residents are compelled to comply with the reporting regime if the value of their investments in Argentina reaches or surpasses the equivalent of US$ 500,000 – measured in terms of the net worth of the company in which they participate or fiscal value of the real estate owned. If the investments do not reach such amount, the compliance with such regime is optional.
According to Communication “A” 4237, companies in which non-Argentine residents participate in and administrators of real estate pertaining to non-Argentine residents are those obliged to comply with the reporting regime.
Direct investments m7ade abroad by Argentine residents
Argentine investors are compelled to comply with the reporting regime if the value of their investments abroad reaches or surpasses the equivalent of US$ 1,000,000 – measured in terms of net worth of the company in which they participate or the fiscal value of the real estate they own.
If the value of those investments abroad does not exceed the equivalent of US$ 5,000,000, the declaration could be carried out annually instead of semiannually. If the investments do not reach the equivalent of US$ 1,000,000, the compliance with such regime is optional.
The first declarations will correspond to the semester ended on December 31, 2004, and will have to be filed within 90 calendar days as of such date.
Conclusions:
While the foreign exchange market system in Argentina has become increasingly flexible under recent regulations, Decree No. 616/05 severely deters short term inflows of foreign currency which are presumed to be of a speculative nature. Such determination on the part of the government is associated also to another short term economic policy goal and combined measures aimed at pegging or reasonably adjusting the United States Dollar value around Ps. 3.10 per U.S. Dollar. We cannot assess whether these policies will be maintained in the longer run and how changes made therein may affect the economy and our business perspectives. Furthermore, we cannot predict how changes in the evolution of the world economy and commodity prices which constitutes an important part of Argentina’s exports may influence exchange rates and control policies. Moreover, failure of the government to comply with financial commitments with the IMF or failure to reach an agreement with said institution may have an impact on the foreign exchange system. No assurance can be made as to the extent to which all such factors may lead to future restrictions that might further tighten foreign exchange controls or otherwise change the current foreign exchange system.
E. Taxation
United States Taxation
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Certain United States Federal Income Tax Consequences
The following summary describes certain United States federal income tax consequences of the ownership of GDS rights, common share rights, common shares, GDSs and warrants (collectively, “Equity Securities”) by U.S. Holders (as defined below) as of the date hereof. Except where noted, it deals only with Equity Securities held as capital assets and does not deal with special situations, such as those of dealers in securities or currencies, financial institutions, regulated investment companies, real estate investment trusts, tax-exempt entities, insurance companies, traders in securities that elect to use the mark-to-market method of accounting for their securities, persons holding Equity Securities as part of a hedging, integrated, conversion or constructive sale transaction or a straddle, persons owning 10% or more of our voting stock, persons liable for alternative minimum tax, investors in pass-through entities or persons whose “functional currency” is not the U.S. dollar.
As used herein, the term “U.S. Holder” means a beneficial holder of an Equity Security that is for United States federal income tax purposes:
an individual citizen or resident of the United States;
a corporation (or other entity treated as a corporation for United States federal income tax purposes) created or organized in or under the laws of the United States, any state thereof or the District of Columbia;
an estate the income of which is subject to United States federal income taxation regardless of its source; or
a trust.
if it is subject to the primary supervision of a court within the United States and one or more United States persons have the authority to control all substantial decisions of the trust; or
that has a valid election in effect under applicable United States Treasury regulations to be treated as a United States person.
The discussion below is based upon the provisions of the Internal Revenue Code of 1986, as amended (the “Code”), and regulations, rulings and judicial decisions thereunder as of the date hereof, and such authorities may be repealed, revoked or modified so as to result in United States federal income tax consequences different from those discussed below. In addition, this summary is based, in part, upon representations made by the GDS depositary to us and assumes that the deposit agreement, and all other related agreements, will be performed in accordance with their terms.
PERSONS CONSIDERING THE PURCHASE, OWNERSHIP OR DISPOSITION OF EQUITY SECURITIES SHOULD CONSULT THEIR OWN TAX ADVISORS CONCERNING THE UNITED STATES FEDERAL INCOME TAX CONSEQUENCES IN LIGHT OF THEIR PARTICULAR SITUATIONS AS WELL AS ANY CONSEQUENCES ARISING UNDER THE LAWS OF ANY OTHER TAXING JURISDICTION.
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If a partnership holds Equity Securities, the tax treatment of a partner will generally depend upon the status of the partner and the activities of the partnership. U.S. Holders that are partners of a partnership holding Equity Securities should consult their own tax advisors.
Issuance of GDS Rights, Common Share Rights or Warrants
A U.S. Holder will not be subject to United States federal income taxation with respect to the receipt of GDS rights, common share rights or warrants.
Basis and Holding Period of the GDS Rights and Common Share Rights
Except as provided in the following sentence, the basis of the GDS rights or common share rights distributed to a U.S. Holder will be zero. However, if either (i) the fair market value of the GDS rights or common share rights is 15% or more of the fair market value (on the date of distribution ) of the GDSs or common shares with respect to which they are distributed or (ii) the U.S. Holder of the GDS rights or common share rights irrevocably elects, in such holder’s United States federal income tax return for the taxable year in which the GDS rights or common share rights are received, to allocate part of the basis of such GDSs or common shares to such GDS rights or common share rights, then upon exercise or sale of the GDS rights or common share rights the U.S. Holder’s basis in such GDSs or common shares will be allocated between such GDSs or common shares and the GDS rights or common share rights in proportion to the fair market values of each on the date of distribution of the GDS rights or common share rights. No basis will be allocated to any such GDS rights or common share rights that lapse. A U.S. Holder will include its holding period in GDSs or common shares with respect to which the GDS rights or common share rights were distributed in determining the holding period of the GDS rights or common share rights.
Sale of Common Share Rights
Subject to the discussion under “—Passive Foreign Investment Company” below, for United States federal income tax purposes, a U.S. Holder will recognize taxable gain or loss upon the sale or other disposition of common share rights (including the sale by the GDS rights agent of common share rights corresponding to unexercised GDS rights of a U.S. Holder) in an amount equal to the difference between the amount realized for the common share rights (or, in the case of unexercised GDS rights, distributions by the depositary with respect to the sale of the underlying common share rights) and the U.S. Holder’s tax basis in the GDS rights or common share rights. Such gain or loss will generally be treated as capital gain or loss. Capital gain of individuals derived with respect to capital assets held for more than one year are eligible for reduced rates of taxation. The deductibility of capital losses is subject to limitations under the Code. Gain or loss recognized by a U.S. Holder on a sale of common share rights generally will be treated as United States source gain or loss for United States foreign tax credit purposes.
Exercise of the GDS Rights or Common Share Rights
U.S. Holders of GDS rights or common share rights will not recognize any gain or loss upon the exercise of the GDS rights or common share rights. The aggregate basis of GDSs or common shares and warrants acquired upon exercise of GDS rights or common share rights will be equal to the sum of such U.S. Holder’s basis in the GDS rights or common share rights exercised and the amount paid upon exercise of those GDS rights or common share rights. The basis of the GDSs or common shares and warrants will be determined by allocating such aggregate basis among the GDSs or common shares and the warrants received in proportion to the
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relative fair market values of these securities on the date the GDS rights or common share rights are exercised. The holding period of GDSs or common shares and warrants acquired upon exercise of GDS rights or common share rights will begin on the date the GDS rights or common share rights are exercised.
GDSs
If you hold GDSs, for United States federal income tax purposes, you generally will be treated as the owner of the underlying common shares that are represented by such GDSs. Accordingly, deposits or withdrawals of common shares for GDSs will not be subject to United States federal income tax.
The United States Treasury has expressed concerns that intermediaries in the chain of ownership between holders of GDSs and the issuer of the securities underlying the GDSs may be taking actions that are inconsistent with the claiming of foreign tax credits for holders of GDSs. Such actions would also be inconsistent with the claiming of the reduced rate of tax, described below, applicable to dividends received by certain non-corporate holders. Accordingly, the analysis of the creditability of Argentinean taxes and the availability of the reduced rate of tax for dividends received by certain non-corporate holders, each as described below, could be affected by actions taken by intermediaries in the chain of ownership between the holder of an GDS and our company.
Taxation of Dividends
Subject to the discussion under “—Passive Foreign Investment Company” below, distributions on our common shares or GDSs (including amounts withheld to reflect Argentinean withholding taxes) will be taxable as dividends to the extent paid out of our current or accumulated earnings and profits, as determined under United States federal income tax principles. Such dividends will be includable in your gross profit as ordinary income on the day actually or constructively received by you, in the case of our common shares, or by the depositary, in the case of our GDSs. Such dividends will not be eligible for the dividends received deduction allowed to corporations. With respect to United States non-corporate investors, certain dividends received before January 1, 2011 from a qualified foreign corporation may be subject to reduced rates of taxation. A foreign corporation is treated as a qualified foreign corporation with respect to dividends received from that corporation on common shares (or GDSs backed by such common shares) that are readily tradable on an established securities market in the United States. United States Treasury Department guidance indicates that our GDSs (which are listed on the NYSE), but not our common shares, are readily tradable on an established securities market in the United States. Thus, we do not believe that dividends that we pay on our common shares that do not underlie GDSs currently meet the conditions required for these reduced tax rates. Furthermore, there can be no assurance that our GDSs will be considered readily tradable on an established securities market in later years. Non-corporate holders that do not meet a minimum holding period requirement during which they are not protected from the risk of loss or that elect to treat the dividend income as “investment income” pursuant to Section 163(d)(4) of the Code will not be eligible for the reduced rates of taxation regardless of our status as a qualified foreign corporation. In addition, the rate reduction will not apply to dividends if the recipient of a dividend is obligated to make related payments with respect to positions in substantially similar or related property. This disallowance applies even if the minimum holding period has been met. Non-corporate U.S. Holders should consult their own tax advisors regarding the application of these rules given their particular circumstances.
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The amount of any dividend paid in Pesos will equal the U.S. dollar value of the Pesos received calculated by reference to the exchange rate in effect on the date the dividend is actually or constructively received by you, in the case of our common shares, or by the depositary, in the case of our GDSs, regardless of whether the Pesos are converted into U.S. dollars. If the Pesos received as a dividend are not converted into U.S. dollars on the date of receipt, you will have a tax basis in the Pesos equal to their U.S. dollar value on the date of receipt. Any gain or loss realized on a subsequent conversion or other disposition of the Pesos will be treated as United States source ordinary income or loss.
Subject to certain complex conditions and limitations, Argentinean withholding taxes on dividends may be treated as foreign taxes eligible for credit against your United States federal income tax liability. For purposes of calculating the foreign tax credit, dividends paid on our common shares or GDSs will be treated as income from sources outside the United States and will generally constitute passive income. If you do not elect to claim a credit for any foreign taxes paid during a taxable year, you may instead claim a deduction in respect of such foreign taxes. Further, in certain circumstances, if you:
have held our common shares or GDSs for less than a specified minimum period during which you are not protected from risk of loss, or
are obligated to make payments related to the dividends,
you will not be allowed a foreign tax credit for foreign taxes imposed on dividends paid on our common shares or GDSs. The rules governing the foreign tax credit are complex. You are urged to consult your tax advisors regarding the availability of the foreign tax credit under your particular circumstances.
To the extent that the amount of any distribution (including amounts withheld to reflect Argentinean withholding taxes) exceeds our current and accumulated earnings and profits for a taxable year, as determined under United States federal income tax principles, the distribution will first be treated as a tax-free return of capital, causing a reduction in the adjusted basis of our common shares or GDSs (thereby increasing the amount of gain, or decreasing the amount of loss, to be recognized by you on a subsequent disposition of our common shares or GDSs), and thereafter as capital gain recognized on a sale or exchange (as discussed below under “—Taxation of Capital Gains”). Consequently, such distributions in excess of our current and accumulated earnings and profits would generally not give rise to foreign source income and you would generally not be able to use the foreign tax credit arising from any Argentinean withholding tax imposed on such distributions unless such credit can be applied (subject to applicable limitations) against United States federal income tax due on other foreign source income in the appropriate category for foreign tax credit purposes. However, we do not expect to keep earnings and profits in accordance with United States federal income tax principles. Therefore, you should expect that a distribution will generally be treated as a dividend (as discussed above).
Distributions of our common shares that are received as part of a pro rata distribution to all of our shareholders generally will not be subject to United States federal income taxes.
Passive Foreign Investment Company
Based on the current and projected composition of our income and the valuation of our assets, including goodwill, we do not believe we were a passive foreign investment company (“PFIC”) for United States federal income tax purposes for the taxable year ending June 30, 2008, and we do not currently expect to become a PFIC, although there can be no assurance in this regard.
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In general, we will be a PFIC for any taxable year in which:
at least 75% of our gross profit is passive income; or
at least 50% of the value (determined based on a quarterly average) of our assets is attributable to assets that produce or are held for the production of passive income.
For this purpose, cash is a passive asset and passive income generally includes dividends, interest, royalties, and rents (other than royalties and rents derived in the active conduct of a trade or business and not derived from a related person). If we own at least 25% by value of the stock of another corporation, we will be treated, for purposes of the PFIC tests, as owning our proportionate share of that other corporation’s assets and receiving our proportionate share of its income.
The determination of whether we are a PFIC is made annually. Accordingly, it is possible that we may become a PFIC in the current or any future taxable year due to changes in the fair market value of our assets or income composition. If we are a PFIC for any taxable year during which you hold our Equity Securities, you will be subject to special tax rules discussed below.
If we are a PFIC for any taxable year during which you hold any of our Equity Securities, you will be subject to special tax rules with respect to any gain realized from a sale or other disposition, including a pledge, of such Equity Securities. If we are a PFIC for any taxable year during which you hold our common shares or GDSs, you will also be subject to special tax rules with respect to any “excess distribution” received. Distributions received in a taxable year that are greater than 125% of the average annual distributions received during the shorter of the three preceding taxable years or your holding period for the common shares or GDSs will be treated as excess distributions. Under these special tax rules:
the gain will be allocated ratably over your holding period for the Equity Securities;
the excess distribution will be allocated ratably over your holding period for our common shares or GDSs;
the amount allocated to the current taxable year, and any taxable year prior to the first taxable year in which we become a PFIC, will be treated as ordinary income; and
the amount allocated to each other year will be subject to tax at the highest tax rate in effect for that year and the interest charge generally applicable to underpayments of tax will be imposed on the resulting tax attributable to each such year.
If we are a PFIC for any taxable year during which you hold our Equity Securities and any of our non- United States subsidiaries is also a PFIC, a U.S. Holder would be treated as owning a proportionate amount (by value) of the common shares of the lower tier PFIC for purposes of the application of these rules. You are urged to consult your tax advisors about the application of the PFIC rules to any of our subsidiaries.
In addition, non-corporate U.S. Holders will not be eligible for reduced rates of taxation on any dividends received from us prior to January 1, 2011, if we are a PFIC in the taxable year in
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which such dividends are paid or in the preceding taxable year. You will be required to file Internal Revenue Service Form 8621 if you hold our Equity Securities in any year in which we are classified as a PFIC.
In certain circumstances, in lieu of being subject to the excess distribution rules discussed above, you may make an election to include gain on our common shares and GDSs as ordinary income under a mark-to-market method, provided that our common shares or GDSs are regularly traded on a qualified exchange or other market. Our common shares are listed on the Buenos Aires Stock Exchange , which must meet certain trading, listing, financial disclosure and other requirements to be treated as a qualified exchange under applicable United States Treasury regulations for purposes of the mark-to-market election, and no assurance can be given that the common shares are or will continue to be “regularly traded” for purposes of the mark-to-market election. Our GDSs are currently listed on the NYSE, which constitutes a qualified market, although there can be no assurance that the GDSs are or will be “regularly traded.” The mark to market election is currently not available with respect to GDS rights, common share rights and warrants.
If you make an effective mark-to-market election, you will include in each year as ordinary income the excess of the fair market value of our common shares or GDSs at the end of the year over your adjusted tax basis in our common shares or GDSs. You will be entitled to deduct as an ordinary loss each year the excess of your adjusted tax basis in our common shares or GDSs over their fair market value at the end of the year, but only to the extent of the net amount previously included in income as a result of the mark-to-market election.
Your adjusted tax basis in our common shares or GDSs will be increased by the amount of any income inclusion and decreased by the amount of any deductions under the mark-to-market rules. If you make a mark-to market election, it will be effective for the taxable year for which the election is made and all subsequent taxable years unless our common shares or GDSs are no longer regularly traded on a qualified exchange or the Internal Revenue Service consents to the revocation of the election. You are urged to consult your tax advisors about the availability of the mark-to-market election, and whether making the election would be advisable in your particular circumstances.
In some cases, holders of commons shares or GDSs (but not holders of GDS rights, common share rights or warrants) in a PFIC may be able to avoid the rules described above by electing to treat the PFIC as a “qualified electing fund” under Section 1295 of the Code. This option will not be available to you because we do not intend to comply with certain calculation and reporting requirements necessary to permit you to make this election.
You are urged to consult your tax advisors concerning the United States federal income tax consequences of holding our Equity Securities if we are considered a PFIC in any taxable year.
Taxation of Capital Gains
Subject to the discussion under “—Passive Foreign Investment Company” above, for United States federal income tax purposes, you will recognize taxable gain or loss on any sale, exchange, redemption or other taxable disposition of our Equity Securities in an amount equal to the difference between the amount realized for the common shares or GDSs and your tax basis in the common shares or GDSs. Such gain or loss will generally be treated as capital gain or loss. Capital gains of non-corporate shareholders derived with respect to capital assets held for more than one year are eligible for reduced rates of taxation. The deductibility of capital losses is
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subject to limitations under the Code. Any gain or loss recognized by you will generally be treated as United States source gain or loss for United States foreign tax credit purposes.
Information Reporting and Backup Withholding
In general, information reporting will apply to dividends in respect of our Equity Securities and the proceeds from the sale, exchange or redemption of our Equity Securities that are paid to you within the United States (and in certain cases, outside the United States), unless you are an exempt recipient such as a corporation. A backup withholding tax may apply to such payments if you fail to provide a taxpayer identification number or certification of other exempt status or fail to report in full dividend and interest income.
Backup withholding is not an additional tax. Any amounts withheld under the backup withholding rules will be allowed as a refund or a credit against your United States federal income tax liability provided the required information is timely furnished to the Internal Revenue Service.
Argentine Taxation
The following discussion is a summary of certain Argentine tax considerations associated with an investment in, ownership or disposition of, the shares or the GDSs by (i) an individual holder that is resident in Argentina, (ii) an individual holder that is neither domiciled nor resident in Argentina, (iii) a legal entity organized under the laws of Argentina and (iv) a permanent business establishment in Argentina owned by a foreign entity and (v) a legal entity that is not organized under the laws of Argentina, that does not have a permanent establishment in Argentina and is not otherwise doing business in Argentina on a regular basis. The discussion is for general information only and is based on current Argentine tax laws. Moreover, while this summary is considered to be a correct interpretation of existing laws in force as of the date of this annual report, no assurance can be given that the courts or administrative authorities responsible for the administration of such laws will agree with this interpretation or that changes in such laws or interpretations will not occur.
PROSPECTIVE INVESTORS ARE URGED TO CONSULT THEIR OWN TAX ADVISOR REGARDING THE PARTICULAR TAX CONSEQUENCES ARISING UNDER ANY TAXING JURISDICTION.
Dividends, either in cash, shares, or kind approved by our shareholders are currently exempt from Argentine withholding or other taxes.
Notwithstanding the foregoing, according to Argentine law, income tax will be applied to the amount of dividends distributed in excess of a company’s net taxable income determined in accordance with general income tax regulations for the fiscal years preceding the date of the distribution of such dividends. The legislation requires that companies withhold 35% of the amount of distributed dividends in excess of the net taxable income of such distribution, as determined in accordance with the income tax law. The withholding would not be applied to the payment of future dividends derived out of retained earnings obtained in the fiscal years ended prior to December 30, 1998. Dividends distributed by an Argentine company are not subject to this tax to the extent that those dividends arise from dividend income or other distributions received by such company from other Argentine companies.
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Due to certain amendments made to the Argentine Income Tax Law, it is not entirely clear whether certain amendments concerning payment of income tax on capital gains arising from the sale, exchange, or other disposition of shares are in effect or not. Although Opinion No. 351 of the National Treasury General Attorney Office clarified the legal status of certain matters affecting the tax treatment of capital gains certain issues still remain unclear.
Resident individuals
Under what we believe to be a reasonable interpretation of existing applicable tax laws and regulations: (i) income derived from the sale, exchange or other disposition of shares or GDSs by resident individuals who do not sell or dispose of Argentine shares on a regular basis would not be subject to Argentine income tax, and (ii) although there still exists uncertainty regarding this issue, income derived from the sale, exchange or other disposition of shares or GDSs by resident individuals who sell or disposes of Argentine shares on a regular basis should be exempt from Argentine income tax.
Foreign beneficiaries
Capital gains obtained by non residents or foreign entities from the sale, exchange or other disposition of shares or GDSs are exempt from income tax. Pursuant to a reasonable interpretation of existing applicable laws and regulations, and although the matter is not completely free from doubt, such treatment should also apply to those foreign beneficiaries that qualify as “offshore entities” for Argentine tax law purposes, when the shares are not listed in Argentina or in other jurisdictions. For this purpose, an offshore entity is any foreign legal entity which pursuant to its by-laws or to the applicable regulatory framework: (i) its principal activity is to invest outside the jurisdiction of its incorporation and/or (ii) cannot perform in such jurisdiction certain transactions.
Local entities
Capital gains obtained by Argentine entities (generally entities organized or incorporated under Argentine law, certain traders and intermediaries, local branches of non Argentine entities, sole proprietorships and individuals carrying on certain commercial activities in Argentina) derived from the sale, exchange or other disposition of shares or GDSs are subject to income tax at the rate of 35%.
Losses arising from the sale, exchange or other disposition of shares or GDSs can be applied only to offset such capital gains arising from the sale, exchange or other disposition of these securities.
WE RECOMMEND PROSPECTIVE INVESTORS TO CONSULT THEIR OWN TAX ADVISOR REGARDING THE PARTICULAR TAX CONSEQUENCES CONCERNING THE SALE OR OTHER DISPOSITIONS OF SHARES AND GDSs.
Value Added Tax
The sale, exchange, disposition, or transfer of shares or GDSs is not subject to Value Added Tax.
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Personal Assets Tax
Law No. 25,585 issued on April 24, 2002 and published in the Official Gazette on May 15, 2002 (and applicable to personal assets held as of December 31, 2002) introduces amendments to Law No. 23,966 and imposes the personal assets tax on shares and GDSs held by individuals and undivided estates domiciled or located in Argentina or abroad and legal entities not domiciled in Argentina, separately from other assets.
This amendment imposes the obligation to pay the personal assets tax on the Argentine private issuer of the shares and GDSs, and authorizes it to seek recovery of the amount so paid, without limitation, by way of withholding or by foreclosing on the assets that gave rise to such payment. The tax is levied on the proportional equity value of the shares as reflected in the most recent balance sheet closed as of December 31 of the taxable year, at the rate of 0.5% without any non-taxable minimum being applicable.
Our shareholders approved the absorption of personal asset tax by the Company for the years 2002 to 2008. There can be no assurance that in the future this tax will be absorbed by the Company.
Tax on Minimum Notional Income (Impuesto a la Ganancia Mínima Presunta, IGMP)
Companies domiciled in Argentina, partnerships, foundations, sole proprietorships, trusts, certain mutual funds organized in Argentina, and permanent business establishments owned by foreign persons, among other taxpayers, shall apply a 1% rate to the total value of assets held by such persons, above an aggregate nominal amount of Ps. 200,000. Nevertheless, shares and GDSs issued by entities subject to such tax are exempt from paying the IGMP.
Gross Income Tax
The gross income tax is a local tax; therefore, the rules of the relevant provincial jurisdiction should be considered, which may levy this tax on the customary purchase and sale, exchange or other disposition of shares and GDSs, and/or the collection of dividends at an average rate of 3%, unless an exemption is applicable. In the particular case of the City of Buenos Aires, any transaction involving shares and/or the collection of dividends and revaluations is exempt from this tax.
There is no gross income tax withholding system applicable to the payments made to foreign beneficiaries.
Stamp Tax
The stamp tax is a local tax that is generally levied on the instrumentation of onerous acts executed within a certain territorial jurisdiction or outside a certain territorial jurisdiction but with effects in such jurisdiction.
In the City of Buenos Aires, the stamp tax has been repealed for all those acts that do not imply an onerous conveyance of real property or the lease of real property. However, most provincial tax authorities maintain this tax in effect for all acts in general; therefore, the instruments which implement onerous transactions (including issuance, subscription, placement and transfer) involving the shares or GDSs, executed in other jurisdictions, or with effects in those jurisdictions, could be deemed to be subject to this tax.
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Tax on Credits and Debits in Bank Accounts
This tax is levied upon debits and credits in bank accounts and upon other transactions which, due to their special nature and characteristics, are similar or could be used in substitution for a checking account, such as payments on behalf of or in the name of third parties, procedures for the collection of securities or documents, drafts and transfers of funds made by any means, when these transactions are performed by local banks.
The tax law and its regulations provide several exemptions to this tax. For example, it does not apply to entities recognized as exempt from income tax, to debits and credits relating to salaries, to retirement and pension emoluments credited directly by banking means and withdrawals made in connection with such credits, to credits in checking accounts originated from bank loans, and to transfers of checks by endorsement.
The general rate of the tax is 0.6%. An increased rate of 1.2% applies in cases in which there has been a substitution for the use of a checking account.
Pursuant to Argentine Regulatory Decree 380/2001, as amended, 34% of the tax paid on credits levied at the 0.6% rate and 17% of the tax paid on transactions levied at the 1.2% tax rate can be used, to its exhaustion, as a credit against income tax, tax on minimum notional income and/or the special contribution on cooperatives capital.
Court and Other Taxes
In the event that it becomes necessary to institute legal actions in relation to the shares or GDS’s in Argentina, a court tax (currently at a rate of 3.0%) will be imposed on the amount of any claim brought before the Argentine courts sitting in the City of Buenos Aires.
Argentina imposes neither an estate nor gift tax on a decedent, donor, legatee or donee. No Argentine tax is imposed on the deposit or withdrawal of shares in exchange for GDSs. Other than the taxes discussed above, no other Argentine taxes are applicable to an investment in shares or GDSs. At present, there is no national tax specifically applicable to the transfer of securities.
Tax Treaties
Argentina has entered into tax treaties with several countries. There is currently no tax treaty or convention in effect between Argentina and the United States.
F. Dividends and Paying Agents
This Section is not applicable.
G. Statement by Experts
This section is not applicable.
H. Documents on display
We file annual, quarterly and other information with the SEC. You may read and copy any document that we file at the public reference rooms of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549; and 500 West Madison Street, Suite 1400, Chicago, Illinois 60661. You may obtain information on the operation of the Public Reference Rooms by calling the SEC at 1-
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800-SEC-0330. Our Internet address is http://www.irsa.com.ar. It should be noted that nothing on our website should be considered part of this annual report. You may request a copy of these filings at no cost, by writing or calling the offices of IRSA, Moreno 877, (C1091AAQ) Buenos Aires, Argentina. Our telephone number is +54-11-4323-7400.
I. Subsidiary Information
In the normal course of business, we are exposed to interest rate and exchange rates risks, primarily related to changes in exchanges rates and interest rates. We manage our exposure to these risks through the use of various financial instruments, none of which are entered into for trading purposes. We have established policies and procedures governing the use of such financial instruments. The use of financial derivatives instruments is oriented to our core business and is supervised by internal control policies.
The following discusses our exposure to these risks. This discussion contains forward-looking statements that are subject to risks and uncertainties. Actual results could vary materially as a result of a number of factors including those set forth in the risk factors section of this Form 20-F. Uncertainties that are either nonfinancial or nonquantifiable, such as political, economic, tax, other regulatory, or credit risks, are not included in the following assessment of our market risks.
Interest Rate Risk
The primary objective of our investment activities is to preserve capital while maximizing yields without significantly increasing risk. To achieve this objective, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including both government and corporate obligations and money market funds.
Investments in both fixed rate and floating rate interest earning instruments carry varying degrees of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates. In general, longer dated securities are subject to greater interest rate risk than shorter dated securities. While floating rate securities are generally subject to less interest rate risk than fixed rate securities, floating rate securities may produce less income than expected if interest rates decrease. Due in part to these factors, our investment income may fall short of expectations or we may suffer losses in principal if securities that have declined in market value due to changes in interest rates are sold. To date, we have not utilized derivative financial instruments to hedge interest rate risk; however, there can be no assurance as to the employment of hedging strategies in the future.
We are also exposed to changes in interest rates primarily as a result of our borrowing activities, which include short-term borrowings, and other floating-rate long-term debt used to maintain liquidity and fund our business operations.
We are also exposed to changes in interest rates as a result of Tarshop S.A.´s retained interests in securitized credit card receivables which fair value depends, among others factors, on the TDFs interest rate. Under securitization programs, TDFs pay the variable interest rate published by Argentine Central Bank, known as “BADLAR” plus a fixed spread. The spread
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level is set according to general market conditions at the time of issuance. Both TDFs “A” and “B” have different cap and floor settings in order to mitigate interest rate risk exposure. Regarding to the fair value calculation, revolving series have less interest rate risk than non revolving series.
Foreign Exchange Risk
From April 1, 1991, until the beginning of 2002, Convertibility Law No. 23,928 was applicable to Argentina. This law established a fixed exchange rate, under which the Argentine Central Bank was obliged to sell U.S. Dollars to any person at a fixed rate of one Peso per U.S. Dollar. Accordingly, the foreign currency fluctuations were reduced to a minimum level, during this period.
The primary economic change implemented by the current Argentine government in January 2002 was the announcement of the devaluation of the Peso. Due to the end of the Convertibility Plan, our foreign exchange exposure has increased considerably.
Foreign currency exchange rate fluctuations could impact our cash flow in Pesos, since some of our products and inputs are payable in U.S. Dollars.
Foreign currency exchange restrictions imposed by the Argentine government in the future could prevent or restrict our access to U.S. Dollars, thus affecting our ability to service our U.S. Dollar-denominated liabilities. Also, fluctuations in the exchange rate between the Peso and the U.S. Dollar may adversely affect the U.S. Dollar equivalent of the Peso price of our common shares on the Buenos Aires Stock Exchange, and as a result would likely affect the market price of our GDSs in the United States.
IRSA Indebtedness
Long-Term Debt:
Fixed rate
(US$ denominated)(1)(3)
(US$ denominated)(1)(4)
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Alto Palermo Indebtedness
Fixed rate Debt (US$)(5)
Principal Payment and accrued interest(1)
Average Interest Rate
Principal Payment and accrued interest(2)
Fixed rate Debt (Pesos)
Principal Payment and accrued interest(3)
Sensitivity to Exchange Rates and Interest rates
We are also exposed to changes in interest rates primarily as a result of our borrowing activities, which include short-term borrowings, and other floating-rate long-term debt used to maintain liquidity and fund our business operations. Our interest expense is sensitive to changes in the general level of interest rates because part of our long-term debt (i.e., our secured floating rate notes and syndicated loan, which as of the date of this annual report have been repaid) bear interest at floating rates.
As of the date of this annual report we do not have any floating rate notes or loans, as a result our interest expenses are not sensitive to changes in the general level of interest rates.
As of the date of this Form 20-F, outstanding indebtedness represented by our notes due 2017 accrues interest at a fix rate of 8.5% per year. Its fair market value tends to drop 5.3% per 100 Bps of increase in interest rate levels. In addition, APSA’s Series I fair market value tends to drop 5.5% and Series II 1.99% per 100 Bps of increase in interest rate levels.
Also, a change of 1% in Ps. / US$ exchange rate would imply a Ps. 5.6 million change in the Peso equivalent of our debt face value and increases our interest expenses in Ps. 0.5 million annually. In addition, a change of 1% in Ps. / US$ exchange rate would imply a Ps. 5.1 million change in the Peso equivalent of APSA’s debt face value and increases their interest expenses in Ps. 0.4 million annually.
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Since June 30, 2008, the Peso has deppreciated versus the U.S. dollar from an exchange rate of Ps.3.025 =US$1.00 to an exchange rate of Ps.3.4060=US$1.00 at December 17, 2008 as quoted by Banco de la Nación Argentina at the U.S. dollar selling rate. The devaluation of the Peso against the U.S. dollar during such period was 12,6%.
This sensitivity analysis provides only a limited, point-in-time view of the market risk sensitivity of certain of our financial instruments. The actual impact of our market foreign exchange rate and/or interest rate changes on our financial instruments may differ significantly from the impact shown in the sensitivity analysis
Current Situation
Although during the six months after the close of fiscal year ended June 30, 2008, the nominal value of our debt did not change, variations in market prices and in exchange rates produced significant variations on the fair value of our debt.
As of December 10, 2008, the fair market value of the outstanding indebtedness was Ps. 216.5 millions. The fair market value of our debt tends to drop 4.6% per 100 Bps of increase in interest rate levels. In addition, APSA’s Series I fair market value tends to drop 4.1% and Series II 0.8% per 100 Bps of increase in interest rate levels.
Also, a change of 1% in Ps. / US$ exchange rate would imply a Ps. 6.3 million change in the Peso equivalent of our debt face value and would increase our interest expenses in Ps. 0.6 million annually. In addition, a change of 1% in Ps. / US$ exchange rate would imply a Ps. 5.7 million change in the Peso equivalent of APSA’s debt face value and increases their interest expenses in Ps. 0.5 million annually.
As of December 10, 2008 the amount of cash, cash equivalents and current investments was reduced by approximately 75% since Junes 30, 2008. A 100 BPs parallel change in the interest rate curve would not have a significant impact on the value of our investment portfolio, its value tends to drop in Ps. 0.17 millions per 100 Bps of increase in interest rate level. Also, an increase of 1% in Pesos / dollars exchange rate would imply an increase of Ps. 0.1 million in the value of our investments in foreign currency.
The resuts of Alto Palermo’s subsidiary Tarshop S.A., might be negatively impacted by a reduction in revenues because of lower transaction volumes following a general slowdown in the economy, increased competition or regulation and increased perceived risk thatmay prompt Tarshop to reduce its credit exposure. A drop in interest rates on customer accounts may reduce revenues as a result of increased regulations or more competition in the marketplace. Results may also be affected negatively because of higher funding costs that result from negative conditions in global and local financial markets, higher levels of subordination upon the underwriting of Credit Card Trusts as a result of increasing delinquency levels, lack of traditional sources of funding such as Pension Funds or increased financial trust operating costs. We cannot assure you that it will be able to seek funding through financial trusts in the furture. Results may also be adversely affected because of increases in bad loans and write offs caused by a decrease in the purchasing power of cardholders or a slowdown of the economy, extending our credit portfolio average duration.
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PART II
A. Fair Price Provision
At our annual meeting held on October 30, 2000, our shareholders approved an amendment to our bylaws which included the adoption of a fair price provision (the “Fair Price Provision”). On March 8, 2002 our shareholders decided to make a new amendment to Article Nine of our bylaws including, among others, an increase in the minimum percentage of capital obliged to comply with the Fair Price Provision, from twenty percent (20%) to thirty five percent (35%), according to Decree No. 677/2001. On October 10, 2007, our shareholders decided to make a new amendment to Article Nine of our bylaws, to include the control concept under Decree No. 677/2001, which provides for the effective control regularly held in addition to the legal control.
The following description is a summary of the main provisions of the Fair Price Provision, which constitutes Article Nine of our bylaws and does not contain a description of all of the terms of the Fair Price Provision. The Fair Price Provision prohibits a party seeking to acquire, directly or indirectly, either control or (together with such party’s other holdings) thirty five percent (35%) or more of our capital stock without complying with the procedural and price requirements described below. Acquisitions made in violation of the Fair Price Provision are deemed ineffective against us and will not be registered in our share registry. Shares acquired in violation of the Fair Price Provision shall have no voting or equity rights until the Fair Price Provision has been complied with. The Fair Price Provision applies to transactions involving shares of our common stock and any securities convertible in shares of our common stock, including, without limitation, convertible debentures and bonds and our global depositary receipts (“GDRs”). The Fair Price Provision excludes certain acquisitions of shares in certain limited circumstances.
The Fair Price Provision provides that a party seeking to acquire, directly or indirectly, control of our company or thirty five percent (35%) or more of our capital stock shall be required to make a public tender offer for all of the outstanding common stock of us and any shares of common stock into which outstanding securities of our company are presently convertible or exchangeable in accordance with the procedural and price terms of the Fair Price Provision and in accordance with applicable law. For purposes of the thirty five percent threshold contained in the Fair Price Provision parties acting in concert or which are under common control or administration are deemed a single party.
There are cases excluded from the tender offer requirements:
acquisitions by existing shareholders or by those exercising control over shares or convertible securities in accordance with the provisions under Decree 677/2001, irrespective of the application of the regulations imposed by the Comisión Nacional de Valores; and
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The Fair Price Provision requires the offering party to notify use of the tender offer simultaneously with its filing of the public tender offer with the Comisión Nacional de Valores. The notice to us is required to set forth all of the terms and conditions of any agreement that the offering party has made with any other of our shareholders with respect to the proposed transaction and to provide, among other things, the following information:
the identity and nationality of the offering party and, in the event the offer is made by a group, the identity of each member of the group;
the terms and conditions of the offering, including the price, the tender offer period and the requirements for accepting the tender offer;
accounting documentation required by Argentine law relating to the offering party;
details of all prior acquisitions by the offering party of shares or securities convertible into shares of our capital stock.
We will distribute the information provided by the offering party to our shareholders.
The Comisión Nacional de Valores regulations require that transactions which cause a person’s holdings of capital stock of a registered Argentine company, to hold 5% or more of the voting power, should be immediately notified to the Comisión Nacional de Valores. Thereafter, every change in the holdings that represents a multiple of 5% of the voting power should also be notified.
The Fair Price Provision requires that the consideration paid in the tender offer be paid in cash and that the price paid for each share in the tender offer be the same and not less than the highest price per share derived from the five following alternative valuation methods:
the highest price per share of our common stock paid by the offering party, or on behalf of the offering party, for any acquisition of shares or convertible securities within the 2 years prior to the commencement of the tender offer;
the highest closing selling price of a share of our common stock on the Bolsa de Comercio de Buenos Aires during the thirty day period immediately preceding the commencement of the tender offer;
the highest price resulting from the calculations made according to the provisions of (i) and (ii) above multiplied by a fraction the numerator of which is such highest price and the denominator of which is the lowest closing price of a share of our common stock on the Bolsa de Comercio de Buenos Aires during the two-year period prior to the period referred to in sub-sections (i) or (ii), as applicable;
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our aggregate net earnings per share during our preceding four completed fiscal quarters prior to the commencement of the tender offer, multiplied by our highest price to earnings ratio during the two-year period immediately preceding the commencement of the tender offer. Such multiples shall be determined considering the average closing selling price of our common stock on the Bolsa de Comercio de Buenos Aires, and our aggregate net income from our preceding four completed fiscal quarters; and,
the book value per share of our common stock at the time the tender offer is commenced, multiplied by the highest ratio determined by a fraction the numerator of which is the closing selling price of a share of our common stock on the Bolsa de Comercio de Buenos Aires on each day during the two year period prior to the commencement of the tender offer and the denominator of which is the latest known book value per share of our common stock on each such date.
B. Limitations on the payment of dividends.
On February 2, 2007 we issued our 2017 fixed rate notes for a total amount of US$150 million at an annual interest rate of 8.5% payable semi-annual and mature on February 2, 2017. This bond limits our ability to pay dividends which may not exceed the sum of:
100% of our cumulative consolidated net income if the consolidated interest coverage ratio is at least 4.0 to 1.
C. This section is not applicable.
D. This section is not applicable.
E. This section is not applicable.
A. Disclosure Controls and Procedures.
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the reports we file or submit under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized
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and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our Chief Executive Officer, Chief Financial Officer and Chief Administrative Officer, as appropriate, to allow timely decisions regarding required disclosure. In connection with the preparation of this Annual Report on Form 20-F, we carried out an evaluation under the supervision and with the participation of our management, including our Chief Executive Officer, Chief Financial Officer and Chief Administrative Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2008. Based upon this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of fiscal year 2008.
B. Management’s Annual Report on Internal Control Over Financial Reporting
The management of IRSA Inversiones y Representaciones S.A. is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a–15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with Argentine generally accepted accounting principles and reconciling the Argentine GAAP figures to US GAAP.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of June 30, 2008. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in Internal Control–Integrated Framework. Based on this assessment and the criteria set forth in Internal Control–Integrated Framework, management concluded that, as of the end of fiscal year 2008, our internal control over the financial reporting was effective.
C. Attestation Report of the Registered Public Accounting Firm
The Company’s independent registered public accounting firm, Price Waterhouse & Co. S.R.L., Buenos Aires, Argentina -member firm of PricewaterhouseCoopers-, has issued an attestation report on the effectiveness of the Company’s internal control over financial reporting, as stated in their report included herein. See “Report of Independent Registered Public Accounting Firm”.
D. Changes in Internal Control Over Financial Reporting
During the period covered by this report, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
A. Audit Committee Financial Expert
Pursuant to the System governing the Transparency of Public Offers established through Decree No. 677/2001, the rules of the Comisión Nacional de Valores, its Resolution No. 400 and 402, the board of directors established that the Audit Committee shall be a committee of the board of directors. The main function of the Audit Committee is to assist the board of directors in performing its duty of exercising due care, diligence and competence in issues relating to us,
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specifically in the enforcement of the accounting policy and in the issue of accounting and financial information, the management of business risk and of internal control systems, the conduct and ethical soundness of the company’s business, the supervision of the integrity of our financial statements, the compliance by our company with the legal provisions, the independence and capability of the independent auditor and the performance of the internal audit function of our company and of the external auditors. Also, the audit committee may be requested by the board of directors to report if the conditions of a related party transaction may be reasonably considered adequate according to normal market conditions.
On November 3, 2008, our board of directors appointed Ricardo Liberman as member of the audit committee. As of the date of this annual report, the members of the audit committee are Cedric Bridger, Ricardo Liberman, and Mario Blejer, all of them independent members. Cedric Bridger is the financial expert in accordance with the relevant SEC rules. We have a fully independent audit committee as per the standard provided in Rule 10(A)-3(b)(1).
B. Code of Ethics
We have adopted a code of ethics that applies to our directors, officers and employees. Our code of ethics is posted in our website www.irsa.com.ar. On July 25 2005, our Code of Ethics was amended by our board of directors. The amendment was reported in a report on Form 6-K on August 1, 2005.
If we make any substantive amendment to the code of ethics or grant any waivers, including any implicit waiver to any of its provision we will disclose the nature of such amendment or waiver in a report on Form 6-K or in our next annual report and we will post it in our website.
C. Principal Accountant Fees and Services
Audit Fees
During the fiscal years ended June 30, 2008 and June 30, 2007, we were billed a total amount of Ps. 3.8 million and Ps.2.4 million respectively, for professional services rendered by our principal accountants for the audit of our annual financial statements, performance of the audit or review of our interim financial statements, and other services normally provided in connection with regulatory filings or engagements.
Audit-Related Fees
During the fiscal years ended June 30, 2008 and June 30, 2007, we were billed a total amount of Ps.0.02 million and Ps.0.3 million respectively, for professional services rendered by our principal accountants mainly related to the issuance of covenants certificates and other certifications.
Tax Fees
During the fiscal years ended June 30, 2008 and June 30, 2007, we were billed a total amount of Ps.0.1 million and Ps.0.00 million, respectively, for professional services rendered by our principal accountants for tax compliance, tax advice, and tax planning.
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All Other Fees
During fiscal year ended June 30, 2008 and June 30, 2007 we were billed for professional services rendered by our principal accountants, including fees mainly related to special assignments and courses, a total amount of Ps. 0.4 million and Ps. 0.0 million, respectively.
Audit Committee Pre-Approval Policies and Procedures
Audit Committee pre-approves all services, fees and services provided by the external auditors to ensure auditors’ independence. One of the main tasks of the Audit Committee is to give it opinion in relation to the appointment of the external auditors, proposed by the Board of Directors to the General Shareholder’s Meeting. In order to accomplish such task, the Audit Committee shall:
Require any additional and complementary documentation related to this analysis.
Verify the independence of the external auditors;
Analyze different kinds of services that the external auditor would provide to the company. This description must also include an estimate of the fees payable for such services, specifically in order to maintain the principle of independence;
Inform the fees billed by the external auditor, separating the services related to the Audit Committee and other special services that could be not included as fees related to the Audit Committee;
Take notice of any strategy proposed by of the external auditors and review it in accordance with the reality other business and the risks involved;
Analyze and supervise the working plan of the external auditors considering the business’ reality and the estimated risks;
Propose adjustments (if necessary) to such working plan;
Hold meetings with the external auditors in order to: (a) analyze the difficulties, results and conclusions of the proposed working plan; (b) analyze eventual possible conflicts of interests, related party transactions, compliance with the legal framework and information transparency;
Evaluate the performance of external auditors and their opinion regarding the Financial Statements.
D. Exemption from the Listing Standards for Audit Committees
E. Purchase of Equity Securities by the Issuer and its Affiliates
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PART III
The Registrant has responded to Item 18 in lieu of responding to this Item.
Reference is made to pages F-1 through F-171.
Index to Financial Statements (see page F-1).
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ExhibitNo.
Description of Exhibit
252
SIGNATURES
The registrant hereby certifies that it meets all of the requirements for filing on Form 20-F and that it has duly caused and authorized the undersigned to sign this annual report on its behalf.
Chief Executive Officer
Date: December 30, 2008
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IRSA Inversiones y Representaciones Sociedad Anónima
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of June 30, 2008 and 2007
Consolidated Statements of Income for the years ended June 30, 2008, 2007 and 2006
Consolidated Statements of Changes in Shareholders’ Equity for the years ended June 30, 2008, 2007 and 2006
Consolidated Statements of Cash Flows for the years ended June 30, 2008, 2007 and 2006
Notes to the Consolidated Financial Statements
Banco Hipotecario S.A.
Consolidated Statements of Changes in Shareholders’ Equity for the years ended June 30,2008, 2007 and 2006
To the Board of Directors and Shareholders of
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position of IRSA Inversiones y Representaciones Sociedad Anónima and its subsidiaries at June 30, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2008 in conformity with accounting principles generally accepted in Argentina. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on our audits (which was an integrated audit for the year ended June 30 2008). We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
Accounting principles generally accepted in Argentina vary in certain significant respects from accounting principles generally accepted in the United States of America. Information relating to the nature and effect of such differences is presented in Note 28 to the consolidated financial statements.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
F-2
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Andrés Suarez (Partner)
Andrés Suarez
Buenos Aires, Argentina
December 30, 2008
F-3
Consolidated Balance Sheets
as of June 30, 2008 and 2007
(Amounts in thousands, except share data and as otherwise indicated)
ASSETS
Current Assets
Cash and banks (Notes 4.a. and 29.e.)
Investments (Notes 4.b. and 29.e.)
Accounts receivable, net (Notes 4.c. and 29.e.)
Other receivables and prepaid expenses (Notes 4.d. and 29.e.)
Inventories (Note 4.e.)
Non-Current Assets
Fixed assets, net (Note 29.a.)
Intangible assets, net (Note 29.b.)
Subtotal Non-Current Assets
Negative goodwill, net
Total Assets
LIABILITIES
Current Liabilities
Trade accounts payable (Notes 4.f. and 29.e.)
Mortgages payable (Notes 4.l. and 29.e.)
Customer advances (Notes 4.g. and 29.e.)
Short-term debt (Notes 4.i. and 29.e.)
Salaries and social security payable (Note 4.h.)
Taxes payable (Notes 4.j. and 29.e.)
Other liabilities (Notes 4.k. and 29.e.)
Non-Current Liabilities
Customer advances (Note 4.g.)
Long-term debt (Notes 4.i. and 29.e.)
Taxes payable (Note 4.j.)
Total Liabilities
SHAREHOLDERS’ EQUITY
Total Liabilities and Shareholders’ Equity
The accompanying notes are an integral part of these consolidated financial statements.
F-4
Consolidated Statements of Income
for the years ended June 30, 2008, 2007 and 2006
Costs (Note 29.d)
Net (loss) income from retained interest in securitized receivables (Note 16)
Gain from operations and holdings of real estate assets, net (Note 7)
Financial results, net (Note 8)
Other expenses, net (Note 9)
Earnings per share (Note 18):
Basic net income per share
Diluted net income per share
F-5
Consolidated Statements of Changes in Shareholders’ Equity
Balances as of June 30, 2005
Conversion of debt into common shares
Exercise of warrants
Accumulated losses absorption of approved by shareholders meeting held November 29, 2005
Net income for the year
Balances as of June 30, 2006
Appropriation of retained earnings approved by shareholders meeting held October 31, 2006
Balances as of June 30, 2007
Appropriation of retained earnings approved by shareholders meeting held October 10, 2007
Balances as of June 30, 2008
F-6
Consolidated Statements of Cash Flows
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation and amortization
Accruals for director’s fees
Allowances and provisions
Loss (gain) on equity investees
Financial results
Goodwill impairment
Gain from sale of inventories
Changes in certain assets and liabilities, net of non-cash transactions and the effects of acquisitions:
(Increase) decrease in current investments
Increase in non-current investments
Increase in accounts receivable, net
(Increase) decrease in other receivables and prepaid expenses, net
Decrease in inventories
(Increase) decrease in intangible assets
Increase in trade accounts payable
Decrease in customer advances, salaries and social security payable and taxes payable
Increase (decrease) in other liabilities
Increase in accrued interest
CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of businesses and assets net of cash acquired (i)
Acquisition of undeveloped parcels of land
Acquisition of fixed assets
Increase in equity investees and non-current investments
Decrease in minority interest
Guarantee deposit
Sale of IRSA Telecommunications N.V.
Advance payments for the acquisition of shares
Loans granted to related parties
Cash collected from insurance claims
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from settlement of swap agreement
Increase in short-term and long-term debt
Payment of short-term and long-term debt
Dividends paid by subsidiaries to minority shareholders
Payment of seller financing of Mendoza Plaza Shopping S.A.
Decrease in mortgages payable
Settlement of debt with related companies
Re purchase of debt
Capital contribution by minority owners in related parties
Net (decrease) increase in cash and cash equivalents
Cash and cash equivalents as of the beginning of the year
Cash and cash equivalents as of the end of the year
F-7
for the years ended June 30, 2008, 2007 and 2006 (continued)
Supplemental cash flow information:
Cash paid during the year for:
Interest paid
Income tax paid
Non-cash investing and financing activities:
Increase in inventory through a decrease in undeveloped parcels of land
Liquidation of interest in credit card receivables
Increase in fixed assets through a decrease in undeveloped parcels of land
Increase in inventory through a decrease in fixed assets
Increase in fixed assets through an increase in other receivables
Increase in undeveloped parcels of land through an increase in accounts payable
Increase in fixed assets through a decrease in inventory
Increase in other receivables through a decrease in fixed assets
Increase in other receivables through a decrease in intangible assets
(Decrease) Increase in fixed assets through an (increase) decrease in other investments
Increase in intangible assets through a decrease in fixed assets
Decrease in undeveloped parcels of land through an increase in inventories
Transfer of inventories to long-term investment
Increase in non current investment through an increase in long-term debt
Increase in fixed assets through an increase in accounts payable
Increase in accounts receivable through a decrease in inventories
Increase in costs of issuance of debt through an increase in trade accounts payables
Increase in short-term and long-term debt through a decrease in other liabilities
Decrease in inventory through a decrease in mortgages payables
Seller financing for acquisition of subsidiaries and minority interest
Increase in long-term investment through a decrease in other receivables
Increase in fixed assets through an increase in mortgages payable
Acquisitions of business or net assets:
Cash and cash equivalents
Fair market value of inventories
Fair market value of fixed assets acquired (i)
Fair market value of intangible assets acquired (i)
Fair market value of other assets acquired
Fair market value of liabilities assumed (i)
Net assets acquired
Goodwill (negative goodwill)
Purchase price
Seller financing
Purchase price paid
Less: cash and cash equivalents acquired
Net cash paid for the acquisition
F-8
IRSA Inversiones y Representaciones Sociedad Anónima (“IRSA”), is a real estate company incorporated under the laws of Argentina which, through its investments in subsidiaries and joint ventures (IRSA and subsidiaries are collectively referred hereinafter as the “Company”), is primarily involved in (i) the acquisition and development of residential properties primarily for sale and the acquisition of undeveloped land reserves either for future development or sale, (ii) the acquisition, development and operation of office and other non-shopping center properties primarily for rental purposes, (iii) the acquisition, development and operation of shopping center properties, (iv) the acquisition and operation of luxury hotels, (v) the origination of consumer loans and credit card receivables and securitization activities and (vi) other non-core activities. The Company is the only Argentine real estate company whose shares are listed and traded on both the Buenos Aires Stock Exchange (“BASE”) and the New York Stock Exchange (“NYSE”).
The consolidated financial statements of the Company have been prepared in accordance with generally accepted accounting principles used in Argentina, as set forth by the Federación Argentina de Consejos Profesionales de Ciencias Económicas (“FACPCE”) and implemented, adapted, amended, revised and/or supplemented by the Consejo Profesional de Ciencias Económicas de la Ciudad Autónoma de Buenos Aires (“CPCECABA”) (collectively “Argentine GAAP”). In addition, the Company must comply with the regulations of the Comisión Nacional de Valores (“CNV”), the National Securities Commission in Argentina. Argentine GAAP and the regulations of the CNV, as applicable, differ in certain significant respects from generally accepted accounting principles in the United States of America (“US GAAP”). Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by US GAAP and Regulation S-X of the Securities and Exchange Commission (“SEC”). A description of the significant differences between Argentine GAAP and US GAAP as they relate to the Company are set forth in Note 28 to these consolidated financial statements.
Additionally as discussed in Note 3.n. in order to comply with regulations of the CNV, the Company recognized deferred income taxes on an undiscounted basis. This accounting practice represented a departure from Argentine GAAP but did not have a material effect on the consolidated financial statements for the year ended June 30, 2006. As further discussed in Note 2.d., in December 2005 and January 2006, the CPCECABA issued revised accounting standards. One of these standards required companies to account for deferred income taxes on an undiscounted basis, thus aligning its accounting practices with that of the CNV. Since the CNV adopted the CPCECABA standards effective for the Company for the fiscal year ended June 30, 2007, there was no longer a difference on this subject between Argentine GAAP and the CNV regulations.
As discussed in Note 2.c., in order to comply with the regulations of the CNV, the Company discontinued inflation accounting as from February 28, 2003. Since Argentine GAAP required companies to discontinue inflation adjustments only as from October 1, 2003, the application of CNV resolution represented a departure from Argentine GAAP. However, due to low inflation rates during the period from March to September 2003, such a departure has not had a material effect on the consolidated financial statements.
The consolidated financial statements include the accounts of the Company and its subsidiaries over which the Company has effective control. Investments in companies in which the Company exercises significant influence, but not control, are accounted for under the equity method. Investments in joint ventures and/or jointly controlled operations in which the company exercises joint control are accounted for under the proportionate consolidation method. All significant intercompany balances and transactions have been eliminated in consolidation.
In accordance with Argentine GAAP, the presentation of the parent company’s individual financial statements is mandatory. Consolidated financial statements are to be included as supplementary information to the individual financial statements. For the purpose of these financial statements, individual financial statements have been omitted since they are not required for SEC reporting purposes.
F-9
A description of the subsidiaries over which the Company has effective control and joint control, with their respective percentage of capital stock owned, is presented as follows:
Controlled and jointly controlled companies
Ritelco S.A. (“Ritelco”)
Palermo Invest S.A. (“Palermo Invest”) (iii) and (iv)
Abril S.A. (“Abril”) (ii) and (iii)
Pereiraola S.A. (“Pereiraola”) (ii)
Baldovinos S.A. (“Baldovinos”) (ii)
Hoteles Argentinos S.A. (“Hoteles Argentinos”)
Patagonian Investment S.A. (“Patagonian Investment”) (v)
Alto Palermo S.A. ( “APSA”)
Llao Llao Resorts S.A. (“LLR”)
Rummaala S.A. (“Rummaala”) (iii)
Canteras Natal Crespo S.A. (“Canteras Natal Crespo”)
CYRSA S.A. (“CYRSA”) (vi)
Solares de Santa María S.A. (“Solares de Santa María”) (iii)
Inversora Bolívar S.A.(“Inversora Bolívar”)
Quality Invest S.A. (iii)
E-Commerce Latina S.A. (“E-Commerce”) (iii)
Financel Communications S.A. (iii)
Proportionate consolidation
The Company exercises joint control over Metroshop (through APSA), Canteras Natal Crespo, Rummaala and CYRSA. As required by Technical Resolution No. 21 “Equity Method of Accounting, Consolidation of Financial Statements and Related Party Transactions” (“RT No. 21”), under Argentine GAAP, the Company accounted for these investments under the proportionate consolidation method. Accordingly, these financial statements reflect the Company’s pro rata equity interest in these investments on a line-by-line basis.
On August 22, 1995, the Argentine government issued Decree No. 316/95 discontinuing the requirement that financial information be restated for inflation for any date or period after August 31, 1995. Effective September 1, 1995 in accordance with CNV resolutions and Argentine GAAP, the Company began accounting for its financial transactions on a historical cost basis, without considering the effects of inflation. Prior to September 1, 1995, the financial statements were prepared on the basis of general price level accounting, which reflected changes in purchasing power of the Argentine Peso in the historical financial statements. The financial statement information of periods prior to August 31, 1995 was restated to pesos of general purchasing power as of August 31, 1995. The August 31, 1995 balances, adjusted to the general purchasing power of the Peso at that date, became the historical cost basis for subsequent accounting and reporting.
F-10
However, as a result of the inflationary environment in Argentina in 2002, the CPCECABA approved on March 6, 2002, a resolution reinstating the application of inflation accounting in financial statements as from January 1, 2002. This resolution provided that all recorded amounts restated for inflation through August 31, 1995, as well as those arising between that date and December 31, 2001 are to be considered stated in currency as of December 31, 2001.
On July 16, 2002, the Argentine government issued a decree, instructing the CNV to issue the necessary regulations for the acceptance of financial statements prepared in constant currency. On July 25, 2002, the CNV reinstated the requirement to submit financial statements in constant currency.
However, after considering inflation levels for the second half of 2002 and the first months of 2003, on March 25, 2003, the Argentine government repealed the provisions of the previous decree related to the inflation adjustment and instructed the CNV to issue the necessary regulations to preclude companies under its supervision from presenting price-level restated financial statements. Therefore, on April 8, 2003, the CNV issued a resolution providing for the discontinuance of inflation accounting as of March 1, 2003. The Company complied with the CNV resolution and accordingly recorded the effects of inflation until February 28, 2003.
Since Argentine GAAP required companies to discontinue inflation accounting as from October 1, 2003, the application of the CNV resolution represented a departure from Argentine GAAP. However, due to the low level of inflation rates during the period from March to September 2003, such a departure did not have a material effect on the consolidated financial statements.
The CNV issued General Resolutions 485 and 487 on December 29, 2005 and January 26, 2006, respectively adopting, with certain modifications, the new accounting standards previously issued by the CPCECABA through its Resolution CD 93/2005. The standards were effective for the Company for the year ended June 30, 2007.
The most significant changes included in the accounting standards adopted by the CNV related to (i) changes in the impairment test of long-lived assets, (ii) changes to deferred income tax accounting and (iii) accounting of deferred income taxes on a non-discounted basis.
Under the new standards, the carrying value of a long-lived asset is considered impaired by a company when its value in use or its net realizable value, whichever is greater, is less than its carrying value. Value in use is determined by the expected cash flows from the assets discounted at a rate commensurate with the risk involved. Net realizable is determined by the selling price of the assets costs to sell.
The new standards provided for the accounting treatment of differences between the tax basis and book basis of non-monetary items for deferred income tax calculation purposes when companies prepare price-level restated financial statements. The new accounting standard mandated companies to treat these differences as temporary differences but allowed a one-time accommodation to continue treating these differences as permanent at the time of adoption of the standard. As a result, the Company elected to continue treating differences as permanent. Should the inflation adjustment be treated as a temporary difference for deferred income tax purposes, the shareholders´ equity as of June 30, 2008 would have decreased approximately Ps. 155.4 million with a corresponding effect of Ps. 20.6 million and Ps. 176.0 million in the in statement of income of the year ended June 30, 2008 and retained earnings, respectively.
In accordance with the Company’s Management the potential effect that the new accounting standards would have in its subsidiary Banco Hipotecario S.A. would not be significant on the amount of the Company’s investment.
F-11
Certain reclassifications of prior year’s information have been made to conform to the current year presentation. The reclassifications had no impact on previously reported net income, net income per share, shareholders’ equity or cash flows.
The Company’s functional and reporting currency is the Argentine Peso. Solely for the convenience of the reader certain amounts are alternatively expressed in Argentine Pesos or US Dollars in the notes to the financial statements. Translations should not be construed as a representation that the amounts shown could have been, or could be, converted into US Dollars at that or any other rate.
In the preparation of these consolidated financial statements, unless otherwise indicated, the operating results of all acquired businesses have been included in the Company’s consolidated financial statements since the date of the respective acquisition.
Year ended June 30, 2008
In August 2007, the Company together with an unrelated party, Prisma Investments S.A., formed Financel Communications S.A. (“Financel”) for the purpose of creating innovative solutions for collections and payments through the use of cell phones. Financel together with Tarjeta Shopping S.A. (a subsidiary of APSA) and CTI Móvil (a cell phone company in Argentina) created “Compra Móvil”, a cell phone purchase system by which CTI cell users would be able to complete purchase transactions in a quick and secure fashion. As of the date of these financial statements, Financel has not started operations yet.
In August 2007, the Company formed Quality Invest S.A. for the purpose of investing in different individual or corporate businesses, as well as, transacting with financial instruments except for transactions which would require registration of the company under the law for financial institutions. As of the date of these financial statements, Quality Invest has not started operations yet.
Exercise of option
In August 2007, APSA exercised the option to purchase a 75% interest in a company engaged in the development of a cultural, recreational and entertainment complex in the Palermo neighborhood in Buenos Aires. APSA paid US$ 0.6 million for the option and is accounted for under non current investments. The purchase is subject to certain approvals by the regulatory authorities which have not been obtained as of the date of these financial statements. Should the approvals be obtained, APSA committed to invest approximately US$ 24.4 million.
Barter transaction agreement
In October 2007, APSA entered into a barter agreement with an unrelated party Condominios del Alto S.A. pursuant to which APSA bartered a plot of land located in Rosario, Province of Santa Fe for future 15 apartments and 15 parking spaces of the total units to be constructed on the land. Under this agreement, APSA will have a 14.85% and 15% of the total square meters covered by the apartments and garages, respectively. The total fair value of the transaction is US$ 1.1 million. Upon signing of the agreement, Condominios del Alto S.A. paid APSA US$ 15 and assumed certain obligations. Condominios del Alto S.A. (i) guaranteed the transaction by the assumption of a first degree mortgage on the land in favor of APSA for US$ 1.1 million; (ii) established a security insurance of which APSA will be assignor of the insured amount of US$ 1.6 million; and (iii) the shareholders of Condominios del Alto S.A. assumed a personal guarantee of the obligations of Condominios del Alto S.A. up to the amount of US$ 0.8 million.
F-12
Acquisition of Soleil Factory shopping center business
On December 28, 2007, APSA entered into an agreement with INCSA, an unrelated party, for the acquisition of Soleil Factory shopping center business, for an aggregate purchase price of US$ 20.7 million, of which US$ 8.1 million were paid. The transaction is subject to certain suspensive conditions. Upon fulfillment of the conditions and transfer of the business, the remaining balance of the purchase price amounting to US$ 12.6 million will accrue fixed interest at 5% per year. This balance will be paid in seven annual and consecutive installments starting on the first anniversary of the signing of the contract. As part of the same agreement, APSA entered into an offer to acquire, construct and operate a shopping center on land property of INCSA located in San Miguel de Tucumán, Province of Tucumán, in the northwest of Argentina. This transaction is also subject to the completion of the “Soleil Factory” transaction among other suspensive conditions. The parties determined the value of this transaction to be US$ 1.3 million, of which a de minimis amount was paid in January 2008.
Acquisition of plot of land
On June 24, 2008, APSA purchased from Dowler Company S.A, an unrelated party,. a plot of land located at Beruti street No. 3351/3359 in the vicinity of the Alto Palermo shopping mall. The purchase price was US$ 17.8 million of which, as of the date of these financial statements, US$ 8.9 million was paid. The unpaid balance will be paid in two annual and consecutive installments of US$ 4.4 million due on February 2009 and 2010. The plot of land was mortgaged in favor of Dowler Company S.A..
Acquisition of 50% of Bank Boston building.
In August 2007, the Company acquired a 50% interest in the building (including in place leases) known as “Bank Boston Tower”, a 31,670 sq. meter property located in Buenos Aires, for total consideration of US$ 54 million. The acquisition has been accounted for as a business acquisition.
Offer for the acquisition of Uruguayan company.
In May 2008, the Company offered to acquire an Uruguayan company owner of several plots of land in Montevideo, Uruguay for approximately US$ 7 million. The Company intends to develop an urban project on the site. As of the date of these financial statements, the transaction has not been closed yet.
Acquisition of a plot of land in Luján
In May 2008, IRSA entered into a preliminary purchase contract with transfer of possession with Birafriends S.A. (an unrelated party) for the acquisition of a plot of land in Luján, Province of Buenos Aires, for a total purchase price of US$ 3.0 million. IRSA paid US$ 1.2 million and the remaining balance will be paid at the time of the signing of the deed. On December 2008, IRSA assigned the preliminary purchase contract to Cresud. Cresud will pay the remaining balance at the time of the signing of the deed, and will also refund IRSA the amount the Company paid at the time of the signing of the preliminary purchase.
Barter transaction with CYRSA
The Company signed with CYRSA a deed of exchange for US$ 12,600 by which IRSA handed over to CYRSA a plot of land in the Caballito neighborhood. On its part, CYRSA committed itself to build a housing real estate development in such plot. In a first stage two buildings will be constructed and a third future building will be developed in the second stage, upon CYRSA´s election. As consideration CYRSA will pay US$ 120 and the balance will be cancelled by handing over 25% of the functional units of the buildings to be constructed in the plot of land. If CYRSA decides not to construct the third building by June 2010, then IRSA will receive the functional unit having the right to over-raise the future third building. To guarantee the compliance with its obligations CYRSA has mortgaged the plot of land in the amount of US$ 12,600. This transaction generated a gross result before taxes of Ps. 29,100, which was eliminated in accordance with the ownership of CYRSA S.A. On July 31, 2008, the title deed to the land was executed.
F-13
Acquisition of Museo Renault
In December 2007 the Company acquired certain functional units (including in place lease) of the “Palacio Alcorta” (also known as “Museo Renault”) real estate for the total consideration of US$ 3,200. The acquisition has been accounted for as a business acquisition.
Acquisition of minority interest in Mendoza Plaza Shopping S.A.
On September 29, 2004, upon executing the agreement to purchase the capital stock of Mendoza Plaza Shopping S.A., APSA signed an agreement with Inversiones Falabella Argentina S.A. (“Falabella”), the remaining minority shareholder of Mendoza Plaza Shopping S.A., pursuant to which, among other things, Falabella had the irrevocable right to sell to APSA (put option) its ownership interest in Mendoza Plaza Shopping S.A. for a total consideration of US$ 3.0 million.
On June 30, 2008, Inversiones Falabella Argentina S.A. formally notified the put exercise previously granted by which this company sells to APSA 2,062,883 nonendorsable, registered share of common stock, Class A, with face value of Ps. 1 each and with 5 voting rights per share and 2,062,883 nonendorsable, registered shares of common stock, Class B, with face value of Ps. 1 each and with 1 voting rights per share, thus acquiring 5% of the share on behalf of Shopping Alto Palermo S.A. (“SAPSA”).
Total shares acquired represent 14.6% of the capital stock of Mendoza Plaza Shopping S.A. at the price of US$ 3.0 million established in the respective option agreement (equivalent to Ps. 9.1 million). Such price was fully paid in by APSA on July 2, 2008, when the respective deed to close between both companies was executed.
The shares acquired on behalf of SAPSA were transferred to such company on July 2, 2008 by means of a Shares Assignment Agreement and the amount paid of US$ 1.0 million will be returned to APSA on October 2, 2008.
Sale of Bouchard building
On January 9, 2008, the Company sold to Techint Compañía Técnica International S.A.C.I. (Techint) an undivided 29.85% interest in the building known as Bouchard Plaza Building including in-place lease contracts for an aggregate price of US$ 34.4 million. The gain on the sale was Ps. 19 million.
Acquisition of Patio Olmos
In November 2006, APSA acquired from the Provincial Government of Cordoba a property known as “Edificio Ex Escuela Gobernador Vicente de Olmos” (“Olmos”) located in Córdoba, Argentina for an aggregate purchase price of Ps. 32.5 million, of which APSA made a down payment of Ps. 9.7 million as of that date. The property, which is located in the City of Córdoba, is a 5,147 square meter four-story building. The property is leased to an unrelated party who exploits the building as a shopping center. APSA did not acquire any rights to the shopping center business. The transaction was pending certain approvals which were obtained in September 2007 when the deed was signed and remaining balance paid.
As part of the agreement, two spaces of the building aggregating 931 sq. meters had been reserved for public use from governmental authorities until 2032. Thus, APSA was unable to exploit the space through that date. However, in November 2007, the Government enacted a law declaring the spaces as for public use and subject to expropriation procedures for the spaces subject to payment of Ps. 0.5 million. APSA challenged the valuation before the corresponding authorities. As of the date of these financial statements, expropriation has not taken place and final payment has not been negotiated.
F-14
Acquisition of Edificio República.
In April 2008, the Company acquired a building known as “República Building”, a property located in Buenos Aires. The Company paid US$ 70.2 million partially financed by a mortgage loan from Banco Macro for an amount of US$ 33.6 million accruing interest at a fixed rate of 12% per annum and payable in five equal, annual and consecutive installments as from April 2009. The Company consulted with the Argentine Antitrust Commission whether or not this transaction should be reported as a transaction regarded as infringing antitrust laws. The Commission resolved unfavorably and the Company challenged this ruling judicially. As of the date of these financial statements, there was no final sentence as to this matter.
Commercialization of Dique III
Plot 1c) Dique III
In September 2004, the Company and Desarrollos y Proyectos Sociedad Anónima (“DYPSA”) signed a commitment of barter contract whereby the Company delivered DYPSA plot 1c) of Dique III in exchange for receiving, within a maximum term of 36 months, housing unit, parking lots and parking spaces, representing in the aggregate 28.50% of the square meters built in the building constructed by DYPSA. The transaction amounted to US$ 8,030. As a guaranty for the transaction, DYPSA set up a first degree mortgage for US$ 8,030 plot in favor of IRSA. During the fiscal year DYPSA transferred to the Company the possession of all of the individual storage spaces and parking lots in a total amount of US$ 487, corresponding to the barter for the plot 1c). The Company signed preliminary sales agreements for certain units to be received which where valued at its net realizable value. The increase for this method of valuation amounted to Ps. 21,012; of which Ps. 2,618 and Ps. 18,394 were recorded as of June 30, 2008 and 2007, respectively.
Plot 1e) Dique III
In June 2006, the Company and DYPSA signed a barter contract whereby the Company delivered DYPSA plot 1e) of Dique III in exchange for receiving, within a maximum term of 36 months, house units, parking and storages representing in the aggregate 31.50% of the square meters built in the building to be constructed by DYPSA. The value of the transaction to amount of US$ 13,530. In November 2007, the Company and DYPSA resolved the substitution of the mentioned exchange for a payment of US$ 18,250, which was fully collected as of June 30, 2008. The gain on the substitution was Ps. 14.8 million.
Purchase of additional shares of APSA
During the fiscal year ended June 30, 2008 the Company acquired 672,639 shares of APSA for a total amount of Ps. 7,071. As a result of this transaction, as of the date of these financial statements, IRSA’s ownership interest in APSA is 63.34%.
Year ended June 30, 2007
Acquisition of plots of land in Bariloche
In December 2006, LLR acquired from an unrelated party a plot of land located in Bariloche in the Province of Río Negro, Argentina, for an aggregate purchase price of US$ 7,000. The company paid US$ 4,200 in cash and the remaining US$ 2,800 was financed through the assumption of a first-degree mortgage on the property. The mortgage, bearing interest at a fixed rate of 7% per annum, will be payable in 36 monthly installments of US$ 86 each, beginning on January 14, 2007.
F-15
Acquisition of additional interest in Palermo Invest
In October 2006, the Company acquired the remaining 33,33% of Palermo Invest from GSEM/AP Holdings, L.P. for an aggregate purchase price of US$ 18,000. Palermo Invest is a corporation whose main activity is the purchase and holding of equity securities of entities which principal businesses are real estate and investment in equity securities and other form of investment. The transaction was financed US$ 9,000 in cash and US$ 9,000 through a note payable in three annual installments of US$ 3.0 million each, beginning on October 4, 2007. The note will accrue interest at a fixed rate of 9% per annum.
Acquisition of plot of land in Vicente López and creation of CYRSA
On January 16, 2007, the Company acquired the total shares of the company named Rummaala, the main asset of which was a plot of land located in Vicente López, Province of Buenos Aires. The purchase price was US$ 21,172, payable as follows: (i) US$ 500 in cash paid in April 2006; (ii) US$ 3,752 in cash and (iii) by delivering certain units of the building to be constructed in the plot of land owned by Rummaala in the amount of US$ 16,920, within a 4-year term as from the approval date of the plans by the related authorities or when the facilities be vacated, whichever last occurs. As security for compliance with the construction of the future building and transfer of the future units, the shares acquired were pledged. Simultaneously with the above transaction, Rummaala acquired a plot of land adjacent to its own property in the amount of US$ 15,000, payable as follows: (i) US$ 500 in cash paid in April 2006; (ii) by delivering certain units of buildings Cruceros I and II owned by the Company in the amount of US$ 1,247 and (iii) by delivering certain units of the building to be constructed in the land acquired in the amount of US$ 13,253, within a 40-month term considered as from the approval date of the plans by the related authorities or when the facilities be vacated, whichever last occurs. As security for compliance with the construction of the future building and transfer of the future units, the Company’s property located at Suipacha 652 was mortgaged.
In April, 2007, the Company constituted CYRSA S.A., to have a legal entity that allows developing a specific project together with one or more investors having the required knowledge and expertise. In August 2007, Cyrela Brazil Realty S.A. Emprendimentos e Partiçipacões (“CYRELA”) is incorporated with the ownership of 50% of CYRSA capital stock.
In the same act, the Company contributed 100% of the shareholding of Rummaala S.A. and the liability in kind related to the acquisition of the plot of land to CYRSA in the amount of Ps. 21,500 and CYRELA contributed Ps. 21,500 (amount equivalent to the net value of the shares contributed by the Company).
The Company has subscribed with CYRELA an agreement, by which through CYRSA, operating under the name IRSA- CYRELA will start developing housing units in the Argentine Republic.
During May and June 2008 the Company (through Rummaala) continued the marketing process of the building units to be constructed on the plot referred to above called “Horizons”. Certain clients have made advances by means of signing preliminary sales contracts for 96% of the units to be marketed, which are disclosed in customer advances.
The sales price in the preliminary sales contracts consist of a fixed portion and a variable portion that will be determined according to future construction expenses. The buyer can choose from the following purchase plans:
- The balance is cancelled in installments and is fully paid at the time of transfer and signature of the deeds.
- The balance can be partially cancelled by the time of transfer and signatures of the deeds, with the remaining balance financed for 90 months, with the units mortgaged as security.
The Company has committed to transfer the functional units by February, 2011.
F-16
Panamerican Mall Project
In June 2006, APSA acquired from an unrelated party, Phillips Argentina S.A., a 28,741 square meters plot of land (the “Phillips land”) located in Saavedra, a neighborhood in the northern area of Buenos Aires, for an aggregate purchase price of US$ 17.9 million. APSA developed a project for the construction of a mall including a hypermarket, a movie theatre complex and office and/or residential buildings. For that purpose, in December 2006, APSA entered into a Construction, Management and Commercialization Agreement with an unrelated party, Centro Comercial Panamericano S.A. (“CCP”). APSA incorporated Panamerican Mall S.A. (“PAMSA”) for this purpose. APSA contributed cash and the Phillips land to PAMSA amounting to Ps. 158.3 million. APSA acquired from CCP an adjacent property amounting to Ps. 36.9 million through cash and 20% of the stock of PAMSA. In addition, APSA and CCP committed to make capital contributions amounting to US$ 37.8 million and US$ 9.4 million, respectively, to complete the project.
During the fiscal year ended June 30, 2008, APSA and CCP made irrevocable contributions to PAMSA for Ps. 87.5 million and Ps. 21.9 million, respectively.
Córdoba Shopping
On December 27, 2006, APSA acquired 100% interest in the Cordoba Shopping Villa Cabrera located in Cordoba, Argentina, owned by Empalme S.A.I.C.F.A.I.G. (“Empalme”). The property, which is located in the Villa Cabrera neighborhood of the city of Cordoba, is a 35,000 square meter shopping center comprising 106 stores, a 12 movie theatre complex and a 1,500 vehicle parking lot.
The interest was acquired for US$ 13.3 million. APSA paid US$ 5.3 million in cash and financed the remaining portion of the purchase price in four equal installments of US$ 2.0 million each due every six months as from December 2007. This financing accrues interest at a fixed rate of 6% per annum. The unpaid balance was collateralized by a pledge on the shares of Empalme in favor of the sellers. Governmental approval was obtained in December 2006. Subsequent to year end, on December 11, 2008, the fourth installment was paid.
APSA’s purchase of Empalme has been accounted for following the guidance in Technical Resolution No. 18 (RT No. 18), as explained in Note 3.i. The purchase price was allocated based on the fair value of each component. However, since the sum of the individual fair values of the identifiable tangible and intangible assets exceeded the purchase price paid, negative goodwill exists. Under Argentine GAAP, when negative goodwill exists after an acquiring entity initially assigns values to all assets acquired and liabilities assumed, RT No. 18 states that the entity must first reassess whether all acquired assets and assumed liabilities have been identified and properly valued. If an amount of negative goodwill still results after this reassessment, intangible assets acquired (including above and below market leases, in-place leases and tenant relationships, as applicable), are subject to reduction. If after all of these intangible assets are reduced to zero and an amount of negative goodwill still remains, the remaining unallocated negative goodwill is amortized under the straight-line method over the weighted average useful life of the main tangible assets acquired.
Incorporation of Solares de Santa María – Sale of Santa María del Plata and sale of shares
In May 2007, the Company formed Solares de Santa María (“Solares”) and contributed cash in the amount of Ps. 310,000. Solares acquired the Ex Ciudad Deportiva Boca Juniors (Santa María del Plata) plot of land located in Buenos Aires for US$ 100,000. On June 26, 2007, the Company sold in commission a 10% interest in Solares to Israel Sutton Dabbah.
F-17
Transfer of the administration of Abril
On May 24, 2006, the Company revised the May 4, 2005 proposal submitted to the Residents Subcommision of Abril Club de Campo (the “Club”) pursuant to which the Company would transfer the Club’s management and shares of Abril to the residents (the “Letter of Offer”).The proposal included monetary and non monetary renderies to be done by the company.
In June 2007, after compliance of the Letter of Offer, IRSA transferred the shares of Abril to a trust. The trustee, as instructed by the residents of the Club, elected three directors of the Board of Directors of Abril. The mentioned transaction transferred Abril S.A. shareholding to the owners of plots of land of Abril Club de Campo.
Acquisition of additional shares of Canteras Natal Crespo
In a series of transactions between December 2006 and January 2007, the Company increased its ownership interest in Canteras Natal Crespo to 55.93% for an aggregate purchase price of US$ 645. Subsequently, in April 2007, the Company sold 5.93% to ECIPSA for US$ 312. The Company’s interest in Canteras Natal Crespo is 50% as of the date of these financial statements.
Acquisition of the Bouchard Building
On March 15, 2007, the Company acquired from an unrelated party a 33,324 square meter office building and the related lease contracts known as “Bouchard Building” for an aggregate purchase price of US$ 84,100. The transaction was fully paid in cash as of the date of these financial statements. In April 22, 2008 the notice of the operation was filed with the Argentine Antitrust Authority. As of the date of these financial statements the Commission has not issued the resolution yet.
Acquisition of the Dock Del Plata Building
In June 2005, the Company entered into a Credit Default Swap Agreement (the “Agreement”) with Credit Suisse International (“CSI”) pursuant to which the Company, provided certain conditions were met, would acquire a mortgage receivable for US$ 10,000 on a 8,900 square meter office building known as Dock del Plata Building located in Puerto Madero, Buenos Aires. As guarantee for the Agreement, the Company paid a deposit US$ 4,000. The Agreement was rescinded in November 2006 and the guarantee deposit was released. The Company executed the mortgage and acquired the building (including in place leases) for US$ 8,800 (using US$ 4,000 of the deposit guarantee plus available cash of US$ 4,800).
Year ended June 30, 2006
Investment in IRSA Telecomunicaciones N.V. (ITNV)
On August, 2005, a share purchase agreement was entered into by and between ITNV, Ritelco and Dolphin Fund PLC (another shareholder of ITNV) whereby ITNV acquired all the common shares held by those shareholders for US$ 0.147 per share. The amount of this transaction was US$ 850, of which US$ 604 correspond to Ritelco. On that date, ITNV cancelled the total amount of the transaction.
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Acquisition of Canteras Natal Crespo
During the fiscal year ended June 30, 2006, the Company acquired from Ecipsa Holding S.A. (ECIPSA), a 43.18% equity interest in Canteras Natal Crespo. Such shares have equal percentage of votes. The total amount agreed for such purchase was US$ 1,541.
Canteras Natal Crespo is a company located in the Province of Cordoba, Argentina, which primary operations are the development of own or third-party plots, countries, sale or rent of plots of land, real estate and house-building.
Purchase of additional shares and convertible notes of APSA
During the fiscal year ended June 30, 2006 the Company acquired 759,393 shares of APSA for a total amount of Ps. 4,300. As a result of this transaction, the Company’s ownership interest in APSA increased from 60.69% to 61.54%.
Sale of the Alcorta Plaza plot of land
On December 22, 2005, APSA subscribed a preliminary purchase contract with possession, by which the Company sold to RAGHSA S.A. the plot of land denominated Alcorta Plaza for a total price of US$ 7.7 million. On March 13, 2006 the deed title of the building was registered and a first privilege degree mortgage guarantee was established on certain functional units to be used as offices and garages of the building property of RAGHSA S.A., located in Buenos Aires. The mortgage amounted to US$ 4.4 million. The agreed terms and conditions of payment were determined in four installments of US$ 1.9 million and 7.5% annual interest on the balance. During December, 2007, the last installment was collected.
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires the company’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities as of the date of the financial statements, and the reported amounts of revenues and expenses during the reporting years. Significant estimates include those required in the accounting for barter transactions, gain from recognition of inventories at net realizable value, provisions for allowances and contingencies, impairment of long-lived assets, depreciation and amortization, current value of assets acquired in business combination and assets acquisition, deferred income asset and asset tax credit. Future actual results could differ from those estimates and evaluations made at the date of preparation of these financial statements.
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The following is a summary of significant accounting policies followed by the Company in the preparation of these consolidated financial statements.
The Company primarily derives its revenues from domestic office and shopping center leases, the development and sale of properties, hotel operations, origination of consumer loans and credit card receivables and other non-core activities. See Note 6 for details on the Company’s business segments.
The Company records revenue from the sale of properties when all of the following criteria are met:
The Company uses the percentage-of-completion method of accounting with respect to sales of development properties under construction effected under fixed-priced contracts. Under this method, revenue is recognized based on the ratio of costs incurred to total estimated costs applied to the total budget cost. The Company does not commence revenue and cost recognition until such time as the decision to proceed with the project is made and construction activities have begun.
The percentage-of-completion method of accounting requires company’s management to prepare budgeted costs (i.e. the estimated costs of completion) in connection with sales of properties and/or units. All changes to estimated costs of completion are incorporated into revised estimates during the contract period.
Leases and services from office and other buildings
Leases with tenants are accounted for as operating leases. Tenants are charged a monthly rent. Rental income is recognized on a straight-line basis over the term of the lease and unpaid rents are included in accounts receivable in the accompanying consolidated balance sheets.
Leases and services from shopping center operations
Leases with tenants are accounted for as operating leases. Tenants are generally charged a rent which consists of the higher of (i) a monthly base rent (the “Base Rent”) and (ii) a specified percentage of the tenant’s monthly gross retail sales (the “Percentage Rent”) (which generally ranges between 4% and 10% of tenant’s gross sales). Furthermore, pursuant to the rent escalation clause in most leases, the tenant’s Base Rent generally increases between 7% and 12% each year during the term of the lease. For the years ended June 30, 2008, 2007 and 2006, the majority of the tenants were charged with the Percentage Rent.
Certain lease agreements contain provisions, which provide for rents based on a percentage of sales or based on a percentage of sales volume above a specified threshold. The Company determines the compliance with specific targets and calculates the additional rent on a monthly basis as provided for in the contracts. Thus, these contingent rents are not recognized until the required thresholds are exceeded.
Generally, the Company’s lease agreements vary from 36 to 120 months. Law No. 24,808 provides that tenants may rescind commercial lease agreements after the initial six months, upon not less than 60 days’ written notice, subject to penalties which vary from one to one and a half months rent if the tenant rescinds during the first year of its lease, and one month of rent if the tenant rescinds after the first year of its lease.
The Company also charges its tenants a monthly administration fee relating to the administration and maintenance of the common area and the administration of contributions made by tenants to finance promotional efforts for the overall shopping centers’ operations. The administration fee is prorated among the tenants according to their leases, which varies from shopping center to shopping center. Administration fees are recognized monthly when earned.
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In addition to rent, tenants are generally charged “admission rights”, a non-refundable admission fee that tenants may be required to pay upon entering into a lease and upon lease renewal. Admission right is normally paid in one lump sum or in a small number of monthly installments. Admission rights are recognized using the straight-line method over the life of the respective lease agreements.
The Company also derives revenues for parking lot fees charged to visitors. Parking revenues are recognized as services are performed.
Lease agent operations
In September 2000, APSA completed the acquisition of the 99.99% equity interest of Fibesa S.A. (“Fibesa”). Fibesa acts as the leasing agent bringing together the Company and potential lessees for the retail space available in certain of the Company’s shopping centers. Fibesa’s revenues are derived primarily from success fees paid by tenants calculated as a percentage of the final rental income value for both the lessee and the Company. Revenues related to success fees are recognized at the time that the transaction is successfully concluded. A transaction is considered successfully concluded when both parties have signed the related lease contract.
The Company, through APSA subsidiary’s Tarshop S.A. (“Tarshop”) is engaged in the origination of consumer loans and credit card transactions and securitization of corresponding receivables. Revenues from credit card transactions are primarily comprised of (i) merchant discount fees which are recognized when transactional information is received and processed by the Company; (ii) data processing services which consist of processing and printing cardholders statement of accounts, and which are recognized as services are provided; (iii) life and disability insurance charges to cardholders which are recognized on an up-front basis, and (iv) interest income generated by financing and lending activities. Revenue from financing and lending activities are comprised of interest income which is recognized on an accrual basis. For securitization activity see Note 16 for details.
The Company recognizes revenues from its rooms, catering, and restaurant facilities as earned on the close of each business day.
For purposes of the statements of cash flows, the Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash equivalents consist of time deposits with original maturities of less than three months at date of purchase and mutual funds. Mutual funds are considered to be cash equivalents by reference to the frequency with which liquidity is available according to current Argentine GAAP guidance and practice.
Current investments primarily include mutual funds, time deposits, government bonds and mortgage bonds. Time deposits are valued at cost plus accrued interest at year-end. Mutual funds, government bonds and mortgage bonds are carried at market value at year-end.
Unrealized gains and losses on these investments are included within “Financial results, net” in the accompanying consolidated statements of income.
Current investments also include retained interests in securitized receivables pursuant to the securitization programs of Tarshop (See Note 16) and the retained interest in securitized mortgage receivables (See Note 15).
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The Company has an 11.76% investment in Banco Hipotecario S.A. (“BHSA”). This investment is accounted for under the equity method due to the significant influence of the Company on the decisions of BHSA and to the intention of holding the investment permanently. In accordance with regulations of the Banco Central de la República Argentina (“BCRA”) and also as imposed by the agreements signed by BHSA as a result of its financial debt restructuring process, there are certain restrictions on the distribution of profits by BHSA. The Company also has a 5.10% investment in Banco de Crédito y Securitización S.A. (“BACSA”).
The financial statements of BHSA and BACSA are prepared in accordance with BCRA standards. For the purpose of valuation of the investment in the Company adjustments necessary to adequate the financial statements to Argentine GAAP have been considered.
Non-current investments also include the non-current portion of the Company’s retained interests in securitized receivables (evidenced as “Certificates of Participation” or “CPs”) and trust debt securities (“TDFs”) pursuant to the securitization programs of credit card and personal loans receivables (See Note 16 for details).
This balance also includes a residual amount related to a retained interests in securitized mortgage receivables pursuant to the securitization programs entered into by the Company back in 2001 (see Note 15).
The Company acquires undeveloped land in order to provide an adequate and well-located supply for its residential and office building operations. The Company’s strategy for land acquisition and development is dictated by specific market conditions where the Company conducts its operations.
Land held for development and sale and improvements are stated at cost (adjusted for inflation as described in Note 2.c.) less allowances for impairment or estimated fair market value, whichever is lower. Land and land improvements are transferred to inventories or fixed assets, as appropriate, when the Company determines that the properties are to be marketed for sale, when construction commences or the land is leased.
The carrying amount does not exceed their respective estimated recoverable value at the end of this year.
During the years ended June 30, 2002 and 2003 the Company recognized significant impairment. As permitted by Argentine GAAP, due to increases in fair market values, these impairment charges were subsequently reversed during the years ended June 30, 2004 through the current fiscal year. Impairment charges and subsequent reversals are included in the line item “Gain from operations and holdings of real estate assets, net” in the income statement. The balance of allowance for impairment of undeveloped parcels of land amounts to Ps. 360, Ps. 458 and Ps. 1,758 for the years ended June 30, 2008, 2007 and 2006, respectively. See Note 3.t. for details on accounting for impairment losses.
Inventories are comprised primarily of properties held for development and sale and to a lesser extent other minor inventories from hotel operations. A property is classified as held for sale upon determination by the Board of Directors that the property is to be marketed for sale in the normal course of business.
Residential, office and other non-retail properties completed or under construction are stated at acquisition or construction cost (adjusted for inflation as described in Note 2.c.) less allowances for impairment or estimated fair market value, whichever is lower. The Company records impairment losses for certain inventories which have market values lower than costs. Costs include land and land improvements, direct construction costs, construction overhead cost, interest on indebtedness and real estate taxes.
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Inventories on which the Company received down payments that fix the sales price and the terms and conditions of the contract provide reasonable assurance the closing of the transaction and realization of the gain are valued at net realizable value. See “Gain from recognition of inventories at net realizable value” in the consolidated statements of income.
Properties held for sale are classified as current or non-current based on the estimated date of sale and the time at which the related receivable is expected to be collected by the Company.
In addition, inventory includes receivables representing the rights to receive certain property units. The units relating to the projects called “Caballito (CYRSA)”, “Caballito (Koad)”, “Benavidez”, “Rosario” and “Dique III” have been valued at acquisition or construction cost, as applicable.
During the years ended June 30, 2002, 2003 and 2005, the Company recognized significant impairment losses. As permitted by Argentine GAAP, due to increases in fair market values, these impairment charges were subsequently reversed partially during the years ended June 30, 2004 until 2007. Impairment charges and subsequent reversals are included in the line item “Gain from operations and holdings of real estate assets, net” in the income statement. The balance of allowance for impairment of inventory amounts to Ps. 1,111, Ps. 1,140 and Ps. 2,229 for the years ended June 30, 2008, 2007 and 2006, respectively. See Note 3.t. for details on accounting for impairment losses.
Fixed assets, net are comprised primarily of rental properties (including shopping centers), hotels and other property and equipment held for use by the Company.
Rental properties (including shopping centers)
Rental properties are carried at cost (adjusted for inflation as described in Note 2.c.), less accumulated depreciation and allowances for impairment. Accumulated depreciation is computed under the straight-line method over the estimated useful lives of the assets, which are estimated between 10 to 30 years for office buildings and related improvements and between 19 and 31 years for shopping centers. Expenditures for maintenance and repairs are charged to expense as incurred. Significant renewals and improvements are capitalized and depreciated over their estimated remaining useful lives. At the time depreciable assets are retired or otherwise disposed of, the cost and the accumulated depreciation and allowances for impairment of the assets are removed from the accounts and any profit or loss is recognized. The Company capitalizes financial costs (interest and foreign exchange differences) on long-term construction projects. Capitalized financial costs amounted to Ps. 10,509 Ps. 7,100 and Ps. 2,100 for the years ended June 30, 2008, 2007 and 2006, respectively, mainly in connection with the construction of the Panamerican Mall and Shopping Alto Rosario.
During the year ended June 30, 2002, 2003 and 2005 the Company recognized significant impairment losses. As permitted by Argentine GAAP, due to increases in fair market values, these impairment charges were subsequently reversed partially during the years ended June 30, 2003 through the current fiscal year. Impairment charges and subsequent reversals are included in the line item “Gain from operations and holdings of real estate assets, net” in the income statement. The balance of allowance for impairment of fixed assets amounts to Ps. 4,974. Ps. 7,613 and Ps. 11,723 for the years ended June 30, 2008, 2007 and 2006, respectively.
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Other property and equipment
Other property and equipment are carried at cost (adjusted for inflation as described in Note 2.c.), less accumulated depreciation at the end of the year. Accumulated depreciation is computed under the straight-line method over the estimated useful lives of the assets, as specified below:
Asset
Estimated useful life (years)
Leasehold improvements
Facilities
Machinery and equipment
Vehicles
Software
Computer equipment
Furniture and fixtures
Intangible assets are carried at cost, adjusted for inflation (as described in Note 2.c.), less accumulated amortization.
Preoperating and organization expenses
Represents primarily expenses incurred relating to pre-opening activities of certain shopping centers and development projects. These expenses are amortized on a straight-line basis over a three-year period commencing upon the opening of the shopping center or the sale of the project.
Trademarks
Fees and expenses related to the registration of trademarks are amortized on a straight line basis over 10 years.
Above and below market leases an In-place leases
See Note 3.g. for details on accounting for these intangibles.
Acquisitions are accounted for under the purchase method of accounting. Under the purchase method of accounting, the Company allocates the purchase price of properties to tangible and identified intangible assets acquired based on their fair values in accordance with the provisions of Technical Resolution No. 18. In making estimates of fair values for the purpose of allocating purchase price, management utilized a number of sources. The Company also considers information about each property obtained as a result of our pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of tangible and intangible assets acquired. The Company allocates a portion of the purchase price to tangible assets including the fair value of the building on an as-if-vacant basis and to land determined either by real estate tax assessments, third-party appraisals or other relevant data. Generally the Company determines the as-if-vacant value by using a replacement cost method. Also, a portion of the purchase price is allocated to above-market and below-market in-place lease values for acquired properties based on the present value (using an interest rate which reflects the risks associated with the leases acquired) of the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over a period equal to the remaining noncancelable term of the lease. The capitalized above-market and below-market lease values are amortized as a reduction of or an addition to rental income over the remaining noncancelable terms of the respective leases. Should a tenant terminate its lease, the unamortized portion of the lease intangibles would be charged or credited to income. A portion of the purchase price is also allocated to the value of leases acquired and management utilizes independent sources or
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management’s determination of the relative fair values of the respective in-place lease values. The Company´s estimates of value are made using methods similar to those used by independent appraisers. Factors considered by management in performing these analyses include an estimate of carrying costs during the expected lease-up periods, considering current market conditions and costs to execute similar leases. In estimating carrying costs, management includes real estate taxes, insurance and other operating expenses and estimates of lost rental revenue during the expected lease-up periods based on current market demand. The Company also estimates costs to execute similar leases including leasing commissions, legal expenses and other related costs. Other intangible assets acquired may include tenant relationships which are valued based on management’s evaluation of the specific characteristics of each tenant’s lease and the Company’s overall relationship with the respective tenant. The Company has not identified any lessee with whom it has developed a type of relationship allowing the recognition of an intangible asset.
Negative goodwill, net represents the net effect of goodwill and negative goodwill arising out of business combinations.
Certain other receivables and liabilities (value added tax, cash reserves and guarantee deposits) have been measured based on the best estimate of the amount receivable and payable, respectively, discounted at the interest rate that reflect the time-value of money and the estimate specific transactions risks at the time of incorporation to assets and liabilities, respectively. The remaining other receivables and liabilities have been valued at their nominal value plus interest, if any.
Financial receivables and payables have been valued at the amount deposited and collected, respectively, net of operating costs, plus accrued interests based on the interest rate estimated at the time of the transaction. In the case, the Company has the intention and feasibility of selling financial receivables after the year-end, those receivables are valued at their net realizable value.
Accounts receivable and trade accounts payable have been valued at the price applicable to spot operations at the time of the transaction plus accrued interest based on the internal rate of return.
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Obligations to deliver units to be built are valued at the higher of (i) the cost of construction of the units to deliver plus additional costs to transfer the assets to the creditor, or (ii) the value of the barter agreed by the parties. Liabilities in kind are disclosed in the “Trade accounts payable”.
Receivables and payables with related parties generated by financial transactions and other sundry transactions have been valued in accordance with the terms agreed by the parties.
The subsidiaries of the Company calculate their income taxes on a separate basis. The Company did not either calculate or pay income taxes on a consolidated basis for any of the years presented. The statutory income tax rate was 35% for all the years presented.
The Company records income taxes using the deferred tax method required by Technical Resolution No. 17 “Overall Considerations for the Preparation of Financial Statements” (“RT 17”). Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized for that component of net deferred tax assets which is not recoverable.
As discussed in note 2.d. the Company has treated the differences between the price-level restated amounts of assets and liabilities and their historical basis as permanent differences for deferred income tax calculation purposes.
In accordance with CNV regulations, deferred tax assets and liabilities have not been discounted. Since Argentine GAAP required (for the Company’s fiscal year ended June 30, 2006) the accounting for deferred tax assets and liabilities on a discounted basis, the application of the CNV resolution represented a departure from generally accepted accounting principles until the Company’s fiscal year ended June 30, 2006. However, such a departure did not have a significant effect on the 2006 consolidated financial statements. As from July 1, 2006, there is no such difference between CNV regulations and Argentine GAAP, as discussed in Note 2.d..
The company and its subsidiaries are subject to the Minimum Presumed Income Tax Law (“Impuesto a la Ganancia Mínima Presunta” or “MPIT”). The MPIT is calculated on an individual entity basis at the statutory tax rate of 1%, and is based upon the taxable assets of each Argentine entity as of the end of the year. This tax is complementary to Income Tax and the Company is required to pay the greater of the income tax or the MPIT. Any excess of the MPIT over the income tax may be carried forward and recognized as a payment on account of any excess of income tax over MPIT occurring within the subsequent ten years. In the opinion of that the Company will utilize such asset against future taxable income charges within the next ten years and, as a result, the Company has recognized the accumulated MPIT charge within “Other current and non-current receivables”, as appropriate, in the accompanying consolidated balance sheet. This tax credit has been recorded at its nominal value.
Customer advances represent payments received in advance in connection with the sale and lease of certain properties and have been valued at the amount collected.
Mortgage payables includes the debt assumed in the acquisition of Bouchard 710 and LLR (see Notes 13 and 2.g., respectively, for details) and have been valued at the amount collected net of expenses plus accrued interests based on the interest rate estimated at the time of the transaction.
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The Company provides for losses relating to mortgage, lease and other accounts receivable. The allowance for losses is recognized when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the terms of the agreements. The allowance is determined on a one-by-one basis considering the present value of expected future cash flow or the fair value of collateral if the loan is collateral dependent, when applicable. While management uses the information available to make evaluations, future adjustments to the allowance may be necessary if future economic conditions differ substantially from the assumptions used in making the assessments. Management has considered all events and/or transactions that are subject to reasonable and normal methods of estimations, and the consolidated financial statements reflect that consideration.
The Company has certain contingent liabilities with respect to existing or potential claims, lawsuits and other proceedings, including those involving tax claims and labor. The Company accrues liabilities when it is probable that future costs will be incurred and such costs can be reasonably estimated. Such accruals are based on developments to date, the Company’s estimates of the outcomes of these matters and the Company’s lawyers’ experience in contesting, litigating and settling other matters. As the scope of the liabilities becomes better defined, there may be changes in the estimates of future costs, which could have a material effect on the Company’s future results of operations and financial condition or liquidity.
At the date of issuance of these financial statements Company’s Management understands that there are no elements to foresee other potential contingencies having a negative impact on these financial statements.
The Company generally expenses advertising and promotion costs as incurred.
Advertising and promotion expenses were approximately Ps. 37,375, Ps. 31,720 and Ps. 19,495 for the years ended June 30, 2008, 2007 and 2006, respectively.
The Company periodically evaluates the carrying value of its long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The carrying value of a long-lived asset is considered impaired by the Company when its value in use or its net realizable value, whichever is grater, is less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the greater of the value in use or the net realizable value. Value in use is determined by the expected cash flows from the assets discounted at a rate commensurate with the risk involved. Net realizable value is determined by the selling price of the assets less costs to sell.
Under Argentine GAAP, the impairment loss is recorded in the income statement against a liability account. This liability account is a contra account to fixed assets or undeveloped parcels of land or inventories, which means that it is presented on the balance sheet as a direct reduction from the book value of these assets to arrive at the carrying value at any particular point in time. The liability account is depreciated over the useful life of the related asset decreasing depreciation expense each period. Under Argentine GAAP, a previously recognized impairment loss should only be reversed when there is a subsequent change in estimates used to compute the value in use or its net realizable value, whichever is greater. In that event, the new carrying amount of the asset should be the lower of its value in use or its net realizable value, whichever is greater, or the net carrying amount the asset would have had if no impairment had been recognized. Both the impairment charge and the impairment reversal are recognized in earnings in the period in which they are incurred.
Vacation expenses are fully accrued in the period the employee renders services to earn such vacation.
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As part of its risk management strategy, the Company may use derivative financial instruments. In entering into these contracts, the Company assumes the risk that might arise from the possible inability of counter parties to meet the terms of their contracts. The Company does not expect any losses as a result of counterparty defaults. The Company applies Technical Resolution No. 20 (“RT No. 20”), “Accounting for Derivative Instruments and Hedging Activities”, which establishes accounting and reporting standards for derivative instruments and for hedging activities. RT No. 20 requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet and measure those instruments at fair value. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and how it is designated. RT No. 20 prescribes that changes in the fair value of effective cash flow hedges are deferred as a separate component of the balance sheet and subsequently reclassified into earnings when the hedged items affect earnings. Gains and losses from fair value hedges are recognized in earnings in the period of any changes in the fair value of the related recognized asset or liability. Gains and losses on derivative instruments that are not designated as a hedging instrument are recognized in earnings in the period of change.
The Company also engages in trading of certain financial instruments. For details on the Company’s derivative instruments activity, see Note 14.
Monetary assets and liabilities are disclosed at their face value, adding or deducting the corresponding financial results.
The Company is required to disclose earnings per share information for all years presented. Basic earnings per share (“basic EPS”) are computed by dividing the net income available to common shareholders for the years by the weighted-average number of common shares outstanding during the year. Diluted earnings per share (“diluted EPS”) are computed by dividing the adjusted net income for the year by the weighted-average number of common shares and potential common shares outstanding during the year.
In computing diluted EPS, income available to common shareholders used in the basic EPS calculation is adjusted to add back the after-tax amount of interest recognized for the year with respect to any debt convertible to common stock. Additional adjustments are made for any other income or loss items that would result from the assumed conversion of potential common shares. The weighted-average number of common shares outstanding is adjusted to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued. Diluted EPS is based on the most advantageous conversion rate or exercise price over the entire term of the instrument from the standpoint of the security holder. The calculation of diluted EPS excludes potential common shares if their effect is anti-dilutive. For the fiscal year ended June 30, 2008 the Company does not have convertible debt and warrants outstanding. For the year ended June 30, 2007 and 2006 the Company considered the dilutive effect of outstanding warrants and convertible debt in calculating diluted EPS.
Expenses incurred in connection with the issuance of debt are amortized over the term of the debt, applying effective interest method. Debt issuance costs are classified within short-term or long-term debts, as appropriate. In the case of redemption or conversion of these debts, the related expenses are amortized using the accelerated depreciation method. Amortization of debt issuance costs are included within “Financial results, net” in the accompanying statements of income as a greater financing expense.
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Bank accounts
Cash on hand
Checks to be deposited
Current
Mutual funds (iv)
Retained interests in securitized receivables (i)
U.S. Treasury Bonds
Government bonds
TDFs (i)
Other investments
Mortgage bonds issued by BHSA (see Note 11)
Retained interest in securitized mortgage receivables (ii)
Allowance for impairment of CPs (i)
Non-Current
Equity investments:
Manibil S.A.
Banco de Crédito y Securitización S.A.
Retained interests in securitization programs:
Undeveloped parcels of land (iii):
Puerto Retiro (Note 13)
Terreno Beruti plots of land (Note 2.g.)
Caballito (v) (Note 13)
Patio Olmos (Note 2.g.)
Pereiraola
Torres Rosario
Air space Supermercado Coto – Agüero 616
Luján (Note 2.g.)
Torre Jardín IV
Caballito plot of land
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Consumer financing receivables (Tarshop)
Leases and services receivables
Debtors under legal proceedings (i)
Pass-through expenses receivables (ii)
Hotel receivables
Receivables with collection agents (Tarshop)
Related parties (Note 11)
Receivables from the sale of properties (iii) (iv)
Less:
Allowance for doubtful accounts (Note 29.c.)
Receivables from the sale of properties (iv)
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Receivables from the sale of shares
Prepaid expenses and services
MPIT
Miscellaneous debtors (iii)
Guarantee deposits re. securitization programs (Note 16)
Value Added Tax (“VAT”)
Receivable for third party services offered in Tarshop stores
Income tax prepayment
Gross revenue tax prepayment
Guarantee deposits (i)
Guarantee of defaulted credits (Note 23)
Deferred income tax (Note 17)
VAT
Mortgage receivable (ii)
Allowance for doubtful mortgage receivable (ii)
Gross revenue tax prepayment.
Guarantee deposits
Present value – other receivables
.
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Plot 1 c) Dique III (i)
Abril / Baldovinos
San Martín de Tours
Dock 13 Puerto Madero
Torres de Rosario (v)
Benavidez (iii)
Other inventories
Horizons (vi)
Caballito (iv)
Credit from barter transaction of Caballito (CYRSA) (Note 2.g.)
Credit from barter transaction of Rosario
San Martin de Tours
Plot 1 e) Dique III (ii)
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Suppliers (i)
Accruals
Suppliers
Customers advances (iii)
Admission rights (Note 3.a)
Lease advances (i)
Advance for the sale of Torres Rosario plot of land (ii)
Admission rights (Note 3.a.)
Customer advances (iii)
Provision for vacation and bonuses
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Bank loans (v)
Bank overdrafts including accrued interests
Mortgage loans (viii)
Seller financings (iv)
IRSA Non-Convertible Notes (i)
IRSA Convertible Notes (i)
APSA Non-Convertible Notes (ii)
APSA Convertible Notes (ii) (Note 11)
HASA collateralized loan (Note 23)
Debt issuance costs (vi)
Debt issuance costs (vii)
Uncollateralized Loan Agreement (iii)
Collateralized Notes (iii)
IRSA Non-Convertible (i)
Seller financing (iv)
On July 19, 2002, APSA, issued an aggregate amount of US$ 50.0 million of uncollateralized convertible notes (the “APSA Convertible Notes”) in exchange for cash and the settlement of certain liabilities. The issuance was approved by the meeting of shareholders on December 4, 2001 and subsequently by the CNV on March 15, 2002. The issuance was authorized for listing on the Buenos Aires Stock Exchange on July 8, 2002. Proceeds from the issuance were used to repay certain short-term debt aggregating Ps. 27.3 million and the redemption of previously issued APSA Senior Notes for a principal amount of Ps. 52.8 million. The APSA Convertible Notes accrue interest at a fixed annual interest rate of 10%, are convertible at any time at the option of the holder into common shares of APSA of Ps. 0.10 par value per share and originally matured on July 19, 2006. A meeting of noteholders resolved to extend the maturity date of the APSA Convertible Notes through July 19, 2014 although the remaining terms and conditions were left unchanged. Argentine GAAP requires that an exchange of debt instruments with substantially different terms be considered a debt extinguishment
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and that the old instrument be derecognized. Argentine GAAP clarifies that from a debtor’s perspective, an exchange of debt instruments between, or a modification of a debt instrument by, a debtor and a creditor shall be deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. The new debt instrument should be initially recorded at fair value and that amount should be used to determine the debt extinguishment gain or loss to be recognized. Fair value should be determined by the present value of the future cash flows to be paid under the terms of the new debt instrument discounted at a rate commensurate with the risks of the debt instrument and time value of money. If it is determined that the original and new debt instruments are not substantially different, then a new effective interest rate is to be determined based on the carrying amount of the original debt instrument and the revised cash flows. Based on the analysis performed, the Company concluded that the instruments were not substantially different and accordingly, the old instrument was not derecognized. The outstanding balance was reclassified as non-current in these consolidated financial statements. During fiscal years 2007 and 2006, holders of approximately US$ 0.01 million and US$ 0.05 million Convertible Notes exercised their conversion rights and, as a result, APSA issued 101,580 and 1,539,000 common shares, respectively. During fiscal year 2008 the holders of the Convertible Notes didn’t exercised their conversion rights and, as a result, APSA didn’t issue any shares of common stock. As of June 30, 2008 holders of Convertible Notes have exercised their right to convert ordinary shares for a total of US$ 2.8 million. The outstanding balance of the APSA Convertible Notes as of June 30, 2008 amounts to US$ 47.2 million, of which US$ 31.7 million is held by IRSA. Accordingly, balances shown reflect amount held by third parties after intercompany eliminations. Subsequent to year end, on July 21, 2008 the twelfth interest installment was cancelled by an amount of US$ 2.3 million.
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Income tax provision, net
VAT payable
Gross revenue tax
Provision for tax on shareholders’ personal assets
Income tax withholdings
VAT withholdings
Loans with shareholders of related parties
Accrual for directors fees (Note 11) (iii)
Payables to Nationals Parks Administration (Note 21)
Provision for donations committed (Note 11)
Derivative financial instruments (Note 14)
Below market leases (Note 3.g.)
Provision for contingencies (Note 29.c.) (i)
Contributed leasehold improvements (ii)
Present value – other liabilities
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Mortgage payable Llao Llao (Note 13)
Mortgage payable Bouchard 710 (i)
Mortgage payable Llao Llao
As of June 30, 2008, the Company had 578,676,460 authorized and outstanding shares of common stock, having a par value of Ps. 1.0 per share. Holders of the common stock are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders. Following is a detail of the activity during the years ended June 30, 2006, 2007 and 2008:
Conversion of debt into common shares (Note 10.a)
Exercise of warrants (Note 10.a)
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As mentioned in Note 2.c. the Company’s consolidated financial statements were prepared on the basis of general price-level accounting which reflected changes in the purchase price of the peso in the historical financial statements through February 28, 2003. The inflation adjustments related to common stock and treasury stock were appropriated to inflation adjustment reserves that form part of shareholders’ equity. According to CNV Rules, the balances of the inflation adjustment reserves may be applied only towards the issuance of common stock to shareholders of the Company.
In accordance with the Argentine Corporations Law and the Company’s By-laws, 5% of the net and realized profit for the year calculated in accordance with Argentine GAAP plus (less) prior year adjustments must be appropriated by resolution of the shareholders to a legal reserve until such reserve equals 20% of the Company’s outstanding capital (including inflation adjustment). This legal reserve may be used only to absorb losses.
Pursuant to a resolution of the Inspección General de Justicia, companies should indicate the intended use of the accumulated retained earnings balance of the period. Accordingly, a special reserve labeled as “Reserve for New Developments” is created. The accumulated retained earnings balance is transferred to this equity account. This reclassification has no impact on the total shareholders equity of the Company.
The Company is required to disclose segment information in accordance with RT 18. RT 18 establishes standards for reporting information about operating segments in annual financial statements and requires reporting of selected information about operating segments in interim financial reports issued to shareholders. Operating segments are components of a company about which separate financial information is available that is regularly evaluated by the chief operating decision maker(s) in deciding how to allocate resources and assess performance. The statement also establishes standards for related disclosures about a company’s products and services, geographical areas and major customers. The Company has determined that its reportable segments are those that are based on the Company’s method of internal reporting. Accordingly, the Company has six reportable segments. These segments are Development and Sale of Properties, Office and Other Non-Shopping Center Rental Properties, Shopping Centers, Consumer Financing (formerly known as “Credit Card Operations”), Hotel Operations and Financial Operations and Others.
This segment includes the operating results of the Company’s construction and ultimate sale of residential buildings business.
This segment includes the operating results of the Company’s lease and service revenues of office space and other non-retail building properties from tenants.
This segment includes the operating results of the Company’s shopping centers principally comprised of lease and service revenues from tenants.
This segment was formerly known as “Credit Card Operations”. The Company modified its name to better reflect the nature of operations included in this segment. However, there was no change in the way the business is managed and reviewed. This segment includes the origination of loans and credit card receivables and related securitization programs.
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This segment includes the operating results of the Company’s hotels principally comprised of room, catering and restaurant revenues.
This segment primarily includes revenues and associated costs generated from the sale of equity securities, other securities-related transactions and other non-core activities of the Company. This segment also includes the gains or losses on in equity investees of the Company relating to the banking activity.
Inter-segment transactions, if any, are accounted for at current market prices. The Company evaluates performance of its segments and allocates resources to them based on operating income. The Company is not dependent on any single customer.
The accounting policies of the segments are the same as those described in Note 3.
As of and for the year ended June 30, 2008:
Gain from valuation of inventories at net realizable value
Other (expenses) income, net
Acquisitions of fixed assets and intangible assets
Depreciation and amortization (b)
Non-current investments in affiliated companies
Non-operating assets
Non-operating liabilities
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As of and for the year ended June 30, 2007:
(Loss) Gain from operations and holdings of real estate assets, net
(Loss) Gain on equity investees
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As of and for the year ended June 30, 2006:
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Generated by assets:
Interest income
Foreign exchange gain (loss)
Gain on derivative instruments (Note 14)
Interest on discounting assets
Net unrealized (loss) gain on investments and others
Generated by liabilities:
Interest expense and others (Note 29.f.)
Gain on repurchase of debt (Note 29.f.)
Interest on discounting liabilities
Other income:
Recovery of allowance for doubtful accounts and lawsuit, net
Gain on cancellation of liabilities
Easement income (i)
Other expenses:
Provision for contingencies
Tax on shareholders’ personal assets
Donations
Recovery (loss) on fire damages (net of insurance recoveries)
Unreimbursed expenses
Unrecoverable VAT
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On November 21, 2002, the Company issued US$ 100,000 of 8% convertible notes due November 2007 (the “IRSA Convertible Notes”) with non-detachable warrants to acquire additional shares of common stock (the “Warrants”) in exchange for US$ 85,000 in cash and the settlement of certain liabilities (See Note 4.i.). In accordance with the agreement, the IRSA Convertible Notes were convertible, at any time, at the option of the holder, into a fixed number of common shares of the Company. The agreement provided for an original conversion price of US$ 0.55713, which only could be adjusted as a result of anti-dilution provisions. Once converted, the holder had the right to acquire an additional equal number of shares at the exercise price of US$ 0.66856 per share. The exercise price of the warrants was also adjusted as a result of anti-dilution provisions. Under Argentine GAAP no proceeds were allocated to the conversion feature and warrants. Proceeds from the issuance of the IRSA Convertible Notes were mainly used to the settlement and restructuring of the debts outstanding at that date and for working capital needs. As a result of the distribution of treasury shares approved by the shareholders in November 2002, effective December 20, 2002 the conversion price and the warrants exercise price was decreased to US$ 0.54505 and to US$ 0.65406, respectively.
During the years ended June 30, 2003, 2004, 2005, 2006, 2007 and 2008, certain holders of IRSA Convertible Notes (aggregating US$ 99,900) exercised their conversion rights and, as a result, the Company issued 12,531 shares, 23,734,388 shares, 52,448,952 shares, 55,961,675 shares 16,640,658 and 34,582,162 shares of common stock, respectively. During the years ended June 30, 2004, 2005, 2006, 2007 and 2008 the Company also issued 183,296,821 shares of common stock in exchange for US$ 119,900 in cash as a result of the exercise of warrants.
The IRSA Convertible Notes were fully paid as of June 30, 2008.
In February 2007, the Company issued US$ 150,000 of non-convertible notes (the “IRSA Non-Convertible Notes”) due February 2017 under the Global Program for up to US$ 200,000 authorized by the CNV in December 2006. The IRSA Non-Convertible Notes bear interest at a fixed rate of 8.5% per annum. The IRSA Non-Convertible Notes pay interest in cash semi-annually in arrears on February 2 and August 2 of each year, beginning on August 2, 2007. Principal on the IRSA Non-Convertible Notes is fully paid at maturity.
The IRSA Non-Convertible Notes contain certain customary covenants including restrictions to pay dividends in accordance with certain limits.
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The following is a summary of the balances and transactions with related parties:
Relation
Description of
Transaction / caption
Comercializadora Los Altos S.A.
BHSA
BACSA
Cresud S.A.C.I.F. y A.
Dolphin Fund PLC
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Estudio Zang (legal advisory)
of the Company
Fundación IRSA
Puerto Retiro S.A.
Cactus S.A.
Futuros y Opciones.com S.A.
Managers, Directors and other staff of the Company
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Transaction /caption
Consultores Assets Management S.A.
Museo de los Niños
Parque Arauco S.A.
Canteras Natal Crespo S.A.
CYRSA S.A.
Metroshop S.A.
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Description oftransaction
Personnel
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The breakdown of main assets and liabilities as of June 30, 2008 is as follows:
No fixed term
Assets
Liabilities
Mortgage payables
Short and long term debt
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In the ordinary course of business, certain assets of the Company have been restricted for various reasons.
As of June 30, 2008, these restrictions are as follows:
Suipacha 652
Plots of land in Bariloche
Sheraton Libertador Hotel
Beruti plot of land
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According to the Company’s risk management strategy, the Company entered into certain derivative transactions to minimize financial costs. The Company did not apply hedge accounting for these transactions.
Liabilities originated from Derivative financial instruments relate to foreign-currency forward contracts, as follows:
Forwards contracts
Bank
Open transactions
Purchase of US$
Closed transactions
Loss from derivative instruments
From time to time the Company may enter into derivative financial instruments for trading purposes. During the current fiscal year the Company subscribed future purchase of gold contracts.
As of June 30, 2008, the Company does not have derivative instruments agreements outstanding nor does it have any guarantee.
As of June 30, 2007 the Company had 30 contracts for the purchase of 100 ounces of “gold” due in December 2007 at an average market price of US$ 0.7. As guarantee for such contracts, the Company had deposits in the amount of US$ 81 (equivalent to Ps. 247).
During the years ended June 30, 2008, 2007 and 2006, the Company recognized Ps. 2,689 loss, Ps. 665 gain and Ps. 2,942 gain related to these contracts
In December 2001, the Company, and certain subsidiaries on one side (hereinafter the “Trustors”) and Banco Sudameris Argentina S.A. (hereinafter the “Trustee”) agreed to set up the IRSA I Financial Trust. The Trustors sold their personal and real estate receivables, secured with mortgages or arising from bills of sale with the possession of the related properties, for the total amount of US$ 26,586 to the Trustee, in exchange for (i) US$ 10,000 cash (ii) US$ 3,300 Class A Participation Certificates (iii) US$ 2,600 Class B and C Participation Certificates, (iv) US$ 10,686 Class D Participation Certificates.
As of June 30, 2008, the value of Class D Participation Certificates amounted to Ps. 653. Class A, B, and C Certificates have been totally amortized at year end.
The Company has ongoing revolving year securitization programs through which Tarshop, a majority-owned subsidiary of APSA, transfers a portion of its customer credit card and personal loans receivable balances to master trusts that issue certificates to public and private investors.
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Under the securitization programs, the trusts may issue two types of certificates representing undivided interests in the Trust – Títulos de Deuda Fiduciaria (“TDF”) and Certificados de Participación (“CP”), which represent debt, and equity certificates, respectively. Interest and principal services are paid periodically to the TDF holders throughout the life of the security. CPs are subordinated securities which entitle the CP holders to share pro rata in the cash flows of the securitized credit card and personal loans receivables, after principal and interest on the TDFs and other fees and expenses have been paid. During the revolving period no payments are made to TDF and CP holders. Principal collections of the underlying financial assets are used by the Trust to acquire additional credit card and personal loans receivables throughout the revolving period. Once the revolving period ends, a period of liquidation occurs during which: (i) no further assets are purchased (ii) all cash collections are used to fulfill the TDF service requirements and (iii) the remaining proceeds are used to fulfill the CPs service requirements.
At the time of the securitization, Tarshop transfers credit card and personal loans receivables to the trust in exchange for cash and retained interests in the trust (CPs). Part of the proceeds is retained by the trustee and maintained as a cash reserve to serve as collateral for the payment of amounts due on the TDFs. Cash reserves flow back to Tarshop on a monthly basis according to a schedule until all TDFs are fully paid. Cash reserves are stated at cost and are classified as “Guarantee deposits” within the caption “Other receivables and prepaid expenses” in the accompanying consolidated balance sheets. CPs are carried at their equity value based on financial statements issued by the trusts and classified as “Investments” in the accompanying consolidated balance sheets. Gain or losses on CPs are reported as a component of “Net (loss) income from retained interest in securitized receivables” in the accompanying statements of income. Tarshop recognizes a result on the sale of receivables when the carrying value of transferred credit card and personal loans receivables differs from the amount of cash and CPs received. Results recognized on the sale of receivables are reported as a component of “Net (loss) income from retained interest in securitized receivables” in the accompanying statements of income. Expenses related to the securitization of receivables are expensed as incurred.
As of June 30, 2008 the Company has thirty one securitization programs outstanding, pursuant to which Tarshop has sold an aggregate amount of Ps. 1,440 million of its customer credit card and personal loans receivable balances to Trusts in exchange for Ps. 1,231.4 million in cash proceeds, Ps. 74.4 million variable rate interest TDFs, and Ps. 134.3 million nominal value subordinated CPs. Under the securitization programs, the Trusts issued Ps. 1,231.5 million TDFs which pay the variable interest rate published by Argentine Central Bank, known as “BADLAR” plus a spread between 2% and 4% for TDFs “A” and between 4% and 6% for TDFs “B”, with a floor in the range of 11.5% to 17% for TDFs “A” and 12.5% to 18% for TDFs “B”, a cap between 19% and 25% for TDFs “A” and from 19% to 26% for TDFs “B”. Additionally, one of the Trusts issued TDFs A at a fixed interest rate of 11.5%. Except for certain TDFs acquired by Tarshop as mentioned above, the TDFs were sold to other investors through a public offering in Argentina. As mentioned above, as a credit protection for investors, the trusts have established cash reserves for losses amounting to Ps. 19.4 million
The Company accounts for income taxes using the deferred tax method where by deferred tax asset and liability account balances are determined based on differences between financial reporting and tax based assets and liabilities and are measured using the enacted tax rates.
Income tax expense for the years ended June 30, 2008, 2007 and 2006 consists of the following:
Current income and MPIT expense
Deferred income tax expense
Income and MPIT expense
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The tax effects of temporary differences that give rise to the Company’s deferred tax assets and liabilities at June 30, 2008 and 2007 are presented below:
Deferred tax assets (liabilities):
Cash equivalents
Fixed assets
Intangible assets
Short-term and long-term debt
Tax loss carryforwards (i)
Valuation allowance
Net deferred income tax (liability) asset
Income tax expense for the years ended June 30, 2008, 2007 and 2006 differed from the amounts computed by applying the Company’s statutory income tax rate to pre-tax income as a result of the following:
Pretax income
Statutory income tax rate
Income tax expense at statutory tax rate on pretax income
Non-deductible expenses
Change in valuation allowance
Inflation adjustment
Others, net
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The following tables set forth the computation of basic and diluted net income per share under Argentine GAAP for all years presented:
Numerator:
Net income available to common shareholders
Plus: income impact of assumed conversions:
Interest expense on convertible debt
Foreign currency exchange loss on convertible debt
Net income available to common shareholders plus assumed conversions
Denominator:
Weighted-average number of shares outstanding
Plus: incremental shares of assumed conversions:
Convertible debt and warrants
Adjusted weighted-average number of shares
Basic and diluted EPS:
Basic EPS
Diluted EPS
The following table reconciles the balances included as cash and banks and current investments in the consolidated balance sheets to the total amounts of cash and cash equivalents at the beginning and end of the period shown in the consolidated statements of cash flows:
Current investments
Total cash and banks and current investments as per balance sheet
Less: Items not considered cash and cash equivalents
- Mutual funds
- Retained interest in securitized mortgage receivables
- Government bonds
- Retained interests in securitized receivables
- Mortgage bonds issued by BHSA.
- United States Treasury Bond
- TDFs
- Other investments
Cash and cash equivalents as shown in the consolidated statement of cash flows
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APSA´s subsidiary, Shopping Neuquén S.A.’s sole asset is a 50,000 square meter undeveloped parcel of land located in Neuquén, Argentina, where APSA intends to develop a commercial project including the construction of a shopping center, a hypermarket and other compatible purposes.
On December 13, 2006, Shopping Neuquén S.A. entered into an agreement with the Municipality of Neuquén and with Province of Neuquén by which, mainly, the terms to carry out the commercial and residential venture were rescheduled and authorized Shopping Neuquén S.A. to transfer to third parties the title to the plots of land into which the property is divided, provided that it is not that one on which the Shopping Center will be built. Such agreement was subject to two conditions, both already complied with, consisting in the ratification of the agreement by means of an ordinance of the legislative body of the Municipality of Neuquén, and that the new architectonic project and the extension of the environmental impact research submitted were approved by such Municipality.
After having obtained the approval, Shopping Neuquén S.A. had a 150 days´ term to submit the drafts of the architectonic project, such term maturing on February 17 of the current year. However, such drafts presentation took place prior to the referred date. Once the mentioned drafts are registered, which to the date of these financial statements has not occurred, Shopping Neuquén S.A. has to start the works within a 90 days´ term.
The first stage of the work (contemplating the minimum construction of 21,000 square meters of the Shopping Center and 10,000 square meters of the hypermarket) should be concluded in a maximum 22 month term as from the construction starting date. In case of default in any of the covenants established in the agreement, the Municipality of Neuquén is entitled to terminate the agreement and carry out the actions that may be considered necessary for such respect.
The agreement referred to above put an end to the file called “Shopping Neuquén S.A. against Municipalidad de Neuquén on Administrative Action” under judicial procedure before the High Court of Neuquén.
LLao Llao Holdings S.A. (“LLH”) (in liquidation process following the merger with and into the Company), predecessor of Llao Llao Resorts (“LLR”), as operator of the Llao Llao Hotel was sued in 1997 by the National Parks Administration (“NPA”), a governmental entity, seeking collection of US$ 2,870 in Argentine External Debt Bonds (“EDB”) relating to the unpaid balance of the additional sales price. The Court of First Instance sustained the demand. The Company appealed the sentence but it was rejected by the Court of Appeals which demanded the Company to pay NPA an amount of US$ 3,799 including interest, penalties and attorney’s fees. In March 2004, LLH paid NPA $9,156 in cash and Argentine EDBs. The plaintiff requested the court of original jurisdiction to initiate an incidental procedure for execution of sentence by performing a settlement through the Ministry of Economy, the procedure having being questioned by the Company. In view of the fact that the information provided was not sufficient to evaluate the amount settled by the Ministry of Economy, it was requested that the execution be suspended until there is a sentence on the complaint recourse filed with the National Supreme Court for the denial of the extraordinary recourse soliciting that the debt be converted to pesos (“pesification”).
On July 14, 2008 the Court of Appeal notified LLR that by means of a resolution dated June 18, 2008 it had confirmed the settlement approved by the court of original jurisdiction.
In accordance with the information provided by the attorneys in respect of this lawsuit, the amount to be recorded by virtue of the Court sentence amounts to Ps. 10,189 as of June 30, 2008, such amount being recorded in Other current liabilities – Payable to National Parks Administration.
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As discussed in Note 3.c., the Company has a 11.76% equity interest in BHSA.
Following the Argentine crisis in December 2001 and to prevent widespread insolvencies, the Argentine Government pledged to provide offsetting compensation to banks. The general principles of the compensation scheme were to: (1) maintain the peso value of each bank’s net worth, and (2) leave the banks hedged in terms of currency. To that end, the Argentine Government issued two types of bonds to banks. BHSA sought compensation in the amounts of US$ 360,811 in BODEN 2012 “compensation bonds” and US$ 832,827 in BODEN 2012 “coverage bonds”. In September 2002 and October 2005, the BCRA credited US$ 344,050 and US$ 16,761 in BODEN 2012 compensation bonds, respectively, as compensation. BODEN 2012 compensation bonds are US-dollar denominated bonds that the BCRA offered to affected banks at a discounted price of Ps. 1.40 plus CER indexation to US$ 1.00, to compensate for the consequences of creating a mismatch between a bank’s dollar and peso position as a result of the pesification in 2002. In September 2005, the subscription process for BODEN 2012 coverage bonds commenced. As of June 30, 2008, the subscription amounts to US$ 773,533.
In addition, in July 2007 the Bank requested an advance of Ps. 83,012 (through Dossier 27.551/07) to purchase US$ 59,294 in “National Government Bonds in US Dollars Libor Due 2012” (“BODEN 2012”) pursuant to the provisions of Section 29, subsections f) and g) of Decree No. 905/02 of the Executive Branch and regulations.
In order to guarantee the advance to be received, the Bank submitted as collateral a) Secured Bonds (BOGAR) for a face value of Ps. 47,098 and b) Mortgage Securities granted customers of the non-financial private sectors, in Situation 1, equivalent to Ps. 26,163.
As of June 30, 2008, BHSA has an aggregate asset receivable position with the non-financial public sector amounting to Ps. 2,687,281. On the other hand, liabilities from BCRA amount to Ps. 199,154, representing advances to subscribe BODEN 2012 bonds. The net exposure to the public sector (without considering liquid assets in BCRA accounts) amounts to Ps. 2,488,126 and Ps. 3,053,622 as of June 30, 2008 and 2007, respectively. BHSA intends to use a portion of the assets receivable with the public sector towards the subscription of BODEN 2012 coverage bonds.
For the year ended June 30, 2007, a BCRA ruling established that the total exposure of any bank to the non-financial public sector must not be higher than 40% of the total bank’s assets measured as of the last day of the last month prior to measurement date. For the year ended June 30, 2008, the BCRA reduced the limit to 35%. BHSA was in compliance with these limits for all years presented aggregating 26% and 32% as of June 30, 2008 and 2007, respectively.
On January 5, 2001, the Extraordinary Shareholders Meeting of Hoteles Argentinos (HASA), subsidiary of the Company, entered into a long-term mortgage loan (the “Mortgage Loan”) with Bank Boston N.A. for US$ 12,000, the proceeds of which were used to refinance existing debt. The loan was payable in 19 quarterly installments of US$ 300 each and a final payment of US$ 6,300 at maturity in January 2006. Following the crisis in Argentina, HASA defaulted on the loan after January 26, 2002. In March 2004, Bank Boston N.A. notified HASA of the loan assignment in favor of Marathon Master Fund Ltd. (“MMF”). In December 2004, the Company repurchased the loan from MMF and subsequently, in March 2005, sold the loan to Credit Suisse International (CSI). In April 2006, HASA and CSI entered into an agreement to revise the terms of the Mortgage Loan (the “Revised Mortgage Loan”). Under the Revised Mortgage Loan, HASA paid US$ 2,000 as a partial payment. The remaining principal balance is payable as follows: US$ 213 on March 15, 2008; US$ 225 on September 15, 2008; US$ 239 on March 15, 2009; US$ 253 on September 15, 2009 and US$ 5,070 on March 15, 2010. Interest was payable at a fixed rate of 12.07% per annum for the period March 15, 2006 through September 15, 2006. As from September 15, 2006, interest is payable semi-annually in arrears at a rate of six-month LIBO plus 7%. As part of the restructuring of the debt, a deed was signed between the Company and HASA’s creditor, CSI, for the 80% of the value of the reorganized debt where the Company guarantees the fulfillment of HASA’s debt. As a reward for the guarantee, the Company charges an interest at 6-month LIBOR plus 450 basis points. As of the date of these financial statements the two first installments were paid.
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On March 5, 2006, one of the shopping centers of APSA, Alto Avellaneda Shopping Mall was affected by a fire caused by an electrical failure in one of the stores. The fire produced no injuries to persons, or casualties, but caused significant damages to the property. The total area damaged by the fire represented 36 stores or 15.7% of the square meters built. The area was reopened for normal business between June and August 2006. APSA carries insurance coverage which covers fire damage. Days after June 30, 2007 part of the liquidation process related with the reconstruction work had been finished. As of the issuance date of these financial statements, the insurance liquidation process related with the insurance coverage previously mentioned has been finished. The final indemnification amount obtained and collected corresponding to this item amounts, as of the date of these financial statements, to Ps. 10.5 million.
The Company has a defined contribution plan covering its key managers in Argentina. The Plan was effective from 01/01/2006. Employees may begin participation voluntarily on monthly enrollment dates. Participants may make pre-tax contributions to the Plan of up to 2.5% of their monthly salary (Base Contributions) and pre-tax contributions of up to 15% of their annual bonuses (Extraordinary Contributions). Under the Plan, the Company matches employee contributions to the plan at a rate of 200% for Base Contributions and 300% for Extraordinary Contributions. Contribution expense was Ps.0.4 million and Ps 0.2 million for the years ended June 30, 2008 and June 30, 2007, respectively. Participant contributions are held in trust as required by law. Individual participants may direct the trustee to invest their accounts in authorized investment alternatives. Company’s contributions are also held in trust. Participants or their assignees, as the case may be, may have access to the 100% of the Company contributions under the following circumstances:
In case of resignation or termination without good cause, the manager may redeem the amounts contributed by the Company only if he or she has participated in the Plan for at least 5 years.
As discussed in Note 2.g, APSA acquired Empalme in December, 2006. Prior to APSA´s acquisition, back in August 1996, Empalme had entered into a Financing and Occupancy Agreement with NAI INTERNACIONAL II, INC. (“NAI”) (the “NAI Agreement”) pursuant to which NAI financed the construction of a movie theatre complex and a portion of parking facilities in the Cordoba Shopping for up to US$ 8.2 million. The financing accrued interest at LIBOR plus 1.5%. As part of the NAI Agreement, NAI had the right to occupy a portion of the building for a period of 10 years as from the commencement of NAI operations in October 1997, renewable for four additional periods of 5 years each. Interest payments under the NAI Agreement were to be offset against the lease payments to be received from NAI. The NAI Agreement originally established that in the event that any outstanding loan balance remained unpaid after the total lease period (together with renewals and extensions), the NAI Agreement would be further extended for the lower of a 10-year period or the period necessary to settle the loan. Any unpaid outstanding balance after that extension was to be forgiven by NAI. In July 2002, following the Argentine crisis, the NAI Agreement was amended to, among other matters, (i) pesify the payments, (ii) establish a CER-adjustment indexing clause, and (iii) impose restrictions to Empalme and/or third parties on the use of the space occupied by NAI.
Principal owed as of June 30, 2008 and interest accrued through that date, due to the original loan agreement and respective amendments are disclosed in Customers advances - Lease and pass-through expenses advances for Ps. 17,8 million.
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Barter with CYRSA S.A.
In July 2008 APSA entered into a barter agreement with CYRSA pursuant to which APSA, subject to certain closing conditions, would surrender to CYRSA its right to construct a building over a preexisting structure (owned by a third party) in exchange for a de minimis cash and 25% of the housing units in the future building. The total fair value of the transaction is US$ 5.9 million.
Acquisition of shareholdings of a Company
On July 2, 2008, the Company acquired a 30% interest in Metropolitan 885 Third Avenue LLC (“Metropolitan”), a limited liability company organized under the laws of Delaware, United States of America. The main asset of Metropolitan is a 34 story building known as the Lipstick Building located at third avenue between 53rd and 54th streets in Manhattan, New York City. In addition to this asset, the acquired company also includes the debt related to this building. The purchase price paid was US$ 22.6 million. The property has approximately 59,000 square meters of leasable space.
Also, the Company acquired the right (the “put right”) to sell the 50% acquired in an exercisable period from 6 months after this transaction until 3 years anniversary of this transaction.
Additionally, the Company acquired the right of first offer to purchase the 60% of the 5% currently held by one of the shareholders of Metropolitan.
Subsequent events Tarshop S.A.
On July 30, 2008, Tarshop S.A. obtained a loan of Ps. 4,500 from Banco CMF S.A., payable in six, equal, monthly and consecutive installments, the first of which will fall due in February 2009. Such loan accrues interest at a variable rate.
In security of repayment, the Company created a security interest on the Certificate of the Financial Trust Shopping Card Series XXIX (certificates of participation).
On July 2, 2008 and August 15, 2008, Financial Trust Shopping Card Series 44 and 45, respectively, were placed.
Until the close of fiscal year 2007, Financial Trust Shopping Card, under the non revolving form, were authorized to deduct from their income all amounts that were to be assigned as distribution of income. On August 1, 2008, the Official Bulleting published Decree No. 1.207/2008 that nullifies the previously mentioned tax benefit. As of the issuance date of the financial statements of Fideicomisos Financieros Tarjeta Shopping, the trustee (Banco de Valores S.A.) was analyzing the impact on such provision on the equity and cash flows. Financial Statements of Fideicomisos Financieros Tarjeta Shopping as of June 30, 2008, do not recognize the accounting effect of applying the previously mentioned amendments. Apart from that, Tarshop S.A. has considered such effect upon determining the recoverable values of their holding of Certificates of Participation.
Ordinary and Extraordinary General Meeting of Shareholders held October 31, 2008
The Ordinary and Extraordinary General Meeting of Shareholders held October 31, 2008 decided to approve the following items:
To apply 5% of the income for the year ended June 30, 2008 to the Legal Reserve;
That the balance of the income accounts of the year be carried forward, entitling the Board of Directors to use the balance and free availability reserves for the purposes that follow, among other: appropriate dividends or provide for the acquisition of own shares. All this due to the financial crisis shown in the national and international markets from were it is clear the impact on the quotation prices of the Company values, which certainly do not agree with the Company’s reality. It is, therefore, essential to protect the shareholders’ interests from the sudden fluctuations of quotation prices;
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That the tax on personal assets levied on the shareholders and paid by the Company in its capacity as substitute responsible for up to $ 5,433, be fully absorbed by the Company as long as such decision is not modified by virtue of a meeting of shareholders;
The renewal of the delegation on the Board of Directors of the powers to establish the time and currency of issuance, terms, prices, form and payment conditions, type and rate of interest, destination of the funds and other terms and conditions in conformity with the issues approved by the Meeting of Shareholders held October 31, 2006, of the issuances of negotiable bonds within the global program under the terms of section 9 of Law 23,576.
Meeting of Shareholders of APSA held on October 31, 2008
On October 31, 2008 the Annual Meeting of Shareholders by majority resolved the following items:
Approval of the financial statements for the fiscal year ended June 30, 2008.
Appropriation of a cash dividend of Ps. 60,238 prior to deducting 5% from the results for legal reserve.
Acquisition of Company´ shares by Cresud S.A.C.I.F. y A.
During the quarter and up to December 17, 2008, Cresud S.A.C.I.F. y A. (“Cresud”, a Company shareholder) acquired 32,539,475 and 36,172,530 additional shares of the Company, respectively. Consequently, Cresud´ share in the Company, either directly and indirectly through its subsidiary companies, amounts approximately to 47.76% and 54.01% as of September 30 and December 17, 2008, respectively. Therefore, as from October 2008 Cresud exercises control on the Company as it holds the necessary votes to form the social will in the ordinary meetings of shareholders in accordance with the terms of Technical Resolution 21.
Financial and capital markets situation
During the recent months, the world’s principal financial markets have suffered the impact of volatility conditions as well as lack of liquidity, credit and uncertainty. Consequently, stock market rates showed a significant decline worldwide together with an evident economic slowdown. Although the majority of the countries took immediate action on the matter, the future prospects of the international markets is uncertain, as well as its direct effects on the market value of major financial assets, particularly equity and debt instruments.
As far as the impact in Argentina is concerned, stock markets also showed a pronounced downward trend in the price of equity and debt instruments, as well as increases in interest rates, country risk and foreign exchange rates. As of the date of these financial statements, these effects persist. Management is closely evaluating and monitoring the effects of the current liquidity crisis and will take all corrective actions as necessary.
In addition, the Company and its subsidiaries have experienced declines in their respective stock prices during the three months ended September 30, 2008 as compared to the prior quarter. Management believes that this decline is reflective of the current macro-economic state of the economy and is not related to the operating performance of the Company. The stability of the Company’s shopping center and office buildings tenants (measured by the levels of occupancy as well as the delinquency or uncollectibility rates) as well as the market value of the Company’s properties has not been significantly affected by the current credit crisis as of the date of these financial statements. The Company notes that the stock prices have declined due to reasons unrelated to the Company’s business fundamentals. As of the date of these financial statements, management believes that these declines are temporary.
Furthermore, as discussed in Note 3.c., the Company have a 11,76 % equity interest in Banco Hipotecario as of June 30, 2008 and carried this investment under the equity method of accounting. Banco Hipotecario recorded losses of Ps. 91.0 million for the year ended June 30, 2008. Moreover, for the three months ended September 30, 2008, Banco Hipotecario recorded losses of Ps. 239.6 million and could might record new losses for the rest of the fiscal year. Such losses are primarily due to the decline in the market value of the Argentine government bonds Banco Hipotecario received as compensation and held in its portfolio. In spite of these losses, Banco Hipotecario remains well-capitalized in compliance with regulatory guidelines as of June 30, 2008 and thereafter.
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The Company considered several factors including, but not limited to, the following (1) the reasons for the decline in value (whether it is credit event, interest or market related); (2) the Company’s ability and intent to hold the equity investment for a sufficient period of time to allow for recovery of value; (3) whether the decline is substantial for the Company; (4) the historical and anticipated duration of the events causing the decline in value and (5) the major fundamentals underlying of the Company’s business. The evaluation of other-than-temporary impairments is a quantitative and qualitative process, which is subject to various risks and uncertainties. As of the date of these financial statements, management believes that these declines are temporary and will continue to monitor market conditions and determine if any impairment to the carrying value of the investment is necessary.
The Company´s business segment affected by the current credit crisis is Consumer Financing. This segment includes the origination of consumer loans and credit card receivables and securitization activities through the indirect subsidiary Tarshop.
Consumer loan and credit card receivables arise primarily under open-end revolving credit accounts used to finance purchases of goods and services offered by the Company’s shopping centers, hypermarkets and street stores, and financing and lending activities. These accounts have various billing and payment structures, including varying minimum payment levels and finance charge rates. The Company provides an allowance for uncollectible accounts based on impaired accounts, historical charge-off patterns and management judgment.
Due to the current credit crisis and other conditions, some customers experienced delays in payments and also uncollectibility rates increased during the year ended June 30, 2008. Moreover, delinquency and uncollectibility rates further increased as of September 30, 2008 and thereafter. The Company evaluated all available evidence and increased the level of the allowance for doubtful accounts which amounts to Ps. 66.5 million as of June 30, 2008. The allowance for doubtful accounts was increased to Ps. 83.7 million as of September 30, 2008. The Company is closely monitoring the delays, delinquency and uncollectibility rates.
Tarshop´s generated a net loss of Ps. 18.6 million for the year ended June 30, 2008. For the three months ended September 30, 2008, Tarshop generated an additional net loss of Ps. 57.1 million. As discussed before, the Company contributed Ps. 60.0 million and increased its interest from 80% to 93.4% as of November 30, 2008. The Company has committed to support Tarshop financially under a credit line up to a maximum amount of Ps. 120.0 million, including a loan of Ps. 86 million already contributed. The Company is currently evaluating the appropriateness of capitalizing such loans.
The Company has taken several actions to enhance Tarshop’s capital base from streamlining operations to closing redundant stores to revising and making credit criteria more stringent. The securitization market is still open and Tarshop completed securitization programs during the recent months with no disruptions. As of June 30, 2008, the Company’s credit risk exposure is contractually limited to the subordinated retained interests representing Ps. 156.8 million and Ps. 19.4 million escrow reserves for losses. As of September 30, 2008, the Company’s credit risk exposure is contractually limited to the subordinated retained interests representing Ps. 161.2 million and Ps. 17.9 million escrow reserves for losses. Due to the factors mentioned above, as of June 30, 2008, the Company has recorded an other-than-temporary impairment charge of Ps. 12.0 million to the retained interests to reflect its current fair value. For the three months ended September 30, 2008, no additional impairment charge related to the retained interests in securitized receivables was necessary.
Irrevocable contributions to PAMSA
As subsequent event, APSA and CCP made irrevocable contributions to PAMSA for Ps. 90.9 million and Ps. 19.7 million, respectively.
The project contemplates the construction of a commercial center, a hypermarket, a multiplex cinema and an office and/or apartment building and represents one of the most important ventures to be started by APSA.
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Capital increase and loans in Tarshop S.A.
As a consequence of the international financial context, a high volatility in interest rates and increases in the so-called systemic default has been noted, both having caused a negative impact on the performance and financing of the consumption financing business. The highest default levels provoked an increase in the subordination of financial trusts that, added to the modification of their tax treatment, to the higher interest rate for risk increasing and to certain deceleration of private consumption, generated the need to review the general and specific economic prospects of Tarshop S.A. activities.
To face the increasing volatility of the international financing market and to provide Tarshop S.A. with a capital base in line with the current market conditions, in September 2008 APSA decided to participate in a capital increase of Tarshop S.A. for up to Ps. 60 million by increasing the Tarshop S.A. shareholding from 80% to 93.4%.
Several measures were implemented since then to complement the financial support via the direct advising from APSA´s management to Tarshop S.A. aiming at improving the performance of the latter by lightening the point of sale structure that would lead to 17% decrease of the payroll, the reduction of 13 point of sales and centralized areas leased by 10% of the total. The streamlining of resources included areas such as consulting services.
In line with the commercial actions other measures have been implemented, such as:
Subsequent to June 30, 2008 within the changing general environment and following the strategic plan implemented and carried out by APSA, loans were given to Tarshop S.A. in a total of Ps. 86 million with the purpose of improving its financial position taking into account that Tarshop S.A. develops trust activities and that such segment is undergoing quite a particular moment. APSA is currently evaluating the convenience of capitalizing such loans.
Fideicomisos Financieros Tarjeta Shopping
On July 2, 2008 and August 15, 2008, Financial Trust Shopping Card Series XLIV and XLV, respectively, were placed.
Until the end of fiscal year 2007, Fideicomisos Financieros Tarjeta Shopping, under the non revolving form, were authorized to deduct from their income all amounts that were to be assigned as distribution of income. On August 1, 2008, the Official Bulleting published Decree No. 1207/2008 that nullifies the previously mentioned tax benefit. As of the issuance date of the financial statements of Fideicomisos Financieros Tarjeta Shopping, the trustee (Banco de Valores S.A.) was analyzing the impact of such provision on the equity and cash flows. Financial Statements of Fideicomisos Financieros Tarjeta Shopping as of June 30, 2008, do not recognize the accounting effect of applying the previously mentioned amendments. However, Tarshop S.A. has considered such effect upon determining the recoverable values of its holding over Certificates of Participation.
Purchase of the Anchorena street building
On August 7, 2008, the Company subscribed a preliminary purchase contract by which it acquired the functional units numbers one and two, covering a total surface area of 2,875,9 sq., located in Dr. Tomás Manuel de Anchorena street, numbers 665, 667, 669 and 671, between Tucumán and Zelaya streets. The total price agreed is US$ 2.0 million to be paid as follows: i) US$ 1.0 million were paid on account of the price at the time of signing the preliminary purchase contract; ii) US$ 0.5 million will be paid on January 15, 2009; and iii) US$ 0.5 million will be paid on March 15, 2009 at the time of taking possession and signing the final transfer deed document.
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On August 7, 2008, the Company subscribed a preliminary sales contract by which it acquired the functional unit number three covering a surface area of 988 sq. located in Dr. Tomás Manuel de Anchorena street numbers 665, 667, 669 and 671, between Tucumán and Zelaya streets. The total price agreed is US$ 1.3 million payable as follows: i) US$ 0.3 million on account of the price paid at the time of the signature of the preliminary sales contract; ii) US$ 0.5 million to be paid on January 15, 2009; and iii) US$ 0.5 million will be paid on March 15, 2009 at the time of taking possession and signing the final transfer deed document.
Barter transaction with Condominios del Alto S.A.
On November 27, 2008, APSA entered into a barter agreement with an unrelated party Condominios del Alto S.A. pursuant to which APSA bartered a plot of land located in Rosario, Province of Santa Fe for future 42 apartments and 47 parking spaces of the total units to be constructed on the land. Under this agreement, APSA will have a 22% of the total square meters covered by the apartments and garages. The total fair value of the transaction is US$ 2.3 million. As part of the agreement, Condominios del Alto S.A. will pay APSA US$ 34,125 and assumed certain obligations. Condominios del Alto S.A. (i) guaranteed the transaction by the assumption of a first degree mortgage on the land in favor of APSA for US$ 2.3 million; (ii) established a security insurance of which APSA will be assignor of the insured amount of US$ 2.3 million; and (iii) the shareholders of Condominios del Alto S.A. assumed a personal guarantee of the obligations of Condominios del Alto S.A. up to the amount of US$ 1.0 million.
Repurchase of APSA Notes
As subsequent event, APSA repurchased Series II Non-Convertible Notes for a face value of US$ 3.0 million. Such repurchase generated an income of Ps. 2.5 million. Series II Non-Convertible Notes repurchased amount to US$ 4.8 million.
On November 25, 2008, APSA reported the repurchase of Series I Non-Convertible Notes for a face value of US$ 5.0 million for an average weighted price of US$ 0.3978438 per Note and for a total amount of US$ 2.0 million.
IRSA´s and Cresud´s purchase of APSA Notes
On November 25, 2008, Cresud S.A.C.I.F. y A. reported that, as of that date, it has acquired APSA’s Series I Non-Convertible Notes for a face value of US$ 5.0 million for an average weighted price of US$ 0.4185 per Note and for a total amount of US$ 2.1 million. As of the same date, IRSA acquired APSA´s Series I Non-Convertible Notes for a face value of US$ 8.0 million, for an average weighted price of US$ 0.39820 per Note and for a total amount of US$ 3.2 million.
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BANCO HIPOTECARIO SA AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
As of and for the twelve-month periods ended June 30, 2008, 2007 and 2006
(Expressed in thousands of Argentine pesos, except share data and as otherwise indicated)
The Company’s consolidated financial statements have been prepared in accordance with Argentine GAAP and the regulations of the CNV, which differ in certain significant respects from US GAAP. Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by US GAAP and the Regulation S-X of the SEC.
Since Argentine GAAP required companies to discontinue inflation adjustments only as from October 1, 2003, the application of CNV resolution represented a departure from Argentine GAAP. However, due to low inflation rates during the period from March to September 2003, such a departure has not had a material effect on the consolidated financial statements.
In addition, in accordance with the CNV regulations, deferred income taxes have been accounted for on an undiscounted basis. The CNV resolution represented a departure from Argentine GAAP. Such departure did not have a significant impact on these consolidated financial statements. However, as previously discussed in Note 2.d., the CPCECABA issued revised accounting standards. One of these standards required companies to account for deferred income taxes on an undiscounted basis, thus aligning the accounting to that of the CNV. Since the CNV adopted the CPCECABA standards effective for the Company for the fiscal year ended June 30, 2007, there was no longer a difference on this subject between Argentine GAAP and the CNV regulations.
I. Differences in measurement methods
The following reconciliation to US GAAP does not include the reversal of the adjustments to the consolidated financial statements for the effects of inflation because the application of this standard represents a comprehensive measure of the effects of price level changes in the Argentine economy.
The principal differences, other than inflation accounting, between Argentine GAAP and US GAAP are described below, together with an explanation, where appropriate, of the method used in the determination of the necessary adjustments.
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Reconciliation of net income:
Net income under Argentine GAAP
US GAAP adjustments:
Impact of US GAAP adjustments on equity investees (Note 28.I.(a))
Accounting for marketable securities (Note 28.I.(b))
Depreciation of fixed assets (Note 28.I.(c))
Pre-operating and organization expenses (Note 28.I.(d))
Depreciation and amortization expense (Notes 28.I.(e) and (g))
Securitization accounting (Note 28.I.(f))
Present-value accounting (Note 28.I.(h))
Reversal of previously recognized impairment losses (Note 28.I.(i))
Accounting for IRSA Convertible Notes (Note 28.I.(j))
Reversal of loss recognized on troubled debt restructuring (Note 28.I.(k))
Accounting for real estate barter transactions (Note 28.I.(l))
Reversal of loss (gain) from valuation of inventories at net realizable value (Note 28.I.(m))
Amortization of fees related to Series II of APSA Non-Convertible Notes (Note 28.I.o)
Software developed or obtained for internal use (Note 28.I.(p))
Accounting for increasing rate debt (Note 28.I.(q))
Reversal of capitalized foreign exchange differences (Note 28.I.(r))
Debtor’s accounting for a modification of APSA convertible debt instruments (Note 28.I.(s))
Revenue recognition – deferred commissions (Note 28.I.(t.1))
Revenue recognition – scheduled rent increases (Note 28.I.(t.2))
Deferred revenues – insurance & fees (Note 28.I.(t.3))
Deferred income tax (Note 28.I.(u))
Minority interest (Note 28.I.(v))
Net income under US GAAP
Earnings per share under US GAAP (Note 28.II.(i)):
Basic net income per common share
Diluted net income per common share
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Reconciliation of shareholders’ equity:
Total shareholders’ equity under Argentine GAAP
Mortgage payable with no stated interest rate (Note 28.I.(e))
Differences in basis related to purchase accounting (Note 28.I.(g.1))
Depreciation and amortization expense (Note 28.I.(e) and (g))
Reversal of gain recognized on troubled debt restructuring (Note 28.I.(k))
Reversal of gain from valuation of inventories at net realizable value (Note 28.I.(m))
Appraisal revaluation of fixed assets (Note 28.I.(n))
Amortization of fees related to Serie II of APSA Non-Convertible Notes (Note 28.I.o)
Software obtained for internal use (Note 28.I.(p))
Debtor’s accounting for a modification of convertible debt instruments (Note 28.I.(s))
Revenue recognition – Deferred commissions (Note 28.I.(t.1))
Revenue recognition – Scheduled rent increases (Note 28.I.(t.2))
Shareholders’ equity under US GAAP
Description of changes in shareholders’ equity under US GAAP:
Shareholders’ equity under US GAAP at the beginning of the year
Cumulative effect of the initial application of SAB No. 108
Issuance of common stock upon conversion of debt and exercise of warrants
Additional paid-in-capital common stock
Additional paid-in-capital warrants
Unrealized (loss) gain on available-for-sale securities
Unrealized loss on retained interest in securitization programs
Unrealized (loss) gain on available-for-sale securities on equity investees
Shareholders’ equity under US GAAP at the end of the year
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28. Differences between Argentine GAAP and US GAAP (continued)
Under Argentine GAAP, investments in companies in which the Company exercises significant influence, but not control, are accounted for under the equity method. Under the equity method, the investment is recorded at original cost and periodically increased (decreased) by the investor’s proportionate share of earnings (losses) of the investee and decreased by all dividends received from the investor by the investee. The Company applies its percentage ownership interest to the financial statements of its equity method investments prepared under Argentine GAAP. For purposes of this reconciliation, the Company has assessed the impact of US GAAP adjustments on the Argentine GAAP financial statements of its equity investees. US GAAP adjustments primarily relate to: (i) the accounting for the restructuring of its debts, (ii) the accounting for the acquisition of treasury shares and (iii) the accounting for loans loss reserves for reinstated loans.
For the year ended June 30, 2008, the equity investees of the Company are BHSA, BACSA and Manibil. Accordingly, the Company recognized a net gain of Ps. 10.0 million, Ps. 4.2 million and Ps. 23.8 million for the years ended June 30, 2008, 2007 and 2006, respectively.
Under Argentine GAAP, the Company’s investments in mutual funds, government and mortgage bonds are carried at fair value, with unrealized gains and losses included in the statement of income.
Under US GAAP, the Company has classified these investments as available-for-sale and carried them at fair value with unrealized gains and losses, if any, included in stockholders’ equity in accordance with Statement of Financial Accounting Standards No. 115 “Accounting for Certain Investments in Debt and Equity Securities” (“SFAS No. 115”). The Company’s investments are considered available for sale as these securities could potentially be sold in response to needs for liquidity, changes in the availability of and the yield on alternative instruments or changes in funding sources or terms.
During the years ended June 30, 2008, 2007 and 2006, proceeds from the sale of available-for-sale securities were Ps. 4,455.9 million Ps. 1,307.7 million and Ps. 316.3 million, respectively. Gross realized gain was Ps. 19.3 million, Ps. 8.8 million and Ps. 6.7 million for the years ended June 30, 2008, 2007 and 2006, respectively.
The Company has classified the following investments in marketable securities as available for sale and, as such, the securities are carried at fair value. Unrealized gains and losses determined to be temporary are recorded as other comprehensive income, net of related deferred taxes, until realized. Unrealized losses determined to be other than temporary are recognized in the period the determination is made. As of the date of these financial statements, the Company has not determined any unrealized losses to be other than temporary.
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The cost and estimated fair values of marketable securities available for sale at June 30, 2008, 2007 and 2006 were as follows:
June 30, 2006
Mutual funds
Mortgage bonds
June 30, 2007
June 30, 2008
In evaluating whether a security was other than temporarily impaired, the Company considered the severity and length of time impaired for each security in a loss position and other qualitative data.
At June 30, 2008, government bonds have been in a continuous unrealized loss position for less than 12 months. These unrealized losses are not deemed to be other than temporarily impaired. The Company has the ability and intent to hold these securities for reasonable period of time to allow for recovery of value.
Prior to 2007, certain office and apartment buildings of the Company were being depreciated over a useful life of 50 years under Argentine GAAP. For US GAAP purposes, these buildings were being depreciated over a useful life of 40 years. Accordingly, the US GAAP adjustment reflected higher depreciation charges for US GAAP purposes. As a result of this adjustment, the net book value of these assets for US GAAP purposes differs from the book value for Argentine GAAP purposes. In the year ended June 30, 2007, independent appraisers reassessed the appropriateness of the useful lives of the Company’s office buildings and other properties. As a result of the work, the remaining useful lives of certain of these properties were reduced and no difference exists in the remaining useful life of these assets between Argentine GAAP and US GAAP . However, due to the different cost base of fixed assets for Argentine GAAP and US GAAP purposes, a US GAAP reconciling item for depreciation still exists.
Under Argentine GAAP, the Company capitalizes certain costs related to pre-operating activities of the Company’s shopping centers, residencial projects and expenses incurred in the organization of subsidiaries. These expenses are generally amortized on a straight-line basis over periods ranging from 3 to 5 years commencing upon the opening of the shopping center and/or launching of a project. Under US GAAP, these expenses are charged to expense as incurred.
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In 1991, the Company obtained a non-interest bearing mortgage with a face value of US$ 3,300 to acquire a property (Suipacha 652/64). Under Argentine GAAP, the Company did not make any fair value adjustment for this non-interest bearing mortgage. Under US GAAP however, and in accordance with Accounting Principles Board (“APB”) Opinion No. 21, “Interest on Receivables and Payables”, the non-interest bearing mortgage held by the Company was recorded at the estimated market value of the note. The Company used an interest rate of 12%, which approximated its weighted-average borrowing rate, in determining the present value of this debt. This mortgage was fully repaid in November 1996. As a result, the carrying value of the acquired property was decreased by Ps. 2,000. This adjustment gives rise to differences in depreciation expense and is included in the line item “Depreciation and amortization expense” in the US GAAP reconciliation.
As discussed in Notes 15 and 16, the Company has entered into securitization programs, through which the Company transferred a portion of its mortgage receivables and credit card receivables to the trusts in exchange for cash, debt certificates (TDFs) and retained interests in the trusts (CPs). Part of the proceeds is retained by the trustee and maintained as a cash reserve to serve as collateral for the payment of amounts due on the TDFs. Cash reserves flow back to the Company on a monthly basis according to a schedule until all TDFs are fully paid. In the past the Company remained the servicer on the accounts and received a fee for the services performed. Income from servicing activities was recognized as services were performed.
Under Argentine GAAP, the Company recognizes a result on the sale of receivables when the carrying value of transferred receivables differs from the amount of cash, TDFs and CPs received. Results recognized on the sale of receivables are reported as a component of “Net (loss) income from retained interest in securitized receivables” in the accompanying statements of income. Cash reserves are stated at cost and are classified within the caption “Other receivables and prepaid expenses” in the accompanying consolidated balance sheets. TDFs are valued at amortized costs and CPs are carried at their equity value based on financial statements issued by the trusts. TDFs and CPs are classified as investments in the accompanying consolidated balance sheets. Certain expenses associated with the securitization of receivables are capitalized and amortized over the term of the agreements.
Under US GAAP, the Company applies Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (“SFAS No. 140”). SFAS No. 140 requires an entity to recognize the financial and servicing assets it controls and the liabilities it has incurred and to derecognize financial assets when control has been surrendered. The proceeds of securitized financial assets are allocated to the assets sold, the servicing asset or liability and retained interest, based on their relative estimated fair values at the transfer date in determining the gain on the securitization transaction. SFAS No. 140 also requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service financial assets that have been securitized and amortize it over the period of estimated net servicing income or loss. As of June 30, 2008 the Company has recognized a servicing liability of Ps. 8.2 million due to the fact that Tarshop, resigned its right to collect the fee from the Trusts as compensation for the administration services of the credit card and personal loans receivables which met the requirements for sale accounting.
The retained interests in mortgage and credit card receivables are treated as debt securities classified as available-for-sale in accordance with SFAS No. 115 and are carried at fair value. At the time of securitization, the retained interest is initially recorded at the basis allocated in accordance with SFAS No. 140. This original cost basis is periodically adjusted to fair value, which is based on the discounted anticipated future cash flows on a “cash out” basis. The cash out method projects cash collections to be received only after all amounts owed to investors have been paid. Adjustments to fair value (net of related deferred income taxes) are recorded as a component of other comprehensive income. SFAS No. 115 also states that for individual securities classified as available-for-sale an enterprise shall determine whether a decline in fair value below the amortized cost basis is other than temporary. In such event, accumulated unrealized losses included in other comprehensive income shall be reclassified into the statement of income. Cash reserves are considered retained interests and as such they are considered in calculating the gain or loss on the sale of receivables under US GAAP.
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Provided below is an analysis of the securitization accounting adjustments, including a description of each significant component, where appropriate.
The US GAAP adjustments affecting shareholders’ equity at June 30, 2008 and 2007 are as follows:
Equity value as reported under Argentine GAAP (i) (ii)
Less: retained interests related to securitization programs that did not qualify as a sale under US GAAP
Equity value reported under Argentine GAAP of retained interests related to securitization programs that qualified as a sale under US GAAP (i)
Estimated fair market value of retained interests related to securitization programs that qualified as a sale under US GAAP
US GAAP adjustment
The US GAAP adjustments affecting net income as reported under Argentine GAAP for the years ended June 30, 2008, 2007 and 2006 are as follows:
Reversal of results recognized under Argentine GAAP
Recognition of results under US GAAP
Reclassification of unrealized losses (ii)
Regarding receivables transferred in connection with the Company’s securitization programs that qualified for sale treatment under US GAAP, neither the Company nor the trustee have responsibility over any shortfall or failure in collecting the receivables which are the source of cash payment for the TDF holders. Furthermore, the agreements relating to the securitization stipulate that the rights of the beneficiaries (TDF holders) will not be affected by any financial or liquidity failure of either the trustee or the Company. The agreements also state that the transfer qualifies as a non-recourse transfer of receivables since if receivables are not collected in full, neither the trustee nor the Company is obligated to use its own cash flows to cover any potential shortfall or collection failure.
During the years ended June 30, 2008, 2007 and 2006 proceeds from securitization programs were Ps. 589.4 million, 363.7 million and Ps. 193.9 million, respectively.
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The following summarizes the changes in the balance of the Company’s retained interest under US GAAP for the years ended June 30, 2008, 2007 and 2006:
Balance at June 30, 2005
Increase in retained interest
Liquidation of retained interest
Unrealized loss
Balance at June 30, 2006
Balance at June 30, 2007
Unrealized gain/(loss)
Reclassifications of unrealized losses
Balance at June 30, 2008
As of June 30, 2007 and 2006, the gross net unrealized gain has been offset by a deferred tax loss of Ps 2,965, and Ps. 2,758, respectively.
The key economic assumptions used in measuring the fair value of retained interests at the time of and subsequent to a securitization are the estimated cash flows and the discount rate. The estimated cash flows have been discounted at rates that include charges for losses. The valuation models use information deriving from or that can be observed with market data.
The fair value is more accurately reflected through a quoted market price, if available. If a quoted market price is not available, fair value will be based on the quoted market price of a financial instrument with similar characteristics, the present value of estimated future cash flows or other valuation techniques, which are significantly affected by the assumptions used.
The following represents the sensitivity of the current fair value of retained interest in securitizations at June 30, 2008 to changes to key assumptions:
Discount rate
The above sensitivities are hypothetical and should be used with caution. As the amounts indicate, changes in fair value based on variations in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also, in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another, which might magnify or counteract the sensitivities. The Company’s managed mortgage and credit card receivables consist of retained interests in mortgage and credit card receivable securitizations and investor’s share of securitizations sold to unrelated parties without recourse. The Company records its retained interests in mortgage and credit card receivables securitizations on the consolidated balance sheet.
F-69
The reconciling item of Ps. 48.2 million relates to various adjustments related to purchase accounting for business combinations which occurred prior to 2005 resulting in a difference between the amount of goodwill recorded under Argentine GAAP and US GAAP.
In addition, as discussed in Note 3.g, under Argentine GAAP, the Company followed the guidance in RT No. 18 in accounting for business combination. The purchase price was allocated based on the fair value of each component. A portion of the purchase price was allocated to tangible assets considering the value of the property as if it were vacant. In addition, a portion of the purchase price was allocated to below-market leases and in-place leases. No customer relationships were identified as part of the place leases. For the acquisitions of Empalme, the remaining 33% interest in Palermo Invest, and Bouchard 551 and Dock del Plata buildings consummated during the year ended June 30, 2007, the sum of the individual fair values of the identifiable tangible and intangible assets exceeded the respective purchase price paid. Under Argentine GAAP, the amount of negative goodwill was fully allocated to reduce the value of intangible assets acquired to zero. The remaining amount of negative goodwill is amortized under the straight-line method over the remaining weighted average useful life at the main tangible assets acquired. Under US GAAP, upon acquisitions of real estate, the Company also assesses the fair value of acquired assets (including land, buildings and improvements, and identified intangibles such as above and below market leases and acquired in-place leases and customer relationships) and acquired liabilities in accordance with Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, and SFAS No. 142, Goodwill and Other Intangible Assets, and allocates purchase price based on these assessments. There is no difference between US GAAP and Argentine GAAP in the purchase price allocation process. However, under US GAAP, when negative goodwill exists, eligible assets (tangible and intangible) are subject to pro rata reduction. Accordingly, under US GAAP, a liability for below-market leases and intangible assets for in-place leases amounting to Ps. 28.6 million and Ps. 23.0 million, respectively, were recognized. The fair value of below market leases is recorded as deferred income and amortized as additional lease revenue over the remaining contractual lease period and any renewal option periods included in the valuation analysis.
Intangible assets associated with at-market in-place leases are amortized as additional expense over the remaining contractual lease term. There is no USGAAP adjustment to equity for this item. The US GAAP adjustment to net income as described in note 28.I.(g.2) represents the net effect of (i) reversing the amortization of the negative goodwill recorded under Argentine GAAP; (ii) lower depreciation charges on fixed assets under US GAAP, (iii) amortization charges for intangible assets recognized under US GAAP and (iv) amortization of below-market leases.
Also, in 2006 APSA acquired an additional 2.7% in ERSA. Under Argentine GAAP, the unallocated portion of negative goodwill is amortized over the average remaining useful lives of tangible assets acquired, mainly the shopping center property. Under US GAAP, a pro rata reduction was performed following the guidance in SFAS No. 141. This reduction resulted in lower depreciation charges under US GAAP. Since the amortization of negative goodwill under Argentine GAAP equals the lower depreciation charge of the assets acquired under US GAAP (after pro rata reduction), there is no effect in the US GAAP reconciliation.
As further discussed above, due to certain differences in purchase accounting for acquisitions prior to 2005, goodwill under Argentine GAAP differed from goodwill under US GAAP. In addition, amortization of goodwill under US GAAP ceased effective June 30, 2002. Total goodwill under US GAAP as of adoption of FAS 142 was Ps.82.1 million.
Subsequent acquisitions through June 30, 2007 did not generate additional goodwill under either US GAAP or Argentine GAAP. For the year ended June 30, 2008 goodwill under US GAAP increased Ps. 10.0 million due to the acquisitions completed during fiscal year 2008 (see Note 2.g. for details)
As required by paragraph 26 of SFAS 142, following an acquisition, initial annual goodwill impairment testing should be performed within 12 months of the acquisition date. Therefore, the Company has not yet performed goodwill impairment testing related to the acquisitions completed in 2008 as of June 30, 2008.
In accordance with the requirements of SFAS 142, the Company does not amortize goodwill. SFAS 142 requires the Company to periodically test for goodwill impairment, at least annually, or sooner if evidence of possible impairment arises. The Company performs its annual impairment testing as of June 30, using a two-step process that begins with an estimation of the fair values of the reporting units that have goodwill.
F-70
Step 1 of impairment testing consists of determining and comparing the fair value of a reporting unit to the carrying value of the reporting unit. If step 1 is failed for a reporting unit, indicating a potential impairment, the Company is required to complete step 2, which is a more detailed test to calculate the implied fair value of goodwill, and compare that value to the carrying value of the goodwill. If the carrying value of goodwill exceeds its implied fair value, an impairment loss is required to be recorded.
The Company performed step 1 impairment tests of recorded goodwill as of June 30, 2008 amounting to Ps. 82.1 (excluding goodwill generated for the fiscal 2008 acquisitions which will be tested after year-end as discussed above). The step 1 tests indicated that the fair values of the reporting units, calculated primarily using discounted expected future cash flows, exceeded their carrying values as of the test dates. Accordingly, step 2 of the impairment tests was not required to be performed for those reporting units, and no impairment charges were necessary.
In addition, the broader stock market has experienced significant price and volume fluctuations in recent months. This volatility has affected the market price of the Company’s securities for reasons unrelated to its operating performance. The Company believes that the fact that its market capitalization is trading below book value is not indicative of its operating performance and is not related to its business fundamentals. Moreover, since step 1 of the goodwill impairment test performed as of June 30, 2008 resulted in the fair value of the reporting units being higher for a large percentage than the respective carrying values, the Company believes an interim impairment testing of goodwill is not necessary. The Company continues to monitor current market conditions, which may trigger interim impairment testing analysis at any given point in time.
This reconciling item includes adjustments related to purchase accounting for business combinations which occurred prior to 2005 resulting in a difference between the amount of goodwill recorded under Argentine GAAP and US GAAP. The differences in the carrying amount of goodwill between Argentine GAAP and US GAAP of Ps. 48.2 million gave rise to differences in amortization expense under US GAAP until June 30, 2002. Effective July 1, 2002, the Company adopted SFAS No. 142 and, as such, discontinued amortization of this goodwill as from that date.
In addition, under Argentine GAAP, goodwill is amortized under the straight-line method generating amortization expense of Ps. 14.4 million for the years ended June 30, 2008, 2007 and 2006. Under US GAAP, amortization expense recorded was reversed for all periods presented.
In addition, the differences in the carrying amount of fixed assets, intangible assets and liabilities (below-market leases) acquired between Argentine GAAP and US GAAP and the reversing of the amortization of the negative goodwill recorded under Argentine GAAP as described above gave rise (i) amortization charges for intangible assets recognized under US GAAP, (ii) higher amortization of deferred revenues (below-market leases), (iii) lower (higher) depreciation charges on fixed assets and (iv) reversing the amortization of the negative goodwill recorded under Argentine GAAP, amounting to a net lower effect of Ps. 0.8 million, Ps. 2.3 million and Ps. (2,7) million during fiscal years 2008, 2007 and 2006, respectively.
As indicated in Note 3.i., under Argentine GAAP, certain other tax receivables and liabilities are measured at present-values as of year-end. Under US GAAP, present valuing or discounting of these assets and liabilities is precluded.
Under Argentina GAAP previously recognized impairment losses can be reversed. Amounts reversed in 2008, 2007 and 2006 amounted to Ps. 2.7 million, Ps. 2.6 million and Ps. 13.0 million, respectively, given rise to higher depreciation charges under Argentine GAAP. Under US GAAP, reversal of a previously recognized impairment loss is prohibited. When an impairment loss is recognized, the adjusted carrying amount of the asset becomes the new cost basis, which is depreciated over the remaining useful life of the asset. Depreciation expense reversed under US GAAP for the years ended June 30, 2008, 2007 and 2006 amounted to Ps. 4.3 million, Ps. 4.4 million and Ps. 5.6 million, respectively, and are shown netted against the reversal impairment losses under Argentine GAAP.
F-71
As discussed in Note 10.a., in November 2002, the Company issued US$ 100,000 of IRSA Convertible Notes with non-detachable warrants to acquire additional shares of common stock. In accordance with the agreement, the IRSA Convertible Notes are convertible, at any time, at the option of the holder, into a fixed number of common shares. Once converted, the holder has the right to acquire an additional equal number of shares at the exercise price of the warrant. Under Argentine GAAP purposes, no proceeds were allocated to the conversion feature and non-detachable warrants.
Under US GAAP, the Company applied EITF No. 00-27, “Application of Issue No. 98-5 to Certain Convertible Instruments” (EITF No. 00-27), which address how a beneficial conversion amount should be measured when an entity issues a convertible instrument that, if converted, will result in the holder receiving common stock and other equity instruments of the issuer, such as warrants to acquire common stock of the issuer. In EITF No. 00-27, the Task Force reached a tentative conclusion that the intrinsic value of the conversion option should be computed based on a comparison of (a) the proceeds of the convertible instrument allocated to the common stock portion of the conversion option and (b) the fair value at the commitment date of the common stock to be received by the holder upon conversion. The excess of (b) over (a) is the intrinsic value of the embedded conversion option that should be recognized by the issuer at the issuance date for the convertible instrument. In EITF No. 00-27 the Task Force also reached a consensus that the Issue 98-5 model should be modified for convertible instruments that have a stated redemption date to require a discount resulting from recording a beneficial conversion option to be accreted from the date of issuance to the stated redemption date of the convertible instrument, regardless of when the earliest conversion date occurs. EITF 00-27 also states that the entire unamortized discount, if any, remaining at the date of conversion should be immediately recognized as interest expense.
As a result of applying EITF 00-27, under US GAAP the Company allocated Ps. 36,191 of the proceeds received, representing the intrinsic value of the embedded beneficial conversion feature at the commitment date, to additional paid-in capital (Ps. 23,524 net of income tax). The resulting debt discount is being recognized as expense over the term of the IRSA Convertible Notes. Upon conversion, warrants are recognized as additional paid-in capital and any unamortized discount is immediately recognized as interest expense. Total discount amortization recognized during the years ended June 30, 2008, 2007 and 2006 totaled Ps. 469 Ps. 2,039 and Ps. 7,338, respectively (included accelerated amortization recognized as a result of conversions made during those years). As IRSA Convertible Notes are denominated in U.S. Dollars, the US GAAP adjustment also includes the elimination of exchange rate differences between the Argentine peso and the U.S. Dollar related to the debt discount. Foreign exchange gain (losses) reversed under US GAAP totaled Ps. (3) Ps. 8 and Ps. (580) during the years ended June 30, 2008, 2007 and 2006, respectively.
During the years ended June 30, 2008, 2007, 2006, 2005 and 2004 the holders of IRSA Convertible Notes for a total amount issued, exercised its conversion rights and, as a result, the Company issued 34,582,162, 16,640,658, 55,961,675, 52,448,952, and 23,734,388 shares of common stock, respectively. Upon conversion, during the years ended June 30, 2008, 2007, 2006, 2005, 2004 and 2003 the Company issued US$ 18.9 million , US$ 9.1 million ,US$ 30.5 million , US$ 28.6 million , US$ 12.9 million and US$ 0 million of warrants, of which US$ 43.1 million, US$ 7 million, US$ 12.1 million and US$ 30.5 million were exercised during fiscal year ended June 30, 2008, 2007, 2006 and 2005, respectively. As a result of the conversions and exercises of warrants, under US GAAP the Company has reclassified in 2008 and 2007 a net amount of Ps. 6,659 and Ps. 1,379, respectively from additional paid-in capital of common stock to additional paid-in capital of warrants. As of June 30, 2008 the remaining balance of IRSA’s Convertible Notes have been fully paid.
Under Argentine GAAP, the restructuring of debts occurred in November 2002 was treated as an exchange of debt instruments with substantially different terms. As a result, the Company removed the original loans from the consolidated balance sheet and recognized the new debt instruments at their present value discounted at an 8% market interest rate. Gain on restructuring recorded in fiscal year 2003 amounted to Ps. 36.5 million (Ps. 31.7 million net of related expenses). Under Argentine GAAP the Company also recognized a gain of Ps. 7.6 million from interest expense reductions.
F-72
For US GAAP purposes, the restructuring of the debt was accounted for in accordance with SFAS No. 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings (“SFAS 15”), as the creditors made certain concessions due to the financial difficulties of the Company. SFAS No. 15 requires that a comparison be made between the future cash outflows associated with the new debt instruments (including interest), and the recorded amount of the payables at the time of restructuring. Gain on trouble debt restructuring is only recognized when the carrying amount of the payable at the time of restructuring exceeds the total future cash payments specified by the new debt terms. Since the total future cash outflows associated with the new debt instruments exceeded the carrying value of the old debts, no gain on restructuring was recorded under US GAAP. As a result, the carrying amount of the new debt instruments under US GAAP is greater than the amount recorded under Argentine GAAP and a new effective interest rate was determined, which equates the present value of the future cash payments specified by the new debt instruments with the carrying amount of the old debts. Under US GAAP, expenses incurred in a trouble debt restructuring are recorded in earnings.
As discussed in Note 4.i.(iii) the Company fully paid all of the restructured obligations. Therefore the unrealized gain was fully recognized under USGAAP as of June 30, 2008. The adjustment to interest expense recognized under Argentine GAAP according to the new effective interest rate totaled Ps. 6.9 million, Ps. 3.8 million and Ps. 3.1 million for the years ended June 30, 2008, 2007 and 2006, respectively. As the Company’s new debt instruments are denominated in US Dollars, the US GAAP adjustment also includes the recognition of exchange rate differences related to the difference in the carrying amount of the debts. Foreign exchange gains (losses) recorded under US GAAP were not significant for any of the periods presented.
In the ordinary course of business, the Company enters into certain non-monetary transactions with third parties pursuant to which the Company sells parcels of land held for sale in exchange for cash and/or other real estate properties. See Note 2.g. for details of the transactions.
Under Argentine GAAP, these transactions are recorded based on the fair value of the assets involved and, as a result, a gain or loss is recognized at the time of the exchange. As a result, under Argentine GAAP, the Company recorded gains of Ps. 14,700 and Ps. 44,172 for the years ended June 30, 2008 and June 30, 2006, respectively. No barter transactions were consummated for the year ended June 30, 2007.
Under US GAAP, the Company applied the provisions of Statement of Financial Accounting Standards (SFAS) No. 153, Exchanges of Non-monetary Assets—An Amendment of APB Opinion No. 29. SFAS 153 amends APB Opinion No. 29 (Opinion 29), Accounting for Non-monetary Transactions, which was issued in 1973. The amendments made by SFAS 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replaced it with a broader exception for exchanges of non-monetary assets that do not have “commercial substance.” Previously, Opinion 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. The provisions in SFAS 153 are effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005, thus are effective for all non-monetary exchanges entered into by the Company for the years ended on and after June 30, 2006.
Under SFAS 153 the Company determined that all of its barter transactions have commercial substance and therefore the transactions must be measured at fair value.
In certain barter transactions, the Company does not receive a down payment or receives a down payment which is less than 10% of the sales price. In those cases, the Company follows the deposit method prescribed under FAS 66. Under the deposit method the Company does not recognize profit, nor records a receivable and continues to report the property and related liabilities in its balance sheet even if the liability has been assumed by the buyer. The Company discloses that those items are subject to a sales contract. Therefore, under US GAAP, the gains recognized under Argentine GAAP were reversed.
F-73
However, for the year ended June 30, 2008, the US GAAP adjustment represents the net effect of (i) the reversal of the Ps. 14.7 million recognized under Argentine GAAP and (ii) the recognition of a gain of Ps. 32.0 million related to a prior year barter transaction which was not completed as originally planned.
This latter transaction dated back to the year ended June 30, 2006 when the Company recognized a gain under Argentine GAAP and reversed it for US GAAP purposes due to not meeting FAS 66 criteria (this reversal forms part of the Ps. 44.2 million reconciling item for 2006). No activity occurred during fiscal year 2007. In fiscal year 2008, this transaction was completed by the counterparty surrendering cash in lieu of the future real estate property. Thus the Company recognized the gain on consummation of this transaction in 2008.
Prior to the adoption of SFAS No. 153, under US GAAP, the Company applied the provisions APB Opinion No. 29, “Accounting for Non-monetary Transactions” (“APB 29”). APB 29 stated that exchanges of real estate held for sale in the ordinary course of business in exchange for real estate to be sold in the same line of business are transactions not resulting in a culmination of the earnings process (referred to as “like-kind” exchanges). The recognition of gain on like-kind exchanges depends on whether monetary consideration is received and, if so, how much. If no monetary consideration is involved in the exchange, the property received is recorded at the book value of the property given up and no gain is recorded in the exchange. If monetary consideration is involved in the exchange, the recognition of gain depends on whether the amount of the monetary consideration is less than 25% of the fair value of the exchange. When monetary consideration is less than 25%, the Company should recognize a portion of any gain on the transaction in the ratio of cash received to total consideration (cash plus fair value of the asset received). If monetary consideration is 25% or more of the exchange, the transaction should be allocated between the monetary and nonmonetary component based on the relative fair values of the components at the time of the transaction. Any loss on the exchange should be recognized immediately.
Under US GAAP the barter transactions entered into by the Company prior to July 1, 2005 were accounted for as follows:
The Company recorded the exchange of “Cruceros” in 2004 at its fair market value since the Company incurred a loss of Ps. 763 in the exchange. As a result no difference existed in accounting for this transaction between Argentine and US GAAP.
In connection with the exchange of “Benavidez” in 2004, as monetary consideration represented less than 25% of the fair value of the exchange, the Company recognized a pro-rata gain amounting to Ps. 226. As a result, the US GAAP adjustment represents the partial reversal of the gain recognized under Argentine GAAP amounting to Ps. 907.
The Company recorded the exchange of plot 1c) of Dique III in 2005 at the book value of the land given up, thus not recording any gain on the exchange. As a result, the US GAAP adjustment represents the reversal of the gain recognized under Argentine GAAP amounting to Ps. 14,985 in fiscal year ended June 30, 2007.
In the ordinary course of business, the Company may enter into promissory sales contracts to sell housing units for which the respective transfer title deeds have not been consummated at year-end. However, as the Company received advance payments fixing the sales prices and the terms and conditions of the contracts provide reasonable assurance of the closing of the transaction and the realization of the gain, under Argentine GAAP the Company valued these inventories at net realizable value. Under US GAAP, inventories are valued at cost. As such, the US GAAP adjustment represents the net effect of (i) reversal of the gain recognized under Argentine GAAP in 2008, 2007 and 2006 for non consummated transactions and the (ii) recognition of the gain under US GAAP from deeds executed in 2008, 2007 and 2006. In addition in 2006 the Company recognized an exchange gain difference in connection with the receivable recorded under Argentine GAAP in an amount of Ps. 1,741, which under US GAAP was reversed and recognized in 2007 together with the sale of the property.
Under Argentine GAAP, APSA recognized a parcel of land acquired prior to June 30, 1986 at its appraised value as of such date. This appraisal increased the carrying value of the land by Ps. 4.0 million. Under US GAAP, this parcel of land was recorded at original cost.
F-74
Under Argentine GAAP, fees and expenses relating to Serie II of APSA Non Convertible Notes are amortized on a straight-line method over the term of the agreement. Under US GAAP, following SFAS No. 91 such costs are amortized over the same period using the effective interest method. Since the issuance of the APSA Non- Convertible Notes occurred in May 2007, the amount of the adjustment for the year ended June 30, 2007 was not significant.
Under Argentine GAAP, the Company capitalized certain costs related to software developed as obtained for internal use, which would be expensed under US GAAP pursuant to the provisions of Statement of Position 98-1 “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use” (SOP 98-1). The US GAAP adjustment for the year 2006, 2007 and 2008 represents the effect net of (i) expenses such costs and (ii) reversal of depreciation charges previously capitalized costs under Argentine GAAP and expenses under US GAAP.
The syndicated loan discussed in Note 4.i.(iv), accrued interest at a fixed rate of 7.875% per annum during the first year and “Encuesta” variable rate plus 3% thereafter. The outstanding balance of the syndicated loan was fully paid in April 2007. Under Argentine GAAP, interest was recognized based on the interest rate applicable to each interest period. Under US GAAP, the Company followed the guidance in EITF 86-15, “Increasing Rate Debt”. In EITF 86-15, the Task Force reached a consensus that the borrower’s periodic interest cost should be determined using the interest method based on the estimated outstanding term of the debt. This loan was paid April 5, 2007
Under Argentine GAAP, the Company capitalized financial costs comprising of interest and foreign exchange differences for the year ended June 30, 2007 and 2008 related to the PAMSA project. The Company did not capitalize any financial costs for the year ended June 30, 2006. Under US GAAP, the Company applied the provisions of Statement of Financial Accounting Standards No. 34, “Capitalization of Interest Cost” (SFAS No. 34), which requires interest capitalization on assets which have a period of time to get them ready for their intended use. Capitalization of foreign exchange differences is not allowed under SFAS No. 34. The US GAAP reconciling item represents the effect of reversing the foreign exchange differences capitalized under Argentine GAAP mainly related to the acquisition and construction of PAMSA for the years ended June 30, 2007 and capitalizing interest in the year ended June 30, 2008 for an amount of Ps. 0.4 million and Ps. 5.8 million, respectively.
As indicated in Note 4.i.(ii), in August 2002 APSA issued US$ 50,000 of Convertible Notes. Under US GAAP, the Company applied APB 14, “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants”, which requires that no portion of the proceeds be allocated to the conversion feature if the convertible debt securities are convertible into common stock of the issuer at a specified price at the option of the holder and are sold at a price or have a value at issuance not significantly in excess of the face amount. In considering the accounting treatment of the Convertible Notes under US GAAP the Company took account of the guidance provided in EITF 98-5. This regulation, EITF 98-5, requires that embedded beneficial conversion features present in convertible securities be valued separately at issuance when the non-detachable conversion feature is “in-the-money” at the commitment date. The embedded beneficial conversion feature should be recognized and measured by allocating to additional paid-in capital a portion of the proceeds equal to the intrinsic value of that feature. That amount is calculated at the commitment date as the difference between the conversion price and the fair value of the common stock or other securities into which the security is convertible, multiplied by the number of shares into which the security is convertible (intrinsic value). As a result of the analysis the Company performed, no proceeds were allocated to the embedded conversion feature since it was “out-the-money” at the commitment date (i.e. the intrinsic value at the commitment date was zero).
F-75
As discussed in Note 4.i.(ii), the terms of the convertible debt instrument were modified to extend the maturity date through July 19, 2014. Argentine GAAP requires that an exchange of debt instruments with substantially different terms be considered a debt extinguishment and that the old debt instrument be derecognized. Argentine GAAP clarifies that from a debtor’s perspective, an exchange of debt instruments between, or a modification of a debt instrument by, a debtor and a creditor shall be deemed to have been accomplished with debt instruments that are substantially different if the present value of the cash flows under the terms of the new debt instrument is at least 10 percent different from the present value of the remaining cash flows under the terms of the original instrument. The new debt instrument should be initially recorded at fair value and that amount should be used to determine the debt extinguishment gain or loss to be recognized. Fair value should be determined by the present value of the future cash flows to be paid under the terms of the new debt instrument discounted at a rate commensurate with the risks of the debt instrument and time value of money. If it is determined that the original and new debt instruments are not substantially different, then a new effective interest rate is to be determined based on the carrying amount of the original debt instrument and the revised cash flows. Based on the analysis performed, the Company concluded that the instruments were not substantially different and accordingly the old instrument was not derecognized. The outstanding balance was reclassified to non-current in these consolidated financial statements.
Under US GAAP, in November 2006, the EITF reached a final consensus in EITF Issue 06-6 “Debtor’s Accounting for a Modification (or Exchange) of Convertible Debt Instruments”. EITF 06-6 reconsidered the original consensus in Issue 05-7 “Accounting for Modification to Conversion Options Embedded in Debt Instruments and Related Issues” that the change in fair value of an embedded conversion option should be included in the cash flow analysis under EITF Issue 96-19, “Debtor’s Accounting for a Modification or Exchange of Debt Instruments,” in determining whether a debt instrument has been modified or extinguished. This Issue considers the accounting for a modification of debt terms (or exchange in debt instruments) when a change in the fair value of an embedded conversion option has occurred or an embedded conversion option has been added or eliminated from the debt instrument. This Issue also amended the guidance in EITF Issue 96-19.
The consensus stipulates that, in evaluating whether a convertible debt instrument has been modified or extinguished, three aspects of the modification (or exchange of debt instruments) must be considered.
Any one of the three criteria needs to be met to account for the modification of the debt instrument (or exchange of debt instruments) as an extinguishment. When the result of the three-pronged evaluation above results in a conclusion that a convertible debt instrument has been modified (and not extinguished), the Task Force affirmed as a final consensus that any increase in the fair value of the embedded conversion option should reduce the carrying value of the debt instrument (with a corresponding increase to additional paid-in capital), but any decrease in the fair value of the embedded conversion option is ignored.
Based on the analysis performed, neither of criteria 1, 2 or 3 above are met. Accordingly, the change of the debt instrument has not been accounted for as an extinguishment. Thus, the increase in the fair value of the conversion option reduced the carrying value of the debt instrument with a corresponding increase to additional paid-in-capital. This resulted in an increase in interest expense prospectively.
F-76
In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108 (SAB No. 108), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”, which provides guidance on quantifying financial statement misstatements. SAB No. 108 was issued in order to eliminate the diversity of practice surrounding how public companies quantify financial statement misstatements.
SAB No. 108 was effective for the Company for the year ended June 30, 2007. Traditionally, there have been two widely recognized methods for quantifying the effects of financial statement misstatements: the roll-over method and the iron curtain method. The roll-over method focuses primarily on the impact of a misstatement on the income statement, including the reversing effect of prior year misstatements, but its use can lead to the accumulation of misstatements in the balance sheet. The iron-curtain method, on the other hand, focuses primarily on the effect of correcting the period-end balance sheet with less emphasis on the reversing effects of prior year errors on the income statement. Prior to the Company’s application of the guidance in SAB No. 108, the Company’s management used the roll-over method for quantifying financial statement misstatements both for Argentine GAAP and US GAAP purposes.
In SAB No. 108, the SEC staff established an approach that requires quantification of financial statement misstatements based on the effects of the misstatements on each of the company’s financial statements and the related financial statement disclosures. This model is commonly referred to as a dual approach because it requires quantification of errors under both the iron curtain and the roll-over methods.
SAB No. 108 permitted existing public companies to initially apply its provisions either by (i) restating prior financial statements as if the dual approach had always been applied or (ii) recording the cumulative effect of initially applying the dual approach as adjustments to the carrying values of assets and liabilities with an offsetting adjustment recorded to the opening balance of retained earnings. For the year ended June 30, 2007, under US GAAP, the Company elected to record the effects of applying SAB No. 108 using the cumulative effect transition method. The Company’s management previously quantified these errors under the roll-over method and concluded that they were immaterial.
The total amount of the misstatements that have been corrected as of the date of adoption of SAB 108 (July 1, 2006) was Ps. (10.7) million (excluding the effects for minority interest and deferred income taxes amounting to Ps. 3.3 million and Ps. 3.6 million, respectively) and was related to the US GAAP adjustments for (i) deferred insurance and fees revenues; (ii) deferred commissions; and (iii) scheduled rent increases, further detailed below.
For purposes of the presentation for the year ended June 30, 2008, the Company has included the cumulative effect of these adjustments as part of the respective US GAAP adjustments described in Notes 28.I.(t.3)., 28.I.(t.1) and 28.I.(t.2), respectively. The related effects for minority interest and deferred income taxes have also been included as part of the US GAAP adjustments described in Notes 28.I. (v). and 28.I.(u)., respectively.
Under Argentine GAAP, lease commissions earned are recognized at the time a transaction is successfully completed. A transaction is considered successfully concluded when both parties have signed the related lease contract. Upon adoption of SAB 108, (July 1, 2006), under US GAAP, lease commissions are deferred and amortized to income over the term of the respective leases. The US GAAP adjustment to equity also includes the portion of the total cumulative effect of the initial application of SAB 108 related to this reconciling item.
Under Argentine GAAP, revenue from “non-cancelable” leases subject to rent escalation clauses is recognized when the escalated payment is due rather than recognizing the effects of the scheduled rent increases under the straight-line method over the lease term. Upon adoption of SAB 108, (July 1, 2006), under US GAAP, the Company applied the provisions of SFAS No. 13 and FTB 85-3 and accordingly, recognized escalated rental revenue under the straight-line method over the term of the leases. The US GAAP adjustment to equity also includes the portion of the total cumulative effect of the initial application of SAB 108 related to this reconciling item.
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In the determination of the US GAAP adjustment, the Company considered the definition of lease term in paragraph 5(f) of FAS 13. All lease agreements are cancelable pursuant to Law 23,091 as amended by Law 24,808. This law provides that after an initial six-month period tenants may rescind commercial lease agreements upon 60 days’ written notice by incurring non-significant monetary penalties (cancellations are subject to one-and-a-half month’s rent if rescinded during the first year of the lease and one month’s rent if rescinded after the first year of the lease).
Paragraph 5(f) of FAS 13 provides that a lease that is cancelable (a) only upon the occurrence of some remote contingency, (b) only with the permission of the lessor, (c) only if the lessee enters into a new lease with the same lessor or (d) only if the lessee incurs a penalty in such amount that continuation of the lease appears, at inception, reasonably assured shall be considered “noncancelable” for purposes of this definition.
Based on the provisions of paragraph 5(f) of FAS 13, the Company concluded that, even though the lease are cancelable, lessees would incur significant “economic penalties” if these agreements were to be rescinded prior to maturity. The Company considered that these economic penalties are of such an amount that continuation of the lease agreements by lessees appear to be reasonably assured at the inception of the respective agreements.
The Company reached this conclusion based on the factors mentioned in paragraph 5(o) of FAS 13, including (i) the geographical location and accessibility of the Company’s properties; (ii) the nature and tenure of tenants, (iii) limited availability of identical space in certain neighborhoods; (iv) the tenants’ brand image and other competitive considerations; (v) tenants’ significant expenses in renovation, maintenance and improvements
The Company believes that all of the above mentioned factors represent significant non-contractual penalties for the lessees which support the Company’s view that it is reasonably assured at the inception of lease agreements that such leases will not be rescinded prior to maturity even though they are cancelable as permitted by law.
Under Argentine GAAP, the Company, accounts for revenues from life and disability insurance and origination fees on an up-front basis. Upon adoption of SAB 108, (July 1, 2006), under US GAAP, life and disability insurance and origination fees are recognized to income on a straight-line basis over the term of the respective receivables. The US GAAP adjustment to equity also includes the portion of the total cumulative effect of the initial application of SAB 108 related to this reconciling item.
The Company accounts for income taxes using the liability method under both Argentine GAAP and US GAAP. Argentine GAAP is similar to the guidance in SFAS No. 109 “Accounting for Income Taxes”. However, as discussed in Note 2.e, following CNV Resolutions 485 and 487, the Company elected to continue treating the differences between book basis and inflation-adjusted basis of non-monetary balance sheet items as permanent for deferred income tax calculation purposes.
Under US GAAP, the Company applies EITF 93-9, “Application of FASB Statement No.109 in Foreign Financial Statements Restated for General Price-Level Changes”, which requires such differences to be treated as temporary differences in calculating deferred income taxes.
In addition, the US GAAP adjustment includes the effect on deferred income taxes of the foregoing reconciling items, as appropriate.
This adjustment represents the effect on minority interest of the reconciling items, as appropriate.
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On July 1, 2007, the company adopted FASB interpretation no. 48, “accounting for uncertainty in income taxes — an interpretation of FASB statement no. 109” (FIN 48). FIN 48 addresses the accounting and disclosure of uncertain tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The difference between the tax benefit recognized in the financial statements for a position in accordance with FIN 48 and the tax benefit claimed in the tax return is referred to as an unrecognized tax benefit.
The adoption of FIN 48 did not result in an increase to the net liability for unrecognized tax benefits.
The total amount of unrecognized tax benefits as of the adoption of FIN 48 at July 1, 2007, was not significant. The company classified unrecognized tax benefits not expected to be paid in the next 12 months in other non-current liabilities.
The company’s principal taxable jurisdiction is Argentina. At any point in time, the company may have tax audits underway at various stages of completion. The company evaluates the tax positions and establishes liabilities for uncertain tax positions that may be challenged by local authorities and may not be fully sustained, despite the company’s belief that the underlying tax positions are fully supportable. Uncertain tax positions are reviewed on an ongoing basis and are adjusted in light of changing facts and circumstances, including progress of tax audits, developments in case law, and closing of statute of limitations. Such adjustments are reflected in the tax provision as appropriate.
The Company has tax years open ranging from 2003 and forward. The Company is generally not able to reliably estimate the ultimate settlement amounts until the close of an audit.
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II. Additional disclosure requirements
Under Argentine GAAP, assets and liabilities are classified as current or non-current depending on their respective settlement dates. Under US GAAP, balance sheets of real companies generally do not present a classified balance sheet.
In addition, under Argentine GAAP the Company has classified the net deferred tax asset as of June 30, 2008 amounting to Ps. 39.0 million and the net deferred tax liability as of June 30, 2007 amounting to Ps. 1.9 million, as follows: Ps. 70.1 million and Ps. 25.4 million as of June 30, 2008 and 2007, respectively, as non-current other receivables and prepaid expenses; and Ps. 31.1 million and Ps. 27.3 million as of June 30, 2008 and 2007, respectively, as non-current taxes payable. Under US GAAP, the classification of deferred taxes is determined by the classification of the asset or liability for financial reporting to which the temporary difference is related. A temporary difference is related to an asset or liability if reduction of the asset or liability causes the temporary difference to reverse. For deferred tax balances not related to an asset or liability for financial reporting (e.g. tax loss carryforwards), the classification is based on the expected realization date. As of June 30, 2008 and 2007, Ps. 24.2 million and Ps. 13.7 million, respectively, would have been classified as current assets, and Ps. 87.7 million and Ps. 21.5 million, respectively, would have been classified as non-current assets. As June 30, 2008 and 2007 Ps. 2.1 million and Ps. 6.4 million, respectively, would have been classified as current liabilities and Ps. 70.9 million and Ps. 30.7 million, respectively, would have been classified as non-current liabilities.
Furthermore, under Argentine GAAP, deferred debt costs are shown as a deduction of the corresponding liability. Under US GAAP, and in accordance with Accounting Principles Board (“APB”) Opinion No. 21, “Interest on Receivables and Payables”, issue costs should be reported as deferred charges of Ps. 13,382.
As these differences have no effect on net income or on shareholders’ equity, no reconciling items are presented for US GAAP purposes.
Should a US GAAP income statement be presented, certain items shown in some line items of the income statement under Argentine GAAP would have to be reclassified to affect other line items. The following reclassifications are intended to present Argentine GAAP numbers using a different criterion of classification under US GAAP. The numbers included below are not US GAAP numbers.
Gross vs. net presentation
As part of the lease agreements, tenants are required to pay their proportionate share of common area maintenance expenses. The Company does not charge any mark up on reimbursable costs. These expenses are incurred and paid by the Company and then passed through to tenants as reimbursable costs.
Under Argentine GAAP, pass-through expenses, such as these reimbursable costs, are accounted for on a net basis and, as such, excluded from revenues and expenses in the consolidated financial statements. However, Note 29.f shows the total amount of expenses passed through to tenants by expense category with the corresponding offsetting amount therefore having no impact in the consolidated costs of the Company. No amount is shown as revenues.
Under US GAAP, the Company accounts for pass-through revenue and expenses in accordance with Emerging Issues Task Force, or EITF, Issue 01-14, “Income Statement Characterization of Reimbursements Received for Out of Pocket Expenses Incurred,” and include these costs incurred as a component of revenue and as a component of operating expenses in the statement of income. These costs, which are pass-through expenses to tenants included in both revenues and expenses were Ps. 181.2, Ps. 134.4 million and Ps. 107.3 million for the years ended June 30, 2008, 2007 and 2006, respectively. As these expenses are fully reimbursed, without mark-up, by the tenants, there is no impact on operating income, net income, EPS, cash flows or the balance sheet.
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Should the EITF 01-14 be applied to the Argentine GAAP income statement, net revenues under Argentine GAAP would have been Ps. 1,265.4 million, Ps. 873.1 million and Ps. 685.0 million for the years ended June 30, 2008, 2007 and 2006, respectively.
Under US GAAP, certain income and expense items included in the Argentine GAAP financial statements of the Company within “Other expenses, net” would have been included in the determination of operating income. In addition, under Argentine GAAP, the recovery of certain allowances and provisions has been included within “Other expenses, net”. Under US GAAP, such items would have been classified as a reversal to the amounts in the line items which were originally recorded.
Should certain other expenses, financial results and the recovery of allowances and provisions be reclassified into/out of operating income, as applicable, operating income under Argentine GAAP would have been Ps. 263.3 million, Ps. 201.3 million, and Ps. 194.7 million for the years ended June 30, 2008, 2007 and 2006, respectively.
Aggregate annual maturities during the next years (excluding current portion and capitalized costs of issuance of debt—See Note 28.II.(a)), as of June 30, 2008, are as follows:
2012
Thereafter 2013
This note discloses operating leases information of the Company and its controlled and jointly controlled subsidiaries:
- Operating lease information:
The Company enters into cancelable commercial leases with its tenants for terms ranging from three to five years, with most leases having terms of no more than 5 years. Tenants are charged a base rent on a monthly basis. No contingent rentals were recorded for the years ended June 30, 2008, 2007 and 2006.
The Company enters into cancelable commercial leases with its tenants for terms ranging from three to ten years, with most leases having terms of no more than five years. Tenants are generally charged a rent, which consists of the higher of (i) the base rent and (ii) the percentage rent (which generally ranges between 4% and 10% of the tenants sales). Furthermore, pursuant to the rent escalation clause in most leases, a tenant’s base rent generally increases between 7% and 12% each year during the term of the lease. Included in lease revenues for the years ended June 30, 2008, 2007 and 2006 were contingent rentals of P.s 73.3 million, Ps. 51.9 million and Ps. 40.9 million, respectively. Even though the leases are cancelable by law, the Company considered them to be non-cancelable for these purposes. See Note 28.I.(t.2). for more information as to how the Company considered this definition.
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Minimum future rentals on cancelable leases as of June 30, 2008 for each of the five succeeding fiscal years are as follows:
The following additional disclosures of transactions with related parties are required under US GAAP:
- Acquisition of IRSA Units by Cresud: During November and December 2002, Cresud purchased 49.7 million Convertible Notes issued by us and during July and November 2003, Cresud purchased an additional 0.25 million Convertible Notes.
In May 2004 Cresud decided to exercise their option to convert 5.0 million aggregate principal amount of our Convertible Notes. As a result of this conversion, Cresud has received 9.2 million of our common shares.
In July 2004, Cresud purchased 0.35 million of convertible notes issued by us for US$ 0.5 million.
On September 30, 2004, Cresud exercised 5.0 million of our Warrants for 9.2 ordinary shares at a total cost of US$ 6 million.
In February 2006 and April 2006, Cresud purchased 5.0 million and 16.0 million of convertible notes issued by us for 9.2 million and 29.3 million ordinary shares.
In April 2006, Cresud converted 16.0 million of convertible notes issued by us for 29.3 million ordinary shares.
Between June 2007 and November 2007, 12.0 million convertible notes were exercised. In addition Cresud incremented it’s participation in the Company by adquisitions in the market.
As of June 30, 2008 Cresud owned 38.4% of our common shares
- Donations: For the years ended June 30, 2008, 2007, and 2006, the Company made unconditional promises to give money to two not-for-profit organizations, namely Fundación IRSA and Museo de los Niños, amounting Ps.4.8 million, Ps. 2.5 million and Ps. 4.3 million, respectively. Unconditional promises are paid in the subsequent year. A director and shareholder of the Company is the President of these organizations.
- Lease agreements: Our principal executive offices are located at Bolívar 108, in the City of Buenos Aires. In the past we subleased a portion of our headquarters from Consultores Assets Management S.A. (formerly Dolphin Fund Management) pursuant to two lease agreements dated June 30, 1997. As of November 25, 2003 Dolphin Fund Management S.A has spun off in two companies. One of them is Consultores Assets Management S.A. and the other remains as Dolphin Fund Management S.A. In respect of Consultores Assets Management S.A., Eduardo Elsztain is the owner of 100% of its capital stock. Consultores Assets Management S.A. (formerly Dolphin Fund Management) leased such offices both from Elsztain e Hijos S.C.A., a company controlled by relatives of Eduardo S. Elsztain, our chairman, and also from Hamonet S.A., a company controlled by Fernando A. Elsztain, our director, and certain of his relatives.
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These lease and sublease agreements were cancelled on February, 2004 and a new lease agreement was signed by the Company, APSA, Cresud and Isaac Elsztain e Hijos S.C.A. We have leased our headquarters located in Bolivar 108, City of Buenos Aires pursuant to this agreement since March 2014. This lease has a term of 120 months and rent of Ps. 10.3 is payable monthly. The Company, APSA and Cresud each pay one-third of such rent in an amount of Ps. 3.4 each.
- Mutual investment fund: Since 1996, the Company has investments in Dolphin Fund Plc, an open – ended investment fund which is related to the Company’s directors. These investments are carried at market value as of year-end, with unrealized gains reported in earnings within “Financial results, net” in the accompanying consolidated statements of income.
The Company recognized net (loss) gains of Ps. (37.8) million; Ps. 46.8 million and Ps. 0.0 million for the years ended June 30, 2008, 2007 and 2006 respectively.
- Corporate services: In order to reduce administrative expenses and to achieve a more efficient allocation of corporate resources, a program for partial operating integration in the areas of Human Resources, Finance, Institutional Relations, Administration, Systems, Insurance, Purchasing, Contracts and Operations, among others, was implemented on June 30, 2003 by the Company, and its subsidiary APSA and Cresud (the “Parties”). This program was implemented to reduce operating costs by optimizing the individual administrative efficiencies of each Party.
On the basis of this program, the Parties entered into the Exchange of Operating Services Agreement on June 30, 2004, a two-year agreement (being renewed for an equal period of time unless any of the Parties decides to terminate it) by which tasks are performed by one or more Parties for the benefit of one or more other Parties in exchange for a fee to be paid primarily through the provision of services in other areas. Through this agreement, each party continues to maintain its strategies and commercial independence, while increasing operating efficiency.
In the ordinary course of business, the Company shares corporate services (finance, human resources, procurement, internal audit, systems, administration, etc.) with APSA and Cresud under an Exchange of Operating Services Agreement entered into by all three companies in 2004 and amended on August 2008. The Company pays a fee, primarily through the provision of services to the other parties.
- Legal services: During the years ended June 30, 2008, 2007 and 2006, the Company paid the law firm Zang, Bergel & Viñes an aggregate amount of Ps. 3.8 million, Ps. 3.3 million and Ps. 1.9 million, respectively, for legal services. Certain directors or alternative directors of the Company are partners of the law firm and an alternate director of the Company is off counsel of the law firm.
Under Argentine GAAP, there are no specific rules regarding disclosure of fair value of financial instruments.
Under US GAAP, SFAS No. 105 requires reporting entities to disclose certain information about financial instruments with off-balance sheet risk of accounting loss. SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”, requires disclosure of fair value information about financial instruments whether or not recognized in the balance sheet, for which it is practicable to estimate fair value. Financial instruments include such items as to cash and cash equivalents and accounts receivable and other instruments. SFAS No. 107 excludes from its disclosure requirements lease contracts and various significant assets and liabilities that are not considered to be financial instruments. SFAS No. 119 requires reporting entities to disclose certain information for derivative financial instruments. SFAS No. 133 superseded SFAS No. 105 and SFAS No. 119 and amended SFAS No. 107 to include in SFAS No. 107 the disclosure requirements of credit risk concentrations from SFAS No. 105. See Note 28.II. (g) for details of concentration of credit risk.
Fair value estimates are made as of a specific point in time based on the characteristics of the financial instruments and the relevant market information. Quoted market prices are used when available. In other cases, fair values are based on estimates using other valuation techniques, such as discounting estimated future cash flows using a rate commensurate with the risks involved or other acceptable methods. These techniques involve uncertainties and are significantly affected by the assumptions used and the judgments made regarding risk characteristics of various financial instruments, prepayments, discount rates, and estimates of future cash flows, future expected loss
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experience, and other factors. Changes in assumptions could significantly affect these estimates. Derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in an immediate sale of the instrument. Also, because of differences in methodologies and assumptions used to estimate fair value, the Company’s fair values should not be compared to those of other companies.
Under this statement, fair value estimates are based on existing financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Accordingly, the aggregate fair value amount presented does not represent the underlying value of the Company. For certain assets and liabilities, the information required under this statement is supplemental with additional information relevant to an understanding of the fair value.
The methods and assumptions used to estimate the fair values of each class of financial instruments as of June 30, 2008 and 2007 are as follows:
The Company considers all highly liquid investments with original maturities of three months or less, consisting of time deposits and mutual funds, to be cash and cash equivalents. The carrying amounts reported in the consolidated balance sheets approximate fair value.
Marketable securities
The fair value of marketable securities is based on quoted market prices for those or similar investments. Marketable securities are carried at fair value on the consolidated balance sheet.
Mortgages and leases receivable, net
The carrying value of mortgages and lease receivables reported in the consolidated balance sheet approximates its estimated fair value. All amounts that are assumed to be uncollectible within a reasonable time are written off and/or reserved.
Retained interest in transferred mortgage, credit card and personal loans receivables
Fair value is estimated by discounting anticipated future cash flows using a discount rate based on specific factors. The anticipated future cash flows are projected on a “cash out” basis to reflect the restriction of cash flows until the investors have been fully paid. As of June 30, 2008 and 2007, the fair value of retained interests in transferred mortgage and credit card receivables totaled Ps. 104.0 million and Ps. 61.6 million, respectively.
The carrying amounts of accounts and notes payable reported in the consolidated balance sheets approximate their fair value.
The carrying amounts of short-term debt reported in the consolidated balance sheets approximate fair value due to its short-term nature.
Long-term debt(includes current portion of the non-current item)
As of June 30, 2008 and 2007, except for the Convertible Notes issued by IRSA and Non-Convertible Notes of APSA and IRSA, the carrying amounts of long-term debt reported in the consolidated balance sheets approximate their fair value.
The fair value of APSA Convertible Notes was Ps 616.1 million and Ps. 794.3 million at June 30, 2008 and 2007, respectively. Such fair value was determined based on the market price of the shares assuming full conversion of the notes at year-end.
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The fair value of IRSA Convertible Notes was Ps. 325.3 million at June 30, 2007. Such fair value was determined based on the market price of the shares assuming full conversion of the notes at year-end plus the estimated fair value of the warrants that should be issued by the Company upon conversion.
The fair value of IRSA Notes (see Note 10) was Ps. 341.7 million, Ps. 441.8 million at June 30, 2008 and 2007, respectively and was determined based on quoted market prices of the notes.
Other receivables and other liabilities
The carrying amounts of other receivables and other liabilities reported in the consolidated balance sheets approximate fair value.
Options and future contracts to purchase foreign currency and metals
The fair value of the futures contracts is based on the estimated amount at which they could be settled based on future market prices. The fair value of future contracts outstanding at June 30, 2008 and 2007 was Ps. 4.6 million and Ps. (0.13) million. Future contracts are reported at their fair market value on the consolidated balance sheet. There were no future contracts in 2006.
Seller financings
The fair value of the seller financings is estimated based on discounted cash flows using rates offered to the Company for debt of the same remaining maturities. The carrying value approximates fair value.
Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash, cash equivalents, accounts receivable, and short-term investments.
The Company places its cash and cash equivalents, investments, and other financial instruments with various high credit quality financial institutions, thus mitigating the amount of credit exposure to any one institution. The Company has not experienced any significant losses in such accounts.
The Company’s accounts receivable are primarily derived from leases and services from the Company’s shopping center and office buildings customers and origination of consumer loans and credit card receivables. The Company is not dependent on any single customer. Accounts receivable derived from leases and services are related to the Company’s shopping center operations and rental of office buildings. The Company has not experienced any significant losses resulting from non-performance of any counterpart to the lease contracts.
Consumer loan and credit card receivables arise primarily under open-end revolving credit accounts used to finance purchases of goods and services offered by the Company’s shopping centers, hypermarkets and street stores, and financing and lending activities through the Company’s indirect subsidiary Tarshop. These accounts have various billing and payment structures, including varying minimum payment levels and finance charge rates. The Company provides an allowance for uncollectible accounts based on impaired accounts, historical charge-off patterns and management judgment. Due to the current credit crisis and other conditions, some customers experienced delays in payments and also uncollectibility rates increased during the year ended June 30, 2008 and thereafter. As of June 30, 2008, the allowance for doubtful accounts increased Ps. 45.9 million, or 223.2 % as compared to June 30, 2007, which reflects current economic conditions and recent delinquency trends. As of September 30, 2008 the allowance for doubtful accounts increased Ps. 17.2 million, or 25.9% as compared to June 30, 2008, reflecting weakening economic environment affecting consumers and card members delinquencies and charge-offs. The Company is closely monitoring the delays, delinquency and uncollectibility rates.
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As discussed in Note 16, as of June 30, 2008, the Company sold receivables aggregating Ps. 1,440.2 million through securitization programs outstanding, for which the Company’s credit risk exposure is contractually limited to the subordinated CPs held by the Company representing Ps. 156.8 million and Ps. 19.4 million escrow reserves for losses. As of September 30, 2008, the Company’s credit risk exposure is contractually limited to the subordinated CPs held by the Company representing Ps. 161.2 million and Ps. 17.9 million escrow reserves for losses. Due to the factors mentioned above, the Company has recorded an other-than-temporary impairment charge of Ps. 12.0 million to the CPs to reflect current fair value. For the three months ended September 30, 2008, no additional impairment charge related to the retained interests in securitized receivables was necessary.
In September 2006, the FASB issued SFAS No. 157 (“SFAS 157”), “Fair Value Measurements.” This statement defines fair value and establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The key changes to current practice are (1) the definition of fair value, which focuses on an exit price rather than an entry price; (2) the methods used to measure fair value, such as emphasis that fair value is a market-based measurement, not an entity-specific measurement, as well as the inclusion of an adjustment for risk, restrictions and credit standing and (3) the expanded disclosures about fair value measurements. This statement does not require any new fair value measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years.
The FASB has issued FASB Staff Position No. FAS 157-2, “Effective Date of FASB Statement No. 157” which defers the provisions of SFAS 157 relating to nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.
In October 2008, the FASB issued FASB Staff Position No. FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active,” to clarify the provisions of SFAS 157 relating to valuing a financial asset when the market for that asset is not active. This FSP will be effective upon issuance of SFAS 157.
Therefore SFAS 157 will be effective for the Company’s year ended June 30, 2009 as it relates to financial assets and liabilities currently recorded or disclosed at fair value and SFAS 157 will be effective for the Company’s year ended June 30, 2010 as it relates to non financial assets and liabilities.
The Company has not finalized the assessment of SFAS 157 as it relates to the financial assets and liabilities currently recorded or disclosed at fair value, although is not expected to materially affect how the Company determines fair value, but it may result in certain additional disclosures
In February 2007, the FASB issued SFAS No. 159 (“SFAS 159”), “The Fair Value Option for Financial Assets and Financial Liabilities.” SFAS 159 expands opportunities to use fair value measurement in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Therefore SFAS 159 will be effective for the Company’s year ended June 30, 2009. The Company has not yet decided whether or not it would elect to measure any of its current eligible financial assets or liabilities at fair value upon adoption.
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In December 2007, the FASB issued SFAS No. 141 (revised 2007) (“SFAS 141R”), “Business Combinations.” SFAS 141R expands the original guidance’s definition of a business. It broadens the fair value measurement and recognition to all assets acquired, liabilities assumed and interests transferred as a result of business combinations. SFAS 141R requires expanded disclosures to improve the ability to evaluate the nature and financial effects of business combinations. SFAS 141R is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. Therefore SFAS 141R will be effective for the Company for business combinations made on or after July 1, 2009. While the Company has not yet finalized the full evaluation of potential impact of this statement, the Company expects the adoption of SFAS 141R to have a material effect on the accounting for future acquisitions of businesses and properties.
In December 2007, the FASB issued SFAS No. 160 (“SFAS 160”), “Noncontrolling Interests in Consolidated Financial Statements—an amendment of ARB No. 51.” SFAS 160 requires that a noncontrolling interest in an unconsolidated entity be reported as equity and any losses in excess of an unconsolidated entity’s equity interest be recorded to the noncontrolling interest. The statement requires fair value measurement of any noncontrolling equity investment retained in a deconsolidation. SFAS 160 is effective for annual periods beginning after December 15, 2008. Therefore SFAS 160 will be effective for the Company’s year ended June 30, 2010 and many provisions will be applied retrospectively. The Company is currently evaluating the impact SFAS 160 will have on the consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161 (“SFAS 161”), “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133.” SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged, as amended by FASB Staff Position No. FAS 133-1 and FIN 45-4 (see below) on December 31, 2008. Therefore SFAS 161 will be effective for the Company’s year ended June 30, 2010. The Company is currently evaluating the impact SFAS 161 will have to the disclosures included in the consolidated financial statements.
In April 2008, the FASB issued FASB Staff Position No. FAS 142-3 (“FSP FAS 142-3”), “Determination of the Useful Life of Intangible Assets.” FSP FAS 142-3 amends the factors that should be considered in developing renewal and extension assumptions used to determine the useful life of a recognized intangible asset and the period of expected cash flows used to measure the fair value of assets considered in a business combination. FSP FAS 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is prohibited. Therefore FSP FAS 142-3 will be effective for the Company’s year ended June 30, 2010. The Company is currently evaluating the impact FSP FAS 142-3 will have on the consolidated financial statements.
In May 2008, the FASB issued FASB Staff Position No. APB 14-1 (“FSP APB 14-1”), “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” FSP APB 14-1 will require that the initial debt proceeds from the sale of convertible and exchangeable debt instruments be allocated between a liability component and an equity component in a manner that will reflect the effective nonconvertible borrowing rate. The resulting debt discount would be amortized using the effective interest method over the period the debt is expected to be outstanding as additional interest expense. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Early adoption is not permitted. Therefore FSP APB 14-1 will be effective for the Company’s year ended June 30, 2010 and will require retroactive application. The Company is currently evaluating the impact FSP FAS 142-3 will have on the consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162 (“SFAS 162”), “The Hierarchy of Generally Accepted Accounting Principles.” SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in presenting financial statements in conformity with generally accepted accounting principles in the United States. The Company believes that the adoption of this standard on its effective date will not have a material effect on the consolidated financial statements.
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In September 2008, the FASB issued FASB Staff Position No. FAS 133-1 and FIN 45-4 (“FSP FAS 133-1”), “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161.” FSP FAS 133-1 requires disclosures by sellers of credit derivatives; additional disclosures on current status of payment/performance risk of guarantees and clarified the effective date of SFAS 161. FSP FAS 133-1 is effective for reporting periods (annual or interim) ending after November 15, 2008. Therefore FSP FAS 133-1 will be effective for the Company’s year ended June 30, 2010. The Company is currently evaluating the impact FSP FAS 133-1 will have on the consolidated financial statements.
In June 2008, the Emerging Issues Task Force (EITF) of the FASB issued EITF Issue No. 07-5, (“EITF 07-5”) “Determining Whether an Instrument (or Embedded Feature) Is Indexed to an Entity’s Own Stock”. This Issue is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. Earlier application by an entity that has previously adopted an alternative accounting policy is not permitted. Therefore, EITF 07-5 will be effective for the Company’s year ended June 30, 2010. The guidance in this Issue shall be applied to outstanding instruments as of the beginning of the fiscal year in which this Issue is initially applied. The cumulative effect of the change in accounting principle shall be recognized as an adjustment to the opening balance of retained earnings (or other appropriate components of equity or net assets in the statement of financial position) for that fiscal year, presented separately. The cumulative-effect adjustment is the difference between the amounts recognized in the statement of financial position before initial application of this Issue and the amounts recognized in the statement of financial position at initial application of this Issue. The amounts recognized in the statement of financial position as a result of the initial application of this Issue shall be determined based on the amounts that would have been recognized if the guidance in this Issue had been applied from the issuance date of the instrument(s). However, in circumstances in which a previously bifurcated embedded conversion option in a convertible debt instrument no longer meets the bifurcation criteria in Statement 133 at initial application of this Issue, the carrying amount of the liability for the conversion option (that is, its fair value on the date of adoption) shall be reclassified to shareholders’ equity. Any debt discount that was recognized when the conversion option was initially bifurcated from the convertible debt instrument shall continue to be amortized. Paragraphs 12 and 13 of this Issue shall not result in a transition adjustment at the effective date because that guidance is consistent with guidance previously contained in Issue 01-6, which is nullified by this Issue. The transition disclosures in paragraphs 17 and 18 of Statement 154 shall be provided. The Company is currently evaluating the impact EITF 07-5 will have on the consolidated financial statements.
In November 2007, the EITF issued EITF Issue No. 07-6, (“EITF 07-6”) “Accounting for the Sale of Real Estate Subject to the Requirements of FASB Statement No. 66, When the Agreement Includes a Buy-Sell Clause”. This Issue is effective for new arrangements entered into and assessments performed in fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. Earlier application is not permitted. Therefore EITF 07-6 will be effective for the Company’s year ended June 30, 2009. For purposes of the transition guidance, assessments are any assessment performed pursuant to Statement 66 after the effective date of this Issue for arrangements accounted for under the deposit, profit-sharing, leasing, or financing methods for reasons other than the existence of a buy-sell clause. The Company is currently evaluating the impact EITF 07-6 will have on the consolidated financial statements.
In September 2008, the FASB issued for comment revisions to SFAS No. 140 (“SFAS 140”) “Transfers of Financial Assets and Extinguishments of Liabilities” and FASB Interpretation No. 46, as revised (“FIN 46R”), “Consolidation of Variable Interest Entities.” The changes proposed include a removal of the scope exemption from FIN 46R for QSPEs, a revision of the current risks and rewards-based FIN 46R consolidation model to a qualitative model based on control and a requirement that consolidation of VIEs be reevaluated on an ongoing basis. Although the revised standards have not yet been finalized, these changes may have a significant impact on the Company’s consolidated financial statements as the Company may be required to consolidate QSPEs to which the Company has previously sold assets. In addition, the Company may also be required to consolidate other VIEs that are not currently consolidated based an analysis under the current FIN 46R consolidation model. The proposed revisions would be effective for fiscal years that begin after November 15, 2009.
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As described in Note 3.y., under Argentine GAAP the Company is required to disclose earnings per share information in accordance with RT 18 for all periods presented. Note 18 to the consolidated financial statements disclose the computation of basic and diluted net income per common share under Argentine GAAP. Guidance set forth in RT 18 is similar to the basic principles set forth in SFAS No. 128 “Earnings per Share” (SFAS No.128) although certain differences exist.
Under US GAAP, basic and diluted earnings per share are presented in conformity with SFAS No. 128.
Under Argentine GAAP, the Company has considered the dilutive effects of outstanding warrants using the if converted method, as applicable. As of the year ended June 30, 2008 the Company does not have any convertible instruments and/or warrants outstanding. Under US GAAP, dilutive options or warrants that are issued during a period or that expire or are cancelled during a period must be included in the weighted average number of shares outstanding for purposes of computing diluted EPS for the period that they were outstanding. Additionally, dilutive options or warrants exercised during the period must be included in the weighted average number of shares outstanding for purposes of computing diluted EPS for the period prior to actual exercise. Thereafter, the shares issued will be included in the weighted average calculation of shares outstanding used for both basic and diluted EPS. Under US GAAP, the Company applied the treasury-stock method as required by US GAAP. Using the treasury-stock method, the weighted-average number of potential common stock would have been 21,195 shares, 95,918 shares and 139,100, for the years ended June 30, 2008, 2007 and 2006, respectively. Diluted net income per common share under Argentine GAAP for the years ended June 30, 2008, 2007 and 2006 using the treasury-stock method, would have been Ps. 0.22, Ps. 0.23 and Ps. 0.24, respectively.
The following tables set forth the computation of basic and diluted net income per common share under US GAAP for all periods presented:
Plus (less): income (loss) impact of assumed conversions:
Foreign currency exchange gain on convertible debt
Income tax effects
Warrants (i)
Convertible Notes
Earnings per share under US GAAP:
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The Company is subject to certain business risks arising in connection with its operations which include, among others:
Risks associated with Argentine operations. A substantial part of the Company’s operations and properties are located in Argentina. As a result, the Company financial condition and results of operations depend to a significant extent on macroeconomic and political conditions prevailing in Argentina.
Risks associated with office and other buildings leases: The Company’s lease revenues from its real estate operations may be adversely affected by (i) local or national economic conditions in the areas in which the properties are located, (ii) oversupply of office space or a reduction in demand for such space, (iii) increased competition from other real estate operators, (iv) changes in the ability of the Company or the tenants to provide for adequate maintenance and/or insurance, (v) increases in operating expenses, (vi) adverse changes in the regional or national economy, (vii) the bankruptcy or insolvency of, or a downturn in the business of, any of its major tenants, and/or (vii) the possibility that such tenants will not renew their leases as they expire. Unfavorable economic conditions could also result in the inability of tenants in certain sectors to meet their lease obligations and otherwise could adversely affect the Company’s ability to attract and retain desirable tenants.
Risks associated with development properties activities: Include (i) the potential abandonment of development opportunities; (ii) construction costs may exceed the Company’s original estimates, possibly making a project uneconomical; (iii) occupancy rates and rents at a newly completed project may be insufficient to make the project profitable; (iv) the Company’s inability to obtain financing on favorable terms for the development of the project; (v) construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs; and (vi) the Company’s inability to obtain, or the delays in obtaining, all necessary zoning, land-use, building, occupancy and other required governmental permits and authorizations; (vii) preconstruction buyers may default on their purchase contracts or units in new buildings may remain unsold upon completion of constructions. (viii) sales prices for residential units may be insufficient to cover development cost.
Risks associated with the hotel industry. The success of the Company’s operated hotels will depend, in large part, upon the Company’s ability to compete in areas such as access, location, quality of accommodations, room rate structure, quality and scope of food and beverage facilities and other services and amenities. The Company’s hotels may face additional competition if other companies decide to build new hotels or improve their existing hotels such that they are more attractive to potential guests. In addition, the profitability of the Company’s hotels depends on (i) the Company’s ability to form successful relationships with international operators to run the hotels; (ii) changes in travel patterns, including seasonal changes; and (iii) taxes and governmental regulations which influence or determine wages, prices, interest rates, construction procedures and costs.
Shopping center operating risks: The development, administration and profitability of shopping centers are impacted by various factors including: the accessibility and the attractiveness of the area where the shopping center is located, the intrinsic attractiveness of the shopping center, the flow of people and the level of sales of each shopping center rental unit, increasing competition from internet sales, the amount of rent collected from each shopping center rental unit and the fluctuations in occupancy levels in the shopping centers. In the event that there is an increase in operational costs, caused by inflation or other factors, it could have a material adverse effect on the Company if its tenants are unable to pay their higher rent obligations due to the increase in expenses.
Since May 28, 1997, Law No. 24,808 provides that tenants may rescind commercial lease agreements after the initial six months upon not less than sixty days written notice, subject to penalties of only one-and-a-half months rent if the tenant rescinds during the first year of the lease, and one-month rent if the tenant rescinds after the first year of the lease. The exercise of such rescission rights could materially and adversely affect the Company.
The Company’s property is currently and will continue to be subject to risks incident to the ownership and operation of commercial real estate and residential development properties. The Company’s lease sales from its real estate operations may be adversely affected by (i) local or national economic conditions in the areas in which the properties are located; (ii) oversupply of retail space or a reduction in demand for retail space; (iii) increased competition from other real estate operators; (iv) changes in the ability of the Company or the tenants to provide for adequate maintenance and/or insurance; (v) increases in operating expenses; and/or (vi) adverse changes in the regional or national economy. Other risks include the
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inability to collect rent due to bankruptcy or insolvency of tenants or otherwise, the need to periodically renovate, repair and release space and the costs thereof and the ability of a tenant to provide adequate maintenance and insurance. In addition, the failure to sell the property to be constructed (General Paz Project, Caballito Project, Coto Residential Project and Rosario Project), could have a material adverse effect on the Company.
An economic downturn in the areas in which the shopping centers are located might adversely affect the Company’s sales (through bankruptcy of tenants and reduction in the shopping center sales due to lower variable income). Increases in operating costs due to inflation and other factors may result in some tenants being unable or unwilling to pay rent or expense increases. In addition, the Company has several tenants occupying space in more than one shopping center and, as a result, if any of such tenants should experience financial difficulties and cease paying rent, the Company’s operating results could be adversely affected. Furthermore, as leases on properties expire, the Company may be unable to find new tenants or tenants may enter into new leases on terms that are less favorable to the Company. The failure to lease such properties could have a material adverse effect on the Company.
Credit card operating risks: Credit card operations are subject to federal legislation and regulation. From time to time, such legislation, as well as competitive conditions, may affect, among other things, credit card finance charges. While the Company cannot predict the effect of future competitive conditions and legislation or the measures the Company might take in response thereto, a significant reduction in the finance charges imposed by Tarshop would have an adverse effect on the Company. In addition, adverse changes in general Argentine economic conditions, including, but not limited to changes in regulations affecting capital market access, market volatility, higher interest rates and increases in delinquencies, charge-offs and personal bankruptcies have a negative effect on the Company.
Equity investments in unconsolidated affiliated companies where the Company exercises significant influence, generally representing between 20% and 50% of the capital stock in such companies, have been accounted for under the equity method.
The Company’s share of the income of these affiliates was Ps, 13.2 loss in 2008, Ps. 40.0 million gain in 2007 and Ps. 41.7 million gain in 2006, and its investment in these companies totaled Ps. 318.2 million and Ps. 306.9 million at June 30, 2008 and 2007, respectively.
Summarized financial information in accordance with Central Bank’s policies which prescribe the reporting and disclosure requirements for banks and financial institutions in Argentina (“Argentine Banking GAAP”) of BHSA a significant equity investee (on a 100% basis) is as follows:
Current assets
Non-current assets
Current liabilities
Non-current liabilities
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Under Argentine law and labor agreements, the Company is required to make minimum severance payments to its dismissed employees without cause and employees leaving its employment in certain other circumstances. Under Argentine GAAP, severance payments are expensed as incurred. Under US GAAP, the Company follows the guidelines established by SFAS No. 112, “Employers’ Accounting for Post-employment Benefits”, and SFAS No. 43, “Accounting for Compensated Absences”, which requires the accrual of severance costs if they relate to services already rendered, are related to rights that accumulate or vest, are probable of payment and are reasonably estimable. While the Company expects to make severance payments in the future, it is impossible to estimate the number of employees that will be dismissed without proper cause in the future, if any, and accordingly the Company has not recorded such liability.
The statements of cash flows presented in the primary financial statements are prepared based on Argentine GAAP amounts.
Under Argentine GAAP, the Company considers all short-term, highly liquid investments that are readily convertible to known amounts of cash and with original maturities of three months or less to be cash equivalents. Under Argentine GAAP, mutual funds are considered to be cash equivalents since original maturity is determined by reference to the frequency with which liquidity is available according to current Argentine GAAP guidance and practice. However, under SFAS No. 95 “Statement of Cash Flows”, the original maturity is determined by reference to the stated term of the security or the timeframe for exercising any put features to the issuer, not by reference to the frequency with which liquidity may be available through an auction, a put feature to a third party, or otherwise.
Therefore, for US GAAP purposes, certain mutual funds are not considered to be cash equivalents. As a result, differences exist between the total amount of the increase or decrease in cash and cash equivalents reported in the primary financial statements and the same totals that would be reported in a statement of cash flows prepared following SFAS 95 provisions.
The following tables set forth the amounts of cash and cash equivalents at the beginning and end of each year and corresponding increases and/or decreases that would be reported in a statement of cash flow following SFAS 95 provisions:
Cash and cash equivalents under US GAAP as of the beginning of the year
Cash and cash equivalents under US GAAP as of year-end
Net increase in cash and cash equivalents under US GAAP
Differences exist between cash flows from operating, investing and financing activities reported in the primary financial statements and the cash flows from operating, investing and financing activities that would be reported under SFAS No. 95. Due to the difference in the definition of cash and cash equivalents, cash flows from purchasing and selling of mutual funds would be reported as cash flows from investing activities following SFAS 95 provisions.
In addition, under Argentine GAAP the effect of exchange rate changes on cash and cash equivalents were not disclosed by presenting a fourth cash flow statement category as required by US GAAP.
The following tables set forth the condensed statements of cash flows prepared in accordance with US GAAP:
Net increase in cash and cash equivalents
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Additionally, under Argentine GAAP, the Company consolidates the accounts of Metroshop S.A., CYRSA and Canteras Natal Crespo S.A. on a pro rata basis. Under US GAAP, proportionate consolidation is not appropriate since the Company does not exercise control over this investment. As a result, differences exist between the amount of cash and cash equivalents reported in the primary financial statements and the amount of cash and cash equivalents that would be reported in a statement of cash flows prepared under US GAAP using Argentine GAAP numbers. For this reason, cash flows from operating, investing and financing activities would be different in a statement of cash flows prepared under US GAAP using Argentine GAAP since each line item would exclude the pro rata equity interest of the accounts of Metroshop S.A., CYRSA and Canteras Natal Crespo S.A.
On July 1, 1998, the Company adopted SFAS No. 130, “Reporting Comprehensive Income”. SFAS No. 130 establishes guidelines for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. Comprehensive income represents the change in shareholder’s equity of the Company during the period from transactions and other events and circumstances from non-owner sources. It includes all changes in equity during a period except those resulting from investments by owners and distributions to owners. The adoption of SFAS No. 130 had no impact on total shareholders’ equity. The following table summarizes the components of comprehensive income for the years ended June 30, 2008, 2007 and 2006.
Other comprehensive income:
Unrealized (loss) gain on available-for-sale-securities (i)
Unrealized (loss) gain on retained interest in transferred mortgage and credit card receivables (ii)
Unrealized (loss) gain on available-for-sale-securities of equity investees
Comprehensive income
Accumulated non-owner changes in equity (accumulated other comprehensive income) for the years ended June 30, 2008, 2007 and 2006 were as follows:
Unrealized gain on available-for-sale securities
Unrealized gain on retained interest in transferred mortgage and credit card receivables
Unrealized gain on available-for-sale-securities on equity investees
Accumulated other comprehensive income
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As discussed in footnote (v) of Note 2.b. under Argentine GAAP the Company consolidates the accounts of Natal Crespo S.A. and CYRSA on a pro-rata basis and also, APSA consolidates Metroshop S.A. on a pro-rata basis. Under US GAAP consolidation is not appropriate since the Company does not exercise control over these subsidiaries.
Presented below is the consolidated condensed information of the Company at June 30, 2008 and 2007 considering Natal Crespo S.A., CYRSA (only for June 30, 2008) and Metroshop S.A. as an equity investee:
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1) Fair values of assets and liabilities acquired
The following table summarizes the estimated fair values of assets acquired and liabilities assumed at the date of acquisition for each transaction (in millions):
Working capital
In place leases
Below market leases
2) Acquisition of Museo Renault, Bank Boston and Mendoza Plaza Shopping S.A.
The following schedule presents 2008 and 2007 supplemental unaudited pro forma information as if the transactions of Museo Renault, Bank Boston and Mendoza Plaza Shopping S.A. had occurred on July 1, 2006. The unaudited pro forma information is presented based on information available, is intended for informational purposes only and is not necessarily indicative of and does not purport to represent what the Company’s future financial condition or operating results will be after giving effect to the transactions and does not reflect actions that may be undertaken by management in integrating this business. In addition, this information does not reflect financial and operating benefits the Company expects to realize as a result of the transactions.
The following table summarizes the unaudited pro forma income statement information of the Company for the fiscal years ended 2008 and 2007:
Earning per share under Argentine GAAP
The Company used the equity method of accounting for its investments over which the Company exercises significant influence. As such, these investments were recorded at the amount of the underlying equity in their net assets and adjusted to recognize the Company’s share of the undistributed earnings or losses. The Company had a 50% ownership interest in E-commerce Latina S.A as of June 30, 2006. In January 2007, the Company acquired the remaining 50% in E-commerce Latina S.A. The Company gained control of E-commerce Latina S.A. through this acquisition and accordingly the results of operations of E-commerce Latina S.A. were fully consolidated as from the date. The Company’s share of the losses of this company was Ps. 0.7 million during the year ended June 30, 2006, and its investment in this company totaled 0.1 million as of that date. Summarized financial information of this affiliate (on a 100% basis) was as follows:
Operating loss
Net loss
As of June 30, 2006 accumulated losses of E-Commerce Latina totaled Ps. 1.4 million. On February 6, 2006 the Extraordinary Shareholders’ Meeting approved a capital increase for the amount of Ps. 22.0 million through the capitalization of additional paid-in-capital. The Company issued 22,010,575 nominative common stock of Ps. 1 nominal value each and 1 vote per share. As a result, the capital stock increased to Ps. 22.0 million.
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The following is a summary of the Company’s investments in real estate as of June 30, 2008 prepared in accordance with SEC Regulation S-X 12-28.
Description
Date of construction
Date acquired
Alto Palermo Park
Alto Palermo Plaza
December 1996- March 1997 and
September 1997
Av. de Mayo 595
Av. Madero 942
September 1994-
March 1995
Dique II Edificio A y B “Edificios Cruceros”
Hotel Intercontinental
October 1973-
November 1990-
December 1997
Libertador 602
Store Cruceros
Reconquista 823
December 1994-
August 1994-
July 1994
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Obras en Curso Dique IV
Shopping Abasto
Shopping Alto Palermo
November 1997-
March 1998
Shopping Alto Avellaneda
Shopping Paseo Alcorta
March 1995-September
1996- January 2000
Mendoza Plaza Shopping
Neuquén Project
Panamerican Mall
Córdoba Shopping - Villa Cabrera -
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Balance, beginning of the year
Additions during the year:
Acquisition
Improvements
Recovery of impairment
Transfers from work-in-progress leasehold improvements
Transfers from undeveloped parcels of land
Transfers from real estate inventory
Transfers from other receivables
Deductions during the year:
Transfers to real estate inventory
Transfers to intangible assets
Transfers to undeveloped parcels of land
Sales
Balance, end of the year
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Prepared in accordance with SEC Regulation S-X 12-29
Col. A.
Customer A
Customer B
Customer C
Customer D
Customer E
Customer F
Customer G
Customer H
Customer I
Customer J
Customer K
Mortgage receivables Ps. 30,000-Ps. 49,999
Mortgage receivables Ps. 50,000-Ps.69,999
July 2014
Mortgage receivables Ps. 70,000-Ps.89,999
December 2014
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The summary of activity in mortgage receivables is as follows:
Balance, beginning of year
New mortgage loans
Collections of principal
Balance, end of year
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The following tables present additional financial statement disclosures required under Argentine GAAP:
a. Fixed assets, net
b. Intangible assets, net
c. Allowances and provisions
d. Cost of sales, leases and services
e. Foreign currency assets and liabilities
f. Other expenses
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Principal account
Advances to suppliers
Properties:
Av. Madero 1020
Edificio Republica
Work-in-progress
Dique IV
Shopping Centers:
Shopping Alto Noa
Shopping Buenos Aires Design
Shopping Patio Bullrich
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Shopping Alto Rosario
Shopping Córdoba
Total as of June 30, 2008
Total as of June 30, 2007
Total as of June 30, 2006
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Intangible assets – savings expenses
-Della Paolera 265
-Museo Renault
-Edificio República
Ps. (12) reclassified to Other receivables and prepaid expenses.
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Item
Deducted from current assets:
Allowance for doubtful accounts
Allowance for Impairment of investments
Deducted from non-current assets:
Allowance for doubtful mortgage receivable
Allowance for impairment of fixed assets
Allowance for impairment of inventories
Allowance for impairment of undeveloped plots of land
Allowance for impairment of intangible assets
Allowance for impairment of non-current investments
Included in current liabilities:
Included in non-current liabilities:
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I. Cost of sales
Stock as of beginning of year
Plus:
Expenses (Note 29.f.)
Transfers to fixed assets
Transfers from investments
Transfers from fixed assets
Transfers to other receivables and prepaid expenses
Capitalized interest
Decrease in mortgage loans
Exchange gain
Transfer from intangible assets
Merger
Adjustment to purchase price of inventory (i)
Stock as of end of year
Gain from valuation of inventories at fair market value
Results from holding of real estate assets
Impairment of the year
Cost of properties sold
II. Cost of leases
Cost of properties leased
III. Cost of fees and services
Cost of fees for services
IV. Cost of hotel activities
Purchases of the year
Cost of hotel activities
V. Cost of consumer financing
Cost of consumer financing
TOTAL COSTS
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Captions
Cash and banks:
Bank Accounts
Investments:
Time deposits and money markets
Accounts receivable, net:
Other receivables and prepaid expenses:
Guarantee of defaulted credits
Guarantee receivable
Credito default swap
Total assets as of June 30, 2008
Total assets as of June 30, 2007
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Trade accounts payable:
Mortgage payables:
Mortgages payables
Customer advancers:
Short-term debt:
Taxes payables:
Other liabilities:
Provision for discount
Long-term debt:
Total liabilities as of June 30, 2008
Total liabilities as of June 30, 2007
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Items
Director’s fees
Fees and payments for services
Salaries and bonuses
Social security contributions
Maintenance of building
Mail and telephone
Advertising
Lease expense
Commissions and property sales charges
Freight and transportation
Taxes, rates and contributions
Subscriptions and publications
Interest and index – adjustment
Bank charges
Safe deposits box
Travel expenses
Food and beverages
Training expenses
Contingencies
Insurances
Surveillance
Training courses
Change for contingencies for lawsuits
Gross sales tax
Expenses recovery
Unrecovered expenses
Total as of June 30,2008
Total as of June 30,2007
Total as of June 30,2006
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REPORT OF INDEPENDENT ACCOUNTANTS
We have audited the accompanying consolidated balance sheets of Banco Hipotecario S.A. and its subsidiaries (collectively referred to as the “Bank”) as of June 30, 2008 and 2007 and the related consolidated statements of income, of changes in shareholders’ equity and of cash flows for each of the three twelve-month periods in the period ended June 30, 2008. These financial statements are the responsibility of the Bank’s management. 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 the United States of America. Those standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Banco Hipotecario S.A. and its subsidiaries at June 30, 2008 and 2007, and the results of their operations and their cash flows for each of the three twelve-month periods in the period ended June 30, 2008 in conformity with accounting rules prescribed by the Banco Central de la República Argentina (the “BCRA”).
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As described in Notes 6 and 34 to the consolidated financial statements, respectively, accounting rules prescribed by the BCRA differ in certain significant respects from, and is a comprehensive basis of accounting other than, accounting principles generally accepted in Argentina for enterprises in general (“Argentine GAAP”) and accounting principles generally accepted in the United States of America and as allowed by Item 17 to Form 20-F (“US GAAP”). Information relating to the nature and effect of the differences between accounting rules prescribed by the BCRA and US GAAP is presented in Note 34 to the consolidated financial statements.
December 30, 2008.
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CONSOLIDATED BALANCE SHEETS
As of June 30, 2008 and 2007
Banks and correspondents
Government and corporate securities (Note 8)
Loans (Note 9)
Mortgage loans
Plus: Accrued interest receivable
Less: Allowance for loan losses (Note 10)
Other receivables from financial transactions (Note 11)
Securities receivable under repurchase agreements
Amounts receivable under derivative financial instruments (Note 21)
Loans in trust pending securitization
Amounts receivable under reverse repurchase agreements of government and corporate securities
Receivable from Argentine Government compensatory and hedge bonds (Note 2)
Other (Note 11)
Investments in other companies
Miscellaneous receivables (Note 12)
Bank premises and equipment (Note 13)
Miscellaneous assets (Note 14)
Intangible assets (Note 13)
In-process items
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CONSOLIDATED BALANCE SHEETS – (Continued)
LIABILITIES AND SHAREHOLDERS’ EQUITY LIABILITIES
Plus: Accrued interest payable
Other liabilities from financial transactions
Other banks and international entities (Note 17)
Bonds (Note 18)
Argentine Central Bank (Note 16)
Amounts payable under derivative financial instruments (Note 21)
Borrowings under repurchase agreements collateralized by government securities
Obligation to return securities acquired under reverse repurchase agreements of government and private securities
Collections and other transactions on behalf of third parties
Miscellaneous liabilities
Taxes
Sundry creditors (Note 23)
Other (Note 23)
Reserve for contingencies (Note 15)
Minority interests
Common stock
Inflation adjustment of common stock
Reserves
Retained earning
Total Shareholders’ Equity
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CONSOLIDATED STATEMENTS OF INCOME
For the twelve-month periods ended June 30, 2008, 2007 and 2006
Interest on loans and other receivables from financial transactions
Income from government and corporate securities
Interest on deposits and other liabilities from financial transactions
Provision for loan losses (Note 10)
Insurance premiums
Commissions (Note 24)
Other (Note 24)
Expenses for services
Insurance claims
Advertising expenses
Value added tax and other taxes
Directors’ and Syndics’ fees
Fees for administrative services
Maintenance and repairs
Net (loss) income from financial transactions
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CONSOLIDATED STATEMENTS OF INCOME – (Continued)
Miscellaneous income
Loans recoveries
Other (Note 25)
Miscellaneous expenses
Provision for other contingencies and miscellaneous receivables
(Loss) income before income taxes and minority interests
Income taxes (Note 27)
Net (loss) income for the period
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CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
Balance as ofJune 30, 2005
Net income for the period
Balance as ofJune 30, 2006
Absorption of accumulated deficit approved by the General Shareholders’ Meeting held on July 21, 2006
Retained earnings distribution approved by the General Shareholders’ Meeting held on April 12, 2007 – Legal Reserve
Balance as ofJune 30, 2007
Retained earnings distribution approved by the General Shareholders’ Meeting held on May 23, 2008 – Legal Reserve
Net loss for the period
Balance as ofJune 30, 2008
The accompanying notes are an integral part of these consolidated financial statements
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CONSOLIDATED STATEMENTS OF CASH FLOW
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by Cash Flows from operating activities:
Provision for loan losses and for contingencies and miscellaneous receivables, net of reversals
Net gain on investment government securities
Gain on derivative financial instruments
Net gain on sale of premises and equipment and miscellaneous assets
Net Indexing (CER and CVS) of loans and deposit
Net Interest and indexing (CER) of borrowings and compensations from Argentine Central Bank
Loss on sale of the equity investment
Net change in trading investments
Net reverse repurchase agreements of government and corporate securities
Net change in other assets
Net change in other liabilities
Cash flows from investing activities:
Increase in loans, net
Proceeds from securitization of consumer loans
Purchase of government securities
Proceeds from government securities
Proceeds from maturities of investments
Sales of investments in other companies
Proceeds from sale of premises and equipment
Purchases of premises and equipment, miscellaneous and intangible assets
Cash flows from financing activities:
Increase in deposits, net
Proceeds from issuance of bonds, notes and other long term debts
Proceeds from borrowings from Banks
Principal payments on bonds, notes, and other debts
(Decrease)/Increase in borrowings, net
Net cash provided by financing activities
Net increase/(decrease) in cash and cash equivalents
Cash and cash equivalents at the beginning of the period
Effect of foreign exchange changes on cash and cash equivalents
Cash and cash equivalents at the end of the period
Supplemental disclosure of cash flow information:
Cash paid for interest
Cash paid for presumptive minimum income tax
Non-cash transactions involving securitizations
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1. General
a. Description of business
Banco Hipotecario SA (herein after referred to as the “Bank” or “BHSA”), is a commercial bank, organized under the laws of Argentina.
The Bank historically has provided general banking services, focused on individual residential mortgage loans and construction-project loans directly to customers as well as indirectly through selected banks and other financial intermediaries throughout Argentina. In 2004, as part of its business diversification strategy, the Bank resumed the mortgage lending and expanded its product offerings, beginning to offer personal loans, credit card loans and also engaging in mortgage loan securitizations, mortgage loan servicing, other corporate loans and mortgage-related insurance in connection with its lending activities.
b. Basis of presentation
The consolidated financial statements of the Bank have been prepared in accordance with the rules of Banco Central de la República Argentina (“Argentine Central Bank” or “BCRA”) which prescribes the accounting reporting and disclosure requirements for banks and financial institutions in Argentina (“Argentine Banking GAAP”). These rules differ in certain respects from generally accepted accounting principles in Argentina (“Argentine GAAP”) applicable to companies in general. The significant differences between Argentine Banking GAAP and Argentine GAAP are described in Note 6 to the consolidated financial statements. Argentine Banking GAAP and Argentine GAAP also differ in certain significant respects from generally accepted accounting principles in the United States of America (“US GAAP”). Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by US GAAP and regulations of the Securities and Exchange Commission (“SEC”). These consolidated financial statements include solely a reconciliation of net income and shareholders’ equity to US GAAP. Pursuant to Item 17 of Form 20-F, this reconciliation does not include disclosure of all information that would be required by US GAAP and Regulation S-X of the SEC. See Note 34 for details.
Certain disclosures required by the Argentine Banking GAAP have not been presented herein since they are not required under US GAAP or the SEC and are not considered to be relevant to the accompanying consolidated financial statements taken as a whole.
c. Principles of consolidation
The consolidated financial statements include the accounts of the Bank and its subsidiaries over which the Bank has effective control. The percentages directly or indirectly held in those companies’ capital stock as of June 30, 2008 are as follows:
Issuing Company
BHN Sociedad de Inversión Soeciedad Anónima
BHN Seguros Generales Sociedad Anónima
BACS Banco de Crédito y Securitización Sociedad Anónima
BH Valores Sociedad de Bolsa SA
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All significant intercompany accounts and transactions have been eliminated in consolidation.
d. Presentation of financial statements in constant argentine pesos
Effective September 1, 1995, pursuant to Decree No. 316/95, the Bank discontinued its prior practice of adjusting the financial statements for inflation. Effective January 1, 2002, however, as a result of the application of Argentine Central Bank, National Securities Commission (“CNV”) and Argentine Federation of Professional Councils in Economic Sciences (“FACPCE”) rules, the Bank resumed the application of the adjustment for inflation.
In 2002, Argentina experienced a high rate of inflation. The wholesale Price Index “WPI” increased approximately 118.44% in 2002.
Primarily as a result of the stabilization of the WPI during the first half of 2003, the Argentine government, the Argentine Central Bank and the CNV eliminated the requirement that financial statements be prepared in constant currency.
2. Economic and social situation prevailing in Argentina
2.1 Current economic situation
As regards Argentina, and after June 30, 2008 stock markets reflected significant drops in the prices of government and corporate securities, as well as an increase in interest rates, country risk and exchange rates, a situation that is still ongoing as of the date of issuance of these financial statements. The Bank considers that these situations did not exist as of June 30, 2008 but arose subsequent to that date.
As a result of the situation described above, the market value of the BODEN 2012, BOGAR and Discount bonds as of December 15, 2008 decreased approximately by Ps.806,451 compared to its market value as of June 30 2008.
The Bank’s management is permanently evaluating and monitoring the effects derived from the above situation in order to implement the necessary measures to mitigate its effect. These financial statements must be analyzed taking into consideration the scenario described above.
The net position of the derivative financial instruments have experienced a decline of Ps.114,388 as of September 30, 2008 compared to June 30, 2008, as a consequence of the financial crisis described above. Subsequently and as of the date of issuance of these financial statements the main variables that determine these fair value (EURO/US Dollar/BADLAR/LIBOR/Country Risk), continue being affected by the market volatility mentioned before, however management believes that the subsequent changes in the variables would not significantly affect the Bank’s Shareholders’ Equity at the date of issuance of these financial statements.
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The Bank’s management is monitoring the effects derived from the above situation described in order to implement the necessary measures to mitigate its effect. These financial statements must be analyzed taking into consideration the scenario described above.
2.2 Pending events derived from the system’s crisis in late 2001
As a consequence of the crisis that took place in Argentina during 2001 and 2002, the National government adopted measures that influenced the banking activity, and specifically the Bank’s activity, among which were: i) a single free exchange market system was established, ii) Deposits and Loans in US dollars or any other foreign currency granted by the Argentine financial system were converted into pesos, iii) compensations to the Financial System for the effects of the asymmetric pesification process, iv) certain adjustments to the Reorganization and Bankruptcy Laws and v) conversion of provincial public debt.
Compensation granted by the National Government to financial institutions.
Asymmetric pesification
Through Decree 905, the Government established the issuance of “National Government Compensating Bonds” to compensate financial institutions for the negative effects on their equities of the conversion into pesos at different exchange rates of receivables and obligations denominated in foreign currency, as provided for by Law 25561, Decree 214 and its amendments and complementary rules, and to cover the negative difference between assets and liabilities denominated in foreign currency arising from their conversion into pesos, as established by the above-mentioned regulations.
The Bank complied with the reporting requirements established by Sections 28 and 29 of Decree 905—Compensation to financial institutions, applying for such purpose the regulations in force and particular criteria, exercising the following options:
National Government Compensating Bond in US dollars, due 2012: Compensatory bond—difference between assets and liabilities converted into pesos at Ps. 1.00, for the exchange rate difference of Ps. 0.40, converted into pesos at the Ps. 1.40 =US$ 1 rate: US$ 374,647 thousand (consolidated amount).
National Government Hedge Bond in US dollars, due 2012: Hedge Bond—difference between assets and liabilities in US dollars, net of the compensating bond: US$ 845,729 thousand (consolidated amount).
In September 2002 and October 2005 the Argentine Central Bank credited US$ 356,015 thousand and US$ 16,761 thousand in BODEN 2012, respectively, as compensation (consolidated amount).
Finally, between September 2005 and January 2006, hedge BODEN 2012 for US$ 773,531 were subscribed.
In addition, in July 2007 the Bank requested an advance of Ps. 83,012 to purchase US$ 59,294,200 in “National Government Bonds in US Dollars Libor Due 2012” (“BODEN 2012”) pursuant to the provisions of Section 29, subsections f) and g) of Decree No. 905/02 of the Executive Branch and regulations.
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In order to guarantee the advance to be received, the Bank submitted as collateral a) Secured Bonds (BOGAR) for a face value of 83,011,880, and b) Mortgage Securities granted customers of the non-financial private sectors, in Situation 1, equivalent to Ps. 26,163.
For purposes of these financial statements, i) BODEN 2012 bonds credited by the Argentine Central Bank have been recorded in Government and Corporate Securities – Held-for-investment, ii) the amount in respect of the right to receive the Compensatory and Hedge bonds has been recorded in Other receivables for financial transactions – Receivable for Argentine Government—Compensatory and Hedge bond—In foreign currency, iii) bonds delivered as collateral for Negotiable Obligations and secured facilities to banks, have been recorded in Miscellaneous receivables, and iv) the advance to be requested for the acquisition of the Hedge bond, has been recorded in Other liabilities for financial transactions—Argentine Central Bank.
Mortgage refinancing system
On November 6, 2003, Law 25798, regulated by Decree N° 1284/03, established the creation of a system for the refinancing of mortgage loans and of a restructuring unit for the purpose of analyzing loans arranged prior to the application of the Convertibility Law 23928.
On December 12, 2006, the National Congress approved Law 26177 modifying the Mortgage Refinancing System. The new law establishes the Reestructuring Unit, which will be in charge of the analysis and proposal of refinancing of mortgage loans agreed among awardees and the ex Banco Hipotecario Nacional, settled before the Convertibility Law (Law 23928).
On November 21, 2007, National Congress through Law No. 26313, established a mandatory procedure for restructuring mortgage loans included in Section 23 of Law 25798, pursuant to the guidelines of Law 26177. For such purpose, a new calculation of some mortgage loans originated by the former Banco Hipotecario Nacional before April 1, 1991 was established. On December 19, 2008, through Decree 2107/08 the government issued regulations explaining its application. This law applies only to non-performing mortgage loans granted before April 1, 1991 and requires a new balance calculation for loans affected. Banco Hipotecario S.A., as legal successor to the former Bank, has estimated that it has enough loan allowances to face possible negative economic effects that could arise from this situation.
3. Comprehensive financial debt restructuring
The financial debt restructuring process resulting from the significant adverse changes that took place in Argentina in 2002, which affected the Bank’s balance sheet and financial position, ended on December 29, 2003. On that date, the term for receiving exchange offers expired and the Bank accepted all existing validly offered securities in view of compliance with the conditions for the Bank’s exchange offers and the simultaneous restructuring of all its outstanding debt with bank creditors. On January 14, 2004, the total final principal on validly offered securities of Ps. 2,662,242, representing approximately 93% of the total principal on the outstanding securities existing at that date, was settled.
After January 14, 2004, the settlement date of the transaction, the Bank continued to exchange negotiable obligations with holders adhering to the offering late. At June 30, 2008, the face value of the obligations exchanged amounted to US$ 8,995 thousand and Euro 10,695 thousand.
At the date of these financial statements, the Bank had honored the total amount of amortization and interest according to the contractual terms.
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4. Exposure to the Public Sector
As of June 30, 2008, the Bank maintains Ps. 2,765,827, in government-related assets:
As of June 30, 2008, the Bank has Ps. 239,104 in advances to be requested from Argentine Central Bank for the acquisition of the Hedge Bond (BODEN 2012).
The net exposure to the Public Sector, without considering liquid assets in BCRA accounts, amounts to Ps.2,526,723 and Ps. 3,096,580 at June 30, 2008 and 2007, respectively.
To guarantee the loan to be received by the government, the bank granted the following assets as collateral: a) Secured Bonds (BOGAR) for a face value of 47,097,934, and b) Mortgage Securities granted customers of the non-financial private sectors, classified as performing, equivalent to Ps. 26,163,258.29.
In addition, Decree 905/02 states that in the event of default by the National Government on the payment of principal or interest of BODEN, Secured Loans or BOGAR, of more than 30 days following the respective maturity dates, each financial institution will be entitled to repay in advance, either fully or partially, the advances received for the acquisition of the Hedge bond, using for that purpose all or the equivalent portion of the assets provided as collateral, taken at the value in which they were recorded at the time the advances were granted, plus interest accrued until the repayment date, less the amount actually repaid.
Since January 1, 2006 according to BCRA regulations, the financial assistance to the Public Sector, may not exceed 40% of total assets as of the last day of the previous month. The Bank’s exposure to the public sector stems from compensations received from the National Government. Therefore, and considering that the exposure to the Public Sector exceed said limit, on January 19, 2006 the Bank informed the BCRA that it would gradually reduce the ratio of its exposure to the Public Sector, to the extent that bonds received from the National Government, as compensation for the asymmetric pesification will start amortizing principal. As of the date of issuance of these financial statements, there were no objections from the BCRA.
Communication “A” 4546 dated July 9, 2006, stated that, as from July 1, 2007, exposure to the Public Sector, may not exceed 35% of total assets as of the last day of the previous month.
As of June 30, 2008 the Bank’s exposure to the public sector represents 26.2% of its total assets.
5. Significant Accounting Policies
The following is a summary of significant accounting policies used in the preparation of the consolidated financial statements.
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5.1. Foreign Currency Assets and Liabilities
Foreign currency assets and liabilities are translated at the prevailing exchange rate at period-end. Transactions denominated in foreign currencies are translated into pesos at the prevailing exchange rates on the date of transaction settlement. Foreign currency transactions net gains or losses are recorded within “Financial income” or “Financial expenses” in the accompanying consolidated statements of income.
5.2. Government and Corporate Securities
BODEN US$ 2012 received as compensatory bonds, are classified as “Investment Securities” and are recognized at their technical value (the adjusted balance of each instrument according to contractual conditions), in accordance with the rules issued by the BCRA.
Securities classified as “held for trading – quoted” are marked to market, at the Buenos Aires Stock Exchange spot quotation, and any changes in their market value is recognized as a gain or loss in the consolidated income statement.
Secured Bonds (“BOGAR”) issued by the Provincial Government within the framework of Decree 1579/02 are classified as “held for trading – unquoted” and are recorded at its present value as required by the BCRA.
Discount Bonds exchanged for sovereign debt are classified as “held for trading – unquoted” and have been recorded at the lower of (a) the aggregate nominal cash flow until maturity, under the contractual conditions of the new securities, and (b) the carrying value of the securities offered, which is equivalent to the present value of the Secured Bonds.
5.3. Loans
The portfolio of performing loans and loans with 90 days or less past due, has been recorded at principal amounts, net of amortization, adjusted by CER, and CVS, where applicable, plus accrued interest and net of allowance for loan losses.
Other loans to the public sector originally granted in foreign currency have been converted into pesos at the exchange rate of Ps. 1.40 per US dollar, as established by Law 25561, Decree 214 and complementary rules and amendments. Since February 3, 2002, the CER has been applied to the amount of those loans and maximum rates have been established, as provided for by Decree 1579/02, if those assets were subject to the Exchange of Provincial Public Debt.
Loans to the non-financial private sector originally granted in foreign currency prior to December 2001 have been converted into pesos at the exchange rate of Ps. 1.00 per US dollar, as established by Law 25561, Decree 214 and complementary rules and amendments. Since February 3, 2002, the CER and CVS have been applied to the amount of those loans and maximum rates have been established, depending on the borrower.
Law 25796 established the elimination of the CVS since April 2004.
5.4. Interest accruals and adjustments of principal amounts (CER and CVS)
Interest income is recognized on an accrual basis using the straight-line method. For all lending and certain borrowing transactions in local and foreign currency with maturities greater than 92 days, interest is recognized on a compounded basis, which provides for an increasing effective rate over the life of the loan. Interest accruals for loans past due more than 90 days, were discontinued.
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Adjustments of principal amounts from the application of the CER and CVS, were accrued as established by BCRA regulations, and interest accruals for loans past due more than 90 days, were discontinued.
Interest is recognized on a cash basis on past due loans of more than 90 days, after reducing the balance of accrued interest.
5.5. Derivative Financial Instruments
The rights and obligations arising from currency swap transactions carried out as a hedge for the restructured obligations issued in Euros have been recorded at the exchange rate of that currency following the criterion described in Note 5.1.
Currency swap transactions carried out as a hedge for the Bank’s exposure to foreign currency-denominated liabilities, without transferring the underlying asset, have been recorded according to the net asset or liability position derived from variations in the underlying assets and variations in the US dollar exchange rate plus interest agreed for liabilities.
Interest rate swap transactions carried out for purposes of hedging assets and liabilities with fixed and floating rates, have been recorded in accordance with the unsettled balances of on the agreed upon lending and borrowing interests rates.
The CER swap, linked to Secured loans due in 2008 and External Debt transaction, has been recorded in accordance with unsettled balances of the agreed upon lending and borrowing interests rates.
5.6. Securitizations of Loans
The Bank accounted for the transfer of US dollar-denominated and peso-denominated mortgage loans to a mortgage trust and the issuance of mortgage bonds, as a sale and recorded its retained interest in the securitization trusts at their principal amounts. Retained interests relating to certificates of participation are adjusted on a monthly basis to reflect the net results of the Bank’s equity in the trusts. A gain or loss is recognized for the difference between the cash proceeds received and the principal balance of mortgage loans underlying the mortgage bonds sold.
Debt securities have been recorded at face value, adjusted by CER, where applicable, plus accrued interest.
5.7. Allowance for Loan Losses
Allowances for loan losses recorded at June 30, 2008 and 2007, cover the minimum reserves required by the BCRA, which consist of the debtors payment capacity and cash-flows analysis for commercial loans and clients aging for consumer loans, and were calculated considering the accounting policies adopted for certain refinanced consumer loans and the changes in certain estimates related to the loan portfolio.
Pursuant to the guidelines of Law 24441 on Housing and Construction Financing, the criterion followed by the Bank to set up reserves for construction projects, where the fiduciary ownership is transferred, consists in classifying debtors on the basis of the evaluation of the future cash flow of the individual project financed by the Bank.
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Until Communication “A” 4648 were made effective, the Bank held the following policy regarding the procedure followed for classifying non-performing and restructured individual loans:
b.1. If the loan is no more than 30 days past due, it shall be reclassified as “performing” loan.
b.2. If the loan is more than 30 days past due, its classification will arise from the aggregate of the current number of days in arrears and those recorded before the refinancing.
As a result of the policies adopted, and in line with BCRA rules, at June 30, 2008 and 2007 the Bank has recorded in memorandum accounts Ps. 836,993 and Ps. 816,237, respectively, for loans charged off from the Bank’s assets three months after the date on which those loans were fully reserved.
Through Communications “4648”, supplementary rules and amendments, the BCRA established new application regulations for the classification and provisioning of consumer loan portfolios. For such purpose, as from November 27, 2007, consumer loans refinancing will generate the freezing of the debtor classification and provision before refinancing. Furthermore, as from March 1, 2008, the aforementioned regulations are in force, and their main effects are the following: i) the classification of refinanced loans is maintained for three installments (or until collection of an equivalent amount), ii) the improvement of the situation of the refinanced client is based on paid installments (periodical, monthly or quarterly payment financing) or on the percentage of paid capital (sole payment financing or periodical payment, when over two months or irregular payment), iii) timely payment of the refinanced payments (or default of no more than 31 days) is a requirement for improving the situation, iv) advance payments and/or prepayments to access refinancing or after it are calculated in equivalent “installments” to measure the possibility of improving the client’s situation and v) in case the refinanced client shows arrears of more than 31 days, the “theoretical default” days are determined by adding the number of days in default in refinancing and minimum default in the category the debtor had at the time of refinancing, and based on these theoretical default days, he or she will be reclassified in the category corresponding to said default, as if it was real. As to the date of these financial statements, the Bank started implementing the detailed regulation.
The individual mortgage loans granted and managed by the Retail Bank Network, in which said banks assume 100% of funds flow guarantees, have been classified pursuant to the categories corresponding to financial institutions involved pursuant to BCRA standards.
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As of June 30, 2006, the Bank’s Risk and Credit Committee decided to maintain a 100% coverage of the loan loss reserve, relative to the total amount of those loans classified as non-performing.
Based on the foregoing, the Board of Directors of the Bank believes that the allowance for loan losses set up are sufficient to cover the minimum reserves required by Argentine Banking GAAP rules.
5.8. Mortgage Related Insurance
The Bank records provisions for incurred but not reported insurance claims and pending insurance claims based on historical loss experience. The Bank provides property damage, life and unemployment insurance for its mortgage loan customers as well as for debtors of loans which the Bank services. Income from insurance premiums is recognized as it is charged as a component of the monthly loan installment under “Income from services” in the accompanying consolidated statement of income.
The Bank has set up a reserve for incurred but not reported and pending insurance claims for Ps.10,513 and Ps.10,947 as of June 30, 2008 and 2007, respectively.
The Bank discontinues accruing insurance premiums for individual loans when the related loan is over 90 days past due.
5.9. Loans in trust pending securitization
The Bank has executed various financial trust agreements under which it has transferred the fiduciary ownership of certain of its mortgage loans to other financial entities as trustees for the benefit of trust. Once the mortgage loans have been transferred, the trust fund issues the corresponding debt securities and certificates of participation and remits the proceeds to the Bank. The Bank may also retain an ownership interest in the trust in the form of debt securities or certificates of participation.
These receivables, corresponding to pesified mortgage loans registered in the name of the trustee, are recorded as an asset of the Bank, since the trustee has not issued the corresponding debt securities and certificates participation, and therefore the Bank maintains the dual roles of trustor and sole beneficiary.
All the loans in trust at June 30, 2008 are held in a trust where the Bank is the only beneficiary and are not intended to be securitized.
5.10. Investments in Other Companies
Investments in Other Companies include equity interest in companies where a minority interest is held.
Under Argentine Banking GAAP, the equity method is used to account for investments where a significant influence in the corporate decision making process exists.
Permanent equity investments in companies where corporate decision are not influenced, are accounted for at the lower of cost and the equity method.
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5.11. Bank Premises and Equipment and Miscellaneous Assets
Bank premises and equipment are recorded at cost, adjusted for inflation (as described in Note 1.d), less accumulated depreciation.
Depreciation is computed under the straight-line method over the estimated useful lives of the related assets. The estimated useful lives for bank premises and equipment are as follows:
Buildings
The cost of maintenance and repairs of these properties is charged to expense as incurred. The cost of significant renewals and improvements is added to the carrying amount of the respective assets. When assets are retired or otherwise disposed of, the cost and related accumulated depreciation are removed from the accounts, and any resulting gain or loss is reflected in the consolidated statement of income.
The Bank has recorded under “Miscellaneous assets”—properties received in lieu of payment of loans. These assets are initially recognized at the lower of market value or the value of the loan, net of allowances and subsequently, adjusted for inflation (as described in Note 1.d), and depreciation. Depreciation of Miscellaneous assets is also computed under the straight-line method over the estimated useful of the related assets.
5.12. Intangible Assets, Net
Intangible assets represent software expenses as well as start-up costs. These assets are carried at cost, adjusted for inflation (as described in Note 1.d), less accumulated amortization. Intangible assets are amortized under the straight-line method over their estimated useful life.
5.13. Other Financial Instruments
On January 29, 2004, the Bank entered into a transaction to partially hedge its Stock Appreciation Right clause (“StARS”) included in the issuance of the Medium-term Secured Facility. This transaction includes the acquisition of 71,100,000 Class D ordinary shares of Banco Hipotecario SA (see Note 29.a.). The amount agreed under this transaction was US$17,519. The Bank recognized the right to receive its shares as an asset, which is marked to market based on the market value of its shares at year end. The maturity date is January 30, 2009.
The rights arising from this purchase have been valued at the lower of the market price of the underlying asset or average quotation price for the last two months.
In order to offset the CER index-adjustable foreign currency assets and liabilities the Bank enter into several repurchase agreements with certain international entities, which, in aggregate amounted to US$ 714,315 of face value of BODEN 2012.
Underlying assets of repurchase agreements with BODEN 2012 have been recorded following the criteria mentioned in the first paragraph of Note 5.2.
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As of June 30, 2008, the Bank recorded Ps. 22,965 (asset position) as reverse repurchase agreements involving government securities.
5.14. Miscellaneous receivables
BODEN 2012 deposited as collateral, have been valued following the criteria described in the mentioned in the first paragraph of Note 5.2.
5.15. Minority interest
The breakdown of supplementary equity interests recorded in “Minority interests” in the accompanying consolidated balance sheets is as follows:
BHN Sociedad de Inversión SA
BACS Banco de Crédito y Securitización SA
5.16. Income Tax
The Bank recognizes income tax charges and liabilities on the basis of the tax returns corresponding to each fiscal year at the statutory tax rates. As of June 30, 2008, 2007 and 2006, the corporate tax rate was 35%. Under Argentine Banking GAAP the Bank does not recognize deferred income taxes.
5.17. Statements of Cash Flows
The consolidated statements of cash flows were prepared using the measurement methods prescribed by the BCRA, but in accordance with the presentation requirements of Statement of Financial Accounting Standards N° 95: Statement of Cash Flows (“SFAS 95”).
For purposes of reporting cash flows, “Cash and cash equivalents” include “Cash and due from banks”.
5.18. Use of Estimates
The preparation of the consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the financial statement dates and the reported amounts of revenues and expenses during the reporting periods. Significant estimates include those required in the accounting of the reserve for loan losses and the reserve for contingencies. Since management’s judgment involves making estimates concerning the likelihood of future events, the actual results could differ from those estimates which would have a positive or negative effect on future period results.
5.19. Dismissal indemnities
The disbursements in respect to dismissal indemnities are expensed in the year in which they occur.
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5.20. Personnel benefits
The Bank has set up provisions recorded at the present value of the remaining payment for its employees’ retirement plans.
5.21. Reclassifications
Certain balances from prior periods have been reclassified to conform to the twelve-month period ended June 30, 2008 presentation.
5.22. Deposits
Deposits have been valued at their placement value, plus adjustments from application of the CER and accrued interest, when applicable.
5.23. Reserve for contingencies
The Bank estimates contingencies and records them in Reserve for contingencies, under Liabilities. These reserves cover various items, such as insurance risk, provisions for lawsuits, other contingencies, etc.
5.24. Other liabilities from financial transactions
Unsubordinated negotiable obligations have been valued at their residual value plus interests accrued.
6. Summary of differences between Argentine Banking GAAP and Argentine GAAP
The Bank’s accounting policies and financial statement presentation generally conform to the rules prescribed by the Argentine Central Bank which prescribes the reporting and disclosure policies for all banks and financial institutions in Argentina. These rules differ in certain respects from Argentine GAAP. The following is a summary of the principal differences between Argentine Banking GAAP and Argentine GAAP:
Valuation criteria
a) Compensation to be received, per Sections 28 and 29 of National Executive Branch Decree 905/02, and investment account securities
As of June 30, 2008 and 2007, the Bank carries the government securities received and to be received in the “Government Securities – holdings in investment accounts”, “Miscellaneous receivables” and “Other Receivables for financial transactions” captions, respectively, arising from the compensation established by Sections 28 and 29 of National Executive Branch Decree 905/02.
Under Argentine GAAP, those assets should be marked to market with the resulting gain or loss reflected in the income statement, unless the Bank demonstrates the ability and the intention to maintain these securities upon maturity.
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b) Accounting for income taxes
The Bank determines income tax at the statutory rate applicable to the estimated taxable income, without considering the effect of any timing differences between the accounting and taxable results. Under Argentine GAAP applicable in the Autonomous City of Buenos Aires, income tax must be recognized according to the deferred tax method and, therefore, deferred tax assets or liabilities based on temporary differences must be recognized.
c) Secured Bonds and other government securities
As established by Decree 1579/02 the Bank and the Fiduciary Fund for the Provincial Development exchanged loans to the provincial governments for Provincial Secured Loans (BOGAR) which at June 30, 2008 and 2007 have been disclosed under Government and Corporate Securities.
At those dates, the Bank valued the two assets at the lower of present or technical value, as established by the BCRA, except for those granted as collateral for advances granted by the Governing Entity for the subscription of the bonds foreseen in Decree 905/02. Under Argentine GAAP, those assets should be valued at their quotation values net of estimated selling expenses, charging the quotation differences to the results for each period or fiscal year, except there is a possibility and intention to carry them until maturity.
Discount Bonds have been valued pursuant to the provisions of Communication “A” 4270, supplementary rules and amendments thereof. Under professional accounting standards, those bonds should be valued at their quotation value less estimated selling expenses.
d) Derivatives
Under Argentine Banking GAAP, derivatives financial instruments have been valued according to the criterion described in Note 5.5. Under Argentine GAAP, the derivatives financial instruments are recorded at fair value.
e) Receivables and debts stemming from refinancing
Under Argentine GAAP, when certain receivables and debts are replaced by others the terms and conditions thereof are substantially different to the original ones, the existing account shall be closed and a new receivable or debt shall be recorded, the accounting measurement thereof shall be made on the best possible estimate of the amount payable or receivable, discounted at a market rate that reflects market valuations on the time value of money and the specific risks of such assets and liabilities. Said transactions are valued under Argentine Banking GAAP standards based on the rates contractually agreed upon and, as the case may be, the risk is measured pursuant to the classification and provisioning criteria specifically set forth.
f) Financial Trusts
Under Argentine Banking GAAP, the certificates of participation in financial trusts have been valued according to the equity method of accounting. In addition, debt securities issued by the trust are recorded at face value, adjusted by CER, when applicable, plus accrued interest and less the negative amount of the equity method applied to the certificates of participation, when applicable. Under Argentine GAAP the certificates of participation and debt securities must be recorded at the lesser of the amortized cost and the market value.
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g) Commissions, Interest and Costs related to Loans and Credit Cards
Pursuant to Argentine GAAP, certain items for commissions, fees, charges and costs incurred in connection with loans or credit cards, should be capitalized according to future income. This criterion is not applied under Argentine Banking GAAP.
7. Restricted Assets
At June 30, 2008 and 2007, the Bank has deposited BODEN 2012 for Ps. 131,548 and Ps. 114,253, respectively as collateral for the currency swap transaction.
As of June 30, 2008, Mercado de Valores de Buenos Aires SA’s share belonging to BH Valores Sociedad de Bolsa SA (ex-Hexagon Argentina SA Sociedad de Bolsa) is pledged on behalf of Chubb Argentina de Seguros SA.
On July 07, 2006, BACS Banco de Crédito y Securitización SA assigned Senior trust debt securities of the BACS III Mortgage Trust as collateral under the “Warehousing Credit Line Agreement” executed with International Finance Corporation.
8. Government and Corporate securities
Government and Corporate Securities held by the Bank consist of the following balances:
Held for investment
BODEN 2012- Compensatory bond (denominated in US$) (*)
Held for Trading
- Quoted
Argentine government bonds (denominated in Pesos)
Corporate equity securities (denominated in Pesos)
Argentine Central Bank bills—Lebacs (denominated in Pesos)
Corporate equity securities (denominated in US$)
- Unquoted
National and Guaranteed government bonds (denominated in Pesos)
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9. Loans
Descriptions of the categories of loans in the accompanying balance sheets include:
Mortgage loans:
Construction project loans—loans made to various entities for the construction of housing units
Individual residential mortgage loans—mortgage loans made to individuals to finance the acquisition, construction, completion, enlargement, and/or remodeling of their homes
Other loans:
Certain financial and non-financial sector loans including loans to credit cardholders and to individuals
Public Loans—loans to National Government and Provinces
Under Argentine Central Bank regulations, the Bank must disclose the composition of its loan portfolio by non-financial Public sector, and financial and non-financial private sector. Additionally, the Bank must disclose the type of collateral pledged on non-financial private sector loans. The breakdown of the Bank’s loan portfolio in this regard is as follows:
Non-financial public sector
Financial sector
Non-financial private sector
With preferred guarantees (a)
Without preferred guarantees (b)
Accrued interest receivable
Reserve for loan losses (see Note 10)
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10. Allowance for loan losses
The activity in the allowance for loan losses for the periods presented is as follows:
a) Loans:
Balance at beginning of period
Provision charged to income
Loans charged off
Balance at end of period
b) Loans in trust pending securitization (Note 5.9):
11. Other receivables from financial transactions
The breakdown of other receivables from financial transactions, by type of guarantee for the periods indicated, is as follows:
Preferred guarantees, including deposits with the Argentine Central Bank
Unsecured guarantees (1)
Less: Allowance for loan losses
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The breakdown of the caption “Other” included in the balance sheet is as follows:
Class B subordinated mortgage-backed bonds
Certificates of participation
Bonds held in the Bank’s portfolio (1)
Treasury shares receivable (See Note 5.13)
Assignment of outstanding mortgage loans (2)
12. Miscellaneous receivables
Miscellaneous receivables are comprised of the following for the periods indicated:
Withholdings, credits and prepaid income tax
Receivables from governmental entities
Recoverable expenses, taxes, and advances to third parties
Attachments for non-restructured ON
Guarantee deposit (1)
Presumptive minimum income – Credit tax (Note 28)
Receivables from master servicing activities
Other Directors fees
Loans to Bank staff
Less: Allowance for collection risks
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13. Bank Premises and Equipment and Intangible Assets
The book values of major categories of bank premises and equipment and total accumulated depreciation as of the periods indicated are as follows:
Land and buildings
Accumulated depreciation
Intangible assets, net of accumulated amortization, as of the end of periods indicated are as follows:
Third parties fees, re-engineering, restructuring and capitalized software costs
14. Miscellaneous assets
Miscellaneous assets consists of the following as of the end of each period:
Properties held for sale
Assets leased to others
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15. Reserve for contingencies
The reserve for contingencies as of the end of each period is as follows:
Legal Contingencies (1)
Incurred but not reported and pending insurance claims (2)
Contingency risks (3)
Tax Provision
Stock Appreciation Rights (StAR)
Directors Compensation Plan
Contingency sale of non-performing mortgage portfolio
Retirement plans
Municipality guarantee fund (a)
16. Other Liabilities from Financial Transactions—Argentine Central Bank
The amounts outstanding corresponding to the Argentine Central Bank debt and advances, as of the end of twelve month periods are as follows:
Advances to be requested for the acquisition of the Hedge bond (1)
The Bank has been paying the advances to be requested for the acquisition of the Hedge bond for a face value of US$ 773,531 thousand.
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17. Other Liabilities from Financial Transactions—Other Banks and International Entities
The breakdown of the bank debt is as follows:
Warehousing Credit Line Agreement with IFC.
Interbank loans in pesos
On January 17, 2006 BACS Banco de Crédito y Securitización SA executed a Warehousing Credit Line Agreement with International Finance Corporation. Under this agreement IFC grants the Bank line of credit for up to of US$ 50,000 in two tranches of US$ 25,000 for a term of three years.
18. Other Liabilities from Financial Transactions—Bonds
The balance of the negotiable obligations has been included in the “Other liabilities for financial transactions” caption. The residual face values of the different negotiable obligation series issued are as follows:
EMTN (CHA)
Series III (US$ 100,000 thousand)
GMTN
Series I (US$ 300,000 thousand)
Series IV (US$ 175,000 thousand)
Series VI (US$ 135,909 thousand)
Series XVI (US$ 125,000 thousand)
Series XVII (EURO 100,000 thousand)
Series XXIII (EURO 150,000 thousand)
Series XXIV (US$ 107,000 thousand)
Series XXV (EURO 165,700 thousand)
Long term bond (US$ 449,880 thousand)
Long term bond (EURO 278,367 thousand)
Series 4 (US$ 150,000 thousand)
Series 4-Trnache II (US$ 100,000 thousand)
Series 5 (US$ 250,000 thousand)
Series 6 (US$ 150,000 thousand)
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The contractual maturities of bonds are as follows as of June 30, 2008:
Past due (*)
June 30, 2009
June 30, 2010
June 30, 2011
June 30, 2012
Thereafter
The General Shareholders’ Meeting held on May 23, 2008, approved the creation of a new Global Program for issuing Negotiable Obligations, not convertible into shares, with or without collateral, for an amount of up to two billion US dollars (US$ 2,000,000,000) or the equivalent thereof in pesos.
19. Prepayment of financial debt
On September 21, 2007, the anticipated redemption of negotiable obligations Series 4 – maturity date 2010 – was made for a face value of US$ 40,000 thousand.
Between October 2007 and January 2008, out of court settlements were agreed with defaulting holders of negotiable obligations, who had not accepted the exchange offer made by the Bank back in January 2004. Settlements amounted to a face value of US$ 11,401 thousand and Euro 819 thousand.
On January 29, 2008, the Bank launched an offer to purchase in cash up to US$ 56,000 thousand of the total Negotiable Obligations capital in US dollars due in 2013 and the equivalent to a capital amount of up to US$ 56,000 thousand in Euro-denominated negotiable obligations due in 2013. The purchase offer expired on February 27, 2008. As a result of this transaction, securities were bought back for US$ 16,536 thousand and US$ 44,517 thousand for the series in US dollars and Euro, respectively.
20. Level I American Depositary Receipts Program
On March 27, 2006 the US Securities and Exchange Commission (SEC) has made effective the Level I American Depositary Receipts, “ADR” program.
This program allows foreign investors to buy the Bank’s stock through the secondary market where ADRs are traded freely within the United States. The Bank of New York has been appointed as depositary institution.
21. Derivative Financial Instruments
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On March 5, 2004, the Bank and Deutsche Bank AG executed a currency swap contract for Euros 150,000 thousand which due date shall be December 1, 2013.
On October 29, 2004, the Bank and Credit Suisse First Boston executed a currency swap contract for Euros 70,000 thousand which due date shall be December 1, 2013.
On July 25, 2007, the Bank and Deutsche Bank AG executed a currency swap contract for Euros 30,000 thousand which due date shall be December 1, 2013.
The net book value as of June 30, 2008 amounts of Ps. 209,619.
On January 25, 2005, the Bank entered into a currency swap contract (Cross Currency Swap) with Deutsche Bank AG. According to this transaction, the Bank receives interest at a rate of 2% on a notional principal of Ps. 438,870 adjusted by applying the CER and pays interest at 180-day LIBOR plus 435 basis points on a notional principal of US$ 150,000 thousand without transfer of principal on each due date.
On February 1, 2005, the Bank entered into a currency swap contract (Cross Currency Swap) with Credit Suisse First Boston. According to this transaction, the Bank receives interest at a rate of 2% on a principal of Ps. 87,537 adjusted by applying the CER and pays interest at 180-day LIBOR plus 420 basis points on a principal of US$ 30,000 thousand.
The net book value as of June 30, 2008 amounts of Ps. 112,046.
The net book value as of June 30, 2008 amounts of Ps. (206).
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The net book value as of June 30, 2008 amounts of Ps. (420).
In addition to the interest rate paid, the Bank assumed the credit risk of the Secured Loans issued by the National Government. In any event of default of those loans, the Bank committed to pay the defaulted amount to Deutsche Bank.
The net book value as of June 30, 2008 amounts of Ps. 1,217.
The net book value as of June 30, 2008 amounts of Ps. (539).
22. Securitization of mortgage loans
The Bank created sixteen separate mortgage trusts (BHN I Mortgage Fund, BHN II Mortgage Trust, BHN III Mortgage Trust, BHN IV Mortgage Trust, BACS I Mortgage Trust, BACS Funding I Mortgage Trust, BACS Funding II Mortgage Trust BHSA I 2002 Mortgage Trust, CHA I Financial Trust, CHA II Financial Trust, CHA III Financial Trust, CHA IV Financial Trust, CHA V Financial Trust, CHA VI Financial Trust, CHA VII and CHA VIII Financial Trust) under its US securitization program and “Cédulas Hipotecarias Argentina – program”; and a consumer trust (Cédulas Personales I Financial Trust) under BACS’s Global Trust Securities Program. For each mortgage or consumer trust, the Bank transfers a portfolio of mortgages or consumer originated by banks and other financial institutions in trust to the relevant trustee. The trustee then issues Class A senior Bonds, Class B subordinated bonds and certificates of participation. The trust’s payment obligations in respect of these instruments are collateralized by, and recourse is limited to, the trust’s assets consisting of the portfolio of mortgages or consumer and any reserve fund established by the Bank for such purpose. The securitizations were recorded as sales, and accordingly, the mortgage loans conveyed to the trusts are no longer recorded as assets of the Bank.
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At the date of these financial statements the following trust funds have been set up:
BHN I – Issued on 10.29.96 (*)
Face value in Ps.
Declared Maturity Date
BHN II – Issued on 05.09.97 (*)
BHN III – Issued on 10.29.97 (*)
BHN IV – Issued on 03.15.00 (*)
BACS I – Issued on 02.15.2001 (*)
BACS Funding I Issued on 11.15.2001 (*)
BACS Funding II Issued on 11.23.2001 (*)
BHSA I Issued on 02.01.2002
CHA I Issued on 6.25.2004
CHA II Issued on 11.19.2004
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CHA III Issued on 04.07.2005
CHA IV Issued on 6.22.2005
CHA V Issued on 10.20.2005
CHA VI Issued on 04.07.2006
CHA VII Issued on 09.27.2006
CHA VIII Issued on 03.26.2007
Cedupe I Issued on 04.03.2008
23. Miscellaneous Liabilities
Sundry creditors and other miscellaneous liabilities consist of the following as of the end of each period:
Sundry creditors:
Accrued fees and expenses
Unallocated collections
Withholdings and taxes payable
Other:
Directors and Syndics accrued fees
Payroll withholdings and contributions
Gratifications
Salaries and social securities
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24. Income from Services and Expenses on Services
Income from Services—Commissions and Other
Commissions earned consist of the following for each period:
Commissions from FONAVI
Commissions for credit cards
Other (1)
Other income from services is comprised of the following for each period:
Reimbursement of loan expenses paid by third parties
Expenses on Services—Commissions
Commissions expensed consist of the following for each period:
Retail bank originations
Commissions paid to real state agents
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25. Other Miscellaneous Income and Miscellaneous Expenses
Other miscellaneous income are comprised of the following for each year:
Income on operations with premises and equipment and miscellaneous assets
Recovery of Director’s fees
Capitalization of the presumptive minimum income tax
Bank loan interest
Recovery of guarantee funds
Other miscellaneous expenses are comprised of the following for each period:
Depreciation of miscellaneous assets
BOGAR and Secured Loans valuation adjustment
Equity in loss of affiliates
Allocation of mortgage loan relief fund
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26. Balances in Foreign Currency
The balances of assets and liabilities denominated in foreign currency (principally in US dollars and Euros) are as follows:
Assets:
Government and corporate securities
Other receivables from financial transactions
Miscellaneous receivables
Liabilities:
27. Income Tax
Prior to January 1, 1996, the Bank was exempt from the payment of income tax. Beginning January 1, 1996, the Bank was only exempt from the payment of income tax on income from its operations, assets, and interest income attributable to its residential mortgage lending activities. Effective October 1997, as a result of conversion to a sociedad anónima, the Bank is subject to income tax in Argentina except on its income attributable to mortgage loan commitments made prior to that date.
As a general rule, the income tax law allows the deduction of expenses incurred to obtain or maintain the source of taxable income. For purposes of deducting from the taxable revenues those expenses incurred to obtain jointly taxable and non –taxable income, expenses should be segregated accordingly.
Furthermore, the fiscal rule gives prerogative to the direct allocation method rather than the apportionment method to determine the deductible expenses. Thus, the apportionment method should only be used when it is not possible to make direct allocation of expenses to the taxable revenue.
The Bank has a tax net operating loss carry forward of Ps. 309,868 and Ps. 838,675 at June 30, 2008 and 2007, respectively.
28. Presumptive Minimum Income Tax
The Bank is subject to presumptive minimum income tax. Pursuant to this tax regime, the Bank is required to pay the greater of the income tax or the presumptive minimum income tax. Any excess of the presumptive minimum income tax over the income tax may be carried forward and recognized as a tax credit against future income taxes payable over a 10-year period. The presumptive minimum income tax provision is calculated on an individual entity basis at the statutory asset tax rate of 1% and is based upon the taxable assets of each company as of the end of the year, as defined by Argentine law. For financial entities, the taxable basis is 20% of their computable assets.
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As accepted by the BCRA, at June 30, 2008 the Bank capitalized the Ps.103,167 tax credit corresponding to the fiscal years between 1999 and 2007.
The tax credit balances held by BHSA at the closing date of these financial statements are the following:
Fiscal Year
29. Shareholders’ Equity
The following information relates to the statements of changes in the Bank’s shareholders’ equity.
(a) Common Stock
Prior to June 30, 1997, the Bank’s capital stock consisted of assigned capital with no par value owned 100% by the Argentine government. In accordance with the by-laws approved as a result of the conversion of the Bank to a sociedad anónima, the Bank’s capital stock was established at Ps.1,500,000 and divided into four classes of ordinary common shares.
As of June 30, 2008, the Bank’s capital stock consists of:
Argentine government (through FFFRI)
Banco Nación, as trustee for the Bank’s Programa de Propiedad Participada (a)
Public investors
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The Class B shares have been set aside for sale to the Bank’s employees in the future pursuant to the PPP on terms and conditions to be established by the Argentine government. Any Class B shares not acquired by the Bank’s employees at the time the Bank implements the PPP will automatically convert into Class A shares. The Class C shares are eligible for sale only to companies engaging in housing construction or real estate activities. Any Class B shares transferred by an employee outside the PPP will automatically convert to Class D shares or Class C shares transferred to persons not engaged in construction or real estate activities will automatically convert into Class D shares.
(b) Restriction on the distribution of profits
In accordance with the regulations of the Argentine Central Bank, 20% of the Bank’s annual net income net of any adjustments for prior periods must be allocated to a legal reserve. Legal reserve may be used to absorb losses.
Under Argentine law, cash dividends may be declared and paid only out of the Bank’s unrestricted retained earnings reflected in the audited annual financial statements and approved by the shareholders.
Those banks which proceed to distribution of profits must be previously authorized by the Financial and Exchange Institutions Superintendency.
Furthermore, on October 29, 2002 Argentine Central Bank restricted the distribution of cash dividends and established that the Bank should adjust its earnings to be distributed as cash dividends with the difference between the market value and the carrying value of the compensatory and hedge bonds after netting the legal reserve and other reserves established by the Bank’s by-laws.
Under the contracts signed as a result of the restructuring of the Bank’s financial debt, there are restrictions on the distribution of profits until such time as at least 60% of the total initial principal amount of the long-term and guaranteed tranches of the new debt has been amortized.
In addition, for the purposes of determining distributable balances, the minimum presumed income tax asset shall be deducted from retained earnings.
On April 24, 2006, the BCRA established that when the Legal Reserve is used to absorb losses, earnings shall not be distributed until the reimbursement thereof. Should the balance prior to the absorption exceed 20% of the Capital Stock plus the Capital Adjustment, profits may be distributed once the latest value is reached.
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(c) Minimum Capital Requirements
Under the Argentine Central Bank regulations, the Bank is required to maintain minimum levels of capital (“minimum capital”). The minimum capital is based upon risk-weighted assets, and the balances of Bank premises and equipment, intangible assets and unquoted equity investments. The required minimum capital and the Bank’s capital calculated under Argentine Central Bank requirements were as follows:
As established for by Argentine Central Bank, effective January 2004, financial institutions were to comply with regulations on minimum capital which had been suspended until that time. Effective January 2004, an “alpha 1” coefficient is to be applied to temporarily reduce the minimum capital requirement to cover credit risk attaching to holdings in investment accounts and financing granted to the national non-financial public sector until May 31, 2003. It also provides for the application of an “alpha 2” coefficient effective January 2004, to temporarily reduce the minimum capital requirement to cover interest rate risk.
30. Employee Benefit Plan
The Bank is obligated to make employer contributions to the National Pension Plan System determined on the basis of the total monthly payroll. These expenses are recorded in “Salaries and social security contributions” under the “Administrative expenses” caption in the accompanying consolidated statements of income.
31. Financial Instruments with Off-Balance Sheet Risk
In the normal course of its business the Bank is party to financial instruments with off-balance sheet risk in order to meet the financing needs of its customers. These instruments expose the Bank to credit risk in addition to amounts recognized in the balance sheets. These financial instruments include commitments to extend credit.
Commitments to extend credit are agreements to lend to a customer at a future date, subject to such customers meeting of pre-defined contractual milestones. Typically, the Bank will commit to extend financing for construction project lending on the basis of the certified progress of the work under construction. Most arrangements require the borrower to pledge the land or buildings under construction as collateral. As of June 30, 2008 and 2007, the commitments to extend credit under these arrangements amounted to approximately Ps.54,916 and Ps.147,914, respectively. Furthermore, the Bank has a unilateral and irrevocable right to reduce or change the credit card limit, thus it considered there is no off-balance sheet risk. The total unused credit card limit at June 30, 2008 and 2007 amounts to Ps. 1,266,212 and Ps. 592,048.
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In the opinion of management, the Bank’s outstanding commitments do not represent unusual credit risk. The Bank’s exposure to credit loss in the event of nonperformance by the other party is represented by the contractual notional amount of those commitments.
The Bank accounts for items drawn on other banks in memorandum accounts until such time as the related item clears or is accepted. In the opinion of management, the Bank’s risk of loss on these clearing transactions is not significant as the transactions primarily relate to collections on behalf of third parties. The amounts of clearing items in process were Ps. 52,782 and Ps 74,549 as of June 30, 2008 and 2007, respectively.
Additionally, the Bank recorded in memorandum accounts: i) Guarantees provided to the Argentine Central Bank for Ps. 86,209 and Ps. 101,353 as of June 30, 2008 and 2007 respectively, and ii) other guarantees provided not included in the debtor classification regulations for Ps.162,748 and Ps. 114,368 as of June 30, 2008 and 2007 respectively.
32. Out-of-court reorganization plan
On June 9, 2004, the Bank requested approval of an out-of-court reorganization plan from the Federal Court of Original Jurisdiction on Commercial Matters N° 14, Clerk’s Office N° 28. On October 29, 2004 that court rejected the plan submitted, because it considered that financial institutions may not resort to this type of proceeding. The Bank filed an appeal against the lower court decision, which was rejected by a decision issued by Division D of the Federal Court of Appeals in Commercial Matters; notice thereof was served in May 31, 2006. Against this last Resolution, on June 15, 2006, the Bank filed an extraordinary appeal before the ante la Argentine Supreme Court of Justice, which was granted on October 13, 2006; therefore, this court shall make the final decision on the issue.
Through Resolution N° 282 dated August 16, 2006, the Superintendent of Financial and Exchange Institutions of the BCRA decided to conduct a preliminary investigation on the Bank, its Directors, members of the Syndics Committee and the Financial area Manager (who held office at that time), since it considered the provisions of item 1.3 of Resolution by the BCRA Board of Directors N° 301 dated July 24, 2003, have been violated, since it established that the Bank needed to eliminate all references to an out-of-court reorganization plan, to the terms of the external liabilities restructuring plan submitted before the monetary authority, within the framework of the provisions of Communication “A” 3940. This was informed to the National Securities Commission (CNV) on September 29, 2006. The Bank, as well as its Directors, members of the Supervisory Committee and the Financial area Manager have duly submitted the corresponding deposition requesting to be exempted from any kind of penalty, since to the best of their knowledge no punishable actions took place.
33. Claim by the Federal Tax Commission
Through note N° 42/08 dated June 3, 2008, the “Federal Tax Commission” served the Bank notice about a Declaratory Order issued by Executive Committee No. 4, dated September 28, 2007, stating the following: i) Banco Hipotecario SA’s right to collect commissions on National Housing Fund resource transfers to the Provinces and to the Autonomous City of Buenos Aires expired on July 23, 2007, ii) this task shall be transferred to Banco Nación Argentina, and iii) Banco Hipotecario SA shall refrain from withholding such banking commission as from the day following notice thereof and shall credit the respective accounts with the commissions collected after July 23, 2007.
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On July 23, 2008, the Bank objected said order by arguing the following: i) the incompetence of the Federal Tax Commission for issuing such order, based on the legal origin of the Bank’s exclusive right to centralize and distribute FONAVI funds; ii) the incorrect interpretation of the provisions of decree 927/97, containing the regulations for Law 24855, Act for Privatizing former Banco Hipotecario Nacional, since it only obliged the Bank to maintain the service provision conditions in force at the time of passing said law during 10 years, without any expiration provisions regarding the role of the Bank in the process, and iii) the unlawfulness of requiring a retroactive reimbursement of commissions, giving consideration to the fact they were collected for services that were effectively rendered on behalf of the Department of Urban Development and Housing.
As of the date of these financial statements, no decision about the objection had been made yet, and funds were still being sent to the Bank for distribution to the Provinces, in accordance with the directives of the Department of Urban Development and Housing.
34. Summary of Significant Differences between Argentine Banking GAAP and US GAAP
The Bank’s consolidated financial statements have been prepared in accordance with Argentine Banking GAAP, which differs in certain significant respects from US GAAP. Such differences involve methods of measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by US GAAP and regulations of the SEC. These consolidated financial statements include solely a reconciliation of net income and shareholders’ equity to US GAAP. Pursuant to Item 17 of Form 20-F, this reconciliation does not include disclosure of all information that would be required by US GAAP and regulations of the SEC.
a. Loan origination fees and costs
Under Argentine Banking GAAP, the Bank does not defer loan origination fees and costs on mortgage, personal and credit card loans.
In accordance with US GAAP, under SFAS N° 91, “Accounting for Non-refundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases”, loan origination fees and certain direct loan origination costs should be recognized over the life of the related loan as an adjustment of yield.
b. Public Sector Loan – Exchange of Public Debt
During the fiscal year ended December 31, 2001, and as a consequence of Decree N° 1387/01, effective as of November 6, 2001, the Bank swapped part of its Argentine public-sector debt instruments, under the Promissory Note/Bond program, for secured loans.
As established by article 20 of the above mentioned decree, the conversion was made at the nominal value, at a rate of exchange of Ps. 1.0 = US$ 1.0 and in the same currency as that of the converted obligation.
The Argentine Central Bank provided that the difference between the nominal value of the secured loans and the book value of the public-sector debt instruments exchanged (in the case of securities, classified and valued as “investment accounts” or “for trading purposes”, under Argentine Central Bank rules) must be credited to income and added to the recorded amount included in Loans to the non-financial public sector on a monthly basis, in proportion to the term of each of the secured loans received. Consequently a discount of the current value of these loans has been recorded based on the interest rate determined on each period by the Central Bank.
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In accordance with US GAAP, specifically in the Emerging Issues Task Force N° 01-07 (“EITF 01-07”), satisfaction of one monetary asset (in this case a loan or debt security) by the receipt of another monetary asset (in the case a secured loan) for the creditor is generally based on the market value of the asset received in satisfaction of the debt (an extinguishment). In this particular case, the secured loan being received is significantly different in structure and in interest rates than the debt securities swapped. Therefore, the fair value of the loans was determined on the balance sheet date based on the contractual cash flows of the loan received discounted at an estimated market rate. The estimated fair value of the loan received constitutes the cost basis of the asset. Any difference between the old asset and the fair value of the new asset is recognized as a gain or loss. The difference between the cost basis and amounts expected to be collected is amortized on an effective yield basis over the life on the loan.
During the period ended June 30, 2007, the Bank sold its remaining position in Secured Loans. Therefore, no US GAAP shareholders’ equity adjustment has been recorded as of June 30, 2008 and 2007.
c. Allowance for loan losses
The Bank’s accounting for its allowance for loan losses differs in some significant respects with practices of US-based banks.
Under Argentine Banking GAAP, the allowance for loan losses is calculated according to specific criteria. This criteria is different for commercial loans (those in excess of Ps. 500) and consumer loans. Loan loss reserves for commercial loans are principally based on the debtors’ payment capacity and cash-flows analysis. Loan loss reserves for consumer loans are based on the client’s aging. Argentine banks may maintain other reserves to cover potential loan losses which management believes to be inherent in the loan portfolio, and other Argentine Central Bank required reserves.
Under US GAAP, the allowance for loan losses should be in amounts adequate to cover inherent losses in the loan portfolio at the respective balance sheet dates. Specifically:
All large commercial loans which are considered impaired in accordance with SFAS N° 114, Accounting by Creditors for an Impairment of a Loan (“SFAS N° 114”), as amended by SFAS N° 118, Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures (“SFAS N° 118”), are valued at the present value of the expected future cash flows discounted at the loan’s effective contractual interest rate or at the fair value of the collateral if the loan is collateral dependent.
As of June 30, 2008, 2007 and 2006, the result of applying SFAS N° 114, shows that the Bank recorded an adjustment to Shareholders’ Equity for US GAAP purposes of Ps. (1,119), Ps. 8,878 and Ps. 3,290, respectively.
In addition, the Bank has performed a migration analysis for mortgage, credit cards and consumer loans following the SFAS 5 considerations.
As of June 30, 2008 and 2007, the result of the migration analysis showed that the Bank has provided for loan losses in deficit of this analysis for Ps.105,762 and Ps. 46,813. For US GAAP purposes, this amount of provision has been charged.
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As of June 30, 2006, the result of the migration analysis showed that the bank provided for loan losses in excess of this analysis for Ps. 16,036. For US GAAP purposes, this amount of provision has been reversed.
Under Argentine Banking GAAP, loans that were previously charged-off, which are subsequently restructured and become performing loans, are included again in the Bank’s assets, according to the policies adopted by the bank mentioned in Note 5.7. Under US GAAP recoveries of loans previously charged off should be recorded when received.
d. Derivative Instruments
As mentioned in Note 21 and 5 the Bank entered in several derivative transactions, mainly, to hedge: i) the exchange rate risk attached to liabilities denominated in euros and in pesos plus CER, ii) assets denominated in US dollars (BODEN 2012) and iii) interest rate swaps to manage its interest rate risk.
Under US GAAP, the Bank accounts for derivative financial instruments in accordance with SFAS N° 133 as amended, which establishes the standards of accounting and reporting derivative instruments, including certain derivative instruments embedded within contracts (collectively referred to as derivatives) and hedging activities. This statement requires institutions to recognize all derivatives in the balance sheet, whether as assets or liabilities, and to measure those instruments at their fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge for the exposure to changes in the fair value of a recorded asset or liability or unrecorded firm commitment, (b) a hedge for the exposure of future cash flows and (c) a hedge for the exposure of foreign currency. If such a hedge designation is achieved then special hedge accounting can be applied for the hedged transactions, that will reduce the volatility in the income statement to the extent that the hedge is effective. In order for hedge accounting to be applied the derivative and the hedged item must meet strict designation and effectiveness tests.
The Bank’s derivatives do not qualify for hedge accounting treatment under US GAAP. Therefore gains and losses are recorded in earnings in each period.
Under US GAAP, the Bank’s estimates the fair value of the receivable and payable on the derivative instrument. As of June 30, 2008, 2007 and 2006 the difference between Argentine Banking GAAP and US GAAP amounts to Ps. (212,577), Ps. (50,188) and Ps. (18,087), respectively.
Under US GAAP, derivatives should be recorded at fair value, on a net basis, and therefore the Bank’s assets and liabilities should both be decreased by approximately Ps. 1,048,000, Ps. 1,047,000 and Ps. 990,000 at June 30, 2008, 2007 and 2006, respectively.
e. Compensatory and hedge bonds
In connection with the Bank’s right (but not the obligation) to purchase the hedge bond, under Argentine Banking GAAP the Bank has recognized it at their equivalent value as if the Bank had the associated bonds in their possession (technical value), and recognized the associated liability to fund the hedge bonds as if the Bank had executed the debt agreement with the Argentine Central Bank. The receivable is denominated in U.S. dollars bearing interest at Libor whereas the liability to the Argentine Central Bank is denominated in pesos with interest being accrued at CER plus 2%, each retroactive to February 3, 2002.
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As of June 30, 2005, the Bank obtained the benefit of the hedge bond to be purchased as the transaction was approved by the Argentine Central Bank. During September 2005, the Bank started to purchase the bonds.
Therefore, for US GAAP purposes, the Bank started recognizing the fair value of the option to receive the Hedge bond in the period ended June 30, 2005. The remaining portion of the Hedge bond to be received as of June 30, 2008 and 2007 is also recognized at their fair value for US GAAP purposes.
In connection with the Compensatory Bonds received or receivable by the Bank they were recognized at the technical value (nominal value plus interest accrued) according to Argentine Banking GAAP. Under US GAAP such amounts should initially be recognized at their quoted market value (limited to the amounts of the loss BHSA suffered in connection with the asymmetric pesification). Thereafter, Compensatory Bonds received are classified as available for sale securities and recognized at market value with the gains or losses recognized as a charge or credit to equity through other comprehensive income. In connection with the Compensatory Bond to be received it has been recognized at market value with the gain or loss recognized through income statement.
The Bank has evaluated whether there was a decline in the value of the security that is other-than temporary as defined by SFAS N°115 and SAB 59. As of June 30, 2008 the fair value of the investment is greater than its amortized cost, consequently no impairment was recognized for US GAAP purposes.
f. Other government securities
As of june 30, 2004 the Bank held certain defaulted Argentine government bonds. Such bonds were not quoted in the public market. On January 2005, the Bank accepted the offer to exchange its defaulted government securities for “Discount Bonds in pesos” issued under the Argentine debt restructuring. On April 1, 2005 the government securities were exchange.
For US GAAP purposes and in accordance with EITF 01-07, satisfaction of one monetary asset (in this case a defaulted government securities) by the receipt of another monetary asset (in this case Discount Bonds) from the creditor is generally based on the market value of the asset received in satisfaction of the debt. In this particular case, the Bonds being received are significantly different in structure and in interest rates than the securities swapped. Therefore, the fair value of the Bonds was determined on the balance sheet date based on their market value and will constitute the cost basis of the asset. Any difference between the old asset and the fair value of the new asset is recognized as a gain or loss.
Under Argentine Banking GAAP, the Discount Bonds have been recorded at the lower of the total future nominal cash payments up to maturity, specified by the terms and conditions of the new securities tendered as of March 17, 2005, equivalent to the present value of the BOGAR Bonds’ cash flows at that date.
As of June 30, 2008, 2007 and 2006 the Discount Bonds were considered available for sale securities for US GAAP purposes according with SFAS N° 115 and recorded at fair value with the unrealized gains and losses recognized as a charge or credit to equity through other comprehensive income.
The Bank has evaluated whether there was a decline in the value of the security that is other-than temporary as defined by SFAS N°115 and SAB 59. As of June 30, 2008 the fair value of the investment is less than its amortized cost, consequently the Bank has recorded an other-than temporary impairment of Ps.2,218 for US GAAP purposes. Therefore the fair value of the security was determined on the balance sheet date based on their market value and will constitute the cost basis for the asset.
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g. Provincial Public Debt
As of June 2002, the Bank offered to exchange certain loans to Argentine provincial governments for loans or securities of the Argentine National Government; however the exchange had not been finalized until 2003. As these loans were performing no provision was recorded under US GAAP in accordance with SFAS N° 114.
In 2003, the Bank tendered in the exchange under Decree N°1579/02 almost all its portfolio of loans to provincial governments and received securities of the Argentine National Government (“BOGAR”).
For US GAAP purposes and in accordance with EITF 01-07, satisfaction of one monetary asset (in this case a loan) by the receipt of another monetary asset (in this case BOGAR) from the creditor is generally based on the market value of the asset received in satisfaction of the debt. In this particular case, the BOGAR being received is significantly different in structure and in interest rates than the loans swapped. Therefore, such amounts should initially be recognized at their market value. The estimated fair value of the securities received will constitute the cost basis of the asset. Any difference between the old asset and the fair value of the new asset is recognized as a gain or loss. The difference between the cost basis and the amount expected to be collected will be amortized on an effective yield basis over the life of the bond.
For US GAAP purposes, these BOGAR are classified by the Bank, as available for sale securities and recorded at fair value with the unrealized gains or losses recognized as a charge or credit to equity through other comprehensive income.
h. Trouble debt restructuring
On January 14, 2004, the Bank refinanced its outstanding defaulted debt. Under Argentine Banking GAAP the restructuring of the debt was treated as an exchange of debt instruments with substantially different terms. As a result, the Bank removed the original loans and its related accrued interest payable and recognized new debt instruments and associated cash payments for interest payable and for certain principal settlements, resulting in a gain on restructuring of Ps. 783,698. Under Argentine Banking GAAP, expenses incurred in a trouble debt restructuring are reported in earnings.
For US GAAP purposes, the restructuring of the debt was accounted for in accordance with SFAS N° 15, Accounting by Debtors and Creditors for Troubled Debt Restructurings (“SFAS N° 15”), as the creditors made certain concessions due to the financial difficulties of the Company. SFAS N° 15 requires that a comparison be made between the future cash outflows associated with the new debt instruments (including interest), and the recorded amount of the payables at the time of restructuring. Gain on trouble debt restructuring is only recognized when the carrying amount of the payable at the time of restructuring exceeds the total future cash payments specified by the new debt terms, and only for the difference between the book value of the old debt and the future cash flows of the new debt. The total future cash outflows associated with the new debt instruments exceeded the carrying value of
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the old debts for some payables. The gain on restructuring recorded under US GAAP was lower than the gain recorded under Argentine Banking GAAP and therefore, the carrying amount of the new debt instruments under US GAAP was greater than the amount recorded under Argentine Banking GAAP and a new effective interest rate was determined, which equates the present value of the future cash payments specified by the new debt instruments with the carrying amount of the old debts. Under US GAAP, expenses incurred in a trouble debt restructuring are reported in earnings.
During 2006, 2007 and 2008, the Bank repurchased restructured negotiable obligations and debt. The difference between the carrying value of the repurchased debt under US GAAP and the price paid by the Bank was recognized as a gain for US GAAP purposes.
i. Securitization of mortgage loans
The Bank has securitized certain of their mortgage loans originated by the retail banks on their behalf through the transfer of such loans to a special purpose mortgage trust which issues multiple classes of mortgage bonds and certificates of participation.
Under Argentine Banking GAAP, the Bank accounted for its securitizations as sales of loans. The Bank retained certain interests in the transferred loans represented by the Class A and Class B bonds and the certificates of participation as applicable. The Class A and Class B bonds and the certificates of participation retained were originally recorded at their stated amounts which represent a percentage of the principal value of the underlying mortgage loans. The Class A and Class B bonds accrue interest at various rates. The certificates of participation accrue income based upon the net income of the securitization trust.
For US GAAP purposes, these types of transactions are covered by different accounting pronouncements depending on the transaction date. For transactions prior to January 1, 1997, SFAS N° 77, Accounting for Sales of Receivables with Recourse and FASB Technical Bulletin N° 85-2, Accounting for Collateralized Mortgage Obligations, provided the authoritative accounting guidance. Under this guidance, the BHN I securitization should be accounted for as a collateralized borrowing. The loans and the restated bond obligations would be reinstated on the balance sheet for US GAAP purposes and would be accounted for in the normal manner as other mortgage loans and borrowings.
SFAS N° 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS N° 125”) became effective for securitizations of receivables after December 31, 1996 (since amended by SFAS N° 140). SFAS N° 125 bases the accounting for transfers on the consistent application of a financial-components approach that focuses on control. Upon a transfer of assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred and derecognizes the financial assets when control has been surrendered. This statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are collateralized borrowings. Under SFAS N° 125, the BHN II and BHN III securitizations that occurred during the year ended December 31, 1997 would be accounted for as sales. For US GAAP purposes under SFAS N° 140, BHN IV and BACS I securitizations were considered sales. For that reason debt securities and certificates retained by the Bank are considered as “available for sale securities” under U.S. GAAP and the unrealized gains (losses) on these securities are reported as an adjustment to shareholder’s equity, unless unrealized losses are deemed to be other than temporary in accordance with Emerging Issues Task Force N° 99-20. The unrealized loss on the retained interests at June 30, 2002 has been deemed to be other than temporary and such loss has been charged to income. The retained interests were initially recorded based on their allocated book value using the fair value allocation method. At the date of the securitization, the Bank recognized interests in the securitization
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trust through the bonds and the certificates of participation hold and cease recognizing the loans over which they have surrendered control. The basis of retained interest and the sold interest are based upon a relative fair value allocation of the basis of the loans transferred.
Subsequent to the initial recognition, any retained interests in the securitizations should be recorded for as securities under SFAS N° 115, Accounting for Certain Investments in Debt and Equity Securities (“SFAS N° 115”) and accounted for as available for sale securities
Mortgage-backed securities created after a securitization of mortgages held for sale should be classified as either trading or available for sale securities in accordance with SFAS N° 65, Accounting for Certain Mortgage Banking Activities and as amended by SFAS N° 134, Accounting for Mortgage-Backed Securities Retained after the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise.
Consequently, the adjustments to record the securitization of the portfolio under U.S. GAAP consists of:
The re-consolidation of the loans under BHN I, BACS Funding I, BACS Funding II, BHSA I, BACS III, CHA I and Cédulas Personales I resulted in an adjustment. See Note 34.c. for allowance for loan losses.
The recognition of the effect of accounting for the certificates of participation in BHN II and BHN III, BHN IV and BACS I as available for sale securities that includes the recognition of other than temporary impairment for a 100% of the carrying values of such securities as of June 30, 2006, considering the economic projections as of those dates and the declarative actions mentioned in Note 22. During the twelve-month period ended June 30, 2007, expectations about the recoverability of such securities have significantly changed considering among others, (a) decisions of the Supreme Court related to pesification matters and (b) new expectations about the CER, which adjusts the face value of the senior debt securities issued by the trust. The fair value of the securities is determined based on expected cash flows, discounted at a market interest rate. Increases in the fair value of these securities are recorded in other comprehensive income. As of June 30, 2007 and 2008, such carrying values are determined based upon an estimate of cash flows to be remitted to us as holder of the retained interests discounted at an estimated market rate.
The fair value recognition of those certificates of participation and debt securities held by the Bank from certain securitization trusts (CHA II, CHA III, CHA IV, CHA V, CHA VI, CHA VII and CHA VIII) considered sales under US GAAP and classification as available for sale securities.
The Bank has evaluated whether there has been an adverse change in the estimated cash flows of the certificates of participation and debt securities. For certain securitizations (CHA II, CHA III, CHA IV, CHA V, CHA VI, CHA VII and CHA VIII) the condition of an accrual of loss contingencies is met and an other-than-temporary impairment of Ps.25,630 is considered to have occurred and the beneficial interest have been written down to fair value, with the resulting change between the fair value and the amortized cost being charged to the income statement. The fair value at June 30, 2008 represents the new cost basis of these trusts.
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j. Acquisition of Treasury shares
Under Argentine Banking GAAP, an acquisition by a company of its own shares is recognized as an asset and marked to market daily with the resulting gain or loss reflected in the statement of income (see Note 5.13.). Under US GAAP acquisitions of the Bank’s shares adjust Shareholders’ Equity and changes in quoted market prices between the acquisition date and the reporting date are not recognized.
On January 29, 2004 BHSA entered in a transaction with Deutsche Bank AG (“DBAG”). Under this transaction Banco Hipotecario SA paid US$ 17.5 M and DBAG agreed to transfer to the Bank 71,100,000 BHSA Class D shares on January 29, 2009 or at an earlier date, if requested by BHSA (see Note 29.a.). Under Argentine Banking GAAP, BHSA recognized the right to receive its shares as an asset, which is marked to market based on the market value of its shares at period end. Changes in fair value are recognized in earnings. Under US GAAP, following the guidance of SFAS N° 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” BHSA recognized the right to receive its shares at a future date at cost, as a reduction of equity. Subsequent charges in the market value of the shares are not recognized.
k. Intangible Assets
Under Argentine Banking GAAP fees paid for a re-engineering project and for restructuring expenses incurred in relation to certain equity transactions are recognized as an intangible asset and amortized in a maximum of five years. Such cost should be expensed as incurred under US GAAP.
Under Argentine Banking GAAP, the Bank capitalizes costs relating to all three of the stages of software development. Under US GAAP SOP 98-1, effective for fiscal years beginning after December 15, 1998, defines three stages for the costs of computer software developed or obtained for internal use: the preliminary project stage, the application development stage and the post-implementation operation stage. Only the second stage costs should be capitalized.
l. Impairment of fixed assets and foreclosed assets
Under Argentine Banking GAAP, fixed assets and foreclosed assets are restated for inflation using the WPI index at February 28, 2003. As such, the balances of fixed assets and foreclosed assets were increased approximately 120%.
In accordance with Statement of Accounting Standards N° 144, “Impairment of Long-lived Assets”, such assets are subject to impairment tests in certain circumstances. Because projected cash flows associated with fixed assets and foreclosed assets are insufficient to recover the restated carrying amounts of the assets, those assets should be tested for impairment. During 2002, in the absence of credible market values for our fixed and foreclosed assets, the Bank under US GAAP reversed the restatement of fixed and foreclosed assets.
Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. During the year these assets have evidenced an increase in the market prices.
As of June 2008 and 2007, no additional impairment was recorded in fixed and foreclosed assets, since the carrying amount of long lived assets does not exceed the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset.
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m. Minority Interest
This adjustment represents the effect on minority interest on the US GAAP reconciling items, as appropriate.
n. Vacation Provision
The Bank’s policy for vacation benefits is to expense such benefits as taken. For U.S. GAAP purposes, the vacation accrual is based on an accrual basis, where earned but untaken vacation is recognized as a liability.
o. Insurance Technical reserve
Until September 2003, the calculation of the local technical reserves performed by the Bank was the same as that used under US GAAP.
On September 2003, the National Insurance Superintendency issued certain regulations on the calculation of reserves introducing changes to the local regulations. For US GAAP purposes the Bank has accounted these type of transactions under SFAS N° 60.
Therefore, the technical reserves for the twelve month periods ended June 2006, 2007 and 2008 were adjusted for US GAAP.
p. Capitalization of interest cost
Under Argentine Banking GAAP, during the process of construction of an asset the capitalization of interest is not recognized.
For US GAAP purposes, as stated in paragraph 12 of FAS 34, the amount of interest cost to be capitalized for qualifying assets is intended to be that portion of the interest cost incurred during the assets’ acquisition periods that theoretically could have been avoided (for example, by avoiding additional borrowings or by using the funds expended for the assets to repay existing borrowings) if expenditures for the assets had not been made.
The amount capitalized in an accounting period shall be determined by applying an interest rate to the average amount of accumulated expenditures for the asset during the period. The capitalization rates used in an accounting period shall be based on the rates applicable to borrowings outstanding during the period.
The total amount of interest cost capitalized in an accounting period shall not exceed the total amount of interest cost incurred by the enterprise in that period.
q. Income Tax
In accordance with Statement of Financial Accounting Standards, or SFAS, N° 109, Accounting For Income Taxes, under US GAAP income taxes are recognized on the liability method whereby deferred
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tax assets and liabilities are established for temporary differences between the financial reporting and tax bases of our assets and liabilities. Deferred tax assets are also recognized for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recorded or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is recognized for that component of net deferred tax assets which is more likely than not that it will not be recoverable.
For the twelve-month period ended June 30, 2006, the Bank believed it was more likely than not, that it would not generate future taxable income sufficient to absorb any of its net deferred tax assets. For that reason, the Bank provided a full reserve of its net deferred tax assets for such years.
As of June 30, 2007, and based on the analysis performed on the realizability of the tax loss carryforwards, the Bank believes it will recover only a portion of the net operating tax loss carryforwards and all the temporary differences, with future taxable income. Therefore, the remaining portion of the net operating tax loss carryforward is more likely than not to be recovered in the carryforwards periods, and hence, a valuation allowance was provided against it.
As of June 30, 2008, and based on the analysis performed on the realizability of the tax loss carryforwards, the Bank believes it will recover only the temporary differences, with future taxable income. Therefore, the net operating tax loss carryforward is more likely than not to be recovered in the carryforwards periods, and hence, a valuation allowance was provided against it.
In a consolidated basis, the Bank has recognized a net deferred tax asset that amounted to Ps. 185,466 and Ps. 215,185, as of June 30, 2008 and 2007, respectively.
The Bank classifies income tax-related interest and penalties as income taxes in the financial statements. The adoption of this pronouncement had no effect on the Bank’s overall financial position or results of operations.
The following table shows the tax years open for examination as of June 30, 2008, by major tax jurisdictions in which the Bank operates:
Jurisdiction
Argentina
r. Items in process of collection
The Bank does not give accounting recognition to checks drawn on the Bank or other banks, or other items to be collected until such time as the related item clears or is accepted. Such items are recorded by the Bank in memorandum accounts. U.S. banks, however, account for such items through balance sheet clearing accounts at the time the items are presented to the Bank.
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The Bank’s assets and liabilities would be increased by approximately Ps. 51,164, Ps. 74,443 and Ps. 27,624, had US GAAP been applied at June 30, 2008, 2007 and 2006, respectively.
s. Fair Value Measurements Disclosures
In September 2006, the FASB issued SFAS 157, which is effective for fiscal years beginning after November 15, 2007 and interim periods within these fiscal years, with early adoption permitted. SFAS 157:
Defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, and establishes a framework for measuring fair value;
Establishes a three-level hierarchy for fair value measurements based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date;
Nullifies the guidance in EITF 02-3, which required the deferral of profit at inception of a transaction involving a derivative financial instrument in the absence of observable data supporting the valuation technique;
Eliminates large position discounts for financial instruments quoted in active markets and requires consideration of the Bank’s creditworthiness when valuing liabilities; and
Expands disclosures about instruments measured at fair value.
SFAS 159 provides an option to elect fair value as an alternative measurement for selected financial assets, financial liabilities, unrecognized firm commitments and written loan commitments not previously recorded at fair value. Under SFAS 159, fair value is used for both the initial and subsequent measurement of the designated assets, liabilities and commitments, with the changes on fair value recognized in net income. As a result of SFAS 159 analysis, the Bank has not elected to apply fair value accounting for any of its financial instruments not previously carried at fair value.
Valuation hierarchy
SFAS 157 establishes a three-level valuation hierarchy for disclosure of fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follows.
Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument.
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Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.
Determination of fair value
Following is a description of the Bank’s valuation methodologies for assets and liabilities measured at fair value
Fair value is based upon quoted market prices, where available. If listed prices or quotes are not available, fair value is based upon internally developed models that use primarily market-based or independently-sourced market parameters, including interest rate yield curves, option volatilities and currency rates. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments include amounts to reflect counterparty credit quality, the Bank’s creditworthiness, liquidity and unobservable parameters that are applied consistently over time.
The Bank believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
a) Securities
The Bank’s securities are classified within level 1 of the valuation hierarchy using quoted prices available in the active market where the securities are traded. Level 1 securities include national and government bonds, instruments issued by BCRA and corporate securities.
b) Securities receivable under repurchase agreements
The Bank’s securities receivable under repurchase agreements which do not qualify for sale accounting for US GAAP purposes, are classified within level 1 of the valuation hierarchy. To estimate the fair value of this securities (BODEN 2012), quoted prices are available in active market.
c) Subordinated mortgage backed bonds / Retained interests in securitizations
The Bank’s retained interests in securitizations are classified within level 3 of the valuation hierarchy. As quoted market prices are not available, then fair values are estimated by using a discount cash flow model which includes assumptions based upon projected finance charges related to the securitized assets, estimated net credit losses, prepayment assumptions and contractual interest paid to third-party investors.
The fair value of level 3 derivative positions are determined using internally developed models that utilize both market observable and unobservable parameters. Level 3 derivative instruments have primary risk characteristics that relate to unobservable pricing parameters such as private name credit spreads, credit correlations, long dated equity or interest rate
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volatility skews and forward spreads. Such derivatives include long-dated interest rate or currency swaps, and credit default swaps where swap rates may be unobservable for longer maturities.
e) Derivatives
The fair value of level 3 derivative positions are determined using internally developed models that utilize both market observable and unobservable parameters. Level 3 derivative instruments have primary risk characteristics that relate to unobservable pricing parameters such as private name credit spreads, credit correlations, long dated equity or interest rate volatility skews and forward spreads. Such derivatives include long-dated interest rate or currency swaps, and credit default swaps where swap rates may be unobservable for longer maturities.
The following table presents the financial instruments carried at fair value as of June 30, 2008, by SFAS 157 valuation hierarchy (as described above).
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Assets and liabilities measured at fair value on a recurring basis
Securities
BODEN 2012 – Compensatory Bond
Provincial Public Debt – BOGAR
Other government securities
Instrument issued by the BCRA
Corporate securities
Hedge Bond – BODEN 2012
Securities receivable under repurchase agreements – BODEN 2012
Subordinated mortgage backed bonds / Retained interests in securitizations
Subordinated mortgage backed bonds
Derivatives
Cross Currency Swap (Euro/Dollar)
Credit Currency Swap (Ps. CER/Dollar)
TOTAL ASSETS AT FAIR VALUE
Foreign currency forward contracts
Interest rate Swaps
CER Swap linked to Secured Loans due 2008 and External Debt
TOTAL LIABILITIES AT FAIR VALUE
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Changes in level 3 fair value measurements
The table below includes a roll forward of the balance sheet amounts as of June 30, 2008 (including the change in fair value) for financial instruments classified by the Bank within level 3 of the valuation hierarchy. When a determination is made to classify a financial instrument within level 3 of the valuation hierarchy, the determination is based upon the significance of the unobservable factors to the overall fair value measurement.
Fair value, July 1, 2007
Total gains or losses (realized/unrealized)
Included in earnings
Included in other comprehensive income
Purchases, issuances and settlements
Transfers in to/ out of level 3
Fair value, June 30, 2008
The table below summarizes gains and losses due to changes in fair value, recorded in earnings for level 3 assets and liabilities during the year:
Classification of gains and losses (realized/unrealized) included in earnings for 2008:
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t. Effects of Conforming to US GAAP
Reconciliation of shareholders’ equity
Total shareholders’ equity under Argentine Banking GAAP
- Loan origination fees and costs
- Loan losses reserve
- Derivative Instruments
- Compensatory and Hedge Bonds
- Other government securities
- Provincial Public Debt
- Trouble debt Restructuring
- Securitization of mortgage loans
- Acquisition of treasury shares
- Intangible assets
- Impairment of fixed and foreclosed assets
- Minority Interest on US GAAP Adjustments
- Vacation provision
- Insurance technical reserve
- Capitalization of interest cost
- Deferred Income Tax
Total Shareholders’ Equity under US GAAP
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Net (loss) income as reported under Argentine Banking GAAP
- Public Sector Loan received from Bond Swap
- Derivative instruments
- Provincial public debt
- Minority interest on US GAAP Adjustments
- Capitalization of interest of cost
- Deferred tax
Net income in accordance with US GAAP
Basic and diluted net income per share in accordance with U.S. GAAP
Average number of shares outstanding (in thousands)
Balance as of June 30, 2006
Other comprehensive Income
Net income for the twelve month period in accordance with US GAAP
Balance as of June 30, 2007
Balance as of June 30, 2008
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SFAS N° 130 “Reporting Comprehensive Income” establishes standards for reporting and disclosure of comprehensive income and its components (revenues, expenses, gains and losses) in the financial statements. Comprehensive income is the total of net income and other charges or credits to equity that are not the result of transactions with owners.
The following disclosure presented for the twelve-month periods ended June 30, 2008, 2007 and 2006, shows all periods in Argentine Banking GAAP format reflecting US GAAP income and comprehensive statement adjustments.
Income Statement
Net income from financial transactions
Income before income taxes and minority interests
Income taxes
Net income under U.S. GAAP
Unrealized gains on securities
Other comprehensive income
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Concentration of risk.
1) Total exposure to the public sector—Argentine government and provinces
The Bank has significant exposure to the Argentine national government and provinces in the form of government securities, secured loans and other debt obligations. As of June 30, 2008 and 2007, the Bank had the following assets outstanding (excluding balances with the BCRA):
Argentine national government loans
Argentine provincial debt
Other Argentine public-sector receivables (3)
Compensatory bond received
Compensatory and hedge bonds to be received (1) (2)
Risks and Uncertainties
As we mentioned in note 2.1, over the past few months, the financial markets in the most important countries in the world have been affected by volatility, lack of liquidity and credit, which entailed a significant drop in international stock indexes, and an economic slow-down started to become evident worldwide. Despite the actions taken by central countries, the international markets’ future is still uncertain.
The quality of the Bank financial condition and results of operations depend to a significant extent on macroeconomic and political conditions prevailing from time to time in Argentina. Risks and
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uncertainties facing the Bank that are generally the result of the recent economic crisis and the resulting government actions, include the fact that an important amount of the Bank’s assets are concentrated in Argentine public-sector debt instruments.
As of June 30, 2008, the Bank’s exposure to the Argentine public sector, including the compensatory and hedge bonds represented approximately 26,2% of total assets under Argentine Banking GAAP. Although the Bank’s exposure to the Argentine public sector consists mostly of performing assets, the realization of the Bank’s assets, its income and cash flow generation capacity and future financial condition may be dependent on the Argentine government’s ability to comply with its payment obligations, and on its ability to establish an economic policy that is successful in promoting sustainable economic growth in the long run.
2) Concentration of deposits
As of June 30, 2008 and 2007, the concentration of deposits is a follow:
Number of customers
10 largest customers
50 following largest customers
100 following largest customers
Rest of customers
US GAAP estimates
Valuation reserves, impairment charges and estimates of market values on assets, as established by the Bank for US GAAP purposes are subject to significant assumptions of future cash flows and interest rates for discounting such cash flows. Losses on the exchange of government and provincial bonds, and on retained interests in securitization trusts were affected by the impact of discount rates. Discount rates remained stable in June 30, 2008 and 2007. Should the discount rates change in the future years, the carrying amounts and charges to income and shareholders’ equity will also change. In addition, as estimates to future cash flows change, so too will the carrying amounts which are dependent on such cash flows.
35. Subsequent events
Legal regulations
On August 1, 2008 Decree 1207/2008 by the Executive Branch was published in the Official Gazette, which limits the deduction of profits deriving from participation certificates in trust fund related to utilities’ infrastructure works when they meet the requirements of section 70.2 the income tax regulatory decree. In turn, all the requirements included in the amendment are similar to those included in section 70.2 of the income tax regulatory decree. Accordingly, those trust funds created for a purpose other than the abovementioned will not be subject to deduction of profits allocatable to participation certificates.
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Financial trust redemption
Through Minutes N° 239 dated October 23, 2008, the Board of Directors resolved:
Guarantees deposited for swap and repo transactions
The decrease in prices of government securities and the increase in Argentine credit risk originated the need to set up additional guarantees. As of November 25, 2008, the guarantees deposited for swap and repo transactions amounts Ps.640,576 (in U$S) and Ps.96,005 in BODEN 2012. These escrow deposits have been recorded in “Miscellaneous Receivables”. The breakdown of the abovementioned guarantees for each transaction is described as follows (See Note 7):
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