PUERTO RICO EXPORTS DEVELOPMENT CORPORATION
Financial Statements for the Years
Ended June 30, 1999 and 1998 and
Independent Auditors’ Report

Independent Auditors’ Report

Board of Directors
Puerto Rico Exports Development Corporation:

We have audited the accompanying statements of condition of Puerto Rico Exports Development Corporation (the "Corporation") as of June 30, 1999 and 1998, and the related statements of income, changes in capital, and cash flows for the years then ended. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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, such financial statements present fairly, in all material respects, the financial position of Puerto Rico Exports Development Corporation as of June 30, 1999 and 1998, and the results of its operations and its cash flows for the years then ended in conformity with generally accepted accounting principles.

The year 2000 supplementary information is not a required part of the basic financial statements, but is supplementary information required by the Governmental Accounting Standards Board, and we did not audit and do not express an opinion on such information. Further, we were unable to apply to the information certain procedures prescribed by professional standards because of the unprecedented nature of the year 2000 issue and its effects, and the fact that authoritative measurement criteria regarding the status of remediation efforts have not been established. In addition, we do not provide assurance that the Corporation is or will become year 2000 compliant, that the Corporation’s year 2000 remediation efforts will be successful in whole or in part, or that the parties with which the Corporation does business are or will become year 2000 compliant.

September 17, 1999
Stamp No.
affixed to original.

Act No. 124 provided, among others, for the transfer of: (1) the Export Promotion Program from the Economic Development Bank for Puerto Rico (the "Bank") to the Corporation, (2) certain net assets, including the loan portfolio and foreclosed assets to the Bank, and (3) the administration of the Farm Credit Guaranty and the Loan for Eligible Businesses Funds. Net assets transferred to the Bank amounted to $8,063,347 (see Note 12). Act No. 124 also changed the composition of the Corporation’s Board of Directors.

The Corporation is not required to pay any taxes on any assets acquired or to be acquired for its operations or activities, or on the revenues received from any of its operations or activities.

The accounting policies followed by the Corporation are in accordance with generally accepted accounting principles ("GAAP"), as applicable to governmental entities. The activities of the Corporation are accounted for as an enterprise fund. Accordingly the Corporation follows the accrual basis of accounting. Revenues are recognized when earned, regardless of when recurred and expenses are recorded when incurred, regardless of when paid. The following is a description of the most significant policies:

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The accompanying 1998 financial statements included the accounts of the enterprise and agro-industrial development funds, which assets and proceeds from loan repayments are restricted for granting loans with specific purposes by the Corporation. All balances and transactions between funds have been eliminated in the financial statements.

The Corporation applies all applicable Governmental Accounting Standards Board (GASB) pronouncements as well as Statements and Interpretations issued by the Financial Accounting Standards Board, Accounting Principles Board Opinions, and Accounting Research Bulletins of the Committee on Accounting Procedure that do not conflict with or contradict GASB pronouncements.

The Corporation uses the accrual method of accounting to recognize revenues and expenses.

Interest-bearing deposits represent nonparticipating investment contracts which are carried at accreted cost.

The Corporation leases buildings under the operating method of accounting which recognizes lease revenues as earned over the life of the lease. Rent receivable is presented at the unpaid balance less the allowance for doubtful accounts. This allowance is based on management's evaluation of the effects on rent receivables of current economic conditions, changes in the composition of the portfolio and other pertinent factors. Because of uncertainties inherent in the estimation process, management’s estimate of bad debts and the related allowance for doubtful accounts may change in the near term.

Rental properties are stated at cost, less accumulated depreciation. Depreciation is computed on the straight-line basis over the estimated useful lives of the depreciable assets as follows:

Expenditures for major improvements are capitalized and maintenance and repairs are charged to expense.

The Corporation reviews long-lived assets and long-lived assets to be disposed of for possible impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. During the years ended June 30, 1999 and 1998, there was no recognition of a loss on impairment of value of rental properties.

Real estate owned, included within other assets in 1998, comprised properties acquired through foreclosure proceedings and was carried at the lower of fair value minus estimated costs to sell or cost. Results of operations related to real estate owned were included within other expenses in the accompanying statements of income. Real estate owned was transferred to the Bank during fiscal year 1999 as provided by Act No. 124 (see Note 12).

The accompanying statements of cash flows are presented in accordance with the provisions of GASB Statement No. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities that Use Proprietary Fund Accounting. For purposes of reporting cash flows, cash includes cash on hand and amounts due from banks.

GASB Statement No. 34, Basic Financial Statements and Management Discussion and Analysis for State and Local Governments, establishes new financial reporting requirements for state and local governments. In the case of entities engaged only in business-type activities, this statement will require, among other, the inclusion of management’s discussion and analysis of the entity’s financial activities along with other required supplementary information. Entities such as the Corporation should apply this statement for fiscal years beginning after June 15, 2002.

Certain reclassifications have been made to the prior year financial statements to conform with the current year presentation.

As of June 30, 1999, the carrying amount and corresponding depository bank balance of cash and interest-bearing deposits were as follows:

Depository bank balances amounting to $594,534 were insured or collateralized with securities held by the Department of the Treasury and the remaining balance was comprised of uninsured and uncollateralized deposits with the Government Development Bank for Puerto Rico ("GDB") and the Bank amounting to $14,060,590 and $23,666,212 respectively.

Pursuant to various grants and loan agreements, the Corporation’s interest-bearing deposits as of June 30, 1999 and 1998 are restricted as follows:

At June 30, 1999 and 1998, rental properties consisted of the following:

The Corporation's principal leasing activities consist of building space rentals under noncancellable operating leases. Lease terms expire at various future dates. Minimum future rentals to be received on noncancellable leases for each of the next five years ending June 30, and thereafter are approximately as follows:

The Corporation has granted a purchase option on a rental property for a total sale price of approximately $2,500,000. The stipulated selling price of the optioned property exceeds its carrying value.

Borrowed funds at June 30, 1999 and 1998 consist of the following:

These obligations contain various covenants with which the Corporation was in compliance as of June 30, 1999 and 1998.

The aggregate maturities of borrowed funds during each of the next five years and thereafter are as follows:

Rental expense for operating leases during 1999 and 1998 amounted to approximately $356,000 and $284,000, respectively.

As of June 30, 1999, the Corporation has entered into various construction agreements amounting to approximately $5,691,000 of which $4,013,194 have already been certified and paid or accrued.

At June 30, 1999, the Corporation is a defendant in various lawsuits challenging the method used to assign lay-offs, in connection with the Corporation’s restructuring plan initiated in 1994. Management, after consultation with legal counsel, has established an accrual which amounts to approximately $672,000 as of June 30, 1999 to cover its estimate of the ultimate liability that may result from such legal claims. Because of the uncertainties inherent in the evaluation of pending or threatened litigation, the Corporation’s ultimate liability under such claims may be significantly different from management’s current estimate.

The Corporation's rental activities are directed for the most part to private enterprises, usually chain stores, small businesses and farmers, craftsmen and the like, with the purpose to initiate and keep in operation all types of agricultural and business activities. All of the Corporation’s property and equipment are located in Puerto Rico, however, appropriate insurance coverage is carried.

The Corporation has other concentrations in interest-bearing deposits and amounts due from guarantee funds.

The Employees’ Retirement System of the Government of Puerto Rico and its instrumentalities (the "System") is a cost-sharing multiple-employer defined benefit pension plan sponsored by, and reported as a component unit of the Commonwealth. All regular employees of the Corporation under fifty-five (55) years of age at the date of employment become members of the System as a condition to their employment.

The System provides retirement, death and disability benefits pursuant to legislation enacted by the Commonwealth’s legislature. Disability retirement benefits are available to members for occupational and non-occupational disabilities. However, a member must have at least ten (10) years of service to receive non-occupational disability benefits. Retirement benefits depend upon age at retirement and number of years of creditable service. Benefits vest after ten years of plan participation.

Members who have attained fifty-five (55) years of age and have completed at least twenty-five (25) years of creditable service or members who have attained fifty-eight (58) years of age and have completed ten (10) years of creditable service, are entitled to an annual benefit, payable monthly for life.

The amount of the annuity shall be one and one-half percent of the average compensation multiplied by the number of years of creditable service up to twenty (20) years, plus two percent of the average compensation, as defined, multiplied by the number of years of creditable service in excess of twenty (20) years. In no case will the annuity be less than $200 per month.

Participants who have completed thirty (30) years of creditable service are entitled to receive the Merit Annuity. Participants who have not attained fifty-five (55) years of age will receive 65% of the average compensation, as defined, otherwise, they will receive 75% of the average compensation, as defined.

No benefits are payable if the participant receives a refund of his/her accumulated contributions.

Commonwealth legislation requires employees to contribute 5.775% for the first $550 of their monthly gross salary and 8.275% for the excess of $550 of monthly salary. The Corporation is required by the same statute to contribute 9.275% of the participant’s salary. Total employee and employer contributions during the year ended June 30, 1999 amounted to approximately $133,000 and $160,000, respectively. Total payroll covered for the year was approximately $1,725,000.

For the two preceding fiscal years, the Corporation contributed $120,000 and $106,000, which represented approximately 100% of required contributions.

Additional information on the System will be provided in its financial statements for the year ended June 30, 1999, a copy of which may be obtained directly from the System.

Following is a summary of significant balances and transactions between the Corporation and the Bank and the Guarantee Funds as of June 30, 1998 and for the year then ended:

Cash: The carrying amount reported in the statement of condition for cash approximates its fair value.

Interest-bearing deposits: Interest-bearing deposits at June 30, 1999 and 1998, amounting to $23,666,212 and $27,181,027, respectively, mature within 90 days. Accordingly, the carrying amounts reported in the statements of condition approximates their fair value. The remaining balance of $13,641,026 in 1999 and $12,611,895 in 1998 corresponds to a Zero Coupon Time Deposit due on November 14, 1999. The fair value of this time deposit at June 30, 1999 and 1998, using discounted cash flows analyses was approximately $13,713,000 and $11,646,000, respectively.

Borrowed funds: Fair value of borrowed funds with fixed interest rate and maturity is determined using discounted cash flows analysis. The fair value of borrowed funds with variable interest rates approximates their carrying amount.

The carrying value and estimated fair value of financial instruments at June 30, 1999 and 1998 are as follows:

After the creation of the Corporation, the Funds discontinued the granting of guarantees. The principal activity of the Funds consists of honoring their outstanding guarantees.

Effective July 14, 1998, the Legislature of the Commonwealth approved amendments to the law that created the Corporation. These amendments provide for the transfer of the administration functions over the Funds from the Corporation to the Bank. See Note 1.

Non-cash transactions, excluded from the accompanying statements of cash flows, for the years ended June 30, 1999 and 1998 were as follows:

Assets transferred to (received from) and liabilities assumed from the Bank:

PUERTO RICO EXPORTS DEVELOPMENT CORPORATION

Puerto Rico Exports Development Corporation (the "Corporation") relies on Economic Development Bank for Puerto Rico (the "Bank") for certain information systems services. The Bank has conducted a comprehensive review of its computer systems to identify the systems that could be affected by the Year 2000 Issue. The year 2000 Issue is the result of computer programs being written using two digits rather than four to define the applicable year. Any of the Bank’s programs that have time-sensitive software can recognize a date using "00" as the year 1900 rather than the year 2000. This could result in a major system failure or miscalculations. The Bank presently believes that, with modification to existing software and converting to new software, the Year 2000 Issue will not pose significant operational problems for the computer systems as so modified and converted.

As of June 30, 1999, in connection with the Bank’s Year 2000 Compliance Project (the "Project"), the Bank established a project plan and a budget for dealing with the Year 2000 Issue. The Bank has also identified mission-critical systems and equipment and believes it has already converted them to be year 2000 compliant. Completion of the above, however, is not a guarantee that systems and equipment will be year 2000 compliant. Cost and expenses relating to modifications and conversions of systems covered under the professional services contract between the Bank and the Corporation will be absorbed by the Bank. Other costs and expenses will be absorbed by the Corporation.