Form 20-F
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 20-F

 


 

¨ REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

 

OR

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

for the fiscal year ended December 31, 2003

 

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission file number 1-14554

 


 

BANCO SANTANDER-CHILE

(FORMERLY KNOWN AS BANCO SANTIAGO)

(Exact name of Registrant as specified in its charter)

 

SANTANDER-CHILE BANK

(Translation of Registrant’s name into English)

 

Chile

(Jurisdiction of incorporation)

 


 

Bandera 140

Santiago, Chile

Telephone: 011-562 320-2000

(Address of principal executive offices)

 

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


American Depositary Shares, each representing the right to receive 1,039 Shares of Common Stock without par value   New York Stock Exchange
Shares of Common Stock, without par value*   New York Stock Exchange
* Santander-Chile’s shares of common stock are not listed for trading, but only in connection with the registration of the American Depositary Shares, pursuant to the requirements of the New York Stock Exchange.

 


 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None

(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None

(Title of Class)

 

The number of outstanding shares of each class of common stock of Banco Santander-Chile at

December 31, 2003 was:

 

188,446,126,794 Shares of Common Stock, without par value

 


 

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.

 

Yes  x    No  ¨

 

Indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17  ¨    Item 18  x

 



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CAUTIONARY STATEMENT CONCERNING

FORWARD-LOOKING STATEMENTS

 

We have made statements in this Annual Report on Form 20-F that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements appear throughout this annual report and include statements regarding our intent, belief or current expectations regarding:

 

•     asset growth and alternative sources of funding

 

•     projected capital expenditures

•     growth of our fee-based business

 

•     liquidity

•     financing plans

 

•     trends affecting:

•     impact of competition

 

•     our financial condition

•     impact of regulation

 

•     our results of operation

•     exposure to market risks:

 

•     expected synergies from the merger

•     interest rate risk

 

•     projected costs savings from the merger

•     foreign exchange risk

 

•     merger expenses

•     equity price risk

 

•     integration of our computer system

 

The sections of this annual report which contain forward-looking statements include, without limitation, “Item 3: Key Information—Risk Factors,” “Item 4: Information on the Company—Strategy,” “Item 4: Information on the Company,” “Item 5: Operating and Financial Review and Prospects—,” “Item 8: Financial Information—Legal Proceedings,” and “Item 11: Quantitative and Qualitative Disclosures About Market Risk—.” Our forward-looking statements also may be identified by words such as “believes,” “expects,” “anticipates,” “projects,” “intends,” “should,” “could,” “may,” “seeks,” “aim,” “combined,” “estimates,” “probability,” “risk,” “VaR,” “target,” “goal,” “objective,” “future” or similar expressions.

 

You should understand that the following important factors, in addition to those discussed elsewhere in this annual report and in the documents which are incorporated by reference, could affect our future results and could cause those results or other outcomes to differ materially from those expressed in our forward-looking statements:

 

•     changes in capital markets in general that may affect policies or attitudes towards lending to Chile or Chilean companies

 

•     the monetary and interest rate policies of the Central Bank

 

•     inflation

 

•     deflation

 

•     unemployment

 

•     unanticipated turbulence in interest rates

 

•     movements in foreign exchange rates

 

•     movements in equity prices or other rates or prices

 

•     changes in Chilean and foreign laws and regulations

 

•     changes in taxes

 

•     competition, changes in competition and pricing environments

 

•     natural disasters

 

•     our inability to hedge certain risks economically

 

•     the adequacy of loss allowances

 

•     technological changes

 

•     changes in consumer spending and saving habits

 

•     the success of our post-merger branding strategy

 

•     successful implementation of new technologies

 

•     loss of market share

 

•     increased costs

 

•     unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms

 

•     changes in, or failure to comply with, banking regulations

 

•     our ability to integrate the businesses of Santiago and Old Santander-Chile successfully after the merger

 

•     our ability to integrate back-office operations

 

•     obstacles in the integration of our systems

 

•     the challenges inherent in diverting management’s focus and resources from other strategic opportunities and from operational matters during the integration process

 

•     conditions imposed in connection with the merger

 

•     our ability to successfully market and sell additional services to our existing customers

 

•     disruptions in client service

 

•     successful integration of both banks

 

•     an inaccurate or ineffective client segmentation model

 

•     our ability to carry our anticipated headcount reductions

 

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You should not place undue reliance on such statements, which speak only as of the date that they were made. Our independent public auditors have neither examined nor compiled the forward-looking statements and, accordingly, do not provide any assurance with respect to such statements. The forward-looking statements contained in this document speak only as of the date of this Annual Report, and we do not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

CERTAIN TERMS AND CONVENTIONS

 

As used in this annual report, “Santander-Chile”, “the Bank”, “we,” “our” and “us”, we mean Banco Santander-Chile and its consolidated subsidiaries, the bank resulting from the merger of Santiago and Old Santander-Chile.

 

When we refer to “Santiago” in this Annual Report, we refer to Banco Santiago and its consolidated subsidiaries prior to its merger with Old Santander-Chile. When we refer to “Old Santander-Chile” in this Annual Report, we refer to the former Banco Santander-Chile and its consolidated subsidiaries, which ceased to exist upon its merger into Santiago, effected on August 1, 2002.

 

As used in this Annual Report, the term “billion” means one thousand million (1,000,000,000).

 

In this Annual Report, references to “$”, “US$”, “U.S.$”, “U.S. dollars” and “dollars” are to United States dollars, references to “Chilean pesos,” “pesos” or “Ch$” are to Chilean pesos and references to “UF” are to Unidades de Fomento. The UF is an inflation-indexed Chilean monetary unit with a value in Chilean pesos that changes daily to reflect changes in the official Consumer Price Index (“CPI”) of the Instituto Nacional de Estadísticas (the Chilean National Institute of Statistics). See “Item 5: Operating and Financial Review and Prospects” and Note 1(c) to the Audited Consolidated Financial Statements.

 

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TABLE OF CONTENTS

 

     Page

Cautionary Statement Concerning Forward-Looking Statements

   ii

Certain Terms and Conventions

   iii

Presentation of Financial Information

   1
    Item 2.    Offer Statistics and Expected Timetable    4
    Item 3.    Key Information    4
    Item 4.    Information on the Company    17
    Item 5.    Operating and Financial Review and Prospects    36
    Item 6.    Directors, Senior Management and Employees    94
    Item 7.    Major Shareholders and Related Party Transactions    103
    Item 8.    Financial Information    106
    Item 9.    The Offer and Listing    107
    Item 10.    Additional Information    109
    Item 11.    Quantitative and Qualitative Disclosures about Market Risk    124
    Item 12.    Description of Securities Other Than Equity Securities    141

PART II

   142
    Item 13.    Defaults, Dividend Arrearages and Delinquencies    142
    Item 14.    Material Modifications to the Rights of Security Holders and Use of Proceeds    142
    Item 15.    Controls and Procedures    142
    Item 16A.    Audit Committee Financial Expert    142
    Item 16B.    Code of Ethics    142
    Item 16C.    Principal Accountant Fees and Services    143

PART III

   144
    Item 17.    Financial Statements    144
    Item 18.    Financial Statements    144
    Item 19.    Exhibits    144

 

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PRESENTATION OF FINANCIAL INFORMATION

 

Currency and Accounting Principles

 

Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and prepares its Audited Consolidated Financial Statements in conformity with generally accepted accounting principles in Chile and the rules of the Superintendencia de Bancos e Instituciones Financieras (the Superintendency of Banks and Financial Institutions, which is referred to herein as the “Superintendency of Banks”), which together differ in certain significant respects from generally accepted accounting principles in the United States (“U.S. GAAP”). References to “Chilean GAAP” in this Annual Report are to accounting principles generally accepted in Chile, as supplemented by the applicable rules of the Superintendency of Banks. See Note 26 to the Audited Consolidated Financial Statements of Santander-Chile as of December 31, 2002 and 2003 and for the years ended December 31, 2001, 2002 and 2003 contained elsewhere in this Annual Report (together with the notes thereto, the “Audited Consolidated Financial Statements”) for a description of the principal differences between Chilean GAAP and U.S. GAAP, as they relate to Santander-Chile, and a reconciliation to U.S. GAAP of net income and shareholders’ equity. Pursuant to Chilean GAAP, amounts expressed in the Audited Consolidated Financial Statements and all other amounts included elsewhere throughout this Annual Report for all periods expressed in Chilean pesos are expressed in constant Chilean pesos as of December 31, 2003. See Note 1(c) to the Audited Consolidated Financial Statements.

 

Loans

 

Unless otherwise specified, all references herein (except in the Audited Consolidated Financial Statements) to loans are to loans and financial leases before deduction for loan loss allowance, and, except as otherwise specified, all market share data presented herein are based on information published periodically by the Superintendency of Banks. Non-performing loans include loans for which either principal or interest is overdue, and which do not accrue interest. Restructured loans for which no payments are overdue are not ordinarily classified as non-performing loans. Past due loans include, with respect to any loan, only the portion of principal and interest that is 90 or more days overdue, and do not include the installments of such loan that are not overdue or that are less than 90 days overdue, unless legal proceedings have been commenced for the entire outstanding balance according to the terms of the loan, in which case the entire loan is considered past due within 90 days after initiation of such proceedings. This practice differs from that normally followed in the United States, where the amount classified as past due would include the entire amount of principal and interest on any and all loans which have any portion overdue. See “Item 5D: Asset and Liability Management—Selected Statistical Information—Loan Portfolio—Classification of Loan Portfolio—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

According to the regulations established by the Superintendency of Banks, Santander-Chile is required to charge off corporate loans no later than 24 months after being classified as past due, if unsecured, and if secured, no later than 36 months after being classified as past due. When an installment of a past due corporate loan (whether secured or unsecured) is charged off, Santander-Chile must charge off all installments which are overdue. However, this does not preclude Santander-Chile from charging off the entire amount of the loan, if it deems such action to be necessary. Once any amount of a loan is charged off, each subsequent installment must be charged off as it becomes overdue. In the case of past due consumer loans, a similar practice applies, except that after the first installment becomes three months past due, Santander-Chile must charge off the entire remaining part of the loan. Santander-Chile may charge off any loan (whether corporate or consumer) before the first installment becomes overdue, but only in accordance with special procedures established by the Superintendency of Banks and must charge off an overdue loan (whether corporate or consumer) before that time according to the terms set forth above in certain circumstances.

 

Outstanding loans and the related percentages of Santander-Chile’s loan portfolio made up of corporate and consumer loans in the section entitled “Item 4B: Business Overview” are categorized based on the nature of the borrower. Outstanding loans and related percentages of the loan portfolio of Santander-Chile made up of corporate and consumer loans in the section entitled “Item 5D: Asset and Liability Management—Selected Statistical Information” are categorized in accordance with the reporting requirements of the Superintendency of Banks, which are based on the type and term of loans.

 

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Shareholder’s Equity

 

Unless otherwise specified, all references to “shareholders’ equity” (except in the Audited Consolidated Financial Statements) as of December 31 of any year are to shareholders’ equity in the Audited Consolidated Financial Statements excluding dividends, if any, paid in respect of such year then ended, such dividends having been paid in the following year. See “Item 8A: Consolidated Statements and Other Financial Information—Dividends and Dividend Policy.”

 

Effect of Rounding

 

Certain figures included in this Annual Report and in the Audited Consolidated Financial Statements have been rounded for ease of presentation. Percentage figures included in this Annual Report have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, certain percentage amounts in this Annual Report may vary from those obtained by performing the same calculations using the figures in the Audited Consolidated Financial Statements. Certain other amounts that appear in this Annual Report may not sum due to rounding.

 

Economic and Market Data

 

In this Annual Report, unless otherwise indicated, all macro-economic data related to the Chilean economy is based on information published by the Banco Central de Chile (the Chilean Central Bank) (the “Central Bank”), and all market share and other data related to the Chilean financial system is based on information published by the Superintendency of Banks and our analysis of such information. Information regarding the consolidated risk index of the Chilean financial system as a whole is not available. The Superintendency of Banks publishes the unconsolidated risk index for the financial system three times a year in February, June and October.

 

Exchange Rates

 

This Annual Report contains translations of certain Chilean peso amounts into U.S. dollars at specified rates solely for the convenience of the reader. These translations should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts, were converted from U.S. dollars at the rate indicated in preparing the audited and interim unaudited consolidated financial statements, could be converted into U.S. dollars at the rate indicated or were converted at all. Unless otherwise indicated, such U.S. dollar amounts, in the case of information concerning Santiago and Old Santander-Chile, have been translated from Chilean pesos based on the observed exchange rate reported by the Central Bank on December 31, 2003, which was Ch$599.42 per US$1.00. The observed exchange rate reported by the Central Bank on December 31, 2003 is based upon the actual exchange rate of December 31, 2003 and is the exchange rate specified by the Superintendency of Banks for use by Chilean banks in the preparation of their financial statements for the periods ended December 31, 2003. The observed exchange rate on June 23, 2004 was Ch$643.42 per US$1.00, reflecting an accumulated depreciation of 7.3% from December 31, 2003. The Federal Reserve Bank of New York does not report a noon buying rate for the Chilean peso. For more information on the observed exchange rate see “Item 3: Exchange Rates.”

 

Merger – Accounting Treatment

 

On August 1, 2002, Old Santander-Chile merged into Santiago. Immediately thereafter, Santiago changed its name to “Banco Santander Chile.” The merger was accounted for under Chilean GAAP in a manner commonly referred to as a “pooling of interests” on a prospective basis from January 1, 2002. Under Chilean GAAP, any financial statements we issue as of or for periods ending August 1, 2002 or thereafter will reflect the combined operations of Santiago and Old Santander-Chile from January 1, 2002. Our historical financial statements under Chilean GAAP as of and for periods ended prior to August 1, 2002 have not been and will not be restated to reflect the merger. As such, for Chilean GAAP purposes, our historical financial statements as of and for the years ended December 31, 1998, 1999, 2000 and 2001 are those of Santiago which is deemed to be the predecessor entity of Santander-Chile.

 

Under US GAAP, the merger was accounted for as a merger of entities under common control, as Banco Santander Central Hispano S.A (“Banco Santander Central Hispano”) controlled both Santiago and Old Santander-Chile beginning May 3, 1999. US GAAP requires that we record the transaction in a manner similar to a pooling of

 

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interests based on the carrying values for Santiago and Old Santander-Chile included in the accounting records of the common parent, Banco Santander Central Hispano. However, to the extent that in connection with the merger Santiago issued Santiago shares or paid cash (in the case of fractional shares) for Old Santander-Chile shares held by parties other than Banco Santander Central Hispano and its affiliates, the transaction has been accounted for using the purchase method based on fair values. As a consequence of the merger, Santiago and Old Santander-Chile were required to restate their US GAAP historical financial statements previously issued for all periods during which common control existed. See “Item 8A: Consolidated Statements and Other Financial Information.

 

Unaudited Combined Financial and Statistical Information

 

Unless otherwise indicated financial and statistical data included in this Annual Report and identified as “combined” reflect the aggregation of Santiago’s and Old Santander-Chile’s financial condition and results of operation as separately reported under the Chilean GAAP as of the dates and for the periods indicated, without elimination of inter-company balances or transactions and without reflecting merger synergies or expenses. Tables showing this aggregation are provided in “Item 5G: Operating and Financial Review and Prospects—Reconciliation of Combined Financial and Statistical Information.” There were no material inter-company balances or transactions between Santiago and Old Santander-Chile as of the dates and for the periods for which combined information is provided.

 

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ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not Applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following table presents historical financial information about us as of the dates and for each of the periods indicated. The following table should be read in conjunction with, and is qualified in its entirety by reference to, our Audited Consolidated Financial Statements appearing elsewhere in this Annual Report. Our Audited Consolidated Financial Statements are prepared in accordance with Chilean GAAP and the rules of the Chilean Superintendency of Banks, which together differ in certain significant respects from U.S. GAAP. Note 26 to our Audited Consolidated Financial Statements provides a description of the material differences between Chilean GAAP and U.S. GAAP and a reconciliation to U.S. GAAP of net income for the years ended and as of December 31, 2001, 2002 and 2003 and shareholders’ equity at December 31, 2002 and 2003.

 

Under Chilean GAAP, the merger between Santiago and Old Santander-Chile was accounted for as a “pooling of interest” on a prospective basis. As such, the historical financial statements for periods prior to the merger were not restated under Chilean GAAP. Under U.S. GAAP, the merger between the two banks, which have been under the common control of Banco Santander Central Hispano since May 3, 1999, is accounted for in a manner similar to a pooling of interest under U.S. GAAP. As a consequence of the merger, we are required to restate our previously issued U.S. GAAP historical financial information to retroactively present the financial results for the merged bank as if Santiago and Old Santander-Chile had been combined throughout the periods during which common control existed. Under U.S. GAAP, the reported financial information for periods presented prior to May 3, 1999 reflects book values of Old Santander-Chile. See Note 26(a) to our Audited Consolidated Financial Statements.

 

     As of and for the Year Ended December 31,

 
     1999

    2000

    2001

    2002

    2003

    2003

 
     (in millions of constant Ch$ as of December 31, 2003)(1)     (in thousands
of U.S.$)(1)(2)
 

CONSOLIDATED INCOME STATEMENT DATA

                                    

Chilean GAAP:

                                    

Interest revenue

   591,266     650,161     602,448     1,041,405     613,562     1,023,593  

Interest expense

   (372,657 )   (407,087 )   (339,922 )   (517,010 )   (310,876 )   (518,628 )
    

 

 

 

 

 

Net interest revenue

   218,608     243,074     262,526     524,395     302,686     504,965  

Allowances for loan losses

   (69,621 )   (48,042 )   (48,403 )   (92,076 )   (101,340 )   (169,064 )

Total fees and income from services, net

   34,524     40,971     50,247     103,115     111,839     186,578  

Other operating income, net

   22,681     17,214     13,004     (13,951 )   159,500     266,092  

Loan loss recoveries

   8,894     9,444     11,784     25,374     33,921     56,590  

Other income and expenses, net

   9,110     3,212     10,371     (32,262 )   35,930     59,942  

Operating expenses

   (157,316 )   (149,066 )   (160,063 )   (289,564 )   (250,259 )   (417,502 )

Loss from price-level restatement

   (7,406 )   (12,087 )   (7,918 )   (13,148 )   (7,702 )   (12,849 )

Income before income taxes

   50,581     95,276     119,764     186,509     250,654     418,162  

Income taxes

   6,112     (428 )   3,680     (27,695 )   (43,679 )   (72,869 )
    

 

 

 

 

 

Net income

   56,694     95,848     123,444     158,814     206,975     345,293  

Net income per share

   0.58     0.96     1.25     0.84     1.10     0.00183  

Net income per American Depositary Share(3)

   595.42     996.10     1,296.40     875.60     1,141.13     1.90  

Dividends per share(4)

   0.79     0.58     0.96     1.25     0.84     0.00118  

Dividends per ADS(4)

   822.66     595.42     996.06     1,296.40     875.60     1.23  

Weighted-average shares outstanding (in millions)

   98,934.2     98,934.2     98,934.2     188,446.1     188,446.1     —    

Weighted-average shares outstanding (in millions) US GAAP

   155,106.7     188,446.1     188,446.1     188,446.1     188,446.1     —    

 

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     As of and for the Year Ended December 31,

 
     1999

    2000

    2001

    2002

    2003

    2003

 
     (in millions of constant Ch$ as of December 31, 2003)(1)     (in thousands
of U.S.$)(1)(2)
 

U.S. GAAP:

                                    

CONSOLIDATED INCOME STATEMENT DATA

                                    

Net interest income (5)

   356,849     438,460     483,866     520,620     304,477     507,953  

Provision for loan losses

   86,410     (57,184 )   (72,311 )   (66,780 )   (86,542 )   (144,376 )

Amortization of goodwill

   29,950     40,501     50,533     —       —       —    

Long-term borrowings

   3,346,707     3,091,484     3,766,310     3,121,630     2,397,506     3,999,710  

Net income

   66,577     135,836     160,988     139,444     178,516     298,148  

Net income per Share(6)

   0.43     0.72     0.86     0.74     0.95     0.00158  

Net income per ADS (6)

   446.00     748.90     887.58     768.86     985.35     1.64  

Weighted-average ADS outstanding (in millions) US GAAP

   149.285     181.377     181.377     181.377     181.377     —    

CONSOLIDATED BALANCE SHEET DATA

                                    

Chilean GAAP:

                                    

Cash and due from banks

   375,733     536,316     577,501     987,553     984,068     1,641,701  

Investments (7)

   768,813     593,242     981,606     2,523,190     1,913,617     3,192,450  

Loans, net of allowances

   4,668,490     4,809,268     5,140,076     7,772,447     7,450,406     12,429,361  

Loan loss allowances

   (96,197 )   (92,815 )   (98,190 )   (169,251 )   (168,226 )   (280,648 )

Other assets

   258,530     330,881     328,180     205,857     286,160     477,395  
    

 

 

 

 

 

Total assets (5)

   6,071,566     6,269,707     7,027,363     11,771,557     10,920,427     18,218,329  

Deposits

   3,231,996     3,261,944     3,613,343     6,141,870     5,526,688     9,220,061  

Other interest-bearing liabilities

   1,914,171     2,054,229     2,354,175     3,958,564     3,390,732     5,656,690  

Shareholders’ equity

   488,825     530,470     560,230     972,382     1,017,392     1,697,295  

U.S. GAAP:

                                    

Total assets

   11,065,364     10,611,970     12,107,334     11,444,298     10,566,019     17,627,071  

Shareholders’ equity (8)

   1,406,626     1,437,651     1,425,529     1,805,735     1,808,811     3,017,600  

Goodwill

   604,302     563,769     523,237     743,742     743,742     1,240,769  

 

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     As of for the Year Ended December 31,

 
     1999

    2000

    2001

    2002

    2003

 

CONSOLIDATED RATIOS

                              

Chilean GAAP:

                              

Profitability and Performance

                              

Net interest margin(9)

   3.9 %   4.6 %   4.5 %   4.8 %   3.0 %

Return on average total assets(10)

   0.9 %   1.6 %   1.9 %   1.3 %   1.8 %

Return on average shareholders’ equity(11)

   12.2 %   19.8 %   23.2 %   16.2 %   22.1 %

Capital

                              

Average shareholders’ equity as a percentage of average total assets

   7.4 %   8.1 %   8.1 %   8.3 %   8.1 %

Total liabilities as a multiple of shareholders’ equity

   11.4     10.8     11.5     11.1     9.7  

Credit Quality:

                              

Non-performing loans as a percentage of a total loans

   3.5 %   2.4 %   2.1 %   3.2 %   3.9 %

Allowance for loans losses as percentage of total loans

   2.0 %   1.9 %   1.9 %   2.1 %   2.2 %

Past due loans as a percentage of total loans (12)

   1.3 %   1.3 %   1.3 %   2.1 %   2.2 %

Operating Ratios:

                              

Operating expenses/operating revenue(13)

   57.0 %   49.5 %   49.1 %   47.2 %   43.6 %

Operating expenses/average total assets

   2.5 %   2.5 %   2.4 %   2.4 %   2.2 %

U.S. GAAP:

                              

Profitability and Performance:

                              

Net interest margin(14)

   3.5 %   4.4 %   4.5 %   4.7 %   3.0 %

Return on average total assets(15)

   0.7 %   1.2 %   1.4 %   1.2 %   1.6 %

Return on average shareholders’ equity(16)

   5.4 %   10.1 %   11.7 %   8.6 %   9.9 %

OTHER DATA

                              

Inflation Rate(17)

   2.3 %   4.5 %   2.6 %   2.8 %   1.1 %

Revaluation (Devaluation) Rate (Ch$/U.S.$) at period end(17)

   11.4 %   8.5 %   14.6 %   8.6 %   (15.9 %)

Number of employees at period end(18)

   4,747     4,772     4,489     8,314     7,561  

Number of branches and offices at period end

   162     167     169     347     345  

Note: n/a = not applicable.

(1) Except per share data, percentages and ratios, share amounts, employee numbers and branch numbers.
(2) Amounts stated in U.S. dollars as of and for the year ended December 31, 2003 have been translated from Chilean pesos at the observed exchange rate of Ch$599.42 = U.S.$1.00 as of December 31, 2003. See “Item 3: Key Information—Exchange Rates” for more information on the observed exchange rate.
(3) 1 ADS = 1,039 shares of common stock.
(4) The dividends per share of common stock and per ADS are determined based on the previous year’s net income. The dividend per ADS is calculated on the basis of 1,039 shares per ADS.
(5) Net interest income and total assets on a U.S. GAAP basis have been determined by applying the relevant U.S. GAAP adjustments to net interest income and total assets presented in accordance with Article 9 of Regulation S-X. See Note 26 to our Consolidated Financial Statements.
(6) Net income per share in accordance with U.S. GAAP has been calculated on the basis of the weighted-average number of shares outstanding at the end of the period.
(7) Includes principally Chilean government securities, corporate securities, other financial investments and investment collateral under agreements to repurchase.
(8) Shareholders’ equity as of December 31 of each year.
(9) Net interest revenue divided by average interest earning assets (as presented in “Item 5: Selected Statistical Information”).

 

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(10) Net income divided by average total assets (as presented in “Item 5: Selected Statistical Information”).
(11) Net income divided by average shareholders’ equity (as presented in “Item 5: Selected Statistical Information”).
(12) Past due loans are loans that are 90 days or more overdue.
(13) Operating revenue includes “Net interest revenue,” “Total fees and income from services, net” and “Other operating income, net.”
(14) Net interest margin on a U.S. GAAP basis has been determined by applying the relevant U.S. GAAP adjustments to net interest income presented in accordance with Article 9 of Regulation S-X but calculated on a Chilean GAAP basis. See Note 26(y) to our Consolidated Financial Statements.
(15) Net income divided by average total assets. Average total assets were calculated as an average of the beginning and ending balance for each year, and total assets on a U.S. GAAP basis has been determined by applying the relevant U.S. GAAP adjustments to total assets presented in accordance with Article 9 of Regulation S-X. See Note 26 to our Audited Consolidated Financial Statements.
(16) Average shareholders’ equity was calculated as an average of the beginning and ending balance for each year. Shareholders’ equity on a U.S. GAAP basis has been determined by applying the relevant U.S. GAAP adjustments to shareholders’ equity presented in accordance with Article 9 of Regulation S-X. See Note 26(y) to our Audited Consolidated Financial Statements.
(17) Based on information published by the Central Bank.
(18) The number of employees presented in this table for the years 1998-2001 are those of Santiago only, excluding subsidiaries, because consolidated employee information is not available for all years presented.

 

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Exchange Rates

 

Chile has two currency markets, the Mercado Cambiario Formal, or the Formal Exchange Market and the Mercado Cambiario Informal, or the Informal Exchange Market. Under the Central Bank Act, the Central Bank determines which purchases and sales of foreign currencies must be carried out in the Formal Exchange Market. Pursuant to Central Bank regulations which are currently in effect, all payments, remittances or transfers of foreign exchange abroad which are required to be effected through the Formal Exchange Market may be effected with foreign currency procured outside the Formal Exchange Market. The Formal Exchange Market is comprised of the banks and other entities so authorized by the Central Bank. The conversion from pesos to U.S. dollars of all payments and distributions with respect to the ADSs described in this Annual Report must be transacted at the spot market rate in the Formal Exchange Market. Current regulations require that the Central Bank be informed of certain transactions and that they be effected through the Formal Exchange Market.

 

The reference exchange rate for the Formal Exchange Market is reset daily by the Central Bank, taking internal and external inflation into account, and is adjusted daily to reflect variations in parities between the peso and each of the U.S. dollar, the Euro and the Japanese yen. The observed exchange rate for a given date is the average exchange rate of the transactions conducted in the Formal Exchange Market on the immediately preceding banking day, as certified by the Central Bank.

 

Until August 1999, authorized transactions by banks were generally transacted within a certain band above or below the reference exchange rate. In order to maintain the average exchange rate within such limits, the Central Bank intervened by selling and buying foreign currencies on the Formal Exchange Market.

 

On September 2, 1999, the Central Bank eliminated the exchange rate band as an instrument of exchange rate policy, introducing more flexibility to the exchange market. The Central Bank announced it will intervene in the exchange market only in special and qualified cases.

 

Purchases and sales of foreign currencies which may be effected outside the Formal Exchange Market can be carried out in the Informal Exchange Market. The Informal Exchange Market reflects transactions carried out at informal exchange rates by entities not expressly authorized to operate in the Formal Exchange Market, such as certain foreign exchange houses and travel agencies. There are no limits imposed on the extent to which the rate of exchange in the Informal Exchange Market can fluctuate above or below the observed exchange rate. On December 31, 2003, the average exchange rate in the Informal Exchange Market was approximately the same as the published observed exchange rate for such date of Ch$599.42 per U.S.$1.00.

 

The following table sets forth the annual low, high, average and period-end observed exchange rate for U.S. dollars for each of the following periods, as reported by the Central Bank.

 

     Daily Observed Exchange Rate Ch$ Per U.S.$(1)

Year


   Low(2)

   High(2)

   Average(3)

   Period End

1999

   468.69    550.93    508.78    527.70

2000

   501.04    580.37    539.49    572.68

2001

   557.13    716.62    634.94    656.20

2002

   641.75    756.56    689.24    712.38

2003

   593.10    758.21    691.54    599.42

Month


                   

December 2003

   593.10    621.30    602.9    599.42

January 2004

   559.21    596.78    573.64    596.78

February 2004

   571.35    598.60    584.31    594.32

March 2004

   588.04    623.21    603.91    623.21

April 2004

   596.61    624.84    608.19    624.84

May 2004

   622.25    644.42    635.76    632.32

Source: Central Bank.

(1) Nominal figures.

 

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(2) Exchange rates are the actual low and high, on a day-by-day basis for each period.
(3) The average of monthly average rates during the year.

 

Dividends

 

Under the current General Banking Law, a Chilean bank may only pay a single dividend per year (i.e., interim dividends are not permitted), Santander-Chile’s annual dividend is proposed by its Board of Directors and is approved by the shareholders at the annual ordinary shareholders’ meeting held the following year with respect to which the dividend is proposed. For example, the 1998 dividend would be proposed and approved in 1999. Following shareholder approval, the proposed dividend is declared and paid. Historically, the dividend for a particular year has been declared and paid no later than one month following the shareholders meeting. Dividends are paid to shareholders of record on the fifth day preceding the date set for payment of the dividend. The applicable record dated for the payment of dividends to holders of ADSs will, to the extent practicable, be the same.

 

Under the Chilean Companies Law, Chilean companies are generally required to distribute at least 30% of their earnings (calculated in accordance with Chilean GAAP) as dividends, but a bank is permitted to distribute less than 30% of its earnings, and may distribute no dividends at all, in any given year if the holders of at least two thirds of the bank’s outstanding shares of common stock so determine. The balances of Santander-Chile’s distributable net income is generally retained for use in Santander-Chile’s business (including for the maintenance of any required legal reserves). Although Santander-Chile’s Board of Directors currently intends to pay regular annual dividends, the amount of dividend payments will depend upon, among other factors, Santander-Chile’s then current level of earnings, capital and legal reserve requirements, as well as market conditions, and there can be no assurance as to the amount or timing of future dividends.

 

Dividends payable to holders of ADSs are net of foreign currency conversion expenses of the depositary and will be subject to the Chilean withholding tax currently at the rate of 35% (subject to credits in certain cases as described in “Taxation”). Owners of the ADSs will not be charged any dividend remittance fees by the Depositary with respect to cash or stock dividends. See “Item 10E: Taxation.”

 

Under the Foreign Investment Contract (as defined herein), the Depositary, on behalf of ADS holders, is granted access to the Formal Exchange Market to convert cash dividends from Chilean pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile, net of taxes, and no separate registration by ADR holders is required. In the past, Chilean law required that holders of shares of Chilean companies who were not residents of Chile to register as foreign investors under one of the foreign investment regimes contemplated by Chilean law in order to have dividends, sale proceeds or other amounts with respect to their shares remitted outside Chile through the Formal Exchange Market. On April 19, 2001, the Central Bank deregulated the Exchange Market eliminating the need to obtain approval from the Central Bank in order to remit dividends, but at the same time this eliminated the possibility of accessing the Formal Exchange market. These changes do not affect the current Foreign Investment Contract, which was signed prior to April 19, 2001 which grants access to the Formal Exchange Market with prior approval of the Central Bank. SeeItem 10D: Exchange Controls.

 

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The following table presents dividends paid by us in nominal terms:

 

Year


   Dividend
MCh$ (1)


   Per share
Ch$/share (2)


  

Per ADR

Ch$/ADR (3)


   % over
earnings


2001

   88,510    0.89    929.53    100

2002

   118,764    1.20    1,247.25    100

2003

   157,315    0.83    867.40    100

2004

   206,975    1.10    1,141.16    100

(1) Million of nominal pesos.
(2) Calculated on the basis of 98,934 million shares for 2001 and 2002 and 188,446 million shares for 2003 and 2004.
(3) Calculated on the basis of 1,039 shares per ADS.

 

The following table presents dividends paid by Old Santander-Chile in the three years prior to the merger.

 

Year


   Dividend
MCh$ (1)


   Per share
Ch$/share (2)


  

Per ADR

Ch$/ADR (3)


   % over
earnings


 

2000

   40,742    1.61    353.49    75.0 %

2001

   47,406    1.88    414.05    60.0  

2002

   92,093    3.66    804.35    100.0  

(1) Million of nominal pesos.
(2) Calculated on the basis of 25,188 million shares.
(3) Calculated on the basis of 220 shares per ADS.

 

B. Capitalization and Indebtedness

 

Not applicable

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable

 

D. Risk Factors

 

You should carefully consider the following risk factors, as well as all the other information presented in this Annual Report before investing in securities issued by us. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we do not know about or that we currently think are immaterial may also impair our business operations. Any of the following risks, if they actually occur, could materially and adversely affect our business, results of operations, prospects and financial condition.

 

We are subject to market risks that are presented both in this subsection and in “Item 5: Operating and Financial Review and Prospects.

 

Risks Associated with Our Business

 

Increased competition and industry consolidation may adversely affect results of our operations

 

The Chilean market for financial services is highly competitive. We compete with other Chilean private sector domestic and foreign banks, with Banco del Estado, a public-sector bank, and with large department stores that make consumer loans to a large portion of the Chilean population. The lower-middle to middle income segments of the Chilean population and the small and medium-sized corporate segments have become the target markets of several banks, and competition in these segments is likely to increase. As a result, net interest margins in these segments are likely to decline. Although we believe that demand for financial products and services from the lower-

 

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middle to middle income market segments and for small and medium-sized companies will continue to grow during the remainder of the decade, we cannot assure you that net interest margins will be maintained at their current levels.

 

We also face competition from non-bank and non-finance competitors (principally department stores) with respect to some of our credit products, such as credit cards and consumer loans. In addition, we face competition from non-bank finance competitors, such as leasing, factoring and automobile finance companies, with respect to credit products, and mutual funds, pension funds and insurance companies, with respect to savings products. Currently, banks continue to be the main suppliers of leasing, factoring and mutual funds, and the insurance sales business has seen rapid growth.

 

The increase in competition within the Chilean banking industry in recent years has led to, among other things, consolidation in the industry. For example, in January 2002 Banco de Chile and Banco de A. Edwards, the third and fifth largest banks in Chile respectively, merged to become the largest Chilean bank at that time. We expect the trends of increased competition and consolidation to continue and result in the formation of new large financial groups. Consolidation, which can result in the creation of larger and stronger competitors, may adversely affect our financial condition and results of operations by decreasing the net interest margins we are able to generate. In addition, the recently enacted Law No. 19,769 allows insurance companies to participate and compete with us in the residential mortgage business.

 

Banco Santander Central Hispano controls a significant percentage of our share capital and exercises significant influence over board decisions

 

Banco Santander Central Hispano owns approximately 84.137% of our outstanding ordinary shares, which gives it the power to elect a majority of our board of directors and to determine the outcome of most matters submitted to a vote of shareholders, including matters that could affect our duration and existence.

 

We currently engage in, and expect from time to time in the future to engage in, financial and commercial transactions with subsidiaries and affiliates of Banco Santander Central Hispano. Among other transactions, we may, from time to time, have credit lines and outstandings with Banco Santander Central Hispano and its affiliated financial institutions around the world. As of December 31, 2003, we have no outstanding loan amounts with Santander Central Hispano. In addition, from time to time, in the normal course of business and on prevailing market terms, we enter into certain transactions with Banco Santander Central Hispano and other related parties for the provision of advisory and advertising services and for the rental of real estate. For additional information concerning our transactions with affiliates and other related parties, see Note 14 to our Audited Consolidated Financial Statements. While we believe that such transactions in the past have generally had a beneficial effect on us, no assurances can be given that any such transaction, or combination of transactions, will not have a material adverse effect on us in the future.

 

Our exposure to individuals and small businesses could lead to higher levels of past due loans and subsequent write-offs

 

A substantial number of our customers consists of individuals (approximately 36.2% of the value of the total loan portfolio as of December 31, 2003) and, to a lesser extent, small and medium-sized companies (those with annual sales of less than US$5.8 million) which comprised approximately 19.8% of the value of the total loan portfolio as of December 31, 2003. As part of our business strategy, we seek to increase lending and other services to small companies and individuals. Small companies and individuals are, however, more likely to be adversely affected by downturns in the Chilean economy than large corporations and high-income individuals. Consequently, in the future we may experience higher levels of past due loans, which could result in higher provisions for loan losses. There can be no assurance that the levels of past due loans and subsequent write-offs will not be materially higher in the future.

 

Our results of operations are affected by interest rate volatility

 

Our results of operation depend to a great extent on our net interest revenue. In 2003, net interest revenue represented 79.2% of our operating income. Changes in market interest rates could affect the interest rates earned on our interest-earning assets differently from the interest rates paid on our interest-bearing liabilities leading to a

 

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reduction in our net interest revenue. Interest rates are highly sensitive to many factors beyond our control, including the reserve policies of the Central Bank, deregulation of the financial sector in Chile, domestic and international economic and political conditions and other factors. Any volatility in interest rates could adversely affect our business, our future financial performance and the price of our securities. Over the period from December 31, 1999 to December 31, 2003, yields on the Chilean government’s 90 day note as reported on those dates moved from 11.09% to 2.58%, decreasing every year, with a high of 6.00% and a low of 2.87% in the twelve months ended December 31, 2002 and a high of 2.97% and a low of 2.48% in the twelve months ended December 31, 2003.

 

The growth of our loan portfolio may expose us to increased loan losses

 

From December 31, 1998 to December 31, 2003, our aggregate loan portfolio (on an unconsolidated combined basis) grew by 9.1% in nominal terms to Ch$7,554,175 million, while our consumer loan portfolio grew by 33.8% in nominal terms to Ch$777,191 million, each calculated in accordance with the loan classification system of the Superintendency of Banks. Because the method of classification of loans used by the Superintendency of Banks for its public information differs in minor respects from that used by us for internal accounting purposes, the foregoing figures may differ from the figures included in our financial statements. The further expansion of our loan portfolio (particularly in the consumer and real estate segments) can be expected to expose us to a higher level of loan losses and require us to establish higher levels of provisions for loan losses.

 

Our loan portfolio may not continue to grow at the same rate

 

There can be no assurance that in the future our loan portfolio will continue to grow at the same or similar rates as the historical growth rate of that previously experienced by Santiago or Old Santander-Chile. Due to the economic slowdown in Chile in recent years and the recession of 1999, loan demand has not been as strong as it was in the mid 1990s. Average loan growth has, however, remained significant in the last five years. According to the Superintendency of Banks, from December 31, 1998 to December 31, 2003, the aggregate amount of loans outstanding in the Chilean banking system (on an unconsolidated basis) grew 37.2% in nominal terms to Ch$33,480,530 million as of December 31, 2003. A reversal of the rate of growth of the Chilean economy could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required reserves for loan losses.

 

Operational problems or errors can have a material adverse impact on our business, financial condition and results of operations

 

Santander-Chile, like all large financial institutions, is exposed to many types of operational risks, including the risk of fraud by employees and outsiders, failure to obtain proper internal authorizations, failure to properly document transactions, equipment failures and errors by employees. Although Santander-Chile maintains a system of operational controls, there can be no assurance that operational problems or errors will not occur and that their occurrence will not have a material adverse impact on our business, financial condition and results of operation.

 

Risks Relating to Chile

 

Our growth and profitability depend on the level of economic activity in Chile and other emerging markets

 

A substantial amount of our loans are to borrowers doing business in Chile. Accordingly, the recoverability of these loans in particular, our ability to increase the amount of loans outstanding and our results of operations and financial condition in general, are dependent to a significant extent on the level of economic activity in Chile. The Chilean economy has been influenced, to varying degrees, by economic conditions in other emerging market countries. We cannot assure you that the Chilean economy will continue to grow in the future or that future developments in or affecting the Chilean economy, including further consequences of continuing economic difficulties in Brazil, Argentina and other emerging markets, will not materially and adversely affect our business, financial condition or results of operations.

 

Our results of operations and financial condition could be affected by changes in economic or other policies of the Chilean government, which has exercised and continues to exercise a substantial influence over many aspects of the private sector, or other political or economic developments in Chile.

 

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Although economic conditions are different in each country, investors’ reactions to developments in one country may affect the securities of issuers in other countries, including Chile. For instance, the devaluation of the Mexican peso in December 1994 set off an economic crisis in Mexico that negatively affected the market value of securities in many countries throughout Latin America. The crisis in the Asian markets, beginning in July 1997, resulted in sharp devaluation of other Asian currencies and negatively affected markets throughout Asia, as well as in many markets in Latin America, including Chile. Similar adverse consequences resulted from the 1998 crisis in Russia and the devaluation of the Brazilian real in 1999. In part due to the Asian and Russian crises, the Chilean stock market declined significantly in 1998 to levels equivalent to 1994.

 

The economic problems being encountered by other countries in Latin America, especially Argentina and Brazil may adversely affect the Chilean economy, our results of operations and the market value of our securities

 

We are directly exposed to risks related to the weakness and volatility of the economic and political situation in Latin America, especially in Argentina and Brazil. As of December 31, 2003, approximately 0.0% and 0.14% of our loan portfolio was comprised of loans to Argentine and Brazilian companies, respectively.

 

Argentina’s insolvency and recent default on its public debt, which deepened the existing financial, economic and political crises in that country, could adversely affect Chile, the market value of our securities, or our business. If Argentina’s economic environment continues to deteriorate or does not improve, the economy in Chile, as both a neighboring country and a trading partner, could also be affected and could experience slower growth than in recent years. The recent cuts in gas exports from Argentina to Chile could also adversely affect economic growth in Chile. Diplomatic relations with Bolivia have also worsened.

 

Our business could be affected by political uncertainty in Brazil. This could result in the need for us to increase our loan allowances, thus affecting our financial results, our results of operations and the price of our securities (including the notes).

 

Securities prices of Chilean companies including banks are, to varying degrees, influenced by economic and market considerations in other emerging market countries and by the US economy. We cannot assure you that the Argentine economic crisis and the political uncertainty in Brazil will not have an adverse effect on Chile, the price of our securities, or our business.

 

Currency fluctuations could adversely affect our financial condition and results of operations and the value of our securities

 

The Chilean government’s economic policies and any future changes in the value of the Chilean peso against the US dollar could affect the dollar value of our securities. The peso has been subject to large devaluations in the past and could be subject to significant fluctuations in the future. In the period from December 31, 1998 to December 31, 2003, the value of the Chilean peso relative to the US dollar decreased approximately 26.5%. The observed exchange rate on December 31, 2003 was Ch$599.42 = US$1.00, reflecting an appreciation of 15.9% in the year 2003. Our results of operations may be affected by fluctuations in the exchange rates between the peso and the dollar despite our policy and Chilean regulations relating to the general avoidance of material exchange rate mismatches. In order to avoid material exchange rate mismatches, we enter into forward exchange transactions. As of December 31, 2003, our foreign currency denominated assets and Chilean peso-denominated assets that contain repayment terms linked to changes in foreign currency exchange rates exceeded our foreign currency denominated liabilities and Chilean peso-denominated liabilities that contain repayment terms linked to changes in foreign currency exchange rates by Ch$58,791 million (US$98.1 million).

 

We may decide to change our policy regarding exchange rate mismatches. Regulations that limit such mismatches may also be amended or eliminated. Greater exchange rate mismatches will increase our exposure to the devaluation of the peso, and any such devaluation may impair our capacity to service foreign-currency obligations and may, therefore, materially and adversely affect our financial condition and results of operation. Notwithstanding the existence of general policies and regulations that limit material exchange rate mismatches, the economic policies of the Chilean government and any future fluctuations of the peso against the dollar could affect our financial condition and results of operations.

 

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Inflation could adversely affect our financial condition and results of operations

 

Although Chilean inflation has moderated in recent years, Chile has experienced high levels of inflation in the past. High levels of inflation in Chile could adversely affect the Chilean economy and have an adverse effect on our results of operations and, indirectly, the value of our securities. The following table shows the annual rate of inflation (as measured by changes in the Chilean consumer price index and as reported by the Chilean National Institute of Statistics during the last five years ended December 31). There can be no assurance that Chilean inflation will not change significantly from the current level.

 

Year


   Inflation (CPI)

1999

   2.3

2000

   4.5

2001

   2.6

2002

   2.8

2003

   1.1

Source: Chilean National Institute of Statistics

 

There can be no assurance that our operating results will not be adversely affected by changing levels of inflation, or that Chilean inflation will not change significantly from the current level.

 

Banking regulations may restrict our operations and thereby adversely affect our financial condition and results of operations

 

We are subject to regulation by the Superintendency of Banks. In addition, we are subject to regulation by the Central Bank with regard to certain matters, including interest rates and foreign exchange. During the Chilean financial crisis of 1982 and 1983, the Central Bank and the Superintendency of Banks strictly controlled the funding, lending and general business matters of the banking industry in Chile.

 

Pursuant to the Ley General de Bancos, Decreto con Fuerza de Ley No. 3 de 1997, or the General Banking Law, all Chilean banks may, subject to the approval of the Superintendency of Banks, engage in certain businesses other than commercial banking depending on the risk associated with such business and the financial strength of the bank. Such additional businesses include securities brokerage, mutual fund management, securitization, insurance brokerage, leasing, factoring, financial advisory, custody and transportation of securities, loan’s collection and financial services. The General Banking Law also applies to the Chilean banking system a modified version of the capital adequacy guidelines issued by the Basle Committee on Banking Regulation and Supervisory Practices and limits the discretion of the Superintendency of Banks to deny new banking licenses. There can be no assurance that regulators will not in the future impose more restrictive limitations on the activities of banks, including us, than those currently in effect. Any such change could have a material adverse effect on our financial condition or results of operations.

 

Historically, Chilean banks have not paid interest on amounts deposited in checking accounts. However, effective June 1, 2002, the Central Bank allows banks to pay interest on checking accounts. Currently, there are no applicable restrictions on the interest that may be paid on checking accounts. We have begun to pay interest on some checking accounts under certain conditions. If competition or other factors lead us to pay higher interest rates on checking accounts, to relax the conditions under which we pay interest or to increase the number of checking accounts on which we pay interest, any such change could have a material adverse effect on our financial condition or results of operations.

 

This Bank must maintain higher capital to risk weighted assets than other banks in Chile. The merger of Old Santander-Chile and Santiago required a special regulatory preapproval of the Superintendency of Banks, which was granted on May 16, 2002. The resolution granting this preapproval imposed a mandatory minimum capital to risk-weighted assets ratio of 12% for the merged bank compared to 8% minimum for other banks in Chile.

 

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Chile has different corporate disclosure and accounting standards than those you may be familiar with in the United States

 

The accounting, financial reporting and securities disclosure requirements in Chile differ from those in the United States. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a US company.

 

There are also important differences between Chilean and US accounting and financial reporting standards. As a result, Chilean financial statements and reported earnings generally differ from those reported based on US accounting and reporting standards.

 

As a regulated financial institution, we are required to submit to the Superintendency of Banks unaudited unconsolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with Chilean GAAP and the rules of the Superintendency of Banks on a monthly basis. Such disclosure differs in a number of significant respects from information generally available in the United States with respect to US financial institutions.

 

The securities laws of Chile, which govern open or publicly listed companies such as us, have as a principal objective promoting disclosure of all material corporate information to the public. Chilean disclosure requirements, however, differ from those in the United States in some important respects. In addition, although Chilean law imposes restrictions on insider trading and price manipulation, applicable Chilean laws are different from those in the United States and in certain respects the Chilean securities markets are not as highly regulated and supervised as the US securities markets.

 

Chile imposes controls on foreign investment and repatriation of investments that may affect your investment in, and earnings from, our ADSs.

 

Equity investments in Chile by persons who are not Chilean residents have generally been subject to various exchange control regulations which restrict the repatriation of the investments and earnings therefrom. In April 2001, the Central Bank eliminated the regulations that affected foreign investors except that investors are still required to provide the Central Bank with information related to equity investments and conduct such operations within Chile’s Formal Exchange Market. The ADSs are subject to a contract, dated May 17, 1994, among the depositary, us and the Central Bank that remains in full force and effect. The ADSs continue to be governed by the provisions of such contract subject to the regulations in existence prior to April 2001. The contract grants the depositary and the holders of the ADSs access to the Formal Exchange Market, which permits the depositary to remit dividends it receives from us to the holders of the ADSs. The contract also permits ADS holders to repatriate the proceeds from the sale of shares of our common stock withdrawn from the ADS facility, or that have been received free of payment as a consequence of spin-offs, mergers, capital increases, wind-ups, share dividends or preemptive rights transfers, enabling them to acquire the foreign currency necessary to repatriate earnings from such investments. Pursuant to Chilean law, the contract cannot be amended unilaterally by the Central Bank, and there are judicial precedents (although not binding with respect to future judicial decisions) indicating that contracts of this type may not be abrogated by future legislative changes or agreements of the Advisory Council of the Central Bank. Holders of shares of our common stock, except for shares of our common stock withdrawn from the ADS facility or received in the manner described above, are not entitled to the benefits of the contract, may not have access to the Formal Exchange Market, and may have restrictions on their ability to repatriate investments in shares of our common stock and earnings therefrom.

 

Owners of ADSs are entitled to receive dividends on the underlying shares to the same extent as the holders of shares. Dividends received by holders of ADSs will be paid net of foreign currency exchange fees and expenses of the depositary and will be subject to Chilean withholding tax, currently imposed at a rate of 35.0% (subject to credits in certain cases). If for any reason, including changes in Chilean law, the depositary were unable to convert Chilean pesos to U.S. dollars, investors would receive dividends and other distributions, if any, in Chilean pesos.

 

We cannot assure you that additional Chilean restrictions applicable to holders of our ADSs, the disposition of the shares underlying them or the repatriation of the proceeds from such disposition or the payment of dividends will not be imposed in the future, nor can we advise you as to the duration or impact of such restrictions if imposed.

 

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Risks Relating to our ADSs

 

There may be a lack of liquidity and market for our shares and ADSs.

 

The ADSs are listed and traded on the NYSE. The common stock is listed and traded on the Santiago Stock Exchange, the Chile Electronic Stock Exchange and the Valparaiso Stock Exchange, which we refer to collectively as the Chilean Stock Exchanges, although the trading market for the common stock is small by international standards. As of December 31, 2003, we had 188,446,126,794 shares of common stock outstanding. The Chilean securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. According to Article 14 of the Ley de Mercado de Valores, Ley No. 18,045, or the Chilean Securities Market Law, the Superintendencia de Valores y Seguros, or the Superintendency of Securities and Insurance, may suspend the offer, quotation or trading of shares of any company listed on one or more Chilean Stock Exchanges for up to 30 days if, in its opinion, such suspension is necessary to protect investors or is justified for reasons of public interest. Such suspension may be extended for up to 120 days. If, at the expiration of the extension, the circumstances giving rise to the original suspension have not changed, the Superintendency of Securities and Insurance will then cancel the relevant listing in the registry of securities. In addition, the Santiago Stock Exchange may inquire as to any movement in the price of any securities in excess of 10 and suspend trading in such securities for a day if it deems necessary.

 

Although the common stock is traded on the Chilean Stock Exchanges, there can be no assurance that a liquid trading market for the common stock will continue. Approximately 15.9% of our outstanding common stock was held by the public (i.e., shareholders other than Banco Santander Central Hispano). A limited trading market in general and our concentrated ownership in particular may impair the ability of an ADS holder to sell in the Chilean market shares of common stock obtained upon withdrawal of such shares from the ADR facility in the amount and at the price and time such holder desires, and could increase the volatility of the price of the ADSs.

 

You may be unable to exercise preemptive rights.

 

The Ley Sobre Sociedades Anónimas, Ley No. 18,046 and the Reglamento de Sociedades Anónimas, which we refer to collectively as the Chilean Corporations Law, and applicable regulations require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs), giving them the right to purchase a sufficient number of shares to maintain their existing ownership percentage. Such an offering would not be possible unless a registration statement under the U.S. Securities Act of 1933, as amended, were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.

 

Since we are not obligated to elect to make a registration statement available with respect to such rights and the common stock, you may not be able to exercise your preemptive rights. If a registration statement is not filed or an applicable exemption is not available, the depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.

 

You may have fewer and less well defined shareholders’ rights than with shares of a company in the United States.

 

Our corporate affairs are governed by our estatutos, or bylaws, and the laws of Chile. Under such laws, our shareholders may have fewer or less well-defined rights than they might have as shareholders of a corporation incorporated in a U.S. jurisdiction. For example, under legislation applicable to Chilean banks, our shareholders would not be entitled to appraisal rights in the event of a merger or other business combination undertaken by us.

 

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ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

Overview

 

The legal predecessor of Santander-Chile was Banco Santiago (Santiago). Santiago was incorporated by public deed dated September 7, 1977 granted at the Notary Office of Alfredo Astaburuaga Gálvez. Santiago received its permission to incorporate and function as a bank by Resolution No. 118 of the Superintendency of Banks on October 27, 1977. The Bank’s bylaws were approved by Resolution No. 103 of the Superintendency of Banks on September 22, 1977. In January 1997, Santiago merged with Banco O’Higgins with Santiago being the surviving entity. In 1999, Santiago became a controlled subsidiary of Banco Santander Central Hispano.

 

On August 1, 2002, we were formed by the merger of Santiago and Old Santander-Chile, both of which were subsidiaries of our controlling shareholder, Banco Santander Central Hispano. We are the largest bank in Chile in terms of total assets, total deposits, loans and shareholder’s equity. As of December 31, 2003, we had total assets of Ch$10,920,427 million (US$18,218 million), loans net of allowances outstanding of Ch$7,450,406 million (US$12,429 million) deposits of Ch$5,526,688 million (US$9,220 million) and shareholders’ equity of Ch$1,017,392 million (US$1,697 million).

 

As of December 31, 2003 we employed 7,535 people and had the largest branch network in Chile with 345 branches. Our headquarters are located in Santiago and we operate in every major regional sector in Chile.

 

We provide a broad range of commercial and retail banking services to our customers. Among the products we offer are Chilean peso and foreign currency denominated loans to finance a variety of commercial transactions, trade financing, foreign currency forward contracts, credit lines and a variety of retail banking services, including mortgage financing. We seek to offer our customers a wide range of products while providing high levels of service. In addition to our traditional banking operations, we offer a variety of financial services including financial leasing, financial advisory services, mutual fund management, securities brokerage, insurance brokerage and investment management.

 

Prior to the merger, Santiago was the most profitable bank in Chile in terms of return on equity among the five largest Chilean banks in terms of shareholders’ equity, which we consider our peer group, while Old Santander-Chile had the best efficiency ratio within the same peer group. Santiago had the largest market share in terms of loans in the middle segment (middle to upper-income retail) while Old Santander-Chile had the largest such market share in the corporate and low- to middle-income segments. We believe the complementary strengths of the two banks give us the ability to compete effectively across all segments.

 

Old Santander-Chile was established as a subsidiary of Banco Santander Central Hispano in 1978. In 1982, Old Santander-Chile acquired a significant portion of the assets and liabilities of Banco Español-Chile, a domestic bank that had become insolvent. In July 1996, Old Santander-Chile was merged into Banco Osorno y la Unión becoming “Banco Santander-Chile”, the third largest private bank in terms of outstanding loans at that date. The combined efficiency ratio of the merged bank decreased from 63.1% on a combined basis as of year-end 1995 to 44.5% as of year-end 2001.

 

Santiago was founded in 1977 and by 1982 had become the second largest private sector Chilean bank in terms of outstanding loans. In January 1997, Santiago merged with Banco O’Higgins with Santiago being the surviving entity. In 1999, Santiago became a controlled subsidiary of Banco Santander Central Hispano. As of June 30, 2002, Santiago was the second largest private sector bank in Chile in terms of total assets, deposits, loans and shareholders’ equity. Following the merger with Banco O’Higgins, the combined efficiency ratio of the merged bank decreased to 49.1% as of year-end 2001 from 56.9% on a combined basis as of year-end 1996.

 

Our principal executive offices are located at Bandera 140, Santiago, Chile (our telephone number is 011-562-320-2000 and our website is www.santandersantiago.cl).

 

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Relationship with Banco Santander Central Hispano

 

We believe that our relationship with our controlling shareholder, Banco Santander Central Hispano, offers us a significant competitive advantage over our peer Chilean banks. Banco Santander Central Hispano is one of the largest financial groups in Latin America, in terms of total assets measured on a region-wide basis, and a leading financial institution in Europe. Banco Santander Central Hispano’s principal operations are in Spain, Portugal, Germany, Italy, Belgium and Latin America. Banco Santander Central Hispano also has significant operations in New York, Puerto Rico and London, as well as strategic investments in The Royal Bank of Scotland Group, and financial investments in Commerzbank, San Paolo-IMI and Banque Commerciale du Maroc. In Latin America, Banco Santander Central Hispano has majority shareholdings in banks in Argentina, Bolivia, Brazil, Chile, Colombia, Mexico, Uruguay and Venezuela.

 

Our relationship with Banco Santander Central Hispano provides us with access to the group’s client base, while its multinational focus allows us to offer international solutions to our clients’ financial needs. We also have the benefit of selectively borrowing from Banco Santander Central Hispano’s product offerings in other countries. Banco Santander Central Hispano has extensive experience in developing innovative financial products, particularly in the areas of residential mortgages, bancassurance and savings products.

 

We believe that our relationship with Banco Santander Central Hispano will also enhance our ability to manage credit and market risks by adopting policies and know-how developed by Banco Santander Central Hispano. Our internal auditing function has been strengthened and is more independent from management as a result of the addition of an internal auditing department that concurrently reports directly to our credit committee and the audit committee of Banco Santander Central Hispano. We believe that this structure leads to greater monitoring and control of our exposure to operational risks.

 

Banco Santander Central Hispano’s support includes the assignment of managerial personnel to key supervisory areas of Santander Chile, like Credit Risk, Auditing, Accounting and Financial Control. Santander Chile does not pay any management fees to Banco Santander Central Hispano in connection with these or other support services.

 

Merger Update

 

We completed the merger integration process in 2003. The last major areas to be integrated were information systems (in the Operations and Technology area), and branch network, which were the most sensitive to changes and their integration was deferred to minimize disruption of client services. We substantially completed the integration of systems and integrated the branch network on April 17, 2003.

 

B. Organizational Structure

 

The following table sets forth our significant subsidiaries as of December 31, 2003, including the principal activity, ownership interest and, if different, percentage of voting power held by us. All of our significant subsidiaries are incorporated in Chile.

 

     Percentage Owned

     2002

   2003

     Direct

   Indirect

   Total

   Direct

   Indirect

   Total

     %    %    %    %    %    %

Subsidiary

                             

Santiago Leasing S.A.

   99.50    0.50    100.00    99.50    —      99.50

Santiago Corredores de Bolsa Ltda.

   99.19    0.81    100.00    99.19    0.81    100.00

Santander S.A. Administradora General de Fondos

   99.96    0.04    100.00    99.96    0.04    100.00

Cobranzas y Recaudaciones Ltda. (C y R)

   99.90    0.10    100.00    —      —      —  

Santiago Factoring Ltda.

   99.90    0.10    100.00    —      —      —  

Santander S.A. Agente de Valores

   99.03    —      99.03    99.03    —      99.03

Santander Administradora de Fondos Mutuos S.A.

   99.96    —      99.96    —      —      —  

Santander S.A. Sociedad Securitizadora

   99.64    —      99.64    99.64    —      99.64

Corredora de Seguros Santander Ltda.

   99.99    —      99.99    99.99    —      99.99

 

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On April 25, 2003, Santander Administradora de Fondos Mutuos S.A. was absorbed by Santander S.A. Administradora General de Fondos. On October 31, 2003, the subsidiary Cobranzas y Recaudaciones Ltda. (C y R) was sold to America Consulting S.A. On December 1, 2003, Santiago Factoring Ltda was absorbed by the Bank.

 

The following chart shows Banco Santander Central Hispano’s ownership structure of us as of December 31, 2003.

 

LOGO

 

Management Team

 

The chart below sets forth the names and areas of responsibility of our senior commercial managers.

 

Commercial Structure

 

LOGO

 

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The chart below sets forth the names and areas of responsibilities of our operating managers.

 

Operating Structure

 

LOGO


* Employees of other companies owned by Santander Central Hispano in Chile.

 

Santiago Express

 

In the fourth quarter of 2003, the Bank and Almacenes Paris, the third largest retailer in Chile, announced a strategic alliance to strengthen commercial synergies between both entities and offer exclusive benefits to their clients. The main point of this agreement were the following:

 

  Santander-Chile will transfer to Banco Paris (in formation) part of the financial assets and branch network of Santander-Chile’s Santiago Express division, and the hiring of this division’s personnel, which will be the core structure of the future Banco Paris. The final value of this transaction is subject to due diligence, which should be concluded in 2004.

 

  Santander-Chile will have the option to acquire the financial assets of the Prime (high-income) customers of Almacenes Paris, which will become part of the Bank’s retail banking business segment.

 

  Santander-Chile will technically evaluate the access of Almacenes Paris’ and Banco Paris’ customers to Santander-Chile’s ATM network, the largest in Chile.

 

  Santander-Chile and Almacenes Paris will develop and extend all their loyalty and affinity programs, offering innovative and exclusive benefits to both client bases.

 

  Santander-Chile customers will be allowed to use their debit cards in Almacenes Paris stores.

 

  Almacenes Paris will also distribute through its retail stores some of Santander-Chile’s financial products and services.

 

The finalization of this agreement is subject to the approval of the Superintendency of Banks and to the results of a due diligence process by both parties, which should be concluded during 2004.

 

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Capital Expenditures

 

The following table reflects capital expenditures in each of the three years ended December 31, 2001, 2002 and 2003.

 

     Years ended December 31,

     2001

   2002

   2003

    

(in millions of constant Ch$ of

December 31, 2003)

Land and Buildings

   2,322    1,920    6,893

Machinery and Equipment

   5,871    4,904    6,325

Furniture and Fixtures

   486    1,540    1,058

Vehicles

   345    788    412

Other

   199    6,652    1,993
    
  
  

Total

   9,223    15,804    16,681
    
  
  

 

For a discussion of our capital expenditures for the past three fiscal years and our projected expenditures for 2002, see “Item 5: Operating and Financial Review and Prospects—Capital Expenditures.”

 

C. Business Overview

 

Our internal organization is structured on the basis of the client segments we serve. We provide a full range of financial services to corporate and individual customers through two major business units: Retail Banking and Wholesale Banking.

 

Retail Banking

 

This segment includes lending carried out through our branch network primarily to individuals, medium and small companies and micro-businesses. Retail Banking offers customers a range of products, including consumer loans, credit cards, auto loans, commercial loans, foreign trade financing and residential mortgage loans. As of December 31, 2003, retail banking represented 51.5% of our total loans outstanding. As of the same date, we had 345 total branches, 64 of which operated under the Banefe brand name and 35 under the Santiago Express brand name. The remaining 246 branches are operated under the newly created Santander Santiago brand name.

 

We divide clients in this segment into the following sub-segments:

 

  Middle- and upper-income, consisting of individuals with a monthly income of Ch$500,000 (US$833) and above. This segment accounts for 31.8% of our loans as of December 31, 2003.

 

  Lower-middle to middle-income, consisting of individuals with monthly income between Ch$150,000 (US$250) and Ch$500,000 (US$833), which are served through our Banefe division. This segment accounts for 4.4% of our loans as of December 31, 2003.

 

  Small businesses, consisting of small companies with annual sales between Ch$96 million (US$160,000) and Ch$800 million (US$1.3 million). As of December 31, 2003, small companies represented approximately 14.1% of our total loans outstanding.

 

  Middle-market companies, consisting of companies with annual sales between Ch$800 million (US$1.3 million) and Ch$3.5 billion (US$5.8 million). As of December 31, 2003, medium-sized companies represented 5.7% of our total loans outstanding. In 2003, this segment was reclassified from wholesale banking to retail banking.

 

Wholesale Banking

 

Customers in this segment include medium-sized real estate companies and large domestic and multinational companies. The Wholesale Banking business includes commercial lending, leasing, factoring, infrastructure construction financing, trade financing and financial advisory, payment and cash management services. We also

 

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provide a diversified range of treasury and risk management products to these customers. In addition, we finance real estate construction and significant infrastructure projects. Customers of this group have annual sales in excess of Ch$3.5 billion (US$4.9 million) (Ch$800 million (US$1.3 million) in the case of real estate developers) and represented 40.2% of our total loans outstanding as of December 31, 2003.

 

We divide clients in this segment into the following sub-segments:

 

  Multinationals, consisting of companies with annual sales in excess of Ch$12.5 billion (US$20.9 million). As of December 31, 2003, these clients represented 22.6% of our total loans outstanding.

 

  Large corporations, consisting of companies with annual sales in excess of Ch$3.5 billion (US$4.9 million). As of December 31, 2003, these clients represented 12.3% of our total loans outstanding.

 

  Real estate, consisting mainly of companies in the real estate sector with annual sales in excess of Ch$800 million (US$1.3 million). As of December 31, 2003, these clients represented 5.4% of our total loans outstanding.

 

The table below sets forth our lines of business and certain statistical information relating to each of them as of December 31, 2003.

 

     As of December 31, 2003

Segment


   Net Interest
Revenue (1)


   Fees & Income
from Services


   Net Loan Loss
Allowances(2)


    Net Client
Contribution (3)


     (millions of constant Ch$ as of December 31, 2003, except for
percentages)

Retail Banking(1)

   312,351    80,406    (79,786 )   312,971

Wholesale Banking

   57,763    13,935    438     72,136

Others(4)

   84,529    17,498    11,929     113,956
    
  
  

 

Total

   454,643    111,839    (67,419 )   499,063
    
  
  

 

(1) Includes net interest revenue and foreign exchange transactions, net.
(2) Includes allowances for loan losses, charge-offs and loan loss recoveries.
(3) Equal to net interest revenue plus fee income minus allowances for loan losses.
(4) Includes contribution of Bank subsidiaries and other non-segmented items.

 

Operations through Subsidiaries

 

The General Banking Law once restricted the ability of banks to provide non-banking financial services. Beginning in 1986, the restrictions were somewhat eased, allowing banks to provide services deemed to be complementary to the commercial banking business, provided that the services are offered through subsidiaries.

 

The new General Banking Law, as amended on November 4, 1997, extended the scope of permissible activities to permit us to provide directly the leasing and financial advisory services we could formerly offer only through our subsidiaries, to offer investment advisory services outside of Chile and to undertake activities we could not formerly offer directly or through subsidiaries, such as factoring, securitization, foreign investment funds, custody and transport of securities and insurance brokerage services (except social security insurance).

 

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For the year ended December 31, 2003, our subsidiaries collectively accounted for approximately 14.6% of our consolidated net income. The assets and operating income of these subsidiaries as of December 31, 2003 represented 7.8% and 10.3% of our total assets and operating income, respectively.

 

     Percentage Owned

     2002

   2003

     Direct

   Indirect

   Total

   Direct

   Indirect

   Total

     %    %    %    %    %    %

Subsidiary

                             

Santiago Leasing S.A.

   99.50    0.50    100.00    99.50    —      99.50

Santiago Corredores de Bolsa Ltda.

   99.19    0.81    100.00    99.19    0.81    100.00

Santander S.A. Administradora General de Fondos

   99.96    0.04    100.00    99.96    0.04    100.00

Cobranzas y Recaudaciones Ltda. (C y R)

   99.90    0.10    100.00    —      —      —  

Santiago Factoring Ltda.

   99.90    0.10    100.00    —      —      —  

Santander S.A. Agente de Valores

   99.03    —      99.03    99.03    —      99.03

Santander Administradora de Fondos Mutuos S.A.

   99.96    —      99.96    —      —      —  

Santander S.A. Sociedad Securitizadora

   99.64    —      99.64    99.64    —      99.64

Corredora de Seguros Santander Ltda.

   99.99    —      99.99    99.99    —      99.99

On April 25, 2003 Santander Administradora de Fondos Mutuos S.A. was absorbed by Santander S.A. Administradora General de Fondos. On October 31, 2003 the subsidiary Cobranzas y Recaudaciones Ltda. (C y R) was sold to America Consulting S.A. On December 1, 2003 Santiago Factoring Ltda. was absorbed by the Bank.

 

Competition

 

Overview

 

The Chilean financial services market consists of a variety of largely distinct sectors. The most important sector, commercial banking, includes a number of privately-owned banks and one public sector bank, Banco del Estado (which operates within the same legal and regulatory framework as the private sector banks). The private sector banks, in turn, have traditionally been divided between those that are Chilean-owned, i.e., controlled by a Chilean entity and a number of foreign-owned banks which are operated in Chile but controlled by a foreign entity. The Chilean banking system is comprised of 25 private sector banks and one public sector bank. Three private sector banks along with the state-owned bank together accounted for 63.8% of all outstanding loans by Chilean financial institutions as of December 31, 2003.

 

The Chilean banking system has experienced increased competition in recent years largely due to consolidation in the industry and new legislation. For example, the merger of Banco de Chile with Banco de A. Edwards, effective January 2, 2002, resulted in the creation at that moment of the largest bank in Chile. As of December 31, 2003 Banco de Chile had a market share in total loans of 18.1%. Shortly after that merger was effective, Santander Central Hispano announced the merger of the two banks it owned in Chile, Banco Santander-Chile and Banco Santiago, creating the largest bank in Chile. Commercial banks face increasing competition from other financial intermediaries who can provide larger companies with access to the capital markets as an alternative to bank loans. The enactment of the Capital Markets Reform Bill in 2001, has made it more tax-advantageous and easier for companies to issue commercial paper, adding an additional financing alternative. To the extent permitted by the General Banking Law, we seek to maintain a competitive position in this respect through the investment banking activities of our subsidiaries.

 

Under the General Banking Law, a bank must have a minimum of UF800,000 (Ch$13,536 million or approximately US$22.6 million) in paid-in capital and reserves. However, following the approval of the Capital Markets Reform Bill a bank may begin its operations with 50.0% of such amount, provided that it has a total capital ratio (effective capital to risk weighted assets) of not less than 12.0%. When the paid-in capital reaches UF600,000 (approximately Ch$10,152 million or approximately US$16.9 million) the required total capital ratio will be reduced to 10.0% of its risk weighted assets.

 

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As shown in the following table, as a result of the merger we are the market leader in practically every aspect of the banking industry in Chile:

 

     Market Share
at December
31, 2003


    Rank as of
December 31,
2003


Commercial loans

   19.9 %   1

Consumer loans

   24.5     1

Mortgage loans (residential and general purpose)

   23.3     1

Residential mortgage loans

   21.9     2

Foreign trade loans (loans for export, import and contingent)

   27.3     1

Total loans

   22.6     1

Deposits

   19.0     1

Mutual funds (assets managed)

   20.3     2

Credit card accounts

   30.5     1

Branches (1)

   21.8     1

ATM locations

   28.5     1

Source: Superintendency of Banks (unconsolidated data).

(1) Excluding special-service payment centers.

 

The following tables set out certain statistics comparing our market position in comparison to our peer group, defined as the five largest banks in Chile in terms of shareholders’ equity as of December 31, 2003.

 

Loans

 

As of December 31, 2003, our loan portfolio was the largest among Chilean banks. Our unconsolidated portfolio represented 22.6% of the market for loans in the Chilean financial system (comprising all commercial banks and finance companies) as of such date. The following table sets forth the market shares in terms of loans for us and our peer group as of December 31, 2003:

 

     As of December 31, 2003

 

Loans(1)


   Ch$ million

   In thousand of
US$


   Market
Share


 

Santander-Chile

   7,554,175    12,602,474    22.6 %

Banco de Chile

   6,074,122    10,133,332    18.1 %

Banco del Estado

   4,456,446    7,434,597    13.3 %

Banco de Crédito e Inversiones

   3,684,265    6,146,383    11.0 %

BBVA, Chile

   2,407,741    4,016,785    7.2 %
    
  
  

Total

   24,176,749    40,333,571    72.2 %
    
  
  


Source: Superintendency of Banks (unconsolidated data).

(1) Because the method of classification of assets used by the Superintendency of Banks, this information differs in minor respects from that used by us for accounting purposes, the amounts in this table may differ from the figures included in our financial statements and those of our predecessor banks.

 

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Table of Contents

Deposits

 

In unconsolidated terms, our 19.9% of the market for deposits ranks us in first place among banks. The following table sets forth the market shares in terms of deposits for us and our peer group as of December 31, 2003:

 

     As of December 31, 2003

 

Deposits(1)


   Ch$ million

   In thousand of
US$


   Market
Share


 

Santander-Chile

   5,592,486    9,329,829    19.9 %

Banco de Chile

   4,867,113    8,119,704    17.3  

Banco del Estado

   4,406,461    7,351,208    15.7  

Banco de Crédito e Inversiones

   3,031,560    5,057,489    10.8  

BBVA, Chile

   2,174,925    3,628,382    7.7  
    
  
  

Total

   20,072,545    33,486,611    71.4  
    
  
  


Source: Superintendency of Banks (unconsolidated basis).

(1) Because the method of classification of assets used by the Superintendency of Banks, this information differs in minor respects from that used by us for accounting purposes, the amounts in this table may differ from the figures included in our financial statements and those of our predecessor banks.

 

Shareholders’ equity

 

With Ch$1,071,391 million (US$1,697 million) in shareholders’ equity, as of December 31, 2003, we were the largest commercial bank in Chile in terms of shareholders’ equity. The following table sets forth the level of shareholders’ equity for us and our peer group as of December 31, 2003:

 

     As of December 31, 2003

 

Equity(1)


   Ch$ millions

   In thousands of
US$


   %(1)

 

Santander-Chile(1)

   1,017,392    1,697,295    23.4 %

Banco de Chile

   695,676    1,160,582    16.0  

Banco del Estado

   378,934    632,168    8.7  

Banco de Crédito e Inversiones

   361,536    603,143    8.3  

BBVA, Chile

   264,579    441,392    6.1  
    
  
  

Total

   2,718,116    4,534,577    62.5  
    
  
  


Source: Superintendency of Banks.

(1) Percentage of total shareholders’ equity of financial system.

 

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Efficiency

 

As of December 31, 2003, on an unconsolidated basis we were the most efficient bank in our peer group. The following table sets forth the efficiency ratio (defined as operating expenses divided by operating income) for us and our peer group as of December 31, 2003:

 

     As of December
31, 2003


 

Efficiency ratio


   %

 

Santander-Chile

   43.6 %

Banco de Chile

   50.5  

Banco del Estado

   62.7  

Banco de Crédito e Inversiones

   49.3  

BBVA, Chile

   55.0  

Chilean Financial System

   53.2  

Source: Superintendency of Banks (unconsolidated data).

 

Return on capital

 

As of December 31, 2003, we were the second most profitable bank in our peer group. The following table sets forth the annualized return on capital (as defined by the Superintendency of Banks) for us and our peer group as of December 31, 2003:

 

     As of December 31,
2003


 

Return on Capital


   %

 

Santander-Chile

   25.5 %

Banco de Chile

   23.1  

Banco del Estado

   8.5  

Banco de Crédito e Inversiones

   25.6  

BBVA, Chile

   11.4  

Chilean Financial System

   16.6  

Source: Superintendency of Banks (unconsolidated data).

 

Asset Quality

 

As of March 31, 2004, on an unconsolidated basis, we had the third best loan loss allowance to total loans ratio in our peer group. The following table sets forth the ratio of loan loss allowance to total loans ratio as defined by the Superintendency of Banks. This ratio replaced the risk index in 2004.

 

Mar-04


   As of March 31, 2004
Loan Loss allowances/total loans


Santander-Chile

   1.96

Banco de Chile

   2.79

Banco del Estado

   2.04

Banco de Crédito e Inversiones

   1.95

BBVA, Chile

   1.80

 

Source: Superintendency of Banks (unconsolidated data).

 

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D. Regulation and Supervision

 

General

 

In Chile, only banks may maintain checking accounts for their customers, conduct foreign trade operations, and together with financial companies, accept time deposits. The principal authorities that regulate financial institutions in Chile are the Superintendency of Banks and the Central Bank. Chilean banks are primarily subject to the General Banking Law and secondarily, to the extent not inconsistent with this statute, the provisions of the Chilean Corporations Law governing public corporations, except for certain provisions which are expressly excluded.

 

The modern Chilean banking system dates from 1925 and has been characterized by periods of substantial regulation and state intervention, as well as periods of deregulation. The most recent period of deregulation commenced in 1975 and culminated in adoption of a series of amendments to General Banking Law. That law, amended most recently in 2001, granted additional powers to banks, including general underwriting powers for new issues of certain debt and equity securities and the power to create subsidiaries to engage in activities related to banking, such as brokerage, investment advisory, mutual fund services, administration of investment funds, factoring, securitization products and financial leasing services. Following the Chilean banking crisis during 1982 and 1983, the Superintendency of Banks assumed control of 21 financial institutions representing approximately 51% of the total loans in the banking system. As part of the solution to this crisis, the Central Bank permitted financial institutions to sell to it a certain portion of their problem loan portfolios, at the book value of such loan portfolios. Each institution then repurchased such loans at their economic value (which, in most cases, was much lower than the book value at which the Central Bank had acquired the loans) and the difference was to be repaid to the Central Bank out of future income. Pursuant to Law No. 18,818, which was passed in 1989, this difference was converted into a subordinated obligation with no fixed term, known as “deuda subordinada” or subordinated debt which, in case of liquidation of the institution, would be paid after the institution’s other debts had been paid in full.

 

The Central Bank

 

The Central Bank is an autonomous legal entity created by the Chilean Constitution. It is subject to the Chilean Constitution and its own ley organica constitucional, or organic constitutional law. To the extent not inconsistent with the Chilean Constitution or the Central Bank’s organic constitutional law, the Central Bank is also subject to private sector laws (but in no event is it subject to the laws applicable to the public sector). It is directed and administered by a board of directors composed of five members designated by the President of Chile, subject to the approval of the Senate.

 

The legal purpose of the Central Bank is to maintain the stability of the Chilean peso and the orderly functioning of Chile’s internal and external payment system. The Central Bank’s powers include setting reserve requirements, regulating the amount of money and credit in circulation, establishing regulations and guidelines regarding finance companies, foreign exchange (including the Formal Exchange Market) and banks’ deposit-taking activities.

 

The Superintendency of Banks

 

Banks are supervised and controlled by the Superintendency of Banks, an independent Chilean governmental agency. The Superintendency of Banks authorizes the creation of new banks and has broad powers to interpret and enforce legal and regulatory requirements applicable to banks and financial companies. Furthermore, in case of noncompliance with such legal and regulatory requirements, the Superintendency of Banks has the ability to impose sanctions. In extreme cases, it can appoint, with the prior approval of the board of directors of the Central Bank, a provisional administrator to manage a bank. It must also approve any amendment to a bank’s bylaws or any increase in its capital.

 

The Superintendency of Banks examines all banks from time to time, generally at least once a year. Banks are also required to submit their financial statements monthly to the Superintendency of Banks, and a bank’s financial statements are published at least four times a year in a newspaper with countrywide coverage. In addition, banks are required to provide extensive information regarding their operations at various periodic intervals to the

 

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Superintendency of Banks. A bank’s annual financial statements and the opinion of its independent auditors must also be submitted to the Superintendency of Banks.

 

Any person wishing to acquire, directly or indirectly, 10.0% or more of the share capital of a bank must obtain the prior approval of the Superintendency of Banks. The absence of such approval will cause the holder of such shares so acquired not to have the right to vote such shares. The Superintendency of Banks may only refuse to grant its approval, based on specific grounds set forth in the General Banking Law.

 

According to Article 35 bis of the General Banking Law, the prior authorization of the Superintendency of Banks is required for:

 

  the merger of two or more banks;

 

  the acquisition of all or a substantial portion of a banks’ assets and liabilities by another bank;

 

  the control by the same person, or controlling group, of two or more banks; or

 

  a substantial increase in the share ownership of a bank by a controlling shareholder of that bank.

 

Such prior authorization is required solely when the acquiring bank or the resulting group of banks would own a significant market share in loans, defined by the Superintendency of Banks to be more than 15.0% of all loans in the Chilean banking system. The intended purchase may be denied by the Superintendency of Banks; alternatively, the purchase may be conditioned on one or more of the following:

 

  that the bank or banks maintain an effective equity higher than 8.0% and up to 14.0% of their risk weighted assets;

 

  that the technical reserve established in article 65 of the General Banking Law be applicable when deposits exceed one and a half times the resulting bank’s paid-in capital and reserves; or

 

  that the margin for interbank loans be diminished to 20.0% of the resulting bank’s effective equity.

 

Pursuant to the regulations of the Superintendency of Banks, the following ownership disclosures are required:

 

  banks are required to inform the Superintendency of Banks of the identity of any person owning, directly or indirectly, 5.0% or more of such banks’ shares;

 

  holders of ADSs must disclose to the depositary the identity of beneficial owners of ADSs registered under such holders’ names; and

 

  the depositary is required to notify the bank as to the identity of beneficial owners of ADSs which such depositary has registered and the bank, in turn, is required to notify the Superintendency of Banks as to the identity of the beneficial owners of the ADSs representing 5.0% or more of such bank’s shares.

 

Limitations on Types of Activities

 

Chilean banks can only conduct those activities allowed by the General Banking Law: making loans, accepting deposits and, subject to limitations, making investments and performing financial services. Investments are restricted to real estate for the bank’s own use, gold, foreign exchange and debt securities. Through subsidiaries, banks may also engage in other specific financial service activities such as securities brokerage services, mutual fund management, investment fund management, financial advisory and leasing activities. Subject to specific limitations and the prior approval of the Superintendency of Banks and the Central Bank, Chilean banks may own majority or minority interests in foreign banks.

 

On March 2, 2002, the Central Bank of Chile authorized banks to pay interest on checking accounts. On March 20, 2002, the Superintendency of Banks published guidelines establishing that beginning on June 1, 2002, banks could offer a new checking account product that pays interest. The Superintendency of Banks also stated that these accounts may be subject to minimum balance limits and different interest rates depending on average balances held

 

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in the account. This product is optional and banks may also charge fees for the use of this new product. For banks with a solvency score of less than A (See Item 4B: Chilean Regulation and Supervision—Management and Capitalization Evaluation) the Central Bank has also imposed additional caps to the interest rate that can be charged.

 

Deposit Insurance

 

In Chile, the State guarantees up to 90.0% of the principal amount of certain time and demand deposits held by natural persons. The State guarantee covers those obligations with a maximum value of UF120 per person (Ch$2,009,294 or U.S.$2,821 as of December 31, 2002) per calendar year.

 

Reserve Requirements

 

Deposits are subject to a reserve requirement, of 9.0% for peso-denominated demand deposits, 3.6% for UF- and peso-denominated time deposits, 19.0% for dollar-denominated and other foreign currency denominated demand deposits and 13.6% for dollar-denominated and other foreign currency denominated time deposits (with terms of less than one year). Banks are authorized to deduct daily from their foreign currency denominated liabilities subject to reserve requirement, the balance in foreign currency of certain loans and financial investments held outside of Chile. The deductions should be done as follows:

 

  first, term liabilities denominated in foreign currency and subject to reserve requirements;

 

  second, if there is any positive difference, demand liabilities denominated in foreign currency and subject to reserve requirements; and

 

  finally, foreign loans subject to reserve requirements. The total amount deductible cannot exceed 70.0% of a bank’s effective equity.

 

The Central Bank has statutory authority to increase reserve requirements up to an average of 40.0% for demand deposits (of any denomination) and up to 20.0% for time deposits (of any denomination) to implement monetary policy. In addition, a 100.0% technical reserve applies to demand deposits, deposits in checking accounts, or obligations payable on sight incurred in the ordinary course of business, other deposits unconditionally payable immediately or within a term of less than 30 days and time deposits payable within 10 days prior to maturity, to the extent their aggregate amount exceeds 2.5 times the amount of a bank’s paid-in capital and reserves.

 

Minimum Capital

 

Under the General Banking Law, a bank must have a minimum paid-in capital and reserves of UF800,000 (Ch$13,536 million or U.S.$22.6 million as of December 31, 2003). However, a bank may begin its operations with 50.0% of such amount, provided that it has a total capital ratio (defined as effective equity as a percentage of risk weighted assets) of not less than 12.0%. When such a bank’s paid-in capital reaches UF600,000 (Ch$10,152 million or U.S.$16.9 million as of December 31, 2003) the total capital ratio required is reduced to 10.0%.

 

Capital Adequacy Requirements

 

According to the General Banking Law, each bank should have an effective equity of at least 8.0% of its risk weighted assets, net of required allowances. Effective equity is defined as the aggregate of:

 

  a bank’s paid-in capital and reserves, excluding capital attributable to subsidiaries and foreign branches;

 

  its subordinated bonds, considered at the issuing price (but decreasing 20.0% for each year during the period commencing six years prior to maturity), but not exceeding 50.0% of its Net Capital Base; and

 

  its voluntary allowances for loan losses, up to 1.25% of risk weighted assets.

 

Banks should also have Capital basico, or Net Capital Base, of at least 3.0% of its total assets, net of allowances. Net Capital Base, is defined as a bank’s paid-in capital and reserves and is similar to Tier 1 capital except that it does not include net income for the period. An amendment to the General Banking Law enacted on

 

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November 7, 2001, eliminated the exclusion of the investment in subsidiaries and foreign branches from the calculation of Net Capital Base.

 

The calculation of risk weighted assets is based on a five category risk classification system to be applied to a bank asset that is based on the Basle Committee recommendations.

 

Lending Limits

 

Under the General Banking Law, Chilean banks are subject to certain lending limits, including the following material limits:

 

  A bank may not extend to any entity or individual (or any one group of related entities), directly or indirectly, unsecured credit in an amount that exceeds 5.0% of the bank’s effective equity, or in an amount that exceeds 25.0% of its effective equity if the excess over 5.0% is secured by certain assets with a value equal to or higher than such excess. In the case of foreign export trade financing, the 5.0% ceiling for unsecured credits is raised to 10.0% and the 25.0% ceiling for secured credits to 30.0%. In the case of financing infrastructure projects built through the concession mechanism, the 5.0% ceiling for unsecured credits is raised to 15.0% if secured by a pledge over the concession, or if granted by two or more banks or finance companies which have executed a credit agreement with the builder or holder of the concession;

 

  a bank may not extend loans to another financial institution subject to the General Banking Law in an aggregate amount exceeding 30.0% of its effective equity;

 

  a bank may not directly or indirectly grant a loan whose purpose is to allow an individual or entity to acquire shares of the lender bank;

 

  a bank may not lend, directly or indirectly, to a director or any other person who has the power to act on behalf of the bank; and

 

  a bank may not grant loans to related parties (including holders of more than 5.0% of its shares) on more favorable terms than those generally offered to non-related parties. Loans granted to related parties are subject to the limitations described in the first bullet point above. In addition, the aggregate amount of loans to related parties may not exceed a bank’s regulatory capital.

 

In addition, the General Banking Law limits the aggregate amount of loans that a bank may grant to its employees to 1.5% of its effective equity, and provides that no individual employee may receive loans in excess of 10.0% of this 1.5% limit. Notwithstanding these limitations, a bank may grant to each of its employees a single residential mortgage loan for personal use once during such employee’s term of employment.

 

Allowance for Loan Losses

 

Chilean banks are required to provide to the Superintendency of Banks detailed information regarding their loan portfolio on a monthly basis. Each bank is also required to maintain a global allowance for loan losses, the amount of which must at least equal the aggregate amount of its outstanding loans multiplied by the greater of (1) its “risk index” or (2) 0.75%. See Item 5D: Asset and Liability Management—Selected Statistical Information” for an explanation of the “risk index” and other information regarding allowance for loan losses.

 

Banks in Chile are also required to maintain an individual allowance for loans on which any payment of principal or interest is 90 days or more overdue. An individual allowance for loan losses equal to 100.0% of the past due portion of such past due loan is required to the extent that the loan is unsecured. In the event that non-payment of a portion of a loan permits a bank to accelerate the loan, and the bank commences legal proceedings against the debtor to collect the full amount of the loan, the individual loan loss reserve must be equal to 100.0% of the loan within 90 days as of the filing of the lawsuit. The Superintendency of Banks has ruled that in the case of past due loans, individual loans loss reserves should be made only for the difference between 100.0% of the past due portion of a past due loan (or the full amount of the loan if the preceding sentence applies) and the reserve made for such loan when calculating the global loan loss reserve. A bank may also voluntarily maintain additional allowances for

 

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loan losses in excess of the minimum amounts required as global and individual allowances. SeeItem 5D: Asset and Liability Management—Selected Statistical Information.

 

New Regulations

 

The Superintendency of Banks presently examines and evaluates each financial institution’s credit management process, including its compliance with the loan classification guidelines, and on that basis classifies banks and other financial institutions into three categories: I, II and III. Category I is reserved for institutions that fully comply with the loan classification guidelines. Institutions are rated as Category II if their loan classification system has deficiencies that must be corrected by the bank’s management. Category III indicates significant deviations from the Superintendency of Banks’ guidelines that clearly reflect inadequacies in the evaluation of the risk and estimated losses associated with loans. We have been classified as a Category I bank since December 1991 (this classification system was established by the Superintendency of Banks in 1990 and has been applied to us since 1991).

 

In accordance with the new regulation, banks will be classified in categories 1, 2, 3 and 4. The category of each bank will depend on the models and methods used by the bank to classify its loan portfolio, as determined by the Superintendency of Banks. Category 1 banks will be those banks whose methods and models are satisfactory to the Superintendency of Banks. Category 1 banks will be entitled to continue using the same methods and models they currently have in place. A bank classified as a category 2 bank will have to maintain the minimum levels of reserves established by the Superintendency of Banks while its board of directors is made aware of the problems detected by the Superintendency of Banks and takes steps to correct them. Finally, banks classified as categories 3 and 4 banks will have to maintain the minimum levels of reserves established by the Superintendency of Banks until they are authorized by the Superintendency of Banks to do otherwise.

 

Under the new classifications, loans are divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the acquisition of consumer goods or payment of services); (ii) residential mortgage loans (including loans granted to individuals for the acquisition, construction or repair of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); (iii) leasing operations (including consumer leasing, commercial leasing and residential leasing); (iv) factoring operations and (v) commercial loans (includes all loans other than consumer loans and residential mortgage loans).

 

In accordance with the new regulations, which became effective as of January 1, 2004, the models and methods used to classify our loan portfolio must follow the following guiding principles, which have been established by the Superintendency of Banks.

 

Models based on the individual analysis of borrowers

 

  Must assign a risk category level to each borrower and its respective loans.

 

  Must consider the following risk factors within the analysis: industry or sector of the borrower, owners or managers of the borrower, their financial situation, their payment capacity and payment behavior.

 

  Must assign one of the following risk categories to each loan and borrower upon finishing the analysis:

 

  Classifications A1, A2 and A3, correspond to borrowers with no apparent credit risk.

 

  Classifications B, correspond to borrowers with some credit risk but no apparent deterioration of payment capacity.

 

  Classifications C1, C2, C3, C4, D1 and D2 correspond to borrowers whose loans have deteriorated.

 

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For loans classified as A1, A2, A3 and B, the board of directors of a bank is authorized to determine the levels of required reserves. For loans classified in Categories C1, C2, C3, C4, D1 and D2, the bank must have the following levels of reserves:

 

Classification


  

Estimated range of loss


   Reserve

C1

   Up to 3%          2%

C2

   More than 3% up to 19%    10

C3

   More than 19% up to 29%    25

C4

   More than 29% up to 49%    40

D1

   More than 49% up to 79%    65

D2

   More than 79%    90

 

Models based on group analysis

 

  Suitable for the evaluation of a large number of borrowers whose individual loan amounts are relatively small. These models are intended to be used primarily to analyze loans to individuals and small companies.

 

  Levels of required reserves are to be determined by the Bank, according to the estimated loss that may result from the loans, by classifying the loan portfolio using one or both of the following models:

 

  A model based on the characteristics of the borrowers and their outstanding loans. Borrowers and their loans with similar characteristics will be placed into groups and each group will be assigned a risk level.

 

  A model based on the behavior of a group of loans. Loans with analogous past payment histories and similar characteristics will be placed into groups and each group will be assigned a risk level.

 

Additional Reserves

 

Effective January 1, 2004, banks are permitted to create reserves above the limits described above only to cover specific risks that have been authorized by their board of directors. The concept of voluntary reserves has been eliminated by the new regulation.

 

Obligations Denominated in Foreign Currencies

 

Foreign currency denominated obligations of Chilean banks are subject to four requirements.

 

  There is a reserve requirement of 19.0% for dollar-denominated and other foreign currency denominated demand deposits and obligations and 13.6% in respect of dollar-denominated and other foreign currency denominated time deposits and obligations, excluding foreign currency denominated obligations with a maturity of more than one year. See “—Reserve Requirements above”;

 

  A bank’s risk adjusted net asset (liability) foreign currency position cannot exceed 20% of its Net Capital Base;

 

  Under Central Bank regulations applicable since August 31, 1999, (1) the aggregate amount of our net foreign currency liabilities having an original maturity of less than 30 days cannot exceed our Net Capital Base and (2) the aggregate amount of our net foreign currency liabilities having an original maturity of less than 90 days cannot exceed twice our Net Capital Base; and

 

  After June 30, 2000, the interest rate mismatches of our foreign currency liabilities may not exceed 8.0% of our Net Capital Base.

 

Capital Markets

 

Under the General Banking Law, banks in Chile may purchase, sell, place, underwrite and act as paying agents with respect to certain debt securities. Likewise, banks in Chile may place and underwrite certain equity securities. Bank subsidiaries may also engage in debt placement and dealing, equity issuance advice and securities brokerage,

 

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as well as in financial leasing, mutual fund and investment fund administration, investment advisory services and merger and acquisition services. These subsidiaries are regulated by the Superintendency of Banks and, in some cases, also by the Superintendency of Securities and Insurance, the regulator of the Chilean securities market and of open-stock corporations.

 

Legal Provisions Regarding Banking Institutions with Economic Difficulties

 

The General Banking Law provides that if specified adverse circumstances exist at any bank, its board of directors must correct the situation within 30 days from the date of receipt of the relevant financial statements. If the board of directors is unable to do so, it must call a special shareholders’ meeting to increase the capital of the bank by the amount necessary to return the bank to financial stability. If the shareholders reject the capital increase, or if it is not effected within the term and in the manner agreed to at the meeting, or if the Superintendency of Banks does not approve the board of directors proposal, the bank will be barred from increasing its loan portfolio beyond that stated in the financial statements presented to the board of directors and from making any further investments in any instrument other than in instruments issued by the Central Bank. In such a case, or in the event that a bank is unable to make timely payment in respect of its obligations or if a bank is under provisional administration of the Superintendency of Banks, the General Banking Law provides that the bank may receive a two-year term loan from another bank. The terms and conditions of such a loan must be approved by the directors of both banks, as well as by the Superintendency of Banks, but need not be submitted to the borrowing bank’s shareholders for their approval. In any event, a creditor bank cannot grant interbank loans to an insolvent bank in an amount exceeding 25.0% of the creditor bank’s effective equity. The board of directors of a bank that is unable to make timely payment of its obligations must present a reorganization plan to its creditors in order to capitalize the credits, extend their respective terms, forgive debts or take other measures for the payment of the debts. If the board of directors of a bank submits a reorganization plan to its creditors and such arrangement is approved, all subordinated debt issued by the bank, whether or not matured, will be converted by operation of law into common stock in the amount required for the ratio of effective equity to risk-weighted assets not to be lower than 12.0%. If a bank fails to pay an obligation, it must notify the Superintendency of Banks, which shall determine if the bank is solvent.

 

Dissolution and Liquidation of Banks

 

The Superintendency of Banks may establish that a bank should be liquidated for the benefit of its depositors or other creditors when such bank does not have the necessary solvency to continue its operations. In such case, the Superintendency of Banks must revoke a bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The Superintendency of Banks must also revoke a bank’s authorization if the reorganization plan of such bank has been rejected twice. The resolution by the Superintendency of Banks must state the reason for ordering the liquidation and must name a liquidator, unless the Chilean Superintendent of Banks assumes this responsibility. When a liquidation is declared, all checking accounts, other demand deposits received in the ordinary course of business, other deposits unconditionally payable immediately or that have a maturity of no more than 30 days, and any other deposits and receipts payable within 10 days, are required to be paid by using existing funds of the bank, its deposits with the Central Bank or its investments in instruments that represent its reserves. If these funds are insufficient to pay these obligations, the liquidator may seize the rest of the bank’s assets, as needed. If necessary and in specified circumstances, the Central Bank will lend the bank the funds necessary to pay these obligations. Any such loans are preferential to any claims of other creditors of the liquidated bank.

 

Investments in Foreign Securities

 

Under current Chilean banking regulations, banks in Chile may grant loans to foreign individuals and entities and invest in certain foreign currency securities. Chilean banks may only invest in equity securities of foreign banks and certain other foreign companies which may be affiliates of the bank or which would support the bank’s business if such companies were incorporated in Chile. Banks in Chile may also invest in debt securities traded in formal secondary markets. Such debt securities shall qualify as (1) securities issued or guaranteed by foreign sovereign states or their central banks or other foreign or international financial entities, and (2) bonds issued by foreign companies. Such foreign currency securities must have a minimum rating as follows:

 

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Rating Agency


   Short Term

   Long Term

Moody’s

   P2    Baa3

Standard and Poor’s

   A3    BBB-

Fitch IBCA

   F2    BBB-

 

However, a Chilean bank may invest up to 20.0% of its effective equity in securities having a minimum rating as follows:

 

Rating Agency


   Short Term

   Long Term

Moody’s

   P2    Ba3

Standard and Poor’s

   A3    BB-

Fitch IBCA

   F2    BB-

 

Additionally, a Chilean bank may invest up to 70.0% of its effective equity in securities having a minimum rating as follows:

 

Rating Agency


   Short Term

   Long Term

Moody’s

   P1    Aa3

Standard and Poor’s

   A1+    AA-

Fitch IBCA

   F1+    AA-

 

Subject to specific conditions, a bank may grant loans in dollars to subsidiaries or branches of Chilean companies located abroad, to companies listed on foreign stock exchanges authorized by the Central Bank and, in general, to individuals and entities domiciled abroad, as long as the Central Bank is kept informed of such activities.

 

In the event that the sum of the investments of a bank in foreign currency and of the commercial and foreign trade loans granted to foreign individuals and entities exceeds 70.0% of the effective equity of such bank, the excess is subject to a mandatory reserve of 100.0%.

 

Mortgage Finance Bonds

 

The Superintendency of Banks as of December 31, 2002 established a new mechanism for accounting for mortgage bonds issued by the Bank and subsequently held as financial investments. Previously, the Bank recorded the bond as a liability and the same bond held as an asset in financial investments. Now such mortgage finance bond is offset against the corresponding liability.

 

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E. Property, Plants and Equipment

 

We are domiciled in Chile and own our principal executive offices located at Bandera 140, Santiago, Chile. We also own fourteen other buildings in the vicinity of our headquarters and we rent seven other buildings. We are in the process of optimizing our central office structure and we are constructing an additional building which will permit us to stop renting some office space. At June 2004, we owned the locations at where 49% of our branches were located. The remaining branches operate at rented locations.

 

Main properties as of June 2004


   Number

Central Offices*

    

Own

   16

Rented

   5

Total

   21

Branches*

    

Own

   165

Rented

   173

Total

   338

*Some branches are located inside central office buildings. Including these branches the total amount of branches is 345.

 

Below is a summary of the main computer hardware and other systems-equipment that we own. We believe that our existing physical facilities are adequate for our needs.

 

Category


  

Brand


  

Application


Mainframe

   IBM    Back-end, Core-System Altamira, Credit risk admissions, Payment services, internal software development

Midrange

   IBM    Communications (front-end)

Midrange

   Stratus    Teller systems

Midrange

   IBM    WEB Individuals/Corporate Segment

Desktop

   IBM    Platform applications

 

The main software systems used by us are:

 

Category


  

Product


  

Origin


Core-System    ALTAMIRA    Accenture
Credit admissions for individuals and companies    GARRA    Internal
Payment services    PAMPA    Internal
Loans data base    DEUDORES    Internal
Behavioral Scoring    EVALUACIÓN Y SEGUIMIENTO CLIENTES    Internal
Data base    DB2    IBM
Data base    Oracle    Oracle
Data base    SQL Server    Microsoft
WEB Service    Internet Information Server    Microsoft
Message Service    MQSeries    IBM
Transformation    MQIntegrator    IBM

 

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Item 5. Operating and Financial Review and Prospects

 

A. Critical Accounting Policies

 

We prepare our financial statements in accordance with Chilean GAAP and the related rules of the Superintendency of Banks, which requires management to make estimates and assumptions in the application of some of them because they are related to matters that are inherently uncertain. We believe that the following are the more critical judgment areas or involve a higher degree of complexity in the application of the accounting policies that currently affect our financial condition and results of operations:

 

  a) Interest revenue and expense recognition.

 

  b) Foreign currency and derivative activities

 

  c) Financial investments

 

  d) Premises and equipment

 

  e) Allowance for loan losses

 

The Notes to the Consolidated Financial Statements contain a summary of our significant accounting policies, including a description of the significant differences between these and the accounting principles generally accepted in the United States, additional disclosures required under such rules, a reconciliation between shareholders’ equity and net income to the corresponding amounts that would be reported in accordance with U.S. GAAP and a discussion of recently issued accounting pronouncements.

 

Interest revenue and expense recognition

 

Interest revenue and expense are recognized on an accrual basis using the effective interest method. Loans, investments and liabilities are stated at their cost, adjusted for accrued interest and the indexation adjustment applicable to such balances that are index-linked.

 

The Bank suspends the accrual of interest and principal indexation adjustments on loans beginning on the first day that such loans are overdue. Accrued interest remains on the Bank’s books and is considered a part of the loan balance when determining the allowances for loan losses. Payments received on overdue loans are recognized as income, after reducing the balance of accrued interest, if applicable.

 

Foreign currency and derivative activities

 

The Bank enters into forward foreign exchange contracts and spot exchange contracts for its own accounts and the accounts of its customers. The Bank’s forward contracts are marked to market monthly using the spot rates reported by the Central Bank of Chile at the balance sheet date. The initial premium or discount on these contracts is deferred and included in determining net income over the life of the contract. The Bank’s interest rate and cross-currency swap agreements are treated as off-balance-sheet financial instruments and the net interest effect, which corresponds to the difference between interest income and interest expense arising from such agreements, is recorded in net income in the period that such differences originate.

 

In addition, the Bank makes loans and accepts deposits in amounts denominated in foreign currencies, principally the U.S. dollar. Such assets and liabilities are translated at the applicable rate of exchange at the balance sheet date.

 

The amount of net gains and losses on foreign exchange includes the recognition of the effects that variations in the exchange rates have on assets and liabilities denominated in foreign currencies and the gains or losses on foreign exchange spot and forward transactions undertaken by the Bank.

 

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Financial investments

 

Financial investments that have a secondary market are carried at market value. The Bank’s financial investments are classified as trading or permanent in accordance with the regulations of the Superintendency of Banks with unrealized gains and losses on trading investments included in Other operating income (expenses), and unrealized gains and losses on permanent investments included in a separate component of Shareholders’ equity. As of December 31, 1999, market value adjustments were performed only for those investments with maturities greater than one year.

 

The Bank enters into security repurchase agreements as a form of borrowing. In this regard, the Bank’s investments that are sold subject to a repurchase obligation and that serve as collateral for the borrowing are reclassified as “investment collateral under agreements to repurchase” and is carried at market value. The liability for the repurchase of the investment is classified as “investments under agreements to repurchase” and is carried at cost plus accrued interest.

 

All other financial investments are carried at acquisition cost plus accrued interest and UF indexation adjustments, as applicable. This considers mainly those with maturities of less than one year (23.5% of total financial investments) most of which were liquid government securities or deposits in other Chilean banks. See discussion of Financial Investments in Item 5-Sources of Liquidity-Financial Investments.

 

The Bank also enters into resale agreements as a form of investment. Under these agreements the Bank purchases securities, which are included as assets under the caption “investments under agreements to resell”.

 

Premises and equipment

 

Premises and equipment are stated at acquisition cost net of accumulated depreciation and have been restated for price-level changes. Depreciation is calculated on a straight-line method over the estimated useful lives of the underlying assets.

 

The costs of maintenance and repairs are charged to expense. The costs of significant refurbishment and improvements are capitalized and are then amortized over the period of the benefit on a straight-line basis.

 

Allowance for loan losses

 

Chilean banks are required to maintain loan loss allowances in amounts determined in accordance with the regulations issued by the Superintendency of Banks. Under these regulations, we must classify our portfolio into various categories of payment capability. The minimum amount of required loan loss allowances are determined based on fixed percentages of estimated loan losses assigned to each category. As of January 1, 2004, the new loan loss allowance regulations set by the Superintendency of Banks came into effect.

 

New Regulations

 

Under the new classifications, loans are divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the acquisition of consumer goods or payment of services); (ii) residential mortgage loans (including loans granted to individuals for the acquisition, construction or repair of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); (iii) leasing operations (including consumer leasing, commercial leasing and residential leasing); (iv) factoring operations and (v) commercial loans (includes all loans other than consumer loans and residential mortgage loans).

 

A detailed description of this accounting policy is discussed below under “—Selected Statistical Information—Loan loss allowances” and in Note 1 of our Consolidated Financial Statements. For a description of the regulations relating to loan loss allowances to which we were subject to in 2003 and the new regulations, see “Item 4: Information on the Company—Regulation and Supervision—Allowance for Loan Losses.”

 

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Goodwill and Intangible Assets with Indefinite Useful Lives

 

Under U.S. GAAP, we have significant intangible assets related to goodwill and trademarks with indefinite useful lives. We record all assets and liabilities acquired in purchase acquisitions, including goodwill and other acquired intangibles, at fair value. These include amounts pushed down from Banco Santander Central Hispano. Goodwill and indefinite-lived assets are no longer amortized over their estimated useful lives using straight-line and accelerated methods, and are subject to at least an annual impairment review. The initial goodwill and intangibles recorded and subsequent impairment analysis requires management to make subjective judgments concerning estimates of how the acquired asset will perform in the future using a discounted cash flow analysis. Additionally, estimated cash flows may extend beyond ten years and, by their nature, are difficult to determine. Events and factors that may significantly affect the estimates include, among others, competitive forces, customer behavior and attrition, changes in revenue growth trends, cost structures and technology and changes in interest rates and specific industry or market sector conditions. For a further discussion of accounting practices for goodwill and intangible assets with indefinite useful lives under U.S. GAAP, see Note 26 to our Audited Consolidated Financial Statements.

 

Differences between Chilean and United States Generally Accepted Accounting Principles

 

Accounting principles generally accepted in Chile vary in certain important respects from the accounting principles generally accepted in the United States. Such differences involve certain methods for measuring the amounts shown in the consolidated financial statements, as well as additional disclosures required by accounting principles generally accepted in the United States and the accounting treatment of the merger.

 

Note 26 to the Consolidated Financial Statements presents a description of the significant differences between Chilean GAAP and U.S. GAAP.

 

B. Operating Results

 

Chilean Economy

 

All of the operations and substantially all of our customers are located in Chile. Accordingly, our financial condition and results of operations are substantially dependent upon economic conditions prevailing in Chile. The Chilean economy experienced an increase in economic activity in 2003 after several years of sluggish growth. In 2003, Chile’s GDP grew 3.3% compared to 2.2% in 2002. Despite the uncertainty caused by the war in Iraq, in the second half of 2003 the Chilean economy began to show more positive indicators in line with the economic recovery of the U.S. economy and the strong growth of China. In addition, the improvement of economic growth in the Eurozone and Japan helped to improve the demand for Chilean exports, which led to an important recovery of Chilean commodity exports. Exports totaled US$21 billion in 2003 and increased 15.8% compared to 2002. The signing of free trade agreements with the U.S. and European Community and the lack of financial crisis in Latin America also fueled internal consumer confidence, which was another factor which led to better internal economic indicators. The unemployment rate adjusted for seasonality decreased from 8.8% as of December 2002 to 8.3% as of December 2003.

 

The Chilean economy also benefited from low interest rates and from low inflation. CPI inflation reached a record low level of 1.1% in 2003, partially due to the Chilean peso’s 15.9% appreciation against the U.S. dollar. As a result of this low inflation, the Central Bank continued to relax its monetary policy in 2003. The overnight interbank rate set by the Central Bank was reduced to a historical low of 1.75% per annum in nominal terms in January 2004.

 

Despite these developments at the macroeconomic level, we believe there still exists the potential for a reduction in economic activity in Chile given the volatility of international markets and the potential for reduction in world economic growth.

 

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Impact of Inflation

 

Inflation impacts the Bank’s results of operation. Usually, positive inflation benefits the Bank’s net income, with higher inflation resulting in higher gains. Negative inflation negatively affects the Bank’s results. In summary:

 

  The Bank’s asset and liabilities are denominated in Chilean nominal pesos, Unidades de Fomento (“UF”), which are inflation indexed pesos, and foreign currencies. The Bank generally has generally more UF-denominated financial assets than UF-denominated financial liabilities. This means that the Bank is funding assets denominated in Unidades de Fomento with nominal pesos. Therefore, when inflation is positive this signifies a gain for the Bank’ net interest income.

 

  We maintain a substantial amount of non interest bearing peso-denominated demand deposits. Because such deposits are not sensitive to inflation, any decline in the rate of inflation adversely affects our net interest margin on assets funded with such deposits and any increase in the rate of inflation increases the net interest margin on such assets.

 

  This positive effect of inflation on net income is partially offset by the loss from price level restatement. Chilean GAAP requires that financial statements be restated to reflect the full effects of loss in the purchasing power of the Chilean peso on the financial position and results of operations of reporting entities. The Bank must adjust its capital, fixed assets and other assets for the variations in price levels. Since the Bank’s capital is generally larger than the sum of fixed and other assets, when inflation is positive the Bank records a loss from price level restatement.

 

In 2003, the interest gained on interest earning assets denominated in Unidades de Fomento decreased 31.3%, in part, as a result of the decrease in inflation which reduced the nominal rate paid on these assets. The same is true of interest paid on interest bearing liabilities denominated in Unidades de Fomento. The interest paid on these liabilities decreased 44.8%, in part as a result of the decline in inflation in 2003 versus 2002. The lower inflation rate in 2003 versus 2002 also signified a lower loss from price level restatement. The net effect in monetary terms is unclear since variation in real interest rates and balances also affect result, but an approximation is as follows:

 

Inflation sensitive income


   2002

    2003

    % Change

 
     (In million of constant Chilean pesos
December 31, 2003)
 

Interest gained on UF assets

   504,391     346,741     (31.3 )%

Interest paid on UF liabilities

   (337,325 )   (186,188 )   (44.8 )%

Price level restatement

   (13,148 )   (7,702 )   (41.4 )%
    

 

 

Total

   153,918     152,851     (0.7 )%
    

 

 

 

Although Chilean inflation has moderated in recent years, Chile has experienced high levels of inflation in the past. High levels of inflation in Chile could adversely affect the Chilean economy and have an adverse effect on our business, financial condition and results of operations. In 2003, inflation reached 1.1% mainly as a result of the appreciation of Chilean pesos against the dollar, which reduced the cost of imported goods. There can be no assurance that Chilean inflation will not change significantly from the current level. Although we currently benefit from moderate levels of inflation in Chile due to the current structure of our assets and liabilities (i.e., we have a significant amount of deposits that are not indexed to the inflation rate and/or do not accrue interest, while a significant portion of our loans are indexed to the inflation rate), there can be no assurance that our business, financial condition and result of operations in the future will not be adversely affected by changing levels of inflation.

 

UF-denominated Assets and Liabilities. The “Unidad de Fomento” (UF) is revalued in monthly cycles. On every day in the period beginning the tenth day of the current month through the ninth day of the succeeding month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect each day a proportional amount of the prior calendar month’s change in the CPI. One UF was equal to Ch$16,262.66, Ch$16,744.12 and Ch$16,920.00 at December 31, 2001, 2002 and 2003, respectively. The effect of any changes in the nominal peso value of our UF-denominated assets and liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest revenue and expense, respectively. Our net interest

 

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revenue will be positively affected by an inflationary environment to the extent that our average UF-denominated assets exceed our average UF-denominated liabilities. Our net interest revenue will be negatively affected by inflation in any period in which our average UF-denominated liabilities exceed our average UF-denominated assets. Our average UF-denominated assets exceeded our average UF-denominated liabilities by Ch$322,968 million, Ch$1,010,739 million and Ch$1,148,421 million during the years-ended December 31, 2001, 2002 and December 31, 2003, respectively. See “Item 5D: Asset and Liability Management—Selected Statistical Information—Average Balance Sheets and Interest Rate Data.”

 

Peso-denominated Assets and Liabilities. Rates of interest prevailing in Chile during any period reflect in significant part the rate of inflation during the period and expectations of future inflation. The responsiveness to such prevailing rates of our peso-denominated interest earning assets and interest bearing liabilities varies. See “Item 5B: Operating Results—Interest Rates.” We maintain a substantial amount of non interest bearing peso-denominated demand deposits. The ratio of such demand deposits to average interest earning assets was 15.1%, 15.2% and 16.4% as of December 31, 2001, 2002 and 2003, respectively. Because such deposits are not sensitive to inflation or changes in the market interest rate environment, any decline in market rates of interest or the rate of inflation adversely affects our net interest margin on assets funded with such deposits and any increase in the rate of inflation increases the net interest margin on such assets.

 

Interest Rates

 

Interest rates earned and paid on our assets and liabilities reflect, to a certain degree, inflation, expectations regarding inflation, shifts in short term interest rates set by the Central Bank and movements in long-term real rates. The Central Bank manages short term interest rates based on its objectives of balancing low inflation and economic growth. Because our liabilities generally reprice faster than our assets, changes in the rate of inflation or short term rates in the economy are reflected in the rates of interest paid by us on our liabilities before such changes are reflected in the rates of interest earned by us on our assets. Therefore, when short-term interest rates fall, our net interest margin is positively impacted, but when short-term rates increase, our interest margin is negatively affected. At the same time, our net interest margin tends to be adversely affected in the short term by a decrease in inflation since generally our UF-denominated assets exceeds UF-denominated liabilities. See “Item 5B: Operating Results—Impact of Inflation—Peso denominated Assets and Liabilities.” An increase in long-term rates also has a positive effect on our net interest margin, because our interest-earning assets generally have a longer duration than our interest-bearing liabilities. In addition, because our peso-denominated liabilities have relatively short repricing periods, they are generally more responsive to changes in inflation or short term rates than our UF-denominated liabilities. As a result, during periods when current inflation or expected inflation exceeds the previous month’s inflation, customers often switch funds from UF-denominated deposits to more expensive peso-denominated deposits, thereby adversely affecting our net interest margin.

 

Foreign Exchange Fluctuations

 

A significant portion of our assets and liabilities is denominated in foreign currencies, principally the U.S. dollar, and we historically have maintained and may continue to maintain material gaps between the balances of such assets and liabilities. Because such assets and liabilities, as well as interest earned or paid on such assets and liabilities, and gains (losses) realized upon the sale of such assets, are translated to Chilean pesos in preparing our financial statements, our reported income is affected by changes in the value of the Chilean peso with respect to foreign currencies (principally the U.S. dollar). The Chilean government’s economic policies and any future changes in the value of the Chilean peso against the U.S. dollar could adversely affect our financial condition and results of operations. The Chilean peso has been subject to significant devaluation in the past, including a decrease of 14.7% in 2001 and 8.6% in 2002, and may be subject to significant fluctuations in the future. In 2003 the Chilean peso appreciated 15.9% against the dollar. See “Item 3A: Selected Financial Data—Exchange Rates.”

 

Our results of operations may be affected by fluctuations in the exchange rates between the Chilean peso and the U.S. dollar, despite our policy and Chilean regulations relating to the general avoidance of material exchange rate mismatches. Entering into forward exchange transactions enables us to avoid such material exchange rate mismatches. Santander-Chile also sets an absolute limit on the size of Santander-Chile’s net foreign currency position. As of December 31, 2003, this was equal to US$150 million. This limit is a useful measure in limiting Santander-Chile’s exposure to foreign exchange risk. The limit on the size of the net foreign currency position is

 

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determined by the Assets and Liabilities Committee (“ALCO”) and is calculated and monitored by the Market Risk and Control Department. The Bank also uses a VaR model to limit foreign currency risk. In the years ended December 31, 2001, 2002 and 2003, the gap between foreign currency denominated assets and foreign currency denominated liabilities, including forward contracts was Ch$195,313 million, Ch$11,505 million and Ch$58,791 million, respectively. Given the restriction on foreign currency mismatches, the net effect on results of fluctuations in the exchange rate between Chilean pesos and U.S. dollars is not clear.

 

Results of Operations for the Years Ended December 31, 2001, 2002 and 2003

 

The following discussion is based upon and should be read in conjunction with the Audited Consolidated Financial Statements. The Audited Consolidated Financial Statements have been prepared in accordance with Chilean GAAP (including the rules of the Superintendency of Banks relating thereto), which differ in certain significant respects from U.S. GAAP. Note 26 to the Audited Consolidated Financial Statements describes the principal differences between Chilean GAAP and U.S. GAAP and includes a reconciliation to U.S. GAAP of our net income for the years ended December 31, 2002 and 2003 and of our shareholders’ equity at December 31, 2002 and 2003. The Audited Consolidated Financial Statements have been restated in constant Chilean pesos of December 31, 2003. See Note 1(c) to the Audited Consolidated Financial Statements.

 

Introduction

 

On August 1, 2002, Old Santander-Chile was merged into Santiago. Upon giving effect to the merger, Santiago changed its name to Banco Santander-Chile. See “Item 4A: Information on the Company—History and Development of the Company—Overview” For an explanation of the accounting treatment of the merger see “Presentation of Financial Information—Merger-Accounting Treatment” and “Item 8A: Consolidated Statements and Other Financial Information.”

 

Unless otherwise stated, the following financial data reflect the merger as follows:

 

  The 2001 financial data is derived from the historical income statement of Santiago prepared under Chilean GAAP.

 

  The 2002 financial data is derived from our historical income statement, which reflects the merger of Santiago and Old Santander-Chile on a prospective basis from January 1, 2002 as mandated by Chilean GAAP.

 

  The column labeled “2001/2002” presents the variation expressed in percentage points between the historical financial data presented for the years ended December 31, 2001 and 2002.

 

Because this year both 2002 and 2003 are comparable, the 2002/2001 comparisons only include 2001 ex-Santiago and not 2001 proforma combined financial data. Readers should refer to our annual report for the fiscal year ended December 31, 2002 if they would like more information regarding how our 2002 results compare to 2001 combined results.

 

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The following table sets forth the principal components of our net income for the years ended December 31, 2001, 2002 and 2003.

 

     For the year-ended December 31,

    % Change

 
     2001

    2002

    2003

    2003

    2001/
2002(1)


    2002/2003

 
     (in millions of constant Ch$ as of as of
December 31, 2003)
    (in thousands
of US$)(2)
             

CONSOLIDATED INCOME STATEMENT DATA

                                    

Chilean GAAP:

                                    

Interest income and expense

                                    

Interest revenue

   602,448     1,041,405     613,562     1,023,593     72.9 %   (41.1 )%

Interest expense

   (339,922 )   (517,010 )   (310,876 )   (518,628 )   52.1 %   (39.9 )%
    

 

 

 

 

 

Net interest revenue

   262,526     524,395     302,686     504,965     99.7 %   (42.3 )%
    

 

 

 

 

 

Provision for loan losses

   (48,403 )   (92,076 )   (101,340 )   (169,064 )   90.2 %   10.1 %
    

 

 

 

 

 

Fees and income from services

                                    

Fees and other services income

   62,527     125,908     137,010     228,571     101.4 %   8.8 %

Other services expense

   (12,280 )   (22,793 )   (25,171 )   (41,993 )   85.6 %   10.4 %
    

 

 

 

 

 

Total fees and income from services, net

   50,247     103,115     111,839     186,578     105.2 %   8.5 %
    

 

 

 

 

 

Other operating income, net

                                    

Net gain (loss) from trading and brokerage

   8,997     29,955     27,454     45,801     233.0 %   (8.3 )%

Foreign exchange transactions, net

   10,484     (25,583 )   151,957     253,507     (344.0 )%   (694.0 )%

Others, net

   (6,477 )   (18,323 )   (19,911 )   (33,216 )   182.9 %   8.7 %
    

 

 

 

 

 

Total other operating income, net

   13,004     (13,951 )   159,500     266,092     (207.3 )%   (1,243.3 )%
    

 

 

 

 

 

Other income and expenses

                                    

Loan loss recoveries

   11,784     25,374     33,921     56,590     115.3 %   33.7 %

Non-operating income, net

   (1,613 )   (57,898 )   500     834     3,489.5 %   (100.9 )%

Income attributable to investments in other companies

   200     446     1,669     2,785     123.0 %   274.2 %

Losses attributable to minority interest

   —       (184 )   (160 )   (267 )   —       (13.0 )%
    

 

 

 

 

 

Total other income and expenses

   10,371     (32,262 )   35,930     59,942     (411.1 )%   (211.4 )%
    

 

 

 

 

 

Operating expenses

                                    

Personnel salaries and expenses

   (84,785 )   (148,922 )   (126,164 )   (210,477 )   75.6 %   (15.3 )%

Administrative and other expenses

   (57,806 )   (100,914 )   (83,933 )   (140,024 )   74.6 %   (16.8 )%

Depreciation and amortization

   (17,472 )   (39,728 )   (40,162 )   (67,001 )   127.4 %   1.1 %
    

 

 

 

 

 

Total operating expenses

   (160,063 )   (289,564 )   (250,259 )   (417,502 )   80.9 %   (13.6 )%
    

 

 

 

 

 

Gain (loss) from price-level restatement

   (7,918 )   (13,148 )   (7,702 )   (12,849 )   66.1 %   (41.4 )%
    

 

 

 

 

 

Income before income taxes

   119,764     186,509     250,654     418,162     55.7 %   34.4 %

Income taxes

   3,680     (27,695 )   (43,679 )   (72,869 )   (852.6 )%   57.7 %
    

 

 

 

 

 

Net income

   123,444     158,814     206,975     345,293     28.7 %   30.3 %
    

 

 

 

 

 


(1) Compares 2002 historical financial data to 2001 historical financial data.
(2) Amounts stated in US dollars as of and for the year ended December 31, 2003 have been translated from Chilean pesos at the exchange rate of Ch$599.42 = US$1.00 as of December 31, 2003. See “Item 3A: Selected Financial Data—Exchange Rates” for more information on the observed exchange rate.

 

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2002 and 2003. Net income for the twelve month period ended December 31, 2003 increased 30.3% to Ch$206,975 million compared to net income of Ch$158,814 million for the same period in 2002. The increase in net income primarily reflects the Ch$51,921 million charge for merger integration expenses and harmonization of amortization criteria incurred during the second half of 2002 and recognized as a non-operating expense. Excluding the effect of merger-related charges, pre-tax income would have increased by 5.1% compared to pre-tax net income in 2002 primarily reflecting the 8.5% rise in fee income, the 13.6% decrease in operating expenses and the 33.7% rise in loan loss recoveries. This offset the decline in net interest income, the rise in provision expense and the higher effective tax rate in 2003 compared to the tax expense in 2002. Our efficiency ratio was 43.6% in 2003 compared to 47.2% in 2002, the lowest among our peer group competitors. Our return on average equity reached 22.1% in 2003 compared to 16.2% in 2002. Our return on capital as measured by the Superintendency of Bank reached 25.5% compared to 16.6% for the banking industry and was the second highest among our Peer Group.

 

2001 and 2002. Net income for the twelve-month period ended December 31, 2002 increased 28.7% compared to 2001 Santiago stand-alone figures. This was mainly due to the merger.

 

Net interest revenue

 

     Year Ended December 31,

    % Change

 
     2001

    2002

    2003

    2001/2002

    2002/2003

 
     (in millions of constant Ch$ as of December 31, 2003,
except percentages)
 

Interest revenue

   602,448     1,041,405     613,562     72.9 %   (41.1 )%

Interest expense

   (339,922 )   (517,010 )   (310,876 )   52.1 %   (39.9 )%
    

 

 

 

 

Net interest revenue

   262,526     524,395     302,686     99.7 %   (42.3 )%
    

 

 

 

 

Average interest earning assets

   5,773,548     10,963,183     10,140,440     89.9 %   (7.5 )%

Average non-interest bearing demand deposits

   871,621     1,665,303     1,666,761     91.1 %   0.1 %

Net interest margin(1)

   4.6 %   4.8 %   3.0 %            

Adjusted net interest margin(2)

   4.7 %   4.6 %   4.5 %            

Average shareholders’ equity and average demand deposits to total average earning assets

   24.3 %   24.2 %   25.7 %            

(1) Net interest margin is net interest revenue divided by average interest earning assets.
(2) Net interest margin including results of forward contracts. Pursuant to Chilean GAAP, Santander-Chile cannot include as net interest revenue the results of forward contracts, which hedge foreign currencies. Under the rules of the Superintendency of Banks, these gains (or losses) cannot be considered interest revenue, but must be considered as gains (or losses) from foreign exchange transactions and, accordingly, recorded as a different item in the income statement. This distorts net interest revenue and foreign exchange transaction gains especially during periods when the exchange rate is highly volatile.

 

2003 and 2002. Net interest revenue for the year ended December 31, 2003 decreased 42.3% to Ch$302,686 million compared to net interest revenue of Ch$524,395 million for the same period in 2002. This decrease was mainly due to the decline of the net interest margin from 4.8% in 2002 to 3.0% in 2003. This decline was mainly due to the fall in the yield of dollar denominated interest earning assets. In 2003 the real rate earned on dollar assets reached (20.1%) compared to 11.4% in 2003, reflecting the 15.9% appreciation of the Chilean peso against the dollar in the year.

 

It is important to point out that the Bank hedges this currency mismatch mainly through forward contracts, the results of which are included in foreign exchange transactions. The Bank has strict market risk guidelines regarding currency mismatches which cannot exceed US$150 million. See “Item 11: Quantitative and Qualitative Disclosures About Market Risk”. Including the results from foreign exchange transactions, which are mainly hedging operations, our net interest margin declined from 4.6% in 2002 to 4.5% in 2003 and net interest revenue declined 8.9% from Ch$498,812 million in 2002 to Ch$454,643 million for the 2003 period.

 

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The decline in our net interest margin adjusted for the results of hedging transactions mainly reflected the impact of low interest rates and the low-inflation environment during the 2003 period, which was partially offset by improvements in our asset and funding mix. This trend continued in the first quarter of 2004. We expect that the effect of declining interest rates will be further exacerbated by expected lower inflation rates, which we expect will cause the contraction of the spreads earned on non interest-bearing liabilities, e.g. checking accounts, and amounts earned on UF-denominated interest-earning assets.

 

The average nominal rate earned on our nominal peso denominated interest earning assets decreased from 14.4% in 2002 to 12.6% in 2003. The average nominal rate earned on our inflation-indexed assets also decreased from 9.0% in 2002 to 6.9% in 2003. The 90-day Central Bank rate, a benchmark rate for deposits and short-term loans expressed in nominal terms, decreased from 2.88% as of December 31, 2002 to 2.58% as of December 31, 2003.

 

The average real rate earned on our nominal peso interest earning assets increased slightly to 11.6% in 2003 from 11.2% in 2002. The average real rate earned on our inflation-indexed assets remained stable at 5.9% in 2003 compared to 2002. The improvement of our asset mix through the growth of higher-yielding retail loans helped to keep the real rates earned on our non-foreign currency assets stable.

 

Compared to 2002, interest-earning assets decreased 7.5% and total loans decreased 4.1%, while higher yielding consumer loans increased 8.5% in 2003. Demand for consumer financing loans increased as a result of prevailing lower interest rates and better unemployment figures. This was apparent in all income segments. Loans at Banefe increased 8.1% in 2003 and consumer lending among middle- to upper-income individuals grew 9.9% compared to 2002. Total commercial loans, on the other hand, decreased 14.2% as a result of our strategy of reducing our participation in both the low-yielding short-term large corporate lending market.

 

Lower funding costs also offset in part the decline of our hedging-adjusted net interest margin. The nominal rate paid on nominal peso-denominated interest-bearing deposits decreased 110 basis points to 3.6% in 2003 compared to 2002. The nominal rate paid on inflation-indexed deposits also decreased 240 basis points to 5.2% in 2003 compared to 2002, driven mainly by the reduction in inflation and interest rates. Time deposits continue to be the main source of funding, representing 34.2% of total average liabilities. The majority of these time deposits have a maturity of 90 days or less and therefore, the cost of these funds varies according to short-term interest rates. As a result, the real rate paid on nominal peso time deposits fell 120 basis points to 3.6% and the real rate paid on inflation-indexed time deposits fell 250 basis points in 2003 to 3.6%.

 

The average balance of time deposits decreased 19.1% as a result of various factors including a reduction in low-yielding assets which are mainly funded through our deposit base. Low inflation rates and lower interest rates have made other investment alternatives more attractive. We have also been proactively encouraging clients to invest in mutual funds instead of short-term deposits given our strong liquidity position.

 

Our ratio of average non-interest-bearing demand deposits and equity to average earning assets increased in 2003 to 25.7% compared to 24.2% in 2002. The growth rate of average non-interest-bearing demand deposits was flat in 2003. The balance of non-interest bearing demand deposits, net of clearance increased 18.6% reflecting individual consumers’ preference for readily available funds deposited into checking accounts instead of low-yielding time deposits.

 

2001 and 2002. Net interest revenue in the year ended December 31, 2002 increased 99.7% mainly as a result of the merger.

 

Provision for loan losses

 

Chilean banks up to 2003 were required to maintain reserves to cover possible credit losses that at least equal their loans to customers multiplied by the greater of (i) their risk index or (ii) 0.75%. The risk index is derived from management’s classification of our portfolio according to objective criteria relating to the performance of the loans or, in the case of commercial loans, management’s estimate of the likelihood of default. Banks in Chile are also required to establish individual loan loss allowances for loans that are more than 90 days past due. The amount of the individual loan loss provision is equal to 100% of the unsecured past due portion of the loan if such amounts in

 

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the aggregate exceed the global loan loss allowance. See “Item 5D: Asset and Liability Management—Loan Portfolio—Classification of Loan Portfolio” and “Item 5D: Asset and Liability Management—Loan Loss Allowances.” Banks in Chile were also required to maintain additional consumer loan loss provisions. A bank may also voluntarily maintain additional loan loss provisions in excess of the minimum amounts required as global and individual loan loss allowances.

 

For statistical information with respect to our substandard loans and reserves for possible loan losses, see “Item 5D: Asset and Liability Management—Loan Loss Provisions—Analysis of Substandard Loans and Amounts Past Due” and “Item 5D: Asset and Liability Management—Loan Loss Provisions—Analysis of Loan Loss Provisions”, as well as Note 6 to the Audited Consolidated Financial Statements. The amount of provision charged to income in any period consists of net provisions established for possible loan losses, net of provisions made with respect to real estate acquired upon foreclosure and charge-offs against income (equal to the portion of loans charged off that is not allocated to a required reserve at the time of charge off).

 

As of January 1, 2004, the new loan loss allowance regulations set by the Superintendency of Banks came into effect. For purposes of these new classifications, loans will be divided into: (i) consumer loans (including loans granted to individuals for the purpose of financing the acquisition of consumer goods or payment of services); (ii) residential mortgage loans (including loans granted to individuals for the acquisition, construction or repair of residential real estate, in which the value of the property covers at least 100% of the amount of the loan); (iii) leasing operations (including consumer leasing, commercial leasing and residential leasing); (iv) factoring operations and (v) commercial loans (includes all loans other than consumer loans and residential mortgage loans). See “Item 5D: Asset and Liability Management—Loan Portfolio—Classification of Loan Portfolio” and “Item 5D: Asset and Liability Management—Loan Loss Allowances.”

 

In accordance with the new regulations, which became effective as of January 1, 2004, the models and methods used to classify our loan portfolio must follow the guiding principles established by the Superintendency of Banks and the Bank.

 

2002 and 2003. In 2003, total provisions established reached Ch$125,216 million and increased 21.1% compared to 2002. This was offset by a reversal of Ch$11,669 million of voluntary provisions in the year and the reversal of provisions previously established on charged-off loans in the year. Charge-offs totaled Ch$100,230 million increasing 23.3%. The net charge to income of provisions and charge-offs for year-ended December 31, 2003 increased 10.1% and totaled Ch$101,340 million compared to loan losses for the year-ended December 31, 2002. This rise in provisions and charge-offs was mainly a result of the rise of our risk index from 1.68% as of December 31, 2002 to 1.88% as of December 31, 2003. The rise in the risk index was a direct result of the full implementation of Old-Santander’s credit risk culture throughout the entire organization. The effects of a slower economic growth also prompted the increase in provisions, especially in the first half of 2003.

 

The rise in provisions compared to 2002 was also due to the reclassification of Ch$7,006 million from voluntary loan loss allowances to other liabilities on our balance sheet and from voluntary provisions to nonoperating income, net on our income statement in 2002. The reclassification was in response to new guidelines issued by the Superintendency of Banks, which required that these voluntary loan provisions be reclassified because they were not linked to any specific credit risk.

 

Past due loans at December 31, 2003 increased 1.0% to Ch$170,095 million compared to past due loans of Ch$168,440 million at year-end 2002. The coverage ratio decreased to 98.9% as of December 31, 2003 from 100.5% as of December 31, 2002. The increase in past due loans was mainly related to temporary operational disruptions in loan portfolio management caused by the merger integration process. This culminated with the end of the merger integration and credit review process in April 2003. As of that date until year-end 2003 past due loans decreased 13.8%.

 

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LOGO

 

2001 and 2002. Provisions for loan losses for year-ended December 31, 2002 increased 90.2% compared to 2001 mainly as a result of the merger. It is important to point out that in the second half of 2002 we leveled the credit risk classifications of duplicated clients that had a dissimilar rating in Old Santander-Chile and former Santiago loan portfolio. In cases in which a client common to both banks had been assigned a dissimilar risk classification, we have adopted the policy of classifying such client at the lower classification level. This also resulted in a higher level of provisions and charge-offs. The weaker economic environment also contributed to the increase in both our risk index and past due loans by negatively impacting asset quality throughout the financial system.

 

Fee income

 

The following table sets forth certain components of our income from services (net of fees paid to third parties directly connected to providing those services, principally fees relating to credit card processing and ATM network administration) in the years ended December 31, 2002 and 2003.

 

     Year ended December 31,

   % Change

    % Change

 
     2001

   2002

   2003

   2001/2002

    2002/2003

 
     (in millions of constant Ch$ as of December 31, 2003, except percentages)  

Checking accounts

   9,790    28,554    33,395    191.7 %   17.0 %

Credit cards(1)

   5,151    11,755    14,567    128.2 %   23.9 %

Mutual fund services

   6,445    13,999    12,702    117.2 %   (9.3 )%

Automatic Teller cards(2)

   3,320    6,964    10,899    109.8 %   56.5 %

Payment agency services

   9,641    14,779    6,172    53.3 %   (58.2 )%

Letters of credit, guarantees, pledges and other contingent loans

   899    2,909    3,272    223.6 %   12.5 %

Lines of credit

   3,176    4,585    3,058    44.4 %   (33.3 )%

Sales and purchases of foreign currencies

   2,486    3,946    5,001    58.7 %   26.7 %

Insurance brokerage

   3,306    3,587    4,827    8.5 %   34.6 %

Underwriting

   1,034    4,968    4,676    380.5 %   (5.9 )%

Bank drafts and fund transfers

   0    181    237    100.0 %   30.9 %

Custody and trust services

   292    585    537    100.3 %   (8.2 )%

Savings accounts

   2,070    1,566    718    (24.3 )%   (54.2 )%

Other

   2,637    4,737    11,778    79.6 %   148.6 %
    
  
  
            

Total

   50,247    103,115    111,839    105.2 %   8.5 %
    
  
  
            

(1) Net of payments to Transbank in respect of credit card purchase processing expenses.
(2) Net of payments to REDBANC in respect of ATM transaction processing expenses.

 

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2002 and 2003. Fee income for the year ended December 31, 2003 increased 8.5% compared to the same period in 2002. The overall rise in fee income was due to an increase in fees from various business lines. Credit cards fees rose 23.9% in 2003, as the Bank placed special emphasis in increasing the usage of credit cards. For example, in 2003 we launched a special promotion to increase the use of credit cards by giving discounts on the purchase of gasoline on weekends. At the same time, we offered clients the possibility of paying for goods in installments with no interest with their credit cards. We also offered gift and prizes for clients that reached certain level of indebtedness using their credit card.

 

Likewise checking account fee income was up 17.0% from 2002, mainly as a result of an increase in the fees charged to account holders. ATM fee income increased 56.5% due to increased pricing and greater usage of ATMs. We own the largest ATM network in Chile with 1,081 ATMs, which represents a 28.5% market share. During the second half of 2003, we adopted a promotional policy with respect to some fees, in order to increase usage of Bank products and to improve client retention levels. For this reason, fees for lines of credit decreased 33.3%. We expect this trend to continue in 2004, with a similar effect on checking account and ATM fees.

 

In 2003 fee income from contingent loan operations increased 12.5% compared to 2002. In order to increase the profitability of foreign trade operations, the Bank has been serving as a guarantor for Chilean companies for their foreign trade operations with foreign banks. As a result, the Bank improved the profitability of the foreign trade business by generating greater fee income.

 

Insurance brokerage fee income grew 34.6% in 2003 compared to 2002. The Bank also launched various new simple and low cost insurance products that boosted insurance brokerage fees. This included health insurance, credit card and check fraud insurance and property and casualty insurance.

 

The increases in fee income were partially offset by a 9.3% decline in mutual fund management fee income. Average funds under management totaled Ch$1,028,848 million and increased 0.2% compared to 2002. During the first half of 2003, asset management fees were affected by the Corfo-Inverlink affair, which resulted in a large outflow of assets under management into checking accounts and time deposits. In the second half of the year, funds under management began to recover. We have also been proactively encouraging clients to invest in mutual funds instead of short-term deposits given our strong liquidity position. Given the low interest rate environment the profitability generated by the fee income from asset management is greater than the spread that could be obtained on our excess liquidity.

 

LOGO

 

2001 and 2002. Fee income for the year-ended December 31, 2002 increased 105.2% compared to 2001, mainly as a result of the merger.

 

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Other operating income (expenses), net

 

2002 and 2003. Other operating income, net for the year-ended December 31, 2003 totaled a gain of Ch$159,500 million compared to a loss of Ch$13,951 million for the year-ended December 31, 2002. This mainly reflects a gain of Ch$151,957 million from foreign exchange transactions, net in 2003 compared to a loss of Ch$25,583 million in 2002. These results from foreign exchange transactions consist mainly of the accrual cost of foreign currency forward contracts to hedge net interest revenue and reflected the appreciation of the Chilean peso against the U.S. dollar in 2003. Under applicable Superintendency of Banks guidelines these gains or losses cannot be considered interest revenue, but must be considered as gains or losses from foreign exchange transactions and, accordingly, registered in a different line item of the income statement. This accounting asymmetry distorts net interest income and foreign exchange transaction gains, especially in periods of high exchange rate volatility.

 

This higher gain from foreign exchange transactions was partially offset by the 8.3% decrease in unrealized gains on financial investments and realized gains from trading. In 2002, these gains totaled Ch$29,955 million compared to Ch$27,454 million in 2003. Although interest rates declined considerably in both periods, they declined more strongly in 2002.

 

The 8.7% increase in the loss in other operating expenses in the year-ended December 31, 2003 compared to year-end December 31, 2002 figures was primarily the result of higher sales force expenses. The increase in sales force expenses mainly reflected a rise in retail banking activity especially in the second half of 2003. Other operating losses also included the tax expenses incurred in our offer to exchange new subordinated notes due 2012 for our outstanding 7% subordinated notes due 2007, realized in January 2003.

 

2001 and 2002. Our total other operating income, net decreased 207.3% in 2002 compared to 2001 mainly as a result of the merger.

 

Other income and expenses, net

 

2002 and 2003. Other income and expenses, net for the year-ended December 31, 2003 totaled a gain of Ch$35,930 million compared to a loss of Ch$32,262 million in 2002. Other expenses, in 2002, included a charge of Ch$38,997 million accrued in connection with the merger, included in non-operating income, net. Other expenses also included in 2002 a Ch$12,924 million charge related to the harmonization of depreciation criteria of fixed assets. Old Santander-Chile and Santiago depreciated some fixed assets at different rates. We adopted the most conservative criteria between the two used by the separate banks.

 

Excluding merger-related expenses, total other income and expenses, net in 2003 increased 82.8% compared to 2002. In 2003, we restructured our collection procedures to improve loan loss recovery levels. As a part of this process, in the fourth quarter 2003 the Bank sold the subsidiary Cobranzas y Recaudaciones Limitada (C y R), that managed loan loss recoveries for former Banco Santiago, to an external company that former Banco Santander Chile used for its recovery process. The Bank’s recovery efforts have now been fully centralized under the same external company. In 2003, loan loss recoveries increased 33.7% to Ch$33,921 million.

 

The decrease in other non-operating losses was also due to the reclassification of Ch$7,006 million from voluntary loan loss allowances to other liabilities in the balance sheet and from voluntary provisions to nonoperating income, net in the income statement in 2002. The reclassification was in response to new guidelines issued by the Superintendency of Banks, which required that these voluntary loan provisions be reclassified because they were not linked to any specific credit risk.

 

2001 and 2002. Our total other income (net) decreased 411.1 % in 2002 compared to 2001 primarily due to merger-related expenses incurred in 2002.

 

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Operating expenses

 

The following table sets forth information regarding our operating expenses in the years ended December 31, 2001, 2002 and 2003.

 

     Year ended December 31,

    % Change

 
     2001

    2002

    2003

    2001/2002

    2002/2003

 
     (in millions of constant Ch$ as of December 31, 2003, except percentages)  

Personnel salaries and expenses

   84,785     148,922     126,164     75.6 %   (15.3 %)

Administrative expenses

   57,806     100,914     83,933     74.6 %   (16.8 %)

Depreciation and amortization

   17,472     39,728     40,162     127.4 %   1.1 %
    

 

 

           

Total

   160,063     289,564     250,259     80.9 %   (13.6 %)
    

 

 

           

Efficiency ratio(1)

   49.1 %   47.2 %   43.6 %            

(1) The efficiency ratio is the ratio of total operating expenses to total operating revenue. Total operating revenue consists of net interest revenue, fees and income from services, net, and other operating income, net.

 

2002 and 2003. Operating expenses for the year ended December 31, 2003 decreased 13.6% to Ch$250,259 million compared to operating expenses of Ch$289,564 million for the same period in 2002. The efficiency ratio was 43.6% for the year ended December 31, 2003 compared to 47.2% for the year ended December 31, 2002. Personnel expenses decreased 15.3% in 2003 compared to 2002 due mainly to the reduction in headcount during the merger integration process. As of December 31, 2003, total headcount in the Bank was 7,535 persons compared to 8,314 persons at the same date in 2002. Since the beginning of the merger process in August 2002 total headcount decreased 15.7%.

 

Administrative expenses decreased 16.8% in 2003 compared to administrative expenses for the year-ended December 31, 2002, reflecting cost savings produced by the merger.

 

2001 and 2002. Our total operating expenses increased 80.9% in 2002 compared to 2001 as a result of the merger and the implementation of our new technology platform.

 

Loss from price level restatement

 

2003 and 2002. Loss from price level restatement for the twelve month period ended December 31, 2003 decreased 41.4% to Ch$7,702 million compared to Ch$13,148 million for the same 2002 period. The lower loss from price level restatement reflects the lower inflation rate used for calculating price level restatement in the twelve month period ended December 31, 2003 (0.95%) compared to the same period of 2002 (3.0%). Because our capital is larger than the sum of our fixed and other assets, price level restatement usually results in a loss and fluctuates with the variation of inflation.

 

2001 and 2002. The 66.1% increase in the loss from price-level restatement in 2002 from 2001 is attributable to the merger.

 

Income tax

 

2002 and 2003. Our income tax expense increased 57.7% to Ch$43,679 million for the twelve month period ended December 31, 2003 compared to income tax expense of Ch$27,695 million for the same 2002 period. Our net income before taxes rose 34.4% in 2003 compared to 2002 and was the main driver of the rise in tax expense. The statutory tax rate in 2002 was 16% and rose to 16.5% in 2003, which also explains the rise in tax expense in this period. In 2004, the statutory tax rate will rise to 17%. In the first quarter of 2002, Santiago was still benefiting from tax loss carry-forwards related to the subordinated debt issue with the Central Bank of Chile. These tax loss carry-forwards were fully utilized by March 2002.

 

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C. Liquidity and Capital Resources

 

Sources of Liquidity

 

Santander-Chile’s liquidity depends upon its (i) capital, (ii) reserves and (iii) financial investments, including investments in government securities. To cover any liquidity shortfalls and to augment its liquidity position, Santander-Chile has established lines of credit with foreign and domestic banks and also has access to Central Bank borrowings.

 

The following table sets forth our contractual obligations and commercial commitments by time remaining to maturity. As of December 31, 2003, the scheduled maturities of our contractual obligations and of other commercial commitments, including accrued interest were as follows:

 

Contractual Obligations


  

Due within

1 year


   Due after
1 year but
within 3 years


   Due after
3 years but
within 6 years


  

Due after

6 years


   Total 2003

     (in millions of constant Ch$ as of December 2003)

Deposit and other obligations(1)

   3,272,506    220,278    12,372    15,890    3,521,046

Mortgage finance bonds

   189,479    218,316    292,096    583,506    1,283,397

Subordinated bonds

   —      117,166    53,377    217,839    388,382

Bonds

   24,258    13,468    25,419    194,117    257,262

Chilean Central Bank borrowings:

                        

Credit lines for renegotiations of Loans

   12,466    —      —      —      12,466

Other Central Bank borrowings

   338,712    3,770    —      —      342,482

Borrowings from domestic financial institutions

   35,800    —      —      —      35,800

Investments sold under agreements to Repurchase

   465,336    —      —      —      465,336

Foreign borrowings

   483,161    50,647    6,948    —      540,756

Other obligations

   49,289    8,075    5,382    2,105    64,851
    
  
  
  
  

Total of cash obligations

   4,871,007    631,720    395,594    1,013,457    6,911,778
    
  
  
  
  

(1) Excludes demand accounts, saving accounts

 

As of December 31, 2003, the scheduled maturities of other commercial commitments, including accrued interest, were as follows:

 

Other Commercial Commitments


   Due within
1 year


   Due after
1 year but
within 3 years


   Due after
3 years but
within 6 years


   Due after
6 years


   Total 2003

     (in millions of constant Ch$ as of December 2003)

Letter of Credit

   100,356    949    385    —      101,690

Guarantees

   255,752    12,813    3,178    —      271,743

Other commercial commitments

   229,416    97,853    105,122    23,977    456,368
    
  
  
  
  

Total other commercial commitments

   585,524    111,615    108,685    23,977    829,801
    
  
  
  
  

 

(i) Capital

 

Santander-Chile currently has shareholders’ equity in excess of that required by all current Chilean regulatory requirements. According to the General Banking Law, a bank should have an effective net worth of at least 8% of its risk-weighted assets, net of required reserves, and paid-in capital and reserves (“basic capital”) of at least 3% of its total assets, net of required reserves. For these purposes, the effective net worth of a bank is the sum of (a) the bank’s basic capital; (b) subordinated bonds issued by the bank valued at their placement price up to 50% of its basic capital; provided that the value of the bonds shall decrease 20% for each year that lapses during the period

 

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commencing six years prior to their maturity and (c) voluntary loan loss allowances up to 1.25% of the bank’s risk-weighted assets. The calculation of the effective net worth does not include the capital contributions made to subsidiaries of the bank nor its foreign branches. In 2002, the reforms to the capital markets resulted in changes in the calculation of the Bank’s regulatory capital, which became effective in 2003. This consisted of changing the calculation of capital contributions from an unconsolidated basis to a consolidated basis. The merger of Old Santander-Chile and Santiago required a special regulatory preapproval of the Superintendency of Banks, which was granted on May 16, 2002. The resolution granting this preapproval imposed a mandatory minimum capital to risk-weighted assets ratio of 12% for the merged bank. For purposes of weighing the risk of a bank’s assets, the General Banking Law considers five different categories of assets, based on the nature of the issuer, the availability of funds, the nature of the assets and the existence of collateral securing such assets. The following table shows Santander-Chile’s actual equity versus the minimum effective equity required by law:

 

     At December 31,

 
     2002

    2003

 
     (in millions of constant Ch$
as of December 31, 2003)
 

Effective Equity

   1,152,684     1,080,473  

12% of the risk-weighted assets

   (940,369 )   (887,662 )

Excess over minimum effective equity

   212,315     192,811  

 

(ii) Reserves

 

In accordance with the General Banking Law regulations prior to November 4, 1997, banks were required to have a minimum of UF400,000 (approximately US$9.4 million as of December 31, 2003) of paid in capital and reserves. Pursuant to the new General Banking Law, for all periods subsequent to November 4, 1997, banks are required to have a minimum of UF800,000 (approximately US$18.8 million as of December 31, 2003) of paid in capital and reserves, an effective net worth of at least 8% of its risk weighted assets, net of required reserves, and paid in capital and reserves of at least 3% of its total assets, net of required reserves. See “Item 4B: Business Overview—Chilean Regulation and Supervision.” In 2002, the General Banking Law was modified again, allowing banks to begin operations with a minimum capital of UF 400,000 (approximately US$9.4 million as of December 31, 2003) of paid-in capital and reserves with the obligation to increase it to UF 800,000 (approximately US$18.8 million as of December 31, 2003) in an undetermined period of time. If the Bank maintains a minimum capital of UF 400,000 (approximately US$9.4 million as of December 31, 2003) then it will be required to maintain a minimum Bank for International Settlements (“BIS”) ratio of 12%. If the bank increases its capital to UF 600,000 (approximately US$14.1 million as of December 31, 2003) then the minimum BIS ratio that the bank must maintain is 10%.

 

The following table sets forth our minimum capital requirements set by the Superintendency of Banks as of the dates indicated. See Note 12 to our financial statements for a description of the minimum capital requirements.

 

     As of December 31,

 
     2002

    2003

 
     (in millions of constant Ch$
of December 31, 2003
except for percentages)
 

Net capital base

   813,568     810,417  

3% of total assets net of provisions

   (366,870 )   (328,069 )

Excess over minimum required equity

   446,698     482,348  

Net capital base as a percentage of the total assets, net of provisions

   6.7 %   7.4 %

Effective equity

   1,152,684     1,080,473  

12% of the risk-weighted assets

   (940,369 )   (887,662 )

Excess over minimum required equity

   212,315     192,811  

Effective equity as a percentage of the risk-weighted assets

   14.3 %   14.6 %

 

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(iii) Financial Investments

 

The following table sets forth our investment in Chilean government and corporate securities and certain other financial investments as of December 31, 2001, 2002 and 2003. Financial investments that have a secondary market are carried at market value. Since 1999, market value adjustments were performed only for those investments with maturities greater than one year. All other financial investments are carried at acquisition cost, plus accrued interest and indexation readjustments, as applicable.

 

     As of December 31,

     2001

   2002

   2003

    

(in millions of constant Ch$

as of December 31, 2003)

Central Bank and government securities

              

Marketable debt securities(1)

   404,329    1,156,964    586,771

Investments collateral under agreements to repurchase(2)

   193,257    639,438    510,578

Investments purchased under agreements to resell

   7,091    335,497    43,575

Other investments(3)

   30,564    54,388    —  
    
  
  

Subtotal

   635,241    2,186,287    1,140,924
    
  
  

Corporate securities

              

Marketable securities(1)

   201,163    270,560    653,745

Mortgage finance bonds issued by the Bank(4)

   42,723    —      —  

Investment collateral under agreements to repurchase

   33,581    64,295    63,688
    
  
  

Subtotal

   277,467    334,855    717,433
    
  
  

Time deposits in Chilean institutions

   4,130    2,048    55,260

Time deposits in foreign financial institutions

   64,768    —      —  
    
  
  

Total

   981,606    2,523,190    1,913,617
    
  
  

(1) Including market value adjustment.
(2) Under Chilean GAAP, investment securities that are sold subject to repurchase agreements are reclassified from their investment category to “investments under agreements to repurchase.” Under U.S. GAAP, no such reclassification would be made since, in substance, the investment securities serve only as collateral for the borrowing.
(3) Investments held to maturity.
(4) In 2001, these mortgage finance bonds issued by us were shown as investments. As such, these assets were matched by an equal liability. At December 31, 2002 and 2003, these investments are presented net of its corresponding liability.

 

Under Chilean GAAP, investments held for trading must be marked-to-market.

 

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The following table sets forth an analysis of our investments, by time remaining to maturity and the weighted average nominal rates of such investments:

 

    Within
one year


  Weighted
Average
Nominal
Rate


    After one
year but
within five
years


  Weighted
Average
Nominal
Rate


    After five
years but
within ten
years


   Weighted
Average
Nominal
Rate


    After ten
years


  Weighted
Average
Nominal
Rate


    Total

  Weighted
Average
Nominal
Rate


 
    (in millions of constant Ch$ as of December 31, 2003)  

Government securities

                                                  

Central Bank securities

  279,380   3.70 %   207,211   3.49 %   15,067    3.96 %   9,899   4.33 %   511,557   3.87 %

Chilean Treasury Bonds

  7,268   6.93 %   —     —       —      —       —     —       7,268   6.93 %

Government Pension Bonds

  50,225   3.79 %   12,019   3.90 %   5,529    4.72 %   173   5.39 %   67,946   4.45 %
   
       
       
        
       
     

Total

  336,873         219,230         20,596          10,072         586,771      
   
       
       
        
       
     

Investment Purchased under Resale Agreements

  43,575   3.51 %   —     —       —      —       —     —       43,575   3.51 %

Other Financial Investment

                                                  

Time deposits in Chilean Financial Institutions

  55,260   0.77 %   —     —       —      —       —     —       55,260   0.77 %

Other Marketable Securities

  14,646   4.39 %   223,818   5.24 %   225,388    6.42 %   189,893   5.53 %   653,745   5.77 %
   
       
       
        
       
     

Total

  69,906         223,818         225,388          189,893         709,005      
   
       
       
        
       
     

Investment Collateral under agreements to repurchase

  244,575   3.86 %   185,763   2.90 %   143,926    6.58 %   2   4.80 %   574,266   4.54 %
   
       
       
        
       
     

Total Financial Investment

  694,929         628,811         389,910          199,967         1,913,617      
   
       
       
        
       
     

 

Unused sources of liquidity

 

In December 2002, we signed and registered a European Medium Term Note program (the “MTN Program”) for US$300 million. Under this program we will be able to issue debt instruments in the European and U.S. markets pursuant to Rule 144A. These financial instruments can be issued in a wide variety of currencies and maturities with fixed or floating rates. The program also allows us to issue subordinated and senior bonds, as well as certificates of deposit. We have not yet issued debt instruments under this program and therefore the MTN Program constitutes an unused source of liquidity for us.

 

The Bank also has credit ratings from three international agencies. Our ratings are equivalent to the Chilean sovereign ratings. We believe our credit ratings are a positive factor when obtaining financing. In January 2004, Standard and Poor’s raised the sovereign rating of the Republic of Chile from A- to A. This rating agency also increased the ratings of our parent company from A to A+. Following these rating changes, Standard and Poor’s raised our rating from A- to A.

 

Moody’s


   Rating

Long-term Bank Deposits

   Baa1

Subordinated Debt

   A3

Bank Financial Strength

   B-

Short-term

   P-2

Outlook

   Stable

 

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Table of Contents

Standard & Poor’s


   Rating

LT Foreign Issuer Credit

   A

LT Local Issuer Credit

   A

ST Foreign Issuer Credit

   A-1

ST Local Issuer Credit

   A-1

Outlook

   Stable

 

Fitch


   Rating

Foreign Currency LT Debt

   A-

Local Currency LT Debt

   A+

Foreign Currency ST Debt

   F2

Local Currency ST Debt

   F1

Outlook

   Positive

 

Working capital

 

As a bank, we satisfy our working capital needs through general funding; the majority of which derives from deposits and other borrowings from the public. See “Item 5C: Liquidity and Capital Resources Deposits and other Borrowings.” In our opinion, our working capital is sufficient for our present needs.

 

Liquidity Management

 

Liquidity management seeks to ensure that, even under adverse conditions, we have access to the funds necessary to cover client needs, maturing liabilities and capital requirements. Liquidity risk arises in the general funding for our financing, trading and investment activities. It includes the risk of unexpected increases in the cost of funding the portfolio of assets at appropriate maturities and rates, the risk of being unable to liquidate a position in a timely manner at a reasonable price and the risk that we will be required to repay liabilities earlier than anticipated.

 

Our general policy is to maintain liquidity adequate to ensure our ability to honor withdrawals of deposits, make repayments of other liabilities at maturity, extend loans and meet our own working capital needs. Our minimum amount of liquidity is determined by the reserve requirements of the Central Bank. Deposits are subject to a reserve requirement of 9% for peso-denominated demand deposits, 3.6% for peso and UF-denominated time deposits and 19% for demand deposits and 13.6% for time deposits for dollar and other foreign currency obligations. See “Item 4D: Business Overview—Regulation and Supervision.” The Central Bank has statutory authority to increase these percentages to up to 40% for demand deposits and up to 20% for time deposits. In addition, a 100% special reserve (reserva técnica) applies to demand deposits, deposits in checking accounts, other demand deposits received or obligations payable on sight and incurred in the ordinary course of business, other deposits unconditionally payable immediately or within a term of less than 30 days and other time deposits payable within 10 days to the extent their aggregate amount exceeds 2.5 times the amount of a bank’s paid-in capital and reserves. Interbank loans are deemed to have a maturity of more than 30 days, even if payable within the following 10 days.

 

In 1999, the Central Bank passed new regulations regarding liquidity which is summarized as follows:

 

  The sum of the liabilities with a maturity of less than 30 days cannot exceed the sum of the assets with maturity of 30 days by more than an amount equal to a bank’s capital. This limit must be calculated separately for the gap in pesos and the gap in foreign currency. In any case the sum of the gap in local currency and foreign currency cannot be greater than a bank’s capital.

 

  The sum of the liabilities with a maturity of less than 90 days cannot exceed the sum of the assets with a maturity of less than 90 days by more than 2 times a bank’s capital. This limit must be calculated in local currency and foreign currencies together as one gap.

 

We have set other liquidity limits and ratios that minimize liquidity risk. See “Item 11: Quantitative and Qualitative Disclosure About Market Risk.”

 

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Table of Contents

Cash Flow

 

The tables below sets forth our main sources of cash. The subsidiaries are not an important source of cash flow for us and therefore have no impact on our ability to meet our cash obligations. No legal or economic restrictions exist on the ability of subsidiaries to transfer funds to us in the form of loans or cash dividends as long as these subsidiaries abide by the regulations in the Ley de Sociedad Anonimas regarding loans to related parties and minimum dividend payments.

 

     Year ended December 31,

     2001

    2002

   2003

    

(in millions of constant Ch$

as of December 31, 2003)

Net cash (used in) provided by operating activities

   (212,446 )   363,250    290,894

 

Cash provided by operating activities decreased Ch$72,356 million in 2003 compared to 2002, reflecting a similar level of operating activity in 2003 as in 2002, excluding merger provisions taken in 2002 that were actually spent in 2002 and 2003.

 

     Year ended December 31,

     2001

    2002

   2003

    

(in millions of constant Ch$

as of December 31, 2003)

Net cash (used in) provided by investing activities

   (276,995 )   753,738    461,568

 

Cash provided by investing activities decreased Ch$284,170 million in 2003 compared to 2002 as a result of a decrease in financial investments and a lower decrease in loans in 2003 compared to 2002.

 

     Year ended December 31,

 
     2001

   2002

    2003

 
    

(in millions of constant Ch$

as of December 31, 2003)

 

Net cash provided by (used in) financing activities

   515,497    (1,175,460 )   (736,863 )

 

The negative net cash provided by funding activities in 2003 reflects the decrease in the deposit base in line with the reduction of loans. The decrease in cash used by funding activities in 2003 compared to 2002 was mainly due to a lower decrease in deposits in 2003 compared to 2002.

 

Deposits and Other Borrowings

 

The following table sets forth our average daily balance of liabilities for the years ended December 31, 2001, 2002 and 2003, in each case together with the related average nominal interest rates paid thereon.

 

     Year ended December 31,

 
     2001

    2002

    2003

 
     Average
Balance


   % of
Total
Average
Liabilities


    Average
Nominal
Rate


    Average
Balance


   % of Total
Average
Liabilities


    Average
Nominal
Rate


    Average
Balance


   % of Total
Average
Liabilities


    Average
Nominal
Rate


 
     (in millions of constant Ch$ as of December 31, 2003, except for percentages)  

Savings accounts

   90,980    1.4 %   6.2 %   166,008    1.4 %   4.0 %   160,199    1.4 %   1.6 %

Time deposits

   2,443,722    37.1 %   6.5 %   4,897,524    40.1 %   4.7 %   3,963,477    34.2 %   3.1 %

Central Bank borrowings

   31,643    0.5 %   6.0 %   42,640    0.3 %   6.7 %   31,823    0.3 %   5.0 %

Repurchase agreements

   196,095    3.0 %   3.6 %   536,917    4.4 %   5.4 %   654,377    5.7 %   0.0 %

Mortgage finance bonds

   1,056,118    16.0 %   9.5 %   1,727,719    14.1 %   8.7 %   1,503,662    13.0 %   7.1 %

Other interest bearing liabilities

   825,592    12.5 %   8.0 %   1,459,069    11.9 %   6.8 %   1,478,068    12.7 %   5.3 %

Subtotal interest bearing liabilities

   4,644,150    70.5 %   7.3 %   8,829,877    72.2 %   5.9 %   7,791,606    67.3 %   4.0 %

 

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Table of Contents
    Year ended December 31,

    2001

  2002

  2003

    Average
Balance


  % of
Total
Average
Liabilities


    Average
Nominal
Rate


  Average
Balance


  % of
Total
Average
Liabilities


    Average
Nominal
Rate


  Average
Balance


  % of
Total
Average
Liabilities


    Average
Nominal
Rate


    (in millions of constant Ch$ as of December 31, 2003, except for percentages)

Non-interest bearing liabilities

                                         

Non-interest bearing deposits

  871,621   13.2 %       1,665,303   13.7 %       1,666,761   14.4 %    

Contingent liabilities

  312,745   4.7 %       671,281   5.5 %       670,104   5.8 %    

Other non-interest bearing liabilities

  228,317   3.5 %       74,067   0.6 %       517,479   4.4 %    

Shareholders’ equity

  531,515   8.1 %       982,595   8.0 %       935,805   8.1 %    

Subtotal non-interest bearing liabilities

  1,944,198   29.5 %       3,393,246   27.8 %       3,790,149   32.7 %    

Total liabilities

  6,588,348   100.0 %       12,223,123   100.0 %       11,581,755   100.0 %    

 

Our most important source of funding is our time deposits. Time deposits represented 34.2% of our average total liabilities in the year ended December 31, 2003. Our current funding strategy is to continue to utilize all sources of funding in accordance with their cost, their availability and our general asset and liability management strategy. Special emphasis is being placed on increasing deposits from retail customers, which we consider to be a cheaper and more stable source of funding. We also intend to continue to broaden our customer deposit base, to emphasize core deposit funding and to fund our mortgage loans with the matched funding available through the issuance of mortgage finance bonds in Chile’s domestic capital markets. See “Item 4B: Business Overview—Lines of Business—Banca Comercial—Residential Mortgage Lending.” Management believes that broadening our deposit base by increasing the number of account holders has created a more stable funding source.

 

Composition of Deposits and Other Commitments

 

The following table sets forth the composition of our deposits and similar commitments as of December 31, 2001, 2002 and 2003.

 

     As of December 31,

     2001

   2002

   2003

    

(in millions of constant Ch$

as of December 31, 2003)

Checking accounts

   539,676    1,110,298    1,121,141

Other demand liabilities

   329,678    724,856    855,141

Savings accounts

   93,539    189,650    144,837

Time deposits

   2,635,177    4,078,238    3,376,209

Other commitments (1)

   15,273    38,828    29,360
    
  
  

Total

   3,613,343    6,141,870    5,526,688
    
  
  

(1) Includes primarily leasing accounts payable relating to purchases of equipment.

 

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Table of Contents

Maturity of Deposits

 

The following table sets forth information regarding the currency and maturity of our deposits as of December 31, 2003, expressed in percentages. UF–denominated deposits are similar to peso-denominated deposits in all respects, except that the principal is readjusted periodically based on variations in the Chilean consumer price index.

 

     Ch$

    UF

    Foreign
Currency


    Total

 

Demand deposits

   1.5 %   %   %   0.8 %

Savings accounts

   %   13.7 %   %   4.1 %

Time deposits:

                        

Maturing within 3 months

   66.1 %   20.5 %   97.0 %   57.6 %

Maturing after 3 but within 6 months

   15.2 %   23.8 %   2.6 %   15.7 %

Maturing after 6 but within 12 months

   13.6 %   25.0 %   0.3 %   14.8 %

Maturing after 12 months

   3.6 %   17.0 %   0.1 %   7.0 %

Total time deposits

   98.5 %   86.3 %   100.0 %   95.1 %

Total deposits

   100.0 %   100.0 %   100.0 %   100.0 %

 

The following table sets forth information regarding the maturity of the outstanding time deposits in excess of U.S.$100,000 issued by us as of December 31, 2003.

 

     Ch$

   UF

   Foreign
Currency


   Total

    

(in millions of constant Ch$

as of December 31, 2003)

Time deposits:

                   

Maturing within 3 months

   1,026,814    178,438    395,898    1,601,150

Maturing after 3 but within 6 months

   274,445    236,514    13,790    524,749

Maturing after 6 but within 12 months

   197,878    244,963    555    443,396

Maturing after 12 months

   60,612    156,278    719    217,609
    
  
  
  

Total time deposits

   1,559,749    816,193    410,962    2,786,904
    
  
  
  

 

Short-term Borrowings

 

The principal categories of our short-term borrowings are amounts borrowed under foreign trade lines of credit, domestic interbank loans and repurchase agreements. The table below presents the amounts outstanding at the end of each period indicated and the weighted-average nominal interest rate for each such period by type of short-term borrowing.

 

     As of and for the Year Ended December 31,

 
     2001

    2002

    2003

 
     Year End
Balance


   Weighted-
Average
Nominal
Interest
Rate


    Year End
Balance


   Weighted-
Average
Nominal
Interest
Rate


    Year End
Balance


   Weighted-
Average
Nominal
Interest
Rate


 
     (in millions of constant Ch$ as of December 31, 2003, except for rate data)  

Investments under repurchase agreements

   226,964    2.6 %   737,101    4.0 %   465,336    0.0 %

Central Bank borrowings

   109,398    6.0 %   14,093    6.7 %   331,693    2.8 %

Domestic interbank loans

   83,783    5.3 %   20,705    3.6 %   35,800    5.0 %

Borrowings under foreign trade credit lines

   111,958    2.7 %   37,075    8.5 %   117,355    (0.3 )%

Total short-term borrowings

   532,103    4.0 %   808,974    7.3 %   950,184    1.0 %

 

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Table of Contents

The following table shows the average balance and the average nominal rate for each short-term borrowing category during the periods indicated:

 

     As of and for the Year Ended December 31,

 
     2001

    2002

    2003

 
     Average
Balance


   Average
Nominal
Interest
Rate


    Average
Balance


   Average
Nominal
Interest
Rate


    Average
Balance


   Average
Nominal
Interest
Rate


 
     (in millions of constant Ch$ as of December 31, 2003, except for rate data)  

Investments under repurchase agreements

   196,095    3.6 %   536,917    5.4 %   654,377    0.0 %

Central Bank borrowings

   31,643    6.0 %   42,640    6.7 %   31,823    5.0 %

Investments under repurchase agreements

   196,095    3.6 %   536,917    5.4 %   654,377    0.0 %

Domestic interbank loans

   131,130    5.3 %   33,309    6.7 %   65,427    2.6 %

Borrowings under foreign trade credit lines

   84,758    1.8 %   1,103,594    6.8 %   89,328    1.5 %

Total short-term borrowings

   443,626    3.8 %   1,716,460    6.4 %   840,955    0.6 %

 

The following table presents the maximum month-end balances of our principal sources of short-term borrowings during the periods indicated:

 

     Maximum 2001
Month-End
Balance


   Maximum 2002
Month-End
Balance


   Maximum 2003
Month-End
Balance


    

(in millions of constant Ch$

as of December 31, 2003)

Investments under agreements to repurchase

   237,970    47,836    381,153

Central Bank borrowings

   109,398    —      331,693

Domestic interbank loans

   218,619    20,705    73,934

Borrowings under foreign trade credit lines

   149,041    115,408    220,408
    
  
  

Total short-term borrowings

   715,028    183,949    1,007,188
    
  
  

 

Total Borrowings

 

Our long-term and short-term borrowings are summarized below. Borrowings are generally classified as short-term when they have original maturities of less than one year or are due on demand. All other borrowings are classified as long-term, including the amounts due within one year on such borrowings.

 

     December 31, 2002

     Long-term

   Short-term

   Total

     (MCh$)

Central Bank borrowings

   —      14,093    14,093

Credit lines for renegotiations of loans

   15,903    —      15,903

Investments under agreements to repurchase

   —      737,101    737,101

Mortgage finance bonds

   1,576,891    —      1,576,891

Other borrowings: bonds

   404,451    —      404,451

Subordinated bonds

   459,296    —      459,296

Borrowings from domestic financial institutions

   42,034    20,705    62,739

Foreign borrowings

   573,382    37,075    610,457

Other obligations

   35,580    42,053    77,633
    
  
  

Total borrowings

   3,107,537    851,027    3,958,564
    
  
  

 

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Table of Contents
     December 31, 2003

     Long-term

   Short-term

   Total

     (MCh$)

Central Bank borrowings

   10,789    331,693    342,482

Credit lines for renegotiations of loans

   12,466    —      12,466

Investments under agreements to repurchase

   —      465,336    465,336

Mortgage finance bonds

   1,283,397    —      1,283,397

Other borrowings: bonds

   257,262    —      257,262

Subordinated bonds

   388,382    —      388,382

Borrowings from domestic financial institutions

   —      35,800    35,800

Foreign borrowings

   423,401    117,355    540,756

Other obligations

   21,809    43,042    64,851
    
  
  

Total borrowings

   2,397,506    993,226    3,390,732
    
  
  

 

a) Credit lines for renegotiations of loans

 

Central Bank borrowings include credit lines for the renegotiations of loans and other Central Bank borrowings. These credit lines were provided by the Central Bank for the renegotiations of loans due to the need to refinance debts as a result of the economic recession and crisis of the banking system in the early 1980’s. The lines for the renegotiations, which are considered long-term, are related with mortgage loans linked to the UF index and bear a real annual interest rate of 4.6%. Other Central Bank borrowings carry a nominal annual interest rate of 5.0%. The maturities of the outstanding amounts due to the Central Bank pursuant to credit loans for renegotiation of loans are as follows:

 

     December 31,

     2002

   2003

     (MCh$)

Total credit lines for renegotiations of loans

   15,903    12,466

 

The maturities of the outstanding amounts due under these credit lines, which are considered long-term, are as follows:

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   12,466

Due after 1 year but within 2 years

   —  

Due after 2 years but within 3 years

   —  

Due after 3 years but within 4 years

   —  

Due after 4 years but within 5 years

   —  

Due after 5 years

   —  
    

Total credit lines for renegotiations of loans

   12,466
    

 

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Table of Contents

(b) Mortgage finance bonds

 

These bonds are used to finance the granting of mortgage loans. The outstanding principal amounts of the bonds are amortized on a quarterly basis. The range of maturities of these bonds is between five and twenty years. The bonds are linked to the UF index and bear a real weighted-average annual interest rate of 6.1%.

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   189,479

Due after 1 year but within 2 years

   108,332

Due after 2 years but within 3 years

   109,984

Due after 3 years but within 4 years

   105,407

Due after 4 years but within 5 years

   93,611

Due after 5 years

   676,584
    

Total mortgage finance bonds

   1,283,397
    

 

(c) Other borrowings: bonds

 

     As of December 31,

     2002

   2003

     (MCh$)

Santiago Leasing S.A.’s bonds

   79,968    66,062

Santiago bonds

   134,820    76,210

Santander bonds

   189,663    114,990
    
  

Total other borrowings: bonds

   404,451    257,262
    
  

 

Santiago Leasing S.A.’s bonds are linked to UF and carry an annual interest rate of 5.6%.

 

Bond obligations included in the line Santiago bonds include series A, B, C and F issued by Santiago and series B and D issued by the former Banco O’Higgins, prior to its merger with us in 1997. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and carry a weighted average annual interest rate of 7.0% with interest and principal payments due semi-annually.

 

Bond obligations included in the line Santander reflect bonds issued by Old Santander-Chile. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index and carry a weighted average annual interest rate of 6.5%.

 

The maturities of these bonds are as follows:

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   24,258

Due after 1 year but within 2 years

   5,059

Due after 2 years but within 3 years

   8,409

Due after 3 years but within 4 years

   3,972

Due after 4 years but within 5 years

   18,026

Due after 5 years

   197,538
    

Total bonds

   257,262
    

 

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Table of Contents

d) Subordinated bonds

 

     As of December 31,

     2002

   2003

     (MCh$)

Santiago bonds denominated in US$ (1)

   219,460    47,713

Santander bonds denominated in US$ (2)

   —      130,097

Old Santander-Chile bonds denominated in US$ (3)

   145,052    120,989

Santiago bonds linked to the UF (4)

   62,643    58,892

Santander bonds linked to the UF (5)

   31,141    30,691
    
  

Total subordinated bonds

   458,296    388,382
    
  

(1) On July 17, 1997, Santiago issued subordinated bonds abroad, denominated in U.S. dollars, for a total of US$300 million. The bonds carried a nominal interest rate of 7.0% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.
(2) On January 16, 2003, we completed the process of voluntary exchange of our new subordinated notes which will mature in 2012. A total of US$221,961,000 in principal of the previous issue was offered and accepted by the Bank at the moment of the exchange. The bonds carry a nominal interest rate of 7.375% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.
(3) On October 30, 1998, Old Santander-Chile issued subordinated bonds abroad, denominated in U.S. dollars, for a total of US$200 million. The bonds carry a nominal interest rate of 6.5% per annum, semi-annual interest payments and one repayment of principal after a term of 7 years.
(4) The Series C, D and E Bonds outstanding as of December 31, 2003 are intended for the financing of loans having a maturity of greater than one year. They are linked to the UF index and carry an annual interest rate of 7.0% with interest and principal payments due semi-annually.
(5) The Series C and E Bonds outstanding as of December 31, 2003 are intended for the financing of loans having a maturity of greater than one year. They are linked to the UF index and carry an annual interest rate of 7.5% and 6.0% respectively, with interest and principal payments due semi-annually.

 

The maturities of these bonds, which are considered long-term, are as follows:

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   —  

Due after 1 year but within 2 years

   117,166

Due after 2 years but within 3 years

   —  

Due after 3 years but within 4 years

   53,377

Due after 4 years but within 5 years

   —  

Due after 5 years

   217,839
    

Total subordinated bonds

   388,382
    

 

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Table of Contents

e) Foreign borrowings

 

These are short-term and long-term borrowings from foreign banks. All of these loans are denominated principally in U.S. dollars, are principally used to fund our foreign trade loans and carry an annual average interest rate of 3.4%. The maturities of these borrowings are as follows:

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   365,805

Due after 1 year but within 2 years

   46,411

Due after 2 years but within 3 years

   4,236

Due after 3 years but within 4 years

   2,405

Due after 4 years but within 5 years

   4,544
    

Due after 5 years

   —  
    

Total long-term

   423,401

Total short-term

   117,355
    

Total foreign borrowings

   540,756
    

 

f) Other obligations

 

Other obligations are summarized as follows:

 

     As of December 31,
2003


     (MCh$)

Due within 1 year

   6,247

Due after 1 year but within 2 years

   5,913

Due after 2 years but within 3 years

   2,162

Due after 3 years but within 4 years

   2,166

Due after 4 years but within 5 years

   1,774

Due after 5 years

   3,547
    

Total long term obligations

   21,809
    

Short-term obligations:

    

Amounts due to credit card operator

   35,205

Acceptance of letters of credit

   7,837
    

Total short-term obligations

   43,042
    

Total other obligations

   64,851
    

 

Other Off-Balance Sheet Arrangements and Commitments

 

We are party to transactions with off-balance-sheet risk in the normal course of our business. These transactions expose us to credit risk in addition to amounts recognized in the consolidated financial statements.

 

These transactions include commitments to extend credit not otherwise accounted for as contingent loans, such as overdraft protection and credit card lines of credit. Such commitments are agreements to lend to a customer at a future date, subject to the customer compliance with meeting of the contractual terms. The amounts of these commitments are Ch$2,504,906 million as of December 31, 2003.

 

Since a substantial portion of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent our actual future cash requirements. We use the same credit policies in making commitments to extend credit as we do for granting loans. In the opinion of our management, our outstanding commitments do not represent an unusual credit risk.

 

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The Bank and its brokerage subsidiary enter into derivative transactions, particularly foreign exchange contracts, as part of their asset and liability management and in acting as dealers to satisfy their clients’ needs. The notional amount of these contracts are carried off-balance-sheet. See Note 11 to the Audited Consolidated Financial Statements.

 

Operational leases

 

Certain banks and equipment are leased under various operating leases. Future minimum rental commitments as of December 31, 2003 under non-cancelable leases are as follows:

 

     As of December 31,
2003


     MCh$

Due within 1 year

   5,879

Due after 1 year but within 2 years

   5,251

Due after 2 years but within 3 years

   4,774

Due after 3 years but within 4 years

   4,228

Due after 4 years but within 5 years

   3,524

Due after 5 years

   5,837
    

Total

   29,493
    

 

D. Asset and Liability Management

 

Our policy with respect to asset and liability management is to capitalize on our competitive advantages in treasury operations, maximizing our net interest revenue and return on assets and equity with a view to interest rate, liquidity and foreign exchange risks, while remaining within the limits provided by Chilean banking regulations. Subject to these constraints, we occasionally take mismatched positions with respect to interest rates and foreign currencies. Our asset and liability management policies are developed by the Asset and Liability Committee (the “ALCO”) following guidelines and limits established by our Board of Directors, Banco Santander Central Hispano’s Global Risk Department and our Market Risk and Control Department. The ALCO is composed of the Chairman of the Board, three members of the Board, the Chief Executive Officer, the Manager of the Finance Division and the Financial Controller. Senior members of Santander Chile’s Finance Division meet daily and, on a formal basis, weekly with the Asset and Liabilities Management Committee and outside consultants. In addition, our Controller reports weekly on all of our positions to the ALCO. Our limits and positions are reported on a daily basis to Banco Santander Central Hispano’s Global Risk Department. The ALCO reports as often as deemed necessary to our Board of Directors. The risk limits set by the ALCO are implemented by our Finance Division and are controlled by the Market Risk and Control Department, which establishes guidelines and policies for risk management on a day-to-day basis. For a further discussion of the ALCO and its role in market risk management, See “Item 11: Quantitative and Qualitative Disclosure About Market Risk.”

 

The composition of our assets, liabilities and shareholders’ equity at December 31, 2003 by currency and term is as follows:

 

     December 31, 2003

 
     Ch$

   UF

   Foreign
Currency


   Total

   Percentage

 
     (in millions of constant Ch$ as of December 31, 2003, except percentages)  

Assets

                          

Cash and due from banks

   848,158    —      135,910    984,068    9.0 %

Other assets:(1)

                          

Less than one year

   2,123,603    1,704,956    686,424    4,514,983    41.3 %

From one to three years

   445,645    1,275,606    174,467    1,895,718    17.4 %

More than three years

   167,691    2,541,621    412,236    3,121,548    28.6 %

 

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     December 31, 2003

 
     Ch$

    UF

    Foreign
Currency


    Total

    Percentage

 
     (in millions of constant Ch$ as of December 31, 2003, except percentages)  

Bank premises and equipment and other

   507,141     4,121     61,074     572,336     5.2 %

Allowance for loan losses

   (168,226 )   —       —       (168,226 )   (1.5 %)
    

 

 

 

 

Total

   3,924,012     5,526,304     1,470,111     10,920,427     100.0 %
    

 

 

 

 

Percentage of total assets

   35.9 %   50.6 %   13.5 %   100.0 %      

Liabilities and Shareholders’ Equity

                              

Non-interest bearing deposits

   1,935,672     26,763     199,021     2,161,456     19.8 %

Other liabilities:(1)

                              

Less than one year

   2,578,003     1,313,652     1,564,874     5,456,529     50.0 %

From one to three years

   55,429     407,718     280,188     743,335     6.8 %

More than three years

   12,048     1,208,424     321,243     1,541,715     14.1 %

Shareholders’ equity

   810,417     —       —       810,417     7.4 %

2003 net income

   206,975     —       —       206,975     1.9 %
    

 

 

 

 

Total

   5,598,544     2,956,557     2,365,326     10,920,427     100.0 %
    

 

 

 

 

Percentage of total liabilities and shareholders’ equity

   51.2 %   27.1 %   21.7 %   100.0 %      

(1) Other assets include our rights under foreign exchange contracts, and other liabilities include our obligations under foreign exchange contracts. For purposes of our financial statements, our rights and obligations under foreign exchange contracts are included on a net basis. Mortgage finance bonds issued by us are included as other liabilities and mortgage finance bonds held in our financial investment portfolio (issued by third parties) are included as other assets.

 

We have generally maintained more peso-denominated liabilities than peso-denominated assets and more UF-denominated assets than UF-denominated liabilities. In the context of a rising CPI, this has in the past had a positive impact on our net income by generating net income from adjustments of the UF that exceeds losses arising from price-level restatements. This effect is expected to decrease significantly if rates of inflation decrease.

 

Interest Rate Sensitivity

 

A key component of our asset and liability policy is the management of interest rate sensitivity. Interest rate sensitivity is the relationship between market interest rates and net interest revenue due to the maturity or repricing characteristics of interest earning assets and interest bearing liabilities. For any given period, the pricing structure is matched when an equal amount of such assets and liabilities mature or reprice in that period. Any mismatch of interest earning assets and interest bearing liabilities is known as a gap position. A positive gap denotes asset sensitivity and means that an increase in interest rates would have a positive effect on net interest revenue while a decrease in interest rates would have a negative effect on net interest revenue.

 

Our interest rate sensitivity strategy takes into account not only the rates of return and the underlying degree of risk, but also liquidity requirements, including minimum regulatory cash reserves, mandatory liquidity ratios, withdrawal and maturity of deposits, capital costs and additional demand for funds. We monitor our maturity mismatches and manage them within established limits.

 

The following table sets forth the repricing of our interest earning assets and interest bearing liabilities at December 31, 2003 and may not reflect interest rate gap positions at other times. In addition, variations in interest rate sensitivity may exist within the repricing periods presented due to the differing repricing dates within the period. Variations may also arise among the different currencies in which interest rate positions are held.

 

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As the following table reflects, we have a negative gap in the 30 day or less bucket since 41.3% of deposits, our main source of funding are short-term. This is an industry-wide phenomenon. However, our exposure to potential changes in nominal peso interest rates are reduced by the fact that at December 31, 2003 approximately 47.5% of our interest-bearing liabilities and 26.5% of our interest earning assets had a repricing period of less than 90 days. The majority of assets and liabilities with a maturity of 90 days or less are denominated in nominal pesos. Ninety days or more is also the most common repricing period for UF-denominated time deposits. In the case of interest earning assets and interest-bearing liabilities denominated in UF, our exposure to changes in interest rates is reduced by the fact that a significant portion of the interest rate earned or paid on such assets or liabilities is indexed to reflect the daily effect of inflation, and as a result our gap position is limited to variations in the real interest rate among such assets and liabilities. Further, substantially all of Santander-Chile’s foreign currency-denominated loans were funded by foreign currency borrowings and time deposits with comparable maturity or repricing dates. Moreover, mortgage loans which have 8 to 20-year terms were generally financed through mortgage finance bonds issued for the same terms and in the same currency.

 

     As of December 31, 2003

     Up to 30
days


    31-60
days


    61-90
days


    91-180
days


    181-365
days


    1-3 years

    Over 3
years


    Total

     (in millions of constant Ch$ as of December 31, 2003, except for percentages)

Interest-earning assets:

                                              

Interbank deposits

   83,466     —       —       —       —       —       —       83,466

Financial investments

   110,169     37,270     15,884     44,769     486,838     444,387     774,300     1,913,617

Loans

   1,360,644     221,794     264,187     497,812     673,525     1,028,886     1,078,849     5,125,697

Mortgage loans

   13,394     9,984     9,983     30,516     61,623     246,734     1,121,585     1,493,819

Contingent loans

   81,885     135,420     37,741     99,780     151,670     175,711     146,814     829,021

Past due loans

   170,095     —       —       —       —       —       —       170,095
    

 

 

 

 

 

 

 

Total interest-earning assets

   1,819,653     404,468     327,795     672,877     1,373,656     1,895,718     3,121,548     9,615,715
    

 

 

 

 

 

 

 

Interest-bearing liabilities:

                                              

Deposits

   1,453,695     505,120     231,959     556,455     525,276     220,278     28,263     3,521,046

Central Bank borrowings

   334,353     1,872     314     3,251     11,387     3,771     —       354,948

Repurchase agreements

   294,825     150,545     18,468     631     867