UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 20-F



o 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, 2005  
     
OR
     
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934  
     

Commission file number 1-14554

BANCO SANTANDER-CHILE
(d/b/a Banco Santander Santiago and Santander Santiago)

(Exact name of Registrant as specified in its charter)

SANTANDER-CHILE BANK
(d/b/a Santander Santiago Bank and Santander Santiago)

(Translation of Registrant’s name into English)



Chile
(Jurisdiction of incorporation or organization)

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:
7.375% Subordinated Notes due 2012

The number of outstanding shares of each class of common stock of Banco Santander-Chile at December 31, 2005 was:
188,446,126,794 Shares of Common Stock, without par value


    Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes  x   No  o

    If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

Yes  o   No  x

    Note - Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

     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  o

    Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x Accelerated filer o Non-accelerated filer o

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

Item 17  o   Item 18  x

    If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o   No  x

 

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    TABLE OF CONTENTS  
      Page

Cautionary Statement Concerning Forward-Looking Statements  
Certain Terms and Conventions  
Presentation of financial Information  
   Item 2.   Offer Statistics and Expected Timetable  
   Item 3.   Key Information  
   Item 4.   Information on the Company  
   Item 4A.   SEC Staff comments  
   Item 5.   Operating and Financial Review and Prospects  
   Item 6.   Directors, Senior Management and Employees  
   Item 7.   Major Shareholders and Related Party Transactions  
   Item 8.   Financial Information  
   Item 9.   The Offer and Listing  
   Item 10.   Additional Information  
   Item 11.   Quantitative and Qualitative Disclosures about Market Risk  
   Item 12.   Description of securities other than equity securities  
PART II      
   Item 13.   Defaults, Dividend Arrearages and Delinquencies  
   Item 14.   Material Modifications to the Rights of Security Holders and Use of Proceeds  
   Item 15.   Controls and Procedures  
   Item 16A.   Audit Committee Financial Expert  
   Item 16B.   Code of Ethics  
   Item 16C.   Principal Accountant Fees and Services  
   Item 16D.   Exemptions from the Listing Standards for Audit Committees.  
   Item 16E.   Purchases of Equity Securities by the Issuer and Affiliated Purchasers.  

3






PART III      
   Item 17.   Financial Statements  
   Item 18.   Financial Statements  
   Item 19.   Exhibits  


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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
 
  growth of our fee-based business
 
  financing plans
 
  impact of competition
 
  impact of regulation
 
  exposure to market risks:
 
    interest rate risk
 
    foreign exchange risk
 
    equity price risk
 
  projected capital expenditures
 
  liquidity
 
  trends affecting:
 
    our financial condition
 
    our results of operation
 

     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 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

  • changes in economic conditions

  • the monetary and interest rate policies of the Central Bank

  • inflation

  • deflation

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  • 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

  • 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 successfully market and sell additional services to our existing customers
  • disruptions in client service

  • successful implementation of new technologies

  • loss of market share

  • an inaccurate or ineffective client segmentation model

     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.

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CERTAIN TERMS AND CONVENTIONS

     As used in this Annual Report, “Santander-Chile”, “the Bank”, “we,” “our” and “us” 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.

     In this Annual Report, references to the Audit Committee are to the Bank’s Comité de Directores y Auditoría. This committee is the successor of the Directors Committee created under Law 19,705 in 2000 and the Audit Committee created by the Board of Directors of Banco Santiago in 1995. On September 22, 2004, the Superintendency of Banks authorized that the functions of the Audit Committee be performed by the Directors Committee. On October 19, 2004, the Board of Directors of Banco Santander Chile, by resolution No. 357, approved the merger of both committees and the transfer of all functions of both committees to the Comité de Directores y Auditoría, which was created on the same date.

In this Annual Report, references to “BIS” are to the Bank for International Settlement, and references to “BIS ratio” are to the capital adequacy ratio as calculated in accordance with the Basel Capital Accord.

 

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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 27 to the Audited Consolidated Financial Statements of Santander-Chile as of December 31, 2004 and 2005 and for the years ended December 31, 2003, 2004 and 2005 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, 2005. 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 commercial 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, 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

8






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.

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.

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 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, 2005, which was Ch$514.21 per US$1.00. The observed exchange rate reported by the Central Bank on December 31, 2005 is based upon the actual exchange rate of December 30, 2005 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, 2005. The observed exchange rate on March 31, 2006 was Ch$527.70 per US$1.00, reflecting an accumulated depreciation of 2.62% from December 31, 2005. 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 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, 2001 are those of Santiago which is deemed to be the predecessor entity of Santander-Chile.

9






     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 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.

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

     Not Applicable.

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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, which differs in certain significant respects from U.S. GAAP. Note 27 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 December 31, 2003, 2004 and 2005 and shareholders’ equity at December 31, 2004 and 2005.

     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 were 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. See Note 27(a) to our Audited Consolidated Financial Statements.

11






    As of and for the Year Ended December 31,
   
    2001   2002   2003   2004   2005   2005
   

 

 

 

 

 

    (in millions of constant Ch$ as of December 31, 2005)(1)   (in thousands of
U.S.$)(1)(2)
CONSOLIDATED INCOME                                    
     STATEMENT DATA                                    
Chilean GAAP:                                    
Interest revenue   639,738     1,105,866     651,540     812,032     985,669     1,916,860  
Interest expense   (360,962 )   (549,012 )   (330,119 )   (326,743 )   (439,790 )   (855,273 )












Net interest revenue   278,776     556,854     321,421     485,289     545,879     1,061,587  
Allowances for loan losses   (38,886 )   (70,831 )   (71,592 )   (83,677 )   (63,532 )   (123,554 )
Total fees and income from                                    
     services, net   53,357     109,497     118,762     126,013     138,366     269,085  
Other operating income, net   13,808     (14,815 )   169,373     20,555     (12,514 )   (24,336 )
Other income and expenses,                                    
     net   11,013     (34,259 )   2,132     (4,206 )   (21,468 )   (41,749 )
Operating expenses   (169,970 )   (307,487 )   (265,749 )   (277,989 )   (279,053 )   (542,683 )
Loss from price-level                                    
     restatement   (8,408 )   (13,962 )   (8,179 )   (12,417 )   (18,140 )   (35,227 )
Income before income taxes   127,177     198,054     266,169     253,570     289,538     563,073  
Income (taxes) benefit   3,908     (29,409 )   (46,382 )   (47,578 )   (49,828 )   (96,902 )












     Net income   131,084     168,645     219,786     205,991     239,710     466,171  
Net income per share   1.33     0.89     1.17     1.09     1.27     0.00247  
Net income per American                                    
     Depositary Share(3)   1,376.64     929.83     1,211.82     1,135.71     1,321.61     2.57  
Dividends per share(4)   1.03     1.33     0.89     1.17     1.09     0.00212  
Dividends per ADS(4)   1,068.90     1,376.64     929.83     1,211.82     1,135.71     2.21  
Weighted-average shares                                    
     outstanding (in millions)   98,934.2     188,446.1     188,446.1     188,446.1     188,446.1     -  
                                     
U.S. GAAP:                                    
Net interest income (5)   513,803     552,831     299,796     464,832     553,121     1,075,671  
Provision for loan losses   (76,785 )   (70,912 )   (91,093 )   (67,493 )   (64,561 )   (125,554 )
Amortization of goodwill   43,040     -     -     -     -     -  
Net income   170,949     148,071     189,778     206,130     226,042     439,591  
Net income per Share(6)   0.91     0.79     1.01     1.10     1.20     0.00233  

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    As of and for the Year Ended December 31,
   
    2001   2002   2003   2004   2005   2005
   

 

 

 

 

 

    (in millions of constant Ch$ as of December 31, 2005)(1)   (in thousands of
U.S.$)(1)(2)
CONSOLIDATED                                    
     INCOME                                    
     STATEMENT                                    
     DATA                                    
Net income per ADS (6)   942.55     816.41     1,046.34     1,136.50     1,246.26     2.42  
Weighted-average shares                                    
     outstanding (in                                    
     millions) US GAAP   188,446.1     188,446.1     188,446.1     188,446.1     188,446.1     -  
Weighted-average ADS                                    
     outstanding (in                                    
     millions) US GAAP   181.377     181.377     181.377     181.377     181.377     -  
                                 
CONSOLIDATED BALANCE SHEET DATAM                                
                                     
Chilean GAAP:                                    
Cash and due from                                    
     banks   613,247     1,048,680     1,044,980     982,576     1,224,962     2,382,221  
Investments (7)   1,042,365     2,679,370     2,032,066     2,061,505     1,249,495     2,429,931  
Loans, net of allowances   5,458,235     8,253,544     7,911,569     8,752,111     9,996,407     19,440,321  
Loan loss allowances   (104,268 )   (179,727 )   (178,639 )   (179,559 )   (147,866 )   (287,560 )
Other assets   348,494     218,599     303,873     433,377     347,923     676,617  
Total assets (5)   7,462,341     12,500,190     11,596,376     12,507,481     13,096,821     25,469,791  
Deposits   3,837,001     6,522,038     5,868,778     6,991,517     8,075,521     15,704,714  
Other interest-bearing                                    
     liabilities   2,499,893     4,203,590     3,600,611     3,279,243     2,842,461     5,527,824  
Shareholders’ equity   594,907     1,032,570     1,080,366     1,069,103     1,081,832     2,103,872  
                                     
U.S. GAAP:                                    
Total assets   12,856,751     12,152,674     11,220,032     12,256,764     13,837,675     26,910,552  
Long-term borrowings   3,999,436     3,314,851     2,545,906     1,870,374     1,427,677     2,776,447  
Shareholders’ equity (8)   1,513,766     1,917,506     1,920,773     1,911,668     1,898,262     3,691,608  
Goodwill   555,624     789,779     789,779     789,779     789,779     1,535,908  

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Note: n/a = not applicable.

    As of for the Year Ended December 31,
   
    2001   2002   2003   2004   2005
   

 

 

 

 

CONSOLIDATED RATIOS                              
Chilean GAAP:                              
Profitability and Performance                              
Net interest margin(9)   4.5 %   4.8 %   3.0 %   4.4 %   4.7 %
Adjusted net interest margin (10)         4.6 %   4.5 %   4.5 %   4.7 %
Return on average total assets(11)   1.9 %   1.3 %   1.8 %   1.7 %   1.8 %
Return on average shareholders’ equity(12)   23.2 %   16.2 %   22.1 %   20.2 %   24.1 %
Capital                              
Average shareholders’ equity as a percentage of average total assets   8.1 %   8.3 %   8.1 %   8.2 %   7.4 %
Total liabilities as a multiple of shareholders’ equity   11.5     11.1     9.7     11.7     12.1  
Credit Quality:                              
Substandard loans as a percentage of a total loans(13)   2.2 %   3.2 %   3.6 %   3.7 %   2.6 %
Allowance for loans losses as percentage of total loans   2.1 %   2.1 %   2.2 %   2.0 %   1.5 %
Past due loans as a percentage of total loans (14)   1.3 %   2.1 %   2.2 %   1.5 %   1.1 %
Operating Ratios:                              
Operating expenses/operating revenue(15)   49.1 %   47.2 %   43.6 %   44.0 %   41.5 %
Operating expenses/average total assets   2.4 %   2.3 %   2.2 %   2.2 %   2.1 %
Ratio of earnings to fixed charges (16)                              
Calculation including interest on deposits   1.35     1.36     1.81     1.77     1.65  
Calculation excluding interest on deposits   1.68     1.65     2.34     2.26     2.46  
                               
U.S. GAAP:                              
Profitability and Performance:                              
Net interest margin(17)   4.5 %   4.7 %   2.8 %   4.3 %   4.8 %
Return on average total assets(18)   1.4 %   1.2 %   1.6 %   1.8 %   1.7 %
Return on average shareholders’ equity(19)   11.7 %   8.6 %   9.9 %   10.8 %   11.9 %
Ratio of earnings to fixed charges                              
Calculation including interest on deposits   1.36     1.37     1.83     1.87     1.71  
Calculation excluding interest on deposits   1.71     1.67     2.35     2.43     2.51  
                               
OTHER DATA                              
Inflation Rate(20)   2.6 %   2.8 %   1.1 %   2.4 %   3.7 %
Devaluation (Revaluation) Rate (Ch$/U.S.$) at period end(20)   14.6 %   8.6 %   (15.9 %)   (6.6 %)   (8.1 %)
Number of employees at period end(21)   4,489     8,314     7,535     7,380     7,482  
Number of branches and offices at period end   169     347     345     315     352  


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, 2005 have been translated from Chilean pesos at the observed exchange rate of Ch$514.21 = U.S.$1.00 as of December 31, 2005. 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 27 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”).
(10)      Net interest revenue plus foreign exchange transactions divided by average interest earning assets (as presented in “Item 5: Selected Statistical Information”). Pursuant to Chilean GAAP, Santander-Chile must include as net interest income the gain or loss in book value of dollar indexed interest earning assets and liabilities. At the same time and pursuant to Chilean GAAP, the Bank must report the results of forward contracts, which hedge foreign currency, as foreign currency transactions in the income statement. The accounting asymmetry produced by incorporating the changes in book value of dollar indexed assets and liabilities as net interest revenue and the financial results of forward contracts as financial exchange transactions results in a presentation that is not reflective of our underlying business, especially during periods when the exchange rate is highly volatile and, therefore, for analysis purpose only, we add foreign exchange transactions to net interest revenue. For a reconciliation of this non-GAAP measure, see “Reconciliation of non-GAAP measures” in Item 5.
(11)      Net income divided by average total assets (as presented in “Item 5: Selected Statistical Information”).
 
(12)      Net income divided by average shareholders’ equity (as presented in “Item 5: Selected Statistical Information”).
 

14






(13)      Substandard loans in the old rating system included all loans rated B- or worse. In the new loan risk classification system which took effect in 2004, substandard loans include all consumer and mortgage loans rated B- or worse and for commercial loans all loans rated C1 or worse. See Item5D-Asset and Liability Management-Analysis of Substandard Loans and Past Due loans”.
(14)      Past due loans are loans the principal or interest amount of which is 90 days or more 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.
(15)      Operating revenue includes “Net interest revenue,” “Total fees and income from services, net” and “Other operating income, net.”
(16) For the purpose of computing the ratios of earnings to fixed charges, earnings consist of earnings before income tax and fixed charges. Fixed charges consist of gross interest expense and the proportion deemed representative of the interest factor of rental expense.
(17)      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 27(y) to our Consolidated Financial Statements.
(18)      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 27 to our Audited Consolidated Financial Statements.
(19)      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 27(y) to our Audited Consolidated Financial Statements.
(20)      Based on information published by the Central Bank.
(21)      The number of employees presented in this table for the years 2001 are those of Santiago only, excluding subsidiaries, because consolidated employee information was not available that year.

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 Law 18,840, the organic law of the Central Bank, or the Central Bank Act (Ley Orgánica Constitucional del Banco Central de Chile), 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.

     Purchases and sales of foreign currencies may be legally effected outside the Formal Exchange Market 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. 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, 2005, the average exchange rate in the Informal Exchange Market was Ch$512.0 or 0.43% lower than the published observed exchange rate for such date of Ch$514.21 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. We make no representation that the Chilean peso or the US dollar amounts referred to herein actually represent, could have been or could be converted into US dollars or Chilean pesos, as the case may be, at the rates indicated, at any particular rate or at all.

15






    Daily Observed Exchange Rate Ch$ Per U.S.$(1)
   
Year   Low(2)   High(2)   Average(3)   Period End

 


 


 


 


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
2004       559.21       649.45       609.55       559.83
2005       509.70       592.75       559.86       514.21
                                 
Month                                

October 2005   526.56       546.92       535.50       543.72    
November 2005   518.96       544.87       529.88       518.96    
December 2005   509.70       518.63       514.33       514.21    
January 2006   512.50       535.36       524.48       524.78    
February 2006   516.91       532.35       525.70       517.76    
March 2006   516.75       536.16       528.77       527.70    

Source: Central Bank.
   
(1)      Nominal figures.
(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 year following that in which the dividend is proposed. For example, the 2005 dividend must be proposed and approved during the first four months of 2006. 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 general Banking Law, subject to certain exceptions, unless otherwise decided by a two-thirds vote of its issued and subscribed shares, a bank must distribute cash dividends in respect of any fiscal year in an amount equal to at least 30% of its net income for that year. 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 are permitted to distribute less than 30% of their earnings, and may distribute no dividends at all, in any given year if the holders of at least two-thirds of their outstanding shares of common stock so determine. The balances of our distributable net income are generally retained for use in our business (including for the maintenance of any required legal reserves). Although our Board of Directors currently intends to pay regular annual dividends, the amount of dividend payments will depend upon, among other factors, our 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—Chilean Tax Considerations”). See “Item 10E: Taxation.” Owners of the ADSs will not be charged any dividend remittance fees by the depositary with respect to cash or stock dividends.

     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 ADS 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.

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

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Year   Dividend
MCh$ (1)
  Per share
Ch$/share (2)
  Per ADR
Ch$/ADR (3)
  % over
earnings

 
 
 
 
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
2005   198,795   1.05   1,096.06   100

(1)      Million of nominal pesos.
(2)      Calculated on the basis of 98,934 million shares for 2002 and 188,446 million shares for 2003-2005.
(3)      Calculated on the basis of 1,039 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 Prospect.” and “Item 11: Quantitative and Qualitative Disclosures about Market Risk”

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, with department stores and the larger supermarket chains that make consumer loans and sell other financial products 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 individuals 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, consumer loans and insurance brokerage. In addition, we face competition from non-bank finance competitors, such as leasing, factoring and automobile finance companies, with respect to credit products, and from 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, Law No. 19,769 allows insurance companies to participate and compete with us in the residential mortgage and credit card businesses.

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

     Banco Santander Central Hispano controls 84.14% 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 outstanding with Banco Santander Central Hispano and its affiliated financial institutions around the world. As of December 31, 2005, we had 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 15 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 41.5% of the value of the total loan portfolio as of December 31, 2005) and, to a lesser extent, small and medium-sized companies (those with annual sales of less than US$2.3 million) which comprised approximately 14.4% of the value of the total loan portfolio as of December 31, 2005. 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 operations depend to a great extent on our net interest revenue. In 2005, net interest revenue represented 81.3% of our operating revenue. 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 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. The following table shows the yields on the Chilean government’s 90-day note as reported by the Central Bank of Chile at year-end for the last five years.

    Period-end
Year   90 day note (%)

 
2001   6.51
2002   2.88
2003   2.58
2004   2.32
2005   4.75
     

Source: Central Bank of Chile

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

     From December 31, 2000 to December 31, 2005, our aggregate loan portfolio (on an unconsolidated combined basis) grew by 35.2% in nominal terms to Ch$10,139,333 million (US$19,718 million), while our consumer loan portfolio grew by 92.5% in nominal terms to Ch$1,189,842 million (US$2,314 million), excluding lines of credit and 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

18






loan portfolio (particularly in the consumer, small and mid-sized companies 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 previously experienced by Santiago or Old Santander-Chile. Average loan growth has remained significant in the last five years. According to the Superintendency of Banks, from December 31, 2000 to December 31, 2005, the aggregate amount of loans outstanding in the Chilean banking system (on an unconsolidated basis) grew 59.7% in nominal terms to Ch$44,833,507 million (US$87,530 million) as of December 31, 2005. 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 allowances 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 operations.

Risks Relating to Chile

   Our growth and profitability depend on the level of economic activity in Chile.

     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. 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.

      The recent positive growth figures of the Chilean economy can be attributed in part to the rising prices of Chile’s main exports, most importantly, copper. The price of copper in 2005 reached record levels, increasing 45.4% in 2005, following a rise of 42.9% in 2004. Exports of cooper totaled US$17.4 billion in 2005 or 44% of total Chilean exports. Other important commodities exported from Chile include paper pulp, fish meal and agricultural products. We cannot assure you that the Chilean economy will continue to grow in the future or that those future developments in or affecting Chile’s exports will not materially and adversely affect our business, financial condition or results of operations.

  Economic problems encountered by other countries may adversely affect the Chilean economy, our results of operations and the market value of our securities.

     The prices of securities issued by Chilean companies, including banks, are to varying degrees influenced by economic and market considerations in other 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 consequences of economic difficulties in other markets, will not materially and adversely affect our business, financial condition or results of operations.

     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.

     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. If Argentina’s economic environment significantly deteriorates or does not improve, the economy in Chile, as both a neighboring country and a trading partner, could also be affected and could

19






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. Our business could be affected by an economic downturn 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. Diplomatic relations with Bolivia and Peru have worsened. As of December 31, 2005, approximately 1.45% of our loans were held abroad and 0.34% of our loans were comprised of loans to companies in Latin American countries. We cannot assure you that crisis and political uncertainty in other Latin American countries 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.

     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. 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, 2005, the net position of our foreign currency denominated liabilities and Chilean peso-denominated liabilities that contain repayment terms linked to changes in foreign currency exchange rates exceeded our foreign currency denominated assets and Chilean peso-denominated assets that contain repayment terms linked to changes in foreign currency exchange rates by Ch$6,269 million (US$12.2 million). The following table shows the value of the Chilean peso relative to the US dollar as reported by the Central Bank of Chile at year-end for the lasty five years.


    Exchange rate (Ch$)   Devaluation (Revaluation)
Year   Year-end   (%)

2001   656.20   14.6 %
2002   712.38   8.6 %
2003   599.42   (15.9 %)
2004   559.83   (6.6 %)
2005   514.21   (8.1 %)

Source: Central Bank of Chile

     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 operations. 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.

      Furthermore, Chilean trading in the shares underlying our ADSs will be conducted in pesos. Cash distributions with respect to our shares of common stock are received in Chilean pesos by the depositary which then will convert such amounts to U.S. dollars at the then-prevailing exchange rate for the purpose of making payment sin respect of our ADSs. If the value of the Chilean peso falls relative to the U.S. dollar, the dollar value of our ADSs and any distributions to be received from the depositary will be reduced. In addition, the depositary will incur customary current conversion costs (to be borne by the holders of our ADSs) in connection with the conversion and subsequent distribution of dividends or other payments.

   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.)

Year   Inflation (CPI)

 
2001   2.6
2002   2.8
2003   1.1
2004   2.4
2005   3.7
     

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.

20






   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 reserve requirements and interest rates and foreign exchange mismatches and market risks . 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 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.

     We 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. Effective January 1, 2005, the Superintendency of Banks lowered our mandatory effective minimum capital to risk-weighted assets ratio to 11%. Although we have not failed in the past to comply with our capital maintenance obligations, there can be no assurance that we will be able to do so in the future.

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

     We prepare our financial statements in accordance with Chilean GAAP, which requires management to make estimates and assumptions with respect to certain matters that are inherently uncertain. The consolidated financial statements include various estimates and assumptions, including but not limited to the adequacy of the allowance for loan losses, estimates of the fair value of certain financial instruments, the selection of useful lives of certain assets and the valuation and recoverability of goodwill and deferred taxes. We evaluate these estimates and judgments on an ongoing basis. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results in future periods could differ from those produced by such estimates and assumptions, and if these differences were significant enough, our reported results of operations would be affected materially.

     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 financial institution. 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.

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  Our status as a controlled company and a foreign private issuer exempts us from certain of the corporate governance standards of the New York Stock Exchange, limiting the protections afforded to investors.

     We are a “controlled company” and a “foreign private issuer” within the meaning of the New York Stock Exchange corporate governance standards. Under the New York Stock Exchange rules, a controlled company is exempt from certain New York Stock Exchange corporate governance requirements. In addition, a foreign private issuer may elect to comply with the practice of its home country and not to comply with certain New York Stock Exchange corporate governance requirements, including the requirements that (1) a majority of the board of directors consist of independent directors, (2) a nominating and corporate governance committee be established that is composed entirely of independent directors and has a written charter addressing the committee's purpose and responsibilities, (3) a compensation committee be established that is composed entirely of independent directors and has a written charter addressing the committee's purpose and responsibilities and (4) an annual performance evaluation of the nominating and corporate governance and compensation committees be undertaken. We currently use these exemptions and, following this offering, intend to continue using these exemptions. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all New York Stock Exchange corporate governance requirements.

  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 ADR 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 resolutions 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.

     Holders 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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  ADS holders may not be able to effect service of process on, or enforce judgments or bring original actions against, us, our directors or our executive officers, which may limit the ability of holders of ADSs to seek relief against us.

      We are a Chilean corporation. None of our directors are residents of the United States and most of our executive officers reside outside the United States. In addition, a substantial portion of our assets and the assets of our directors and executive officers are located outside the United States. As a result, it may be difficult for ADS holders to effect service of process outside Chile upon us or our directors and executive officers or to bring an action against us or such persons in the United States or Chile to enforce liabilities based on U.S. federal securities laws. It may also be difficult for ADS holders to enforce in the United States or in Chilean courts judgments obtained in United States courts against us or our directors and executive officers based on civil liability provisions of the U.S. federal securities laws. If a U.S. court grants a final judgment in an action based on the civil liability provisions of the federal securities laws of the United States, enforceability of this judgment in Chile will be subject to the obtaining of the relevant "exequator" (i.e., recognition and enforcement of the foreign judgment) according to Chilean civil procedure law currently in force, and consequently, subject to the satisfaction of certain factors. The most important of these factors are the existence of reciprocity, the absence of a conflicting judgment by a Chilean court relating to the same parties and arising from the same facts and circumstances and the Chilean courts’ determination that the U.S. courts had jurisdiction, that process was appropriately served on the defendant and that enforcement would not violate Chilean public policy. Failure to satisfy any of such requirements may result in non-enforcement of your rights.

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, 2005, 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 15.86% of our outstanding common stock is held by the public (i.e., shareholders other than Banco Santander Central Hispano and its affiliates), including our shares that are represented by ADSs trading on the NYSE. 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 Companies 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.

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   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.

  ADS holders may not be able to exercise withdrawal rights that are granted by the Chilean Companies Law to registered shareholders of publicly traded Chilean corporations.

      Under the Chilean Companies Law, if any of the following resolutions is adopted by our shareholders at any extraordinary shareholders meeting, dissenting shareholders have the right to withdraw from Santander-Chile and to require us to repurchase their shares, subject to the fulfillment of certain terms and conditions. A dissenting shareholder is a shareholder who either attends the shareholders meeting and votes against a resolution which results in a withdrawal right or, if absent from the shareholders meeting, a shareholder who notifies the company in writing within 30 days of the shareholders meeting of his opposition to the resolution and that he is exercising his right to withdraw from the company.

     The resolutions that result in a shareholder’s right to withdraw are the following:

  • the transformation of Santander-Chile into a different type of legal entity;

  • the merger of Santander-Chile with or into another company;

  • the disposition of 50% or more of our assets, whether or not that sale includes our liabilities or the proposal or amendment of any business plan involving the transfer of more than 50% of our assets;

  • the granting of security interests or personal guarantees to secure or guarantee obligations of third parties (other than our subsidiaries) exceeding 50% of our assets;

  • the creation of preferential rights for a class of shares or an amendment to those already existing, in which case the right to withdraw accrues only to dissenting shareholders of the class or classes of shares adversely affected;

  • the amendment of our bylaws to correct any formal defect in our incorporation, or any amendment of our bylaws that grants a shareholder a right to withdraw;

  • the approval by our shareholders of our ceasing to be subject to the regulations applicable to publicly held corporations in the event we no longer meet the requirements under Chilean law to qualify as such a corporation; and

  • any other causes as may be established by Chilean law and our bylaws (our bylaws currently do not establish any instances).

      In addition, shareholders of a publicly held corporation such as Santander-Chile, have the right to withdraw if a person acquires 2/3 or more of the outstanding voting stock of the company and does not make a tender offer for the remaining shares within 30 days of that acquisition at a price not lower than the price that would be paid shareholders exercising their rights to withdraw. However, the right of withdrawal described in the previous sentence does not apply in the event the company reduces its capital as a result of not having fully subscribed and paid an increase of capital within the statutory term.

      ADS holders own a beneficial interest in shares held by the depositary and, accordingly, they are not listed as shareholders on the share registry of Santander-Chile. The depositary will not exercise withdrawal rights on behalf of ADS holders. Accordingly, in order to ensure a valid exercise of withdrawal rights, an ADS holder must cancel his ADSs and become a registered shareholder of the Company no later than the date which is five Chilean business days before the shareholders' meeting at which the vote which would give rise to withdrawal rights is taken, or the applicable record date for withdrawal rights that arise other than as a result of a shareholder vote. Withdrawal rights must then be exercised in the manner prescribed in the notice to shareholders that is required to be sent to shareholders of Chilean public companies advising such holders of their right of withdrawal. If an event occurs that gives rise to withdrawal rights, ADS holders will have a limited time to cancel their ADSs and to become registered shareholders of the Company prior to the record date for the shareholders meeting or other event giving rise to such withdrawal rights. If an ADS holder does not become a registered shareholder of the Company prior to such record date he will not be able to exercise the withdrawal rights available to registered shareholders.

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ITEM 4. INFORMATION ON THE COMPANY

A. History and Development of the Company

Overview

      We were formed on August 1, 2002, 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 shareholders’ equity. As of December 31, 2005, we had total assets of Ch$13,096,821 million (US$25,470 million), loans net of allowances outstanding of Ch$9,996,407 million (US$19,440 million), deposits of Ch$8,075,521 million (US$15,705 million) and shareholders’ equity of Ch$1,081,832 million (US$2,104 million). As of December 31, 2005, we employed 7,482 people and had the largest private branch network in Chile with 352 branches. Our headquarters are located in Santiago and we operate in every major region of Chile.

     We provide a broad range of commercial and retail banking services to our customers, including 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.

     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. 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.

     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.

     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).

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. It is the largest financial group in Spain and is a major player elsewhere in Europe, including the United Kingdom through its Abbey subsidiary and Portugal, where it is the third-largest banking group. Through Santander Consumer it also operates a leading consumer finance franchise in Germany, Italy, Spain and nine other European countries.

     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 as well as benefiting from their know-how in systems management. 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 Audit Committee and the

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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 Risks, Auditing, Accounting and Financial Control. Santander-Chile does not pay any management fees to Banco Santander Central Hispano in connection with these support services.

B. Organizational Structure

     Banco Santander Central Hispano controls Santander-Chile through its holdings in Teatinos Siglo XXI and Santander-Chile Holding, which are controlled subsidiaries, and through the indirect ownership of ADSs representing 7.23% of Santander-Chile’s outstanding capital stock. As of December 31, 2005, Banco Santander Central Hispano directly and indirectly owned or controlled 99.0% of Santander-Chile Holding. Banco Santander Central Hispano directly and indirectly owned or controlled 100% of Teatinos Siglo XXI S.A. Banco Santander Central Hispano also owned 7.23% of the Bank through Grupo Empresarial Santander via ADRs. This gives Santander Central Hispano control over 84.14% of the shares of the Bank and actual participation when excluding minority shareholders is 83.94%.

   Shareholder   Number of Shares   Percentage  




Teatinos Siglo XXI S.A.                            78,108,391,607   41.45 %
Santander Chile Holding                            66,822,519,695   35.46  
Grupo Empresarial Santander vía ADRs                            13,626,663,708   7.23  

   Management Team

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

 

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

Operating Structure



C. Business Overview

     We have 352 total branches, 92 of which operated under the Santander Banefe brand name. The remaining 260 branches are operated under the Santander Santiago brand name. We provide a full range of financial services to corporate and individual customers. We divide our clients into the following segments:

  • Lower-middle to middle-income (Santander Banefe) , consisting of individuals with monthly income between Ch$120,000 (US$233) and Ch$400,000 (US$ 778), which are served through our Banefe branch network. This segment accounts for 4.8% of our loans as of December 31, 2005. This segment offers customers a range of products, including consumer loans, credit cards, auto loans, residential mortgage loans, debit card accounts, savings products, mutual funds and insurance brokerage.

  • Middle- and upper-income, consisting of individuals with a monthly income greater than Ch$400,000 (US$778). Clients in this segment account for 36.6% of our loans as of December 31, 2005 and are offered a range of products, including consumer loans, credit cards, auto loans, commercial loans, foreign trade financing, residential mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.

  • Small businesses, consisting of small companies with annual sales less than Ch$1,200 million (US$2.3 million). As of December 31, 2005, small companies represented approximately 14.4% of our total loans outstanding. Customers in this segment are offered a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, savings products, mutual funds and insurance brokerage.

  • Institutional lending, consisting mainly of institutional corporations such as universities, government agencies, municipalities and regional governments. As of December 31, 2005, these clients represented 1.9% of our total loans outstanding and offer customers a range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, savings products, mutual funds and insurance brokerage.

  • Mid-sized companies, consisting of companies with annual sales over Ch$1,200 million (US$2.3 million) and up to Ch$3,500 million (US$6.8 million). Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. As of December 31, 2005, these clients represented 7.9% of our total loans outstanding.

  • Real estate. This segment also includes all companies in the real estate sector. As of December 31, 2005, these clients represented 4.9% of our total loans outstanding. To clients in the real estate sector we offer apart from traditional banking services, specialized services for financing primarily residential projects in order to increase the sale of residential mortgage loans.

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  • Large companies, consisting of companies with annual sales over Ch$3,500 million (US$6.8 million). Customers in this segment are offered customers a wide range of products, including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage. As of December 31, 2005, these clients represented 9.8% of our total loans outstanding.

  • Wholesale banking, consisting of companies that are foreign multinationals or part of a large Chilean economic group with sales over Ch$3,500 million (US$6.8 million). As of December 31, 2005, these clients represented 17.5% of our total loans outstanding. Customers in this segment are offered a wide range of products, including commercial loans, leasing, factoring, foreign trade, mortgage loans, checking accounts, cash management, treasury services, financial advisory, savings products, mutual funds and insurance brokerage.

  • Treasury Division, provides sophisticated financial products mainly to companies in the wholesale banking and the Middle market segments. This includes products such as short-term financing and funding, securities brokerage, interest rate and foreign currency derivatives, securitization services and other tailor made financial products. The Treasury division also manages the Bank’s trading positions as well as the non-trading investment portfolio.

     The table below sets forth our lines of business and certain statistical information relating to each of them for the year ended December 31, 2005. We modified our segmentation model in 2005, and restated our 2004 segment information accordingly. Please see Note 27(y) to our Audited Consolidated Financial Statements.

    For the year ended December 31, 2005
   
Segment   Loans   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, 2005)











Santander Banefe   491,424   82,063   15,900   (26,271)   71,692
Middle-upper income   3,715,575   189,584   58,567   (24,928)   223,223
Santiago Leasing   494   158       29   187











Total Individuals   4,207,493   271,805   74,467   (51,170)   295,102











Small businesses   1,462,521   91,427   18,736   (15,411)   94,752
Total Retail   5,670,014   363,232   93,203   (66,581)   389,854











Institutional lending   193,190   6,482   1,633   (16)   8,099











Mid-sized companies   805,091   24,537   4,176   (1,750)   26,963
Real estate   499,422   8,342   1,068   (697)   8,713
Large companies   994,439   18,425   3,187   3,397   25,009
Santiago Leasing   2,371   758   --   140   898











Total Middle Market   2,301,323   52,062   8,431   1,090   61,583











Wholesale banking   1,777,361   26,438   7,476   1,919   35,833











Treasury(4)   -   75,399   -   -   75,399











Others(5)   202,385   24,950   27,623   56   52,629











Total   10,144,273   548,563   138,366   (63,532)   623,397






(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 Santander S.A. Agente de Valores.
(5)      Includes contribution of other Bank subsidiaries and other non-segmented items.
 

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   Operations through Subsidiaries

     The General Banking Law once restricted the ability of banks to provide non-banking financial services. Beginning in 1986, these 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.

     For the year ended December 31, 2005, our subsidiaries collectively accounted for approximately 14.5% of our consolidated net income. The assets and operating income of these subsidiaries as of and for the year ended December 31, 2005 represented 6.5% and 10.4% of our total assets and operating income, respectively.

    Percentage Owned
   
    2004   2005
   




 




    Direct   Indirect   Total   Direct   Indirect   Total
   
 
 
 
 
 
    %   %   %   %   %   %
Subsidiary                        
Santiago Leasing S.A.   99.50   -   99.50   99.50   -   99.50
Santiago Corredores de Bolsa Ltda.   99.19   0.81   100.00   99.19   0.81   100.00
Santander Santiago S.A. Administradora General de                        
     Fondos   99.96   0.02   99.98   99.96   0.02   99.98
Santander S.A. Agente de Valores   99.03   -   99.03   99.03   -   99.03
Santander Santiago S.A. Sociedad Securitizadora   99.64   -   99.64   99.64   -   99.64
Santander Santiago Corredora de Seguros Ltda.   99.99   -   99.99   99.99   -   99.99

   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 include local banks and a number of foreign-owned banks which are operating in Chile. The Chilean banking system is comprised of 25 private sector banks and one public sector bank. Five private sector banks along with the state-owned bank together accounted for 80.7% of all outstanding loans by Chilean financial institutions as of December 31, 2005.

     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, 2005 Banco de Chile had a market share in total loans of 18.1% . Shortly after that merger was consummated, 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. 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, consumer loans and insurance brokerage. 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 grown rapidly.

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     As shown in the following table, we are the market leader in practically every banking service in Chile:

    Market Share
at
December 31,
2004
    Market Share
at
December 31,
2005
    Rank as of
December 31,
2005
   
   
   
Commercial loans                
    20.3 %   19.8 %   1
Consumer loans   24.8     25.6     1
Mortgage loans (residential and general purpose)   22.8     23.5     1
Residential mortgage loans   23.5     24.9     2
Foreign trade loans (loans for export, import and contingent)   24.8     22.0     1
Total loans   22.7     22.6     1
Deposits   20.9     21.5     1
Mutual funds (assets managed)   20.6     21.6     2
Credit card   34.1     37.3     1
Branches (1)   19.3     20.3     1
ATM locations   29.7     28.1     1

     Source: Superintendency of Banks
     (1) Excluding special-service payment centers.

     The following tables set out certain statistics comparing our market position to that of our peer group, defined as the five largest banks in Chile in terms of shareholders’ equity as of December 31, 2005.

   Loans

     As of December 31, 2005, our loan portfolio was the largest among Chilean banks. Our loan portfolio on a stand–alone basis represented 22.6% of the market for loans in the Chilean financial system 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, 2005:

    As of December 31, 2005   As of December 31, 2004
   
 
Loans   Ch$ million   In thousand of
US$
  Market
Share
  Market
Share

 
 
 

 
Santander-Chile   10,139,333   19,718   22.6 %   22.7 %
Banco de Chile   8,098,294   15,749   18.1     17.6  
Banco del Estado   5,962,235   11,595   13.3     13.3  
Banco de Crédito e Inversiones   5,535,929   10,766   12.3     11.6  
BBVA, Chile   3,579,169   6,961   8.0     7.7  
Corpbanca   2,848,625   5,540   6.4        
Others   8,669,922   16,861   19.3        
   
 
 

 
Chilean financial system   44,833,507   87,189   100.0     100.0  




 


Source: Superintendency of Banks

30






   Deposits

     On a stand alone basis our 21.5% of the market for deposits ranked us in first place among banks in Chile at December 31, 2005. Deposit market share is equal to total time deposits plus average monthly checking and sight accounts, net of clearance. The following table sets forth the market shares in terms of deposits for us and our peer group as of December 31, 2004 and 2005:

    As of December 31, 2005   As of December 31, 2004
   
 

Deposits(1)   Ch$ million   In thousand of
US$
  Market
Share
    Market
Share
 

 
 
 

 

Santander-Chile   7,875,812   15,316   21.5 %   20.9 %
Banco de Chile   6,012,492   11,693   16.4     16.4  
Banco del Estado   6,286,001   12,225   17.2     15.0  
Banco de Crédito e Inversiones   4,398,971   8,555   12.0     11.2  
BBVA, Chile   2,916,150   5,671   8.0     8.4  
Corpbanca   1,905,845   3,706   5.2        
Others   7,241,080   14,082   41.0        
   Chilean financial system   36,636,351   71,248   100.0     100.0  




 


(1) The figure used for checking and sight account balances is the average monthly balances instead of year-end balances as we believe that period end balances are not always reflective of a bank’s position in checking and sight accounts. The source for the average balances is the Superintendency of Banks.

   Shareholders’ equity

     With Ch$1,081,832 million (US$2,104 million) in shareholders’ equity, as of December 31, 2005, 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, 2004 and 2005:

    As of December 31, 2005   As of December 31, 2004
   
 

Equity(1)   Ch$ million   In thousand of
US$
  %(1)     %(1)  

 
 
 

 

Santander-Chile   1,081,832   2,104   21.1 %   22.3 %
Banco de Chile   775,106   1,506   15.1     14.5  
Banco del Estado   444,676   865   8.7     8.9  
Banco de Crédito e Inversiones   500,874   974   9.8     9.2  
BBVA, Chile   288,478   561   5.6     5.8  
Corpbanca   407,526   793   7.9        
Others   1,636,419   3,182   31.9        
Chilean financial system   5,134,911   9,986   100.0     100.0  




 


Source: Superintendency of Banks.
(1) Percentage of total shareholders’ equity of financial system.

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   Efficiency

     As of December 31, 2005, on a stand alone basis we were the second most efficient bank in our peer group. The following table sets forth the efficiency ratio (defined as operating expenses as a percentage of operating revenue which is aggregate of net interest revenue, fees and income from services (net) and other operating income (net)) for us and our peer group as of December 31, 2004 and 2005:

Efficiency ratio   As of December 31,
2005
  As of December 31,
2004

 

 

    %   %
Santander-Chile   44.0 %   47.7 %
Banco de Chile   50.4 %   51.2 %
Banco del Estado   60.7 %   64.5 %
Banco de Crédito e Inversiones   52.7 %   53.1 %
BBVA, Chile   68.6 %   68.1 %
Corpbanca   40.7 %      
Chilean Financial System   54.1 %   53.5 %

Source: Superintendency of Banks

   Return on average equity

     As of December 31, 2005, we were the second most profitable bank in our peer group and the second most capitalized as measured by the BIS ratio as of December 31, 2005. The following table sets forth the average return on equity for the year ended December 31, 2004 and 2005 and BIS ratio for us and our peer group as of December 31, 2004 and 2005:

    Return on average equity
as of December 31,
  BIS Ratio
as of December 31,
   




 




    2005   2004   2005   2004
   

 

 

 

    %     %     %     %  
Santander-Chile   24.1 %   23.9 %   12.9 %   14.9 %
Banco de Chile   26.7     29.2     11.2     11.7  
Banco del Estado   9.2     12.1     10.7     10.1  
Banco de Crédito e Inversiones   23.4     26.3     10.3     10.1  
BBVA, Chile   10.7     5.7     10.8     11.4  
Corpbanca   13.8           13.5        
Chilean Financial System   16.3     16.7     13.0     13.2  

Source: Superintendency of Banks, except Santander-Chile based on average equity calculated by the Bank (See Item 5 Average Balances).

   Asset Quality

     As of December 31, 2005, on a stand alone basis we had the second lowest 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 for us and our peer group as of December 31, 2004 and 2005.

    Loan Loss allowances/total loans
   




Dec-04   As of December 31,
2005
  As of December 31,
2004

 

 

Santander-Chile   1.42 %   1.96 %
Banco de Chile   1.70     2.23  
Banco del Estado   1.64     1.76  
Banco de Crédito e Inversiones   1.54     1.70  
BBVA, Chile   1.35     2.04  
Corpbanca   1.56        
Chilean Financial System   1.61        

Source: Superintendency of Banks

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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 Companies 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.

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 orgánica 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 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. Absent such approval, the acquiror of shares so acquired will not have the right to vote them. 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 existing control of a bank by a controlling shareholder of that bank.

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     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:

  • a bank is 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, equity investments, securities, 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 in the account and that banks may also charge fees for the use of this new product. For banks with a solvency score of less than A (See Item 4D: Regulation and Supervision—Management and Capitalization Evaluation) the Central Bank has also imposed additional caps to the interest rate that can be paid.

Deposit Insurance

     In Chile, the State guarantees up to 100% of demand deposits and time deposits with a maturity of 10 days or less. The State also guarantees 90.0% of the principal amount of time deposits and savings accounts held by natural persons with a maximum value of UF108 per person (Ch$1,941,280 or U.S.$3,775 as of December 31, 2005) per calendar year in the entire financial system.

Reserve Requirements

     Deposits are subject to a reserve requirement of 9.0% for peso and foreign currency denominated demand deposits and 3.6% for UF, peso and foreign currency denominated time deposits (with terms of less than one year). For purposes of calculating the reserve obligation, banks are authorized to deduct daily from their foreign currency denominated liabilities, the balance in foreign currency of certain loans and financial investments held outside of Chile, the most relevant of which include:

  • cash clearance account, which should be deducted from demand deposit for calculating reserve requirement;

  • certain payment orders issued by pension providers;

  • the amount set aside for “technical reserve” (as described below), which can be deducted from reserve requirement.

     The Central Bank has statutory authority to require banks to maintain reserves of up to an average of 40.0% for demand deposits and up to 20.0% for time deposits (irrespective, in each case, of the currency in which they are denominated) to implement monetary policy. In addition, to the extent that the aggregate amount of the following types of liabilities exceeds 2.5 times the amount of a bank’s paid-in capital and reserves, a bank must maintain a 100% “technical reserve” against them: 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.

Minimum Capital

     Under the General Banking Law, a bank is required to have a minimum of UF800,000 (approximately Ch$14,380 million and US$28 million as of December 31, 2005) of paid-in capital and reserves, an effective equity of at least 8% of its risk weighted assets, net of required allowances, and paid in capital and reserves of at least 3% of its total assets, net of required allowances.

     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%. 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 by 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.

     In 2002, the General Banking Law was modified, allowing banks to begin operations with a minimum capital of UF 400,000 (approximately US$14 million as of December 31, 2005) of paid-in capital and reserves with the obligation to increase it to UF 800,000 (approximately US$28 million as of December 31, 2005) in an undetermined period of time. If a bank maintains a minimum capital of UF 400,000 (approximately US$14 million as of December 31, 2005), it is required to maintain a minimum BIS ratio of 12%. When such a bank’s paid-in capital reaches UF600,000 (approximately Ch$10,785 million and US$21 million as of December 31, 2005), 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. The calculation of risk weighted assets is based on a five-category risk classification system for bank assets that is based on the Basle Committee recommendations.

     Banks should also have Capital básico, or Base Net Capital, of at least 3.0% of their total assets, net of allowances. Base Net Capital 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.

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), except for another financial institution, 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 1.0% of its shares) on more favorable terms than those generally offered to non-related parties. Loans granted to related parties are subject to the

34






limitations described in the first bullet point above. In addition, the aggregate amount of loans to related parties may not exceed a bank’s effective equity.

     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. The Superintendency of Banks examines and evaluates each financial institution’s credit management process, including its compliance with the loan classification guidelines. Banks are classified into four categories: 1, 2, 3 and 4. Each bank’s category depends on the models and methods used by the bank to classify its loan portfolio, as determined by the Superintendency of Banks. Category 1 banks are those banks whose methods and models are satisfactory to the Superintendency of Banks. Category 1 banks are 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 will be made aware of the problems detected by the Superintendency of Banks and required to take steps to correct them. Banks classified as categories 3 and 4 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. We are classified in category 1.

     Under the classifications effective January 1, 2004, 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); and (iii) commercial loans (includes all loans other than consumer loans and residential mortgage loans).

     In accordance with the 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 (Commercial loans)

  • 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.

  • Classification B corresponds 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.

     For loans classified as A1, A2, A3 and B, the board of directors of a bank is authorized to determine the levels of required loan loss reserves. We have assigned a 0% reserve requirement for loans classified as A1 and A2, a 0.5% reserve requirement for loans classified as A3 and a 1% reserve requirement for commercial loans classified as B. For loans classified in Categories C1, C2, C3, C4, D1 and D2, the bank must have the following levels of loan loss reserves:

35






   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 allowances 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.

         Commencing in 2006 the Bank will no longer analyze commercial loans on a group basis. All commercial loans will be rated on an individual basis in an automated system that has been approved by the Superintendency of Banks and our Board of Directors.

         Models based on the individual analysis of borrowers (Commercial loans)

         The risk category of these loans is directly related to the amount of days an installment is past due.

        Consumer loans past due
    status (1)
      Residential mortgage loans
    past due status(1)
      Allowances as a
    percentage of
    aggregate
    exposure (1)
       


     


     
       Category   From   To   From   To  







        (Days)       (Days)      
    A   -   -   -   -   - %
    B   1   30   1      180   1  
    B-   31   60   181   >181   20  
    C   61   120   -   -   60  
    D   121   >121   -   -   90  


    (1) Required reserve amounts are percentages of the aggregate amount of the principal and accrued but unpaid interest of the loan.

    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, 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, open-stock corporations and insurance companies.

    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.

    36






    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, condone 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.

    Obligations Denominated in Foreign Currencies

         Foreign currency denominated obligations of Chilean banks are subject to various limits and obligations. The regulations of the Central Bank do not permit the difference, whether positive or negative, between a bank’s assets and liabilities denominated in any foreign currency (including assets and liabilities denominated in U.S. dollars but payable in pesos, as well as those denominated in pesos and indexed to the U.S. dollar exchange rate) to exceed 20% of the bank’s paid-in capital and reserves; provided that if the balance of such assets exceeds the balance of such liabilities, the difference may exceed 20% of such capital and reserves in an amount not to exceed the bank's allowances and reserves denominated in such foreign currency (excluding profits to be remitted abroad). Santander-Chile must also comply with various regulatory and internal limits regarding exposure to movements in foreign exchange rates (See “Item 11: Quantitative and Qualitative Disclosure about Market Risks”).

    Investments in Foreign Securities

         Under current Chilean banking regulations, banks in Chile may grant loans to foreign individuals and entities and invest in certain securities of foreign issuers. 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 be complimentary to 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 must be (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. A Bank may invest up to 5% of its effective equity in securities of foreign issuers. Such securities must have a minimum rating as follows:

         Table 1

    Rating Agency   Short Term   Long Term



    Moody’s   P2   Baa3
    Standard and Poor’s   A3   BBB-
    Fitch IBCA   F2   BBB-
    Duff & Phelps   D2   BBB-
    Thomson Bank Watch   TBW2   BBB

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         In the event that the sum of the investments in foreign securities which have a: (i) rating below to the indicated in the Table 1 above, and equal or exceeds the ratings mentioned in the Table 2 below; and (ii) loans granted to other entities resident abroad; exceed 20% (and 30% for banks with a BIS ratio equal or exceeding 10%), of the effective equity of such bank, the excess is subject to a mandatory reserve of 100%.

         Table 2

    Rating Agency   Short Term   Long Term



    Moody’s   P2   Baa3
    Standard and Poor’s   A3   BB-
    Fitch IBCA   F2   BB-
    Duff & Phelps   D2   BB-
    Thomson Bank Watch   TBW2   BB

         In addition, banks may invest in foreign securities for an additional amount equal to a 70% of their effective equities which ratings are equal or exceeds those mentioned in the following Table 3. This limit constitutes an additional margin and it is not subject to the 100% mandatory reserve.

         Additionally, a Chilean Bank may invest in foreign securities which rating is equal or exceeds those mentioned in the following Table 3 in: (i) term deposits with foreign banks; and (ii) securities issued or guaranteed by sovereign states or their central banks or those securities issued or guaranteed by foreign entities adhered to the Chilean State; such investment will be subject to the limits by issuer up to 30% and 50%, respectively, of the effective equity of the Chilean bank that make the investment.

    Table 3      

    Rating Agency   Short Term   Long Term



    Moody’s   P1   Aa3
    Standard and Poor’s   A1+   AA-
    Fitch IBCA   F1+   AA-
    Duff & Phelps   D1+   AA-
    Thomson Bank Watch   TBW1   BB

         Chilean banks may invest in securities without ratings issued or guaranteed by sovereign states or their central banks and structured notes issued by investment banks with a rating equal or above that in the immediately preceding Table 3, which return is linked with a corporate or sovereign note with a rating equal or above that in Table 2.

         Subject to specific conditions, a bank may grant loans in U.S. 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.

    New Regulations Regarding Market Risk

          In 2005, the Superintendency of Banks introduced new market risk limits and measures for Chilean banks. On an unconsolidated basis the Banks must separate its balance sheet in two separate categories: trading portfolio (Libro de Negociación) and unconsolidated non-trading, or permanent, portfolio (Libro de Banca). The trading portfolio as defined by the Superintendency of Banks includes all instruments valued at market prices, free of any restrictions for their immediate sale and that are frequently bought and sold by the bank or are maintained with the intention of selling them in the short-term in order to profit from short-term price variations. The non-trading portfolio is defined as all instruments in the balance sheet not considered in the trading portfolio.

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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 fifteen other buildings in the vicinity of our headquarters and we rent four other buildings. At December 2005, we owned the locations at which 47% of our branches were located. The remaining branches operate at rented locations.

       Main properties as of December 2005   Number


    Central Offices    
    Own   16
    Rented   4
    Total   20
    Branches (1)    
    Own   150
    Rented   168
    Total   318
    Other property (2)    
    Own   84
    Rented   2
    Total   86

    (1) Some branches are located inside central office buildings and other properties. Including these branches the total number of branches is 352.
    (2) Consists mainly of parking lots and spaces

         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.
    Midrange   IBM   Interconnections between Mainframe and mid-range
    Midrange   Stratus   Tellers
        SUN/Unix   Interconnections applications Credit & debit cards
        SUN/UNIX   Treasury, MIS, Work Flow
    Midrange   IBM   WEB
    Desktop   IBM   Platform applications
    Call   Avaya   Telephone system
    Center   Genesys   Integration Voice/data
        Nice   Voice recorder
        Periphonics   IVR

    39






    The main software systems used by us are:

    Category   Product   Origin



    Core-System   ALTAMIRA   Accenture
    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

    ITEM 4A. UNRESOLVED STAFF COMMENTS

          As of the date of the filing of this Annual Report on 20-F we do not have any unresolved comments from the Securities and Exchange Commission staff regarding our periodical reports under the Exchange Act.

     

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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, which requires management to make estimates and assumptions with respect to certain matters that are inherently uncertain. We also reconcile our financial statements to US GAAP (See Note 27 to our Audited Consolidated Financial Statements) and are required to make estimates and assumptions in this reconciliation process. Certain critical accounting policies, in particular those relating to goodwill and intangible assets are only applicable for US GAAP purposes. Our consolidated financial statements include various estimates and assumptions, including but not limited to the adequacy of the allowance for loan losses, estimates of the fair value of certain financial instruments, the selection of useful lives of certain assets and the valuation and recoverability of goodwill and deferred taxes. We evaluate these estimates and assumptions on an ongoing basis. Management bases its estimates and assumptions on historical experience and on various other factors that are believed to be reasonable under the circumstances. Actual results in future periods could differ from those estimates and assumptions, and if these differences were significant enough, our reported results of operations would be affected materially.

         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) Valuation and recognition of income and expense in connection with foreign currency and derivative activities;
     
      c) Valuation and recognition of income and expense in connection with financial investments;
     
      d) Estimating useful life of premises and equipment; and
     
      e) Allowance for loan losses.
     
      f) Performance and impairment of goodwill (US GAAP only)

         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 account and the accounts of its customers. The Bank’s forward contracts are valued monthly using the observed rates reported by the Central Bank of Chile at the balance sheet date. The initial premium or discount on these contracts, calculated as the difference between the spot rate and the forward rate, 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.

    41






         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.

         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. See “Item 4D: Regulation and Supervision — New Regulations Regarding Market Risk”.

         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 are carried at market value. The liabilities for the repurchase of the investment are classified as “investments under agreements to repurchase” and are 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 includes mainly those with maturities of less than one year (22.8% of total financial investments at December 31, 2005) 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”.

         In accordance with Circular N°3345 issued by the Superintendency of Banks and Financial Institutions, effective January 1, 2006, the accounting criteria for valuing financial instruments acquired for negotiation or investment purposes, derivative instruments, hedges and disposals from the financial assets on the balance sheets, will be amended. The instructions of Circular N°3345 will become effective starting on June 30, 2006, with valuation differences arising from prior years’ investments being adjusted directly against the Bank’s equity.

         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 is 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. 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); and (iii) commercial loans (includes all loans other than consumer loans and residential mortgage loans).

          Commencing in 2006 the Bank will no longer analyze commercial loans on a group basis. All commercial loans will be rated on an individual basis in an automated system that has been approved by the Superintendency of Banks and our Board of Directors. In the modified system to be gradually adopted throughout 2006 all commercial loans will be assigned a rating on an individual basis utilizing a more automated and sophisticated statistical model. In 2005 we performed back testing of this more advanced system with minimal differences in the calculation of required provisions compared to the actual amount of provisions under the current system, but no assurance can be given as to the difference in provisioning level the two models would have in 2006.

    42






         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 previously subject to and the new regulations, see “Item 4: Information on the Company—Regulation and Supervision—Allowance for Loan Losses.”

         Goodwill and Intangible Assets with Indefinite Useful Lives

         Under U.S. GAAP, we have significant intangible assets consisting of 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 27 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 27 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 our 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 grew by 6.3% in 2005 following growth of 6.1% in 2004 and 3.7% in 2003. The strength of the emerging Asian economies and the stable economic environment in the rest of the developed world continued to benefit Chile’s economy in 2005 despite the rise in international oil prices. In 2005 the price of Chile’s main export, copper, surged 45.5%, boosting economic growth. Total exports in 2005 increased 23.5% to US$39.5 billion. This positive external scenario also led to strong consumer and investor confidence that in turn resulted in a strong rebound of internal demand (investment plus consumption). With this growth the Chilean economy ended the year with solid economic fundamentals. The fiscal surplus as a percentage of GDP was 4.5%, the current account surplus reached 0.1% of GDP and the average unemployment rate decreased to 8.1% in 2005 compared to 8.8% in 2004.

         Inflation in 2005 reached 3.7%, the highest level since 1998 mainly driven by rising oil prices and stronger internal demand. As a result of this increase and growth and rising inflation due to the hike in international oil prices, the Central Bank continued to tighten monetary policy. The overnight interbank rate set by the Chilean Central Bank increased 225 basis points in 2005 to 4.5% in December 2005. Long-term rates on the other hand did not rise at the same pace. In the first 9 months of the year strong liquidity in the Chilean financial systems dampened long-term yields. As the economy strengthened and as inflation continued to go up this trend reversed sharply in the last quarter of the year. As of December 31, 2004 the market rate of the 10 year Central Bank bond in real terms reached 3.29% . As of September 30, 2005 the yield on this same instrument reached 2.43% and as of December 31, 2005 the yield on this bond was 3.29%. This rate environment and the growth of exports led to an 8.2% appreciation of the Chilean peso in 2005.

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

    43






    Impact of Inflation

         Inflation impacts the Bank’s 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 business, financial condition and results of operations. In 2005, inflation reached 3.7% compared to 2.4% in 2004, mainly as a result of the recovery in internal demand and consumption and the rise in international oil prices. 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., a significant portion of our loans are indexed to the inflation rate, but there are no corresponding features in deposit, or other funding sources that would increase the size of our funding base), 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. In summary:

         UF-denominated Assets and Liabilities. The Bank’s assets and liabilities are denominated in Chilean nominal pesos, “Unidades de Fomento” (UF), which are inflation indexed pesos, and foreign currencies. The “Unidad de Fomento” (UF) is revalued in monthly cycles. On each 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 a proportional amount of the change in the Chilean Consumer Price Index during the prior calendar month. One UF was equal to Ch$16,920.00, Ch$17,317.05 and Ch$17,974.81 at December 31, 2003, 2004 and 2005, 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 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$1,219,507 million, Ch$1,258,606 million and Ch$1,416,266 million during the years-ended December 31, 2003, 2004 and 2005, respectively. See “Item 5D: Asset and Liability Management—Selected Statistical Information—Average Balance Sheets and Interest Rate Data.” The Bank generally has more UF-denominated financial assets than UF-denominated financial liabilities. In 2005, the interest gained on interest earning assets denominated in UF increased 17.9%, in part, as a result of the increase in inflation which increased the nominal rate paid on these assets. The same is true of interest paid on interest bearing liabilities denominated in UF. The interest paid on these liabilities increased 19.1%, in part as a result of the rise in inflation in 2005 versus 2004. Changes in balances of assets and liabilities denominated in UFs also affect the level of interest earned and paid over these items.

    Inflation sensitive income   2004   2005   % Change







        (In million of constant Chilean pesos
    December 31, 2005)
    Interest gained on UF assets   395,030     465,883     17.9 %
    Interest paid on UF liabilities   (207,780 )   (247,447 )   19.1 %
    Net Gain   187,250     218,436     16.7 %
    • 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. Because such deposits are not sensitive to inflation, any decline in the rate of inflation adversely affects our net interest margin on inflation-indexed assets funded with such deposits and any increase in the rate of inflation increases the net interest margin on such assets. The ratio of such demand deposits to average interest earning inflation-indexed assets was 16.4%, 16.6% and 16.4% as of December 31, 2003, 2004 and 2005, respectively.

    • 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 non-financial assets for variations in price levels. Since the Bank’s capital is generally larger than the sum of fixed and other non-financial assets, when inflation is positive the Bank records a loss from price level restatement. In 2005 the loss from price level restatement totaled a loss of Ch$18,140 million compared to a loss of Ch$12,417 million in 2004.

    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

    44






    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 exceed our 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 longer tenors 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

         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 2004 and 2005 the Chilean peso appreciated 6.6% and 8.1% against the dollar, respectively. See “Item 3A: Selected Financial Data—Exchange Rates.” A significant portion of our assets and liabilities are 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 and 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 regulations of the Central Bank do not permit the difference, whether positive or negative, between a bank's assets and liabilities denominated in any foreign currency (including assets and liabilities denominated in U.S. dollars but payable in pesos, as well as those denominated in pesos and the variation of the U.S. dollar exchange rate) to exceed 20% of the bank's paid-in capital and reserves. Provided that if the balance of such assets exceeds the balance of such liabilities, the difference may exceed 20% of such capital and reserves in an amount not to exceed the bank's allowances and reserves denominated in such foreign currency (excluding profits to be remitted abroad). In the years ended December 31, 2003, 2004 and 2005, the gap between foreign currency denominated assets and foreign currency denominated liabilities, including forward contracts, was Ch$62,430 million, Ch$(35,767) million and Ch$(6, 269) million, respectively. The Bank also uses a sensitivity analysis to limit the potential loss in fluctuations of US interest rates on interest income and a VaR model to limit foreign currency trading risk ( See “Item 11: Quantitative and Qualitative Disclosure of Market Risk” ).

         Foreign currency indexed interest earning assets and interest bearing liabilities. The gain or loss in book value of dollar indexed interest earning assets and liabilities is recorded as interest income and expense. Accordingly, an appreciation of the peso may result in a negative nominal or real rate earned or paid over these assets and liabilities. In 2004 and 2005, the appreciation of the peso was lower than the average increase in stated interest rates, resulting in a positive nominal rate in the period. As a result, on December 31, 2005, the average nominal rate earned on dollar assets reached 2.3%, but the average real rate earned was negative 9.2%, reflecting a loss in book value of assets indexed to the US dollar. In 2004 the nominal rate paid earned on dollar assets reached 1.7% and the real rate earned was negative 7.3%.

         Foreign exchange transactions . The income statement also includes an item called foreign exchange transactions. This includes net gain or loss in the book value of assets and liabilities denominated in foreign currency (and does not include any gain or loss in the book value of assets or liabilities indexed to a foreign currency of which is included in net interest income). This line also includes the financial results of foreign currency forward contracts. Since the foreign currency gap between assets and liabilities denominated in foreign currencies is limited by Central Bank regulation and our internal policies, the results from foreign exchange transactions are mainly the results of our hedging transactions. The net gain from foreign exchange transactions was Ch$2,684 million in 2005, Ch$7,915 million in 2004 and Ch$161,363 million in 2003.

    Results of Operations for the Years Ended December 31, 2003, 2004 and 2005

         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 27 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, 2003, 2004 and 2005 and of our shareholders’ equity at December 31, 2004 and 2005. The Audited Consolidated Financial Statements

    45






    have been restated in constant Chilean pesos of December 31, 2005. See Note 1(c) to the Audited Consolidated Financial Statements.

    Introduction

         The following table sets forth the principal components of our net income for the years ended December 31, 2003, 2004 and 2005.

        For the year-ended December 31,   % Change
       
     
        2003   2004   2005   2005   2003/2004   2004/2005
       

     

     

     

     

     

        (in millions of constant Ch$ as of
    December 31, 2005)
      (in thousands
    of US$)(1)
               
    CONSOLIDATED INCOME STATEMENT DATA                                    
    Chilean GAAP:                                    
    Interest income and expense                                    
               Interest revenue   651,540     812,032     985,669     1,916,860     24.6 %   21.4 %
               Interest expense   (330,119 )   (326,743 )   (439,790 )   (855,273 )   (1.0 %)   34.6 %
       

     

     

     

     

     

                      Net interest revenue   321,421     485,289     545,879     1,061,587     51.0 %   12.5 %
       

     

     

     

     

     

    Provision for loan losses   (71,592 )   (83,677 )   (63,532 )   (123,554 )   16.9 %   (24.1 %)
       

     

     

     

     

     

    Fees and income from services                                    
               Fees and other services income   145,491     153,720     169,786     330,188     5.7 %   10.5 %
               Other services expense   (26,729 )   (27,707 )   (31,420 )   (61,103 )   3.7 %   13.4 %
       

     

     

     

     

     

                       Total fees and income from services, net   118,762     126,013     138,366     269,085     6.1 %   9.8 %
       

     

     

     

     

     

    Other operating income, net                                    
               Net gain (loss) from trading and brokerage   29,153     37,943     8,404     16,344     30.2 %   (77.9 %)
               Foreign exchange transactions, net   161,363     7,915     2,684     5,220     (95.1 %)   (66.1 %)
               Others, net   (21,143 )   (25,302 )   (23,602 )   (45,900 )   19.7 %   (6.7 %)
       

     

     

     

     

     

                       Total other operating income, net   169,373     20,556     (12,514 )   (24,336 )   (87.9 %)   (160.9 %)
       

     

     

     

     

     

    Other income and expenses                                    
               Non-operating income, net   530     (4,572 )   (22,013 )   (42,810 )   (962.6 %)   381.5 %
               Income attributable to investments in other companies   1,772     556     678     1,319     (68.6 %)   21.9 %
               Losses attributable to minority interest   (170 )   (190 )   (133 )   (258 )   11.8 %   (30.0 %)
       

     

     

     

     

     

                       Total other income and expenses   2,132     (4,206 )   (21,468 )   (41,749 )   (297.3 %)   410.4 %
       

     

     

     

     

     

    Operating expenses                                    
               Personnel salaries and expenses   (133,973 )   (137,824 )   (139,220 )   (270,745 )   2.9 %   1.0 %
               Administrative and other expenses   (89,128 )   (100,038 )   (100,585 )   (195,611 )   12.2 %   0.6 %
               Depreciation and amortization   (42,648 )   (40,127 )   (39,248 )   (76,327 )   (5.9 %)   (2.2 %)
       

     

     

     

     

     

                       Total operating expenses   (265,749 )   (277,989 )   (279,053 )   (542,683 )   4.6 %   0.4 %
       

     

     

     

     

     

    Loss from price-level restatement   (8,179 )   (12,417 )   (18,140 )   (35,277 )   51.8 %   46.1 %
       

     

     

     

     

     

    Income before income taxes   266,168     253,569     289,538     563,073     (4.7 %)   14.2 %
    Income taxes   (46,382 )   (47,578 )   (49,828 )   (96,902 )   2.6 %   4.7 %
       

     

     

     

     

     

    Net income   219,786     205,991     239,710     466,171     (6.3 %)   16.4 %
       

     

     

     

     

     



    (1) Amounts stated in US dollars as of and for the year ended December 31, 2005 have been translated from Chilean pesos at the exchange rate of Ch$514.21 = US$1.00 as of December 31, 2005. See “Item 3A: Selected Financial Data— Exchange Rates” for more information on the observed exchange rate.

         2004 and 2005. Net income for the year ended December 31, 2005 increased 16.4% to Ch$239,710 million compared to net income of Ch$205,991 million in 2004. This increase was mainly due to a 12.5% increase in net interest revenue, a 24.1% decline in provisions for loan losses and a 9.8% increase in fee income. Net interest revenue, net of related hedging transactions recorded under “Foreign exchange transactions, net,” increased 11.2% in 2005 compared to 2004. Our net interest margin for 2005, net of such hedging transactions, improved to 4.7% in 2005 compared to 4.5% in 2004. In 2005 the positive economic environment led to higher loan growth and banking activity in general which fueled the increases of Ch$60,590 million in net interest revenue and the Ch$12,353 million in net fee income. At the same time the quality of the Bank's loan portfolio improved leading to a Ch$20,145 million decrease in provision expense mainly due to an improvement in economic conditions.

         The results were partially offset by the 77.9% decrease in net gains from trading and brokerage activities which mainly reflects variations in the market value of our debt securities portfolios resulting from interest rate movements. In 2004 the Bank benefited from an important decline in long-term rates which was much more subdued in 2005 leading to a Ch$29,539

    46






    million drop in gains from trading and brokerage activities. Net non-operating losses also increased Ch$17,262 million or 410.4% in 2005 compared to 2004 because results in 2004 included a one-time gain of Ch$22,614 million from the sale of our Santiago Express division to Empresas París. Operating expenses in 2005 increased 0.4% or Ch$1,064 million and the efficiency ratio, operating expenses divided by operating income, improved to 41.5% in 2005 from 44.0% in 2004.

         2003 and 2004 . Net income for the year-ended December 31, 2004 decreased 6.3% compared to the same period in 2003. This decrease was principally attributable to the 87.9% decrease in net other operating income, the 16.9% increase in provisions for loan losses and the 12.2% increase in administrative and other expenses in 2004. The increase in the provision for loan losses was mainly due to the reversal of voluntary loan loss reserves in 2003 and a 16.3% increase in charge-offs in 2004 compared to 2003. The rise in charge-offs was mainly due to the growth of the consumer loan portfolio and the implementation at the beginning of this year of a new loan classification system mandated by the Superintendency of Banks. Net income was also adversely affected by an increase in charge-offs of foreclosed property and a rise in provisions for contingencies, both of which ar e recorded under “non-operating income, net.” This was offset by the gain from the sale of our Santiago Express division to Empresas París. Net income was also positively affected by an increase in the net gains from trading and investment activities, which reflected increases in the market value of our debt securities portfolios resulting from the continuing decline in interest rates. Net income in the 2004 period also benefited from an increase in recoveries of loans previously written off, which was mainly due to an increased stock of written-off loans and improved economic conditions in Chile. Net interest revenue, net of related hedging transactions recorded under “Foreign Exchange transactions, net,” increased 2.2% in 2004 compared to 2003. Our net interest margin for 2004, net of such hedging transactions, remained flat at 4.5% in 2004 compared to the 2003 period. Fee income increased 6.1% in the same period.

    Net interest revenue

        Year Ended December 31,   % Change
       
     
        2003   2004   2005   2003/2004   2004/2005
       

     

     

     

     

        (in millions of constant Ch$ as of December 31, 2005, except percentages)
    Interest revenue   651,540     812,032     985,669     24.6 %   21.4 %
    Interest expense   (330,119 )   (326,743 )   (439,790 )   (1.0 %)   34.6 %
       

     

     

     

     

    Net interest revenue   321,421     485,289     545,879     51.0 %   12.5 %
       

     

     

     

     

    Average interest earning assets   10,768,109     10,917,863     11,585,272     1.4 %   6.1 %
    Average non-interest bearing demand deposits   1,769,930     1,817,097     1,905,182     2.7 %   4.8 %
    Net interest margin(1)   3.0 %   4.4 %   4.7 %            
    Adjusted net interest margin(2)   4.5 %   4.5 %   4.7 %            
    Average shareholders’ equity and average                              
         demand deposits to total average earning                              
         assets   25.7 %   26.0 %   25.0 %            


    (1) Net interest margin is net interest revenue divided by average interest earning assets.
    (2) For a reconciliation of this non-GAAP measure, see “Reconciliation of non-GAAP measures” in Item 5G below.

         2004 and 2005. Net interest revenue for the year-ended December 31, 2005 increased 12.5% in 2005 mainly as a result of the 6.1% increase in average interest-earning assets and an increase in our net interest margin from 4.4% in 2004 to 4.7% in 2005.

         Adjusted net interest margin including results of forward contracts reached 4.7% in 2005 compared to 4.5% in 2004. Pursuant to Chilean GAAP, Santander-Chile must include as net interest income the gain or loss in book value of dollar-indexed interest-earning assets and liabilities. Therefore, an appreciation of the peso, as occurred in 2003, 2004 and 2005 affects net interest revenue and net interest margins. In the year-ended December 31, 2005, the average nominal rate earned on dollar assets was 2.3% and the average real rate was negative 9.2%, reflecting the loss in book value of assets indexed to the US dollar. Pursuant to Chilean GAAP, the Bank must report the results of forward contracts that hedge foreign currencies as foreign currency transactions in the income statement. Because the foreign currency gap is limited by Central Bank regulation and our internal policies, the results from foreign exchange transactions are mainly the results of our hedging transactions. The accounting asymmetry produced by incorporating the changes in book value of dollar-indexed assets and liabilities as net interest revenue and the financial results of forward contracts as financial exchange transactions results in a presentation that is not reflective of our underlying business, especially during periods when the exchange rate is highly volatile and, therefore, for analysis purposes only, we add foreign exchange transactions to net interest revenue.

         The principal factors positively affecting our net interest margin were the change in asset mix and the higher inflation rate. Total average loans in 2005 increased 23.6% compared to a 6.1% increase in interest-earning assets. Average loans in 2005 represented 64.4% of interest-earning assets compared to 55.3% in 2004. The average nominal rate paid on loans was 10.4% compared to 8.5% for average interest earning assets as a whole.

    47






         Period end loans increased 13.6% in 2005 compared to 2004, led by a 24.4% increase in consumer loans, an 11.9% increase in general commercial loans, mainly reflecting an increase in lending to small and mid-sized companies, and a 23.3% increase in residential mortgage loans. The amount of mortgage loans appearing on our balance sheet, which only includes commercial and residential mortgage loans funded with mortgage bonds, decreased 33.5% . Residential and commercial mortgage lending funded through general borrowings are classified as “other loans”. The following table shows the breakdown of residential mortgage loans into those funded with mortgage bonds and those funded through general funding, and the total growth of this loan product, which was a key area of growth in 2005. This also reflects a change in funding strategy in 2005 away from mortgage bonds in order to increase the spread of mortgage lending.

    Interest Earning Assets Year-end December 31, %Change
    (Ch$ million) 2004 2005 Dec. 2005/2004
    Residential mortgage loans funded through mortgage bonds (1)
    600,314 414,070 (31.0%)
    Residential mortgage loans funded through general borrowing (2)
    1,252,614 1,871,055 49.4%
    Total loans 1,852,928 2,285,125 23.3%
    (1)      Included as mortgage loans on our balance sheet.
     
    (2)      Included as “other loans” on our balance sheet.
     

         At the same time the higher inflation rate in 2005 compared to 2004 also helped to boost the net interest margin. In 2005 inflation reached 3.7% compared to 2.4% in 2004. Our average UF-denominated assets exceeded our average UF-denominated liabilities by Ch$1,416,266 million in 2005, compared to Ch$1,258,606 million in 2004. This 12.5% rise in the average UF gap combined with a higher inflation had a positive effect on the net interest margin. See “Item 5B: Operating Results Impact of Inflation”.

         The principal factors negatively affecting the net interest margin were the rise in short-term interest rates and the lower ratio of non-interest-bearing demand deposits and shareholders’ equity to interest-earning assets. As interest-bearing liabilities generally have shorter terms than interest-earning assets, a rise in short-term rates has a negative effect on the Bank’s net interest margin. The average nominal rate paid on interest-bearing liabilities increased from 4.3% in 2004 to 5.2% in 2005. In 2005 the overnight reference rate set by the Chilean Central Bank increased 225 basis points to 4.50% in December 2005. The average 90-day Central Bank rate, a benchmark rate for deposits, increased in nominal terms from 1.75% in 2004 to 3.29% in 2005. As of December 31, 2005, the amount of our interest bearing liabilities with a maturity of 90 days or less was greater than our interest earning assets with the same maturity by Ch$491,182 million. The main reason for this gap is that interest-bearing liabilities are mainly comprised of time deposits and short-term repurchase agreements. Average time deposits and repurchase agreements represented 66.4% of interest bearing liabilities in 2005, and 51.5% of total time deposits had a maturity of 90 days or less as of December 31, 2005.

         The rise in short-term interest rate also negatively affected the funding mix. Average time deposits increased 22.0% in 2005 compared to a 4.8% increase in non-interest bearing demand deposits. Average time deposits represented 37.7% of average liabilities in 2005 compared to 33.4% in 2004. As short-term interest rates increased, so did the attractiveness of time deposits. In order to reduce the impact on margins of rising rates, the Bank increased the maturity of deposits. In 2005 16.5% of time deposits had a maturity greater than 12 months compared to 8.8% in 2004. The ratio of average free funds (non-interest bearing liabilities and shareholders’ equity) as a percentage of interest bearing liabilities also decreased as a result of this rise in short-term rates from 26.0% in 2004 to 25.0% in 2005. This was partially offset by the rise in spread earned over free funds as a result of the higher inflation rates in the per iods being compared.

         2003 and 2004. Our net interest revenue for the year ended December 31, 2004 increased 51.0% from the same period in 2003, mainly reflecting an increase in our net interest margin from 3.0% to 4.4%, which was principally due to an increase in the yield of dollar-denominated and dollar-indexed interest-earning assets. In the year-ended December 31, 2004, the nominal rate earned on dollar assets reached 1.7%, compared to negative 4.1% in the same period of 2003. In 2004, the exchange rate appreciated 6.6% compared to 15.9% in 2003. The gain or loss in book value of dollar-indexed interest-earning assets is recorded as interest income, and an appreciation of the peso may therefore result in a negative nominal or real rate earned over these assets. In 2003, the aforementioned negative nominal rate resulted from appreciation of the peso in that period at a rate that exceeded the average nominal interest rate on dollar-denominated or indexed interest-earning assets. In 2004, the rate of appreciation of the peso was lower than the average nominal rate resulting in a positive nominal rate and higher yield earned on dollar denominated and dollar indexed interest-earning assets. The gain or loss in book value of such assets due to exchange rate movements is recorded as interest income.

         The effects of foreign exchange movements are largely eliminated if the results of our foreign exchange hedging transactions are considered. These transactions are entered into to hedge foreign currency exposure arising from our dollar-denominated or dollar-indexed assets and liabilities, but the results of these hedging operations are included in foreign exchange transactions. After hedging transactions, our adjusted net interest margin was essentially flat in the 2003 and 2004 period at 4.5% .

         The principal factor negatively affecting our net interest margin was the lower interest rate environment, which, together with continued competition in the lending markets, put pressure on spreads. The average 90-day Central Bank rate, a benchmark rate for deposits and loans expressed in nominal terms, decreased from 2.77% in 2003 to 1.75% in 2004. As a result the nominal rate earned on the Bank’s interest earning assets nominally denominated in Chilean pesos declined from 12.6% in 2003 to 11.2% in 2004.

         The most significant factor positively affecting net interest margin in 2004 was the higher inflation rate in 2004 compared to 2003. Inflation as measured by the Chilean Consumer Price Iindex in 2004 reached 2.4% from 1.1% in 2003. This rise in inflation has a positive impact on net interest margins as the Bank has more inflation-indexed assets than liabilities and, therefore, a rise in the rate of inflation has a positive impact on the net interest margin. In 2004 the nominal rate earned over inflation adjusted assets increased to 7.8% from 6.9% in 2003.

    48






         The lower interest rate environment also lowered funding costs of interest bearing deposits denominated in nominal Chilean pesos in 2004. The nominal rate paid on nominally (non-indexed) peso-denominated interest-bearing time deposits decreased 90 basis points to 2.7% in 2004 compared to 2003. The majority of these time deposits have a maturity of 90 days or less, and the cost of these funds therefore varies directly corresponding to short-term interest rates. As a result, in 2004 the real rate paid on nominally peso-denominated time deposits fell 240 basis points to 0.2% and the real rate paid on inflation-indexed time deposits fell 80 basis points to 1.8%. Time deposits continue to be the main source of funding. Time deposits represented 33.4% of total average liabilities in 2004 compared to 34.2% in 2003, reflecting the higher growth of cheaper non-interest bearing liabilities to fund asset expansion.

         Our margins also benefited from an improvement of our funding mix in 2004 as a result of an increase in our non-interest-bearing liabilities. At December 31, 2004, our ratio of average non-interest-bearing demand deposits and equity to average interest-earning assets reached 26.0%, compared to 25.7% in the same period of 2003. We believe that the increase was due in part to increased use of cash management services by our corporate clients, which resulted in growth in non-interest-bearing demand deposits. In addition, the current low interest rate environment led retail customers to prefer readily-available funds deposited in checking accounts rather than low-yielding time deposits.

         The improvement of our asset mix, through an increased percentage of loans, also helped to minimize the negative impacts on our net interest margin of increased competition and lower rates. Average interest-earning assets in 2004 increased 1.4% compared to 2003. Meanwhile, the average balance of loans increased 3.8% in the same period. The average balance of loans to total interest-earning assets increased from 54.0% in 2003 to 55.3% in 2004. The balance of total loans in 2004 increased 10.4%, with higher yielding consumer loans, excluding lines of credit, increasing 13.3% in the same period. Demand for consumer financing loans increased as a result of prevailing lower interest rates and lower unemployment. Total commercial loans, excluding lines of credit, increased 16.8%, led by a 22.4% increase in loans to higher yielding small and mid-sized companies.

       Provision for loan losses

         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 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); and (iii) 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 these regulations, the models and methods used to classify our loan portfolio must follow the guiding principles established by the Superintendency of Banks and the Bank.

         For statistical information with respect to our substandard loans and reserves for probable 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 7 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 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).

         2004 and 2005. Provisions for loan losses totaled Ch$63,532 million in the year ended December 31, 2005, a decrease of 24.1% compared to 2004. The growth of the Chilean economy has led to an improvement in asset quality indicators which in turn resulted in a lower provision expense in the year. Past due loans as of year-end 2005 decreased 21.6% from year-end 2004. Past due loans as a percentage of total loans decreased from 1.52% as of year-end 2004 to 1.05% as of year-end 2005. Substandard loans as of year-end 2005 decreased by 19.9% to Ch$265,902 million. The coverage ratio (loan loss allowance as a percentage of past due loans) improved to 138.8% at year-end 2005 from 132.2% as of year-end 2004.

         Charge-offs in 2005 totaled Ch$136,773 million, increasing 10.5% in the twelve month period ended December 31, 2005 compared to the same period of 2004, mainly as a result of an increase in charge-off of commercial loans that had been previously restructured and that bear no interest See Item5D: Asset and Liability Management – Analysis of Loan Loss Allowances and Item5: Classification of Loan Portfolio Based on the Borrower’s Payment Performance). These loans were already classified as D2 and were 90%

    49






    provisioned for. Therefore, this increase in charge-offs was offset by the subsequent release of provisions previously set aside for these loans.

         We expect provisions for loan losses to increase in future periods in line with overall growth of our loan portfolio and our increased lending to small companies and individuals. See “Risk Factors—Risks Associated with our Business—Our exposure to individuals and small businesses could lead to higher levels of past due loans and subsequent write-offs” and “Risk Factors—Risks Associated with our Business— The growth of our loan portfolio may expose us to increased loan losses.”

         2003 and 2004. In the year-ended December 31, 2004, provisions for loan losses increased 16.9% and charge-offs in the period grew 16.3% from 2003. This rise in charge-offs was mainly due to the increase in loans, especially consumer lending which involves a higher risk and according to the guidelines of the Superintendency of Banks must be completely charged-off after 180 days past due. The rise in charge-offs was also due in part to the implementation at the beginning of the year of a new loan classification system mandated by the Superintendency of Banks, which among other things, required banks to reclassify overdraft lines of credit for individuals from Other loans to Consumer loans, thus placing these loans under the charge-off policy established for consumer lending.

         Past due loans as of year-end 2004 decreased 24.8% from year-end 2003, principally due to improved economic conditions in Chile and high levels of charge-offs resulting from the reclassification of lines of credit. As a result of this decrease in past due loans, the coverage ratio (loan loss allowance as a percentage of past due loans) improved to 132.2% at year-end 2004 from 98.9% as of year-end 2003. Past due loans as a percentage of total loans decreased from 2.23% as of year-end 2003 to 1.52% as of year-end 2004. Substandard loans as of year-end 2004 increased by 14.5%, principally due to application of the new Superintendency of Banks classification system, which classifies as “substandard” loans with required allowance levels that would not have resulted in a substandard classification under the old system. Loan loss allowance as a percentage of substandard loans declined from 61.7% as of year-end 2003 to 54.2% as of year-end 2004.

       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, 2003, 2004 and 2005.

        Year ended December 31,   % Change   % Change
        in million of constant Ch$ as of December 31, 2005
        2003   2004   2005   2003/2004   2004/2005
                         
    Checking accounts & lines of credit   38,709   34,666   41,547   (10.4%)   19.8%
    Collection and administration of insurance policies 12,991   17,327   20,170   33.4%   16.4%
    Mutual fund services   13,488   18,691   18,875   38.6%   1.0%
    Credit cards(1)   15,469   13,186   13,824   (14.8%)   4.8%
    Automatic teller cards (2)   11,573   12,751   13,571   10.2%   6.4%
    Insurance brokerage   5,126   6,648   8,231   29.7%   23.8%
    Sales and purchase of foreign currencies   5,310   5,162   6,481   (2.8%)   25.6%
    Payment agency services   6,555   4,100   2,821   (37.5%)   (31.2%)
    Letters of credit, guarantees, pledges and other contingent operations   3,474   4,728   2,757   36.1%   (41.7%)
    Underwriting   3,803   6,191   2,333   62.8%   (62.3%)
    Stock brokerage   1,162   1,385   1,619   19.2%   16.9%
    Office banking   -   -   1,351   -    100% 
    Custody and trust services   570   578   638   1.4%   10.4%
    Bank drafts and fund transfers   252   256   253   1.6%   (1.2%)
    Saving accounts   763   255   239   (66.6%)   (6.3%)
    Other   (483)   89   3,656   (118.4%)   4,007.9%
    Total   118,762   126,013   138,366   6.1%   9.8%
       
     
     
           

    (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.
     

    50






         2004 and 2005

         In 2005 total fee income increased 9.8% to Ch$138,366 million. The positive economic environment led to a rise in the usage and penetration of bank products in 2005. Fees from checking accounts and lines of credit increased 19.8% mainly a result of a rise in the fee charged for lines of credit and greater usage and opening of lines of credits on behalf of checking account holders. These products are sold together and, therefore, are being analyzed as a single product (See Item 5G. Reconciliation of Non-GAAP Measures).

         Insurance brokerage fees went up 23.8% mainly as a result of an industry wide expansion of insurance brokerage as banks have successfully introduced simple and low cost insurance products to the market. The 6.4% rise in ATM fees was mainly driven by the rise of ATMs installed by the Bank that increased 19.5% in 2005 to 1,422 tellers. This was offset in part by the US$2 million one-time fee earned in 2004 as a result of the strategic alliance signed between the Bank and Empresas París in December 2004. Excluding this item, ATM fees increased 17.1% in line with the increase of ATMs in the period.

         Other fees increased by 4,008% mainly due to a Ch$2,102 million in fees paid to the Bank in connection with financial advisory services provided to a companies.

         Fees from our mutual fund asset management subsidiary increased 1.0% . Total assets under management increased 4.7% in 2005 compared to 2004 to Ch$1,507,312 million (US$2,931 million). In 2005 the Bank launched 12 new funds. The inflow to these new funds offset a reduction in amount managed in fixed income funds as money flowed away from these funds toward bank deposits.

         The growth in fees was offset by a 41.7% decrease in fees from letters of credit, guarantees, pledges and other contingent operations in line with the decline in low yielding contingent loans. Underwriting fees decreased 62.3% mainly due to lower corporate bond issuances in 2005 compared to 2004. Payment agency service fees declined 31.2% in 2005 compared to 2004. These charges are mainly related to collection services the Bank performs on behalf of corporate customers. These services are increasingly being performed through our internet banking services. Fees charged for Office Banking, which is internet banking service for companies, totaled Ch$1,351 million in 2005 compared to no significant income in previous years.

         2003 and 2004.

         Fee income for the year ended December 31, 2004 increased 6.1% from the same period in 2003. The overall rise in fee income was due to an increase in fees from various business lines. Fees from underwriting increased 62.8% in 2004 compared to 2003 as a result of growth of non-lending activities in wholesale banking and the strength of our corporate finance division. The low interest rate environment and the recovery of the economy also led to a greater demand on behalf of corporate clients for issuing bonds in the market. Fees for insurance brokerage and mutual fund services sold by our subsidiaries were substantially higher in 2004 period compared to 2003. The 38.6% rise in mutual fund fees is directly related to a 30.8% increase in assets under management as of December 31, 2004. We believe that the increase in mutual fund fees was primarily attributable to the low interest rate environment in Chile in 2004, which made the rate of return on our mutual funds more attractive for our clients than deposit accounts. We believe that we could experience a decrease in mutual fund fees if interest rates were to increase in the future. Fees from insurance brokerage increased 29.7% in the year-ended December 31, 2004 compared to the same period of 2003, reflecting our introduction of new products and marketing campaigns.

         The rise in fee income from these products was offset in part by decreases in fee income from checking accounts and lines of credit and from credit card and payment agency services. The 10.4% decrease in fee income from checking accounts and lines of credit and from credit cards was mainly due to a decrease in the average number of accounts resulting from customer service challenges. These challenges arose in connection with integration of the operations of Old Santander-Chile and Santiago and from our current promotional policy, which was adopted in 2004, of waiving certain checking account fees as an incentive to increase the client base and promote increased product usage. As a result of this promotional policy, our customer base has begun to rebound. The total number of checking accounts in retail banking has risen 13.4% between year-end 2003 and year-end 2004. The decrease in fees from payment agency services mainly reflects the sale of our subsidiary Cobranzas y Recaudaciones Limitada (C y R) in October 2003.

         Fee income in 2004 also included a US$2 million fee paid by Empresas París to the Bank in connection with the strategic alliance signed by these two companies which included both the sale of the Santiago Express Division to Empresas París and the payment of a fee for access on behalf of future Banco París card holders to the Bank’s ATM network. Excluding this fee, fees from ATMs increased 0.6% in 2004 compared to 2003.

    51






       Other operating income (expenses), net

         The following table sets forth information regarding our Other operating income (expenses), net in the years ended December 31, 2003, 2004 and 2005.

        Year ended December 31,   % Change   % Change
       
     
     
        2003   2004   2005   2003/2004   2004/2005
       

     

     

     

     

        (in millions of constant Ch$ as of December 31, 2005, except percentages)
    Net gains from trading and mark-to-market   29,153     37,943     8,404     30.2 %   (77.9 %)
    Foreign exchange transactions, net   161,363     7,915     2,684     (95.1 %)   (66.1 %)
    Other operating losses, net   (21,143 )   (25,302 )   (23,602 )   19.7 %   (6.7 %)
    Total other operating income   169,373     20,556     (12,514 )   (87.9 %)   (160.9 %)






         2004 and 2005. Other operating income, net totaled a loss of Ch$12,514 million in 2005 compared to a gain of Ch$20,556 million in 2004. This was mainly due to the 77.9% decline in net gains from trading and mark-to-market. These lower gains reflect the movement of long-term local interest rates in 2005 compared to 2004. In the first 9 months of the year strong liquidity in the Chilean financial systems dampened long-term yields, resulting in important mark-to-market gains. As the economy strengthened and as inflation continued to rise, this trend reversed sharply in the last quarter of the year, reversing a substantial portion of the gains recorded to that point in the year. As of December 31, 2004 the market rate of the 10 year Central Bank bond in real terms was 3.29%. As of September 30, 2005 the yield on this same instrument had declined to 2.43%, but by December 31, 2005 it recovered to 3.29%. In 2004, the 10-year Chilean Central Bank bond was yielding 3.23%, down 104 basis points from year-end 2003.

         Foreign exchange transactions, net in 2005 decreased 66.1% from 2004, to Ch$2,684 million. This line item includes the net gain or loss in book value of assets and liabilities denominated in foreign currency, excluding the gain or loss in book value of assets or liabilities indexed to a foreign currency that is included as net interest income. This line also includes the financial results of foreign currency trading and foreign currency forward contracts. The Bank usually enters forward exchange transactions in order to avoid material exchange rate mismatches. Since the foreign currency gap is limited by Central Bank regulation and our internal policies (See Item 11: Quantitative and Qualitative Disclosures about Market Risk), the results from foreign exchange transactions are mainly the results of our hedging transactions. The accounting asymmetry produced by incorporating the changes in book value of dollar indexed assets and liabilities as net interest revenue and the financial results of forward contracts as financial exchange transactions results in a presentation that is not reflective of our underlying business and therefore, for analysis purposes only, we add foreign exchange transactions to net interest revenue.

         Other operating losses, net decreased 6.7% in 2005 compared to 2004, totaling a loss of Ch$23,602 million. This decrease was mainly due to the 20.9% decrease in commissions paid to our external sales force which totaled Ch$16,869 million in 2005. This decrease was mainly due to the fact that in 2004 sales force expenses included the recognition of Ch$4,087 million in one-time sales force expenses as a result of the sale of the Santiago Express Division to Empresas París. Expenses on assets received in lieu of payment also decreased 84.4% in 2005 compared to 2004. This was offset by a 16.6% decline in income from the sale of repossessed assets and a rise in other expenses related to our credit card business.

         2003 and 2004. Other operating income, net for the year-ended December 31, 2004 decreased 87.9% compared to the year-ended December 31, 2003, principally reflecting a 95.1% decrease in the gain from foreign exchange transactions in 2004 compared to 2003. The lower gain from foreign exchange transactions was offset in part by a 30.2% increase in unrealized gains on financial investments and realized gains from trading. These gains reflected the increase in the value of our investment securities portfolios resulting from declining interest rates. At December 31, 2004 the 10-year Chilean Central Bank bond was yielding 3.23% in real terms compared to 4.27% as of December 31, 2003. Net gain from trading and mark-to-market of securities in the year-ended December 31, 2004 also included a one-time gain of Ch$10,602 million arising from the sale of a single, large substandard loan and a one-time pre-tax loss of Ch$6,537 million arising from the pre-payment of US$170 million in various senior bonds, which were issued at higher rates of interest than those currently prevailing in the market. These bonds were replaced with lower cost funding which compensates for this one-time loss.

         The 19.7% increase in the loss in other categories of other operating income, net in 2004 compared to 2003 was primarily the result of the recognition of Ch$4,087 million in sales force expenses in connection with the sale of the Santiago Express Division to Empresas París. The expenses were incurred in relation to fees earned by the sales force on sales of bank products, which are generally recognized on an accrual basis over the life of the product as other operating expenses.

    52






       Other income and expenses, net

         The following table sets forth information regarding our operating expenses in the years ended December 31, 2003, 2004 and 2005.

        Year ended December 31,   % Change   % Change
       
     
     
        2003   2004   2005   2003/2004   2004/2005
       

     

     

     

     

        (in millions of constant Ch$ as of December 31, 2005, except percentages)
    Non-operating income (loss), net   530     (4,572 )   (22,013 )   (962.6 %)   381.5 %
    Income attributable to investments in other companies   1,772     556     678     (68.6 %)   21.9 %
    Losses attributable to Minority interest   (170 )   (190 )   (133 )   11.8 %   (30.0 %)
    Total   2,132     (4,206 )   (21,468 )   (297.3 %)   410.4 %






         2004 and 2005. The net loss recorded in Other income and expenses, net increased 410.4% in 2005 compared to 2004. In 2004 the Bank recognized a one-time gain of Ch$22,614 million from the sale of our former Santiago Express Division to Empresas París. Excluding the sale, the net loss recorded in Other income and expenses, net decreased 20.0% in 2005 compared to 2004 mainly as a result of the 141.1% increase in income from the sale of repossessed assets previously charged off. This was partially offset by the 67.1% increase in provisions for other contingencies. These contingencies are mainly related to non-credit risks, including non-specific contingencies, tax contingencies and other non-credit contingencies or impairments. See Note 17 to our Consolidated Financial Statements.

         2003 and 2004. Other income and expenses, net for the year-ended December 31, 2004 totaled a loss of Ch$4,206 million compared to a gain of Ch$2,132 million in this item in 2003. This reflects an increase in charge-off of assets acquired upon foreclosure. The increase in charge-offs of assets acquired upon foreclosure mainly reflects a change in Superintendency of Bank guidelines in the last quarter of 2004 regarding the charge-off of repossessed assets. Repossessed assets must be charged off if not sold twelve months after they have been repossessed. This limit can be extended by eighteen months in some cases. In 2000 the Superintendency of Bank temporarily extended this 18 month period to all assets repossessed between 1999 and 2002. In 2003 this extension period was reduced to 12 additional months for all assets repossessed in 2003. In the last quarter of 2004 the extension period was reduced to six months for assets repossessed in 2004. We expect that in 2005 the Superintendency of Banks will eliminate this extension period and the repossessed assets will have to be charged off after 12 months. Non-operating losses, net in 2004 included an increase in provisions for contingencies which mainly reflect a billing dispute with a vendor and a probable loss due to fraud by a vendor. These losses were offset by one-time gain obtained from the sale of the Santiago Express Division to Empresas París. See Note 17 to our Consolidated Financial Statements.

       Operating expenses

         The following table sets forth information regarding our operating expenses in the years ended December 31, 2003, 2004 and 2005.

        Year ended December 31,   % Change   % Change
       
     
     
        2003   2004   2005   2003/2004   2004/2005
       

     

     

     

     

        (in millions of constant Ch$ as of December 31, 2005, except percentages)
    Personnel salaries and expenses   133,973     137,824     139,220     2.9 %   1.0 %
    Administrative expenses   89,128     100,038     100,585     12.2 %   0.6 %
    Depreciation and amortization   42,648     40,127     39,248     (5.9 %)   (2.2 %)
    Total   265,749     277,989     279,053     4.6 %   0.4 %






    Efficiency ratio(1)   43.6 %   44.0 %   41.5 %            

    (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.
     

         2004 and 2005. Operating expenses in 2005 increased 0.4% compared to 2004. The 1.0% rise in personnel expenses reflects an increase in variable compensation paid to commercial teams for reaching commercial targets. This was partially offset by the 1.7% decrease in average headcount in 2005 compared to 2004 as a result of the sale of Santiago Express. The 0.6% increase in administrative expenses reflects an increase in spending in branches and ATMs, which was partially offset by savings produced by the outsourcing of certain back office functions, such as systems management and mortgage processing, which we believe has improved productivity. We expect personnel and administrative expenses to grow at a higher pace in future periods as a result of our strategy to expand our retail banking business. This trend was already observable in the second half of 2005.

    53






         Depreciation and amortization expenses decreased 2.2% in 2005 compared to 2004. Depreciation and amortization expenses were positively affected by the completion of the depreciation schedule of our core systems. Going forward we expect depreciation expenses to rise as the Bank continues to invest in branches and other fixed assets.

         2003 and 2004. Operating expenses for the year-ended December 31, 2004 increased 4.6% over 2003, and the efficiency ratio reached 44.0% in 2004 compared to 43.6% in 2003. The increase in operating expenses was mainly due to efforts to expand our retail banking business. The increase in administrative expenses in 2004 was due in part to the outsourcing of certain systems management functions to Altec, a wholly-owned subsidiary of Banco Santander Central Hispano, in order to save costs and improve the management of systems. As a result, certain fixed personnel costs were eliminated and new variable costs associated with the Altec contract and recognized in administrative expenses were being incurred.

       Loss from price level restatement

         2004 and 2005. Losses from price level restatement totaled Ch$18,140 and increased 46.1% compared to 2004. The higher loss from price level restatement reflected the higher inflation rate used for calculating price level restatement in the periods being analyzed (3.62% in 2005 compared to 2.35% in 2004). The Bank must adjust its capital, fixed assets and other assets for the variations in price levels. 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 inflation rate.

         2003 and 2004. Loss from price level restatement for the year-ended December 31, 2004 increased 51.8% compared to the same period of 2003. The higher loss from price level restatement reflected the higher inflation rate used for calculating price level restatement in the periods being analyzed (2.35% compared to 1.05%) .

       Income tax

         2004 and 2005. Our income tax expense increased 4.7% to Ch$49,828 million for the year-ended December 31, 2005 compared to the same period in 2004. This rise was mainly due to a net charge to deferred taxes of Ch$4,756 million compared to a net benefit of Ch$12,715 million in 2004. This was partially offset by a 23.7% reduction in income tax provisions in 2005 compared to 2004. (See Note 20 of our Consolidated Financial Statements). As a result the total income tax expenses in 2005 increased at a lower rate than the growth of pre-tax income leading to a lower effective tax rate. The Bank’s effective tax rate was 17.2% in the year-ended December 31, 2005, compared to 18.8% in 2004. The statutory corporate tax rate is 17%.

         2003 and 2004. Our income tax expense increased 2.6% in 2004 compared to 2003. The Bank’s effective tax rate reached 18.8% in the year-ended December 31, 2004, compared to 17.4% in 2003. This increase was mainly due to the rise in provisions for contingencies described above under “Other income and expenses, net,” which are not deductible from income in calculating tax, and to the increase in the statutory corporate tax rate from 16.5% in 2003 to 17% in 2004.

    54






    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, 2005, 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 2005

     
     
     
     
     
        (in millions of constant Ch$ as of December 2005)
    Deposit and other obligations(1)   4,984,944   842,367   68,719   10,681   5,906,711
    Mortgage finance bonds   117,189   129,823   167,165   254,784   668,961
    Subordinated bonds   -   43,131   -   342,620   385,751
    Bonds   1,718   12,172   319,116   82,237   415,243
                         
    Chilean Central Bank borrowings:                    
    Credit lines for renegotiations of Loans   6,655   -   -   -   6,655
    Other Central Bank borrowings   173,206   -   -   -   173,206
                         
    Borrowings from domestic financial institutions   2,528   -   -   -   2,528
    Investments sold under agreements to Repurchase   49,779   -   -   -   49,779
       Foreign borrowings   1,034,004   60,900   3,342   -   1,098,246
    Other obligations   30,341   6,405   3,811   1,535   42,092
                         
         Total of cash obligations   6,400,371   1,094,798   562,153   691,850   8,749,172

    (1)      Excludes demand accounts and saving accounts
    (2)      The Bank as of the date of the filing of this 20-F has no significant purchase obligation

    Operational leases

         Certain bank premises and equipment are leased under various operating leases. Future minimum rental commitments as of December 31, 2005 under non-cancelable leases are as follows:

        As of December 31,
    2005

        (in millions of constant Ch$
    as of December 2005)
           
    Due within 1 year   5,307  
    Due after 1 year but within 2 years   4,667  
    Due after 2 years but within 3 years   3,856  
    Due after 3 years but within 4 years   2,590  
    Due after 4 years but within 5 years   1,180  
    Due after 5 years   376  
       
     
              Total   17,976  

    55






         As of December 31, 2005, 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 2005

     
     
     
     
     
        (in millions of constant Ch$ as of December 2005)
    Letters of credit   43,536   81,503   62,127   -   187,166
    Guarantees   481,449   25,517   831   -   507,797
    Other commercial commitments   232,070   3,994   291   -   236,355
               Total other commercial commitments   757,055   111,014   63,249   -   931,318




     

       (i) Capital and Reserves

         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 equity of at least 8% of its risk-weighted assets, net of required allowances, and paid-in capital and reserves (“basic capital”) of at least 3% of its total assets, net of required allowances. For these purposes, the effective equity of a bank is the sum of (a) the bank's basic capital and (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 elapses during the period commencing six years prior to their maturity. The calculation of the effective equity does not include the capital contributions made to subsidiaries of the bank nor its foreign branches. The merger of Old Santander - Chile an d 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. This indicator was reduced to 11% by the Superindentency of Banks effective January 1, 2005. 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.ers 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 sets forth our minimum capital requirements set by the Superintendency of Banks as of the dates indicated. See Note 13 to our financial statements for a description of the minimum capital requirements.

        As of December 31,
       
        2004   2005
       
     
        (in millions of constant Ch$ of December 31,
    2005 except for percentages)
             
    Base net capital   863,112    842,122 
    3% of total assets net of provisions   (376,324)   (394,078)
    Excess over minimum required equity   486,788    448,044 
    Base net capital as a percentage of the total assets, net of provisions   6.9%   6.4%
    Effective equity   1,275,642    1,206,421 
    11% of risk-weighted assets (12% in 2004)   (1,027,403)   (1,029,863)
    Excess over minimum required equity   248,239    176,558 
    Effective equity as a percentage of risk-weighted assets   14.9%   12.9%


    56






       (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, 2003, 2004 and 2005. Financial investments that have a secondary market are carried at market value. All other financial investments are carried at acquisition cost, plus accrued interest and indexation readjustments, as applicable.

        As December 31,
       
        2003   2004   2005
       
     
     
        (In Millions of constant Ch$ of
    December 31, 2005
    Central Bank and Government Securities            
    Marketable debt securities (1)   623,091   972,661   460,181
    Investment collateral under agreements to repurchase (2)   542,182   542,336   56,967
    Investment purchased under agreements to resell   46,273   24,516   23,120
    Other investments            
        1,211,546   1,539,513   540,268
    Subtotal            
                 
    Corporate securities            
    Marketable securities (1)   694,210   431,061   617,010
    Investment collateral under agreements to repurchase (2)   67,630   51,030   34,251
                 
    Subtotal   761,840   482,091   651,261
                 
    Time deposits in Chilean institutions   58,680   39,900   57,966
    Total   2,032,066   2,061,504   1,249,495



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

    57






         The following table sets forth an analysis of our investments as of December 31, 2005, by time remaining to maturity and the weighted average nominal rates of such investments:

        Time Remaining to Maturity
       
        Less than
    one year
      Weighted
    Average
    Nominal
    Rate
      One
    to five
    years
      Weighted
    Average
    Nominal
    Rate
      Five
    to ten
    years
      Weighted
    Average
    Nominal
    Rate
      More than
    ten years
      Weighted
    Average
    Nominal
    Rate
      Total   Weighted
    Average
    Nominal
    Rate
       
     
     
     
     
     
     
     
     
     
        (in millions of constant Ch$ of December 31, 2005)
    Government securities                                        
    Central Bank securities   187,245   4.1   126,548   4.3   83,370   3.7   30,033   3.3   427,196   4.0
    Government pension bonds   4,443   1.5   13,866   2.1   13,152   3.4   1,524   4.1   32,985   3.0
       
         
         
         
         
       
    Total   191,688       140,414       96,522       31,557       460,181    
       
         
         
         
         
       
    Investments Purchased                                        
         under Resale                                        
         Agreements   23,120   5.4                           23,120   5.4
       
                                 
       
    Other Financial                                        
         Investments                                        
    Time deposits in Chilean                                        
         Financial Institutions   48,022   6.1   26,847   3.9           1,917   6.5   76,786   4.9
    Other Marketable Securities   18,320   5.1   35,871   5.0   147,018   5.1   396,980   5.0   598,190   5.1
       
         
         
         
         
       
    Total   66,342       62,718       147,018       398,897       674,976    
       
         
         
         
         
       
    Investment Collateral                                        
         under Agreements to                                        
         Repurchase   3,705   3.4   56,215   3.8   706   4.1   30,593   4.6   91,218   3.9
       
         
         
         
         
       
    Total Financial Investment   284,855       259,347       244,246       461,047       1,249,495    
       
         
         
         
         
       

    Unused sources of liquidity

         The Bank also has credit ratings from three international agencies. Our ratings are equivalent to the Chilean sovereign ratings, but our bond ratings from Moody’s Investor Services pierce the sovereign ceiling. We believe our credit ratings are a positive factor when obtaining financing. In 2005, Fitch rating also improved the Bank’s credit ratings from A- to A following a similar change for the Republic of Chile. Moody’s in 2005 improved the outlook for the Bank’s long-term deposit rating from Stable to Positive.

       Moody’s   Rating


    Long-term Bank Deposits   Baa1
    Senior bonds   A2
    Subordinated Debt   A3
    Bank Financial Strength   B-
    Short-term   P-2
    Outlook   Positive
         
       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

    58






    Fitch   Rating


    Foreign Currency LT Debt   A
    Local Currency LT Debt   A+
    Foreign Currency ST Debt   F1
    Local Currency ST Debt   F1
    Outlook   Stable

    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 demand deposits and 3.6% for peso and UF-denominated time deposits. 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 than deposits unconditionally payable immediately or within a term of less than 30 days and other time deposits payable within 10 days. This special reserve requirement applies to the amount by which the total of such deposits 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.

         The Central Bank also requires us to comply with the following liquidity limits:

    • Our total liabilities with maturities of less than 30 days cannot exceed our total assets with maturities less than of 30 days by an amount greater than our capital. This limit must be calculated in local currency and foreign currencies together as one gap.

    • Our total liabilities with maturities of less than 90 days cannot exceed our total assets with maturities of less than 90 days by more than twice our 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.”

    Cash Flow

         The tables below set 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 Anónimas regarding loans to related parties and minimum dividend payments.

      Year ended December 31,
     




      2003   2004 2005

     
     
      (in millions of constant Ch$ as of
    December 31, 2005)
    Net cash provided by operating activities   308,901   411,975 326,684

         The Ch$85,291 million reduction in cash provided by operating activities in 2005 compared to 2004 was mainly due to a Ch$82,679 million decrease in the net change in interest accruals in the same period. Cash provided by operating activities

    59






    increased Ch$103,074 million in 2004 compared to 2003, reflecting a higher level of operating activity in 2004 than in 2003 and the net change in interest accruals in 2004 compared to 2003.

      Year ended December 31,
     




      2003   2004 2005

     
     
      (in millions of constant Ch$ as of
    December 31, 2005)
               
    Net cash provided by (used in) investing activities   479,519   (1,054,022) (668,349)

         Net cash used in investing activities in 2005 totaled Ch$668,349 million mainly as a result of the growth of the Bank’s loan book. Compared to 2004 net cashed used decreased 36.6% as the growth of loans in 2005 was partially offset by the sale of financial investments. Cash provided by investing activities decreased Ch$1,533,541 million in 2004 compared to 2003 primarily as a result of loan growth in 2004 compared to 2003.

      Year ended December 31,
     




      2003 2004 2005

     
     
      (in millions of constant Ch$ as of
    December 31, 2005
       
    Net cash provided by (used in) financing activities   (782,474) 577,897 580,691

         In 2005 the Bank financed its activities with an increase in time deposits and senior bonds which explains the proceeds of net cash provided by financing activities and the increase compared to 2004. The positive net cash provided by funding activities in 2004 compared to 2003 reflects the increase in the deposit base in line with the increase in lending.

    Deposits and Other Borrowings

         The following table sets forth our average daily balance of liabilities for the years ended December 31, 2003, 2004 and 2005, in each case together with the related average nominal interest rates paid thereon.

      Year ended December 31, 
     





















        2003        2004         2005     
     






     






     





      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, 2005, except for percentages)
    Savings accounts   170,115   1.4 %   1.6 %   137,671   1.2 %   2.0 %   115,657   0.9 %   4.3 %
    Time deposits   4,208,808   34.2 %   3.1 %   4,166,651   35.3 %   3.0 %   5,084,766   37.7 %   4.7 %
    Central Bank borrowings   33,793   0.3 %   5.0 %   37,887   0.3 %   4.5 %   126,464   0.9 %   3.7 %
    Repurchase agreements   694,880   5.7 %   0.0 %   645,733   5.5 %   2.8 %   516,903   3.8 %   3.1 %
    Mortgage finance bonds   1,596,735   13.0 %   7.1 %   1,306,662   11.1 %   8.2 %   803,767   6.0 %   9.4 %
    Other interest bearing liabilities   1,569,557   12.8 %   5.3 %   1,366,931   11.6 %   5.2 %   1,792,069   13.3 %   5.6 %
    Subtotal interest bearing liabilities   8,273,888   67.3 %   4.0 %   7,661,535   65.0 %   4.3 %   8,439,626   62.5 %   5.2 %
    Non-interest bearing liabilities                                                
    Non-interest bearing deposits   1,769,930   14.4 %         1,817,097   15.4 %         1,905,182   14.1 %      
    Contingent liabilities   711,583   5.8 %         1,009,613   8.6 %         875,825   6.5 %      
    Other non-interest bearing liabilities   549,509   4.5 %         956,434   2.4 %         1,282,957   9.5 %      
    Shareholders’ equity   993,729   8.1 %         1,017,401   8.6 %         994,306   7.4 %      
    Subtotal non-interest bearing liabilities   4,024,750   32.7 %         4,800,544   35.0 %         5,058,270   37.5 %      
    Total liabilities   12,298,639   100.0 %         12,462,080   100.0 %         13,497,896   100.0 %      

         Our most important source of funding is our time deposits. Average time deposits represented 37.7% of our average total liabilities in the year ended December 31, 2005. 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 increase the duration of time deposits received form institutional investors. See “Item 4B: Business Overview—Lines of

    60






    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, 2003, 2004 and 2005.

      As of December 31,
     




      2003   2004   2005



      (in millions of constant Ch$ as of
    December 31, 2005)
         
    Checking accounts   1,190,537   1,335,113   1,455,924
    Other demand liabilities   908,072   987,338   668,325
    Savings accounts   153,802   127,247   109,423
    Time deposits   3,585,189   4,502,066   5,797,288
    Other commitments (1)   31,177   39,753   44,561
                 
               Total   5,868,777   6,991,517   8,075,521




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

    Maturity of Deposits

         The following table sets forth information regarding the currency and maturity of our deposits as of December 31, 2005, 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   1.8 %   -   -   0.8 %
    Savings accounts   -   4.2 %   -   1.9 %
    Time deposits:        
    Maturing within 3 months   71.8 %   20.0 %   91.6 %   52.1 %
    Maturing after 3 but within 6 months   17.9 %   27.5 %   7.3 %   20.5 %
    Maturing after 6 but within 12 months   4.8 %   16.0 %   1.0 %   9.1 %
    Maturing after 12 months   3.7 %   32.3 %   0.1 %   15.6 %
    Total time deposits   98.2 %   95.8 %   100.0 %   97.4 %
    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, 2005.

      Ch$   UF   Foreign
    Currency
      Total   




     
    (in millions of constant Ch$ as of December 31, 2005)  
    Time deposits:        
               Maturing within 3 months   1,580,046   456,565   632,921   2,669,532  
               Maturing after 3 but within 6 months   429,885   654,958   60,941   1,145,784  
               Maturing after 6 but within 12 months   115,195   391,785   7,699   514,679  
               Maturing after 12 months   82,094   776,178   301   858,573  
                       
    Total time deposits   2,207,220   2,279,486   701,862   5,188,568  




     

    61






    Short-term Borrowings

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

      As of December 31,
     












      2003   2004    2005
     


     


     


      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, 2005, except for rate data)
    Investments under repurchase agreements   494,139   -   448,464   1.3 %   49,779   1.8 %
    Central Bank borrowings   352,224   2.8 %   340,959   0.3 %   173,206   2.1 %
    Domestic interbank loans   38,016   5.0 %   29,778   3.4 %   2,528   1.6 %
    Borrowings under foreign trade credit lines   124,619   (0.3 %)   251,504   4.4 %   1,034,003   4.0 %
    Total short-term borrowings   1,008,998   1.0 %   1,070,705   1.8 %   1,259,516   2.4 %

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

      For the year Ended December 31,
     












      2003   2004   2005
     


       


       


      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, 2005, except for rate data)
                 
    Investments under repurchase agreements   694,881   -   645,734   2.8 %   516,903   3.1 %
    Central Bank borrowings   33,793   5.0 %   37,888   4.5 %   126,464   3.7 %
    Domestic interbank loans   69,477   2.6 %   52,667   0.8 %   41,676   3.6 %
    Borrowings under foreign trade credit lines      94,857   1.5 %   253,193   2.3 %   312,191   9.6 %
    Total short-term borrowings   893,008   0.6 %   989,482   2.6 %   997,234   5.0 %

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

      Maximum 2003
    Month-End
    Balance
      Maximum 2004
    Month-End
    Balance
      Maximum 2005
    Month-End
    Balance



      (in millions of constant Ch$ as of December 31, 2005)
                 
    Investments under agreements to repurchase   404,746   354,344   580,502
    Central Bank borrowings   352,224   333,150   370,823
    Domestic interbank loans   78,511   137,874   42,993
    Borrowings under foreign trade credit lines   234,051   450,600   492,702
       Total short-term borrowings   1,069,531   1,275,967   1,487,019




    62






    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, 2004
     
      Long-term   Short-term   Total



      (in millions of constant Ch$ as of
    December 2005)
                 
    Central Bank borrowings   -   340,959   340,959
    Credit lines for renegotiations of loans   9,662   -   9,662
    Investments under agreements to repurchase   -   448,464   448,464
    Mortgage finance bonds   798,612   194,534   993,146
    Other borrowings: bonds   370,565   -   370,565
    Subordinated bonds   432,695   117,181   549,876
    Borrowings from domestic financial institutions   -   29,778   29,778
    Foreign borrowings   244,068   251,504   495,572
    Other obligations   14,773   26,448   41,221
                 
            Total borrowings   1,870,375   1,408,868   3,279,243



           
      December 31, 2005





      Long-term   Short-term   Total



      (in millions of constant Ch$ as of
    December 2005)
                 
    Central Bank borrowings   -   173,206   173,206
    Credit lines for renegotiations of loans (a)   6,655   -   6,655
    Investments under agreements to repurchase   -   49,779   49,779
    Mortgage finance bonds (b)   551,772   117,189   668,961
    Other borrowings: bonds (c)   413,525   1,718   415,243
    Subordinated bonds (d)   385,751   -   385,751
    Borrowings from domestic financial institutions   -   2,528   2,528
    Foreign borrowings (e)   64,243   1,034,003   1,098,246
    Other obligations (f)   11,751   30,341   42,092
                 
           Total borrowings   1,433,697   1,408,764   2,842,461



           
          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 3.6%.

        2004   2005  
       
     
     
        (in millions of constant Ch$ as of
    December 2005)
     
               
    Total credit lines for renegotiations of loans    9,662   6,655  
       
     
     

    63






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

    As of December 31,
    2005

    (in millions of constant Ch$
    as of December 2005)       
    Due within 1 year   6,655  
    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   6,655

           (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 5.5% .

    As of December 31, 2005

    (in millions of constant Ch$ as of December 2005)
         
    Due within 1 year   117,189  
    Due after 1 year but within 2 years   66,969  
    Due after 2 years but within 3 years   62,854  
    Due after 3 years but within 4 years   59,276  
    Due after 4 years but within 5 years   56,949  
    Due after 5 years   305,724  
           
           Total mortgage finance bonds   668,961  

           (c) Bonds

      As of December 31,
     


      2004   2005



      (in millions of constant Ch$
    as of December 2005)
    Santiago bonds, Series A,B,C,D and F   45,456   11,115
    Santander Bonds denominated in US$   231,152   242,434
    Santander Bonds denominated in UF   93,957   161,694


      370,565   415,243


    Santiago bonds include series A, B, C and F issued by the former Santiago S.A. and series B and D issued by the former Banco O’Higgins, prior to its merger with the Bank 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 bear a weighted-average annual interest rate of 7.0% with interest and principal payments due semi-annually.

    On December 9, 2004, the Bank issued senior bonds, denominated in U.S. dollars, for a total of US$400 million. These bonds carry a nominal interest rate of LIBOR plus 0.35% per annum (4.81 % at December 31, 2005), quarterly interest payments and one repayment of principal after a term of 5 years.

    Santander bonds denominated in UF are bonds issued by former Banco Santander-Chile and new senior bonds denominated in UF issued by the Bank in 2005. These bonds are intended to finance loans that have a maturity of greater than one year, are linked to the UF index. The bond issued by former Banco Santander-Chile bear a weighted average annual interest rate of 6.5% . The new bonds issued in 2005 have a coupon rate of 2.6% with semi-annual interest payments and one repayment of principal after 5 years.

    64






    The maturities of these bonds are as follows:

    As of December 31,

    2005
    (in millions of constant Ch$
    as of December 2005)
    Due within 1 Year   1,718  
    Due after 1 year but within 2 years   12,172  
    Due after 2 years but within 3 years   -  
    Due after 3 years but within 4 years   205,280  
    Due after 4 years but within 5 years   105,443  
    Due after 5 years   90,630  

       Total bonds   415,243  

         d) Subordinated bonds

      As of December 31, 
     


      2004   2005
     
     
      (in millions of constant Ch$
    as of December 2005)
    Santiago bonds denominated in US$ (1) 46,310 43,131
    Santander bonds denominated in US$ (2) (6)   297,291   259,872
    Old Santander bonds denominated in US$ (3)   117,181   -
    Santiago Bonds linked to the UF (4)   58,084   53,354
    Santander Bonds linked to the UF (5)   31,010   29,394


       Total subordinated bonds   549,876   385,751


       
    1. On July 17, 1997, the former Banco Santiago issued subordinated bonds, denominated in U.S. dollars, for a total of US$300 million. The bonds bear interest at a nominal rate of 7.0% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.
    2. On January 16, 2003, the Bank completed the voluntary exchange of its new subordinated bonds, which will mature in 2012. A total of US$ 221,961,000 in principal of the Santiago bonds was offered and accepted by the Bank. The bonds bear interest at a nominal 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, denominated in U.S. dollars, for a total of US$200 million. The bonds bear interest at a nominal rate of 6.5% per annum, semi-annual interest payments and one repayment of principal after a term of 7 years. This bond was due and paid in November 2005.
    4. The Series C and E Bonds outstanding as of December 31, 2004 are intended for the financing of loans with a maturity of greater than one year. They are linked to the UF index and bear interest at an annual rate of 7.5% and 6.0% respectively, with interest and principal payments due semi-annually.
    5. The Series C, D and E Bonds outstanding as of December 31, 2004 are intended for the financing of loans with a maturity of greater than one year. They are linked to the UF index and bear interest at an annual interest rate of 7.0% with interest and principal payments due semi-annually.
    6. On December 9, 2004, the Bank issued subordinated bonds, denominated in U.S. dollars, for a total of US$ 300 million. These bonds bear interst at a nominal interest rate of 5.375% per annum, semi-annual interest payments and one repayment of principal after a term of 10 years.

    65






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

    As of December 31,

    2005
    (in millions of constant Ch$
    as of December 2005)
    Due within 1 Year   -
    Due after 1 year but within 2 years   43,131
    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   342,620

       Total subordinated bonds   385,751

    e) Foreign borrowings

    These are short-term and long-term borrowings from foreign banks. The maturities of these borrowings are as follows:

    As of December 31,

    2005
    (in millions of constant
    Ch$
    as of December 2005)
    Due within 1 Year   1,034,003  
    Due after 1 year but within 2 years   54,820  
    Due after 2 years but within 3 years   6,080  
    Due after 3 years but within 4 years   -  
    Due after 4 years but within 5 years   -  
    Due after 5 years   3,343  

    Total foreign borrowings   1,098,246  

    The foreign borrowings are denominated principally in U.S. dollars, and are principally used to fund the Bank’s foreign trade loans and bear an annual average interest rate of 3.7%.

    66






    f) Other obligations

    Other obligations are summarized as follows:

    As of December 31,

    2005
    (in millions of constant
    Ch$
    as of December 2005)
     Due within 1 Year   2,045  
     Due after 1 year but within 2 years   4,518  
     Due after 2 years but within 3 years   1,887  
     Due after 3 years but within 4 years   1,629  
     Due after 4 years but within 5 years   1,263  
     Due after 5 years   2,454  

         Total long term obligations   13,796  

    Short-term obligations:  
     Amounts due to credit card operators   21,564  
     Acceptance of letters of credit   6,732  

    Total short – term obligations   28,296  

         Total other obligations   42,092  


       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$1,357,637 million as of December 31, 2005, which will be financed with our deposit base. Since a substantial portion of these commitments is 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.

         From time to time, the Bank enters into agreements to securitize certain assets by selling those assets to unconsolidated and unaffiliated entities, which then sell debt securities secured by those assets. These sales are non-recourse to the Bank. However, in the past the Bank has occasionally purchased a subordinated bond issued by the unconsolidated entity. As of December 31, 2005 we did not hold any of these subordinated bonds in our investment portfolio.

         The Bank and its brokerage subsidiary enter into derivative transactions as part of their asset and liability management and in acting as dealers to satisfy their clients’ needs. The notional amounts of these contracts are carried off-balance-sheet. See Note 12 to the Audited Consolidated Financial Statements.

         Foreign exchange forward contracts involve an agreement to exchange the currency of one country for the currency of another country at an agreed-upon price and settlement date. These contracts are generally standardized contracts, normally for periods between 1 and 180 days and are not traded in a secondary market; however, in the normal course of business and with the agreement of the original counterparty, they may be terminated or assigned to counterparty.

         When we enter into a forward exchange contract, we analyze and approve the credit risk (the risk that the counterparty might default on its obligations). Subsequently, on an ongoing basis, we monitor the possible losses involved in each contract. To manage the level of credit risk, we deal with counterparties of good credit standing, enter into master netting agreements whenever possible and, when appropriate, obtain collateral.

         The Chilean Central Bank requires that foreign exchange forward contracts be made only in US dollars and other major foreign currencies. Most of our forward contracts are made in U.S. dollars against the Chilean peso or the UF. Occasionally, forward contracts are also made in other currencies, but only when the Bank acts as an intermediary.

    67






         Unrealized gains, losses, premiums and discounts arising from foreign exchange forward contracts are shown on a net basis under Other assets and Other liabilities (see Note 10 to our Consolidated Financial Statements).

         During 2004 and 2005 we entered into interest rate and cross currency swap agreements to manage exposure to fluctuation in currencies and interest rates. The differential between the interest paid or received on a specified notional amount is recognized under “Foreign exchange transactions, net”. The fair value of the swap agreement and changes in the fair value as a result of changes in market interest rates are not recognized in the consolidated financial statement.

         In 2005 banks were authorized to operate in the currency and interest rate options market. The notional amounts of these options are carried off balance sheet. These contracts are valued at fair value and the changes in fair value are recognized in the consolidated financial statements.

         Our foreign currency futures, forward operations, options and other derivative products outstanding at December 31, 2004 and in 2005 are summarized below:

       (a) Foreign currency and interest rate contracts:

              Notional amounts
      Number of
    contracts
     






    Up to 3 months   Over 3 months
     


     





      2004   2005   2004   2005   2004   2005






          ThUS$   ThUS$   ThUS$   ThUS$
    Chilean market:            
    Future purchase of foreign currency with Chilean pesos   865   956   1,348,734   5,198,228   4,156,016   3,418,092
    Future sale of foreign currency with Chileanpesos   1,371   2,146   1,104,042   3,077,468   2,842,398   3,490,314
    Futures or other interest rate contracts   199   340   104,596   6,119,545   3,419,526   1,273,247
    Foreign currency forwards   112   253   34,127   289,972   20,230   226,011
                 
    Foreign markets:            
    Foreign currency swaps   109   129   51,245   573,982   22,670   199,397
    Interest rate swaps   120   107   86,100   1,305,457   2,487,128   2,558,182

         The notional amounts refer to the US dollars bought or sold or to the US dollar equivalent of foreign currency bought or sold for future settlement. The contract terms correspond to the duration of the contracts as from the date of the transaction to the date of the settlement.

       (b) Contracts expressed in the UF index:

              Notional amounts
      Number of
    contracts
     






    Up to 3 months   Over 3 months
     


     





      2004   2005   2004   2005   2004   2005






          UF   UF   UF   UF
    Forwards in UF/Ch$ sold   28   19   2,200,000   2,100,000   3,700,000   3,300,000
    Forwards in UF/Ch$ purchased   32   36   1,600,000   3,600,000   5,600,000   5,400,000

       (c) Options:














     
    In US$ths.           30 days   31 to 60 days   61 to 90 days   > 90 days  













     
    Call Bought Currency       50,000  
      Interest rate          
      Sold Currency          
      Interest rate          













     
    Put Bought Currency       10,000  
      Interest rate          
      Sold Currency       10,000  
      Interest rate          













     
               

    68






    D. Asset and Liability Management

    Please refer to Item 11: Asset and Liability Management regarding our policies with respect to asset and liability management.

    Capital Expenditures

         The following table reflects capital expenditures in each of the three years ended December 31, 2003, 2004 and 2005:

      For the Year Ended December 31, 
     




      2003   2004   2005



      (in millions of constant Ch$ as of
    December 31, 2005)
    Land and Buildings   7,320   3,636   5,564
    Machinery and Equipment   6,717   9,435   10,389
    Furniture and Fixtures   1,123   2,707   3,734
    Vehicles   437   436   847
    Other   2,117   3,384   943
                 
               Total   17,714   19,598   21,477



         The increase in capital expenditures in 2005 compared to 2004 was mainly due to the investment in branches and automatic teller machines (ATMs). In 2005 the Bank opened 37 new branches. Our branch network now totals 352 branches (260 Bank branches and 92 Santander Banefe branches). In 2005 a total of 232 new ATMs were installed and our ATM network now includes 1,422 machines. For 2006 we expect a similar level of investment in expanding our distribution network.

    69






    Selected Statistical Information

         The following information is included for analytical purposes and should be read in conjunction with our financial statements as well as the discussion in “Item 5: Operating and Financial Review and Prospects.” Pursuant to Chilean GAAP, the financial data in the following tables for all periods through December 31, 2004 have been restated in constant Chilean pesos as of December 31, 2005. The UF is linked to, and is adjusted daily to, reflect changes in the previous month’s Chilean consumer price index. See Note 1(c) to our financial statements.

    Average Balance Sheets, Income Earned from Interest Earning Assets and Interest Paid on Interest-Bearing Liabilities

          The average balances for interest earning assets and interest-bearing liabilities, including interest and readjustments received and paid, have been calculated on the basis of daily balances for us on an unconsolidated basis. Such average balances are presented in Chilean pesos (Ch$), in Unidades de Fomento (UF) and in foreign currencies (principally U.S.$). Figures from our subsidiaries have been calculated on the basis of monthly balances. The average balances of our subsidiaries, except Santander S.A. Agente de Valores , have not been categorized by currency. As such it is not possible to calculate average balances by currency for such subsidiaries on the basis of daily, weekly or monthly balances.

         The nominal interest rate has been calculated by dividing the amount of interest and principal readjustment due to changes in the UF index (gain or loss) during the period by the related average balance, both amounts expressed in constant pesos. The nominal rates calculated for each period have been converted into real rates using the following formulas:

    Where:

    Rp=   real average rate for peso-denominated assets and liabilities (in Ch$ and UF) for the period;
    Rd=   real average rate for foreign currency-denominated assets and liabilities for the period;
    Np=   nominal average rate for peso-denominated assets and liabilities for the period;
    Nd=   nominal average rate for foreign currency-denominated assets and liabilities for the period;
    D=   devaluation rate of the Chilean peso to the U.S. dollar for the period; and
    I=   inflation rate in Chile for the period (based on the variation of the Chilean Consumer Price Index).

         The real interest rate can be negative for a portfolio of peso-denominated loans when the inflation rate for the period is highe