UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 20-F

 

(Mark One)

 

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

 

OR

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017

 

OR

 

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

 

Commission file number: 1-14554

 

BANCO SANTANDER-CHILE
(d/b/a Santander and Banco Santander)
(Exact name of Registrant as specified in its charter)

 

SANTANDER-CHILE BANK
(d/b/a Santander and Banco Santander)
(Translation of Registrant’s name into English)

 

Chile
(Jurisdiction of incorporation or organization)

 

Bandera 140, 20th floor
Santiago, Chile
Telephone: 011-562-320-2000
(Address of principal executive offices)

Robert Moreno Heimlich

Tel: 562-2320-8284, Fax: 562-696-1679, email: robert.moreno@santander.cl

Bandera 140, 20th Floor, Santiago, Chile

 

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 (“ADS”), each representing the right to receive 400 Shares of Common Stock without par value New York Stock Exchange
Shares of Common Stock, without par value* New York Stock Exchange

 

 

  

*Santander-Chile’s shares of common stock are not listed for trading, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the New York Stock Exchange.

 

 

 

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

 

None
(Title of Class)

 

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

 

None
(Title of Class)

 

The number of outstanding shares of each class of common stock of Banco Santander-Chile at December 31, 2017, 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 No

 

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

 

Yes No

 

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 No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes No

 

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

 

Large Accelerated Filer Accelerated Filer Non-accelerated Filer
    Emerging Growth Company 

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP International Financial Reporting Standards as issued by the International Accounting Standards Board Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17 Item 18

 

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

 

Yes No

 

 

 

 

 

TABLE OF CONTENTS

 

 

Page

 

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS 2
CERTAIN TERMS AND CONVENTIONS 4
PRESENTATION OF FINANCIAL INFORMATION 4
PART I 7
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 7
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 7
ITEM 3. KEY INFORMATION 7
ITEM 4. INFORMATION ON THE COMPANY 40
ITEM 4A. UNRESOLVED STAFF COMMENTS 57
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 58
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 128
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 139
ITEM 8. FINANCIAL INFORMATION 145
ITEM 9. THE OFFER AND LISTING 146
ITEM 10. ADDITIONAL INFORMATION 147
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 166
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 187
PART II 189
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 189
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 189
ITEM 15. CONTROLS AND PROCEDURES 189
ITEM 16. [RESERVED] 191
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 191
ITEM 16B. CODE OF ETHICS 191
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 191
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 192
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 192
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 192
ITEM 16G. CORPORATE GOVERNANCE 192
ITEM 16H. MINE SAFETY DISCLOSURE 194
PART III 195
ITEM 17. FINANCIAL STATEMENTS 195
ITEM 18. FINANCIAL STATEMENTS 195
ITEM 19. EXHIBITS 195

 

 

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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 Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements appear throughout this 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 including:

 

·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—B. Business Overview—Competition,” “Item 5. Operating and Financial Review and Prospects,” “Item 8. Financial Information—A. Consolidated Statements and Other 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 Central Bank (as defined below);

 

·inflation;

 

·deflation;

 

·unemployment;

 

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·increases in defaults by our customers and impairment losses;

 

·decreases in deposits;

 

·customer loss or revenue loss;

 

·unanticipated turbulence in interest rates;

 

·movements in foreign exchange rates;

 

·movements in equity prices or other rates or prices;

 

·the effects of non-linear market behavior that cannot be captured by linear statistical models, such as the VaR model we use;

 

·changes in Chilean and foreign laws and regulations;

 

·changes in taxes;

 

·competition, changes in competition and pricing environments;

 

·our inability to hedge certain risks economically;

 

·the adequacy of loss allowances;

 

·technological changes;

 

·changes in consumer spending and saving habits;

 

·changes in demographics, consumer spending, investment or 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;

 

·acquisitions or restructurings of businesses that may not perform in accordance with our expectations;

 

·our ability to successfully market and sell additional services to our existing customers;

 

·disruptions in client service;

 

·damage to our reputation;

 

·natural disasters;

 

·implementation of new technologies;

 

·the Group’s exposure to operational losses (e.g., failed internal or external processes, people and systems); and

 

·an inaccurate or ineffective client segmentation model.

 

You should not place undue reliance on such statements, which speak only as of the date at which they were made. The forward-looking statements contained in this report 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 (the “Annual Report”), “Santander-Chile”, “the Bank”, “we,” “our” and “us” or similar terms refer to Banco Santander-Chile together with its consolidated subsidiaries.

 

When we refer to “Santander Spain,” we refer to our parent company, Banco Santander, S.A. References to “the Group,” “Santander Group” or “Grupo Santander” mean the worldwide operations of the Santander Spain conglomerate, as indirectly controlled by Santander Spain and its consolidated subsidiaries, including Santander-Chile.

 

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

 

In this Annual Report, references to “$”, “U.S.$”, “U.S. dollars” and “dollars” are to United States dollars; references to “Chilean pesos,” “pesos” or “Ch$” are to Chilean pesos; references to “CHF” or “CHF$” are to Swiss francs; references to “CNY” or “CNY$” are to Chinese yuan renminbi); 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) for the previous month. See “Item 3. Key Information—A. Selected Financial Data—Exchange Rates” for information regarding exchange rates.

 

As used in this Annual Report, the terms “write-offs” and “charge-offs” are synonyms.

 

In this Annual Report, references to the Audit Committee are to the Bank’s Comité de Directores y Auditoría.

 

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. References to the “Central Bank” are to the Banco Central de Chile. References to the SBIF are to the Superintendency of Banks and Financial Institutions.

 

Certain figures included in this Annual Report have been subject to rounding adjustments. Accordingly, figures shown as totals in certain tables may not be an arithmetic aggregation of the figures that precede them.

 

PRESENTATION OF FINANCIAL INFORMATION

 

Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and prepares its consolidated financial statements in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). Any reference to IFRS in this document is to IFRS as issued by the IASB.

 

As required by local regulations, our locally filed consolidated financial statements have been prepared in accordance with the Compendium of Accounting Standards issued by the SBIF the Chilean regulatory agency (“Chilean Bank GAAP”). Therefore, our locally filed consolidated financial statements have been adjusted to IFRS in order to comply with the requirements of the Securities and Exchange Commission (the “SEC”). Chilean Bank GAAP principles are substantially similar to IFRS but there are some exceptions. For further details and a discussion of the main differences between Chilean Bank GAAP and IFRS, see “Item 5. Operating and Financial Review and Prospects—Accounting Standards Applied in 2017.”

 

This Annual Report contains our consolidated financial statements as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015 (the “Audited Consolidated Financial Statements”). Such Audited Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the IASB, and have been audited by the independent registered public accounting firm PricewaterhouseCoopers Consultores Auditores SpA for the years ended December 31, 2017 and 2016 and by the independent registered accounting firm Deloitte Auditores y Consultores Limitada for the year ended December 31, 2015. See page F-2 of the Audited Consolidated Financial Statements for the 2017 and 2016 audit report issued by PricewaterhouseCoopers Consultores Auditores SpA and page F-4 of the Audited Consolidated Financial Statements for the 2015 audit report issued by Deloitte Auditores y Consultores Limitada. The Audited Consolidated Financial Statements have been prepared from accounting records maintained by the Bank and its subsidiaries.

 

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The notes to the Audited Consolidated Financial Statements form an integral part of the Audited Consolidated Financial Statements and contain additional information and narrative descriptions or details of these financial statements.

 

We have formatted our financial information according to the classification format for banks in Chile for purposes of IFRS. We have not reclassified the line items to comply with Article 9 of Regulation S-X. Article 9 is a regulation of the SEC that contains formatting requirements for bank holding company financial statements.

 

Functional and Presentation Currency

 

The Chilean peso is the currency of the primary economic environment in which the Bank operates and the currency that influences its structure of costs and revenues, and in accordance with International Accounting Standard 21 – The Effects of Changes in Foreign Exchange Rates has been defined as the functional and presentation currency. Accordingly, all balances and transactions denominated in currencies other than the Chilean peso are treated as “foreign currency.” See “Note 1—Summary of Significant Accounting Principles—e) Functional and presentation currency.”

 

For presentational purposes, we have translated Chilean pesos (Ch$) into U.S. dollars (U.S.$) using the rate as indicated below under “Exchange Rates,” for the financial information included in this Annual Report.

 

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 is based on information published periodically by the SBIF. Non-performing loans include the entire principal amount and accrued but unpaid interest on loans for which either principal or interest is past-due for 90 days or more. Restructured loans for which no payments are past-due are not ordinarily classified as non-performing loans. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

Under IFRS, a loan is evaluated on each financial statement reporting date to determine whether objective evidence of impairment exists. A loan will be impaired if, and only if, objective evidence of impairment exists as a result of one or more events that occurred after the initial recognition of the loan, and such event or events have an impact on the estimated future cash flows of such loan that can be reliably estimated. It may not be possible to identify a single event that was the individual cause of the impairment.

 

An impairment loss relating to an individually significant loan recorded at amortized cost which has experienced objective evidence of impairment is calculated as the difference between the recorded amount of the asset and the present value of estimated future cash flows, discounted at the financial asset’s original effective interest rate.

 

Those loans individually assessed for impairment and found not to be individually impaired are included in the loans collectively assessed for impairment (so that the collective assessment includes both the remainder of the loans not individually assessed and those not found to be individually impaired) where grouping of such loans on a collective basis is performed using similar credit characteristics.

 

The reversal of an impairment loss occurs only if it can be objectively related to an event occurring after the initial impairment loss was recorded. In the case of loans recorded at amortized cost, the reversal is recorded in income. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Analysis of Loan Loss Allowances.”

 

Outstanding loans and the related percentages of our loan portfolio consisting of corporate and consumer loans in the section entitled “Item 4. Information on the Company—B. Business Overview” are categorized based on the nature of the borrower. Outstanding loans and related percentages of our loan portfolio consisting of corporate and consumer loans in the section entitled “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information” are categorized in accordance with the reporting requirements of the SBIF, which are based on the type and term of loans. This disclosure is consistent with IFRS.

 

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Effect of Rounding

 

Certain figures included in this Annual Report and in the Audited Consolidated Financial Statements have been rounded up 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 macroeconomic data related to the Chilean economy is based on information published by the Central Bank, and all market share and other data related to the Chilean financial system is based on information published by the SBIF 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, were converted or will be converted at all.

 

Unless otherwise indicated, all U.S. dollar amounts at any year end, for any period have been translated from Chilean pesos based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period. On December 31, 2017 and 2016, the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm on these days was Ch$616.85 and Ch$666.00 respectively, or 0.26% more and 0.19% less, respectively, than the observed exchange rate published by the Central Bank for such date of Ch$615.22 and Ch$667.29 respectively, per U.S.$1.00. 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. Key Information—A. Selected Financial Data—Exchange Rates” of the Annual Report.

 

As of December 31, 2017 and 2016, one UF was equivalent to Ch$26,798.14 and Ch$26,347.98, respectively. The U.S. dollar equivalent of one UF was U.S.$43.56 as of December 31, 2017, using the observed exchange rate reported by the Central Bank as of December 30, 2017 of Ch$39.49 per U.S.$1.00.

 

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PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following table presents selected historical financial information for Santander-Chile as of the dates and for each of the periods indicated. Financial information for Santander-Chile as of and for the years ended December 31, 2017, 2016, 2015, 2014, and 2013 has been derived from our audited consolidated financial statements prepared in accordance with IFRS. In the F-pages of this Annual Report on Form 20-F, our audited financial statements as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015 are presented. The audited financial statements for 2014 and 2013 are not included in this document, but they can be found in our previous Annual Reports on Form 20-F. These consolidated financial statements differ in some respects from our locally filed financial statements as of and for the years ended December 31, 2017, 2016, 2015, 2014 and 2013 prepared in accordance with Chilean Bank GAAP. See “Item 4. Information on the Company—Differences between IFRS and Chilean Bank GAAP.”

 

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.

 

   As of and for the years ended December 31,
   2017  2017  2016  2015  2014  2013
   In U.S.$ thousands(1)  In Ch$ millions (2)
CONSOLIDATED STATEMENT OF INCOME DATA (IFRS)                  
Net interest income    2,150,751    1,326,691    1,281,366    1,255,206    1,317,104    1,076,762 
Net fee and commission income    452,400    279,063    254,424    237,627    227,283    229,836 
Financial transactions, net (3)    210,346    129,752    140,358    145,499    112,565    124,437 
Other operating income    100,537    62,016    6,427    6,439    6,545    88,155 
Net operating profit before provision for loan losses    2,914,034    1,797,522    1,682,575    1,644,771    1,663,497    1,519,190 
Provision for loan losses    (489,998)   (302,255)   (342,083)   (399,277)   (354,903)   (371,462)
Net operating profit    2,424,036    1,495,267    1,340,492    1,245,494    1,308,594    1,147,728 
Total operating expenses    (1,262,787)   (778,950)   (756,041)   (719,958)   (683,819)   (610,191)
Operating income    1,161,249    716,317    584,451    525,536    624,775    537,537 
Income from investments in associates and other companies    6,425    3,963    3,012    2,588    2,165    1,422 
Income before tax    1,167,674    720,280    587,463    528,124    626,940    538,959 
Income tax expense    (235,116)   (145,031)   (109,031)   (76,395)   (51,050)   (94,530)
Net income for the year    932,558    575,249    478,432    451,729    575,890    444,429 
Net income for the period attributable to:                              
Equity holders of the Bank    912,379    562,801    476,067    448,466    569,910    442,294 
Non-controlling interests    20,180    12,448    2,365    3,263    5,980    2,135 
Net income attributable to Equity holders of the Bank per share    4.84    2.99    2.53    2.38    3.02    2.35 
Net income attributable to Equity holders of the Bank per ADS    2,280.87    1,406.96    1,010.51    951.92    1,208.00    938.83 
Weighted-average shares outstanding (in millions)    188,446.10    188,446.10    188,446.1    188,446.1    188,446.1    188,446.1 
Weighted-average ADS outstanding (in millions)    471.1    471.1    471.1    471.1    471.1    471.1 

  

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   As of and for the years ended December 31,
   2017  2017  2016  2015  2014  2013
   In U.S.$ thousands(1)  In Ch$ millions (2)
CONSOLIDATED STATEMENT OF FINANCIAL POSITION DATA (IFRS)                              
Cash and deposits in banks    2,355,389    1,452,922    2,279,389    2,064,806    1,608,888    1,571,810 
Cash items in process of collection    1,083,156    668,145    495,283    724,521    531,373    604,077 
Trading investments    787,446    485,736    396,987    324,271    774,815    287,567 
Investments under resale agreements    -      -      6,736    2,463    -      17,469 
Financial derivative contracts    3,629,159    2,238,647    2,500,782    3,205,926    2,727,563    1,494,018 
Interbank loans, net    262,970    162,213    268,672    9,711    11,942    124,954 
Loans and accounts receivable from customers, net    43,402,033    26,772,544    26,147,154    24,528,745    22,196,390    20,320,874 
Available-for-sale investments    4,173,699    2,574,546    3,388,906    2,044,411    1,651,598    1,700,993 
Investments in associates and other companies    44,719    27,585    23,780    20,309    17,914    9,681 
Intangible assets    102,487    63,219    58,085    51,137    40,983    66,703 
Property, plant, and equipment    393,203    242,547    257,379    240,659    211,561    180,215 
Current taxes    -      -      -      -      2,241    1,643 
Deferred taxes    601,590    371,091    359,600    320,527    272,118    227,285 
Other assets    1,239,215    764,410    847,272    1,100,174    927,961    514,938 
TOTAL ASSETS    58,075,066    35,823,605    37,030,025    34,637,660    30,975,347    27,122,227 
Deposits and other demand  liabilities    12,593,282    7,768,166    7,539,315    7,356,121    6,480,497    5,620,763 
Cash items in process of being cleared    789,051    486,726    288,473    462,157    281,259    276,379 
Obligations under repurchase agreements    434,564    268,061    212,437    143,689    392,126    208,972 
Time deposits and other time liabilities    19,314,169    11,913,945    13,151,709    12,182,767    10,413,940    9,675,272 
Financial derivative contracts    3,468,409    2,139,488    2,292,161    2,862,606    2,561,384    1,291,785 
Interbank borrowing s   2,753,274    1,698,357    1,916,368    1,307,574    1,231,601    1,682,377 
Issued debt instruments    11,499,802    7,093,653    7,326,372    5,957,095    5,785,112    5,198,658 
Other financial liabilities    392,364    242,030    240,016    220,527    205,125    189,781 
Current taxes    10,432    6,435    29,294    17,796    1,077    50,242 
Deferred taxes    15,665    9,663    7,686    3,906    7,631    26,753 
Provisions    492,499    303,798    292,210    274,998    285,970    217,310 
Other liabilities    1,208,338    745,363    795,785    1,045,869    654,557    311,479 
TOTAL LIABILITIES    52,971,849    32,675,685    34,091,826    31,835,105    28,300,279    24,749,771 
Capital    1,444,927    891,303    891,303    891,303    891,303    891,303 
Reserves    2,888,576    1,781,818    1,640,112    1,527,893    1,307,761    1,130,991 
Valuation adjustments    (3,748)   (2,312)   6,640    1,288    25,600    (5,964)
Retained earnings    705,566    435,228    370,803    351,890    417,321    327,622 
Attributable to Equity holders of the Bank    5,035,321    3,106,037    2,908,858    2,772,374    2,641,985    2,343,952 
Non-controlling interest   67,898    41,883    29,341    30,181    33,083    28,504 
TOTAL EQUITY (4)    5,103,219    3,147,920    2,938,199    2,802,555    2,675,068    2,372,456 
TOTAL LIABILITIES AND EQUITY    58,075,068    35,823,605    37,030,025    34,637,660    30,975,347    27,122,227 

 

   As of and for the years ended December 31,
   2017  2016  2015  2014  2013
CONSOLIDATED RATIOS               
(IFRS)               
Profitability and performance:               
Net interest margin (5)    4.3%   4.3%   4.4%   4.9%   4.6%
Return on average total assets (6)    1.6%   1.4%   1.3%   1.8%   1.6%
Return on average equity (7)    19.2%   16.8%   16.0%   21.4%   18.9%
Capital:                         
Average equity as a percentage of average total assets (8)    8.5%   8.1%   8.2%   8.2%   8.7%
Total liabilities as a multiple of equity (9)    10.4    11.6    11.4    10.6    10.4 
Credit Quality:                         
Non-performing loans as a percentage of total loans (10)    2.3%   2.1%   2.5%   2.8%   2.9%
Allowance for loan losses as percentage of total loans    2.9%   2.9%   3.0%   2.9%   2.9%
Operating Ratios:                         
Operating expenses /operating revenue (11)    44.3%   44.9%   43.8%   41.1%   40.2%
Operating expenses /average total assets    2.3%   2.1%   2.1%   2.1%   2.3%

 

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   As of and for the years ended December 31,
   2017  2016  2015  2014  2013
OTHER DATA                         
CPI Inflation Rate (12)    2.3%   2.7%   4.4%   4.7%   3.0%
Revaluation (devaluation) rate (Ch$/U.S.$) at year end (12)    7.8%   5.7%   (16.5%)   (16.0%)   (9.4%)
Number of employees at period end    11,068    11,354    11,723    11,478    11,516 
Number of branches and offices at period end    385    423    471    474    493 

 

 

 

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2017 have been translated from Chilean pesos at the interbank market exchange rate of Ch$616.85 = U.S.$1.00 as of December 31, 2017 based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period.

 

(2)Except per share data, percentages and ratios, share numbers, employee numbers and branch numbers.

 

(3)Net income (expense) from financial operations and net foreign exchange gain.

 

(4)Total equity includes equity attributable to Equity holders of the Bank plus non-controlling interests.

 

(5)Net interest income divided by average interest earning assets (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”).

 

(6)Net income for the year divided by average total assets (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”).

 

(7)Net income for the year divided by average equity (as presented in “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information”).

 

(8)This ratio is calculated using total average equity (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”) including non-controlling interest.

 

(9)Total liabilities divided by equity.

 

(10)Non-performing loans include the aggregate unpaid principal and accrued but unpaid interest on all loans with at least one installment over 90 days past-due.

 

(11)The efficiency ratio is equal to operating expenses over operating income. Operating expenses includes personnel salaries and expenses, administrative expenses, depreciation and amortization, impairment and other operating expenses. Operating income includes net interest income, net fee and commission income, net income from financial operations (net trading income), foreign exchange gain, net and other operating income.

 

(12)Based on information published by the Central Bank.

 

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. According to Law 18,840, the organic law of the Central Bank and 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 currently in effect, all payments, remittances or transfers of foreign currency 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 Informal Exchange Market is comprised of entities that are not expressly authorized to operate in the Formal Exchange Market, such as certain foreign exchange houses and travel agencies, among others. The Central Bank is empowered to require that certain purchases and sales of foreign currencies be carried out on the Formal Exchange Market. 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.

 

Both the Formal and Informal Exchange Markets are driven by free market forces. Current regulations require that the Central Bank be informed of certain transactions and that they be effected through the Formal Exchange Market. In order to keep the average exchange rate within certain limits, the Central Bank may intervene by buying or selling foreign currency on the Formal Exchange Market.

 

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The U.S.$ Observed Exchange Rate (dólar observado), which is reported by the Central Bank and published daily in the Chilean newspapers, is the weighted average exchange rate of the previous business day’s transactions in the Formal Exchange Market. The Central Bank has the power to intervene by buying or selling foreign currency on the Formal Exchange Market to attempt to maintain the Observed Exchange Rate within a desired range. Even though the Central Bank is authorized to carry out its transactions at the Observed Exchange Rate, it generally uses spot rates for its transactions. Other banks generally carry out authorized transactions at spot rates as well.

 

Purchases and sales of foreign currencies may be legally carried out in the Informal Exchange Market. The Informal Exchange Market reflects transactions carried out at informal exchange rates by entities not expressly authorized to operate in the Formal Exchange Market. 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. In recent years, the variation between the Observed Exchange Rate and the Informal Exchange Rate has not been significant. On December 31, 2016 and 2017 the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm on these days was Ch$666.00 and Ch$616.85 respectively, or 0.19% less and 0.26% more, respectively, than the Central Bank’s published observed exchange rate for such date of Ch$667.29 and Ch$615.22, respectively, 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 U.S. dollar amounts referred to herein actually represent, could have been or could be converted into U.S. dollars or Chilean pesos, as the case may be, at the rates indicated, at any particular rate or at all. The Federal Reserve Bank of New York does not report a noon buying rate for pesos.

 

   Daily Observed Exchange Rate Ch$ Per U.S.$(1)
Year  Low(2)  High(2)  Average(3)  Period End
             
2013    466.50    533.95    495.09    523.76 
2014    524.61    621.41    570.01    607.38 
2015    597.10    715.66    654.25    707.34 
2016    645.22    730.31    676.83    667.29 
2017    615.22    679.05    649.33    615.22 

 

 

   Daily Observed Exchange Rate Ch$ Per U.S.$(1)
Month  Low(2)  High(2)  Average(3)  Period End
October 2017    651.65    670.88    663.92    651.65 
November 2017    650.72    679.24    666.12    675.48 
December 2017    649.40    677.11    667.17    667.29 
January 2018    599.33    614.75    605.53    604.42 
February 2018    588.28    603.25    597.01    589.15 
March 2018 (through March 22, 2017)    593.61    609.58    602.47    607.23 

 

 

 

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 generated. For example, the 2017 dividend must be proposed and approved during the first four months of 2018. 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

 

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are paid to shareholders of record on the fifth day preceding the date set for payment of the dividend. The applicable record dates for the payment of dividends to holders of ADSs will, to the extent practicable, be the same.

 

Under the General Banking Law, 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, as long as the dividend does not result in the infringement of minimum capital requirements. 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 Bank of New York Mellon, as depositary (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 “Item 10. Additional Information—E. Taxation—Material Tax Consequences of Owning Shares of Our Common Stock or ADSs”).

 

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 and eliminated 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. See “Item 10. Additional Information—D. Exchange Controls.”

 

The following table presents dividends declared and paid by us in nominal terms in the past four years:

 

Year  Dividend
Ch$ millions (1)
  Dividend
U.S.$ millions (2)
  Per share Ch$/share (3)  Per ADS U.S.$/ADS (4)  % over earnings (5)  % over earnings (6)
2014    265,156    476.0    1.41    1.01    60    60 
2015    330,198    540.4    1.75    1.15    60    58 
2016    336,659    503.7    1.79    1.07    75    75 
2017    330,646    496.5    1.75    1.05    70    69 

 

 

 

(1)Millions of nominal pesos.

 

(2)Millions of U.S.$ using the observed exchange rate of the day the dividend was approved at the annual shareholders’ meeting.

 

(3)Calculated on the basis of 188,446 million shares.

 

(4)Dividend in U.S.$ million divided by the number of ADS, which was calculated on the basis of 400 shares per ADS.

 

(5)Calculated by dividing dividend paid in the year by net income attributable to the equity holders of the Bank for the previous year under Chilean Bank GAAP. This is the payment ratio determined by shareholders.

 

(6)Calculated by dividing dividend paid in the year by net income attributable to the equity holders of the Bank for the previous year under IFRS.

 

B. Capitalization and Indebtedness

 

Not applicable.

 

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C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

D. Risk Factors

 

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

 

We are subject to market risks that are presented both in this subsection and in “Item 5. Operating and Financial Review and Prospects” and “Item 11. Quantitative and Qualitative Disclosures about Market Risk.”

 

Risks Associated with Our Business

 

We are vulnerable to disruptions and volatility in the global financial markets.

 

Global economic conditions deteriorated significantly between 2007 and 2009, and many countries fell into recession. Many major financial institutions, including some of the world’s largest global commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies experienced, and some continue to experience, significant difficulties. Around the world, there were runs on deposits at several financial institutions, numerous institutions sought additional capital or were assisted by governments, and many lenders and institutional investors reduced or ceased providing funding to borrowers (including to other financial institutions).

 

In particular, we face, among others, the following risks related to the economic downturn:

 

·Reduced demand for our products and services.

 

·Increased regulation of our industry. Compliance with such regulation will continue to increase our costs and may affect the pricing for our products and services, increase our conduct and regulatory risks to non-compliance and limit our ability to pursue business opportunities.

 

·Inability of our borrowers to timely or fully comply with their existing obligations. Macroeconomic shocks may negatively impact the household income of our retail customers and may adversely affect the recoverability of our retail loans, resulting in increased loan losses.

 

·The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the sufficiency of our loan loss allowances.

 

·The value and liquidity of the portfolio of investment securities that we hold may be adversely affected.

 

·Any worsening of global economic conditions may delay the recovery of the international financial industry and impact our financial condition and results of operations.

 

An economic slowdown or recession would have a negative impact on our business and results of operations. A return to volatile conditions in the global financial markets could have a material adverse effect on us, including on our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers and become unable to maintain certain liability maturities. Any such increase in capital markets funding availability or costs or in deposit rates could have a material adverse effect on our interest margins and liquidity.

 

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Additionally, the results of the 2016 United States presidential and congressional elections generated volatility in the global capital and currency markets and created uncertainty about the relationship between the United States and its major trade partners. The uncertainty persists in relation to the United States trade policy, in particular the renegotiation of the North American Free Trade Agreement and a further protectionist shift.

 

If all or some of the foregoing risks were to materialize, this could have a material adverse effect on our financing availability and terms and, more generally, on our results, financial condition and prospects.

 

Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. Any downgrade in Chile’s, our controlling shareholders or our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative contracts and adversely affect our interest margins and results of operations.

 

Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings of our debt are based on a number of factors, including our financial strength and conditions affecting the financial services industry generally. In addition, due to the methodology of the main rating agencies, our credit rating is affected by the rating of Chile’s sovereign debt. If Chile’s sovereign debt is downgraded, our credit rating would also likely be downgraded by an equivalent amount.

 

In August 2017, Fitch downgraded our main ratings from A+ to A following a similar action on the sovereign rating of the Republic of Chile. Standard and Poor’s Ratings Services (“S&P”) placed the Bank’s ratings on Outlook Negative in August 2017 and re-affirmed this rating and outlook in November 2017. Currently Moody’s has a negative outlook on the Republic of Chile’s sovereign rating and on our rating as well.

 

In addition, our ratings may be adversely affected by any downgrade in the ratings of our parent company, Santander Spain. The long-term debt of Santander Spain is currently rated investment grade by the major rating agencies: A3 (stable) by Moody’s, A- (positive) by S&P and A- (stable) by Fitch Ratings Ltd. (“Fitch”).

 

Any downgrade in our debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivative contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a ratings downgrade could adversely affect our ability to sell or market certain of our products, engage in certain longer-term and derivatives transactions and retain our customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivative contracts and other financial commitments we may be required to maintain a minimum credit rating or terminate such contracts or post collateral. Any of these results of a ratings downgrade could reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.

 

While certain potential impacts of these downgrades are contractual and quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of our long-term credit rating precipitates downgrades to our short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than the preceding hypothetical examples, depending upon certain factors including which credit rating agency downgrades our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity. Although unsecured and secured funding stresses are included in our stress testing scenarios and a portion of our total liquid assets is held against these risks, a credit rating downgrade could still have a material adverse effect on us.

 

In addition, if we were required to cancel our derivatives contracts with certain counterparties and were unable to replace such contracts, our market risk profile could be altered.

 

There can be no assurance that the rating agencies will maintain the current ratings or outlooks. Failure to maintain favorable ratings and outlooks could increase our cost of funding and adversely affect interest margins, which could have a material adverse effect on us.

 

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Increased competition, including from non-traditional providers of banking services such as financial technology providers, and industry consolidation may adversely affect our results of operations.

 

The Chilean market for financial services is highly competitive. We compete with other private sector Chilean and non-Chilean banks, with Banco del Estado de Chile, the principal government-owned sector bank, with department stores and with larger supermarket chains that make consumer loans and sell other financial products to a large portion of the Chilean population. The lower to middle-income segments of the Chilean population and the small- and mid- sized corporate segments have become the target markets of several banks and competition in these segments may increase. In addition, there has been a trend towards consolidation in the Chilean banking industry in recent years, which has created larger and stronger banks with which we must now compete. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank (such as department stores, insurance companies, cajas de compensación and cooperativas) and non-finance competitors (principally department stores and larger supermarket chains) 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.

 

Non-traditional providers of banking services, such as internet based e-commerce providers, mobile telephone companies and internet search engines may offer and/or increase their offerings of financial products and services directly to customers. These non-traditional providers of banking services currently have an advantage over traditional providers because they are not subject to banking regulation. Several of these competitors may have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may adopt more aggressive pricing and rates and devote more resources to technology, infrastructure and marketing. New competitors may enter the market or existing competitors may adjust their services with unique product or service offerings or approaches to providing banking services. If we are unable to successfully compete with current and new competitors, or if we are unable to anticipate and adapt our offerings to changing banking industry trends, including technological changes, our business may be adversely affected. In addition, our failure to effectively anticipate or adapt to emerging technologies or changes in customer behavior, including among younger customers, could delay or prevent our access to new digital-based markets, which would in turn have an adverse effect on our competitive position and business.

 

The rise in customer use of internet and mobile banking platforms in recent years could negatively impact our investments in bank premises, equipment and personnel for our branch network. The persistence or acceleration of this shift in demand towards internet and mobile banking may necessitate changes to our retail distribution strategy, which may include closing and/or selling certain branches and restructuring our remaining branches and work force. These actions could lead to losses on these assets and may lead to increased expenditures to renovate, reconfigure or close a number of our remaining branches or to otherwise reform our retail distribution channel. Furthermore, our failure to swiftly and effectively implement such changes to our distribution strategy could have an adverse effect our competitive position.

 

Increasing competition could also require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us, including our profitability. It may also negatively affect our business results and prospects by, among other things, limiting our ability to increase our customer base and expand our operations and increasing competition for investment opportunities.

 

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If our customer service levels were perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

 

Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties, and we may not be able to manage various risks we face as we expand our range of products and services that could have a material adverse effect on us.

 

The success of our operations and our profitability depends, in part, on the success of new products and services we offer our clients and our ability to continue offering products and services from third parties. However, we cannot guarantee that our new products and services will be responsive to client demands, or that they will be successful. In addition, our clients’ needs or desires may change over time, and such changes may render our products and services obsolete, outdated or unattractive and we may not be able to develop new products that meet our clients’ changing needs. Our success is also dependent on our ability to anticipate and leverage new and existing technologies that may have an impact on products and services in the banking industry. Technological changes may further intensify and complicate the competitive landscape and influence client behavior. If we cannot respond in a timely fashion to the changing needs of our clients, we may lose clients, which could in turn materially and adversely affect us.

 

As we expand the range of our products and services, some of which may be at an early stage of development in the markets of certain regions where we operate, we will be exposed to new and potentially increasingly complex risks and development expenses in those markets, with respect to which our experience and the experience of our partners may not be sufficient. Our employees and our risk management systems may not be sufficient to enable us to properly manage such risks. In addition, the cost of developing products that are not launched is likely to affect our results of operations. Any or all of these factors, individually or collectively, could have a material adverse effect on us.

 

Our strong position in the credit card market is in part due to our credit card co-branding agreement with Chile’s largest airline. This agreement expires in August 2020 and no assurance can be given that it will be renewed, which may materially and adversely affect our results of operations and financial condition in the credit card business.

 

While we have successfully increased our customer service levels in recent years, should these levels ever be perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

 

The financial problems faced by our customers could adversely affect us.

 

Market turmoil and economic recession could materially and adversely affect the liquidity, credit ratings, businesses and/or financial conditions of our borrowers, which could in turn increase our non-performing loan ratios, impair our loan and other financial assets and result in decreased demand for borrowings in general. In addition, our customers may further significantly decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds, which would adversely affect our fee and commission income. We may also be adversely affected by the negative effects of the heightened regulatory environment on our customers due to the high costs associated with regulatory compliance and proceedings. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

 

We may generate lower revenues from fee and commission based businesses.

 

The fees and commissions that we earn from the different banking and other financial services that we provide represent a significant source of our revenues. Our customers may significantly decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds for a number of reasons, including a market downturn, which would adversely affect us, including our fee and commission income.

 

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Banco Santander Chile sold its asset management business in 2013 and signed a management service agreement for a 10 year-period with the acquirer of this business in which we sell asset management funds on their behalf. Therefore, even in the absence of a market downturn, below-market performance by the mutual funds of the firm we broker for may result in a reduction in revenue we receive from selling asset management funds and adversely affect our results of operations.

 

Market conditions have resulted, and could result, in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.

 

In the recent past, financial markets have been subject to significant stress resulting in steep falls in perceived or actual financial asset values, particularly due to volatility in global financial markets and the resulting widening of credit spreads. We have material exposures to securities, loans and other investments that are recorded at fair value and are therefore exposed to potential negative fair value adjustments. Asset valuations in future periods, reflecting then-prevailing market conditions, may result in negative changes in the fair values of our financial assets and these may also translate into increased impairments. In addition, the value ultimately realized by us on disposal may be lower than the current fair value. Any of these factors could require us to record negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition or prospects.

 

In addition, to the extent that fair values are determined using financial valuation models, such values may be inaccurate or subject to change, as the data used by such models may not be available or may become unavailable due to changes in market conditions, particularly for illiquid assets, and particularly in times of economic instability. In such circumstances, our valuation methodologies require us to make assumptions, judgments and estimates in order to establish fair value, and reliable assumptions are difficult to make and are inherently uncertain and valuation models are complex, making them inherently imperfect predictors of actual results. Any consequential impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.

 

The credit quality of our loan portfolio may deteriorate and our loan loss reserves could be insufficient to cover our actual loan losses, which could have a material adverse effect on us.

 

Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent in a wide range of our businesses. Non-performing or low credit quality loans have in the past negatively impacted our results of operations and could do so in the future. In particular, the amount of our reported non-performing loans may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios that we may acquire in the future (the credit quality of which may turn out to be worse than we had anticipated), or factors beyond our control, such as adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in economic conditions in Chile or in global economic and political conditions. If we were unable to control the level of our non-performing or poor credit quality loans, this could have a material adverse effect on us.

 

As of December 31, 2017, our non-performing loans were Ch$633,461 million, and the ratio of our non-performing loans to total loans was 2.3%. As of December 31, 2017, our allowance for loan losses was Ch$791,157 million, and the ratio of our allowance for loan losses to total loans was 2.9%. For additional information on our asset quality, see “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information–Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

Our allowance for loan losses is based on our current assessment of and expectations concerning various factors affecting us, including the quality of our loan portfolio. These factors include, among other things, our borrowers’ financial condition, repayment abilities and repayment intentions, the realizable value of any collateral, the prospects for support from any guarantor, Chile’s economy, government macroeconomic policies, interest rates and the legal and regulatory environment. As the 2008 financial crisis has demonstrated, many of these factors are beyond our control. In addition, as these factors evolve, the models we use to determine the appropriate level of allowance for loan losses and other assets require recalibration, which can lead to increased provision expense. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results–Results of Operations for the Years ended December 31, 2017, 2016 and 2015—Provision for loan losses, net of recoveries.”

 

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As a result, there is no precise method for predicting loan and credit losses, and we cannot assure you that our allowance for loan losses will be sufficient in the future to cover actual loan and credit losses. If our assessment of and expectations concerning the above-mentioned factors differ from actual developments, if the quality of our total loan portfolio deteriorates, for any reason, including the increase in lending to individuals and small and medium enterprises, the volume increase in the consumer loan portfolio and the introduction of new products, or if the future actual losses exceed our estimates of incurred losses, we may be required to increase our provisions and allowance for loan losses, which may adversely affect us. If we are unable to control or reduce the level of our non-performing or poor credit quality loans, this could have a material adverse effect on us.

 

The value of the collateral securing our loans may not be sufficient, and we may be unable to realize the full value of the collateral securing our loan portfolio.

 

The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including macroeconomic factors affecting Chile’s economy. The value of the collateral securing our loan portfolio may be adversely affected by force majeure events, such as natural disasters, particularly in locations where a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage, which could impair the asset quality of our loan portfolio and could have an adverse impact on Chile’s economy. The real estate market is particularly vulnerable in the current economic climate and this may affect us, as real estate represents a significant portion of the collateral securing our residential mortgage loan portfolio. We may also not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If any of the above were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.

 

The growth of our loan portfolio may expose us to increased loan losses. Our exposure to individuals and small and mid-sized businesses could lead to higher levels of past due loans, allowances for loan losses and charge-offs.

 

The further expansion of our 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. See “Note 8—Interbank Loans” and “Note 9—Loans and Accounts Receivables from Customers” in our Audited Consolidated Financial Statements for a description and presentation of our loan portfolio as well as “Item 5-Selected Statistical Information—Loan Portfolio.”

 

Retail customers represent 69.4% of the value of the total loan portfolio as of December 31, 2017. As part of our business strategy, we seek to increase lending and other services to retail clients, which are more likely to be adversely affected by downturns in the Chilean economy. In addition, as of December 31, 2017, our residential mortgage loan portfolio totaled Ch$9,096,895 million, representing 32.8% of our total loans. See “Note 9—Loans and Accounts Receivables from Customers” in our Audited Consolidated Financial Statements for a description and presentation of our residential mortgage loan portfolio. If the economy and real estate market in Chile experience a significant downturn, this could materially adversely affect the liquidity, businesses and financial conditions of our customers, which may in turn cause us to experience higher levels of past-due loans, thereby resulting in higher provisions for loan losses and subsequent charge-offs. This may materially and adversely affect our asset quality, results of operations and financial condition.

 

The growth rate of our loan portfolio may be affected by economic turmoil, which could also lead to a contraction in our loan portfolio.

 

There can be no assurance that our loan portfolio will continue to grow at similar rates to the historical growth rate described above. A reversal of the rate of growth of the Chilean economy, a slowdown in the growth of customer demand, an increase in market competition or changes in governmental regulations could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required allowances for loan losses. An economic turmoil could materially adversely affect the liquidity, businesses and financial condition of our customers as well as lead to a general decline in consumer spending and a rise in unemployment. All this could in turn lead to decreased demand for borrowings in general.

 

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Our financial results are constantly exposed to market risk. We are subject to fluctuations in interest rates and other market risks, which may materially and adversely affect us and our profitability.

 

Market risk refers to the probability of variations in our net interest income or in the market value of our assets and liabilities due to volatility of interest rate, inflation, exchange rate or equity price. Changes in interest rates affect the following areas, among others, of our business:

 

·net interest income;

 

·the volume of loans originated;

 

·credit spreads;

 

·the market value of our securities holdings;

 

·the value of our loans and deposits; and

 

·the value of our derivatives transactions.

 

Interest rates are sensitive to many factors beyond our control, including increased regulation of the financial sector, the reserve policies of the Central Bank, deregulation of the financial sector in Chile, monetary policies and domestic and international economic and political conditions. Variations in interest rates could affect the interest earned on our assets and interest paid on our borrowings, thereby affecting our net interest income, which comprises the majority of our revenue, reducing our growth rate and potentially resulting in losses. Interest rate variations could adversely affect us, including our net interest income, reducing our growth rate or even resulting in losses. When interest rates rise, we may be required to pay higher interest on our floating-rate borrowings while interest earned on our predominately fixed-rate assets may not rise as quickly, which could cause profits to grow at a reduced rate or decline in some parts of our portfolio.

 

Increases in interest rates may reduce the volume of loans we originate. Sustained high interest rates have historically discouraged customers from borrowing and have resulted in increased delinquencies in outstanding loans and deterioration in the quality of assets. Increases in interest rates may reduce the value of our financial assets and may reduce gains or require us to record losses on sales of our loans or securities.

 

If interest rates decrease, although this is likely to decrease our funding costs, it is likely to adversely impact the income we receive from our investments in securities as well as loans with similar maturities. In addition, we may also experience increased delinquencies in a low interest rate environment when such an environment is accompanied by high unemployment and recessionary conditions.

 

The market value of a security with a fixed interest rate generally decreases when the prevailing interest rates rise, which may have an adverse effect on our earnings and financial condition. In addition, we may incur costs as we implement strategies to reduce interest rate exposure in the future (which, in turn, will impact our results). The market value of an obligation with a floating interest rate can be adversely affected when interest rates increase, due to a lag in the implementation of repricing terms or an inability to refinance at lower rates.

 

We are also exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities denominated in different currencies. Fluctuations in the exchange rate between currencies may negatively affect our earnings and value of our assets and securities. Therefore, while the Bank seeks to avoid significant mismatches between assets and liabilities due to foreign currency exposure, from time to time, we may have mismatches. “See Item 11. Quantitative and Qualitative Disclosure About Market Risks— E. Market Risks—Foreign exchange fluctuations.”

 

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Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.

 

The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate.

 

Some of our qualitative tools and metrics for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. We could face adverse consequences as a result of decisions, which may lead to actions by management, based on models that are poorly developed, implemented or used, or as a result of the modelled outcome being misunderstood or the use of such information for purposes for which it was not designed. In addition, if existing or potential customers or counterparties believe our risk management is inadequate, they could take their business elsewhere or seek to limit their transactions with us. This could have a material adverse effect on our reputation, operating results, financial condition and prospects.

 

As a commercial bank, one of the main types of risks inherent in our business is credit risk. For example, an important feature of our credit risk management system is to employ an internal credit rating system to assess the particular risk profile of a customer. As this process involves detailed analyses of the customer, taking into account both quantitative and qualitative factors, it is subject to human or IT systems errors. In exercising their judgment on current or future credit risk behavior of our customers, our employees may not always be able to assign an accurate credit rating, which may result in our exposure to higher credit risks than indicated by our risk rating system.

 

Failure to effectively implement, consistently monitor or continuously refine our credit risk management system may result in an increase in the level of non-performing loans and a higher risk exposure for us, which could have a material adverse effect on us.

 

The effectiveness of our credit risk management is affected by the quality and scope of information available in Chile.

 

In assessing customers’ creditworthiness, we rely largely on the credit information available from our own internal databases, the SBIF, Directorio de Información Comercial (Dicom) en Capital, a Chilean nationwide credit bureau, and other sources. Due to limitations in the availability of information and the developing information infrastructure in Chile, our assessment of credit risk associated with a particular customer may not be based on complete, accurate or reliable information. In addition, although we have been improving our credit scoring systems to better assess borrowers’ credit risk profiles, we cannot assure you that our credit scoring systems will collect complete or accurate information reflecting the actual behavior of customers or that their credit risk can be assessed correctly. Without complete, accurate and reliable information, we will have to rely on other publicly available resources and our internal resources, which may not be effective. As a result, our ability to effectively manage our credit risk and subsequently our loan loss allowances may be materially adversely affected.

 

Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.

 

Liquidity risk is the risk that we either do not have available sufficient financial resources to meet our obligations as they fall due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation. While we implement liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors make it difficult to eliminate completely these risks. Continued constraints in the supply of liquidity, including in inter-bank lending, has affected and may materially and adversely affect the cost of

 

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funding our business, and extreme liquidity constraints may affect our current operations and our ability to fulfill regulatory liquidity requirements as well as limit growth possibilities.

 

Increases in prevailing market interest rates and in our credit spreads can significantly increase the cost of our funding. Changes in our credit spreads may be influenced by market perceptions of our creditworthiness. Changes to interest rates and our credit spreads occur continuously and may be unpredictable and highly volatile.

 

We rely, and will continue to rely, primarily on commercial deposits to fund lending activities. The ongoing availability of this type of funding is sensitive to a variety of factors outside our control, such as general economic conditions and the confidence of commercial depositors in the economy and in the financial services industry, and the availability and extent of deposit guarantees, as well as competition between banks or with other products, such as mutual funds, for deposits. Any of these factors could significantly increase the amount of commercial deposit withdrawals in a short period of time, thereby reducing our ability to access commercial deposit funding on appropriate terms, or at all, in the future. If these circumstances were to arise, this could have a material adverse effect on our operating results, financial condition and prospects.

 

We anticipate that our customers will continue, in the near future, to make short-term deposits (particularly demand deposits and short-term time deposits), and we intend to maintain our emphasis on the use of banking deposits as a source of funds. As of December 31, 2017, 99.1% of our customer deposits had remaining maturities of one year or less, or were payable on demand. A significant portion of our assets have longer maturities, resulting in a mismatch between the maturities of liabilities and the maturities of assets. Historically, one of our principal sources of funds has been time deposits. Time deposits represented 33.3% and 35.5% of our total liabilities and equity as of December 31, 2017 and 2016, respectively. The Chilean time deposit market is concentrated given the importance in size of various large institutional investors such as pension funds and corporations relative to the total size of the economy. As of December 31, 2017, the Bank’s top 20 time deposits represented 29.7% of total time deposits, or 9.9% of total liabilities and equity, and totaled U.S.$5.7 billion. No assurance can be given that future economic stability in the Chilean market will not negatively affect our ability to continue funding our business or to maintain our current levels of funding without incurring increased funding costs, a reduction in the term of funding instruments or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.

 

The short-term nature of this funding source could cause liquidity problems for us in the future if deposits are not made in the volumes we expect or are not renewed. If a substantial number of our depositors withdraw their demand deposits or do not roll over their time deposits upon maturity, we may be materially and adversely affected.

 

Central banks have taken extraordinary measures to increase liquidity in the financial markets as a response to the financial crisis. If current facilities were rapidly removed or significantly reduced, this could have an adverse effect on our ability to access liquidity and on our funding costs.

 

We cannot assure that in the event of a sudden or unexpected shortage of funds in the banking system, we will be able to maintain levels of funding without incurring high funding costs, a reduction in the term of funding instruments or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.

 

We are subject to regulatory capital and liquidity requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

Chilean banks are required by the General Banking Law to maintain regulatory capital of at least 8% of risk-weighted assets, net of required loan loss allowance and deductions, and paid-in capital and reserves (“core capital”) of at least 3% of total assets, net of required loan loss allowances. As we are the result of the merger between two predecessors with a relevant market share in the Chilean market, we are currently required to maintain a minimum regulatory capital to risk-weighted assets ratio of 11%. As of December 31, 2017, the ratio of regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, was 13.9% and the core capital ratio was 11.0%. Certain developments could affect our ability to continue to satisfy the current capital adequacy requirements applicable to us, including:

 

·the increase of risk-weighted assets as a result of the expansion of our business or regulatory changes;

 

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·the failure to increase our capital correspondingly;

 

·losses resulting from a deterioration in our asset quality;

 

·declines in the value of our investment instrument portfolio;

 

·changes in accounting standards;

 

·changes in provisioning guidelines that are charged directly against our equity or net income; and

 

·changes in the guidelines regarding the calculation of the capital adequacy ratios of banks in Chile.

 

In June 2017 a proposed bill that changes the General Banking Law in Chile was sent to the Chilean Congress for discussion. The bill proposes the creation of a new regulatory body for the financial system as well as new capital regulation for banks in Chile in line with Basel III standards. The bill proposes to adopt the guidelines set forth under the Basel III Capital Accord with adjustments incorporated by the SBIF. These changes should be approved by the Chilean Congress in 2018 or 2019. Following this approval, Chilean banks will most likely have to fully comply with Basel III requirements by 2024.

 

In 2017, Law 21,000 created the Comisión para el Mercado Financiero or Financial Market Commission (FMC). The FMC would become the sole supervisor for the Chilean financial system overseeing insurance companies, companies with publicly traded securities, credit unions, credit card and prepaid card issuers, and eventually banks. It will be the responsibility of this commission to ensure the proper functioning, development and stability of the financial market, facilitating the participation of market agents and defending public faith in the financial markets. To do so, it must maintain a general and systemic vision of the market, considering the interests of investors and policyholders. It shall also be responsible for ensuring that the persons or entities audited, from their initiation until the end of their liquidation, comply with the laws, regulations, statutes and other provisions that govern them.

 

The Commission will be in charge of a Council, which will be composed of five members, who are appointed and are subject to the following rules:

 

·A Commissioner appointed by the President of the Republic, of recognized professional or academic prestige in matters related to the financial system, which will have the character of President of the Commission.

 

·Four commissioners appointed by the President of the Republic, from among persons of recognized professional or academic prestige in matters related to the financial system, by supreme decree issued through the Ministry of Finance, after ratification of the Senate by the four sevenths of its members in exercise, in session specially convened for that purpose.  

 

The Council’s responsibilities include regulation, sanctioning and the definition of general supervision policies. In addition, there will be a prosecutor in charge of investigations and the Chairman will be responsible for supervision. The FMC will act in coordination with the Chilean Central Bank (BCCh).

 

The date of entry into operation of the Commission for the Financial Market was December 14, 2017. The Superintendency of Securities and Insurance was eliminated on January 15, 2018 and all functions of this Superintendency were absorbed by the FMC. Once the new General Banking Law is passed the SBIF will also be absorbed by the FMC. All current SBIF attributions would be transferred to the FMC.

 

According to the New Banking Law being discussed in congress minimum capital requirements would increase in terms of amount and quality. Total Regulatory Capital remains at 8% of risk-weighted assets which would include credit, market and operational risk. Minimum Tier 1 capital increases from 4.5% to 6% of risk-weighted assets, of which up to 1.5% may be Additional Tier 1 (AT1) either in the form of preferred shares or perpetual bonds, both of which may be convertible to common equity. The FMC will establish the conditions and requirements for the issuance of perpetual bonds and preferred equity. Tier 2 capital will be set at 2% of risk-weighted assets. Additional capital demands are incorporated through a Conservation Buffer of 2.5% of risk-weighted assets, setting a Total Equity Requirement of 10.5% of risk-weighted assets. As well, the BCCh may set an additional Counter Cyclical

 

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Buffer of up to 2.5% of risk-weighted assets with agreement from the FMC. Both buffers must be comprised of core capital. The FMC, with agreement from the BCCh, may impose additional capital requirements for Systemically Important Banks (SIB) of between 1-3.5% of risk-weighted assets. The FMC will have to establish the criteria to assess which banks are considered as SIBs. It is probable that we would be classified as a SIB. The following table sets forth a comparison between the current regulatory capital demands, and those proposed by the SBIF.

 

Capital requirements: Basel III, current GBL and new proposed requirements
Capital categories   Current Law   Proposed Bill
(% over risk weighted assets)
(1) Total Tier 1 Capital (2+3)   4.5   6
(2) Basic Capital   4.5   4.5
(3) Additional Tier 1 Capital (AT1)     1.5
(4) Tier 2 Capital   3.5   2
(5) Total Regulatory Capital (1+4)   8   8
(6) Conservation Buffer   2% over regulatory capital in order to be classified in Category A solvency.   2.5
(7) Total Equity Requirement (5+6)   8   10.5
(8) Counter Cyclical Buffer     up to 2.5
(9) SIB* Requirement   Up to 6% in case of a merger   Between 1 - 3.5

 

* Systemically Important Banks

 

According to initial estimates of the impact of market risk on regulatory capital, published by the SBIF for informational purposes only, our ratio of regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, including an initial estimate of the adjustments for market risk was 12.3% as of December 31, 2017. No assurance can be given that the adoption of the Basel III capital requirements will not have a material impact on our capitalization ratio.

 

The proposed bill also incorporates Pillar II capital requirements with the objective of assuring an adequate management of risk. The FMC will have the power to impose additional regulatory capital demands of up to 4% of risk-weighted assets, either Tier I or Tier II, if it determines that the previous capital levels and buffers are not enough for a financial institution. The FMC will be responsible for establishing weightings for risk-weighted assets as a separate regulation based on the implementation of standard models, subject to agreement from the BCCh. The FMC will have until December 31 of the next year in which the bill is passed to establish the weightings. Nevertheless, banks will be allowed to use internal models to define risk-weighted assets, subject to approval from the FMC with agreement from the BCCh, in which case calculated requirements will have to be within the limits set by the FMC.

  

We may also be required to raise additional capital in the future in order to maintain our capital adequacy ratios above the minimum required levels. Our ability to raise additional capital may be limited by numerous factors, including: our future financial condition, results of operations and cash flows; any necessary government regulatory approvals; our credit ratings; general market conditions for capital raising activities by commercial banks and other financial institutions; and domestic and international economic, political and other conditions. If we require additional capital in the future, we cannot assure you that we will be able to obtain such capital on favorable terms, in a timely manner or at all. Furthermore, the SBIF may increase the minimum capital adequacy requirements applicable to us. Accordingly, although we currently meet the applicable capital adequacy requirements, we may face difficulties in meeting these requirements in the future. If we fail to meet the capital adequacy requirements, we

 

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may be required to take corrective actions. These measures could materially and adversely affect our business reputation, financial condition and results of operations. In addition, if we are unable to raise sufficient capital in a timely manner, the growth of our loan portfolio and other risk-weighted assets may be restricted, and we may face significant challenges in implementing our business strategy. As a result, our prospects, results of operations and financial condition could be materially and adversely affected.

 

The SBIF and the Central Bank published new liquidity standards in 2015 and ratios that must be implemented and calculated by all banks. These will eventually replace the current regulatory limits imposed by the SBIF and the Central Bank described above. These new liquidity standards are in line with those established in Basel III. The most important liquidity ratios that will eventually be adopted by Chilean banks are:

 

·Liability concentration per institutional and wholesale counterparty. Banks will have to calculate the percentage of their liabilities coming from institutional and wholesale counterparties, including ratios regarding renovation, renewals, restructurings, maturity and product concentration of these counterparties.

 

·Liquidity coverage ratio (LCR), which measures the percentage of liquid Assets over net cash outflows. The new guidelines also define liquid assets and the formulas for calculating net cash outflows.

 

·Net Stable Funding Ratio (NSFR) which will measure a bank’s available stable funding relative to its required stable funding. Both concepts are also defined in the new regulations.

 

Beginning on March 30, 2016, banks began reporting these ratios to the Central Bank and the SBIF. The evolution of these indicators is still being monitored and adjustments to the required ratios could be made. The final limits and results should begin to be published by the end of 2018 or 2019. The initial limits banks must meet in order to comply with these new ratios have not been published yet. For this reason, we cannot yet determine the effect that the implementation of these models will have on our business. Such effect could be material and adverse if it materially increases the liquidity we are required to maintain.

 

We are subject to regulatory risk, or the risk of not being able to meet all of the applicable regulatory requirements and guidelines.

 

As a financial institution, we are subject to extensive regulation, inspections, examinations, inquiries, audits and other regulatory requirements by Chilean regulatory authorities, which materially affect our businesses. We cannot assure you that we will be able to meet all of the applicable regulatory requirements and guidelines, or that we will not be subject to sanctions, fines, restrictions on our business or other penalties in the future as a result of noncompliance. If sanctions, fines, restrictions on our business or other penalties are imposed on us for failure to comply with applicable requirements, guidelines or regulations, our business, financial condition, results of operations and our reputation and ability to engage in business may be materially and adversely affected.

 

Changes in regulations may also cause us to face increased compliance costs and limitations on our ability to pursue certain business opportunities and provide certain products and services. As some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate, it may face higher compliance costs. No assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have a material adverse effect on our business and results of operations.

 

Modifications to reserve requirements may affect our business.

 

Deposits are subject to a reserve requirement of 9.0% for demand deposits and 3.6% for time deposits (with terms of less than one year). 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 these deposits 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 regulatory capital, a bank must maintain a 100% reserve against them: demand deposits, deposits in checking accounts, obligations payable on sight incurred in the ordinary course of business and, in general, all deposits unconditionally payable immediately. If the Central Bank were to increase reserve requirements, this could lead to lower loan growth and have a negative effect on our business.

 

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Our business could be affected if its capital is not managed effectively or if changes limiting our ability to manage our capital position are adopted.

 

Effective management of our capital position is important to our ability to operate our business, to continue to grow organically and to pursue our business strategy. However, in response to the global financial crisis, a number of changes to the regulatory capital framework have been adopted or continue to be considered. As these and other changes are implemented or future changes are considered or adopted that limit our ability to manage our balance sheet and capital resources effectively or to access funding on commercially acceptable terms, we may experience a material adverse effect on our financial condition and regulatory capital position.

 

Changes to the pension fund system may affect the funding mix of the Bank

 

The current pension fund system dates from the 1980s when pension saving went from being state-funded to private funds which require Chilean employees to set aside 10% of their wages. While the system is widely regarded as a success, the demographics of the Chilean society have changed and there have been some modifications to the system. As of December 31, 2017, the Chilean pension fund management companies (Administradora de Fondos de Pensión, or “AFPs”) had US$7,521 million invested in the Bank via equity, deposits and fixed income. There is no assurance that in the future there will not be significant reforms that may affect our funding mix which may have an adverse effect on our financial condition and results of operations.

 

The legal restrictions on the exposure of Chilean pension funds to different asset classes may affect our access to funding.

 

Chilean regulations impose a series of restrictions on how Chilean pension fund management companies (Administradora de Fondos de Pensión, or “AFPs”) may allocate their assets. In the particular case of financial issuers’ there are three restrictions, each involving different assets and different limits determined by the amount of assets in each fund and the market and book value of the issuer’s equity. As a consequence, limits vary within funds of AFPs and issuers. According to our estimates in December 2017, the AFPs still had the possibility of being able to invest another US$11,425 million in the Bank via equity, deposits and fixed income. If the exposure of any AFP to Santander-Chile exceeds the regulatory limits, we would need to seek alternative sources of funding, which could be more expensive and, as a consequence, may have a material adverse effect on our financial condition and results of operations.

 

Our financial statements are based in part on assumptions and estimates which, if inaccurate, could cause material misstatement of the results of our operations and financial position.

 

The preparation of financial statements requires management to make judgments, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgments and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to our results and financial position, based upon materiality and significant judgments and estimates, include impairment of loans, valuation of financial instruments, valuation of derivatives, impairment of available-for-sale financial assets, deferred tax assets and liabilities and provisions -contingent liabilities.

 

If the judgment, estimates and assumptions we use in preparing our consolidated financial statements are subsequently found to be incorrect, there could be a material effect on our results of operations and a corresponding effect on our funding requirements and capital ratios.

 

Changes in accounting standards could impact reported earnings.

 

The accounting standard setters and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. For example, IFRS 9 will be adopted as of January 1, 2018 and will establish a new impairment model of expected loss and make changes to the classification and measurement requirements for financial assets and liabilities. In addition, IFRS 16, to be adopted as of January 1, 2019, specifies new standards for recognition, measurement, presentation and disclosure of leases. Changes made to accounting standards can materially impact how we record and report our financial

 

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condition and results of operations. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. For further information about developments in financial accounting and reporting standards, see Note 1 to our Audited Consolidated Financial Statements.

 

We are subject to review by taxing authorities, and an incorrect interpretation by us of tax laws and regulations may have a material adverse effect on us.

 

The preparation of our tax returns requires the use of estimates and interpretations of complex tax laws and regulations and is subject to review by taxing authorities.

 

We are subject to the income tax laws of Chile and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and relevant governmental taxing authorities, which are sometimes subject to prolonged evaluation periods until a final resolution is reached. In establishing a provision for income tax expense and filing returns, we must make judgments and interpretations about the application of these inherently complex tax laws.

 

If the judgment, estimates and assumptions we use in preparing our tax returns are subsequently found to be incorrect, there could be a material adverse effect on our results of operations. In some jurisdictions, the interpretations of the taxing authorities are unpredictable and frequently involve litigation, which introduces further uncertainty and risk as to tax expense.

 

Disclosure controls and procedures over financial reporting may not prevent or detect all errors or acts of fraud.

 

Disclosure controls and procedures over financial reporting are designed to provide reasonable assurance that information required to be disclosed by the company in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

These disclosure controls and procedures have inherent limitations, which include the possibility that judgments in decision-making can be faulty and that breakdowns can occur because of errors or mistakes. Additionally, controls can be circumvented by any unauthorized override of the controls. Consequently, our businesses are exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions, civil claims and serious reputational or financial harm. In recent years, a number of multinational financial institutions have suffered material losses due to the actions of ‘rogue traders’ or other employees. It is not always possible to deter employee misconduct and the precautions we take to prevent and detect this activity may not always be effective. Accordingly, because of the inherent limitations in the control system, misstatements due to error or fraud may occur and not be detected.

 

We engage in transactions with related parties that others may not consider to be on an arm’s-length basis.

 

We and our affiliates have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others.

 

Chilean law applicable to public companies and financial groups and institutions and our bylaws provide for several procedures designed to ensure that the transactions entered into with or among our financial subsidiaries and/or affiliates do not deviate from prevailing market conditions for those types of transactions, including the requirement that our board of directors approve such transactions. Furthermore, all significant related party transactions must be approved by the Audit Committee and the Board. These significant transactions are also reported in our annual shareholders meeting. Please see Note 34 of our Audited Consolidated Financial Statements and “Item 7. Major Shareholders and Related Party Transactions.”

 

We are likely to continue to engage in transactions with our affiliates. Future conflicts of interests between us and any of affiliates, or among our affiliates, may arise, which conflicts are not required to be and may not be resolved in our favor.

 

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Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner or any failure to successfully implement new IT regulations could have a material adverse effect on us.

 

Our ability to remain competitive depends in part on our ability to upgrade our information technology on a timely and cost-effective basis. We must continually make significant investments and improvements in our information technology infrastructure in order to remain competitive. We cannot assure you that in the future we will be able to maintain the level of capital expenditures necessary to support the improvement or upgrading of our information technology infrastructure. Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner could have a material adverse effect on us.

 

In addition, several new regulations are defining how to manage cyber risks and technology risks, how to report a data breach, and how the supervisory process should work, among others. These regulations are quite fragmented in terms of definitions, scope and applicability. A failure to successfully implement all or some of these new global and local regulations, that in some cases have severe sanctions regimes, could have a material adverse effect on us.

 

Risks relating to data collection, processing and storage systems and security are inherent in our business.

 

Like other financial institutions, we manage and hold confidential personal information of customers in the conduct of our banking operations, as well as a large number of assets. Accordingly, our business depends on the ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and email services, software and networks, as well as on the secure processing, storage and transmission of confidential sensitive personal data and other information using our computer systems and networks. The proper functioning of financial control, accounting or other data collection and processing systems is critical to our businesses and to our ability to compete effectively. Losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or from external events that interrupt normal business operations. We also face the risk that the design of our controls and procedures prove to be inadequate or are circumvented such that our data and/or client records are incomplete, not recoverable or not securely stored. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure data and information processing, storage and transmission capabilities to prevent against information security risk, we routinely manage personal, confidential and proprietary information by electronic means, and we may be the target of attempted cyber-attack. If we cannot maintain an effective and secure electronic data and information, management and processing system or we fail to maintain complete physical and electronic records, this could result in regulatory sanctions and serious reputational or financial harm to us.

 

We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure, data and information from misappropriation or corruption, but our systems, software and networks nevertheless may be vulnerable to unauthorized access, misuse, computer viruses or other malicious code and other events that could have a security impact. An interception, misuse or mishandling of personal, confidential or proprietary information sent to or received from a client, vendor, service provider, counterparty or third party could result in legal liability, regulatory action, reputational harm and financial loss. There can be no absolute assurance that we will not suffer material losses from operational risk in the future, including those relating to any security breaches.

 

We have seen in recent years computer systems of companies and organizations being targeted, not only by cyber criminals, but also by activists and rogue states. We have been and continue to be subject to a range of cyber-attacks, such as denial of service, malware and phishing. Cyber-attacks could give rise to the loss of significant amounts of customer data and other sensitive information, as well as significant levels of liquid assets (including cash). In addition, cyber-attacks could disrupt our electronic systems used to service our customers. As attempted attacks continue to evolve in scope and sophistication, we may incur significant costs in order to modify or enhance our protective measures against such attacks, or to investigate or remediate any vulnerability or resulting breach, or in communicating cyber-attacks to our customers. If we fail to effectively manage our cyber security risk, e.g. by failing to update our systems and processes in response to new threats, this could harm our reputation and adversely affect our operating results, financial condition and prospects through the payment of customer compensation, regulatory penalties and fines and/or through the loss of assets. In addition, we may also be impacted by cyber-attacks against national critical infrastructures of the countries where we operate; for example, the telecommunications network. Our information technology systems are dependent on such national critical

 

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infrastructure and any cyber-attack against such critical infrastructure could negatively affect our ability to service our customers. As we do not operate such national critical infrastructure, we have limited ability to protect our information technology systems from the adverse effects of such a cyber-attack. For further information see “Item 11. Quantitative and Qualitative Disclosures about Market Risk—2. Non-financial risks—Cyber-security and data security plans.”

 

Although we have procedures and controls to safeguard personal information in our possession, unauthorized disclosures could subject us to legal actions and administrative sanctions as well as damages and reputational harm that could materially and adversely affect our operating results, financial condition and prospects. Further, our business is exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions and serious reputational or financial harm. It is not always possible to deter or prevent employee misconduct, and the precautions we take to detect and prevent this activity may not always be effective. In addition, we may be required to report events related to information security issues (including any cyber security issues), events where customer information may be compromised, unauthorized access and other security breaches, to the relevant regulatory authorities. Any material disruption or slowdown of our systems could cause information, including data related to customer requests, to be lost or to be delivered to our clients with delays or errors, which could reduce demand for our services and products, could produce customer claims and could materially and adversely affect us.

 

We rely on third parties and affiliates for important products and services.

 

Third party vendors and certain affiliated companies provide key components of our business infrastructure such as loan and deposit servicing systems, back office and business process support, information technology production and support, internet connections and network access. Relying on these third parties and affiliated companies can be a source of operational and regulatory risk to us, including with respect to security breaches affecting such parties. We are also subject to risk with respect to security breaches affecting the vendors and other parties that interact with these service providers. As our interconnectivity with these third parties and affiliated companies increases, we increasingly face the risk of operational failure with respect to their systems. We may be required to take steps to protect the integrity of our operational systems, thereby increasing our operational costs and potentially decreasing customer satisfaction. In addition, any problems caused by these third parties or affiliated companies, including as a result of them not providing us their services for any reason, or performing their services poorly, could adversely affect our ability to deliver products and services to customers and otherwise conduct our business, which could lead to reputational damage and regulatory investigations and intervention. Replacing these third party vendors could also entail significant delays and expense. Further, the operational and regulatory risk we face as a result of these arrangements may be increased to the extent that we restructure such arrangements. Any restructuring could involve significant expense to us and entail significant delivery and execution risk which could have a material adverse effect on our business, operations and financial condition.

 

Damage to our reputation could cause harm to our business prospects.

 

Maintaining a positive reputation is critical to protect our brand, attract and retain customers, investors and employees and conduct business transactions with counterparties. Damage to our reputation can therefore cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, including the possibility of fraud perpetrated by our employees, litigation or regulatory enforcement, failure to deliver minimum standards of service and quality, compliance failures, unethical behavior, and the activities of customers and counterparties. Further, negative publicity regarding us may result in harm to our prospects.

 

Actions by the financial services industry generally or by certain members of, or individuals in, the industry can also affect our reputation. For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement has caused public perception of us and others in the financial services industry to decline.

 

We could suffer significant reputational harm if we fail to identify and manage potential conflicts of interest properly. The failure, or perceived failure, to adequately address conflicts of interest could affect the willingness of clients to deal with us, or give rise to litigation or enforcement actions against us. Therefore, there can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.

 

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We rely on recruiting, retaining and developing appropriate senior management and skilled personnel.

 

Our continued success depends in part on the continued service of key members of our senior executive team and other key employees. The ability to continue to attract, train, motivate and retain highly qualified and talented professionals is a key element of our strategy. The successful implementation of our strategy and culture depends on the availability of skilled and appropriate management, both at our head office and at each of our business units. If we or one of our business units or other functions fails to staff its operations appropriately or loses one or more of its key senior executives or other key employees and fails to replace them in a satisfactory and timely manner, our business, financial condition and results of operations, including control and operational risks, may be adversely affected.

 

In addition, the financial industry has and may continue to experience more stringent regulation of employee compensation, which could have an adverse effect on our ability to hire or retain the most qualified employees. If we fail or are unable to attract and appropriately train, motivate and retain qualified professionals, our business may also be adversely affected.

 

We may not be able to detect or prevent money laundering and other financial crime activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.

 

We are required to comply with applicable anti-money laundering (“AML”), anti-terrorism, anti-bribery and corruption, sanctions and other laws and regulations applicable to us. These laws and regulations require us, among other things, to conduct full customer due diligence (including sanctions and politically-exposed person screening), keep our customer, account and transaction information up to date and have implemented financial crime policies and procedures detailing what is required from those responsible. We are also required to conduct AML training for our employees and to report suspicious transactions and activity to appropriate law enforcement following full investigation by our AML team.

 

Financial crime has become the subject of enhanced regulatory scrutiny and supervision by regulators globally. AML, anti-bribery and corruption and sanctions laws and regulations are increasingly complex and detailed. Compliance with these laws and regulations requires automated systems, sophisticated monitoring and skilled compliance personnel.

 

We have developed policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and other financial crime related activities. However, emerging technologies, such as cryptocurrencies and blockchain, could limit our ability to track the movement of funds. Our ability to comply with the legal requirements depends on our ability to improve detection and reporting capabilities and reduce variation in control processes and oversight accountability. These require implementation and embedding within our business effective controls and monitoring, which in turn requires on-going changes to systems and operational activities. Financial crime is continually evolving and, as noted is subject to increasingly stringent regulatory oversight and focus. This requires proactive and adaptable responses from us so that we are able to deter threats and criminality effectively. Even known threats can never be fully eliminated, and there will be instances where we may be used by other parties to engage in money laundering and other illegal or improper activities. In addition, we rely heavily on our employees to assist us by spotting such activities and reporting them, and our employees have varying degrees of experience in recognizing criminal tactics and understanding the level of sophistication of criminal organizations. Where we outsource any of our customer due diligence, customer screening or anti financial crime operations, we remain responsible and accountable for full compliance and any breaches. If we are unable to apply the necessary scrutiny and oversight of third parties to whom we outsource certain tasks and processes, there remains a risk of regulatory breach.

 

If we are unable to fully comply with applicable laws, regulations and expectations, our regulators and relevant law enforcement agencies have the ability and authority to impose significant fines and other penalties on us, including requiring a complete review of our business systems, day-to-day supervision by external consultants and ultimately the revocation of our banking license.

 

The reputational damage to our business and global brand would be severe if we were found to have breached AML, anti-bribery and corruption or sanctions requirements. Our reputation could also suffer if we are unable to protect our customers’ bank products and services from being used by criminals for illegal or improper purposes.

 

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In addition, while we review our relevant counterparties’ internal policies and procedures with respect to such matters, we, to a large degree, rely upon our relevant counterparties to maintain and properly apply their own appropriate compliance procedures and internal policies. Such measures, procedures and internal policies may not be completely effective in preventing third parties from using our (and our relevant counterparties’) services as a conduit for illicit purposes (including illegal cash operations) without our (and our relevant counterparties’) knowledge. If we are associated with, or even accused of being associated with, breaches of AML, anti-terrorism or sanctions requirements, our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to “black lists” that would prohibit certain parties from engaging in transactions with us), any one of which could have a material adverse effect on our operating results, financial condition and prospects.

 

Any such risks could have a material adverse effect on our operating results, financial condition and prospects.

 

We are exposed to risk of loss from legal and regulatory proceedings.

 

We face risk of loss from legal and regulatory proceedings, including tax proceedings, that could subject us to monetary judgments, regulatory enforcement actions, fines and penalties. The current regulatory and tax enforcement environment in the jurisdictions in which we operate reflects an increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, and may lead to material operational and compliance costs.

 

We are from time to time subject to certain regulatory investigations and civil and tax claims and party to certain legal proceedings incidental to the normal course of our business, including in connection with conflicts of interest, lending activities, relationships with our employees and other commercial or tax matters. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in the early stages of investigation, discovery, we cannot state with confidence what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be. The amount of our reserves in respect of these matters is substantially less than the total amount of the claims asserted against us and in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by us. As a result, the outcome of a particular matter may be material to our operating results for a particular period.

 

We are subject to market, operational and other related risks associated with our derivative transactions that could have a material adverse effect on us.

 

We enter into derivative transactions for trading purposes as well as for hedging purposes. We are subject to market, credit and operational risks associated with these transactions, including basis risk (the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost) and credit or default risk (the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral).

 

Market practices and documentation for derivative transactions in Chile may differ from those in other countries. For example, documentation may not incorporate terms and conditions of derivatives transactions as commonly understood in other countries. In addition, the execution and performance of these transactions depend on our ability to maintain adequate control and administration systems. Moreover, our ability to adequately monitor, analyze and report derivative transactions continues to depend, largely, on our information technology systems. These factors further increase the risks associated with these transactions and could have a material adverse effect on us.

 

We are subject to counterparty risk in our banking business.

 

We are exposed to counterparty risk in addition to credit risks associated with lending activities. Counterparty risk may arise from, for example, investing in securities of third parties, entering into derivative contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades from proprietary trading activities that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearing houses or other financial intermediaries.

 

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We routinely transact with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual funds, hedge funds and other institutional clients. Defaults by, and even rumors or questions about the solvency of, certain financial institutions and the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by other institutions. Many of the routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties.

 

Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.

 

Our fixed rate loan and investment portfolios are subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a declining interest rate environment, prepayment activity increases, which reduces the weighted average lives of our earning assets and could have a material adverse effect on us. We would also be required to amortize net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralized mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent to our commercial activity and an increase in prepayments could have a material adverse effect on us.

 

A significant deterioration in economic conditions may make it more difficult for us to continue funding our business on favorable terms with institutional investors.

 

Large denominations of funding from time deposits from institutional investors may, under some circumstances, be a less stable source of funding than savings and bonds, such as during periods of significant changes in market interest rates for these types of deposit products and any resulting increased competition for such funds. As of December 31, 2017, short-term funding from institutional investors as defined by our Asset and Liability Committee totaled US$ 3.4 billion or 5.9% of total liabilities and equity. Significant future market instability in global markets, specifically the Eurozone and the U.S., may negatively affect our ability to continue funding our business or maintain our current levels of funding without incurring higher funding costs or having to liquidate certain assets.

 

If we are unable to manage the growth of our operations, this could have an adverse impact on our profitability.

 

We allocate management and planning resources to develop strategic plans for organic growth, and to identify possible acquisitions and disposals and areas for restructuring our businesses. From time to time, we evaluate acquisition and partnership opportunities that we believe offer additional value to our shareholders and are consistent with our business strategy. However, we may not be able to identify suitable acquisition or partnership candidates, and our ability to benefit from any such acquisitions and partnerships will depend in part on our successful integration of those businesses. Any such integration entails significant risks such as unforeseen difficulties in integrating operations and systems and unexpected liabilities or contingencies relating to the acquired businesses, including legal claims. We can give no assurances that our expectations with regard to integration and synergies will materialize. We also cannot provide assurance that we will, in all cases, be able to manage our growth effectively or deliver our strategic growth objectives. Challenges that may result from our strategic growth decisions include our ability to:

 

·manage efficiently the operations and employees of expanding businesses;

 

·maintain or grow our existing customer base;

 

·assess the value, strengths and weaknesses of investment or acquisition candidates, including local regulation that can reduce or eliminate expected synergies;

 

·finance strategic investments or acquisitions;

 

·align our current information technology systems adequately with those of an enlarged group;

 

·apply our risk management policy effectively to an enlarged group; and

 

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·manage a growing number of entities without over-committing management or losing key personnel.

 

Any failure to manage growth effectively could have a material adverse effect on our operating results, financial condition and prospects.

 

In addition, any acquisition or venture could result in the loss of key employees and inconsistencies in standards, controls, procedures and policies.

 

Moreover, the success of the acquisition or venture will at least in part be subject to a number of political, economic and other factors that are beyond our control. Any of these factors, individually or collectively, could have a material adverse effect on us.

 

Risks Relating to Chile

 

Our growth, asset quality and profitability may be adversely affected by macroeconomic and political conditions in Chile.

 

A substantial number of our loans are to borrowers doing business in Chile. Chile’s economy has experienced significant volatility in recent decades, characterized, in some cases, by slow or regressive growth, declining investment and hyperinflation. This volatility resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the economies to which we lend. The Chilean economy may not continue to grow at similar rates as in the past or future developments may negatively affect Chile’s overall levels of economic activity.

 

Negative and fluctuating economic conditions, such as slowing or negative growth and a changing interest rate and inflationary environment, impact our profitability by causing lending margins to decrease and credit quality to decline and leading to decreased demand for higher margin products and services. Negative and fluctuating economic conditions in Chile could also result in government defaults on public debt. This could affect us in two ways: directly, through portfolio losses, and indirectly, through instabilities that a default in public debt could cause to the banking system as a whole, particularly since commercial banks’ exposure to government debt is high in Chile.

 

Our revenues are also subject to risk of loss from unfavorable political and diplomatic developments, social instability, and changes in governmental policies, including expropriation, nationalization, international ownership legislation, interest-rate caps and tax policies.

 

The recent fall and subsequent fluctuation in oil prices may give rise to volatility in the global financial markets and further economic instability in oil-dependent regions, such as Chile. In addition, the ability of borrowers in or exposed to the oil sector has been and may be further adversely affected by such price fluctuations.

 

Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions in Chile.

 

Any material change to United States trade policy with respect to Chile could have a material adverse effect on the economy, which could in turn materially harm our financial condition and results of operations.

 

Portions of our loan portfolio are subject to risks relating to force majeure events and any such event could materially adversely affect our operating results.

 

Chile lies on the Nazca tectonic plate, making it one of the world’s most seismically active regions. Our financial and operating performance may be adversely affected by force majeure events, such as natural disasters, particularly in locations where a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage which could impair the asset quality of our loan portfolio and could have an adverse impact on the economy of the affected region.

 

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Changes in taxes, including the corporate tax rate, in Chile may have an adverse effect on us and our clients.

 

The Chilean Government enacted in 2014 and again in 2016 a reform to the tax and other assessment regimes to which we are subject in order to finance greater expenditure in education. The most important changes approved were:

 

1.A corporation such as Banco Santander Chile with a majority of shareholders that are incorporated entities is obliged to adhere to the sistema integrado parcial (SIP or partially integrated tax system). The statutory tax rate rose to 25.5% in 2017 and will rise to 27% in 2018 and onward, with personal taxes paid on a dividend basis, therefore retaining some benefits for shareholders of companies that reinvest profits.

 

2.The Taxable Profits Fund (FUT), a mechanism that gives shareholders tax exemptions on reinvested profits, will be eliminated in fiscal 2018.

 

3.Decree-Law 600, which gives foreign investors certain tax and other guarantees, will be replaced by a new law, yet to be designed.

 

4.The maximum personal income tax rate will be reduced from 40% to 35%, starting in 2018.

 

5.An increase in stamp tax from 0.45% to 0.8% in 2016.

 

6.Lowering of VAT exemption for construction of houses up to 2,000 UF to 225 UF per dwelling.

 

7.Charge VAT tax on real estate transactions beginning in 2016. VAT tax is 19% in Chile.

 

8.Extension of certain tax benefits and simplified accounting for companies with annual sales lower than 50,000 UF.

 

9.Withholding tax on dividends paid to ADR holders remains unchanged at 35% with the statutory corporate tax rate paid by the company still available as credit to the withholding tax.

 

In general, these reforms may have an adverse effect on the growth rate of mortgage loans and could slow down the rate of economic growth if tax receipts are not spent efficiently or for their intended purposes. We cannot predict at this time if these reforms will have a material impact on our business or clients or if further tax reforms will be implemented in the future. Banco Santander Chile’s effective corporate tax rate should rise in the future, which may have an adverse impact on our results of operations. Please see “Item 10—Additional information—E. Taxation” for more information regarding the impacts of this tax reform on ADR holders.

 

Developments in other countries may affect us, including the prices for our securities.

 

The prices of securities issued by Chilean companies, including banks, are influenced to varying degrees by economic and market considerations in other countries. We cannot assure you 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.

 

We are exposed to risks related to the weakness and volatility of the economic and political situation in Asia, the United States, Europe (including Spain, where Santander Spain, our controlling shareholder, is based), Brazil, Argentina and other nations. Although economic conditions in Europe and the United States may differ significantly from economic conditions in Chile, investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Chilean issuers. In particular, investor perceptions of the risks associated with our securities may be affected by perception of risk conditions in Spain.

 

If these nations’ economic conditions deteriorate, the economy in Chile, as both a neighboring country and a trading partner, could also be affected and could experience slower growth than in recent years, with possible adverse impact on our borrowers and counterparties. If this were to occur, we would potentially need to increase our allowances for loan losses, thus affecting our financial results, our results of operations and the price of our securities. As of December 31, 2017, approximately 3.6% of our assets were held abroad. There can be no assurance that the ongoing effects of the global financial crisis will not negatively impact growth, consumption,

 

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unemployment, investment and the price of exports in Chile. Crises and political uncertainties in other Latin American countries could also have an adverse effect on Chile, the price of our securities or our business.

 

Chile has considerable economic ties with China, the United States and Europe. In 2017, approximately 27.5% of Chile’s exports went to China, mainly copper. China’s economy has grown at a strong pace in recent times, but a slowdown in economic activity in China may affect Chile’s GDP and export growth as well as the price of copper, which is Chile’s main export. Chile exported approximately 14.4% of total exports to the United States and 14.9% to Europe in 2017.

 

Chile is also involved in an international litigation with Bolivia regarding maritime borders. We cannot assure you that crises and political uncertainty in other Latin American countries will not have an adverse effect on Chile, the price of our securities or our business.

 

Fluctuations in the rate of inflation may affect our results of operations.

 

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. Extended periods of deflation could also have an adverse effect on our business, financial condition and results of operations. In 2009, Chile experienced deflation of 1.4% as the global economy contracted. In 2017, CPI inflation was 2.3% compared to 2.7% in 2016.

 

Our assets and liabilities are denominated in Chilean pesos, UF and foreign currencies. The UF is revalued in monthly cycles. On each day in the period beginning on the tenth day of any given 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 proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month. For more information regarding the UF, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Impact of Inflation.” Although we benefit from 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 deposits, 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, including from extended periods of inflation that adversely affect economic growth or periods of deflation.

 

Any change in the methodology of how the CPI index or the UF is calculated could also adversely affect our business, financial condition and results of operations.

 

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 U.S. dollar will affect the U.S. dollar value of our securities. The Chilean peso has been subject to large devaluations and appreciations 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 exposure. In order to avoid material exchange rate exposure, we enter into forward exchange transactions. The following table shows the value of the Chilean peso relative to the U.S. dollar as reported by the Central Bank at year end for the last five years and the devaluation or appreciation of the peso relative to the U.S. dollar in each of those years.

 

Year  Exchange rate (Ch$) at year end  Devaluation (Appreciation) (%)
2013    523.76    9.4 
2014    607.38    16.0 
2015    707.34    16.5 
2016    667.29    (5.7)
2017    615.22    (7.8)
2018 (through March 22, 2018)    607.23    (1.3)

Source: Central Bank.

 

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We may decide to change our policy regarding exchange rate exposure. Regulations that limit such exposures may also be amended or eliminated. Greater exchange rate risk 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 exposures, 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.

 

We are subject to substantial regulation and regulatory and governmental oversight which could adversely affect our business, operations and financial condition.

 

As a financial institution, we are subject to extensive regulation, which materially affects our businesses. The statutes, regulations and policies to which we are subject may be changed at any time. In addition, the interpretation and the application by regulators of the laws and regulations to which we are subject may also change from time to time. In the wake of the global financial crisis, the financial services industry continues to experience significant financial regulatory reform in jurisdictions outside of Chile that directly or indirectly affect our business, including Spain, the European Union, the United States, Latin America and other jurisdictions. Changes to current legislation and their implementation through regulation (including additional capital, leverage, funding, liquidity and tax requirements), policies (including fiscal and monetary policies established by central banks and financial regulators, and changes to global trade policies), and other legal and regulatory actions may impose additional regulatory burden on Santander Group, including Santander-Chile, in these jurisdictions. The manner in which these laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate we may face higher compliance costs.

 

Any legislative or regulatory actions and any required changes to our business operations resulting from such legislation and regulations, as well as any deficiencies in our compliance with such legislation and regulation, could result in significant loss of revenue, limit our ability to pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional compliance and other costs on us or otherwise adversely affect our businesses. In particular, legislative or regulatory actions resulting in enhanced prudential standards, in particular with respect to capital and liquidity, could impose a significant regulatory burden on the Bank or on its bank subsidiaries and could limit the bank subsidiaries’ ability to distribute capital and liquidity to the Bank, thereby negatively impacting the Bank. Future liquidity standards could require the Bank to maintain a greater proportion of its assets in highly-liquid but lower-yielding financial instruments, which would negatively affect its net interest margin. Moreover, the Bank's regulatory authorities, as part of their supervisory function, periodically review the Bank's allowance for loan losses. Such regulators may require the Bank to increase its allowance for loan losses or to recognize further losses. Any such additional provisions for loan losses, as required by these regulatory agencies, whose views may differ from those of the Bank's management, could have an adverse effect on the Bank’s earnings and financial condition. Accordingly, there can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.

 

The wide range of regulations, actions and proposals which most significantly affect the Bank, or which could most significantly affect the Bank in the future, relate to capital requirements, funding and liquidity and regulatory reforms in Chile, and are discussed in further detail below. These and other regulatory reforms adopted or proposed in the wake of the financial crisis have increased and may continue to materially increase our operating costs and negatively impact our business model. Furthermore, regulatory authorities have substantial discretion in how to regulate banks, and this discretion, and the means available to the regulators, have been increasing during recent years. Regulation may be imposed on an ad hoc basis by governments and regulators in response to a crisis. In addition, the volume, granularity, frequency and scale of regulatory and other reporting requirements necessitate a clear data strategy to enable consistent data aggregation, reporting and management. Inadequate management information systems or processes, including those relating to risk data aggregation and risk reporting, could lead to a failure to meet regulatory reporting requirements or other internal or external information demands and we may face supervisory measures as a result.

 

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The main regulations and regulatory and governmental oversight that can adversely impact us include but are not limited to the following (see more details on “Item 4. Information on the Company—B. Business Overview—Regulation and Supervision”):

 

We are subject to regulation by the SBIF and by the Central Bank with regard to certain matters, including reserve requirements, interest rates, foreign exchange mismatches and market risks. Chilean laws, regulations, policies and interpretations of laws relating to the banking sector and financial institutions are continually evolving and changing. Any new reforms could result in increased competition in the industry and thus may have a material adverse effect on our financial condition and results of operations.

 

Pursuant to the General Banking Law, all Chilean banks may, subject to the approval of the SBIF, engage in certain businesses other than commercial banking depending on the risk associated with such business and their financial strength. 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 Basel Committee on Banking Regulation and Supervisory Practices and limits the discretion of the SBIF 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. 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. 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.

 

On November 20, 2013, the Chilean Congress approved new legislation to reduce the maximum rates that can be charged on loans. This new legislation is aimed at loans of less than UF50 (US$2,178) and between UF50 and UF 200 (U.S.$8,712) and with a term of more than 90 days, and thus includes consumer loans in installments, lines of credit and credit card lines. Previously, the maximum interest rate for loans of less than UF 200 and with a term of more than 90 days was calculated as the average rate of all transactions undertaken within the banking industry over the previous month of loans of less than UF 200 and with a term of more than 90 days, multiplied by a factor of 1.5. The objective was to lower the maximum rate to a level closer to the average interest rate for loans between UF 200 (US$8,712) to UF 5,000 (US$217,793) plus 14%, unless the flow of new loans in the industry decreases by 10%-20%, in which case the reduction will be partially or completely suspended until the next period. The average and maximum rates are published daily by the SBIF. By year-end 2017, the maximum rate for loans equal or lower than UF 50 (US$2,178) was 35.82%. The maximum rate for loans between UF 50 (US$2,178) and UF 200 (US$8,712) was 28.82%.

 

The SBIF and the Ministry of Finance have drafted a new General Banking Law that is expected to be approval by the Chilean Congress in 2018. Among other things, the new banking law is expected to include clearer guidelines for the adoption of Basel III regulations in Chile and new regulations regarding the SBIF’s corporate governance and its absorption by the newly created Comité de Mercado Financiero (CMF).

 

A change in labor laws in Chile or a worsening of labor relations in the Bank could impact our business.

 

As of December 31, 2017, on a consolidated basis, we had 11,068 employees. We have traditionally enjoyed good relations with our employees and their unions. Of the total headcount of us and our subsidiaries, 8,206 or 74.1% were unionized as of December 31, 2017. In February 2018, a new collective bargaining agreement was signed with the main unions ahead of schedule, which will come into effect on September 1, 2018 and which expires on August 31, 2021, though it may also be renegotiated ahead of schedule with the consent of management and the union. We generally apply the terms of our collective bargaining agreement to unionized and non-unionized employees. We have traditionally had good relations with our employees and their unions, but we cannot assure you that in the future, a strengthening of cross-industry labor movements will not materially and adversely affect our business, financial condition or results of operations.

 

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Congress passed a new labor law in 2016 that became effective April 1, 2017. The main points included in this law are:

 

·Expands the scope of collective bargaining. Currently some groups of workers are excluded from the collective bargaining process.

 

·Expands workers ability to switch unions and gives workers the same rights under a collective bargaining agreement if they affiliate themselves post-negotiations.

 

·Expand the right to greater information of unions including the wages of each worker included in a collective bargaining agreement.

 

·Simplifies the standard collective bargaining process.

 

·Collective bargaining agreements must last maximum three years instead of four.

 

·Eliminate the ability of the employer to replace workers on strike and establishes minimum service guidelines that workers must respect.

 

·Establishes the current collective bargaining agreement as the bargaining floor for future collective bargaining agreements.

 

·Amplifies the matters that can be negotiated in collective bargaining.

 

·Greater hours for training of union representatives.

 

·Strengthen the participation of women in unions.

 

The Bank currently has a high unionization level and good labor relations. At this time, we are unable to estimate the impact these new regulations will have on labor relations and costs. The current project may also suffer additional modification will being discussed in Congress.

 

These and any additional legislative or regulatory actions in Chile, Spain, the European Union, the United States or other countries, and any required changes to our business operations resulting from such legislation and regulations, could result in reduced capital availability, significant loss of revenue, limit our ability to continue organic growth (including increased lending), pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional costs on us or otherwise adversely affect our businesses. Accordingly, we cannot provide assurance that any such new legislation or regulations would not have an adverse effect on our business, results of operations or financial condition in the future.

 

Our corporate disclosure may differ from disclosure regularly published by issuers of securities in other countries, including the United States.

 

Issuers of securities in Chile are required to make public disclosures that are different from, and that may be reported under presentations that are not consistent with, disclosures required in other countries, including the United States. In particular, as a Chilean regulated financial institution, we are required to submit to the SBIF on a monthly basis unaudited consolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with Chilean Bank GAAP as issued by the SBIF. This disclosure differs in a number of significant respects from generally accepted accounting principles in the United States and information generally available in the United States with respect to U.S. financial institutions or IFRS. In addition, as a foreign private issuer, we are not subject to the same disclosure requirements in the United States as a domestic U.S. registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports, the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules under Section 16 of the Exchange Act. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. company and may be reported in a manner that you are not familiar with.

 

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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 relating 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 (the “Foreign Investment Contract”) that remains in full force and effect. The ADSs continue to be governed by the provisions of the Foreign Investment Contract subject to the regulations in existence prior to April 2001. The Foreign Investment 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 Foreign Investment 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 Foreign Investment 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 Foreign Investment 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 37.0% (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.

 

Investors may find it difficult to enforce civil liabilities against us or our directors, officers and controlling persons.

 

We are a Chilean corporation. None of our directors are residents of the United States and most of our executive officers reside outside of 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. Although we have appointed an agent for service of process in any action against us in the United States with respect to our ADSs, none of our directors, officers or controlling persons has consented to service of process in the United States or to the jurisdiction of any United States court. As a result, it may be difficult for investors to effect service of process within the United States on such persons.

 

It may also be difficult for ADS holders to enforce in the United States or in Chilean courts money 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 money judgment in an action based on the civil liability provisions of the federal securities laws of the United States, enforceability of this money judgment in Chile will be subject to the obtaining of the relevant “exequatur” (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.

 

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Risks Relating to Our Controlling Shareholder and our ADSs

 

Our controlling shareholder has a great deal of influence over our business and its interests could conflict with yours.

 

Santander Spain, our controlling shareholder, controls Santander-Chile through its holdings in Teatinos Siglo XXI Inversiones S.A. and Santander Chile Holding S.A., which are controlled subsidiaries. Santander Spain has control over 67.18% of our shares and actual participation, excluding non-controlling shareholders that participate in Santander Chile Holding, S.A. of 67.06%.

 

Due to its share ownership, our controlling shareholder has the ability to control us and our subsidiaries, including the ability to:

 

·elect the majority of the directors and exercise control over our company and subsidiaries;

 

·cause the appointment of our principal officers;

 

·declare the payment of any dividends;

 

·agree to sell or otherwise transfer its controlling stake in us; and

 

·determine the outcome of substantially all actions requiring shareholder approval, including amendments of our bylaws, transactions with related parties, corporate reorganizations, acquisitions and disposals of assets and issuance of additional equity securities, if any.

 

In December 2012, primarily in response to the requirements of the European Banking Authority, the Bank of Spain and regulators in various jurisdictions, Santander Spain adopted a corporate governance framework (Marco de Gobierno Interno del Grupo Santander). The purpose of the framework is to organize and standardize the corporate governance practices of Santander Spain and its most significant subsidiaries, including us. (Our Board of Directors approved the adoption of this corporate governance framework in July 2013,) subject to certain overarching principles, such as the precedence of applicable laws and regulations over the framework to the extent they are in conflict. See “Item 16G. Corporate Governance.” Our adoption of this framework may increase Santander Spain’s control over us.

 

We operate as a stand-alone subsidiary within the Santander Group. Our controlling shareholder has no liability for our banking operations, except for the amount of its holdings of our capital stock. The interests of Santander Spain may differ from the interests of our other shareholders, and the concentration of control in Santander Spain may differ from the interests of our other shareholders, and the concentration of control in Santander Spain will limit other shareholders’ ability to influence corporate matters. As a result, we may take actions that our other shareholders do not view as beneficial.

 

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 (“NYSE”), limiting the protections afforded to investors.

 

We are a “controlled company” and a “foreign private issuer” within the meaning of the NYSE corporate governance standards. Under the NYSE rules, a controlled company is exempt from certain NYSE 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 NYSE 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. Although we have similar practices, they do not entirely conform to the NYSE requirements for U.S. issuers; therefore we currently use these exemptions and intend to continue using them. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all NYSE corporate governance requirements.

 

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

 

Our ADSs are listed and traded on the NYSE. Our 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. At December 31, 2017, 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 our common stock is traded on the Chilean Stock Exchanges, there can be no assurance that a liquid trading market for our common stock will continue to exist. Approximately 33.0% of our outstanding common stock is held by the public (i.e., shareholders other than Santander Spain 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 in the United States unless a registration statement under the U.S. Securities Act of 1933 (“Securities Act”), 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 make a registration statement available with respect to such rights and the common stock, you may not be able to exercise your preemptive rights in the United States. If a registration statement is not filed or an applicable exemption is not available under U.S. securities law, 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.

 

As a holder of ADSs you will have different shareholders’ rights than in the United States and certain other jurisdictions.

 

Our corporate affairs are governed by our estatutos, or by-laws, and the laws of Chile, which may differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States or in certain other jurisdictions outside Chile. Under Chilean corporate law, you may have fewer and less well-defined rights to protect your interests than under the laws of other jurisdictions outside Chile. 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.

 

Although Chilean corporate law imposes restrictions on insider trading and price manipulation, the form of these regulations and the manner of their enforcement may differ from that in the U.S. securities markets or markets in certain other jurisdictions. In addition, in Chile, self-dealing and the preservation of shareholder interests may be regulated differently, which could potentially disadvantage you as a holder of the shares underlying ADSs.

 

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Holders of ADSs may find it difficult to exercise voting rights at our shareholders’ meetings.

 

Holders of ADSs will not be our direct shareholders and will be unable to enforce directly the rights of shareholders under our by-laws and the laws of Chile. Holders of ADSs may exercise voting rights with respect to the common stock represented by ADSs only in accordance with the deposit agreement governing the ADSs. Holders of ADSs will face practical limitations in exercising their voting rights because of the additional steps involved in our communications with ADS holders. Holders of our common stock will be able to exercise their voting rights by attending a shareholders’ meeting in person or voting by proxy. By contrast, holders of ADSs will receive notice of a shareholders’ meeting by mail from the Depositary following our notice to the Depositary requesting the Depository to do so. To exercise their voting rights, holders of ADSs must instruct the Depositary on a timely basis on how they wish to vote. This voting process necessarily will take longer for holders of ADSs than for holders of our common stock. If the Depositary fails to receive timely voting instructions for all or part of the ADSs, the Depositary will assume that the holders of those ADSs are instructing it to give a discretionary proxy to a person designated by us to vote their ADSs, except in limited circumstances.

 

Holders of ADSs also may not receive the voting materials in time to instruct the Depositary to vote the common stock underlying their ADSs. In addition, the Depositary and its agents are not responsible for failing to carry out voting instructions of the holders of ADSs or for the manner of carrying out those voting instructions. Accordingly, holders of ADSs may not be able to exercise voting rights, and they will have little, if any, recourse if the common stocks underlying their ADSs are not voted as requested.

 

ADS holders may be subject to additional risks related to holding ADSs rather than shares.

 

Because ADS holders do not hold their shares directly, they are subject to the following additional risks, among others:

 

·as an ADS holder, you may not be able to exercise the same shareholder rights as a direct holder of ordinary shares;

 

·we and the Depositary may amend or terminate the deposit agreement without the ADS holders’ consent in a manner that could prejudice ADS holders or that could affect the ability of ADS holders to transfer ADSs; and

 

·the Depositary may take or be required to take actions under the Deposit Agreement that may have adverse consequences for some ADS holders in their particular circumstances.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

Overview

 

We are the largest bank in Chile in terms of total assets and loans. As of December 31, 2017, we had total assets of Ch$35,823,605 million (U.S.$58,075 million), outstanding loans, net of allowances for loan losses of Ch$ 26,772,544 million (U.S.$43,402 million), total deposits of Ch$19,682,111 million (U.S.$31,907 million) and equity of Ch$3,147,920 million (U.S.$5,103 million). As of December 31, 2017, we employed 11,068 people. We have a leading presence in all the major business segments in Chile, and the largest distribution network with national coverage spanning across all the country. We offer unique transaction capabilities to clients through our 385 branches and 926 ATMs. 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, foreign currency forward contracts and 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”). Old Santander-Chile was established as a subsidiary of Santander Spain in 1978. On August 1, 2002, Santiago and Old Santander Chile merged, whereby the latter ceased to exist and Santander-Chile (formerly known as Santiago) being the surviving entity.

 

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Our principal executive offices are located at Bandera 140, 20th floor, Santiago, Chile. Our telephone number is +562-320-2000 and our website is www.santander.cl. None of the information contained on our website is incorporated by reference into, or forms part of, this Annual Report. Our agent for service of process in the United States is Puglisi & Associates, 850 Library Ave., Suite 204, Newark, DE  19711.

 

Relationship with Santander Spain

 

We believe that our relationship with our controlling shareholder, Santander Spain, offers us a significant competitive advantage over our peer Chilean banks. Santander Spain, our parent company, is one of the largest financial groups in Brazil and the rest of Latin America, in terms of total assets measured on a regional basis. It is the largest financial group in Spain and is a major player elsewhere in Europe, including the United Kingdom, Poland and Portugal, where it is the third-largest banking group. Through Santander Consumer, it also operates a leading consumer finance franchise in the United States, as well as in Germany, Italy, Spain, and several other European countries.

 

Our relationship with Santander Spain 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 Santander Spain’s product offerings in other countries, as well as of its know-how in systems management. We believe that our relationship with Santander Spain will also enhance our ability to manage credit and market risks by adopting policies and knowledge developed by Santander Spain. In addition, our internal auditing function has been strengthened as a result of the addition of an internal auditing department that concurrently reports directly to our Audit Committee and the audit committee of Santander Spain. We believe that this structure leads to improved monitoring and control of our exposure to operational risks.

 

Santander Spain’s support of Santander-Chile includes the assignment of managerial personnel to key supervisory areas of Santander-Chile, such as risks, auditing, accounting and financial control. Santander-Chile does not pay any management or other fees to Santander Spain in connection with these support services.

 

Recent Event

 

During the Ordinary Board Meeting of Banco Santander Chile, held on March 27, 2018, the following matters were agreed upon:

 

1.Due to the resignation of the directors Mr. Roberto Méndez Torres and Mr. Roberto Zahler Mayanz, as of this date, the Board has announced the appointment of Mr. Félix de Vicente Mingo and Mr. Alfonso Gómez Morales, who will be incorporated as independent directors.

 

2.Mr. Orlando Poblete Iturrate has been appointed as First Vice President and Mr. Oscar Von Chrismar Carvajal as the Second Vice President.

 

B. Business Overview

 

We have 385 total branches, 276 of which are operated under the Santander brand name, with the remaining branches under certain specialty brand names, including 51 under the Select brand name, 7 specialized branches for the Middle Market and 31 as auxiliary and payment centers. During 2017, we also opened 20 Santander Workcafés and completed the process of closing all branches under the Santander Banefe brand name. We provide a full range of financial services to corporate and individual customers. We divide our clients into the following groups: (i) Retail banking, (ii) Middle-market, (iii) Global Corporate Banking and (iv) Corporate Activities (“Other”).

 

The Bank has the reportable segments noted below (see “Segmentation Criteria” for further information):

 

Retail Banking

 

Consists of individuals and small to middle-sized entities (SMEs) with annual sales less than Ch$1,200 million (U.S.$1.9 million). This segment gives customers a variety of services, including consumer loans, credit cards, auto loans, commercial loans, foreign exchange, mortgage loans, debit cards, checking accounts, savings products, mutual funds, stock brokerage, and insurance brokerage. Additionally, the SME clients are offered government-guaranteed loans, leasing and factoring.

 

Middle-market

 

This segment serves companies and large corporations with annual sales exceeding Ch$1,200 million (U.S.$1.9 million). It also serves institutions such as universities, government entities, local and regional governments and companies engaged in the real estate industry who carry out projects to sell properties to third parties and annual sales exceeding Ch$800 million (U.S.$1.3 million) with no upper limit. The companies within this segment have access to many products including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, transactional services, treasury services, financial consulting, savings products, mutual funds,

 

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and insurance brokerage. Also, companies in the real estate industry are offered specialized services to finance projects, chiefly residential, with the aim of expanding sales of mortgage loans.

 

Global Corporate Banking

 

This segment consists of foreign and domestic multinational companies with sales over Ch$10,000 million (U.S.$16.2 million). The companies within this segment have access to many products including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, transactional services, treasury services, financial consulting, investments, savings products, mutual funds and insurance brokerage.

 

This segment also consists of a Treasury Division which provides sophisticated financial products, mainly to companies in the Middle-market segment and Global Corporate Banking. These include products such as short-term financing and fund raising, brokerage services, derivatives, securitization and other tailor-made products. The Treasury Division may act as broker to transactions and also manages the Bank’s trading fixed income portfolio.

 

Corporate Activities (“Other”)

 

This segment mainly includes our Financial Management Division, which develops global management functions, including managing inflation rate risk, foreign currency gaps, interest rate risk and liquidity risk. Liquidity risk is managed mainly through wholesale deposits, debt issuances and the Bank’s available-for-sale portfolio. This segment also manages capital allocation by unit. These activities usually result in a negative contribution to income.

 

In addition, this segment encompasses all the intra-segment income and all the activities not assigned to a given segment or product with customers.

 

The segments’ accounting policies are those described in the summary of accounting policies. The Bank earns most of its income in the form of interest income, fee and commission income and income from financial operations. To evaluate a segment’s financial performance and make decisions regarding the resources to be assigned to segments, the Chief Operating Decision Maker (CODM) bases his or her assessment on the segment's interest income, fee and commission income, and expenses.

 

The tables below show the Bank’s results by reporting segment for the year ended December 31, 2017, in addition to the corresponding balances of loans and accounts receivable from customers:

 

      For the year ended December 31, 2017
  

Loans and accounts receivable from customers

(1)

  Net interest income  Net fee and commission income 

Financial transactions, net

(2)

  Provision for loan losses 

Support expenses

(3)

  Segment`s
net contribution
   Ch$mn
                      
Retail Banking   19,223,169    970,332    206,449    20,595    (293,956)   (534,970)   368,450 
Middle-market   6,775,734    264,663    36,280    13,751    (19,235)   (91,882)   203,577 
Global Corporate Banking   1,633,796    100,808    27,626    50,714    6,440    (62,685)   122,903 
Other   83,215    (9,112)   8,708    44,692    4,496    (15,356)   33,428 
Total   27,725,914    1,326,691    279,063    129,752    (302,255)   (704,893)   728,358 
                                    
Other operating income                                 62,016 
Other operating expenses and impairment                                 (74,057)
Income from investments in associates and other companies                                 3,963 
Income tax expense                                 (145,031)
Net income for the year                                 575,249 

 

 

(1) Corresponds to loans and accounts receivable from customers, without deducting their allowances for loan losses.

 

(2) Corresponds to the sum of the net income from financial operations and the foreign exchange profit or loss.

 

(3) Corresponds to the sum of personnel salaries and expenses, administrative expenses, depreciation and amortization.

 

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Operations through Subsidiaries

 

Today, the General Banking Law permits us to directly provide the leasing and financial advisory services that we could formerly offer only through our subsidiaries, to offer investment advisory services outside of Chile and to undertake activities that 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 twelve–month period ended December 31, 2017, our subsidiaries collectively accounted for 1.2% of our total consolidated assets.

 

      Percent ownership share As of December 31,
      2017  2016  2015
Name of the Subsidiary  Main activity  Direct  Indirect  Total  Direct  Indirect  Total  Direct  Indirect  Total
      %  %  %  %  %  %  %  %  %
Santander Corredora de Seguros Limitada  Insurance brokerage   99.75    0.01    99.76    99.75    0.01    99.76    99.75    0.01    99.76 
Santander Corredores de Bolsa Limitada(*)  Financial instruments brokerage   50.59    0.41    51.00    50.59    0.41    51.00    50.59    0.41    51.00 
Santander Agente de Valores Limitada  Securities brokerage   99.03    -      99.03    99.03    -      99.03    99.03    -      99.03 
Santander S.A. Sociedad Securitizadora  Purchase of credits and issuance of debt instruments   99.64    -      99.64    99.64    -      99.64    99.64    -      99.64 

 

 

 

 

 

(*)On June 19, 2015, Santander Corredores de Bolsa Limitada, our stock brokerage company changed its corporate structure to that of a limited liability company.

 

The following companies have been consolidated based on the determination that they are controlled by the Bank, in accordance with IFRS 10 Consolidated Financial Statements:

 

-Santander Gestión de Recaudación y Cobranza Limitada (collection services)

 

-Bansa Santander S.A. (management of repossessed assets and leasing of properties)

 

During 2015, Multinegocios S.A. (management of sales force), Servicios Administrativos y Financieros Limitada (management of sales force) and Multiservicios de Negocios Limitada (call center) have ceased rendering sales services to the Bank and the Bank no longer controls their relevant activities. Therefore, as of June 30, 2015, these entities have been excluded from our consolidated results.

 

In September 2017, Bansa Santander S.A. celebrated a legal cession of rights, which generated an income of Ch$20,663 million before tax (Ch$15,197 million net of taxes).

 

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Competition

 

Overview

 

The Chilean financial services market consists of a variety of largely distinct sectors. The most important sector, commercial banking, includes a number of privately-owned banks and one public-sector bank, Banco del Estado de Chile (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 operating in Chile. The Chilean banking system is comprised of 20 banks, including one public-sector bank. The four largest banks accounted for 64.8% of all outstanding loans by Chilean financial institutions as of December 31, 2017 (excluding assets held abroad by Chilean banks).

 

The Chilean banking system has experienced increased competition in recent years, largely due to consolidation in the industry and new legislation. We also face competition from non-bank and non-finance competitors, principally department stores, credit unions and cajas de compensación (private, non-profitable corporations whose aim is to administer social welfare benefits, including payroll loans, to their members) 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.

 

All the competition data in the following sections is based on Chilean Bank GAAP.

 

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 total loans as of December 31, 2017 (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2017,
unless otherwise noted
   Market Share  Rank
Commercial loans    17.1%   2 
Consumer loans    22.4%   1 
Residential mortgage loans    20.7%   1 
Total loans    19.0%   1 
Deposits    17.3%   2 
Credit card issued    15.5%   1 
Checking accounts (1)    25.1%   1 
Branches(1)    17.7%   1 

 

 

Source: SBIF

 

(1)As of November 2017, the latest available information

 

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Loans

 

As of December 31, 2017, our loan portfolio was the largest among Chilean banks. Our loan portfolio, including interbank loans, represented 19.0% of the market for loans in the Chilean financial system as of such date. The following table sets forth our and our peer group’s market shares in terms of loans (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2017
(Chilean Bank GAAP)
Loans  Ch$ million  U.S.$ million  Market
Share
Santander-Chile    27,725,914    44,948    19.0%
Banco de Chile    25,848,904    41,905    17.7%
Banco del Estado de Chile    21,740,780    35,245    14.9%
Banco de Crédito e Inversiones    19,512,480    31,632    13.3%
Itaú Corpbanca    15,405,121    24,974    10.5%
Scotiabank Chile    10,448,237    16,938    7.1%
BBVA, Chile    9,724,985    15,766    6.6%
Others    15,843,909    25,685    10.8%
Chilean financial system    146,250,331    237,092    100.0%

 

 

Source: SBIF

 

Deposits

 

We had a 17.3% market share in deposits, ranking second among banks in Chile as of December 31, 2017. Deposit market share is based on total time and demand deposits as of the respective dates. The following table sets forth our and our peer group’s market shares in terms of deposits (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2017
(Chilean Bank GAAP)
Deposits  Ch$ million  U.S.$ million  Market Share
Banco del Estado de Chile    23,016,163    37,312    20.2%
Santander-Chile    19,682,111    31,907    17.3%
Banco de Chile    18,983,484    30,775    16.6%
Banco de Crédito e Inversiones    14,525,225    23,547    12.7%
Itaú Corpbanca    9,832,856    15,940    8.6%
Scotiabank Chile    7,024,759    11,388    6.2%
BBVA, Chile    6,810,027    11,040    6.0%
Others    14,173,043    22,976    12.4%
Chilean financial system    114,047,668    184,887    100.0%

 

 

Source: SBIF.

 

Total equity

 

With Ch$3,108,063 million (U.S.$5,039 million) in equity in Chilean Bank GAAP as of December 31, 2017, we were the second largest commercial bank in Chile in terms of shareholders’ equity. The following table sets forth our and our peer group’s shareholders’ equity.

 

   As of December 31, 2017
(Chilean Bank GAAP)
Total Equity  Ch$ million  U.S.$ million  Market Share
Itaú Corpbanca    3,399,830    5,512    18.3%
Santander-Chile    3,108,063    5,039    16.7%
Banco de Chile    3,105,715    5,035    16.7%
Banco de Crédito e Inversiones    2,728,286    4,423    14.7%
Banco del Estado de Chile    1,654,457    2,682    8.9%
Scotiabank Chile    993,995    1,611    5.3%
BBVA, Chile    902,368    1,463    4.8%
Others    2,713,215    4,399    14.6%
Chilean financial system    18,605,929    30,163    100.0%

 

 

Source: SBIF.

 

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Efficiency

 

As of December 31, 2017, we were the most efficient bank in our peer group. The following table sets forth our and our peer group’s efficiency ratio (defined as operating expenses as a percentage of operating revenue, which is the aggregate of net interest income, fees and income from services (net), net gains from mark-to-market and trading, exchange differences (net) and other operating income (net)) in each case under Chilean Bank GAAP.

 

Efficiency ratio as defined by the SBIF

  As of
December 31, 2017
(Chilean Bank GAAP)
Santander-Chile    43.0%
Banco de Chile    45.8%
Banco de Crédito e Inversiones    53.5%
Scotiabank Chile    51.5%
BBVA, Chile    53.4%
Banco del Estado de Chile    63.8%
Itaú Corpbanca    67.9%
Chilean financial system    52.6%

 

 

Source: SBIF.

 

Net income for the period attributable to equity holders

 

In 2017, we were the second largest bank in Chile in terms of net income attributable to shareholders of Ch$564,815 million (U.S.$916 million) measured under Chilean Bank GAAP. The following table sets forth our and our peer group’s net income.

 

   As of December 31, 2017
(Chilean Bank GAAP)
Net income attributable to equity holders  Ch$ million  U.S.$ million  Market Share
Banco de Chile    576,012    934    26.1%
Santander-Chile    564,815    916    25.6%
Banco de Crédito e Inversiones    371,403    602    16.9%
Banco del Estado de Chile    120,501    195    5.5%
BBVA, Chile    106,006    172    4.8%
Scotiabank Chile    103,299    167    4.7%
Itaú Corpbanca    57,447    93    2.6%
Others    361,807    587    16.4%
Chilean financial system    2,203,843    3,573    100.0%

 

 

Source: SBIF.

 

Return on equity

 

As of December 31, 2017, we were the most profitable bank in our peer group (as measured by return on period-end equity under Chilean Bank GAAP) and the fourth most capitalized bank as measured by the Chilean BIS ratio. The following table sets forth our and our peer group’s return on average equity and BIS ratio.

 

   Return on period-end equity as of December 31, 2017
(Chilean Bank GAAP)
  BIS Ratio as of November 30, 2017
(Chilean Bank GAAP)
Santander-Chile    18.6%   13.5%
Banco de Chile    18.5%   14.5%
Banco de Crédito e Inversiones    13.6%   13.3%
Banco del Estado de Chile    8.0%   11.0%
BBVA, Chile    11.8%   12.1%
Itaú Corpbanca    1.6%   14.4%
Scotiabank Chile    11.5%   10.9%
Chilean Financial System    12.0%   13.6%

 

 

Source: SBIF.

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Asset Quality

 

As of December 31, 2017, we had the second-highest non-performing loan to loan ratio in our peer group. The following table sets forth our and our peer group’s non-performing loan ratio as defined by the SBIF as of December 31, 2017.

 

  

Non-performing loans / total loans(1) as of December 31, 2017
(Chilean Bank GAAP)

Santander-Chile    2.30%
Banco de Chile    1.19%
Banco de Crédito e Inversiones    1.41%
Banco del Estado de Chile    3.09%
BBVA, Chile    1.18%
Itaú Corpbanca    2.26%
Scotiabank Chile    2.41%
Chilean financial system    1.95%

 

 

Source: SBIF.

 

(1)Excluding interbank loans.

 

Regulation and Supervision

 

General

 

In Chile, only banks may maintain checking accounts for their customers, conduct foreign trade operations, and, together with non-banking financial institutions, accept time deposits. The principal authorities that regulate financial institutions in Chile are the SBIF and the Central Bank. Chilean banks are primarily subject to the General Banking Law, and secondarily subject, 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 the 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 and 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 Chilean 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 systems. 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.

 

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The SBIF

 

Banks are supervised and controlled by the SBIF, an independent Chilean governmental agency. The SBIF 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 cases of noncompliance with such legal and regulatory requirements, the SBIF 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 by-laws or any increase in its capital.

 

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

 

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 SBIF. Absent such approval, the acquirer of shares so acquired will not have the right to vote. The SBIF may only refuse to grant its approval, based on specific grounds set forth in the General Banking Law.

 

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

 

·the merger of two or more banks;

 

·the acquisition of all or a substantial portion of a bank’s 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.

 

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 SBIF to be more than 15.0% of all loans in the Chilean banking system. The intended purchase, merger or expansion may be denied by the SBIF; or, if the acquiring bank or resulting group would own a market share in loans determined to be more than 20.0% of all loans in the Chilean banking system, the purchase, merger or expansion may be conditioned on one or more of the following:

 

·that the bank or banks maintain regulatory capital 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 reduced to 20.0% of the resulting bank’s regulatory capital.

 

If the acquiring bank or resulting group would own a market share in loans determined by the SBIF to be more than 15.0% but less than 20.0%, the authorization will be conditioned on the bank or banks maintaining a regulatory capital not lower than 10.0% of their risks-weighted assets for the period specified by the SBIF, which may not be less than one year. The calculation of the risk-weighted assets is based on a five-category risk classification system applied to a bank’s assets that is based on the Basel Committee recommendations.

 

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

 

·a bank is required to inform the SBIF 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;

 

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·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 SBIF as to the identity of the beneficial owners of the ADSs representing 5.0% or more of such banks’ shares; and

 

·bank shareholders who individually hold 10.0% or more of a bank’s capital stock and who are controlling shareholders must periodically inform the SBIF of their financial condition.

 

Financial Market Commission

 

In 2017, Law 21,000 created the Comisión para el Mercado Financiero or Financial Market Commission (FMC). The FMC would become the sole supervisor for the Chilean financial system overseeing insurance companies, companies with publicly traded securities, credit unions, credit card and prepaid card issuers, and eventually banks. It will be the responsibility of this commission to ensure the proper functioning, development and stability of the financial market, facilitating the participation of market agents and defending public faith in the financial markets. To do so, it must maintain a general and systemic vision of the market, considering the interests of investors and policyholders. Likewise, it shall be responsible for ensuring that the persons or entities audited, from their initiation until the end of their liquidation, comply with the laws, regulations, statutes and other provisions that govern them.

 

The Commission will be in charge of a Council, which will be composed of five members, who are appointed and are subject to the following rules:

 

·A Commissioner appointed by the President of the Republic, of recognized professional or academic prestige in matters related to the financial system, which will have the character of President of the Commission.

 

·Four commissioners appointed by the President of the Republic, from among persons of recognized professional or academic prestige in matters related to the financial system, by supreme decree issued through the Ministry of Finance, after ratification of the Senate by the four sevenths of its members in exercise, in session specially convened for that purpose.  

 

The Council’s responsibilities include regulation, sanctioning and the definition of general supervision policies. In addition, there will be a prosecutor in charge of investigations and the Chairman will be responsible for supervision. The FMC will act in coordination with the Chilean Central Bank (BCCh).

 

The date of entry into operation of the Commission for the Financial Market was December 14, 2017. The Superintendency of Securities and Insurance will be eliminated on January 15, 2018 and all functions of this Superintendency will be absorbed by the FMC. Once the new General Banking Law is passed the SBIF will also be absorbed by the FMC. All current SBIF attributions would be transferred to the FMC.

 

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 SBIF and the Central Bank, Chilean banks may own majority or non-controlling interests in foreign banks.

 

Since June 1, 2002, Chilean banks are allowed to offer a new checking account product that pays interest. The SBIF 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, the Central Bank has also imposed additional caps to the interest rate that can be paid.

 

On June 5, 2007, pursuant to Law 20.190, new regulations became effective authorizing banks to enter into transactions involving a wider range of derivatives, such as futures, options, swaps, forwards and other derivative

 

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instruments or contracts subject to specific limitations established by the Central Bank of Chile. Previously, banks were able to enter into transactions involving derivatives, but subject to more restrictive guidelines.

 

Deposit Insurance

 

The Chilean government guarantees up to 90.0% of the principal amount of certain time and demand deposits and savings accounts held by natural persons with a maximum value of UF120 per person (Ch$3,215,777 or U.S.$5,227 as of December 31, 2017) per calendar year in the entire financial system.

 

Reserve Requirements

 

Deposits are subject to a reserve requirement of 9.0% for demand deposits and 3.6% for 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; and

 

·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 regulatory capital, a bank must maintain a 100.0% “technical reserve” against them: demand deposits, deposits in checking accounts, or obligations payable on sight incurred in the ordinary course of business, and in general all deposits unconditionally payable immediately but excluding interbank demand deposits.

 

Minimum Capital

 

Under the General Banking Law, a bank is required to have a minimum of UF800,000 (approximately Ch$21,439 million or U.S.$34.8 million as of December 31, 2017) of paid-in capital and reserves, calculated in accordance with Chilean Bank GAAP, regulatory capital of at least 8.0% of its risk weighted assets, net of required allowances, and paid in capital and reserves of at least 3.0% of its total assets, net of required allowances, as calculated in accordance with Chilean Bank GAAP.

 

Regulatory capital is defined as the aggregate of:

 

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

 

·its subordinated bonds, valued at their placement price (but decreasing by 20.0% for each year during the period commencing six years prior to maturity), for an amount up to 50.0% of its core capital; and

 

·its voluntary allowances for loan losses for an amount of up to 1.25% of risk weighted-assets.

 

Capital Adequacy Requirements

 

According to the General Banking Law, each bank should have regulatory capital 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 Basel Committee recommendations. The SBIF is expected to implement in 2017 the Basel III capital standards in Chile, which will includes the implementation of capital limits with market risk and operational risk-weighted assets. These changes must be approved by the Chilean Congress, as it involves a modification to the General Banking Law.

 

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Banks should also have capital básico, or core capital, of at least 3.0% of their total assets, net of allowances. Core capital is defined to include shareholders’ equity.

 

Within the scope of Basel III in Chile, further changes in regulation may occur. See “Item 3. Key Information—D. Risk Factors—Risks Relating to Chile—We are subject to substantial regulation and regulatory and governmental oversight which could adversely affect our business, operations and financial condition.”

 

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 10.0% of the bank’s regulatory capital, or in an amount that exceeds 30.0% of its regulatory capital if the excess over 10.0% is secured by certain assets with a value equal to or higher than such excess. These limits were raised from 5.0% and 25.0%, respectively, in 2007 by the Reformas al Mercado de Capitales II (also known as MK2). In the case of financing infrastructure projects built by government concession, the 10.0% 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 regulatory capital;

 

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

 

In addition, the General Banking Law limits the aggregate amount of loans that a bank may grant to its employees to 1.5% of its regulatory capital, 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 during such employee’s term of employment.

 

Allowance for Loan Losses

 

Chilean banks are required to provide to the SBIF detailed information regarding their loan portfolio on a monthly basis. The SBIF 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 SBIF. Category 1 banks are those banks whose methods and models are satisfactory to the SBIF. Category 1 banks will be entitled to continue using the same methods and models they currently have in place. A bank classified as a category 2 bank will have to maintain the minimum levels of reserves established by the SBIF while its Board of Directors will be made aware of the problems detected by the SBIF 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 SBIF until they are authorized by the SBIF to do otherwise. Santander-Chile is categorized as a “Category 1” bank.

 

Differences between IFRS and Chilean Bank GAAP

 

As stated above, Chilean Bank GAAP, as prescribed by the Compendium of Accounting Standards (the “Compendium”), differs in certain respects from IFRS. The main differences that should be considered by an investor are the following:

 

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Suspension of Income Recognition on Accrual Basis

 

In accordance with the Compendium, financial institutions must suspend recognition of income on an accrual basis in their statements of income for certain loans included in the impaired portfolio. IFRS does not allow the suspension of accrual of interest on financial assets for which an impairment loss has been determined. This difference does not materially impact our Audited Consolidated Financial Statements.

 

Charge-offs and Accounts Receivable

 

The Compendium requires companies to establish deadlines for the charge-off of loans and accounts receivable. IFRS does not require any such deadline for charge-offs. A charge-off due to impairment would be recorded, if and only if, all efforts at collection of the loan or account receivable had been exhausted. Accordingly, this difference does not materially impact our Audited Consolidated Financial Statements.

 

Assets Received In Lieu of Payment

 

The Compendium requires that the initial value of assets received in lieu of payment be the value agreed upon with a debtor as a result of the loan settlement or the value awarded in an auction, as applicable. These assets are required to be written off one year after their acquisition, if the assets have not been previously disposed of. IFRS requires that assets received in lieu of payment be initially accounted for at fair value. Subsequently, asset valuation depends on the classification provided by the entity for that type of asset. No deadline is established for charging-off an asset. The Bank has adjusted the Audited Consolidated Financial Statements accordingly.

 

Loan loss allowances

 

The main difference between Chilean bank GAAP and IFRS regarding loan loss allowances is that under Chilean Bank GAAP, these are calculated based on specific guidelines set by the SBIF, which are in turn based on an expected losses approach, and under IFRS, we use an incurred loss approach. The Bank has adjusted the Audited Consolidated Financial Statements accordingly. The SBIF has announced that it will not be adopting IFRS 9 in 2018. The most significant impact of IFRS 9 on the Bank´s financial statements arises from the new impairment requirements. Impairment losses will increase and become more volatile for financial instruments in the scope of the IFRS 9 impairment model. Based on the assessment undertaken to date, the total estimated adjustment (net of tax) of the adoption of IFRS 9 on the opening balance on the Bank's equity at 1 January 2018 is Ch$82,454 million (net of tax).

 

Provisions for country risk and for contingent loan risk

 

Under Chilean GAAP, the Bank provisions for country risk to cover the risk taken when holding or committing resources with any foreign country. These allowances are established according to country risk classifications established by the SBIF and therefore are not in accordance with IFRS as issued by the IASB. Our Audited Consolidated Financial Statements have been adjusted accordingly.

 

Also under Chilean GAAP, the Bank has established allowances related to the undrawn available credit lines and contingent loans in accordance with the SBIF. As IFRS only permits allowances following its internal models based on incurred debt, the Bank has adjusted the Audited Consolidated Financial Statements accordingly.

 

These differences do not materially impact our financial statements.

 

Deferred taxes

 

The Bank records, when appropriate, deferred tax assets and liabilities for the estimated future tax effects attributable to differences between the carrying amount of assets and liabilities and their tax bases. Due to the adjustments made to the consolidated financial statements, we adjust deferred taxes accordingly.

 

Provision for mandatory dividends

 

This provision is made in accordance with the Bank’s internal policy, pursuant to which at least 30% of net income for the period is distributed, except in the case of a contrary resolution adopted at the respective

 

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shareholders’ meeting by unanimous vote of the outstanding shares. While the Bank uses the same policy under Chilean GAAP and IFRS, the net income used to calculate the provision is adjusted in accordance with IFRS principles, however for the distribution of dividends, the Bank uses the net income according to Chilean GAAP.

 

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 SBIF 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 SBIF does not approve the Board of Directors’ proposal, the bank will be barred from increasing its loan portfolio beyond that stated in the financial statements presented to the Board of Directors and from making any further investments in any instrument other than in instruments issued by the Central Bank. In such a case, or in the event that a bank is unable to make timely payment in respect of its obligations, or if a bank is under provisional administration of the SBIF, 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 SBIF, 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 regulatory capital. 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 regulatory capital to risk-weighted assets to be not lower than 12.0%. If a bank fails to pay an obligation, it must notify the SBIF, which shall determine if the bank is solvent.

 

Dissolution and Liquidation of Banks

 

The SBIF 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 SBIF must revoke a bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The SBIF must also revoke a bank’s authorization if the reorganization plan of such bank has been rejected twice. The resolution by the SBIF must state the reason for ordering the liquidation and must name a liquidator, unless the SBIF assumes this responsibility. When a liquidation is declared, all checking accounts and other demand deposits received in the ordinary course of business, 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

 

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 Disclosures About Market Risk”).

 

Loans and 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. Banks may grant commercial loans and foreign trade loans, and

 

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can buy loans granted by banks abroad. 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. If the sum of investment in foreign securities and loans granted outside of Chile surpasses 70.0% of regulatory capital, the amount that exceeds 70.0% is subject to a mandatory reserve of 100.0%.

 

Table 1

 

Rating Agency

Short Term

Long Term

Moody’s P2 Baa3
Standard and Poor’s A3 BBB-
Fitch F2 BBB-
Dominion Bond Rating (DBRS) R-2 BBB (low)

 

In the event that the sum of: (a) loans granted abroad that are not to subsidiaries of Chilean companies, and that have a rating of BB- or less and do not trade on a foreign stock exchange, and (b) the investments in foreign securities which have a rating that is below that indicated in Table 1 above, but is equal to or exceeds the ratings mentioned in the Table 2 below and exceeds 20.0% (and 30.0% for banks with a BIS ratio equal or exceeding 10% of the regulatory capital of such bank), the excess is subject to a mandatory reserve of 100.0%.

 

Table 2

 

Rating Agency

Short Term

Long Term

Moody’s P2 Ba3
Standard and Poor’s A-2 BB-
Fitch F2 BB-
Dominion Bond Rating (DBRS) R-2 BB (low)

 

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

 

Additionally, a Chilean bank may invest in foreign securities whose rating is equal to or exceeds those mentioned in Table 3 below in: (i) demand deposits with foreign banks, including overnight deposits in a single entity; and (ii) securities issued or guaranteed by sovereign states or their central banks or securities issued or guaranteed by foreign entities within the Chilean State, though investment will be subject to the limits by issuer up to 30.0% and 50.0%, respectively, of the regulatory capital of the Chilean bank that makes the investment. If these foreign securities do not have a rating, the individual limit will be 10.0% of regulatory capital.

 

Table 3

 

Rating Agency

Short Term

Long Term

Moody’s P1 Aa3
Standard and Poor’s A1+ AA-
Fitch F1+ AA-
DBRS R-1 (high) AA(low)

 

Moreover, the sum of all demand deposits with foreign banks, including overnight deposits to related parties, as defined by the Central Bank and the SBIF, cannot surpass 25.0% of a bank’s regulatory capital. This limit excludes foreign branches of Chilean banks or their subsidiaries, but must include amounts deposited by these entities in related parties abroad.

 

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 complementary to the bank’s business if such companies were incorporated in Chile.

 

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United States Supervision and Regulation

 

Financial Regulatory Reform

 

Banking statutes and regulations are continually under review by the United States Congress. In addition to laws and regulations, the U.S. bank regulatory agencies may issue policy statements, interpretive letters and similar written guidance. Many changes have occurred as a result of the Dodd-Frank Act and its implementing regulations, most of which are now in place. More recently, President Trump issued an executive order in 2017 that sets forth principles for financial regulatory and legislative reform, and the Republican majority in Congress has also suggested an agenda for financial legislative reform. It is too early to assess whether there will be any major changes in the regulatory environment or merely a rebalancing of the post-financial crisis framework, but we will monitor these developments and assess their impact on our operations, if any.

 

Volcker Rule

 

Section 13 of the U.S. Bank Holding Company Act of 1956, as amended, and its implementing rules, (collectively, the “Volcker Rule”) prohibit “banking entities” from engaging in certain forms of proprietary trading or from sponsoring or investing in “covered funds,” in each case subject to certain exceptions. The Volcker Rule also limits the ability of banking entities and their affiliates to enter into certain transactions with covered funds with which they or their affiliates have certain relationships. Banking entities such as Santander-Chile and Santander Spain were required to bring their activities and investments into compliance with the requirements of the Volcker Rule by the end of the conformance period applicable to each requirement. Santander Spain has assessed how the Volcker Rule affects its businesses and subsidiaries, including Santander-Chile, and has brought its activities into compliance. The Group has adopted processes to establish, maintain, enforce, review and test the compliance program designed to achieve and maintain compliance with the Volcker Rule. The Volcker Rule contains exclusions and certain exemptions for market-making, hedging, underwriting, trading in U.S. government and agency obligations, as well as certain foreign government obligations, and trading solely outside the United States, and also permits certain ownership interests in certain types of funds to be retained. Santander Spain and its non-U.S. banking organization subsidiaries, including Santander-Chile, are largely able to continue their activities outside the United States in reliance on the “solely outside the U.S.” exemptions from the Volcker Rule. Those exemptions generally exempt proprietary trading, and sponsoring or investing in covered funds if, among other restrictions, the essential actions take place outside the United States and any transactions are not with U.S. persons.

 

On July 21, 2017 the five regulatory agencies charged with implementing the Volcker Rule announced the coordination of reviews of the treatment of certain foreign funds that are investment funds organized and offered outside of the United States and that are excluded from the definition of covered fund under the agencies' implementing regulations. Also in July 2017, the Federal Reserve issued guidelines for banking entities seeking an extension to conform certain “seeding” investments in covered funds to the requirements of the Volcker Rule.

 

The Volcker Rule and its implementing regulations are currently subject to financial reform developments in the United States, including a notice issued by the Office of the Comptroller of the Currency requesting public comment on potential changes to the regulations implementing the Volcker Rule and seeking specific recommendations on how the Volcker Rule regulations could be tailored in certain focus areas to enhance their effectiveness. Santander Spain will continue to monitor these developments and assess their impact on its operations, including those of Santander-Chile, as necessary.

 

U.S. Anti-Money Laundering, Anti-Terrorist Financing, and Foreign Corrupt Practices Act Regulations

 

The Bank, as a foreign private issuer whose securities are registered under the U.S. Securities Exchange Act of 1934, is subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”). The FCPA generally prohibits such issuers and their directors, officers, employees and agents from using any means or instrumentality of U.S. interstate commerce in furtherance of any offer or payment of money to any foreign official or political party for the purpose of influencing a decision of such person in order to obtain or retain business. It also requires that the issuer maintain books and records and a system of internal accounting controls sufficient to provide reasonable assurance that accountability of assets is maintained and accurate financial statements can be prepared. Penalties, fines and imprisonment of the Bank’s officers and/or directors can be imposed for violations of the FCPA.

 

Furthermore, the Bank is subject to a variety of U.S. anti-money laundering and anti-terrorist financing laws and regulations, such as the Bank Secrecy Act of 1970, as amended, and the USA PATRIOT ACT of 2001, as amended, and a violation of such laws and regulations may result in substantial penalties, fines and imprisonment of the Bank’s officers and/or directors.

 

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Disclosure pursuant to Section 219 of the Iran threat reduction and Syria human rights act

 

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.

 

The following activities are disclosed in response to Section 13(r) with respect to affiliates of Santander UK within the Group. During the period covered by this annual report:

 

(a)       Santander UK holds two savings accounts and one current account for two customers resident in the UK who are currently designated by the US under the Specially Designated Global Terrorist (SDGT) sanctions program. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2017 were negligible relative to the overall profits of Banco Santander SA.

 

(b)       Santander UK holds two frozen current accounts for two UK nationals who are designated by the US under the SDGT sanctions program. The accounts held by each customer have been frozen since their designation and have remained frozen through 2017. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK Collections & Recoveries department. No revenues or profits were generated by Santander UK on these accounts in the year ended December 31, 2017.

 

(c) On September 6, 2017, Santander Brasil received a payment order in an amount of €1,603.00 in favor of a Brazilian recipient from an entity based in Turkey. Upon receipt of the supporting documentation, Santander Brasil became aware of the fact that the ultimate payer was actually Iran Water and Electrical Equipments Engineering Co., an entity based in Iran and controlled by the Iranian government. Santander Brasil therefore declined to process the transaction. The intended recipient of the funds obtained an order from the Court of Justice of the State of São Paulo (Tribunal de Justiça Estado de São Paulo) requiring Santander Brasil to process the payment. Santander Brasil complied with the court order and processed the payment accordingly. Revenues and profits generated by Santander Brasil on this transaction in the year ended December 31, 2017 were negligible relative to the overall profits of Banco Santander, S.A.

 

The Group also has certain legacy performance guarantees for the benefit of Bank Sepah and Bank Mellat (stand-by letters of credit to guarantee the obligations – either under tender documents or under contracting agreements – of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007.

 

In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2017, which were negligible relative to the overall revenues and profits of Banco Santander, S.A. The Group has undertaken significant steps to withdraw from the Iranian market such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. The Group is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, the Group intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.

 

C. Organizational Structure

 

Santander Spain controls Santander-Chile through its holdings in Teatinos Siglo XXI Inversiones S.A. and Santander Chile Holding S.A. which are controlled subsidiaries. Santander Spain control over 67.18% of our shares and actual participation when excluding non-controlling interests participating in Santander Chile Holding S.A. of 67.06%.

 

Shareholder  Number of Shares  Percentage
Santander Chile Holding S.A.    66,822,519,695    35.46 
Teatinos Siglo XXI Inversiones S.A.    59,770,481,573    31.72 

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The chart below sets forth the names and areas of responsibility of our senior managers as of March 27, 2018.

 

 

D. Property, Plant and Equipment

 

We are domiciled in Chile and own our principal executive offices located at Bandera 140, 20th floor, Santiago, Chile. At December 31, 2017, we owned the locations at which 24.9% of our branches were located. The remaining branches operate at rented locations. We believe that our existing physical facilities are adequate for our needs.

 

Main properties as of December 31, 2017

 

Number 

Central Offices   
Owned    4 
Rented    5 
Total    9 
      
Branches     
Owned    96 
Rented    289 
Total    385 
      
Other property(1)     
Owned    54 
Rented    5 
Total    59 

 

 

(1)       Consists mainly of parking lots, mini-branches and property owned by our subsidiaries.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Accounting Standards Applied in 2017

 

Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and prepares its consolidated financial statements in accordance with IFRS as issued by the IASB in order to comply with requirements of the SEC. As required by the General Banking Law, which subjects Chilean banks to the regulatory supervision of the SBIF, and which mandates that Chilean banks abide by the accounting standards stipulated by the SBIF, our locally-filed consolidated financial statements have been prepared in accordance with Chilean Bank GAAP as issued by the SBIF. The accounting principles issued by the SBIF are substantially similar to IFRS but there are some exceptions, as described in Item 4. Therefore, our locally-filed consolidated financial statements have been adjusted according to IFRS as issued by the IASB.

 

Critical Accounting Policies

 

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 and the selection of useful lives of certain assets.

 

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 it believes 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 most 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.

 

Allowance for loan losses

 

The Bank records its allowances following its internal models for the recording of incurred losses. These models have been approved by the Board. To establish impairment losses, the Bank carries out an evaluation of outstanding loans and accounts receivable from customers, as detailed below:

 

·Individual assessment of debtors: when debtors are recorded as individually significant, i.e., when they have significant debt levels or, even for those that do not have these levels, could be classified in a group of financial assets with similar credit risk features and who, due to the size, complexity or level of exposure, require detailed information. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio—Classification of Loan Portfolio—Credit Approval: Loans approved on an individual basis” and “Note 1—Summary of Significant Accounting Policies—(p) Provisions for loan losses” of our Audited Consolidated Financial Statements.

 

·Group assessment of debtors: when there is no evidence of impairment for individually-assessed debtors and debtors with loans grouped collectively—whether or not significant—the Bank groups debtors with similar credit risk features and assesses them for impairment. Debtors individually assessed for impairment and for whom a loss due to impairment has been recorded, are not included in the group assessment of impairment. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio—Classification of Loan Portfolio—Credit Approval: Loans approved on a group basis” and “Note 1—Summary of Significant Accounting Policies—(p) Provisions for loan losses” of our Audited Consolidated Financial Statements.

 

Valuation of financial instruments

 

Fair value is the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. IFRS 13 provides a hierarchy that separates the inputs and/or valuation technique assumptions used to measure the fair value of financial instruments. The hierarchy reflects the significance of the inputs used in making the measurement.

 

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The hierarchy gives the highest priority to (unadjusted) quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The Bank uses valuation techniques appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.

 

For financial instruments with no available market prices, fair values are estimated using recent transactions in analogous instruments, and in the absence thereof, the present values or other valuation techniques based on mathematical valuation models sufficiently accepted by the international financial community. In the use of these models, consideration is given to the specific particularities of the asset or liability to be valued, and especially to the different kinds of risks associated with the asset or liability.

 

These techniques are significantly influenced by the assumptions used, including the discount rate, the estimates of future cash flows and prepayment expectations. See “Note 36— Fair value of financial assets and liabilities” in our Audited Consolidated Financial Statements.

 

Derivative activities

 

Derivatives are measured at fair value on the statement of financial position and the net unrealized gain (loss) on derivatives is classified as a separate line item within the income statement. Under IFRS, banks must mark-to-market derivatives. Within the fair value of derivatives are included Credit Valuation Adjustment (CVA) and Debit Valuation Adjustment (DVA), all with the objective that the fair value of each instrument includes the credit risk of its counterparty and Bank’s own risk. The CVA is a valuation adjustment to OTC derivatives as a result of the risk associated with the credit exposure assumed by each counterparty in each future period. The DVA is a valuation adjustment similar to the CVA but, in this case, it arises as a result of the Bank’s own risk assumed by its counterparties. The following inputs are used to calculate the CVA and DVA:

 

·Expected exposure: Including for each transaction the mark-to-market (MtM) value plus an add-on for the potential future exposure for each period. Mitigating factors such as collateral and netting agreements are taken into account, as well as a temporary impairment factor for derivatives with interim payments.

 

·LGD: percentage of final loss assumed in a counterparty credit event/default.

 

·Probability of default: for cases where there is no market information, proxies based on comparable companies in the same industry and with the same external rating as the counterparty, are used.

 

·Discount factor curve.

 

Impairment of available-for-sale financial assets,

 

Available for sale financial assets are evaluated for impairment throughout the year and at each reporting date in order to assess whether events or changes in circumstances indicate that these assets are impaired, such as an adverse change in business climate or observable market data, indicate that these assets may be impaired. If there is objective evidence of an impairment of an asset, an impairment test is performed by comparing the investments’ recoverable amount, which is the higher of its value in use and fair value less costs to sell, with its carrying amount.

 

The Bank evaluates available-for-sale financial assets with unrealized losses as of the end of each period and concludes if these were impaired. This review consists of evaluating the economic reasons for any declines, the credit ratings of the securities’ issuers, and the Bank’s intention and ability to hold the securities until the unrealized loss is recovered. See “Note 10— Available for sale investments” in our Audited Consolidated Financial Statements.

 

Deferred tax assets and liabilities

 

The Bank records, when appropriate, deferred tax assets and liabilities for the estimated future tax effects attributable to differences between the carrying amount of assets and liabilities and their tax bases. The measurement of deferred tax assets and liabilities is based on the tax rate, in accordance with the applicable tax laws, using the tax rate that applies to the period when the deferred asset and liability will be settled. The future effects of changes in tax legislation or tax rates are recorded in deferred taxes beginning on the date on which the law is enacted or substantially enacted. See “Note 14—Current and deferred taxes” of our Audited Consolidated Financial Statements.

 

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Provisions - contingent liabilities

 

Provisions related to contingencies associated to pending signature of contracts, potential clients and other administrative claims, operational risk arise from financial transactions, potential property tax associated to leasing contracts are quantified using the best available information of uncertain future events that are not wholly within control of the Bank. These are reviewed and adjusted at each reporting date. See “Note 20—Provisions” of our Audited Consolidated Financial Statements.

 

A. 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. In 2017, the Chilean economy grew approximately 1.5% compared to 1.3% in 2016 and 2.3% in 2015. In the same period, the Central Bank of Chile reported that internal demand increased 3.1% compared to an increase of 1.3% in 2016 and an increase of 2.5% in 2015. The growth of internal demand was led by growth of total consumption, which was up 2.7% while growth in the mining sector contracted due to low levels of investment in this sector despite a recovery in copper prices.

 

As of December 2017, the unemployment rate was 6.4% compared to 6.1% in 2016 and 5.8% in 2015. The exchange rate appreciated in 2017 by 7.8% compared to an appreciation of 5.7% in 2016. As a result of this appreciation of the peso, CPI inflation reached 2.3% in 2017 compared to 2.7% in 2016 and 4.4% in 2015. Given the slower economic growth in 2016 and the lower inflation rate, the Central Bank reduced its mandatory policy rate to 2.5% during 2017. Economic activity is expected to increase by approximately 3.5% in 2018, led by a higher level of investment fueled by a growing world economy.

 

The growth of the Chilean banking sector evolved in line with overall economic developments, with an increase in the volume of loans and deposits. Total loans as of December 31, 2017 in the Chilean financial system were Ch$146,250,331 million (U.S.$237 billion), excluding loans held by subsidiaries of Chilean banks abroad, grew 4.3% in 2017. Total customer deposits (defined as time deposits plus checking accounts), excluding deposits held by subsidiaries of Chilean banks abroad grew 3.8% in 2017 and totaled Ch$114,047,668 million (U.S.$185 billion) as of December 31, 2017. The non-performing loan (defined as loans with an installment that is at least 90 days past-due) to total loans ratio remained stable at year end for both 2017 and 2016 at 1.9%.

 

Impact of inflation

 

Our assets and liabilities are denominated in Chilean pesos, Unidades de Fomento (UF) and foreign currencies. Inflation impacts our results of operations as some loan and deposit products are contracted in UF. The UF is revalued in monthly cycles. Each day in the period beginning on 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 proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month. One UF equaled Ch$26,798.14 at December 31, 2017, Ch$26,347.98 at December 31, 2016 and Ch$25,629.09 at December 31, 2015. High levels of inflation in Chile could adversely affect the Chilean economy and could have an adverse effect on our business, financial condition and results of operations. Negative inflation rates also negatively impact our results. Inflation measured as the annual variation of the UF was 1.7% in 2017, 2.8% in 2016 and 4.1% in 2015. 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, 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 significantly less features in deposits and 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 effect of any changes in the nominal peso value of our UF-denominated interest earning assets and interest-bearing liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest income and expense, respectively. Our net interest income will be positively affected by an inflationary environment to the extent that our average UF-denominated interest earning assets exceed our average UF-denominated interest-bearing liabilities. Our net interest income will be positively affected by deflation in any period in which our average UF-denominated interest-bearing liabilities exceed our average UF-denominated interest earning assets. Our net interest income will be negatively affected in a deflationary environment if our average UF-denominated interest earning assets exceed our average UF-denominated interest-bearing liabilities.

 

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·Inflation and interest rate hedge. A key component of our asset and liability policy is the management of interest rate risk. The Bank’s assets generally have a longer maturity than our liabilities. As the Bank’s mortgage portfolio grows, the maturity gap tends to rise as these loans, which are contracted in UF, have a longer maturity than the average maturity of our funding base. As most of our long term financial instruments and mortgage loans are contracted in UF and most of our deposits are in nominal pesos, the rise in mortgage lending increases the Bank’s exposure to inflation and to interest rate risk. The size of this gap is limited by internal and regulatory guidelines in order to avoid excessive potential losses due to strong shifts in interest rates. In order to keep this duration gap below regulatory limits, the Bank issues long term bonds denominated in UF or interest rate swaps. The financial cost of the bonds and the efficient part of these hedges is recorded as net interest income. In 2017, the loss from the swaps taken in order to hedge mainly for inflation and interest rate risk and included in net interest income totaled a gain of Ch$15,408 million compared to a loss of Ch$42,420 million in 2016 and of Ch$107,867 million in 2015. The average gap between our interest earnings assets and total liabilities linked to the inflation, including hedging, was Ch$4,340,626 million in 2017, Ch$4,659,534 million in 2016 and Ch$3,507,250 million in 2015. Therefore, our sensitivity to a 100 basis point shift in UF inflation considering our year end gap would be approximately Ch$43 billion.

 

·The financial impact of the gap between our interest earning assets and liabilities denominated in UFs including hedges was in the results of the Bank Ch$73,050 million in 2017, Ch$133,702 million in 2016 and Ch$130,666 million in 2015. The 45.4% decrease in the results from our UF gap was due to a lower UF inflation rate in 2017 compared to 2016, which was managed by a lower UF gap.

 

   As of December 31,  % Change  % Change
Impact of inflation on net interest income  2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Results from UF GAP (1)    73,050    133,702    130,666    (45.4%)   2.3%
Annual  UF inflation    1.7%   2.8%   4.1%          

 

 

 

(1)UF GAP is net interest income from asset and liabilities denominated in UFs and include the results from hedging the size of this gap via interest rate swaps.

 

·Peso-denominated assets and liabilities. Interest rates prevailing in Chile during any period primarily reflect the inflation rate during the period and the expectations of future inflation. The sensitivity of our peso-denominated interest earning assets and interest-bearing liabilities to changes to such prevailing rates varies. See “Item 5. Operating and Financial Review and Prospects—A. 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 would adversely affect our net interest margin on inflation indexed assets funded with such deposits, and any increase in the rate of inflation would increase the net interest margin on such assets. The ratio of the average of such demand deposits and average shareholder’s equity to average interest-earning assets was 29.8%, 29.0%, and 29.9% for the years ended December 31, 2017, 2016, and 2015, respectively.

 

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Interest Rates

 

Interest rates earned and paid on our assets and liabilities reflect, to a certain degree, inflation, expectations regarding inflation, changes in short term interest rates set by the Central Bank and movements in long term real rates. The Central Bank manages short term interest rates based on its objectives of balancing low inflation and economic growth. Because our liabilities are generally re-priced sooner 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 rates since generally our UF-denominated assets exceed our UF-denominated liabilities. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Impact of Inflation—Peso-denominated assets and liabilities.” An increase in long term rates has a positive effect on our net interest margin, because our interest earning assets generally have longer terms than our interest-bearing liabilities. In addition, because our peso-denominated liabilities have relatively short re-pricing 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 or expected inflation exceeds the previous period’s inflation, customers often switch funds from UF-denominated deposits to peso-denominated deposits, which generally bear higher interest rates, 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 and may be subject to significant fluctuations in the future. The Central Bank exchange rate appreciated 7.8% in 2017 and 5.7% in 2016. See “Item 3. Key Information—A. 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. Our current strategy is not to maintain a significant difference between the balances of our assets and liabilities in foreign currencies. In 2017, 2016 and 2015, the Bank, usually in its spot position, held more liabilities than assets in foreign currencies, mainly the U.S. dollar, as a result of an ample supply of U.S. dollar deposits from companies that receive export revenues, foreign correspondent bank loans and bonds issued abroad. This difference is usually hedged using forwards and cross-currency swaps. Including derivatives, the Bank seeks to run no foreign currency risk in its non-trading balance sheet. 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 relative to foreign currencies (principally the U.S. dollar). The translation gain or loss over assets and liabilities (excluding derivatives held for trading) and derivatives accounted under hedge accounting standards are included as foreign exchange transactions in the income statement. The translation and mark-to-market of foreign currency derivatives held for trading is recognized as a gain or loss in the net results from mark-to-market and trading. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk—E. Market Risks—Foreign exchange fluctuations” for more detail on the Bank’s exposure to foreign currency.

 

The Bank also uses a sensitivity analysis with both internal limits and regulatory limits to seek to manage the potential loss in net interest income resulting from fluctuations of interest rates on U.S. dollar denominated assets and liabilities and a VaR model to limit foreign currency trading risk.

 

We also set an absolute limit on the size of Santander-Chile’s consolidated net foreign currency trading position. As of December 31, 2017, the net difference between assets and liabilities in foreign currency was a net asset position of U.S.$186.4 million. The average gap, be it a net asset or liability position in foreign currency, in 2017 was U.S.$92.3 million. Both figures include derivatives used to hedge foreign currency risk. See “Item 11. Quantitative and Qualitative Disclosures About Market Risk—Volume limits.” The limit on the size of the net foreign currency position is determined by the Asset and Liability Committee and is calculated and monitored by our Market Risk and Control Department.

 

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Segmentation criteria

 

The accounting policies used to determine the Bank’s income and expenses by reporting segment are the same as those described in the summary of accounting policies in “Note 1—Summary of Significant Accounting Policies” of the Bank’s Consolidated Financial Statements, and are customized to meet the needs of the Bank’s management. The Bank earns most of its income in the form of interest income, fee and commission income and income from financial operations.

 

To evaluate a segment’s financial performance and make decisions regarding the resources to be assigned to segments, the Chief Operating Decision Maker (CODM) bases his or her assessment on the segment's interest income, fee and commission income, and expenses. The Bank’s reporting segments have three Chief Operating Decision Makers: (i) Director of Retail banking, (ii) the Director of the Middle-market segment and (iii) the Director of Global corporate banking, each of which report to our Chief Executive Officer. All reporting segment information is presented following this structure.

 

Under IFRS 8, the Bank has aggregated operating segments with similar economic characteristics according to the aggregation criteria specified in the standard. A reporting segment consists of clients that are offered differentiated but, considering how their performance is measured, homogenous services based on IFRS 8 aggregation criteria, thus they form part of the same reporting segment. The clients included in each business segment are constantly revised and reclassified if a client no longer meets the criteria for the segment they are in and transferred to a different CODM. Therefore, variations of loan volumes and profit and loss items reflect business trends as well as client migration effects. Overall, this aggregation has no significant impact on the understanding of the nature and effects of the Bank’s business activities and the economic environment.

 

The Bank’s reportable segments are (i) Retail banking, (ii) Middle-market, (iii) Global Corporate Banking and (iv) Corporate Activities (“Other”). See “Note 3—Reporting Segments” of our Audited Consolidated Financial Statements for more information.

 

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Results of Operations for the Years Ended December 31, 2017, 2016 and 2015

 

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 IFRS as issued by the IASB. The following table sets forth the principal components of our net income for the years ended December 31, 2017, 2016 and 2015.

 

  

2017 

 

2017 

 

2016 

 

2015 

      
CONSOLIDATED INCOME STATEMENT DATA  (ThU.S.$)(1)  (Ch$ million)  % Change
2017/2016
  % Change
2016/2015
IFRS:                  
Interest income and expense                  
Interest income    3,337,028    2,058,446    2,137,044    2,085,988    (3.7%)   2.4%
Interest expense    (1,186,277)   (731,755)   (855,678)   (830,782)   (14.5%)   3.0%
Net interest income    2,150,751    1,326,691    1,281,366    1,255,206    3.5%   2.1%
Fees and income from services                              
Fees and commission income    738,523    455,558    431,184    402,900    5.7%   7.0%
Fees and commission expense    (286,123)   (176,495)   (176,760)   (165,273)   (0.1%)   7.0%
Total net fees and commission income    452,400    279,063    254,424    237,627    9.7%   7.1%
Financial transactions, net                              
Net income (expense) from financial operations    4,533    2,796    (367,034)   (457,897)   (100.8%)   (19.8%)
Net foreign exchange gain    205,813    126,956    507,392    603,396    (75.0%)   (15.9%)
Financial transactions, net    210,346    129,752    140,358    145,499    (7.6%)   (3.5%)
Other operating income    100,537    62,016    6,427    6,439    864.9%   (0.2%)
Net operating profit before provision for loan losses    2,914,034    1,797,522    1,682,575    1,644,771    6.8%   2.3%
Provision for loan losses    (489,998)   (302,255)   (342,083)   (399,277)   (11.6%)   (14.3%)
Net operating profit    2,424,036    1,495,267    1,340,492    1,245,494    11.5%   7.6%
Operating expenses                               
Personnel salaries and expenses    (643,539)   (396,967)   (395,133)   (387,063)   0.5%   2.1%
Administrative expenses    (373,029)   (230,103)   (226,413)   (220,531)   1.6%   2.7%
Depreciation and amortization    (126,162)   (77,823)   (65,359)   (53,614)   19.1%   21.9%
Impairment of property, plant and equipment    (9,150)   (5,644)   (234)   (21)   2312.0%   1014.3%
Other operating expenses    (110,907)   (68,413)   (68,902)   (58,729)   (0.7%)   17.3%
Total operating expenses    (1,262,787)   (778,950)   (756,041)   (719,958)   3.0%   5.0%
Net Operating income    1,161,249    716,317    584,451    525,536    22.6%   11.2%
Income from investments in associates and other companies    6,425    3,963    3,012    2,588    31.6%   16.4%
Income before tax    1,167,674    720,280    587,463    528,124    22.6%   11.2%
Income tax expense    (235,116)   (145,031)   (109,031)   (76,395)   33.0%   42.7%
Consolidated Net income for the year    932,558    575,249    478,432    451,729    20.2%   5.9%
Net income for the year attributable to:                              
Equity holders of the Bank    912,379    562,801    476,067    448,466    18.2%   6.2%
Non-controlling interests    20,180    12,448    2,365    3,263    426.3%   (27.5%)

 

 

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2017 have been translated from Chilean pesos at the exchange rate of Ch$616.85 = U.S.$1.00 as of December 31, 2017. See “Item 3. Key Information—A. Selected Financial Data—Exchange Rates” for more information on exchange rate.

 

Results of operations for the years ended December 31, 2017 and 2016. Consolidated net income for the year ended December 31, 2017 increased 20.2% to Ch$575,249 million. Our return on annualized average equity was 19.2% in 2017 compared to 16.8% in 2016.

 

In 2017, net operating profit before loan losses was Ch$1,797,522 million, an increase of 6.8% compared to 2016. Our net interest income increased 3.5% to Ch$1,326,691 million in 2017 compared to 2016.

 

Our net interest income increased 3.5% in 2017 compared to 2016. Our net interest margin remained stable at 4.3% in 2017 compared to 2016. The negative impact of lower inflation was offset by a higher yielding loan mix and lower funding costs as short-term interest rates declined in the year.

 

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Net fees and commission income increased 9.7% to Ch$279,063 million in the twelve-month period ended December 31, 2017 compared to the same period in 2016. In 2017, the Bank continued to experience positive client base and product usage growth. Fees from Retail banking increased 4.9% in 2017 compared to 2016. Total retail clients with a checking account increased 5.6% to 896,144. This has led to high fee growth among retail bank clients, especially cards, insurance brokerage, brokerage of asset management products and checking accounts. The 17.6% increase in fees from the Middle-market segment was mainly due to the positive expansion of business volumes in this segment from greater client loyalty and product usage. Also, this segment’s client base grew as SME clients graduated into this segment. Fees from the Global corporate banking segment increased 10.2% in 2017 compared to 2016, mainly due to cash management services, financial advisory and investment banking fees.

 

Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain (loss), totaled Ch$129,752 million in the year ended December 31, 2017, a decrease of 7.6% compared to the same period in 2016. These results include the results of our Treasury Division’s transactions with customers, as well as the results of our non-client treasury operations, mainly the Financial Management Division. Client treasury services totaled Ch$82,039 million, a decrease of 8.6% compared to 2016. The results from client treasury products and market-making mainly include the results from the sale of derivatives, foreign exchange and fixed income instruments to our client base. In 2017, the results from client treasury products decreased 2.0%. The appreciation of the peso and lower market volatility led to lower demand for hedging from our Corporate and Middle-market clients. The results from market-making with client services decreased 23.7% in 2017, mainly due to a decrease in business volumes of tailor-made treasury services and cash management sold to specific corporate clients. These results may vary year-to-year as some large operations with corporate clients may not be repeated in subsequent years.

 

The results from non-client treasury income decreased 5.7% and totaled a gain of Ch$47,713 million in 2017 compared to Ch$50,572 million in 2016. These results include the income from sale of loans, including charged-off loans, proprietary trading and the results from our Financial Management Division. In 2017, income from the Bank’s Financial Management Division decreased 3.1% to Ch$45,018 million. This decrease in results was mainly due to lower realized gains from our available-for-sale portfolio.

 

Other operating income totaled a gain of Ch$62,016 million in the year ended December 31, 2017, a 864.9% increase compared to 2016 mainly due to (i) an increase of 100.2% in the income from the assets received in lieu of payment and the recovery of assets previously charged-off, which totaled Ch$ 3,330 million in 2017 (ii) a reversal of provisions for non-credit contingencies and (iii) an extraordinary income from the sale of property for Ch$20,663 million from the sale of repossessed assets by Bansa S.A., a company that is consolidated by the Bank due to control, but not owned. For the purposes of consolidation, this one-time income forms part of the net income attributable to minority interest and has no impact on net income attributable to shareholders or shareholders’ equity.

 

Provisions for loan losses, net of recoveries totaled Ch$302,255 million in 2017 and decreased 11.6% compared to the amount of provisions recorded in 2016. Net provisions expense from retail banking decreased 9.2% in 2017 compared to 2016. This is in line with our strategy of focusing on higher income clients, net of risk for loans for individuals which has led to less provisions for loan losses and the reversal of provision due to the calibration of the consumer provisioning model. This was partially offset by the negative impact of slower economic growth and rising unemployment on consumer asset quality and the greater provision expense recognized in commercial loans analyzed on a group basis due to the recalibration of the provisioning model.

 

Net provision expense from the Middle-market segment decreased by 28.1% in 2017 due to the improvement in asset quality, compensated by an increase of 5.9% in the loan portfolio.

 

Net provision expense from Global corporate banking totaled a release of provisions of Ch$6,440 million, a 15.0% decrease from the release of provisions in 2016 due to a 23.0% decrease in the loan portfolio in this segment as the Bank focused on non-lending products, such as cash management, that generate a higher return than lending in this segment.

 

As a result of the factors mentioned above, net operating profit increased 11.5% in 2017 compared to 2016 and totaled Ch$1,495,267 million.

 

Operating expenses in the year ended December 31, 2017 increased 3.0% compared to the corresponding period in 2016. The efficiency ratio was 44.3% in 2017, 44.9% in 2016 and 43.8% in 2015.

 

The 0.5% increase in personnel salaries and expenses was below the CPI inflation of 2.3%, even though all salaries are indexed to inflation pursuant to the collective bargaining agreement. This was mainly due to the 2.5% reduction in headcount in December 2017.

 

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Administrative expenses increased 1.6% in the year ended December 31, 2017 compared to the corresponding period in 2016, mainly due to IT investments to develop the Bank’s digital platform, which is allowing the Bank to consolidate the branches and create efficiencies in the long term. This has led to a 11.3% decrease in the number of branches in the period. The Bank has also been reducing the ATM network from 1,295 to 926.

 

Depreciation and amortization expense increased 19.1% in 2017 compared to 2016 and totaled Ch$77,823 million. This expense is in line with the greater investments in software, hardware and other equipment that the Bank has invested in as it modernizes its branch network and systems. This has also led to an increase in impairment charges to Ch$ 5,644 million in 2017 compared to Ch$234 million in 2016 mainly related to obsolete fixed asset in remodeled branches.

 

Other operating expenses were Ch$68,413 million in 2017, a 0.7% decrease compared to 2016. This was mainly due to lower operational charge-offs.

 

Total income tax expense by the Bank in 2017 totaled Ch$145,031 million, a 33.0% increase compared to 2016. The Bank paid an effective tax rate of 20.1% in 2017 compared to 18.6% in 2016. The higher effective tax rate was mainly due to the fact that the statutory corporate tax rate increased from 24.0% in 2016 to 25.5% in 2017.

 

Net interest income

 

   Year ended December 31,  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$, except percentages)
Retail banking    970,332    931,105    873,026    4.2%   6.7%
Middle-market    264,663    244,960    229,812    8.0%   6.6%
Total commercial banking    1,234,995    1,176,065    1,102,838    5.0%   6.6%
Global corporate banking    100,808    95,105    85,553    6.0%   11.2%
Total reporting segments    1,335,803    1,271,170    1,188,391    5.1%   7.0%
Other (1)    (9,112)   10,196    66,815    (189.4%)   (84.7%)
Net interest income    1,326,691    1,281,366    1,255,206    3.5%   2.1%
Average interest-earning assets    30,595,059    29,671,311    28,523,005    3.1%   4.0%
Average non-interest-bearing demand deposits    6,117,644    5,753,622    5,719,889    6.3%   0.6%
Net interest margin (2)    4.34%   4.32%   4.40%          
Average shareholders’ equity and average non-interest-bearing demand deposits to total average interest-earning assets    29.8%   29.0%   29.9%          

 

 

 

(1)Consists mainly of net interest income from the Financial Management Division and the cost of funding our fixed income trading portfolio. Each segment obtains funding from its clients. Any surplus deposits are transferred to the Financial Management Division, which in turn makes such excess available to other areas that need funding. The Financial Management Division also sells the funds it obtains in the institutional funding market at a transfer price equal to the market price of the funds. This segment also includes intra-segment income and activities not assigned to a given segment or product line.

 

(2)Net interest margin is net interest income divided by average interest-earning assets.

 

For the years ended December 31, 2017 and 2016 our net interest income totaled Ch$1,326,691 million in the year ended December 31, 2017, an increase of 3.5% from Ch$1,281,366 million in 2016. Average interest earning assets increased 3.1% in the same period, driven mainly by lending in the Retail banking and Middle-market segments. While net interest income from our reporting segments grew 5.1% during 2017 driven by loan growth, a higher yielding loan mix and cheaper funding mix, the total net interest margin remained stable at 4.3% due to the lower UF inflation in 2017. Because the Bank has more interest earning assets indexed to the UF than interest bearing liabilities, any decline in inflation adversely affects our net interest margin. The lower inflation rate in 2017 compared to 2016 caused our average nominal interest rate earned on interest earning assets indexed to the UF to decrease from 6.6% in 2016 to 5.4% in 2017.

 

The average nominal interest rate for interest earning assets denominated in pesos decreased from 9.9% in 2016 to 9.6% in 2017 due to the decrease in the Central Bank’s short-term rate during the year which also led to a lower cost of funding with the average nominal rate for interest bearing liabilities denominated in pesos decreasing from 4.7% in 2016 to 3.6% in 2017.

 

Average nominal interest rate earned on interest earning assets  2017  2016  2015
Ch$    9.6%   9.9%   9.6%
UF    5.4%   6.6%   7.6%
Foreign currencies    2.7%   2.1%   1.8%
Total    6.7%   7.2%   7.3%

 

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The average rate paid on our interest bearing liabilities decreased to 3.3% in 2017 from 3.9% in 2016. This was mainly due to a lower rate paid on UF denominated liabilities as a result of the lower UF inflation in the year, which decreased to 4.4% in 2017 compared to 5.6% in 2016. This partially offset the negative impact of inflation on the interest earning assets. The decrease in the average rate paid on interest bearing liabilities was also due to the effect of the decrease in the short term central bank rates on peso denominated liabilities.

 

Average nominal interest rate paid on interest bearing liabilities  2017  2016  2015
Ch$    3.6%   4.7%   4.4%
UF    4.4%   5.6%   7.2%
Foreign currencies    1.5%   1.1%   1.3%
Total    3.3%   3.9%   4.0%

 

The changes in net interest income by segment in 2017 as compared to 2016 were as follows:

 

·Net interest income from Retail banking increased 4.2%, mainly as a result of the 3.3% increase in loan volumes in this segment, lower funding costs and an increase in the average yield obtained over consumer loans from 13.9% in 2016 to 14.9% in 2017.

 

·Net interest income from the Middle-market segment increased 8.0% in 2016, higher than the loan growth of 5.9% in this segment due to improvements in funding costs. Loan growth has been more selective, focusing on the potential return net of risk with a focus on cash management which is positive for margin growth, such as the spread between the rate on deposits and the Central Bank rate.

 

·The focus for Global corporate banking was on growth of non-lending products especially cash management which generates a higher return than lending in this segment. This led to an increase in net interest income of 6.0% in 2017 despite a 23.0% decrease in loan volumes as a result of lower loan demand due to the slower economy and the Bank avoiding growth in low yielding loans.

 

·Other net interest income consists mainly of net interest income from the Bank’s ALCO, which includes the available-for-sale investment portfolio, deposits in the Central Bank, the financial cost of supporting our cash position and investment portfolio for trading, the interest income from which is recognized as net income from financial operations and not interest income. The result of the Bank’s inflation gap is also included in this line. The net interest income included as “other” decreased from a gain of Ch$10,196 million in 2016 to a loss of Ch$9,112 million in 2017. This was due to the lower inflation rate in 2017. As the Bank has more assets than liabilities linked to inflation when inflation decreases, margins also decrease. Other interest income also includes the cost of liquidity which is a net interest expense for the Bank.

 

The following table shows our balances of loans and accounts receivable from customers and interbank loans by segment at the dates indicated.

 

   At December 31,  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$, except percentages)
Retail banking    19,223,169    18,604,936    17,034,707    3.3%   9.2%
Middle-market    6,775,734    6,396,376    6,006,282    5.9%   6.5%
Global corporate banking    1,633,796    2,121,513    2,178,643    (23.0%)   (2.6%)
Other (1)    83,215    83,606    81,125    (0.5%)   3.1%
Total loans    27,715,914    27,206,431    25,300,757    1.9%   7.5%

 

 

 

(1)Includes interbank loans.

 

For the years ended December 31, 2016 and 2015. Our net interest income totaled Ch$1,281,366 million in the year ended December 31, 2016, an increase of 2.1% from Ch$1,255,206 million in 2015. Average interest earning assets increased 4.0% in the same period, driven mainly by lending in the Retail banking and Middle-market segments. While interest income from our reporting segments grew 7.0% during 2016, net interest margin in 2016

 

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decreased to 4.3% compared to 4.4% in 2015 due to the lower UF inflation in 2016. Because the Bank has more interest earning assets indexed to the UF than interest bearing liabilities, the lower inflation rate in 2016 compared to 2015 caused our average nominal interest rate earned on interest earning assets indexed to the UF to decrease from 7.6% in 2015 to 6.6% in 2016.

 

The average nominal interest rate for interest earning assets denominated in pesos increased from 9.6% in 2015 to 9.9% in 2016, while the average nominal rate for interest bearing liabilities denominated in pesos also increased from 4.4% in 2015 to 4.7% in 2016.

 

The average rate paid on our interest bearing liabilities decreased to 3.9% in 2016 from 4.0% in 2015. This was mainly due to a lower rate paid on UF denominated liabilities as a result of the lower UF inflation in the year, which decreased to 5.6% in 2016 compared to 7.2% in 2015. This partially offset the negative impact of inflation on the interest earning assets.

 

The changes in net interest income by segment in 2016 as compared to 2015 were as follows:

 

·Net interest income from Retail banking increased 6.7%, mainly as a result of the 9.2% increase in loan volumes in this segment. The Bank focused growth in the high end of this segment in order to focus on margins net of risks, especially considering that in 2016 economic growth continued to slow. As a result, the highest growing loan product was residential mortgage loans that have a lower yield compared to other retail loans.

 

·Net interest income from the Middle-market segment increased 6.6% in 2016, mainly as a result of stable loan growth of 6.5% in this segment. Loan growth has been more selective, focusing on the potential return net of risk with a focus on non-lending products which are positive for margin growth, such as the spread between the rate on deposits and the Central Bank rate.

 

·The focus for Global corporate banking was on growth of non-lending products especially cash management which generates a higher return than lending in this segment. This led to an increase in net interest income of 11.2% in 2016 despite a 2.6% decrease in loan volumes.

 

·Other net interest income consists mainly of net interest income from the Bank’s ALCO, which includes the available-for-sale investment portfolio, deposits in the Central Bank, the financial cost of supporting our cash position and investment portfolio for trading, the interest income from which is recognized as net income from financial operations and not interest income. The result of the Bank’s inflation gap is also included in this line. The net interest income included as “other” decreased from a gain of Ch$66,815 million in 2015 to a gain of Ch$10,196 million in 2016. This was due to the lower inflation rate in 2016 and lower interest income from the Bank’s liquidity position as well as the gradual introduction of Basel III liquidity requirements, which led the Bank to take more investments with higher liquidity and shorter maturities that have a lower yield.

 

Fee and commission income

 

For the years ended December 31, 2017 and 2016. Net fees and commission income increased 9.7% to Ch$279,063 million in the twelve-month period ended December 31, 2017 compared to the same period in 2016. 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, 2017, 2016, and 2015.

 

   Year ended December 31,  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Credit, debit and ATM cards    51,982    52,057    46,066    (0.1%)   13.0%
Collections    44,312    31,376    30,399    41.2%   3.2%
Insurance brokerage    36,430    40,882    39,252    (10.9%)   4.2%
Letters of credit    33,882    35,911    35,276    (5.7%)   1.8%
Checking accounts    31,901    31,540    30,291    1.1%   4.1%
Custody and brokerage services    9,232    8,358    8,685    10.5%   (3.8%)
Lines of credit    7,413    5,754    6,597    28.8%   (12.8%)
Others    63,911    48,546    41,061    31.7%   18.2%
Total fees and commission income, net    279,063    254,424    237,627    9.7%   7.1%

 

 

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Fees from credit, debit and ATM cards decreased slightly by 0.1% in 2017, reflecting the reductions made to the ATM network during the period. This was partially offset by the positive growth of the usage of the Bank’s credit and debit cards. Active credit cards totaled 1.9 million by year-end 2017 with monetary purchases increasing by 6.8% in the year.

 

Fees from collections increased by 41.2% in 2017 compared to 2016 due to a growth in loan volumes, particularly in mortgage loans. This line item includes, among other items, fees collected on behalf of insurance companies for fire and earthquake insurance that are mandatory with mortgage loans for which we negotiated better terms with the insurance providers during the year.

 

Insurance brokerage fees decreased 10.9% due to more competition and a slower economy.

 

Fees from letters of credit and other contingent operations decreased 5.7% in 2017, mainly due to less international and foreign trade financing business with clients during the year.

 

Fees from checking accounts increased 1.1% in 2017 compared to 2016. This was mainly due to a rise in the Bank’s checking account base. The number of clients with a checking account increased 5.6% to 896,144. Combined with this an increase in corporate cash management services also boosted fee growth in this product.

 

Brokerage and custody fees increased 10.5% in 2017 as compared to 2016 due to higher trading volumes in local equity market during 2017.

 

Fees from lines of credit increased 28.8% due to greater cross-selling of this product among checking account holders.

 

The rise in other fee income of 31.7% in 2017 compared to 2016 was mainly due to higher fees from the brokerage of asset management services. In December 2013, our Asset Management business was sold. The Bank is no longer in the asset management business, but serves as an exclusive broker for Santander Asset Management, the acquirer of our asset management business. In 2017, asset management brokerage fees totaled Ch$43,331 million and increased 13.3% compared to 2016. Other fees also include fees from our Global corporate banking segment, which include financial advisory and investment banking.

 

The following table sets forth, for the periods indicated our fee income broken down by segment and sub-segment for the periods indicated:

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Retail banking   206,449    196,845    190,380    4.9%   3.4%
Middle-market   36,280    30,851    28,537    17.6%   8.1%
Global corporate banking   27,626    25,077    15,231    10.2%   64.6%%
Other   8,708    1,651    3,479    427.4%   (52.5%)
Total fees and commission income, net   279,063    254,424    237,627    9.7%   7.1%

 

Fees from Retail banking increased 4.9% in 2017 compared to 2016. Total retail clients with a checking account increased 5.6% to 896,144. In 2017, the Bank continued to experience positive client base and product growth that drove fee growth in various products. Internally, we measure the quantity of products that a client uses and identify them as a loyal customer when they meet certain internal criteria for their segment. Client loyalty continues to rise in retail banking, especially among high income earners, which was the area we focused on growing given the low growth environment. Loyal individual customers (clients with >4 products plus minimum usage and profitability

 

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levels) in the high-income segment grew 9.5% during 2017. This has led to high fee growth among retail bank clients, especially cards, insurance brokerage, brokerage of asset management products and checking accounts.

 

The 17.6% increase in fees from the Middle-market segment was mainly due to the positive expansion of business volumes in this segment from greater client loyalty and product usage. Loyal SME and Middle market companies, defined by client size using a point system that depends on the number of products, usage of products and income net of risk, rose 3.9% in 2017. This segment’s client base also grew as SME clients graduated into this segment.

 

Fees from the Global corporate banking segment increased 10.2% in 2017 compared to 2016, mainly due to cash management services, financial advisory and investment banking fees.

 

Fees in Other increased 427.4% from Ch$1,651 million in 2016 to Ch$8,708 million in 2017 due to a higher rebate paid by insurance companies we broker for after a successful renegotiation of terms and conditions with them.

 

For the years ended December 31, 2016 and 2015. Net fees and commission income increased 7.1% to Ch$254,424 million in the twelve-month period ended December 31, 2016 compared to the same period in 2015. In 2016, the Bank continued to experience positive client base and product growth that drove fee growth in various products. Internally, we measure the quantity of products that a client uses and identify them as a loyal customer when they meet certain internal criteria for their segment. For example, loyal individual customers use four products and have a minimum profitability level and a minimum usage indicator. For SMEs and Middle-market customers, cross-selling is differentiated by client size using a point system that depends on the number of products, usage of products and income net of risk. According to this measurement, the number of loyal high-income clients increased 6.5% and the number of loyal SMEs and middle-market clients increased by 13.8% during 2016.

 

Fees from credit, debit and ATM cards increased by 13.0% in 2016, reflecting the positive growth of the usage of the Bank’s credit and debit cards. Active credit cards totaled 2,002,998 as of November 2016, the latest market data available, and increased 3.3% compared to the same period in 2015. In the second half of 2015, our contract with Redbank, an ATM services provider, was renegotiated, which led to higher interbank fees charged for ATM usage for the second half of 2015 and the year 2016.

 

Fees from collections increased by 3.2% in 2016 compared to 2015 due to a growth in loan volumes, particularly in mortgage loans. This line item includes, among other items, fees collected on behalf of insurance companies for fire and earthquake insurance that are mandatory with mortgage loans.

 

Insurance brokerage fees increased 4.2% due to higher sales volume from cross-selling of insurance products to customers.

 

Fees from letters of credit and other contingent operations increased 1.8% in 2016. This increase was mainly due to growth of our international and foreign trade financing businesses with clients.

 

Fees from checking accounts increased 4.1% in 2016 compared to 2015. This was mainly due to a rise in the Bank’s checking account base. The amount of retail banking clients with a checking account rose 4.3% in 2016, totaling 844,971. Combined with this an increase in corporate cash management services also boosted fee growth in this product.

 

Brokerage and custody fees decreased 3.8% in 2016 as compared to 2015 due to weak trading volumes in local equity market during 2016.

 

Fees from lines of credit decreased 12.8% as there was a switch from clients using credit lines to credit cards and other facilities offered by online banking.

 

The rise in other fee income of 18.2% in 2016 compared to 2015 was mainly due to higher fees from the brokerage of asset management services. In December 2013, our Asset Management business was sold. The Bank is no longer in the asset management business, but serves as an exclusive broker for Santander Asset Management, the acquirer of our asset management business. In 2016, asset management brokerage fees totaled Ch$38,244 million and increased 5.7% compared to 2015. Other fees also include fees from our Global corporate banking segment. The positive growth of our client loyalty in this segment led to higher advisory fees in global transactional banking.

 

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Fees from Retail banking increased 3.4% in 2016 compared to 2015. Since mid-2013, the Bank has been executing a profound overhaul of its Client Relationship Management (CRM) systems, client service and other changes to its commercial team front-office functions, which has continued to increase product sales and usage. This has led to high fee growth among retail bank clients, especially cards, insurance brokerage, brokerage of asset management products and checking accounts. Total retail clients reached 3.58 million at year-end 2016 and total retail clients with a checking account increased 4.3% to 844,971. Loyal retail clients increased 7.7% to 600,132 by year-end 2016.

 

The 8.1% increase in fees from the Middle-market segment was mainly due to the positive expansion of business volumes in this segment from greater client loyalty and product usage.

 

Fees from the Global corporate banking segment increased 64.6% in 2016 compared to 2015. In 2016, the Bank won an important share of the investment banking, cash management and advisory services for the large projects being developed in Chile.

 

Fees in Other decreased 52.5% from Ch$3,479 million in 2015 to Ch$1,651 million in 2016 due to distributing more fee and commission income among segments.

 

Financial transactions, net

 

The following table sets forth information regarding our income (loss) from financial transactions for the years ended December 31, 2017, 2016 and 2015.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Net income from financial operations    2,796    (367,034)   (457,897)   100.8%   19.8%
Foreign exchange gain, net    126,956    507,392    603,396    (75.0%)   (15.9%)
Total financial transactions, net    129,752    140,358    145,499    (7.6%)   (3.5%)

 

For the years ended December 31, 2017 and 2016. Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain, totaled Ch$129,752 million in the year ended December 31, 2017, a decrease of 7.6% compared to the same period in 2016. These results include the results of our Treasury Division’s trading business and financial transactions with customers, as well as the results of our Financial Management Division.

 

Internal Bank policy does not allow significant foreign currency mismatches and requires that the results included in Total financial transactions, net include not only the market-to-market of our foreign currency spot position, but also the results of the derivatives used to hedge currency risk. The mark-to-market of our spot position is included in the line item Foreign exchange gain, net along with the effect of those derivatives accounted for under hedge accounting rules. The derivatives used to hedge foreign currency risk but which are classified as trading are included in the line item Net income from financial operations. For more details regarding our management and exposure to foreign currency risk, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk—E. Market Risks—Market risk management— Market risk – local and foreign financial management.”

 

The results from net income (loss) from financial operations totaled a gain of Ch$2,796 million in 2016 compared to a loss of Ch$367,034 million in 2016.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Derivatives classified as trading    (18,974)   (395,209)   (503,981)   95.2%   21.6%
Trading investments    10,008    18,229    21,505    (45.1%)   (15.2%)
Sale of loans    6,040    4,190    863    44.2%   385.5%
Available-for-sale instruments sales    8,956    14,598    23,655    (38.6%)   (38.3%)
Other results    (3,234)   (8,842)   61    63.4%   (14,595.1%)
Net income (loss) from financial operations    2,796    (367,034)   (457,897)   100.8%   19.8%

 

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The income from financial operations in 2017 compared to a loss in 2016 was mainly due to:

 

(i)Lesser losses in the sub-item derivatives classified as trading. In 2017, the average yearly exchange rate appreciated 4.1% compared to a depreciation of 3.5% in 2016 with the appreciation of the peso mainly occurring at year-end 2017. Movements in foreign currency affect this line item because it includes the valuation adjustments of our derivatives classified as trading. We use derivatives classified as trading, mainly forwards and cross-currency swaps, to hedge the net foreign currency spot position between short-term assets and short-term liabilities. On average, the Bank has more short-term assets, such as U.S. dollars invested in overnight, than short-term deposits in U.S. dollars, so we usually have a short-term foreign currency liability hedge position classified as trading. The average exchange rate appreciated 4.1% in 2017, producing a lower loss in derivatives classified as trading especially at year-end 2017 when the peso appreciated strongly against the U.S. dollar.

 

(ii)The 45.1% lower gain from trading investments was mainly due to the lower UF inflation rate in 2017 compared to 2016. In this line item the mark-to-market and interest income of the trading fixed income portfolio are recognized. In 2017, the lower UF inflation decreased interest from this portfolio, which is mainly comprised of Central Bank instruments denominated in UF.

 

(iii)The results from our available-for-sale portfolio decreased 38.6% in 2017 compared to 2016 due to lower realized gains from our available for sale portfolio.

 

(iv)The loss in other results of Ch$3,234 million in 2017 was due to results from the partial repurchase of senior bonds during the year. See Note 18 – issued debt instruments and other financial liabilities – b) Senior bonds in the Audited Consolidated Financial Statements.

 

The net result from foreign exchange transactions totaled a gain of Ch$126,956 million in 2017 compared to Ch$507,392 million in 2016.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Net profit or loss from foreign currency exchange differences    113,115    116,117    (197,875)   (2.6%)   158.7%
Hedge-accounting derivatives    22,933    399,875    777,254    (94.3%)   (48.6%)
Translation gains and losses over assets and liabilities indexed to foreign currencies, net    (9,092)   (8,600)   24,017    5.7%   (135.8%)
Net results from foreign exchange gain    126,956    507,392    603,396    (75.0%)   (15.9%)

 

Included in these results is the sub-item Net profit or loss from foreign currency exchange differences which totaled a gain of Ch$113,115 million in 2017 compared to Ch$116,117 million in 2016. This result includes the mark-to-market of the Bank’s spot position and results from our client foreign currency business, such as currency transactions and market making. The lower market- making FX transactions and the appreciation of the peso lowered this result.

 

Results from the sub-item hedge-accounting derivative are mainly comprised of the mark-to-market of derivatives that are used to mainly hedge the foreign currency risk of our long-term foreign currency funding. Therefore, we generally have a net foreign currency position in our hedge-accounting derivatives. These are mainly cross-currency swaps that are accounted under hedge accounting rules. These derivatives produced a gain of Ch$22,933 million in 2017. This gain was lower than in 2016 due to the appreciation of the peso in 4Q17.

 

Finally, the Bank has some assets and liabilities that are in Chilean pesos, but indexed to foreign currency. This position produced a translation loss in 2017 of Ch$9,092 million. This exposure is also hedged.

 

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In order to more easily compare the results from financial transactions, net, we present the following table that separates the results by lines of business for 2017, 2016 and 2015.

 

   Year ended December 31,  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Client treasury products    61,156    62,404    60,995    (2.0%)   2.3%
Market-making with clients    20,883    27,382    22,850    (23.7%)   19.8%
Client treasury services    82,039    89,786    83,845    (8.6%)   7.1%
Sale of loans and charged-off loans    6,040    4,190    863    44.2%   3 85.5% 
Proprietary trading and CVA adjustments    (3,345)   (94)   (567)   3458.3%   83.5%
Financial Management Division and others (1)    45,018    46,475    61,358    (3.1%)   (24.3%)
Non-client treasury income (loss)    47,713    50,572    61,654    (5.7%)   (18.0%)
Total financial transactions, net    129,752    140,358    145,499    (7.6%)   (3.5%)

 

 

 

(1)The Financial Management Division manages the structural interest rate risk, the structural position in inflation-indexed assets and liabilities, capital requirements and liquidity levels. The aim of the Financial Management Division is to provide stability and continuity in our net interest income from commercial activities, and to ensure that we comply with internal and regulatory limits regarding liquidity, regulatory capital, reserve requirements and market risk.

 

Client treasury services totaled Ch$82,039 million, a decrease of 8.6% compared to 2016. The results from client treasury products and market-making mainly include the results from the sale of derivatives, foreign exchange and fixed income instruments to our client base. In 2017, the results from client treasury products decreased 2.0%. The appreciation of the peso and lower market volatility led to lower demand for hedging from our Corporate and Middle-market clients. The results from market-making with client services decreased 23.7% in 2017, mainly due to a decrease in business volumes of tailor-made treasury services and cash management sold to specific corporate clients. These results may vary year-to-year as some large operations with corporate clients may not be repeated in subsequent years.

 

The results from non-client treasury income decreased 5.7% and totaled a gain of Ch$47,713 million in 2017 compared to Ch$50,572 million in 2016. These results include the income from sale of loans, including charged-off loans, proprietary trading and the results from our Financial Management Division.

 

The results from the sale of loans increased to Ch$6,040 million in 2017. The results from proprietary trading and Credit Value Adjustments totaled a loss of Ch$3,345 million. This was mainly due to a higher loss from CVA adjustments of our derivative portfolio, which totaled Ch$2,821 million. This is included in this line item, since the CVA generated by derivatives taken for hedging and on behalf of clients is not part of client income or part of Financial Management’s profit and loss. Since year-end 2012, the Bank no longer has a proprietary trading area and the results from proprietary trading are from residual positions that are being closed.

 

In 2017, income from the Bank’s Financial Management Division decreased 3.1% to Ch$45,018 million. This department manages the structural interest rate risk, the structural position in inflation-indexed assets and liabilities, capital requirements and liquidity levels. The aim of the Financial Management Division is to provide stability and continuity in our net interest income from commercial activities, and to ensure that we comply with internal and regulatory limits regarding liquidity, regulatory capital, reserve requirements and market risk. This decrease in results was mainly due to lower realized gains from our available-for-sale portfolio. The results from Financial Management Division also include the offset of the foreign currency exposure hedging on provision expenses for loans denominated in U.S. dollars. As the peso appreciated against the dollar, this lowered the provision expense for our loans in U.S. dollars and had a corresponding offset loss recognized by financial management in this line.

 

For the years ended December 31, 2016 and 2015. Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain, totaled Ch$140,358 million in the year ended December 31, 2016, a decrease of 3.5% compared to the same period in 2015. These results include the results of our Treasury Division’s trading business and financial transactions with customers, as well as the results of our Financial Management Division.

 

The results from net income (loss) from financial operations totaled a loss of Ch$367,034 million in 2016 compared to a loss of Ch$457,897 million in 2015.

 

 

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The lower loss from financial operations in 2016 compared to 2015 was mainly due to:

 

(v)Lesser losses in the sub-item derivatives classified as trading. In 2016, the average yearly exchange rate depreciated 3.5% compared to 14.8% in 2015. Movements in foreign currency affect this line item because it includes the valuation adjustments of our derivatives classified as trading. We use derivatives classified as trading, mainly forwards and cross-currency swaps, to hedge the net foreign currency spot position between short-term assets and liabilities. On average, the Bank has more short-term assets, such as U.S. dollars invested in overnight, than short-term deposits in U.S. dollars. The average exchange rate depreciated 3.5% in 2016, producing a loss in derivatives classified as trading. This loss was lower than in 2015, since the average depreciation rate was lower in 2016 against 2015.

 

(vi)The 15.2% lower gain from trading investments was mainly due to the lower UF inflation rate in 2016 compared to 2015. In this line item the mark-to-market and interest income of the trading fixed income portfolio are recognized. In 2016, the lower UF inflation decreased interest from this portfolio, which is mainly comprised of Central Bank instruments denominated in UF.

 

(vii)The results from our available-for-sale portfolio decreased 38.3% in 2016 compared to 2015. The results for 2015 were very high due to gains realized when interest rates fell abruptly in the first quarter of 2015; this situation was not repeated in 2016.

 

(viii)The loss in other results of Ch$8,842 million in 2016 was due to the effect of depreciation in the average exchange rate on the partial repurchase of senior bonds during the year. See Note 18 – issued debt instruments and other financial liabilities – b) Senior bonds in the Audited Consolidated Financial Statements.

 

The net result from foreign exchange transactions totaled a gain of Ch$507,392 million in 2016 compared to Ch$603,396 million in 2015.

 

Included in these results is the sub-item Net profit or loss from foreign currency exchange differences which totaled a gain of Ch$116,117 million in 2016 compared to a loss of Ch$197,875 million in 2015. This result includes the mark-to-market of the Bank’s spot position and results from our client foreign currency business, such as currency transactions and market making. The lower rate of average depreciation of the peso in 2016 compared to 2015 and the increase in client currency transactions resulted in a higher result in this sub-item compared to 2015.

 

Results from the sub-item hedge-accounting derivative that are used to hedge the foreign currency risk of our long-term foreign currency funding. These are mainly cross-currency swaps that are accounted under hedge accounting rules. These derivatives produced a gain of Ch$399,875 million in 2016 attributable to the average depreciation of the peso in the year. This gain was lower than in 2015 due to the lower rate of depreciation in 2016 compared to 2015.

 

Finally, the Bank has some assets and liabilities that are in Chilean pesos, but indexed to foreign currency. This position produced a translation loss in 2016 of Ch$8,600 million. This exposure is also hedged.

 

Client treasury services totaled Ch$89,786 million, a gain of 7.1% compared to 2015. The results from Santander Global Connect and market-making mainly include the results from the sale of derivatives, foreign exchange and fixed income instruments to our client base. In 2016, the results from Santander Global Connect increased 2.3%. The depreciation of the peso and high market volatility led to a larger demand for hedging from our Corporate and Middle-market clients, driving this income line. The results from market-making with client services increased 19.8% in 2015, mainly due to a growth in business volumes of tailor-made treasury services and cash management sold to specific corporate clients. These results may vary year-to-year as some large operations with corporate clients may not be repeated in subsequent years.

 

The results from non-client treasury income decreased 18.0% and totaled a gain of Ch$50,572 million in 2016 compared to Ch$61,654 million in 2015. These results include the income from sale of loans, including charged-off loans, proprietary trading and the results from our Financial Management Division.

 

The results from the sale of loans increased to Ch$4,190 million in 2016. The results from proprietary trading totaled a loss of Ch$94 million. Since year-end 2012, the Bank no longer has a proprietary trading area and these results are from residual positions that are being closed.

 

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In 2016, income from the Bank’s Financial Management Division decreased 24.3% to Ch$46,475 million. This department manages the structural interest rate risk, the structural position in inflation-indexed assets and liabilities, capital requirements and liquidity levels. The aim of the Financial Management Division is to provide stability and continuity in our net interest income from commercial activities, and to ensure that we comply with internal and regulatory limits regarding liquidity, regulatory capital, reserve requirements and market risk. This decrease in results was mainly due to lower realized gains from our available-for-sale portfolio. The results from our available-for-sale portfolio decreased 38.3% in 2016 compared to 2015 and totaled Ch$14,598 million due to the significant decrease in long-term interest rates in the first quarter of 2015. The results from Financial Management Division also include the offset of the foreign currency exposure hedging on provision expenses for loans denominated in U.S. dollars.

 

Other operating income

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (In millions of Ch$)
Income from assets received in lieu of payment    3,330    1,663    2,455    100.2%   -32,3%
Net results from sale of investment in other companies    -      -      617    --%     --%  
Operational leases (as lessor)    264    519    708    (49.1%)   (26.7%)
Gain on sale of Bank property, plant and equipment    23,229    2,017    381    1051,7%   429.4%
Compensation from insurance companies due to damages    1,237    1,530    435    (19.2%)   251.7%
Other    33,956    698    1,843    77,2%   (62.1%)
Sub-total other income    58,686    4,764    3,984    1,131.9%   19,6%
Total other operating income    62,016    6,427    6,439    864.9%   (0.2%)

  

For the years ended December 31, 2017 and 2016. Total other operating income increased by 864.9% in 2017 compared to 2016 and totaled a gain of Ch$62,016 million mainly due to (i) an increase in the income from the assets received in lieu of payment and the recovery of assets previously charged-off (ii) a reversal of provisions for non-credit contingencies and (iii) an extraordinary income from the sale of property for Ch$20,663 million from the sale of repossessed assets by Bansa S.A. Bansa is a company that is consolidated by the Bank due to control in accordance with IFRS 10. For the purposes of consolidation, this one-time income forms part of the net income attributable to non-controlling interest and has no impact on net income attributable to shareholders or shareholders’ equity.

 

For the years ended December 31, 2016 and 2015. Total other operating income fell by 0.2% in 2016 compared to 2015 and totaled a gain of Ch$6,427 million mainly due to less income from assets received in lieu of payment partially offset by a larger gain from the sale of property as a result of the consolidation of our branch network. Also during 2016, there was a greater gain from the compensation from insurance companies due to damages claimed from natural disasters such as earthquakes.

 

Provision for loan losses

 

The following table sets forth, for the periods indicated, certain information relating to our provision for loan losses.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Provision for loan losses    (370,083)   (409,159)   (454,462)   (9.6%)   (10.0%)
Charge-off of loans analyzed on an individual basis    (15,699)   (11,222)   (12,955)   39.9%   13.4%
Recoveries on loans previously charged-off    83,527    78,298    68,140    6.7%   14.9%
Provision for loan losses, net    (302,255)   (342,083)   (399,277)   (11.6%)   (14.3%)
Year end loans (1)    27,725,914    27,206,431    25,300,757    1.9%   7.5%
Non-performing loans (2)    633,461    564,131    643,468    12.3%   (12.3%)
Impaired loans (3)    1,803,173    1,615,441    1,669,340    11.6%   (3.2%)
Allowance for loan losses (4)    791,157    790,605    762,301    0.1%   3.7%
Impaired loans / Year end loans (5)    6.50%   5.94%   6.60%          
Non-performing loans / Year end loans (2)    2.28%   2.07%   2.54%          
Allowances for loan losses / Total loans    2.85%   2.91%   3.01%          
Coverage ratio non-performing loans (5)    124.89%   140.15%   118.47%          
Non-performing loans / Year end loans (2)    2.28%   2.07%   2.54%          
Allowances for loan losses / Total loans    2.85%   2.91%   3.01%          
Coverage ratio non-performing loans (5)    124.89%   140.15%   118.47%          

 

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(1)Loans and accounts receivable from customers, including Ch$162,685 million in 2017, Ch$272,807 million in 2016 and Ch$10,877 million in 2015 in interbank loans.

 

(2)Non-performing loans include the aggregate unpaid principal and accrued but unpaid interest on all loans with at least one installment at least 90 days past-due.

 

(3)Impaired loans include: (a) for loans individually evaluated for impairment: (i) the carrying amount of all loans to clients that are rated C1 through C4, D1 and D2 and (ii) the carrying amount of all loans to an individual client with at least one non-performing loan (which is not a residential mortgage loan past due less than 90 days), regardless of category; and (b) for loans collectively evaluated for impairment, the carrying amount of all loans to a client, when at least one loan to that client is not performing or has been renegotiated. See “Note 9—Loans and Accounts Receivables from Customers—(a) Loans and accounts receivables from customers” in the Audited Consolidated Financial Statements.

 

(4)Allowance for loan losses for loans and accounts receivable from customers, including Ch$472 million in 2017, Ch$4,135 million in 2016 and Ch$1,166 million in 2015 in allowance for loan losses for interbank loans.

 

(5)Calculated as allowance for loan losses divided by non-performing loans.

 

For the years ended December 31, 2017 and 2016. Provisions for loan losses, net totaled Ch$302,255 million in 2017 and decreased 11.6% compared to the amount of provisions recorded in 2016.

 

Provision for loan losses, which includes the full amount of provisions recognized as a result of loan growth and change in risk classification as well as the net result of provisions and charge-offs of loans analyzed on a group basis, totaled Ch$370,083 million in 2017 compared to Ch$409,159 million in 2016 and decreased 9.6%. The following table breaks down provision for loans losses by loan product for the years ended December 31, 2017, 2016 and 2015.

 

   Year ended December 31,  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Interbank loans    3,663    (2,969)   (1,165)   --%    --% 
Commercial loans    (136,923)   (137,242)   (197,247)   (0.2%)   (30.4%)
Mortgage loans    (32,194)   (16,646)   (27,168)   93.4%   (38.7%)
Consumer loans    (205,949)   (249,754)   (230,811)   (17.5%)   8.2%
Contingent loans    1,320    (2,548)   1,929    --%    --%
Total(1)    (370,083)   (409,159)   (454,462)   (9.6%)   (10.0%)

 

 

 

(1)Includes the full amount of provisions recognized as a result of loan growth and change in risk classification as well as the net result of provisions and charge-offs of loans analyzed on a group basis

 

The provision expense for loan loss for commercial loans decreased from Ch$137,242 million in 2016 to Ch$136,923 million in 2017. The non-performing loan ratio of commercial loans reached 2.6% in 2017 compared to 2.3% in 2016 and the impaired loan ratio increased from 6.7% in 2016 to 7.3% in 2017. This can be explained by the 23.0% decrease in loan volumes in GCB, which have practically no non-performing loans and also the negative effects of a low growth economic environment over commercial loans, especially in the SME portfolio.

 

At the same time during September 2017, and as part of the normal process of updating the provisioning model for loans analyzed on a group basis, the Bank calibrated these models, incorporating a greater historical depth, including a recession period, thus strengthening the parameters of probability of default and loss given default. This calibration resulted in an increase in provisions associated with commercial loans analyzed on group basis of Ch$9,040 million.

 

Provisions for mortgage loans increased by 93.4% to Ch$32,194 million in 2017 compared to Ch$16,646 million in 2016. The non-performing ratio for mortgage loans increased to 1.8% in 2015 from 1.7% in 2016, however, the impaired mortgage loans ratio went up from 4.6% in 2016 to 4.4% in 2017.

 

At the same time during September 2017, and as part of the normal process of updating the provisioning model for loans analyzed on a group basis, the Bank calibrated the provisioning model for mortgage loans, incorporating a greater historical depth, including a recession period, thus strengthening the parameters of probability of default and loss given default. This calibration resulted in an increase in provisions associated with mortgage loans of Ch$8,161 million.

 

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 The provision expense for consumer loans decreased 17.5%. During September 2017, and as part of the normal process of updating the provisioning model for loans analyzed on a group basis, the Bank recalibrated these models, resulting in a decrease in provisions associated with consumer loans in the amount of Ch$19,499 million. Excluding this, the decrease in provision expense from consumer loans was 9.7%. This reduction was mainly due to the continued process of lowering our exposure to Santander Banefe, the brand aimed at the lower end of the consumer market, and increasing exposure to high-income earners. This was partially offset by the negative impact of slower economic growth and rising unemployment on consumer asset quality. The consumer non-performing loans ratio was 2.3% in 2017 compared to 2.2% in 2016. The impaired consumer loan ratio increased from 6.5% in 2016 to 7.2% in 2017.

 

For a description of the provisions related to our consumer loans, residential mortgage loans and commercial loans analyzed on a group basis, please see “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio—Classification of Loan Portfolio—Loans analyzed on a group basis—Allowances for residential mortgage loans” and “—Loans analyzed on a group basis.”

 

Additionally, the provisions for interbank loans totaled a reversal of Ch$3,663 million. This was due to the decline in interbank loans in the year.

 

Recoveries on loans previously charged-off increased 6.7% in 2017 compared to 2016. This was due to higher recoveries from charged-off commercial loans mainly due to improved recovery efforts. The following table shows recoveries of loans previously charged-off by type of loan.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Recovery of loans previously charged-off               
Consumer loans    39,972    41,072    35,565    (2.7%)   15.5%
Residential mortgage loans    10,942    10,041    6,543    9.0%   53.5%
Commercial loans    32,613    27,185    26,032    20.0%   4.4%
Total recoveries    83,527    78,298    68,140    6.7%   14.9%

 

In some instances, we will sell a portfolio of charged-off loans to a third party. Gain (loss) on these charged-off loans is recognized as net income from financial transactions as disclosed in “Note 27—Profit and Loss from Financial Operations” of our Audited Consolidated Financial Statements. The following table sets forth information about our sale of charged-off loans for the year ended December 31, 2017, 2016 and 2015.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Gains (losses) on sale of loans previously charged-off    3,020    2,720    (58)   11.0%   -% 

 

The following table sets forth, for the periods indicated, our net provision expense broken down by business segment:

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Retail banking    (293,956)   (323,888)   (332,657)   (9.2%)   (2.6%)
Middle-market    (19,235)   (26,748)   (26,147)   (28.1%)   2.3%
Global corporate banking    6,440    7,579    (28,426)   (15.0%)   --% 
Other    4,496    974    (12,047)   --%    --% 
Total provisions, net    (302,255)   (342,083)   (399,277)   (11.6%)   (14.3%)

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Net provisions expense from retail banking decreased 9.2% in 2017 compared to 2016. This is in line with our strategy of focusing on higher income clients, net of risk for loans for individuals which has led to less provisions for loan losses and the reversal of provision due to the calibration of our consumer provisioning model described above. This was partially offset by the negative impact of slower economic growth and rising unemployment on consumer asset quality and the greater provision expense recognized in commercial loans analyzed on a group basis due to the recalibration of the provisioning model.

 

Net provision expense from the Middle-market segment decreased by 28.1% in 2017 due to the improvement in asset quality, compensated by an increase of 5.9% in the loan portfolio.

 

Net provision expense from Global corporate banking totaled a release of provisions of Ch$6,440 million, a 15.0% decrease from the release of provisions in 2016 due to a 23.0% decrease in the loan portfolio in this segment as the Bank focused on non-lending products, such as cash management, that generate a higher return than lending in this segment.

 

Total provisions, net included in Others reached a gain of Ch$4,496 million compared to Ch$974 million. In Other provision expense, we mainly include the impact of the fluctuation of the exchange rate on our provision expense. When the peso appreciates, the amount of provisions set aside for these loans translated to local currency decreases. In 2017 the average appreciation of the peso was 4.1%, compared to the depreciation in 2016 of 3.5%, leading to a greater release of provisions. This impact has a corresponding hedge recognized in the results from financial transactions and for this reason it is not assigned to any reporting segment.

 

We believe that our loan loss allowances are currently adequate for all known and estimated incurred losses.

 

For the years ended December 31, 2016 and 2015. Provisions for loan losses, net of recoveries totaled Ch$342,083 million in 2015 and decreased 14.3% compared to the amount of provisions recorded in 2015.

 

Provision for loan losses, which includes the full amount of provisions recognized as a result of loan growth and change in risk classification as well as the net result of provisions and charge-offs of loans analyzed on a group basis, totaled Ch$409,159 million in 2016 compared to Ch$454,462 million in 2015 and decreased 10.0%.

 

In general, there was a decrease in the provision expense for commercial loans due to improving asset quality. Non-performing loans as a percentage of the loan portfolio decreased from 2.5% in 2015 to 2.1% in 2016 and the non-performing loans coverage ratio increased from 118.5% to 140.2%. This environment also led to a decrease in the loans charged-off during 2016 to Ch$11,222 million.

 

The provision expense for loan loss for commercial loans decreased from Ch$197,247 million in 2015 to Ch$137,242 million in 2016. This was mainly due to an improvement in asset quality in commercial loans. The non-performing loan ratio of commercial loans reached 2.3% in 2016 compared to 2.6% in 2015. This improvement in asset quality was due to two factors. First, the NPL ratio among small to middle-sized entities in retail banking decreased from 6.8% in 2015 to 5.8% in 2016. Second, there was an improvement in asset quality among loans evaluated on an individual basis, which resulted in a provision expense of Ch$17,819 million in 2016 compared to an expense of Ch$78,354 million in 2015. This was due to (i) a 2.6% decrease in loan volumes in global corporate banking, (ii) an unusually high provision expense in 2015 for specific corporate clients that were downgraded and (iii) an increase in 2016 in the number of clients that either improved their risk status or paid their loans.

 

Provisions for mortgage loans decreased by 38.7% from Ch$27,168 million in 2015 compared to Ch$16,646 million in 2016. During 2016, the Bank lowered its exposure to the lower end of the market and lowered the loan-to-value of residential mortgages at origination, which led to an improvement in mortgage loan asset quality and in April 2016 the mortgage loan allowance model was recalibrated resulting in a decrease in mortgage loan allowance of approximately Ch$3,500 million. The Bank also focused mortgage loan growth on higher income earners with less risk and, as a result, mortgage loans for high income earners grew 10.3% in 2016. The non-performing ratio for mortgage loans decreased from 2.1% in 2015 to 1.7% in 2016 and the impaired mortgage loans ratio also improved from 5.1% in 2015 to 4.6% in 2016.

 

The provision expense for consumer loans increased 8.2% during 2016, primarily attributable to growth of 7.1% in the loan portfolio in 2016. During 2016, the Bank lowered its exposure to the lower end of the consumer market and restricted renegotiations for consumer clients presenting payment difficulties, which led to an increase in

 

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charge-offs in 2016 and improvements in consumer loan asset quality. This was partially offset by recoveries from loans previously charged-off that increased from Ch$35,565 million in 2015 to Ch$41,072 million in 2016. The consumer non-performing loans ratio was 2.2% in 2016 compared to 2.7% in 2015 and the impaired consumer loan ratio decreased from 8.9% in 2015 to 6.5% in 2016.

 

Recoveries on loans previously charged-off increased 14.9% in 2016 compared to 2015. This was due to higher recoveries from charged-off consumer and residential mortgage loans mainly due to improved recovery efforts.

 

For a description of the provisions related to our residential mortgage loans and commercial loans analyzed on a group basis, please see “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio—Classification of Loan Portfolio—Loans analyzed on a group basis—Allowances for residential mortgage loans” and “—Loans analyzed on a group basis—Small and mid-sized commercial loans.”

 

Additionally, the provisions for interbank loans increased in 2016 to Ch$2,969 million, mainly due to the growth in the loan portfolio. In 2016, the Bank granted loans to Chinese banks due to Chilean foreign trade with China. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information-Classification of Loan Portfolio—Foreign Assets and loans.” The contingent loans in 2016 registered a provision expense of Ch$2,548 million in 2016 compared to a release of Ch$1,929 million in 2015, due to an increase in preapproval of available credit lines.

 

In some instances, we will sell a portfolio of charged-off loans to a third party. Gain (loss) on these charged-off loans is recognized as net income from financial transactions as disclosed in “Note 27—Profit and Loss from Financial Operations” of our Audited Consolidated Financial Statements.

 

Net provisions expense from retail banking decreased 2.6% in 2016 compared to 2015. This is in line with our strategy of focusing on higher income clients, net of risk for loans for individuals and SMEs, which has led to better asset quality in the loan portfolio.

 

Net provision expense from the Middle-market segment was stable in 2016, increasing 2.3% compared to 2015 due to an increase of 6.5% in the loan portfolio.

 

Net provision expense from Global corporate banking totaled a release of provisions of Ch$7,579 million, a 126.7% decrease from 2015 due to the significant increase of provisions in 2015 for specific clients that were downgraded and that in 2016 either improved their risk status or paid their loans.

 

Total provisions, net included in Others reached a gain of Ch$974 million compared to the loss of Ch$12,047 million. In Other provision expense, we mainly include the impact of the fluctuation of the exchange rate on our provision expense. Of our total loan book, 12.1% is in foreign currency, mainly in U.S. dollars and consisting of short-term foreign trade loans. When the peso depreciates, the amount of provisions set aside for these loans translated to local currency rises. In 2016 the average depreciation of the peso was 3.5%, considerably less than the depreciation in 2015 of 14.8%. This impact has a corresponding hedge recognized in the results from financial transactions and for this reason it is not assigned to any reporting segment.

 

Operating expenses

 

The following table sets forth information regarding our operating expenses in the years ended December 31, 2017, 2016 and 2015.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Personnel salaries and expenses    (396,967)   (395,133)   (387,063)   0.5%   2.1%
Administrative expenses    (230,103)   (226,413)   (220,531)   1.6%   2.7%
Depreciation and amortization    (77,823)   (65,359)   (53,614)   19.1%   21.9%
Impairment    (5,644)   (234)   (21)   2312.0%   1014.3%
Other operating expenses    (68,413)   (68,902)   (58,729)   (0.7%)   17.3%
Total operating expenses    (778,950)   (756,041)   (719,958)   3.0%   5.0%
Efficiency ratio(1)    44.3%   44.9%   43.8%          

 

 

 

(1)The efficiency ratio is the ratio of total operating expenses to total operating income. Total operating income consists of net interest income, fee income, financial transactions, net and other operating income.

 

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For the years ended December 31, 2017 and 2016. Operating expenses in the year ended December 31, 2017 increased 3.0% compared to the corresponding period in 2016. The efficiency ratio was 44.3% in 2017, 44.9% in 2016 and 43.8% in 2015.

 

The 0.5% increase in personnel salaries and expenses was below the CPI inflation of 2.3%, even though all salaries are indexed to inflation pursuant to the collective bargaining agreement. This was mainly due to the 2.5% reduction in headcount to 11,068 employees in December 2017, in line with the Bank’s strategy of reducing mid-upper level management levels and the sales force.

 

Administrative expenses increased 1.6% in the year ended December 31, 2017 compared to the corresponding period in 2016, mainly due to IT investments to develop the Bank’s digital platform, which is allowing the Bank to consolidate the branches and create efficiencies in the long term. In 2016, the Bank began to transform the branch network, adopting two main formats (i) a multi-segment approach with smaller branches that are multi-segment with dedicated spaces for the different business segments (Select, SME Advance, Banefe, etc.) and (ii) our Work Café spaces that are high tech / high touch branches with no human tellers or back offices. This was also accompanied by the closure of less efficient branches, especially in the Santander Banefe network, which were completely eliminated by year-end 2017. This has led to a 11.3% decrease in the number of branches in the period. The Bank has also been reducing the ATM network from 1,295 to 926. This reduction has mainly been for ATMs outside of branches and is leading to less expenses for security and the transportation of cash by 17.7%.

 

   Year ended December 31,  % Change
   2017  2016  2017/2016
Traditional branches    276    274    0.7%
Middle-market centers    7    8    (12.5%)
Santander Select    51    53    (3.8%)
Workcafés    20    0    —% 
Banefe and other payment centers(1)    31    88    (64.8%)
Total branches    385    434    (11.3%)

  

 

  

(1)As of December 31,2017, all Banefe branches were closed down.

 

Depreciation and amortization expense increased 19.1% in 2017 compared to 2016 and totaled Ch$77,823 million. This expense is in line with the greater investments in software, hardware and other equipment that the Bank has invested in as it modernizes its branch network and systems. This has also led to an increase in impairment charges to Ch$ 5,644 million in 2017 compared to Ch$234 million in 2016 mainly related to obsolete fixed asset in remodeled branches.

 

Other operating expenses were Ch$68,413 million in 2017, a 0.7% decrease compared to 2016. This was mainly due to lower operational charge-offs. See “Note 33—Other operating income and expenses” to our Audited Consolidated Financial Statements for more detail on Other operating expenses.

 

The following table sets forth, for the periods indicated, our personnel salaries, administrative and depreciation and amortization expenses broken down by business segment. These amounts exclude impairment and other operating expenses.

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Retail banking   (534,970)   (529,909)   (533,086)   1.0%   (0.6%)
Middle-market   (91,882)   (83,412)   (77,261)   10.2%   8.0%
Global corporate banking   (62,685)   (53,935)   (49,533)   16.2%   8.9%
Other   (15,356)   (19,649)   (1,328)   (21.8%)   1,379.6%
Total personnel, administrative expenses, depreciation and amortization (1)   (704,893)   (686,905)   (661,208)   2.6%   3.9%

 

 

 

(1)Excludes impairment and other operating expenses.

 

 

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By business segment, the 2.6% increase in costs excluding impairment and other operating expenses in 2017 compared to the corresponding period in 2016 was mainly due a rise in cost in the Middle-market and GCB. Costs in the Middle-market segment grew 10.2% in 2017 compared to 2016 and 16.2% in the Global corporate banking segment in line with business growth in this segment, especially in transactional banking and cash management services that are intense in data processing.

 

In Retail banking costs grew 1.0% due to lower average headcount and saving from the closure of branches and ATMs as well as efficiencies produced by greater digital banking services.

 

For the years ended December 31, 2016 and 2015. Operating expenses in the year ended December 31, 2016 decreased 5.0% compared to the corresponding period in 2015. The efficiency ratio was 44.9% in 2016, 43.8% in 2015 and 41.1% in 2014.

 

The 2.1% increase in personnel salaries and expenses was mainly due to an increase in personnel compensation and greater costs related to benefits included in the Bank’s collective bargaining agreement. In 2016, CPI inflation was 2.7% and all salaries are indexed to inflation pursuant to the collective bargaining agreement. This was offset by the 3.1% reduction in headcount to 11,354 employees in December 2016, in line with the Bank’s strategy of reducing mid-upper level management levels and the sales force.

 

Administrative expenses increased 2.7% in the year ended December 31, 2016 compared to the corresponding period in 2015, mainly due to IT and communication expenses that increased from Ch$28,420 million in 2015 to Ch$37,351 million in 2016 as part of technological innovation to maintain and develop the Bank’s digital platform, which will allow the Bank to consolidate the branches and create efficiencies in the long term.

 

This expense is in line with the greater investments in hardware and other equipment that the Bank has made as it modernizes its branch network and systems. See “Note 33—Other operating income and expenses” to our Audited Consolidated Financial Statements for more detail on Other operating expenses.

 

By business segment, the 3.9% increase in costs excluding impairment and other operating expenses in 2016 compared to the corresponding period in 2015 was mainly due to the 0.6% decrease in costs incurred in retail banking. In 2016, retail banking costs decreased mainly as a result of lower headcount partially offset by greater expenses related to the investment in better digital banking services. Costs in the Middle-market segment grew 8.0% in 2016 compared to 2015 and 8.9% in the Global corporate banking segment in line with business growth in this segment, especially in transactional banking and cash management services that are intense in data processing.

 

Income tax

 

   Year ended December 31,  % Change  % Change
   2017  2016  2015  2017/2016  2016/2015
   (in millions of Ch$)
Net income before tax    720,280    587,463    528,124    22.6%   11.2%
Income tax expense    (145,031)   (109,031)   (76,395)