Company Quick10K Filing
Banco Santander Chile
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$0.00 188,446 $5,576,121
20-F 2020-03-06 Annual: 2019-12-31
20-F 2019-03-22 Annual: 2018-12-31
20-F 2018-03-28 Annual: 2017-12-31
20-F 2017-03-24 Annual: 2016-12-31
20-F 2016-05-02 Annual: 2015-12-31
20-F 2015-05-14 Annual: 2014-12-31
20-F 2014-04-30 Annual: 2013-12-31
20-F 2013-04-30 Annual: 2012-12-31
20-F 2012-04-30 Annual: 2011-12-31
20-F 2011-06-30 Annual: 2010-12-31
20-F 2010-06-30 Annual: 2009-12-31
BSAC 2019-12-31
Part I
Item 1. Identity of Directors, Senior Management and Advisers
Item 2. Offer Statistics and Expected Timetable
Item 3. Key Information
Item 4. Information on The Company
Item 4A. Unresolved Staff Comments
Item 5. Operating and Financial Review and Prospects
Item 6. Directors, Senior Management and Employees
Item 7. Major Shareholders and Related Party Transactions
Item 8. Financial Information
Item 9. The Offer and Listing
Item 10. Additional Information
Item 11. Quantitative and Qualitative Disclosures About Market Risk
Item 12. Description of Securities Other Than Equity Securities
Part II
Item 13. Defaults, Dividend Arrearages and Delinquencies
Item 14. Material Modifications To The Rights of Security Holders and Use of Proceeds
Item 15. Controls and Procedures
Item 16. [Reserved]
Item 16A. Audit Committee Financial Expert
Item 16B. Code of Ethics
Item 16C. Principal Accountant Fees and Services
Item 16D. Exemptions From The Listing Standards for Audit Committees
Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers
Item 16F. Change in Registrant's Certifying Accountant
Item 16G. Corporate Governance
Item 16H. Mine Safety Disclosure
Part III
Item 17. Financial Statements
Item 18. Financial Statements
Item 19. Exhibits
Note 01
Note 02
Note 03
Note 04
Note 05
Note 06
Note 07
Note 08
Note 09
Note 10
Note 11
Note 12
Note 13
Note 14
Note 15
Note 16
Note 17
Note 18
Note 19
Note 20
Note 21
Note 22
Note 23
Note 24
Note 25
Note 26
Note 27
Note 28
Note 29
Note 30
Note 31
Note 32
Note 33
Note 34
Note 35
Note 36
Note 37
Note 38
Note 39
Note 40
EX-2.C dp122070_ex2c.htm
EX-8.1 dp122070_ex801.htm
EX-12.1 dp122070_ex1201.htm
EX-12.2 dp122070_ex1202.htm
EX-12.3 dp122070_ex1203.htm
EX-13.1 dp122070_ex1301.htm

Banco Santander Chile Earnings 2019-12-31

BSAC 20F Annual Report

Balance SheetIncome StatementCash Flow

Comparables ($MM TTM)
Ticker M Cap Assets Liab Rev G Profit Net Inc EBITDA EV G Margin EV/EBITDA ROA
BSAC 5,576,121 39,132,512 35,887,052 0 0 0 0 4,751,258 0%
BCH 2,904,241 35,617,447 31,943,731 0 0 0 0 2,024,160 0%
HDB 311,029 13,280,074 11,644,449 0 0 0 0 637,843 0%
LYG 182,520 797,598 747,399 0 0 0 0 182,520 0%
BCS 124,858 1,133,283 1,069,504 0 0 0 0 124,858 0%
SAN 70,142 1,459,271 1,351,910 0 0 0 0 70,142 0%
MUFG 69,022 305,228,899 289,244,151 0 0 0 0 -46,517,503 0%
ING 41,369 884,603 834,751 0 0 0 0 41,369 0%
BBVA 35,140 676,689 623,814 0 0 0 0 35,140 0%
BAP 20,734 177,263 152,997 0 0 0 0 -1,435 0%

20-F 1 dp122070_20f.htm FORM 20-F

 

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, 2019

 

OR

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from                           to                          .

 

OR

 

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

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

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

 

Title of each class

Trading Symbols

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 BSAC New York Stock Exchange
Shares of Common Stock, without par value* BSAC 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)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

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 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, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

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.

 

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 1
CERTAIN TERMS AND CONVENTIONS 3
PRESENTATION OF FINANCIAL INFORMATION 3
PART I 5
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 5
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 5
ITEM 3. KEY INFORMATION 5
ITEM 4. INFORMATION ON THE COMPANY 42
ITEM 4A. UNRESOLVED STAFF COMMENTS 63
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 63
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 142
ITEM 7.  MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 153
ITEM 8.  FINANCIAL INFORMATION 157
ITEM 9.  THE OFFER AND LISTING 157
ITEM 10.  ADDITIONAL INFORMATION 158
ITEM 11.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 175
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 197
PART II 199
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 199
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 199
ITEM 15. CONTROLS AND PROCEDURES 199
ITEM 16. [RESERVED] 201
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 201
ITEM 16B. CODE OF ETHICS 201
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 201
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 202
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 202
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 202
ITEM 16G. CORPORATE GOVERNANCE 202
ITEM 16H. MINE SAFETY DISCLOSURE 203
PART III 204
ITEM 17. FINANCIAL STATEMENTS 204
ITEM 18. FINANCIAL STATEMENTS 204
ITEM 19. EXHIBITS 204

 

i 

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; and

 

·equity price risk;

 

·projected capital expenditures;

 

·liquidity;

 

·trends affecting:

 

·our financial condition; and

 

·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;

 

1

·deflation;

 

·unemployment;

 

·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.

 

2

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.

 

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$” are to Chilean pesos; references to “JPY” or “JPY$” are to Japanese Yen; references to “AUD” or “AUD$” are to Australian dollars; references to “CHF” or “CHF$” 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. References to the “FMC” are to the Financial Market Commission, into which the SBIF merged on June 1, 2019.

 

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 FMC, 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 2019.”

 

This Annual Report contains our consolidated financial statements as of December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 (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, 2019, 2018 and 2017. See page F-2 of the Audited Consolidated

 

3

Financial Statements as of December 31, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 for the audit report issued by PricewaterhouseCoopers Consultores Auditores SpA. The Audited Consolidated Financial Statements have been prepared from accounting records maintained by the Bank and its subsidiaries.

 

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 presentation 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 FMC.

 

Outstanding loans and the related percentages of our loan portfolio consisting of corporate and consumer loans as defined 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 FMC, which are based on the type and term of loans.

 

Non-performing loans are also presented in accordance with reporting requirements of the FMC and 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.”

 

At the end of each reporting period the Bank evaluates the impairment of the loan book. For December 31, 2019 and 2018 this has been assessed in accordance with IFRS 9 and for prior periods in accordance with IAS 39.

 

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.

 

4

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 FMC and our analysis of such information.

 

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, 2019 the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm was Ch$747.37, or 0.4% more than the observed exchange rate published by the Central Bank for such date of Ch$744.62 per U.S.$1.00. The Federal Reserve Bank of New York does not report a noon buying rate for the Chilean peso.

 

The U.S. dollar equivalent of one UF was U.S.$38.02 as of December 31, 2019, using the observed exchange rate reported by the Central Bank as of December 30, 2019 of Ch$744.62 per U.S.$1.00.

 

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, 2019, 2018, 2017, 2016 and 2015 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, 2019 and 2018 and for the years ended December 31, 2019, 2018 and 2017 are presented. The audited financial statements for 2016 and 2015 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, 2019, 2018, 2017, 2016 and 2015 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.

 

5

 

  

As of and for the years ended December 31,

   
  

2019

 

2019

 

2018

 

2017

 

2016 

 

2015

   In U.S.$ thousands(1)  In Ch$ millions (2)   
CONSOLIDATED STATEMENT OF INCOME DATA (IFRS)               
Net interest income    1,895,934    1,416,964    1,414,368    1,326,691    1,281,366    1,255,206 
Net fee and commission income    384,128    287,086    290,885    279,063    254,424    237,627 
Financial transactions, net (3)    269,869    201,692    105,082    129,752    140,358    145,499 
Other operating income    17,396    13,001    23,129    62,016    6,427    6,439 
Net operating profit before provision for loan losses    2,567,327    1,918,743    1,833,464    1,797,522    1,682,575    1,644,771 
Provision for loan losses    (432,598)   (323,311)   (317,408)   (302,255)   (342,083)   (399,277)
Net operating income    2,134,729    1,595,432    1,516,056    1,495,267    1,340,492    1,245,494 
Total operating expenses    (1,072,949)   (801,890)   (754,314)   (778,950)   (756,041)   (719,958)
Operating income    1,061,780    793,542    761,742    716,317    584,451    525,536 
Income from investments in associates and other companies (4)    1,533    1,146    1,324    1,144    3,012    2,588 
Income before tax    1,063,313    794,688    763,066    717,461    587,463    528,124 
Income tax expense    (234,253)   (175,074)   (167,144)   (145,031)   (109,031)   (76,395)
Income from continuing operations    829,060    619,614    595,922    572,430    478,432    451,729 
Income from discontinued operations (4)    2,273    1,699    3,771    2,819    –      –   
Net income for the year    831,333    621,313    599,693    575,249    478,432    451,729 
Net income for the period attributable to: Equity holders of the Bank    828,359    619,091    595,333    562,801    476,067    448,466 
Non-controlling interests    2,974    2,222    4,360    12,448    2,365    3,263 
                               
Net income attributable to Equity holders of the Bank per share    4.40    3.29    3.16    2.99    2.53    2.38 
Net income attributable to Equity holders of the Bank per ADS    1,758.29    1,314.10    1,263.71    1,406.96    1,010.51    951.92 
Weighted-average shares outstanding (in millions)    188,446    188,446    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 
                               
CONSOLIDATED STATEMENT OF FINANCIAL POSITION DATA (IFRS)                  
Cash and deposits in banks    4,756,038    3,554,520    2,065,441    1,452,922    2,279,389    2,064,806 
Cash items in process of collection    475,082    355,062    353,757    668,145    495,283    724,521 
Investments under resale agreements    –      –      –      –      6,736    2,463 
Financial derivative contracts    10,903,044    8,148,608    3,100,635    2,238,647    2,500,782    3,205,926 
Trading investments    –      –      –      485,736    396,987    324,271 
Interbank loans, net    –      –      –      162,213    268,672    9,711 
Loans and accounts receivable from customers, net    –      –      –      26,772,544    26,147,154    24,528,745 
Available-for-sale investments    –      –      –      2,574,546    3,388,906    2,044,411 
Financial assets held for trading    361,540    270,204    77,041    –      –      –   
Loans and account receivable at amortized cost    42,516,317    31,775,420    29,331,001    –      –      –   
Loans and account receivable at fair value through other comprehensive income    88,397    66,065    68,588    –      –      –   
Debt instrument at fair value through other comprehensive income    5,365,846    4,010,272    2,394,323    –      –      –   
Equity instruments at fair value through other comprehensive income    645    482    483    –      –      –   
Investments in associates and other companies    13,617    10,177    32,003    27,585    23,780    20,309 
Intangible assets    98,196    73,389    66,923    63,219    58,085    51,137 
Property, plant, and equipment    337,645    252,346    253,586    242,547    257,379    240,659 
Rights of use assets    208,715    155,987    –      –      –      –   
Current taxes    15,585    11,648    –      –      –      –   
Deferred taxes    603,969    451,388    397,515    371,091    359,600    320,527 
Other assets    1,925,613    1,439,146    991,216    764,410    847,272    1,100,174 
TOTAL ASSETS    67,670,249    50,574,714    39,132,512    35,823,605    37,030,025    34,637,660 
                               
Deposits and other demand liabilities    13,778,225    10,297,432    8,741,417    7,768,166    7,539,315    7,356,121 
Cash items in process of being cleared    265,261    198,248    163,043    486,726    288,473    462,157 
Obligations under repurchase agreements    508,523    380,055    48,545    268,061    212,437    143,689 
Time deposits and other time liabilities    17,652,323    13,192,817    13,067,819    11,913,945    13,151,709    12,182,767 
Financial derivative contracts    9,888,882    7,390,654    2,517,728    2,139,488    2,292,161    2,862,606 

 

 

6

 

  

As of and for the years ended December 31,

   
  

2019

 

2019

 

2018

 

2017

 

2016 

 

2015

   In U.S.$ thousands(1)  In Ch$ millions (2)   
Interbank borrowings    3,371,580    2,519,818    1,788,626    1,698,357    1,916,368    1,307,574 
Issued debt instruments    12,712,208    9,500,723    8,115,233    7,093,653    7,326,372    5,957,095 
Other financial liabilities    302,873    226,358    215,400    242,030    240,016    220,527 
Obligation for lease contract    212,069    158,494                 
Current taxes            8,093    6,435    29,294    17,796 
Deferred taxes    132,675    99,157    15,470    9,663    7,686    3,906 
Provisions    436,370    326,130    305,271    303,798    292,210    274,998 
Other liabilities    3,754,935    2,806,325    900,408    745,363    795,785    1,045,869 
TOTAL LIABILITIES    63,015,924    47,096,211    35,887,053    32,675,685    34,091,826    31,835,105 
                               
Capital    1,192,586    891,303    891,303    891,303    891,303    891,303 
Reserves    2,840,283    2,122,742    1,923,022    1,781,818    1,640,112    1,527,893 
Valuation adjustments    (11,850)   (8,856)   11,352    (2,312)   6,640    1,288 
Retained earnings    526,755    393,681    373,619    435,228    370,803    351,890 
Attributable to Equity holders of the Bank    4,547,774    3,398,870    3,199,296    3,106,037    2,908,858    2,772,374 
Non-controlling interest    106,551    79,633    46,163    41,883    29,341    30,181 
TOTAL EQUITY (5)    4,654,325    3,478,503    3,245,459    3,147,920    2,938,199    2,802,555 
TOTAL LIABILITIES AND EQUITY    67,670,249    50,574,714    39,132,512    35,823,605    37,030,025    34,637,660 
                               

 

   As of and for the years ended December 31,
   2019  2018  2017  2016  2015
CONSOLIDATED RATIOS               
(IFRS)               
Profitability and performance:               
Net interest margin (6)    4.0%   4.3%   4.3%   4.3%   4.4%
Return on average total assets (7)    1.4%   1.6%   1.6%   1.4%   1.3%
Return on average equity (8)    18.0%   18.4%   19.2%   16.8%   16.0%
                          
Capital:                         
Average equity as a percentage of average total assets (9)    8.0%   8.8%   8.5%   8.1%   8.2%
Total liabilities as a multiple of equity (10)    13.5    11.1    10.4    11.6    11.4 
Credit Quality:                         
Non-performing loans as a percentage of total loans (11)    2.1%   2.1%   2.3%   2.1%   2.5%
Allowance for loan losses as percentage of total loans(12)    2.7%   2.9%   2.9%   2.9%   3.0%
Operating Ratios:                         
Operating expenses /operating revenue (13)   41.8%   41.1%   43.3%   44.9%   43.8%
Operating expenses /average total assets    1.9%   2.0%   2.3%   2.1%   2.1%
OTHER DATA                         
CPI Inflation Rate (14)    3.0%   2.6%   2.3%   2.7%   4.4%
Revaluation (devaluation) rate (Ch$/U.S.$) at year end (14)    (7.1%)   (13.1%)   7.8%   5.7%   (16.5%)
Number of employees at period end    11,200    11,305    11,068    11,354    11,723 
Number of branches and offices at period end    377    380    385    423    471 

 

 

 

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2019 have been translated from Chilean pesos at the interbank market exchange rate of Ch$747.37 = U.S.$1.00 as of December 31, 2019 based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period. Per share data in US$ is not in thousands.

 

(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.

 

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(4)In 2019 Banco Santander has entered into the process of selling the investments in Redbanc S.A., Transbank S.A. and Nexus S.A. in accordance with IFRS 5, the Bank has reclassified and presented these investments in Other Assets classified as held for sale separate from the rest of the investments in associates and presented the effects in the income statement as discontinued operations. See “Note 39- Non-current assets held for sale”.

 

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

 

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

 

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

 

(9)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.

 

(10)Total liabilities divided by equity.

 

(11)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. Total loans in 2019 and 2018 corresponds to loans at amortized cost.

 

(12)Allowance for loan losses as of December 31, 2019 and 2018 corresponds to allowances for loans at fair value through other comprehensive income at amortized cost according to IFRS 9. Prior periods are in accordance with IAS 39.

 

(13)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.

 

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

 

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 2019 dividend must be proposed and approved during the first four months of 2020. Following shareholder approval, the proposed dividend is declared and paid. Historically, the dividend for a particular year has been declared and paid no later than one month following the shareholders’ meeting. Dividends are paid to shareholders of record on the fifth day preceding the date set for payment of the dividend. The applicable record 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 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

 

8

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)

2016    336,659    503.7    1.79    1.07    75    75 
2017    330,646    500.9    1.75    1.06    70    69 
2018    423,611    705.3    2.25    1.50    75    75 
2019    355,141    531.5    1.88    1.13    60    60 

 

 

 

(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.

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

9

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 some countries fell into recession. Although many countries have recovered, this recovery may not be sustainable. Some 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.

 

Despite the improvement of the global economy, uncertainty remains concerning the future economic environment. Such economic uncertainty could have a negative impact on our business and results of operations. A slowing or failing of the economic expansion would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.

 

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.

 

10

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 with respect to any 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. 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 Ratings Ltd. (“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 reaffirmed this rating and outlook in November 2017. In August 2018, the Bank’s outlook changed from negative to stable after the outlook for the sovereign rating of the Republic of Chile was changed to stable in July 2017 and the Bank’s A rating was affirmed in August 2017.

 

In July 2018, Moody’s downgraded our main rating to A1 from Aa3, after revising the sovereign rating of the Republic of Chile to A1 as well. Moody’s currently has a stable outlook on the Republic of Chile’s sovereign rating and on our rating as well.

 

In March 2019, Japan Credit Rating Agency started covering Santander Chile, assigning an international rating of A+ (stable), after assigning the sovereign rating of the Republic of Chile AA- (stable).

 

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: A2 (stable) by Moody’s, A (stable) by S&P and A- (stable) by 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 some 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.

 

11

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.

 

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, auto-lenders 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. Furthermore, the widespread adoption of new technologies, including cryptocurrencies and payment systems, could require substantial expenditures to modify or adapt our existing products and services as we continue to grow our Internet and mobile banking capabilities. Our customers may choose to conduct business or offer products in areas that may be considered speculative or risky. Such new technologies 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 the 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.

 

12

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 was renewed in January 2019 for seven more years. Once this agreement expires, 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.

 

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.

 

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.

 

13

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 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, 2019, our non-performing loans were Ch$671,336 million, and the ratio of our non-performing loans to total loans was 2.1%. As of December 31, 2019, our allowance for loan losses was Ch$896,095 million, and the ratio of our allowance for loan losses to total loans was 2.7%. 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, 2019, 2018 and 2017—Provision for loan losses, net of recoveries.”

 

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 expected losses, we may be required to increase our provisions and allowance

 

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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 9—Loans and Account Receivable at Amortized Cost – under IFRS 9” and “Note 10—Loans and Account Receivable at Fair Value through Other Comprehensive Income – under IFRS 9” in our Audited Consolidated Financial Statements for a description and presentation of our loan portfolio as well as “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Loan Portfolio.”

 

Retail customers represent 70.2% of the value of the total loan portfolio at amortized cost as of December 31, 2019. 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, 2019, our residential mortgage loan portfolio totaled Ch$11,262,995 million, representing 34.5% of our total loans. See “Note 9— Loans and Account Receivable at Amortized Cost –under IFRS 9” 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 historical growth rates. 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. 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.

 

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:

 

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·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.”

 

We are also exposed to equity price risk in our investments in equity securities in the banking book and in the trading portfolio. The performance of financial markets may cause changes in the value of our investment and trading portfolios. The volatility of world equity markets due to the continued economic uncertainty and sovereign debt crisis has had a particularly strong impact on the financial sector. Continued volatility may affect the value of our investments in equity securities and, depending on their fair value and future recovery expectations, could become a permanent impairment which would be subject to write-offs against our results. To the extent any of these risks materialize, our interest income / (charges) or the market value of our assets and liabilities could be materially adversely affected.

 

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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, among others. 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 may 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 FMC, Directorio de Información Comercial (Dicom), 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 enough 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 have in place liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors make it difficult to eliminate completely these risks. Constraints in the supply of liquidity, including in inter-bank lending, has affected and may adversely affect the cost of funding our business, and extreme liquidity

 

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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. Credit spreads variations 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 for deposits between banks or with other products, such as mutual funds. 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, 2019, 97.7% 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 28.0% and 33.4% of our total liabilities and equity as of December 31, 2019 and 2018, 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, 2019, the Bank’s top 20 time deposits represented 23.4% of total time deposits, or 6.1% of total liabilities and equity, and totaled U.S.$ 4.1 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, 2019, the ratio of our regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, was 12.9% and our core capital ratio was 10.1%. 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;

 

·the failure to increase our capital correspondingly;

 

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·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.

 

On January 19, 2019, the Chilean government passed a law that amends, among others, the General Banking Law (the General Banking Law, as amended, is referred to herein as the “New General Banking Law”) and establishes new capital regulation for banks in Chile in line with Basel III standards and the merger of the banking regulator with the FMC, with all current SBIF attributions being transferred to the FMC. The FMC was created by Law 21,000 in 2017 and started operations December 14, 2017 (eliminating the Superintendency of Securities and Insurance as of January 15, 2018). As of June 1, 2019, the SBIF merged into the FMC.

 

Therefore, the FMC has 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 banks. This Commission is responsible for 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 is also 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 is in charge of a Council, which is composed of five members, who are appointed and are subject to the following rules:

 

·A Commissioner appointed by the President of Chile, 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 Chile, 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 is a prosecutor in charge of investigations and the Chairman is responsible for supervision. The FMC acts in coordination with the Chilean Central Bank (Central Bank).

 

Under the New General Banking Law, minimum capital requirements have increased in terms of amount and quality. Total Regulatory Capital remains at 8% of risk-weighted assets which includes credit, market and operational risk. Minimum Tier 1 capital increased 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 also establishes the conditions and requirements for the issuance of perpetual bonds and preferred equity. Tier 2 capital is now set at 2% of risk-weighted assets.

 

Additional capital demands are incorporated through a Conservation Buffer of 2.5% of risk-weighted assets. The Central Bank may set an additional Counter Cyclical Buffer of up to 2.5% of risk-weighted assets in agreement with the FMC. Both buffers must be comprised of core capital.

 

The FMC, with agreement from the Central Bank, may impose additional capital requirements for Systemically Important Banks (“SIB”) of between 1-3.5% of risk-weighted assets. Notably, the Central Bank may require: (1) the addition of up to 2% to the core capital to a bank’s total assets ratios; (2) a reduction in the technical reserve requirement trigger from 2.5 times regulatory capital to 1.5 times regulatory capital; and/or (3) a reduction in the interbank loan limit to 20% of regulatory capital of any SIB.

 

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The FMC will have until December 1, 2020 to establish the weightings. Until then, banks must 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. We must maintain a minimum regulatory capital to risk-weighted assets ratio of 11%. As of December 31, 2019 our ratio of regulatory capital to risk weighted assets was 13.4%.

 

The FMC has already started publishing drafts for consultation. On August 12, 2019, the FMC published their first draft for the identification and core capital charge for those banks considered SIBs. There are a total of four factors that are then weighted to reach a market share:

 

1.Size (weighted at 30%): Includes total assets consolidated in the domestic market.

 

2.Domestic interconnection (weighted at 30%): Includes assets and liabilities with financial institutions (banks and non-banks) and assets in circulation in the Chilean financial market (equity and fixed income).

 

3.Domestic substitution (weighted at 20%): Includes the share in local payments, assets in custody, deposits and loans.

 

4.Complexity (weighted at 20%): Includes factors that could lead to greater difficulties regarding costs and/ or time for the orderly resolution of the Bank. These include notional amount of OTC derivatives, inter-jurisdictional assets and liabilities and available-for-sale assets.

 

The minimum amount of the sum of the factors to be considered systemic is 1000 bp, equivalent to a weighted participation of 10% of all four factors. The core capital additional charge depends on the size of the total factor, as set out in the table below:

 

Systemic Level Range (bp) Core capital additional charge (% of risk-weighted assets)
I 1000-1300 1.0%-1.25%
II 1300-1800 1.25%-1.75%
III 1800-2000 1.75%-2.5%
IV >=2000 2.5%-3.5%

 

Given our size and market share, it is likely that we will be classified as a SIB, according to the FMC’s proposed regulation on SIBs.

 

On September 13, 2019, the FMC published the risk weightings for operational risk. In order to estimate the operational risk coefficient, two factors are considered:

 

1.The business indicator component (BIC): A component that considers interest income, interest earning assets, dividend income, financial transactions, fees, and other operational income and expenses. These are then multiplied by a marginal coefficient.

 

2.Internal Loss Multiplier (ILM): This component is based on 10 years of historical operational losses, or at least five years in some special cases.

 

On January 27, 2019, the FMC published for consultation the risk weighting model for credit risk. The Basel Committee on Banking Supervision (BCBS) defines credit risk (CR) as the risk that a debtor or bank counterparty does not meet its obligations in accordance with the agreed terms. Credit risk is the most relevant in the Chilean banking industry. The mechanism in force today estimates Risk Weighted Assets by Credit Risk (RWCR) using a methodology based on the Basel I standard. The proposed standard method with Basel III standards is more advanced, since it has categories that depend on the type of counterparty and different risk factors. These categories are not based on accounting criteria, but rather on the underlying risk. Thus, all exposures that have mortgage guarantees, for example mortgage loans for housing, have a different treatment from those exposures not guaranteed by a mortgage. Additionally, in the case of mortgage-backed exposures, there will be different types of treatment depending on the type of real estate and whether the obligations are paid with income generated by the property itself. The new framework will also allow the use of internal methodologies, subject to compliance with minimum requirements. The standard in consultation includes the possibility of reducing RWCR when considering credit risk mitigators, such as compensation agreements, guarantees and other compensations.

 

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The New General Banking Law also incorporates Pillar II capital requirements with the objective of assuring an adequate management of risk. The FMC, with at least four votes from the Council of 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 particular 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 Central Bank.

 

The following table sets forth a comparison between the regulatory capital demands under the previous law, and those under the New General Banking Law:

 

Capital requirements: Basel III, previous GBL and new requirements

Capital categories

 

Previous Law

 

New General Banking Law

(% over risk weighted assets)
(1) Total Tier 1 Capital (2+3)   4.5   6
(2) Shareholders’ Equity   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

 

The regulations for calculating RWA under the new guidelines must be implemented by December 1, 2020. We may 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 FMC 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 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 enough 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 (now the FMC) 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 FMC 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.

 

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·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.

 

Finally, the implementation of internationally accepted liquidity ratios might require changes in business practices that affect our profitability. The LCR is a liquidity standard that measures if banks have enough high-quality liquid assets to cover expected net cash outflows over a 30-day liquidity stress period. At December 31, 2019, our LCR ratio was 143% under Chilean regulations, which is above the 60% minimum requirement for 2019. The net stable funding ratio (NSFR) provides a sustainable maturity structure of assets and liabilities such that banks maintain a stable funding profile in relation to their activities. The Chilean regulator has not yet defined a calendar of implementation for the local NSFR. This could materially increase the liquidity we are required to maintain on our balance sheet.

 

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.

 

In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential returns, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.

 

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 way 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, we 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. The New General Banking Law also states that the FMC, with the approval from the Central Bank, may lower this threshold from 2.5 times to 1.5 times a bank’s regulatory capital for a bank considered to be a SIB. 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 pensions went from being state-funded to privately-funded, which requires Chilean employees to set aside 10% of their wages. As of December 31, 2019, the Chilean pension fund management companies (Administradora de Fondos de Pensión, or “AFPs”) had U.S.$7,409 million invested in the Bank via equity, deposits and fixed income. The demographics of Chilean society have changed resulting in needs to modify this system. In January 2020, the Chilean government presented a proposal for pension reform to Congress for discussion. These changes include increasing minimum pensions and introducing a social insurance scheme for events such as longevity. The amount each worker must set aside is also expected to increase from the current 10% of wages to 16%. The additional 6% would be gradually introduced over 12 years and would be a cost of the employer, thus potentially raising personnel expenses. The additional 6% would not be managed by the AFPs, but by a new government pension entity. Although the bill is currently being discussed and widely expected to be approved, we are unable to predict the final content of the law. The potential adverse effect of the proposed law on our financial condition and results of operations cannot yet be ascertained.

 

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 2019, the AFPs still had the possibility of being able to invest another U.S.$11,975 million in the Bank via equity, deposits and fixed income. If the exposure of any AFP to Santander-Chile exceeds the regulatory limits or the regulatory limits are reduced, 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.

 

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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 was adopted as of January 1, 2018, establishing a new impairment model of expected loss and make changes to the classification and measurement requirements for financial assets and liabilities. In addition, the Bank adopted IFRS 16 as of January 1, 2019, requiring new standards for recognition, measurement, presentation and disclosure of leases. This led to approximately Ch$154,284 million of assets for the right of use and lease liabilities for the same amount as of the date of adoption of IFRS 16. Changes made to accounting standards can materially impact how we record and report our financial 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, including internal controls, 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 of 1934 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 by-laws 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

 

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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 36 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.

 

We may not effectively manage risks associated with the replacement of benchmark indices.

 

Interest rate, equity, foreign exchange rate and other types of indices which are deemed to be “benchmarks,” including those in widespread and long-standing use, have been the subject of ongoing international, national and other regulatory scrutiny and initiatives and proposals for reform. Some of these reforms are already effective while others are still to be implemented or are under consideration. These reforms may cause benchmarks to perform differently than in the past, or to disappear entirely, or have other consequences, which cannot be fully anticipated.

 

Any of the benchmark reforms which have been proposed or implemented, or the general increased regulatory scrutiny of benchmarks, could also increase the costs and risks of administering or otherwise participating in the setting of benchmarks and complying with regulations or requirements relating to benchmarks. Such factors may have the effect of discouraging market participants from continuing to administer or contribute to certain benchmarks, trigger changes in the rules or methodologies used in certain benchmarks or lead to the disappearance of certain benchmarks.

 

Any of these developments, and any future initiatives to regulate, reform or change the administration of benchmarks, could result in adverse consequences to the return on, value of and market for loans, mortgages, securities, derivatives and other financial instruments whose returns are linked to any such benchmark, including those issued, funded or held by Banco Santander.

 

Various regulators, industry bodies and other market participants in the U.S. and other countries are engaged in initiatives to develop, introduce and encourage the use of alternative rates to replace certain benchmarks. There is no assurance that these new rates will be accepted or widely used by market participants, or that the characteristics of any of these new rates will be similar to, or produce the economic equivalent of, the benchmarks that they seek to replace. If a particular benchmark were to be discontinued and an alternative rate has not been successfully introduced to replace that benchmark, this could result in widespread dislocation in the financial markets, engender volatility in the pricing of securities, derivatives and other instruments, and suppress capital markets activities, all of which could have adverse effects on Banco Santander’s results of operations. In addition, the transition of a particular benchmark to a replacement rate could affect hedge accounting relationships between financial instruments linked to that benchmark and any related derivatives, which could adversely affect Banco Santander’s results.

 

On July 27, 2017, the Chief Executive of the U.K. Financial Conduct Authority (the “FCA”), which regulates the London interbank offered rate (“LIBOR”), announced that the FCA will no longer persuade or compel banks to submit rates for the calculation of the LIBOR benchmark after 2021. This announcement indicates that the continuation of LIBOR on the current basis cannot be guaranteed after 2021. Therefore, after 2021 LIBOR may cease to be calculated. The Bank of England and the FCA are working with market participants to catalyze a transition to using the Sterling Overnight Index Average (Sonia). In addition, the European Money Market Institute (EMMI) announced the discontinuation of the EONIA after January 3, 2022 and that from October 2, 2019 until its total discontinuation it will be replaced by the €STR plus a spread of 8.5 basis points. Many unresolved issues remain, such as the timing of the successor benchmarks, introduction and the transition of a particular benchmark to a replacement rate, which could result in wide spread dislocation in the financial markets, engender volatility in the pricing of securities, derivatives and other instruments, and suppress capital markets activities. These and other reforms may cause benchmarks to perform differently than in the past, or to disappear entirely, or have other consequences which cannot be fully anticipated which introduces a number of risks for the Group. These risks include (i) legal risks arising from potential changes required to documentation for new and existing transactions; (ii) risk management, financial and accounting risks arising from market risk models and from valuation, hedging, discontinuation and recognition of financial instruments linked to benchmark rates; (iii) business risk that the revenues of products linked to LIBOR (in particular those indices that will be replaced) decrease; (iv)

 

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pricing risks arising from how changes to benchmark indices could impact pricing mechanisms on some instruments; (v) operational risks arising from the potential requirement to adapt IT systems, trade reporting infrastructure and operational processes; (vi) conduct risks arising from the potential impact of communication with customers and engagement during the transition period, and (vii) litigation risks regarding our existing products and services, which could adversely impact our profitability. The replacement benchmarks and their transition path have been defined, but the mechanisms for implementation are under development. As of December 31, 2019, the Bank had contracts with a maturity after 2021 that used IBOR as a benchmark. Of these, the majority are linked to the USD LIBOR, including derivatives, loans, and master agreements (e.g. ISDAs, CSAs). Accordingly, it is not currently possible to determine whether, or to what extent, any such changes would affect us. However, the implementation of alternative benchmark rates may have a material adverse effect on our business, results of operations, financial condition and prospects. We may also be adversely affected if the change restricts our ability to provide products and services or if it necessitates the development of additional information technology systems.

 

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.

 

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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 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.

 

The Chilean Congress is currently discussing modifications to Law 20,009, which defines the scope of responsibility for users and issuers when a client’s cards and/or online payment or transfer user information are lost, stolen or fraudulently used (including through hacking and cloning). Cardholders are obligated to notify the bank through an easily accessible channel when their cards have been lost, stolen, or fraudulently used. Some members of Congress are proposing that for those transactions realized prior to the notice of loss or theft of a credit card, the cardholder must also notify the issuer of all of the unauthorized transactions in the same notice or up to five business days following the original notification. In cases of fraud, the user will not be responsible for the transactions that they did not authorize and which were made prior to the fraud notification within the 30 calendar days following the issuance of said notice. In these cases, some members of Congress are seeking that the issuer be responsible for assuming these costs or must demonstrate that the transaction was in fact authorized by the owner or user of the credit card. The law also considers increasing fines and jail time for those committing theft or fraud with credit cards, which must be legally pursued by the card issuer.

 

In light of these developments, we are trying to limit the exposure of our clients to credit card fraud through education, insurance coverage, marketing campaigns, daily transfer amount limits, chip technology, improved ATM software, and other technological improvements, but we cannot assure that this law will not increase the financial costs related to cybercrime and credit card fraud.

 

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

 

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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.

 

We may be the subject of misinformation and misrepresentations deliberately propagated to harm our reputation or for other deceitful purposes, or by profiteering short sellers seeking to gain an illegal market advantage by spreading false information about us. There can be no assurance that we will effectively neutralize and contain a false information that may be propagated regarding the business, which could have an adverse effect on our operating results, financial condition and prospects.

 

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.

 

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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. The Basel Committee is now introducing guidelines to strengthen the interaction and cooperation between prudential and AML/CFT supervisors. 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.

 

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.

 

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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 certainty 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. At December 31, 2019, we had provisions for legal contingencies of Ch$1,274 million.

 

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 or currency trades 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.

 

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,

 

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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 or a reduction in prepayment fees could have a material adverse effect on us. The current administration is presently analyzing an initiative to reduce or limit prepayment fees and the Bank does not yet have an estimate of the potential impact of such initiatives. We cannot assure you that this change or any future regulatory changes related to prepayment fees will not have a material impact on our business.

 

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, interbank loans or commercial paper 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, 2019, short-term funding from institutional investors as defined by our Asset and Liability Committee totaled U.S.$3.0 billion or 4.4% 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 such as our acquisition of 51% of Santander Consumer S.A. in 2019. 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, unexpected liabilities or contingencies relating to the acquired businesses, including legal claims and delivery and execution risks. 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;

 

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

 

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

 

·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.

 

Climate change can create transition risks, physical risks, and other risks that could adversely affect us.

 

Climate change presents a number of risks, including:

 

·Transition risks associated with the move to a low-carbon economy, both at individual and systemic levels, such as through policy, regulatory and technological changes;

 

·Physical risks related to extreme weather impacts and longer term trends, which could result in financial losses that could impair asset values and the creditworthiness of our customers; and

 

·Liability risks derived from parties who may suffer losses from the effects of climate change and may seek compensation from those they hold responsible such as state entities, regulators, investors and lenders.

 

Should any of these risk materialize, they may introduce additional financial risks, including the following:

 

·Credit risks: Physical climate change could lead to increased credit exposure and companies with business models not aligned with the transition to a low-carbon economy may face a higher risk of reduced corporate earnings and business disruption due to new regulations or market shifts. Central Chile is currently enduring the longest drought of its recent history.

 

·Market risks: Market changes in the most carbon-intensive sectors could affect energy and commodity prices, corporate bonds, equities and certain derivatives contracts. Increasing frequency of severe weather events could affect macroeconomic conditions, weakening fundamental factors such as economic growth, employment and inflation.

 

·Operational risks: Severe weather events could directly impact business continuity and operations of both us and customers.

 

·Reputational risk could also arise from shifting sentiment among customers and increasing attention and scrutiny from other stakeholders (investors, regulators, etc.) on our response to climate change.

 

In December 2019, the FMC published new guidelines for discussion on disclosure of social responsibility and sustainable development by issuers. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

 

Our operations and results may be negatively impacted by the coronavirus outbreak.

 

Global or national health concerns, including the outbreak of pandemic or contagious disease, such as the recent coronavirus, may adversely affect us.

 

Since December 2019, a novel strain of coronavirus has spread in China and other countries. Such events could cause disruption of regional or global economic activity, which could affect our operations and financial results. The extent to which the coronavirus impacts our results will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity of the coronavirus and the actions to contain the coronavirus or treat its impact, among others.

 

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Risks Relating to Chile

 

Political, legal, regulatory and economic uncertainty arising from social unrest and the resulting social reforms, as well as the referendum on Chile’s constitution could adversely impact the Bank’s business

 

During October 2019, growing public concern over perceived social inequality led to a rise in social unrest. There are numerous demands by the population, related to more economic inclusion and fairer social relationships. In response to these events, the government has announced a social agenda intended to increase basic pensions, expand social health coverage, reduce working hours, and reduce and stabilize some public services tariffs (including public transport and electricity).

 

To fund these initiatives, the government and opposition lawmakers reached an agreement regarding a new tax reform. The main points of the new agreement are: (i) increasing the marginal rate for the top personal tax bracket from 35% to 40%, (ii) increasing the property tax for high income properties, (iii) limiting the use of retained losses as a mean of reducing taxes, (iv) creating a special tax regime for Small to Mid-size Enterprises (“SMEs”) (sales below US$3 million per year) to avoid owner-operated SMEs from paying a higher tax bill than the income tax rate paid by workers with similar income levels, (v) introducing new tax rules for investment vehicles, (vi) ending the beneficial VAT treatment for construction companies, and (vii) introducing a long-term plan to review tax exemptions for several economic sectors.

 

Important political and social actors claim that the social unrest reflects the desire of a new constitution, as Chile’s current constitution dates to 1980. When the government announced the possibility of enacting a new Constitution, there was increased volatility in the Chilean stock market and exchange rate fluctuations that resulted in a weakening of the Chilean peso against the U.S. dollar. The peso depreciated 12.1% since October 18, 2019, when the more serious events started, to a record high level of Ch$801.83 on November 15, 2019. The share prices on local banks and bond spreads, including Santander Chile, suffered significant declines in the market as social protests continued in the country. Seventy of the Bank’s branches suffered different levels of damages during this period but most of these costs were covered by insurance. There was also a rise in early non-performance levels among SMEs, mortgage and consumer loans due to reduced working hours in the economy. We have cut our GDP forecast for 2019 and 2020 to 1.1% and 1.0%, respectively, and the budget deficit estimate has been increased to 4.5% of GDP in 2020.

 

On November 15, 2019, the majority of the local political parties announced a referendum to vote on two matters: (i) whether a new constitution should be enacted and (ii) if so, whether constituent convention should be comprised of an elected mixed assembly of current Congress members and newly elected persons or entirely comprised of newly-elected citizens. This referendum will take place in April 2020 and the elections for the convention that will draft the new Constitution, if that is decided, will take place in October 2020. Each new article of the Constitution would have to be approved by two thirds of the convention. The convention would have approximately one year, starting in October 2020, to complete the draft of the Constitution. An exit referendum with compulsory participation would then be held to ratify the new Constitution.

 

News of the referendum calmed markets and unrest levels have improved since then. The long-term effects of this social unrest are hard to predict, but could include slower economic growth, which could adversely affect the Bank’s profitability and prospects. A further increase in the unemployment rate could diminish demand for loans and increase the risk of loan losses. The ongoing political environment could further deteriorate economic growth and the business environment in the future.

 

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 and declining investment. 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

 

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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.

 

Any future 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.

 

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

 

The Chilean Government enacted various tax reforms in 2014, 2016 and 2020 in order to finance greater social expenditures. The most relevant change was the rise of the corporate tax rate to 27% by 2018 and the introduction of two corporate taxation regimes (Sistema Parcialmente Integrado (SIP or Semi-Integrated Regime) and the Sistema de Renta Atribuida (Attributed Income Regime)). However, a corporation such as Banco Santander-Chile with a majority of shareholders that are incorporated entities is obliged to adhere to the Semi-Integrated Regime. The statutory tax rate rose to 27% in 2018, with personal and withholding taxes imposed on a cash basis (when dividends are distributed), therefore retaining some benefits for shareholders of companies that reinvest profits.

 

Furthermore, in January 2020, Congress approved the latest tax reform introduced to better finance social demands, becoming law as of February 28, 2020. Key changes to the individual income tax system include (i) the use of electronic receipts, to increase VAT collection, (ii) a new VAT tax on digital services, (iii) higher property taxes for all properties belonging to the same tax identification number with tax appraisal values that exceeds Ch$400 million (US$535 thousand), (iv) to increase the income tax paid by high income earners (individuals earning above US$250,000 a year) from 35% to 40%, and (v) exemptions on property taxes for low income pensioners.

 

The following changes were introduced to the corporate tax regime: (i) the gradual elimination of tax refunds for companies with losses, and (ii) to create a Pro-SME regime for companies with sales of up to UF 75,000 or approximately US$2.8 million, in which 100% of corporate tax can be used as a credit for personal taxes based on withdrawals, SMEs pay a 25% corporate tax rate and benefit from instant depreciation and cash-based taxation. A new “transparency regime” is also created for companies whose owners are natural persons, which includes simplified accounting and taxation rules to equalize an owner-operated business tax rate with the personal income rate.

 

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 could 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.

 

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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, or other 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, 2019, approximately 3.4% of our assets were held abroad. There can be no assurance that the ongoing effects of a global financial crisis will not negatively impact growth, consumption, 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 2019, approximately 30.8% 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 14.3% of total exports to the United States and 13.4% to Europe in 2019.

 

Chile was recently involved in 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. For example, in 2009 Chile experienced deflation of 1.4% as the global economy contracted. In 2019, CPI inflation was 3.0% compared to 2.6% in 2018.

 

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.

 

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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.

 

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 extensive 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, 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, higher capital requirement 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.

 

In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential returns, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.

 

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, we 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.

 

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 FMC 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.

 

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Pursuant to the General Banking Law, all Chilean banks may, subject to the approval of the FMC, 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 FMC 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.

 

The changes in the way banking institutions with economic difficulties should be treated shifts the focus from solving to anticipating potential adverse situations that may affect a bank or the banking system or that implies the dissolution and liquidation of a bank. To that extent banks will be obliged to inform the FMC whenever they are in any of a certain number of situations specified in the proposed bill and present an Early Regularization Plan for approval by the FMC. Banks in such situations will be able to undertake a preventive capital increase or receive a three-year term loan from another bank, which will be considered as capital. The creditors agreement considered in the current banking law is eliminated. In case the Regularization Plan fails or is not presented by the bank, the FMC will appoint a delegated inspector or eventually a Provisional Administrator. We cannot assure you that we will not incur in such situations in the future, which could have a material adverse impact on you.

 

Currently, a credit line associated to a current account accrues interest until the client directly pays off the credit line. Starting January 1, 2020, a new law regarding the automatic credit line payments will come into governance. This law states that the credit line associated to current accounts will automatically be paid off when there are funds available in the current account. Bank clients will have the possibility to decide to turn off this feature of automatic discount, but must expressly and voluntarily do so. In this manner, the Bank may have a negative material impact on the future accrual of interest under this item. We estimate this impact will be of Ch$20,000 million of less net interest income in 2020.

 

A draft bill currently in Congress proposes to regulate prepayment commissions. This bill eliminates the prepayment fee for all interest-bearing loans, permitting the debtor to pay off capital and the interests accrued at any moment during the duration of the loan, unless otherwise expressly specified in the contract. This bill also prohibits grace periods to accrue interest. These bills are still in the early phases of congressional discussion so we cannot estimate an impact, bur no assurance can be given that this will not have a material impact on future income.

 

A draft bill currently in Congress will also modify the responsibility of credit card and internet frauds. It is proposed that banks will be responsible for all damages that are produced by deficiencies in the protection of technological systems in the payment systems. Additionally, the card issuer will be responsible for all frauds and will subsequently have the ability to seek payment from those responsible of the crime. The bill also protects users from frauds they had no previous knowledge of. If this bill is passed, the Bank could be adversely affected by having to reimburse a larger amount of users for fraudulent operations. There could also be additional costs due to stricter due diligence and more robust processes in order to safeguard the Bank from additional payments.

 

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

 

As of December 31, 2019 on a consolidated basis, we had 11,200 employees, of which 75.1% were unionized. In February 2018, a new collective bargaining agreement was signed with the main unions ahead of schedule, which became effective on September 1, 2018 and 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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There is currently a new labor reform being discussed in Congress, which, among other items, shortens the work week from 45 hours to 40 hours, excluding the lunch break. There is also discussion to increase minimum wage currently set at Ch$301,000/month (US$415/month) by up to 50%. At Santander Chile, the weekly working hours agreed under the collective bargaining agreement are 40 hours- excluding lunch- and our minimum wage is set above the legal minimum. Despite this, we cannot assure at this time that the new labor reform will not have material impact on our expenses.

 

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 FMC 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 FMC. 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.

 

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.

 

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

 

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

 

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.

 

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 67.12%.

 

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 by-laws, transactions with related parties, corporate reorganizations, acquisitions and disposals of assets and issuance of additional equity securities, if any.

 

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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.

 

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

 

Our ADSs are listed and traded on the NYSE (under the ticker “BSAC”). Our common stock is listed and traded on the Santiago Stock Exchange (under the ticker “BSANTANDER”), which we refer to as the Chilean Stock Exchange, although the trading market for the common stock is small by international standards. At December 31, 2019, 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, FMC 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 FMC 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 Exchange, 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.

 

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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.

 

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:

 

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·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 the Chilean market in terms of loans (excluding loans held by subsidiary of Chilean banks abroad) and the second largest bank in terms of total deposits (excluding deposits held by subsidiary of Chilean banks aboard). As of December 31, 2019, we had total assets of Ch$50,574,714 million (U.S.$67,670 million), outstanding loans at amortized cost, net of allowances for loan losses of Ch$ 31,775,420 million (U.S.$42,605 million), total deposits of Ch$23,490,249 million (U.S.$ 31,431 million) and shareholders’ equity of Ch$3,398,870 million (U.S.$5,366 million). As of December 31, 2019, we employed 11,200 people. We have a leading presence in all the major business segments in Chile, and a large distribution network with national coverage spanning across all the country. We offer unique transaction capabilities to clients through our 377 branches and 1,088 ATMs. Our headquarters are 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.

 

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. The SEC maintains a website on the Internet at http://www.sec.gov that contains reports and information statements and other information about us. The reports (including this annual report) and information statements and other information about us can be downloaded from the SEC’s website www.sec.gov website or our investor relations website www.santandercl.gcs-web.com. None of the information contained on our website, or any website referred to in this Annual Report, is incorporated by reference into, or forms part of, this Annual Report.

 

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.

 

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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 fees to Santander Spain in connection with these support services.

 

B. Business Overview

 

We have 377 total branches, 251 of which are operated under the Santander brand name, with the remaining branches under certain specialty brand names, including 38 under the Select brand name, 7 specialized branches for the Middle Market and 28 as auxiliary and payment centers. During 2019, we also opened 13 Santander Workcafés, reaching a total of 53 Workcafés across all regions of Chile. 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) Corporate Investment Banking and (iv) Corporate Activities (“Other”).

 

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

 

Retail Banking

 

This segment consists of individuals and small to medium-sized entities (SMEs) with annual sales less than Ch$2,000 million (U.S.$1.6 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, foreign trade services, leasing and factoring.

 

Middle-market

 

This segment serves companies and large corporations with annual sales exceeding Ch$2,000 million (U.S.$1.6 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.$1.1 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, 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.

 

Corporate Investment Banking

 

This segment consists of foreign and domestic multinational companies with sales over Ch$10,000 million (U.S.$13.4 million). The companies within this segment have access to many products including commercial loans, leasing, factoring, foreign trade, project finance, 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 Corporate Investment Banking. These include products such as short-term financing and fund raising, brokerage services, foreign exchange services, derivatives, securitization and other tailor-made products. The Treasury Division may act as broker to transactions and manages the Bank’s trading fixed income portfolio.

 

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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, with the exception of our inflation gap, 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, 2019, in addition to the corresponding balances of loans and accounts receivable from customers:

 

   For the year ended December 31, 2019
   Loans and accounts receivable at amortized cost (1)  Net interest income  Net fee and commission income  Financial transactions, net (2)  Provision for loan losses  Support expenses (3)  Segment’s net contribution
   (in millions of Ch$)
                      
Retail Banking    22,926,377    960,361    230,627    28,426    (279,969)   (575,511)   363,934 
Middle-market    8,093,496    298,587    38,712    13,535    (38,746)   (97,054)   215,034 
Corporate Investment Banking    1,603,633    98,154    29,103    94,761    224    (65,343)   156,899 
Other    48,009    59,862    (11,356)   64,970    (4,819)   (11,953)   96,704 
Total    32,671,515    1,416,964    287,086    201,692    (323,311)   (749,861)   832,570 
Other operating income                                  13,001 
Other operating expenses and impairment                                  (52,029)
Income from investments in associates and other companies                                  1,146 
Income tax expense                                  (174,074)
Result of continuous operations                                 620,614 
Result of discontinued operations                                 1,699 
Net income for the year                                  622,313 

 

 

 

(1)Corresponds to loans and accounts receivable at amortized cost under IFRS 9, 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, 2019, our subsidiaries collectively accounted for 4.4% of our total consolidated assets.

 

      Percent ownership share as of December 31,
      2019  2018  2017
Name of the Subsidiary  Main activity  Direct  Indirect  Total  Direct  Indirect  Total  Direct  Indirect  Total
      (in %)
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 Asesorias Financieras Limitada   Financial advisory   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 
Klare Corredora de Seguros S.A.  Insurance brokerage   50.10    –      50.10    –      –      –      –      –      –   
Santander Consumer Chile S.A.  Financing   51.00    –      51.00    –      –      –      –      –      –   

As of December 18, 2019, changes were made to the company name and objective of Santander Agente de Valores Limitada, becoming Santander Asesorias Financieras Limitada.

 

As of October 19, 2019 Klare Corredores de Seguros S.A. was established as a digital insurance brokerage and is a banking subsidiary subject to banking regulations. The Bank owns the 50.1% of the company's capital share.

 

As of November 15, 2019 the FMC approved the acquisition of 51% of Santander Consumer Chile S.A. by the Bank. This acquisition had been previously approved in the extraordinary shareholders’ meeting held on July 20, 2019 where it was agreed that the Bank would acquire the ownership held by SK Bergé Financiamiento S.A. and a further 2% held by the Santander Group. The total payment for the total 51% was Ch$62,136 million.

 

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)

 

·Multiplica SpA (management of co-branding agreements)

 

As of December 2019 the Bank no longer directly consolidates Bansa Santander S.A., however it is indirectly consolidated through Santander Consumer Chile S.A. Bansa has developed a new line of business, therefore, based

 

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on IFRS 10 Consolidated Financial Statement, the Bank has ceased to exercise control, since the Bank is not exposed, or has rights, to variable returns from its involvement with the investee.

 

On October 4, 2019 the company Multiplica SpA was created as a banking business support company. In accordance with IFRS 10 Consolidated Financial Statement, the Bank controls the entity, since the relevant activities are addressed by the Bank, and the Bank is exposed, or has rights, to variable returns from its involvement with the investee.

 

The Bank also has significant influence over the following entities:

 

         Percentage of ownership share as of December 31,
         2019  2018  2017
Associates  Main activity  Place of Incorporation and operation  (in %)
Centro de Compensación Automatizado   Electronic fund transfer and compensation services  Santiago, Chile   33.33    33.33    33.33 
Sociedad Interbancaria de Depósito de Valores S.A.   Delivery of securities on public offer  Santiago, Chile   29.29    29.29    29.29 
Cámara Compensación de Alto Valor S.A.   Payments clearing  Santiago, Chile   15.00    15.00    15.00 
Administrador Financiero del Transantiago S.A.   Administration of boarding passes for public transportation  Santiago, Chile   20.00    20.00    20.00 
Servicios de Infraestructura de Mercado OTC S.A.   Administration of the infrastructure for the financial market of derivative instruments  Santiago, Chile   12.48    12.48    12.48 

 

In the case of Cámara Compensación de Pagos Alto Valor S.A., Banco Santander-Chile has a representative on the Board of Directors. As per the definition of associates, the Bank has concluded that it exerts significant influence over this entity.

 

 

In the case of Servicios de Infraestructura de Mercado OTC S.A., the Bank actively participates, through its executives, in the administration and in the process of organization, which is why the Administration has concluded that it exerts significant influence over it.

 

The Bank classifies the following entities as Assets Held for Sale and Discontinued Operations:

 

 

        

Percentage of ownership share as of December 31,

        

2019

 

2018

 

2017

Associates

 

Main activity

 

Place of Incorporation and operation

  (in %)
Sociedad Nexus S.A.   Credit card processor  Santiago, Chile   1.94     12.90    12.90 
Redbanc S.A .   ATM services  Santiago, Chile   33.43    33.43    33.43 
Transbank S.A.   Debit and credit card services  Santiago, Chile   25.00    25.00    25.00 

 

As of December 31, 2019, the Bank is in the process of selling its stake in Redbanc S.A. and Transbank S.A., while the Bank’s stake in Sociedad Nexus S.A. was sold in October 2019 and January 2020. See Note 39 of our Audited Consolidated Financial Statements.

 

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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 18 banks, including one public-sector bank. The six largest banks accounted for 86.7% of all outstanding loans by Chilean financial institutions as of December 31, 2019 (excluding assets held abroad by Chilean banks). In July 2018, Scotiabank Chile acquired BBVA Chile, becoming the third largest bank in terms of loans in the Chilean market. Furthermore, in the last quarter of 2018, BCI acquired the credit card financing business of Walmart Chile and the credit card of CMR Falabella was integrated into Banco Falabella. This represented an increase of total credit cards in the banking system of approximately 6%.

 

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 six largest banks in Chile in terms of total loans as of December 31, 2019 (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2019, unless otherwise noted
   Market Share  Rank
Commercial loans    16.0%   2 
Consumer loans    20.8%   1 
Residential mortgage loans    21.1%   1 
Total loans    19.0%   1 
Deposits    17.4%   2 
Credit card usage(1)    26.4%   1 
Checking accounts(1)    21.6%   1 
Branches    18.8%   2 

 

 

 

Source: FMC

 

(1)As of October 2019, according to the latest publicly available information

 

Loans

 

As of December 31, 2019, our loan portfolio was the largest among Chilean banks. Our loan portfolio, including interbank loans, represented 18.2% 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).

 

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   As of December 31, 2019 (Chilean Bank GAAP)
Loans  Ch$ million  U.S.$ million  Market Share
Santander-Chile    32,731,735    43,796    18.2%
Banco de Chile    30,529,608    40,849    17.0%
Scotiabank Chile    25,349,436    33,918    14.1%
Banco de Crédito e Inversiones    24,920,596    33,344    13.8%
Banco del Estado de Chile    24,872,216    33,280    13.8%
Itaú Corpbanca    17,679,376    23,655    9.8%
Others    23,974,470    32,078    13.3%
Chilean financial system    180,057,437    240,921    100.0%

 

 

 

Source: FMC.

 

Deposits

 

We had a 17.4% market share in deposits, ranking second among banks in Chile as of December 31, 2019. 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, 2019 (Chilean Bank GAAP)
Deposits  Ch$ million  U.S.$ million  Market Share
Banco del Estado de Chile    24,505,565    32,789    18.2%
Santander-Chile    23,490,249    31,431    17.4%
Banco de Chile    22,182,751    29,681    16.5%
Banco de Crédito e Inversiones    17,111,046    22,895    12.7%
Scotiabank Chile    15,989,560    21,394    11.9%
Itaú Corpbanca    12,067,573    16,147    9.0%
Others    19,463,698    26,043    14.4%
Chilean financial system    134,810,442    180,380    100.0%

 

 

 

Source: FMC.

 

Total Equity

 

With Ch$3,390,823million (U.S.$4,537 million) in equity in Chilean Bank GAAP as of December 31, 2019, we were the third 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, 2019 (Chilean Bank GAAP)
Total Equity  Ch$ million  U.S.$ million  Market Share
Banco de Crédito e Inversiones    3,791,478    5,073    17.8%
Banco de Chile    3,528,222    4,721    16.5%
Santander-Chile    3,390,823    4,537    15.9%
Itaú Corpbanca    3,346,102    4,477    15.7%
Scotiabank Chile    2,038,149    2,727    9.6%
Banco del Estado de Chile    1,802,797    2,412    8.5%
Others    3,421,740    4,578    16.0%
Chilean financial system    21,319,311    28,526    100.0%

 

 

 

Source: FMC.

 

Efficiency

 

As of December 31, 2019, 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.

 

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Efficiency ratio as defined by the FMC  As of
December 31, 2019 (Chilean Bank GAAP)
Santander-Chile    41.3%
Banco de Chile    44.8%
Scotiabank Chile    49.9%
Banco de Crédito e Inversiones    50.5%
Itaú Corpbanca    57.7%
Banco del Estado de Chile    58.9%
Chilean financial system    48.4%

 

 

 

Source: FMC.

 

Net Income for the Period Attributable to Equity Holders

 

In 2019, we were the second largest bank in Chile in terms of net income attributable to shareholders of Ch$552,093 million (U.S.$739 million) measured under Chilean Bank GAAP. The following table sets forth our and our peer group’s net income.

 

   As of December 31, 2019 (Chilean Bank GAAP)
Net income attributable to equity holders  Ch$ million  U.S.$ million  Market Share
Banco de Chile    593,008    793    23.4%
Santander-Chile    552,093    739    21.8%
Banco de Crédito e Inversiones    402,645    539    15.9%
Scotiabank Chile    254,226    340    10.0%
Banco del Estado de Chile    167,019    223    6.6%
Itaú Corpbanca    127,065    170    5.0%
Others    437,790    586    17.3%
Chilean financial system    2,533,846    3,390    100.0%

 

 

 

Source: FMC.

 

Return on equity

 

As of December 31, 2019, we were the second most profitable bank in our peer group (as measured by return on period-end equity under Chilean Bank GAAP) and the third 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, 2019 (Chilean Bank GAAP)  BIS Ratio as of November 30, 2019 (Chilean Bank GAAP)
Banco de Chile    16.8    13.7 
Santander-Chile    16.0    12.3 
Banco de Crédito e Inversiones    10.6    11.8 
Banco del Estado de Chile    10.1    10.9 
Itaú Corpbanca    3.9    13.3 
Scotiabank Chile    12.8    10.4 
Chilean financial system    12.1    12.5 

 

 

 

Source: FMC.

 

Asset Quality

 

As of December 31, 2019, we had the fourth lowest 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 FMC as of December 31, 2019.

 

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   Non-performing loans / total loans(1) as of December 31, 2019 (Chilean Bank GAAP)
Banco de Crédito e Inversiones    1.3 
Banco de Chile    1.4 
Scotiabank Chile    1.9 
Santander-Chile    2.1 
Itaú Corpbanca    2.8 
Banco del Estado de Chile    3.7 
Chilean financial system    2.1 

 

 

 

Source: FMC

 

(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 FMC, previously the SBIF prior to being absorbed by the FMC on June 1, 2019, 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 was amended in 2001 to grant 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 most recent amendment to the General Banking Law was introduced by law 21,130, passed in January 2019, which modernizes Chile’s banking legislation by adopting capital and resolution standards in line with the requirements of the Basel Committee.

 

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.

 

Financial Market Commission

 

In 2017, Law 21,000 created the Comisión para el Mercado Financiero or Financial Market Commission (FMC). This law became a Law of the Republic in January 2018. The FMC is now the sole supervisor for the Chilean financial system overseeing insurance companies, companies with publicly traded securities, credit unions,

 

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credit card and prepaid card issuers, and, as of June 1, 2019, banks. It is 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 is in charge of a Council, which is composed of five members, who are appointed and are subject to the following rules:

 

·A Commissioner appointed by the President of Chile, 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 Chile, 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.

 

In January 2019, Law 21,130, which modernized the banking legislation contained in the General Banking Law and amended Law 21,000 (among others), was published in the Official Gazette. The law modernizes Chilean banking regulation in order to comply with Basel III practices and provisions. The law provides for stronger banking capital and reserves requirements in accordance with Basel III guidelines. The law also modernizes the corporate governance function of the FMC and, importantly, transfers the SBIF functions to the domain of the FMC. The FMC now has the faculty to determine the risk weighting of assets through a standardized model to be approved by the FMC or banks can implement their own methodology, subject to approval by the FMC. The law also imposes limitations on dividend distributions and puts in place intervention mechanisms in the event of insolvency.

 

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

 

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

 

According to Article 35bis of the New General Banking Law, the prior authorization of the regulator 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.

 

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The intended purchase, merger or expansion may be denied by the regulator with an accompanying resolution recording the specific reasons for denial and with agreement of a majority of the Board of Directors of the Central Bank.

 

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

 

·a bank is required to inform the FMC 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;

 

·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 FMC 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 FMC of their financial condition.

 

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

 

Deposit Insurance

 

The Chilean government guarantees certain time and demand deposits and savings accounts held by natural persons with a maximum value of UF400 per person (Ch$11,323,976 or U.S.$15,152 as of December 31, 2019) per calendar year in the entire financial system and a maximum of UF200 per person per bank.

 

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.

 

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Minimum Capital

 

Under the General Banking Law, a bank is required to have a minimum of UF800,000 (approximately Ch$22,648 million or U.S.$.30.3 million as of December 31, 2019) 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. Under the New General Banking Law, total regulatory capital remains at 8% of risk-weighted assets which includes credit, market and operational risk, while Minimum Tier 1 capital increases from 4.5% to 6% of risk-weighted assets.

 

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, a bank is required to have regulatory capital of at least 8.0% of its risk-weighted assets, net of required loan loss allowances, and paid-in capital and reserves (i.e., core capital) of at least 3.0% of its total assets, net of required loan loss allowances. For these purposes, the regulatory capital of a bank is the sum of: (1) the bank’s core capital; (2) subordinated bonds issued by the bank valued at their placement price for an amount up to 50.0% of its core capital, provided that the value of the bonds is required to be decreased by 20.0% for each year that elapses during the period commencing six years prior to their maturity; and (3) its voluntary allowances for loan losses, for an amount of up to 1.25% of its risk-weighted assets. Santander-Chile does not have goodwill, but if it did, this value would be required to be deducted from regulatory capital. When calculating risk weighted assets, we also include off-balance sheet contingent loans. The merger of Old Santander Chile and Santiago on August 1, 2002 required a special regulatory pre-approval of the SBIF (predecessor of the FMC), which was granted on May 16, 2002. The resolution granting this pre-approval imposed a regulatory capital to risk weighted assets ratio of 12.0% for the merged bank. This requirement was reduced to 11.0% by the SBIF (now the FMC) effective January 1, 2005. For purposes of weighing the risk of a bank’s assets, the General Banking Law considers five different categories of assets, based on the nature of the issuer, the availability of funds, and the nature of the assets and the existence of collateral securing such assets.

 

On November 19, 2019, the FMC published for consultation a new regulation on regulatory capital to comply with effective net worth rules in accordance with Basel III and the New General Banking Law. The new regulation will become effective on December 1, 2020 and will be gradually implemented and adjusted to be fully in place by December 1, 2024. Pursuant to the proposed regulation, there will be three levels of capital: ordinary capital level 1 or CET1 (basic capital), additional capital level 1 or AT1 (perpetual bonds and preferred stock) and capital level 2 or T2 (subordinated bonds and voluntary provisions). Regulatory capital will be composed of the sum of CET1, AT and T2 after making some deductions, mainly for intangible assets, hybrid securities issued by foreign subsidiaries, partial deduction for deferred taxes and some reserve and profit accounts.

 

Under the New General Banking Law, minimum capital requirements have increased in terms of amount and quality. Total Regulatory Capital remains at 8% of risk-weighted assets which includes credit, market and operational risk. Minimum Tier 1 capital increased 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 also establishes the conditions and requirements for the issuance of perpetual bonds and preferred equity. Tier 2 capital is now set at 2% of risk-weighted assets.

 

Additional capital demands are incorporated through a Conservation Buffer of 2.5% of risk-weighted assets. The Central Bank may set an additional Counter Cyclical Buffer of up to 2.5% of risk-weighted assets in agreement with the FMC. Both buffers must be comprised of core capital.

 

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The FMC, with agreement from the Central Bank, may impose additional capital requirements for Systemically Important Banks (“SIB”) of between 1-3.5% of risk-weighted assets. Notably, the Central Bank may require: (1) the addition of up to 2% to the core capital to a bank’s total assets ratios; (2) a reduction in the technical reserve requirement trigger from 2.5 times regulatory capital to 1.5 times regulatory capital; and/or (3) a reduction in the interbank loan limit to 20% of regulatory capital of any SIB.

 

The FMC will have until December 1, 2020 to establish the weightings. Until then, banks must maintain a 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. We must maintain a minimum regulatory capital to risk-weighted assets ratio of 11%. As of December 31, 2019 our ratio of regulatory capital to risk weighted assets was 13.4%.

 

The FMC has already started publishing drafts for consultation. On August 12, 2019, the FMC published their first draft for the identification and core capital charge for those banks considered SIBs. There are a total of four factors that are then weighted to reach a market share:

 

1.Size (weighted at 30%): Includes total assets consolidated in the domestic market.

 

2.Domestic interconnection (weighted at 30%): Includes assets and liabilities with financial institutions (banks and non-banks) and assets in circulation in the Chilean financial market (equity and fixed income).

 

3.Domestic substitution (weighted at 20%): Includes the share in local payments, assets in custody, deposits and loans.

 

4.Complexity (weighted at 20%): Includes factors that could lead to greater difficulties regarding costs and/ or time for the orderly resolution of the Bank. These include the notional amount of OTC derivatives, inter-jurisdictional assets and liabilities and available-for-sale assets.

 

The minimum amount of the sum of the factors to be considered systemic is 1000 bp, equivalent to a weighted participation of 10% of all four factors. The core capital additional charge depends on the size of the total factor, as set out in the table below:

 

Systemic Level Range (bp) Core capital additional charge (% of risk-weighted assets)
I 1000-1300 1.0%-1.25%
II 1300-1800 1.25%-1.75%
III 1800-2000 1.75%-2.5%
IV >=2000 2.5%-3.5%

 

Given our size and market share, it is likely that we will be classified as a SIB, according to the FMC’s proposed regulation on SIBs.

 

On September 13, 2019, the FMC published the risk weightings for operational risk. In order to estimate the operational risk coefficient, two factors are considered:

 

1.The business indicator component (BIC): A component that considers interest income, interest earning assets, dividend income, financial transactions, fees, and other operational income and expenses. These are then multiplied by a marginal coefficient.

 

2.Internal Loss Multiplier (ILM): This component is based on 10 years of historical operational losses, or at least five years in some special cases.

 

On January 27, 2019, the FMC published for consultation the risk weighting model for credit risk. The Basel Committee on Banking Supervision (BCBS) defines credit risk (CR) as the risk that a debtor or bank counterparty does not meet its obligations in accordance with the agreed terms. Credit risk is the most relevant in the Chilean banking industry. The mechanism in force today estimates Risk Weighted Assets by Credit Risk (RWCR) using a methodology based on the Basel I standard. The proposed standard method with Basel III standards is more advanced, since it has categories that depend on the type of counterparty and different risk factors. These categories are not based on accounting criteria, but rather on the underlying risk. Thus, all exposures that have mortgage guarantees, for example mortgage loans for housing, have a different treatment from those exposures not guaranteed

 

54

by a mortgage. Additionally, in the case of mortgage-backed exposures, there will be different types of treatment depending on the type of real estate and whether the obligations are paid with income generated by the property itself. The new framework will also allow the use of internal methodologies, subject to compliance with minimum requirements. The standard in consultation includes the possibility of reducing RWCR when considering credit risk mitigators, such as compensation agreements, guarantees and other compensations.

 

The New General Banking Law also incorporates Pillar II capital requirements with the objective of assuring an adequate management of risk. The FMC, with at least four votes from the Council of 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 particular 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 Central Bank.

 

The following table sets forth a comparison between the regulatory capital demands under the previous law, and those under the New General Banking Law:

 

Capital requirements: Basel III, previous GBL and new requirements

Capital categories

 

Previous Law

 

New General Banking Law

(% over risk weighted assets)
(1) Total Tier 1 Capital (2+3)   4.5   6
(2) Shareholders’ Equity   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

 

The regulations for calculating RWA under the new guidelines must be implemented by December 1, 2020. We may be required to raise additional capital in the future in order to maintain our capital adequacy ratios above the minimum required levels.

 

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. 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 in the case of export loans in foreign currency the ceiling is raised to 30%;

 

·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;

 

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·a bank may not grant loans to a single business group, as defined in Title XV of Law 18.045, that exceeds 30% of the Bank’s regulatory capital. This limit excludes interbank loans.

 

·if a bank originates a loan in excess of these limits, a fine equivalent to 10% of the excess will be applied to the bank.

 

·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 FMC detailed information regarding their loan portfolio on a monthly basis. The FMC 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 FMC. Category 1 banks are those banks whose methods and models are satisfactory to the FMC. 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 FMC while its Board of Directors will be made aware of the problems detected by the FMC 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 FMC until they are authorized by the FMC to do otherwise. Santander-Chile is categorized as a “Category 1” bank.

 

Differences between IFRS and Chilean Bank GAAP

 

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:

 

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 9 and IAS 39 did not allow the suspension of accrual of interest on financial assets for which an impairment loss has been determined. As of January 1, 2018, the Bank adopted IFRS 9. Under IFRS 9, interest income is calculated by applying the effective interest rate to the gross carrying amount of financial assets, except for financial assets that have subsequently become credit-impaired (or “Stage 3”), for which interest revenue is calculated by applying the effective interest rate to their amortized cost (i.e., net of ECL provision). Off-balance interests are recorded as interest income only if the Bank receives the related payments. 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

 

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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

 

Prior to the adoption of IFRS 9 on January 1, 2018, the Bank calculated loan loss allowances in accordance with IAS 39. The main difference between Chilean Bank GAAP and IFRS 9 and IAS 39 regarding loan loss allowances is that loan loss allowances under Chilean GAAP are calculated using expected loss models based on specific guidelines set by the FMC, which in turn are based on an expected losses approach while IAS 39 used an incurred loss approach. According to both Chilean Bank GAAP and IFRS, loan loss allowances are calculated using expected loss models. The models adopted with IFRS 9 used an expected loss approach, however these are not in accordance with specific guidelines under Chilean Bank GAAP given by the FMC. The FMC has not yet adopted IFRS 9 and therefore the Bank has adjusted the Audited Consolidated Financial Statements to fully comply with IFRS standards. 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 made the total impact (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 Bank 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 FMC 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 Bank GAAP, the Bank has established allowances related to the undrawn available credit lines and contingent loans in accordance with the FMC. Prior to the adoption of IFRS 9, IAS 39 only permitted allowances following internal models based on incurred debt. With the adoption of IFRS 9, provisions for contingent loans are calculated based on expected credit loss. 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 and Article 79 of the Chilean Companies Law, 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 shareholders’ meeting by unanimous vote of the outstanding shares. While the Bank uses the same policy under Chilean Bank 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 Bank GAAP.

 

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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 FMC.

 

Legal Provisions Regarding Banking Institutions with Economic Difficulties

 

Article 112 of the New General Banking Law provides that if specified adverse economic circumstances exist at any bank, its Board of Directors must approve a financing plan to correct the situation and present it to the FMC. In its proposal, the bank must state the scheduled time within which the plan will be completed, which may not exceed 6 months. If one of the measures contained in the financing plan is to increase the capital of the bank by the amount necessary to return the bank to financial stability, the Board of Directors must call a special shareholders’ meeting to the capital increase. If the shareholders reject the capital increase, the FMC may apply one or more of the restrictions stated in Article 116 of the New General Banking Law for a period not exceeding 6 months, which may be renewed once for the same period. These restrictions include limiting the bank’s ability to grant loans to any person or legal entity linked (directly or through third parties) to the property or management of the bank, limiting loan renewals for more than 180 days, limiting security documents governing existing loans, among others.

 

If the approval of shareholders is required for a different measure included in the plan, the Board of Directors must call the shareholders’ meeting within 15 days. The General Banking Law provides that the bank may receive a three-year term loan from one or more banking institutions. The terms and conditions of such a loan must be approved by the directors of both banks, as well as by the FMC, but need not be submitted to any institution’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. If the bank is unable to pay the loan to its creditors, article 115 of the General Banking Law provides that a bank’s unpaid debt may be: (i) capitalized in a merger between the bank and creditor bank, where the creditor bank may establish the terms and conditions of the merger provided such terms and conditions are approved by the FMC; (ii) used to complete a capital increase agreed by the bank, provided that the shares are issued by a third party; and (iii) to subscribe and pay a capital increase. The shares acquired by the creditor bank must be sold within a period of 180 days, which can be extended by the FMC for a further 180 days.

 

Dissolution and Liquidation of Banks

 

The FMC 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 FMC must revoke a bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The FMC must also revoke a bank’s authorization if the reorganization plan of such bank has been rejected twice. The resolution by the FMC must state the reason for ordering the liquidation and must name a liquidator, unless the FMC 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.

 

On January 12, 2019, Law No. 21,130 was published in the Official Gazette of Chile. The law modernizes banking legislation including the General Banking Law by, among other things, transferring the supervisory powers of the SBIF to the FMC, updating the capital and risk management requirements applicable to banking companies in accordance with the Basel III standards, and introducing measures for the early regularization and intervention of banking companies that are at risk of insolvency.

 

With respect to measures for early regularization, Law No. 21,130 establishes an obligation on banks to inform the FMC if any of the regulatory non-compliance situations listed in Article 112 of the New General Banking Law arise or if it has detected any event indicative of financial instability or deficient administration. Within five days of notifying the FMC, the bank must present a regularization plan approved by its board of directors containing

 

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concrete measures that shall remedy the relevant situation and ensure the bank’s normal performance. The bank must comply with the regularization plan within 6 months of the resolution approving it. During the implementation of the plan, the bank must also submit periodic reports on its progress to the FMC, and the FMC may require the implementation of additional measures and/or prohibitions it deems necessary for the plan’s success.

 

Article 161 of the New General Banking Law provides that directors, managers, administrators and attorneys-in-fact who, without written authorization from the FMC, agree to, perform or cause the execution of any of the acts prohibited under Article 116 of the New General Banking Law shall be sanctioned with ordinary imprisonment for a term within the medium to maximum range. If a bank fails to submit the regularization plan, the plan is rejected by the FMC, the bank fails to comply with any of the measures set out in the plan, the bank repeatedly breaches the plan’s terms or is subject to fines, or if any serious event occurs that raises concerns for the bank’s financial stability, the FMC may appoint a delegated inspector, who shall have powers to, among other things, suspend any agreement of the board of directors or act of the attorneys-in-fact of the institution, and/or a provisional administrator, who shall have all the ordinary faculties that the law and the by-laws provide for the board of directors, or whoever acts in its place, and for the general manager.

 

Other amendments incorporated by Law No. 21,130 include the elimination of creditors’ agreements as a mechanism for regularizing a bank’s financial situation, the incorporation of modifications to financial system capitalization and preventive capitalization, and the incorporation of further requirements for bank directors.

 

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 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)

 

 

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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 FMC 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.

 

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 2010 Dodd-Frank Act and its implementing regulations, most of which are now in place. More recently, the President of the United States issued an executive order in 2017 that sets forth principles for financial regulatory and legislative reform. In May 2018 the United States Congress passed, and President Trump signed into law the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) which, among other things, revised the thresholds for total consolidated assets at which certain enhanced prudential standards apply to bank holding companies. EGRRCPA made clear that the Board of Governors of the Federal Reserve System (the "Federal Reserve Board") retains the right to apply enhanced prudential standards to FBOs with greater than $100 billion in global total consolidated assets, such as Santander Spain.

 

In October 2019, the federal banking agencies issued final rules that, pursuant to EGRRCPA, adjust the thresholds at which certain enhanced prudential standards and capital and liquidity requirements apply to certain banking organizations, including large FBOs such as Santander Spain. As a result, Santander Spain is now generally subject to less restrictive enhanced prudential standards and capital and liquidity requirements than under previously applicable regulations.

 

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

 

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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’s 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.

 

As of October 2019, the five regulatory agencies charged with implementing the Volcker Rule finalized amendments to the Volcker Rule. These amendments tailor the Volcker Rule’s compliance requirements to the amount of a firm’s trading activity, revise the definition of trading account, clarify certain key provisions in the Volcker Rule, and modify the information companies are required to provide the federal agencies. Santander-Chile will still largely rely on the “solely outside the U.S. exemption” to conduct its trading activities.

 

In early 2020, the five federal agencies proposed additional amendments to the Volcker Rule related to the restrictions on ownership interests in and relationships with covered funds. Santander Spain will continue to monitor Volcker Rule-related 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

 

Santander-Chile, 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 Santander-Chile’s officers and/or directors can be imposed for violations of the FCPA.

 

Furthermore, Santander-Chile 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 Santander-Chile’s officers and/or directors.

 

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 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.

 

As we are part of the Santander Group, we must also disclose the exposure of other entities of the Santander Group to Iran. The following activities are disclosed in response to Section 13(r) with respect to the Santander Group and its affiliates. During the period covered by this annual report:

 

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a)Santander UK holds accounts for two customers, with the first customer holding one Savings Account and one Current Account, and the second customer holding one Savings Account. Both customers, who are resident in the UK, are currently designated by the US under the SDGT sanctions programme. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2019 were negligible relative to the overall profits of Banco Santander S.A.

 

b)During the period covered by this annual report, Santander UK held one savings account with a balance of £1.24, and one current account with a balance of £1,884.53 for another customer resident in the UK who is currently designated by the US under the SDGT sanctions program. The customer relationship pre-dates the designations of the customer under these sanctions. The United Nations and European Union removed this customer from their equivalent sanctions lists in 2008. Santander UK determined to put a block on these accounts, and the accounts were subsequently closed on January 14, 2019. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2019 were negligible relative to the overall profits of Banco Santander S.A.

 

c)Santander UK holds two frozen current accounts for two UK nationals who are designated by the US under the SDGT sanctions programme. The accounts held by each customer have been frozen since their designation and have remained frozen through 2019. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK Collections and Recoveries department. No revenues or profits were generated by Santander UK on these accounts in the year ended December 31, 2019.

 

d)The Santander 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.

 

e)During the period covered by this annual report, Santander Brasil held one current account with a balance of R$100.0 for a customer resident in Brazil who is currently designated by the US under the SDGT sanctions program. The customer relationship pre-dates the designation of the customer under these sanctions. Santander Brasil determined to terminate the account even prior to the customer being formally designated under the SDGT sanctions program on September 10, 2019, and the account was subsequently closed on October 9, 2019. Revenues and profits generated by Santander Brasil on this account in the year ended December 31, 2019 were negligible relative to the overall profits of Banco Santander S.A.

 

In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2019, which were negligible relative to the overall revenues and profits of Banco Santander, S.A. The Santander 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 Santander 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 Santander 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 67.12%.

 

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 6, 2020.

 

 

D. Property, plants and equipment

 

We are domiciled in Chile and own our principal executive offices located at Bandera 140, 20th floor, Santiago, Chile. At December 31, 2019, we owned the locations at which 34.6% 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, 2019  Number
Central Offices   
Owned    4 
Rented    5 
Total    9 
      
Branches     
Owned    97 
Rented    279 
Total    376 
      
Other property(1)     
Owned    52 
Rented    5 
Total    57 

 

 

 

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

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Accounting Standards Applied in 2019

 

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 FMC, and which mandates that Chilean banks abide by the accounting standards stipulated by the FMC, our locally-filed consolidated financial statements have been prepared in accordance with Chilean Bank GAAP as issued by the FMC. The accounting principles issued by the FMC are substantially similar to IFRS but

 

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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.

 

Adoption of IFRS 9 in 2018: Allowance for Loan Losses

 

Since January 2018, the Bank has replaced the “incurred loss” model in IAS 39 with the “expected credit loss (ECL)” model of IFRS 9. See “Note 2—Accounting Changes” of our Audited Consolidated Financial Statements.

 

The new single impairment model applies to all financial assets measured at amortized cost and fair value through other comprehensive income (“FVOCI”), including loan commitments and contingent loans. The Bank accounted the ECL related to financial assets measured at amortized cost and FVOCI as a loss allowance in the statement of financial position and the carrying amount of these assets is stated net of the loss allowance. The ECL related to contingent loans are accounted as a provision in the statement of financial position. For financial assets that are measured at fair value through other comprehensive income, the loss allowance is recognized in other comprehensive income and does not reduce the carrying amount of the financial asset in the statement of financial position. The new model uses a dual measurement approach, under which the loss allowance is measured as either: (a) 12-month expected credit losses or (b) lifetime expected credit losses

 

Based on changes in credit quality since initial recognition, IFRS 9 outlines a “three-stage” impairment model as illustrated by the following chart:

 

 Change in credit quality since initial recognition
Stage 1 Stage 2 Stage 3
Initial recognition Significant increase in credit risk since initial recognition Credit impaired assets
12-month expected credit losses Lifetime expected credit losses Lifetime expected credit losses

 

The Bank, at the end of each reporting period, evaluates whether a financial instrument’s credit risk has increased since initial recognition, and consequently classifies the financial instrument in the relevant stage:

 

·Stage 1: At initial recognition of a loan or when there has been an improved credit risk following a significant increase or impairment of assets, the Bank recognizes an allowance based on 12 months ECL.

 

·Stage 2: When a loan has shown a significant increase in credit risk since origination, the Bank records an allowance for the lifetime ECL. Stage 2 loans also include loans where the credit risk has improved following a Stage 3 classification.

 

·Stage 3: Loans considered credit-impaired. The Bank records an allowance for the lifetime ECL, setting the probability of default at 100%.

 

The Bank considers reasonable and verifiable information available without undue cost or effort to it that may affect the credit risk on a financial instrument, including forward-looking information to determine whether there is or has been a significant increase in credit risk since initial recognition of a loan. Forward-looking information includes past events that affect future performance, current conditions and forecasts of future economic conditions.

 

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Expected credit loss measurement

 

The expected credit losses is the probability-weighted estimate of credit losses, i.e., the present value of all cash shortfalls. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive. The three main components in measuring expected credit losses are:

 

·PD: The probability of default is an estimate of the likelihood of default over a given time period. A default may only happen at a certain time over the assessed period, if the facility has not been previously de-recognized and is still in the portfolio.

 

·LGD: The loss given default is an estimate of the loss arising after a specific default. It is based on the difference between the contractual cash flows due and those that the lender would expect to receive, including from the realization of any collateral.

 

·EAD: The exposure at default is an estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of principal and interest, whether scheduled by contract or otherwise, expected drawdown on committed facilities and accrued interest from missed payments.

 

For measuring 12-month and lifetime expected credit losses, cash shortfalls are identified as follows:

 

·12-month expected credit losses: the portion of lifetime expected credit losses that represents the expected credit losses that result from default events on the financial instruments that are possible within the 12 months after the reporting date.

 

·Lifetime expected credit losses: the expected credit losses that result from all possible default events over the expected life of the financial instrument.

 

Forward-looking information

 

The ECL model includes a broad range of forward-looking information as economic inputs, such as:

 

·GDP growth;

 

·Unemployment rates;

 

·Central Bank interest rates; and

 

·Real estate prices.

 

Interbank loans

 

According to the new balance presentation required under IFRS 9, the Bank has grouped interbank loans with loans and accounts receivable since both are measured at amortized cost and are evaluated together for impairment purposes.

 

Contingent loans

 

The Bank enters into various irrevocable loan commitments and contingent liabilities. Even though these obligations may not be recognized on the statement of financial position, they contain credit risk and, therefore, form part of the overall risk of the Bank. When the Bank estimates the ECL for contingent loan commitments and letters of credit, it estimates the expected portion of the loan commitment that will be drawn down over its expected life.

 

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Loans and account receivable measured at fair value through other comprehensive income

 

When the Bank enters into arrangements with its major customers for project finance and syndicated loans, the amount requested sometimes exceeds the Bank’s limit for single client exposure under credit risk policy, so these operations are approved under the condition that a portion of the loans be sold in the near term. The Bank also has loans that it expects to sell if market conditions are favorable to the Bank. These loans are measured at fair value through other comprehensive income and are subject to impairment requirements.

 

Allowance for Loan Losses Prior to 2018

 

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.

 

·The following table reconciles the closing impairment allowance measured in accordance with the IAS 39 incurred loss model as of December 31, 2017 to the new impairment model under IFRS 9.

 

   Loans Loss Allowance under IAS 39  Reclassification  Remeasurement  Loans Loss Allowance under IFRS 9
   (in millions of  Ch$)
Loans and receivable (IAS 39)/ Financial assets at amortised cost (IFRS 9)            
Interbank loans    472    (472)   –      –   
Loans and account receivable from customers    790,685    84    97,322    888,091 
Total loans and account receivable at
amortised cost
   791,157    (388)   97,322    888,091 
Available for sale investment (IAS39)/Financial assets at FVOCI (IFRS 9)                    
Loans and account receivable from customer – at FVOCI    –      388    (291)   97 
Total financial assets at FVOCI    –      388    (291)   97 
Other credit- related commitments                    
Contingent liabilities    8,404    –      (3,767)   4,637 
Loan commitments    –      –      19,124    19,124 
Total contingents    8,404    –      15,357    23,761 
Total provision for loan losses    799,561    –      112,388    911,949 

 

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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.

 

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 38—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 Prior to 2018

 

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 12— Debt Instruments at Fair Value through Other Comprehensive Income” in our Audited Consolidated Financial Statements.

 

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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 16—Current and Deferred Taxes” of our Audited Consolidated Financial Statements.

 

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 22—Provisions and Contingent Provisions” of our Audited Consolidated Financial Statements.

 

Adoption of IFRS 16 Leases

 

On January 1, 2019, IFRS 16 Leases has become effective; this standard sets out the principles for the recognition, measurement, presentation and disclosure of leases. The objective is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. IFRS 16 introduces a single lessee accounting model and requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, thus a lessee is required to recognize a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

 

The Bank has elected to adopt IFRS 16 using a modified retrospective approach at the date of initial application, therefore, it has recognized a right-of-use asset for an amount equal to the lease liability, which amounted to Ch$154,284 million. Below is the detail of impacts and reclassifications as of January 1, 2019. For more details, see Note 14 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 2018, the Chilean economy grew 4.0% compared to 1.5% in 2017. During 2019 the Chilean economy grew at a slower rate due to lower global growth which was affected by the China-U.S. trade disputes and the social unrest that affected Chile in the last quarter of the year. It is expected that GDP will grow 1.2% in 2019 and 1.0% in 2020.

 

As of December 2019, the unemployment rate was 7.0% in the last quarter of 2019 compared to 6.7% in the same period of 2018. The higher unemployment rate in 2019 was due to the loss of jobs during the social unrest.

 

The exchange rate depreciated by 7.0% in 2019 and 13.1% in 2018. On November 29, 2019, at the peak of the period of social unrest, the Observed Exchange rate reached a level of Ch$828.25, depreciating 19.1% year-to-date. The peso began to re-appreciate once the Central Bank began to actively intervene in the exchange rate market.

 

CPI inflation remained at 3.0% in 2019. The Central Bank relaxed monetary policy throughout much of 2019 given the slower economic growth in 2019 and an inflation rate consistently at or below the Central Bank’s target of 3%. The current Monetary Policy Rate is 1.75% compared to 2.75% at year-end 2018.

 

The growth of the Chilean banking sector evolved in line with overall economic developments and the acquisition carried out by Chilean banks of loan portfolios previously owned by non-banks. Total loans as of December 31, 2019, in the Chilean financial system, excluding loans held abroad by Chilean banks, and grew 10.0% year-over-year. Total customer deposits (defined as time deposits plus checking accounts), excluding amounts held by Chilean banks abroad increased 9.5% year-over-year as of December 31, 2019. The non-performing loan

 

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(defined as loans with an installment that is at least 90 days past-due) to total loans ratio increased from 1.7% at year-end 2018 to 1.9% at year-end 2019. This rise occurred mainly in the fourth quarter as a result of the impacts of the social unrest on asset quality.  

 

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$28,309.94 at December 31, 2019, Ch$27,565.79 at December 31, 2018 and Ch$26,798.14 at December 31, 2017. 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 2.7% in 2019, 2.9% in 2018 and 1.7% in 2017. 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.

 

·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 2019, the loss from the swaps taken in order to hedge mainly for inflation and interest rate risk and included in net interest income totaled Ch$31,346 million compared to a loss of Ch$18,799 million in 2018 and a gain of Ch$15,408 million in 2017. The average gap between our interest earnings assets and total liabilities linked to the inflation, including hedging, was Ch$4,279,082 million in 2019, Ch$4,537,476 million in 2018 and Ch$4,340,626 million in 2017. Therefore, our sensitivity to a 100 basis point shift in UF inflation considering our year end gap would be approximately Ch$42 billion.

 

·The financial impact of the gap between our interest earning assets and liabilities denominated in UFs including hedges was Ch$114,340 million in 2019, Ch$126,260 million in 2018 and Ch$73,050 million in 2017. The 9.4% decrease in these results was due to a lower UF inflation rate in 2019 compared to 2018.

 

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   As of December 31,  % Change
Impact of inflation on net interest income  2019  2018  2017  2019/2018  2018/2017
   (in millions of Ch$)
Results from UF GAP(1)    114,340    126,260    73,050    (9.4%)   72.8%
Annual UF inflation    2.7%   2.9%   1.7%          

 

 

 

(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 30.5%, 30.6% and 29.8%, for the years ended December 31, 2019, 2018 and 2017, respectively.

 

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. A flattening of the yield curve (i.e. long-term rates falling quicker than short-term rates) negatively affects our margins by lowering loan yields at a greater pace than deposits costs. 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 depreciated 7.0% in 2019 and 13.1% in 2018. 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 2019, the Bank held significant short-term assets in US$ overnight deposits in order to maintain strong liquidity levels in this currency. In 2018 and 2017, the Bank, in its spot position, usually 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. In either case, any differences are 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

 

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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. 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.

 

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.

 

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 Corporate Investment 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) Corporate Investment Banking and (iv) Corporate Activities (“Other”). See “Note 4—Reporting Segments” of our Audited Consolidated Financial Statements for more information.

 

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Results of Operations for the Years Ended December 31, 2019 and 2018

 

In this section, we discuss the results of our operations for the year ended December 31, 2019 compared to the year ended December 31, 2018. For a discussion of the results of our operations for the year ended December 31, 2018 compared to the year ended December 31, 2017, please refer to “Item 5. – A. Operating Results – Results of Operations for the Year Ended December 31, 2018 Compared to the Year Ended December 31, 2017” in our Annual Report on Form 20-F for the year ended December 31, 2018.

 

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, 2019 and 2018.

 

Consolidated Income Statement Data IFRS

 

   2019  2019  2018  % Change
2019/2018
   (U.S.$ thousands)(1)  (Ch$ million)   
Interest income and expense            
Interest income   3,106,067    2,321,381    2,244,317    3.4%
Interest expense   (1,210,133)   (904,417)   (829,949)   9.0%
Net interest income   1,895,934    1,416,964    1,414,368    0.2%
Fees and income from services                    
Fees and commission income   667,217    498,658    484,463    2.9%
Fees and commission expense   (283,089)   (211,572)   (193,578)   9.3%
Total net fees and commission income   384,128    287,086    290,885    (1.3%)
Financial transactions, net                    
Net income (expense) from financial operations   (104,587)   (78,165)   53,174    -%
Net foreign exchange gain   374,456    279,857    51,908    439.1%
Financial transactions, net   269,869    201,692    105,082    91.9%
Other operating income   17,396    13,001    23,129    (43.8%)
Net operating profit before provision for loan losses   2,567,327    1,918,743    1,833,464    4.7%
Provision for loan losses   (432,598)   (323,311)   (317,408)   1.9%
Net operating profit   2,134,729    1,595,432    1,516,056    5.2%
Operating expenses                    
Personnel salaries and expenses   (548,800)   (410,157)   (397,564)   3.2%
Administrative expenses   (312,579)   (233,612)   (245,089)   (4.7%)
Depreciation and amortization   (141,954)   (106,092)   (79,280)   33.8%
Impairment of property, plant and equipment   (3,647)   (2,726)   (39)   6889.7%
Other operating expenses   (65,969)   (49,303)   (32,342)   52.4%
Total operating expenses   (1,072,949)   (801,890)   (754,314)   6.3%
Net Operating income   1,061,780    793,542    761,742    4.2%
Income from investments in associates and other companies (2)   1,533    1,146    1,324    (13.5%)
Income before tax   1,063,313    794,688    763,066    4.1%
Income tax expense   (234,253)   (175,074)   (167,144)   4.7%
Income from continuous operations   829,059    619,614    595,922    4.0%
Income from discontinued operations (2)   2,273    1,699    3,771    (54.9%)
Consolidated net income for the year   831,333    621,313    599,693    3.6%
Net income for the year attributable to:                    
Equity holders of the Bank   828,359    619,091    595,333    4.3%
Non-controlling interests   2,974    2,222    4,360    (49.0%)

 

 

 

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2019 have been translated from Chilean pesos at the exchange rate of Ch$747.37 = U.S.$1.00 as of December 31, 2019. See “Item 3. Key Information—A. Selected Financial Data—Exchange Rates” for more information on exchange rate.

 

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(2)In 2019, we entered into the process of selling the investments in Redbanc S.A., Transbank S.A. and Nexus S.A. In accordance with IFRS 5, the Bank has reclassified and presented these investments in Other Assets classified as held for sale separate from the rest of the investments in associates and presented the effects in the income statement as discontinued operations. See “Note 39- Non-current assets held for sale”.

 

Results of Operations for the Years Ended December 31, 2019 and 2018

 

Net income for the year attributable to equity holders of the Bank increased 4.3% in 2019 compared to 2018 and totaled Ch$619,091 million. Our return on annualized average equity was 18.0% in 2019 compared to 18.4% in 2018.

 

In 2019, net operating profit before loan losses was Ch$1,918,743 million, an increase of 4.7% compared to 2018. Our net interest income increased 0.2% in 2019 compared to 2018. This was mainly driven by loan growth, but offset by the lower gains from inflation-indexed assets as UF inflation was lower in 2019 compared to 2018 and the flattening of the yield curve led to a record level of re-financing of mortgage loans at lower real rates. Overall, our net interest margin declined to 3.95% in 2019 from 4.32% in 2018.

 

Net fees and commission income decreased 1.3% to Ch$287,086 million in the twelve-month period ended December 31, 2019 compared to the same period in 2018. Fees from credit, debit and ATM cards decreased 1.7% in 2019 compared to 2018. This fall was due to the higher upfront costs relating to various initiatives implemented in our card business, which reduced net fee commission income for the period. We began the process of moving into a four-part pricing model, which uses the international interchange fees set by the main card brands (i.e. MasterCard, Visa, AMEX), and moved out of the pricing model set by Chile’s main credit card acquirer (Transbank). Fees from collections decreased 16.8% in 2019 compared to 2018. 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. During 2019, a change in the methodology for estimating incident rates for mandatory fire and earthquake insurance for mortgage loans led to a reduction in the collection of these fees. This was offset by good client growth in 2019 that drove a 24.3% and 6.2% increase in insurance brokerage and checking account fees, respectively.

 

Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain (loss), totaled Ch$201,692 million in the year ended December 31, 2019, an increase of 91.9% compared to the same period in 2018. 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$138,648 million, an increase of 45.7% compared to 2018. The higher market volatility and depreciation of the peso in the second half of 2019 led to higher demand for hedging from our Corporate and Middle-market clients. The results from non-client treasury income increased 537.2% to Ch$63,044 million in 2019 compared to 2018. These results mainly consist of the results of our Financial Management Division, in charge of managing the Bank’s capital, liquidity, funding and inflation positions. The results of the Bank’s Financial Management Division increased 420.4% to Ch$63,691 million in 2019 compared to 2018. This was due to the 651% increase in the net gains on the derecognition of financial assets measured at amortized cost which totaled Ch$63,672 million, which, in turn, was mainly due to the sharp decline in local interest rates across the entire yield curve that increased the realized gains from these investments.

 

Total other operating income decreased by 43.8% in 2019 compared to 2018 and totaled a gain of Ch$13,001 million. This lower result was mainly due to lower income from the release of non-credit contingencies compared to 2018.

 

For the year ended December 31, 2019 provisions for expected credit loss totaled Ch$323,311 million and increased 1.9% compared to 2018. This rise was mainly due to growth of our loan book and an increase in expected losses driven by the economic slowdown and social unrest during the last quarter of the year.

 

As a result of the factors mentioned above, net operating profit increased 5.2% in 2019 compared to 2018 and totaled Ch$1,595,432 million.

 

Operating expenses in the year ended December 31, 2019 increased 6.3% compared to the corresponding period in 2018. The efficiency ratio was 41.7% in 2019 and 41.1% in 2018.

 

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The 3.2% increase in personnel salaries and expenses was mainly due to a rise in variable incentives, severance payments, training and other benefits that increased 8.3%, while salary costs only grew by 0.4%. Headcount increased 1.5% in 2019, including partially as a result of the incorporation of Santander Consumer Chile, which added approximately 200 employees to the Bank.

 

Administrative expenses decreased 4.7% in the year ended December 31, 2019 compared to the corresponding period in 2018, mainly due to the implementation of IFRS 16 during 2019. As a result, rental expenses for branches are now recognized in the line item depreciation and amortization. Excluding this effect, administrative expenses increased 8.5% in the period, mainly due to a rise in marketing expenses, outsourced IT services, insurance costs and IT investments to develop the Bank’s digital services and back-office platform, which is allowing the Bank to consolidate the branches and create efficiencies in the long-term.

 

Depreciation and amortization expense increased 33.8% in 2019 compared to 2018. This increase was mainly due to the adoption of IFRS 16 in 2019 that reclassified certain branch rental expenses as depreciation and amortization.

 

The Bank recognized an impairment expense of Ch$2,726 million in 2019 mainly due to impairment of fixed assets following the social unrest that affected Chile in the fourth quarter that resulted in damage to some branches and facilities.

 

Other operating expenses were Ch$49,303 million in 2019, an increase of 52.4% compared to 2018. This was mainly due to higher general product insurance as a result of an increase in cost of cyber security and fraud insurance to cover the increase in use of digital banking and the development of new digital innovations at the Bank, which required greater cyber security and fraud protection. Also, the Bank recognized Ch$1,823 million in 2019 related to ensuring the safety of our employees and infrastructure during the period of social unrest.

 

Total income tax expense by the Bank in 2019 was Ch$175,074 million, a 4.7% increase compared to 2018, mainly driven by the 3.6% rise in net income before taxes.

 

Net Interest Income

 

   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$, except percentages)   
Retail banking    960,361    949,764    1.1%
Middle-market    298,587    272,912    9.4%
Corporate Investment banking    98,154    96,722    1.5%
Total reporting segments    1,357,102    1,319,398    2.9%
Other(1)    59,862    94,970    (37.0%)
Net interest income    1,416,964    1,414,368    0.2%
Average interest-earning assets    35,850,253    32,760,203    9.4%
Average non-interest-bearing demand deposits    7,466,991    6,763,546    10.4%
Net interest margin(2)    3.95%   4.32%     
Average shareholders’ equity and average non-interest-bearing demand deposits to total average interest-earning assets    30.5%   30.6%     

 

 

 

(1)Consists mainly of net interest income from the Financial Management Division and the cost of funding our financial assets held for trading. 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, 2019 and 2018 our net interest income totaled Ch$1,416,964 million in the year ended December 31, 2019, an increase of 0.2% from Ch$1,414,368 million in 2018 and average interest earning assets increased 9.4% in the same period. During 2019, the loan portfolio grew 8.1%, but mainly in lower yielding commercial and mortgage loans. At the same time, the average nominal interest rate earned on interest

 

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earning assets was also negatively affected by the lower UF inflation rate in 2019 compared to 2018. This caused our average nominal interest rate earned on interest earning assets indexed to the UF to decrease from 6.2% in 2018 to 5.9% in 2019. Moreover, the relatively large decline in long-term interest rates in 2019 also led to a high level of refinancing of residential mortgage loans, which also led to lower rates earned on these assets in 2019. The nominal yield earned on peso-denominated consumer loans also declined due to a lower rate environment for most of 2019 and continued focus on growing among high income earners that obtain a lower yield, but who also have a lower risk profile. This was partially offset by the acquisition of Santander Consumer Chile S.A. in November 2019, which is a company mainly dedicated to higher yielding auto-lending. All the factors mentioned above led to a decline in the overall average interest earned over interest earning assets from 6.9% in 2018 to 6.5% in 2019.

 

Average nominal interest rate earned on interest earning assets  2019  2018
Ch$    8.2%   8.6%
UF    5.9%   6.2%
Foreign currencies    3.4%   3.4%
Total    6.5%   6.9%

 

The average rate paid on our interest bearing liabilities decreased to 3.5% in 2019 from 3.6% in 2018. This was mainly due to a lower rate environment in 2019 triggered by the Central Bank’s relaxation of monetary policy due to lower than expected economic growth and inflation. This especially reduced the nominal rate paid on Ch$ denominated time deposits. The nominal rate paid over the average balance of these deposits fell from 3.0% in 2018 to 2.7% in 2019. The rate paid on UF denominated liabilities also declined due to the lower UF inflation rate in the year.

 

Average nominal interest rate paid on interest bearing liabilities  2019  2018
Ch$    3.3%   3.3%
UF    5.1%   5.4%
Foreign currencies    2.3%   2.2%
Total    3.5%   3.6%

 

Additionally, in 2019, average non-interest bearing demand deposits increased 10.4%, which helped to lower total funding costs as well.

 

In summary, the lower inflation coupled with the growth of lower yielding assets and the negative effects of a flatter yield curve in 2019, partially offset by a cheaper funding cost and mix, led to a decline in our net interest margin to 3.95% in 2019 compared to 4.32% in 2018.

 

Net interest income from our reporting segments totaled Ch$1,357,102 million and increased 2.9% compared to 2018. This rise was mainly due to the growth of the loan book, which grew 8.1% in 2019, partially offset by the lower loan yield earned by each segment due to the lower rate environment and the lower spread earned over their non-interest bearing demand deposits. The changes in net interest income by segment in 2019 as compared to 2018 were as follows:

 

·Net interest income from Retail banking increased 1.1%, led by a 10.3% increase in loan volumes, offset by the growth of lower yielding loans, mainly mortgage loans and a lower return earned on these loans due to greater amount of loan refinancing in this product, following the decline in long-term rates in 2019. Consumer loan volumes in this segment include loans acquired through the incorporation of Santander Consumer Chile, which at year-end 2019 totaled Ch$451 billion.

 

·Net interest income from the Middle-market segment increased 9.4% in 2019, mainly due to loan growth of 5.2% in 2019 and the improvement in funding costs in this segment.

 

·Net interest income from the Corporate Investment Banking segment increased 1.5% in 2019 compared to 2018. Despite a decrease in loan volumes in this segment, the improved funding mix drove the growth in net interest income in this segment.

 

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·Other net interest income consists mainly of net interest income from the Bank’s ALCO, which includes the net interest income from the Bank’s debt instruments recorded at fair value through other comprehensive income, deposits in the Central Bank, and the financial cost of supporting our cash position and financial investments held 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 37% to Ch$59,862 million in 2019 compared to 2018. This was mainly due to the lower UF inflation rate recorded in 2019 compared to 2018 and the lower yield earned on the Bank’s debt instruments recorded at fair value through other comprehensive income, which in turn was due to the lower interest rate environment and flattening of the local currency yield curve.

 

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
   2019  2018  2019/2018
   (in millions of Ch)   
Retail banking    22,926,377    20,786,637    10.3%
Middle-market    8,093,496    7,690,380    5.2%
Corporate Investment banking    1,603,633    1,613,088    (0.6%)
Other (1)    48,009    123,309    (61.1%)
Total loans    32,671,515    30,213,414    8.1%

 

 

 

(1)Includes interbank loans.

 

The following table shows interest income of financial assets by valuation as of December 31, 2019 and 2018.

 

   At December 31,  % Change
   2019  2019/2018   
   (in millions of Ch$)   
Financial assets measured at amortized cost(1)    2,195,339    2,122,253    3.4%
Financial assets measured al FVOCI(2)    97,319    100,213    (2.9%)
Other interest    21,979    20,657    6.4%
Interest income not including income from hedge accounting    2,314,637    2,243,123    3.2%

 

 

 

(1)Financial assets measured at amortized cost include loans measured at amortized cost as described above and investments under resale agreements. The effective interest method is used in the calculation of the amortized cost of the financial asset and in the allocation and recognition of the interest revenue over the relevant period.

 

(2)Financial assets measured at fair value through other comprehensive income include the interest income from debt instruments. These mainly consisted of securities and bonds of the Chilean Central Bank that contain contractual terms that give rise on specific dates to cash flows that are solely payments of principal and interest (SPPI), and are measured at FVOCI.

 

Fee and Commission Income

 

Net fees and commission income decreased 1.3% to Ch$287,086 million in the twelve-month period ended December 31, 2019 compared to the same period in 2018. 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, 2019 and 2018.

 

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   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$)   
Credit, debit and ATM cards    54,189    55,109    (1.7%)
Collections    33,355    40,077    (16.8%)
Insurance brokerage    49,664    39,949    24.3%
Letters of credit    35,039    33,654    4.1%
Checking accounts    35,949    33,865    6.2%
Custody and brokerage services    9,154    9,211    (0.6%)
Lines of credit    10,314    6,624    55.7%
Others    59,422    72,396    (17.9%)
Total fees and commission income, net    287,086    290,885    (1.3%)

  

Fees from credit, debit and ATM cards decreased 1.7% in 2019. This fall was due to higher upfront costs relating to the various initiatives implemented in our card business, which reduced net fee and commission income for the period. We began the process of moving into a four-part pricing model, which uses the international interchange fees set by the main card brands (i.e. MasterCard, Visa, AMEX), and moved out of the pricing model set by Chile’s main credit card acquirer (Transbank). We also modified some aspects of our co-branding agreement with Latam Airlines.

 

Fees from collections decreased 16.8% in 2019 compared to 2018. 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. During 2019, a change in the methodology for estimating incident rates for mandatory fire and earthquake insurance for mortgage loans led to a reduction in the collection of these fees.

 

Insurance brokerage fees increased 24.3% due to higher brokerage of fraud, car and life insurance policies as advances in our digital platforms have enabled clients to search for and purchase these products online.

 

Fees from letters of credit and other contingent operations increased 4.1% in 2019. This line corresponds to international and foreign trade financing business with clients. The depreciation of the peso and business growth drove this revenue line in 2019.

 

Fees from checking accounts increased 6.2% in 2019 compared to 2018. This was mainly due to a rise in the Bank’s checking account base. The number of checking accounts increased 9.2% to 1,066,800. Our corporate cash management services also continued to boost fee growth in this product.

 

Brokerage and custody fees decreased 0.6% in 2019 as compared to 2018 due to lower volumes in our brokerage business, dampening the growth we experienced in 2018.

 

Fees from lines of credit increased 55.7% due to an increase of usage of these lines as a result of the lower rates available and the increase in account openings in 2019.

 

The 17.9% decrease in other fee income in 2019 compared to 2018 was mainly due to lower fees earned by our Corporate Investment Banking segment for investment banking and advisory services, in line with the slowdown of economic growth. On the other hand, fees from the brokerage of mutual funds increased 3.7% in 2019 compared to 2018. In 2019, asset management brokerage fees totaled Ch$47,331 million. In December 2013, our Asset Management business was sold, but we continue to serve as an exclusive broker for Santander Asset Management, the acquirer of our asset management business.

 

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

 

   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$)   
Retail banking    230,627    220,532    4.6%
Middle-market    38,712    36,746    5.4%

  

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   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$)   
Corporate Investment banking    29,103    35,064    (17.0%)
Other    (11,356)   (1,457)   679.4%
Total fees and commission income, net    287,086    290,885    (1.3%)

 

 

Fees from Retail banking increased 4.6% in 2019 compared to 2018. Total retail clients with a checking account increased 9.2% to 1,043,399. In 2019, 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 (clients with more than four products plus minimum usage and profitability levels). Client loyalty continues to rise in retail banking, especially among high income earners, which was the area we continued to focus on. Loyal individual customers in the high-income segment grew 6.9% during 2019. Our debit and credit card products sold through the Santander Life brand also had a strong year, as we added on a new debit card option and the possibility of accumulating airline miles with Santander Life credit cards. As a result, loyal individual customers in the middle-income segment increased 4.3% during 2019. This has led to high fee growth among retail bank clients, especially cards, insurance brokerage, brokerage of asset management products and checking accounts. This has also been driven by digital innovations leading to an increase of digital clients of 13.3% in 2019.

 

The 5.4% increase in fees from the Middle-market segment was mainly due to the positive expansion of business volumes in this segment from a greater client base. Total loyal clients (clients that have a defined minimum amount of products and profitability) increased 5.2% in 2019 compared to 2018.

 

Fees from the Corporate Investment banking segment decreased 17.0% in 2019 compared to 2018, mainly due to lower investment banking fees as a result of lower economic growth. This was offset by better results from Client Treasury activities (See Financial Transactions, net below).

 

Fees in Other decreased from a loss of Ch$1,457 million in 2018 to an expense of Ch$11,355 million in 2019. In this line item we included the impact of the change in the methodology for estimating incident rates for mandatory fire and earthquake insurance for mortgage loans. As this was not assigned to any segment, it is presented in Other.

 

Financial Transactions, Net

 

The following table sets forth information regarding our income (loss) from financial transactions for the years ended December 31, 2019 and 2018.

 

   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$)   
Net income from financial operations    (78,165)   53,174     %
Foreign exchange gain, net    279,857    51,908    439.1%
Total financial transactions, net    201,692    105,082    91.9%

 

Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain, totaled Ch$201,692 million in the year ended December 31, 2019, an increase of 91.9% compared to the same period in 2018. 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

 

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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 loss of Ch$78,165 million in 2019 compared to a gain of Ch$53,174 million in 2018.

 

  

For the year ended December 31, 

 

% Change 

  

2019 

 

2018 

 

2019/2018 

   (in millions of Ch$)   
Net (loss) gains on trading derivatives    (162,183)   38,217    (524.4%)
Net gains on financial assets at fair value through profit or loss    11,878    9,393    26.5%
Net gains on derecognition of financial assets measured at amortized cost    63,672    8,479    650.9%
Sale of loans and accounts receivables from customers    3,310    400    727.6%
Current portfolio    63    (309)   (120.3%)
Charged-off portfolio    3,248    709    358.1%
Repurchase of issued bonds    3,265    (840)   (488.7%)
Other income (expense) from financial operations    1,893    (2,475)   (176.4%)
Total income (expense)    (78,165)   53,174    

– 

%

 

The loss from financial operations in 2019 compared to a gain in 2018 was mainly due to:

 

(i)A loss of Ch$162,183 million in the sub-item net gains on trading derivatives. Movements in foreign currency and interest rates 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 and it includes results from our client foreign currency business, such as the sale of currency derivatives. In 2019, especially towards the end of the year, the Bank increased its dollar over-night liquidity position as a defensive measure due to the strong demand of dollars by most market agents as social unrest intensified in this period. Therefore, on average, the Bank had more short-term assets in dollars than short-term liabilities, which was hedged through a short-term foreign currency liability position classified as trading. The Central Bank exchange rate depreciated 7.0% in 2019 with a 20% depreciation in October and November at the peak of the social unrest. FX forward rates also increased significantly at year-end, leading to net loss from trading of derivatives.

 

This was offset by:

 

(ii)The gain of Ch$11,878 million from financial assets at fair value through profit or loss. In this line item the mark-to-market and interest income of the trading fixed income portfolio are recognized. The sharp decline in local interest rates across the entire yield curve increased the gain from these investments in 2019, which is mainly comprised of Central Bank instruments.

 

(iii)The 651% increase in the gains on the derecognition of financial assets measured at amortized cost, which totaled Ch$63,6782 million. This increase was mainly due to the sharp decline in local interest rates across the entire yield curve that increased the gain from these investments which are mainly comprised of fixed income instruments issued by the Central Bank of Chile and the Republic of Chile.

 

(iv)In 2019, despite falling rates, corporate bond spreads increased, and the Bank repurchased certain bonds at a price below par, resulting in the gain recorded in this line item. See “Note 20—Issued Debt Instruments and Other Financial Liabilities—b) Senior Bonds” in the Audited Consolidated Financial Statements.

 

(v)The Bank also realized a larger gain from the sale of charged off loans in 2019 compared to 2018.

 

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The net result from foreign exchange transactions totaled a gain of Ch$279,857 million in 2019 compared to Ch$51,908 million in 2018.

 

   Year ended December 31,  % Change
   2019  2018  2019/2018
   (in millions of Ch$)