|Part III Item 17. Financial Statements 335 Item 18. Financial Statements 335 Item 19. Exhibits 336|
|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|
|Part 1. Corporate Risk Management and Control Principles|
|Part 2. Corporate Governance of The Risk Function|
|Part 3. Risk Management and Control Model|
|Part 4. Credit Risk|
|Part 5. Market Risk|
|Part 6. Liquidity and Funding Risk|
|Part 7. Operational Risk|
|Part 8. Compliance, Conduct and Reputational Risk|
|Part 9. Model Risk|
|Part 10. Capital Management and Control of Capital Risk|
|Item 12. Description of Securities Other Than Equity Securities.|
|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. Exemption From The Listing Standards for Audit Committees|
|Item 16E. Purchases of Equity Securities By The Issuer and Affiliated Purchasers|
|Item 16F. Changes in Registrant's Certifying Accountant|
|Item 16G. Corporate Governance|
|Item 16H. Mine Safety Disclosure|
|Item 17. Financial Statements|
|Item 18. Financial Statements|
|Item 19. Exhibits|
|Note 3 Provides Information on The Most Significant Acquisitions and Disposals in 2014, 2013 and 2012.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Loans and Receivables and of The Related Average Interest Rates.|
|Note 29 Contains A Detail of The Valuation Adjustments Recognized in Equity on Available-For-Sale Financial Assets.|
|Note 29 Contains A Detail of The Valuation Adjustments Recognized in Equity on Available-For-Sale Financial Assets, and Also The Related Impairment Losses.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Loans and Receivables and of The Related Average Interest Rates.|
|Note 54 Shows The Group's Total Exposure, By Origin of The Issuer.|
|Note 54 Contains Information Relating To The Restructured/Refinanced Loans and Advances To Customers.|
|Note 36 Contains A Description of The Group's Main Hedges.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Financial Liabilities At Amortized Cost and of The Related Average Interest Rates.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Financial Liabilities At Amortized Cost and of The Related Average Interest Rates in Those Years.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Subordinated Liabilities At Each Year-End and of The Related Average Interest Rates in Each Year.|
|Note 51 Contains A Detail of The Residual Maturity Periods of Other Financial Liabilities At Each Year-End.|
|Balance Sheet||Income Statement||Cash Flow|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
|¨||REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934|
|x||ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
For the fiscal year ended December 31, 2014
|¨||TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
for the transition period from to
|¨||SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934|
Date of event requiring this shell company report
Commission file number 001-12518
BANCO SANTANDER, S.A.
(Exact name of Registrant as specified in its charter)
Kingdom of Spain
(Jurisdiction of incorporation)
Ciudad Grupo Santander
28660 Boadilla del Monte (Madrid), Spain
(address of principal executive offices)
José G. Cantera
Banco Santander, S.A.
Ciudad Grupo Santander
28660 Boadilla del Monte
Tel: +34 91 289 32 80
Fax: +34 91 257 12 82
(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
|American Depositary Shares, each representing the right to receive one Share of Capital Stock of Banco Santander, S.A., par value euro 0.50 each||New York Stock Exchange|
|Shares of Capital Stock of Banco Santander, S.A., par value euro 0.50 each||New York Stock Exchange *|
|Guarantee of Non-cumulative Guaranteed Preferred Stock of Santander Finance Preferred, S.A. Unipersonal, Series 1, 4, 5 and 6||New York Stock Exchange **|
|*||Banco Santander Shares are not listed for trading, but are only listed in connection with the registration of the American Depositary Shares, pursuant to requirements of the New York Stock Exchange.|
|**||The guarantee is not listed for trading, but is listed only in connection with the registration of the corresponding Non-cumulative Guaranteed Preferred Stock of Santander Finance Preferred, S.A. Unipersonal (100% owned subsidiary of Banco Santander, S.A.)|
Securities registered or to be registered pursuant to Section 12(g) of the Act.
(Title of Class)
Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No ¨
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 x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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. (Check one):
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
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 x
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 x
Indicate the number of outstanding shares of each of the issuers classes of capital stock or common stock as of the close of business covered by the annual report. 14,060,585,886 shares
BANCO SANTANDER, S.A.
Under Regulation (EC) No. 1606/2002 of the European Parliament and of the Council of July 19, 2002, all companies governed by the law of an EU Member State and whose securities are admitted to trading on a regulated market of any Member State must prepare their consolidated financial statements in conformity with the International Financial Reporting Standards previously adopted by the European Union (EU-IFRS). The Bank of Spain Circular 4/2004 of December 22, 2004 on Public and Confidential Financial Reporting Rules and Formats (Circular 4/2004) requires Spanish credit institutions to adapt their accounting systems to the principles derived from the adoption by the European Union of International Financial Reporting Standards. Therefore, Grupo Santander (the Group or Santander) is required to prepare its consolidated financial statements for the year ended December 31, 2014 in conformity with the EU-IFRS and Bank of Spains Circular 4/2004. Differences between EU-IFRS, Bank of Spains Circular 4/2004 and International Financial Reporting Standards as issued by the International Accounting Standard Board (IFRS-IASB) are not material. Therefore, we assert that the financial information contained in this annual report on Form 20-F complies with IFRS-IASB.
We have presented our financial information according to the classification format for banks used in Spain. We have not reclassified the line items to comply with Article 9 of Regulation S-X (see note 55 of our consolidated financial statements). Article 9 is a regulation of the US Securities and Exchange Commission that contains presentation requirements for bank holding company financial statements.
Our auditors, Deloitte, S.L., an independent registered public accounting firm, have audited our consolidated financial statements in respect of the three years ended December 31, 2014, 2013 and 2012 in accordance with IFRS-IASB. See page F-1 to our consolidated financial statements for the 2014, 2013 and 2012 report prepared by Deloitte, S.L.
Our consolidated financial statements are in Euros, which are denoted euro, euros, EUR or throughout this annual report. Also, throughout this annual report, when we refer to:
|||we, us, our, the Group, Grupo Santander or Santander, we mean Banco Santander, S.A. and its subsidiaries, unless the context otherwise requires;|
|||dollars, US$ or $, we mean United States dollars; and|
|||pounds or £, we mean United Kingdom pounds.|
When we refer to average balances for a particular period, we mean the average of the month-end balances for that period, unless otherwise noted. We do not believe that monthly averages present trends that are materially different from trends that daily averages would show. In calculating our interest income, we include any interest payments we received on non-accruing loans if they were received in the period when due. We have not reflected consolidation adjustments in any financial information about our subsidiaries or other business units.
When we refer to loans, we mean loans, leases, discounted bills and accounts receivable, unless otherwise noted. The loan to value LTV ratios disclosed in this report refer to LTV ratios calculated as the ratio of the outstanding amount of the loan to the most recent available appraisal value of the mortgaged asset. Additionally, if a loan is approaching a doubtful status, we update the appraisals which are then used to estimate allowances for loan losses.
When we refer to non-performing balances, we mean non-performing loans and contingent liabilities (NPL), securities and other assets to collect.
When we refer to allowances for credit losses, we mean the specific allowances for credit losses, and unless otherwise noted, the collectively assessed allowance for credit losses and any allowances for country-risk. See Item 4. Information on the CompanyB. Business OverviewClassified AssetsAllowances for Credit Losses and Country-Risk Requirements.
When we refer to perimeter effect, we mean growth or reduction derived from changes in the companies that we consolidate resulting from acquisitions, dispositions or other reasons.
Where a translation of foreign exchange is given for any financial data, we use the exchange rates of the relevant period (as of the end of such period for balance sheet data and the average exchange rate of such period for income statement data) as published by the European Central Bank, unless otherwise noted.
Management makes use of certain financial measures in local currency to help in the assessment of on-going operating performance. These non-GAAP financial measures include the results of operations of our subsidiary banks located outside the eurozone, excluding the impact of foreign exchange. We analyze these banks performance on a local currency basis to better measure the comparability of results between periods. Because changes in foreign currency exchange rates have a non-operating impact on the results of operations, we believe that evaluating their performance on a local currency basis provides an additional and meaningful assessment of performance to both management and the companys investors. For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see note 2(a) of our consolidated financial statements.
This annual report contains statements that constitute forward-looking statements within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements include, but are not limited to, information regarding:
|||exposure to various types of market risks;|
|||earnings and other targets; and|
Forward-looking statements may be identified by words such as expect, project, anticipate, should, intend, probability, risk, VaR, RORAC, target, goal, objective, estimate, future and similar expressions. We include forward-looking statements in the Operating and Financial Review and Prospects, Information on the Company, and Quantitative and Qualitative Disclosures About Risks sections. Forward-looking statements are not guarantees of future performance and involve risks and uncertainties, and actual results may differ materially from those in the forward-looking statements.
You should understand that the following important factors, in addition to those discussed in Key InformationRisk Factors, Operating and Financial Review and Prospects, Information on the Company and elsewhere in this annual report, could affect our future results and could cause those results or other outcomes to differ materially from those anticipated in any forward-looking statement:
The forward-looking statements contained in this report speak only as of the date of this report. We do not undertake to update any forward-looking statement to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events.
A. Directors and Senior Management
A. Offer Statistics
B. Method and Expected Timetable
Selected Consolidated Financial Information
We have selected the following financial information from our consolidated financial statements. You should read this information in connection with, and it is qualified in its entirety by reference to, our consolidated financial statements.
In the F-pages of this annual report on Form 20-F, our audited financial statements for the years 2014, 2013 and 2012 are presented. The audited financial statements for 2011 and 2010 are not included in this document, but they can be found in our previous annual reports on Form 20-F. These previous annual reports do not include the effect of the application of IFRIC 21, Levies, described below.
The income statement for the year ended December 31, 2014 reflects the impact of the reconsolidation of Santander Consumer USA Inc. (SCUSA) after we gained control of this company in January 2014. Prior to the aforementioned change of control, we accounted for our ownership interest in SCUSA using the equity method (see Item 4. Information on the CompanyA. History and development of the companyPrincipal Capital Expenditures and DivestituresAcquisitions, Dispositions, ReorganizationsSantander Consumer USA). In addition, the income statement for the year ended December 31, 2013 includes the results from Kredyt Bank S.A. after the merger in early 2013 of the subsidiaries in Poland of Banco Santander, S.A. and KBC Bank NV (Bank Zachodni WBK, S.A. and Kredyt Bank S.A.). Finally, the income statement for the year ended December, 31, 2011 reflects the impact of the consolidation of Bank Zachodni WBK, S.A.
In addition, we decided to apply ahead of the mandatory first-time application date pursuant to the endorsement issued by the European Union, IFRIC 21, Levies, which addresses the accounting for a liability to pay a levy if that liability is within the scope of IAS 37. The retroactive effect of this interpretation means anticipating the recording of contributions to the deposit guarantee fund and changing the accounting for the Financial Services Compensation Scheme levy in the UK. As a result, our profit for 2013, 2012 and 2011 was reduced by 195 million, 12 million and 41 million, respectively, and our profit for 2010 was increased by 32 million (see note 1.b and 1.d.a to our consolidated financial statements).
|Year ended December 31,|
|(in millions of euros, except percentages and per share data)|
Interest and similar income
Interest expense and similar charges
Interest income / (charges)
Income from equity instruments
Income from companies accounted for using the equity method
Fee and commission income
Fee and commission expense
Gains/losses on financial assets and liabilities (net)
Exchange differences (net)
Other operating income
Other operating expenses
Other general administrative expenses
Depreciation and amortization
Impairment losses on financial assets (net)
Impairment losses on other assets (net)
Gains/(losses) on disposal of assets not classified as non-current assets held for sale
Negative difference of consolidation
Gains/(losses) on non-current assets held for sale not classified as discontinued operations
Operating profit/(loss) before tax
Profit from continuing operations
Profit/(loss) from discontinued operations (net)
Consolidated profit for the year
Profit attributable to the Parent
Profit attributable to non-controlling interest
Per share information:
Average number of shares (thousands) (1)
Basic earnings per share (euros)
Basic earnings per share continuing operation (euros)
Diluted earnings per share (euros)
Diluted earnings per share continuing operation (euros)
Remuneration paid (euros) (2)
Remuneration paid (US$) (2)
|Year ended December 31,|
|(in millions of euros, except percentages and per share data)|
Loans and advances to credit institutions (net) (3)
Loans and advances to customers (net) (3)
Investment securities (net) (4)
Investments: Associates and joint venture
Deposits from central banks and credit institutions (5)
Customer deposits (5)
Debt securities (5)
Guaranteed subordinated debt excluding preferred securities and preferred shares (6)
Other subordinated debt
Preferred securities (6)
Preferred shares (6)
Non-controlling interest (including net income of the period)
Stockholders equity (7)
Stockholders equity per average share (7)
Stockholders equity per share at the year-end (7)
Other managed funds
Total other managed funds (8)
Net yield (9)
Return on average total assets (ROA)
Return on average stockholders equity (ROE) (10)
Average stockholders equity to average total assets
Ratio of earnings to fixed charges (11)
Excluding interest on deposits
Including interest on deposits
Credit quality data
Loans and advances to customers
Allowances for non-performing balances including country risk and excluding contingent liabilities as a percentage of total gross loans
Non-performing balances as a percentage of total gross loans (12)
Allowances for non-performing balances as a percentage of non-performing balances (12)
Net loan charge-offs as a percentage of total gross loans
Ratios adding contingent liabilities to loans and advances to customers and excluding country risk (*)
Allowances for non-performing balances (**) as a percentage of total loans and contingent liabilities
Non-performing balances as a percentage of total loans and contingent liabilities (**) (12)
Allowances for non-performing balances as a percentage of non-performing balances (**)(12)
Net loan and contingent liabilities charge-offs as a percentage of total loans and contingent liabilities
|(*)||We disclose these ratios because our credit risk exposure comprises loans and advances to customers as well as contingent liabilities, all of which are subject to impairment and, therefore, allowances are taken in respect thereof.|
|(**)||Non-performing loans and contingent liabilities, securities and other assets to collect.|
|(1)||Average number of shares has been calculated on the basis of the weighted average number of shares outstanding in the relevant year, net of treasury stock.|
|(2)||The shareholders at the annual shareholders meeting held on June 19, 2009 approved a new remuneration scheme (scrip dividend), whereby the Bank offered the shareholders the possibility to opt to receive an amount equivalent to the dividends in cash or new shares. The remuneration per share for 2010, 2011, 2012 and 2013 disclosed above, 0.60, is calculated assuming that the four dividends for these years were paid in cash. In 2014, assuming the same criteria, the remuneration per share will be 0.60.|
|(3)||Equals the sum of the amounts included under the headings Financial assets held for trading, Other financial assets at fair value through profit or loss and Loans and receivables as stated in our consolidated financial statements.|
|(4)||Equals the amounts included as Debt instruments and Equity instruments under the headings Financial assets held for trading, Other financial assets at fair value through profit or loss, Available-for-sale financial assets and Loans and receivables as stated in our consolidated financial statements.|
|(5)||Equals the sum of the amounts included under the headings Financial liabilities held for trading, Other financial liabilities at fair value through profit or loss and Financial liabilities at amortized cost included in notes 20, 21 and 22 to our consolidated financial statements.|
|(6)||In our consolidated financial statements, preferred securities and preferred shares are included under Subordinated liabilities.|
|(7)||Equals the sum of the amounts included at the end of each year as Own funds and Valuation adjustments as stated in our consolidated financial statements. We have deducted the book value of treasury stock from stockholders equity.|
|(8)||At December 31, 2014 and 2013 we held a 50% ownership interest in Santander Asset Management (SAM) and controlled this company jointly with Warburg Pincus and General Atlantic. Funds under Other managed funds are mostly managed by SAM.|
|(9)||Net yield is the total of net interest income (including dividends on equity securities) divided by average earning assets. See Item 4. Information on the CompanyB. Business OverviewSelected Statistical InformationAssetsEarning AssetsYield Spread.|
|(10)||The Return on average stockholders equity ratio is calculated as profit attributable to the Parent divided by average stockholders equity.|
|(11)||For the purpose of calculating the ratio of earnings to fixed charges, earnings consist of pre-tax income from continuing operations before adjustment for income or loss from equity investees plus fixed charges. Fixed charges consist of total interest expense (including or excluding interest on deposits as appropriate) and the interest expense portion of rental expense.|
|(12)||Non-performing loans reflect Bank of Spain classifications. These classifications differ from the classifications applied by U.S. banks in reporting loans as non-accrual, past due, restructured and potential problem loans. See Item 4. Information on the CompanyB. Business OverviewClassified AssetsBank of Spains Classification Requirements.|
Set forth below is a table showing our allowances for non-performing balances broken down by various categories as disclosed and discussed throughout this annual report on Form 20-F:
|Year Ended December 31,|
|(in millions of euros)|
Allowances refers to:
Allowances for non-performing balances (*) (excluding country risk)
Less: Allowances for contingent liabilities and commitments (excluding country risk)
Allowances for balances of loans (excluding country risk):
Allowances relating to country risk and other
Allowances for non-performing balances (excluding contingent liabilities)
Allowances for loans and receivables:
Allowances for customers
Allowances for credit institutions and other financial assets
Allowances for debt instruments
Allowances for debt Instruments available for sale
|(*)||Non-performing loans and contingent liabilities, securities and other assets to collect.|
The exchange rates shown below are those published by the European Central Bank (ECB), and are based on the daily consultation procedures between central banks within and outside the European System of Central Banks, which normally takes place at 14:15 p.m. CET.
|Rate During Period|
|Calendar Period||Period End |
|Average Rate |
|Rate During Period|
|Last six months||High $||Low $|
April (through April 28)
On April 28, 2015, the exchange rate for euros and dollars (expressed in dollars per euro), as published by the ECB, was $1.09.
For a discussion of the accounting principles used in translation of foreign currency-denominated assets and liabilities to euros, see note 2 (a) to our consolidated financial statements.
1. Macro-Economic and Political Risks
1.1 Because our loan portfolio is concentrated in Continental Europe, the United Kingdom, Latin America and the United States, adverse changes affecting the economies of Continental Europe, the United Kingdom, certain Latin American countries or the United States could adversely affect our financial condition.
Our loan portfolio is concentrated in Continental Europe (in particular, Spain), the United Kingdom, Latin America and the United States. At December 31, 2014, Continental Europe accounted for 37% of our total loan portfolio (Spain accounted for 22% of our total loan portfolio), the United Kingdom (where the loan portfolio consists primarily of residential mortgages) accounted for 34%, Latin America accounted for 20% (of which Brazil represents 10% of our total loan portfolio) and the United States accounted for 9%. Accordingly, the recoverability of these loan portfolios in particular, and our ability to increase the amount of loans outstanding and our results of operations and financial condition in general, are dependent to a significant extent on the level of economic activity in Continental Europe (in particular, Spain), the United Kingdom, Latin America and the United States. A return to recessionary conditions in the economies of Continental Europe (in particular, Spain), the United Kingdom, the Latin American countries in which we operate or the United States, would likely have a significant adverse impact on our loan portfolio and, as a result, on our financial condition, cash flows and results of operations. See Item 4. Information on the CompanyB. Business Overview.
1.2 We are vulnerable to disruptions and volatility in the global financial markets.
In the past seven years, financial systems worldwide have experienced difficult credit and liquidity conditions and disruptions leading to less liquidity, greater volatility, general widening of spreads and, in some cases, lack of price transparency in interbank lending rates. Global economic conditions deteriorated significantly between 2007 and 2009, and many of the countries in which we operate fell into recession. Although some countries have begun to recover, this recovery may not be sustainable. Many major financial institutions, including some of the worlds 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 have also been runs on deposits at several financial institutions, numerous institutions have sought additional capital or have been assisted by governments, and many lenders and institutional investors have 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 increase our costs and may affect the pricing for our products and services 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 recent improvements in certain segments of the global economy, uncertainty remains concerning the future economic environment. There can be no assurance that economic conditions in these segments will continue to improve or that the global economic condition as a whole will improve significantly. Such economic uncertainty could have a negative impact on our business and results of operations. Investors remain cautious. A slowing or failing of the economic recovery would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.
Increased disruption and volatility in the global financial markets could have a material adverse effect on us, including 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.
If all or some of the foregoing risks were to materialize, this could have a material adverse effect on us.
1.3 We may suffer adverse effects as a result of economic and sovereign debt tensions in the eurozone.
Our results of operations are materially affected by conditions in the capital markets and the economy generally in the eurozone, which, although improving recently, continue to show signs of fragility and volatility. Interest rate differentials among eurozone countries are affecting government finance and borrowing rates in those economies.
The European Central Bank (the ECB) and European Council took actions in 2012 and 2013 to aim to reduce the risk of contagion throughout and beyond the eurozone. These included the creation of the Open Market Transaction facility of the ECB and the decision by eurozone governments to create a banking union. A significant number of financial institutions throughout Europe have substantial exposures to sovereign debt issued by nations that are under financial pressure. Should any of those nations default on their debt, or experience a significant widening of credit spreads, major financial institutions and banking systems throughout Europe could be destabilized, resulting in the further spread of the ongoing economic crisis.
The high cost of capital for some European governments impacted the wholesale markets and there was a consequent increase in the cost of retail funding, with greater competition in the savings market. In the absence of a permanent resolution of the eurozone crisis, conditions could deteriorate.
We have direct and indirect exposure to financial and economic conditions throughout the eurozone economies. While concerns relating to sovereign defaults or a partial or complete break-up of the European Monetary Union, including potential accompanying redenomination risks and uncertainties, seemed to have abated during 2014, such concerns have resurfaced to some extent with the election of a new government in Greece in January 2015. A deterioration of the economic and financial
environment could have a material adverse impact on the whole financial sector, creating new challenges in sovereign and corporate lending and resulting in significant disruptions in financial activities at both the market and retail levels. This could materially and adversely affect our operating results, financial position and prospects.
1.4 Exposure to sovereign debt could have a material adverse effect on us.
Like many other banks, we invest in debt securities of governments in the geographies in which we operate, including debt securities of the countries that have been most affected by the deterioration in economic conditions, such as Spain, Portugal, Italy and Ireland. A failure by any such government to make timely payments under the terms of these securities, or a significant decrease in their market value, could have a material adverse effect on us.
1.5 Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions.
The economies of some of the countries where we operate, particularly in Latin America, have experienced significant volatility in recent decades, characterized, in some cases, by slow or regressive growth, declining investment and hyperinflation. This volatility resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the economies to which we lend. Negative and fluctuating economic conditions, such as slowing or negative growth and a changing interest rate environment, impact our profitability by causing lending margins to decrease and credit quality to decline and leading to decreased demand for higher margin products and services. For instance, Brazils present high rate of inflation, compounded by high and increasing interest rates, declining consumer spending and increasing unemployment, may have a material adverse impact on the Brazilian economy as a whole as well as on our financial condition and earnings in Brazil, which represented 20% of profit attributed to the Parent banks total operating areas in 2014 and 10% of our total loans as of December 31, 2014. In addition, our business in Brazil may be adversely affected by evolving issues of corruption and related political instability.
Negative and fluctuating economic conditions in the countries in which we operate, such as those that certain Latin American and European countries have experienced recently, 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 these regions or countries.
In addition, our revenues are 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.
Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions.
2. Risks Relating to Our Business
2.1 Legal, Regulatory and Compliance Risks
2.1.1 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 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 claims and parties 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 discovery, we cannot state with confidence what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be. We believe that we have made adequate reserves related to the costs anticipated to be incurred in connection with these various claims and legal proceedingssee note 25 of our consolidated financial statements-. However, the amount of these provisions 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, depending upon, among other factors, the size of the loss or liability imposed and our level of income for that period.
2.1.2 We are subject to substantial regulation which could adversely affect our business and operations.
As a financial institution, we are subject to extensive regulation, which materially affects our businesses. The statutes, regulations and policies to which we are subject may be changed at any time. In addition, the interpretation and the application by regulators of the laws and regulations to which we are subject may also change from time to time. Extensive legislation affecting the financial services industry has recently been adopted in regions that directly or indirectly affect our business, including Spain, the United States, the European Union, Latin America and other jurisdictions, and regulations are in the process of being implemented. 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. Any legislative or regulatory actions and any required changes to our business operations resulting from such legislation and regulations could result in significant loss of revenue, limit our ability to pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional compliance and other costs on us or otherwise adversely affect our businesses. Accordingly, there can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.
The regulations which most significantly affect the Bank, or which could most significantly affect the Bank in the future, relate to capital requirements, liquidity and funding, development of a fiscal and banking union in the European Union and regulatory reforms in the United States, and are discussed in further detail below.
Capital requirements, liquidity, funding and structural reform
Increasingly onerous capital requirements constitute one of the Banks main regulatory challenges. Increasing capital requirements may adversely affect the Banks profitability and create regulatory risk associated with the possibility of failure to maintain required capital levels. As a Spanish financial institution, the Bank is subject to Capital Requirements Directive (CRD IV), through which the European Union began implementing the Basel III capital reforms from January 1, 2014, with certain requirements in the process of being phased in until January 1, 2019. The core regulation in the solvency of credit entities is, therefore, the Capital Requirements Regulation (CRR), which is complemented by several binding technical standards, all of which are directly applicable in all EU member states, without the need for national implementation measures. The implementation of the CRD IV Directive into Spanish law has largely taken place through Royal Decree Law 14/2013 and Law 10/2014, and a new Bank of Spain Circular 2/2014. Notwithstanding this, further regulatory developments in this area remain pending as at the date of this report.
The new regulatory regime has, among other things, increased the level of capital required by means of a combined buffer requirement that entities must comply with from 2016 onwards. Article 104 of the CRD IV Directive, as implemented by Article 68 of Law 10/2014, and similarly Article 16 of Council Regulation (EU) No 1024/2013 of October 15, 2013 conferring specific tasks on the European Central Bank (the ECB) concerning policies relating to the prudential supervision of credit institutions (the SSM Regulation), also contemplate that in addition to the minimum Pillar 1 capital requirements (including, if applicable, any buffer capital as discussed below), supervisory authorities may impose further Pillar 2 capital requirements to cover other risks, including those not considered to be fully captured by the minimum own funds requirements under CRD IV or to address macro-prudential considerations. This may result in the imposition of additional own funds requirements on the Bank and/or the Group pursuant to this Pillar 2 framework. Any failure by the Bank and/or the Group to maintain its Pillar 1 minimum regulatory capital ratios, any Pillar 2 additional own funds requirements could result in administrative actions or sanctions, which, in turn, may have a material adverse impact on the Groups results of operations.
The ECB is currently undertaking an assessment of the additional Pillar 2 capital requirements that may be imposed for each of the European banking institutions now subject to the Single Supervisory Mechanism (the SSM). The ECB is required to carry out these assessments under CRD IV at least on an annual basis. There can be no assurance that an additional own funds requirement for the Bank and/or the Group may not be required by the ECB either when it provides its final decision in relation to this initial assessment or at any time in the future. Any additional own funds requirement that may be imposed on the Bank and/or the Group by the ECB pursuant to this initial assessment may require the Bank and/or the Group to hold capital levels similar to, or higher than, those required under the full application of CRD IV. There can also be no assurance that the Group will be able to continue to maintain such capital ratios.
In addition to the above, the EBA published on December 19, 2014 its final guidelines for common procedures and methodologies in respect of its supervisory review and evaluation process (SREP). Included in this were the EBAs proposed guidelines for a common approach to determining the amount and composition of additional own funds requirements to be implemented by January 1, 2016. Under these guidelines, national supervisors must set a composition requirement for the
additional own funds requirements to cover certain specified risks of at least 56% CET1 capital and at least 75% Tier 1 capital. The guidelines also contemplate that national supervisors should not set additional own funds requirements in respect of risks which are already covered by capital buffer requirements and/or additional macro-prudential requirements; and, accordingly, the above combined buffer requirement is in addition to the minimum own funds requirement and to the additional own funds requirement. In this regard, according to Law 10/2014, for those entities not meeting the combined buffer requirement or the Pillar 2 capital requirements described above or where a restriction upon discretionary payments has been imposed pursuant to Article 68 of Law 10/2014 distributions relating to CET1 capital, variable remuneration or discretionary pension revenues and distributions relating to additional tier 1 capital may be subject to restrictions until the Maximum Distributable Amount has been calculated and communicated to the Bank of Spain (and thereafter subject to such Maximum Distributable Amount). The criteria for the calculation of the Maximum Distributable Amount in respect of any such discretionary payments are specified in the Royal Decree 84/2015, of February 13, 2015, which develops Law 10/2014.
At its meeting on January 12, 2014, the oversight body of the Basel Committee endorsed the definition of the leverage ratio set forth in CRD IV, to promote consistent disclosure, starting on January 1, 2015. There will be a mandatory minimum capital requirement as of January 1, 2018, with an initial minimum leverage ratio of 3% that can be raised after calibration, if European authorities so decide.
On November 10, 2014 the Financial Stability Board (the FSB) published a consultative document (the Consultative Document) containing certain policy proposals to enhance the loss absorbing capacity of global systemically important banksexcept for those from emerging countries(G-SIBs), such as the Bank. The policy proposals included in the Consultative Document consist of an elaboration of the principles on loss absorbing and recapitalization capacity of G-SIBs in resolution and a term sheet setting out a proposal for the implementation of these proposals in the form of an internationally agreed standard on total loss absorbing capacity (TLAC) for G-SIBs. The consultation period ended on February 2, 2015.
Once finalized, these proposals will form a new minimum TLAC standard for G-SIBs. If implemented as contemplated, the TLAC requirement may create additional minimum capital requirements for the Bank and could require the Bank to maintain an additional minimum TLAC ratio of (i) the Banks regulatory capital plus certain types of debt capital instruments and other eligible liabilities that can be written down or converted into equity during resolution to (ii) the Banks risk-weighted assets.
The FSB has proposed that a single specific minimum Pillar 1 TLAC requirement will be set at the greater of (a) 16% to 20% of risk weighted assets and (b) twice the amount of capital required to meet the relevant Basel III Tier 1 leverage ratio requirement (equivalent to the leverage ratio set forth in CRD IV). However, the final proposed TLAC amount has not been agreed within the FSB and is the subject of a quantitative impact study, expected to be completed in 2015. The final requirements are expected to be announced in 2015, most probably at the FSBs plenary session in November 2015.
Furthermore, the Bank Recovery and Resolution Directive (BRRD) requires all banks to maintain a minimum requirement for own funds and eligible liabilities (MREL). The purpose of MREL, which is calculated as a percentage of the total liabilities and own funds of an institution, is to ensure that institutions maintain enough capital capable of being written down and/or bailed-in, so as to facilitate resolution.
The TLAC requirements may apply both on a common minimum Pillar 1 basis and with provision for home and host resolution authorities to be able to specify additional Pillar 2 TLAC requirements on an individual institution basis. TLAC requirements may further be imposed in addition to the minimum own funds requirements under CRD IV and the MREL once the BRRD has been implemented in Spain. Any failure by an institution to meet the applicable minimum Pillar 1 and Pillar 2 TLAC requirements may be treated in the same manner as a failure to meet minimum regulatory capital requirements, where resolution authorities must ensure that they intervene and place an institution into resolution sufficiently early if it is deemed to be failing or likely to fail and there is no reasonable prospect of recovery.
The conditions required of TLAC eligible instruments (other than own funds) and those required of eligible liabilities for MREL purposes under the BRRD are different and there can be no assurance that it will be possible for the Bank to issue instruments which simultaneously satisfy both requirements. Markets have not yet been established for such instruments (other than own funds instruments) and there can be no assurance that such markets will develop or that, if they do, the Bank will be able to issue sufficient TLAC and MREL eligible liabilities to meet its requirements. That may limit the quantity of the Banks CET1 capital which is available to meet its combined buffer requirement.
EU fiscal and banking union
The project of achieving a European banking union was launched in the summer of 2012. Its main goal is to resume progress towards the European single market for financial services by restoring confidence in the European banking sector and ensuring the proper functioning of monetary policy in the eurozone.
The Banking union is expected to be achieved through new harmonized banking rules (the single rulebook) and a new institutional framework with stronger systems for both banking supervision and resolution that will be managed at the European level. Its two main pillars are the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM).
The SSM is expected to assist in making the banking sector more transparent, unified and safer. In accordance with the SSM Regulation, the ECB fully assumed its new supervisory responsibilities within the SSM, in particular direct supervision of the 120 largest European banks (including the Bank), on November 4, 2014. In preparation for this step, between November 2013 and October 2014, the ECB conducted, together with national supervisors, a comprehensive assessment of 130 banks, which together hold more than 80% of eurozone banking assets. The exercise consisted of three elements: (i) a supervisory risk assessment, which assessed the main balance sheet risks including liquidity, funding and leverage; (ii) an asset quality review, which focused on credit and market risks; and (iii) a stress test to examine the need to strengthen capital or take other corrective measures.
The SSM represents a significant change in the approach to bank supervision at a European and global level. The SSM will result in the direct supervision of 120 financial institutions, including the Bank, and indirect supervision of around 3,500 financial institutions. The new supervisor will be one of the largest in the world in terms of assets under supervision. In the coming years, the SSM is expected to work to establish a new supervisory culture importing best practices from the 19 supervisory authorities that will be part of the SSM. Several steps have already been taken in this regard such as the recent publication of the Supervisory Guidelines and the creation of the SSM Framework Regulation. In addition, this new body will represent an extra cost for the financial institutions that will fund it through payment of supervisory fees.
The other main pillar of the EU banking union is the SRM, the main purpose of which is to ensure a prompt and coherent resolution of failing banks in Europe at minimum cost. Regulation (EU) No. 806/2014 of the European Parliament and the Council of the European Union (the SRM Regulation), which was passed on July 15, 2014, and takes legal effect from January 1, 2015, establishes uniform rules and a uniform procedure for the resolution of credit institutions and certain investment firms in the framework of the SRM and a Single Resolution Fund (SRF). Under the intergovernmental agreement (IGA) signed by 26 EU member states on May 21, 2014, contributions by banks raised at national level will be transferred to the SRF. The new Single Resolution Board started operating from January 1, 2015 but it will not fully assume its resolution powers until January 1, 2016. From that date onwards the Single Resolution Fund will also be in place, funded by contributions from European banks in accordance with the methodology approved by the Council of the European Union. The Single Resolution Fund is intended to reach a total amount of 55 billion by 2024 and to be used as a separate backstop only after an 8% bail-in of a banks liabilities has been applied to cover capital shortfalls (in line with the BRRD).
By allowing for the consistent application of EU banking rules through the SSM, the banking union is expected to help resume momentum towards economic and monetary union. In order to complete such union, a single deposit guarantee scheme is still needed which may require a change to the existing European treaties. This is the subject of continued negotiation by European leaders to ensure further progress is made in European fiscal, economic and political integration.
Regulations adopted towards achieving a banking and/or fiscal union in the EU and decisions adopted by the ECB in its capacity as the Banks main supervisory authority may have a material impact on the Banks business, financial condition and results of operations. In particular, the BRRD and Directive 2014/49/EU on deposit guarantee schemes were published in the Official Journal of the EU on June 12, 2014. The BRRD was required to be implemented on or before January 1, 2015, although the bail-in tool will not apply until January 1, 2016, except where a bail-out is required during 2015. In this case, a minimum 8% bail-in of a banks liabilities (including senior debt and uncovered deposits) will be required as a precondition for access to any direct recapitalization by the European Stability Mechanism (ESM), as agreed by the eurozone members in December 2014.
The process for the implementation of the BRRD in Spain started on December 1, 2014, with the publication of the BRRD Draft Implementation Law for public consultation by the Spanish Ministry of Economy and Competitiveness. On February 27, 2015, the Council of Ministers submitted to Parliament the Draft Law on the Recovery and Resolution of Credit Institutions and Investment Service Companies (Proyecto de Ley de Recuperación y Resolución de Entidades de Crédito y Empresas de Servicios de Inversión).
In addition, on January 29, 2014, the European Commission released its proposal on the structural reforms of the European banking sector that will impose new constraints on the structure of European banks. The proposal aims at ensuring the harmonization between the divergent national initiatives in Europe. It includes a prohibition on proprietary trading similar to that contained in Section 619 of the Dodd-Frank Act (also known as the Volcker Rule) and a mechanism to potentially require the separation of trading activities (including market making), such as in the Financial Services (Banking Reform) Act 2013, complex securitizations and risky derivatives.
Moreover, regulations adopted on structural measures to improve the resilience of EU credit institutions may have a material impact on the Banks business, financial condition and results of operations. These regulations, if adopted, may also cause the Group to invest significant management attention and resources to make any necessary changes.
United States significant regulation
In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act) which was adopted in 2010 will continue to result in significant structural reforms affecting the financial services industry. This legislation provided for, among other things, the establishment of a Consumer Financial Protection Bureau with broad authority to regulate the credit, savings, payment and other consumer financial products and services that we offer, the creation of a structure to regulate systemically important financial companies, more comprehensive regulation of the over-the-counter derivatives market, prohibitions on engagement in certain proprietary trading activities and restrictions on ownership or sponsorship of, or entering into certain credit-related transactions with related, covered funds, restrictions on the interchange fees earned through debit card transactions, and a requirement that bank regulators phase out the treatment of trust preferred capital instruments as Tier 1 capital for regulatory capital purposes.
With respect to OTC derivatives, the Dodd-Frank Act provides for an extensive framework for the regulation of OTC derivatives, including mandatory clearing, exchange trading and transaction reporting of certain OTC derivatives. Entities that are swap dealers, security-based swap dealers, major swap participants or major security-based swap participants are required to register with the CFTC or the SEC, or both, and are or will be subject to new capital, margin, business conduct, recordkeeping, clearing, execution, reporting and other requirements. Banco Santander, S.A. and Abbey National Treasury Services plc became provisionally registered as a swap dealer with the CFTC on July 8, 2013 and November 4, 2013, respectively. In addition, we may register one more subsidiary as swap dealer with the CFTC. Although many significant regulations applicable to swap dealers are already in effect, some of the most important rules, such as margin requirements for uncleared swaps and capital rules for swap dealers, have not yet been implemented and we continue to assess how compliance with these new rules will affect our business.
In July 2013, the U.S. bank regulators issued the U.S. Basel III final rules implementing the Basel III capital framework for U.S. banks and bank holding companies. Certain aspects of the U.S. Basel III final rules, such as new minimum capital ratios and a revised methodology for calculating risk-weighted assets, became effective for part of the Banks U.S. operations on January 1, 2015. Other aspects of the U.S. Basel III final rules, such as the capital conservation buffer and the new regulatory deductions from and adjustments to capital, will be phased in over several years beginning on January 1, 2015.
In addition, in September 2014 the Board of Governors of the Federal Reserve System (the Federal Reserve) and other U.S. regulators issued a final rule introducing a quantitative liquidity coverage ratio requirement on certain large banks and bank holding companies. The liquidity coverage ratio is part of the Basel Committees international standards on quantitative liquidity metrics, which are in turn part of the international Basel III framework. The U.S. implementation of the liquidity coverage ratio is broadly consistent with the Basel Committees liquidity standards, but is more stringent in several important respects. Although this final rule does not apply to foreign banking organizations (FBOs), the Federal Reserve has stated that it intends, through future rulemakings, to apply the liquidity coverage ratio and another Basel III liquidity metric to the U.S. operations of some or all large FBOs.
On February 19, 2014, the Federal Reserve issued a final rule to enhance its supervision and regulation of certain FBOs. Among other things, this rule requires FBOs with over $50 billion of U.S. non-branch assets to establish or designate a U.S. intermediate holding company (an IHC) and to transfer its entire ownership interest in substantially all of its U.S. subsidiaries to such IHC by July 1, 2016. U.S. branches and agencies are not required to be transferred to the IHC. The IHC will be subject to an enhanced supervision framework, including enhanced risk-based and leverage capital requirements, liquidity requirements, risk management and governance requirements, and stress-testing requirements. A phased-in approach is being used for the standards and requirements. Certain enhanced standards are effective in 2015, with other standards and requirements becoming effective between July 1, 2016 and January 1, 2018. Pursuant to the final rule, as an FBO with over $50 billion of U.S. non-branch assets as of June 30, 2014, we submitted an IHC implementation plan to the Federal Reserve by January 1, 2015. As of the date of this annual report, we are awaiting a determination on the adequacy of the plan from the Federal Reserve. Implementation and compliance with this plan may cause the Group to invest significant management attention and resources.
Within the Dodd-Frank Act, the Volcker Rule prohibits banking entities from engaging in certain forms of proprietary trading or from sponsoring, investing in, or entering into certain credit-related transactions with related, covered funds, in each case subject to certain exceptions. The term covered fund is defined very broadly to include traditional hedge funds, private equity funds, certain securitization vehicles and other entities that rely on Sections 3(c)(1) or 3(c)(7) of the U.S. Investment Company Act of 1940 for an exemption under that Act, as well as certain similar foreign funds. The Volcker Rule became effective on July 21, 2012 and on December 10, 2013, U.S. regulators issued final rules implementing the Volcker Rule. The statute and final rules also contain exclusions and certain exemptions for market-making, hedging, underwriting, trading in U.S. government and agency obligations as well as certain foreign government obligations, trading solely outside the United States, and also permit certain ownership interests in certain types of funds to be retained. On December 10, 2013, the Federal Reserve issued an order extending the period for all banking entities to conform with the Volcker Rule and implement a compliance program until July 21, 2015. In December 2014, the Federal Reserve issued an order extending the Volcker Rules general conformance period until July 21, 2016 for investments in and relationships with covered funds and certain foreign funds that were in place on or prior to December 31, 2013 (legacy covered funds), and stated its intention to grant a final one-year extension of the general conformance period, to July 21, 2017, for banking entities to conform ownership interests in and relationships with legacy covered funds. This extension of the conformance period does not apply to the Volcker Rules prohibitions on proprietary trading and does not appear to apply to any investments in and relationships with covered funds put in place after December 31, 2013. Banking entities such as the Bank must bring their activities and investments into compliance with the requirements of the Volcker Rule by the end of the conformance period. We are assessing how the final rules implementing the Volcker Rule will affect our businesses and are developing and implementing plans to bring affected businesses into compliance.
Furthermore, Title I of the Dodd-Frank Act and the implementing regulations issued by the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) require each bank holding company with assets of $50 billion or more, including us, to prepare and submit annually to the Federal Reserve and the FDIC a plan for the orderly resolution of our subsidiaries and operations that are domiciled in the United States in the event of future material financial distress or failure. In addition, each insured depository institution (IDI) with assets of $50 billion or more, such as the Bank, must submit a separate IDI resolution plan annually to the FDIC. The Title I and IDI plans each must include information on resolution strategy, major counterparties and interdependencies, among other things, and require substantial effort, time and cost to prepare. We submitted our most recent annual U.S. resolution plans in December 2014. The Title I plan resolution plan is subject to review by the Federal Reserve and the FDIC. The IDI plan is subject to review solely by the FDIC.
Each of these aspects of the Dodd-Frank Act, as well as other changes in U.S. banking regulations, may directly and indirectly impact various aspects of our business. The full spectrum of risks that the Dodd-Frank Act poses to us is not yet known; however, such risks could be material and we could be materially and adversely affected by them.
United States stress testing, capital planning, and related supervisory actions
Certain of our U.S. banking subsidiaries, including Santander Holdings USA, our U.S. bank holding company subsidiary, are subject to stress testing and capital planning requirements under regulations implementing the Dodd-Frank Act or other banking laws or policies. In March 2014 and 2015, the Federal Reserve Board, as part of its Comprehensive Capital Analysis and Review (CCAR) process, objected on qualitative grounds to the capital plans submitted by Santander Holdings USA. In its 2015 public report on CCAR, the Federal Reserve Board cited widespread and critical deficiencies in Santander Holdings USAs capital planning processes, including specific deficiencies in governance, internal controls, risk identification and risk management, management information systems, and supporting assumptions and analysis. As a result of the 2014 and 2015 CCAR objections, Santander Holdings USA is not permitted to make any capital distributions without the Federal Reserve Boards approval, other than the continued payment of dividends on Santander Holdings USAs outstanding class of preferred stock, until a new capital plan is approved by the Federal Reserve Board. The deadline for Santander Holdings USAs next capital plan submission is in April 2016, and there is the risk that the Federal Reserve Board will object to Santander Holdings USAs next capital plan.
In addition, we are subject to supervisory actions in the United States related to the CCAR stress testing and capital planning processes. Specifically, on September 15, 2014, Santander Holdings USA and the Federal Reserve Bank of Boston (FRB Boston) executed a written agreement relating to a subsidiarys declaration and payment of dividends in the second quarter of 2014 without the Federal Reserve Boards approval. Under the written agreement, Santander Holdings USA agreed to submit to the FRB Boston written procedures to strengthen board oversight of management regarding planned capital distributions by Santander Holdings USA and its subsidiaries. In addition, Santander Holdings USA agreed to subject future distributions to the prior written approval of Federal Reserve System and to take necessary actions to ensure that no such distributions are made.
Other supervisory actions and restrictions on U.S. activities
In addition to the foregoing, U.S. bank regulatory agencies from time to time take supervisory actions under certain circumstances that restrict or limit a financial institutions activities. In some instances, we are subject to significant legal restrictions on our ability to publicly disclose these actions or the full details of these actions. In addition, as part of the regular examination process, our U.S. banking subsidiaries regulators may advise our U.S. banking subsidiaries to operate under various restrictions as a prudential matter. The U.S. supervisory environment has become significantly more demanding and restrictive since the financial crisis of 2008. Under the U.S. Bank Holding Company Act, the Federal Reserve has the authority to disallow us and our U.S. banking subsidiaries from engaging in certain categories of new activities in the United States or acquiring shares or control of other companies in the United States. Such actions and restrictions currently applicable to us or our U.S. banking subsidiaries could adversely affect our costs and revenues. Moreover, efforts to comply with nonpublic supervisory actions or restrictions could require material investments in additional resources and systems, as well as a significant commitment of managerial time and attention. As a result, such supervisory actions or restrictions could have a material adverse effect on our business and results of operations; and we may be subject to significant legal restrictions on our ability to publicly disclose these matters or the full details of these actions. In addition to such confidential actions and restrictions we expect that SHUSA will become subject to a public enforcement action with the Federal Reserve Bank of Boston in the near future. Although the SHUSA has not yet received a draft of such action, it believes that the action will require SHUSA to make enhancements with respect to, among other matters, board and senior management oversight of the consolidated organization, risk management, and new business initiatives.
As noted above, our business and operations are subject to increasingly stringent regulatory oversight and scrutiny, which may lead to regulatory investigations or enforcement actions. A single event may give rise to numerous and overlapping investigations and regulatory proceedings, by various agencies, regulators and other governmental officials in any of the jurisdictions in which we operate, which in turn could harm our reputation or lead to higher operational costs, thereby reducing our profitability.
2.1.3 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 Spain 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.
2.1.4 Changes in taxes and other assessments may adversely affect us.
The legislatures and tax authorities in the tax jurisdictions in which we operate regularly enact reforms to the tax and other assessment regimes to which we and our customers are subject. Such reforms include changes in the rate of assessments and, occasionally, enactment of temporary taxes, the proceeds of which are earmarked for designated governmental purposes. The effects of these changes and any other changes that result from enactment of additional tax reforms cannot be quantified and there can be no assurance that any such reforms would not have an adverse effect upon our business.
2.1.5 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, sanctions and other laws and regulations in the jurisdictions in which we operate. These laws and regulations require us, among other things, to conduct full customer due diligence regarding sanctions and politically-exposed person screening, keep our customer, account and transaction information up to date and have implemented effective financial crime policies and procedures detailing what is required from those responsible. Our requirements also include AML training for our employees, reporting suspicious transactions and activity to appropriate law enforcement following full investigation by our local AML team.
Financial crime has become the subject of enhanced regulatory scrutiny and supervision by regulators globally. AML sanctions, laws and regulations are increasingly complex and detailed and have become the subject of enhanced regulatory supervision, requiring improved 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. These require implementation and embedding within our business effective controls and monitoring, which in turn require on-going changes to systems and operational activities. Financial crime is continually evolving and subject to increasingly stringent regulatory oversight and focus. This requires proactive and adaptable responses from us so that we are able to effectively deter threats and criminality. 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, 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 or sanctions requirements. Our reputation could also suffer if we are unable to protect our customers or our business 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 anti-money laundering procedures. Such measures, procedures and compliance may not be completely effective in preventing third parties from using our (and our relevant counterparties) services as a conduit for money laundering (including illegal cash operations) without our (and our relevant counterparties) knowledge. If we are associated with, or even accused of being associated with, or become a party to, money laundering, then our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to any 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.
2.2 Liquidity and Financing Risks
2.2.1 Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.
Liquidity risk is the risk that we either do not have available sufficient financial resources to meet our obligations as they fall due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation. While we implement liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors in particular make it difficult to eliminate completely these risks. Adverse and continued constraints in the supply of liquidity, including inter-bank lending, has affected and may materially and adversely affect the cost of funding our business, and extreme liquidity constraints may affect our current operations as well as limit growth possibilities.
Disruption and volatility in the global financial markets could have a material adverse effect on our ability to access capital and liquidity on financial terms acceptable to us.
Our cost of obtaining funding is directly related to prevailing market interest rates and to our credit spreads. Increases in interest rates and our credit spreads can significantly increase the cost of our funding. Changes in our credit spreads are market-driven, and 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.
If wholesale markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits, with a view to attracting more customers, and/or to sell assets, potentially at depressed prices. The persistence or worsening of these adverse market conditions or an increase in base interest rates could have a material adverse effect on our ability to access liquidity and cost of funding.
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, in general, and the financial services industry in particular, and the availability and extent of deposit guarantees, as well as competition between banks for deposits. Any of these factors could significantly increase the amount of commercial deposit withdrawals in a short period of time, thereby reducing our ability to access commercial deposit funding on appropriate terms, or at all, in the future. If these circumstances were to arise, this could have a material adverse effect on our operating results, financial condition and prospects.
We anticipate that our customers will continue, in the near future, to make short-term deposits (particularly demand deposits and short-term time deposits), and we intend to maintain our emphasis on the use of banking deposits as a source of funds. 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.
We cannot assure you 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.
2.2.2 Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. Any downgrading in our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative contracts and adversely affect our interest margins and results of operations.
Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings of our debt are based on a number of factors, including our financial strength and conditions affecting the financial services industry generally. In addition, due to the methodology of the main rating agencies, our credit rating is affected by the rating of Spanish sovereign debt. If Spains sovereign debt is downgraded, our credit rating would also likely be downgraded by an equivalent amount.
Any downgrade in our debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivative contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a ratings downgrade could adversely affect our ability to sell or market certain of our products, engage in certain longer-term and derivatives transactions and retain our customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivative contracts, we may be required to maintain a minimum credit rating or terminate such contracts. Any of these results of a ratings downgrade, in turn, could reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.
Banco Santander, S.A.s long-term debt is currently rated investment grade by the major rating agenciesBaa1 outlook under review for upgrade by Moodys Investors Service España, S.A., BBB+ stable outlook by Standard & Poors Ratings Services and A- stable outlook by Fitch Ratings Ltd. During 2012, following downgrades of Spanish sovereign debt, all three agencies downgraded Banco Santander, S.A.s rating together with that of the other main Spanish banks, due to the weaker-than-previously-anticipated macroeconomic and financial environment in Spain with dimming growth prospects in the near term, depressed real estate market activity and heightened turbulence in the capital markets. In the fourth quarter of 2013 and first quarter of 2014 the three agencies revised our outlook from negative to stable reflecting the gradual improvement of the Spanish economy and the view that any further weakening of our credit profile was unlikely to be significant. During the first half of 2014, all three agencies upgraded our rating following the upgrade revision of Spains sovereign debt (Moodys Investors Service from Baa2 to Baa1, Standard & Poors from BBB to BBB+ and Fitch from BBB+ to A-).
Santander UKs long-term debt is currently rated investment grade by the major rating agencies: A2 with outlook under review for upgrade by Moodys Investors Service, A with negative outlook by Standard & Poors Ratings Services and A with stable outlook by Fitch Ratings. All three agencies revised Santander UKs ratings during 2012 following the downgrades of the Spanish sovereign debt and remained unchanged in 2013. Negative outlook by Standard & Poors reflects the negative trend that they see for the U.K. banking industry.
We conduct substantially all of our material derivative activities through Banco Santander, S.A. and Santander UK. If all the rating agencies were to downgrade Banco Santander, S.A.s long-term senior debt ratings by one or two notches, we will not be required to post additional collateral pursuant to derivative and other financial contracts. However, we may be required to post additional collateral in the event of a downgrade by more than two notches. We estimate that as of December 31, 2014, if all the rating agencies were to downgrade Santander UKs long-term credit ratings by one notch, and thereby trigger a short-
term credit rating downgrade, this could result in contractual outflows from Santander UKs total liquid assets of £5.9 billion of cash and additional collateral that Santander UK would be required to post under the terms of secured funding and derivatives contracts. A hypothetical two notch downgrade would result in an additional contractual outflow of £1.2 billion of cash and collateral under secured funding and derivatives contracts.
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 a firms long-term credit rating precipitates downgrades to its short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than this hypothetical example, 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, it is still the case that a credit rating downgrade could have a material adverse effect on Banco Santander, S.A., and/or its subsidiaries.
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.
In light of the difficulties in the financial services industry and the financial markets, 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.
2.3 Credit Risks
2.3.1 If we are unable to effectively control the level of non-performing or poor credit quality loans in the future, or if our loan loss reserves are insufficient to cover future loan losses, this 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 and can continue to negatively impact our results of operations. We cannot assure you that we will be able to effectively control the level of the non-performing loans in our total loan portfolio. 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, 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 Continental Europe, the United Kingdom, Latin America, particularly Brazil, the United States or global economic conditions, impact of political events, events affecting certain industries or events affecting financial markets and global economies.
Our current loan loss reserves may not be adequate to cover any increase in the amount of non-performing loans or any future deterioration in the overall credit quality of our total loan portfolio. Our loan loss reserves are based on our current assessment of and expectations concerning various factors affecting 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, government macroeconomic policies, interest rates and the legal and regulatory environment. As the recent global financial crisis demonstrated, many of these factors are beyond our control. As a result, there is no precise method for predicting loan and credit losses, and we cannot assure you that our loan loss reserves will be sufficient to cover actual 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 credit card portfolio and the introduction of new products, or if the future actual losses exceed our estimates of incurred losses, we may be required to increase our loan loss reserves, which may adversely affect us. If we were 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.
Mortgage loans are one of our principal assets, comprising 50% of our loan portfolio as of December 31, 2014. We are exposed to developments in housing markets, especially in Spain and the United Kingdom, and to a number of large real estate developers in Spain. From 2002 to 2007, demand for housing and mortgage financing in Spain increased significantly driven by, among other things, economic growth, declining unemployment rates, demographic and social trends, the desirability of Spain as a vacation destination and historically low interest rates in the eurozone. The United Kingdom also experienced an increase in housing and mortgage demand driven by, among other things, economic growth, declining unemployment rates, demographic trends and the increasing prominence of London as an international financial center. During late 2007, the housing
market began to adjust in Spain and the United Kingdom as a result of excess supply (particularly in Spain) and higher interest rates. Since 2008, as economic growth stalled in Spain and the United Kingdom, persistent housing oversupply, decreased housing demand, rising unemployment, subdued earnings growth, greater pressure on disposable income, a decline in the availability of mortgage finance and the continued effect of global market volatility have caused home prices to decline, while mortgage delinquencies and forbearances have increased.
As a result of these and other factors, our NPL ratio increased from 0.94% at December 31, 2007, to 2.02% at December 31, 2008, to 3.24% at December 31, 2009, to 3.54% at December 31, 2010, to 3.90% at December 31, 2011, to 4.54% at December 31, 2012 and to 5.64% at December 31, 2013. At December 31, 2014, our NPL ratio was 5.19%. High unemployment rates coupled with declining real estate prices, could have a material adverse impact on our mortgage payment delinquency rates, which in turn could have a material adverse effect on our business, financial condition and results of operations.
2.3.2 Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.
Our fixed rate loan and investment portfolios are subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a declining interest rate environment, prepayment activity increases, which reduces the weighted average lives of our earning assets and could have a material adverse effect on us. We would also be required to amortize net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralized mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent to our commercial activity and an increase in prepayments could have a material adverse effect on us.
2.3.3 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 Europe, the United States and Latin American countries. 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 the economy of the affected region. 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.
2.3.4 We are subject to counterparty risk in our banking business.
We are exposed to counterparty risk in addition to credit risks associated with lending activities. Counterparty risk may arise from, for example, investing in securities of third parties, entering into derivative contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades from proprietary trading activities that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearing houses or other financial intermediaries.
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.
2.4 Market Risks
2.4.1 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.
Market risk refers to the probability of variations in our net interest income or in the market value of our assets and liabilities due to volatility of interest rate, inflation, exchange rate or equity price. Changes in interest rates affect the following areas, among others, of our business:
|||net interest income;|
|||the volume of loans originated;|
|||the market value of our securities holdings;|
|||gains from sales of loans and securities; and|
|||gains and losses from derivatives.|
Variations in short-term interest rates could affect our net interest income, which comprises the majority of our revenue, reducing our growth rate and potentially 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 fixed-rate assets does not rise as quickly, which could cause profits to grow at a reduced rate or decline in some parts of our portfolio. Interest rates are highly sensitive to many factors beyond our control, including increased regulation of the financial sector, monetary policies, domestic and international economic and political conditions and other factors.
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 also reduce the propensity of our customers to prepay or refinance fixed-rate loans. 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 reduce our funding costs, it is likely to compress our net interest margins, as well as adversely impact our income from investments in securities and loans with similar maturities, which could have a negative effect on us. 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 prevailing interest rates rise, which may have an adverse effect on our earnings and financial condition. In addition, we may incur costs (which, in turn, will impact our results) as we implement strategies to reduce future interest rate exposure. 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. The recent depreciation of the Latin American currencies against the U.S. dollar could make our Latin American subsidiaries foreign currency-linked obligations and funding more expensive and have similar consequences for our borrowers in Latin America.
We are also exposed to equity price risk in connection with our trading investments in equity securities. 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 entities in this sector 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 net interest income or the market value of our assets and liabilities could be materially adversely affected.
2.4.2 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 seven years, 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.
2.4.3 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 the countries where we operate differ from each other. In addition, the execution and performance of these transactions depends on our ability to maintain adequate control and administration systems and to hire and retain qualified personnel. Moreover, our ability to adequately monitor, analyze and report derivative transactions continues to depend, to a great extent, on our information technology systems. This factor further increases the risks associated with these transactions and could have a material adverse effect on us.
2.5 Risk Management
2.5.1 Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.
The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we fail to identify or anticipate.
Some of our qualitative tools and metrics for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account. Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. If existing or potential customers believe our risk management is inadequate, they could take their business elsewhere. This could have a material adverse effect on our 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 error. In exercising their judgment, our employees may not always be able to assign an accurate credit rating to a customer or credit risk, which may result in our exposure to higher credit risks than indicated by our risk rating system.
In addition, we have refined our credit policies and guidelines to address potential risks associated with particular industries or types of customers. However, we may not be able to timely detect these risks before they occur, or due to limited tools available to us, our employees may not be able to effectively implement them, which may increase our credit risk. Failure to effectively implement, consistently follow 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.
2.6 General Business and Industry Risks
2.6.1 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.
2.6.2 Changes in our pension liabilities and obligations could have a material adverse effect on us.
We provide retirement benefits for many of our former and current employees through a number of defined benefit pension plans. We calculate the amount of our defined benefit obligations using actuarial techniques and assumptions, including mortality rates, the rate of increase of salaries, discount rates, inflation, the expected rate of return on plan assets, or others. The accounting and disclosures are based on IFRS and on those other requirements defined by the local supervisors. Given the nature of these obligations, changes in the assumptions that support valuations, including market conditions, can result in actuarial losses which would in turn impact the financial condition of our pension funds. Because pension obligations are generally long term obligations, fluctuations in interest rates have a material impact on the projected costs of our defined benefit obligations and therefore on the amount of pension expense that we accrue.
Any increase in the current size of the deficit in our defined benefit pension plans, due to reduction in the value of the pension fund assets (depending on the performance of financial markets) or an increase in the pension fund liabilities due to changes in mortality assumptions, the rate of increase of salaries, discount rate assumptions, inflation, the expected rate of return on plan assets, or other factors, could result in our having to make increased contributions to reduce or satisfy the deficits which would divert resources from use in other areas of our business and reduce our capital resources. While we can control a number of the above factors, there are some over which we have no or limited control. Increases in our pension liabilities and obligations could have a material adverse effect on our business, financial condition and results of operations.
2.6.3 We depend in part upon dividends and other funds from subsidiaries.
Some of our operations are conducted through our financial services subsidiaries. As a result, our ability to pay dividends, to the extent we decide to do so, depends in part on the ability of our subsidiaries to generate earnings and to pay dividends to us. Payment of dividends, distributions and advances by our subsidiaries will be contingent upon our subsidiaries earnings and business considerations and is or may be limited by legal, regulatory and contractual restrictions. Additionally, our right to receive any assets of any of our subsidiaries as an equity holder of such subsidiaries, upon their liquidation or reorganization, will be effectively subordinated to the claims of our subsidiaries creditors, including trade creditors.
2.6.4 Increased competition and industry consolidation may adversely affect our results of operations.
We face substantial competition in all parts of our business, including in originating loans and in attracting deposits. The competition in originating loans comes principally from other domestic and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other lenders and purchasers of loans.
In addition, there has been a trend towards consolidation in the banking industry, 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 competitors, such as brokerage companies, department stores (for some credit products), leasing and factoring companies, mutual fund and pension fund management companies and insurance companies.
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. 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.
Increasing competition could also require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us, including our profitability. It may also negatively affect our business results and prospects by, among other things, limiting our ability to increase our customer base and expand our operations and increasing competition for investment opportunities.
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.
2.6.5 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 successful once they are offered to our clients, or that they will be successful in the future. 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 our products and services employ technology that is not as attractive to our clients as that employed by our competitors, if we fail to employ technologies desired by our clients before our competitors do so, or if we fail to execute effectively on targeted strategic technology initiatives, our business and results could be adversely affected. In addition, 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. Our employees and risk management systems, as well as our experience and that of our partners may not be sufficient or adequate to enable us to properly handle or 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.
Further, our customers may issue complaints and seek redress if they consider that they have suffered loss from our products and services, for example, as a result of any alleged mis-selling or incorrect application of the terms and conditions of a particular product. This could in turn subject us to risks of potential legal action by our customers and intervention by our regulators. We have in the past experienced losses due to claims of mis-selling in the U.K., Spain and other jurisdictions and may do so again in the future. For further detail on our legal and regulatory risk exposures, please see the risk factor entitled We are exposed to risk of loss from legal and regulatory proceedings.
2.6.6 If we are unable to manage the growth of our operations this could have an adverse impact on our profitability.
We allocate management and planning resources to develop strategic plans for organic growth, and to identify possible acquisitions and disposals and areas for restructuring our businesses. From time to time, we evaluate acquisition and partnership opportunities that we believe offer additional value to our shareholders and are consistent with our business strategy. However, we may not be able to identify suitable acquisition or partnership candidates, and our ability to benefit from any such acquisitions and partnerships will depend in part on our successful integration of those businesses. Any such integration entails significant risks such as unforeseen difficulties in integrating operations and systems and unexpected liabilities or contingencies relating to the acquired businesses, including legal claims. We can give no assurances that our expectations with regards 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;|
|||finance strategic investments or acquisitions;|
|||fully integrate strategic investments, or newly-established entities or acquisitions in line with its strategy;|
|||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, including relating to any or all of the above challenges associated with our growth plans, could have a material adverse effect on our operating results, financial condition and prospects.
2.6.7 Goodwill impairments may be required in relation to acquired businesses.
We have made business acquisitions in recent years and may make further acquisitions in the future. It is possible that the goodwill which has been attributed, or may be attributed, to these businesses may have to be written-down if our valuation assumptions are required to be reassessed as a result of any deterioration in their underlying profitability, asset quality and other relevant matters. Impairment testing in respect of goodwill is performed annually, more frequently if there are impairment indicators present, and comprises a comparison of the carrying amount of the cash-generating unit with its recoverable amount. Goodwill impairment does not, however, affect our regulatory capital. While no material impairment of goodwill was recognized in 2013 or 2014, there can be no assurances that we will not have to write down the value attributed to goodwill in the future, which would adversely affect our results and net assets.
2.6.8 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 management team. The ability to continue to attract, train, motivate and retain highly qualified professionals is a key element of our strategy. The successful implementation of our growth strategy depends on the availability of skilled 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 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.
2.6.9 We rely on third parties for important products and services.
Third party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Third parties can be sources of operational risk to us, including with respect to security breaches affecting such parties. 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, including as a result of their not providing us their services for any reason, their performing their services poorly, or employee misconduct, could adversely affect our ability to deliver products and services to customers and otherwise to conduct business. Replacing these third party vendors could also entail significant delays and expense.
2.6.10 Damage to our reputation could cause harm to our business prospects.
Maintaining a positive reputation is critical to our attracting and maintaining customers, investors and employees. Damage to our reputation can therefore cause significant harm to its business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, litigation or regulatory outcomes, 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, whether or not true, 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 properly identify and manage potential conflicts of interest. Management of potential conflicts of interest has become increasingly complex as we expand our business activities through more numerous transactions, obligations and interests with and among our clients. The failure to adequately address, or the 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.
2.6.11 We engage in transactions with our subsidiaries or affiliates that others may not consider to be on an arms-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.
Spanish law provides 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.
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.
2.7 Technology Risks
2.7.1 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.
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.
2.7.2 Risks relating to data collection, processing and storage systems are inherent in our business.
Our businesses depend 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 and other information in 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. Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure transmission capabilities and prevent against cyber-attacks, we routinely exchange personal, confidential and proprietary information by electronic means, and we may be the target of attempted cyber-attacks. If we cannot maintain an effective data collection, management and processing system, we may be materially and adversely affected.
We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure and data 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 and reputational harm. There can be no assurance that we will not suffer material losses from operational risk in the future, including those relating to cyber-attacks or other such security breaches. Further, as cyber-attacks continue to evolve, we may incur significant costs in our attempt to modify or enhance our protective measures or investigate or remediate any vulnerabilities. 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 and could materially and adversely affect us. For further information see Item 11. Quantitative and Qualitative Disclosures about Market RiskPart 7. Operational risk7.3 Mitigation measuresAnti-cyber-risk measures.
2.7.3 Failure to protect personal information could adversely affect us.
We manage and hold confidential personal information of customers in the conduct of our banking operations. 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 that could materially and adversely affect our operating results, financial condition and prospects. In addition, we may be required to report events related to information security issues (including any cybersecurity issues), events where customer information may be compromised, unauthorized access and other security breaches, to the relevant regulatory authorities.
2.8 Financial Reporting and Control Risks
2.8.1 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. These changes 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.
2.8.2 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 and advances, goodwill impairment, valuation of financial instruments, impairment of available-for-sale financial assets, deferred tax assets provision and pension obligation for 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.
2.8.3 Disclosure controls and procedures over financial reporting may not prevent or detect all errors or acts of fraud.
Disclosure controls and procedures over financial reporting are designed to reasonably assure that information required to be disclosed by the company in reports filed or submitted under the Securities Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SECs 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 occur because of simple errors or mistakes. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or 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 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.
2.9 Foreign Private Issuer and Other Risks
2.9.1 Our corporate disclosure may differ from disclosure regularly published by issuers of securities in other countries, including the United States.
Issuers of securities in Spain 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, for regulatory purposes, we currently prepare and will continue to prepare and make available to our shareholders statutory financial statements in accordance with IFRS, which differs from U.S. GAAP in a number of respects. 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, or 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.
2.9.2 Investors may find it difficult to enforce civil liabilities against us or our directors and officers.
The majority of our directors and officers reside outside of the United States. In addition, all or a substantial portion of our assets and their assets are located outside of 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 or officers 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.
Additionally, investors may experience difficulty in Spain enforcing foreign judgments obtained against us and our executive officers and directors, including in any action based on civil liabilities under the U.S. federal securities laws. Based on the opinion of Spanish counsel, there is doubt as to the enforceability against such persons in Spain, whether in original actions or in actions to enforce judgments of U.S. courts, of liabilities based solely on the U.S. federal securities laws.
2.9.3 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 Bylaws and Spanish corporate law, 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 Spain. Under Spanish corporate law, you may have fewer and less well-defined rights to protect your interests than under the laws of other jurisdictions outside Spain.
Although Spanish 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 Spain, 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.
2.9.4 ADS holders may be subject to additional risks related to holding ADSs rather than shares.
Because ADS holders do not hold their shares directly, they are subject to the following additional risks, among others:
|||as an ADS holder, we may not treat you as one of our direct shareholders and you may not be able to exercise shareholder rights;|
|||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.|
Banco Santander, S.A. (Santander, the Bank, the Parent or the Parent bank) is the Parent bank of Grupo Santander. It was established on March 21, 1857 and incorporated in its present form by a public deed executed in Santander, Spain, on January 14, 1875.
On January 15, 1999, the boards of directors of Banco Santander, S.A. and Banco Central Hispanoamericano, S.A. agreed to merge Banco Central Hispanoamericano, S.A. into Banco Santander, S.A., and to change Banco Santanders name to Banco Santander Central Hispano, S.A. The shareholders of Banco Santander, S.A. and Banco Central Hispanoamericano, S.A. approved the merger on March 6, 1999, at their respective general meetings. The merger and the name change were registered with the Mercantile Registry of Santander, Spain, by the filing of a merger deed. Effective April 17, 1999, Banco Central Hispanoamericano, S.A. shares were extinguished by operation of law and Banco Central Hispanoamericano, S.A. shareholders received new Banco Santander shares at a ratio of three shares of Banco Santander, S.A. for every five shares of Banco Central Hispanoamericano, S.A. formerly held. On the same day, Banco Santander, S.A. changed its legal name to Banco Santander Central Hispano, S.A.
The general shareholders meeting held on June 23, 2007 approved the proposal to change the name of the Bank to Banco Santander, S.A.
The general shareholders meeting held on March 22, 2013 approved the merger by absorption of Banco Español de Crédito, S.A. (Banesto) and Banco Banif, S.A.
We are incorporated under, and governed by the laws of the Kingdom of Spain. We conduct business under the commercial name Santander. Our corporate offices are located in Ciudad Grupo Santander, Avda. de Cantabria s/n, 28660 Boadilla del Monte (Madrid), Spain. Telephone: (011) 34-91-259-6520.
Principal Capital Expenditures and Divestitures
Acquisitions, Dispositions, Reorganizations
Our principal acquisitions and dispositions in 2014, 2013 and 2012 were as follows:
Sale of Altamira Asset Management
On November 21, 2013, we announced that we had reached a preliminary agreement with Apollo European Principal Finance Fund II, a fund managed by subsidiaries of Apollo Global Management, LLC, for the sale of the platform for managing the recovery of Banco Santander, S.A.s loans in Spain and for managing and marketing the properties obtained through this activity (Altamira Asset Management, S.L.).
On January 3, 2014, we announced that we had sold 85% of the share capital of Altamira Asset Management, S.L. to Altamira Asset Management Holdings, S.L., an investee of Apollo European Principal Finance Fund II, for 664 million, giving rise to a net gain of 385 million, which was recognized in our consolidated income statement for 2014.
Following this transaction, we retained the aforementioned property assets and loan portfolio on our balance sheet, while management of these assets is carried out from the platform owned by Apollo.
Santander Consumer USA
In January 2014, the public offering of shares of Santander Consumer USA Inc. (SCUSA) was completed and the company was admitted to trading on the New York Stock Exchange. The offering represented 21.6% of SCUSAs share capital, of which 4.23% related to the ownership interest sold by the Group. Following this sale, we held 60.74% of the share capital of SCUSA (December 31, 2014: 60.46%). Both Sponsor Auto Finance Holdings Series LP (Sponsor Holdings)an investee of funds controlled by Warburg Pincus LLC, Kohlberg Kravis Roberts & Co. L.P. and Centerbridge Partners L.P.and DDFS LLC (DDFS)a company controlled by Thomas G. Dundon, who holds the position of Chief Executive Officer of SCUSAalso reduced their ownership interest in SCUSA.
Since the ownership interests of the aforementioned shareholders were reduced below specified percentages following the offering, the shareholders agreement previously entered into by the shareholders was terminated in accordance with its terms; this entailed the termination of the agreement which, inter alia, had granted Sponsor Holdings and DDFS representation on the board of directors of SCUSA and had established a voting system under which the strategic, financial and operating decisions, and other significant decisions associated with the ordinary management of SCUSA, were subject to joint approval by the Group and the aforementioned shareholders. Therefore, SCUSA ceased to be controlled jointly by all the above and is now controlled by the Group on the basis of the percentage held in its share capital (change of control).
Prior to this change of control the Group accounted for its ownership interest in SCUSA using the equity method. Following the change of control, the Group fully consolidated its ownership interest in SCUSA and, on the date it obtained control, included all of SCUSAs assets and liabilities in its consolidated balance sheet at their fair value.
As a result of the aforementioned transaction, we recognized a net gain of 730 million in the consolidated income statement for 2014.
Agreement with El Corte Inglés
On October 7, 2013, we announced that we had entered into a strategic agreement through our subsidiary Santander Consumer Finance, S.A. with El Corte Inglés, S.A. in the area of consumer finance, which included the acquisition of 51% of the share capital of Financiera El Corte Inglés E.F.C., S.A., with El Corte Inglés, S.A. retaining the remaining 49%. On February 27, 2014, following the receipt of the relevant regulatory and competition authorizations, the acquisition was completed. Santander Consumer Finance, S.A. paid 140 million for 51% of the share capital of Financiera El Corte Inglés E.F.C., S.A.
GetNet Tecnologia Em Captura e Processamento de Transações H.U.A.H. S.A.
On April 7, 2014, Banco Santander (Brasil) S.A. announced that it had reached an agreement to purchase through an investee all the shares of GetNet Tecnologia Em Captura e Processamento de Transações H.U.A.H. S.A. (GetNet). The transaction was completed on July 31, 2014 for a purchase price of BRL1,156 million (approximately 383 million), giving rise to goodwill of 229 million.
Acquisition of non-controlling interests in Banco Santander (Brasil) S.A.
On April 28, 2014, the Banks board of directors approved a bid for the acquisition of all the shares of Banco Santander (Brasil) S.A. not then owned by the Group, which represented approximately 25% of the share capital of Banco Santander (Brasil) S.A., offering in consideration Bank shares in the form of Brazilian Depositary Receipts (BDRs) or American Depositary Receipts (ADRs). As part of the bid, the Bank requested that its shares be listed on the São Paulo Stock Exchange in the form of BDRs.
The offer was voluntary, in that the non-controlling shareholders of Banco Santander (Brasil) S.A. were not obliged to participate, and it was not conditional upon a minimum acceptance level. The consideration offered, following the adjustment made as a result of the application of the Santander Dividendo Elección scrip dividend scheme in October 2014, consisted of 0.7152 new Banco Santander shares for each unit or ADR of Banco Santander (Brasil) S.A. and 0.3576 new Banco Santander shares for each ordinary or preference share of Banco Santander (Brasil) S.A.
The bid was accepted by holders of 13.65% of the share capital of Banco Santander (Brasil) S.A. Accordingly, the Groups ownership interest in Banco Santander (Brasil) S.A. rose to 88.30% of its share capital. To cater for the exchange, the Bank, executing the agreement adopted by the extraordinary general shareholders meeting held on September 15, 2014, issued 370,937,066 shares, representing approximately 3.09% of the Banks share capital at the issue date. The aforementioned transaction gave rise to an increase of 185 million in Share capital, 2,372 million in Share premium and 15 million in Reserves, and a reduction of 2,572 million in Non-controlling interests.
The shares of Banco Santander (Brasil) S.A. continue to be listed on the São Paulo and New York stock exchanges.
On June 19, 2014, we announced that we had reached a definitive agreement with FINESP Holdings II B.V., a subsidiary of Warburg Pincus, to sell a 50% stake in Santanders current custody business in Spain, Mexico and Brazil, retaining the remaining 50%. The transaction values the business at 975 million at the date of the announcement. The sale is subject to receipt of the relevant regulatory authorizations which, in accordance with the agreement, should be obtained in the first half of 2015.
Agreement with GE Capital
On June 23, 2014, we announced that Santander Consumer Finance, S.A., Banco Santanders consumer finance unit had reached an agreement with GE Money Nordic Holding AB to acquire GE Capitals business in Sweden, Denmark and Norway for approximately 693 million at the date of the announcement. The acquisition was completed on November 6, 2014, following the receipt of the relevant authorizations.
Agreement with Banque PSA Finance
We, through our subsidiary Santander Consumer Finance, S.A., and Banque PSA Finance, the vehicle financing unit of the PSA Peugeot Citroën Group, entered into an agreement in July 2014 for the joint operation of the vehicle financing business in eleven European countries. Pursuant to the terms of the agreement, we will finance this business under certain circumstances and conditions from the date on which the transaction is completed, which is expected to occur in 2015 or at the beginning of 2016. In addition, in certain countries, we will purchase the current lending portfolio of Banque PSA Finance. We also entered into a cooperation agreement relating to the insurance business in all these countries through the set up of two insurance companies in Malta. We have obtained authorization from the competition authorities but the transaction remains subject to approval by the other relevant regulatory bodies.
In January 2015, the relevant regulatory authorizations were obtained for the commencement of activities in France and the United Kingdom.
Agreement with CNP
On July 10, 2014, we announced that we had reached an agreement with the French insurance company CNP to acquire a 51% stake in three insurance companies based in Ireland (Santander Insurance Life Limited, Santander Insurance Europe Limited and Santander Insurance Services Ireland Limited) that distribute life and non-life products through the Santander Consumer Finance network.
In December 2014, after the regulatory authorizations were obtained, CNP paid 297 million to acquire 51% , or a controlling interest in, the three aforementioned insurance companies. The agreement includes deferred payments to CNP in 2017 and 2020 and deferred amounts receivable by the Group in 2017, 2020 and 2023, based on the business plan.
The agreement included the execution of a 20-year retail agreement, renewable for five-year periods, for the sale of life and non-life insurance products through the Santander Consumer Finance network, for which we will receive commissions at market rates.
This transaction gave rise to the recognition of a gain of 413 million under Gains/(losses) on disposal of assets not classified as non-current assets held for sale, of which 207 million related to the fair value recognition of the 49% ownership interest retained by us.
Agreement to acquire Carfinco
On September 16, 2014, we announced that we had reached an agreement to acquire the listed Canadian company Carfinco Financial Group Inc. (Carfinco) for an amount of 298 million Canadian dollars (approximately 210 million). Santander will pay 11.25 Canadian dollars per share, which represents a premium of 32% on the share price during the 90 trading sessions prior to September 16, 2014. The board of directors of Carfinco approved the transaction and recommended to its shareholders that they vote in favor of it at the general meeting called for such purpose, and the transaction was completed on March 6, 2015.
The impact of the transaction on the Groups shareholders equity is not material.
On December 19, 2012, the creditor entities that participated in a debt restructuring agreement for the Sanahuja Group under which they received shares of Metrovacesa, S.A. as payment for that groups debt, announced that they reached an agreement to promote the delisting of the shares of Metrovacesa, S.A. and they voted in favor of this at the general meeting held for this purpose on January 29, 2013. Following the approval of the delisting and the public takeover offer at the Metrovacesa, S.A. general meeting, the entities made a delisting public takeover offer of 2.28 per share to the Metrovacesa, S.A. shareholders that had not entered into the agreement. The Group participated in the delisting public takeover offer by acquiring an additional 1.953% of Metrovacesa, S.A. for 44 million.
Following this transaction, at December 31, 2013, the Group held an ownership interest of 36.82% in the share capital of Metrovacesa, S.A.
On December 23, 2014, the Group acquired 19.07% of Metrovacesa, S.A. from Bankia, S.A. for 98.9 million, as a result of which its stake increased to 55.89%, thus obtaining control over this company. After this transaction, Metrovacesa, S.A. is fully consolidated with the Group (until then it was accounted for by the equity method).
For further information see note 3.b. xvi. Metrovacesa, S.A. to our consolidated financial statements.
Invitation to tender American Securities for purchase
On March 6, 2013, we announced an invitation to all holders of callable subordinated notes series 22 issued by Santander Issuances, S.A. Unipersonal (the American Securities) to tender such Securities for purchase (the American Invitation). The American Securities are listed in the London Stock Exchange. The total principal amount of the American Securities comprising the American Invitation amounts to approximately US$ 257.5 million.
Banco Santander announced the final aggregate principal amount accepted for purchase on March 14, 2013 (US$ 26.6 million) and the final purchase prices as a consequence of the tender offers.
The invitation was undertaken as a part of the Groups active management of liabilities and capital, and focused on core capital generation as well as the optimization of the future interest expense.
Invitation to tender European Securities for purchase
On March 6, 2013, we announced an invitation to all holders of certain securities issued by Santander Issuances, S.A. Unipersonal and Santander Perpetual, S.A. Unipersonal (the European Securities) to tender such securities for purchase (the European Invitation). The European Securities are subordinated and perpetual bonds listed in the Luxembourg Stock Exchange, corresponding to 15 different series. The total principal amount of the series comprising the Invitation amounts to approximately 6,575 million and GBP 2,243 million.
Banco Santander announced the final aggregate principal amount accepted for purchase on March 14, 2013 (140.2 million and GBP 178.9 million) and the final purchase prices as a consequence of the European Invitation.
The European Invitation was undertaken as a part of the Groups active management of liabilities and capital, and focused on core capital generation as well as the optimization of future interest expense. The invitation was also designed to provide liquidity in the market and to offer the holders of the European Securities the possibility to exit their investment in the European Securities.
Santander sells 5.2% of its Polish unit as KBC places its 16.2% in the market
On March 18, 2013, KBC Bank NV (KBC) and Banco Santander announced a secondary offering of up to 19,978,913 shares in Bank Zachodni WBK S.A. (BZ WBK) by way of a fully-marketed follow-on offering (the WBK Offering). Through the WBK Offering, KBC would sell 15,125,964 shares (constituting 16.17% of BZ WBK shares outstanding at that date) and Santander was expected to sell not less than 195,216 but up to 4,852,949 shares (constituting between 0.21% and 5.19% of BZ WBK shares outstanding at that date).
KBC and Banco Santander, as selling shareholders, granted the underwriters a reverse greenshoe option in relation to up to 10% of the final Offering size which was not used. KBC and Santander each committed to be locked up for a period of 90 days, and BZ WBK for a period of 180 days, following the closing of the WBK Offering.
The WBK Offering was made to eligible institutional investors and within an indicative price range of PLN240 to PLN270. The final sale price was determined through a book-building process that began on March 18, 2013, and ended on March 21, 2013.
On March 22, 2013, Banco Santander, S.A. and KBC completed the placement of all the shares owned by KBC and 5.2% of the share capital of Bank Zachodni WBK S.A. held by the Group in the market for 285 million, which gave rise to an increase of 292 million in Non-controlling interests.
Following these transactions, we hold 70% of the share capital of Bank Zachodni WBK S.A. and the remaining 30% is held by non-controlling interests.
Agreement with Warburg Pincus and General Atlantic
On May 30, 2013, we announced that we had entered into an agreement with subsidiaries of Warburg Pincus and General Atlantic to foster the global development of our asset management unit, Santander Asset Management (SAM). Pursuant to the terms and conditions of the agreement, Warburg Pincus and General Atlantic together own 50% of the holding company which comprises the eleven management companies we have, mainly in Europe and Latin America, while the other 50% are held by us.
The purpose of the alliance is to enable SAM to improve its ability to compete with the large independent international asset management companies, since the businesses to be strengthened include asset management in the global institutional market, with the additional advantage of having knowledge and experience in the markets in which we are present. The agreement also contemplates the distribution of products managed by SAM in the countries in which we have a commercial network for a period of ten years, renewable for five additional two-year periods, for which we will receive commissions at market rates, thus benefiting from broadening the range of products and services we offer our customers. SAM also distributes its products and services internationally, outside our commercial network.
Since the aforementioned asset management companies belonged to different Group companies, a corporate restructuring took place prior to the completion of the transaction whereby each of the asset management companies was sold by its shareholders for its fair value to SAM Investment Holdings Limited (SAM), a holding company created by us. The aggregate value of the asset management companies was approximately 1.7 billion.
Subsequently, in December 2013, once the required authorizations were obtained from various regulators, the agreement was executed through the acquisition of a 50% ownership interest in SAMs share capital by Sherbrooke Acquisition Corp SPC (an investee of Warburg Pincus and General Atlantic) for 449 million. At that date, SAM had financing from third parties for 845 million. The agreement includes deferred contingent amounts payable and receivable for the Group based on the achievement of the business plan targets over the coming five years.
Also, we entered into a shareholders agreement with Sherbrooke Acquisition Corp SPC shareholders regulating, inter alia, the taking of strategic, financial, operational and other significant decisions regarding the ordinary management of SAM on a joint basis. Certain restrictions on the transferability of the shares were also agreed, and a commitment was made by the two parties to retain the restrictions for at least 18 months. Lastly, Sherbrooke Acquisition Corp SPC will be entitled to sell to the Group its ownership interest in the share capital of SAM at market value on the fifth and seventh anniversaries of the transaction, unless a public offering of SAM shares has taken place prior to those dates.
Following these transactions, at year-end we held a 50% ownership interest in SAM and controlled this company jointly with the aforementioned shareholders.
As a result of the aforementioned transaction, we recognized a gain of 1,372 million in the consolidated income statement for 2013, of which 671 million related to the fair value of the 50% ownership interest retained by us.
Banco Santander (Brasil) optimized its equity structure
On September 29, 2013, we announced that our subsidiary Banco Santander (Brasil) S.A. will optimize its equity structure by replacing BRL 6 billion of common equity (Core Tier I) (amount which will be distributed pro rata among its shareholders) with newly-issued instruments of an equivalent amount qualifying as Additional Tier I and Tier II capital, and which will be offered to Banco Santander (Brasil) S.A.s shareholders.
In January 2014 we subscribed a percentage of the newly issued instruments in proportion to our shareholding in Banco Santander (Brasil) S.A. (approximately 75%), as well as those not subscribed by the other shareholders of Banco Santander (Brasil) S.A.
The new structure improves Banco Santander (Brasil) S.A.s regulatory capital composition, by increasing the return on equity (ROE) while maintaining the total amount of regulatory capital and capital ratios (BIS II ratio of approximately 21.5% and fully loaded BIS III ratio of approximately 18.9%) above the other retail banks in Brazil.
Cooperation agreement and purchase of 7.2% stake in Bank of Shanghai
On May 12, 2014, after obtaining approval from the China Banking Regulatory Commission to the cooperation agreement reached with Bank of Shanghai (BoS) to buy an equity stake in BoS announced on December 10, 2013, we acquired a 7.2% equity stake in BoS from HSBC Ltd -such equity stake represented 8% of the share capital of BoS on the date when the agreement was announced, but after a private placement of shares carried out by BoS completed in February 2014, it represents 7.2%-.
This transaction has made Santander the second-largest shareholder in BoS and its strategic international partner. The cost of the investment, including the purchase of HSBC Ltd.s stake and the cooperation agreement with Bank of Shanghai, was estimated at approximately 470 million. The transaction has had an impact of approximately 1 basis point on the Santander Groups capital.
Under the terms of the agreement, Santander is providing BoS with a permanent team of professionals, who are contributing Santanders knowledge and experience in risk management, commercial, wholesale and retail banking, and are working together with BOS together to find joint business opportunities.
Transfer of interest in Banco Santander (Brasil), S.A.
In January and March 2012 the Group transferred shares representing 4.41% and 0.77%, respectively, of the capital stock of Banco Santander (Brasil), S.A. to two leading international financial institutions. These institutions undertook to deliver these shares to the holders of bonds issued by Banco Santander in October 2010 which were exchangeable for Banco Santander (Brasil), S.A. shares upon maturity, in accordance with their terms.
Merger of Bank Zachodni WBK S.A. and Kredyt Bank S.A.
On February 28, 2012, the Group announced that Banco Santander, S.A. and KBC Bank NV (KBC) had entered into an investment agreement to merge their two subsidiaries in Poland, Bank Zachodni WBK S.A. and Kredyt Bank S.A., respectively, following which the Group would control approximately 76.5% of the entity resulting from the merger and KBC 16.4%, with the remaining 7.1% being owned by non-controlling interests. Also, the Group undertook to place a portion of its ownership interest among investors and to acquire up to 5% of the entity resulting from the merger in order to help KBC to reduce its holding in the merged entity to below 10%. KBCs objective is to dispose of its entire investment in order to maximize its value.
The transaction was carried out through a capital increase at Bank Zachodni WBK S.A., whose new shares would be offered to KBC and the other shareholders of Kredyt Bank S.A. in exchange for their shares in Kredyt Bank S.A. The related exchange ratio was established at 6.96 shares of Bank Zachodni S.A. for every 100 shares of Kredyt Bank S.A.
In early 2013, following the approval from the Polish financial regulator (KNF), the aforementioned transaction was consummated. As a result, the Group controlled approximately 75.2% of the post-merger entity and KBC controlled approximately 16.2%, with the remaining 8.6% being owned by non-controlling holders. This transaction gave rise to an increase of 1,037 million in non-controlling interests169 million as a result of the acquisition of control of Kredyt Bank S.A. and 868 million as a result of the reduction in the percentage of ownership of Bank Zachodni WBK S.A.
On March 22 2013, Banco Santander, S.A. and KBC completed the placement of all the shares owned by KBC and 5.2% of the share capital of Bank Zachodni WBK S.A. held by the Group in the market for 285 million, which gave rise to an increase of 292 million in non-controlling interests.
Following these transactions, the Group held 70% of the share capital of Bank Zachodni WBK S.A. and the remaining 30% was held by non-controlling holders.
On March 30, 2012, we informed that the Ordinary General Shareholders Meeting held that day had resolved to grant the holders of Valores Santander an option to convert their securities on four occasions before October 4, 2012, the mandatory conversion date for the outstanding Valores Santander. As a result on June 7, 2012, July 5, 2012, August 7, 2012 and September 6, 2012 we issued 73,927,779, 193,095,393, 37,833,193 and 14,333,873 new shares related to the conversion requests of 195,923, 511,769, 98,092 and 37,160 Valores Santander, respectively.
In October 2007, a total of 1,400,000 Valores Santander were issued. On October 2008, 2009, 2010 and 2011, and on June, July, August and September 2012 a total to 880,700 Valores Santander were voluntarily converted. On October 4, 2012, the mandatory conversion of the remaining 519,300 Valores Santander took place, representing 37.1% of the original issuance.
Invitation to tender certain securitization bonds for cash
On April 16, 2012, we announced an invitation to all holders of certain securities (the Securities) to tender such Securities for purchase by Banco Santander for cash (the Invitation). The Securities are fixed rate securities (securitization bonds) listed on the AIAF Fixed Rate Market which correspond to 33 different series issued by specific securitization funds managed by Santander de Titulización, S.G.F.T., S.A. series with an aggregate outstanding principal amount of 6 billion.
The rationale for the Invitation was to effectively manage the Groups outstanding liabilities and to strengthen our balance sheet. The Invitation was also designed to provide liquidity to Security holders.
On April 25, 2012 we announced the aggregate outstanding principal amount of each of the Securities accepted for purchase, which for senior securities amounted to 388,537,762.18 and for mezzanine securities 61,703,163.58.
Sale of our Colombian unit to the Chilean group Corpbanca
In December 2011, we entered into an agreement with the Chilean group Corpbanca to sell our shareholding in Banco Santander Colombia S.A. and our other business subsidiaries in this country (Santander Investment Valores Colombia S.A., Comisionista de Bolsa Comercial, Santander Investment Colombia S.A., Santander Investment Trust Colombia S.A., Sociedad Fiduciaria y Agencia de Seguros Santander, Ltda.).
Following receipt of the regulatory authorizations from the competent authorities and the delisting of the shares of Banco Santander Colombia S.A., in the second quarter of 2012 we sold our shareholding in Banco Santander Colombia S.A. and our other business subsidiaries in Colombia to the Corpbanca Group for a total of $1,229 million (983 million), giving rise to a gain of 619 million, which was recognized under Gains/(losses) on disposal of assets not classified as non-current assets held for sale in our 2012 consolidated income statement.
Agreement with Abbey Life Assurance
On July 19, 2012, we reached an agreement with Abbey Life Assurance Ltd, a subsidiary of Deutsche Bank AG, under which Abbey Life Assurance Ltd reinsured 100% of the individual life risk portfolio of the insurance companies of Banco Santander in Spain and Portugal.
This reinsurance transaction enabled us to monetize our life risk insurance portfolio. This transaction gave rise to income of 435 million recognized under Other operating incomeIncome from insurance and reinsurance contracts issued in the consolidated income statement (308 million net of tax).
The policies ceded to Abbey Life Assurance Ltd consist of the portfolio as of June 30, 2012. This reinsurance agreement does not involve any changes for our customers as services will continue to be provided by Santanders insurance companies. Our branches in Spain and Portugal will continue to offer products designed by our insurance companies as the agreement reached with Abbey Life Assurance Ltd does not involve any commitment on future distribution and is limited to the portfolio existing at June 30, 2012.
Placement of shares of Grupo Financiero Santander, S.A.B. de C.V. on the secondary market
On August 16, 2012, we announced our intention to register with both the Mexican Comisión Nacional de Banca y Valores (National Commission of Banking and Securities) and the U.S. Securities & Exchange Commission the registration statements for the placement of shares of Grupo Financiero Santander, S.A.B. de C.V. on the secondary market. The selling institutions would be Banco Santander, S.A. and its subsidiary Santusa Holding, S.L.
On September 26, 2012, we announced that the price of the offering of shares of Grupo Financiero Santander Mexico was set at 31.25 Mexican pesos ($2.437) per share, valuing Santander Mexico at 12,730 million ($16,538 million), making it the 82nd largest bank in the world by market capitalization at that time.
The total volume of the offering represented 24.9% of the share capital of Santander Mexico after the exercise of the green shoe option. The value of the transaction was 3,178 million, making it the largest equity offering in Latin America in 2012 and one of the largest in the world.
The gains obtained by Banco Santander in this transaction were fully allocated to reserves, in line with accounting requirements, as Banco Santander will continue to maintain control over its Mexican subsidiary.
Of the total shares sold, 81% were placed in the United States and elsewhere outside Mexico and 19% in Mexico. The American Depositary Shares of Santander Mexico commenced trading on the New York Stock Exchange on September 26, 2012. The shares of Santander Mexico continue to trade on the Mexican Stock Exchange.
The IPO of our unit in Mexico was an important step in our strategy of having market listings for all of our significant subsidiaries.
Invitation to tender offer
On August 22, 2012, the Bank and Santander Financial Exchanges Limited invited the holders of 21 series of subordinated debt and preferred securities to sell those securities. The aggregate principal amount of the securities traded in euros and sterling amounted to 7,201 million and £3,373 million, respectively.
The rationale for the invitation was to effectively manage the Groups outstanding liabilities and to strengthen our balance sheet. The invitation was also designed to provide liquidity to security holders.
On August 31, 2012, we and Santander Financial Exchanges Limited announced that the holders had agreed to sell an aggregate principal amount of 755 million for the securities traded in euros and £311 million for the securities traded in sterling.
Termination of the agreement to purchase Royal Bank of Scotland branch offices
On October 15, 2012, we announced that the agreement for the sale by The Royal Bank of Scotland (RBS) to Santander UK of approximately 300 branches of RBS in England and Wales and NatWest in Scotland (the Business) would not be completed due to the foreseeable failure to meet the conditions precedent by the agreed final deadline of February 2013.
Santander and Elavon agreement
On October 19, 2012, we announced that we had reached an agreement with Elavon Financial Services Limited (Elavon) to jointly operate a payment services business for credit and debit cards through merchants point of sale terminals in Spain.
The transaction involves the incorporation of a joint venture company whose share capital will be held 51% by Elavon and 49% by the Bank, and to which Santander Group will transfer its aforementioned payment services business in Spain (excluding that of Banesto).
The transaction was completed in the first half of 2013 and generated a gain of 122 million (85 million net of tax).
Mergers by absorption of Banesto and Banco Banif
On December 17, 2012, we announced that we had resolved to approve the plan for the merger by absorption of Banesto and Banco Banif, S.A. as part of the restructuring of the Spanish financial sector. These transactions are part of a commercial integration which brought Banesto and Banif under the Santander brand.
At their respective board of directors meetings held on January 9, 2013, the directors of the Bank and Banesto approved the common draft terms of the merger by absorption of Banesto into the Bank with the dissolution without liquidation of the former and the transfer en bloc of all its assets and liabilities to the Bank, which were acquired, by universal succession, the rights and obligations of the absorbed entity. As a result of the merger, the shareholders of Banesto, other than the Bank, received in exchange shares of the Bank.
January 1, 2013 was established as the date from which the transactions of Banesto shall be considered to have been performed for accounting purposes for the account of the Bank.
On March 22, 2013 and March 21, 2013, the general shareholders meetings of the Bank and Banesto, respectively, approved the terms of the merger.
On April 29, 2013, pursuant to the provisions of the terms of the merger and to the resolutions of the general shareholders meetings of both companies, the regime and procedure for the exchange of Banesto shares for shares of Banco Santander was made public. Banco Santander covered the exchange of Banesto shares with shares held as treasury stock based on the exchange ratio of 0.633 shares of Banco Santander, each with a nominal value of 0.50, for each share of Banesto, each with a nominal value of 0.79, without provision for any supplemental cash remuneration.
On May 3, 2013, the merger was registered with the Commercial Registry of Cantabria and the dissolution of Banesto was completed.
The directors of Banco Banif, S.A., at its board of directors meeting held on January 28, 2013, and the directors of Banco Santander, S.A., at its board of directors meeting held on that same day, approved the common drafts terms of the merger by absorption of Banco Banif, S.A. into Banco Santander, S.A. with the dissolution without liquidation of the former and the transfer en bloc of all its assets and liabilities to Banco Santander, S.A., which acquired, by universal succession, the rights and obligations of the absorbed entity.
January 1, 2013 was established as the date from which the transactions of Banif were considered to have been performed for accounting purposes for the account of the Bank.
On May 7, 2013, the merger was registered with the Commercial Registry of Cantabria and the dissolution of Banco Banif, S.A. was completed.
Insurance business in Spain
On December 20, 2012, we announced that we had reached an agreement with Aegon. In this regard, we created two insurance companies, one for life insurance and the other for general insurance, in which Aegon would acquire ownership interests of 51%, and management responsibility would be shared by Aegon and the Group. We would hold 49% of the share capital of the companies and we would enter into a distribution agreement for the sale of insurance products in Spain through the commercial networks for a period of 25 years. The agreement would not affect savings, health and vehicle insurance, which would continue to be owned and managed by Santander.
In June 2013, after obtaining the relevant authorizations from the Directorate-General of Insurance and Pension Funds and from the European competition authorities, Aegon acquired a 51% ownership interest in the two insurance companies created by the Group for these purposes, one for life insurance and the other for general insurance (currently Aegon Santander Vida Seguros y Reaseguros, S.A. and Aegon Santander Generales Seguros y Reaseguros, S.A.), for which it paid 220 million, thereby gaining joint control together with the Group over the aforementioned companies. The agreement also includes payments to Aegon that are deferred over two years and amounts receivable for the Group that are deferred over five years, depending on the business plan.
The aforementioned agreement includes the execution of a distribution agreement for the sale of insurance products in Spain for 25 years through commercial networks, for which the Group will receive commissions at market rates.
This transaction gave rise to a gain of 385 million recognized under Gains (losses) on disposal of assets not classified as non-current assets held for sale (270 million net of tax), of which 186 million related to the fair value recognition of the 49% ownership interest retained by the Group.
As of December 31, 2012, our capital had increased by 1,412,136,547 shares, or 15.85% of our total capital as of December 31, 2011, to 10,321,179,750 shares as a result of the following transactions:
|||Valores Santander: On March 30, 2012, we informed that the Ordinary General Shareholders Meeting held that day had resolved to grant the holders of Valores Santander an option to convert their securities on four occasions before October 4, 2012, the mandatory conversion date for the outstanding Valores Santander. As a result on June 7, 2012, July 5, 2012, August 7, 2012, September 6, 2012 and October 9, 2012 we issued 73,927,779, 193,095,393, 37,833,193, 14,333,873 and 200,311,513 new shares related to the conversion requests of 195,923, 511,769, 98,092, 37,160 and 519,300 Valores Santander, respectively.|
|||Scrip Dividend: On January 31, 2012, May 2, 2012, July 31, 2012 and November 2, 2012, we issued 167,810,197 shares, 284,326,000 shares, 218,391,102 shares and 222,107,497 shares, giving rise to capital increases of 83,905,098.50, 142,163,000, 109,195,551 and 111,053,748.50, respectively.|
As of December 31, 2013, our capital had increased by 1,012,240,738 shares, or 9.81% of our total capital as of December 31, 2012, to 11,333,420,488 shares as a result of the following transactions:
|||Scrip Dividend: On January 30, 2013, April 30, 2013, July 31, 2013 and October 31, 2013, we issued 217,503,395 shares, 270,917,436 shares, 282,509,392 shares and 241,310,515 shares, giving rise to capital increases of 108,751,697.50, 135,458,718, 141,254,696 and 120,655,257.50, respectively.|
As of December 31, 2014, our capital had increased by 1,250,994,171 shares, or 11.04% of our total capital as of December 31, 2013, to 12,584,414,659 shares as a result of the following transactions:
|||Scrip Dividend: On January 30, 2014, April 29, 2014, July 30, 2014 and November 5, 2014, we issued 227,646,659 shares, 217,013,477 shares, 210,010,506 shares and 225,386,463 shares (2.01%, 1.92%, 1.85%, and 1.99% of the share capital, respectively), giving rise to capital increases of 113,823,329.50, 108,506,738.50, 105,005,253 and 112,693,231.50, respectively.|
|||Acquisition of non-controlling interests in Banco Santander (Brasil) S.A.: On November 4, 2014 we issued 370,937,066 shares (3.27% of the share capital) giving rise to a capital increase of 185,468,533.|
Other Material Events
Asset quality review
On October 26, 2014, regarding the asset quality review (AQR) carried out by the European Central Bank and the European Banking Authority, we announced:
|||That such review, carried out with reference to December 2013, affected 16 portfolios in 7 countries, accounting for more than 50% of our risk assets.|
|||That the impact of the analysis on CET1 was not material (decrease of 4 basis points). The non-performing loan ratio of the reviewed portfolios increased 0.14 percentage points post-AQR, which showed that coverage was appropriate and that risks were correctly classified.|
Furthermore, with respect to the stress test applied to all countries where we operate and which covered a three-year period (20142016) with two scenarios (base and adverse), the results were as follows:
|||In the base scenario, we increase our capital ratio (CET1) as of December 31, 2016 by 1.6 percentage points to 12%.|
|||In the adverse scenario, the CET1 ratio dropped 1.4 percentage points, to 9%. That ratio was 3.5 percentage points above the required minimum, meaning that in this scenario, we would exceed the required capital amount by close to 20 billion.|
At its meeting of January 12, 2015, the Banks executive committee resolved to apply the Santander Dividendo Elección scrip dividend scheme on the dates on which the third interim dividend is traditionally paid, whereby the shareholders were offered the option of receiving an amount equivalent to said dividend, the gross amount of which was 0.146 per share, in shares or cash.
On January 29, 2015 we announced that the holders of 83.73% of the free allotment rights chose to receive new shares. Thus, the definitive number of ordinary shares of 0.5 of face value issued in the free-of-charge capital increase is 262,578,993, corresponding to 1.90% of the share capital, and the amount of the capital increase is 131,289,496.50. The value of the remuneration corresponding to the holders of free allotment rights who requested new shares amounts to 1,686,807,451.03. The shareholders holding the remaining 16.27% of the free allotment rights have accepted the irrevocable undertaking to acquire free allotment rights assumed by Banco Santander. Consequently, Banco Santander has acquired 2,244,531,167 rights for a total gross consideration of 327,701,550.38. Banco Santander has waived the free allotment rights so acquired.
On April 10, 2015 we announced the information in connection with the flexible remuneration program Santander Dividendo Elección (scrip dividend scheme) to be applied to the final 2014 dividend. The shareholders were offered the option of receiving an amount equivalent to said dividend, the gross amount of which was 0.151 per share, in shares or cash.
On January 8, 2015, an extraordinary meeting of the board of directors took place to:
(i) Approve a capital increase with the exclusion of pre-emption rights for an amount of up to 7,500 million, which represents approximately 9.6% of the share capital of Banco Santander before the capital increase. The transaction was implemented through an accelerated book-building. The objective of this transaction was to accelerate our plans to grow organically allowing us to increase both customer credit and market share in our core geographies, and to take advantage of our business model. Our capital was increased for a nominal amount of 606,796,117 through the issuance of 1,213,592,234 ordinary shares of Banco Santander with a nominal value of 0.50 each. The price for the new shares was fixed at 6.18 per share. Consequently, the total amount of the capital increase was of 7,500,000,006.12 euros (606,796,117 nominal amount and 6,893,203,889.12 share premium). The new shares were admitted to trade in the Spanish markets on January 12, 2015.
(ii) Reformulate the dividend policy of Banco Santander to take effect with the first dividend to be paid with respect to our 2015 results, in order to distribute 3 cash dividends and a scrip dividend relating to such 2015 results. Each of these dividends will have an estimated amount of 5 euro cents.
Merger of Santander Asset Management and Pioneer Investments
On April 23, 2015, we announced that we had reached a preliminary and exclusive agreement with our partners Warburg Pincus and General Atlantic, subject to the signing of final terms, to merge Santander Asset Management and Pioneer Investments to create a leading global asset manager in Europe and Latin America. The combined company, with approximately 353 billion in assets under management at the close of 2014, will be called Pioneer Investments.
The agreement contemplates the creation of a new company into which the local asset managers of Santander Asset Management and Pioneer Investments will be incorporated. Santander will have a direct 33.3% stake in the new company, UniCredit will have a 33.3% stake, and private equity fund managers Warburg Pincus and General Atlantic will share a 33.3% stake. Pioneer Investments operations in the United States will not be included in the new company but will be owned by UniCredit (50%) and Warburg Pincus and General Atlantic (50%).
The transaction values Santander Asset Management at 2.6 billion and Pioneer Investments at 2.75 billion. Warburg Pincus and General Atlantic will make an additional equity investment into the company as part of the transaction. This transaction will not have any material impact on our capital. Following the signing of the preliminary agreement, the parties will work towards signing a definitive binding agreement which will be subject to the customary regulatory and corporate approvals.
At December 31, 2014, we had a market capitalization of 88.0 billion, stockholders equity of 80.8 billion and total assets of 1,266.3 billion. We had an additional 161.8 billion in managed and marketed customer funds at that date. As of December 31, 2014, we had 56,245 employees and 5,482 branch offices in Continental Europe, 25,599 employees and 929 branches in the United Kingdom, 85,009 employees and 5,729 branches in Latin America, 15,919 employees and 811 branches in the United States and 2,633 employees in Corporate Activities (for a full breakdown of employees by country, see Item 6. Directors, Senior Management and EmployeesD. Employees herein).
We are a financial group operating principally in Spain, the United Kingdom, other European countries, Brazil and other Latin American countries and the United States, offering a wide range of financial products.
In Latin America, we have majority shareholdings in banks in Argentina, Brazil, Chile, Colombia, Mexico, Peru and Uruguay.
Grupo Santander maintains the general criteria used in our 2013 Form 20-F, with the following exceptions:
1) In the Groups financial statements
|||The Group has applied IFRIC 21, Levies, which addresses the accounting for a liability to pay a levy if that liability is within the scope of IAS 37. The adoption of IFRIC 21 gave rise to a change in the recognition of the contributions made by Santander UK to the Financial Services Compensation Scheme and of the contributions made by the Groups Spanish financial institutions to the Deposit Guarantee Fund. Pursuant to the applicable standard, this change was applied retrospectively, giving rise to changes in the balances for 2013 (negative impacts of 195 million on attributable profit and of 65 million on the Groups reserves) and 2012 (negative impacts of 12 million on attributable profit and of 53 million on the Groups reserves).|
|||Some corporate transactions recently carried out by the Group involved changes in the consolidation method. Taking control of SCUSA in 2014 led to the full consolidation of SCUSA, which was previously accounted for by the equity method. Conversely, the sale of a controlling stake in asset management companies at the end of 2013 requires us to consolidate them by the equity method instead of by full consolidation.|
2) In businesses
|||The United States area includes Santander Bank, Santander Consumer USA, which is now consolidated through full consolidation, and Puerto Rico, which was previously included in Latin America.|
|||The Santander Asset Management units that were sold are consolidated by the equity method in the various countries in which we operate.|
3) Other adjustments
|||The annual adjustment was made of the perimeter of the Global Customer Relationship Model between Retail Banking and Global Banking and Markets. This change has no impact on the geographic segments.|
|||The Asset Management and Insurance area is now called Private Banking, Asset Management and Insurance. As compared to the figures published in 2013, the domestic private banking units of Spain, Portugal, Italy, Brazil, Mexico and Chile are included in this new business segment (with management shared with local banks), as well as Santander Private Banking in Latin America (previously included under the Retail Banking segment).|
The financial statements of each business area have been drawn up by aggregating the Groups basic operating units. The information relates to both the accounting data of the companies in each area as well as that provided by the management information systems. In all cases, the same general principles as those used in the Group are applied.
In accordance with the criteria established by IFRS-IASB, the structure of our operating business areas has been segmented into two levels:
First (or geographic) level. The activity of our operating units is segmented by geographical areas. This coincides with our first level of management and reflects our positioning in the worlds main currency areas.
The reported segments are:
|||Continental Europe. This covers all retail banking business, wholesale banking and private banking and asset management and insurance in this region. This segment includes the following units: Spain, Portugal, Poland, Santander Consumer Finance (which includes the consumer business in Europe, including that of Spain, Portugal and Poland) and Spains run-off real estate.|
|||United Kingdom. This includes retail and wholesale banking, private banking and asset management and insurance conducted by the various units and branches of the Group in the country.|
|||Latin America. This embraces all the Groups financial activities conducted via its subsidiary banks and subsidiaries. It also includes the specialized units of Santander Private Banking, as an independent and globally managed unit, and the Banks New York branchs business.|
|||United States. Includes the businesses of Santander Bank, Santander Consumer USA and Puerto Rico.|
Second (or business) level. This segments the activity of our operating units by type of business. The reported segments are:
|||Retail Banking. This area covers all customer banking businesses (except those of private banking and Corporate Banking, managed through the Global Customer Relationship Model). Also included in this business area are the results of the hedging positions taken in each country within the scope of the relevant ALCO portfolio.|
|||Global Wholesale Banking. This business reflects the revenues from global corporate banking, investment banking and markets worldwide including all treasuries managed globally, both trading and distribution to customers (after the appropriate distribution with Retail Banking customers), as well as equities business.|
|||Private Banking, Asset Management and Insurance. This includes the contribution to the Group for the design and management of mutual and pension funds and insurance, conducted in some cases via wholly-owned subsidiaries and in others via subsidiaries in which the Group participates through joint ventures with specialists. In both cases, the subsidiaries pay fees to the distribution networks used to place these products (basically the Groups, though not exclusively) via agreements. This means that the result recorded in this segment is net for each of the subsidiaries included, in accordance with their participation and consolidation method, (i.e. deducting the distribution cost of sharing agreements from gross income). It also includes private banking business as defined above.|
|||Spains run-off real estate. This unit includes loans to customers in Spain whose activity is mainly real estate development, equity stakes in real estate companies and foreclosed assets.|
In addition to these operating units, which cover everything by geographic area and business, we continue to maintain a separate Corporate Activities area. This area incorporates the centralized activities relating to equity stakes in financial companies, financial management of the structural exchange rate position and of the Parent banks structural interest rate risk, as well as management of liquidity and of stockholders equity through issues and securitizations. As the Groups holding
entity, the Corporate Activities area manages all capital and reserves and allocations of capital and liquidity. It also incorporates the goodwills impairment but not the costs related to the Groups central services except for corporate and institutional expenses related to the Groups functioning.
For purposes of our financial statements and this annual report on Form 20-F, we have calculated the results of operations of the various units of the Group listed below using these criteria. As a result, the data set forth herein may not coincide with the data published independently by each unit individually.
First level (or geographic):
Continental Europe includes all activities carried out in this region: retail banking, global wholesale banking, private banking, asset management and insurance, as well as Spains run-off real estate. During 2014, there were four main units within this area: Spain, Portugal, Poland and Santander Consumer Finance.
Continental Europe is the largest business area of Grupo Santander by assets. At the end of 2014, it accounted for 36% of managed and marketed customer funds, 37% of total loans to customers and 27% of profit attributed to the Parent banks total operating areas.
The area had 5,482 branches and 56,245 employees (direct and assigned) of which 3,476 were temporary employees, at the end of 2014.
In 2014, this segment obtained attributable profit of 2,079 million, an increase of 952 million or 84% mainly due to improved net interest margin (which increased by 605 million) and to the decrease in impairment losses on financial assets (which decreased by 806 million). Return on equity (ROE) stood at 8.1%.
We have a solid retail presence in Spain (3,511 branches, 4,986 ATMs and 12.6 million customers), which is reinforced with global businesses in key products and segments (wholesale banking, private banking, asset management, insurance and cards).
In order to consolidate the Groups leadership in Spain and increase profitability and efficiency, Santander merged its two large retail networks (Santander and Banesto) and its private bank (Banif) in 2013. See A. History and development of the companyPrincipal Capital Expenditures and DivestituresAcquisitions, Dispositions, Reorganizations.
The integration was completed in July 2014, ahead of schedule. All private banking clients were incorporated to Banifs specialized customer attention model. We took advantage of the integration to optimize segmentation and specialization of branches, with a particular emphasis on private banking, Select and company banking, and increasing coverage in specialized portfolios to almost 100%.
At the end of 2014, we had 3,511 branches and a total of 24,979 employees (direct and assigned), all of which were hired on a full time basis.
In 2014 Spain showed sound recovery of economic growth which, combined with the improvement in financial condition (10 year risk premium of 107 basis points at year end), boosted retail banking flows of credit to both households and SMEs. However, the balance of loans to businesses and households declined once again, due to the deleveraging in some sectors and the increasing number of debt issuances by large companies. Deposits were down slightly in response to the decrease in term in an environment of low interest rates that benefited investment funds.
In 2014, profit attributable to the Parent bank in Spain was 1,121 million, a 655 million or 141% increase as compared to 2013, while the ROE was 9.9% (as compared to 3.9% in 2013). The main factors contributing to the growth were: (i) a 411 million increase in net interest income, reflecting the lower cost of deposits, (ii) a 326 million decrease in net gains on financial assets and liabilities, due to lower income from wholesale banking, (iii) a 252 million drop in operating expenses, due to synergies from the merger and optimization plans, and (iv) a 666 million decrease in impairment losses on financial assets, due to lower net entries in non-performing loan balances as credit quality improves.
In 2014, Spains lending decreased by 2%, managed and marketed customer funds increased by 2% with deposits decreasing by 2%, marketable debt securities diminishing by 82% and mutual and pension funds growing by 22%. The increase in mutual and pension funds of 9,629 million due to the greater demand for these products and the improved performance of the markets, with the accompanying increase in share prices, was offset in part by the decrease in marketable debt securities of 3,248 million.
The non-performing loans (NPL) ratio was 7.38%, an 11 basis point decrease as compared to 2013. The coverage ratio remained at 45%.
Our main Portuguese retail and investment banking operations are conducted by Banco Santander Totta, S.A. (Santander Totta).
At the end of 2014, Portugal had 594 branches and 5,410 employees (direct and assigned), of which 42 employees were temporary.
In 2014, profit attributable to the Parent bank was 189 million, a 75 million or 65% increase from 2013. The main drivers for the increase were the growth in net interest income (32 million as a result of the lower funding costs), a 37 million increase in net gains on financial assets and liabilities (greater gains in portfolio management) which offset the 38 million drop in net fees and commissions (affected by both the lower business volume and regulatory changes), and a 69 million decrease in impairment losses on financial assets (benefiting from the decrease in net non-performing loans entries over the past 12 months).
In 2014, the strategy of the Group in Portugal remained closely focused on raising levels of profitability and market share in the various segments. At the same time, management of net interest income and non-performing loans continued to be critical strategic priorities. On the liability side, a cost reduction strategy was combined with a notable increase in liabilities, as a result of harnessing market opportunities and a flight-to-quality effect in order to grow. On the asset side, greater emphasis was placed on the business segment.
Lending continued to decline with a decrease of 5% for 2014 due to the deleveraging environment. At the end of 2014, managed and marketed customer funds increased by 3% with a 1% decrease in deposits, a 23% increase in marketable debt securities, and a 15% increase in mutual and pension funds.
The year 2014 ended with an NPL ratio of 8.89%, as compared to 8.12% at the end of 2013. The coverage ratio stood at 52% compared to 50% in December 2013. The ROE increased 232 basis points to 8.1%.
In February 2012, Banco Santander, S.A. and KBC Bank NV (KBC) reached an investment agreement for the merger of their subsidiaries in Poland, BZ WBK S.A. and Kredyt Bank S.A., which was put into effect in early 2013, after the necessary approval was received from the Polish financial supervisor (KNF). For further details see Item 4. Information on the CompanyA. History and development of the companyPrincipal Capital Expenditures and DivestituresAcquisitions, Dispositions, Reorganizations Merger of Bank Zachodni WBK S.A. and Kredyt Bank S.A.
In the second half of 2014 the merger of BZ WBK and Kredyt Bank was completed.
Santander is the third largest bank in Poland in terms of loans and deposits (market share of 8.9% and 9.5%, respectively, including the business of Santander Consumer Finance in the country). Excluding that business, the market shares are 7.5% in loans and 8.3% in deposits. The unit in Poland had 788 branches, 115 agencies and 11,971 employees (direct and assigned), of which 1,306 employees were temporary, at the end of 2014.
In 2014, attributable profit was 358 million, 24 million or 7% higher than 2013. Income benefited from the increase in total income of 58 million and a decrease in operating expenses of 11 million. Attributable profit was affected by higher taxes (28 million) and minority interests (16 million).
Customer loans increased 5%, managed and marketed customer funds increased 7% with a 9% increase in deposits. The NPL ratio decreased 42 basis points to 7.42% and the coverage ratio decreased 2 percentage points to 60%. The ROE stood at 16.2% compared to 15.9% in 2013.
Santander Consumer Finance
Our consumer financing activities are conducted through our subsidiary Santander Consumer Finance (SCF) and its group of companies. Most of the activity of SCF relates to auto financing, personal loans, credit cards, insurance and customer deposits. These consumer financing activities are mainly focused on Germany, Spain, Italy, Norway, Poland, Finland and Sweden. SCF also conducts business in Portugal, Austria and the Netherlands, among others.
The following agreements were entered into in 2014 and strengthen SCFs position in its markets: (i) the agreement with Banque PSA Finance (PSA Peugeot Citroën Group), (ii) the acquisition in Spain of 51% of Financiera El Corte Inglés, and (iii) the acquisition of GE Nordics (GE Moneys business in Norway, Sweden and Denmark). See A. History and development of the companyPrincipal Capital Expenditures and DivestituresAcquisitions, Dispositions, Reorganizations.
At the end of 2014, this unit had 579 branches and 13,046 employees (direct and assigned), of which 1,240 employees were temporary.
In 2014, this unit generated 891 million in profit attributable to the Parent bank, a 97 million or 12% increase compared with 2013. The effective management of asset spreads and the reduction in the cost of deposits absorbed the decrease in interest rates, leading to a 126 million increase in net interest income. Fees and commissions were up by 49 million compared to 2013. Operating expenses rose by 61 million, almost entirely due to the addition of new units in Spain and the Nordic countries (without the impact of changes in the scope of consolidation, operating expenses were down 0.5%). Impairment losses on financial assets were down by 21 million, taking the cost of lending to all-time lows (under 1%), and reflecting a high credit quality for the business.
Customer loans increased by 8%, and managed and marketed customer funds increased by 13%, mainly due to a 51% increase in marketable debt securities. The NPL ratio increased 81 basis points to 4.82% while the coverage decreased to 100% from 105% in 2013, impacted by the entry of GE Nordics. Without taking into account the impact of GE Nordics, the NPL ratio and coverage ratio would have been 3.86% and 106%, respectively.
Spain run-off real-estate
This segment focuses on: (i) managing real estate clients with whom the Group holds potentially problematic exposures in order to reduce their exposure, and (ii) property and land management, which includes the sale of existing properties and, in certain cases, real estate development and subsequent marketing and sale. This segment also includes our investments in the Spanish Bank Restructuring Asset Management Company, or SAREB, see note 8.b.ii to our consolidated financial statements. As of the end of 2014, the stake in Metrocavesa was consolidated by global integration. See A. History and development of the companyPrincipal Capital Expenditures and DivestituresAcquisitions, Dispositions, ReorganizationsMetrovacesa, S.A. in our 2014 Form 20-F.
At the end of 2014, this segment had 490 employees.
The Groups strategy in recent years has been directed at reducing exposure to these assets, which at year end totaled 8,114 million net and were down by 2,667 million or 25% year on year.
In 2014, this segment had 583 million of losses attributable to the Parent bank, representing 52 million decrease in losses compared to 2013, resulting from the decrease in interest income, a fall in impairment losses and lower write-downs recorded in 2014.
As of December 31, 2014, the United Kingdom accounted for 31% of the total managed and marketed customer funds of the Groups operating areas. Furthermore, it accounted for 34% of total loans to customers and 21% of profit attributed to the Parent banks total operating areas.
Santander UK is focused on the United Kingdom. Around 79% of customer loans are prime mortgages for homes in the U.K. The portfolio of mortgages is of high quality, with no exposure to self-certified or subprime mortgages while buy to let loans represent around 2% of customer loans. As of December 31, 2014, the loan to deposit ratio was 124%, one percentage point higher than at December 31, 2013.
Santander UKs strategy continued to be centered on three priorities: increasing customer loyalty and satisfaction, being the bank of choice for U.K. businesses, and maintaining balance sheet profitability and strength.
At the end of 2014, we had 929 branches and a total of 25,599 employees (direct and assigned), of which 441 employees were temporary, in the United Kingdom.
In 2014, Santander UK contributed 1,576 million profit attributable to the Parent bank, a 427 million or 37% increase from 2013. The ROE was 11.2% (as compared to 8.9% in 2013). The main developments were: (i) a 783 million increase in net interest income due to the reduced cost of retail deposits, (ii) a 421 million increase in operating expenses due to investments in the retail banking and business segments, which were partially offset by the efficiency plans being implemented, and (iii) a 248 million decrease in impairment losses on financial assets mainly due to improved credit quality throughout the range of products we offer and the improved economic environment.
As of December 31, 2014, loans and advances to customers increased by 9%, or 2% excluding the exchange rate impact, and managed and marketed customer funds increased 8%, or 0.4% excluding the exchange rate impact, with a 8% growth in deposits, or 1% excluding the exchange rate impact, and a 9% growth, or 1% excluding the exchange rate impact in marketable debt securities. The NPL ratio decreased 19 basis points to 1.79% and the coverage ratio stood at 42%.
At December 31, 2014, we had 5,729 branches and 85,009 employees (direct and assigned) in Latin America, of which 3,242 were temporary employees. At that date, Latin America accounted for 26% of the total managed and marketed customer funds, 20% of total loans to customers and 41% of profit attributed to the Parent banks total operating areas.
Our Latin American banking business is principally conducted by the following banking subsidiaries:
|Percentage held |
at December 31, 2014
|Percentage held |
at December 31, 2014
Banco Santander (Brasil), S.A.
Banco Santander, S.A. (Uruguay)
Banco Santander Chile
Banco Santander Perú, S.A.
Banco Santander (Mexico), S.A., Institución de Banca Múltiple, Grupo Financiero Santander
Banco Santander Río, S.A. (Argentina)
Banco Santander de Negocios Colombia S.A.
We engage in a full range of retail banking activities in Latin America, although the range of our activities varies from country to country. We seek to take advantage of whatever particular business opportunities local conditions present.
Our significant position in Latin America is attributable to our financial strength, high degree of diversification (by countries, businesses, products, etc.), and the breadth and depth of our franchise. Grupo Santander has the regions largest international franchise. It has over 49 million customers and market share of 9.9% in loans and 10.1% in deposits.
Profit attributable to the Parent bank from Latin America in 2014 was 3,150 million, a 29 million or 1% decrease as compared to 2013. However, in local currencies and eliminating the perimeter effect (the units of Santander Asset Management SAM that were sold and which we now consolidate by the equity method in the various applicable countries), attributable profit increased by 10%. The ROE reached 14.0% (as compared to 13.8% in 2013). Net interest income fell by 1,041 million or 7%, however in local currencies and eliminating the perimeter effect, net interest income increased 3%, mainly affected by the change in business mix toward lower cost of credit products and also reduced spreads. Operating expenses decreased by 505 million or 6%, however, excluding the exchange rate impact and the perimeter effect, expenses grew by 5% mainly due to investment in networks and commercial projects (some traditional and others focused on priority customer segments) and inflationary pressures on employee compensation and contracted services. Impairment losses on financial assets declined 1,342 million or 21% mainly due to the improvement in Brazil continuing the trend started at the beginning of 2013.
As of December 31, 2014, loans and advances to customers increased by 12% (the perimeter effect does not affect loans as SAM does not engage in the credit business). Managed and marketed customer funds increased 15%, with a 13% growth in deposits and a 44% growth in loans due to credit institutions. The NPL ratio decreased 35 basis points to 4.65% and the coverage ratio stood at 85% at December 31, 2014.
Detailed below are the performance highlights of the main Latin American countries in which we operate:
Brazil. Santander Brazil is the countrys third largest private sector bank by assets and the largest foreign bank in the country. The institution operates in the main regions, with 3,411 branches and points of banking attention, 14,856 ATMs, 46,464 employees (direct and assigned), all of which were hired on a full time basis and more than 31 million customers at the end of 2014.
During 2014, Santander Brazils strategy, as a bank with a wide range of products and focus on commercial banking consisted of the following: to improve customer satisfaction and loyalty, to increase the recurring and sustainable nature of transactions, to increase productivity, to strengthen the business lines with lower market share, to maintain capital and liquidity discipline with the objective of preserving the strength of the balance sheet, to manage regulatory changes and to harness opportunities for growth.
During 2014 Santander Brazil entered into or effected the following agreements/acquisitions:
|||Agreement to create a joint venture with Banco Bonsucesso to leverage activities in the payroll business, as well as increase the number of products offered and improve the distribution and marketing capacity. This transaction closed in the first quarter of 2015.|
|||Acquisition of 50% of SuperBank, a digital platform that sells financial products and services for the individuals segment, with a more efficient structure.|
|||Purchase of GetNet to strengthen the credit cards business. Banco Santander (Brasil) S.A. has an indirect participation in GetNet with a stake of 88.5%.|
Profit attributable to the Parent bank from Brazil in 2014 was 1,558 million, a 19 million or 1% decrease (+8% in local currency) as compared to 2013. Total income fell 1,557 million or 11% (or 3% in local currency and at constant perimeter) compared with 2013. This decrease was due to (i) an 11%, or 3% decrease in local currency and excluding the perimeter effect, in net interest income due to the portfolios change in mix to lower risk products/segments and reduced spreads on loans, and (ii) an 82%, or 81% decrease in local currency and excluding the perimeter effect, in trading gains because of the reduced gains from market activity in 2014. Operating expenses decreased by 8% compared with 2013, however in local currency and at constant perimeter they rose 1%, remaining well below the inflation rate. Credit quality continues to improve as loan loss provisions declined by 25%, or 18% in local currency (the perimeter effect did not have an impact). The ROE stood at 13.3%.
During 2014, total loans increased by 12%, or 10% in local currency, mainly due to an increase in mortgages (34%), where market penetration is still low, and large companies (24%). Loan volumes in segments with low risk/spreads such as agri-business (23%) and loans through the Brazilian Development Bank (21%), where we want to increase our presence, also rose strongly. Managed and marketed customer funds increased by 14% with deposits growing by 12%, loans due to credit institution increasing by 77% and mutual and pension funds growing by 17%. The NPL ratio was 5.05% at December 31, 2014 compared with 5.64% at December 31, 2013. The coverage ratio stood at 95% at December 31, 2014.
Mexico. Banco Santander (Mexico), S.A., Institución de Banca Múltiple, Grupo Financiero Santander, is one of the leading financial services companies in Mexico. In the fourth quarter of 2013, Mexico acquired ING Hipotecaria, which consolidated the Bank as the countrys second largest mortgage provider. Santander is the third largest banking group in Mexico by business volume, with a market share in loans of 13.8% and 13.7% in deposits. As of December 31, 2014, it had 1,347 branches throughout the country, 16,933 employees (direct and assigned), of which 3,117 were temporary and more than 11 million customers.
Profit attributable to the Parent bank from Mexico in 2014 declined 7% (or 4% eliminating the exchange rate impact and the perimeter effect) to 660 million. Total income increased 1%, or 6% in local currency and eliminating the perimeter effect, supported by increased business activity and effective management of spreads. Operating expenses rose 2%, or 7% excluding the exchange rate impact and the perimeter effect, due to the greater installed capacity, with the opening of 95 branches in 2014. Loan loss provisions declined 6%, or 2% in local currency (the perimeter effect did not have an impact). As a result, operating profit before taxes increased 4%, or 9% in local currency and eliminating the perimeter effect. However, the normalization of the effective tax rate (7.8% in 2013 and 19.5% in 2014) offset the increase in profit before taxes. The ROE was 14.3% at December 31, 2014, compared to 15.2% at December 31, 2013.
Loans increased by 16% while managed and marketed customer funds increased by 15% mainly due to an increase of 16% in deposits.
At December 31, 2014, the NPL ratio increased 18 basis points to 3.84% while the coverage ratio was 86%.
Chile. Banco Santander Chile is the leading bank in Chile in terms of assets and customers, with a particular focus on retail activity (individuals and SMEs). As of December 31, 2014, its market share in loans was 19.2% and in deposits 17.6%. Of note is its share of loans to individuals it is the leader in consumer finance with a market share of 24.6% and in mortgages with a market share of 20.9%. As of December 31, 2014, Banco Santander Chile had 475 branches, 12,081 employees (direct and assigned), all of which were hired on a full time basis, 1,645 ATMs and 3.6 million customers.
Profit attributable to the Parent bank from Chile increased 17% to 509 million (or 35% in local currency and excluding the perimeter effect). Total income decreased 2% with a 2% increase in net interest income and 11% fall in income from commissions. Operating expenses and loan loss provisions decreased 9% and 13%, respectively.
In local currency and at constant perimeter total income increased by 13%, backed by: (i) an 18% increase in net interest income spurred by growth of volumes in target segments, due to the better mix of deposits and the rise in earnings from the inflation-indexed UF portfolio, and (ii) a 2.2% increase in income from commissions from means of payment (11%), mutual funds (17%) and transaction banking, which offset the impact of the regulatory changes that limited insurance fees we can charge to our customers. Operating expenses rose 6% which is slightly above the inflation rate, due to investments in technology. Loan loss provisions were essentially unchanged with a slight increase of 0.5%. For 2014, the ROE was 19.9%, the NPL ratio increased by 6 basis points to 5.97% and the coverage ratio was 52%.
In 2014, customer loans increased 6% and managed and marketed customer funds rose by 14% resulting from an 11% increase in customer deposits and a 37% growth in mutual and pension funds.
Argentina. Santander Río is the countrys leading private sector bank in terms of assets, loans and customer funds, with market shares of 9.2% in lending and 9.5% in deposits at December 31, 2014. At that date in Argentina we had 396 branches, 7,275 employees and 2.5 million customers.
During the year, lending and deposits increased 7% and 15%, respectively. Nevertheless, in local currency lending rose 23%, focused on lending to SMEs and companies, deposits increased 31%, with similar growth in time deposits (40%) and demand deposits (26%). Loan and deposit growth and trends were aligned with the market.
Profit attributable to the Parent bank was 298 million, an 10% decrease compared with 2013. However, in local currency profit attributable to the Parent bank increased 33% due to improved net interest income and fee and commissions income. At the end of 2014, the ROE was 33.5% and the NPL ratio was 1.61% compared with 33.5% and 1.42% at the end of 2013, respectively.
Uruguay. The Group maintained its leadership in Uruguay. We are the largest private sector bank in the country, with a market share in lending of 17.7% and 15.1% in deposits. Overall, the Group had 89 branches, 1,221 employees and over 500,000 customers in the country at December 31, 2014.
Lending increased by 17%, with particular growth in individual customers and SMEs, and deposits rose by 18%, in each case compared with 2013. Attributable profit in Uruguay was 54 million, an increase of 2%, or 16% in local currency, mainly due to the increase in net interest income and income from fees and commissions.
Peru. As of December 31, 2014, Banco Santander Perú, S.A. had 1 branch and 117 employees. The units activity is focused on companies and on the Groups global customers. A new auto finance company began to operate in 2013, together with a well-known international partner with considerable experience in Latin America. The company has a specialized business model, focused on service and with products that enable customers to acquire any brand of new car from any dealer in Peru.
Profit attributable to the Parent bank from Peru was 24 million, a 25% increase, or a 31% increase in local currency, compared with 2013.
Colombia. Banco Santander de Negocios Colombia S.A. began operating in January 2014. The bank targets the corporate and business markets, with a special focus on global customers and local customers aiming to expand to gain international presence.
Colombia had a 5.1 million loss attributable to the Parent bank.
The U.S. segment includes Santander Holdings USA (SHUSA), a bank holding company with two distinct lines of business: retail banking, via its subsidiary Santander Bank and Banco Santander Puerto Rico since 2014, and consumer finance business through its stake in Santander Consumer USA Inc. (SCUSA).
The business model of Santander Bank, with 705 branches, 10,060 employees (direct and assigned), all of which were hired on a full time basis, and two million customers at December 31, 2014, focuses on retail customers and companies. It conducts business in the north east of the United States, an area that generates 22% of the countrys GDP.
Santander Puerto Rico had 54 branches, 410,000 customers, 1,430 employees and market shares of 10.0% in lending and 11.7% in deposits, as well as a network of 52 shops that tend to our consumer clients, in each case at December 31, 2014. It focuses on individuals and companies.
SCUSA, based in Dallas, has 4,429 employees and specializes in consumer finance, mainly auto finance and leasing of new and used vehicles (mainly focused on retail customers, although also on vehicle dealers), and on unsecured consumer loans, as well as servicing of portfolios for third parties.
At December 31, 2013, our stake in the company was recorded by the equity method. In the first quarter 2014, SCUSA completed an initial public offering of shares at a price of $24 per share, and is now listed on the New York Stock Exchange. As of December 31, 2014, we retain a 60.5% stake; as a result, since 2014 we are fully consolidating SCUSAs financial statements.
The U.S. segment accounted for 7% of the total managed and marketed customer funds, 9% of total loans to customers and 11% of profit attributed to the Parent banks total operating areas.
The U.S. segment obtained attributable profit of 800 million in 2014, in line with the 803 million obtained in 2013. Total income increased 3,157 million or 127%, however, excluding the perimeter effect (as SCUSA was fully consolidated in 2013 and as Puerto Rico was included in this segment in 2013) and exchange rates, total income increased by 16%. This growth was mostly due to the increase in lending by SCUSA while Santander Bank was affected by the reduction in the investments portfolio that impacted net interest income, as well as the decline in fee income largely due to new regulations limiting fees charged on overdrafts. Operating expenses rose 589 million or 41%, or 8% eliminating the perimeter effect, largely due to increased expenses associated with regulatory compliance. Loan loss provisions increased 2,186 million or 713 million eliminating the perimeter effect, mainly due to SCUSAs lending growth.
For 2014, ROE was 7.96% and the NPL ratio was 2.54%, which represents a 109 and 55 basis point reduction from 2013, respectively. The coverage ratio stood at 193% at year end.
Second or business level:
Retail Bankings profit attributable to the Parent bank in 2014 increased 16% (or 26% on a comparable basis as if Private Banking were excluded in 2013 and excluding the impact of exchange rates), to 5,871 million. The results were impacted by: (i) a 12% increase in net interest income (or 7% without the perimeter effect (as if Private Banking were excluded in 2013 and SCUSA was fully consolidated in 2013) and excluding the impact of exchange rates), (ii) a 1% decrease in operating expenses as the depreciation of Latin American currencies offset the perimeter effect and the investments made to develop the network and businesses, and (iii) a 3% increase in loan loss provisions.
In 2014, Retail Banking generated 85% of the operating areas total income and 77% of profit attributable to the Parent bank. This segment had 173,670 employees as of December 31, 2014, of which 6,202 were temporary.
By geographic area, the main features in 2014 were as follows:
|||Continental Europe posted a profit attributable to the Parent bank 71.4% higher than in 2013, due to increased net interest income and lower provisions.|
|||Attributable profit in the U.K. increased 43%, backed by increased net interest income and reduced provisions partly offset by increased operating costs.|
|||Latin Americas attributable profit decreased by 5%. However, in local currencies attributable profit increased 6% resulting from lower provisions.|
|||Attributable profit in the U.S. grew 5% because of a 17% increase in total income due to the increase in net interest income. On the other hand, operating expenses increased (mainly due to increased regulatory compliance costs), and loan loss provisions grew (mainly due to the increase in lending by SCUSA and the increase in the unsecured consumer loan portfolio).|
Global Wholesale Banking
This area covers our corporate banking, treasury and investment banking activities throughout the world.
Global Wholesale Banking generated 12% of total income and 21% of the profit attributable to the Parent bank in 2014. This segment had approximately 7,481 employees at December 31, 2014.
The attributable profit in 2014 was 1,614 million, an increase of 7% compared to 2013. This performance was impacted by an increase in net interest income (3%) and income from fees and commissions (13%),